Where’s the faith in franchising?

In late June, in an extraordinary attack, the Opposition’s small business spokesman Steven Ciobo dramatically called on Federal Small Business Minister Craig Emerson to respond to a parliamentary inquiry into the franchising sector which recommended major changes to Australia’s Franchising Code in December 2008.

“I plead on behalf of all those people in the franchising sector for this Minister and this Government to start doing something,” Ciobo told the House. “Eleven recommendations came from the committee, and I put it to the minister that, in the main, all 11 recommendations are relatively non-controversial. This Minister and this Government need to act.”

“Stop stalling – people’s lives are potentially being destroyed as a result of this Government’s inaction, and it is time that they did something.”

It’s extremely evocative language, but it does highlight the depth of feeling that exists in the franchising sector.

One side of the fence is centered on a group of vocal franchisees and ex-franchisees who have proven to be highly effective at getting their case heard by politicians on both sides, and at a Federal and State level.

They argue that the way the franchising sector currently operates can disadvantage franchisees and believe the sector is in need of new regulation. The failure of franchise systems including Kleins, Midas, EzyDVD and Kleenmaid has only added weight to these arguments.

Frank Zumbo, an associate professor at the University of New South Wales and an advocate for franchisee rights, says there are “underlying tensions” in the sector that have been exacerbated by the state of the economy.

“These underlying tensions are putting a number of franchise systems under pressure and I believe we’ll see more collapse during the next year or two, simply because they are marginal.”

That view is not shared by those on the other side of the debate. The franchisors, led by the Franchise Council of Australia, believe the sector, which generates $128 billion each year, is functioning well. While Franchise Council chief executive Steve Wright says his organisation is open to ways to improve the sector, he does not believe major changes are needed.

The battle over the introduction of new franchising regulations has raged for more than 18 months. Its beginnings can be traced back to wealthy entrepreneur Jack Cowin, owner of the Hungry Jack’s fast food chain and the former owner of more than 40 KFC franchises in Western Australia.

Back in 2007, KFC’s parent company, YUM, offered to buy Cowin’s KFC licenses for a price that Cowin considered too low, and did not take into account the goodwill built up while he ran the stores.

YUM then refused to renew Cowin’s licenses; as each store agreement ended, ownership reverted to YUM. Cowin was incensed and immediately started pushing for change, including the introduction of a “good faith” clause into the Code.

Agitation by Cowin and a vocal band of franchisees and ex-franchisees resulted in parliamentary inquiries in Western Australia (the report was released in April 2008), in South Australia (report released in May 2008) and finally at a Federal level.

The Joint Standing Committee on Corporations and Financial Services inquiry into the sector, which was chaired Labor MP Bernie Ripoll, handed down its bipartisan report in December 2008.

After a six month delay, Emerson announced in late May that he would undertake further “targeted” consultations on the report before making a formal response .Interested parties were given until July 10 to respond to an options paper released by Emerson in late June.

Industry sources have told SmartCompany only two organisations have been consulted as part of the process: the Franchise Council of Australia and the Australian Competition and Consumer Commission. Exactly which organsiations have responded to Emerson’s option paper is not known, as all submissions were treated in confidence, but it is believed representatives from Jack Cowin’s company Competitive Foods have travelled to Canberra to lobby the Department of Innovation.

No date has been set for the release of Emerson’s report, although one source in the sector has been told he will comment in Parliament by the end of the month. Despite the bipartisan report’s strong recommendations, most observers are expecting Emerson’s changes will be relatively minor, although frannchisee groups remain hopeful.

Only one thing is really certain – whatever he does, Emerson is almost guaranteed to annoy a large number of voters whichever way he goes.

Opposition small business spokesman Steven Ciobo got it wrong when he described the 11 recommendations in Bernie Ripoll’s franchising inquiry report as “non-controversial”.

Depending on what side of the franchising fence you sit on, the Bernie Ripoll’s franchising inquiry report’s recommendations are a matter for fierce debate.

The key recommendations include:

The introduction of a “good faith” clause in the franchising code. The inquiry found that the interdependent nature of franchise contracts leaves franchisees “vulnerable to opportunistic conduct” and argued a good faith clause would deter such behaviour. The suggested wording of the clause is: “Franchisors, franchisees and prospective franchisees shall act in good faith in relation to all aspects of a franchise agreement.”

That the Government explores avenues to better balance the rights and liabilities of franchisees and franchisors in the event of franchisor failure. The string of high-profiled franchise collapses shone a harsh light onto the issue of franchisor failure and, the inquiry made a number of recommendations on this issue, including recommending amending the franchise code so that franchisors are forced to provide a clear statement of the liabilities and consequences of franchisees in the event of franchisor collapse.

Forcing franchisors to disclose to franchisees, before the franchise agreement is entered into, the process that will apply in determining the end of franchise arrangements. One of the most common allegations made by disgruntled former franchisees involves the way their franchise agreements were terminated and their franchises sold to new franchisees, often without compensation. The Parliamentary inquiry specifically recommends that franchisors need to outline the way equity in a franchise would be transferred at the end of an arrangement.

