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CONDOMS OR BUST?
EXPECTATIONS AND COMPLIANCE IN FRANCHISING

by Gehan Gunasekara,
last updated 06/07/2012

Gehan Gunasekara asks whether those who buy franchises really know what they are getting into, and suggests proposed changes to consumer law don't go far enough

Recent stories (on TVOne’s Sunday programme and TV 3’s Campbell Live) have once again focused attention on the predicament of some who buy franchises – in this case, Hell Pizza franchises. Reported statements by franchisees raise questions as to whether they really understood the basic nature of the business they were purchasing, whilst alleged harsh treatment of franchisees by the franchisor raises questions as to whether recent reforms to our Fair Trading laws ought to have addressed unfair contract terms and good faith as components of the package.

Franchising as a method of expanding and operating business has been a global success story. However, in countries such as Australia and the United States, it is heavily regulated, unlike in New Zealand. Whatever the merits of regulation – and there is considerable debate as to whether it increases or reduces conflicts between franchisors and franchisees – these countries have seen fit to address the power imbalance between franchisors and franchisees (the latter having invested in the franchise are captives of the former and therefore vulnerable to being exploited) by requiring franchisors to disclose relevant information to franchisees prior to the purchase of the franchise. In New Zealand, only members of the Franchise Association are required to comply with disclosure and a Code of Ethics. However, less than a third of franchise systems belong to the Association. Hell Pizza is not one of them (although another franchise, Green Acres, which was featured on the Target programme the same week as Hell, is a member).

On the other hand, reported complaints by those who have bought franchises raise questions as to whether they really understand the basics of how a franchise operates. The advertisements might suggest a franchisee is his or her “own boss” but the reality is very different. The essence of a franchise is the brand and the image that goes along with it. An article of faith is compliance with the Operating Manual which is every franchisee’s ‘Bible’. This is not an optional extra when it comes to running the business; it is critical in maintaining uniformity and discipline across the network.

A case in point: some Hell Pizza franchisees evidently objected to having to do ‘condom drops’ in letterboxes, as part of one of Hell’s marketing campaigns. Whatever their ethical or religious convictions, this is not something that franchisees can choose for themselves, however. If it is part of the Hell image and therefore a requirement of the operating system then it really is a case of ‘condoms or bust.’

That said, the manner in which franchisors deal with franchisees who are not complying with aspects of the Manual (and therefore the contract) can give cause for concern. Ultimately, franchisees that repeatedly breach the system’s requirements can and ought to have their contract terminated, which usually entails loss of the business entirely with no compensation. However, overly harsh treatment of minor infractions, or disproportionate fines and other penalties levied on franchisees, can be questionable. Such behaviour can deter small business investors from buying franchises in future and therefore damage the very concept of franchising.

Regulation such as that which exists in Australia does not allow arbitrary ‘three-strikes’-type termination notices and also makes ‘unconscionable’ conduct by franchisors illegal. Mandatory dispute resolution also offers highly effective means to resolve minor disputes before they escalate. In New Zealand, dispute resolution is only required of members of the Association (although the Association’s Mediation Panel is available to non-members – Ed).

The Consumer Law currently before Parliament strengthens the Fair Trading Act by prohibiting contracting out from its protections in business to business dealings where this is not ‘fair and reasonable’. Franchise agreements usually contain exclusion clauses barring franchisees from claiming misrepresentation by franchisors as to the profitability of the business they are buying. In future, the validity of such clauses will be open to scrutiny even where franchisees have received independent legal advice as other factors, such as inequality of bargaining power and the unsubstantiated nature of the representations, can be taken into account. In future, a franchisor selling ‘greenfields’ territories will need to show what research has been undertaken in the market justifying claims concerning their viability.

In my opinion, these reforms do not go far enough. Left out is any mention of good faith dealing. We still do not have any laws preventing unfair contract terms. New Zealand is a great place to start a franchise system and to test its viability; however, unfortunately this is too often at the expense of franchisees. The reality is that the small size of our market means there are lots of franchise systems with, on average, around 20 franchise units. The economies of scale and bulk purchasing advantages that underpin the success of this type of business cannot therefore fully kick-in. That makes protection for small businesses such as franchisees even more important.

If we do not wish to follow Australia’s heavy-handed regulation, why not follow China’s ‘light touch’ franchise regulation? After all, we have a free-trade agreement with that country which is the world’s fastest growing market. China’s law requires disclosure by franchisors (so that franchisees know what they are getting into) and ‘good faith’ by both parties in all aspects of their relationship.  It is high time these are made a requirement in New Zealand.

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