The Right Side of The Law

Talking to a highly-respected franchisor recently, they commented that, ‘There are some things that franchisors do to help franchisees in times of trouble, or to get deals over the line, that might expose them to laws they don’t expect – especially in the financial area.’

They offered four specific examples:

• Providing finance
• Providing financial advice
• Setting prices
• Helping franchisees sell their businesses

All of these are quite common practices within the close relationship that often exists between franchisee and franchisor, so we asked business and franchise lawyer Michael Bright for his comments. Will they set your mind at rest?

Providing finance

Over the last couple of years particularly, some franchisors have been providing finance to their franchisees, or allowing initial franchise fees to be paid in instalments, with or without interest. This is just one of the ways in which franchisors have tried to help franchisees get through Covid-19 downturns or sell their businesses. However, the question arises as to whether such arrangements can fall foul of the Financial Service Providers (Registration and Dispute Resolution) Act 2008 (FSP Act).

The purposes of the FSP Act focus on creating fair, efficient and transparent financial markets. Although most franchisors are not involved in the financial markets, the FSP Act applies to those who are in the business of providing a financial service – including those for whom the financial service is not their main business. Where franchisors might sometimes get caught out is that a ‘financial service’ includes lending money under a credit contract.

Michael points out that there are some exemptions to the FSP Act. Most notably, a franchisor who does not charge interest and does not charge any credit fees, or require any other compensation for the credit, will not fall under the Act.

He notes that the FSP Act only applies to those who are making a business of providing credit. But whether a franchisor is making a business of it, or is merely providing one-off or occasional credit, isn’t a clear-cut assessment. It will involve considering whether the franchisor intends to make money from the credit arrangements; how often they lend; what the purpose of the finance is; and how central the lending is to the franchisor’s core business.

The regulator has said that so long as your core business is unrelated to financial markets, and you are issuing one-off or occasional credit, you’re unlikely to be caught by the Act. But if a franchisor’s lending does become so frequent or lucrative that they are effectively making a business of it, no matter how pure their motives, then they could be caught by the FSP Act. This would then require the franchisor to be registered as a financial service provider and to join an approved dispute resolution scheme.

Although the requirements aren’t onerous, they are another arm of compliance most franchisors would prefer to avoid. But, according to Michael, the good news is that franchisors who only provide credit occasionally to help a struggling franchisee, and who don’t make any money out of it, won’t fall under the FSP Act and won’t be of interest to the regulator.

He does caution that credit contracts that are harsh or in breach of reasonable standards of commercial practice can be ‘re-opened’, and a court can order whatever it thinks necessary to remedy the situation, under the Credit Contracts and Consumer Finance Act 2003. ‘Thankfully, however, I haven’t yet seen any franchisor engaging in such behaviour.’

Providing financial advice

In addition to providing advice on running their businesses, franchisors often talk to their franchisees about the franchisee’s financial arrangements – their loans and interest, who their bankers should be, and what options they have around finance. But does this put the franchisor at risk of breaching the financial advice restrictions in the Financial Markets Conduct Act 2013 (FMCA)?

The purposes of the FMCA are similar to those of the FSP Act. The FMCA focuses on financial markets and those who give advice about buying financial products (shares, bonds, insurance, etc).

Michael says anyone who gives ‘regulated financial advice’ has to comply with various restrictions and licencing and disclosure requirements under the FMCA and also has to comply with the FSP Act. The FMCA obligations are more onerous, and are added to, those under the FSP Act.

A franchisor who does not otherwise provide financial services but who recommends or gives an opinion about buying or selling shares, insurance or debt (amongst other things), could be giving financial advice. However, that advice will not be ‘regulated financial advice’, and will not fall under the FMCA, if it is not given in the ordinary course of the franchisor’s (non-financial services) business or if giving such advice is only an ancillary part of the franchisor’s business.

‘So franchisors whose main business activity is something other than providing financial services and who provide gratuitous advice to franchisees from time to time but don’t have it as part of their regular activity or service, should not be concerned about their advice breaching the FMCA,’ says Michael.

If franchisors are regularly giving their franchisees recommendations or opinions about financial products (including insurance), or if franchisees are regularly giving their own customers advice about financial products, then they may be caught by the FMCA.

However, Michael points out there are other useful exclusions that, if followed carefully, will ensure the FMCA is not breached and franchisors, franchisees and customers are all protected. In particular, franchisors and franchisees will avoid breaching the FMCA if they stick to one or more of the following:

1. Ensure recommendations or opinions are generalised to a type of financial product, rather than focusing on specific products (for example, it’s OK to express an opinion about insurance generally, rather than particular insurers or policies).

2. Provide factual information about the terms and conditions of a financial product, or about how to buy it, without expressing an opinion about its suitability or how it compares to alternatives.

3. Pass on financial advice given by someone else, while making it clear that the advice is not your own advice.

Franchise group insurance schemes provide a good example of how to apply these exclusions. Many franchisors have arrangements with a particular insurer or insurance broker, under which a standardised insurance package is made available to franchisees – and may even be mandated through the franchise manuals.

