Franchisor Failure: an Assessment of the Adequacy of Regulatory Response
FRANCHISOR FAILURE: AN ASSESSMENT OF THE ADEQUACY OF REGULATORY RESPONSE
Jennifer Mary Buchan LLB (Otago), LLM (Melbourne)
Submitted in fulfilment of the requirements for the degree of Doctor of Philosophy
School of Law Faculty of Law Queensland University of Technology August 2010
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Keywords
administration, asymmetry, Australia, bankruptcy, benchmark, best practice regulation, business consumer, consumer protection, contracts, Corporations Act 2001 (Cth), cost benefit, disclaim, disclosure, due diligence, education, executory contract, exploitative contract, fail, franchise agreement, franchisee, Franchising Code of Conduct, franchisor, incomplete contract, insolvency, ipso facto clause, lease, liquidator, onerous contract, policy, premises, receivership, regulation, relational contract, Retail Leases Act 1995 (NSW), remedies, stakeholder, standard form contract, Trade Marks Act 1995 (Cth), Trade Practices Act 1974 (Cth), unconscionable conduct, winding up.
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Abstract
Franchisor failure is one of the most problematic areas of the franchise relationship. It impacts negatively on landlords and other suppliers, but the contracting parties that are currently without legal rights to respond when a franchisor fails, and thus without consumer protection, are its franchisees.
In this thesis I explore the current contractual, regulatory and commercial environment that franchisees inhabit, within the context of franchisor failure. I conclude that ex ante there are opportunities to level the playing field through consumer protection legislation. I also conclude that the task is not one solely for the consumer protection legislation; the problem should also be addressed ex post through the Corporations Act.
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Table of Contents
Keywords ...... i Abstract ...... ii List of Figures ...... vi List of Tables ...... vii List of Abbreviations ...... viii Statement of Original Authorship ...... x Acknowledgments ...... xi CHAPTER 1: INTRODUCTION ...... 1 1.1 Effective protection for franchisees whose franchisor fails ...... 3 1.2 Challenges for the law ...... 8 1.3 Aim of the research ...... 10 1.4 Outline of thesis ...... 11 1.5 Information base ...... 13 1.5.1 Empirical research on the facts ...... 14 1.5.2 Research on the current law ...... 16 1.6 Limitations ...... 17 1.7 Matters beyond the scope of this thesis ...... 17 CHAPTER 2: WHAT IS THE PROBLEM AND HOW BIG IS IT? ...... 19 2.1 Research into franchisor failure ...... 19 2.1.1 Australian franchisor failure data ...... 21 2.1.2 Evidence of failed franchisors ...... 30 2.1.3 Why franchisors fail ...... 43 2.1.4 Early warning signs ...... 48 2.2 Franchisor failure from other perspectives ...... 52 2.2.1 Franchisor’s perspective ...... 52 2.2.2 The government’s and the regulator’s perspective ...... 52 2.2.3 Industry organisations’ and commentators’ perspectives ...... 54 2.3 Franchisor failure from franchisees’ perspective ...... 55 2.3.1 Additional implications for franchisees structured like a commission agency ...... 67 2.4 Franchisees from the franchisor liquidator’s perspective ...... 68 2.4.1 Franchisee as creditor ...... 69 2.4.2 Franchisee as debtor ...... 71 2.4.3 Franchisee as potential litigant ...... 73 2.4.4 Challenges facing the liquidator ...... 73 2.5 Conclusion ...... 75 CHAPTER 3: THE PROBLEM IN CONTEXT ...... 79 3.1 Development of business format franchising ...... 80 3.2 Components of 21st century franchise networks ...... 81 3.2.1 Franchisor ...... 83 3.2.2 Trade marks ...... 90 3.2.3 Leases ...... 102 3.2.4 Franchisees ...... 112 3.2.5 Franchisees not traditional suppliers ...... 122
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3.2.6 Franchisees or employees? ...... 123 3.3 The franchise agreement ...... 146 3.3.1 Addressing the failure of the franchisor’s business ...... 148 3.3.2 The desirability of certainty in contracts ...... 149 3.3.3 Parties to commercial and consumer contracts act in their own interests ...... 150 3.3.4 A standard form business consumer contract ...... 153 3.3.5 Relational contract ...... 157 3.3.6 Incomplete contract ...... 159 3.3.7 Exploitative contract ...... 161 3.3.8 Breach of contract ...... 162 3.3.9 Contract and quasi-contract based remedies ...... 166 3.3.10 Contract-related complications ...... 167 3.3.11 Conclusion ...... 169 3.4 Asymmetry issues ...... 173 3.4.1 Information asymmetry ...... 173 3.4.2 Adviser and advice asymmetry ...... 177 3.4.3 Risk asymmetry ...... 183 3.4.4 Resource asymmetry ...... 185 3.4.5 Contract asymmetry ...... 186 3.4.6 Legislative asymmetry ...... 186 3.5 Conclusion ...... 187 CHAPTER 4: IS THE CURRENT REGULATORY RESPONSE ADEQUATE TO DEAL WITH THE PROBLEM? ...... 191 4.1 Theory of the market-led solution ...... 191 4.2 Policy background ...... 194 4.2.1 The regulators ...... 196 4.3 Trade Practices Act 1974 (Cth)...... 197 4.3.1 Trade Practices Act 1974 (Cth) Section 51AC ...... 198 4.3.2 Trade Practices Act 1974 (Cth) Part V Division 1 ...... 202 4.3.3 Trade Practices (Industry Codes- Franchising) Regulations 1998 (Cth) (‘the Code’) ...... 203 4.4 Corporations Act 2001 (Cth) ...... 213 4.4.1 Receivership ...... 213 4.4.2 Administration ...... 213 4.4.3 Winding up in insolvency ...... 215 4.4.4 Specific assets and liabilities under the insolvency provisions of the Corporations Act ...... 220 4.4.5 Impact on suppliers to franchise network ...... 227 4.4.6 Impact on employees if employer becomes insolvent ...... 227 4.5 Retail leasing legislation ...... 227 4.6 Statutory remedies ...... 233 4.7 Conclusion ...... 233 CHAPTER 5: THE DEAL FOR FRANCHISEES ...... 235 5.1 Consumer protection benchmarks ...... 236 5.1.1 Regulation should provide effective protection from serious risks and threats that franchisees as consumers cannot tackle as individuals (B1) ...... 238 5.1.2 There should be accessible, timely and meaningful redress where consumer detriment has occurred (B2) ...... 243 5.1.3 Cost benefit considerations (B3) ...... 246 5.2 Conclusion ...... 250 CHAPTER 6: CONSUMER PROTECTION TO ADDRESS THE BENCHMARKS ...... 251 6.1 Potential non-regulatory solutions ...... 251
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6.1.1 Status quo ...... 251 6.1.2 Education ...... 251 6.1.3 Franchisee union ...... 253 6.1.4 Insurance ...... 254 6.1.5 Reconfigure some obligations ...... 255 6.1.6 Deem franchisors to be trustees ...... 255 6.1.7 Legislate solutions ...... 255 6.2 Regulatory solutions ...... 258 6.2.1 Make franchise agreements accessible ...... 260 6.2.2 Amend s 51AC Trade Practices Act ...... 261 6.2.3 Imply terms into all franchise agreements via Franchise Contracts Act ...... 262 6.2.4 Amend Franchising Code of Conduct ...... 271 6.2.5 Consequential amendments to State and Territory Retail Leases legislation ...... 276 6.2.6 Amend Corporations Act 2001 (Cth) ...... 277 6.3 Evaluation of regulatory solutions against benchmarks B1 and B2 ...... 280 6.4 Costs and Benefits ...... 280 6.4.1 Stakeholders...... 281 6.4.2 Present regime ...... 281 6.4.3 Proposed solutions ...... 282 6.4.4 Costs and benefits ...... 283 6.5 Conclusion ...... 286 CHAPTER 7: CONCLUSION ...... 287 7.1 Leading the world in franchise regulation ...... 287 7.2 Areas for Future research ...... 290 7.2.1 Database ...... 290 7.2.2 Conflicts of interest ...... 291 7.2.3 Intellectual property ...... 291 7.2.4 Contracts ...... 291 7.2.5 The potential liability of lenders ...... 291 7.2.6 Insolvent master franchisees ...... 292 7.2.7 Corporations Act responses ...... 292 7.2.8 International insolvency principles ...... 293 7.2.9 Cross border insolvency ...... 294 7.2.10 Franchisees in unions and representative groups ...... 295 7.2.11 Not purely a legal issue ...... 295 APPENDICES ...... 297 Appendix A: Australian Commonwealth and State legislation ...... 297 Division 2—Conditions and warranties in consumer transactions ...... 312 Appendix B: Foreign legislation ...... 331 Appendix C: Possible categorisation of franchisees’ interests in diverse jurisdictions ...... 333 Appendix D: Franchise network ...... 334 BIBLIOGRAPHY ...... 335
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List of Figures
FigureU 1: Number of identified failed franchisors in Australia 1987 – 2009. U ...... 40
FigureU 2: Known number of franchisees affected by their franchisor failing in Australia 1990-
2009 U...... 41
FigureU 3: Minimum estimated lost investment by franchisees in Australia 1990 - 2009. U ...... 69
The Australian Securities and Investments Commission has approved funding for an investigation into the collapse of white goods business Kleenmaid.
source: www.news.com.au/perthnowU , 25 September 2009 U
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List of Tables
TableU 1: Australian failed franchisor data U ...... 30
TableU 2: National Australia Bank Accredited Franchise Systems 2008 and 2009 U ...... 51
TableU 3: Some costs and losses for one franchisee of Danoz Directions U ...... 61
TableU 4: Features of Employee, Franchisee and Supplier / Independent Contractor. U ...... 125
TableU 5: Additional Features of Employee and Franchisee. U ...... 133
TableU 6: Franchisees’ position under State and Territory retail tenancy legislation. U ...... 231
TableU 7: Risk analysis template U ...... 241
TableU 8: Cost benefit tentative summaryU ...... 283
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List of Abbreviations
AC Appeal Cases ACCC Australian Competition and Consumer Commission ACLC Australian Company Law Cases ANZ Australia and New Zealand Bank ASIC Australian Securities and Investments Commission ATO Australian Taxation Office BHG Beach House Fitness Group CA Chartered Accountants CLR Commonwealth Law Reports Trade Practices (Industry Codes – Franchising) Regulations 1998 Code (Cth). CPA Certified Practicing Accountants, Australia DFV German Franchise Association EFF European Franchise Federation FCA Federal Court of Australia FCA Franchise Council of Australia FCP Franchising Code of Practice 1993 FCR Federal Court Reports GEERS General Employee Entitlements and Redundancy Scheme Griffith Griffith University, Queensland ISoF International Society of Franchising MBE MailBoxes Etc NAB National Australia Bank NSW New South Wales NSWCA New South Wales Court of Appeal NSWLEC New South Wales Land and Environment Court NSWSC New South Wales Supreme Court OBPR Office of Best Practice Regulation
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PC Productivity Commission QLD Queensland RLA Retail Leases Act 1994 (NSW) SA South Australia SGR Superannuation Guarantee Ruling TM Trade mark TMA Trade Marks Act 1995 (Cth) TR Australian Taxation Office Rulings UK United Kingdom UNCITRAL United Nations Commission on International Trade Law USA United States of America USDOC United States Department of Commerce VSC Victorian Supreme Court WASC West Australia Supreme Court WBC Westpac Banking Corporation .
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Statement of Original Authorship
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Acknowledgments
Although working on a PhD is a solitary pursuit the project is not completed without the support and encouragement of many people. I thank my supervisors Professor Stephen Corones and Dr Bill Dixon for their outstanding guidance. I also thank my other academic and professional advisers and mentors; Professor Diana Beal, Associate Professor Dale Boccabella, Bill Butcher, Professor Alan Carsrud, Professor Bill Duncan, Professor Lorelle Frazer, Associate Professor Anne Junor, Philip Linacre, Professor Rosalind Mason, Michael Murray, Dr Paul Omar, Rosemary Pynor, Professor John Piggott, Dr Michael Schaper, Albrecht Schulz, Professor Tania Sourdin, Dr Elizabeth Spencer, Professor John Taylor and The Rt Hon Sir EW (Ted) Thomas, LLD for support and encouragement at critical junctures. I thank Julia Roy for editorial assistance Andre Briel, Caroline Malcolm, Wei Wu, for research assistance; and Phil Cohen, Jane Malady, Hui Yi Thong and Pernilla White for administrative assistance.
I have published extensively from this research and extend my thanks to the anonymous referees who have each made valued comments. The publications are:
Jenny Buchan, ‘Consumer Protection for Franchisees of Failed Franchisors: Is There a Need for Statutory Intervention?’ (2010) 9(2) QUT Law and Justice Journal 232.
Jenny Buchan and Bill Butcher, ‘Premises Occupancy Models for Franchised Retail Businesses in Australia: Factors for Consideration’ (2009) 17(2) Australian Property Law Journal 143.
Jenny Buchan, ‘Can Franchise Agreements Provide for Relief Against Franchisor Failure in the Context of the Common Law?’ (Paper presented at the 23rd Annual International Society of Franchising Conference, San Diego, 12-14 February 2009) 1.
Jenny Buchan, ‘Franchisor’s Registered Trade Marks – Empirical Surprises’ (2009) 21(7) Australian Intellectual Property Law Bulletin 154.
Jenny Buchan, ‘Ex Ante Information and Ex Post Reality for Franchisees – the Case of Franchisor Failure’ (2008) 36 Australian Business Law Review 407.
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Jenny Buchan, ‘Franchisors’ Registered Trade Marks Under Australia’s Trade Marks Act 1995 (Cth)’ (Paper presented at the 22nd Annual International Society of Franchising Conference, St Malo, 20-22 June 2008) paper 30.
Jenny Buchan and Bill Butcher, ‘Franchisees’ Retail Premises Occupancy Models in Australia; the Rights and the Risks’ (Paper presented at the 22nd Annual International Society of Franchising Conference, St Malo, 20-22 June 2008) paper 39.
Jenny Buchan, ‘Challenges that Franchisees of Insolvent Franchisors Pose for Liquidators’ (2008) 16 Insolvency Law Journal 26.
Jenny Buchan, ‘Square Pegs in Round Holes: Franchisees of Insolvent Franchisors’ (2008) 9(2) Business Law International 114.
Jenny Buchan, ‘Reducing Collateral Damage in Franchisor Insolvency’ in Paul Omar (ed), International Insolvency Law: Themes and Perspectives (2008) 367.
Jenny Buchan and Lorelle Frazer, ‘The Domino Effect – How Ansett’s Failure Impacted on Traveland Academy of World Business’ (Paper presented at the Marketing & Management Development Conference, Paris, 10-13 July 2006) 1901.
Jenny Buchan, ‘Is There a Basis for Equating Franchisees with Employees in Priority Ranking on the Insolvency of Franchisors?’ (Paper presented at the 20th Annual International Society of Franchising Conference, Palm Springs, California, 24-26 February 2006) 229.
Jenny Buchan, ‘Franchisor Failure in Australia – Impact on Franchisees and Potential Solutions’ (Paper presented at the 19th Annual International Society of Franchising Conference, London, UK, 20-22 May 2005) 529.
CPA Australia and its then policy adviser Judy Hartcher, the International Bar Association and the University of New South Wales funded and assisted the data collection. On the subject of data, much activity in the world of failing franchisors happens behind the scenes so I particularly wish to record my appreciation for the contribution of former franchisees Ben Morris, David Archibald and several former Traveland franchisees. My colleagues in the International Society of Franchising have forced me to field searching questions that have improved my research. Their interest and generosity is much appreciated.
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My Sunday morning coffee friends provided words of encouragement when caffeine alone did not do the trick. The members of the bluemaumau online community helped me keep my sense of humour.
Finally, and most significantly, my family granted me the time and space to complete this research so I thank especially Graham, Ian and Tamsin Buchan and my parents George and Jo Hitchcock. Without them every step would be more difficult.
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Chapter 1: Introduction
The issue of the franchisee/franchisor relationship when the franchisor goes 1 into liquidation is one of the few vulnerabilities in franchising.0F
Most franchisees believe they are buying into a proven business model. Very few have had previous experience with the consequences of franchisor failure and most do not realise that in this respect, they are largely unprotected by law.
The purpose of this thesis is to critically examine the position of franchisees as consumers of franchise opportunities. It examines the franchisees’ role in the 2 franchise network1F and the options available to them when their franchisor fails. On concluding that the current situation is unsatisfactory, and that the situation will not change without statutory intervention, I recommend legal reforms designed to level the playing field in franchising. The proposed regulatory responses are evaluated against three consumer protection benchmarks (‘the Benchmarks’).
The Benchmarks are:
B1) Regulation should provide effective protection from serious risks and threats that 3 [franchisees as business] consumers cannot tackle as individuals.2F
4 B2) There should be accessible, timely3F and meaningful redress where consumer detriment has occurred.
B3) The cost to the franchisor and the legal system of meeting B1 and B2 should be less than the benefit to franchisees whose franchisor fails.
1 Peter Switzer, ‘Stop Losing Franchisees in the FOG’, The Australian (Sydney), 31 January 2002, quoting Jim McCracken, then CEO of the Franchise Association of Australia, 21. 2 The phrase ‘franchise network’ is used throughout this dissertation. It refers to the entire network created that supports the franchisor’s business, both the upstream entities related to the franchisor, including for example the franchisor’s premises leasing companies, entities that own the registered trade marks, and patents that franchisees use, and the downstream franchisees. This is differentiated from the widely used phrase ‘franchise system’ that includes only the franchisor and its franchisees. 3 Commission of the European Communities, EU Consumer Policy Strategy 2007 – 2013 Empowering Consumers, Enhancing their Welfare, Effectively Protecting them (2007) European Commission 5
Chapter 1: Introduction 1 2
The focus of this thesis is on business format franchising. Business format franchising is a method of expanding a business via a network. It may be used by any business that is capable of documenting its operations sufficiently to enable them to be replicated. The business format franchise model, at its simplest, involves a franchisor and its successful prototype business, a franchisee, a disclosure document and a franchise agreement. The franchise agreement is a contract wherein the franchisor grants the franchisee a licence for typically, a finite number of years to establish a clone of a successful business that the franchisor has developed. The franchisee then builds its own business and operates as a franchisee until the licence contained in the franchise agreement expires. ‘The franchisee is obliged to pay the franchisor certain fees and royalties in exchange for rights [described in contracts]. The franchisor has the obligation to provide the agreed rights and [to] generally 5 support the franchisee.’4F
The franchisee is neither an employee nor an independent contractor – but displays many characteristics that are said to be defining of each relationship. However, if the franchisor becomes insolvent, the franchisee has neither the legal standing and protection employees enjoy nor the right to lodge a proof of debt for all money invested, to ‘cut its losses’ and walk away with its own business intact that a supplier has as an independent contractor.
In 1994 Australia was home to an estimated 555 business format franchisors, 6 and 16,536 franchised units which provided employment for 142,636 people.5F Over the next 14 years these numbers grew to 1,100 franchisors, 63,500 franchisee- operated units, and more than 400,000 people employed in business format franchise 7 organisations.6F The resulting investment by franchisees in start-up costs was 8 approximately A$7.14 billion in 2008.7F
5 PriceWaterhouse Coopers, ‘Economic Impact of Franchised Businesses’ (2004) International Franchise Association Educational Foundation iii. 6 Australian Bureau of Statistics, Department of Industry, Science and Technology, Franchising Sector Survey (1994). Note: this includes petroleum retailers. 7 Lorelle Frazer, Owen Wright and Scott Weaven, Franchising Australia 2008 (2008) 9-10. Note the total excludes an estimated 10,500 retail fuel and motor vehicle retailers and the total number of employees includes those employed by franchisors. 8 Ibid 29-30. What is the total start-up cost of a new franchised unit (excluding GST)? This data is from a sample of 252 franchisors. ‘A significant difference was found between retail and non- retail systems. In the retail sector the median total start-up cost was $246,250 compared with
2 Chapter 1: Introduction 3
As franchisees have no clear standing under the Corporations Act 2001 (Cth) (‘Corporations Act’) compared with other stakeholders in a franchisor’s insolvency they pose a new challenge for both consumer protection and business failure law. Franchisees are problematic. One insolvency lawyer observes that ‘[o]f all 9 insolvency matters, the most difficult is the failure of a franchise group’.8F
Most of the performance by the franchisor occurs after the franchisee has made its investment. Table 3 shows that the franchisee makes a high sunk investment in the early stages of the franchise relationship, particularly where the franchised business is in retail or another sector where the franchisee’s business is conducted from fixed premises such as hotels, motor fuels or car sales. The reality, if the franchisor becomes insolvent, is that the sunk costs and other outlays have been expended by 10 the franchisee, theoretically allowing a claim9F in the franchisor’s insolvency, but with the reality of no prospect of return from the insolvency process. The reasons for this will be explored in chapters 2, 3 and 4.
1.1 EFFECTIVE PROTECTION FOR FRANCHISEES WHOSE FRANCHISOR FAILS
The franchise environment in Australia is described as ‘…a mature franchise 11 sector operating within a regulated framework’.10F An inference that is drawn from such a claim is that the legal framework supporting the franchise model has evolved to satisfactorily accommodate the needs of the key stakeholders at all stages of the relationship.
The opportunities the franchising model provides for franchisors are well recognised:
a multibillion dollar corporation can be built with little regard for the welfare of the thousands of individuals who invest their life savings to build the franchisor’s brand. … By accessing the labour and capital markets with a
$51,000 in non-retail. Food retailing start-up costs averaged $280,000, compared with a median of $210,000 in non-food retailing. The 2008 survey excludes motor trades franchisees. 9 D Binning, ‘Code Wars – A Liquidator’s Worst Fears’, The Australian Financial Review (Sydney), 29 June 2006, 13 quoting David Cowling, insolvency partner with law firm Clayton Utz (then Vice-chair of International Bar Association’s Section on Insolvency and Creditors Rights). 10 Contingent on the franchisee being permitted by the court to litigate, and then successfully establishing a claim that the franchisor breached a contract or the Trade Practices Act 1974 (Cth). 11 Lorelle Frazer, Scott Weaven, Owen Wright, Franchising Australia 2006 (2006) 12.
Chapter 1: Introduction 3 4
franchise business model, franchisors are able to achieve freedom from 12 statutes1F [and common law liabilities] which would otherwise protect workers and investors. Franchisees have far more to lose than … 13 employees.12F
Paul Steinberg and Gerald Lescatre have drawn attention to the somewhat anomalous situation franchising has created – the opportunity for franchisors to shift risk and liability without the law having fully adjusted to the consequential vulnerability of franchisees as adopters of the risk and liability.
Notwithstanding the significant amount of policy and regulatory attention that franchising has attracted in Australia, a fundamental problem still exists. The federal and state government inquiries into franchising, the Review of Australia’s Consumer Policy Framework conducted by the Productivity Commission (‘PC’) in 2008, and the amendments to the Trade Practices Act resulting from the PC’s review have not treated the franchisor’s failure, as a supplier to a franchisee as a business consumer, as a consumer protection issue. This is the nub of the problem. If a supplier of another expensive item like a luxury car fails, service people, spare parts and a resale market for that car continue to exist notwithstanding the supplier’s failure. Where the franchisor is the supplier and the franchisee’s business is the product, the situation is different. There are unlikely to be replacement suppliers willing and able to supply all of the franchisor’s services to franchisees. Further, it is unlikely that there will be a market for the franchisees’ businesses, unsupported by the now failed franchisor.
The particular vulnerability of franchisees stems from numerous asymmetries including; the current legislation, the franchisees’ role within the franchise network, their inability to be a part of major decisions taken by their franchisor that may put the franchise network at risk, and their own very limited ability to self-protect from the legal consequences of franchisor failure.
The law’s response to franchisor failure sits awkwardly at the intersection of contract law, consumer protection law and insolvency law. In all three areas there has
12 For example: statutes that impose requirements on employees to provide insurance for injured workers, superannuation, payroll tax, statutory and common law directors duties in relation to areas such as conflicts of interest that would exist if the franchisees were share holders or employees but do not exist as the franchisees have chosen the franchising method of investment in the franchisor. 13 Paul Steinberg and Gerald Lescatre, ‘Beguiling Heresy: Regulating the Franchise Relationship’ (2004) 109 Pennsylvania State Law Review 105, 121.
4 Chapter 1: Introduction 5 been a considerable shift in attitude during the time that the franchise business model has developed. The standard form relational contract is now widely used in business- 14 to-business transactions.13F In addition there have been significant developments in consumer protection and an increasingly forgiving attitude towards business failure.
Traditionally parties to commercial contracts were of equal bargaining strength, and only signed contracts that had genuinely been negotiated. The franchising contract challenges these assumptions. In franchising, the contract between the franchisor supplier and franchisee consumer conforms to 21st century consumer contract norms. These norms include the intrusion of the standard form into the domain of relational commercial contracts.
On learning of the appointment of an administrator or liquidator to the franchisor, franchisees turn to their franchise agreement and thence to contract law to find what their rights are. For reasons that will be explored in chapter 3.3 and 3.4, franchise agreements do not typically provide for franchisor insolvency. Occasionally individual franchise agreements do address franchisor insolvency. Where they do, the clause will typically offer one relatively crude option, an ipso 15 facto14F clause being a mirror image of the current rights franchisors have under the 16 Franchising Code of Conduct15F (‘the Code’) to terminate the agreement if the franchisee commits an act of bankruptcy. They do not provide avenues for franchisees to work with the administrator to assess alternatives. Usually franchisees discover that they are bound to continue performing their contractual obligations, to wait and see what the administrator or liquidator decides, and obviously to hope for the best.
Australian consumer protection law has recognised that the franchisee is a vulnerable business consumer, as demonstrated by the enactment of s51AC of the
14 For full discussion of the standard form relational contract, its characteristics in the context of franchising and its implications in franchising, see Elizabeth C Spencer, The Regulation of the Franchise Relationship in Australia: A Contractual Analysis (PhD Thesis, Bond University, 2007). 15 Trischa Mann (general ed) and Audrey Blunden (consulting ed), Australian Law Dictionary (2010) 322 ‘by that very fact’. In the context of this thesis, an ipso facto clause might state that the act of bankruptcy being committed entitles the innocent party to rescind the contract. It should be noted that termination of a franchise agreement in the United States as a result of filing a bankruptcy petition is unenforceable, even if the agreement contains an ipso facto clause. W Michael Garner, Franchise and Distribution Law and Practice (1990) §13:17. 16 Trade Practices (Industry Codes – Franchising) Regulations 1998 (Cth) Appendix A.
Chapter 1: Introduction 5 6
Trade Practices Act 1974 (Cth) (‘Trade Practices Act’) and the Code in 1998. The franchisor’s insolvency has not, until now, been cast as a consumer protection issue.
In the realm of business failure, attitudes and expectations have reached a point where business failures are seen by many in the commercial world as:
a productive mechanism. Business failures are part of a process in which inefficient and unprofitable businesses are replaced by efficient and profitable ones. … Economies get better through a process of 17 experimentation and natural selection.16F
Perhaps as a consequence of reframing business failure as a productive mechanism, neither corporate insolvency not personal bankruptcy carry the stigma 18 they once did, and strategic insolvency17F is considered to be a valid strategy for some businesses. US lawyers speaking to an audience of franchise lawyers noted:
Bankruptcy provides a useful business tool for a company to reorganize its operations, deleverage its balance sheet, accomplish a sale of assets, obtain new financing or improve its capital structure. For example, bankruptcy may assist a franchisor in addressing the following challenging business issues; overexpansion in the market and the need to eliminate units, an unworkable equity structure, desire to sell or merge with another entity, threat of franchisee litigation, desire to refinance but the lender has expressed concern 19 about financial or other issues.18F
17 Ian Bickerdyke, Ralph Lattimore, and Alan Madge, ‘Business Failure and Change: An Australian Perspective’ (Productivity Commission Staff Research Paper, 2000) 3. 18 D Noakes, ‘Measuring the Impact of Strategic Insolvency on Employees’ (2003) 11(12) Insolvency Law Journal 91, fn 5, quoting Peta Spender ‘strategic insolvency arises when the bankruptcy is invoked due to strategic decision-making rather than being a passive response to market forces.’ Rizwaan Jameel Mokal, ‘The Search for Someone to Save: A Defensive Case for the Priority of Secured Credit’ (2002) 22(4) Oxford Journal of Legal Studies 687, suggests at 698 that ‘because a significant part of the [small firm] shareholder-managers’ wealth is likely to be invested in the [small] firm, as an undiversified investment, far from being ready to liquidate them strategically, shareholder-managers can be expected to fight … single-mindedly to keep them afloat.’ Mokal’s proposition may help explain the franchisees’ response to impending failure, but is inapplicable to franchisors that diversify business risks through their franchisees. 19 Sarah B Foster and Carolyn Johnsen, ‘The War of the Worlds: Bankruptcy Versus…’ (Paper presented at the American Bar Association, 28th Annual Forum on Franchising, Florida, 19-21 October 2005) 1. The word bankruptcy is used for both corporate insolvency and personal bankruptcy in the USA. In Australia bankruptcy is personal bankruptcy; insolvency is the corporate equivalent.
6 Chapter 1: Introduction 7
The strategic insolvency strategy is a variant of the ‘capricious termination’ 20 problem that was identified by Harold Brown19F in 1973 as the ‘Achilles Heel’ of the entire franchising industry.
Whether the decision by a franchisor to become insolvent was strategic or not, the franchisees’ situation as vulnerable business consumers is brought into sharp relief if an administrator or liquidator is appointed to the franchisor. At that point franchisees must respond to decisions made by third party administrators or liquidators who do not have the same interest in individual franchisee’s ongoing viability as the franchisor has. Franchisees have no meaningful protection under common law or statute once an administrator or liquidator is appointed to their franchisor.
This dissertation explores the ability of the current contract and consumer protection laws to address the franchisees’ situation. The limited avenues of redress currently available to franchisees as business consumers are neither meaningful nor appropriate once an administrator or liquidator is appointed. Following the failure of the franchisor, decisions made by the administrators and liquidators will take into account the size of the debt owed to the franchisor’s creditors, the presence of secured creditors, the value of franchisor’s saleable assets, the existence of interested buyers, distribution of assets and liabilities throughout the franchise network and other factors. Franchisees, as contracting parties have no standing.
Franchisors and franchisees view a franchise network in an entirely different way to the way administrators and liquidators do. The Corporations Act contains the administrators’ and liquidators’ statutory rights and duties towards parties that are in a contractual relationship with the failing entity but under Australian insolvency law franchisees have no specific statutory rights as parties to executory contracts. Throughout the period of administration franchisees must not only continue to honour their obligations under the franchise agreement. They must also continue to meet upstream and downstream contractual obligations under premises sub-lease or licence, supplier, employment and other contractual arrangements.
20 Harold Brown, Franchising: Realities and Remedies (1973) 40 cited in Shelby D Hunt, ‘Franchising: Promises, Problems, Prospects’ (1977) 53(3) Journal of Retailing 71, 77.
Chapter 1: Introduction 7 8
The franchisees’ problems compound if third parties own assets to which the franchisees would need uninterrupted access in order to continue their businesses. These may include for example licences to use trade marks or patents, customer lists or retail leases. Lack of access to third party owned assets makes it difficult for an administrator to restructure the franchise network and virtually impossible for the administrator or liquidator to sell the network intact. It also becomes difficult for franchisees to continue trading independent of the franchise network. Trade marks used by and retail leases of premises occupied by franchisees will be examined in chapters 3.2.1, 3.2.3 and 4.5.
1.2 CHALLENGES FOR THE LAW
Multiple legal issues arise from franchisor failure. It is convenient to say that franchisees should learn to conduct proper due diligence, or that they should be better educated about the risks of franchising. It is also convenient to blame franchisees for not self-protecting as a matter of course by each negotiating a suitable ipso facto clause into their franchise agreement. In theory it is possible for franchisees to self-protect through their franchise agreements but in practice there are impediments to this which are discussed in chapters 3.3 and 3.4. For example, ‘[i]t is costly, if not impossible, to write contracts representing claims on a firm [franchisor] 21 which clearly delineate the rights of holders for all possible contingencies.’20F
Even if negotiating an ipso facto clause were possible, the legal relationships within a franchise network are so numerous and complex that a purely contract-based solution is unsatisfactory as a sector-wide solution. It may suit a franchisee operating a pool cleaning business with a well-established customer base that is loyal to their pool cleaner and will follow him or her regardless of the name on the van but not a franchisee with high, newly sunk investments and years to run on its franchise agreement.
In addition to the theoretical legal issues, the ‘complexity of the operation of 22 law in practice’21F should be taken into account when looking for solutions to
21 Michael C Jensen and William H Meckling, ‘Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure’ (1976) 3(4) Journal of Financial Economics 305, 340. 22 Gillian K Hadfield, ‘The Many Legal Institutions that Support Contractual Commitment’ in Claude Menard and Mary Shirley (eds), Handbook of New Institutional Economics (2004) 175, 177.
8 Chapter 1: Introduction 9 complex problems. In nature ecosystems are most complex at the boundaries of two or more habitats. The problem of how to treat franchisees of failed franchisors is a perfect example of this complexity existing in the legal world at the intersection of the law governing commercial contracts, consumer protection, and insolvency.
Solutions to identified gaps in the law will have the greatest chance of being acceptable to policy makers if they address the seven pre-requisites for the making of sound and informed policy adopted by Australia’s Office of Best Practice Regulation 23 (‘OBPR’) 2F being:
A description of the problem or issues which give rise to the need for action and broad goal of the proposed regulation (‘OBPR 1’). This is addressed in chapters 2, 3 and 5.
A specification of the desired objective(s) (‘OBPR 2’). This is addressed in chapter 5 by reference to the three consumer protection benchmarks already identified.
A description of the options (regulatory and/or non regulatory) expressed as a regulatory form or type that may constitute viable means for achieving the desired objectives (‘OBPR 3’). These are identified in chapter 6.
An assessment of the impact, including costs and benefits, on consumers, business, government and community or each option, with each impacted group identified, noting impacts on competition, small business and trade (‘OBPR 4’). A start has been made on this in chapter 6.3 but a full cost/ benefit analysis is the work of an economist with an appropriate budget and falls outside this thesis.
A consultations statement detailing who was consulted, with a summary of views from the main affected parties, or specific reasons why consultation 24 is inappropriate (‘OBPR 5’).23F Although a consultations statement also falls outside this thesis, stakeholder categories are identified in chapter 6.3.
23 Australian Government, Best Practice Regulation Handbook (2007) Department of Finance and Deregulation A.2
Chapter 1: Introduction 9 10
Comments about the problem from a range of stakeholders are found throughout the thesis.
A recommended option, with an explanation of why it was selected and others were not (‘OBPR 6’). Some recommendations are made in chapter 6.2. Some are made in brief and others more fully. Each would have to be subjected to a full cost/benefit analysis before being accepted or rejected.
A detailed strategy for the implementation and review of the preferred 25 option (‘OBPR 7’)’.24F Formulating detailed implementation and review strategies is the work of regulators and is beyond this thesis.
In addition to the seven OBPR pre-requisites, the UNCITRAL Legislative 26 Guide on Insolvency Law (‘the Guide’)25F raises a further consideration, the relationship between insolvency and other law. The Guide recommends that ‘the relationship between insolvency law and other laws should be clear and, where 27 possible, references to the other laws should be included in the insolvency law’.26F The franchisee, being a part of a business model that evolved after the insolvency laws were fundamentally settled does not comfortably fit within the insolvency regime. In the context of consumer protection it is suggested that rather than relying on the lead coming from insolvency law, the relationship between consumer protection and insolvency law should be addressed pro-actively. This will be re- visited in chapters 6.2 and 7.
1.3 AIM OF THE RESEARCH
This dissertation demonstrates why franchisees need protection and why they are unable to self-protect from the consequences of franchisor failure. It explores and proposes solutions via a statute-based consumer protection approach. The solutions will address the three benchmarks and OBPR prerequisites 1, 2, 3, 5 and 6.
To support the conclusions this dissertation demonstrates why the current emphasis on solving franchising problems through pre-contractual disclosure by
25 Peter Carroll, ‘Rethinking Regulation: An Assessment of the Report of the Taskforce’ (Paper presented at the Australasian Political Studies Association Conference, University of Newcastle, 25-27 September 2006) 6. 26 UNICITRAL, Legislative Guide on Insolvency Law (2005) 19
10 Chapter 1: Introduction 11 franchisors, improved pre-entry education and due diligence by franchisees and the level of consumer protection currently contained in the Trade Practices Act and the Code is inadequate in the context of franchisor failure. This dissertation thus aims to answer three questions:
Can franchisees as business consumers self-protect against the consequences of franchisor failure?
Does the current law meet the identified consumer protection benchmarks and thereby protect franchisees as business consumers in the face of franchisor failure without imposing undue extra costs on franchisors?
How should Australia’s commonwealth consumer protection law be amended to meet the benchmarks?
1.4 OUTLINE OF THESIS
This thesis is presented in seven chapters in the manner outlined below.
This chapter 1 highlights the problems franchisor failure creates for franchisees and introduces the dimensions of the problems that will be addressed. It also identifies limitations of the research.
Chapter 2 identifies the size and scope of the problem of franchisor failure for franchisees. The impacts on franchisees, the perspectives of key franchise sector and insolvent franchisor stakeholders, and the reasons for the particular impacts and stances are identified.
Chapter 3 places the problem in context by identifying the sources of the problem. The outcome of an individual franchisor’s failure for each of its franchisees depends on factors which can be loosely attributed to:
the development of the franchise model,
franchise network structural factors,
franchise agreement-related factors based in contract law, and
asymmetry issues.
The legal structure of the network, the contractual relationship between the franchisor and four key elements of a franchise network are set out in chapter 3. These key elements are the franchisors, trade marks that identify the franchise, the
Chapter 1: Introduction 11 12 legal relationships between landlords, franchisors and the franchisees that conduct their franchisee businesses from the landlords’ retail premises and, of course, the franchisees themselves.
The franchisees’ role within the franchisor’s network is examined, and because there is uncertainty in some people’s minds about the differences between franchisees and suppliers, the role and legal standing of suppliers to a franchise network is also set out in the context of franchisor failure. In chapter 3.2.6 franchisees are compared with employees as there are strong similarities and strong differences in the roles and in the level of protection afforded to them in the event of their employer’s or franchisor’s insolvency.
Chapter 3.3 provides the theoretical discussion of key aspects of the franchise agreement. Chapter 3.3 thus demonstrates how difficult it would be for all 71,400 Australian franchisees to be protected by ipso facto clauses in negotiated franchise agreements. It will demonstrate why franchise agreements will never be drafted voluntarily to routinely provide effective protection to franchisees whose franchisor fails. Before moving from the contractual analysis, breach of contract and remedies for breach of contract are examined.
In chapter 3.4 the numerous asymmetries that affect franchisees as a group of business consumers are identified. The legal relationships between the network’s entities, levels and nature of delegation, allocation of risk, ownership of the assets that make up the franchisors’ offering, and the direction of money flow between franchise and franchisees, all have a strong bearing on the franchisees’ ability to continue trading if their franchisor’s business fails.
On concluding that contract law alone cannot protect franchisees, and that the 28 franchisor failure problem is significant enough to ‘give rise to the need for action’,27F the question of whether the consumer protection regulatory regime is adequate in its present form to deal with the problem is addressed in chapter 4. Chapter 4.1 explores the possibilities of franchisees of failing and failed franchisors receiving protection as business consumers under the current provisions of the Trade Practices Act. Chapter 4.3.3 evaluates the adequacy of the Code.
28 Australian Government, Best Practice Regulation Handbook, above n 23, 27.
12 Chapter 1: Introduction 13
The application of the Corporations Act to franchisor insolvency is examined in chapter 4.4. The limitations posed by the imperfect fit between the consumer protection and insolvency regimes becomes clearer when the roles and responsibilities of a receiver, administrator and liquidator under the Corporations Act are identified. State and territory retail leases legislation are considered in broad terms in chapter 4.5.
The OBPR writes in terms of ‘desired objectives’. This is interpreted as objectives that meet appropriate benchmarks. The three identified consumer protection benchmarks are expanded on in chapter 5. I refer to conclusions drawn in chapters 3 and 4 to demonstrate that benchmarks B1 and B2 are not met under the current Australian law.
On concluding that the current situation fails to attain B1 and B2, this dissertation proposes solutions in chapter 6. First, non-regulatory solutions are considered. They are rejected. The proposed regulatory solutions are then introduced. These include amendments to the Trade Practices Act and to state and territory retail leasing legislation. The solutions would provide laws that meet B1 and B2. As previously stated, B3 concerns cost/benefit considerations and is not pursued in detail in this dissertation.
Chapter 7 brings together the themes and issues explored and exposed in the previous chapters. The central research question is reconsidered with reference to the theoretical conclusions, empirical findings and the Benchmarks. Avenues for future research that have been identified through this research are listed.
1.5 INFORMATION BASE
Michael Trebilcock argues that an ‘information-based approach to consumer protection policy is the appropriate framework for analysing consumer protection 29 problems’.28F Reliable information is a necessary starting point. There are at least two categories of information that must be found and understood before concluding that a legislated solution is required to a problem. Firstly what are the facts, and secondly what is the current law. While much research has been conducted on aspects of the
29 Michael J Trebilcock, ‘Rethinking Consumer Protection Policy’ in Charles E F Rickett and Thomas G W Telfer (eds), International Perspectives on Consumers’ Access to Justice (2003) 69 referring to research conducted with Gillian K Hadfield and Robert Howse.
Chapter 1: Introduction 13 14 franchisor-franchisee relationship, surprisingly little empirical research has previously been conducted on the legal structure of the entire franchise network. To understand the impact of insolvency law on the franchisee’s legal contractual, property-based and consumer protection rights it was necessary to fill this gap. If a solution is proposed in the absence of a strong understanding of both the factual and the legal framework within which a problem subsists, it will not satisfy the OBPR model for the making of sound and informed policy.
The data on which this thesis is based is similar to the depth and amount of data that a prospective franchisee conducting a very thorough due diligence would be able to access. It is submitted that it is sufficient to support the conclusions reached.
1.5.1 EMPIRICAL RESEARCH ON THE FACTS Initial research was conducted to formulate ‘[a] description of the problem or 30 issues which give rise to the need for action’.29F The following areas were investigated:
31 A pilot study30F was conducted (‘the CPA Study’) of franchisors that fail in Australia, the reasons for their failure, the characteristics of failed franchisors, the number of franchisees impacted and the impact of franchisor failure on the franchisees in specific networks including the 32 Ansett Airlines-owned Traveland, travel agency franchise.31F
The nexus between the franchisor, the franchisees and the franchisees’ rights in relation to franchisors’ registered trade marks was explored. (‘the 33 Exploratory Study’)32F
30 Australian Government, Best Practice Regulation Handbook, above n 23, 27. 31 Jenny Buchan, ‘When the Franchisor Fails’ (2006); Jenny Buchan, ‘Franchisor Failure in Australia – Impact on Franchisees and Potential Solutions’ (Paper presented at the 19th Annual International Society of Franchising Conference, London, UK, 20-22 May 2005) 529. 32 Jenny Buchan, ‘Reducing Collateral Damage in Franchisor Insolvency’ in Paul Omar (ed), International Insolvency Law: Themes and Perspectives (2008) 367; Joint Committee on Corporations and Financial Services, Parliament of Australia, Department of the Senate, Inquiry into Franchising and Code of Conduct (2008) Jenny Buchan Submission #89.
14 Chapter 1: Introduction 15
The franchisees’ legal rights to occupy the retail premises they trade from 34 was also examined as part of the Exploratory Study.3F
CPA Study Data contained in the Tables throughout this dissertation is the most comprehensive information that could be assembled, mostly from public records. The CPA Study was conducted in 2005. It was funded and the final report was published by CPA Australia, and was the beginning of a now ongoing search for reliable base information about failing and failed franchisors and their networks. The many challenges are discussed in chapter 2.1.1.
Ultimately, the challenges confronting legal researchers in franchising in Australia is even greater in some ways than those that confront franchisees attempting to conduct thorough due diligence on a particular franchise network. For franchisees, it is extremely difficult, expensive, and sometimes impossible, to verify the information provided by the franchisor in the disclosure statement. The researcher has no ‘as of right’ access to disclosure documents or franchise agreements that provide key information such as the legal identity of parties.
Exploratory Study The Exploratory Study was funded by two research grants from the Australian School of Business at the University of New South Wales. To obtain the data a sample group comprising all franchisors with franchisees trading from premises regulated by the Retail Leases Act 1995 (NSW) (‘Retail Leases Act’) was identified. New South Wales was chosen because it has the highest number of franchisee-owned 35 units of any of Australia’s six states and two territories.34F Retail premises-based franchisees were selected because franchisees establishing in retail premises each 36 made a high average initial investment of $234,00035F and thus have a strong interest in the security of their investment.
34 Jenny Buchan and Bill Butcher, ‘Franchisees’ Retail Premises Occupancy Models in Australia; The Rights and the Risks’ (Paper presented at the 22nd Annual International Society of Franchising Conference, St Malo, France, 20-22 June 2008) paper 39; Jenny Buchan and Bill Butcher, ‘Premises Occupancy Models for Franchised Retail Businesses in Australia: Factors for Consideration’ (2009) 17(2) Australian Property Law Journal 143. 35 Frazer, Weaven and Wright, Franchising Australia 2006, above n 11, 25 shows that franchisors have 34 per cent of their units in NSW, with the next highest percentage being 23.7 per cent in Victoria. 36 Ibid.
Chapter 1: Introduction 15 16
All 850 franchisors in the known population of franchisors in Australia in 2004 37 were listed.36F Their websites were searched to identify those having franchisees in New South Wales (NSW). The addresses of NSW franchisees’ premises were found from the website and checked in the telephone directory. It was then assessed whether the franchisees’ premises would be regulated by the Retail Leases Act. This process identified 350 franchisors as the sample group. For 13 of these, no further information could be found and they were omitted. Hence, the sample group for the Exploratory Study on franchisors’ registered trade marks in chapter 3.2.2 and retail leases in chapter 3.2.3 numbered 337 franchisors.
Information about leasing patterns among the 337 franchisors was sourced from court reports, the New South Wales Land and Property Management Authority records, and the franchisor’s websites. Limitations stemmed from that fact that many franchisees do not register leases or sub-leases on the premises title, and information on franchisors websites is often loosely worded from a legal researcher’s perspective.
Information about ownership of franchisors’ registered trade marks within the 38 sample group was gathered from the IP Australia website37F and franchisors’ websites. Trade mark registration identification numbers and the identity of the trade mark owners were recorded and analysed. Information about how public-company- owned franchisors’ trade marks were recorded in published Annual Reports was sourced from the Notes to Accompany the Financial Statements (‘NTFS’).
1.5.2 RESEARCH ON THE CURRENT LAW Research conducted on franchise law prior to this dissertation has focussed on pre-contractual disclosure and on the franchise agreement as a contract. In addition to disclosure and contract formation, this dissertation required an understanding of:
The legal structure of the franchise network
Trade mark law and practice
Retail lease law and practice
How franchisees compared with employees and independent contractors
37 With the assistance of Professor Lorelle Frazer, Griffith University. 38 IP Australia
16 Chapter 1: Introduction 17
How franchisees compared with traditional suppliers
Law and economics, with a focus on asymmetry
Remedies for breach of contract and the Trade Practices Act
The application of the Code to administrators
The legal rights of franchisees of insolvent franchisors under contract law and under the Corporations Act.
1.6 LIMITATIONS
This research is based on incomplete data in relation to franchisor numbers, number of franchisees impacted and size of the investments lost. Some of the great difficulties of conducting robust empirical research into the legal aspects of Australian franchising are identified more precisely in chapter 2.1.1.
It is acknowledged in chapter 6 that a cost benefit analysis is essential before any proposed legislative responses to problems are enacted. As the author is not an economist, the stakeholders are identified and some costs and benefits are identified but a full cost benefit analysis is left to be conducted by Commonwealth Treasury if it deems such a step to be appropriate.
1.7 MATTERS BEYOND THE SCOPE OF THIS THESIS
This dissertation does not pursue in depth:
Retail leasing enactments which are part of the problem and part of the solution.
The situation of franchisee whose franchisor discontinues franchising but stays solvent.
Tax treatment of franchisees’ sunk costs when the franchisor fails.
The impact of the halo effect referred to in chapter 3 on the depth and quality of franchisees’ due diligence.
The impact of the franchisor’s insolvency on the contracts entered into by franchisees as a consequence of becoming franchisees which is raised but not explored in chapter 3.1.10.
Chapter 1: Introduction 17 18
The possibility of deeming franchisors to hold discrete funds paid by franchisees in trust. This is raised but not pursued in chapter 6.1.6.
The insolvency of master franchisees.
The Corporations Act is part of the solution. Beyond tentative suggestions in chapter 6.2.5 and identification of issues, this thesis does not address the Corporations Act.
18 Chapter 1: Introduction
Chapter 2: What is the problem and how big is it?
According to the OECD Regulatory Checklist, the problem to be solved should be precisely stated, giving clear evidence of its nature and magnitude 39 and explaining why it has arisen.38F
The problem is that when a franchisor’s business fails the law does not provide a clear way for franchisees to respond. In this chapter the evidence of franchisor failure, its causes, magnitude and impact on franchisees is explored. Reasons behind the difficulty of creating an accurate and complete Australian database of failed franchisors and their franchisees are explored. This is followed by a discussion of franchisor failure research and the causes of franchisor’s failure. The impact is discussed from various perspectives: that of the franchisor, of commentators such as industry lobbyists, of the franchisees and the liquidator.
2.1 RESEARCH INTO FRANCHISOR FAILURE
The existence of widespread franchisor failure is acknowledged by franchise 40 lawyers.39F Beyond attempts at establishing how many franchisors fail and when in the franchisor lifecycle the failure occurs ‘the [franchise research] subset of the implications of franchisor failure and the impact of franchise failure on franchisees 41 has received very little academic attention’.40F
Academic studies of the number and timing of franchisor failures have been 42 conducted in the United States, the United Kingdom and France41F but no large-scale data has yet been published to specifically record the number or timing of Australian franchisor failures. In 1977 Shelby Hunt wrote that ‘[e]vidence began to mount that
39 Trebilcock, above n 29, 69 citing OECD, Recommendation of the Council of the OECD on Improving the Quality of Government Regulation (Including the OECD Reference Checklist for Regulatory Decision-Making and Background Notes) Paris: OECD (1995) 9. 40 For example, the Franchise Council of Australia’s annual conference legal day has scheduled a session on franchisor failure every year from 2006 to 2009 inclusive. 41 Benjamin Morris, Franchisor Insolvency (B Laws Honours Thesis, University of Technology Sydney, 2006) 3. 42 French and United States franchising and franchise research are referred to throughout this thesis in addition to Australian. Both France and the United States have strong franchise sectors, active franchise academics and have, either recently (France) or historically (the United States) conducted research or collated statistics on franchisor failure.
Chapter 2: What is the problem and how big is it? 19 20
43 many franchises [ie franchisors] were failing [in the US]. One study42F identified 54 44 entire restaurant franchise systems that turned “belly up” over a two-year period’.43F
Roger Blair and Francine Lafontaine state:
45 the USDOC (1988)4F data … reports the number of franchisor failures and departures… Out of an estimated population of 2,177 franchisors in 1986: ‘A total of 104 franchisors operating 5,423 outlets failed during 1987 … The volume of 1986 sales represented by failed firms amounted to $[US] 1.7 46 billion, of which the franchisee-owned portion was $[US]1.5 billion’. 45F
Commenting on the timing of the failures:
[Scott] Shane suggests heavy failure rates of new franchise systems in the first four years, followed then up to the ten year period by only modest further losses, …. Lafontaine and Shaw, on the other hand, report steady and 47 sustained failure rates from franchise format adoption onwards.46F
The difficulty of obtaining sound data on failed franchisors was noted in 1994 by James Cross who pointed to an information void with regard to franchise failure:
The only systematically compiled statistics on franchise [this could have been franchisors or franchisees] failures have been provided by the Franchising in the Economy reports [produced up until the late 1980s by the US Department of Commerce but since discontinued] and periodic membership surveys by the International Franchise Association. While these efforts are commendable and undoubtedly well intentioned, both are based 48 on potentially incomplete and inaccurate data submitted by franchisors.47F
Lafontaine and K Shaw cite United Kingdom research by John Stanworth who concluded that ‘at best, one franchise company in four could be described as an
43 Urban B Ozanne and Shelby D Hunt, The Economic Effects of Franchising (1971) 93. 44 Hunt, ‘Franchising: Promises, Problems, Prospects’, above n 20, 75. 45 Andrew Kostecka, United States Department of Commerce, Franchising in the Economy (1988) 12. 46 Roger D Blair and Francine Lafontaine, The Economics of Franchising (2005) 272. 47 Francine Lafontaine and K L Shaw, ‘Franchising Growth and Franchisor Entry and Exit in the US Market: Myth and Reality’ (1998) 13(2) Journal of Business Venturing 95, in Frank Hoy and John Stanworth (eds), Franchising: An International Perspective (2003) 163. 48 In John Stanworth, David Purdy and Stuart Price, ‘Franchise Growth and Failure in the USA and the UK: a Troubled Dreamworld Revisited’ (1997) 2(2) Franchising Research: An International Journal 75, 78 citing Janes Cross, ‘Franchising Failures: Definitional and Measurement Issues’ (Paper presented at the International Society of Franchising Conference, Las Vegas, Nevada, 13- 14 February 1994) 1.
20 Chapter 2: What is the problem and how big is it?
unqualified success story … over a ten year period. Around half the [UK] sample 49 was judged to have failed completely and utterly’.48F Blair and Lafontaine conclude that ‘there has been no systematic study of the effect of franchisor exits, whether it be a departure from franchising or a business failure, on the survival or growth of the 50 franchised units that were tied to it’.49F
Rozenn Perrigot and Gérard Cliquet studied 952 franchising networks in 51 France during the period 1992-2002 and found that only 42.13 per cent survived.50F Over half of franchisors in France did not survive 10 years. These are franchisors that have been granting franchisees the right to trade as a franchisee for terms of 0 to 20 years and for which up-front franchise fees would typically have been paid for the 52 entire term.51F Beyond this small amount of research on the number of franchisor failures, the actual cost to franchisees and consequences for franchisees of franchisor 53 failure is under-researched.52F
2.1.1 AUSTRALIAN FRANCHISOR FAILURE DATA As this thesis is about franchisor failure in Australia, it is important to seek Australian data rather than assuming that American, British or French patterns are reproduced in Australia. However, as Colin McCosker and Lorelle Frazer observed in 1998:
When extending the analysis of business failure to franchising, the problem of data collection becomes apparent. No comprehensive database of franchisors or franchisees is available in Australia, so researchers must develop their own. … it is not possible to access failed franchisors. The magnitude of such franchise system failures is unknown but may be disturbingly high. For instance, … the authors found that in the 6-month period from checking firm details in the Telstra White Pages on the Internet (updated daily) to follow-up on non-respondents, 13.4 per cent (127 out of
49 Lafontaine and Shaw, above n 47, 95-112, in Hoy and Stanworth, above n 47, 164. 50 Blair and Lafontaine, above n 46, 44. 51 Rozenn Perrigot and Gérard Cliquet, ‘Survival of Franchising Networks in France from 1992 to 2002’ (Paper presented at the 18th Annual International Society of Franchising Conference, Las Vegas, Nevada, 6-7 March 2004). 52 Rozenn Perrigot, ‘Services vs Retail Chains: Are There Any Differences? Evidence from the French Franchising Industry’ (2006) 34(12) International Journal of Retail & Distribution Management 925. 53 An exploratory study was conducted by Jenny Buchan in 2004-2005 in Australia and reported in ‘When the Franchisor Fails’, above n 31. The Report focussed on consequences of franchisor failure.
