Symposium Debates Franchise Law Options

Following the announcement by Commerce Minister Simon Power that the Government had decided that there was no case for franchise-specific legislation at this time, the symposium proved very valuable in establishing exactly what further research was needed and what specific issues might need to be addressed before further progress could be made.

A story by the New Zealand Herald entitled ‘Franchise decision puts heat on minister ' that suggested Mr Power would ‘face a roasting from franchise law experts' proved somewhat sensationalist, with the Minister receiving a warm and courteous reception.

Two main themes ran through the presentations: first, a recognition of the imbalance of power between franchisor and franchisee; and second, the feasibility and value of pre-contractual disclosure. In the following, we sum up the presentations made by each contributor. The full papers can be read via links, and include some discussion of the concepts of good faith and unconscionability. These are not discussed in this article but are covered separately.

Commerce Minister Simon Power

In his introductory remarks, Simon Power commented that the recent review undertaken by the Ministry of Economic Development had proved valuable in helping the Government appreciate where franchising fitted within the economy. He noted that, while the diversity of franchising attests to its appeal and shows its adaptability, it also makes it difficult to generalise. The current economy points to the advantages that franchising can offer New Zealand, which makes it important to have the right regulatory framework for the sector.

‘This Government has a high threshold for new regulation,' he said. The current need is to lighten the load on businesses to help them cope in the short term. Our long-term focus is on improving productivity and growth.'

The Minister advised that for each issue raised by the Ministry's Review, the question asked was: ‘Is this unique to franchising or common to the small business sector in general?' On balance, he had concluded that it was unlikely that the benefits of regulation would outweigh the costs and believed that current legislation and self-regulation by the Franchise Association of New Zealand were most appropriate to the NZ environment. ‘It's not possible to legislate all risks away, as we have found in other sectors,' he said. ‘By making the announcement that we will not be introducing franchise-specific legislation, we hope to bring some certainty to the sector.'

Mai Chen: Is there a case for franchise law reform?

Mai Chen is Partner with Chen Palmer New Zealand Public Law Specialists

The opening presenter, Mai Chen, delivered a valuable summation of why the Minister had reached the decision not to regulate at this time. She explained:

1. The Ministry Review was initiated by the previous Labour-led Government. A National-led Government is less likely to introduce regulation of any kind.

2. National regards regulation as a tool of last resort. Its aim is to get rid of unnecessary regulation, not add to it.

3. The Government is not convinced that there is what is termed ‘a mischief' requiring law reform. The Cabinet Paper clearly says that there is not enough data to determine whether the disputes that have arisen within franchising are widespread or symptomatic of systemic issues in the sector.

4. Submissions to the review on regulation were evenly split, so it would be difficult to see a ground-swell of opinion in favour of need for regulation. ‘This is especially the case when you are dealing with undermining the sanctity of a contract entered into by consenting adults,' Mai Chen said. Consequently, this Government won't see franchise regulation as a priority over other areas of reform it is committed to carrying out.

5. The recession cuts both ways. While people made redundant may be more vulnerable in considering a franchise, businesses weakened by recession don't need increased compliance costs when there is no clear evidence that regulation would improve the economy.

6. The issues of defining what actually constitutes a franchise are not small ones and the Review did not produce an approach that would be generally acceptable. As she writes, ‘The momentum for reform in Australia seemingly developed before real thought had been given to the problems of definition and what relationships would be subject to increased regulation.'

‘There is therefore a lot of work to be done by those wanting regulation to collect more evidence that there is a mischief and to convince the officials who are advising the Minister of Commerce,' Mai Chen said. ‘You would also have to show that any proposed regulatory model would result in fewer disputes. The ball is in the court of those who want reform.' She recommended that a useful next step would be to get agreement with the Minister on what evidence would be required to convince him of the need for regulation, and to maintain dialogue with other parties too.

Mai Chen's detailed paper covers: what is franchising law; overseas franchising law; is franchising special?; what is the mischief?; and voluntary self-regulation. Her conclusion is that franchise law reform would be desirable, but there is not enough evidence to show that it is essential. In the interim, the sector should improve self-regulation and improve public education. She commented that, ‘At the moment, it would be a leap of faith to regulate.'

