by Simon Lord

last updated 23/07/2009

Regulation Off the Agenda?

by Simon Lord

last updated 23/07/2009

March 2009 - The prospect of franchise legislation seems to have receded following last year's review by the Ministry of Economic Development.

In 2008, the Government commissioned a review of the need for legislation of the franchise sector in New Zealand following an alleged fraud involving Green Acres master franchisee Keith Lapham - a case that is still, at the time of writing, going through the courts.

The Ministry of Economic Development published a Discussion Document in August 2008 and invited submissions from interested parties. It received 32 submissions prior to the closing date; of these, only eight appeared to be in favour of franchise-specific legislation, although five submissions were confidential and their contents are not published. Half the submissions specifically support the status quo of voluntary self-regulation as currently offered by the Franchise Association.

Sources report that, given this response and general agreement that the alleged fraud was adequately covered by existing law, there seems to be little appetite within the Ministry for the introduction of franchise legislation at this time. In the current economic climate, a National-led Government seems unlikely to enact legislation that would increase compliance costs for small business. This is especially the case given the current recognition that franchising has a big part to play in offering new opportunities to those being made redundant.

Who Thinks What?

The published submissions (available on the Ministry website ) make interesting reading, representing as they do not just the views of franchisors and franchisees but also lawyers, academics, trade groups and associations and other interested parties.

Franchisors Five franchisors made submissions, of which one has been reserved as confidential. The four published submissions support the status quo of self-regulation through the Franchise Association. Interestingly, even non-members of the Association support this stance.

Franchisees Three franchisees have elected to make their submissions public. Of these, one believes that the status quo is inadequate but is wary of legislation, suggesting some form of co-regulation as the preferred route. The second public franchisee submission refers to experiences within one specific industry (fuel retail). The third believes that regulation modelled on the Australian system would be hugely beneficial. Franchise Watch, the group set up last year to represent those affected by the actions of Keith Lapham, has elected to keep its submission confidential.

Franchise Lawyers The breadth of opinion within the franchise sector is demonstrated by the fact that, of the seven franchise-specialist lawyers who made submissions, four were in favour of regulation and three were against.

Academics Three academic lawyers made submissions. Two of these called for franchise-specific legislation, one suggesting changing existing laws to address specific franchise situations.

Associations & Trade Groups Nine trade groups made submissions, including the Franchise Association itself which had canvassed opinion from all its members and consulted with overseas associations over a considerable period last year. The Association's position is to support the status quo but, if legislation is thought to be necessary, to prefer regulation based on and limited to its existing Code of Practice. Like many of the others who made submissions, FANZ supports the concept of education for franchisors and franchisees. The majority of submissions from trade groups supported the status quo, with the exceptions being the Motor Trade Association and the aligned Fair Trading Coalition which are seeking to address industry-specific issues.

The Costs of Regulation

One aspect that many of the submissions express concern about is the cost of compliance with any new legislation - something that even large companies are concerned about. Contact Energy, which has 27 franchisees in its Rockgas division, notes: ‘Any move to regulate must, we believe, be subject to a thorough cost-benefit analysis to ensure that it is really necessary. This is important as regulation is costly and time-consuming to implement and if it is too onerous it may even detract from the franchising model.'

And Mark Hawthorne, managing director of McDonald's in New Zealand, puts numbers on it: ‘Recently, in Australia there was a review of the disclosure provisions in the Franchising Code of Conduct. This resulted in amendments to the Code in March 2008. The simple costs incurred in updating the Disclosure Document which was the result of these changes resulted in a cost to McDonald's Australia of some $150,000. Given the franchise sector in Australia has some 1000 franchisors, the overall cost to the sector was significant. If this was to be done from scratch in New Zealand, the costs would be relatively expensive.'

As several of the submissions noted, increased compliance costs would have to be passed on to franchisees and, ultimately, the consumer - not a popular move during the current downturn.