Chapter 2: What is the problem and how big is it? 21 22
946 [franchisor] firms) could not be located and were presumed to be no 54 longer operating.53F
Echoing McCosker and Frazer’s observation in 1998, it is still not possible in 2010 to determine from public records which of the 693 franchisors known to be 55 trading in 1998, the 850 in 2004 and the 1100 in 200854F are still solvent.
Data collected during the CPA Research and subsequently is reproduced in Table 1 on pages 30 to 39. The data in Table 1 tends to support Lafontaine and Shaw’s conclusion that young franchisor networks in Australia are not more vulnerable to failure than the more established ones. By implication, it contradicts Shane’s research as some Australian franchisors have failed long after their businesses passed the 10 year mark.
Frazer et al now conduct a biannual franchising Australia survey. Their database records the franchisors that are not contactable two years later, but the published survey does not identify them by name or by total number. Frazer is cited as saying:
What the latest study [2008] shows is that many franchise systems are relatively new and untested in a recession, many are too small to remain viable long-term, … One-third of systems started up between 2000 and 2005 and one-fifth since 2006. … Between 2004 and 2006, the number of systems increased by 100. There were 200 new entrants and 100 that ceased 56 franchising, so for every two new ones, one got out.5F
Not all of the un-contactable franchisors on the Griffith database failed. Some test the franchise model, decide it is not for them, then buy back the franchisees’ businesses. Others simply stop servicing their franchisees without the franchisor entering administration.
Jason Gehrke writes that his analysis of:
the advertiser list of a 1996 edition of Franchising Magazine indicated that of 113 franchisors then advertising for franchisees, 34 could no longer be
54 Colin McCosker and Lorelle Frazer, Franchising Australia 1998: A Survey of Franchising Practices and Performance (1998). 55 Frazer, Weaven and Wright, Franchising Australia 2008, above n 7, 9. 56 John Kavanagh, A Business Out of a Box (2009) Business Day
22 Chapter 2: What is the problem and how big is it?
found to exist just 10 years later – an attrition rate of 30 per cent. Many of these were very small, start-up systems with a handful of outlets, but the consequences of their failure are equally devastating to their franchisees 57 nonetheless.56F
Gehrke’s methodology does not support his conclusions to the extent that some franchisors included in the 30 percent quoted will no longer be advertising for franchisees because they have moved away from the franchise model. They may still be operating their core business successfully though company owned stores or other business models.
The biggest impediment to determining what happens to franchisees when their franchisor fails is identifying failed franchisors and former franchisees. The list in Table 1 is incomplete. Searches of public records and other sources that are typically available to intending franchisees or their advisers were conducted. The records searched were:
Media reports, using the Factiva database and the Australian Financial Review,
58 The Australian Securities and Investments Commission57F (‘ASIC’) website where administrators and liquidators lodge documents surrounding corporate insolvency at ASIC,
The Insolvency and Trustee Service Australia that maintains records of personal bankruptcy (‘ITSA’),
59 The Australian Competition and Consumer Commission58F (‘ACCC’) website which contains information about investigations and prosecutions for breaches of the Trade Practices Act and the Code,
State and territory business name records, and
60 Federal, state and territory court records.59F
57 Jason Gehrke, When Franchisors Fail (2008) Smart Company Blogs
Chapter 2: What is the problem and how big is it? 23 24
First the identity of the failed franchisor’s legal entity was sought, then the affected franchisees. Many challenges were encountered.
What was the franchisor entity? Franchisors exist within complex networks of legal entities. It is difficult to find a legally meaningful starting point, such as the name of the franchisor entity, from which to begin an investigation. The franchisor entity may be a public or proprietary company, a trust or sole trader with a name different to the trading name of the franchisor. This is apparent by observing the differences in the ‘Trading name’ and the ‘Entity names’ columns in Table 1.
IDENTIFICATION OF FRANCHISOR THROUGH THE MEDIA If a failed franchisor is named in a media report, the franchisor is referred to by its trading name. Where the trading name and the legal entity name of the franchisor are similar it is possible to determine the legal identity of the franchisor (eg The Furniture Wizard Pty Ltd traded as Furniture Wizard). In cases where there is no similarity between the legal entity’s name and the trading name (eg Chaste Corporation Pty Ltd traded as TRIMit) the franchisor cannot be identified from the media report.
Data may be accurate when published but quickly become inaccurate. The media faces the same problems that franchisors face in trying to portray accurate and up to date information. For example, in Business Review Weekly’s 31 January – 5 March 2008 edition ‘The franchisor Beach House Fitness Group [BHG], with 60 outlets at 30 June 2007, was ranked 4th in 2006 [on what measure] and 11th fastest 61 growing franchises by outlet’.60F BHG was wound up, insolvent, in December 2008.
Thirty four of the franchisors in the CPA Study were initially identified 62 through media reports. 61F
61 Business Review Weekly (31 January – 5 March 2008) 49. 62 Using the Factiva database of media records in Australia. This identified the following franchisors that were probably in administration or insolvent: A1 Mobile Radiator Repairs; Barnacle Bills; BB's Coffee & Bake; BC The Body Club; Boston Markets; Busy Bookkeeping; Carlovers Carwash; Cheap as Chips; Cut Price Deli; Delifrance (Australian master); Furniture Wizard; King Pie; Allied Securities; Lloyd Scott Enterprises; Mini Tankers International; Modern Garages; National Express Transport; Nationwide International (Australia); NoRegrets; On Time Business Solutions; PC Company; Personal Actions; Renouf Personal Fitness Centres; Simply No-Knead; Snow Deli; Soils Ain't Soils; Speeds Shoes; Synergy in Business; Tokyo Joe's; Tony Barlow Menswear; Top Snack Foods; Traveland, United Video Franchising; Wonderland of Pets.
24 Chapter 2: What is the problem and how big is it?
IDENTIFICATION USING ASIC RECORDS Once the initial database of likely failed franchise systems was compiled, ASIC records were searched to verify the status of each corporate franchisor. To identify franchisees of the former franchisors, franchisees that appeared by name on any public records were recorded. Franchisees are often proprietary companies, with contractual obligations supported by the personal guarantees of the directors. The 63 franchisors are also primarily companies.62F ASIC does not require franchisors or franchisees to self-identify as being part of a franchise network, so ASIC records are not a reliable way of identifying participants in the franchise sector, or in a particular franchise network. Where the franchisor is a public company there is no record of the franchisees’ identities in the company’s Annual Report.
Liquidators file prescribed documents with ASIC or ITSA. Both the lists of sundry debtors and of unsecured creditors contain names and addresses of people and companies that owe and are owed money by the failing company, but give no indication of the nature of the debt or the claim. A franchisee may be characterised as a sundry debtor or a creditor, depending on the structure of the franchise. In many cases franchisees are not mentioned in the material filed by the liquidator. Details must be cross-referenced to court reports, media releases or a business name extract to determine an individual’s status.
64 The insolvency-related ASIC records of two insolvent franchisors63F were purchased to determine whether franchisees could be identified from the records filed with ASIC by the liquidator and, if so, how they were categorised. They could not, so no further records were purchased. Employees’ claims in the insolvency of the employer by contrast, are identified in a separate schedule – schedule E to the Report of Affairs filed with ASIC by the liquidator.
Following a franchisor failure, the administrator or liquidator receives or compiles a list of franchisees but there is no requirement to lodge that list with ASIC or ITSA. Without access to these records, it is impossible to ascertain whether all of the franchisees have been counted, and whether the number of franchisee per franchisor as reported in the media is accurate.
63 Lorelle Frazer and Scott Weaven, Franchising Australia 2004 (2004) 70. 64 The Furniture Wizard and Traveland.
Chapter 2: What is the problem and how big is it? 25 26
ITSA RECORDS It is not possible to determine from personal bankruptcy records whether the failed sole proprietor was a franchisor or a franchisee.
IDENTIFYING FAILED FRANCHISORS AND THEIR FRANCHISEES THROUGH COURT RECORDS Searches of numerous court records yielded very little. The exception is 65 Synergy in Business which was prosecuted by the ACCC64F in order to establish that it was a franchise network. A list of franchisees was appended to the judgment.
In court cases involving failed franchisors, it can be impossible to determine the identity of the franchise network. For example in Rousellis v Maiurano [1998] NSWCA 196 Fitzgerald AJA referred to the franchisor as ‘two companies, which at 66 the time were insolvent and were later ordered to be wound up on that ground’65F without naming the companies or the trading name of the franchise network. The respondent was a director of the companies.
Sometimes even the courts are unable to identify the franchisor. For example, in Acer Computer Australia Pty Limited v Carter (No 2) [2007] FCA 1943 Justice Graham stated:
The relevant franchisor would appear to have been one or other of the companies in the ‘Betta Group,’ which comprised Betta Stores Limited …, Betta Stores (Southern) Pty Limited …, Betta Stores (Northern) Pty Limited …, A.K. Truscott Investments Pty Limited …, Truscott Electronics Pty Limited …, Truscott Finance Pty Limited …, PGA & Associates Pty 67 Limited … and BSL Finance Pty Limited. 6F
Identifying and finding former franchisees of failed franchisors Precise information is required for legal research. Having finally identified 39 68 failed franchisors in the CPA Study67F a bigger challenge proved to be identifying individual former franchisees by name and finding up to date contact details. This proved almost impossible.
65 Australian Competition and Consumer Commission v Ewing [2004] FCA 5 lists the names of 31 franchisees (called licensees) but not their addresses or the states where they operated. 66 Rousellis v Maiurano [1998] NSWCA 196. 67 Acer Computer Australia Pty Limited v Carter (No 2) [2007] FCA 1943, para 2. 68 Buchan, ‘Franchisor Fails’, above n 31, Appendix 1.
26 Chapter 2: What is the problem and how big is it?
As one of the failed systems was a travel agency, Traveland, an advertisement was placed in a daily electronic newsletter service that circulated to 15,000 69 individuals in the travel industry.68F This elicited three responses from former Traveland franchisees.
Advertisements aimed at former franchisees of failed franchisors were placed in a number of national and state daily newspapers including ‘The Australian’ and the ‘Daily Telegraph’. It was an expensive exercise and the response rate was very 70 low.69F Specific advertisements were not placed in Tasmania, the Northern Territory or Western Australia because of the relatively low number of franchisees in those states. A press release sent to one daily newspaper was picked up and used, and led to one franchisee of a failed franchisor making contact.
An advertisement was posted on the Brisbane bailiff’s office website http://www.bailiff-sheriffaustralia.com.au. A chat strand was set up on franchisechat.com http://www.franchise-chat.com/forum, a global franchise chat site with 736 members. Neither yielded any responses or postings.
IDENTIFYING FRANCHISEES THROUGH STATE AND TERRITORY BUSINESS NAME RECORDS Businesses that do not trade under their company name or their personal name are required to register their business name in the state or territory in which they operate. Many businesses ignore this legal requirement. For example, in the online lingerie retailing franchise, franchisor No Regrets, of the 600 franchisees, only two had registered their business names – one in New South Wales and one in Western Australia. Therefore there are 598 former franchisees that cannot be identified through the business names public records. In ‘The Furniture Wizard’, a furniture repair franchise with 35 franchisees, only 21 had registered business names.
Once a business name has been registered in compliance with state legislation, it is added to the centralised, federal, ASIC website. The information generated by the ASIC search of The Furniture Wizard stated that there is ‘no document list available for this organisation type’. This implies that there is no further information available about the business. In fact, an inquiry at the Western Australian Fair
69
Chapter 2: What is the problem and how big is it? 27 28
Trading Office reveals that historical information about the business named ‘Furniture Wizard – Wangara’ is available. Sometimes this historical information contains the name and residential address details of the former franchisee. As demonstrated by the above examples, eliciting comprehensive information from some public records can be ‘hit and miss’.
Where business names had been registered by franchisees, extracts of the relevant registration were purchased. Although the registration had generally lapsed, the contact details of the former franchisee are still on the records. They are often no longer current.
The electronic white pages directories were searched for a reliable match for franchisees whose name and address was known. For people with common Australian names – eg ‘Smith’, it was not attempted.
Searching state and territory business names registers proved to be the most reliable way of identifying former franchisees of failed franchisors, but it was far from satisfactory.
Surveyed franchisees Ultimately only 87 franchisees from 14 failed systems were identified by name. It was not possible to physically locate many of these. Franchisees were contacted by telephone before they were sent a survey, in order to verify that the correct individual had been located.
Eighteen former franchisees agreed to complete a survey. Three that were 71 eligible declined.70F For the CPA Study two survey instruments were used. The first was tailored for Traveland (46 questions) due to the high proportion of Traveland respondents whose identity was known and the second (45 questions) was generic. Completed surveys were returned by 14 former franchisees. This low response rate means that the survey responses are not statistically valid.
The human dimension A further challenge to research on franchisees of failed franchisors is that former franchisees’ lives have been disrupted by the experience. Former franchisees
71 One who could not face revisiting the issue, one who had signed a confidentiality agreement and one couple who spoke very broken English.
28 Chapter 2: What is the problem and how big is it?
are not always willing to participate in research that will cause them to revisit a difficult time.
Reactions to an invitation to participate in the CPA Study varied from:
… really interested in being involved to
… not interested in being involved. [S]igned confidentiality agreement with Synergy and wouldn't want to breach it … simply doesn't feel up to getting involved in it all again and
… not interested in being involved. Doesn't want to ‘go through it’ all again, as it caused … quite a few problems which they are only now putting behind 72 them.71F
Often franchisees’ only point of connection with each other is via the franchisor. They may not know each other’s last names or addresses. If the franchisor fails, franchisees can lose access to the franchisor’s intranet, and with it their only means of contacting each other. This problem is not overcome by the requirements of 73 the Code.72F To comply with the Code, the franchisor is required to supply business contact details (but not the name of the franchisee) for some or all franchisees in the system at the time the franchisee obtains the disclosure.
Information from administrator and liquidators Because franchisees were difficult to find, letters were sent to administrators and liquidators of specific franchise networks. Five agreed to participate and were interviewed. In all cases these professionals provided valuable insights, all on the condition of confidentiality.
Distinguishing franchised businesses from non-franchised businesses Some businesses do not knowingly establish themselves as a franchise and only realise that they are operating as a franchise after court action. For instance, in Australian Competition and Consumer Commission v Ewing [2004] FCA 5 the
72 Caroline Malcolm, Research Assistant Report after a day of telephoning all known former franchisees of insolvent franchisors. 73 See Trade Practices (Industry Codes – Franchising) Regulations 1998 (Cth) cl 6.2, 6.3 (‘The Code’).
Chapter 2: What is the problem and how big is it? 29 30
ACCC successfully alleged that the licensor, Synergy in Business, was franchising and had breached the Code. Proceedings had commenced on 22 July 2002. On 6 June 2002 Synergy in Business became insolvent. The 31 franchisees had signed licence agreements and had not known they were franchisees until the judgment was handed down 18 months after the franchisor became insolvent.
Interpreting information on franchisors’ websites On learning that the Australian master franchisor for Canadian popcorn franchisor Kernel’s Amazing Popcorn was insolvent, the Australian master franchisor’s website was immediately searched. The website still portrayed a master franchise in good health. It did not identify the franchisor. The only legal entity named was Jatora Pty Ltd which, according to the website, had the role of negotiating and holding the head lease on all the franchised locations. A contemporaneous search of the ASIC company and business name records name had a different outcome with 17 business names registered incorporating ‘Kernel’s Popcorn’, but no names of legal entities. The Australian master franchisor does not have the word Kernels in its name. An ASIC search reveals Jatora Pty Ltd’s status as ‘under external administration and/or controller appointed’. The administrator was appointed on 18 March 2005. A resolution that the company be wound up was recorded by ASIC on 21 April 2005. It was unclear from the master franchisor’s website, whether Jatora played any other role other than head tenant in the leases. However, the liquidators’ report to creditors filed with ASIC to comply with Corporations Act s 239A shows that Jatora Pty Ltd was the Australian master franchisor.
2.1.2 EVIDENCE OF FAILED FRANCHISORS Given the difficulty in obtaining comprehensive data on franchisor failure, Table 1 provides a conservative indication of the size of the problem. The gaps are where the information could not be found.
Table 1: Australian failed franchisor data
Trading Entity Started Started Year failed Amount Known name names business franchising (administrato owed to number r or creditors, of liquidator) (estimated) franchisees Worldwide Navis 2010 85 Online
30 Chapter 2: What is the problem and how big is it?
Trading Entity Started Started Year failed Amount Known name names business franchising (administrato owed to number r or creditors, of liquidator) (estimated) franchisees Printing
Mailpost Mailpost 2007 2007 2010 Australia Postie Network Pty Ltd (franchisor) Mailpost Australia Limited (master franchisee = insolvent) Firepower 2009 $100m secured City Pacific City Pacific 2009 40+ Finance Limited Wengor Pty Ltd First Chartered Capital 11 subsidiaries in total. Storm Storm 2009 Financial Financial Group Limited, + 22 other companies, not EXAD on 3/12/09 Hooters Wings-Aus Failed 2009 Holdings Pty twice in Ltd Australia LPGas 1 LPGas 1 2007 2009 8 franchising Franchising Pty Ltd Samsara Samsara 1993 2009 10 Wholesaling Pty Ltd Samsara Furniture and Café Pty Ltd Samsara Furniture and Homewares Pty Ltd Samsara Exotic Wares and Café Pty Ltd Samsara
Chapter 2: What is the problem and how big is it? 31 32
Trading Entity Started Started Year failed Amount Known name names business franchising (administrato owed to number r or creditors, of liquidator) (estimated) franchisees Licensing Pty Ltd
Jims Pool In Jims 2003 2009 Care Retail Group Kleenmaid Group 1 1985 2009 $102m 15 retail + Lifestyle including 30 van Appliance $28m Corporation secured Pty Ltd (franchisor) Kleenmaid Corporate Pty Ltd Lifestyle Appliance Sales Pty Ltd Kleenmaid Property Pty Ltd EDIS Service Logistics Pty Ltd, Kleenmaid Customer Solutions Pty Ltd Bizco Retail Pty Ltd Kleenmaid Holdings Pty Ltd KM Intellectual Reserves Pty Ltd Orchard KM Pty Ltd Kleenmaid Retail Pty Ltd Manlyvale Pty Ltd Kleenmaid Pty Ltd Kleenmaid Appliances Pty Limited (“the Kleenmaid Group”)
32 Chapter 2: What is the problem and how big is it?
Trading Entity Started Started Year failed Amount Known name names business franchising (administrato owed to number r or creditors, of liquidator) (estimated) franchisees (All Administrato rs Appointed) Group 2 (Orchid Group) (24 entities in total) Beach Beach 2001 2008 $8m 60 House House secured; Group Group Pty $47m Ltd unsecured. BHFC (Australasia) Pty Ltd Skinsama Pty Ltd Skinsama Debt Collections Pty Ltd Skinsama Investments Pty Ltd Skinsama Mentone Pty Ltd Sroll Pty Ltd BH Utilities Pty Ltd Kilbara Pty Ltd Broadbeach Beach House Pty Ltd Simafa Pty Ltd; Beach House Fitness Centre Pty Ltd 3D Commercial Pty Ltd (possibly related) Micklan Pty Ltd Jims In Jims 2001 2008 Appliance Group Repairs Jims Graffiti In Jims 2007 2008 Solutions Group Jims In Jims
Chapter 2: What is the problem and how big is it? 33 34
Trading Entity Started Started Year failed Amount Known name names business franchising (administrato owed to number r or creditors, of liquidator) (estimated) franchisees Heating & Group Cooling EzyDVD EzyDVD 2008 $18m 32 Pty Ltd secured. Midas Midas 1976 $30m 43 Australia (Australia) secured The Base Zafco 2008 Warehouse Kleins Kleins 2008 $20-25m 150 in Franchising secured Australia, Pty Ltd South The Africa and Jewellery New Chain Pty Zealand Ltd (franchisor) JDA Imports Pty Ltd Priority Priority ? 2001 2007 Managemen Management t Systems Pty Ltd (master of Canadian system) Jims Road In Jims 2000 2007 Training Group Betta Betta Stores 2007 Electrical Limited, Betta Stores (Southern) Pty Limited, Betta Stores (Northern) Pty Limited, A.K. Truscott Investments Pty Limited, Truscott Electronics Pty Limited Truscott Finance Pty Limited PGA & Associates Pty Limited BSL Finance Pty Limited PC Masters 2007 Pulp juice Signature 2004 2006 $200,000 + 19 in bars Brands Ltd unsecured Australia to 2 in landlords Middle East
34 Chapter 2: What is the problem and how big is it?
Trading Entity Started Started Year failed Amount Known name names business franchising (administrato owed to number r or creditors, of liquidator) (estimated) franchisees GoManGo Signature 2006 5 (est) juice bars Brands Ltd (floated in 2004) Sureslim Sureslim 2006 Australia Pty Ltd Jims In Jims 2002 2006 irrigation Group Jims Mobile In Jims 1999 2006 BBQ Group Jims In Jims 1999 2006 Wardrobes Group DC 2000 2006 Corporation Australia Pty Ltd Collins Collins 1929 ? 2005 20 Booksellers Booksellers Pty Ltd Jims Alarms In Jims 2000 2005 Group Jims In Jims 2003 2005 Concreting Group Jims In Jims 2004 2005 Earthworks Group Jims Garden In Jims 2003 2005 Edge Group Marie’s In Jims 2003 2005 Mobile Hair Group Danoz Danoz 1998 2005 6 Direct Direct Retail Pty Ltd TVSN Limited Danoz Directions Pty Ltd Danoz Direct Pty Ltd ie Networks IE Networks 2004 2005 Pty Ltd Juice The Juice 1996 2005 17 Station Station Pty Ltd Kernels Jatora Pty 1996 2005 25 Popcorn Ltd Nrgize Nrgize 2005 $2m 17 Australia Pty Ltd Only $2 Only $2 Pty 1999 2005 25 Ltd Party Land Partyland 2000 2005 3 Australia Pty
Chapter 2: What is the problem and how big is it? 35 36
Trading Entity Started Started Year failed Amount Known name names business franchising (administrato owed to number r or creditors, of liquidator) (estimated) franchisees Ltd Sam's Sam's 2005 $17m 16 Seafood Seafood Holdings Ltd Allied Liquid 2004 1160 Securities Engineering Industrial Pty Ltd Servcom Data Vault Data Vault 2002 2004 Services Pty Ltd Office Office 2001 2004 Support Support Services Services International Pty Ltd Photo Safe Photo Safe 2002 2004 Australia Pty Ltd Speeds Speeds 1910 2004 $1m 75 Shoes Shoes Pty Ltd 326SS Pty Ltd Speeds Shoes Group Pty Ltd Jims Preggi In Jims 2004 Bellies Group The Keg Keg (Albert 1998 2004 Park) Pty Ltd CarLovers Carlovers Pre-1998 Pre-1998 2003 30 carwash International Ltd Tokyo Joe’s The 2003 $31,000 6 Australian Sushi Company Pty Ltd (franchisor + supplier) Delifrance Delifrance 1995 2003 19 (Australian Australia arm) Mini Mini- 1991 2003 $4.4m 200 Tankers Tankers secured International International $8m Pty Ltd unsecured Mobile Mobile 1997 2003 56 Computer Computer Cleaning Cleaning Pty Ltd
36 Chapter 2: What is the problem and how big is it?
Trading Entity Started Started Year failed Amount Known name names business franchising (administrato owed to number r or creditors, of liquidator) (estimated) franchisees Personal Personal 1992 2003 $200,000 Actions Action Pty Limited Roger Roger David 2003 David Franchising Pty Ltd Soils Ain’t Soils Ain’t 1980 2003 Up to 4 Soils Soils Pty Ltd $100m incl. $16m to ATO King of King of 1997 2002 Croissant Croissant Pty Ltd Jims Sand In Jims 2001 2002 Soil & Group Gravel NoRegrets NoRegrets 1998 1998 2002 $13m 600 Australia Pty No assets Ltd (and several Norwood- controlled companies) Old Papa’s Old Papa’s 2000 2002 3 Café Franchise Systems Pty Ltd Rugs Galore Rugs Galore 1991 2002 4 Pty Ltd 12 007 343 204 Tony Boutique 2002 $4.8m incl. 5 Barlow Consolidated $700k Menswear Pty Ltd secured to Tony NAB Barlow Australia Ltd (parent) Stockmans Stockman’s 1990 2002 48 Australian Australian Café Café Pty Ltd Synergy in Synergy In 1998 1999 2002 31 Business Business Pty Ltd Cheque Cheque 1998 2001 58 Exchange Exchange (Aust.) Pty Ltd Renouf Personal 2001 $200,000 Fitness Training Centres Lloyd Scott Lloyd Scott 1984 2001 Enterprises Enterprises Pty Ltd ACN002739 773
Chapter 2: What is the problem and how big is it? 37 38
Trading Entity Started Started Year failed Amount Known name names business franchising (administrato owed to number r or creditors, of liquidator) (estimated) franchisees Traveland Traveland 1958 1990? 2001 270 Pty Ltd (in a group of 40 entities including Ansett Australia Limited and 1 trustee company) TRIMit Chaste 1999 2001 70 Corporation Pty Ltd Arby’s Arby’s Pty 1995 2000 Ltd Jims Motor In Jims 1999 2000 Vehicle Group Repair Service On Time On Time 1997 1998 2000 $3m 17 Copy Centre Business Solutions Simply No- Simply No 1985 1989 2000 5 Knead Knead Franchising Pty Ltd Top Snack Top Snack 1994 2000 $800,000 5 Foods Foods Pty Ltd Nick Kritharas Holdings Pty Ltd Adway Holdings Pty Ltd A1 Mobile A1 Mobile ? 1997 1999 4 Radiator Radiator Repairs Repairs Pty Ltd Furniture The 1996 maybe 1998 1999 35 Wizard Furniture Wizard Pty Ltd Modern Arbin (no 1) 1988 1994 1999 Garages Pty Limited (formerly Abrogram Pty Limited, Modern Garages Pty Limited) Mystic Mystic 1993 1999 2 Crystals Crystals Franchises (Australia)
38 Chapter 2: What is the problem and how big is it?
Trading Entity Started Started Year failed Amount Known name names business franchising (administrato owed to number r or creditors, of liquidator) (estimated) franchisees Pty Ltd
Century 21 Century 1988 1988 1998 Pty Ltd 21(South Pacific) Pty Ltd Great Icecreamerie 1977 1982 1998 62 Australian s of Ice Australia Pty Creamery Ltd Wonderland Wonderland 1994 1996 $860,000 3 of Pets of Pets Pty (originally Ltd ; 10) Kiltaro Pty Ltd Cut Price Cut Price 1974 1984 1995 150 Deli Deli Pty Ltd Denny’s Denny’s Pty 1986 1994 Ltd Ozzie Discount 1992 Discount Software Pty Software Limited Underpinnin Aizeema 1990 1993 g buildings (Australia) in NSW Pty Ltd; 1991 Hy-Jack Superlifting Systems Pty Ltd Snow Deli Snowdeli 1987 1990 $8.7m 10 Pty Limited Brumby’s 1988 (survived) Barbara’s Barbaras 1980 1982 1987 House and House & Garden Garden (Retail) Pty Ltd (franchisor) Barbara’s House & Garden Pty Ltd, Barbaras House & Garden (Australia) Pty Ltd Barbaras House & Garden (Wholesale Pty Ltd Cassidy’s Fair
Chapter 2: What is the problem and how big is it? 39 40
Trading Entity Started Started Year failed Amount Known name names business franchising (administrato owed to number r or creditors, of liquidator) (estimated) franchisees Dinkum Bargains Fuddruckers Fuddruckers 1981 Pty Ltd Mermaid’s Catch Sizzler Bumpa T Described as Bumpa ‘defunct’ no more information available The Donut Melbourne Wheel/ The based, vans Chocolate delivering Chip Cookie choc chip wheel cookies to shops LJ Hooker
Figure 1: Number of identified failed franchisors in Australia 1987 – 2009. 16
14
12
Franchisors 10
Failed 8
6 Number of 4
Known 2
0 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
The numbers in Figure 1 for 2006 and 2007 are low because data was not actively sought in those years. There is no evidence that the number of franchisor failures or the number of franchisees affected has reduced since the Code became mandatory. It appears that the opposite occurred, but there is insufficient data to
40 Chapter 2: What is the problem and how big is it?
74 assess the extent of this problem. Garry Williamson73F who ‘has been tracking franchising [in Australia] for more than 20 years. … says his defunct franchisors file 75 is bigger than the current franchisors file by a factor of six to one’.74F On the basis of Williamson’s statement it is suggested that the data in Table 1and the numbers in Figures 1 and 2 are the tip of the iceberg.
Figure 2: Known number of franchisees affected by their franchisor failing in Australia 1990-2009 10,000 scale) 1,235 1,000 686 399 285 285 (logaithmic 150 129 103 100 62 41 27
10 10 franchisees affected
3
Known 1
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 In Australia in 2007, the average number of franchise units per franchise 76 system was 50.75F To use this median to estimate the number of franchisees impacted by franchisor failure in Australia is problematic as franchise systems range ‘from 1 to 77 2,950 total units.’76F While some networks had very few franchisees when they failed, six had over 150. It is not possible to determine the number of franchisees in 53 of the 98 failed networks identified in Table 1.
The number of franchisees at the time of the franchisor failure is not a true representation of franchisees affected by the failure as many may have already left the network, disenchanted at the lack of franchisor support, slow stock deliveries or
74 Australian Franchise Consultant from the Franchising Centre. 75 Emma Connors, ‘The Brave New World of Franchising’, The Weekend Australian Financial Review (Sydney), 6-7 February 2010, 39. 76 Frazer, Weaven and Wright, Franchising Australia 2008, above n 7, 24. 77 Ibid 25.
Chapter 2: What is the problem and how big is it? 41 42 other problems symptomatic of impending business failure. For example, pet shop retail franchise Wonderland of Pets had ten franchisees at its peak, but only three at the time it failed.
78 Consistent with Lafontaine and Shaw’s conclusions,7F franchise networks of any age and structure can fail. Failed franchisors in Australia include:
Public companies and entities wholly owned by public companies (drive in car wash business CarLovers, travel agent Traveland, retail gadget shop Danoz)
Proprietary companies (retail mid-range jewellery franchise Kleins, Top Snack Foods)
Long established businesses (Kleins Jewellery had been in business for 25 years, franchising unknown number of years ; Collins Booksellers, 76 years, franchising unknown number of years; and Speeds Shoes, 94 years, franchising unknown number of years)
Franchisors of short duration (A1 Mobile Radiator Repairs and Danoz Directions - 2 years)
Franchisors with hundreds of franchisees (No Regrets with 600, Traveland with 270)
Businesses requiring franchisees to invest high sunk costs (Kleins, Kleenmaid ($400,000), Stockmans Australian Café, Cut Price Deli)
Those requiring small sunk costs (Furniture Wizard, conducted from the franchisees’ suburban residential garages)
Franchisors established before the mandatory Code was introduced in 1998 (Cut Price Deli, Century 21, Great Australian Ice Creamery)
Those established post the enactment of the Code (Kleins, Danoz, diet business Trimit)
Franchisors with franchisees operating as commission agents (gym business Beach House Group, Kleenmaid)
78 Lafontaine and Shaw, above n 47, 95-112, in Hoy and Stanworth (eds), above n 47, 163.
42 Chapter 2: What is the problem and how big is it?
Franchisees operating on the usual money flow model where franchisees receive money from their customers and pay royalties to their franchisor
Australian master franchisees of overseas based franchisors (Kernels popcorn from Canada, Delifrance from Singapore, Midas and Hooters from the USA).
2.1.3 WHY FRANCHISORS FAIL Common sense suggests that the franchisors do everything in their power to make their business a success. This is not always the case. The Franchising Task 79 Force Report of December 1991 (‘Task Force’) in Australia78F concluded that the:
2.7 … most vulnerable franchise systems are those that have recently 80 commenced franchising and have less than, say, 12-15 units.79F … 2.9 Franchisees are clearly vulnerable to the collapse of the franchisor, however, even when the franchisor has collapsed, some franchisees are capable of surviving as independently owned and operated outlets, as with a number of the Barbara’s House and Garden franchisees. … 2.10 However newer franchisees or franchisees already suffering severe financial strain are unlikely to survive the complete collapse of a franchise 81 system.80F
Three years after the Task Force filed its report, Stanworth, Purdy and Price report that James Cross identified some causes of SME (small and medium-sized enterprise) failure as being generic and concluded that failures of this type should 82 actually be remedied or reduced by franchising.81F These causes are:
undercapitalization
absence of economies of scale
lack of business acumen
79 Robert W Fitzgerald, Franchising Task Force Final Report to the Minister for Small Business and Customs (1991) 2.7–2.10. 80 In the light of the data in Table 1 in this thesis this statement is not supported by current data. 81 Here, I have listed only the reasons that are within the control of the franchisor, omitting those that are a function of the broader economy. 82 Cross, above n 48, 2-4.
Chapter 2: What is the problem and how big is it? 43 44
inability to survive intense competition in sectors (such as retailing) where barriers to entry are low.
Failure as a result of franchising-related factors, is seen by Cross as falling essentially into five key categories: business fraud, intrasystem competition involving franchise outlets being located too close, insufficient support of 83 franchisees, poor franchisee screening and persistent franchisor-franchisee conflict.82F
84 Failure of the parent company83F should be added to this list.
It is not always possible to identify the underlying cause of insolvency from public records. Reported court cases that involve a franchisor at about the same time as it becomes insolvent generally relate to issues with a particular franchisee or group of franchisees and seek to resolve pre-insolvency matters such as alleged misleading and deceptive conduct by the franchisor. Only passing reference is made to causes of franchisor failure.
The following are specific examples of failed franchisors from Australia:
An unsuccessful attempt at expanding to another country can lead a franchisor to fail; for example Mini-Tankers International ‘which operated franchises in Australia, Canada and New Zealand collapsed in September [2003] owing $10.7million as a result of an unsuccessful attempt to launch 85 an operation in the United States’.84F
For Traveland, failure of the parent company, Ansett, was the beginning of the end. ‘Air New Zealand’s decision to buy Ansett and absorb the much larger airline destroyed both. Insufficient due diligence and the need to 86 upgrade Ansett’s ageing fleet were among Air NZ’s problems’.85F
83 John Stanworth, David Purdy and Stuart Price, above n 48, 78-9. 84 For example Ansett Airlines failed, taking its subsidiaries including Traveland with it. 85 Kath Walters, ‘Fuel for Shareholders Anger’, Business Review Weekly (Sydney), 13 May 2004, 17. 86 Stathi Paxinos, ‘Ansett from A to T’, Sunday Age (Melbourne), 17 February 2002, 9. The statement that both airlines were destroyed has turned out to be inaccurate; Air New Zealand is still operating in 2010.
44 Chapter 2: What is the problem and how big is it?
A1 Mobile Radiators breached the consumer protection provisions ss 52 and 59(2) of the Trade Practices Act and became insolvent during the 87 litigation.86F
A similar path to A1 Mobile Radiators was followed by Simply No Knead which was successfully prosecuted for breaching s 51AC of the Trade 88 Practices Act and became insolvent during the litigation.87F
No Regrets, an on-line lingerie retail business, established in 1998, enticed 600 franchisees to invest in a virtual franchise store. The franchise ‘was launched in 1998 as a tax-effective scheme, with the help of prospectuses that set a new standard in steamy financial documents complete with 89 pictures of scantily clad women’.8F The franchise was based on an aggressive tax avoidance scheme where ‘investors put in about [A] $12,500 cash for each so-called virtual franchise store they bought but 90 claimed tax deductions of up to $51,000’.89F It was described as a ‘financial 91 and operational flop’.90F It is estimated that the 600 franchisees lost ‘in excess of [A]$7million through a combination of their original franchise fee, then big bills sent by the tax office as part of a crackdown on tax- 92 effective schemes’.91F Although the dubious wisdom they exhibited in being attracted to a tax minimisation scheme can be questioned, the franchisees did not cause the failure of this franchise.
Lloyd Scott Enterprises, a photocopier franchise became insolvent in June 2001 because of the dishonesty of the franchisor, Mr Lloyd Scott. The media reported:
the fallout continues from the [A]$40 million fraud that brought down Newcastle photocopier franchise Lloyd Scott Enterprises. … Businessman Lloyd Scott had been fraudulently writing multiple leases on photocopier
87 Australian Competition & Consumer Commission v Trayling [1999] FCA 1133. 88 Australian Competition & Consumer Commission v Simply No-Knead (Franchising) Pty Ltd [2000] FCA 1365; Australian Competition and Consumer Commission v Simply No-Knead (Franchising) Pty Ltd (2000) 104 FCR 25. 89 Neale Prior, ‘Lingerie Firm’s Rescue Looks A Little Scanty’, The Australian Financial Review (Sydney), 22 May 2004, 6. 90 Neale Prior, ‘Investors in Norwood’s NoRegrets Left with Plenty of Them’, The West Australian (Perth), 4 February 2005, 37. 91 Ibid. 92 Ibid.
Chapter 2: What is the problem and how big is it? 45 46
equipment, a step that had flooded his company with cash, but which had 93 required him to perpetrate more frauds to keep the various leases paid up.92F
CarLovers Carwash franchise was a public listed company which became insolvent in 2003. The media report stated:
In the 2002 financial year, according to PricewaterhouseCoopers, from every [A]$100 in income that CarLovers earned, 20c came from franchise fees. …. [the franchisor] locked itself into expensive leases of up to 20 years, on sites where the carwashes didn’t reach expectations and the company made big write downs. … [I]n 1998 CarLovers’ problems with its leases were compounded with what became an even greater problem: an increasing number of franchisees stopped paying franchise fees, claiming that CarLovers was not providing the services … it had promised. Then there 94 were the little contretemps CarLovers’ had with its auditors.93F
Failed franchisor, Stockmans Australian Cafes identified what were believed to be critical mistakes which resulted in the franchisor failing. These were:
Failure to provide sufficient field support to franchisees. Appointing master franchisees. … this gave third parties the authority to grow and represent the franchisor but they did not have the requisite skills and passion. No internal compliance standards and a tolerance of non-compliance of franchisees. Having a very wide geographical spread of franchisees, but small numbers. [The franchisor] had all the costs of servicing a national network without many of the economies. Failure to invigorate the network with new product and innovation. Poor communication and complaints management processes. Growth that was too fast and master franchisees that were too focussed on selling franchises rather than providing the necessary support to franchisees. Poor recruitment standards and policies.
93 Greg Ray, ‘Fraud Fallout Action Settled’, The Newcastle Herald (Newcastle), 24 July 2004, 4. 94 Neil Chenoweth, ‘CarLovers is All Washed Up’, The Australian Financial Review (Sydney), 19 July 2003.
46 Chapter 2: What is the problem and how big is it?
95 Lack of detailed monitoring and bench marking.94F
In 2006, the Signature Brands owned Pulp Franchises’ failure was attributed to the fact that by ‘mid 2004 the juice bar industry, estimated to be worth more than $650m by ACNielsen – had become saturated and recent arrivals [such as Pulp] were struggling under the weight of massive 96 leases’.95F
Instances of franchisor failure are increasingly well publicised. Media attention tends to highlight the plight of customers and the franchisor’s employees, paying scant attention to franchisees. For example, the Mercury made no mention of Speeds Shoes’ franchisees who had invested $180,000 - $300,000 on their outlets, rather focussing on employees, writing: ‘[m]ore than 60 workers face losing up to $200,000 in wages, superannuationa and holiday pay after the collapse of a discount shoe 97 chain’.96F This failure of the media to include franchisees in the franchisor failure stories tends to reinforce the mantra that franchising is a safe entry point into small business.
The tale told in the Barbara’s House & Garden litigation rings true even 20 years later. It could provide a salutary warning to people becoming franchisees of a franchisor that is not on a sound financial or managerial footing:
In the second half of 1982, when Mrs. Bateman had been working for the company for some two years, the company became involved in the vigorous promotion of franchises to operate ‘Barbara's House and Garden’ stores …. The promotion was portrayed as the natural expansion of an outstandingly successful business, but financial statements tendered in evidence suggest it was in fact an attempt to keep a foundering business afloat by getting in 98 substantial franchise fees.97F
History repeats itself. Strathfield Car Radio replicated the Barbara’s House and Garden strategy in 2009, going one step further and embracing franchising as a way
95 Stephen Giles and Rod Young, ‘The Rise and Fall of Stockmans Australian Cafes’, FCA Visions Newsletter (Melbourne), August 2005. 96 Sue Mitchell, ‘Signature Out of Pulp but Not Out of Juice’, The Australian Financial Review (Sydney), 1-2 April 2006, 10. 97 Tim Martin and Catherine Hockley The Mercury (Hobart), 2 April 2004, 11. 98 Re Richard Vincent Bateman and Georgina Gay Bateman v Barbara Jean Slatyer; Harvey John Slatyer; Graham Walter Tiekle and Barbara's House & Garden (Retail) Pty Limited [1987] FCA 58, para 3.
Chapter 2: What is the problem and how big is it? 47 48 of resurrecting itself out of administration. Strathfield Car Radios’s administrator adopted a strategy of:
selling franchises in order to rid themselves of unprofitable assets and to raise capital. [For example] mobile phone and electronics retailer Strathfield, … collapsed into administration earlier this year but emerged after a major shareholder injected fresh capital. Strathfield has announced it will pursue a 99 franchise strategy as it attempts to turn its fortunes around.98F
It is beyond the power of the franchisees to influence the franchisor’s management choices. As Doug Frazey observes:
While franchisees are typically required to meet a number of conditions in their franchise agreements (such as sales quotas), franchisors do not share the same responsibilities. … a franchisee is usually powerless to correct a poorly managed franchisor, even though the effects may weigh more heavily 100 on the franchisee.9F
One striking aspect of these insolvencies is that there is no evidence that any of them was of a franchisees’ making.
2.1.4 EARLY WARNING SIGNS Michael Jensen and William Meckling note that ‘[a]s the probability of bankruptcy increases both the operating costs and the revenues of the firm are 101 adversely affected’.10F The flow-on effects of the franchisor not receiving previously favourable trading terms will be noticeable to franchisees that are required to source stock or other services through their franchisor.
Jensen and Meckling use the example of a firm facing possible bankruptcy having to ‘pay higher salaries to induce executives to accept the higher risk of
99 Jacqui Walker, Franchising Under Pressure (2009) Smartcompany
48 Chapter 2: What is the problem and how big is it?
102 unemployment’.10F Whereas in a traditionally structured firm some of these costs can 103 be ‘avoided by merger’102F the opportunities available to a franchise include advertising for new franchisees, increasing costs to franchisees and embarking on a course of strategic insolvency. Consequently, franchisees may find they have to accept less reliable supply of stock or manage hostile premises landlords or other suppliers where the franchisor has failed to pay costs incurred in relation to the franchisees’ business – paid on time by franchisees to franchisor and then not on- paid to the suppliers on time. For example, a BHG franchisee discovered the franchisor had failed to pay the local advertiser, so the advertiser refused to deal with the franchisee until the franchisee got to the bottom of the problem and arranged direct payment from franchisee to supplier, instead of from franchisee to franchisor to supplier, for future local advertising.
It is difficult for franchisees to be pro-active if they believe their franchisor is operating precariously. The franchise agreement and consequential contracts must be adhered to.
Relevance of type of product or service sold by franchisees As Jensen and Meckling point out, ‘in certain kinds of durable goods industries the demand function for the firm’s product will not be independent of the probability 104 of bankruptcy.’103F In franchising, the demand for the early morning take-away coffee sold by a franchisee where payment and supply is completed within a minute will be unaffected by the franchisor’s impending or actual financial woes. Customers will continue to patronise the franchisee so long as they like the coffee. Only if the franchisee’s business closes, will the customers patronize another cafe. By contrast, the demand for expensive items supported by long term warranties, such as motor vehicles, or white ware that will be bailed by the franchisor or franchisee until a builder needs to take delivery, or products and services like travel, hotel or rental car bookings made and paid for now with delivery in the future, will be adversely affected as consumers prefer to deal with solvent suppliers.
In the immediate pre-insolvency phase, the franchisor’s own employees are likely to become aware of the precarious nature of the franchisor’s business before
102 Ibid. 103 Ibid. 104 Ibid.
Chapter 2: What is the problem and how big is it? 49 50 the franchisees do because employees notice irregularities in their wages and hear ‘in house’ whispers. Because the money flows from franchisee to franchisor in most cases, this unofficial early warning system of cash flow problems being exposed may not be available to franchisees. Franchisees may not become aware of the franchisor’s position until a supplier changes the terms of trade, or a landlord locks them out of their shop because the franchisor has not passed on the rent it has collected from the franchisee/ licensee or franchisee/sub-tenant or the franchisee learns of the franchisor’s financial difficulty through the media.
For the franchisee, Canadian insolvency litigator Craig R Colraine states that:
Poor financial performance, including the accumulation of significant debt when the franchise system is not expanding, growing operating losses, the writing down of assets and re-financings are obvious indications [to the financially literate] that a franchise is in difficulty. … Identifying financial 105 problems in non-publicly traded corporations is more difficult.104F
Colraine’s experience as an insolvency litigator also qualifies him to observe that ‘[t]he financial difficulties of a closely held franchisor may become apparent only when the franchisor’s obligation to provide advertising support, equipment and 106 inventory on a timely basis … are breached’.105F
The role of banks Banks are a major stakeholder in both franchisors and franchisees through their role as evaluators and financiers. But, in some cases the early warning signs do not trigger a response by the franchisor’s bank. Allowing a franchisor to continue signing up franchisees whilst the franchisor is in default on a large loan is a way of a bank reducing its exposure by increasing its security.
In the Kleins retail jewellery franchise failure, for example, the franchisor’s bank continued to endorse the franchise network despite being owed millions of dollars by the franchisor and being well-positioned to know that the franchisor’s financial structure was not viable or sustainable. As recently as June 2008, the Kleins franchise was still listed as one of only 20 National Australia Bank ‘Accredited
105 Craig Robin Colraine, ‘Franchises: Insolvency and Restructuring’ (Unpublished paper presented at the Distribution Law: Catch the Wave, Avoid the Rocks, Ontario Bar Association Continuing Legal Education, Toronto, Canada, 26 May 2003) 3. 106 Ibid.
50 Chapter 2: What is the problem and how big is it?
Franchise Systems’. By including Kleins in this list, the bank sent a message to potential consumers of Kleins franchises, and their advisers, that Kleins was of sound financial standing.
Table 2: National Australia Bank Accredited Franchise Systems 2008 and 2009
NAB Accredited Franchise Systems NAB Accredited Franchise Systems 23 May 2008 6 September 2009 Australia Post Australia Post Autobarn Autobarn Bakers Delight Bakers Delight Bob Jane T-Marts Bob Jane T-Marts Choice Hotels (Flag) Choice Hotels (Flag) Clarke Rubber Clarke Rubber Fernwood Fernwood Gloria Jeans Gloria Jeans Hungry Jacks Hungry Jacks KFC/Yum! Restaurants KFC/Yum! Restaurants Kleins Jewellery McDonald’s McDonald’s Michels Patisserie Michels Patisserie National Foods National Foods Natrad Natrad Pizza Hut/Yum! Restaurants Pizza Hut/Yum! Restaurants Quest Serviced Apartments Quest Serviced Apartments Red Rooster Red Rooster Subway Subway The Outdoor Furniture Specialists
Kleins was placed into administration on 30 April 2008 while the National Australia Bank was still demonstrating endorsement on its website.
Litigation against franchisor as an early warning sign The significance of litigation as an early indicator of failure was identified in a Dun & Bradstreet Corporate Health Watch survey. It was concluded from the survey results that ‘[c]ompanies that have had legal action taken against them are nearly 107 eight times more likely to fail than those that haven’t’.106F
107 ‘Warning Signs of Failure’, The Australian Financial Review (Sydney), 2 May 2006.
Chapter 2: What is the problem and how big is it? 51 52
In franchising, further research would reveal whether the threat of franchisee 108 litigation caused the franchisor to consider pre-emptive or strategic bankruptcy107F or whether the litigation caused the subsequent failure of the franchisor.
2.2 FRANCHISOR FAILURE FROM OTHER PERSPECTIVES
2.2.1 FRANCHISOR’S PERSPECTIVE For a financially troubled business, insolvency may be part of a considered business strategy. According to US legal advisers, it provides ‘an opportunity … to 109 solve operational or financial problems and emerge as a more viable company’.108F One US lawyer writes:
Franchisors file for bankruptcy to escape or postpone the consequences of mass franchisee litigation, shareholder litigation, and lender enforcement activities. During the reorganization [in Australia, administration] process, bankruptcy can modify and suspend the obligations of the parties to a franchise agreement. Ultimately, the reorganization plan may permanently 110 modify the rights and obligations of the parties to the franchise agreement.109F
Anecdotal and deduced evidence of this conduct exists in Australia. For example, bake your own bread franchisor Simply No Knead became insolvent between the time the ACCC initiated proceedings and the time the case successfully 111 alleging the franchisor had breached s51AC Trade Practices Act was concluded.10F
Senior US franchise lawyers Rupert Barkoff and Andrew Selden identify ‘the 112 risk that ‘your franchisor goes bankrupt’1F as an ‘uncontrollable risk’ in their practitioner guide on franchise law.
2.2.2 THE GOVERNMENT’S AND THE REGULATOR’S PERSPECTIVE Several government reviews into the franchise sector have been conducted in 113 Australia.12F Some have examined small business generally; others focus on franchising.
108 Foster and Johnsen, above n 19, 1. 109 Ibid. 110 Craig R Tractenberg, ‘What the Franchise Lawyer Needs to Know About Bankruptcy’ (2000– 2001) (3)20 Franchise Law Journal 3. 111 Australian Competition & Consumer Commission v Simply No-Knead (Franchising) Pty Ltd [2000] FCA 1365. 112 Rupert M Barkoff and Andrew C Selden, Fundamentals of Franchising (3rd ed, 2008) 278.
52 Chapter 2: What is the problem and how big is it?
The Franchising Task Force in 1991 was the first Australian government- initiated review to comment directly on franchisor failure, noting:
[t]he main internal network reasons for franchisor failure were under- capitalisation of the franchisor; too rapid expansion of the franchise system, 114 poor product or service, poor franchisee selection, [and] franchisor greed.13F
The main reasons for franchisor failure external to the franchise network were identified as: ‘devaluation of the Australian dollar, an increase of import duties, the withdrawal of an important source of products, an aggressive and cheaper competitor 115 or a severe downturn in the economy’.14F Franchisor and franchisee failure was addressed as the same issue by the Task Force and resulted in recommendations that franchisors should provide better disclosure, and prospective franchisees should conduct better assessment of the nature of the business being purchased and the risks 116 as well as opportunities associated with the system.15F Although the 1992 Supplement included a table on franchise failures, the firms counted were almost certainly franchisees.
No further attention was given to the incidence or impact of franchisor failure until the Mathews Review in 2006. The Matthews Review reported being: ‘made aware of a number of situations where the impact of the failure of a franchise or a franchisor had a major impact on the financial or emotional well being of those 117 involved’.16F
113 Trade Practices Review Committee (Swanson Committee) Report, PP No 228/1976, (1976); Trade Practices Consultative Committee, Small Business and the Trade Practices Act (Blunt) (1979); Standing Committee on Industry, Science and Technology, Parliament of the Commonwealth of Australia House of Representatives Small Business in Australia: Challenges, Problems and Opportunities (‘Beddall Report’) (1990); Robert Fitzgerald, Franchising Task Force Final Report to the Minister for Small Business and Customs, the Hon David Beddall (‘Task Force 1991’); Franchising – Australia and Abroad, Supplement to the Franchising Task Force Final Report, 1992 (‘1992 Supplement’); Robert Gardini, Review of the Franchising Code of Practice (1994); Peter Reith, New Deal: Fair Deal – Giving Small Business a Fair Go (1997); Graeme Matthews, Review of the Disclosure Provisions of the Franchising Code of Conduct (2006); Government of Western Australia, Inquiry into the Operation of Franchise Businesses in Western Australia, Report to the Western Australian Minister for Small Business (2008); Economic and Finance Committee, Parliament of South Australia, Franchises (2008), Parliamentary Joint Committee on Corporations and Financial Services, Commonwealth, Inquiry into the Franchising Code of Conduct (2008). 114 Task Force above n 113, 21-22. 115 Ibid. 116 Ibid 26. 117 Matthews, above n 113, 17.
Chapter 2: What is the problem and how big is it? 53 54
More recently, the ACCC as consumer protection regulator has identified that ‘franchisees often lose their business and their livelihood when their franchise system fails. The 2008 failure of the Kleins Jewellers franchise system highlighted this 118 issue’.17F The ACCC recommended the Parliamentary Joint Committee consider whether: ‘Some measure might be warranted to protect franchisees in circumstances where their franchisor fails – for example granting them the right to exit the franchise 119 agreement’.18F
2.2.3 INDUSTRY ORGANISATIONS’ AND COMMENTATORS’ PERSPECTIVES The mantra of some franchise industry groups is that:
Bankruptcy of the franchisor is not necessarily bad for franchise system or franchisees. There have been cases where bankruptcy and restructuring actually result in [a] stronger network of operators, with stronger financial 120 management at corporate headquarters and a stronger brand position.19F
Singing from the same song sheet as the IFA, the media release below was the only reference to ‘insolvency’ when the FCA’s website was searched in October 2009. It implies that the Ezy DVD franchisees all survived their franchisor’s failure.
