by Gehan Gunasekara and Tiffany Lee

last updated 13/05/2011

Gehan Gunasekara is a senior lecturer in Commercial Law at the University of Auckland Business School and specialises in franchising. Tiffany Lee is a Commerce graduate of the University of Auckland and this research was conducted as part of a summer scholarship project.

franchise regulation

by Gehan Gunasekara and Tiffany Lee

last updated 13/05/2011

Gehan Gunasekara is a senior lecturer in Commercial Law at the University of Auckland Business School and specialises in franchising. Tiffany Lee is a Commerce graduate of the University of Auckland and this research was conducted as part of a summer scholarship project.
Gehan Gunasekara and Tiffany Lee examine the process behind the 2008 Government Review of the possible need for franchise regulation

In 2008, spurred by the fall-out from an alleged fraud committed by a Green Acres master franchisee, the previous Labour Government carried out a review of the laws governing franchising. This was conducted by the Ministry of Economic Development (MED). The current National Government announced in June 2009 that the existing law was adequate in dealing with any problems that existed in the franchise sector and that no specific code or rules were needed. This decision was based on the evidence given in response to the MED Review.

In this article we do not propose to discuss the merits or otherwise of franchise regulation, but instead examine the process followed by the Review. We look especially at who took part in the Review, their motives for doing so and the evidence they submitted to the MED. We also scrutinise the way in which the Review was conducted – an inquiry by Government officials rather than by politicians, and with no opportunity for public hearings – and contrast this with recent inquiries that have been held in Australia.

We look at whether the evidence given to the Review justifies the Government decision. A matter of particular interest was whether there was any common ground between those who were for and against regulation. We conclude with some suggestions for future inquiries.

Nature Of The MED Review

Prior to the publicity given to the alleged fraud (which hit the headlines in December 2007 and has still to come to Court), franchising had been below the radar as far as Government was concerned. The MED therefore drew up a Discussion Document outlining options for regulating franchising which described both the current law it operated under in New Zealand as well as foreign models that could be adopted here. The Document was drawn up with input from the Franchise Association of New Zealand Inc. (FANZ) as well as from legal practitioners well-versed in franchising.

The Discussion Document identified three options for regulating franchising. These were:

1. The Status Quo (generic legislation and self-regulation)

2. Better education of franchisees

3. Franchise-specific Regulation

The Document contained useful information regarding these options and their relative merits. Unfortunately, though, some information contained in the Discussion Document is misleading through being out of date. For example, a recent Australian case (Ketchell vs. Master of Education Service Pty Ltd) was cited as evidence that a disadvantage of franchise-specific rules is the uncertainty arising from their breach. This decision has since been reversed, however, by Australia’s highest court which found that a technical non-compliance with the franchise code does not mean the franchise agreement is unenforceable (although remedies may be available under the Trade Practices legislation where harm can be shown to have occurred). This case thus gives some comfort to franchisors concerned about uncertainty. On the whole, though, the Discussion Document was balanced, well-written and forms a useful point of reference for future debate.

A three month period was given for interested parties to make submissions. The Review, however was not well-publicised, being merely advertised on the MED’s website, amongst members of FANZ and by the Minister of Commerce at the franchise expo at Auckland in August 2008. A press release by the former Minister of Commerce received practically no attention outside specialist media.

By comparison, the major inquiries into franchising that have been held in Australia (most of which were Parliamentary ones) were advertised in all the major Australian newspapers and invitations were sent out to several hundred stakeholders. These elicited responses from a much wider group of respondents, including those representing franchisee viewpoints as well as franchisors. Another distinguishing feature of the Australian inquiries was that they had public hearings which allowed a two-way interchange of views and the ability to question submitters and clarify points made by them.

For example, one submission to the New Zealand Review hinted at oppressive behaviour by a franchisor but gave no facts to illustrate the nature of the conduct. It alleged that the franchise system was defective but the franchisee was locked in by their investment. The submitter then made the intriguing comment that the ‘franchisor believes that he has the same rights as if he actually owned our business – in short – he’s a control freak.’ This suggests that the submitter perhaps had a lack of understanding as to what a business format franchise actually is. It is in the nature of a franchise that uniformity is a key aspect and that the individual discretion afforded to franchisees is often extremely limited. It is also the case that many franchisees think they can improve on the franchisor’s system but the nature of a franchise usually does not allow this – and with good reason. Without the opportunity to question the submitter via a hearing as to the nature of the oppressive behaviour and alleged defects it was, of course, impossible to assess the accuracy of the claims.