Read Mai Chen's paper: Is There A Case For Franchise Law Reform?

Andrew Terry: Global Trends in Franchise Regulation and the Australian Experience: Lessons for New Zealand

Professor Andrew Terry is Head of the School of Business Law & Taxation at the University of New South Wales.

Andrew Terry brought a huge amount of experience and scholarship to the symposium, having had over 30 years' involvement in franchising. He is a former director of the Franchise Council of Australia and also drafted Vietnam's franchise law that took effect in 2006.

He started by acknowledging that entrepreneurship involves risk, and that it is not the role of government to remove risk. However, in the particular circumstances of franchising, he asked the question: Are there elements quite different to normal business development because of the control of the franchisor which can be an over-riding risk for other than purely business or commercial reasons? If the answer to this is ‘yes', how can these additional risks be handled by the parties?

Internationally, there is increasing recognition that there are elements about franchising that are sufficiently different to normal business development to justify regulation. One of the tables in the paper shows that there are now 33 countries with some form of specific franchise regulation. Closer examination reveals that every country has differing forms of regulation but they all involve one or more of the following: prior disclosure, regulation of conduct, registration or franchises, dispute resolution.

Professor Terry believes that the key to franchise legislation is prior disclosure. ‘Regulating conduct is not only much more controversial but much more difficult. It's worth noting that even the fine legal minds of Unidroit (the International Institute for the Unification of Private Law) were not able to produce a model franchise law, but they did produce a model disclosure law.

However, he mounted a spirited defence of the Australian franchise legislation, which has been criticised by many New Zealand commentators, and by the FANZ, as being‘draconian, too wide-ranging in application, too costly in terms of compliance and often ineffective in providing relevant protection to franchisees and potential franchisees.' Commerce Minister Simon Power has himself referred to its onerous and complex disclosure requirements, compliance costs, and the information overload it provides for potential franchisees.

‘The perception in Australia is very different from the NZ perception,' Professor Terry said. ‘The regulation has enjoyed wide sector acceptance, has discouraged scam merchant franchisors, generated greater confidence among prospective franchisees, created better and stronger relationships at all stages and led to fewer disputes. The Franchise Council of Australia itself says that its members believe the Code has had a beneficial effect on the franchising sector and there is no statistical evidence to prove that regulation has impacted upon the growth of the sector - rather the reverse, in fact.' And he said claims that the small size of many New Zealand franchisors meant that they would be disproportionately disadvantaged compared to the large Australian franchisors were nonsense. ‘Out of over 800 franchise systems in Australia, only the top 50 have more than 50 franchisees.'

He concluded that, ‘the experience in Australia under the mandatory Franchising Code of Conduct provides comfort to those franchising sectors facing regulation that appropriate and balanced regulation can have a beneficial effect on the franchising sector and encourage its orderly development for the benefit of all stakeholders.'

Read Andrew Terry's paper: Global Trends in Franchise Regulation and the Australian Experience: Lessons for New Zealand

David Munn: Surgical Intervention - Defining Limits for Regulatory Protection

David Munn is a commercial law partner with Gaze Burt. He has over 30 years' experience representing both franchisors and franchisees and is one of only two New Zealand lawyers listed in the International Who's Who of Franchise Lawyers.

David Munn made out a case for limited franchise-specific legislative reform looking particularly at two aspects of the Ministry's review document: information imbalance and power imbalance. He commented that, ‘sometimes... the value of franchising is overlooked as we over-focus on problems and lose perspective on how a problem has arisen... If the problem is associated with franchising, it does not mean that the franchise concept is the problem and needs constraining. In my experience, the problem, if there is one, is usually related either to the application or management of the franchise concept rather than the concept itself.' He advocated surgical-style intervention ‘which is at its best and most effective when it is precise, targetted and of minimum impact necessary to achieve the desired outcome.' ‘My concern is that some proposals for franchise specific law reform are too invasive and could damage the special characteristics of franchises.'