Franchisors are free to recommend (or require) that franchisees hold insurance and can provide factual information regarding the group insurance scheme and how to join it. They only risk getting on to thin ice if franchisees ask about alternative insurance products, as the temptation will be to express an opinion on the merits of each. Instead, franchisors can either provide factual information about each product (without recommending one or the other or advising which best fits the franchisee’s needs) or simply advise that the franchisor can’t comment on anything other than the group arrangement.  

Setting prices

It is common for franchisors to advise franchisees about pricing, or even to specify prices or discounts so as to get consistency across the franchise network or to drive sales promotions. Under what circumstances might this be unlawful price fixing?

If customers might realistically choose between two franchisees, or between a franchisee and the franchisor’s online sales platform, then the franchisees (or the franchisee and the franchisor) are in competition with each other – regardless of any territorial restrictions in the franchise agreement. In that situation, a franchisor and franchisee who reach any kind of understanding that affects the prices or discounts offered by a franchisee, have probably agreed upon a ‘cartel provision’ and will need to consider the restrictions in the Commerce Act 1986.

Although the Commerce Act prohibits cartel provisions and renders them unenforceable, it does provide some exceptions that will permit otherwise unlawful arrangements. The most useful of these for this particular scenario, is the collaborative activity exemption. Under this exemption, franchisor and franchisee are able to agree and enforce a cartel provision if they are engaged in collaborative activity and the cartel provision is reasonably necessary for the purpose of the collaborative activity.

In Michael’s opinion, it will usually be quite easy for a franchisor and franchisee in a ‘full business format’ franchise system to show that they are conducting collaborative activity. They pool their collective efforts and resources to distribute goods or services to the franchisee’s customers in a way that is sustainable and provides better pricing, quality or service than the franchise system’s competitors. The critical question will be whether the arrangement around pricing is reasonably necessary for the purpose of that collaboration. It might, for instance, support the franchisor in obtaining more favourable trading terms from suppliers, increase stock turn, or ensure pricing is at a level which supports business longevity and helps ensure franchisees don’t breach minimum employment standards.

Michael says that, to date, the Commerce Commission has never been concerned about franchisors who have genuinely set maximum prices or promoted discounted pricing. However, he points out that even activities that might hold prices up will be permissible if they fall under the collaborative activity exemption.

‘The key point is to think carefully about whether the collaborative activity between franchisor and franchisee reasonably requires arrangements around pricing control, then ensure the arrangements don’t go any further than what’s reasonably necessary. It’s also a good idea to document the reasoning behind the cartel provisions, so they can be explained in the context of the wider business model if ever questioned by a regulator or court.’   

Helping franchisees sell their businesses

Franchisors sometimes step in to help franchisees sell their businesses, particularly when a keen buyer comes along with an interest in a particular area, or if a franchisee is under pressure or is struggling to find a buyer. They may not be aware that the Real Estate Agents Act 2008 (REAA) applies to business sales.

Any work that is done, or service that is provided, in trade on behalf of someone else for the purpose of bringing about the sale or purchase of a business, will fall under the REAA. This applies even if the business sale does not involve any sale or leasing of land.

The important point is that the REAA doesn’t just apply to people who hold themselves out as real estate agents or business brokers. It applies to anyone who, as an act of commerce, is engaged by someone else to take active steps to try to sell their business.

‘Perhaps the simplest way to think about it is that if a franchisor tries to help a franchisee sell their business in similar ways to how a business broker might help, and charges something for that service, then their activity is most likely falling under the REAA,’ says Michael. ‘The franchisor would need to be licenced under the REAA and comply with all the duties and obligations and the Code of Conduct that apply to real estate agents and business brokers under the REAA.’

Helpfully, the REAA says that providing general advice or materials to help business owners locate and negotiate with potential buyers is not covered by the Act. ‘So a franchisor who provides general advice about business sale options and processes, or provides templated resources to help advertise a business, but otherwise leaves the franchisee to find and negotiate with buyers, will not be caught by the REAA. Similarly, a franchisor who has a list of prospective franchisees and introduces them to a franchisee who wishes to sell, in the hope of facilitating a sale, won’t be caught by the REAA if they provide that service without charge.’

In order to ensure that franchisees looking to sell receive the best support possible, and to ensure that the franchisor does not need to worry about the REAA, Michael recommends involving a licensed business broker who is experienced in franchise sales.

Conclusion

So is our franchisor worrying needlessly? Definitely not, it seems. No matter how good their intentions, helping out a franchisee could land them in trouble from an unexpected direction.

‘It depends upon the nature of their business, of course, but as long as they pay attention to good advice and don’t overstep the mark, then they might be worrying more than they need to,’ Michael concludes.

We welcome links from other websites to this article. Please note that this article is copyright © Eden Exchange NZ Holdings Limited, Franchise New Zealand magazine and Franchise New Zealand On Line. While it may be downloaded for personal use, no part may be reproduced on any other website, in electronic or printed form or in any other form whatsoever.