Franchise insolvency leads to a ‘rebirth’ for franchisees. In late December 2008, DVD retailer EzyDVD collapsed under the strain of debts of around [A]$18 million. However, a white knight appeared in the form of Franchise Entertainment Group (FEG), the operator of the Blockbuster and Video Ezy chains in Australia and Asia. FEG bought out EzyDVD’s brand and online business, the franchise network, as well as stock, plant and equipment and 11 company-owned EzyDVD stores. The 25 franchised EzyDVD stores will also come under FEG’s control. This turn of events has given new hope to many of the EzyDVD franchisees whose futures were uncertain during the Christmas and New Year period. It is also a clear indication that Franchise insolvency does not necessarily mean the end of the line for franchisees. In fact, it would appear that the
118 Submission to Parliamentary Joint Committee on Corporations and Financial Services, Commonwealth, Inquiry into Franchising Code of Conduct, September 2008, 8.4 (ii) a) 27 (Australian Competition and Consumer Commission). 119 Ibid 28. 120 Emma Maltby, Dragged into a Bankruptcy That isn’t Yours (2009) CNN Small Business, quoting Alisa Harrison, IFA’s spokeswoman
54 Chapter 2: What is the problem and how big is it?
franchisees may fare better than others affected by the EzyDVD insolvency, 121 such as unsecured creditors.120F
Before a company has a chance to attempt ‘rebirth’, it has to go through the pains of bankruptcy – which can be easy, hard or very hard on the franchisees. In a best-case scenario, franchisees continue business as usual, perhaps implementing minor adjustments that the franchisor deems necessary to boost profits or cut overheads. However, it is
not uncommon for franchisees to be left holding the bag while a [franchisor’s] bankruptcy is in progress. Bennigan’s franchisees, who had previously depended on corporate marketing initiatives to advertise their stores, faced the challenge of publicizing that they were open for business 122 despite a whirlwind of press implying otherwise.12F
Another perspective was provided to Australian franchising lawyers by Wayne Jenvey who observed that in general terms:
the effects of franchisor insolvency on the franchise ecosystem translates, upon insolvency, into myriad interests and competing claims among which the franchisee is the least protected. The interests of the franchisees are not protected and franchisees have no control over the business when the franchisor fails. Franchisees are subject to the decisions of the external 123 controller.12F
2.3 FRANCHISOR FAILURE FROM FRANCHISEES’ PERSPECTIVE
Each individual franchisee’s personal and financial resilience and negotiating ability will be factors in how they emerge from franchisor failures. Some can draw from a deep well of prior experience and a strong personal support network; some can only attribute the survival of their business to luck or its demise to bad luck.
A 2009 online news piece on franchisor insolvency sums up the predicament faced by many franchisees:
121 Franchise Council of Australia, Franchise Insolvency Leads to a ‘Rebirth’ for Franchisees
Chapter 2: What is the problem and how big is it? 55 56
Dragged into a bankruptcy that isn’t yours. When a franchise company goes bankrupt, independent operators face a tsunami of legal tangles and 124 marketing challenges.123F
Matthew Dunckley writes, quoting franchisee Mr Maccartney; ‘We put our life 125 savings on the line … and these guys [franchisor] get to treat us like credit cards.’124F
Journalist Trevor Sykes followed the Traveland franchise failure story and 126 described the insolvency of the Traveland franchisor as a tragedy in four acts.125F Sykes writes:
Act I. 24 September 2001 … saw the parent company; Ansett’s administrators sell Traveland to a dot.com company that had not previously been involved in the travel industry, Internova Travel for $500,000. At this stage Traveland had 104 branches and 750 staff. Internova Travel (incorporated specifically for the Traveland purchase) bought the money- losing business with borrowed money, without tying down its potential partners and financiers. Act II. 28 September 2001 saw the Australian Investment Corporation of Western Samoa (AIC) buy half of Internova Travel for [A]$500,000. … ’the half a million AIC put up seems to have disappeared straight down the insatiable maw of Traveland in wages and other costs. Act III. 8 October 2001 Financial Options Group Inc (FOGI), a company owned by the two Sydney entrepreneurs who controlled AIC, paid [A]$2million for the balance of Traveland. Possession of the business passed on 8 October but settlement was not required until 24 October. The money was not paid and on 26 November 2001 Internova Travel’s directors put it into administration, which quickly turned into liquidation. The Australian Securities and Investment Commission put FOGI into liquidation on 18 February 2002. Act IV. 23 December 2001. FOGI’s liquidator sold Traveland to Travelworld for $250,000. Travelworld now has all Traveland’s staff and 127 licenses. Finally, Traveland was vanishing like the Cheshire cat.126F
124 Emily Maltby, above n 120 . 125 Matthew Dunckley, ‘Call to Shield Franchisees’, The Australian Financial Review (Sydney), 17 April 2009, 9. 126 Trevor Sykes, ‘Traveland: Final Tragedy of Errors’, The Australian Financial Review Weekend (Sydney), 9-10 March 2002, 12. 127 Ibid.
56 Chapter 2: What is the problem and how big is it?
Throughout the drama recounted by Sykes, there is little mention of the estimated 270 to 285 Traveland franchisees. The Traveland business was an asset in the Ansett insolvency. The CPA Study tracked down some of the former 128 franchisees.127F One Traveland franchisee did have a clause in his agreement that permitted him to terminate the franchise agreement if Traveland failed – and he did so. For the other franchisees, the Traveland Franchise Council was of the view that franchisees did not have grounds for terminating franchise agreements.
A liquidator does not have an obligation to sell assets of the failed franchisor to the purchaser who would be the most suitable from the franchisees’ perspective, nor to a purchaser who is well motivated towards the franchisees. According to one former franchisee, the purchasers of Traveland knew nothing about travel or franchising. There is nothing to stop a liquidator selling the franchisor’s business to a direct competitor of the franchisor. That direct competitor may elect not to buy the franchise agreements but, instead, buy the brand in order to shelve it. In the United States, albeit in a non-franchise context, ‘Disney purchased customer lists of 129 Toysmart in 2000 so it could ‘retire’ the list (ie. “destroy”)’.128F
The following insights about how their franchisors’ collapse affected its franchisees were collected in the CPA Study. All 18 former franchisee participants in the CPA Study lost money as a result of the franchisor’s insolvency. In response to the question, ‘if you lost money, what caused the loss?’ Sixty four per cent replied that it was because their investment was now valueless.
The insolvency of a franchisor affects many relationships beyond that of franchisor/franchisee. The franchisee’s own creditors will be unsure about the franchisee’s ability to meet its ongoing payments. With this in mind, participants in the CPA Study were asked: ‘did the insolvency of your franchisor mean you could not pay business related liabilities?’ Forty-four per cent were able pay all business related liabilities, while the balance defaulted or could only pay some.
To the question: ‘in total, how much money did you lose because of your franchisor's insolvency? (including in this amount the cost of refurbishing your premises to remove your franchisor’s image and replace it with another, if relevant).’
128 Buchan, ‘When the Franchisor Fails’, above n 31. 129 Gerald L Baldwin, ‘The Role of Intangibles in Bankruptcy’ (2006) 25-8 American Bankruptcy Institute Journal 12, 53.
Chapter 2: What is the problem and how big is it? 57 58
Forty four per cent lost more than A$50,000. Fifty-five per cent lost less than $50,000. The responses are skewed in favour of smaller losses as only one franchisee from a retail shopping centre based franchise responded to the survey.
To the question: ‘if your company could not continue trading, why was this?’ Forty per cent of franchisees replied that they had no money left to start a new business and 20 per cent had other reasons. Some of the franchisees responding ‘not applicable’ were trading as sole traders, not as corporations.
When asked whether they had any comments to make about the impact of the insolvency on their franchise business, or about any other aspects of franchising, none of the CPA Survey participants made any negative comments about franchising per se. Comments were personal:
I lost a lot of money, reputation and health.
I think that the emotional turmoil and lack of assistance from government, associations and lawyers (due to fear of repercussion) left us weaker and more vulnerable, which has resulted in many owners selling up or becoming ill from exhaustion – trying to rescue their business. This even has major impact on staff sick days too.
Very unhappy with how the whole issue was handled by Traveland, their lawyers and buyers.
The former Traveland franchisees who were still running travel agencies had to collect the travel tax levy that the government imposed on all travellers to help fund employees’ claims in the Ansett insolvency. They report that this ‘rubbed salt in their wounds’. In addition, because of the discrepancy in income from the years of being a franchisee to the year following the insolvency, the Australian Taxation Office audited former franchisees’ tax returns.
Decisions the administrator or liquidator takes in relation to disclaiming 130 onerous contracts will impact significantly on the options available to franchisees.129F
130 Michael Murray, Keay’s Insolvency: Personal and Corporate Law and Practice (5th ed, 2005) 340. ‘In some cases liquidators do not wish to retain property because it is too onerous, worth little or is unsaleable. In such circumstances, liquidators wish to get rid of the property in order to avoid responsibilities and costs in relation to it. In disclaiming, the liquidator gives notice to others that he or she wishes to be rid of any interest in the property. If a person suffers loss as a consequence, those persons to whom notice has been given are required to try to mitigate their loss. They may lodge a proof of debt in the liquidation in respect of the amount of that loss. The
58 Chapter 2: What is the problem and how big is it?
If the liquidator disclaims the lease, the franchisee will lose the value of the sunk costs unless it is able to negotiate a new lease. Even then, the franchisee may find that the lack of the power of the brand, or the loss of group bargaining power, may make trade unviable as an independent. For example:
James Rixon was a franchisee in the failed [Australian master franchisee owned] Kernel’s Popcorn chain. He sold his business at a loss nine months after his franchisor went into administration in 2005. … Rixon, a shop-fitter by trade, renegotiated a lease with his landlord, formed direct relationships with his suppliers and got together with other Kernel’s Popcorn franchisees to trade under a new brand, Pop n Go, when his franchisor failed. But the business was not as profitable as he would have liked. Rixon says he did not 131 have the marketing expertise to run the operations without a franchisor….130F
Franchisees who do not weather the storm of franchisor failure successfully may be those that have only recently established their franchise when the franchisor failed, they may not have established personal credibility with their landlord, their working life may be nearing its end as the franchise may have been purchased with redundancy money or with retirement savings, and they may be stretched to the limit. Franchisor failure is a tipping point from which some franchisees have little chance of recovering financially.
The physical whereabouts of a franchisee’s business will have a bearing on the exit strategies available to the franchisee. For example, if the buyer of the network already has an outlet in the same area it may decline to adopt the franchise agreement as it does not want to cannibalize an existing market. Proximity to the end of the term of the franchise agreement and premises lease are also relevant; the nearer to the end, the more of the franchisees’ original investment has been recouped and the more likely they are to have started to think of their future after franchising.
As is documented in Appendix C, insolvency regimes the world over give special recognition to creditors and employees, but almost uniformly exclude franchisees as stakeholders. The franchisee is likely to be contractually bound to
liquidator may disclaim property referred to in section 568(1) Corporations Act 2001 (Cth) (including) land burdened with onerous covenants (for example a lease of retail space in the franchisor’s name that is licensed to a franchisee as occupier with no status on the title and no privity of contact with the landlord) and contracts (including franchise agreements).’ 131 Jacqui Walker, ‘It Pays to Have a Plan B’, Business Review Weekly (Melbourne), 16-22 March 2006, 57.
Chapter 2: What is the problem and how big is it? 59 60 remain in the franchise relationship while the administrator or liquidator explores options for the future of the system and then pursues the best option for the creditors, which can take months.
In Australia, once it became obvious to the franchisees that the new owners of the Traveland brand did not have the expertise to run a franchised chain of travel agents, the franchisees moved in several directions. Joining another franchise network was an exit strategy for many of the former Traveland franchisees.
Twenty franchisees switched to UTAG travel.
Several franchisees switched to Harvey World Travel.
One hundred and fifty Traveland franchisees joined Travelworld.
One franchisee became an employee of another agency, having lost so much that he could not continue as a franchisee.
At least three franchisees re-branded as independent travel agents.
The fate of the remaining 100 or so other former Traveland franchisees is unknown. Some will have continued trading as an independent businesses, unaligned to any particular group.
For some franchisees joining another travel agency franchise was not appealing. A franchisee who owned a Traveland in a country town pointed out that prior to buying into Traveland, she and her husband investigated all of the travel agency franchises available. They decided on Traveland because it had the best systems. When Traveland failed, the franchisee initially contemplated becoming an independent travel agent but concluded this was not feasible as her former customers preferred to deal with a ‘name’ brand. In her words:
Traveland was an excellent franchisor, great to work for but following the collapse of Traveland if I had rebranded as [my name]’s Travel Agency it would not have been acceptable [to the town]. The response would have been “Who does she think she is?” … We were not communicated with at all when Ansett collapsed. From that day all the [franchisor’s] phones were
60 Chapter 2: What is the problem and how big is it?
switched off. We could only call other franchisees. At no stage were the 132 Traveland franchisees offered the opportunity of buying the franchisor.13F
Consequently, she had no real choice but to close the travel agency.
As was noted in The Australian:
...when it comes to liquidation, the laws are stacked in favour of the franchisors. This is seen in the way that franchisors have the right to sell their brand name and franchisees to another buyer, which sounds fair and okay in terms of business law as it pertains to administration and liquidation, but it could ruin the innocent parties, namely the franchisees. This is what happened to 270 Traveland travel-agent franchisees[;] ... one-time solid 133 Traveland agents effectively lost.132F
Dollar cost of franchisor failure to a franchisee. This varies greatly from one franchise network to another, and from one franchisee to another. Table 3 outlines the costs and some of the losses incurred by one franchisee who signed a franchise agreement with Danoz Directions in February 2004. The Danoz franchisor became insolvent eight months after this franchisee signed his franchise agreement.
Table 3: Some costs and losses for one franchisee of Danoz Directions
Item paid by Franchisee’s Relevant Franchisee Outcome for franchisee in franchisee investment in contract paid to insolvency of franchisor $AUD Initial franchise $60,000 plus Franchise Franchisor in Franchisee no statutory fee paid to additional agreement full before right to claim from secure rights $20,000 between commence administrator. for 5 years training franchisee and business Franchisee will be a franchisor creditor for an amount in signed early damages for breach of the 2004 franchise agreement. The franchisee may seek leave to bring proceedings against the insolvent franchisor in order to 134 quantify its claim13F
132 Interview with former Traveland franchisee (conducted at former franchsiee’s home, country Victoria, 17 June 2006). 133 Switzer, above n 1. 134 In Cheque One Pty Ltd v Cheque Exchange (Australia) Pty Ltd (in liq) [2002] FCA 593, 12 applicant franchisees sought leave of the court under s 471B Corporations Act 2001 (Cth) to join proceedings commenced against the franchisor in 2000.
Chapter 2: What is the problem and how big is it? 61 62
Item paid by Franchisee’s Relevant Franchisee Outcome for franchisee in franchisee investment in contract paid to insolvency of franchisor $AUD Sunk Fit out $99,000 Disclosure Franchisor for Lease (in franchisor's costs document payment on to name) disclaimed by independent administrator. Landlord shop fitter would negotiate with franchisee for a continued tenancy agreement if franchisee gave up value of fit out. Lost $99,000 sunk cost of fit out
Franchisor's fit $25,000 Franchise Franchisor as a Service fully performed by out supervision agreement 25per cent fee franchisor; franchisee no between on top of right to claim. Lost franchisee and invoiced fit out $25,000 franchisor cost Inventory/ $45,000 Supplier Supplier Return, sell, depends on stock agreements terms of supply Security Bank guarantee Franchise Provided direct Franchisee negotiated with deposit on - 3 months' rent agreement to landlord landlord to be released - no franchisor's = approx between loss head lease $15,000 franchisee and franchisor Monthly Approx $4,000 Lease between Franchisor for Franchisee debtor of premises rental pm franchisor and forwarding to franchisor. Franchisor in landlord. landlord. breach of lease because of Sublease/ appointment of licence between administrator franchisor and franchisee Training costs $20,000 Franchise To general Franchisee not creditor or agreement revenue of debtor. No claim possible between franchisor or franchisee and franchisor franchisor related company on day paid Other costs $6,000 Franchise Paid to Franchisee not creditor or agreement franchisor up debtor. No claim possible between front franchisee and franchisor Options to $60,000 Agreement Paid to No statute-based claim open 3 future between franchisor up possible. franchisee franchisor and front Franchisee not a creditor owned stores franchisee for $60,000 unless could @ $20,000 per claim breach of contract or option quasi-contract at common law re the $60,000 if court consents to civil proceedings normally prevented under ss 440D or
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Item paid by Franchisee’s Relevant Franchisee Outcome for franchisee in franchisee investment in contract paid to insolvency of franchisor $AUD 471B Corporations Act 2001 Unlikely
The franchisee in Table 3 was not a creditor of the franchisor and was a debtor to the extent of the monthly royalty and the rent, which is ultimately owed to the landlord. This is not a strong negotiating position for a franchisee to be in relation to the franchisor’s liquidator. Of the estimated total outlaid by the franchisee in Table 3 (excluding professional advice and bank charges):
A pro-rated amount of the A$60,000 (initial franchise fee) could be the subject of an equitable claim for unjust enrichment. Any action against the 135 liquidator would need to be approved by the court.134F
A$99,000 is sunk costs, spent on fit out. Depending on how portable the items purchased were, some might have second hand value. Others (eg. shop window, flooring, most electrical works) become part of the landowner’s real property upon installation.
A$25,000 charged by the franchisor for supervising the fit out is deemed earned by the franchisor as soon as the fit out is complete.
A$45,000 inventory is returned to suppliers or sold or thrown away by the franchisee, depending on the relevant terms of trade.
A$15,000 bank guarantee provided by the franchisee to guarantee the franchisor’s obligations under the head lease. Depending on the landlord’s attitude towards the franchisee as a replacement tenant and the amount of rent the now insolvent franchisor owes, this guarantee may be called up by the landlord, or, as in the case described in Table 3, used to support the replacement lease to the former franchisee.
135 Corporations Act 2001 (Cth) s 440D, stay of proceedings for company under administration; s 471B, stay of proceedings and suspension of enforcement process for company in liquidation.
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A$26,000 training costs and other amounts deemed earned by the franchisor pursuant to the franchise agreement. No claim possible.
A$60,000 to secure options to ‘own’ three future territories. This, also, is potentially the subject of a claim for unjust enrichment.
Tax issues Until 1995, from the moment a franchisees’ business closed the interest on the loans taken out to fund the businesses ceased to be tax deductible. Since 1995 the position has altered through a line of cases in relation to s 51(1) of the Income Tax Assessment Act 1936 (Cth) that started with a decision reached by Davies, Hill and Sackville JJ in the Federal Court, Placer Pacific Management Pty Ltd v Federal Commissioner of Taxation 95 ATC 4459. A deduction can now be claimed for interest on loans taken out to fund a business that has ceased generating an 136 income.135F
Possible tax-related consequences All income from the business is taxed, but from the time of the collapse of the franchisor, if the franchisee’s business has stopped trading all new expenses incurred 137 after the collapse may not be deductible.136F
Tax and sunk costs Perhaps a more compelling issue than interest deductibility is whether the franchisee’s sunk costs are deductible if the franchisor fails and the franchisee is unable to trade on. Take, for example, a Kleenmaid franchisee. The franchise network was established in Queensland in 1985 to sell and maintain whitegoods under the Kleenmaid brand. By the time the administrator was appointed in 2009 there were ‘20 retail outlets of which 15 [were] franchised and 5 [were] wholly 138 owned by the company’.137F While ‘[l]iquidators have been selling the products on
136 Federal Commissioner of Taxation v Brown [1999] FCA 721 (Lee, Nicholson and Merkel JJ) The interest payments were deductible under the second limb of s 51(1). The occasion for the interest payments was to be found in the loan entered into by the partnership in carrying on business for the purpose of producing assessable income and that the cessation of the business did not operate to break the nexus between the carrying on of the business and the incurring of the interest liability; Federal Commissioner of Taxation v Jones (2002) 117 FCR 95 (Beaumont, Finn and Sundberg JJ). In this case, refinancing the loan after the business. 137 Income Tax Assessment Act 1997 (Cth) s 40-880. 138 Angela Harper, ‘Liquidators Sell off Kleenmaid Assets’, Sydney Morning Herald (Sydney), 30 June 2009.
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139 Grays Online for very good prices’138F and ‘30 service van franchisees [are] to continue to operate and provide maintenance and repairs to support existing 140 Kleenmaid customers’,139F what becomes of the investment in sunk costs made by the franchisees? A Kleenmaid franchisee will have invested tens of thousands of dollars in sunk costs to open its business. For example, it had to purchase demonstration models of the white goods on display and keep them up–to-date as styles in white goods change. Had Kleenmaid failed six months after a franchisee set up its store, the franchisee would probably have to write off investment in items such as white 141 goods as capital items. 140F An individual small business is unlikely to be able to sell its capital losses and thus another avenue of future research identified in this research is the tax treatment of franchisees’ sunk costs when the franchisor fails.
Commenting on the predicaments of Kleenmaid franchisees Jason Gehrke writes:
Without ongoing stock from Kleenmaid to sell, the retail franchisees have no future under the Kleenmaid brand, and without Kleenmaid to co-ordinate warranty repairs and maintenance schedules, the service franchisees are 142 equally challenged. All franchisees will lose.14F
Franchisees’ ability to source alternative suppliers Some of the Kleins franchisees continue to occupy their sites, and are able to source alternative supplies. Finding alternative suppliers for fashion jewellery accessories, previously supplied to franchisees by a Kleins-related entity, is more feasible than contracting with alternative suppliers for Kleenmaid-branded products. Because Kleenmaid has its own brand of products, franchisees cannot source Kleenmaid goods from other suppliers.
Under Kleenmaid's franchise agreement, franchisees did not stock products in their stores, but operated showrooms featuring only display items.
139 Sue Mitchell, ‘Kleenmaid on Comeback Trail’, The Australian Financial Review (Sydney), 31 August 2009, 16. 140 Harper ‘Liquidators Sell off Kleenmaid Assets’, above n 138. 141 ASIC Funds Kleenmaid Probe (2009) Perth Now
Chapter 2: What is the problem and how big is it? 65 66
Customers could see the products and pay for them in store, but all payments were forwarded to the Kleenmaid national office, which would despatch the products to the customers' homes. Franchisees would generate their income through commissions paid to them by Kleenmaid, so long as those commissions were greater than the amounts franchisees were required to pay to Kleenmaid each month. Payments to Kleenmaid included advertising ($10,000), training and computer support ($2000) and rent. A clawback clause in the franchise agreement would require franchisees to repay commissions if a customer cancelled an order (if the commission had been previously paid). Even though sales proceeds went direct to the franchisor, between the required monthly payments and the potential for commission clawbacks from cancelled sales, it is possible for Kleenmaid franchisees to still owe the franchisor money at the end of a month. If this is the case, the administrators will be duty-bound to pursue all debts owed to Kleenmaid, even if it is from franchisees who are themselves owed money for sale commissions for a subsequent month. In other words, there will be no set-off where franchisees owe money to the franchisor, and the franchisor owes the franchisee money. The franchisees will be required to pay their debts to the franchisor in full, while at the same time standing helplessly in line as unsecured creditors waiting for the money 143 owed to them.142F
Communication between franchisees and administrators One Sydney-based Kleenmaid franchisee told [radio] 2GB's Ray Hadley he bought the franchise in November 2008, and became suspicious about the financial health of the group in December, only one month after the purchase. ‘I'm probably down $270,000 plus expenses’ he said. ‘I've heard nothing verbally from them since 144 November ... we still have not got official notification (of the collapse)’.143F
Franchisees’ ability to remain in premises In Stewart, in the matter of Kleins Franchising Pty Ltd (administrators appointed) (ACN 007 348 236) [2008] FCA 721 in support of an application to extend the time for the administration, the Administrator stated:
143 Ibid. 144 Anthony Klan, ‘Kleenmaid Kitchen Empire Sinks with $67m Debt’, The Australian (Sydney), 11 April 2009.
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In Australia there are 132 franchised stores … Each store is leased by TJC [The Jewellery Chain] from third parties. Each franchisee holds a licence from TJC in respect of their franchised store. Under each of the leases, the landlords are permitted to terminate and re-enter the properties on an event of insolvency, such as administration of the lessee. Some of the lessors have 145 issued notices to remedy the breach.14F
This means the landlords have started exercising their rights to terminate the leases for the retail premises leased by The Jewellery Chain Pty Ltd as the head lessee entity within the Kleins franchise network. Lacking privity of contract between themselves and the landlords, franchisees have no right to continue in occupation under the licences to occupy if the head lease is terminated by reason of the head lessee’s default.
The administrators stated ‘[n]o party (including employees, franchisees, lessors and retention of title claimants) will be detrimentally affected by granting an 146 extension of the convening period for the second meeting of creditors’.145F This statement serves to emphasize the lack of standing the franchisee have in insolvency. Existing franchisees’ responsible for liabilities that are best met by the franchisor trading well, will certainly be detrimentally affected by any protracted administration.
Some franchisees do find a way of making the most of the opportunities that a franchisor’s failure opens to them by forming a buyers group and continuing trading. This action was taken by former Great Australian Ice Creamery franchisees and some franchisees of one of the failed juice shop franchisors. Others re-brand and continue trading under a former competitor’s banner, however this may be difficult if a territory or suburb is already well serviced by a competitor franchisor.
2.3.1 ADDITIONAL IMPLICATIONS FOR FRANCHISEES STRUCTURED LIKE A COMMISSION AGENCY The franchisees of Kleenmaid and BHG were structured as commission agencies. In a commission agency the franchisee makes a sale to its customer; the customer then pays the franchisor and takes delivery of the product or service from
145 In Stewart, in the Matter of Kleins Franchising Pty Ltd (administrators appointed) (ACN 007 348 236) [2008] FCA 721 (20 May 2008) para [4]. 146 Ibid para [10].
Chapter 2: What is the problem and how big is it? 67 68 the franchisee. The franchisor then pays a commission to the franchisee. This 147 commission ‘is the only cash flow our [Allphones franchise] business has’.146F The franchisees’ vulnerability is expressed in the words of a director of franchisee Hoy Mobile Pty Ltd:
All moneys are deposited to the franchisor’s account and three times a month Hoy Mobile was to receive their percentage of the gross profits. All stock is supplied by the franchisor. When our second commission cheque 148 was not forthcoming …147F
Franchise agreements rarely provide for the franchisor to pay the franchisee interest on late payments, or for the franchisor to provide personal guarantees to franchisees. Franchisees operating under the commission agency model have no control over when the franchisor pays commission and minimal control over the customer base they have generated. They have no control over whether the franchisor pays its suppliers, which in turn will influence the franchisor’s ability to supply stock to the franchisees. If the franchisor fails it is the administrator and liquidator that have a list of each franchisee’s customers, not the individual franchisee.
2.4 FRANCHISEES FROM THE FRANCHISOR LIQUIDATOR’S PERSPECTIVE
The appointment of the franchisor’s liquidator triggers a change in the franchisee’s status from being an essential component of the franchisor’s business network, to a party to contracts that are evaluated by the liquidator as being either assets or liabilities. While the franchisor is solvent the franchisee has contractually enforceable rights backstopped by a range of other legal rights flowing from their standing as a consumer. The franchisee has no clear rights under insolvency legislation.
An administrator may be faced with tens, or sometimes hundreds of franchisees that see themselves as key stakeholders of the failed franchisor. Franchisees are widely dispersed geographically. Each is at a different stage in their business life- cycle and faces the prospect of a loss of a different magnitude. Each is a party to consequential contracts. Not all of these contracts are with the franchisor.
147 Commonwealth Senate, Opportunity not Opportunism, Joint Parliamentary Inquiry into Franchising (2008) 1 (Nicole Hoy). 148 Ibid.
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Franchisees will often be both creditors and debtors and may also have a contract or Trade Practices Act based claim they can bring against the franchisor.
Figure 3: Minimum estimated lost investment by franchisees in Australia 1990 - 2009. $60 )
$50 $million (
$40 franchises
y b $30
$20 investment
$10
Estimated lost $0
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Losses shown in Table 1 and Figure 3 are probably an order of magnitude higher. For many franchise networks there is no publicly available data. The data contained in Table 1 does not include legal fees, and does not take into account subsequent costs and collateral losses such as franchisees paying franchisors rental guarantees and meeting the government-imposed travel levy for the Traveland employees.
2.4.1 FRANCHISEE AS CREDITOR ‘Creditor’ is not defined in the Corporations Act.
149 In Selim v McGrath148F Justice Barrett concluded that in the context of a s 439A [Corporations Act] meeting, creditors were all persons who have, as against the company concerned, “debts” or “claims” provable in a winding
149 (2004) 22 ACLC 112, 128-9.
Chapter 2: What is the problem and how big is it? 69 70
up. He said the boundaries were those set by s 533 [Corporations Act] which 150 are very wide.149F
Traditional suppliers of debt finance such as banks are categorised as creditors in insolvency and have had the opportunity to take security, and to price their loans accordingly. Traditional suppliers of equity finance, shareholders, have taken the risk of the entity becoming insolvent knowingly and on the basis of information supplied in a prospectus that has met rigorous standards.
Unless a franchisee is a creditor, there is no room in Australia’s insolvency regime for the franchisee to have a voice in the franchisor’s insolvency, far less a share of the insolvent’s estate. Typically, there are four situations that might place a franchisee into the position of being a creditor, generally unsecured, in a franchisor’s insolvent estate. These are:
First, in some franchise networks the franchisee is remunerated by commission 151 payable by the franchisor.150F For example, in travel agency franchises part of the franchisee’s revenue stream is from the sale of airline tickets. If the airline is the parent company of the franchisor (as Ansett airlines was for the Traveland franchisees) it will owe the travel agent franchisee commission on ticket sales.
Second, the franchisee may be a creditor if, for example, goods that were supplied by the franchisor are returned under warranty by the franchisee’s customers. An example is jewellery supplied by Kleins.
The third instance when the franchisee may be a creditor of the franchisor is for moneys payable by the franchisor pursuant to a concluded dispute. Where the conclusion has been that the franchisor owes the franchisee settlement money, the sums could be substantial.
A fourth category when a franchisee may be a creditor of a franchisor is where the franchisee has to pay its premises rent to the franchisor, that then pays the landlord. On receiving the rent from the franchisee the franchisor is the trustee of the
150 Michael Murray, Keay’s Insolvency: Personal and Corporate Law and Practice, (6th ed, 2008) 531. 151 No empirical research has been conducted on the direction of money flow between franchisors and franchisees. Most franchisees collect payment from their customers and pay royalties to franchisors but some franchisor/franchisee relationships are structured like commission agencies with the franchisor being paid by the franchisees’ customers, and the franchisor then paying franchisees commission.
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funds pending payment to the landlord. This is common, as shown in models 3, 4, 5, 7 and 9 at 3.1.3.
The sums of money owed to the franchisee as a creditor under the above arrangements, with the possible exception of the third instance, are a small proportion of the franchisees’ total investment. For the remainder of its investment the franchisee is not a recognised creditor. The question ‘what rights did you have in the franchisor's liquidation?’ elicited one unexpected response as one franchisee was a secured creditor of the franchisor. The CPA Study did not permit exploration of this response. The remainder were unsecured creditors (56 per cent) or had no status at all in the insolvency (33 per cent). Unsecured creditor status places franchisees well behind the franchisor’s employees in terms of priority.
If the franchisee is not a creditor in relation to a specific sum, liquidators 152 sometimes ‘put franchisees in for a dollar each’.15F This secures the right for each franchisee to exercise one vote at the creditors’ meeting where votes are exercisable by creditors on a pro-rated basis to the size of the debt they are owed. It is not difficult to see how franchisees would quickly be out voted by secured creditors. Table 1 shows the amount of money some failed franchisors owed creditors.
If a franchisee is invited to a creditors’ meeting this puts them in direct communication with the liquidator. Anecdotal evidence from discussions with liquidators is that they do include franchisees in early creditors meetings. The response to the question: ‘were you invited to the creditors' meeting of your franchisor?’ was that the 33 per cent who had no recognized status answered ‘not applicable’. Fifty seven per cent answered ‘no’. These experiences contradict the liquidator’s account of their approach and merit further investigation.
2.4.2 FRANCHISEE AS DEBTOR The appointment of an administrator to a franchisor signals a sea change in the franchisor/franchisee relationship. The franchisor becomes a debtor to its creditors and the franchise agreements become assets or liabilities. Franchisees remain parties to the franchise agreements. Payments due by the franchisee to the franchisor continue to be payable, as do payments by the franchisee to third parties. Franchisees
152 Interview with Liquidator, (Sydney), 2005.
Chapter 2: What is the problem and how big is it? 71 72 trading within franchise networks that are structured like commission agencies will also be debtors – in relation to advertising levies, royalties and other periodic payments.
In some situations the franchisee guarantees the performance of the franchisor 153 under the head lease.152F Being a guarantor would make the franchisee liable for moneys owed to the landlord if the franchisor defaulted on its obligations under the head lease, but would not guarantee the franchisee the right to lease the site if the head lease was disclaimed by a liquidator.
With franchisees’ collateral liabilities in mind, it is interesting to see what approach financiers take to their franchisee customers’ funding needs. In the UK:
Typically 3 in 5 franchisees needed to borrow money when starting up their business. Needless to say, the amounts borrowed vary greatly between different franchises. The mean amount borrowed in this year’s study is £44,700. … As might be expected, the need for specific business premises is a significant driver of borrowing. Those who require specific premises for their operation needed an average of £54,500 compared to the £14,000 among those not needing specific premises. By far the most common source of finance is retail banks, which provided finance to 85 per cent of those 154 borrowing.153F
The CPA Study participants were asked three questions about their borrowing for the business. To the question: ‘how did you finance the purchase of your franchise?’ 62 per cent answered that they financed from savings, 25 per cent borrowed from a bank and the remainder used a combination of savings and loans. These proportions are probably a reflection of the small sample size in the CPA Study and the fact that most subjects did not operate from retail shopping centre premises, rather than being a true reflection of the pattern of funding franchise purchases in Australia. Questions in relation to borrowings showed that where franchisees did borrow, 22 per cent borrowed 80–100 per cent of the total investment cost. These borrowings were secured by a mortgage over the franchisee’s home.
153 For example: Neldue Pty Ltd v Moran & Ors [2004] WASC 100; Loyal No 46 v Miller [2001] FMCA 30. 154 British Franchise Association United Kingdom, Franchise Survey (2004) 37.
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2.4.3 FRANCHISEE AS POTENTIAL LITIGANT If franchisees are contemplating litigation, or have not yet had their case heard, they find that ‘[o]n the appointment of an administrator or liquidator, there is a stay of proceedings so that no action or other civil proceedings may be begun or 155 continued against the company without the leave of the court’.154F
Franchisees do not want their franchisor to fail. They are aware that litigation would impose a significant cost burden on the franchisor. There is anecdotal evidence that, rather than risk making their franchisor financially vulnerable, some franchisees make a conscious decision not to litigate against their franchisors.
There are often franchisees who will not mutiny against the franchisor, no matter what level of provocation exists. Most systems contain, amongst the franchisees, family members, franchisees on ‘special deals’ or who believe they are on special deals, and some that are financially bound to the 156 franchisor.15F
A contract is executed at the conclusion of successful mediation. The contract may be disclaimed by a liquidator. If litigation has been concluded and a judgment entered against the franchisor, but the judgment debt is not yet paid, creditors cannot enforce any judgments or orders they may have obtained against the debtor (being a corporation operated by a voluntary administrator or liquidator); and other legal proceedings many not be brought or pursued against the corporation without the 157 leave of the court.156F
2.4.4 CHALLENGES FACING THE LIQUIDATOR When it comes to companies going bust, the insolvency of a franchise is usually about as shambolic as you can get. Of all insolvency matters, the most difficult is the failure of a franchise group… There are always problems with the Franchise Code, always leasing problems and unforeseen 158 third party issues.157F
155 Above n 89 at pp. 283 and 487. The relevant legislation is Corporations Act ss 440D, 471(2). (See Ibbco Trading Pty Ltd v HIH Casualty and General Insurance Ltd (2001) 19 ACLC 1093). 156 Interview with Australian Franchise Lawyer/Mediator Philip Linacre (Telephone interview, 11 August 2006). 157 Corporations Act 2001 (Cth) s 471B 158 Binning, above n 9, quoting David Cowling, insolvency partner with law firm Clayton Utz, (then Vice-chair of the IBA’s Section on Insolvency and Creditors Rights.)
Chapter 2: What is the problem and how big is it? 73 74
Liquidators have duties under the Corporations Act. This does not include duties to franchisees. Theoretically, in Australia there is nothing to stop a liquidator 159 selling the franchisor’s business to a direct competitor158F of the franchisor. It is unlikely that an acquisition would meet the threshold merger test of, ‘having the effect, or be likely to have the effect of substantially lessening competition in a 160 market,159F that must be met before a merger of two franchise networks would risk being closely examined by the ACCC and potentially prevented from occurring. That direct competitor may elect not to buy the franchise agreements but, instead, to simply buy the brand and shelve it.
Other factors that impact on how individual franchisees fare include the financial climate at the time of the failure and the suitability of the buyer:
Sale of the [franchisor’s] business may subject the franchisee to the control of a company unfamiliar in the area and incapable of running the business profitably. The dramatic demise of Traveland [franchise subsidiary of Australia’s former Ansett Airlines] demonstrates the implications of a buying entity that has little experience in the franchisor’s core business area 161 and has insufficient expertise or resources to support the business.160F
In the short term, the most appropriate way for prospective franchisees to mitigate against the possible harmful effects of their franchisor becoming insolvent is to ‘attempt to structure his or her affairs to ensure minimum personal liability and flexibility in keeping or restructuring the business in the event the franchise business 162 fails or alternatively the franchisor becomes insolvent’.16F Realistically, the opportunity to do so depends on the franchisor’s willingness to negotiate, the franchisors policies regarding matters such as whose name the premises lease is in, and the franchisee’s ability to negotiate.
159 Trade Practices Act 1974 (Cth) s 50 prohibits acquisitions that would result in a lessening of competition. 160 Trade Practices Act 1974 (Cth) s 50(1). 161 Jenvey, above n 123, 9. 162 Steven H Goldman, Tackling Troublesome Insolvency Issues for Franchisees (2003) Unpublished 3-6
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One liquidator’s experience led him to observe: ‘I am only guessing, but very few [franchisor] companies survive the administration, whereas many franchise 163 systems would survive in a new company set-up’.162F
Colraine suggests:
Renegotiating the franchise agreements in order to support the franchise and preserve goodwill may be a possibility. Financing the franchisor could be considered if the franchisor’s primary lenders were willing to engage in 164 reorganizations outside formal proceedings.163F
Intellectual property rights, as noted at 3.2.2, can pose problems for administrators selling a franchise network. For example:
[t]he sale of Queensland-based On Time Business Solutions, [with 17 franchised stores] trading as On Time Copy Centres … was subject to the delivery of intellectual property rights which had been assigned last December. On Time Business Solutions (On Time) had sold the rights to on Time Business Holdings. … On Time which entered into voluntary administration in February was sold to Ausdoc on Demand in May for $1.1m. AusDoc managed the chain while the administrators sought to regain 165 the intellectual property rights.164F
The intellectual property included the business name and trade mark, without which the businesses would have to re-brand and may be exposed to competition from the current owner of the business name and trade mark.
2.5 CONCLUSION
Implicit in the decision to buy a franchise is the belief that the network has a proven ‘product’. Clearly, though, the network is not always proven, and not all franchisors are strongly motivated to ensure that their franchisees’ businesses thrive.
163 Jenny Buchan interview (Sydney, face to face interview in liquidator’s office) (2005). 164 Colraine, above n 105, 6. 165 ‘Sale Finalised’ Inside Retailing (Sydney), 21 August 2000.
Chapter 2: What is the problem and how big is it? 75 76
The Government report titled ‘Opportunity not opportunism: improving 166 conduct in Australian franchising’ (‘Opportunity not opportunism’)’165F has acknowledged that this may not be satisfactory and has recommended:
That the government explore avenues to better balance the rights and 167 liabilities of franchisees and franchisors in the event of franchisor failure.16F
As a result of the numerous assumptions on which franchise law is currently founded, the market fails franchisees of franchisors that are in administration for a number of reasons. These include that:
It is impossible in some franchise networks for franchisees to conduct adequate pre-commitment due diligence – because of the structure of the franchise network and gaps in the publicly available data.
Due diligence on the scale a franchisee can realistically conduct can at best shed light on the past and present – it will not reveal the future.
Franchisees and their legal advisers believe the agreement and the disclosure document that must be provided by the franchisor to comply with the Code contain most of the key information they will be basing their purchasing decision on – it does not.
The franchisee starts down its path to franchising as a business consumer. On signing the franchise agreement, most of its rights to receive consumer protection are derived from pre-contractual conduct by the franchisor. At that point the franchisor was probably, though not invariably, solvent.
Franchisor failure is common enough, as the list of failed franchisors in Table 1 demonstrates, and it has a profound effect on the parties to be included in the template franchise agreement as originally drafted, but seldom is. Franchise agreements are standard form, exploitative contracts and thus not negotiated. They are assumed to be able to adapt to the evolving franchisor/franchisee relationship. Trusting a contract to adapt to administration or insolvency is naïve.
166 Joint Committee on Corporations and Financial Services, Australian Senate, Opportunity Not Opportunism: Improving Conduct in Australian Franchising (2008). 167 Ibid Recommendation 4 (para 6.40) xv.
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The failure to accommodate a franchisee in insolvency is at odds with the ability to self protect and the recognition accorded by the business failure laws to other parties that take the same risks in a non franchised business.
Behavioural economic issues weigh adversely on prospective franchisees. These include the environment of selling the franchise, the timing of the provision of information to prospective franchisees, the fact that franchisees are psychologically committed to one franchise opportunity before they have signed a franchise agreement and could still walk away, the lack of emphasis on the level of commitment that accompanies signed franchise agreements and ancillary contracts, and the over-emphasis by the franchisor on the benefits of being part of a winning team. Some of these issues are pursued in chapter 3.
The franchisee has no control over how the franchisor conducts its business. The franchisor may chose to sell its business, sell parts of its business, encumber assets or transfer assets such as trade marks into related or unrelated entities beyond the reach of the franchisees and of liquidators. Franchisors may actively engage in a course of action that leads to administration or insolvency and neither franchisor, nor administrator nor liquidator is accountable to the franchisees for consequences that flow through to the franchisees. The appointment of a liquidator to the franchisor’s business signals a radical change in the franchisees’ legal position. Unlike employees, lenders, debtors and shareholders, there is no clear way forward for franchisees.
We now move to chapter 3 where the problems that flow from franchisor failure are analysed in the context of the franchise network, the franchise agreement and contract law, and the numerous asymmetries that impact on the franchisor/franchisee relationship.
Chapter 2: What is the problem and how big is it? 77
Chapter 3: The problem in context
New policy initiatives should flow from a ‘clear identification of the nature and 168 169 source of the underlying problem’.167F Currently, outdated assumptions168F inform franchise law and practice and have a detrimental effect on the development of legal responses to the challenge of levelling the playing field for franchisees as business consumers. The problems franchisees encounter when their franchisor fails emanate from several sources. In this chapter the sources of the problem are identified. This is necessary as describing and treating the 21st century franchise relationship as one between a franchisor and its franchisees is too simplistic. Until the franchisor/franchisee relationship is placed in its fuller legal context, any solutions to the treatment of franchisees whose franchisor fails will miss their mark. This chapter is set out in the following way.
At 3.1 the recent development of the business format franchising model is set out. At 3.2, the structure and roles of the component parts of the 21st century franchise network are identified. Specifically, two significant components of the franchisees’ business are the registered trade marks, and the premises lease. With access to the franchise brand and the premises they trade from, the franchisees may be able to regroup and survive if the franchisor becomes insolvent. Without access to both elements the survival of the franchisee’s business is unlikely. Research discussed at 3.2.2 and 3.2.3 reveals significant variations from one franchise network to another. The variations lead to different possible outcomes in insolvency. At 3.2.4 franchisees, their personal profiles and the roles and risks they accept are summarised. Finally, at 3.2.5 and 3.2.5 franchisees are compared with suppliers to, or employees of, a company that is in administration or being wound up. This
168 Australian Government Productivity Commission, vol 2, above n 4, 46. 169 For example: (i) underlying the need for franchisors to disclosure only the health of ‘the franchisor’ is that the franchisor is the only important franchisor-controlled entity in the network; (ii) franchisees cause franchisors to fail; (iii) franchisees are able to conduct adequate due diligence; (iv) franchise agreements are negotiable and are not standard form consumer contracts – this last assumption was put firmly to rest by Spencer in The Regulation of the Franchise Relationship in Australia: A Contractual Analysis, above n 14.
Chapter 3: The problem in context 79 80 comparison with two parties that have long enjoyed defined rights in the franchisor’s insolvency serves to highlight the fact that consumer protection law nor insolvency law have not yet adapted to accommodate franchisees as fully as they might.
At 3.3 the inability of contract law to deal with the problem will be addressed and at 3.4 the asymmetrical environment in which the franchisee gathers and processes information about the prospective franchise, and then conducts its business, is examined.
By the end of chapter 3 it will be clear that the franchisee occupies a small but significant role in a large network. The role includes functions that would be performed by third parties, such as employees and suppliers that are currently accommodated in the insolvency regime; but franchisees that occupy these roles are unwittingly unprotected. Once the problem of providing protection for franchisees whose franchisors fail is placed in the context of the franchise network, it is clear that a solution will not evolve through precedent. Further, a solution is required for the franchise model to remain attractive.
3.1 DEVELOPMENT OF BUSINESS FORMAT FRANCHISING
The current business format franchising model grew out of western society’s changed needs and patterns at the end of World War II. This is demonstrated in the response in two countries with a strong franchising culture; France and the United States. In France, the post-war challenge of rebuilding infrastructure led manufacturers to appoint franchisees to rebuild retail outlets throughout the country, allowing the manufacturer to focus its resources on rebuilding its manufacturing capacity. In the United States, the same post war period created the opportunity to revise work models. Production lines were converted from making tanks to manufacture of cars. Once cars became common the suburb and ultimately the suburban shopping mall became commonplace too. ‘Franchising grew out of servicing these thousands of new suburbs which were coming into existence all over 170 America. … about 50 years ago, in 1947-48’.169F
170 Standing Committee on Industry, Science and Technology, House of Representatives, Fair Trading Inquiry (1996) Mr Atchison (Great Australian Ice Creamery franchisor). Mr Atchison had experienced ‘20 years in ice-cream and 14 in franchising. In fact, we have 87 outlets in Australia, and one lonely outlet in Beijing’ at the time of this evidence. Great Australian Ice Creamery started franchising in 1982 and became insolvent in 1998, at which time it had 62
80 Chapter 3: The problem in context 81
Since the post-1945 development, the business format franchising model has flourished and expanded globally. As franchisors grow their brand, and opportunities 171 present themselves, many franchise networks become multi-national.170F Evidence is supplied by the ever-increasing number of international jurisdictions in which franchise lawyer members of the American Bar Association (ABA) request local 172 franchise counsel recommendations through the ABA’s forum on franchising.17F
A sizeable contribution to a nation’s economy may be made by businesses conducted through the business format franchising model. Over the 2004-5 financial 173 year, estimated sales through franchise systems reached US$1.53 trillion172F in the United States, £13 billion in the United Kingdom, US$142 billion in Japan, 174 US$5billion in Malaysia and AU$111.2 billion in Australia.173F
3.2 COMPONENTS OF 21ST CENTURY FRANCHISE NETWORKS
Franchise networks are perfect examples of ‘organizations [being] simply legal fictions which serve as a nexus for a set of contracting relationships among 175 individuals’.174F To gain a clear understanding of how and why franchisees fare so poorly if the franchisor becomes insolvent one must first ‘unpack’ the franchise organisation, identify the individual contracting entities and explore their roles. It is then possible to trace each contract and each obligation into the insolvency and analyse all from the perspective of the franchisee-consumer.
franchisees.
Chapter 3: The problem in context 81 82
Although franchisees own their own businesses, they are part of a much larger 176 organisation and are not free to develop their own ideas or to ‘go their own way’175F to the extent that an agent, distributor, supplier or even a manager, could. The trade- off franchisees make for their lack of independence is the opportunity to build a business and make money in a secure environment. The inter-related nature of the franchisor’s and franchisee’s business together with the pattern of contractual relationships that bind the franchise network together are strengths that become weaknesses for franchisees when a franchisor fails.
Franchise relationships that begin simply rapidly become complex. Complexity arises as the franchisor expands to other jurisdictions, is bought by a larger entity, or as specific functions are transferred to related entities in the franchisor’s network. Tastee Freez provides an American/Australian example of the speedy growth of a franchise network and its accompanying complexity. The franchisor’s failure to register its trade mark in Australia in a timely way led to Aston v Harlee Manufacturing Co (‘Tastee Freez’) [1960] HCA 47; (1960) 103 CLR 391. In Tastee Freez, Fullagar J documented the growth of Tastee Freez, a typical franchise and identified some of the constraints placed on franchisees:
Harlee was incorporated in Illinois in February 1950. Mr. L.S. Maranz, its president … coined the name "Tastee Freez" ... Harlee … built up an extensive business in a comparatively short time. … Each franchise holder is assigned a specific territory. In this territory the franchise holder sets up operators in stores which are in nearly all instances of a specific design that are built in accordance with plans and specifications supplied by Harlee Manufacturing Company. Each store carries a roof sign bearing the "Tastee Freez" mark in the specific logo type adopted by Harlee Manufacturing 177 Company for its mark.176F
As Harlee, through Tastee Freez demonstrates, franchising is a way of building an extensive business quickly, under a common brand and format. Within two years of incorporation of the franchisor there were 315 Tastee Freez stores, and within seven years, 1778 franchised stores in the USA. Franchisees were required to adopt common trade dress in their stores and to lease freezers and feeding devices patented
176 Tanya Woker, ‘Franchising – The Need for Legislation’ (2005) 17 South African Mercantile Law Journal 50. 177 Aston v Harlee Manufacturing Co (‘Tastee Freez’) (1960) 103 CLR 391, 396.
82 Chapter 3: The problem in context 83 and owned by the franchisor. They were required to purchase a mix made from a franchisor-owned formula. The dry ingredients for the mix were supplied only by one source, selected by the franchisor.
The franchisor thus has a ‘captive’ market of franchisees contractually bound to purchase and sell its products and to use its inventions. Doug Frazey identifies the ‘captive’ market role that franchisees experience as a
structural inevitability of late 20th and early 21st century franchising the fact that the franchisee may depend on the franchisor not only for materials essential to the business, which the franchisee can often only purchase through the franchisor [as was the case in Tastee Freez], but also for 178 premises and finance.17F
When Tastee Freez was formed, the legal structure of the franchisor’s side of the network was simple. Only two legal entities were involved, Harlee Manufacturing Company and Tastee Freez International Ltd. This is in contrast to today’s franchisors which may provide the items identified by Frazey through up to 179 40 legal entities.178F
Franchisees depend on the continued sound operation of their franchisor.
[D]espite the degree to which the franchisee depends on the franchisor, the franchisor is generally not bound to respect the reasonable expectation of the franchisee that, in return for its dependence, the franchisee can continue to 180 operate as long as it [does not breach its franchise] agreement.179F
3.2.1 FRANCHISOR Before starting the franchise network, the franchisor identifies a business opportunity and pilots and documents the business that will be offered to franchisees. The franchisor prepares a disclosure document and drafts a franchise agreement. The franchisor then recruits and appoints franchisees. It makes disclosure to the franchisees, who then sign the franchise agreement. It also supports franchisees as
178 Frazey, above n 100, 728 quoting ABA Antitrust Section: Monograph No 17, Franchise Protection: Laws Against Termination and the Establishment of Additional Franchises 19 (1990). 179 See Appendix A of this thesis. 180 Frazey, above n 100, 728 quoting David Hess, ‘Comment, The Iowa Franchise Act: Towards Protecting Reasonable Expectations of Franchisees and Franchisors’ (1995) 80 Iowa Law Review 333, 355.
Chapter 3: The problem in context 83 84 they develop their business following the franchisor’s procedures. Over time the franchise network evolves, is refined and updated.
The franchisor establishes a business that performs many functions. It is possible for the franchisor entity itself to conduct all functions that support the franchisees. The only network function that is not able to be performed by a franchisor or one of its related entities, is ‘franchisee.’ It is common, however, for the ‘franchisor’ functions to be spread across several legal entities. Some of the entities may be truly independent of the franchisor; others may meet the test of 181 related entities under Corporations Act s 50.180F
These franchise network support functions may include: recruiting franchisees, conducting franchisee training, exploring future directions for the network, owning and managing the intellectual property assets that the franchisees are licensed to use, negotiating and entering into leases of premises the franchisee will occupy, designing 182 and fitting out the franchisees’ premises, providing franchisee finance18F or negotiating relationships with financiers who will offer preferred treatment to franchisee applicants They also include sourcing and negotiating contracts for the supply of items of plant such as pizza ovens or cash registers, and stationery such as pre-printed courier package labels, sourcing and supplying via import, manufacture or distribution, the stock that the franchisees will sell to customers, and delivering stock to franchisees.
Each franchise network is uniquely configured. Anecdotal evidence suggests that in the early days of franchising, the franchisor’s related entities were not nearly as numerous and the franchise networks not as complex as they are today. For 183 example, in the Barbara’s House and Garden litigation182F in 1987, the franchisor was the only party being pursued by the franchisee and the franchisees’ directors. The
181 See Appendix A of this thesis. 182 Bakers Delight Media Relaease, Unique Business Opportunity for Young Guns (2009)
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ASIC records show that there were four companies in the Barbara’s House & Garden 184 group.183F Similarly, there were two entities in the Tastee Freez franchise.
In contrast, franchise networks have now become complex webs of interdependent companies. The franchisor benefits from its ability to structure the network through a number of entities. ‘Diversification on the part of owner-managers [directors of the franchisor] can be explained by risk aversion and optimal portfolio 185 selection’.184F The franchisor’s directors take legal advice that it is desirable to protect some business or personal assets, for instance a suite of registered intellectual property assets, or the franchisor’s family home, from the risk of having to be sold to meet a judgment against the franchisor. They structure the franchise network and manage their personal exposure to loss accordingly.
The legal structure of failed franchisor Kleenmaid is set out by way of example in Appendix D. The solvent Pets Paradise franchise network is a network whose basic structure is an example of a typical 21st century business format franchisor. It is outlined in Pampered Paws Connection Pty Ltd (ACN 116 460 621) v Pets Paradise Franchising (Qld) Pty Ltd (ACN 054 406 272) (No 3) [2009] FCA 138 (‘Pets Paradise’). There, franchisee applicants were each dealing with several of the eight different legal entities that made up the franchisor and its related entities. In describing the role of each entity Justice Mansfield stated:
The first to sixth respondents [Pets Paradise Franchising (Qld) Pty Ltd, Pets Paradise Franchising (SA) Pty Ltd, Pets Paradise Franchising (NSW) Pty Ltd, Global Pet Productions Pty Ltd, Pets Paradise (Franchising) Pty Ltd, Pets Paradise Pty Ltd] are said to be trading corporations with their holding company being the seventh respondent [Paradise Retail Holdings Pty Ltd]. The sole director of all the corporate respondents is the eighth respondent [Gary Diamond]. The eighth respondent is also said to be the managing director of each of the respondents. Hence, each of the corporate respondents
184 It is acknowledged that there may have been other related entities whose name did not include the clause Barbara’s House & Garden and which thus did not appear on the ASIC search. 185 Jensen and Meckling, above n 21, 349.