The amendment of the Trade Practices Act to include pecuniary penalties for breaches of the Franchising Code. The committee believes the introduction of these penalties would help the ACCC in its enforcement role “by providing a greater deterrent for conduct that contravenes the code”.

The ACCC being given power to investigate when it receives credible information about breaches of the franchising code. The ACCC has been criticised in the past be taking too long to investigate franchisee complaints, although the consumer watchdog has denied these allegations.

The Government investigate the development of a simple online registration system for franchisors. This would require franchisors to annually lodge a statement confirming the nature and extent of their franchising network and providing a guarantee that they are meeting their obligations under the franchising code and the Trade Practices Act.

A question of good faith

Of the 11 recommendations made in Ripoll’s report, one fierce battleground stands out: the insertion of a good faith clause in the Code.

For Frank Zumbo, the idea of a “good faith” clause that would require franchisors and franchisees to act in a fair and reasonable way at all times is a no-brainer.

“This would simply implement good franchising proactively. Good franchisers do act with good faith towards their franchisees. They work cooperatively towards mutual benefit,” he says.

Zumbo says that while a number of judges have said an obligation to act in good faith is implied in franchising agreements, putting the clause into the Code would ensure that no franchisor could expressly exclude this obligation from a franchise agreement.

Andrew Robinson, a lawyer who represents the Motor Traders’ Association of New South Wales, also supports the insertion of a “good faith” clause in the Code.

“What a good faith obligation does is say: ‘You may have a negotiated a right to do something, but is it fair for you to do it that way?'”

Car dealers, like many other franchisees, argue a good faith clause would help protect franchisees when a franchise agreement comes to an end.

Franchise agreements often required dealers to invest millions on refurbishing dealerships, intellectual property and specialist tooling. But most agreements – even ones negotiated on a “rolling basis”- can be terminated with as little as a few months’ notice and without compensation. The MTA argues a “good faith” clause could help prevent incidents of unfair termination.

But Franchise Council CEO Steve Wright says this is precisely why his organisation is dead against the insertion of an explicit good faith clause in the Franchise Code.

“This remains an issue where there’s a difference between a concept and the reality of what proponents of a change actually want. What they are seeking is a change to end-of-term arrangements. And frankly that would upturn 25 years of franchising history.”

The Franchise Council’s position on good faith is a little complex.

Like Zumbo, Wright agrees that the concept of good faith has been established in case law.

“The concept of good faith in negations is something we regard as being evident in different parts of the Trade Practices Act and it’s certainly something we regard as a part of the ethical beahviour that we insist on with all our members.”

Despite this, Wright argues that inserting an explicit good faith clause into the Franchise Code would actually create confusion, because no-one would know exactly what it would mean.

He says what the proponents of good faith really want to do is use the clause to force franchisors to automatically negotiate the renewal of a franchise agreement or at least pay a franchisee whose agreement has expired an entitlement for goodwill.

“What we are opposed to is being used as a proxy for goodwill entitlements or automatic renewal of a franchise agreement.”

Wright also argues that the insertion of a good faith clause without proper definition would create uncertainty and lead to a rash of litigation.

But Andrew Robinson calls that a smokescreen. He points out many laws are based around the equally subjective idea of “reasonableness”. “And we haven’t had any problem dealing with that,” Robinson says.

Perhaps most persuasively, Robinson notes that Australia’s largest car company, Toyota, has already incorporated explicit good faith provisions into its dealer agreements.

Minor tinkering, not major changes

Despite the level of feeling around good faith, industry insiders believe it is highly unlikely that this clause will be added to the Franchising Code.

The Franchise Council’s Steve Wright expects “enhancement rather than major overhaul” particularly around the areas of disclosure and mediation.

It appears likely Emerson will push for rules that will result in improved disclosure around what happens at the end of a franchise agreement and what happens in the event of franchisor failure appear likely to be brought in.

Wright says franchisors will be supportive of this. “There are just some things that can be made crystal clear from the start. Almost all franchise agreements have something in there about franchisee failure, so I don’t think it’s an outrageous request to look to have that from the franchise perspective.”

He also expects Emerson to focus on improving accessibility to and the cost of mediation. Wright says the Federal Government may look to replicate the mediation process run by Victoria’s Small Business Commissioner, which has proven to be cheaper for parties to access than the process run by the main franchising mediation body, the Office of the Mediation Adviser.

The disclosure and mediation changes are likely to be welcomed by all segments of the franchising sector. But while Wright would welcome an end to the run of government inquiries into the sector, these modest “enhancements” are unlikely to silence the vocal group of franchisers and ex-franchisees pushing for change.

“My concern is that we’ll get a minimalist response from the Minister, or worse, we’ll get no action,” Zumbo says.

“The last thing we need is window dressing. We need clear leadership. We need those recommendations from the Ripoll report implemented.”