Systemic failure: Franchising report advises massive overhaul of $180 billion industry

A damning Senate report into the state of Australia’s $180 billion franchise sector has identified evidence of systemic abuse, recommending an overhaul of the Franchising Code of Conduct.

Delivering its findings in a long-awaited and four-times delayed report on Thursday morning, the Senate committee recommended the creation of a franchising taskforce to oversee big changes to the sector.

However, in many instances, the committee palmed off much of its advice to the yet-to-be-created taskforce for fine-tuning, disappointing some who wanted more direct action.

Skewering franchisors such as Retail Food Group (RFG) and describing the Franchise Council of Australia (FCA) as inadequate, the committee likened corporate governance failures in the industry to those exposed by the banking royal commission.

“The current regulatory environment has manifestly failed to deter systemic poor conduct and exploitative behaviour and has entrenched the power imbalance,” the committee said, noting poor behaviour is ongoing.

Making 71 recommendations, the committee said the ACCC should be given more powers and responsibilities for policing bad behaviour in the sector, criticising the regulator for past inaction, alongside ASIC.

It also advised expanding civil penalties and infringement notices to all breaches of the franchising code as well as increasing maximum penalties to bring them in line with Australian Consumer Law (ACL).

Franchise expert and UNSW professor Jenny Buchan says the committee has put a lot of work into the lap of its proposed taskforce.

“They’ve recognised the limitations of what the code can do,” Buchan tells SmartCompany.

“Anything that’s beyond an amendment to the code is going to be more tricky to achieve, so a lot of that stuff has been palmed off or given away to this taskforce.”

Buchan says the committee has nevertheless done a good job of advising important reforms to the industry.

“[They’ve] expressed a very good understanding of what is needed to make franchising work for franchisors, and franchisees — economically, legally and in relationship terms,” she says.

Brumby’s founder Michael Sherlock, who sold his business to RFG in 2007, said the committee appears to have addressed most of the problems franchisees are dealing with.

“It’s taken Adele Ferguson to write an article and kick all this off,” he says.

“I’m pleasantly surprised … they’ve had a real swing at the issues.”

Maddison Johnstone of Franchise Redress, a body which worked with Fairfax on its initial report, says the committee has shown it “really understood the issues”.

“Our observations in the franchise sector pointed to problems that were not isolated to a few franchise systems,” she tells SmartCompany.

“It was encouraging the committee came to the conclusion there are systemic issues in franchising, as this will enable real change to be discussed and implemented.”

Johnstone says she’s not surprised franchisors such as RFG, Domino’s and Foodco were mentioned in the inquiry, saying complaints are still flowing in about their behaviour.

“Franchisees we are in touch with have shared with us their joy and relief that their submissions were taken seriously and that the recommendations are of substance,” she says.

Laundry to be aired publicly

The committee said the Franchising Taskforce it wants to be created should consider building a public franchise register that databases updated disclosure documents and template franchise agreements.

Experts who submitted to the inquiry had argued the creation of a public register would help keep franchisors honest in their dealings with potential franchisees.

The committee recommended the taskforce consider whether the ACCC should oversee the register, what information should be included and which penalties should be applied for non-compliance.

Marketing slush fund crackdown

One of the biggest issues which arose from the inquiry was the lack of transparency about the way franchisors spend marketing slush funds paid for by franchisees.

There have been numerous allegations that RFG and others have used these marketing funds to pay for things other than advertising.

The committee recommended amendments to the franchising code which would implement civil penalties for franchisors found to be mismanaging funds and give franchisees access to quarterly bank statements.

Further, it advised the Auditing and Assurance Standards Board to issue guidance and a chart of accounts for marketing and cooperative fund audits to help keep everyone honest.

Rebate rort reforms

Before and during the inquiry, evidence emerged some franchisors have been using supplier rebates to boost their financial positions.

However, there has been considerable concern this creates a perverse incentive that results in worse quality and more costly products for franchisees.

The committee wants the code amended so commissions and other payments relating to suppliers for franchisees are disclosed as a percentage of the full purchase price on each order.

This means franchisees would be able to tell how much franchisors are making in kickbacks on every supply order.

It also advised the franchising taskforce (which does not yet exist) investigate conflicts of interested associated with supplier rebates and third line forcing (where franchisors require franchisees to buy goods from a certain supplier).

This should involve, the committee said, working out how much franchisors are benefitting from these arrangements and whether they exist to the detriment of franchisees.

Disclosure rework on the horizon

There has been ample criticism of the franchisee onboarding process during the course of the inquiry, while franchisors such as RFG have already been successfully prosecuted for misleading potential business partners.

The committee recommended broad changes to franchise disclosure and pre-contractual dealings, including reforms to cooling-off periods.

Potential franchisees should be given two years of business activity statements, a profit-and-loss income statement, balance sheets and an assessment of labour costs for a particular franchise business before they sign the dotted line, the committee recommended.

If the franchise is new, then similar documentation based on a comparable franchise business should be provided, the committee said.

The committee also advised an amendment to the code which would force franchisors to formally vouch they’ve provided accurate, correct and compliant disclosure documents to potential franchisees.

Retail leases scrutinised

Franchisees should also be given copies of lease disclosure statements and final lease agreements before signing onto a franchise opportunity, the committee said.

Commercial leases have been an undercurrent throughout the inquiry, often trapping franchisees who claim they weren’t properly aware of their lease obligations prior to signing up.

It also advised a possible franchising taskforce examine whether it would be appropriate to force franchisors to hold money payable for retail leases in a trust, only to be used for the rental expenses of a given franchisee.

Dispute resolution overhaul

The committee wants the franchising code changes to include the option of binding arbitration, with a capacity to award remedies.

It also wants to stymie the ability of franchisors to bully franchisors with court action by creating a requirement for franchisors to prove matters can’t be solved through mediation.

Further, it recommended its franchising taskforce consider whether the Office of the Franchising Mediation Adviser should be merged with the Australian Small Business and Family Enterprise Ombudsman.

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