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is a related corporation for the purposes of s 50 of the Corporations Act 2001 186 (Cth).185F
and
Each of the respondents, that is the corporate respondents, is said to be implementing part of a system through the instruction of its director, the eighth respondent, and as part of the overall system of which they are a member through their proprietorship by the seventh respondent and the 187 control over all of the eighth respondent. 186F
In Pets Paradise, Justice Mansfield outlined the role of each of the eight entities in the franchisor controlled part of the franchise network:
Each of the first three respondents is said to carry on business in Queensland, South Australia and the Northern Territory, and New South Wales respectively … granting Pets Paradise franchises – and each also operated retail businesses providing pets and pet accessories under that name. The fourth respondent is the supplier of goods to operators of Pets Paradise businesses. The fifth respondent is the author and proprietor of intellectual property rights … and provides support services by way of legal services, copies of documents … to prospective franchisees and franchisees, and from time to time receives payment of franchise fees and legal fees. The sixth respondent is said to be the proprietor of a series of four registered trade marks in relation to categories of pets and pet accessories, and licenses the use of those trade marks to the first, second and third respondents to enable them to sub-license the use of those trade marks to franchisees. It also assumes liability pursuant to hire purchase agreements to make payments in respect of fixtures and fittings used in the operation of retail businesses which are guaranteed by one or some of the other respondents. It also receives, and presumably assesses, preliminary franchise agreements from prospective franchisees.
186 Pampered Paws Connection Pty Ltd (ACN 116 460 621) (on its own behalf and in a representative capacity) v Pets Paradise Franchising (QLD) Pty Ltd (ACN 054 406 272) (No 3) [2009] FCA 138 para 14 (Mansfield J). 187 Ibid para 21.
86 Chapter 3: The problem in context 87
The seventh respondent operates, it appears, as a form of head office. It is said to provide legal services, accounts and management staff for the group, including for the purposes of making representations to and dealing with franchisees on its own behalf and on behalf of the first, second, third and fourth respondents. …, the eighth respondent directly manages the carrying on of the business of each of those corporate respondents by means of daily control and direction 188 of, and participation in, their respective business activities.’187F
There are up to 100 Pets Paradise franchisees throughout Australia. The franchisee executes a franchise agreement with the entity named as franchisor. In a network such as Pets Paradise, the franchisee will subsequently be required by the franchisor to enter contracts with several of the entities related to the franchisor. This will be demonstrated through an explanation of retail leases within the franchise network in chapter 3.2.3.
In addition to related entities, the franchisor will have negotiated arrangements with non-related entities that the franchisee must deal with. For example, Budget Shop Fitting fits out Pets Paradise franchisee shops. The franchisees are required to pay an ongoing royalty for use of the shop fitters’ pet pens. Similarly, in the Bakers Delight Holdings Ltd franchise network (‘Bakers Delight’), franchisees are required to order key products from entities unrelated to Bakers Delight as is described in the 189 Bakers Delight notification to the ACCC18F by which Bakers Delight secured the regulator’s consent to require franchisees to acquire certain key products only from approved suppliers.
Business entities that form part of the franchisor’s group of entities but do not carry the title ‘franchisor’ do not have to make disclosure to prospective franchisees (except in relation to intellectual property rights). Yet the failure of any of these related entities can have an effect on the solvency of the franchisor, and thereby impact the franchisee. The identity of only two of the 51 entities in the Kleenmaid network, being the ‘franchisor’ and the owner of the Kleenmaid trade mark, would have been included in the disclosure provided to incoming Kleenmaid franchisees.
188 Ibid paras 24–30. 189 Notification N92536 under s 47 Trade Practices Act 1974 (Cth) < http://www.accc.gov.au/content/index.phtml/itemId/750777/fromItemId/729985> at 17 June 2010.
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This demonstrates what little information a franchisor must provide to a franchisee about a network in order to satisfy the disclosure provisions of the Code.
Moving the focus from the franchise network to the specific franchisor, in 2006, 70 per cent of the entities identified as the ‘franchisor’ in Australia were 190 proprietary companies, 14 per cent public companies and 10 per cent trusts.189F
Where a franchisor is owned by a public company, the company’s published reports do not contain meaningful information about the franchise division. This is exemplified by the limited amount of information about franchisors’ intangible assets, discussed at 3.2.2.
If the franchisor or some of the entities in the franchisor’s network are set up as trusts, the issue confronting a prospective franchisee becomes not one of the prohibitive cost of obtaining information about the franchisor and its related entities, but the impossibility of obtaining information about the true identity of the franchisor. For example in Australian Competition and Consumer Commission v Chaste Corporation Pty Ltd (In Liquidation) (ACN 089 837 329), Braddon Ralph Webb, Orlawood Pty Ltd (ACN 059 294 334), Peter Clarence Foster, Sean Petrie Allen Cousins, Kevin Anthony McMullan, Alan Kenneth Cooper, Stephen D’alton, Qud 252 of 2001, Lander J in the Federal Court in Queensland observed:
Chaste was entirely controlled by the fourth respondent, Mr Foster and the second respondent, Mr Webb, and those two gentlemen, through the [trusts] which they controlled, namely WMMT and WFDT would receive respectively 75 per cent and 25 per cent of the profits. As far as a bystander [eg: franchisee] was concerned, Chaste was entirely controlled by Mr Webb. No bystander could have known that there were agreements in place between the second and third respondents and the fourth respondent, and an entity controlled by the fourth respondent which gave control of Chaste to Mr 191 Foster.190F
190 Frazer, Weaven and Wright, Franchising Australia 2006, above n 11, 34. 191 Australian Competition and Consumer Commission v Chaste Corporation Pty Ltd (In Liquidation) (ACN 089 837 329), Braddon Ralph Webb, Orlawood Pty Ltd (ACN 059 294 334), Peter Clarence Foster, Sean Petrie Allen Cousins, Kevin Anthony McMullan, Alan Kenneth Cooper, Stephen D’alton, Qud 252 of 2001 [22], [24].
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Performing due diligence It is assumed that a franchisor issuing a disclosure document under the Code will be solvent. Of concern for incoming franchisees is that several of the franchisors in Table 1 were subsequently found to have been offering franchises for sale despite 192 the directors knowing the franchise network was insolvent.19F
It is also assumed that before committing to the purchase, franchisees will double-check any important statement the franchisor has made, including the solvency statement provided as disclosure Item 20. A popular view of due diligence 193 propounded by non-lawyer industry figures like Jason Gehrke192F is that:
… franchisees … don't know what due diligence is and may have never heard the term before. They may figure due diligence is something that is expensive and complicated and therefore done by the lawyers or other professional advisors that they might engage to handle "the paperwork" of the sale. … Due diligence is no more complicated than looking at the facts of 194 a deal from all angles to make sure they stack up.193F
A franchisee reading Gehrke’s comments would be excused for concluding that conducting effective due diligence is lay person’s work, and is quick, easy, cheap and will reveal all that needs to be known about a franchise investment. This prejudices the intending franchisee against being prepared to pay their legal and accounting advisers to conduct thorough due diligence.
Thorough due diligence is expensive and will reveal areas where the information to substantiate the material disclosed cannot readily be obtained, and if obtained, cannot be objectively tested. It will give rise to further questions that the franchisor should be prepared to answer candidly. Attempts to obfuscate by the
192 For example, Dan Minchin, ‘Pets Chain Creditors out in Cold’, The West Australian (Perth), 2 December 1996 reported of Wonderland of pets franchisor that ‘the companies value of assets is estimated to total $A62,216 while the combined liabilities is $853,277; Mr. Conlan’s report also states that both the companies were trading while they were insolvent’. Nick Butterly, ‘Northbridge Gym Fails Fiscal Test’, Sunday Times (Perth), 11 July 2004, 55. ‘I think the company has been insolvent for quite a while prior to appointing administrators’ [administrator] Mr. Lopez says. 193 Director of franchise advisory and training company The Franchise Advisory Centre, Franchise Media Commentator on smartcompany.com, then Member of the Board of the Franchise Council of Australia, Adjunct Lecturer in Franchising at Griffith University. 194 Jason Gehrke, Franchise Tips and Trends (2009) Smartcompany
Chapter 3: The problem in context 89 90 franchisor should ring alarm bells for the franchisee, but by this time many are psychologically committed.
It can be difficult, if not impossible for the franchisee to conduct thorough due diligence to test or verify what the franchisor has told them, or to provide context for the information provided in the Code-mandated disclosure. For example when franchisors and their shareholders are structured as trusts; the nature of a trust means that it is impossible to conduct independent due diligence about it. The only source of further information available to the intending franchisee is the franchisor itself.
Regardless of the number of entities in the franchisor’s network, the franchisor is the key entity that makes disclosure. Limited disclosure is provided in relation to intellectual property rights and retail leases. The number of entities in some of the failed networks is recorded in Table 1: Australian failed franchisor data. Even if the franchisee became aware of others, the more entities there are, the more expensive, difficult and possibly meaningless it becomes for prospective franchisees to conduct robust due diligence.
Because of the difficulty and cost of accessing more information, the franchisee has either to accept what the franchisor discloses at face value, ask more questions and hope the franchisor provides full answers, or walk away.
195 In Australia, franchise networks range in size from one to 2,950 units.194F A franchisee buying into a large and well established franchise network could be forgiven for relying heavily on the reputation of the brand rather than conducting thorough due diligence. This theme is revisited in chapter 3.2.2 under the heading ‘overseas brands and due diligence’.
As discussed in chapter 3.3, regardless of what the franchisee’s advisers discover about the franchise network, no amount of due diligence will enable the franchisee to have the franchise agreement amended.
3.2.2 TRADE MARKS Trade marks are the most visible of the franchisor’s intellectual property assets, providing ‘information to the consumer [both franchisees and their customers]
195 Frazer, Weaven and Wright, Franchising Australia 2008, above n 7, 25.
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196 regarding the quality and source of the product that reduces search costs’.195F US franchise law practitioners and former Subway franchisees, Steinberg and Lescatre, write:
the nature of franchising is that the franchisee is “buying” something that the franchisee can never sell, specifically, the trade marked “name on the door” and such support as the franchisor chooses to provide. Unsophisticated buyers of franchises fail to realize the implications of the fact that they are 197 licensing a trade mark.196F
Franchisees rely on the licence purchased from the franchisor to use, amongst other things, the franchisors’ trade marks, further adding to the brand’s recognition and value. Given the importance of brand recognition, it would be logical for franchisors to register their trade marks. Some franchisors also register patents and designs. These are not as universally recognised as part of the franchisor’s brand. An examination of the property rights aspects of trade marks is sufficient to demonstrate the franchisees’ vulnerability, especially in the franchisor failure scenario.
Registration under the Trade Marks Act 1995 (Cth) The Commonwealth (of Australia) has enacted a number of statutes to regulate intellectual property pursuant to x 51(xviii) of the Constitution. The Trade Marks Act 1995 (Cth) (‘Trade Marks Act’) is the legislation concerned with the identification and registration of, and dealing in, trade marks. Section 6 states that any:
letter, word, name, signature, numeral, device, brand, heading, label, ticket, 198 aspect of packaging, shape, colour, sound or scent or combination thereof’197F may be registered as a trade mark.
The registered trade mark is recognised as personal property by s 21 Trade Marks Act’ and the registered owner is given extensive, exclusive rights to use it and to authorise others (for instance franchisees) to use it under ss 20, 22. Section 26 Trade Marks Act provides a number of additional statutory rights, including the right to bring an action for infringement (s 26(1)(b)) and to grant others, for instance franchisees, the right to use the mark (s 26(1)(f)).
196 Blair and Lafontaine, above n 46, 147. 197 Steinberg and Lescatre, above n 13, 116. 198 Guidelines are available on the IP Australia website. < http://www.ipaustralia.gov.au/trademarks/index.shtml> at 17 June 2010.
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Trade marks under Franchising Code of Conduct Franchisees are entitled to be provided with certain details about the 199 intellectual property that is ‘material to the franchise system’.198F The Code requires 200 pre-contractual, and periodic disclosure of the matters listed in s 7.19F Sections 4.1.1(c) and 7 acknowledge that the franchisor itself may not own the intellectual property, and that the intellectual property may be unregistered.
Trade mark research and literature
201 Gillian K Hadfield refers to a 1971 study conducted by Ozanne and Hunt20F on clauses in fast food industry franchise contracts which found that 77 per cent of 202 franchise agreements granted the franchisee no ownership rights in the trade mark.201F What is surprising is that 23 per cent did grant ownership rights. A comparable study has not been conducted on Australian franchise agreements.
Bruce Schaeffer and Susan Robbins have written about the valuation of intangible assets in franchise companies and multinational groups drawing on the 203 experience in the United States.20F Whilst their article addresses franchises as a category, the authors do not differentiate between the various types of intellectual property – trade marks, patents and designs.
A description of the consumer protection franchisees gain from the registration of trade marks is found in Australian Competition & Consumer Commission v 4WD Systems Pty Ltd [2003] FCA 850. In this case, the franchisor told prospective franchisees:
The 4WD Systems name is a registered and protected name, unauthorised use of the name and associated trade marks is illegal …. This means your business is protected from any unauthorised use of the name within your 204 region. 203F
199 Trade Practices (Industry Codes – Franchising) Regulations 1998 (Cth) s 7.1. 200 See Appendix A of this thesis for wording. 201 Ozanne and Hunt, above n 43, ch 5. 202 Gillian K Hadfield, ‘Problematic Relations: Franchising and the Law of Incomplete Contracts’ (1990) 42 Stanford Law Review 927, 942. 203 Bruce S Schaeffer and Susan J Robbins, ‘Valuation of Intangible Assets in Franchise Companies and Multinational Groups: A Current Issue’ (2008) 27(3) Franchise Law Journal 185. 204 Australian Competition & Consumer Commission v 4WD Systems Pty Ltd [2003] FCA 850, para 78.
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As the franchise agreement usually grants a license to use the franchise trade marks, the franchisor is expected to own the network’s trade marks, or to be able to satisfy its franchisees that it has the right to grant the franchisees a licence to use them. An Australian master licensee of a foreign-based franchisor (regarded by the Australian unit franchisees as ‘the franchisor’) would be expected to have a licence granting it sole and exclusive rights to develop the franchise network using the franchisor’s registered trade marks in Australia. It can then confidently grant franchises.
To understand the options an administrator or liquidator has when faced with a failing franchisor, it is necessary to know the extent to which they can claim the benefit of contractual rights to permit franchisees to use the franchisor’s registered trade marks. Franchisees would, for example, become vulnerable if the Australian master licensee breached the master licence agreement and lost the right to be the Australian ‘franchisor’ unless there was a contractual obligation requiring the overseas franchisor to permit the individual franchisees to continue to use the trade marks. Because no studies could be found that specifically report on ownership and use of trade marks by franchisors and franchise network stakeholders in Australia, I conducted the Exploratory Study on the trade marks registered under the Trade 205 Marks Act used by franchisors in 2005.204F
Exploratory Study findings The Exploratory Study revealed a diversity of trade mark ownership and registration strategies adopted in Australian franchising. The implications of this situation for franchisees of insolvent franchisors are discussed in chapter 4.4.4.
The 337 franchise networks in the sample group together owned at least 1,308 registered trade marks. For 14.24 per cent of franchise systems (48 in total) it was not possible to determine the legal identity of the franchisor entity from the franchisor’s website or from other public records. This meant that it was not possible to take more than an educated guess at whether the trade marks relating to the network were owned by the franchisor. Given the importance of brand protection in franchising, it was surprising to find that 13.65 per cent (46) of franchise networks in the sample
205 Jenny Buchan, Investigation of Real and Intellectual Property Rights under Franchise Systems Operating from Retail Premises in New South Wales (2005). Research funded by University of New South Wales.
Chapter 3: The problem in context 93 94 did not have any registered trade marks. Between 72.1 per cent and 86.5 per cent of franchise networks did register trade marks. The remainder probably use unregistered trade marks that would be defendable through common law or a statutory passing off action under the Trade Practices Act. The franchisor was the sole trade mark owner in 26.11 per cent of networks in the sample (88). In 28.78 per cent of networks the franchisor was one of the trade mark owners. For example in the bedding retailer Forty Winks franchise network, Forty Winks Pty Ltd owned all six registered trade marks and was the franchisor, whereas in the tyre retail Bob Jane network, Bob Jane Corporation Pty Ltd was the franchisor and owned 19 of the 21 trade marks. Bob Jane Telecommunications Pty Ltd and Bob Jane T-Marts Pty Ltd jointly owned the other two.
It was found that 15.73 per cent (53) of the franchisors in the sample were foreign-based in such diverse jurisdictions as the Bahamas, Germany, Hong Kong, 206 Japan, Mauritius, the Netherlands and the USA.205F Of these 53, only one (1.88 per cent) Australian master licensee had registered an interest as an authorised user under s 26. That one, an entity that is presumably the Australian master licensee of Coldwell Banker Corporation, Australian Real Estate Systems Pty registered an interest in nine of the 10 trade marks owned by franchisor Coldwell Banker
206 7-Eleven, Inc (USA); Athletes Foot Brands, Inc (USA); Bartercard International Ltd (Bermuda); Baskin-Robbins International Co (USA); Blockbuster Inc (USA); Bridgestone Corporation (Japan); Candleman Corporation (USA); Dannic IP Holdings Inc (Bahamas); Century 21 Real Estate LLC (USA); Hanic Publishing LLC (USA) Company; Chipmunks IP Limited (New Zealand); Coldwell Banker Corporation (USA); Italtile Mauritius (Proprietary) Limited (Mauritius); Italtile Franchising (Proprietary) Limited (Mauritius); Discount Car & Truck Rentals Ltd (Canada); Domino's Pizza, PMC, Inc a Michigan corporation (USA); Produits Ella Bache Laboratoire Suzy (France); Europcar International (France); Express Services, Inc (USA); Fastway Limited (NZ); Voith Turbo GmbH & Co KG (Germany); Gloria Jean's Gourmet Coffees Corp (USA); The Goodyear Tyre & Rubber Company an Ohio corporation (USA); HRB Royalty, Inc (Bahamas); H2O Plus, LP; A Delaware Corporation (USA); Hertz System Inc, a Delaware Corporation (USA); Arana Ltd (Hong Kong); Burger King Corporation (USA); IGA, Inc (USA); Kernels Popcorn Limited (Canada); Yum! Australia Holdings I LLC and Yum! Australia Holdings II LLC (Both USA); Kumon Institute of Education Co Limited (Japan); ICED Management, Inc, a Delaware Corporation (USA); LPNZ Limited (New Zealand); Madame Et Monsieur LLC a Californian Corporation (USA); United Parcel Service of America, Inc a Delaware Corporation (USA); McDonald's Corporation a Delaware Corporation (USA); Medicine Shoppe International Inc a Delaware Corporation (USA); Pinnacle Intellectual Property Services - International, Inc a Nevada Corporation (USA); Mend-A-Bath International (Pty) Ltd (Cape Province); Midas International Corporation (USA); Mrs. Fields' Original Cookies, Inc, a Delaware Corporation (USA); Nando's International Ltd (Republic of Ireland); Number Works Ltd (New Zealand); Pizza Hut International LLC a Delaware Corporation (USA); Quik International a Nevada Corporation (USA); The Quizno's Master LLC (USA); Sign*A*Rama, Inc (USA); Fastsigns International Inc, A Texas Corporation (USA); International Spar Centrale BV (The Netherlands); Doctor's Associates Inc (USA); SureSlim International Limited (UK); Mascolo Limited (UK); Warner Bros Entertainment Inc (USA).
94 Chapter 3: The problem in context 95
Corporation (USA), a real estate franchise. The Australian licensee has registered its interest pursuant to a licensed user agreement on the trade mark registry. No unit franchisees in the sample group had registered their interest as authorised users of any franchisor’s trade mark.
In 3.26 per cent of all identified networks (11 in total), there was more than one owner of certain trade marks. In 8.01 per cent of networks (27 in total), there were several individual owners of several individual trade marks. Typically, this was two or three individuals where the franchisor was a corporation. For example Margaret Kerr Kent Sasse and Harry Arthur Sasse owned the franchise Gymbaroo trade marks. The franchisor is a corporation called Toddler Kindy Gymbaroo Pty Ltd. In some instances the first trade mark registered by a franchisor was found to be owned by two individuals, but subsequent trade marks in the network were owned by the franchisor or a corporate entity related to the franchisor. For example, D Williams and J Clow were registered as the owner of one trade mark and Fernwood Fitness Centre Pty Ltd was the owner of all subsequently registered trade marks for the Fernwood Women's Health Club. The franchisor entity was Fernwood Womens Health Clubs Pty Ltd.
An alternative to registration as an ‘authorised user’ is that all levels of franchisee, could record their interests as licensees on the TM Register by relying on 207 the provisions of Trade Marks Act Part 11.206F This would be useful protection if they are prohibited by their franchise agreement from registering their interest as an ‘authorised user’. However, there is no evidence that franchisees register their interest as licensees under the Trade Marks Act.
Trade marks and franchise agreements One of the key functions of the franchise agreement is to grant the franchisee a licence to use the franchisor’s intellectual property, including its trade marks. Based on the Trade Mark Research it appears that franchisees rely solely on the contractual rights granted to them in the licence agreements with the franchisor. There is therefore a strong incentive for the franchisee to ensure that they have a contractual nexus with the owner of the trade mark.
207 See Appendix A of this thesis.
Chapter 3: The problem in context 95 96
A valid franchise agreement does not require the trade marks to be registered or for the franchisor to own them. For example, the precedent franchise agreement in 208 the Australian Encyclopaedia of Forms and Precedents207F refers to the trade marks as being part of the franchisor’s image. In it, the franchisor grants the franchisee the right, under clause 2(1)(a):
to operate the franchised business within the territory using the image, and the system; ‘marks’ means the trade marks or logos and trade names described at Item 4 of the Schedule and any variations or modifications thereto.
In relation to the trade mark, the franchisor, in clause 12 of the precedent agreement, is contractually bound to:
12(1)(a) make the image and the system available to the franchisee; 12(1)(b) actively develop and promote the image and system; and, at 12(5), the: Franchisor shall take reasonable steps to maintain the integrity of the system and to protect the marks against any action or infringement by any person.
By agreeing to clause 15(6):
The franchisee acknowledges that franchisor is the owner of the marks and that the franchisee's sole right to use them is derived from this agreement. The franchisee shall not use any other trade marks, trade names, business names, logos, designs or colour schemes in connection with the franchised 209 business.208F
The requirement in relation to the trade marks in the Traveland franchise agreement was:
6.1 Use of Marks and Corporate Identity. The Franchisee must: Display the marks in and on the Premises and on all signs, fixtures, fittings, display stands, stationery, uniforms and other items used in relation to the Business; … Strictly in accordance with the operations manual or as the Franchisor may require from time to time. 6.3 The Marks
208 LexisNexis Butterworths, Australian Encyclopaedia of Forms and Precedent, Form 40.1. 209 Ibid.
96 Chapter 3: The problem in context 97
The franchisee must, if requested by the franchisor, execute a registered user agreement in relation to the Marks. 6.3 Ownership The Franchisee and the Guarantors: Acknowledge the franchisor’s exclusive ownership of all intellectual property rights and goodwill accrued in the marks at the date of this Agreement; (b) acknowledge that any goodwill accruing to the marks, the Business name or the business during the term and any copyright materials produced by the Franchisee during the Term relating to the Business will be the exclusive property of the franchisor; and Will not contest or challenge the franchisor’s exclusive ownership of these intellectual property rights and this goodwill. 11.1 Immediate Termination The franchisor may terminate this Agreement immediately by notice in writing to the Franchisee if: The franchisee makes improper or unauthorized use of the Marks … or is involved in any act or conduct which, in the Franchisor’s opinion, is likely to 210 adversely affect the Mark …209F
Clearly, both franchisors and franchisees regard the trade marks as an important and valuable part of what the franchisee as a business consumer and investor is paying for. Also clear is that Australian master franchisees and franchisees’ and franchisors’ financiers are generally lax about accessing the statutory rights available under the Trade Marks Act to register their interest in trade marks.
Overseas Brands and due diligence The law cannot protect all consumers from their own perceptions. Paul Steinberg and Gerald Lescatre describe the ‘halo effect’ that can result where franchisees are unsophisticated investors:
… ownership of a household-name franchise conveys a degree of status and may result in a non-rational purchase decision. … A powerful franchise brand further distorts analysis of the franchise investment. ... Trade mark owners are acutely aware of reputational risk as applied to the brand value of
210 Copy of Traveland franchise agreement on author’s file.
Chapter 3: The problem in context 97 98
the retailed product but inefficient dissemination of reputational data with regard to the wholesaled product (franchises) means that the franchisors can benefit from an unsophisticated consumer’s perception that if Dunkin’ has quality donuts and if Burger King is concerned about the humane treatment of cattle, then the consumer’s positive perceptions of the brand carry over to 211 the consumer’s positive perception of the franchise. 210F
Unsophisticated investors possibly overvalue a known franchise brand emotionally rather than objectively assessing their forthcoming investment. It is 212 speculated that the notion of ‘cultural cringe’21F may be a version of the halo effect, resulting in franchisees exercising less due diligence in purchasing into an overseas based franchise than would be exercised in relation to a local franchisor.
For instance, as the trade mark research shows, only one Australian master licensee has registered its authorised user status at the trade marks office. Cultural cringe may lead less sophisticated franchisee consumers to favour one of the 53 overseas brands over a home grown Australian brand. A conclusion that can be drawn from the Trade Mark Research concerning the use of registration and authorisation opportunities under the Trade Marks Act is that overseas franchisors are not necessarily models of best practice. The idea that the overseas brand is a more secure, better organised investment, may be ill founded. The list in Table 1 contains the failed Australian master franchisees of several franchisors of overseas 213 origin.21F
Taking into account the halo effect and the fact that some well known franchisor brands with registered trade marks fail completely, for example Australian based Traveland and Australian master licensees of Canadian based Kernel’s Popcorn, Singapore based Deli France and US based Midas, it is suggested that concluding that having a widely recognised trade mark is indicative of a ‘good’ franchisor is a flawed indicator of franchisor quality for a potential franchisee.
211 Steinberg and Lescatre, above n 13, 155. 212 An attitude characterised by deference to the cultural achievements of other countries and disparagement of Australian (ie ones own) culture. The Australian Oxford Dictionary (2nd ed, 2004) 307. 213 For example, the Australian master franchisees Kernel’s Popcorn, Priority Management Systems Pty Ltd, of Canadian franchisors.
98 Chapter 3: The problem in context 99
Due diligence should extend beyond verifying the existence of the owner of the trade mark to verifying the ‘chain of title’, so the franchisee can be confident it will have an ongoing right to use the trade marks if the franchisor becomes insolvent.
Valuation – security Bruce Schaeffer and Susan Robbins argue that ‘intangibles [registered and unregistered intellectual property] often account for more than 80 per cent of the total 214 enterprise value’,213F and write that:
The value of the trade mark gauges the success of the franchisor in assuring that franchisees provide an otherwise valuable product or service or system according to the franchisor’s plan. The more valuable the trade mark, the greater the price at which franchises can be sold and the greater the royalties 215 collected.214F
Access to property rights as security is fundamental to lenders and to liquidators. Much of the asset base of the franchisor is ‘personal’ property (including intellectual property) which may pose greater difficulties for liquidators to sell than does real property.
As trade marks are a recognised item of property, franchisors are able to offer them to lenders as security for loans. As trade marks are an essential asset of the network lenders may want security over them. However, their value is notoriously difficult to quantify. A multitude of valuation methods can be applied to intellectual 216 property assets215F and the technique chosen will be influenced by the context. It is also believed by economists that ‘the greater the volume of sales under the trade mark, the greater is the likelihood that a consumer has had direct or indirect contact 217 with the trade mark, increasing its value’.216F
From the perspective of accountants, however, discrepancies in the presentation of trade mark valuation in the reports of public companies arise through
214 Bruce S Schaeffer and Susan J Robbins, ‘Valuation of Intangible Assets in Franchise Companies and Multinational Groups: A Current Issue’ (2008) 27(3) Franchise Law Journal 185. 215 Hadfield, ‘Problematic Relations: Franchising and the Law of Incomplete Contracts’, above n 202, 949. 216 See Paul McGuinness, Intellectual Property Commercialisation: a Business Manager’s Companion (2003) ch 23. 217 Hadfield, ‘Problematic Relations: Franchising and the Law of Incomplete Contracts’, above n 202, 950.
Chapter 3: The problem in context 99 100
218 standard accounting and audit practices.217F The rules of accounting do not permit the creation of an entry that recognises what is known as ‘internally generated goodwill’, because it is an intangible. Accountants are only allowed to recognise ‘purchased goodwill’. Purchased goodwill arises in two ways. First, by purchasing a trade mark, in which case the accountant can record the purchase price. Second, by purchasing a company. The excess paid over the net value of the assets is deemed to be the goodwill that has been purchased. Items such as registered trade marks are included in the goodwill. In the case of Harvey World Travel for example, the A$5,000 value attributed to intangibles is likely the administrative cost of applying for the trade marks.
As several of the franchisors in the Exploratory Study were Australian public companies their annual accounts could be accessed via the internet. Although this sample is small, it is useful to demonstrate the range of approaches public company franchisors take to expressing the value and identity of their trade mark assets in the accounts.
Depending on whether the purpose is simply to comply with accounting standards (as appears to be the case for most companies including Domino’s, Rebel Sport and Harvey World Travel in the Exploratory Study) or to attract franchisees to a fledgling franchisor (as appears to be the case in the light of subsequent litigation with Danoz Direct); trade mark values in 2005 were entered as either the ‘cost of acquisition’ or as a ‘directors’ valuation’. The lack of standardisation increases the uncertainty of the franchisees’ pre-purchase due diligence. It also makes the administrator’s or liquidator’s task of accurately assessing the value of trade marks for the purpose of deciding whether to advertise them for sale or not, difficult. Four examples follow.
In 2005, Domino’s Pizza Australia New Zealand Ltd, included its ‘Intangibles’ in the Notes to Accompany the Financial Statements under ‘goodwill’ and ‘franchise distribution network’. The 21 registered trade marks that Dominos Pizza franchisees were licensed to use were not included as they were owned by the US parent company. Dominos Pizza Australia New Zealand Ltd had not registered its licence to
218 As described also by Ahmad Sujan and Indra Abeysekera, ‘Intellectual Capital Reporting Practices of the Top Australian Firms’ (2007) 17(2) Australian Accounting Review 71.
100 Chapter 3: The problem in context 101 use the trade marks at the time of the research. Even though the trade marks were owned by the US parent, there seemed to be no way in the accounting standards of expressing the value of the registered user licenses for the 21 registered Dominos Pizza trade marks to the Australia and New Zealand master licensee. This theoretically leaves the Australian and New Zealand Dominos franchisees exposed to not being allowed to use the trade marks if the US parent failed. The franchisor’s liquidators could disclaim the licences as onerous contracts.
Rebel Sport Ltd did not list any of the five registered trade marks that it owned on its 2005 balance sheet.
Harvey World Travel Ltd, with over 500 offices internationally, a turnover in 219 excess of A$1.7 billion218F and at least six registered trade marks, included a heading ‘Patents and Trade Marks’ in its 2004 Notes to and Forming Part of the Financial Statement as above (‘NTFS’). It stated: ‘Patents and Trade marks are valued in the financial statements at cost of acquisition ($5,000) and are amortised over the period 220 in which their benefits are expected to be realised’.219F
That incoming franchisees should not necessarily place reliance on the stated value of the trade marks is underscored by the experience of the franchisees of Danoz Direct. TVSN Ltd, the parent company of franchisor Danoz Direct, was formed in 2003. It became insolvent in 2005. It reported in relation to intangible assets in the 2004 Notes to and Forming Part of the Financial Statements (NTFS) that:
The identifiable intangible asset of the company comprises the name ‘Danoz’. No amortisation is provided against this asset as the life of the asset is of such duration and the residual value is such that the amortisation charge, if any, would not be material. The carrying value of $8million is in accordance with a valuation by Directors. At each reporting date, assessment 221 of the carrying value will be made by the Directors.20F
219 Harvey World Travel, Franchise Information
Chapter 3: The problem in context 101 102
Danoz Direct paid A$8 million more than the value of the assets because the parent company, TVSN Ltd, self-assessed that this represented the value of the customers and the brand. Franchisees therefore believed they were buying into a valuable name, without realising that the value was self-generated by the franchisor’s parent entity.
A public company’s published annual reports are an unreliable source of information about the existence and value of its trade marks. When trade marks are specifically mentioned, their value(s) are given in order to comply with accounting standards and are not objectively verifiable.
Trademarks are an asset categorised in the company’s accounts as an 222 ‘intangible’ asset. The effective life21F of standard patents is a maximum period of 20 223 years.2F For tax purposes, trade marks do not fall within s40-30(2)(c) Income Tax Assessment Act 1997 (Cth) as ‘items of intellectual property’ as ‘intellectual property’ is defined in s995-1 Income Tax Assessment Act in terms that do not include trade marks. Debt finance is a common form of finance for a business in Australia. The debt is secured over assets owned by the borrower. Yet this valuable 224 asset is rarely used as security for loans in Australian franchises.23F
If the creditor has to sell the franchisor’s business in a mortgagee’s sale, the value would potentially be much greater if the trade mark were also available for sale.
3.2.3 LEASES Many franchisees trade from retail premises. The presence of premises owners as stakeholders in a franchise network can be a significant factor in how the administration or insolvency is resolved. ‘Of the 960 business format franchises operating in Australia in 2006, 44.7 per cent had franchisees operating from a retail
intangible assets. For more information see Catherine Pozzi and Mark Shyling (eds) Accounting Handbook (2010) 747 – 775. 222 The effective life of a depreciating asset determines the rate at which the asset declines in value Income Tax Assessment Act 1997 (Cth) ss 40-70, 40-75 in RL Deutsch et al, Australian Tax Handbook, Tax Return Edition (2009) 681. 223 Deutsch et al, above n 222, 685. 224 But see Darin Neumyer, ‘Future of Using Intellectual Property and Intangible Assets as Collateral’ (2008) 64(1) The Secured Lender New York 42.
102 Chapter 3: The problem in context 103
225 226 site.24F This numbered nearly 2,900 individual retail premises’ (2,887).25F Fit-out 227 costs payable by franchisees range from $0 to $550,000.26F
Franchisors shed or manage risk through the legal relationships created with the owners of franchisees’ retail premises. Franchisees may be required to enter a retail premises lease, sub-lease or licence with the franchisor or with third parties, or to fit out premises with no security of tenure. The consequences of these choices will be expanded on under the heading ‘Legal relationships and management of premises related risks’ on page 109.
Property interests in a retail site can take many different forms as was recognised in the 1991 Franchising Task Force’s Final Report to the Minister for Small Business and Customs:
some franchisors insist on taking the head lease while others allow the Franchisees to take the lease of the premises. … there is a diverse range of 228 arrangements that can successfully exist under the franchising umbrella.27F
The consequences of the franchisor’s failure for the franchisees’ site will vary depending on the leasing model. Twelve common franchisee premises occupancy models are outlined below. The ramifications for the franchisees if the franchisor becomes insolvent are discussed in chapter 4.2.4.
225 Frazer, Weaven, and Wright, Franchising Australia 2006, above n 11, 28. The concept ‘retail premises’ was not defined in the survey so the figure does not equate perfectly with the definitions of ‘retail premises’ in the Australian legislative instruments. The data for the Franchising Australia 2008 survey was not analysed by reference to location of franchisees’ business but by business type. In 2008, 28 per cent of the 1100 franchisors were identified as being in ‘retail trade’. This figure excluded cafes and other food services, travel agencies, financial services and postal services. The figure for the separate categories of franchise can not simply be added to the retail figure to provide a 2008 total as the café category includes accommodation, which is not retail and travel agencies, financial services and postal services may be conducted from retail or from non-retail premises. The mismatch between the 2008 survey data and the legal definitions of retail highlights the difficulty of using data that was collected for one purpose for another. 226 Buchan and Butcher, ‘Premises Occupancy Models for Franchised Retail Businesses in Australia: Factors for Consideration’, above n 34, 143-4. 227 Frazer, Weaven, and Wright, Franchising Australia 2008, above n 7, 30. Note, some franchisors answering this question would have franchisees without fixed premises, hence $0. 228 Franchising Task Force, Final Report to the Minister for Small Business and Customs (1991) 87.
Chapter 3: The problem in context 103 104
Models Model 1: The franchisor owns the premises and leases them to the franchisee.
Landlord = Lessee = Franchisee Franchisor Lease
…………….. Model 2: A legal entity related to the franchisor owns the premises and leases them to the franchisee.
Franchisor related Franchisor landlord
Franchise agreement Lease
Lessee = Franchisee
……………………
104 Chapter 3: The problem in context 105
Model 3: The franchisor leases the premises from a landlord and sub leases to the franchisee.
Landlord Lessee = Franchisor Lease Sublease Franchise agreement Guarantee
Sub lessee = Franchisee
…………………..
Model 4: A legal entity related to the franchisor leases the premises from a landlord and sub leases them to the franchisee.
Landlord Lessee = Franchisor related entity Lease Sublease
Guarantee
Franchisor Sub lessee = Franchise Franchisee agreement
………………
Chapter 3: The problem in context 105 106
Model 5: The franchisor leases the premises from premises owner and grants a licence to occupy to the franchisee.
Landlord Lessee = Franchisor Lease License Franchise agreement
Licensee = Franchisee
……………….. Model 6: An entity related to the franchisor leases the premises and licenses them to the franchisee.
Landlord Lessee = Franchisor related entity Lease Licence
Guarantee
Franchisor Sub lessee/ Licensee Franchise = Franchisee agreement
……………….
106 Chapter 3: The problem in context 107
Model 7: A master franchisee leases the premises from a landlord and sub leases them to the franchisee.
Landlord Australian master franchisee Lease Sublease Franchise Guarantee agreement
Master Franchisor franchise Franchisee
……………….
Model 8: A legal entity related to a master franchisee leases the premises from a landlord and sub leases them to the franchisee.
Landlord Australian subsidiary = master franchisee
Sublease Franchise Lease agreement
Overseas License Franchisee franchisor
………………
Chapter 3: The problem in context 107 108
Model 9: A master franchisee leases the premises from a landlord and grants a licence to occupy them to the franchisee.
Landlord Master franchisee = Lessee Lease Licence Franchise agreement Master franchise agreement
Franchisor Licensee = Franchisee
………………… Model 10: The franchisee or an entity related to the franchisee leases the premises direct from a landlord.
Landlord Franchisor
Franchise agreement Lease
Guaranteed by Franchisee’s directors Franchisee = Tenant
……………..
108 Chapter 3: The problem in context 109
Model 11: The franchisee or franchisee related entity owns the premises.
Franchisor Owner = franchisee Franchise agreement
…………….. Model 12: There are no formal occupancy arrangements.
Landlord Franchisor
Franchise agreement No written premises agreement
Franchisee
Legal relationships and management of premises related risks Typically the premises leasing model is dictated by the franchisor’s 229 preference28F and tempered by the amount of control the landlord wishes to assert in 230 each instance.29F In some networks more than one model is chosen.
Australian research has shown that where the franchise unit operates from a specific site, the head lease is held by the franchisee in 64 per cent of cases. Twenty six per cent of franchisors hold the head lease. Franchisors are more likely to hold 231 the head lease in retail (food and non food) systems.230F
229 In an unpublished NSW Government Retail Tenancy Survey (2008), 33 per cent of landlords required the franchisor to be the head tenant. 230 Barkoff and Selden, above n 112, 67. 231 Frazer, Weaven and Wright, Franchising Australia 2006, above n 11, Question A15, 30. Thus, Models 1–6.
Chapter 3: The problem in context 109 110
Depending on the occupancy model that is adopted, there may not be any contractual relationship between the landlord and the franchisee tenant prior to the 232 franchisee fitting out the premises.231F The franchisee may have protection as a lessee under the State or Territory retail leasing legislation, but this is not uniform across 233 Australia.23F
As occurs in models 4, 6, 7 and 10, it is increasingly common in Australia when the franchisor takes a head lease of retail premises, for the franchisee to provide a personal guarantee or the security deposit to back the franchisor’s performance under the head lease. The relevant clause in the franchise agreement might read:
The franchisor shall hold the head lease to the store site. The franchisee shall 234 make available the security deposit upon signing the sub-lease.23F
The franchisee, thus, takes ultimate financial risk on the premises, while the franchisor retains the full benefit of the site lease being in the franchisor’s name.
Contracts may be made between franchisee and landlord, as in models 1, 10 and 11. Alternatively, the franchisee’s contractual relationship may not be with the landlord; rather, the landlord is in a direct contractual relationship with the franchisor or its related entity, as in models 3, 4, 5, 6. The franchisee then enters a sub-lease, licence or has an informal verbal agreement with the franchisor concerning the premises.
Master franchisees may be contractually bound through their own franchise agreements with the franchisor to ensure the head leases in their territory are under their control. As there is no public database of franchise agreements or master franchise agreements, or franchise disclosure documents in Australia it is not 235 possible to conduct quantitative research.234F It is a common practice in franchising
232 In the case of a shopping centre, the franchisor commonly negotiates the lease agreement - or heads of agreement - with the owner's leasing manager. The franchisee then fits out the shop under the scrutiny of the centre manager. The centre manager is an employee of the shopping centre management company, which is normally a subsidiary of the shopping centre owner. 233 See Buchan and Butcher, ‘Premises Cccupancy Models for Franchised Retail Businesses in Australia: Factors for Consideration’, above n 34, 143–78 for discussion of the situation State by State. And see Table E of this thesis. 234 Danoz Directions Franchise Agreement (2004) cl 3. 235 Matthews, above n 113, Recommendation 23; Inquiry into the Operation of Franchise Businesses in Western Australia, Report to the Western Australian Minister for Small Business (2008) Recommendation 2.5; Economic and Finance Committee, Parliament of South Australia,
110 Chapter 3: The problem in context 111 for the franchisor to take a head lease on a retail site, and then sublet (usually on the same terms) to the franchisee. This enables the franchisor to maintain control of the outlets through which the franchise operates, and it also assists in negotiating a better deal with large retail centre managers that would not otherwise be available to a single tenant.
In the 2004 version of the Danoz Directions Franchise Agreement, which used a Model 5 structure, Clause 8 states that:
8.1 The franchisor will on or before the Commencement Date enter into a lease of the Premises from which the Franchised Business is to be carried on. 8.2 The franchisee must, on the date this agreement is executed, enter into a licence agreement to occupy the premises on those terms and conditions contained in the Franchisor’s Standard Occupation Licence.
In model 6 the franchisee’s tenure is secured only by a licence. The following passage by a former Bakers Delight, franchisee describes model 6 from a franchisee’s perspective:
When a franchisee signs their franchisor’s licence agreement, they are binding themselves to the lease, without having any of the protections offered by the lease. Neither the landlord nor the franchisor is required to provide the franchisee/licensee with any information about their negotiation process, nor does the franchisee see the landlord’s disclosure document – if they even know it exists. As a Bakers Delight franchisee, I did not even see a copy of the leases for two of my stores until after I had signed the licence 236 agreement. The third one I never saw.235F
It is difficult for a researcher to identify the preferred model for specific franchisors as there is no requirement to place such details on a public database. However, a clause such as the following in the Traveland Franchise Agreement provides clues as to the franchisor’s preference, in this case for a Model 10 arrangement, by providing:
Franchises (2008) Recommendation 7.2.1; Parliamentary Joint Committee on Corporations and Financial Services, Commonwealth, Opportunity not Opportunism: Improving Conduct in Australian Franchising, above n 166, Recommendation 2; all state that franchise disclosure documents should be registered on a centralised database. 236 Evidence to Retail Tenancies Inquiry, Retail Tenancy Unit, New South Wales Government (Sydney) (2008) 3. Report embargoed. (Deanne de Leeuw former Bakers Delight franchisee) quoted with permission of the author.
Chapter 3: The problem in context 111 112
Lease. The Franchisee must provide the Franchisor with details of its existing lease or licence of the premises and of any proposed new lease or 237 licence of the Premises.236F
The franchisee is at risk at several junctures before and after a franchisor fails. The franchisor’s conduct in relation to its obligations under a head lease can result in the franchisee losing the right to occupy retail premises. Even if the franchisor is not directly involved in the premises lease, its insolvency can still cause great difficulties for the franchisee tenant.
3.2.4 FRANCHISEES Franchisees, as consumers of the franchisor supplier’s vision typified the enterprise worker the then Prime Minister of Australia, who observed:
…‘white collar’ and ‘blue collar’, even ‘knowledge worker’ are no longer adequate to properly encapsulate a growing number of people, some of whom own their own businesses …as franchisees … [W]orking together for our future … is the dominant consideration, and working in an environment where the success of the enterprise is indistinguishable from your own personal success. [T]here are now more Australians who are self employed as owner-managers at 1.91 million than there are members of a registered 238 trade union.237F
The success of the enterprise is indistinguishable from the individual franchisee’s own personal success, but so is the failure of the franchisor part of the enterprise often indistinguishable from its franchisees’ failure.
As enterprise workers, 21st century franchisees replace the labour and capital the franchisor would otherwise have to carry on its own books and, as exemplified in relation to trade marks and retail leases. Franchisees accept levels of commercial, financial and legal risk that an employer would not be able to require an employee or an independent contractor to accept.
Franchisors are aware of the divesting of legal and financial responsibility that follows a move into franchising. This was acknowledged by Commander Communications in 2007 which ‘says the effect of franchising will be an increase in
237 Draft Individual Unit Traveland Pty Ltd Franchise Agreement (undated) 14. 238 The Hon John Howard MP Prime Minister of Australia, ‘Opening address’ (Speech delivered at the Franchise Council of Australia's 2005 Annual Convention, Canberra, 10 October 2005).
112 Chapter 3: The problem in context 113 sales, movement of costs from fixed to variable and a reduction in direct labour costs 239 with an increase in commissions’.238F
A group with diverse skills and motivation In South Africa:
the Government has identified franchising as a means of encouraging the development of small businesses, creating jobs, alleviating poverty and creating black empowerment because it has the capacity to address many of the problems which make it difficult for a new business to get off the 240 ground.239F
For example a stand-alone start up business owner would usually not have the credibility to negotiate a lease with one of the large shopping centre owners in Australia or the ability to generate the consumption of supplies required to obtain the benefits of economies of scale which franchising can offer.
Franchising provides an opportunity for immediate gainful work and standing in the community for immigrants who may be unable to earn an income using the qualifications gained in their country of origin. The franchisee may be fluent in English and accustomed to local culture or may be a new migrant with limited English language skills but with access to funds. Franchisees may be self-funded or borrowing money from family or commercial lenders to fund their franchise. Both the well educated and those with little formal education become franchisees.
Franchisees may be embarking on their first career, or be older workers using 241 their superannuation as funding.240F They may be using a retrenchment pay-out to fund the purchase, as were franchisees Peter and Sandra of whom Ambrose J noted:
239 Jacqui Walker, Small Business Does it Tough … Hardie Trio Quit … Economists Tip Wages to Firm … Gloria Jean’s Tax Trouble … Domino’s Setback … Small Biz Stats … Commander to Franchise … Economic Roundup (2007) Smartcompany
Chapter 3: The problem in context 113 114
… neither … had any experience in conducting a business. …Peter had spent most of his life in the public service and had latterly been a purchasing officer ... Sandra had worked as a bus driver. In 1995 Peter, then aged about 46 years, was retrenched and received about $225,000 as severance pay. He had been taking a business training course for some time at a university ... [Peter and Sandra] decided between them that they would try to buy a business that they could manage and which would allow them to work together, produce an income to support their 242 family and give them an interest.241F
Through franchising, many former employees make their first foray into self- 243 employment.24F Peter and Sandra, on purchasing a Spud Mulligan’s franchise, were buying what they believe to be:
A business out of a box. …[Often] one of the family's breadwinners has lost his or her job and is wondering what to do with the redundancy payout. On the list of options are paying off a chunk of the mortgage and other debts, putting money into super, taking a holiday or buying into a franchise and 244 becoming a small-business owner.243F
The franchise might be the principal source of income for the family. One in 245 four franchisees in Australia in 2004 was female.24F The franchisees’ education may be specific to the franchise business (such as travel agencies) or may be in an unrelated field. The franchisee may be a city dweller or may be establishing a business in a country town. Some franchisees are engaged in ‘cross border 246 shopping’245F as they have purchased the right to be the master licensee of an overseas based franchise.
People wanting to own a small to medium sized business choose franchising partly because, in the words of one liquidator, ‘[t]he start up costs for a similar
242 Neilson Investments (Qld) P/L & Ors v Spud Mulligan's P/L & Ors [2002] QSC 258. 243 Frazer, Weaven and Wright, Franchising Australia 2008, above n 7, Question B6 on page 35 reported that immediately prior to entering the franchise, according to information supplied by their franchisor 52.6 per cent of new franchisees had been in salaried work and 4 per cent had ‘other experience’ (eg unemployed, parental duties, etc). Forty three per cent had independent business experience immediately prior to becoming a franchisee. 244 Kavanagh, above n 56. 245 Deloitte, above n 241, 6. 246 Commission of the European Communities, above n 3, 2.
114 Chapter 3: The problem in context 115 business in the same industry that is not a franchise are remarkably dearer, unless the 247 person already has a strong knowledge in a particular field’.246F
‘In legal terms, there is no relationship quite like that between a franchisor and its franchisees. The execution of the franchise agreement often triggers a significant 248 commitment from the franchisee in the form of sunk investments in premises’,247F hire of staff and entry into long term contracts with parties other than the franchisor for finance, premises rental, vehicle rental, and stock purchase.
Franchisees from the franchisor’s perspective Some franchisors have a clear profile of the type of franchisee they want. For example, in 1994 McDonald’s identified ‘owner-operators whose livelihoods are 249 dependent on their units’ as ideal franchisees.248F Other less discerning franchisors seek only warm bodies and the willingness to write cheques.
The appeal of granting licences to franchisees as opposed to pursuing organic growth is described by franchisor, Commander Communications:
...the effect of (moving from a traditional business structure and into) franchising will be an increase in sales, movement of costs from fixed to variable and a reduction in direct labour costs with an increase in 250 commissions.249F
The legal liabilities the franchisee potentially assumes on signing the franchise agreement compare starkly with the rights (many) and liabilities (few) that accrue to parties that perform the equivalent functions in a non-franchised network. ‘The relationship between franchisor and franchisee is akin to a partnership, wider and 251 more complicated in fact than any document could contain’. 250F
247 Telephone Survey conducted by Jenny Buchan on 6 December 2004. 248 Frazer, Weaven and Wright, Franchising Australia 2006, above n 11, 35. The total start up cost of a new franchised unit (excluding GST) was $78,000 with the range being $2,100 to $960,000 in 2006. 249 Patrick J Kaufmann and Francine Lafontaine, ‘Costs of Control: The Sources of Economic Rents for McDonald’s Franchisees’ (1994) XXXVII Journal of Law and Economics 417, 444 in (ed) Francine Lafontaine, Franchise Contracting and Organization (2005) 303. 250 Jacqui Walker, IT News - Commander to Franchise (2007) Smartcompany
Chapter 3: The problem in context 115 116
As Commander Communications acknowledged above, franchisees are a saving on labour costs, borrowed and equity finance, and a risk devolving mechanism, not available to a non-franchised business owner.
Labour Force Credit is the lifeblood of the modern industrialized economy. The employee 252 who is paid at the end of the working week gives credit to his employer.251F
The NatWest March 2004 United Kingdom Franchise Survey asked franchisees what their working status was immediately before taking out their 253 franchise.25F Sixty-two per cent were former employees. In 2006, 64 per cent were in 254 salaried employment immediately before taking out their franchise.253F There is no reason to expect Australian franchisees to differ significantly.
A non-franchised business sources labour by hiring employees or contractors. Both categories of worker have well defined legal rights. Employees derive their rights in relation to remuneration, entitlements, leave and work conditions from specific legislation and may be assisted by trade unions representing them in negotiations and disputes with their employers. Contractors, including suppliers, negotiate the terms on which they will perform a job and are remunerated accordingly.
The role the franchisees play as the franchisor’s labour force was acknowledged by the New South Wales Court of Appeal in Majik Markets Pty Ltd v Brake and Service Centre Drummoyne Pty Ltd and ors where Kirby P observed on behalf of himself and Mahoney and Handley JJA:
While the franchisees, if natural persons are working for themselves, they are also in a very real sense working for the franchisor. If the business was not operated by some franchisee, the franchisor would either have to employ staff of its own or sell or lease the site to an independent purchaser or 255 lessee.254F
252 Sir Kenneth Cork, Great Britain Insolvency Law and Practice Report of the Review Committee (1982) 10. 253 NatWest bfa United Kingdom, Franchise Survey (2004) Question 5.2. 254 NatWest bfa United Kingdom, Franchise Survey (2006) 29. 255 Majik Markets Pty Ltd v Brake and Service Centre Drummoyne Pty Ltd and ors (1991) 28 NSWLR 443, 465.
116 Chapter 3: The problem in context 117
In legal terms, an incorporated franchisee cannot be an employee, but in numerous other aspects the franchisee and the employee are functionally 256 indistinguishable.25F A more detailed analysis of the franchisees’ role compared to the employee and the independent contractor will be conducted in chapter 3.1.6.
Financier The franchisee supplies capital in the form of the initial franchisee fee, and it funds the establishment of its franchisee business, to help grow the franchisor’s brand. For example, the franchisor of Boost Juice, Janine Allis, ‘was able to roll out [a juice bar concept] around Australia at an extraordinary pace and with limited [franchisor] capital by developing a franchise system … [commenting that] [w]e 257 have been able to grow using other people’s capital’.256F
A franchisee makes a significant financial investment in the franchisor. For 258 instance, ‘on average it costs $380,000 to open a Baker’s Delight franchise’.257F ‘The working capital required is approximately 30 per cent of the business or $120,000 259 whichever is the greater’.258F The franchisor does not offer the franchisee security for its investment. The same reliance on the franchisees’ access to funds is acknowledged by Australia Post that:
is planning to franchise 150 PostShops as part of its plan to gain revenue and offset the steady decline of its snail mail business. … [A]nother 50 will be created by buying out licensees and reselling those sites as franchises. … [T]he plan will allow Australia post to retain control over its network and allow it to gain initial franchise fees and a potential share of capital gains when the franchises are sold. Franchises also provide greater contractual flexibility than the present licence and branch systems, as well as reducing Australia Post’s direct exposure to rising wages, retail downturns and further slowing in demand for traditional mailing methods. … To secure a franchise,
256 Penelope Ward, ‘Can Franchisees be Treated as Employees?’ (Paper presented at the 22nd Annual IBA/IFA Conference, Washington DC, 18-19 May 2006). 257 Virginia Marsh, ‘Entrepreneur Enjoys Fruits of Fast-Expanding Juice Chain – Janine Allis Squeezed her Way to Success from Humble Beginnings’, Financial Times (London) 24 June 2005, 5 quoting Boost’s chief operating officer, Simon McNamara. 258 Amber Plum, ‘Bakers Delight to Help Fund New Franchisees’ Smartcompany (Melbourne), 11 September 2009.