The Australian approach, Mr Munn argued, has been invasive and questionable, and he quoted respected Professor Warren Pengilley who seriously criticised ‘the ill-considered speed and politically high-handed attitude with which Australia introduced its mandatory Code of Practice.' Instead, he too pointed to the Unidroit model disclosure law as being very pro-business and providing international uniformity.

‘Initial disclosure enables the franchisee to make far more informed decisions prior to contracting, provides less scope for future misunderstandings and leads to better comparative judgements between franchises,' he said. He accepted that over-complex disclosure documents can create a danger of ‘information overload' for prospective franchisees, and also agreed that disclosure requirements have to be balanced against compliance costs. However, he emphasised that disclosure is a valuable risk management tool for franchisors.

Mr Munn advocated making many of the provisions of the FANZ Franchising Code of Practice mandatory for franchisors, including disclosure, a requirement for franchise buyers to take independent legal advice, the incorporation of a cooling-off period following execution of a contract and alternative dispute resolution by way of mediation.

‘Some argue that we already have sufficient law to deal with the imbalance of information and the imbalance of power at both the pre-contract stage and the subsequent relational stage. In many ways that is true... However, there is no legal requirement for pre-contract disclosure or independent advice which would address both information and power imbalance factors.' And, he said, ‘Even with existing law providing available rights and remedies, these are of little value if one does not have the financial resources (or indeed the emotional energy) to exercise those legal rights... A fence at the top of the cliff is better than rights at the bottom.'

Read David Munn's paper: Surgical Intervention - Defining Limits for Regulatory Protection 

Estelle Logan: The Franchise Association's View

Estelle Logan is Chairman of the Franchise Association of New Zealand and a practising franchisor, having been national franchisor for VIP Home Services in New Zealand for the past 15 years.

Estelle Logan stated the position of the FANZ, which welcomed the Commerce Minister's decision not to proceed with franchise regulation. She accepted that ‘There is little doubt that there are a small number of problem franchisors who damage the reputation of the franchise sector. If legislation were to rid franchising of problem franchisors then it would be well worth it, but the evidence is clearly to the contrary. There is little evidence anywhere in the world that franchise regulation inhibits or deters the behaviour of rogue or fraudulent franchisors.'

Unlike Professor Terry, the FANZ does believe that the introduction of regulation in Australia slowed the growth of the franchise sector there. Estelle Logan also pointed to the increased compliance costs experienced in Australia, quoting a statement by McDonald's Australia that updating their disclosure document to comply with the latest changes had cost some $150,000. ‘Compliance... in Australia has become so onerous that few if any franchisors have the ability to prepare a compliant disclosure document,' she claimed, adding that ‘Many prospective franchisees do not read the disclosure document because it so complex and detailed that those reading it often find it difficult to comprehend.'

She stated that, given the nature of franchising, contractual imbalance is necessary for the protection of the franchise business format itself. ‘If an imbalance of power is too oppressive, it can be dealt with by the courts on a case-by-case basis.'

One of the main lobbyists for the introduction of franchise legislation has been the Motor Trade Association (MTA), which represents the motor vehicle dealers who are often franchisees of the manufacturers. Estelle Logan specifically addressed the main concern of MTA members that within motor dealerships it is common for franchise agreements to be able to be terminated (by either party) with 90 days notice without cause. She pointed out that this is uncommon in franchising outside the motor trade and that almost all franchise agreements deal with issues of renewal and transferability in a sensible manner. ‘Nevertheless, it is a matter of free choice - if you don't like the agreement, don't sign it,' she said.

It is worth noting that during question time it was claimed by the representative of the Motor Industry Association (which represents the manufacturers) that in the majority of cases where franchises had been terminated using the 90 day no-cause provision, the termination had been initiated by the vehicle dealer (franchisee), not the manufacturer (franchisor).

Read the abstract of Estelle Logan's address

Patrick Learmonth: Does The Nature Of The Franchise Relationship Give Rise To Any Need For Regulation?

Patrick Learmonth is a partner at Kensington Swan and heads the firm's franchising practice group.