The Respondents To The Review

Review submissions by categoryA variety of individuals, companies and trade and other associations made submissions representing diverse interests. The single largest group of submissions was from industry and trade associations (accounting for almost a third of all submissions), followed by law practitioners and academics. The diagram right represents the break-down of submitters. Somewhat surprising was the fact that individual franchisors and franchisees only accounted for ten percent each of the submissions. It should be noted that the category of ‘Others’ includes miscellaneous submitters who included banks, government bodies and an advocacy group. (One submitter was included in three categories, hence the diagram accounts for two more submissions than the original number.)

Associations, it must be acknowledged, represent vested interests. In the case of the submissions to the review, with the exception of The New Zealand Law Society the submissions represented the interests of the association members. These represented influential New Zealand trade and industry groups including The Employers’ and Manufacturers’ Association, The Law Society and Business NZ. Apart from the Motor Trade Association (MTA), all were in favour of the status quo and opposed to franchise-specific regulation. This was hardly surprising as these associations generally have been opposed to increased business regulation.

The submission made by the Commercial and Business Law Committee of The Law Society, however, also supported the status quo and opposed any new regulatory paradigm for franchising. This, together with the opposition of FANZ (the franchise sector’s own industry association the majority of whose members are franchisors), essentially determined the outcome of the review. The opposition of a highly respected professional body such as The Law Society together with the submission made by FANZ made it highly improbable that any outcome other than the status quo would eventuate.

It is worth contrasting this with those who made submissions to the several Australian franchise inquiries. There again, industry associations played a big role. The big difference, however, was that many of these represented the views of franchisees as opposed to those of big businesses – this reflects perhaps on the lack of comparable organisations in New Zealand. The only franchisee-aligned submissions here were made by the MTA and the New Zealand Fair Trade Coalition, two groups that are closely linked.

The second largest group of submitters, lawyers, was divided in their submissions – probably reflecting their client base. Four academics (three of them Australian) made submissions, all of them generally in favour of franchise-specific regulation and opposed to the status quo. The academics could not be said to represent vested interests and their views may therefore be of particular interest. Significantly, some Australian academics were critical of aspects of the Australian regulatory environment but felt that New Zealand could improve on it.

The submissions of franchisees and franchisors were evenly balanced (no surprises) reflecting their respective interests. One submitter, though, had worn all three hats as franchisor, franchisee and academic and because of this the submission was a valuable one.

Curiously, the only Government body to make a submission was the Commerce Commission. Its submission was unusual in that it leaned towards the status quo but hedged its bets by submitting that it wanted to enforce any franchise-specific regulation should this be the outcome of the Review! The Commission’s faith in the existing laws such as the Fair Trading Act is possibly misplaced in light of recent court decisions such as that of the Court of Appeal in David vs TFAC Ltd that have shown they are of only limited use to those who buy franchises, as well as the current inquiry into Consumer Law Reform by the Ministry of Consumer Affairs.

Lastly, 15% of the submissions were confidential with one additional submission withholding the identity of its author. In the Discussion Document the MED, whilst offering confidentiality in appropriate cases, stressed that this could not be guaranteed in light of The Official Information Act. This may well have put off some people who might otherwise have had interesting stories to tell. If the inquiry had been a Parliamentary one, as Australian inquiries have been, absolute parliamentary privilege would have meant that those giving evidence would have had complete protection as to what they said, irrespective of confidentiality agreements, confidential settlements and the like. A recent Australian inquiry (the Matthews Inquiry 2006) stated in its report that:

The focus of the committee’s inquiry was on addressing broad structural, procedural and regulatory issues relating to franchise agreements in Australia, rather than on any particular franchising disputes. As such, the committee decided that it would not publish the details of individuals or corporations adversely commented on in submissions. Material deemed to have fallen within this category was deleted by the committee, and the amended version of submissions was made public on the inquiry webpage.