Chapter 3: The problem in context 117 118
a candidate will need access to investment capital, typically $250,000 to 260 $500,000.259F
Jim Cohen states that: ‘A bad business model will not be saved by franchising 261 it’.260F How the franchisees investing in the PostShops are going to recoup their investments and make money in an environment where there is a steady decline in the core business product of the PostShop, snail mail, is not obvious.
Access to its franchisees’ capital resources and individual borrowing capacity, unencumbered by reciprocal legal obligations beyond what is in the franchisor- controlled franchise agreement, is also reportedly acknowledged by franchisors of Australian telecommunications franchise Telcoinabox:
The biggest challenge to date for [the franchisor] has been access to capital. None of the banks would lend to them (directors of the franchisor) because they unanimously refused to put their houses on the line. ''Banks don't want to invest in a concept or idea,'' [the franchisor] says. They were never interested in seeking venture capital because of the hefty chunk of equity demanded in return for the investment. ''We did speak to a number of people but they basically want the soul of your first-born son. Equity is the most expensive form of finance you can get,'' Mr Kay says. Telcoinabox relied heavily on franchising fees ($50,000 per franchisee) in the first year. ([T]he franchisor) says not being answerable to 262 investors is liberating …261F
Risk taker James Brickley and Frederick Dark described the risk/reward trade-offs in franchising in noting that:
[f]ranchising has its own set of potential costs and incentive problems…. One such cost is that associated with inefficient risk-bearing. If the manager [ie the franchisee owner] of a franchised unit has a large proportion of his [or her] wealth and income tied to the performance of the unit, his [or her] investment portfolio will be relatively undiversified. This inefficient risk-
260 Damien Lynch, ‘Postal Franchisees Sought’, The Australian Financial Review (Sydney), 8 November 2005, 56. 261 Jim Cohen, Franchise Statistics Debunked Again! (2008) Blue Maumau
118 Chapter 3: The problem in context 119
bearing generates at least two types of agency costs. First, the manager is likely to make less ideal investment decisions than an efficiently diversified decision maker… The franchisee is more likely to be concerned with the total risk of the project than a diversified decision maker who is concerned only with the systematic risk. Second inefficient risk-bearing can lead to 263 higher required rates of expected compensation because of increased risk.26F
A traditional analysis of a franchisee as a contracting party with the ability to fully understand and assess a range of risks and then factor them into price and contract terms is incomplete because of the nature of the franchise agreement. This is explored in detail at 3.3.
Whereas a
franchisor can manage risk through contract, a franchisee cannot. … the ‘contract as commodity’ approach of the standard form as opposed to a ‘contract as relationship’ approach of the relational … contract creates a conflict where the standard form prevails. A franchisee takes on qualities of 264 consumer of product, rather than an equal party to negotiation of terms.263F
The risk taking in franchising is relatively one-sided. Franchisees are typically required to supply all financial details to a franchisor prior to being accepted as a franchisee, and accept that a cost of being allowed to become a franchisee is providing personal guarantees by directors and their spouses. This makes it difficult for franchisees to diversify their risk.
When negotiating a contract on behalf of a client one approach is to ask them to identify the main commercial areas that, if not addressed properly, would radically compromise the deal for them. If the client is the franchisor, the franchisee’s death or the administration, insolvency or bankruptcy of the franchisee would appear in this list. If representing a franchisee, the converse should apply. However, in my experience as a franchisee adviser, franchisees typically identify only their own, but not the franchisor’s potential death or failure. It is very rare for a franchisee to identify franchisor failure as a potential risk. In the course of my research only three
263 James A Brickley and Frederick H Dark, ‘The Choice of Organizational Form: The Case of Franchising’ (1987) 18 Journal of Financial Economics 401, 405 in Francine Lafontaine (ed) Franchise Contracting and Organization (2005) 57. 264 Spencer, The Regulation of the Franchise Relationship in Australia: A Contractual Analysis, above n 14, 170.
Chapter 3: The problem in context 119 120 franchisees were found to have a clause inserted into their franchise agreement that permitted the franchisee to terminate the contract if the franchisor became insolvent; one Traveland franchisee of 270 and one of the 60 or so BHG franchisees and one master franchisee of a network that remains solvent.
In the absence of franchisees, all risks associated with conducting the business would be taken directly by the franchisor or indirectly by financiers. The ability to devolve risk is an under-acknowledged, but significant, benefit to the franchisor. The amount of risk franchisees take, compared with the amount the franchisor takes, and their respective ability to manage it by closing the store, is highlighted by the observation, especially when read with the insight added by the last sentence:
[A]fter Bennigan’s restaurants filed for Chapter 7 in July 2008, the corporate locations shuttered while nearly 140 franchisees remained open. “One problem with Bennigan’s was that they had too many company-owned stores. When the economics changed, the company-owned stores were no longer profitable and they were losing money faster than the franchisees were paying royalties” explains iFranchise’s Siebert. ‘But even if they’re not that profitable it’s hard [for a franchisor] to actually lose money on a 265 franchisee’.264F
Franchisees knowingly take on the risk of their own business failing. They pay for their premises fit out, the franchise fee, ongoing royalties, hire employees, insure their business, pay their employees’ payroll tax, and sign contracts with suppliers. At its most extreme, the franchisee also accepts, unwittingly, the risk that the franchisor might become insolvent.
The franchisee is sometimes portrayed as a willing and aware risk taker. One theory is that a
risk averse franchisee would clearly prefer to invest in a portfolio of shares in all franchise outlets, rather than confining his investment to a single store. This means, essentially, that the franchisee will require a higher rate of return on his capital if he is required to invest in one outlet than in a portfolio. Conversely the franchisor, by forcing a relatively large risk on the franchisee, will himself earn a lower rate of return. This argument thus appears to make sense only if we assume that franchisors are more risk
265 Maltby, above n 120.
120 Chapter 3: The problem in context 121
averse than franchisees. But since franchisees commonly invest a large share of their assets in acquiring the franchise, it is unlikely that this will be the 266 case.265F
The underlying assumption is that franchisors do not have control over the amount of risk they take. However, franchisors have ultimate control through a range of mechanisms including:
their ability to configure the ownership of their personal and business assets ex ante to protect their personal assets from subsequent claims,
control of the separate entities that own the trade marks,
prescribing the nature of premises lease arrangements,
managing supplier relationships,
the ultimate power of being able to force a franchisee to breach the franchise agreement, thus giving the franchisor the right to terminate, or to refuse to renew.
Ultimately, franchisees assume all of their own, plus some of the franchisor’s business risk. In the absence of franchisees, the franchisor’s business risk would be taken directly by the franchisor, indirectly by the franchisor’s financiers, or not taken at all.
Reward sharer Jensen and Meckling note that
[w]e don’t find many large firms financed almost entirely with debt-type claims (ie non-residual claims) because of the effect such a financial structure would have on the owner-manager’s behaviour. Potential creditors will not loan $100,000 to a firm in which the entrepreneur has an investment of $10,000. With that financial structure the owner-manager will have a strong incentive to engage in activities (investments) which promise very high payoffs if successful even if they have a very low probability of
266 Paul H Rubin, ‘The Theory of the Firm and the Structure of the Franchise Contract’ (1978) XXI (1) The Journal of law and Economics 223, 225 in Francine Lafontaine’s (ed), Franchise Contracting and Organization (2005) 20.
Chapter 3: The problem in context 121 122
success. If they turn out well, he captures most of the gains. If they turn out 267 badly, the creditors bear most of the costs.26F
Franchisors have solved the problem of accessing more capital than their core business could support as debt by appointing franchisees and incorporating the equity and debt raising capacity of those franchisees into the franchisor’s business structure. By reporting the income of franchisees as part of the income of the network, and describing the franchise agreements as income generating assets of the franchisor, the franchisor can both receive initial franchise fees from the franchises and convince the franchisor’s own lenders that its business is capable of bearing more debt than an objective analysis of the franchisor would support. In this way when a franchisor becomes insolvent they fail with few assets and with secured creditors claiming 268 many millions of dollars. 267F
Franchisees, whilst assuming some of the franchisor’s business risk, have no right to receive a corresponding reward, as the venture capital providers or shareholders typically would, if the franchisor entity is sold for a profit.
It is suggested that franchisees are, in effect, taking quasi equity risk in the franchisor, often for returns more typically associated with employment or fixed interest debt.
3.2.5 FRANCHISEES NOT TRADITIONAL SUPPLIERS Some advisers and academics struggle to see the difference between franchisees and traditional suppliers. Indeed, the contracting parties most severely affected by a franchisor’s insolvency, other than its franchisees, are its suppliers, and sometimes the franchise network’s customers. Its franchisees are generally exposed to greater loss and are less able to protect against such loss than is a supplier for a number of reasons.
First; even though a supplier may have taken significant steps, such as retooling a production line, or committing to grow a particular crop in reliance on its contract with the franchisor, it would normally have done so in the context of an already-established business. For example, a farmer will negotiate a supply
267 Jensen and Meckling, above n 21, 334. Compare with anecdotal evidence which suggests that in New Zealand at least one major trading bank will lend franchisees $25,000 unsecured, of the $30,000 required to purchase a home cleaning franchise, in 2009. 268 See Table 1 column headed ‘Amount owed to creditors (estimated)’ of this thesis.
122 Chapter 3: The problem in context 123 agreement to grow potatoes or a printer will negotiate to print labels to specific standards for a franchisor.
Second; a traditional supplier is viewed by the franchisor as a strategic partner that is, effectively, making an investment in the whole network. The supplier relationship may have begun by the supplier successfully tendering. The franchisor and supplier negotiate and agree the terms of their contract. These are likely to include retention of title clauses and penalty provisions for late payment by the franchisor. They may include franchisors directors’ guarantees. The supply agreement is relational but is not a standard form contract.
Third; while both suppliers and franchisees commit their own capital to the franchisor’s brand, franchisees must then build a business along lines tightly prescribed by the franchisor. Unlike a supplier, the franchisee that sees its franchisor is in financial trouble has little flexibility to prepare for continuing its business with another partner in the event of the franchisor’s insolvency. Suppliers have their own business that they can adapt to supply other buyers if the business with the franchisor becomes unviable.
Fourth; both franchisee and supplier to some extent put themselves at the mercy of the franchisor’s ongoing viability but because of the standard form of the franchise agreement, the franchisee does so to a greater extent and with less capacity to protect itself either legally or practically. Suppliers are not 'owned' by the franchisor.
Fifth; suppliers own their own customer lists but not all franchisees do so. Anecdotal evidence suggests that an increasing number of franchisors operate as commission agencies. This means the franchisor has all of the franchisees’ customers’ details and the franchisee is likely to have difficulty convincing the customer to continue to have faith in the franchisee where the franchisor has failed to deliver a purchased product. An example is the Australian whitegoods franchise Kleenmaid.
3.2.6 FRANCHISEES OR EMPLOYEES? The relevance of comparing franchisees with employees is that they are sometimes indistinguishable in function, but are each treated differently if the employer/ franchisor becomes insolvent. The employee, whose role the franchisee
Chapter 3: The problem in context 123 124 has assumed in many organisations, is provided with significant protection in Australia’s regulatory regime. This is pursued in chapter 4.4.3. The franchisee has no protection from legislation or government.
Dependence and control are the major features of the employer-employee relationship. Franchisees undeniably experience a relationship of dependence and control with their franchisors. These features are put in place through the franchise agreement and maintained in numerous ways through the administration of the franchise network. From their customers’ perspective, a franchisee, an employee and an independent contractor are indistinguishable. Depending on nuances of the precise franchise model used by the network, the differences, however, may be numerous and significant.
There is far more than dependence and control to an employer- employee relationship. Franchisors are aware of the relative cost of staff compared to shedding the staff in favour of franchisees, as demonstrated by the words of a franchisor:
The other big challenge is just the cost of employing staff in Australia. Having a company-owned network of stores is just so expensive, and too expensive to own all our stores with payroll tax, and so on. That's obviously 269 part of the reason we've moved to a franchise system.268F
It is, however, useful to identify the characteristics of an employee and a franchisee and thereby to understand why they are sometimes indistinguishable and at other times a franchisee is clearly not an employee. Useful sources on which to found this analysis are:
Australian Taxation Office (ATO) Rulings (TR) identifying characteristics of an employee,
franchise agreements and
reported judgments.
The ATO has not been asked for a ruling to distinguish an employee from a franchisee but it has had to distinguish an employee from an independent contractor. The features of an employment contract were presented in table form in ATO Ruling
269 Patrick Stafford quoting Homschek in A Bigger Slice of the Pie (2009) SmartCompany
124 Chapter 3: The problem in context 125
2000/14. Whilst this ruling has now been superseded by TR 2005/16 and Superannuation Guarantee Ruling SGR 2005/1, the features of employment that were compared with independent contracting remain valid. The column headed ‘Franchisee’ in Table 4 has been added to demonstrate in which respects the franchisee exhibits features of the employee or the independent contractor.
Table 4: Features of Employee, Franchisee and Supplier / Independent Contractor.
The nearest relationships are identified in ‘Franchisee is more like …’ column for each feature.
Features of Franchisee Employee Franchisee Supplier/ 270 relationship269F is more like independent ... contractor
Lawful employee Under a contract of Method of conducting The hallmark of a authority to service, the payer franchise is set out in contract for command usually has the right detail in Operating services is said to to direct the manner Manual(s). Franchisor be that the of performance. has right to require the contract is one for Where the nature of franchisee to work in a given result. The the work involves a certain way and to contractor works the professional skill terminate the to achieve the or judgment of the franchise if franchisee result in terms of worker, the degree does not follow the contract. The 271 of control over the system270F contractor works manner of on his/her own performance is account diminished. What is important is the lawful authority to command that rests with the payer
270 Adapted from Schedule B in ATO TR 2000/14. 271 Zuijs v Wirth Bros Pty Ltd (1955) 93 CLR 561; Australian Mutual Provident Society v Chaplin (1978) 18 ALR 385; Glambed v FCT (1989) 20 ATR 428; Sgobino v South Australia (1987) 46 SASR 292; Re Clothing Trades Award 1982 (1987) 19 IR 416; City Motors (1981) Pty Ltd v Commissioner of State Taxation (WA) (1993) 26 ATR 291; Samrani v Roads and Traffic Authority of New South Wales (1994) Aust Torts Reports ¶81-314; Climaze Holdings Pty Ltd v Dyson (1995) 13 WAR 487; Australian Building Construction Employees and Building Labourers Federation (WA Branch) v Pacesetter Homes Pty Ltd (1994) 56 IR 51; Humberstone v Northern Timber Mills (1949) 79 CLR 389; Stevens v Brodribb Sawmilling Co Pty Ltd (1986) 160 CLR 16; Ready Mixed Concrete (South East) Ltd v Minister of Pensions and National Insurance [1968] 2 QB 497 (list sourced from CCH).
Chapter 3: The problem in context 125 126
Features of Franchisee Employee Franchisee Supplier/ 270 relationship269F is more like independent ... contractor
How is the employee Tasks are performed Tasks are performed Enters into a work at the request of the following the method contract for a performed? employer. The prescribed by the specific task or worker is said to be franchisor. Franchisee series of tasks. working in the typically has little Maintains a high business of the discretion in how and level of discretion payer whether they perform and flexibility as the work. The to how the work is franchisee is working to be performed. in own business Contract may within the parameters contain precise mandated by the terms as to franchisor materials used and methods of performance and still be one for services Risk independent Bears little or no Bears all risk for own Stands to make a contractor risk. Employee is performance. profit or loss on not exposed to any Franchisee bears risk the task. Bears the commercial risk. of the franchisor commercial risk This is borne by the failing or and the employer. underperforming. responsibility and liability for any The employer is Franchisor may be poor workmanship generally liable in tort for injury or injury sustained responsible for any caused by 272 in performance of loss occasioned by franchisee271F or under the task. poor workmanship workcover legislation Generally, would or negligence of the for injury to be expected to employee franchisee’s 273 carry their own employee27F insurance
272 The 1996 (US) court decisions in the Foodmaker and Ely cases both held that the franchisors were not vicariously liable for franchisees' acts. In Ely, General Motors was not liable for a wrongful death caused by a dealer's employee since GM did not have specific control over the test drive or employee involved in the death. In Foodmaker, the franchisor was not vicariously liable for a franchisee-employee's murder by a co-worker; the plaintiffs had alleged liability due to inadequate security or negligent hiring. In a Dairy Queen case the franchisor was liable for a tort that occurred on a franchisee’s site because the injury was sustained by the plaintiff as a result of the franchisee complying with franchisor’s prescribed construction requirements. The franchisor had control of the process. 273 For example WorkCover Authority of New South Wales (Insector Petar Ankucic) v McDonald's Australia Limited and Another [2000] NSWIRComm 277; and Workcover Authority of NSW (Inspector Ankucic) v McDonald's Australia Limited and anor matter [2000] NSWIRComm 1123 where franchisor was held liable for death of franchsiees’ employees at franchisee’s outlets.
126 Chapter 3: The problem in context 127
Features of Franchisee Employee Franchisee Supplier/ 270 relationship269F is more like independent ... contractor
Place of employee Worker under a Provides own assets Generally performance contract of service and equipment and provides all own will generally own premises. May assets and perform the tasks on sub-lease premises equipment the payer's premises from franchisor and using the payer's be required to place assets and orders through a equipment centralized ordering system owned and operated by franchisor Hours of work employee Generally works Works the hours Generally sets standard or set hours dictated by own hours of work 274 franchisor273F Leave independent The contract Franchisee does not Generally, an entitlements contractor generally provides receive benefit of independent for annual leave, statutory leave contract does not long service leave, provisions. Sometime contain leave sick leave and other franchise systems provisions benefits or require franchisees to allowance obtain franchisor’s consent to be absent from franchise Payment independent Generally paid an Payment usually by Payment is based contractor hourly rate, piece franchisee’s company; upon performance but if rates or award rates of the contract Some franchisees structured receive commission like from franchisor commission agency, employee Expenses independent Generally Meets own expenses; Generally incurs contractor reimbursed for if required to deal own expenses expenses incurred in with suppliers the course of mandated by employment franchisor may be unable to negotiate terms or price
274 Hadfield, ‘Problematic Relations: Franchising and the Law of Incomplete Contracts’, above n 202, 943. Twelve per cent of franchisors require franchisee to manage full time. Nine per cent require approval of manager.
Chapter 3: The problem in context 127 128
Features of Franchisee Employee Franchisee Supplier/ 270 relationship269F is more like independent ... contractor
Appointment employee Generally recruited Recruited by Likely to advertise through an franchisor or its their services to 275 advertisement by the agent.274F Once the public at large employer franchisee’s business established, franchisee and franchisor market the system’s services or products to the public Termination employee Employer reserves Franchise Agreement Contracted to the right to dismiss typically for a fixed complete a set 276 an employee at any term.275F task. The payer time (subject to may only Franchise agreement State or Federal terminate the and Code contain legislation) contract without termination penalty where possibilities contractor has not exercisable by 277 fulfilled the franchisor 276F conditions of contract. Insolvency of either party a specified event of default
275 Franchisor is required to supply intending franchisee with a disclosure that complies with the Franchising Code of Conduct 1998. Failure to do so gives franchisee rights under Trade Practices Act 1974 (Cth) s 51AC but currently there is no right to damages. 276 Both an employee and a franchisee expect to be in the particular work relationship for a number of years; for an employee this will vary with the nature of the job. For a franchisee, there is an expectation that the franchisee will be in the relationship for the term of the franchise agreement, or will sell at a profit before then. Frazer, Weaven and Wright, Franchising Australia 2008, above n 7, 23 report the initial terms of the current franchise agreement of the 264 franchisors that responded ranged from 1 to 50 years. Of these, 67 per cent of franchisees have an initial term of 5 years. 277 Hadfield, ‘Problematic Relations: Franchising and the Law of Incomplete Contracts’, above n 202, 940 reports that in the US, all franchise contracts contain termination rights for franchisors and 79 per cent state that [the franchsiee’s] bankruptcy automatically terminates the contract and all rights revert to franchisor. In Australia, clauses 21, 22 and 23 of the Franchising Code of Conduct stipulate when a franchisor may terminate a franchise agreement (see chapter 4.2.3 and for full wording see Appendix A – of this thesis). This is in addition to contractual provisions.
128 Chapter 3: The problem in context 129
Features of Franchisee Employee Franchisee Supplier/ 270 relationship269F is more like independent ... contractor
Delegation employee Employee has no Typically may not May delegate all inherent right to delegate management or some of the delegate tasks to role except with tasks to another another. However, franchisor’s express person, and may there may be a consent. Most employ other 278 power to delegate franchisees have persons27F some duties to other employees. Franchise employees agreement contains provisions for familial succession on death/ incapacity of franchisor
Against the criteria in Table 4, over half of the identified features of the business relationship place the franchisee nearer to having an employment relationship with its franchisor than an independent contractor relationship. Only a third locate the franchisee nearer to an independent contractor.
279 In answering the question ‘who is an employee?’278F the 2005 rulings examine the features of employment and independent contracting relationships under the six headings; control, results contracts, whether the work can be delegated or sub- contracted, risk, provision of tools and equipment and payment of business expenses, and other indicators. Each is expanded on below in the context of franchisees.
Control The notion of control encompasses features 1, 2, 4 and 5 of TR 2000/14. It includes both degree of control and the ability to dictate what, how and where work is to be done. Essentially, the question here is whether the worker operates on his or her own account or in the business of the payee. ‘In Hollis v Vabu (2001) 207 CLR 280 21, 39279F (Vabu) the majority of the High Court quoted the following statement made by Windeyer J in Marshall v Whittaker's Building Supply Co (1963) 109 CLR 210.
278 ATO TR 2000/14, Attachment B. 279 For the purposes of interpreting the word ‘employee’ as it appears in Taxation Administration Act 1953 (Cth) pt IVAAA and Superannuation Guarantee (Administration) Act 1992 (Cth) s 12. 280 (2001) 207 CLR 21, 39 (Gleeson CJ, Gaudron, Gummow, Kirby and Hayne JJ) (McHugh and Callinan JJ dissenting).
Chapter 3: The problem in context 129 130
... the distinction between an employee and independent contractor is 'rooted fundamentally in the difference between a person who serves his employer in his, the employer's business, and a person who carries on a trade or 281 business of his own.280F
282 This distinction is also referred to as the integration or organisation test.281F In Vabu, the majority in the High Court found that a bicycle courier was a common law employee of Vabu and stated that ‘[v]iewed as a practical matter, the bicycle couriers were not running their own business or enterprise, nor did they have independence in 283 the conduct of their operations’.28F
In the franchising context, McDonald's Australia Holdings Ltd & Anor v Industrial Relations Commission of NSW & 2 Ors [2005] NSWCA 286 the expectations on McDonald’s licensee (ie: franchisees) are set out:
The foundation and essence of the McDonald’s System is the adherence by licensees to standards and policies of McDonald’s and its related corporations providing for the uniform operation of all McDonald’s restaurants within the McDonald’s System including, but not limited to, serving designated food and beverage products; the use only of prescribed equipment and building layout and designs; and strict adherence to designated food and beverage specifications and to prescribed standards of quality, service and cleanliness in restaurant operation. Compliance by licensees with the foregoing standards and policies in conjunction with McDonald’s trade marks, service marks and trade names provides the basis for the valuable goodwill and wide acceptance of the McDonald’s System. Moreover the establishment and maintenance of a close personal relationship with Licensee in the conduct of his McDonald’s restaurant business, his accountability for performance of the obligations contained in this agreement, and his adherence to the tenets of the McDonald’s system 284 constitute the essence of the licence provided for herein.283F
281 [FN 25 in TR 2005/16]; Hollis v Vabu (2001) 207 CLR 21, 39. 282 [FN 26 in TR 2005/16]. The notion of an 'integration' test arose in Montreal v Montreal Locomotive Works (1947) 1 DLR 161, 169 and was affirmed by Lord Denning in Stevenson Jordan and Harrison Ltd v MacDonald and Evans [1952] 1 TLR 101, 111 and reaffirmed in Bank Voor Handel En Scheepvaart NV v Slatford [1953] 1 QB 248, 295. 283 [FN 27 in TR 2005/16]; Hollis v Vabu (2001) 207 CLR 21, 41 and TR 2005/15 para 32, 33. 284 McDonald's Australia Holdings Ltd & Anor v Industrial Relations Commission of NSW & 2 Ors [2005] NSWCA 286, para 19 (Spigelman CJ, Mason P, Handley JA).
130 Chapter 3: The problem in context 131
Given the prescriptive nature of the business environment for the McDonald’s franchisee, it would arguably be open for the High Court to find a McDonald’s franchisee is an employee if it applied Vabu without considering additional distinguishing traits.
Results contracts While the notion of 'payment for a result' is expected in a contract for services, it is not necessarily inconsistent with a contract of service. Stephen J in the High Court in Federal Commissioner of Taxation v Barrett & Ors [1973] HCA 49; (1973) 129 CLR 395 found that land salesmen who were engaged by a firm of land agents to find purchasers for land entrusted to the firm for sale and who were remunerated by commission only were employees and not independent contractors. Likewise, the High Court in Vabu considered that payment to the bicycle couriers per delivery, rather than per time period engaged, was a natural means to remunerate employees whose sole purpose is to perform deliveries. Further, the Full Court of the Supreme Court of South Australia in The Commissioner of State Taxation v The Roy Morgan Research Centre Pty Ltd [2004] SASC 288 Mullighan, Nyland and Anderson JJ found that interviewers who were only paid on the completion of each assignment, 285 not on an hourly basis, were employees and not independent contractors.284F This analysis poses challenges for those franchisors whose franchisees are effectively commission agents. Such franchisees may be found to be employees. In the majority of franchise relationships, however, the franchisee does not receive commission from the franchisor but pays the franchisor a periodical royalty, regardless of results.
Risk of liability for injury or for substandard work This feature of the relationships takes up point 3 of TR 2000/14 which focuses on the consequences of the risk of physical injury or of liability for substandard product or workmanship. Whilst franchisees are widely assumed to be liable for the physical injury occurring on their premises a franchisor has, on occasion, been found 286 liable for the death of a franchisee’s employee.285F In such cases, the franchisees and their employees followed the franchisor’s methods and instructions to the letter, for example by employing the franchisor’s prescribed tradespeople to conduct work on
285 SGR 2005/16 para 46; TR 2005/16 para 39. 286 For example: WorkCover Authority of New South Wales (Insector Petar Ankucic) v McDonald's Australia Limited and Another [2000] NSWIRComm 277.
Chapter 3: The problem in context 131 132 the franchisees site. The franchisor’s prescribed methods or instructions were found by the courts to be flawed, resulting in the court attributing liability to the franchisor.
Provision of tools and equipment and payment of business expenses In this category, the franchisee is more like an independent contractor. TR 287 2005/16286F compares the employee and the independent contractor.
The weight or emphasis given to this indicator … depends on the particular circumstances and the context and nature of the contractual work. All the other facts must be considered to determine the nature of the contractual relationship.
Other indicators These include:
Right to suspend or dismiss
Right to exclusive service
Provision of statutory or award mandated benefits
Requirement that the worker wear a uniform bearing the employer’s logo.
Ultimately it is concluded that the TR are of limited assistance in defining a franchisee. The answer to the question: ‘What differentiates an employee or an independent contractor from a franchisee?’ is far from uniform and far from clear.
It is therefore helpful to examine the differences from other perspectives. The features listed in Table 5 have been categorized to reflect widespread norms. It should be noted that not all franchise networks exhibit all features. In Table 5 the issues are approached in a different way to that of the Australian Taxation Office and case law. The relationships are looked at in time sequence – the pre-engagement phase, followed by the time when the employee is working for the employer or the franchisee is operating under a franchise agreement. Finally, the period after the end of the relationship is examined. The analysis that follows Table 5 expands on significant features.
287 Paras 49, 50.
132 Chapter 3: The problem in context 133
Table 5: Additional Features of Employee and Franchisee. (Bolded features are common to both)
Feature of Relationship Employee Franchisee
Prior to commencement of relationship Invest money in activity to get started No Yes Some money invested in sunk costs No Yes
Decides where business will be located No No Contract is the basis of the relationship Yes Yes Consumer protection under Trade Practices Act if advertisement Yes Yes misleading or deceptive Once committed to relationship Personal responsibility for premises costs No Yes
Wear uniform; adopt prescribed “trade dress” Yes Yes Right to choose suppliers No No Owns improvements to intellectual property made by employees No No or franchisee Subject to ongoing performance reviews by employer/ franchisor Yes Yes Relationship recognized specifically by law Yes Yes Duty of confidentiality Yes Yes Restraints on other work that may be done during term of Yes Yes contract Vulnerable to capricious behaviour by employer/ franchisor Yes Yes Duties owed to employer/ franchisor – fidelity, good faith, care and Yes Yes skill, confidentiality, obedience and cooperation, render service May join a trade union to enforce rights Yes No Personally assumes financial risk on behalf of employer/ franchisor No Yes May sell the role No Yes
If employer/franchisor becomes insolvent, right to sue under Yes Yes Trade Practices Act, subject to liquidators rights under Corporations Act If employer/franchisor becomes insolvent, specific rights under Yes No Corporations Act After relationship ends Opportunity to make capital gain if enterprise succeeds No Yes
Owns the goodwill at the end Employer Franchisor Post-relationship restraints Sometimes Sometimes On termination of relationship employee or franchisee usually has No Yes
Chapter 3: The problem in context 133 134
Feature of Relationship Employee Franchisee financial obligations re the employer/ franchisors business Clear statutory rights if employer/ franchisor becomes insolvent Yes No
Contract may be terminated without consulting employee or Yes Yes franchisee on liquidation of employer/ franchisor
Prior to commencement of relationship
INVEST MONEY IN ACTIVITY TO GET STARTED An employee does not invest money in the employer as a pre-requisite to being employed. A franchisee in Australia pays between $5,000 and $1,402,500 for the 288 right and then the cost of starting up a new franchised unit.287F To quote the Lenard’s poultry franchisor, Lenard Poulter, ‘[u]nless you [as franchisor] pile up a lot of debt, franchising is the only way to expand retail operations. It means that other people 289 supply the capital’.28F
SOME MONEY INVESTED IS SUNK COSTS The issue of sunk costs is not relevant to employees, but it is very real to franchisees. The amount of sunk costs depends on the type of franchise. Where, for example, a franchisee is required to fit out a hotel or a café, the sunk costs are high; where it operates a lawn mowing, house cleaning or courier franchise, the sunk costs are relatively low. The opportunity to recover sunk costs following the franchisor’s insolvency varies greatly – a franchisee establishing a retail outlet will not be able to recover sunk costs if the franchisor fails and the premises lease is disclaimed, whereas a franchisee will find a market for a second hand vehicle or lawn mower more readily. A franchisee with low exposure to fixed premises or other purpose- built branded assets will be in a better position to mitigate its losses in relation to sunk costs.
DECIDES WHERE BUSINESS WILL BE LOCATED Having decided to commit to a particular employer or franchise system, an employee or franchisee requiring fixed premises may not have a genuine choice of location. This is exemplified in the judgment of Justice Ryan in Kaytonruby Pty Ltd & Ors v Glev Franchisees Pty Ltd & Ors (1998) VG 438 of 1993, who noted:
288 Frazer, Weaven and Wright, Franchising Australia 2008, above n 7, 30. 289 Derek Parker, ‘Counting on His Chickens’, The Australian (Sydney), 24 June 2005.
134 Chapter 3: The problem in context 135
He [the prospective franchisee] was … given several maps…on which were delineated “territories” … to be allocated to franchisees. … It was further indicated … that no franchise had by then been allocated in Victoria but Mr Leong would have to be quick. … After a … short lapse of time [the franchisor’s agent’s observed that]…‘I think Noble Park is a better area any way you look at it’. Eventually, the franchisor could not find suitable premises in Noble Park and the franchisor’s agent suggested that Mr Leong should consider taking a franchise in Malvern which [until] then had not been offered to prospective franchisees but had been reserved as a company 290 shop.289F
The only option for the franchisee was the suburb of Malvern.
CONSUMER PROTECTION UNDER TRADE PRACTICES ACT IF ADVERTISEMENT MISLEADING OR DECEPTIVE Employees and franchisees both have specific recourse to Trade Practices Act in relation to pre-contractual claims made to them and relied on that turned out to be misleading or deceptive. Employees can rely on Trade Practices Act ss 51A, 52 and 53B and franchisees on ss 51A, 52 and 59.
Once committed to relationship
WEAR UNIFORM / ADOPT PRESCRIBED TRADE DRESS The requirement that a worker wear a company uniform is an indicator of an 291 employment relationship existing between the contracting parties. In Vabu290F the fact that the couriers were presented to the public and to those using the courier services as emanations of Vabu (the couriers were wearing uniforms bearing Vabu’s logo) was an important factor supporting the majority’s 292 decision that the bicycle couriers were employees.291F
The franchisee’s business is often distinguished by the franchisor’s prescribed trade dress. A failure to adopt correct trade dress is a breach of the franchise agreement. The trade dress may include a uniform, as is the case in many fast food networks, or an emblem or colour scheme to identify the business as belonging to the franchise brand. In this regard employment and franchising are indistinguishable.
290 Kaytonruby Pty Ltd & Ors v Glev Franchisees Pty Ltd & Ors (1998) VG 438 of 1993, para 24. 291 (2001) 207 CLR 21, 42 (Gleeson CJ, Gaudron, McHugh, Gummow, Kirby, Hayne JJ). (Callinan J dissenting). 292 Australian Taxation Office TR 2005/16, 12, para 52.
Chapter 3: The problem in context 135 136
OWNS EMPLOYEE’S OR FRANCHISEE’S IMPROVEMENTS TO INTELLECTUAL PROPERTY In both the employer-employee and the franchisor – franchisee relationship, the employer and the franchisor own the intellectual property and all improvements to it unless the parties have made a specific contract to the contrary. Intellectual property typically includes registered and unregistered trade marks, patents and registered designs and any improvements to systems and products. A clause from the Australian Autobarn franchise agreement is typical of the relevant clause in franchise agreements:
2.9.4 All rights in and to the Marks and the Industrial [ie intellectual] Property and any part thereof and any addition thereto shall be and remain the property of the franchisor and the Franchise Holder shall not acquire any 293 right, title or interest therein except as provided in this agreement.29F
Thus, again, employment and franchising are the same.
SUBJECT TO ONGOING PERFORMANCE REVIEWS Performance reviews are an entrenched aspect of employment. They do not disappear if an employee becomes a franchisee. They help ensure franchisees maintain the standards set by the franchisor. For both employees, and for franchisees, the performance review may be comprehensive. For example, for franchisees in the McDonald’s network, as described in Far Horizons Pty Ltd v McDonald's Australia Ltd [2000] VSC 310 (‘Far Horizons’):
The Store Owner must have a positive, co-operative and contributive attitude towards the McDonald's System. He/she must have demonstrated a pro- active record of sales building and involvement in their local community; an attitude which is in tune with today's competitive market place for good solid business rationale and one that will enhance the future growth of their store 294 and the development of the McDonald's System.293F
This was explained by the McDonald's witnesses as having two components:
first an appropriate attitude towards the McDonald’s organisation including other licensees, and, second, an appropriate attitude to the conduct of the
293 Copy of franchise agreement in researcher’s possession. 294 Far Horizons Pty Ltd v McDonald's Australia Ltd [2000] VSC 310, para 5(f).
136 Chapter 3: The problem in context 137
business, including a readiness to engage in local activities which would 295 promote the image of the business and of McDonald’s’.294F
Being subject to ongoing performance reviews is not a meaningful way of distinguishing employees from franchisees.
Choice of suppliers The employee is motivated by job description and ideally by loyalty to the firm to choose the best suppliers. Ideally, there is no conflict of interest between an employee and their employer. Where a director is also a supplier there may be a 296 breach of director’s equitable duties if a conflict of interest is not disclosed.295F
Ideally there will be no conflict of interest between franchisor and franchisee in relation to choice of suppliers or treatment of franchisees stemming from supplier issues. In theory, the franchisor’s ability to negotiate on the basis of the combined buying power of the franchisees will secure better terms from suppliers than the franchisee could negotiate as sole operators.
The choice of suppliers to franchisees can, however, be a source of considerable franchisee dissatisfaction if the franchisor is perceived to be taking undisclosed commissions from the supplier, or if the franchisee would be able to source the same product elsewhere if it were not contractually bound to the franchisor. The potential for conflict of interest is significant when the franchisor or a related entity is the supplier. Three typical positions franchisors have in relation to suppliers are exemplified by excerpts from Australian individual unit franchise agreements.
At the least controlling level, the franchise agreement in Jax Franchising Systems Pty Limited v State Rail Authority (New South Wales); Jax Tyres Pty Limited v State Rail Authority (New South Wales) [2003] NSWLEC 397 leaves Jax Tyres franchisees free to secure supplies from any supplier. This avoids conflicts of interest between franchisor and franchisee. The Jax Tyres franchise agreement stipulates:
295 Ibid para 32. 296 For extensive discussion on directors duties and conflicts of interest see RP Austin and IM Ramsay, Ford’s Principles of Corporations Law (13th ed, 2007) ch 8, 9.
Chapter 3: The problem in context 137 138
The franchisor shall not limit the suppliers from which such items may be 297 purchased.296F
A middle position existed in the Mail Boxes Etc (MBE) single unit franchise agreement that stipulated, in Clause 9.1 that:
During this agreement the franchisee must not: Purchase those products, materials, equipment or services required by the Operating Manual to be purchased from suppliers approved by the Franchisor from any person other than those suppliers without the written 298 consent of the Franchisor:297F
For McDonald’s franchisees Justice Byrne noted:
The McDonald’s System is a comprehensive restaurant system for the retailing of a limited menu of uniform and quality food products. The foundation and essence of the McDonald’s System is the adherence by licensees [ie: franchisees] to standards and policies of McDonald’s and its related corporations providing for the uniform operation of all McDonald’s restaurants within the McDonald’s System including, but not limited to, serving designated food and beverage products; the use of only prescribed equipment and building layout and designs; and strict adherence to designated food and beverage specifications and to prescribed standards of quality, service and cleanliness in restaurant operation. Compliance by licensees with the foregoing standards and policies in conjunction with McDonald’s trade marks, service marks and trade names provides the basis 299 for the valuable goodwill and wide acceptance of the McDonald’s System.298F
In comparison with the franchise systems mentioned above, the case of Australian Competition & Consumer Commission v Simply No-Knead (Franchising) Pty Ltd [2000] FCA 1365 (‘SKN’) provides a glimpse into supply chain abuse by a franchisor. There, the franchisor required the franchisee to purchase most supplies through the franchisor, then refused to deliver the products ordered to the franchisees. This provided the first test case of the business-to-business
297 Jax Franchise Agreement, cl 9.6. 298 This agreement has possibly been superseded as MBE was taken over by UPS, but it is not possible to be sure because of the absence of a franchise agreement database in Australia. 299 Far Horizons Pty Ltd v McDonald's Australia Ltd [2000] VSC 310.
138 Chapter 3: The problem in context 139 unconscionable conduct provisions of the Trade Practices Act, s 51AC, introduced in 1998. SKN is now insolvent.
Clearly issues around sourcing and dealing with suppliers are one significant area where employment and franchising differ.
The relationship is recognised specifically by law Both employment and franchise relationships are created by contract, both are recognised by statutes that need to be adhered to before a business fails. Clause 10.16 of the Jax Tyres franchise agreement is replicated in similar words in the boilerplate clauses of all single unit franchise agreements:
The relationship between the franchisor and the franchisee is strictly that of franchisor and franchisee. This agreement does not constitute either party a 300 joint venturer, partner, agent, employee or fiduciary of the other. 29F
The employment relationship is the subject of a comprehensive statutory regime that provides employees with ‘cradle to grave’ rights in relation to their employers. These include statutory rights to accurate job advertisements, employer funded superannuation, paid leave, recourse in the event of discrimination and recognised status and rights under the Corporations Act if the employer becomes insolvent. The impact of an employer’s insolvency on employees is addressed in chapter 4.4.6.
Recognition of franchisees by the law stops if the franchisor enters administration or becomes insolvent. Aspects of the resulting problems are addressed in detail in chapters 2.3 and 4.4.1 – 4.4.4.
Duty of confidentiality/secrecy Employees and franchisees both have obligations to keep some matters confidential. In both situations termination of the relationship may result from a breach of this obligation.
Employment entails confidentiality obligations that stem from the employment contract, professional codes of ethics, or specific confidentiality agreements such as those many franchisors require that their franchisees’ employees sign.
300 Jax Franchising Systems Pty Limited v State Rail Authority (New South Wales); Jax Tyres Pty Limited v State Rail Authority (New South Wales) [2003] NSWLEC 397.
Chapter 3: The problem in context 139 140
The contractual obligation in Clause 6.12 of the Donut King franchise agreement typifies the franchisees’ confidentiality obligations towards its franchisor:
Secrecy: The Franchisee and the Guarantors hereby covenant and agree that they shall: (a) maintain, and ensure that their employees maintain, strict secrecy about the modes and methods of business of the Franchisor and the System, including but without limiting the foregoing, any manuals … issued by the Franchisor, the Franchisor’s trade secrets, advertising and publicity material. The Franchisee shall take all reasonable steps to ensure that its employees observe the Franchisor’s requirements for secrecy, including, if required by the Franchisor, the Franchisee’ procuring the execution of a deed of confidentiality in favour of the Franchisor by each employee; (b) not and will procure that their employees shall not, during the Term of this Agreement, or after its termination or expiration, disclose any Confidential Information, including all manuals …, communications, marketing programs, products under development and methods of operations received by any of them during the Term hereof unless disclosure is required by law; ( c) not, and shall procure that their employees shall not , after the expiration or earlier determination of this Agreement use any of the Confidential Information without the written consent of the Franchisor first had and 301 obtained.30F
Employment and franchising respond in a very similar way to this issue.
Restraints on other work that may be done during term of contract An employer expects an employee to devote the agreed amount of time to their work. An employer adopts policies to ensure this occurs, including policies for managing conflicts of interest. The situation is very similar for franchisees. For example franchisor MBE mandates that:
During this agreement the franchisee must not: 9.1(q) without the Franchisor’s prior written consent in any capacity whatsoever be directly or indirectly engaged in any business or undertaking
301 Copy of franchise agreement is in researcher’s possession.
140 Chapter 3: The problem in context 141
which in the sole opinion of the Franchisor is considered competitive to the 302 Business.301F
The equivalent clause in a McDonald’s licence agreement is:
6.05 Best Efforts Licensee or, where Licensee is a company, Principal shall … personally devote… his full time and attention to and exercising his best efforts in the operation of the Restaurant. Licensee [etc] … shall keep free from conflicting enterprises or any other activities which would be detrimental to 303 or interfere with the business of the Restaurant.302F
Where a single franchisee operates multiple units of the same or a diversified portfolio of franchise units with more than one franchisor, they do so with the consent of their franchisors. Thus, in-term restraints are not a reliable distinguishing characteristic of the relationships.
VULNERABLE TO CAPRICIOUS BEHAVIOUR BY EMPLOYER OR FRANCHISOR Employees and franchisees are potentially affected by capricious or unreasonable behaviour by their employer or franchisor. In both situations, despite the existence of fair work and anti-discrimination legislation for employment, and statutory prohibitions against unconscionable conduct and discrimination for franchisees, in practical terms the employer/franchisor has the ‘upper hand.’
If their employer abuses its stronger position, employees may have recourse to a trade union for assistance.
Franchisees in Australia do not have a representative body that functions in the 304 same way a trade union does.30F Franchisees sometimes feel vulnerable and disempowered and may have to go to court to attempt to assert legal rights.
302 Copy of franchise agreement is in researcher’s possession. 303 McDonald's Australia Holdings Ltd & Anor v Industrial Relations Commission of NSW & 2 Ors [2005] NSWCA 286, para 23 of Judgment of Spigelman CJ. 304 A Franchisees Association of Australia Incorporated was established in 1983 but lacked funding and did not function like a trade union; the Franchise Council of Australia claims to represent franchisors and franchisees but ‘current figures suggest that only 200 franchisors of 1100 in total are members, which represents less than 20 per cent while the percentage of franchisees who are members is even lower.’ Elizabeth Crawford Spencer, ‘All for One and One for All: A Survey of Franchise Trade Associations’ Roles in the Governance of the Franchise Relationship.’ (Paper presented at the 23rd Annual International Society of Franchising Conference, San Diego, California, 12-14 February 2009) 15.
Chapter 3: The problem in context 141 142
For example, in Far Horizons Mr Hackett, director of a McDonald’s franchise, vulnerability as a franchisee is obvious in the words of his witness statement:
Mr Xipolitos appeared to me to be determined and insistent on grading me as operationally unsatisfactory…. … I came to realise that my future security and prospects in the McDonald's System, being my $2 million plus investment in my restaurants and my desire to expand, were ultimately in the hands of a very subjective evaluation of my restaurants by one or two people and the personal relationship 305 between myself as licensee and my Consultant. 304F
The increased vulnerability for a franchisee over an employee is that franchisees like Mr Hackett have sunk investments, their own employees, ongoing contractual obligations to the franchisor and third parties and consequential liabilities secured in contractual relationships. The franchisee does not have the option of finding another job.
Thus, while both employees and franchisees are potentially victims of capricious behaviour, the franchisee is arguably more vulnerable and less able to retaliate appropriately because of lack of a representative body to turn to, numerous contingent contractual relationships requiring ongoing performance and an investment in sunk costs to protect.
MAY JOIN A UNION TO ENFORCE RIGHTS Employees are legally permitted to join trade unions in Australia. During the Ansett insolvency in 2001 the trade union provided assistance to the employees in the form of representation at the creditors’ meetings, up to date information on a designated website, and its ‘weight’ in negotiations with the federal government. This resulted in especially favourable treatment for employees.
One enduring, effective, and widely respected franchisee association is the Motor Traders Association of Australia. It represents vehicle dealers and associated franchisees, licensees of vehicle and oil companies and independent operators in the motor trades. For franchisees outside motor trades, several franchisee representative groups have formed and been disbanded over the years. The possible benefit of franchisees joining unions is discussed in chapter 6.1.3.
305 Far Horizons Pty Ltd v McDonald's Australia Ltd [2000] VSC 310, para 42.
142 Chapter 3: The problem in context 143
Accordingly, the possibility of joining a trade union is a significant point of difference between employees with access to union membership and franchisees.
PERSONALLY ASSUME FINANCIAL RISK OF EMPLOYER/ FRANCHISOR’S FAILURE This is another area where the outcomes for employees and franchisees starkly differ. The employee loses his or her job if the employer’s business fails. Some ‘read the writing on the wall’ and leave before the administrator is appointed. For example, Vicky Kay, employee manager of the franchisor owned store Traveland Bondi Junction, is reported as saying that she resigned on 20 November 2001 as manager after 29 years of working for Traveland, fed up with being paid late.
306 They kept saying the money’s coming.305F
Vicky’s employer, Traveland, was a travel agency with 100 non-franchised and 270 franchisee owned agencies. It was wholly owned by Australia’s failed Ansett Airlines. Being paid wages fortnightly or monthly … employees would quickly know if they did not receive wages.
Key staff may be retained by, and paid by, the administrator whilst the administrator reorganises the business structure. The financial risk the employee assumes is in relation to unpaid wages and bonuses. However, statutory protection exists for some wages and allowances, and a government backed GEERS scheme compensates for some wages that cannot be paid from the insolvent estate.
The franchisees may be at a significant disadvantage compared with the franchisor’s employees when it comes to detecting early warning signs of the franchisor’s financial woes. The difference between employees and franchisees was also demonstrated when the Kleins jewellery franchisor failed. It was reported that Kleins:
… collapsed with debts of approximately $20-25 million in May 2008. It became readily apparent that Kleins could never be returned to its former glory and was simply a ‘tired’ business. … all employees would be likely to
306 Alison Rehn and David Penberthy, ‘Traveland liquidators to be paid $1m’, Daily Telegraph (Australia) 15 March 2002, 15.
Chapter 3: The problem in context 143 144
receive their entitlements, under the GEERS scheme, but unsecured creditors 307 [and franchisees] should expect nothing.306F
Franchisee may not become aware of the franchisor’s position until a supplier changed the terms of trade, or they hear about the franchisor’s demise through the media.
MAY SELL THE ROLE This is a significant point of difference. An employee is not at liberty to sell their job. The franchisee, on the other hand, expects to be able to sell their business. Strong re-sales of franchisees’ businesses by incumbent franchisees is one indicator of a successful franchise network.
After relationship ends
OPPORTUNITY TO MAKE CAPITAL GAINS IF ENTERPRISE SUCCEEDS An employee in a middle or senior management position in a public company may be rewarded in the form of a bonus package of options or shares. They would then be free to trade these on the stock exchange at future dates.
Ideally, franchisees also make capital gains if their business succeeds. This is available to the franchisee if they can sell the business during the term of franchise. A longer franchise term provides more opportunity for the franchisee to recover its initial investment while building the franchise, and ideally leaving a residual term to sell.
WHO OWNS THE GOODWILL AT THE END? Goodwill is a complex issue, and is a clear point of differentiation between an employee and a franchisee. An employer owns the goodwill in its business. Its employees do not own the goodwill.
The franchisee situation opens the door for a debate about the type of goodwill that is being sold: is it goodwill that attaches to the person (the franchisee), or the brand (the franchisor) or the location (potentially either or both)? In ATO ruling 308 ‘PCD 8 Capital Gains: Goodwill’307F possible viewpoints on the question of whether a
307 Alexander Samson, Alicia Hill and Derek Sutherland, Back to Basics – Insolvency and Franchising (2009) Dibbsbarker < http://www.dibbsbarker.com/industry/Franchising/Recent_Publications.aspx?publicationid=d835 666ba19cfd1d> at 18 February 2010. 308 Australian Taxation Office, PCD 8 Capital Gains: Goodwill (1995).
144 Chapter 3: The problem in context 145 franchisee can own goodwill are discussed. There is authority for the view that in the absence of a specific contractual provision to the contrary, on the termination of a franchise, the benefit of the goodwill remains in the franchisor. The amount of time still to run under the franchise agreement will be relevant to the conclusion.
Some franchise agreements state the matter clearly. For instance, clause 17.2 of the MBE individual franchise agreement states:
Consequences of Termination The Franchisee shall have no claim against the Franchisor for … compensation for the loss of the business, loss of goodwill or any similar loss.
It would be usual for a franchisee to expect to receive some of the goodwill on the sale of a franchise during the term, particularly where the franchisor has not 309 terminated the franchise agreement for franchisee misconduct.308F
POST-RELATIONSHIP RESTRAINTS Post-contract restraints apply to franchisees and less commonly to employees in Australia. The validity of the restraint depends on how reasonable it is – in time, scope and distance. Franchise related restraint cases in Australia include The Cheesecake Shop v A & A Shah Enterprises [2004] NSWSC 625 which discussed the following clause in the franchise agreement:
16. Post Termination Covenant Not To Compete 16.5 The Franchisee, Nominated Manager and the Guarantors shall not during the term or the period, after the expiration or earlier termination of this Agreement, as specified in the Schedule conduct on his own account or be concerned or interested in whether directly or indirectly as agent, representative, consultant, adviser, servant, employee, trustee, partner, shareholder, or director in any firm or corporation conducting a business similar to the Franchised Operation or in any cake manufacturing or cake retail or cake wholesale enterprise, within the distance [stipulated in the 310 agreement] from the location specified in the Schedule.309F
309 Goodwill is discussed by Ian Tregoning in ‘Goodwill in the Context of Licensing, Leasing and Franchising: Some Considerations’ (2009) 37 Australian Business Law Review 296. 310 The Cheesecake Shop v A & A Shah Enterprises [2004] NSWSC 625.
Chapter 3: The problem in context 145 146
Justice Windeyer was not prepared to enforce a post-term non-compete covenant, writing:
I cannot see how the restraint could be justified. It is really a prohibition against competition without any evidence to establish anything being competed against. There is no evidence that The Cheesecake Shop (TCS) wished to open a Cheesecake Shop within the postcode referred to or anywhere near Bonnyrigg or anywhere within the restrained area. Thus there is no evidence of disadvantage to TCS if a shop selling cheesecake products operated from the premises. In the absence of evidence the covenant would seem to operate to preserve an area for TCS operations which do not presently exist and may never exist. … such a restraint could not be upheld as it could not be shown to be necessary or reasonable to preserve the 311 goodwill of TCS.310F
ON TERMINATION OF RELATIONSHIP EMPLOYEE OR FRANCHISEE HAS FINANCIAL OBLIGATIONS RE THE BUSINESS. While an employee would expect to have an ongoing obligation not to disclose confidential information obtained during a period of employment, some franchisors impose a more onerous obligation through their franchise agreements. The independent contractor or the employee is free to look for new work as soon as the administrator is appointed. At the time of the franchisor’s insolvency a key difference between employees and franchisees is that the employees are supported by government policy, franchisees are not.
The differences between franchisees and employees are often as striking as the similarities, especially when the franchisor fails. The implications for employees are discussed in chapter 4.4.6.
3.3 THE FRANCHISE AGREEMENT
The first question when considering any problem from a legal perspective is: can the problem be addressed within the existing law? Is anything preventing franchisees from protecting themselves against the consequences of franchisor failure by negotiating contracts better? Intuitively, it would seem that franchisors and franchisees should be able to incorporate provisions into the contract that address the possibility of the franchisor’s business failing, and thereby provide franchisees with
311 Ibid para 36
146 Chapter 3: The problem in context 147 appropriate consequential rights. New York franchise lawyer Craig Tractenberg recommends:
The best protection against the risks inherent in the bankruptcy process is to terminate the franchise agreement before bankruptcy is filed. If the franchise agreement is terminated before bankruptcy is filed, it is not protected by the 312 automatic stay and the franchise is not property of the estate.31F
313 Tractenberg also advises that ‘[c]omplete termination is required’.312F Similarly, the best protection for franchisees is for them to be legally entitled to terminate the franchise agreement during the period of administration before the franchisor’s liquidator is appointed.