The final speaker was Patrick Learmonth of Kensington Swan. He had been billed in advance by the MTA as ‘putting the MTA's case for the introduction of franchise law', but in fact his paper made no specific reference to the termination issue. His paper suggested that the franchisor/franchisee relationship is often too complex for successful litigation and made some suggestions for redress in the areas of dispute resolution and disclosure.

He noted that franchises are diverse and multi-layered relational arrangements. ‘They are often little understood by participants, prone to abuse, but, overall, successful.' The nature of the relationship requires a high level of trust between franchisor and franchisee, and that trust is part of the reason for its success. ‘It is the opportunity for mistrust that causes press perception that there's more of a problem than there actually is,' he suggested. None the less, it is true that franchisees are heavily reliant upon franchisors.

A useful comparison might be made with the investment sector. Parliament recognises that some contractual relationships between the public and sophisticated commercial parties are worthy of protection. A securities investor buying shares is deemed worthy of protection, whereas an investor buying a franchise is not. As Mae Chen commented in her paper, recent decisions have found that franchise relationships are indistinguishable from other commercial/contractual relationships and are governed by contract law rather than consumer law.

With regard to the imbalance of power, ‘franchisors don't create franchise agreements heavily in their favour just for their own benefit. The degree of power allowed for in favour of the franchisor is purposefully crafted to ensure that one franchisee cannot damage the franchise to the detriment of all.'
In fact, he described the franchisor franchisee relationship as inherently ‘dysfunctional. The franchisor holds all the cards yet, despite this, is totally reliant on the franchisee to run the business and maintain the strength of the brand. The franchisee, on the other hand, relies completely on the franchisor for everything required to run the business. Ideally the franchise agreement would contain checks and balances to ensure both parties' positions are equally protected, but a review of the submissions made to the MED indicates this does not exist in any real form.'

Like David Munn, Patrick Learmonth recommends the inclusion of compulsory dispute resolution clauses within franchise agreements. The franchisor's position means that it is more likely that it is a franchisee who will want legal redress yet it is the franchisee who is likely to have the least resources - personally and economically - to gain such redress. ‘Franchisees should be protected in that access to justice should be provided for in a real and meaningful way in franchise agreements. Dispute resolution won't always work but that is no reason not to make it available.'

He also advocates mandatory disclosure. Given the power imbalance, ‘Pre-contract disclosure might at least put the franchisee in a position of better understanding. The fact that people won't always use the information you supply is no reason not to supply it... The requirement for some form of disclosure by franchisors will cast a burden on a franchisor - but that in itself is not a reason [for not] requiring some form of disclosure.'

However, he was not in favour of compelling potential franchisees to take independent professional advice. ‘If you require people to take advice, they don't seem to take any notice of it,' he said. ‘A compulsory requirement for independent professional advice is often only "ticking the box".'

Read Patrick Learmonth's paper: Does The Nature Of The Franchise Relationship Give Rise To Any Need For Regulation? 

Professor Tim Hazeldine: Closing Notes

The symposium was closed by Professor Tim Hazeldine, Head of Department of Economics, University of Auckland Business School

Professor Hazeldine closed the symposium by making two general points from his perspective as an economist. The first was about the nature of regulation in general. ‘People say that regulation is interference in a free market. Well, as an economist I would say that markets aren't free. In fact, franchising exists because markets aren't perfect - it exists as a way to help businesses expand when they are unable to raise the money to do it themselves or manage huge numbers of people themselves.

His second point was that ‘Regulation needn't be perfect to be useful.' Compliance is valuable in making society work: for example, we all agree to drive on the left. Good focal points, standard terms and contracts can reduce transaction costs for all involved. ‘In fact,' he concluded, ‘I'd reverse what Mai Chen said and I'd suggest it would be a leap of faith NOT to regulate.'

About the Symposium

The symposium was jointly hosted by The Department of Commercial Law and New Zealand Governance Centre at the University of Auckland Business School on 25 June 2009. It was organised by Gehan Gunasekara, a senior lecturer in commercial law at the School, and was attended by around 70 participants.

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