The Balance of Power

One of the areas on which the Discussion Document sought feedback is the apparent imbalance of power between franchisors and franchisees that is enshrined in the contract between the two. As one anonymous and unhappy franchisee submitted, ‘Franchise agreements are heavily favouring the franchisor, leaving the franchisee with limited recourse and very little or no avenue for redress... When a franchisee has a poor relationship with an oppressive franchisor, he/she has little or no scope for improving his/her position.'

On the other hand, the McDonald's submission argues that ‘the contract power must reside with the franchisor because:
A. Intellectual property (ie, brand protection, and goodwill in intellectual property) is essential not just for the franchisor but for all franchisees and the system. This is one of the benefits to acquiring a franchise.
B. There is a need to consider the wider interests of the franchise system, not just the interests between the franchisor and an individual franchisee.
C. A necessary component of a strong and successful franchise system is the flexibility available to the franchisor through a strong contract position.

This gearing is essential for the protection of the franchise business format itself. A successful franchise has the components of a recognised brand, a proven and uniform operating system, consistency and predictability and, therefore, a very specific formula for business operations. The prescriptive nature of a franchise is the reason it is successful and the reason it is attractive to prospective franchisees in the first place. Regulation would try to adjust any imbalance with negative consequences. Imposing statutory requirements for franchise agreements is contrary to the fundamental principle of freedom of contract.'

It is this requirement to balance franchisees' rights with the ability of franchisors to enforce standards and impose necessary changes that many of the submissions are concerned with. McDonald's suggests that, ‘Perceived issues of "contractual imbalance" need be addressed on a case-by-case basis and individual rogue operators need to be dealt with individually.' While Duncan Cotterill Lawyers suggest that, ‘Whilst there is no pressing need to regulate, on balance there may be an advantage to have uniform standards in the industry,' others point to the fact that franchising as a means of doing business is so varied, and applies across so many different industries, that it is either impossible or undesirable to legislate for the many different types of relationship involved.

The Need for Education

According to the submission of the Commerce Commission, over the last twelve months the Commission has registered approximately 40 enquiries/complaints in regard to franchising issues. It reports that ‘The most common types of franchise complaints concern:
- misrepresentations in relation to the profitability of the venture;
- guarantees of volume of work;
- misrepresentations about the goods/services which are the subject of the franchise; and
- misrepresentations about the area covered by the franchise, or the extent to which it is an
exclusive area.

‘Although the Commission has historically taken some enforcement actions in the franchise area, more recently the Commission has declined to investigate the majority of complaints received (which) were more suitable for private action. In this sector, fair trading complaints are often intertwined with contractual issues wherein evidence can be difficult to establish - particularly in the criminal context - with much of the allegations being based on future events and verbal representations.'

The Commerce Commission then goes on to voice a common concern: ‘It would appear that many people entering into franchising agreements are not seeking independent legal advice, even though they have had little or no previous experience in running a business. Education in this area should be part of any solution, to ensure that independent advice is sought.'

Lawyers Deirdre Watson, Sarah Pilcher and Rory Macdonald, among others, suggest that, ‘there should be compulsory requirements for franchisors to ensure their franchisees obtain legal and accounting advice and that the lawyer and accountant certify that the effects and implication of any agreement have been explained to the franchisee.'

Ken Billot, who has experience both as a franchisee and franchisor, expresses particular concern about those for whom English is not a first language and those taking up low-investment franchises. Along with several other submitters, he suggests that such people are more likely to rely on unqualified friends or family and less likely to take proper independent advice. He submits that, ‘Legislation is not required to protect the franchisee, but franchisees do require access to independent and cost-effective advice, particularly in the pre-execution phase.'

While the review is unlikely to result in franchise legislation, at least in the foreseeable future, it is apparent that there is a general feeling that more education and more affordable advice would be of considerable assistance. It remains to be seen how those in the franchise sector will respond, and what encouragement and assistance might be provided by the Ministry which carried out the review.

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