‘Contracts are fundamental to commerce. Contract law determines how a contract is made, whether it is enforceable, whether it has been breached, and what 314 remedies are available for its breach’.31F Blair and Lafontaine summarise a franchise agreement as being:
…most often understood as a contractual arrangement between two legally independent firms in which one firm, the franchisee, pays the other firm, the franchisor, for the right to sell the franchisor’s product and/or the right to use its trademarks and business format in a given location for a specified period 315 of time.314F
Franchise agreements perform the same role everywhere. In South Africa, for example, the franchise agreement has been described in Cacun Trading No 24 CC &
312 Tractenberg, above n 110, end note 8; See, for example, Moody v Amoco Oil Company 734 F 2d 1200 (7th Cir) cert denied, 469 US 982 (1984). Tractenberg is writing for an audience of lawyers whose clients are franchisors whose franchisees are becoming bankrupt but the same applies to franchisees. Whilst being a high-risk strategy for franchisees in Australia, termination for anticipatory breach is the avenue that gives individual franchisees the quickest exit from a doomed franchise agreement; see ch 3.3 of this thesis. 313 Tractenberg, above n 110, end note 9. If the franchise agreement expired prepetition or is otherwise not in existence because of having been completely terminated prepetition it is not property of the estate. See, for example, Days In v Gainesville P-H Properties, Inc 77 BR 285 (Bankr MD Pa 1993); But compare with Baskin Robbins Inc v Neiberg 161 BR 606 (Bankr BD Pa 1993) (no waiver by franchisor of termination rights) with In re Karfakis, 162 BR 719 (Bankr BD Pa 1993) (franchise agreement and real property lease were indivisible contracts and purported termination of franchise agreement without taking possession of real estate was incomplete termination of the integrated franchise rights of the debtor). 314 M P Ellinghaus, E W Wright and M Karras, Models of Contract Law an Empirical Evaluation of Their Utility (2005). 315 Blair and Lafontaine, above n 46, 3-4.
Chapter 3: The problem in context 147 148
Others v Seven-Eleven Corporation SA (Pty) Ltd unreported case no 18/IR/Dec 99 thus:
[a] franchise agreement is neither an employment relationship nor an independent contracting relationship. It rather combines elements of integration and delegation, control and independence and is thus a multifaceted vertical structure that paves the way for endless relational and 316 commitment problems.315F
Any problems are ideally addressed to the satisfaction of both parties as the relationship develops. After conducting an inquiry into franchising in 2008, the Economics and Finance Committee of the South Australian Parliament writes:
The basic premise on which the principles of freedom of contract and sanctity of contract rest is that contracts are negotiated at arm’s length by equally positioned participants in the bargaining process. That premise is not 317 fulfilled in the typical franchise arrangement.316F
‘Contractual relations are the essence of the firm, not only with employees but 318 with suppliers, customers, creditors’317F and franchisees. The franchise agreement is also the starting point for the courts, administrators and liquidators determining the parties’ rights. The franchise agreement will now be examined as the record of a bargain, and in the context of the franchisor failing.
3.3.1 ADDRESSING THE FAILURE OF THE FRANCHISOR’S BUSINESS The franchise agreement documents a relationship that is commercial and consumer. The subject of the contract is a commercial relationship. The parties are the franchisor as a business supplier and a franchisee as a business consumer. Once executed, like all commercial agreements, it sits in the proverbial ‘bottom drawer’ until one party needs to invoke legal rights. Then, it commands the undivided attention.
Because there is no public register of franchise agreements in Australia, 70 franchise agreements … were chosen from the US website FreeFranchise
316 Tanya Woker, ‘Franchising – The Need for Legislation’ (2005) 17 South African Mercantile Law Journal 49, 51. 317 Economics and Finance Committee, Parliament of South Australia, Franchises (2008) 17. 318 Jensen and Meckling, above n 21, 311.
148 Chapter 3: The problem in context 149
319 docs.318F [We] examined [them] to determine what a typical franchise agreement might say about insolvency of one of the signatories. None of these agreements mentioned franchisor bankruptcy … In the same agreements, 23.5 per cent were silent on the right for franchisors to terminate the agreement if the franchisee became bankrupt. Seventy six per cent permitted the franchisor to terminate the franchise agreement, usually with 320 no notice and no right to cure if the franchisee became bankrupt.319F
In Australia, the ex post experience of a Traveland travel agency franchisee is consistent with the US findings above:
We’d just renewed the franchise agreements on our 4 [Traveland] outlets for 5 years when the franchisor’s administrator was appointed. We went to see a 321 QC to see if we could get out of the agreements and there was no way.320F
This failure to provide for an event which is demonstrably common is problematic. The ideal world where ‘negotiations between two … parties, … are
322 designed to advance the wants and needs of each of those contracting parties’321F does not describe the experience of franchisees. Contract theory helps explain how this imbalance arises and why it has not been redressed by the common law.
3.3.2 THE DESIRABILITY OF CERTAINTY IN CONTRACTS Notwithstanding that one would assume for all stakeholders that certainty is an outcome of the contracting process and
[t]he classical theory of contract was seen to offer predictability and certainty, although, as Sir Anthony Mason has observed; “It later emerged, as is the case with many legal concepts rooted in formalism, that the element 323 of certainty was illusory”32F
Acknowledging that the franchise agreement is a relational contract is also to acknowledge that whilst procedural certainty may be achieved, substantial certainty need not be an outcome of the contracting process. Certainty in all dimensions is
319 Free Franchise Docs
Chapter 3: The problem in context 149 150 widely accepted as being desirable in commercial relationships. Heather Ridout 324 points out that ‘uncertainty is death for business’32F in the context of the carbon trading debate. Hadfield observes:
… incomplete contracts (such as franchise agreements) often exist deeply embedded in an ongoing relationship. The parties are not strangers; much of their interaction takes place “off the contract” mediated not by visible terms enforceable by a court, but by a particular balance of cooperation and 325 coercion, communication and strategy.324F
There is an assumption underlying a relational contract that the major foreseeable events which could fundamentally change the relationship, are addressed in the contract. Other events are foreseeable but seem so unlikely to one or both parties that they are not included. The parties acknowledge, by implication, that some events are not foreseeable and will be the subject of negotiation if and when they occur. Where certainty is not possible, a balanced contract would be a desirable outcome.
3.3.3 PARTIES TO COMMERCIAL AND CONSUMER CONTRACTS ACT IN THEIR OWN INTERESTS As E W Thomas observes, ‘[i]t is the law of contract that has the greatest impact on interactions where freedom of choice and action and freedom from 326 interference are most coveted’.325F Parties to commercial contracts should act in their own interests but, as K M Sharma writes:
… the liberal fiction that all the effects of a contract should be attributed to the will of those who made it still persists though contract law today even though the overwhelming majority of contracts are the product of the will of 327 only one of the contracting parties.326F
Parties to contracts act in their own interest. In franchising, though, the will of the franchisor dominates the franchise agreement. Franchisors draft the agreement
324 Sky News, ‘Australian Industry Group, Heather Ridout, with Kieran Gilbert’, Agenda (5 May 2009). 325 Hadfield, ‘Problematic Relations: Franchising and the Law of Incomplete Contracts’, above n 202, footnote 28 at 928. 326 E W Thomas, The Judicial Process: Realism, Pragmatism, Practical Reasoning and Principles (2005) 382. 327 K M Sharma, ‘From Sanctity to Fairness’ (1999) 18 New York Law School Journal of International and Comparative Law 95, 115.
150 Chapter 3: The problem in context 151 acting in their own interest. This makes sense to the extent that franchisors can thereby ensure that the major risks for the future integrity of their network are addressed, and can achieve administrative efficiency through standardisation.
That franchisors do act in their own interest is demonstrated by franchisors’ responses to compliance with the voluntary Franchising Code of Practice (FCP). The FCP was ‘introduced in 1993 to address significant problems in franchising 328 identified in the 1991 report by the Franchising Task Force’.327F The FCP was a form 329 of ‘soft law’328F recognised within the franchising community as being a final opportunity for the franchising sector in Australia to prove to the Australian Government that it could self-regulate. The alternative to demonstrated, sector-wide, voluntary compliance was that the Government would enact legislation to regulate franchising. After one year of proactive, government funded promotion of the benefits of the FCP it was perceived that the FCP was not delivering on hopes, and the Gardini Review was commissioned. Robert Gardini wrote that ‘[a]s at 30 September 1994, 376 franchisors had registered with the FCAC [the body administering the FCP]. … it appears that approximately 50 – 60 per cent of 330 franchisors are registered’.329F
Both the franchisors that did register and those that did not, acted in their own interest. Some registered because most banks required registration as a pre condition of lending to franchisees. It was considered at the time that ‘restraints contained in 331 the Code on financial institutions and publishers30F would increase the pressure on 332 franchisors to register’.31F Those that did register may also have been motivated by the credibility that they hoped the ‘FCP compliant’ by-line lent to their businesses.
328 Robert Gardini, Review of the Franchising Code of Practice (1994) v. 329 Iain Ramsay, ‘Consumer Law, Regulatory Capitalism and the ‘New Learning’ in Regulation’ (2006) 28(1) Sydney Law Review 9. 330 Gardini, above n 328, 15. 331 ‘Publisher’ was included under the definition of ‘Service Provider’ in clause 3(e) of the Franchising Code of Practice 1993 but the definition did not expand on who would be considered to be a ‘publisher’. Clause 16.2 of the Code of Practice stated: Service Providers which are publishers and advertising media providers who register with the Code will comply with the Code by agreeing not to take or place advertisements from persons purporting to sell or provide Franchise opportunities unless those persons are able to provide a current Code Registration Number. 332 Gardini, above n 328, v.
Chapter 3: The problem in context 151 152
However, ‘…the motor vehicle industry … decided not to participate in the 333 Code, as [did] significant areas in the real estate sector’.32F Those that did not register also acted in their own interest for reasons which included:
lawyers advising franchisor clients not to voluntarily expose themselves to the obligations the FCP imposed on signatories,
that the franchisor had nothing to hide and concluded that compliance would impose a financial and administrative cost that they would pass on to franchisees while not generating any greater security for their franchisees,
that the franchisor did have something to hide and did not want to risk exposing themselves to a random audit, and
a few franchisors claimed not to know of the existence of the FCP.
Each franchisor, thus, acted in its own interest. This rational approach helps explain why franchisors make no mention of franchisor failure in franchise agreements. They believe they are acting in their own interest. The franchise sector’s equivocal response to complying with the FCP is likely to be an indication of how they would respond to the suggestion that all franchise agreements voluntarily include provisions addressing franchisees’ rights if the franchisor failed.
A further example of the stronger party acting in its own interest is the way issues of risk and reward are addressed in franchise agreements. A contract negotiated between parties of equal weight and with a mutual interest in the success of the venture would result in the contract addressing both risk and gain in a balanced way. For example, despite having assumed a considerable amount of the franchisor’s business risk franchisees have no right to receive the corresponding reward that a franchisor’s venture capital providers or shareholders typically would be entitled to if 334 the franchisor entity is sold for a profit.3F
Thus the assumption that franchisors will act in their own interests is correct. The assumption that the weaker party to the contract, the franchisee, will act in their
333 Ibid. 334 For example S Mitchell, ‘Cartridge Refiller Tops up With $60m’, The Australian Financial Review (Melbourne), 2 August 2007, reports on a private equity led management buyout of 80 per cent of the franchisor’s business for an estimated $60m.
152 Chapter 3: The problem in context 153 own interests, is debateable. If they want to become a franchisee of a specific network they have no ability to act in their own interests; in order to be approved as a franchisee they hand the franchisor all of their financial information, then prior to becoming a franchisee they execute the standard form, non-negotiated agreement drafted by the franchisor.
3.3.4 A STANDARD FORM BUSINESS CONSUMER CONTRACT In its submission to The Australian Consumer Law Consultation on Draft Provisions on Unfair Contract Terms, the Law Society of NSW provides examples of ‘standard form contracts’ frequently used in conveyancing transactions and states that:
the Committee believes that the use of these forms has significant consumer benefits: [being] familiarity, comprehensiveness, compliance with legislative provisions, frequently updates, flexibility, efficiency, risk management, 335 balance between the parties to the transactions.34F
Whilst all of these points are valid in respect of standard form contracts drafted by an impartial party, standard form agreements such as franchise agreements are drafted by the overwhelmingly more powerful party in a commercial relationship. The Law Society’s thinking about standard form contracts is inaccurate in the context of standard form franchise agreements.
Franchisors use standard form franchise agreements drafted to maximize their position. For example:
Clauses identical or substantially similar to clause 10 appear in franchise agreements for over 14,000 Subway franchises throughout the world. The reason Subway Systems and Doctor's Associates require disputes with franchisees to be resolved in accordance with clause 10 is that they want to develop an internationally consistent approach to dispute resolution with 336 franchisees.35F
Thus, in the Subway franchise network the franchisor maximizes its position by requiring disputes that are not able to be resolved by mediation at national level to
335 Law Society of New South Wales, Australian Consumer Law – Consultation on Draft Provisions on Unfair Contract Terms (2009) Australian Government, The Treasury
Chapter 3: The problem in context 153 154 be resolved by arbitration or litigation in the location nominated by the franchisor, 337 Connecticut, USA.36F Such a strategy is beneficial to the franchisor but is a significant disincentive to robust dispute resolution for Subway franchisees in Australia.
Franchisees are encouraged to read the franchise agreement and ask questions, but any requests for changes are typically rejected by the franchisor. Standardisation of outcome is a more important result for a franchisor than letting a new franchisee enter the relationship in the mistaken belief that he or she has any bargaining power. The franchisee accepts the franchisor’s unwillingness to negotiate because standardisation reinforces the franchisor’s mantra – we know how to do it, trust us and sign on with us and you will be successful before you know it.
Nevertheless franchise agreements are:
long-term contracts [that] involve continuing financial commitment in the course of which the consumer, being imperfectly informed and not fully aware about his needs – is largely reliant on the advice, guidance and skills 338 of his counter-party.37F
In addition to being a contract concerning the purchase and operation of a business the franchise agreement is a contract between a supplier and a business consumer. It places a franchisee in a position of dependence on the franchisor in relation to services provided by both the franchisor and by third parties. Despite all the words about support and nurturing that have resulted in the franchisee purchasing the business, the franchisor’s position is clearly stated in the wording of the franchise agreement, as is shown for example in a typical Australian franchise agreement.
‘Clause 10.1 of the [Lenard’s] retail chicken shop franchise agreement reads as follows:
337 ‘Doctor's Associates Inc, an American corporation, is the owner of proprietary and other rights and interests in various service marks, trade marks, trade names and goodwill used in its business including the trade name and trade mark ‘Subway’. Subway Systems is the Australian licensee of Doctor's Associates. … Clauses identical or substantially similar to clause 10 appear in franchise agreements for over 14,000 Subway franchises throughout the world. The reason Subway Systems and Doctor's Associates require disputes with franchisees to be resolved in accordance with clause 10 is that they want to develop an internationally consistent approach to dispute resolution with franchisees.’ In Timic v Hammock [2001] FCA 74. 338 Andromachi Georgosouli, ‘Investor Protection Regulation: Economically Rational?’ (2006) Working Paper Series, University of London, Centre for Commercial Law Studies 10
154 Chapter 3: The problem in context 155
The National Franchisor, the Master Franchisee and the Franchisee are each independent contractors. They are not and shall not be considered as joint venturers, partners or agents of each other and no fiduciary relationship shall 339 be deemed to exist between them’.38F
Elizabeth Spencer observes:
The inherent dynamic in franchisor/franchisee relationship … involves maintaining the franchisee in a subordinate position. This increases the franchisee’s motivation to provide assurances of performance, among them taking on risk. … Despite being overburdened with risk, because of the standard form the franchisee is faced with the choice of accepting the 340 contract terms or giving up on the deal entirely.39F
But, as Rick Bigwood points out, ‘standardized [as manifested by standard form] contracts are mostly to be endured as beneficial in complex free market 341 economies. This is largely because they reduce transaction costs’.340F Bigwood 342 acknowledges that ‘consumer protection through market forces alone is weak’.341F The inability of market forces to remodel franchise agreements to accommodate franchisor failure is an aspect of extreme one sidedness that is not to be endured. For example, franchise agreements always provide for the death or insolvency of the franchisee. There are no statistics available for the number of franchisees who die while being a party to a franchise agreement. In the author’s experience acting for franchisors of large networks, a franchisee died on two occasions. On both occasions the death affected one outlet and the transition to a new owner was managed by the franchisor without interruption to any other franchisees. By way of contrast, a ‘standard form contract … does not anticipate [the franchisor equivalent of the franchisee’s death] insolvency of the franchisor. This limits the ability of the 343 franchisee to self protect’.342F
339 Poulet Frais Pty Ltd v The Silver Fox Company Pty Ltd [2005] FCAFC 131 (Branson, Nicholson and Jacobson JJ). 340 Elizabeth Spencer, ‘Standard Form and Relational Aspects of Franchise Contracts’ (Paper presented at the 20th International Society of Franchising Conference, Palm Springs, California, 24-26 February 2006) 21, quoting Silvana Sciarra, ‘Franchising and Contract of Employment: Notes on a Still Impossible Assimilation’ in Christian Joerges (ed), Franchising and the Law: Theoretical and Comparative Approaches in Europe and the United States (1996) in Journal Institutional & Theoretical Economics, 152, 297-324. 341 Rick Bigwood, Exploitative Contracts (2003) 274. 342 Ibid 274-5. 343 Jenvey, above n 123.
Chapter 3: The problem in context 155 156
Another way of expressing the problems caused by the standard form is that:
[c]onflicts of interest may, and do, create counter-incentives for [creating and] complying with contractual obligations. Especially in long term contracts and in conditions of asymmetric information, the possibility of opportunistic behaviour appears considerably increased not least because the value of the contract and the investment depends on the firm’s performance 344 after the point of purchase.34F Contracting out would be a way in which consumers could avoid being exposed to the risk of their counter-party’s misconduct, nevertheless the costs involved discourage them from doing 345 so.34F
It is easy to suggest that, having observed that other franchisees have already made the investment in the franchise business, franchisee consumers free ride and do not conduct extensive due diligence. Even if adequate due diligence were possible the contract is not negotiable. As Carter et al state:
the assumption that will and intention form the substratum of every contract is heavily attenuated by inequality of bargaining power between individual and corporation whose power is marked by common use of standard form 346 contracts.345F
Willmott et al add that
[s]tandard form contracts are typically used by parties who are in such a strong bargaining position … that they are able to prescribe the terms on 347 which they are prepared to contract on a ‘take or leave it’ basis.346F
The franchise agreement is an example of such a contract negotiation process. The franchisor supplier drafts the franchise agreement. The franchisee business consumer takes it or leaves it, seldom having the opportunity to vary the standard form. Experience of legal practitioners suggests that the only franchisees in the position to negotiate non-standard terms into their franchise agreement may be the first franchisees of a new network or the first master franchisee entering a new state or country where a franchisor is very keen to establish a presence.
344 Georgosouli, above n 338, 10-11, fn 40 citing I D C Ramsey, ‘Rationales for Intervention in the Consumer Marketplace’ (1984) Occasional Paper for the Office of Fair Trading 28. 345 Ibid 11. 346 J W Carter, Elisabeth Peden and G J Tolhurst, Contract Law in Australia (5th ed, 2007) 8. 347 Willmott et al, above n 322, 583.
156 Chapter 3: The problem in context 157
3.3.5 RELATIONAL CONTRACT Franchise agreements are relational contracts, and are necessarily incomplete. Underlying a relational contract is the assumption that the major foreseeable events that could fundamentally change the relationship have been addressed in the contract. As Hadfield observes
incomplete contracts [such as franchise agreements] often exist deeply embedded in an ongoing relationship. The parties are not strangers; much of their interaction takes place ‘off the contract’ mediated not by visible terms enforceable by a court, but by a particular balance of cooperation and 348 coercion, communication and strategy.347F
‘In contract theory, incompleteness is [also] due to the cost and sometimes 349 unavailability of information’.348F During the initial contract negotiations ‘parties incur ex ante transaction costs, including the costs of anticipating future 350 contingencies and writing a contract that specifies an outcome for each one’.349F ‘Both ex ante and ex post contracting costs prevent parties from writing complete contracts 351 and give rise to what economists refer to as the problem of incomplete contracts’.350F
Ex ante, the parties might not foresee all possible contingencies or they would have to incur prohibitively high negotiation and drafting costs to partition all contingencies sufficiently to provide for efficient obligations in each case. The contingency that the franchisor’s business might fail is the least likely from a franchisees’ perspective, as most believe they are buying a proven concept. ‘A challenge for parties designing contracts is to preordain or at least constrain the 352 course of future renegotiation so as to yield both ex ante and ex post efficiency’.351F
As Hadfield points out, once the contract moves beyond negotiation or performance to litigation:
[t]o the extent that courts cannot distinguish between the derogation of a commitment in an incomplete contract, and an exercise of the flexibility
348 Hadfield, ‘Problematic Relations: Franchising and the Law of Incomplete Contracts’, above n 202, 928. 349 Robert E Scott and George G Triantis, ‘Incomplete Contracts and the Theory of Contract Design’ (2005) 56(1) Case Western Reserve Law Review, 187, 191. 350 Ibid 190. 351 Ibid. 352 Ibid 194.
Chapter 3: The problem in context 157 158
which is part of that commitment, incomplete contracts cannot fully function 353 in their role as anchor for many complex transactions.352F
354 The franchise agreement is necessarily incomplete because of its long term35F and the unpredictability of human relationships and commercial environments.
the legal system is likely to be a poor venue for specifying the substantive terms of the [long term franchise] contract. It would be unrealistic to expect a relational contract to cover all contingencies. From a franchisee’s perspective, then, perhaps the biggest problem with franchising lies not so much in what it is, but rather what it is not and yet sometimes appears to 355 be.354F
‘To a lawyer, a contract may be incomplete in failing to describe the 356 obligations of the parties in each possible state of the world’.35F It is thus difficult to explain why franchisors would knowingly leave gaps around the possibility of franchisor failure when ‘the cost of making contracts complete in this sense is 357 trivial’.356F A flaw in applying the theory of trading off ‘front-end and back-end 358 costs’357F to justify not providing for franchisor failure ‘up front’ is that franchisors fail sufficiently often for the risk to be eligible for inclusion in the franchise agreement from the outset. It would be relatively inexpensive to insert provisions about franchisor failure into the franchise agreement, and the traditional justification that issues left for the back end will be resolved by the courts is not justifiable where the trigger event is the insolvency of one party.
Justice Hammond in Dymocks Franchise Systems v Bilgola Enterprises Ltd 8 TCLR 612 recognised that the
underlying recognition is that a relational contract is of an ongoing, and often relatively open-ended, character; and that it is in society’s interest to
353 Hadfield, ‘Problematic Relations: Franchising and the Law of Incomplete Contracts’, above n 202, 928. 354 Shelby D Hunt, ‘The Trend Towards Company-Operated Units in Franchise Chains’ (1973) 49(2) Journal of Retailing 3, 10 reported that typically fast food franchisors in the US granted terms with a median length of 15 years, and that frequently the franchisee had an option to renew. Frazer, Weaven and Wright, Franchising Australia 2008, above n 7, 23 found the initial term of a franchise agreement in Australia across all sectors except motor vehicles varied from one to 50 years, with a median term of 5 years. 355 Blair and Lafontaine, above n 46, 221. 356 Scott and Triantis, above n 349, 187, 190. 357 Ibid. 358 Ibid 196.
158 Chapter 3: The problem in context 159
accord to each party to a contract of this kind, reasonable security for the 359 protection of his or her justified expectations.358F
A franchisee’s ‘justified expectations’ are unmet if the franchisor fails.
3.3.6 INCOMPLETE CONTRACT Carter et al identify that ‘The absence of genuine [pre-contractual] negotiation can result in the weaker party signing an unfavourable contract. Partly in response to this, the law of contract implies terms into certain commonly occurring contractual 360 relationships to complete the parties’ bargain’.359F Under the common law some 361 situations merit implying terms into contracts’.360F These may be implied to give 362 effect to the ‘presumed intentions of the parties’.361F The presumed intentions of the parties could rarely be proven, to the satisfaction of a court, to have included the franchisor’s failure. It is thus not open to the franchisee to argue that clauses providing the franchisee with contract-based rights on the franchisor’s insolvency were omitted because the contract did not reflect the intentions of the parties.
363 Alternatively terms are implied into contracts ‘regardless of intention’362F because the type of contract or a specific statute mandates inclusion of that term.
Currently no terms are implied into franchise agreements to fit the second category following the appointment of a receiver, administrator or liquidator. The possibility of implying terms into franchise agreements by statute is addressed in chapter 6.2.
E W Thomas adds a judicial perspective to the conclusions drawn by Carter writing that:
[i]t would be quite wrong to think that a contract that omits a provision to deal with a particular contingency is due to an oversight or the finite capacity of business people and their legal advisers to predict future events with accuracy. … there are sound commercial and economic reasons why the parties may deliberately choose to enter into agreements in which no 364 provision is made for known contingencies.36F
359 Dymocks Franchise Systems v Bilgola Enterprises Ltd 8 TCLR 612, 630. 360 Carter, Peden, Tolhurst, above n 348, 8. 361 See Des Butler et al, Contract Law Casebook (2009) 73. 362 Ibid 73–4. 363 Ibid 77. 364 Thomas, above n 326, 296.
Chapter 3: The problem in context 159 160
Contracts may not be complete because they were never intended to be complete. In the franchising arena, for example, franchisors may negotiate directly with a landlord to reach heads of agreement in relation to the franchisees’ premises, then both franchisor and landlord may hand the negotiations over to the landlord’s shopping centre manager or lawyer to complete the lease details with the franchisee. The heads of agreement may constitute a binding contract, but it is incomplete.
Thomas accurately observes that in a typical commercial negotiation
[t]he decision as to what is the most efficient will be made having regard to … the time available for further negotiations, the cost of more comprehensive drafting, the risk that the core bargain will be lost, the chances of the contingency actually occurring, and the consequences or alternatives available if the contingency does not occur. Further, with long- term or relational contracts … the parties can anticipate that some terms of the contract will be renegotiated and developed in the light of experience or 365 necessity.364F
But, by taking each of the factors identified by Thomas and placing them in the context of the franchise sale and purchase process it can be concluded that franchise contracts are not the result of typical commercial negotiations. There is, in theory, ample time. The franchisee has a 14-day cooling off period in which to consider the deal. By this time the franchise agreement has already been settled through a process of franchisor centric drafting and it is likely that no amendments will be agreed to.
Cost is not the issue. The additional cost of drafting to provide a termination right for franchisees would be negligible, especially once that provision had been incorporated as standard into the franchisor’s usual franchise agreement. However, the franchisee is required to sign the standard franchise agreement for the network.
There is a perceived risk that the core bargain – the sale of the franchise to the franchisee – will be lost if the franchisee insists on additional terms. However, once a franchisee has decided which franchise to buy, it is very difficult to dissuade them. This is explored further in chapter 3.4.
The damage resulting from franchisor failure is more widespread than that caused by the failure of an individual franchisee. When a franchisor fails, all of its
365 Ibid 296-7.
160 Chapter 3: The problem in context 161 franchisees are affected, most adversely. If an individual franchisee fails the franchisor will not fail, and nor will any other franchisees. Damage resulting from franchisor failure was explored in chapter 2.3.
3.3.7 EXPLOITATIVE CONTRACT A franchisor has no incentive to include terms to protect the franchisee from the consequences of the franchisors’ administration or insolvency. The franchisor has every incentive to put itself into a contractual position where it can exploit its franchisees if the relationship does not evolve as the franchisor expected. The concept of exploitative contracts has been investigated in depth by Bigwood, who describes the power imbalance between the franchisee (Plaintiff) and franchisor (Defendant) that creates the environment for exploitation:
What is crucial is that the vulnerability that gives rise to the asymmetric power relation between the parties is such that P ought to be excused … from having to exercise that level of responsibility or self-reliance expected and required of the generality of contracting parties. … the exploitable circumstances condition presupposes a weakness or vulnerability that, in the circumstances, removes P from the normal assumptions made about the bargaining ‘game’… the crux of the exploitable circumstances criterion lie in the nature and extent of the power relation existing between the parties. What matters is that P’s interests have become peculiarly sensitive to – that is, they can be directly, strongly and adversely affected by – D’s choices and actions and this resultant vulnerability becomes the source of D’s bargaining 366 power.365F
The nature of the franchise agreement as a standard form contract means a franchisee is typically unable to effectively negotiate amendments to provide it with rights if the franchisor fails. Consequently, the supplier franchisor is entering a franchise agreement that potentially exploits the franchisee consumer.
In Meridian Madam Justice Dodds-Streeton acknowledged that:
[implying] a term [of good faith], whatever the basis of its implication and whatever its precise content, may validly operate to protect a vulnerable or
366 Bigwood, above n 341, 143.
Chapter 3: The problem in context 161 162
disadvantaged party “from exploitative conduct which subverts the original 367 purpose for which the contract was made.36F
If protection of franchisees from the consequences of franchisor failure is not achievable through the franchise agreement, how has the legislature responded? This will be explored in chapters 4.3, 4.4 and 4.5.
3.3.8 BREACH OF CONTRACT In theory, franchisees whose franchisor failed could claim breach of the franchise agreement by the franchisor and make out a contract law based claim, or a quasi-contract claim. In practice, it is difficult for a franchisor to breach a franchise agreement as the agreement imposes so few obligations on the franchisor. In the absence of a breach of a term of the contract, a contract-based claim against a franchisor could be based on the doctrine of frustration or on unjust enrichment or anticipatory breach.
Frustration Events may occur after a contract has been made which makes its performance pointless, more difficult or more costly, or even impossible. Such events may result in the termination of the contract by operation of 368 law, on the basis that it has been frustrated.367F
Frustration of a contract can only arise if the following conditions are met: a. The supervening event must cause a fundamental or radical change to the nature of the contractual rights and obligations; b. Neither party should have caused or brought about the supervening event; c. The supervening event must be such that it was not contemplated by the parties when they entered the contract. It follows, therefore that there should be no provision in the contract designed to deal with it; and
367 Meridian Retail Pty Ltd v Australian Unity Retail Network Pty Ltd [2006] VSC 223, para 210 at [4] citing Warren CJ in Esso Australia Resources Pty Ltd v Southern Pacific Petroleum NL (receiver and manager appointed) [2004] VSC 477, who contemplated that only protection of a ‘particularly vulnerable’ party or a party ‘at a substantial disadvantage’ may justify curial interference. In Meridian, the franchisor’s conduct was not considered to be exploitative. 368 NC Seddon and M F Ellinghaus, Cheshire and Fifoot’s Law of Contract (8th Australian ed, 2002) 881.
162 Chapter 3: The problem in context 163 d. It must be unjust to hold the parties to the contract to its terms as originally 369 agreed upon.368F
The failure of the franchisor will meet the first condition. The fundamental change from the franchisees’ perspective is that the franchisor becomes unable to deliver on its side of the bargain. It may have lost the right to grant licences to franchisees to use the trade marks. It may have breached head leases that, in turn, deprive franchisees of their premises.
The franchise agreement is re-categorised as an asset or a liability and, whereas prior to the franchisor’s liquidator being appointed the franchisee was entitled to rely on the franchise agreement as a source of franchisor’s obligations, from the time the liquidator is appointed the franchisee has no right of access to remedies for breach of contract and the liquidator is entitled to disclaim the franchise agreement as an onerous contract.
Condition b. may preclude franchisees of some failed franchisors from accessing frustration as a cause of action. If, for example, the franchisor brought about its own failure by acting strategically, or caused it by failing to manage its finances prudently, it is possible that franchisees may be prevented from claiming frustration.
Condition c. is met in almost all franchise agreements. Solutions proposed in chapter 6.2.2 would lead to franchisees being unable to access the remedy of frustration because all franchise agreements would address franchisor failure.
Whether condition d. is met will depend on whose perspective is taken into account. From the administrator’s perspective, it would be reasonable for the franchisee to be held to the contract, whereas for the franchisee, it may be unjust.
It is suggested that an Australian franchisee could not successfully argue frustration while the franchisor was under administration because the franchise agreement is between the franchisor or its assigns (which includes the administrator) and the franchisee.
It is also possible that the sale of the franchise network by a liquidator to an unsuitable buyer could frustrate the contract if Penrith District Rugby League
369 D Khoury and YS Yamouni, Understanding Contract Law (7th ed, 2007) 419.
Chapter 3: The problem in context 163 164
Football Club Ltd v Bradley Scott Fittler BC9600163 NSWSC is applied. In that case, competition under a new league was found to be radically different from that contemplated by the contracts signed by Bradley Fittler and Matthew Sing (‘the players’). A proposal to enter into new competitions and to transfer club's assets to new competition licensee discharged parties from further performance of contracts and the innocent party (in this case the players) were not responsible for bringing about circumstances frustrating the contract. The contracts were held to have been frustrated.
Frustration has not been raised in any Australian franchise cases. In Canada, a plaintiff franchisee:
… sought rescission of its franchise agreement based upon fundamental 370 breach.369F It also sought the return of the franchise fee, royalty fees and advertising fees paid to the franchisor. In considering the issue of fundamental breach and the numerous alleged breaches of the franchise agreement by the franchisor, the [British Columbia Supreme] Court found that the franchisee had obtained substantially what it bargained for under the franchise agreement, and accordingly found that there was no fundamental 371 breach of the agreement.370F
Goldman explains this particular decision stating:
Whether a fundamental breach argument has any chance of success is fact dependent. The greater the benefit that the franchisee has already received from being part of the franchised system, the less likely that the franchisor’s bankruptcy will be found to have fundamentally breached the franchise 372 agreement. 371F
Unjust enrichment
373 Alternatively, franchisees could make out a claim in quasi-contract372F against the administrator or liquidator, for unjust enrichment. This action would theoretically be available to franchisees in Australia, though it has not been tested in the context of insolvency in Australian courts. It depends firstly on the court granting consent to
370 Magnetic Marketing Ltd v Print Three Franchising Corp et al (1991) 38 CPR (3d) 540. 371 Goldman, above n 162, 11. 372 Ibid 12. 373 Bruce Moore (ed), The Australian Oxford Dictionary (2nd ed, 2010) 479. ‘Quasi-contract (implied contract) a form of the equitable remedy of restitution to restore an innocent party to his previous position.’
164 Chapter 3: The problem in context 165 franchisees to embark on litigation against the administrator or liquidator or against the directors or solvent related entities of the failed franchisor. Success in
a restitutionary claim based on unjust enrichment depends upon the plaintiff establishing the following elements: Benefit or enrichment [defendant has been enriched by the receipt of a benefit – in the case of the franchisor, upfront fee that was charged for the right to conduct a franchise for, say, 5 years, but the franchisor became insolvent after 2 years – 3/5 of the initial franchise fee could be the starting point] At the plaintiff’s expense Unjust factor (unjust to allow the defendant to retain the benefit); and No bars to the restitutionary claim (no other consideration barring the claim, such as a subsisting valid and enforceable contract between the parties). To succeed in a restitutionary claim all these elements must be satisfied. In the first instance, the plaintiff must prove elements 1-3 on the balance of probabilities. In many cases this would be sufficient. Generally speaking it is up to the defendant [liquidator] to raise the issue of a bar to restitution. Then the plaintiff must prove element 4. If, on the balance of probabilities, the court is not satisfied that there is no bar to a restitutionary claim, then the 374 plaintiff fails.37F
The use of an unjust enrichment action could be considered by franchisees that recently paid a franchise fee but derived very little benefit prior to the franchisor’s failure. The pool of money available to the liquidator to pay creditors is artificially expanded by the franchise fee; thus the liquidator is ‘unjustly enriched’. This was pleaded by a group of franchisees in Ontario, Canada in one of the Country Style 375 Food Services cases.374F There, whilst the franchisees did not act quickly or cohesively enough to succeed, the court did not rule out unjust enrichment as a possible cause of action for future franchisor insolvency cases.
374 P Davenport and C Harris, Unjust Enrichment (1997) 34. 375 Country Style Food Services Cases: Country Style Food Services Inc v 1304271 Ontario Ltd Ontario Superior Court of Justice Chapnik J, Judgement: 11 February 2003; in the matter of the Companies Creditors Arrangement Act, RSC 1985 C c-36, As amended AND In the matter of the Courts of Justice Act RSO 1990 c-43, As amended AND in the matter of a plan of compromise or arrangement of Country Style Food Services Inc, Country Style Food Services Holdings Inc, Country Style Realty Limited, Melody Farms Specialty Foods and Equipment Limited, Buns Master Bakery Systems Inc and Buns Master Bakery Realty Inc 15 April 2002 Court of Appeal for Ontario Docket M28458 (Unreported decision).
Chapter 3: The problem in context 165 166
Both the action for frustration and the action for unjust enrichment may have the best chance of success where the franchise term has only just begun, as the franchisee will have paid all upfront costs but derived minimal benefit from the investment.
Anticipatory breach Anticipatory breach
… occurs where a party, prior to the time for performance under the contract, evinces an intention no longer to be bound by the contract. … [I]f the anticipatory breach relates to a breach of an essential term or the repudiation goes to the root of the contract, the promisee [in this case, 376 franchisee] may terminate prior to the time for actual performance.375F
The alternative to repudiation relying on anticipatory breach is for the franchisee to wait for the franchisor to fail to perform an obligation under the franchise agreement, and then terminate for actual breach.
Consideration of anticipatory breach raises the issues of exactly what terms the franchisor breached. Typically the franchisor has few contractual obligations, while the franchisee has many. It can be difficult to identify an actual contract term on which to found the claim of anticipatory breach following the appointment of an administrator.
Franchisees without the appropriate ipso facto termination trigger in their franchise agreements have to decide whether to adopt the high-risk strategy of terminating their agreements or remaining bound to the failed franchisor in a legal ‘holding pattern’. To pursue any of the three responses to breach of contract by the franchisor outlined in chapter 3.2.8 would tax an individual franchisee’s resources. Litigation would be best undertaken by a group of franchisees.
3.3.9 CONTRACT AND QUASI-CONTRACT BASED REMEDIES Currently all remedies accessed through the law of contract and the Trade Practices Act assume the supplier is able to deliver the prescribed solution, or that an insurer could meet a claim. But, if the supplier is insolvent this assumption is fatally
376 Willmott et al, above n 322, 677.
166 Chapter 3: The problem in context 167 flawed. Franchisees’ access to remedies for breach of contract brought about by the failure of the franchisor is hindered by a number of factors.
First, contract law remedies rely on the doctrine of privity of contract. The law presumes that franchisees and franchisors have a contractual relationship with each 377 other and that this contract is the source of the breach.376F This does not acknowledge the complex matrix of contracts and entities that underpin the franchise relationship, as was demonstrated here and in Appendix D. The commitments that a franchisee has under third party contracts are not contingent on the franchisors remaining solvent.
Second, Hadfield observes, limitations in effectiveness ‘when contract law is limited to the awarding of damages, a remedy that may be inadequate to deter deliberate fraud and that may be no deterrence at all against those who have no 378 assets’.37F
Where the franchisor is insolvent, there is not enough money available to meet a judgment debt to put the ‘innocent’ party back into their pre-contractual situation. The problems are exacerbated when the number of franchisees affected by one franchisor insolvency are counted; the ‘innocent parties’ may include as many as 600 379 franchisees, their families and employees.378F Any litigated or mediated victory by the franchisees will be hollow.
Third, the powers given to administrators and liquidators under the Corporations Act render franchisees’ consumer protection and contract law rights impotent. This is explored in chapter 4.
3.3.10 CONTRACT-RELATED COMPLICATIONS Consequential contracts The execution of the franchise agreement also means that the franchisee is entering a number of consequential contractual commitments. This was demonstrated in chapters 3.2.2 and 3.2.3 by examinations of the franchisor and franchisees’
377 The Franchising Code of Conduct requires the franchisor to make disclosure, but only requires limited information about the other franchisor’s controlled entities that the franchisee must do business with. Appendix D of this thesis graphically demonstrates the numerous possible relationships. 378 Hadfield, ‘The Many Legal Institutions that Support Contractual Commitment’, above n 22, 194. 379 See Table 1 of this thesis.
Chapter 3: The problem in context 167 168 contractual or lack of contractual, relationships with the owners of the trade marks that identify the franchise network and its products, and the premises that franchisees trade from. The franchisor:
serves as a nexus for contracting relationships and … is also characterized by the existence of divisible residual claims on the assets and cash flows of the [franchisor] which can generally be sold without permission of the other contracting individuals. … emphasizing the essential contractual nature of [franchise networks] … [This] focuses attention on a crucial set of questions – [including] and how [the contractual relationships] are affected by changes 380 exogenous to the organization.379F
These legally binding contract-based commitments will be noted and identified, but not explored in detail here. Their fate following the franchisor’s insolvency is an area for future research. Consequential contracts in this context occupy three categories:
First: Contracts entered into with the franchisor; including such agreements as licences to use intellectual property, software and premises, and various finance 381 arrangements.380F
Second: Contracts entered into with third parties, related to the franchisor such as supplier agreements concerning stock, licence to use intellectual property, lease of 382 premises and finance arrangements.381F
Third: Contracts entered into with third parties unrelated to the franchisor such 383 as supplier contracts, vehicle leases, lease or licence of premises,382F equipment leases, loan agreements – secured over real property or shares owned by the franchisee before it becomes a franchisee and employment contracts with the franchisee’s employees.
All of the contracts in the three categories above are executory.
380 Jensen and Meckling, above n 21, 311. 381 Frazer and Weaven, Franchising Australia 2004, above n 63, found that 29 per cent of franchisors provide finance to franchisees, with the most popular being direct finance supplied by the franchisor (59 per cent). 382 Ibid, found that of the franchisors providing finance in Australia, 4.9 per cent did so through a company related to the franchisor. 383 In Australia, 47.1 per cent of franchsiees conduct their business from a retail site or kiosk, 29.3 per cent from mobile unit, van or trailer, 26.8 per cent home based (office or garage), 21.8 per cent of franchisees operate from specific commercial sites, and 4 per cent operate from an industrial site, Frazer, Weaven and Wright Franchising Australia 2008, above n 7, 27.
168 Chapter 3: The problem in context 169
Pending assumption or rejection [by the liquidator] the debtor [here, franchisor] is technically not required to perform the obligations under the executory contract, whereas the non-debtor party [here, the franchisee] is 384 still required to perform.38F
Typically, none of the consequential contracts in the three categories above contemplates the franchisee’s rights and obligations when the franchisor becomes insolvent. They assume the franchisor will remain solvent. While this thesis concentrates on the relationship between a franchisor and its franchisees, the franchisee’s situation under any of the above consequential contracts will also be impacted by the franchisor’s failure.
International dimensions of franchise agreements Franchise relationships and agreements often contain international dimensions. This was identified in the pattern of trade mark ownership at 3.2.2, and in Subway’s standard franchise agreement referred to earlier in this chapter. International law may have an impact on the jurisdiction and forum in which a franchise agreement is judged. Importantly, cross border insolvency issues may become relevant to domestic franchisees by virtue of the franchisor, the parent company, the owner of trade marks or the franchisor’s financier being outside Australia. This is touched on again in chapter 4.5 but not explored in depth as it is substantial enough to constitute a significant research project on its own.
3.3.11 CONCLUSION During the initial contract negotiations ‘parties incur ex ante transaction costs, including the costs of anticipating future contingencies and writing a contract that 385 specifies an outcome for each one’.384F
When the franchisor/ franchisee relationship is placed in jeopardy through the appointment of an administrator or liquidator to the franchisor, the franchise agreement is the first place an administrator or liquidator looks to determine what responsibilities the franchisor has and what rights its franchisees have. At that point it is too late for the franchisor and franchisee to negotiate a change in the terms of the franchise agreement. It is thus important to understand whether franchise
384 Tractenberg, above n 110, end note 22–5. 385 Scott above n 349,190.
Chapter 3: The problem in context 169 170 agreements, as a genre, can realistically be expected to contain provisions relating to franchisor failure.
Private law does matter to those who can use it effectively, for example businesses that incorporate judicial rulings in standard terms or that seek judicial [or
386 regulator]385F rulings as a framework for structuring their business methods. Consumers have rarely been able to harness private law to have such systemic
387 effects.386F
Private contract law is, however, unable to provide solutions to the problem. ‘The franchise situation is a classic example of an unresolved treatment of contracts. Executory contracts, of which franchise agreements are an example, are not 388 specifically considered in the UNCITRAL Legislative Guide on Insolvency Law’.387F Countryman defines an executory contract as ‘one under which the obligation of both the bankrupt and the other party … are so far underperformed that the failure of either to complete performance would constitute a material breach excusing the 389 performance of the other’.38F Rohrbacher explains that ‘the troublesome issue in executory contracts is not that property and contracts are treated so differently but 390 that debtors and creditors are treated so differently’.389F
The franchise agreement purports to be a complete package of rights, distilling the franchisors and franchisees rights and obligations for the duration of the term. Nevertheless, almost without exception, franchise contracts make no reference to franchisees’ rights on franchisor failure. This cannot be justified on the basis that it is so unlikely to occur that no provision needs to be made.
The [franchisor] is a legal fiction which serves as a focus for a complex process in which the conflicting objectives of individuals (some of whom may ‘represent’ other organizations) are brought into equilibrium within a framework of contractual relations. In this sense the ‘behaviour’ of the firm
386 For example Bakers Delight’s successful application under Trade Practices Act 1974 (Cth) s 47. 387 Ramsay, above n 329, 33. 388 United Nations Commission on International Trade Law, UNCITRAL Legislative Guide on Insolvency Law (2004)
170 Chapter 3: The problem in context 171
[the franchisor] is like the behaviour of a market, that is, the outcome of a 391 complex equilibrium process.390F
The insolvency of the nexus triggers a move to a new equilibrium in which the administrator, and then the liquidator, controls the destiny of the franchisees through the twin mechanisms of the franchise agreement and the Corporations Act.
The justifications for a contract not to be comprehensive in its terms - that it is relational, too expensive to include all possible future contingencies, that the franchise agreement needs to be standardised for ease of administration - do not support the omission of terms about franchisor failure; an event whose possibility is real, and whose consequences can be devastating for the franchisee consumer. It can be concluded that relational contracts are not well equipped to deal with franchisor failure as the event that triggers a need to renegotiate, franchisor failure, also signals the end of the relationship between the franchisor and its franchisees.
Ultimately there is no equitable, logical or cost-based justification for the franchise agreement making extensive provision for some known possible events that would have a relatively minor effect on the network, such as the possibility of a franchisee dying, while failing to provide for known and potentially network- debilitating events, such as franchisor failure.
The franchise agreement is, in theory, negotiable. It may be possible for the franchisee to insert a provision in the contract that gives the franchisee the right to ‘walk away’ from the franchise system, and to retain the right to use the premises, if the franchisor fails. In reality the possibility of the franchisor failing is generally the furthest thing from the new franchisee’s mind, and the franchise agreement is not negotiable.
Woker observes that ‘the law of contract is wholly inadequate for the purpose 392 of regulating modern franchise relationships and practices’.391F This is exemplified clearly when the franchisor fails. The report ‘Opportunity not opportunism’ acknowledged that the current contractual arrangements between franchisor and franchisee are not satisfactory and recommended ‘that the government explore
391 Jensen and Meckling, above n 21, 311. 392 Tanya Woker, ‘Franchising – The Need for Legislation’ (2005) 17 South African Mercantile Law Journal 49.
Chapter 3: The problem in context 171 172 avenues to better balance the rights and liabilities of franchisees and franchisors in 393 the event of franchisor failure’.392F
An action for breach of contract presupposes that there has been a breach. Franchise agreements always permit the franchisor to terminate the franchise agreement if the franchisee commits an act of bankruptcy, but seldom makes provision for franchisees’ rights following the administration or insolvency of the franchisor. Franchise agreements also require franchisees to obey all relevant laws, failure to do so constitutes a breach of the franchise agreement and entitles the franchisor to terminate. Franchise agreements only require the franchisor, as a term of the contract, to comply with the Code, not with the Corporations Act. Thus a breach of the Corporations Act or of any other financial regulation by the franchisor does not pave the way for the franchisee to argue that the franchisor has breached the franchise agreement.
It is concluded that the franchise agreement, in its current form, is unable to address franchisor failure satisfactorily. If protection of franchisees from the consequences of franchisor failure cannot be achieved through the standard franchise agreement, it is logical to ask how the legislature has responded. In chapter 4.1 the effectiveness of legislative initiatives in providing consumer protection for franchisees of failed franchisors is considered. However, before moving to the legislature, I will explore the asymmetry of the franchisees’ world in chapter 3.3. As Thomas J wrote in relation to a distributorship agreement, ‘The sheer commercial absurdity of this lopsided bargain prompts the question as to how it could have come 394 about. There is an explanation’.39F
In relation to franchisor failure, the explanation lies partly in the franchise agreement, as discussed in chapter 3.3, and partly in economic and legal considerations. These will now be explored.
393 Joint Committee on Corporations and Financial Services, Australian Senate, Opportunity Not Opportunism: Improving Conduct in Australian Franchising, above n 166, Recommendation 4 [6.40] xv. 394 Bobux Marketing Limited v Raynor Marketing Limited [2001] NZCA 348, para 18 (Thomas J, dissenting).
172 Chapter 3: The problem in context 173
3.4 ASYMMETRY ISSUES
The problems franchisees experience when their franchisor fails are particularly difficult to address ex ante because they are unanticipated by franchisees, who enter the relationship unprepared for franchisor failure. The lack of preparation by franchisees is contributed to by numerous asymmetrical features of franchising.
Asymmetry exists in every aspect of franchising; in the structure of the franchise network, the timing of events, the contents of contracts, and the legislation designed to protect consumers. It compromises the parties’ awareness of the need to self-protect and on their so opportunity to do so. Franchisees make, and re-make their investment based on fatally flawed information. This devalues the due diligence process, reduces the effectiveness of the Code and limits franchisees’ ability to plan an effective exit strategy from a failing or insolvent franchisor.
Despite the requirement of pre contractual disclosure, franchisees as consumers seldom anticipate the possibility of the franchisor’s business failing or the effect that event may have on their rights and obligations as a franchisee. The franchisee is a typical consumer functioning in an environment where Iain Ramsay observes:
The ‘responsibilisation’ of the consumer is being pursued … governments are investing heavily in projects to ensure that individuals become responsible consumers through the use of information … These programs often make heroic assumptions about the ability of consumers to use and process information on market choices and their ultimate results remain 395 uncertain and difficult to measure.394F
The exploration of asymmetry between franchisor and franchisee that follows demonstrates areas where the information supplied to educate franchisee consumers to become more responsible may serve to mislead them about the risks they should consider before signing the franchise agreement. It also helps underscore Ramsay’s concerns that the ‘heroic assumptions’ made by governments are flawed.
3.4.1 INFORMATION ASYMMETRY It is assumed that parties to a long-term contract will perform comprehensive due diligence on each other as prospective business associates and on the business
395 Ramsay, above n 329, 13.
Chapter 3: The problem in context 173 174 offering. The franchisor provides the franchisee with the information that it wants the franchisee to know, and complies with the disclosure requirements of the Trade Practices Act.
Franchisees are advised to conduct their own due diligence beyond the Code disclosure. Franchisees are routinely blamed by courts, commentators and franchisors for failure to conduct adequate pre-purchase due diligence. For example a delegate of the FCA, when asked to comment on a report about franchisor failure replied that ‘[f]ranchising is risky and some people might not be adhering to the 396 correct process’.395F Such a dismissive response to a serious issue by an industry representative tends to make prospective franchisees think that as long as they follow the process established by their franchisor, they will not be part of a franchisor failure. The facts do not support this.
When it comes to disclosing the possibility of franchisor failure the franchise market is a little like ‘the market for cigarettes: manufacturers compete among themselves for market share but have a common incentive not to disclose information about the risks from smoking so long as these risks apply to all 397 cigarettes’.396F Similarly, any franchisor may fail. All franchisors have an interest in holding the line that they will succeed.
Given the high costs of investigating the safety of a given unfamiliar product prior to purchasing, it is not surprising that a general expectation that products on the market are acceptably safe is a crucial assumption of most consumer behaviour, influencing the value that consumers place on 398 information.397F
The 2006 UK franchise survey reports that its initial source of information about the franchise industry was equally (20 - 21 per cent) magazines, newspapers 399 and friends/relatives.398F In the United Kingdom, information about a specific 400 franchisor came from magazines (18 per cent) and exhibitions (20 per cent).39F None
396 Jacqui Walker, ‘Help for Squeezed Business’, Business Review Weekly (Melbourne), 30 March 2006, 24. 397 Trebilcock, above n 29, 70. 398 Ibid. 399 NatWest bfa United Kingdom, Franchise Survey 2006, above n 254, 30. 400 Ibid 20.
174 Chapter 3: The problem in context 175 of these are objective information sources. Such information is often not capable of being objectively verified.
‘A consumer protection problem is more likely to be present where there is no obvious reason for consumers to doubt their general expectation of safety, so their 401 expectation can easily be exploited’.40F ‘An important implication of this focus on general consumer expectation is that the more obvious a consumer protection 402 problem has become the less of a problem it may come to be’.401F
Rights and liabilities recorded in the franchise agreement are asymmetrical. So too is the opportunity for franchisors and franchisees to shelter their assets from creditors.
[I]ndividuals have preferences that change through time, are concerned for others, have varying attitudes to risk depending on how risks are framed and what reference points are available, violate rationality by overestimating their skills, over-project the current state, use rules of thumb or heuristics to 403 solve problems and make decisions affected by transient emotion.402F
A franchisee conducting due diligence to verify information disclosed by the franchisor is potentially confronted with numerous impediments to obtaining full information.
Franchisees often do not register their business names. It is thus impossible to verify from the public record, the identity of the owners and former owners of franchisees of franchised outlets. The 2008 Amendments to the Disclosure Document under the Code partially rectified this problem by S 11.2 of Annexure 1 (the 404 Disclosure).403F
Due diligence cannot anticipate the events that precede some franchisor administrations or insolvencies and no franchisee or franchisee’s professional adviser could reliably anticipate when a franchisor might to embark on a course of strategic
401 Trebilcock, above n 29, 70. 402 Ibid. 403 Steven Kennedy, ‘The Future of Consumer Policy: Should we Regulate to Protect Homo Economicus?’ (Accord Industry Leaders Briefing, Old Parliament House, Canberra 13 August 2009) 10 citing Stefano Della Vigna, ‘Psychology and Economics: Evidence from the Field’ (2009) 47(2) Journal of Economic Literature 315, 316. 404 Appendix A of this thesis.
Chapter 3: The problem in context 175 176 insolvency. Any disclosure document is a snapshot of the franchisor’s business at the date it is made. It is always going to be of limited value for that reason.
405 Franchise agreements last from a short term of 1 year40F to, in some cases, (eg Signwave) 35 years and in rare cases (eg Fastway couriers) indefinitely. It is unrealistic to expect a franchisee to conduct due diligence that sees far into the future, even if infinite resources were available for the task.