This showed that businesses had nothing to fear from a Parliamentary inquiry and meant people would be more likely to air genuine concerns.

Response To The Questions Asked By MED

Ten specific questions were put to submitters. Question one was perhaps the most important as it asked whether franchise contracts were unique in their nature. It is worth noting that the majority said they were. This included submissions made by FANZ and the MTA – groups that were otherwise in opposing camps. Both identified the relational and standard form nature of franchise agreements and the opportunities for conflicts of interests to arise.

Question three, which asked whether problems were sector-wide or limited to some areas, also saw common ground as both FANZ and the MTA stated that the problems that existed were due to the relational nature of franchising. A very strong consensus existed amongst submitters that such problems as existed tended to be in franchises with a low capital outlay (such as the home services sector), which disproportionately affected franchise purchasers from an immigrant background, often with poor English skills. Few such purchasers obtained legal advice beforehand and were therefore vulnerable.

Question six asked submitters what information should be given to franchisees in the event this became a requirement. Again, there was significant agreement. On the one hand there was general agreement that franchisees needed better access to information, while on the other hand there was a consensus that the Australian requirements were excessive. The danger of ‘information overkill’ was a common theme, with many submitters stressing that it was important that franchisees should understand the information given to them, and that it should therefore be as simply worded as possible.

The Preferred Option For Regulation

PreferredOptionOne of the questions asked submitters which option for regulation they preferred. The diagram above shows there was a clear preference for the status quo, even though there was general agreement that better education was needed across the board (including education of professionals such as accountants and lawyers as to the unique aspects of franchising). Most interesting of all was the fact that FANZ seemingly wanted to have its cake and eat it – while being in favour of the status quo, its submission listed the benefits of mandatory information disclosure to franchisees (as required of its own members by the FANZ Code of Practice) as well as its content. It also listed the benefits of mandatory professional advice, a cooling-off period and better dispute resolution – all items also included in the Code but not required of the majority of franchisors as they choose not to be members of FANZ.

The somewhat ambivalent stance taken by FANZ and the fact that it had previously stated its position in favour of regulation suggests that political factors may have dictated its position. Between its February 2008 statement supporting regulation and the time of its submission, the Association polled its members as to their views. The chairmanship of FANZ had also changed from a lawyer to a franchisor. The fact that FANZ had changed its position is worth noting because this could occur again in future as, possibly, differing views exist within the FANZ Board and membership.

Suggestions For The Future

Our review of the Franchise Review highlights a number of issues.

In our opinion the process of a departmental review and the relative lack of publicity for it undermined its credibility somewhat. The inability to question submitters and to afford them a chance to be heard in person also stifled genuine inquiry. In spite of this, the submissions made in response to the Review show a remarkable degree of agreement as to what makes franchise relationships different from others and as to the groups that are particularly vulnerable when purchasing franchises.

Second, the submitters overwhelmingly represented vested interests that were in favour of the status quo and opposed franchise-specific regulation. Little convincing evidence was produced by the submitters that the current law was inadequate in dealing with issues within franchising. This contrasts with the major Parliamentary inquiry in Australia in 1997 that preceded comprehensive regulation of the sector there. More recent Parliamentary inquiries in Australia, however, have failed to find evidence of serious problems – for example, a recommendation that risk factors be highlighted for franchisees in a similar way to cigarette cartons was rejected by the Federal Government. This may indicate that there are diminishing returns for those continuing to push for more regulation there or it may simply be that the major changes Australia made in 1998 have done their job.

We believe that future inquiries in New Zealand should be of a Parliamentary kind. They should be better advertised and opportunity given to those making submissions to be heard and to be questioned.

Finally we recommend that the MED make greater use of 21st century technology such as Internet forums for discussions around submissions. This has been used to good effect in other jurisdictions and might stimulate greater input from franchisees and franchisors unable to go to the considerable lengths required to make a full submission.

Gehan Gunasekara is a senior lecturer in Commercial Law at the University of Auckland Business School and specialises in franchising. Tiffany Lee is a Commerce graduate of the University of Auckland and this research was conducted as part of a summer scholarship project.
Order a Print Copy
Order a Print Copy