Information asymmetry includes the difference between what is written in the contracts and what is the ‘culture’ of a particular franchise. This has been expressed as: ‘Each contract says what it says, but the culture underlying the way parties choose to operate the levers that contract gives them may be producing quite a 406 different effect than appears to a superficial or even a close reading’.405F
In Australia neither disclosure documents nor a network’s pro forma franchise agreements are available to the public. This means that the franchisee’s advisers cannot compare the offering before them with either the usual documentation for franchisees in the network or with the franchise agreements of other comparable franchisors. This limits the value of professional advice as it is unable to be contextualized. This issue was raised in several of the submissions to the inquiry that culminated in the Opportunity not opportunism report. The government has partly accepted that the problem causes a real impediment to the creation of responsive policy. Recommendation 2 starts to address a solution by recommending:
…that the government investigate the benefits of developing a simple online registration system for Australian franchisors, requiring them on an annual basis to lodge a statement confirming the nature and extent of their franchising network and providing a guarantee that they are meeting their obligations under the Franchising Code of Conduct and the Trade Practices Act.
405 Frazer, Weaven, Wright Franchising Australia 2008, above n 7. 406 Evidence to Economic and Finance Committee, Parliament of South Australia, Official Hansard Report, 6 February 2008, 38 (JR Rau MP).
176 Chapter 3: The problem in context 177
Recommendation 2 represents incremental progress, but if it is adopted franchisees and their advisers will still not have a means of establishing a context for 407 the specific franchise agreement being advised on and signed.406F
Typically, the franchise agreement does not provide any specific rights to the franchisee on the franchisor’s insolvency. Thus, neither the Disclosure Document nor the franchise agreement would direct a legal adviser to consider franchisor failure or its consequences unless the lawyer or accountant providing advice also happens to work in the highly specialised field of insolvency.
3.4.2 ADVISER AND ADVICE ASYMMETRY The calibre and expertise of their advisers has a bearing on a franchisee’s understanding of what they are signing. It also has a bearing on whether any meaningful pre-purchase or post failure negotiation occurs.
Legal and accounting advice Franchisors frequently use professional advisers who have created numerous franchise agreements for a range of franchise models. For example, Stephen Giles, of Norton Rose law firm, says: ‘[m]y firm would represent over 300 franchisors (due to 408 our size we do not have a large franchisee constituency)’.407F Large legal and accounting firms also have experience in advising franchisors on how to shelter personal assets from franchisees.
The franchisee will, ideally, also engage advisers with franchise expertise. The identity of these professional advisers is found through advertisements in franchise magazines, their presence at trade shows, ‘asking around’ or searching the 409 internet.408F Lawyers with specific areas of expertise can be found through the state or territory law society. The ‘business law expert’ is superficially the ideal lawyer to provide franchisee advice. But, as Solomon observes:
knowledge of business law may enable someone to 'read' a contract competently, but that isn't really the due diligence on the transaction itself.
407 Joint Committee on Corporations and Financial Services, Australian Senate, Opportunity Not Opportunism: Improving Conduct in Australian Franchising, above n 166, para 4.81. 408 Evidence to Economic and Finance Committee, Parliament of South Australia, Official Hansard Report, 6 February 2008, 33 (Stephen Giles). 409 For example, unsing the Findlaw website http://www.findlaw.com.au/wld/QuickSearch.asp lawyers are searchable under the specialty area ‘franchises’. No lawyers possessing franchise expertise are listed for the Northern Territory or Tasmania.
Chapter 3: The problem in context 177 178
… a business lawyer who is not up to date on what is happening in the franchise industry most probably will not 'spot' many of the contract 410 language traps.409F
Solomon continues, ‘[t]he franchise industry … uses that lack of available 411 [legal and also accounting] expertise to enable rampant misrepresentation’.410F
Franchisees will seek an accountant’s advice in relation to the feasibility of the business opportunity described in the disclosure document. Australian accountants are either Chartered Accountants (‘CAs’) or members of CPA Australia (‘CPAs’). As a generalization, the CAs advise larger commercial clients (franchisors and master franchisors), work in the city, include liquidators in their number, and may be members of the FCA. The CPAs are more often suburban or country town accountants who would typically advise franchisees and would be less likely to join the FCA as their practices would not specialise on franchising and could not justify the expense.
Accountants are not necessarily able to predict the future solvency of the franchisor, even with access to the disclosure document. In testing the return on investment, the accountant is unlikely to model the return based on the franchisor itself failing one or two years into the relationship. If they did, they would be quick to tell their client to select another form of investment.
The regulator as educator The Matthews Report identified that:
[t]he ACCC and peak industry associations undertake an important role in providing education and information resources for franchisees and franchisors. These resources should strengthen the message to prospective franchisees in particular that they should seek advice from suitable and 412 independent franchise sector advisors.41F
410 Richard Solomon, ‘License to Lie, Cheat and Steal: Impact of Acknowledgement & Integration Clauses’ (2008) Blue Maumau
178 Chapter 3: The problem in context 179
413 The Government agreed with this recommendation.412F However two years 414 later, the ACCC published Franchisee Manual,413F made no mention of the care that should be taken to ensure advice comes from advisers who understand franchising. In 2009 the ACCC finally added information to its website under the heading ‘What if 415 the franchisor becomes insolvent (fails)?’41F
In its role as educator the ACCC can do more to make franchisees aware of the fact that franchisors fail more often than the rhetoric suggests. However their ability to warn franchisees of risks of specific networks will always be hampered by the differences among franchisors’ legal structures, and their varying approaches and attitudes to risk sharing. Each individual franchisor is thus the only party that can adequately predict the possible effect of its failure on its own franchisees.
Trading banks Although 21.2 per cent of franchisors ranked ‘difficulty in finding franchisee finance’ as the third greatest hindrance to growth in 2006, all four major trading banks in Australia have specific policies to assist in the purchase of franchisee 416 businesses. All four - ANZ,415F Commonwealth Bank of Australia (CBA), National 417 Australia Bank (NAB), and Westpac (WBC)416F - are ‘service provider’ members of 418 the FCA.417F
None of the four mentions the risk of franchisor failure on their websites. This tends to indicate one of two things. Either, the area of the bank dealing with loans that have ‘gone bad’ and the business lending and the marketing areas of the banks do not communicate with each other about specific customers. Or, banks decide that because they have adequate security from franchisees they are not worried that their policies of lending to the franchising sector will trigger awkward questions at shareholders meetings.
413 Australian Government Response to the Review of the Disclosure Provisions of the Franchising Code of Conduct (2007) 4. 414 ACCC, Franchisee Manual (7th ed, 2008). 415 ACCC, What if the Franchisor Becomes Insolvent (fails)?
Chapter 3: The problem in context 179 180
The situation of failed jewellery retail franchisor Kleins and the NAB is a clear reason why banks need to monitor the ongoing viability of the franchisors they approve. Failure to do so places them at risk of misleading franchisees that the franchisors business is still a sound investment.
Turning to each of the banks to see what their customers might be able to learn from them about the franchisors whose franchisees they will fund, and about franchisor failure. The ANZ does not publicise the names of those franchisors to which it has accorded preferred status. It states:
We work from the basic belief that franchise businesses are different and usually inherit some strengths and capabilities from the franchisor. ANZ offers ANZ Preferred status to selected franchisors to reflect the value of 419 their franchise system.418F
420 The CBA website publishes a list of 35 accredited franchises419F but does not mention protecting franchisee customers against the risk of franchisor failure.
NAB publishes a list of approved franchise systems, stating:
For franchisees, ‘Joining a NAB Accredited Franchise System means that you may be able to borrow up to 70 per cent of the total set up cost of a new franchise, or purchase cost of an existing franchise, without necessarily 421 providing your home as collateral for the loan.420F
The message to prospective franchisees is that each of these Accredited franchisors is a reputable, secure investment in the eyes of the NAB. The list of NAB 422 Accredited Franchise Systems included Kleins on 23 May 2008.421F As at May 2008, there was no public record that any of the three central companies that make up the Kleins group had filed any documents with ASIC since January 2003. On seeing Kleins on the NAB list, between KFC and McDonald’s, prospective franchisees would have been entitled to conclude, as late as 23 May 2008 that NAB had confidence in Kleins as an investment. NAB was identified in May 2008 as the
419 ANZ, ANZ Franchising
180 Chapter 3: The problem in context 181 biggest secured creditor of the Kleins group (in administration), being owed approximately A$15million. This raises issues that will not be dealt with here of a bank’s duties to its Kleins franchisee customers, and the extent to which it exposes itself to claims by Kleins’ disenfranchised franchisees.
In WBC
[f]ranchise lending is one of the four core business units in the TPD [Third Party Distribution] system. ... The business maximises Westpac's share of the franchising market by developing profitable relationships with franchisors, providing referrals and expert advice to Business Banking sales people; and also providing input into WBC's franchising policies and 423 systems.42F
This indicates that WBC manages its risk exposure by securing loans to franchisees over the franchisees’ home. This protects the bank from losing money if a franchisor fails, but exposes the franchisee to the risk of significant loss. Westpac also recommends that prospective franchisees should consider the following questions:
What's the franchisor’s track record (financial and management)? How much control do you (and the franchisor) have? What are the renewal and termination terms and conditions? 424 Do you see your investment in a franchise as a long-term commitment?423F
These questions are generic and are not supported by examples or placed within a context. They will not make a franchisee ask questions about the consequences of franchisor failure.
The banks go no further than to hint in oblique terms that one of the considerations for an intending franchisee should be the consequence to the franchisee of franchisor failure.
Additional sources of advice Governments and banks direct prospective franchisees to additional sources of general franchise information. These additional sources of general information are
423 Westpac Bank Website
Chapter 3: The problem in context 181 182 the FCA, franchise magazines and Do-It-Yourself or primer books. None is sufficient to put the franchisee on notice that the franchisor might fail.
The FCA is an influential industry group. It provides information through its website, its publication The Franchise Review, and its education programs. None of these provide any information about franchisor insolvency. The FCA website also states:
… the nature of the franchise relationship was open to exploitation prior to 1998 in Australia, when franchising operated in a de-regulated environment. As a consequence the public perception of franchising was tarnished by several high profile franchise failures … Behaviour in the sector was not universally appropriate, and franchisees had far less investment security. Since 1998 the sector has not only grown, but matured and developed into 425 one of the primary engines for economic growth in Australia.42F
The inference to be drawn from this statement is that prior to 1998, when pre- contract disclosure was voluntary for franchisors, there were some unprofitable franchisors and some of them failed but that this does not happen any more. Table 1 demonstrates that numerous franchisors’ businesses have failed since 1998.
The first introduction to a specific franchise network may be at a franchise business opportunity expo. These are held in major population centres annually and are a widely accepted franchise promotion method. Regardless of the source of 426 information,425F there is a ‘sameness’ about all franchise opportunity advertising. In the words of American franchise lawyer and commentator Richard Solomon:
If you look at all the franchise adverts for franchise opportunities in any business category, they all say the same thing -- we know how to do it -- we can show you how to do it -- you save a lot of money and reduce risk of failure if you do it with us -- we have the 'secret' to success -- we will support you to achieve success -- we have the proven system -- we have the name recognition -- we get you up and running quickly. In actual fact, most 427 of this is not even remotely true.426F
425 Franchise Council of Australia, above n 121, 7. 426 Be it a broker, the FCA, or the franchisor’s website. 427 Solomon, above n 412.
182 Chapter 3: The problem in context 183
Prospective franchisees reading franchise advertisements feel secure buying into a long-established franchise, believing them to be well-proven. They trust the information supplied by the franchisor and have difficulty obtaining objective third party perspectives. There is no incentive for anyone involved in the franchise sales process, nor for any current franchisee of the network, to mention the risk of the franchisor failing.
3.4.3 RISK ASYMMETRY In reply to the question ‘Are there risks the [intending franchisee’s] business plan cannot address?’ the ACCC wrote in 2009: ‘[e]very business faces risk. One risk to franchisees is the franchisor becoming insolvent, which can sometimes 428 happen unexpectedly’.427F
429 The franchise agreement is effectively a contract uberrimae fidei428F for the franchisee, but not for the franchisor as the franchisor entity has only specific disclosure requirements. The shifting of risk that is achieved by appointing franchisees is a significant benefit to the franchisor. A fundamental aspect of franchising is the separation of ownership, by the franchisees, from control, which remains with the franchisor. This can also be expressed as a separation of risk bearing, again by the franchisees, and decision functions, which rest with the 430 franchisor.429F For example, as was seen in chapter 3.2.3, when the franchisor takes a head lease of retail premises in its own name, it is common for the franchisee to become the guarantor of the franchisor’s performance under the head lease. The franchisee, thus, takes almost all the risk on the premises, while the franchisor retains the full benefit of the site lease being in the franchisor’s name. The franchisor executes the franchise agreement and requires the franchisee, and if the franchisee is a corporation, its guarantors, to sign, whereas the franchisor’s directors rarely provide personal guarantees to franchisees.
Another example of risk shifting is the practice of structuring a franchise relationship to function like a commission agency. Here, the franchisee attracts the
428 Australian Competition and Consumer Commission, ‘Understanding the Issues in Franchising’ (2009) Franchise Review 65. 429 Mann and Blunden, above n 15, 585, Utmost Good Faith. 430 See Eugene F Farma and Michael C Jensen, ‘Separation of Ownership and Control’ (1983) XXVI(2) Journal of Law and Economics 301, 304 who do not include franchise networks in the spectrum of organizations discussed.
Chapter 3: The problem in context 183 184 customers, but payment by the customers for the products or services they purchase is made directly to the franchisor. The franchisor then pays a commission to the franchisee. The two risks that the franchisee assumes in this scenario are that the franchisor will be prepared to chase the customer for payment and that the franchisor will remit the commission to the franchisee, both in a timely manner.
Research on approaches to risk in franchising has been carried out by Paul Rubin and by Lafontaine and Bhattacharyya. Neither factored the failure of the franchisor into their risk research. Looking at the franchise investment as a proportion of an individual’s entire portfolio of assets, Rubin’s view is that ‘since franchisees commonly invest a large share of their assets in acquiring the franchise, it 431 is unlikely that’430F franchisors are more risk averse than franchisees.
432 Lafontaine and Bhattacharyya consider the role of risk in franchising431F from the perspective of the investment in the single franchise unit rather than as a component of an individual’s entire investment portfolio. After examining a number of factors in the franchisor/franchisee relationship they conclude that franchising is not necessarily selected for its risk shedding potential.
One of the factors evaluated by Lafontaine and Bhattacharyya was failure rates. They confined their inquiry to the failure of franchisees and of franchisor-owned outlets, and did not extend their inquiry to entire networks. They note that:
… failure rates will still be sensitive to franchisor moral hazard; if a franchisor shirks, or behaves opportunistically, this will increase the probability of failure for all units in the chain and is likely to show up in the 433 discontinuation statistics.432F
Lafontaine and Bhattacharyya conclude that:
… there are patterns in the data that seem to imply that franchisees bear more risk than franchisors. Under models based on efficient risk allocation this leads to the conclusion that franchisors are more risk averse than
431 Paul H Rubin, ‘The Theory of the Firm and the Structure of the Franchise Contract’ (1978) XXI(1) The Journal of Law and Economics 223, 225 in Francine Lafontaine (ed), Franchise Contracting and Organization (2005) 18, 20. 432 Francine Lafontaine and Sugato Bhattacharyya, ‘The Role of Risk in Franchising’ (1995) 2 Journal of Corporate Finance 39, 55 in Francine Lafontaine (ed), Franchise Contracting and Organization (2005) 164, 180. 433 Ibid.
184 Chapter 3: The problem in context 185
franchisees, a conclusion we find unappealing given their respective sizes 434 and differential access to capital markets.43F
3.4.4 RESOURCE ASYMMETRY The FCA acknowledges that there are disadvantages to the franchise model including:
3. The prospective franchisee may find it difficult to assess the quality of the franchisor. This factor must be weighed very carefully by the potential franchisee for it can affect the franchisee in two ways. A. Firstly, the franchisor's offer of a business-format package may not amount to what it appears to be on the surface. B. Secondly, the franchisor may be unable to maintain the continuing services which the franchisee is likely to need in order to sustain their business. 6. The franchisor's policies may affect the franchisee's profitability. For example, the franchisor may wish to see his franchisee build up to a higher turnover from which he gets his continuing franchise fee, while the franchisee may be more concerned with increasing his profitability, which does not always necessarily follow from increased turnover. 7. The franchisor may make mistakes in their policies. They may arrive at decisions, relating to innovations in the business which turn out to be unsuccessful and detrimental to the franchisee. 8. The good name of the franchised business and its brand image may 435 become less reputable for reasons beyond their own control.43F
Prospective franchisees would have difficulty assessing whether a specific franchisor has any of the possible flaws listed above. Disadvantages 6, 7 and 8, like insolvency, refer to future matters. Even with unlimited resources, it is impossible for a franchisee to make an informed assessment about these issues.
434 Ibid 193. 435 Franchise Council of Australia http://www.franchise.org.au/scripts/cgiip.exe/WService=FCAWWW/ccms.r?PageId=10111 at 22 Juen 2010.
Chapter 3: The problem in context 185 186
3.4.5 CONTRACT ASYMMETRY In economic terms, the ‘role of contract law is to minimize the cost of the parties writing contracts + the cost of the courts writing contracts + the cost of 436 inefficient behaviour arising from poorly written or incomplete contracts’.435F
437 ‘Standardised contract terms are … [a] regulatory instrument’436F that places all of the power to regulate the difficult times the relationship will experience, in the hands of the drafter, the franchisor.
In the context of economics, contract terms play a dual role; ‘creating the correct marginal incentives on a contractually specified measure of (or proxy for) performance, and ... the creation of rents sufficient to make the relationship self- 438 enforcing’.437F In franchising, the marginal incentives created within the franchise agreement do not outweigh the disadvantages to the franchisees whose franchisor operates its business so poorly or recklessly that an administrator or liquidator is appointed. In theory franchisees can negotiate some protection into the franchise agreement. In practice, most cannot.
At negligible extra cost a franchisor can include a provision to give franchisees the right to terminate the franchise agreement if an administrator is appointed. Yet anecdotal evidence suggests that only one franchisee in each of the 270-franchisee Traveland and the 60-franchisee BHG networks had a clause in their agreements 439 permitting them to terminate the agreement if the franchisor fails.438F Franchisors have no incentive to write contracts that fully acknowledge both parties’ risks.
3.4.6 LEGISLATIVE ASYMMETRY [R]isk is a key concern for policymakers. All other things being equal and where possible, we aim to reduce the overall level of risk and complexity in 440 society.439F
A risk that is currently addressed in both franchisor agreements and the 441 Code40F is the risk of the franchisee’s business failing - there is no reciprocal
436 D Wittman, Economic Foundations of Law and Organization (2006) 194. 437 Trebilcock, above n 29, 77. 438 Benjamin Klein, ‘The Economics of Franchise Contracts’ (1995) 2 Journal of Corporate Finance 9, 19 in Francine Lafontaine (ed), Franchise Contracting and Organization 2005, 323. 439 Liquidator appointed by the court 18 December 2008, ASIC, National Names Index
186 Chapter 3: The problem in context 187 statutory protection if the franchisor fails. As we saw in 3.4.5 contracts remain asymmetrical to the disadvantage of franchisees. The legislation does not provide the level playing field it was enacted to provide in response.
Hadfield observes that ‘[e]ither because current regulation is piecemeal or more fundamentally, because franchise relationships are too complex to reduce to 442 precise statutory terms, the heart of franchising’s legal structure is still contract’.41F The contract could, theoretically, provide protection for franchisees from some of the consequences of their franchisor’s failure. In reality, because of asymmetry, they cannot routinely do so.
The nature of the franchise agreement, the difficulty of conducting adequate affordable due diligence, the possibility of strategic insolvency, the fact that the Code may not bind administrators and the stay on proceedings during administration and insolvency mean that the most solid avenue forward for fair franchise contracts is for terms to be implied into all franchise agreements via a Franchise Contract Act along the lines of the Insurance Contracts Act 1984 (Cth). This option will be examined in chapter 6.2.2.
Steven Kennedy also identifies that ‘in many cases government actions tend to 443 reallocate risk between different groups’.42F This reallocation is partly a result of lobbying. At least one researcher has suggested that:
the dearth of information on franchisor failure is largely a reflection on the strength of the franchise lobby constituted by franchisors and their representatives. Similar franchisor biased representation is prevalent in the Australia, American, Canadian and British context. This lobby has an interest in promoting the franchise cause, and hence has resisted (and 444 perhaps limited) published research on franchisor failure.43F
3.5 CONCLUSION
The franchisee investigates the franchise opportunity believing the business is sound and viable. It may be impossible to conduct due diligence much beyond what
441 Trade Practices (Industry Codes – Franchising) Regulations 1998 (Cth) s 23. See Appendix A of this thesis. 442 Hadfield, ‘Problematic Relations: Franchising and the Law of Incomplete Contracts’, above n 202, 939. 443 Kennedy, above n 403, 15. 444 Morris, above n 41, 3.
Chapter 3: The problem in context 187 188 the franchisor has disclosed. This may be for any of numerous reasons. In chapter 3.2 we saw that franchisors are more diverse, and in some cases far more complex than many franchisees, financiers, regulators and franchisee advisers recognise.
Franchisors are becoming more complex as the model evolves. The franchisor may not be a corporation; it may, as Kleenmaid was, be one of 14 interdependent entities sitting alongside another related corporate group of 10 corporations that dealt 445 directly with the ‘franchisees’ customers,4F whose roles are not identified or explained to the franchisee. The franchisees’ money may flow freely among the franchisors’ entities, it may not be used for the purposes the franchisees paid it for. The cost of the due diligence may be prohibitive, or the franchisee may decide to save money on advisers and believe the layman’s rhetoric that due diligence requires only that that they have looked ‘at the facts of [the] deal from all angles to make sure 446 they stack up’.45F
The franchisee’s ongoing contractual liabilities to third parties assume, but are not contingent on, the franchisor’s solvency. The franchisor may, for example, may control all head leases on franchisees’ premises. If the franchisor has breached the head leases by failing to pay rent or committing an act of bankruptcy, landlords may terminate leases and evict the franchisees even though the franchisees are up to date with rental payments to the franchisor. At the level of state and territory legislation, if the franchisor breaches the head lease, even a franchisee sub-lessee or licensee that could trade strongly without the franchisor’s brand has no statutory rights to become head lessee. Although the existence of the trade marks and other intellectual property used by franchisees will be identified in the disclosure document, they may not be owned by the franchisor. This was explored in chapter 3.2.2. The consequences of the franchisees’ lack of rights will be visited in chapter 4.4.
Similarly, where franchisees need to trade from retail premises, there is a wide range of possible models, as was demonstrated in chapter 3.2.3. Not all of these provide suitable options for franchisees if the franchisor fails. This will be explored in chapter 4.4.4 and 4.5.
445 See Appendix D of this thesis. 446 Jason Gehrke, What is Due Diligence (2009) Smartcompany
188 Chapter 3: The problem in context 189
It was shown, at 3.2.4–3.2.6 that franchisees occupy a unique space in the business world, being neither employees nor independent contractors/suppliers. Other players that would perform the roles in a non-franchised business that franchisees perform in the franchise network would negotiate appropriate protection from identified legal and business risks before signing contracts. Chapter 3.3 explored the franchise contract and demonstrated three key aspects of franchise agreements: they are not traditional commercial contracts between two business people, a few individual franchise agreements may contain ipso facto clauses relating to the franchisor’s insolvency, but most of the 11,000 or so do not, and even if they did include clauses to protect franchisees, the remedies available for breach of contract are inappropriate as a means of compensating franchisees.
Some of the asymmetries in franchise relationship were introduced in chapter 3.4. From every perspective explored; information, risk, resource, contract and legislation, franchisees experience significant asymmetry, always to their detriment. Franchisees are vulnerable as business consumers.
Chapter 3: The problem in context 189
Chapter 4: Is the current regulatory response adequate to deal with the problem?
In chapter 2 the problem of franchisor failure, and some of its impacts, together with some of the challenges that liquidators face were identified. In chapter 3.2 it was demonstrated that franchisees cannot self protect against the consequences of franchisor failure through contract law. In this chapter the efficacy of the current consumer protection regime for franchisees whose franchisor fails will be examined.
Consumer protection policy and legislation is designed to moderate the effects of the free market. For Australian franchisees consumer protection is provided through the Trade Practices Act and the Code. If current consumer protection regulation is up to the task of addressing the challenges presented by franchisor failure in a way that meets benchmarks B1 and B2 and B3 that were introduced in chapter 1, the current law should remain unamended.
On realising that neither their franchise agreement nor the common law of contract provides them with legal rights to respond to their franchisor’s failure, franchisees turn to the Trade Practices Act, the Code and the Corporations Act. If the franchisee traded from retail premises they may also turn to their lease, sub-lease or 447 licence agreement and the relevant state or territory retail tenancies legislation.46F The potential avenues under the Trade Practices Act, the Code, the Corporations Act and the Retail Leases Act 1994 (NSW) will be explored in chapters 4.3 to 4.5.
4.1 THEORY OF THE MARKET-LED SOLUTION
The traditional view in the late 20th century was that markets worked things out over time, but ‘[i]n the case of a competitive market, there are a number of characteristics that may lead to a hypothesis that a market-based solution is unlikely
447 Leases (Commercial and Retail) Act 2001 (ACT); Retail Leases Act 1994 (NSW); Business Tenancies (Fair Dealings) Act 2003 (NT); Retail Shop Leases Act 1994 (Qld); Retail and Commercial Leases Act 1995 (SA); Fair Trading (Code of Practice for Retail Tenancies) Regulations 1998 (Tas); Retail Leases Act 2003 (Vic); Commercial Tenancy (Retail Shops) Agreements Act 1985 (WA).
Chapter 4: Is the current regulatory response adequate to deal with the problem? 191 192
448 to emerge.’47F Trebilcock identifies five characteristics that are all relevant to the market for the sale of franchise businesses to franchisee consumers.
First, ‘[r]epeat transactions are rare, and consequently the performance incentives created by the possibility of repeat business from satisfied customers are 449 blunted.’48F Franchisees as consumers of the franchisor’s business opportunity would typically only purchase one franchise. If they purchase into a second franchise network after the first franchisor fails they are likely to insist on the franchise agreement containing an ipso facto clause – this explains the presence of an ipso facto clause in the agreements of one of the 270 Traveland franchise agreements and one of the 60 BHG franchise agreements.
Second, ‘[e]ntry and exit costs in the industry are low, leading to the possibility of a large number of fly by night operators with few sunk costs and only modest 450 investments in reputational capital’.49F Trebilcock is referring to franchisors and national master franchisors. Sometimes entry costs in franchising are relatively low, even where the franchisee is required to pay a high franchise fee. However, even where entry and exit costs are very high for the franchisee business consumer, fly- by-night operators at franchisor and national master franchisee level still exist. Reputational capital may indeed be only a modest investment for some franchisors; many trade through companies with forgettable names, in large markets, and can 451 easily disassociate their own name and reputation from that of the failed entry.450F Alternately they are able to hide their true identify by using trusts, as occurred in Australian Competition and Consumer Commission v Chaste Corporation Pty Ltd (in liquidation) [2005] FCA 1212. Because the failure of a franchisor is not specifically identified by a bank or by ASIC as being linked to all of its franchisees the magnitude of the fallout is easy to under-estimate.
Third, ‘[m]any sellers or producers are extra jurisdictional, making redress through private law more difficult for customers. Sellers characteristically have few
448 Trebilcock, above n 29, 72. 449 Ibid. 450 Ibid. 451 Although, one director of a now failed Australian franchisor went so far as to change his name by deed poll to distance his identity from his past as a solicitor who had been jailed for fraud following misuse of his firm’s trust account.
192 Chapter 4: Is the current regulatory response adequate to deal with the problem? 193
452 assets against which a judgment may be enforced’.451F In franchising up to 25 per cent of franchisors are foreign based and many more are based within Australia, but in a different state or territory from the franchisee. This extra jurisdictional dimension to franchise relationships potentially hamper franchisees’ ability to conduct due diligence, and to resolve disputes.
The franchisees’ ability to conduct pre contractual ‘soft’ due diligence beyond what can be found on the public record is much easier if the franchise network is locally based. Soft due diligence consists, for example, of speaking with suppliers to the network and existing and former franchisees to discover what is the franchisor really like and what is being a franchisee of this network really like?
The existence of an overseas franchisor may make it difficult and expensive for franchisees to access redress through private law. Contributing factors include 453 jurisdictional issues,452F the language in the franchisor’s jurisdiction, distance to travel 454 to court,453F the size of the dispute and the amount of time away from the business that litigation will necessitate.
In addition, the franchisor entity is likely to have few assets, as the individuals involved have the opportunity to shelter assets from the franchisor’s creditors.
Fourth, ‘[t]he costs to consumers of a ‘bad’ transaction are delayed or potentially catastrophic, making ex post relief an inadequate or unsatisfactory 455 solution’.45F The costs to franchisees of a failed franchisor are often catastrophic, extending beyond loss of the franchised business to loss of their home (because of personal guarantees and loans secured over the franchisee’s personal assets) and relationships. This is a strong example of Trebilcock’s fourth characteristic as the franchisor’s administrator or liquidator is not appointed until after the franchisee has made the whole of its sunk investment. Satisfactory ex post relief is not available from an insolvent, asset-poor, debt-burdened franchisor.
452 Trebilcock, above n 29, 72. 453 For example, disputes must ultimately be resolved in Connecticut under all ‘Subway’ franchise agreements. 454 Even within Australia litigation may be between one party based in NSW and the other in Western Australia, three time zones and several hours by air from each other. 455 Trebilcock, above n 29, 72.
Chapter 4: Is the current regulatory response adequate to deal with the problem? 193 194
Finally, ‘[t]he small size of a typical transaction creates significant disincentive 456 to seeking ex post relief through the courts’.45F Regardless of whether a franchisee has made a million dollar investment or an A$15,000 investment, administrators claim the Code, with its cost effective dispute resolution provisions, does not bind them. This leaves a franchisee that wishes to terminate its franchise agreement with the choice of walking away from the investment, and thereby risking action by the administrator or liquidator for breach of contract, or litigating. Litigation is often prohibitively expensive. For example, in relation to costs leading up to the appeal that was reported in Hoy Mobile Pty Ltd v Allphones Retail Pty Ltd (No 2) [2008] FCA 810 and Hoy Mobile Pty Ltd v Allphones Retail Pty Ltd (No 3) [2008] FCA 967, the franchisee wrote:
July 2006, my barrister began preparing to file an injunction. On the same day without notice our franchisor released our commission payment…. [the matter eventually went to court]. We received judgment in our favour on the 30 May 2008. [Allphones, franchisor] has appealed the entire judgment. … The matter will most likely be heard in February or March 2009, three years and over $650,000 after Hoy Mobile requested mediation. … Our five year 457 agreement will expire before the appeal is heard.456F
4.2 POLICY BACKGROUND
As early as 1976, the Swanson Committee, while not specifically considering franchisor failure:
… identified two broad value judgments as providing the foundation upon which the body of trade practices legislation in Australia has been constructed. The first of these is the acceptance of competitive capitalism as a socio-economic system based upon the institution of private enterprise. The second is that the economically weak should be protected against the unfair or predatory acts of the economically strong, a belief that is derived from notions of human dignity and acceptable norms in the conduct of human affairs. [The Committee acknowledged that] [a]ttitudes as to what
456 Ibid. 457 Senate Standing Committee for Corporations and Financial Services, [Commonwealth of Australia], Joint Parliamentary Inquiry into Franchising (2008), Submission Number 8, (Nicole Hoy). This submission details the cost of litigation for franchisees whose franchisor refuses to mediate.
194 Chapter 4: Is the current regulatory response adequate to deal with the problem? 195
constitute norms in human affairs will change from generation to generation and the change will show in the practical expression they receive in legislative enactment and administrative enforcement; exercises of economic power which were accepted by society a generation ago are no longer tolerated today. Thus trade practices legislation looks not only to the preservation of competition but also to the regulation of potential misuse of economic power which is inimical to the public interest of the public 458 benefit.457F
It was in an environment in which a simple franchisor corporate structure, as described in chapter 3.2.1, was the norm, that the initial moves to regulate business format franchising were made in Australia. Voluntary regulation of the sector under the Franchising Code of Practice (‘FCP’) in 1993 was the first step. It failed.
By the time the Trade Practices Act s 51AC and the mandatory Code were enacted Parliament acknowledged that there were:
… particular problems for small firms in: obtaining full information on a venture prior to entering into it; understanding complex documentation; having terms and conditions of contracts imposed rather than being given an opportunity to negotiate them; harsh business conduct within a commercial relationship; and accessing the justice system. These problems were found to be most prevalent in the franchising and retail 459 tenancies sectors.458F
In 1997, The Hon Peter Reith introduced s 51AC and the Code to ‘give small 460 business protection in its dealings with big business.’459F At this time business failure implied a failure of the business that had been the consumer of deficient information - here, franchisees - not a failure of the supplier of the information, the franchisor. Failure was also not understood to have any greater impact on franchisees than on
458 The Trade Practices Review Committee (Swanson Committee) Report, above n 113, paras 10.40- 49. 459 The Parliament of the Commonwealth of Australia House of Representatives, Explanatory Memorandum, Trade Practices Amendment (Fair Trading) Bill (Cth) 1997, (Circulated by the authority of the Minister for Customs and Consumer Affairs, Senator the Honourable Christopher Ellison). 460 Statement by the then Minister for Workplace Relations and Small Business, the Hon Peter Reith, MP ‘New Deal: Fair Deal – Giving Small Business a Fair Go’, above n 113.
Chapter 4: Is the current regulatory response adequate to deal with the problem? 195 196 independent small business people. It was not considered that the failure of a supplier franchisor’s business might have intractable consequences for the franchisee- business consumers. There is now a better picture of the scope, magnitude and cost 461 of the failure of a single franchisor’s business.460F
In December 2006 Australia’s Productivity Commission (‘PC’) was asked to report on … ‘ways to improve the consumer policy framework to assist and empower consumers, including disadvantaged and vulnerable consumers, to operate effectively 462 in increasingly complex markets’.461F The PC reported the:
[k]ey considerations [included]: The need to ensure that consumers and businesses, including small businesses, are not burdened by unnecessary regulation or complexity … the need for consumer policy to be based on evidence from the operation of consumer produce markets, … and the importance of promoting certainty and consistency for businesses and consumers in the operation of Australia’s consumer protection laws. The Commission proposes … common [Australia-wide] objectives for consumer policy, with the overarching objective being to ‘improve consumer wellbeing by fostering effective competition and enabling the confident participation of consumers in markets in which both consumers and 463 suppliers can trade fairly and in good faith.462F
No mention was made of ‘business consumers’ in the brief to the PC or in its subsequent report. This was an unfortunate omission as business consumers, the ‘small firms’ above have been acknowledged as an especially vulnerable group of consumers in government policy since 1997 and have received protection under Australian consumer protection law since 1998.
4.2.1 THE REGULATORS The ACCC has responsibility for consumer protection insofar as it relates to franchisees, ASIC has responsibility for regulating corporations and the ITSA has responsibility for personal bankruptcy matters that arise under the Bankruptcy Act 1966 (Cth). The existence of separate regulators for different parts of the business continuum makes it difficult for any one agency to achieve a macro perspective.
461 See Table 1 and Appendix D of this thesis. 462 Australian Government Productivity Commission, Review of Australia’s Consumer Policy Framework, Report No 45 (2008) Volume 1, summary vii, viii. 463 Australian Government Productivity Commission, vol 2, above n 4, ix.
196 Chapter 4: Is the current regulatory response adequate to deal with the problem? 197
A consequence of this is that issues such as franchisor failure do not appear significant to any of the three regulators. The ACCC does not maintain a database of franchisors so has no way of knowing, other than anecdotally, that so many fail. ASIC and ITSA, as agencies that regulate the failure end of the spectrum do not know which failed entities are franchisors or franchisees. In addition, as already discussed at 3.2.1 and demonstrated in Table 1 and Appendix D, a franchise network might consist of numerous entities and none may have the trading name of the franchise in its legal name. This makes it virtually impossible to ‘join the dots’ when attempting to research which franchisors have failed.
4.3 TRADE PRACTICES ACT 1974 (CTH)
464 Globally, franchisees are variously categorized as consumers,463F business consumers, entrepreneurs, business entities, and in some litigation, employees. In Australia they are recognised as ‘business consumers’ under the Trade Practices Act s 51AC by virtue of their status as vulnerable small firms for whose protection s 51AC and the Code were enacted. Specific franchising legislation including mandatory disclosure obligations has been enacted in numerous jurisdictions, including Australia, to facilitate pre-contractual due diligence for intending franchisees. In-term issues receive less franchise-specific attention, often being addressed under generic fair trading laws.
The object of the Trade Practices Act, stated in s 2 is:
to enhance the welfare of Australians through the promotion of competition and fair trading and provision for consumer protection.
In Canada, Côté J discussed the interpretation of protective legislation, in Hi Hotel Limited Partnership and Holiday Hospitality Franchising Inc and ors. 2008 ABCA 276 (Hi Hotel), concluding:
[19] the latest authority says that protective consumer legislation should not be interpreted narrowly, nor ‘through the lens of freedom of contract and competition’: Assoc. des courtiers et agents immobiliers du Québec v Proprio Direct, 2008 SCC 32 (para 34).
464 For example under Consumer Protection Act 2008 (South Africa) s 6 ‘the following transactions must be regarded as a transaction between a supplier and consumer within the meaning of this Act: (d) a franchise agreement or an agreement supplementary to a franchise agreement.’ The Consumer Protection Act is estimated to become law in October 2010.
Chapter 4: Is the current regulatory response adequate to deal with the problem? 197 198
[20] … Whatever the bargaining power of a prospective franchisee, large or small, he or she will rarely know much about the franchisor, its officers and 465 its actual practices (absent full disclosure).46F
To an extent, the statutory legal framework has evolved to accommodate the needs of franchisees. We now turn to the parts of the Trade Practices Act that provide consumer protection for franchisees.
4.3.1 TRADE PRACTICES ACT 1974 (CTH) SECTION 51AC
466 ‘Dubious conduct which may be detrimental to consumers will not always’465F fit within the statutory notion of misleading or deceptive contained in the Trade Practices Act Part V Division 1. Despite not meeting the statutory tests of misleading or deceptive, the conduct may be ‘harsh, unfair or even dishonest … and may offend 467 community-held standards as to apposite standards of business conduct.’46F The conduct may be unconscionable. To enable business consumers to challenge unconscionable conduct by business suppliers the Trade Practices Act was amended in 1998 by the addition of s 51AC. This was statutory acknowledgement of the particular vulnerability of business consumers. The phrase ‘business consumers’ is used in s 51AC but the term is not defined.
In announcing [the introduction of s 51AC], the Government has accepted the principle that small business people are entitled to a legal protection against unfair business conduct comparable with that which consumers 468 already have against corporations.467F
Both procedural and substantive unconscionable conduct may be caught by s 51AC.
Posner explores the lack of information versus the lack of sophistication, and concedes that lack of information seems to play a role in unconscionable conduct cases. He argues, in mitigation, that consumers who lack information have incentives to acquire information. Posner says:
465 Hi Hotel Limited Partnership and Holiday Hospitality Franchising Inc and ors 2008 ABCA 276. Reasons for the Judgment reserved of the Honourable Mr Justice Côté. 466 Lynden Griggs, Eileen Webb and Aviva Freilich, Consumer Protection Law (2008) 97. 467 Ibid. 468 Reith, above n 113.
198 Chapter 4: Is the current regulatory response adequate to deal with the problem? 199
[I]f sellers cannot easily distinguish informed and uninformed consumers, they cannot exploit the latter by charging a higher price. Thus, information deficiency alone does not justify judicial intervention on the basis of 469 unconscionable conduct.468F
However in franchising the seller can reasonably readily distinguish between informed and uninformed consumers. The seller (franchisor) may chose to keep franchisees uninformed about its decision to take on a high debt load that threatens the network, or to become insolvent to meet its own strategic objectives. The lack of information is a fundamental problem ex ante for franchisee consumers.
If it became apparent that the franchisor had chosen to keep franchisees uninformed about significant risky behaviour, well-funded franchisees, sufficiently incentivised, may be able to secure redress under s 51AC. Franchisees might be able to make out a case that s 51AC (3) (i), (j) or (k) was breached. The basis of the argument under s 51AC(3)(i):
(i) the extent to which the supplier [franchisor] unreasonably failed to disclose to the business consumer [franchisee]:
(i) any intended conduct of the supplier that might affect the interests of the business consumer; and (ii) any risks to the business consumer arising from the supplier’s intended conduct (being risks that the supplier should have foreseen would not be apparent to the business consumer) would be that the franchisees would have no inkling of the impending voluntary administration or strategic insolvency, and no ability to predict it or prepare their own businesses to deal with the consequences of the franchisor’s strategic insolvency. The franchisor’s conduct was deliberate. The franchisor is able to foresee clearly the consequences for all of its franchisees.
An argument based on s 51AC(3)(j);
(j) the extent to which the supplier was willing to negotiate the terms and conditions of any contract for supply of the goods or services with the business consumer; may be able to be made out if the franchisee had sought amendment to the standard form agreement to include an ipso facto termination on franchisor insolvency clause;
469 Eric A Posner, Economic Analysis of Contract Law after Three Decades: Success or Failure (Working Paper No 146, (2d series) (2002)) 14.
Chapter 4: Is the current regulatory response adequate to deal with the problem? 199 200 but that request had been denied. The franchisor’s administrator may counter with a claim that the franchisee was not misled, that they subsequently signed the agreement with their eyes wide open.
The third possible avenue under s 51AC (3) is:
(k) the extent to which the supplier and the business consumer acted in good faith.
Although the concept of ‘good faith’ is not defined in the Trade Practices Act, 470 ‘parties to a relational contract are not expected to break the relational rules’.469F These include the rule that ‘a [franchisee] party to this type of [franchise] contract does not (rationally) intend to assume the risk of [the franchisor’s] opportunistic 471 behaviour’.470F
In practice, however, an action against the franchisor for breach of s 51AC Trade Practices Act would only result in meaningful relief to the franchisees if they were able to include the failed franchisor’s solvent directors as defendants. As already noted in chapters 3.4.1 and 4.1 directors are likely to have sheltered their personal assets.
On a theoretical level, Eric Posner writes:
[a] simple model of the consumer goods market implies that courts should not use the unconscionability doctrine to strike down contracts. More complex models that take account of asymmetric information and bargaining power imply that such contracts should be struck down only in particular circumstances, when courts have information about variables that are 472 intrinsically difficult to measure.471F
It is suggested that a franchisor’s future intentions are an example of a variable that is intrinsically impossible for a franchisee to measure before the franchisee
470 William Michael Dixon, An Examination of the Common Law Obligation of Good Faith in the Performance and Enforcement of Commercial Contracts in Australia (Thesis (SJD), Queensland University of Technology, Brisbane, 2005) 77 citing NC Seddon, ‘Australian Contract Law: Malestrom or Measured Mutation?’ (1994) 7 Journal of Contract Law 93, 96. 471 Ibid, citing G Hadfield who has suggested an interpretation of ‘good faith’ as fidelity to an implicit obligation not to use discretion opportunistically: G Hadfield, ‘The Second Wave of Law and Economics: Learning to Surf’ in M Richardson and G Hadfield (eds), The Second Wave of Law and Economics (1990) 60 as referred to by JM Paterson, ‘Good Faith in Commercial Contracts? A Franchising Case Study’ (2002) 29 Australian Business Law Review 270, 290. 472 Posner, above n 469, 15.
200 Chapter 4: Is the current regulatory response adequate to deal with the problem? 201 commits to the investment. This would leave the way open for courts to strike down franchise agreements if the franchisor behaved unconscionably by pursuing voluntary administration or strategic insolvency.
Bigwood recognises limitations of arguments based on unconscionability, albeit in the context of common law, as being that:
No matter how attractive the precept of unconscionability is as a judicial matter, the number of transactions that can be reached and controlled is too small to have a social impact, and the reluctance of courts to review 473 countless arguments is too strong.472F
From a practical perspective the unconscionable conduct provisions of the Trade Practices Act are not useful to all franchisees in the situation of franchisor administration and insolvency. It may be possible to establish that the franchisor behaved unconscionably. If the insolvency was not ‘strategic’, however, it will be difficult to establish that the franchisor acted unconscionably. Taking the decision to become insolvent is also a decision to withhold supply. Franchisees, like many consumers, are widely dispersed geographically. This makes working cohesively to litigate against the franchisor or negotiate with the administrator, while concurrently (as required by administrators) continuing to meet obligations under the franchise agreement, extremely difficult.
Recently legislation was:
… introduced into Parliament to enhance the range of enforcement mechanisms for unconscionable conduct. The amendments will increase the punitive consequences for engaging in statutory unconscionable conduct. The Trade Practices Amendment (Australian Consumer Law) Bill 2009 includes provisions to introduce: pecuniary penalties of up to [A]$1.1million for corporations and $220,000 for individuals for contraventions of the unconscionable conduct provisions; infringement notices, which the Australian Competition and Consumer Commission (ACCC) may issue for alleged contraventions of the unconscionable conduct provisions;
473 Bigwood, above n 341, 277, citing R A Epstein, ‘The Social Consequences of Common Law Rules’ (1982) 95 Harvard Law Review 1717, 1750.
Chapter 4: Is the current regulatory response adequate to deal with the problem? 201 202
disqualification orders, allowing the Court to ban those involved in a contravention of the unconscionable conduct provisions from managing corporations; public warning notices, which the ACCC may issue about corporations it has reasonable grounds to suspect have contravened an unconscionable conduct provision; and Court orders to redress loss or damage suffered by non-party consumers as a result of a contravention of an unconscionable 474 conduct provision.473F
These changes will not make any difference to franchisees whose franchisor is in administration or being wound up.
4.3.2 TRADE PRACTICES ACT 1974 (CTH) PART V DIVISION 1 Franchisees may take action under Trade Practices Act ss 52, 53A or 59 475 against a franchisor, or other ‘persons involved in a contravention’47F who misled them before the franchise agreement was signed, or in relation to any matter not 476 addressed in contracts that occurred subsequently.475F Section 75B lists by role the potential ‘person[s] involved in a contravention’ who may be prosecuted if, for example, the franchisor breaches parts of the Trade Practices Act.
477 Actions against the insolvent franchise systems A1 Mobile Radiator Repairs476F and Furniture Wizard provide examples of franchisees proceeding under ss 52 and 478 59.47F
474 Australian Government, the Treasury, The Nature and Application of Unconscionable Conduct Regulation, Issues Paper November (2009)
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4.3.3 TRADE PRACTICES (INDUSTRY CODES- FRANCHISING) REGULATIONS 1998 (CTH) (‘THE CODE’) The Code was enacted as a mandatory industry code of conduct pursuant to Trade Practices Act s 51AE. Its overall objective is to ‘to regulate the conduct of 479 participants in franchising towards other participants in franchising’478F by levelling the playing field between franchisors and franchisees.
Regulation is achieved under the Code through three avenues: by requiring franchisors to provide disclosure (Part 2), by implying terms into franchise 480 agreements (Part 3),479F and by mandating a dispute resolution process (Part 4).
Disclosure In Côté J’s assessment in Hi Hotel the Canadian legislature was of the view that: ‘Someone soliciting such an investment [ie a franchisor selling a franchise] or the fees for a franchise must put into the investor’s or franchisee’s hands accurate 481 complete written information.’480F
In Australia, compliance with the Code by franchisors should mean that 482 complete, accurate information about the franchise system481F is given to prospective franchisees. However, it is shown in chapter 3.1, Table 1, and Appendix D, that the 483 franchise system482F is only part of the larger franchise network. The purposes of the disclosure document are set out in s 6A:
(a) to give to a prospective franchisee, or a franchisee proposing to enter into, renew or extend a franchise agreement, information from the franchisor to help the franchisee to make a reasonably informed decision about the franchise; and (b) to give a franchisee current information from the franchisor that is 484 material to the running of the franchised business.483F
The content and format of the disclosure are dictated by the Code. The franchisor’s duty to disclose extends only to matters listed in the Code. Franchisees
479 Trade Practices (Industry Codes—Franchising) Regulations 1998 (Cth) s 2. 480 As outlined in ch 2.2.3 of this thesis. 481 Hi Hotel Limited Partnership and Holiday Hospitality Franchising Inc and ors 2008 ABCA 276. 482 Franchise system is defined very loosely in s 3 of the Trade Practices (Industry Codes – Franchising) Regulations 1998 (Cth)]. See Appendix A of this thesis. 483 The franchise system is the franchisor, its master franchisees and franchisees, but not the franchisor’s related entities. 484 See Appendix A of this thesis.
Chapter 4: Is the current regulatory response adequate to deal with the problem? 203 204 may be forgiven for not looking beyond the 250 items that are addressed in the disclosure and the numerous clauses in the ancillary documentation including the franchise agreement. Because these documents refer to the consequences of franchisee failure, but not of franchisor failure, franchisees are unlikely to consider franchisor failure and its possible consequences.
In relation to insolvency and personal bankruptcy, item 4.2 of the Code dictates that disclosure should provide relevant information concerning the franchisors’ 485 directors’ involvement in previous business failures.48F In a situation that is disclosed under item 4 (2)(c) there is almost never an accompanying case report from which a franchisee can objectively verify information supplied by the franchisor, so the 486 franchisee is reliant on the information supplied in the disclosure document.485F
Shortcomings of the Code Section 10 of the Code sets out the requirement for a statement about the financial details that have been supplied to the franchisee. It is effectively a statement 487 of current solvency.486F This is taken literally by franchisors whose ‘franchisor’ entity is the solvent face of an insolvent or soon to be insolvent network. Some franchisors are willing to sign a statement of solvency, despite knowing their business is insolvent. For example, BHG was still accepting franchise fees from new franchisees in the third quarter of 2006. The liquidator wrote that ‘in my opinion the company 488 became insolvent in 2005 and remained insolvent from that time’.487F The liquidator also reported having
discovered an email prepared by one of the company directors dated 7 May 2007 admitting the company was insolvent and that the company should be wound up. There is no evidence to show the relevant director took any steps 489 to prevent the company from incurring further debts.48F
485 See Appendix A of this thesis for full wording. 486 If there was a case that had ended in a judgment the franchisee could obtain a copy of the judgment, or even be aware of it by searching the court records electronically (
204 Chapter 4: Is the current regulatory response adequate to deal with the problem? 205
No franchisee could have uncovered this information through due diligence in time to avoid investing. Discovering post investment that the franchisor is insolvent is unhelpful. A franchisee would compound the fraud if it decided to sell its business without disclosing its knowledge of the franchisor’s insolvency.
In addition to being open to compromise by the lack of personal integrity of the franchisors’ directors, the value of the information provided by the franchisor is limited by the prospective franchisee’s advisers’ experience and by budget. This was addressed at 3.4.
Implied terms In an attempt to prevent dependence from becoming a form of predation or 490 servitude489F Part 3 of the Code implies terms into the franchise agreement. The terms:
provide a 14 day cooling off period for franchisees (13),
require franchisors to provide a copy of the premises lease in some circumstances (14),
forbid the franchisor from preventing franchisees or prospective franchisees to associate with each other (15),
prohibit the franchisor from requiring franchisees to sign a general release from liability (16),
mandate audit and reporting requirements in relation to franchise network marketing and other cooperative funds (17),
require disclosure of materially relevant facts by the franchisor to the franchisees within 14 days of the franchisor becoming aware, including contravention of the Corporations Act by the franchisor and the franchisor becoming an externally administered body corporate (18),
require the franchisor to provide a current disclosure document if the franchisee requests it (19),
490 Elizabeth C Spencer, ‘Conditions for effective disclosure in the regulation of franchising’ (2008) 22(4) International Review of Applied Economics 509.
Chapter 4: Is the current regulatory response adequate to deal with the problem? 205 206
forbid the franchisor from unreasonably withholding a franchisee’s request to be permitted to transfer its franchise (20).
The Code sets out three situations when a franchisor may terminate a franchise agreement. The trigger events are:
a breach by the franchisee (21),
a range of events where there has been no breach by franchisee (22), and
if the franchisee becomes bankrupt, insolvent under administration or an externally administered body corporate, the franchisor does not have to give the franchisee notice of its intention to exercise the franchisor’s right to terminate that is contained in franchise agreements. This is considered to be ‘special circumstances’ (Regulation 23).
The franchisees, in legislation that is supposed to level the playing field and provide them with protection, have no mirror rights. In defence its decision not to amend the Code to extend the rights provided for franchisors in regulation 23 to franchisees, the Government commented in 2009 that:
The inclusion of an automatic right of termination for franchisees (in the Franchising Code) in the event of franchisor failure would give one area of small business an advantage over others (preferential treatment). It would also provide franchisees with an automatic right under the Franchising Code 491 that is not available to franchisors.490F
The government fails to appreciate that the franchisors already have the right to automatically terminate franchisees to which receivers or administrators are appointed. They give it to themselves in the standard franchise agreements. They do not need legislative protection.
The early identification of problems within the franchise may be aided by the franchisees’ rights of association under s 15 of the Code.
A franchisor must not induce a franchisee not to form an association or not to associate with other franchisees for a lawful purpose.
491 Commonwealth Government Response to the Report of the Parliamentary Joint Committee on Corporations and Financial Services, Opportunity Not Opportunism: Improving Conduct in Australian Franchising (2009) above n 166, 22.
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492 This, combined with the right each franchisee has under s 19 of the Code491F to request and receive a copy of the disclosure document every 12 months would enable a well coordinated franchisee group to access a moving annual picture of the franchise system, but still not of the whole network. A well organized franchisee group may thus, be able to detect that a franchisor is experiencing financial difficulties before it is too late for the franchisees to work out how to protect their collective interest in the brand. This assumes that it is the franchisor itself experiencing solvency problems, not related entities or its parent – being entities that are exempt from the ongoing disclosure requirement.
ADMINISTRATORS AND CODE DISPUTE RESOLUTION When the administrator is appointed to investigate the franchisor’s business the applicability of the Code become contentious.
Mediators are unsure as to whether administrators are ‘a party to a franchise agreement’, a threshold requirement for the purposes of mediation under Part 4 s 27 of the Code. In the franchise contract the franchisor is typically described thus; ‘the term [franchisor] includes it successors in title and its assigns’. This raises the question of whether an administrator fits within the wording of ‘a successor in title or an assign’?
493 Under s 437B492F the Corporations Act the administrator’s role to act as the company’s agent. An agent is typically able to enter contracts and bind the principal so long as it is acting within its authority. The authority of the administrator as agent could be taken to be the performance of the role ad outlined in s 437A Corporations Act. This is a broad enough authority to permit the administrator to attend mediation and to execute a contract recording a mediated settlement.
The ACCC approaches the problem from another perspective. The ACCC issued an undated ‘Release for distribution to Insolvency Practitioners Association of Australia’ in which it advised that, in its view:
The franchisor company continues to be bound by the Code during the administration period. As an administrator, you are obliged to continue to
492 See Appendix A of this thesis. 493 See ibid.
Chapter 4: Is the current regulatory response adequate to deal with the problem? 207 208
comply with the franchising Code of Conduct on behalf of the franchisor company.
It cites Smith v Federal Commissioner of Taxation (1996) 71 FCR 150 in support of the proposition that the Code does cover administrators, arguing:
the appointment of an administrator for a franchise system under Part 5.3A of the Corporations Act does not, of itself, terminate or constitute a 494 repudiation of the franchise agreement.493F
The third argument in favour of the Code applying to administrators is that, from a policy perspective, the purpose of the administration process is to maximise 495 the survival prospects of a flagging company.49F Attempting to resolve disputes through the inexpensive and quick mechanism provided in the Code is consistent with survival of the franchise.
Administrators, however, cite the Corporations Act part 5.3 and argue that an administrator does not have to involve itself in substantive responses to a dispute notice issued under the Code. To become involved would, they say, distract from carrying out the tasks of an administrator. Administrators claim Brian Rochford Ltd (Administrator appointed) v Textile Clothing & Footwear Union of NSW (‘Brian Rochford’) (1998) 47 NSWLR 47; (1998) 149 FLR 125 supports their argument. In Brian Rochford, Austin J considered an application under s 440D of the Corporations Act for leave to allow proceedings against a company under administration.
The key words of s 440D were: ‘proceedings in a court’. Despite the definition of the word ‘court’ in Corporations Act s 58AA, Justice Austin held that the Industrial Relations Commission was a ‘court’. For Brian Rochford to be applied to administrators refusing to mediate with franchisees, the mediation process set up under the Code to resolve disputes would have to be analogous to ‘proceedings in a 496 497 court’. Leave under s 440D is not required for arbitration495F proceedings.496F
494 ACCC Submission to the Parliamentary Joint Committee on Corporations and Financial Services Inquiry into Franchising Code of Conduct (2008) 8.4(ii) d) 495 Foxcroft v The Ink Group Pty Ltd (1994) 12 ACLC 1063; see R Fisher, Corporate Insolvency Law (2000) 142. 496 Auburn Council v Austin Australia Pty Ltd (2004) 22 ACLC 766. 497 Murray, above n 150, 536.
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Consistent with the interpretation of arbitration proceedings, Professor Warren Pengilley distinguished mediation under the Code from ‘proceedings in a court’ writing that:
… proper mediation procedures are possible only if there is legislation with the relevant procedures and safeguards embedded into it. The Government’s regulatory path (Code created by Regulation) means that the essential 498 elements of mediation are not law.497F
The consequences of refusing to mediate, where the franchisor’s alleged breaches of the franchise agreement are the cause of the dispute, may be that the franchisees will become entitled to abandon their contracts. If the Code does apply to administrators, and they refuse to adhere to it, franchisees become entitled to seek leave of the court to litigate, and would be entitled to remedies available under the Trade Practices Act for breaches of the Code. These remedies would be available against the franchisor, but of greater value is that through the application of s 75B Trade Practices Act remedies should also available from the administrator.
On balance it is concluded that the Code does apply to franchisors under administration. The lack of funds for court action during the administration process, however, mean it is unlikely that franchisees will be able to litigate to force administrators to adhere to the Code. Because of the power imbalance during the administration, the fact that franchisees tend not to operate as a cohesive group, and the lack of time available it is concluded that the only way to make administrators adhere to the Code is by legislating the need for compliance.
CODE DOES NOT APPLY TO LIQUIDATORS Transition from administration to winding up on the appointment of the liquidator signals a change in focus. From the time the liquidator is appointed the Corporations Act ‘trumps’ the Trade Practices Act and the Code. As a consequence, the Code should not, and does not apply to liquidators.
Weaknesses of the Code. The Code has weaknesses, which are especially prominent in the context of franchisor entity failure.
498 Warren Pengilley, ‘The Franchising Code of Conduct: Does its Coverage Address the Need?’ (1998-99) 1(3) Newcastle Law Review 32.
Chapter 4: Is the current regulatory response adequate to deal with the problem? 209 210
SNAPSHOT, NOT CRYSTAL BALL The disclosure is a snapshot of the current status of the franchise network, focusing on the financial and legal fitness of the entity called the franchisor. Even in jurisdictions where the franchisees have a recurring right to receive updated 499 disclosure documents498F this will not enable a franchisee to predict the franchisor or the franchisor network’s future prosperity or insolvency.
AM I A FRANCHISOR? Some franchisors do not recognise that they are franchising, and thus do not adhere to the Code. For example law firm Freehills reminded clients involved in ‘commercial agreements such as intellectual property licences and distributorship 500 agreements’49F of:
the need to carefully consider whether the Code governs [the arrangement]. The directors of Synergy in Business Pty Ltd and Lawsons Trading Co Pty Ltd found out the hard way that the requirements of the Code cannot be 501 avoided simply by describing a franchise relationship as a licence. 50F
TIMING OF DISCLOSURE The timing of the disclosure is problematic from three perspectives.
First, a potential franchisee is psychologically committed to become a franchisee of the particular franchise network before receiving the disclosure. Franchisees in Australia tend not to compare several disclosure documents as they have to pay a deposit before being given the document. Second, when a franchise offering does not withstand due diligence investigation by the potential franchisee’s pre-purchase professional advisers, it can be difficult for the advisers to dissuade the potential franchisee. The experience of a retail pie shop franchisee, detailed below, illustrates this problem.
Mr Thadani [franchisee of failed pie franchise outlet in Sydney CBD] gave evidence of negotiations conducted by him and Mr Muriniti [franchisee’s lawyer], with Mr Gualdi and others, during September 2003. According to his evidence, Mr Gualdi [franchisor] told him more than once not to listen to Mr Muriniti because Mr Muriniti was not a franchise lawyer and was
499 For example Australia and Vietnam. 500 David Sarkin, Franchise Follies: Lessons From the ACCC (2004)
210 Chapter 4: Is the current regulatory response adequate to deal with the problem? 211
causing delay that would only add to the cost of the transaction. ... Mr Muriniti told his client … that there was something seriously wrong with the deal ... Amongst the unresolved matters was absence of consent to 502 Multipye’s occupation by Westfield, the landlord.501F
The franchisee ignored his solicitor, preferring to be seen as cooperative by the franchisor. Obviously, things did not go well thereafter.
Third, disclosure of current and past facts is not a guarantee of the franchisor’s future performance, or policies.
SCOPE OF DISCLOSURE It is widely assumed that the Code protects franchisees in key risk areas. Or, that it provides franchisees with the information they need to structure their affairs so as to protect themselves. However, the disclosure provided under the Code is no more than current information, predominantly concerned with the financial and legal fitness of the entity identified as the franchisor. ‘The primary focus of disclosure is 503 contract formation’.502F
Further, the Code’s narrow focus on ‘the franchisor’ and ‘the franchisee’ means it is ineffective if the franchisor fails. There are many stakeholders in the franchise network whose conduct may impact on the network and ultimately on the franchisee. These may include entities related to the franchisor, the franchisor’s administrator, and unrelated landlords or master franchisees. Franchisees are required to enter contracts with some of these entities. Problems can be hidden elsewhere in the network, where they incubate until they destroy the franchisor.
COST OF DISCLOSURE For franchisors the disclosure is an expensive document to create and maintain. Revising the structure of the disclosure could result in considerable cost savings for franchisors while resulting in a more informative document for the business consumer franchisees.
INTERPRETATION OF THE AUDIT REQUIREMENT
502 Shakespeares Pie Co v Multipye [2006] NSWSC 930, para 36. 503 Elizabeth C Spencer, ‘The Efficacy of Disclosure in the Regulation of the Franchise Sector in Australia’, (Paper presented at the third meeting of the European Network on the Economics of the Firm, France, September 2006) 7.
Chapter 4: Is the current regulatory response adequate to deal with the problem? 211 212
A director of the franchisor is required to sign a statement that complies with clause 20.1 of the Code by providing a statement that in the director’s opinion the 504 franchisor is solvent,503F as part of the pre-purchase disclosure supplied to the franchisee. From franchisors that are not trading strongly this may be of limited value. Usually, only public companies are required to be audited. Even if the auditor has identified a situation that casts doubt on an entity’s ‘going concern’ status, the directors may have been able to satisfy the auditor that there are mitigating circumstances and all will be well for the franchisor. Such mitigating circumstances, for instance new franchisees committed to investing, may or may not eventuate. Thus, a Code compliant audit may present an inaccurate and misleading picture of the franchisor’s solvency.
Attempted action on weaknesses In 2006, the Mathews Report recommended that disclosure should include specific information about what would happen to it if the franchisor became insolvent. This recommendation was loosely adapted by the Federal Government, in the form of a request to the ACCC to provide general information about the consequences of franchisor failure.
‘Opportunity not opportunism’ recommended that the continued absence of specific warnings about franchisor failure should be addressed:
Recommendation 1 The committee recommends that the Franchising Code of Conduct be amended to require that disclosure documents include a clear statement by franchisors of the liabilities and consequences applying to 505 franchisees in the event of franchisor failure.504F
The government responded with a watered down requirement that the Code be amended to alert franchisees that ‘franchising is a business and like any business the
504 See Appendix A of the thesis for full wording, of 20.1 of the Trade Practices (Industry Codes - Franchising) Regulations 1998. 505 Parliament of Australia, Joint Committee, Inquiry into the Franchising Code of Conduct (2008) para 4.80
212 Chapter 4: Is the current regulatory response adequate to deal with the problem? 213
506 franchise (or franchisor) could fail’.50F This response will be discussed in chapter 6.2.3.
4.4 CORPORATIONS ACT 2001 (CTH)
In Australia an external party can be appointed to take control of a company from its directors by three broad mechanisms; a creditor can appoint a receiver, the directors or the court can appoint an administrator, or the court can appoint a liquidator. Receivers, administrators and liquidators must act within strict statutory time limits prescribed by the Corporations Act. This does not allow parties such as franchisees time to attempt to protect their interests by bringing court actions to test prospective consumer protection, contract or equity based rights. Each status will now be summarised.
4.4.1 RECEIVERSHIP Receivership status may lead to the administration or winding up of an insolvent entity. In receivership, a receiver is appointed by one creditor. The receiver’s role is to recover debts owed to that creditor. The receiver is indemnified for all decisions.
For example, a receiver was appointed to manage the Brumby’s bread franchisor in 1988. By 1991, the receiver had sold the company owned stores, reducing the overall number of Brumby’s outlets from 76 to 54. In the process the receiver satisfied the needs of the creditor that appointed it. The company was sold to a new owner formed from the original franchisor and a group of the remaining franchisees. From 1991 on the reinvigorated Brumby’s operated as a successful franchise network.
4.4.2 ADMINISTRATION The administration process allows the company to evaluate its options. On the appointment, the administrator exercises the rights and fulfils the responsibilities of the franchisor to the extent prescribed in s 437A Corporations Act. The administrator ‘has effective control of the [franchisor] company and may decide to discontinue the company’s business and dispose of any of its property, [including franchise
506 Commonwealth Government Response to the report of the Parliamentary Joint Committee on Corporations and Financial Services, above n 166, 22.
Chapter 4: Is the current regulatory response adequate to deal with the problem? 213 214 agreements, supplier contracts and leases] subject to the restrictions under s 442c 507 Corporations Act’.506F
This enables the creditors, guided by the administrator, to make a decision about the company’s fate. …Recovery, protection and preservation of the company’s property are not of themselves the direct concern of the 508 administrator.507F
There is no legal obligation for an administrator or creditors to consult franchisees or take the interests of franchisees into account. From the franchisees’ perspective, the administration process ‘only serves to protect directors by putting up 509 endless barriers to accountability’.508F If franchisees are not creditors they have no statutory right to attend a creditors meeting.
The administrator becomes personally liable for new debts, all existing debts are frozen and all actions for recovery against the debtor, in this case the franchisor, are frozen. The administrator is not indemnified for decisions taken during the administration. There are three possible outcomes of the administration process:
the company may be declared solvent and returned to the directors. In his experience as an administrator and liquidator Richard Hughes states that in his experience ‘this never happens with franchisors in administration in 510 Australia’.509F
The creditors may vote that the company is insolvent and it should be wound up. This was the outcome for Kleenmaid, which was ‘incredibly 511 insolvent’.510F
A Deed of Company Arrangement (DOCA) may be entered into. This is a compromise arrangement where creditors agree to allow the company to
507 Murray, above n 150, 528. 508 Tolcher v National Australia Bank (2004) 22 ACLC 397, 401 (Barnett J) (cited in Murray, above n 150). 509 Interview with Franchisee of an Insolvent Franchisor (Telephone interview, 28 September 2006). 510 Richard Hughes, (Speech delivered at the Griffith University Franchising Seminar, Southbank, Brisbane, 18 November 2009) about the Kleenmaid insolvency. 511 Ibid. Kleenmaid was an asset-less administration. ‘The liquidator successfully applied to ASIC for funds to carry out its work. Kavanagh, above n 56.
214 Chapter 4: Is the current regulatory response adequate to deal with the problem? 215
pay debts by instalments. The DOCA is very flexible. It is useful as a tool 512 to ‘cut off stores that are not working’.51F
Franchisees whose franchisor is in administration are unlikely to have resources to fight administrator decisions and in any event the Corporations Act s 440D
… establishes a moratorium on civil actions against the company: Court proceedings in relation to company property or against the company cannot proceed or be commenced unless the administrator gives written consent or 513 the leave of the court is obtained…. In Foxcraft v The Ink Group Pty Ltd,512F the court (Young J) said that leave under s 440D should only be granted rarely, so as to ensure that administrator is not deflected from the necessary 514 tasks in having to defend litigation and in having to incur costs.513F
Not only is there a stay on commencing actions, the appointment of an administrator also serves to suspend enforcement and execution actions. Under the Corporations Act, s 440F and 440G, ‘during the administration no enforcement process in relation to company property can proceed or be commenced except with 515 516 the leave of the court’.514F There are exceptions to this rule.51F
4.4.3 WINDING UP IN INSOLVENCY The final step along the continuum from solvent to insolvent is the appointment of a liquidator. This appointment recognises that there is no hope of the company continuing trading or re-structuring its way into solvency. The general policy objective of the insolvency provisions in the Corporations Act is to allow for the orderly winding up and ultimate deregistration of insolvent companies.
The general purposes of bankruptcy law [including corporate insolvency] are to provide a protective and ordered process in the event of financial distress; to facilitate the equal access by creditors to a debtor’s property in order to compensate them for their loss; and to allow individuals who find
512 Hughes, above n 510. 513 (1994) 15 ACSR 203. 514 Murray, above n 150, 536. 515 Ibid 538. 516 Corporations Act 2001 (Cth) pt 5.3A, div 7, for example the rule is relaxed under s 441G in relation to perishable property.
Chapter 4: Is the current regulatory response adequate to deal with the problem? 215 216
themselves in financial difficulties to be given a fresh start, freed from the 517 financial obligations that were the subject of the bankruptcy.516F
As mentioned in chapter 1, attitudes to business failure have changed as it is recognised that any business can fail and that events beyond the immediate control of the debtor can impact severely on solvency. Of the late 1980s and early 1990s, K Freed, D Gurnick and E Honesty write:
This era has witnessed a marked change in the attitude towards bankruptcy. No longer is bankruptcy considered the last desperate act of a financially 518 defeated person or entity. Bankruptcy517F is now viewed as a viable business 519 option and financial planning tool.518F
This attitude to insolvency is pragmatic. The Global Financial Crisis of late 2008 – 2010 will have cemented the pragmatism. Franchisors are business people and are not exempt.
The basic components of the legislative corporate insolvency scheme in Australia are:
If a corporation cannot pay its debts as and when they fall due (that is, the 520 corporation is insolvent),519F an application may be made to the Court to appoint a liquidator. The application may be made by a creditor, the corporation, a director or member of the corporation, ASIC or a 521 liquidator.520F
Once the liquidation has commenced, the directors no longer manage the affairs of the corporation; the liquidator manages them. The liquidator is the only person empowered to dispose of company property.
A corporation in liquidation is given some protection; creditors cannot 522 enforce any judgments or orders they may have obtained521F and other legal
517 A Keay and Michael Murray, Keay’s Insolvency: Personal and Corporate Law and Practice (4th ed, 2002) 17–18, cited in Michael Murray, Submission CAP 10 (31 August 2002) 2. 518 The US term generically used for personal bankruptcy and corporate insolvency. 519 K Freed, D Gurnick and E Honesty, ‘Bankruptcy Issues’ (Paper presented at the International Franchise Association 29th Annual Legal Symposium, Washington, May 1996) 2. 520 Corporations Act 2001 (Cth) s 95A. 521 Corporations Act 2001 (Cth) s 459P. 522 Corporations Act 2001 (Cth) ss 468(4), 500(1); this includes franchisees who have obtained judgments in their favour.
216 Chapter 4: Is the current regulatory response adequate to deal with the problem? 217
proceedings may not be brought or pursued against the corporation without 523 the leave of the court.52F
The assets of the corporation are realised and the proceeds distributed by the liquidator proportionately to those creditors who are able to prove 524 debts in the corporate insolvency.523F
525 Whilst insolvency policies and priorities vary from one country to another,524F the insolvency regime in Australia generally tends to favour creditors over 526 shareholders. Apart from claims by liquidators, employees,52F and other listed in the Corporations Act:
Insolvency law tries to encompass all ‘creditors’ by having a wide definition of that term, including contingent claims damages claims, future claims as set out in s 553. Insolvency law … does alter the priorities of certain groups, 527 for example employee creditors.526F
As early as 1988, the Cork Report recognised that there were potential problems for small traders who depended on the insolvent party for their livelihood. Franchisees were not expressly contemplated but they fit within the category contemplated by the Cork Report, which reads:
[T]he effect of the [employee] priority is to deprive other unsecured creditors of their claim to a share of the available assets. Included in that class of unsecured creditors may be small traders who were substantially dependent upon the insolvent for their business and persons who were in an employee- like relationship with the insolvent but who are classified (in a strict legal sense) as independent contractors. There, creditors may be as vulnerable as employees in the event of bankruptcy or liquidation but enjoy no 528 protection.527F
523 Corporations Act 2001 (Cth) ss 471B, 500(2). 524 Some creditors may be granted priority by the Corporations Act 2001 (Cth) for some of the moneys owed to them. 525 As is demonstrated in part in Appendix D of this thesis. 526 Corporations Act 2001(Cth) s 558 deals with ‘debts due to employees’. 527 Australian Law Reform Commission, General Insolvency Inquiry (1988) para 722, quoting the Cork Report, para 1428. The [employee] priority was introduced into insolvency legislation for social welfare reasons ‘to ease the financial hardship caused to a relatively poor and defenceless section of the community by the insolvency of their employer.’ 528 Ibid, quoting the Cork Report, para 723.
Chapter 4: Is the current regulatory response adequate to deal with the problem? 217 218
The functions of a liquidator of an insolvent company are threefold: to wind up the affairs of the company; to distribute equitably the company’s assets among its creditors; and to examine the circumstances which precipitated the liquidation and 529 which may reveal improper dispositions of property and criminal offences.528F
When a liquidator is appointed to one of the parties to a contract, contract law is ‘trumped’ by rights given to liquidators under the Corporations Act. This would be appropriate if the franchisor operated a standalone business, but it is highly problematic in franchising where the franchisor is the lynchpin of a network of dependent entities. The franchisee’s contract-based rights are in the franchise agreement. Once the liquidator is appointed the franchise agreement becomes an asset or a liability in the franchisor’s insolvent estate. The franchisee has no separate rights as a consumer or a contracting party. As was seen in chapter 4.1, the Trade Practices Act does not provide any avenues for relief. The franchisee is not a stakeholder in the franchisor’s insolvency unless it has rights as a creditor. This was explored in chapter 3.6.1. Consequently, in relation to the majority of its exposure, it has no standing under the Corporations Act.
A ‘company is a separate legal entity and if it is in liquidation must be treated as such. In some cases however, the company’s affairs are inextricably bound with other companies in liquidation in a group. In such cases, since the Corporations Amendment (Insolvency) Act 2007, a statutory pooling regime is available to facilitate the winding up of companies in corporate groups – see Div 8, Pt 5.5 530 Corporations Act’.529F Pooling is obviously relevant in franchise networks. It will not be explored in this thesis as it would entail a major deviation from the consumer protection focus.
The liquidator has a statutory right to disclaim onerous assets pursuant to the 531 Corporations Act s 568.530F In the franchise situation this may include a lease of the premises a franchisee trades from, an agreement with a supplier, an agreement between the insolvent master franchisee and the international franchisor, or the unit
529 Murray, above n 150, 258. 530 Ibid 385. 531 Onerous assets are referred to as ‘burdensome assets’ in the UNCITRAL Legislative Guide on Insolvency, above n 26, 4, and defined as ‘assets that may have no value or an insignificant value to the insolvency estate or that are burdened in such a way that retention would require expenditure that would exceed the proceeds of realization of the asset or give rise to an onerous obligation or a liability to pay money’.
218 Chapter 4: Is the current regulatory response adequate to deal with the problem? 219 franchise agreement. Because the franchisee is a party to a contract with the franchisor, the franchisor’s liquidator has the right to disclaim the franchise 532 agreement as an onerous contract.531F The viability of each of the agreements that the franchisee has entered with third parties will also be directly impacted by the liquidator’s decisions. Regardless of the way the liquidator elects to treat each franchise agreement, the event of insolvency does not provide the franchisee any statutory rights to terminate the franchise agreement or consequential contracts between itself and third parties. Franchisees must continue to meet their obligations under all contracts.
When the franchisor was solvent, the franchisee was an essential component of the franchisor’s business network. It had contractually enforceable rights to use real, personal and intellectual property, backstopped by a range of other legal rights flowing from its standing as consumer. The appointment of a liquidator or administrator to the franchisor’s business signals a significant change in the franchisee’s legal position.
The effect of a winding up order is that contracts of employment are terminated. Employees have safety nets in the form of statutory priority and the government scheme, the General Employee Entitlements and Redundancy Scheme (GEERS). Additionally, in response to the Ansett failure, the Special Employee Entitlements Scheme for Ansett (‘SEESA’) was established for people whose employment was terminated from an Ansett group company (while under 533 administration) on or after 12 September 2001.532F The latter includes employees of the former franchisor Traveland Pty Ltd, but not the 270 former franchisees or their employees.
When a franchisor fails the franchisee has no legal right to respond – it has to ‘sit tight’, continue complying with the franchise agreement and hope for a satisfactory outcome. The franchise agreement is an asset or a liability when seen through the eyes of the administrator or liquidator. If the liquidator assesses that a 534 contract is ‘too onerous, worth little or is unsaleable’53F they have a statutory right
532 Corporations Act 2001 (Cth) s 568(1). 533 Australian Government, Employee Entitlement Schemes
Chapter 4: Is the current regulatory response adequate to deal with the problem? 219 220 under the Corporations Act s 568 to disclaim that contract. At that point all of the insolvent franchisor’s liabilities and rights under the disclaimed contract cease. In deciding whether a contract is eligible to be disclaimed liquidators are guided by Chesterman J who concluded in Re Real Investments Pty Ltd [2000] 2 Qd R 555 that:
A contract is unprofitable for the purpose of section 568 [Corporations Act 2001] if it imposes on the company continuing financial obligations which may be regarded as detrimental to the creditors, which presumably means that the contract confers no sufficient reciprocal benefit. Before a contract may be unprofitable for the purposes of the section it must give rise to prospective liabilities. Contracts which will delay the winding-up of the company's affairs because they are to be performed over a substantial period of time and will involve expenditure that may not be recovered are unprofitable. No case has decided that a contract is unprofitable merely because it is financially disadvantageous. The cases focus upon the nature and cause of the disadvantage. A contract is not unprofitable merely because the company could have made 535 or could make a better bargain.534F
4.4.4 SPECIFIC ASSETS AND LIABILITIES UNDER THE INSOLVENCY PROVISIONS OF THE CORPORATIONS ACT A fundamental difficulty, identified by Rohrbacher, in developing legal policies around contract based property rights is that ‘[f]or executory contracts in bankruptcy, the debtor’s [ie franchisor/liquidator’s] right to performance is treated as 536 property, but the debtor’s obligation to perform is treated as contract’.53F Thus, the franchisee finds the liquidator can at the same time have the right to exercise quasi ownership rights over the franchisee’s business and to disclaim the franchise agreement as an onerous contract.
The problem of categorisation and the consequences of splitting up the franchisor’s business along ‘asset’ and ‘liability’ lines will be demonstrated through retail leases, title to stock and the franchisor’s trade marks.
535 Re Real Investments Pty Ltd [2000] 2 Qd R 555, para 21. 536 B Rohrbacher, ‘More Equal Than Others: Defending Property-Contract Parity in Bankruptcy’ (2005) 114(5) Yale Law Journal 1099, 1101.
220 Chapter 4: Is the current regulatory response adequate to deal with the problem? 221
Retail Leases First, the franchisor or master franchisor may breach the head-lease. Breaches give the lessor a right to remedy the breach, or to terminate the lease. If the franchisor fails to pay the rent there is typically a remedy period. The problem for the franchisee in models 3, 4, 5, 6, 7, 8, 9 and possibly 12 in chapter 3.2.3 is that the franchisor is contractually positioned between the franchisee and the landlord. The franchisee becomes vulnerable if the franchisor breaches the head lease in a way that permits the landlord to terminate it. The franchisee in this situation pays its premises rent to the franchisor, that is meant to then pay it to the landlord. The franchisee does not enjoy privity of contract with the landlord. If the franchisor does not pay the rent, the franchisee does not necessarily learn of the default under the head lease until the rent is in arrears. The franchisee has been used by the franchisor as a free line of credit.
In exercising his or her statutory duty the liquidator will determine whether each contract is a liability or an asset. If the franchisor holds the head lease, the liquidator’s right to disclaim onerous property has implications for the franchisee. The result of disclaiming is that: ‘[a]fter disclaiming 17 leases on the loss-making bars [ie. the leases of premises occupied by Pulp franchisees], the only assets the 537 liquidators had available to sell were ‘fridges, blenders and mixers’.536F The franchisees have lost their right to trade from the premises.
The franchisee would have the best claim to retain the premises if it occupied its premises pursuant to models 1, 2, 10 or 11. Under all other models, the franchisee would have, at best, a tenuous right to remain in the premises.
In both models 1 and 2 the franchisee is able to verify the premises’ ownership and determine the extent of other registered interests by conducting a search of the title. For greater security, the franchisee could register its lease on the title. It would not, however, preserve the franchisee’s leasehold interest if a liquidator decided the premises would fetch a better return for creditors if sold with vacant possession. In that case, the liquidator of an insolvent franchisor-premises owner could disclaim the lease.
537 Mitchell, ‘Signature Out of Pulp But Not Out of Juice’, above n 96, 10.
Chapter 4: Is the current regulatory response adequate to deal with the problem? 221 222
In models 2, 4 and 6, the implications for the franchisee if the franchisor entity fails depend on whether the related entity was in the pool of failed companies, or survives the franchisor’s insolvency without being wound up. If the franchisee still has a valid lease, but the franchise agreement has been disclaimed, the franchisee may find itself with a liability to pay rent to the end of the term, but no right to operate the business.
In model 10, while the benefits of leasing direct from the landlord are obvious for the franchisee, there may be a significant disadvantage. If the franchisor becomes insolvent, the franchisee has ongoing legal obligations under the lease but the liquidator may disclaim the franchise agreement. If that were to occur, the franchisee would no longer be entitled to trade under the former franchisor’s brand and would have to re-fit the premises. Disclaiming disentitles the franchisee to any benefits it was entitled to under the contract.
Even if the franchisee under model 10 or 11 is not evicted as a consequence of the franchisor’s failure, they can still suffer financially. Having renovated the premises to accommodate the franchisor’s specific fit-out requirements, if the franchise agreement is disclaimed by the liquidator the premises would have to be de-identified before the franchisee could continue trading from them.
In the worst-case scenario, a franchise may have recently bought into a franchise network that requires it to trade in a shopping centre with significant investment sunk in the shop fit-out. It may also have provided a personal guarantee for the franchisor’s head lease. The failing franchisor is likely to have used the franchisee’s rent payments as a line of credit to prefer creditors other than the landlord. The landlord will simultaneously call on the franchisee’s guarantee, and terminate the head lease on two grounds – arrears of rent and outgoings (owed by the franchisor, paid to the franchisor by the franchisee but not passed on to the landlord) and administration or insolvency of the tenant (the franchisor).
Implications – specific facts and figures Franchisees who participated in the 2004/05 CPA Study were asked ‘How many years did the lease of business premises have still to run when administrator or liquidator was appointed?’ Forty four per cent answered two-three years and 11 per cent, four-five years. Where a lease has four-five years remaining it has probably
222 Chapter 4: Is the current regulatory response adequate to deal with the problem? 223 only been on foot for one or two years. The franchisees would be very vulnerable. They would not have had an opportunity to trade long enough to recoup the cost before the franchisor became insolvent.
One of the biggest problems for Kleins was the structural issues with the franchise system. The franchisor entered into the lease arrangements for every franchise premises and in some cases provided income guarantees and rent subsidies to franchisees. … [who] have lost their right of occupation of their sites being locked out by landlords whose leases were with the franchisor, who had defaulted despite the franchisees paying to the 538 franchisor the monthly rent payments537F
An advantage for the franchisee in the model 10 leasing structure became clear when the ‘Carlovers’ carwash franchisor was placed into voluntary administration on 10 July, 2003. In Carlovers, ‘after the construction of the structural plant by the Landowner [sic] the property [would] be leased to the Car Wash Operator (ie the 539 franchisee), who [would] then install items of operating plant’.538F
Commitment to lease payments [in CarLovers] appears to have been a contributing factor to the financial distress of the franchisor that had ‘locked itself into expensive leases of up to 20 years, on sites where the carwashes didn’t reach expectations and the [franchisor] company made big 540 writedowns.539F A few days earlier, franchisees reported being unaffected by the administration. “The day to day operations of the individual franchisees 541 would continue as normal.”540F
The franchisees would not have been able to confidently predict their futures if the franchisor had been the head lessor.
The Kernels Popcorn Australian master franchisee’s insolvency, operating retail premises through model 7, provides an example of the impact of a
538 Samson, Hill and Sutherland, above n 307. 539 Re Taxation Appeals No NT95/211 AAT No 10709. 540 N Chenowerth, ‘Car Lovers Is All Washed Up’, The Australian Financial Review (Sydney), 19 July 2003. 541 ‘Car Wash Sites Still Running’, The Newcastle Herald (Newcastle), 15 July 2003.
Chapter 4: Is the current regulatory response adequate to deal with the problem? 223 224
542 franchisor/lessee’s insolvency on franchisees. Kernel’s became insolvent in 2005.541F In the report to creditors the administrator wrote:
There were 24 Kernel’s Extraordinary Popcorn stores, of which 20 operated pursuant to franchise agreements. The company was also lessor of the 20 franchisee-owned stores and four franchisor owned stores. [The liquidator reports] I was without funds … it was necessary for me to disclaim all of the 543 company’s leases on 24 March 2005.542F
In the Danoz Directions franchise, the franchisee did not have any security of tenure as a licensee and bore all of the premises risk. In Danoz Directions the franchisor/lessee was placed into voluntary administration only a few weeks after one franchisee’s franchise agreement had been signed. The franchisor lessee’s voluntary administration constituted a breach of the lease. Thus, the franchisees, as licensee of the franchisor, found itself in the position of negotiating directly with the landlord or closing the newly opened shop. One Danoz Directions franchisee:
…almost lost the lease on the store because the franchisor held the head lease. …[the franchisee] was able to negotiate with his landlord to keep the 544 site, but he had to bargain away ownership of his store fit-out.543F
The fit out bargained away had cost $125,000.00 a few weeks prior. This figure includes fit out supervision claimed by the franchisor.
Because fitting out retail premises is a significant sunk investment for many franchisees, the solutions proposed in this dissertation include proposed amendments to retail leasing legislation. This is addressed at 6.2.4.
Title to stock Kleenmaid did not transfer title in the goods sold by its franchisees until the goods were delivered to the customer. This is a departure from the usual arrangement under the state sale of goods legislation in which title can pass on the receipt of full 545 payment by the supplier.54F As many of the suites of whitegoods purchased from Kleenmaid were to be installed after customers’ renovations had been completed,
542 Refer to 11 April 2005, ASIC Form 535 Formal Proof of Debt or Claim filed by the Administrators pursuant to Corporations Act 2001 (Cth) s 439A re Jatora Pty Ltd, formerly T/A Kernels Extraordinary Popcorn. 543 Ibid 5. 544 Walker, ‘It Pays to Have a Plan B’, above n 131, 56. 545 See, for example, Appendix A of this thesis, Sale of Goods Act 1896 (Qld).
224 Chapter 4: Is the current regulatory response adequate to deal with the problem? 225
Kleenmaid warehoused the purchased whitegoods until it suited the customer to take delivery. Once the franchisor failed, the warehouses exercised a lien to sell the stock so the warehouse would be paid before handing the balance of the money to the liquidators. This meant the only stock available for franchisees to sell once the administrator was appointed was their own demonstration/floor stock.
Trade Marks ‘Much of a company’s goodwill is associated with its name, which may be the 546 subject of trade mark protection. … [T]he crystallizing event’54F of franchisor insolvency is likely to damage the value of that name. Franchisees assume that they will continue to have the right to use the franchisors’ trade marks so long as they adhere to their contractual obligations. In the case of franchisor insolvency, this assumption is incorrect. If the trade mark was owned by the failed franchisor company, it is a task of the liquidator to sell that trade mark, or maintain the goodwill of the name, if possible, in order to realize value for creditors. Trade marks provide an example of the difficulties liquidators face when trying to retain the franchise network as a cohesive trading entity. If any of the 88 franchisors identified in the Exploratory Study in chapter 3.2.2 that owned their trade marks became insolvent the trade mark would be an asset the liquidator could sell without needing to consult co- owners or franchisees. Where the franchisor does not own the trade marks the liquidator must decide whether it is worthwhile negotiating with the owner(s) for ongoing rights for use of the trade marks.
The franchisor’s intellectual property becomes an asset in the franchisor’s liquidation. It is an asset, in the same way as franchise agreements are an asset – both are available to be sold by the liquidator for the best possible price, but they do not need not be sold to the same buyer. A buyer of the trade marks may elect not to purchase the franchise agreements. For example the liquidator of Kleenmaid sold the name ‘Kleenmaid’, to an entity that did not buy any other part of the former Kleenmaid business.
Compass Capital will now set up a new kitchen and laundry goods business using the Kleenmaid name. The Kleenmaid website will be updated by early next week with details about how people can buy products… Compass
546 McGuinness, above n 216, 328.
Chapter 4: Is the current regulatory response adequate to deal with the problem? 225 226
Capital acquired the right to Kleenmaid’s brand and logo following 547 [Kleenmaid’s] collapse last year.546F
An asset is only available for sale if it belongs to the debtor or another pooled entity controlled by the franchisor. If it is merely licensed to the debtor then the act of bankruptcy will trigger a default in the licence agreement and entitle the trade mark owner to terminate the licence. A third party owner of the franchised trade marks may not wish to continue licensing to a franchisor that is demonstrably in financial difficulty. This leaves the liquidator in a position of having to decide whether to negotiate with the trade mark owner for the right to continue using the trade marks. Where trade mark owners live in foreign jurisdictions it is inevitably more expensive for liquidators to negotiate ongoing use rights for franchisees, even if a buyer wanted to keep the network together.
The implication of using trade marks as securities for loans is that they might be repossessed and on-sold to a new owner if the franchisor defaults on the loan. At the time the searches of the trade mark registry were conducted 2.38 per cent (8 548 franchisors) of the franchisor trade mark owners had failed.547F Kleins, which failed since the research on trade marks was conducted, owed the National Australia Bank $20 million at the time it failed. The administrator said the Kleins trade mark was 549 part of the loan security by way of a fixed and floating charge.548F Three of the 337 franchisors in the sample analysed in chapter 3.1.2 had security interests registered 550 against their trade marks.549F This would mean the secured party would be a priority creditor in the franchisor’s insolvency.
Even if the administrator or liquidator is able to retain the right for the franchisees to use the trade marks,
the greatest difficulty for a financier in taking a security interest over a trade mark is whether the trade mark will retain its value once it has ceased to be associated with the original business or company… If the crystallizing event
547 AAP, ‘Compass Deal a Fresh Start for Kleenmaid’, The Australian Financial Review (Sydney), 7 January 2010, 7. 548 Australian Master Licensee for Kernels, Australian Master Licensee for Midas, Sure Slim, Danoz Directions, Collins. 549 Interview with liquidator James Stewart of Ferrier Hodgson (Sydney, 7 August 2008). 550 The Athlete's Foot Australia P/L; Coldwell Banker Corporation (USA); Rams Home Loans P/L.
226 Chapter 4: Is the current regulatory response adequate to deal with the problem? 227
for the transfer of the trade mark is insolvency then it is likely that the value 551 of the trade mark will be severely damaged.50F
For a master franchisee that has not registered its interest as an authorised user under the procedures established in the Trade Marks Act, the process of defending the trade marks that they in turn are licensing franchisees to use, is more cumbersome. A greater degree of initiative will be required from the liquidator wishing to negotiate the right to ongoing use of the trade marks.
Unregistered trade marks almost certainly prove more difficult, expensive and time consuming than registered trademarks for liquidators to value, assert ownership over, and sell.
4.4.5 IMPACT ON SUPPLIERS TO FRANCHISE NETWORK Suppliers were discussed in 3.2.5. If a liquidator is appointed to the franchisor, the supplier becomes a creditor or debtor. At that point, the franchisor has breached the particular supplier agreement and the supplier can access remedies and mitigate losses. Unlike franchisees, suppliers do not have their entire businesses reclassified as franchisor’s assets or liabilities in the franchisor’s insolvency following the appointment of the liquidator.
4.4.6 IMPACT ON EMPLOYEES IF EMPLOYER BECOMES INSOLVENT As many franchisees were formerly employees they are used to having statutory rights if their employer’s business fails. Some franchisees can be likened to a middle or senior manager in a corporation. Others are more accurately compared to junior employees. The incorporated franchisee that employs hundreds of staff and invests hundreds of thousands of dollars in premises and stock is in a very different position in the franchisor insolvency to an unincorporated sole trader franchisee who has paid less than A$50,000 for the licence to conduct a dog wash business, do domestic ironing or mow lawns. In each situation, and all variables in between, the franchisee will fare differently to an employee if the franchisor becomes insolvent.
4.5 RETAIL LEASING LEGISLATION
Property law recognises that several legal entities may have concurrent rights in the same premises, the most obvious example being under a lease, where an owner
551 McGinness, above n 216, 328.
Chapter 4: Is the current regulatory response adequate to deal with the problem? 227 228 grants to a lessee/tenant the right to occupy the premises to the exclusion of all others, including the owner itself, for a specified period. Retail leases are legally binding contracts that define the relationship between a lessor (the landlord) and a retailer (the lessee or tenant). The lease contract addresses a range of matters including identifying the parties and the lettable space, the rent and permitted uses, relocation, redevelopment, quality and maintenance, rent reviews, fit-outs and 552 expiry.51F
In addition to contract terms, real property in Australia is regulated by state and territory laws. Ownership, the strongest real property right, enables the owner (also 553 known as the registered proprietor) to do anything it wishes with the land,52F subject to any restrictions specifically imposed by statute. These restrictions can include planning requirements and laws that permit the government to compulsorily acquire 554 land.53F
All Australian states have adopted the Torrens system of land registration, 555 issuing a title to each identified parcel of land.54F Part 6 of the Real Property Act 556 1900 (NSW)5F provides for interests in land to be registered on the title. The effect of registration is that it identifies the registered proprietor (owner) of the property and alerts third parties as to who, in addition to the owner, has a legal claim to an interest in the property. The information on the title is recognised as being conclusive in the absence of fraud. If the landowner provides its land as security for a loan, the mortgagee may register its interest. Lessees may also register their interests. Registered interests take priority over unregistered interests if an issue arises such as the financial distress of the landowner. If a party has a registrable interest but decides 557 not to register, it may lodge a caveat on the title.56F
552 Productivity Commission, The Market for Retail Tenancy Leases in Australia’ Draft Report (2007) xvii. 553 For example Real Property Act 1900 (NSW) s 42 states that the estate of the registered proprietor is paramount. 554 Land may also be subject to restrictions at common law; for example nuisance, right of support, and rights reserved to the Crown such as mining rights. 555 B J Edgeworth, C J Rossiter, M A Stone and P A O”Connor, Sackville and Neave, Australian Property Law (8th ed, 2008) 460. 556 Similarly, in other States and Territories, Land Titles Act 1925 (ACT); Land Title Act (NT) part 3; Real Property Act 1861 (Qld); Real Property Act 1886 (SA); Land Titles Act 1980 (TAS); Transfer of Land Act 1958 (Vic); Transfer of Land Act 1874 (WA). 557 For example under Real Property Act 1900 (NSW) s 74F.
228 Chapter 4: Is the current regulatory response adequate to deal with the problem? 229
An owner may borrow money against the security of the land. If the owner (the ‘mortgagor’) defaults on its payments the land can be sold by the lender (the 558 ‘mortgagee’) to fund repayment of the loan.57F If there is a lessee over premises on the land, the mortgagee, and subsequently the buyer, has to allow the tenant to remain in the premises for the term of its lease, or to pay it out, provided the Real 559 Property Act 1900 (NSW) s53 or its equivalent58F has been complied with. Section 53 provides:
53 (1) When any land under the provisions of this Act is intended to be leased or demised for a life or lives or for any term of years exceeding three years, the proprietor shall execute a lease in the approved form. 53 (4) A lease of land which is subject to a mortgage, charge or covenant charge is not valid or binding on the mortgagee, chargee or covenant chargee unless the mortgagee, chargee or covenant chargee has consented to the lease before it is registered.
Even if the lease is unregistered, the lessee’s rights are preserved as long as any mortgagee of the premises has consented to the lease or any buyer of the premises 560 has notice of it.59F
Premises leases must comply with the Retail Leases Act 1994 (NSW) (‘RLA’) 561 or its equivalent in other states and territories.560F If a lessee wishes to grant occupation of the premises to another party, it may, subject to the terms of the lease, assign or novate the lease or grant a sub lease or a licence to that other party. In all cases, the consent of the landlord is required. Where a sub lease or licence is granted, the original lease between landlord and lessee continues and is referred to as the head lease. For the lessee, subleasing or licensing provides a continuing connection to the occupancy that would be lost in the case of assignment or novation of the lease. A sub lease must be consistent with the terms of the head lease in its key parameters. It
558 The power of sale is conferred in NSW by Real Property Act 1900 (NSW) s 58. Each State and Territory has similar legislation. 559 Land Title Act (NT) s 67. 560 Figgins Holdings Pty Ltd v SEAA Enterprises Pty Ltd [1999] HCA 20; and see Joycey Tooher, ‘Let Mortgagees and their Buyers Beware: Figgins Holdings Pty Ltd v SEAA Enterprises Pty Ltd’ (2000) 26(1) Monash Law Review 216; Peter Butt, ‘Variation of Lease Binding Purchaser from Mortgagee’ (1999) 73(12) Australian Law Journal 861. 561 Leases (Commercial and Retail) Act 2001 (ACT); Business Tenancies (Fair Dealings) Act 2003 (NT); Retail Shop Leases Act 1994 (Qld); Retail and Commercial Leases Act 1995 (SA); Fair Trading (Code of Practice for Retail Tenancies) Regulations 1998 (Tas); Retail Leases Act 2003 (Vic); Commercial Tenancy (Retail Shops) Agreements Act 1985 (WA).
Chapter 4: Is the current regulatory response adequate to deal with the problem? 229 230 is possible to register a sub lease on title, but in the context of retail leasing this is not common. Retail tenancy legislation enables the lessor to refuse to allow a tenant to 562 grant a sub lease.561F
A lessee that has assigned the lease may not be relieved of all of the underlying contractual liabilities. A would be assignor-lessee that wants no ongoing rights may ask the landlord to novate the lease to a replacement tenant who will replace the original tenant in respect of all of its rights and obligations.
Alternatively, the landlord or the lessee may grant a licence. Fewer rights accrue to a licensee than to a sub lessee or assignee. Property laws do not provide for a licensee to register its interest on the title to the premises, nor can the licensee protect its interest by registering a caveat as a licence is a personal property interest, not an interest in real property. The fewest rights accrue to a mere occupier with no contract to define its rights.
A pre-requisite for protection under retail leasing legislation is that the franchisor’s occupancy situation falls under the legislation. As demonstrated in Table E, a review of the definitions of ‘landlord’/’lessor’, ‘tenant’/’lessee’ and ‘lease’ in each of the Acts reveals that none of the state and territory retail tenancy legislation covers all 12 models of franchisee occupancy described in chapter 3.1.3.
563 For example, the Western Australia legislation562F defines ‘lease’ broadly but contains an additional definition of ‘retail shop lease’ that may deprive some franchisees of protection if their franchisor is a public corporation or a subsidiary of one. The legislation in some states does not apply to tenancy arrangements of shorter 564 than 12, 6 or 1 months’ duration.563F Only the legislation of Western Australia designates minimum tenancy terms before becoming applicable.
562 For example Retail Leases Act 1994 (NSW) s 42, see Appendix A of this thesis. 563 Commercial Tenancy (Retail Shops) Agreements Act 1985 (WA) s 3. 564 Retail Leases Act 2003 (Vic) s 12 (1) exempts some leases of shorter than 1 year duration. Business Tenancies (Fair Dealings) Act 2003 (NT) s 7(1); s 13(8) exempts short term leases from the provisions of the Retail Shop Leases Act 1994 (Qld) and s 13(9) defines ‘short term’; licences of six months or less for parts of common area in shopping centres are excluded from the Fair Trading (Code of Practice for Retail Tenancies) Regulations (1998) (Tas) under Reg 1(b) and from the Retail Leases Act 1994 (NSW) by s 6A. Retail and Commercial Leases Act 1995 (SA) s 4(2)(ab).
230 Chapter 4: Is the current regulatory response adequate to deal with the problem? 231
State and territory laws permit the lessee or sub lessee to register its interest on the
565 title.564F Registration puts a third party dealing with the title, such as a purchaser, mortgagee or a liquidator, on notice of the property interest. Even when a franchisee has property interests recognised by the legislation, they may not be able to be registered on the landlord’s title. And, where interests are registrable, registration is not always customary. Franchisees occupying premises as licensees are not protected 566 by most jurisdictions’ legislation.56F
In practice, whether a lease is registered on the title will depend on the practice in the state or territory where the premises are located. For example, it is usual for a tenant to register a lease of three years duration or longer on the title in New South Wales, but neither registration of a lease nor lodging a caveat to protect the tenant’s interest is necessary or usual for retail premises 567 in Victoria.56F
568 Table 6: Franchisees’ position under State and Territory retail tenancy legislation.567F
Australia Western New South Northern Queenslan South Tasmani
Model568F n Capital Victoria Australi Wales Territory d Australia a 569 Territory a 1 Covered Covered Covered Covered Covered Probably Covered Covered 2 Covered Covered Covered Covered Covered covered. Covered Covered 3 Covered Covered Covered Covered Covered Lessor Covered Covered 4 Covered Covered Covered Covered Covered and Covered Covered lessee not defined 5 Not Arrangeme Arrangeme Covered so Arrangeme Probably Not Covered covered nt covered nt covered long as nt covered covered. covered in in premises in Lessor definition definition owner definition and of lease: of lease: consents to of retail lessee franchisee franchisee franchisee shop lease; not may not be may not be occupation franchisee defined
565 Real Property Act 1900 (NSW) s 53(1); Land Title Act 1994 (QLD) s 64; Real Property Act 1886 (SA) ss 116-17; Land Titles Act 1925 (ACT) s 82; Land Titles Act 1980 (Tas) s 64(1); Transfer of Land Act 1958 (Vic) s 661(1); Transfer of Land Act 1893 (WA) s 91; see Edgeworth, above n 556, 870-871. 566 Licensees and franchisees are, however, specifically included under the definition of ‘lease’ in the Duties Act 1997 (NSW). 567 Buchan and Butcher, ‘Premises Occupancy Models for Franchised Retail Businesses in Australia: Factors for Consideration’, above n 34, 178. 568 Relevant tenancy legislation is: Leases (Commercial and Retail) Act 2001 (ACT); Retail Leases Act 1994 (NSW); Business Tenancies (Fair Dealings) Act 2003 (NT); Retail Shop Leases Act 1994 (Qld); Retail and Commercial Leases Act 1995 (SA); Fair Trading (Code of Practice for Retail Tenancies) Regulations 1998 (Tas), Retail Leases Act 2003 (Vic); Commercial Tenancy (Retail Shops) Agreements Act 1985 (WA). 569 See ch 3.2.3 of this thesis.
Chapter 4: Is the current regulatory response adequate to deal with the problem? 231 232
covered by covered by may not be definition definition covered by of lessee of lessee definition of lessee 6 Covered Covered if Covered if Covered Covered if Covered Covered Covered term longer term longer term longer unless if ‘lease’ than six than six than one related to interprete months months month common d broadly with right with right area of of renewal to extend shopping term centre and term shorter than six months 7 Covered Covered Covered Covered Covered Probably Covered Covered 8 Covered Covered Covered Covered Covered covered - Covered Covered 9 Not Not Not Covered so Not lessor Not Covered covered covered for covered for long as covered for and covered same same premises same lessee reason as reason as owner reason as not model 5 model 5 consents to model 5 defined franchisee occupation 10 Covered Covered Covered Covered Covered Covered Covered 11 N/A N/A N/A N/A N/A N/A N/A N/A 12 Not Not Not May be May be Not Not Not covered covered covered covered covered if covered, covered covered prospective no lessee agreemen t ‘Covered' means the franchisee's occupancy arrangement fits within the retail tenancy legislation ‘Not covered' means the franchisee fails to qualify because it or its occupancy arrangement does not fit under the definitions in the relevant legislation N/A applies where the franchisee owns the premises
The parties to a retail lease are free to negotiate and include a response to franchisor insolvency in their lease contract. As was demonstrated in chapter 3.1.3, franchisees may not have privity of contract with the owner of the premises. This increases the franchisees’ vulnerability if the franchisor becomes insolvent in three ways:
Franchisees will not be recognised as creditors in relation to their lost premises interests as there will be no contractual rights to connect their loss to the insolvency;
If they were a guarantor, the landlord will have made a legitimate call on the guarantee when the franchisor breached the lease; thereby depleting the franchisees’ financial resources, and
232 Chapter 4: Is the current regulatory response adequate to deal with the problem? 233
They have lost the right to trade from the premises as result of the franchisor breaching the lease.
4.6 STATUTORY REMEDIES
Benchmark 2 is that there should be accessible, timely and meaningful redress where consumer detriment has occurred. Up until the time an administrator is appointed to their franchisor, franchisees have access to protection and redress under Trade Practices Act parts IVA, and V division 1 and through the Code.
In practical terms however none of the remedies available in Trade Practices Act pt IV are applicable to the franchisor administration/insolvency situation. Damages, injunctions, deleting the offending words of a contract, enforceable undertakings, and advertisements are all remedies based on the assumption that the breaching party is still solvent. As mentioned in 4.2.3 administrators reject franchisees’ requests that they attend mandatory mediation under the Code and the Code does not apply to liquidators.
As was seen in 4.4, even if remedies were available to franchisees, the stay of proceedings under Corporations Act s 440D means they are not able to pursue any remedies through the courts while the franchisor entity is in administration. Nor are 570 franchisees able to initiate proceedings without the consent of the court569F if a liquidator is appointed. ‘While legal proceedings against the company are stayed, existing proceedings by the company are not stayed…The liquidator has to decide 571 whether to continue such proceedings’.570F Thus, the franchisees are vulnerable if they decide, for example, to stop paying franchise fees following the appointment of the administrator. The administrator may issue proceedings for anticipatory breach without seeking leave of the court.
4.7 CONCLUSION
As has been shown in chapter 4, once the franchisor is controlled by a liquidator, the consumer protection provisions of the Trade Practices Act and the Code cease for practical purposes, to protect franchisees. Enforcing contractual and statutory rights through litigation is slow and expensive. Even if litigation were affordable, the
570 Corporations Act 2001 (Cth) s 471B. 571 Murray, above n 150, 318.
Chapter 4: Is the current regulatory response adequate to deal with the problem? 233 234
Corporations Act imposes barriers on commencing or continuing litigation during the insolvency process, as discussed in chapters 2.4 and 4.4.
Whilst a franchisee whose franchise agreement or premises lease has been disclaimed has a right to lodge a proof of debt in the liquidation as an unsecured 572 creditor for its loss,571F this is a deficient form of consumer protection.
From the time an administrator is appointed to the franchisor, franchisees have no meaningful voice, let alone any control over their future in the insolvency process.
The current solutions available to franchisees are too fact-specific, expensive, slow and uncertain. More elegant solutions than the law currently provides require 573 analysis along the lines of the OBPR’s model572F for the making of sound and informed policy.
572 Corporations Act 2001 (Cth) s 568D(2). 573 Introduced in ch 1 of this thesis.
234 Chapter 4: Is the current regulatory response adequate to deal with the problem?
Chapter 5: The deal for franchisees
In this chapter the current ‘fair and in good faith’ Australian benchmark for evaluating consumer protection laws will be discussed briefly. Then, the three more appropriate consumer protection benchmarks identified in chapter 1 will be put forward as a basis for evaluating proposed consumer protection for franchisees whose franchisor fails.
The Productivity Commission (‘PC’) recommends that ‘policy makers should 574 have regard to the evidence on how consumers and businesses actually behave.’573F In the past, lack of collated evidence on how failed franchisor suppliers and their liquidators behave towards franchisee consumers has meant that the regulators have not regarded the situation as one requiring attention. Since the Matthews Inquiry in 2006 the government and the ACCC have become more aware that they could play a role ex ante in alleviating the effects of franchisor insolvency on franchisees. Ex post, the consequences of franchisors failure for franchisees are still dealt with on an ad hoc basis by individual insolvency practitioners.
The actual behaviour of franchisors as suppliers and franchisees as business consumers was addressed in chapter 2 where the causes and magnitude of the problem were identified. It was shown that franchisors fail in greater numbers and with more serious consequences for franchisees than rhetoric suggests. It was also shown that the failure is seldom caused by franchisees.
In chapter 3 the problem was placed in the context of an issue that is influenced by:
choices made by the franchisor about structuring the franchise network
the franchise agreement as a contract, for which traditional breach of contract remedies are ill-fitted when the monopoly supplier becomes insolvent
asymmetries of information, adviser, risk, resource, contract and legislation
574 Australian Government Productivity Commission, vol 2, above n 4, 42.
Chapter 5: The deal for franchisees 235 236
It was concluded that contract law will not evolve, unaided, to provide an adequate solution. The current statutory framework was discussed in chapter 4. It is concluded that the law in its current form cannot deliver consumer protection to franchisees in the event of franchisor failure. Rather, it lulls franchisees, as well as financiers and franchisee advisers into a false sense that the franchisee’s future is secure in the franchise model.
5.1 CONSUMER PROTECTION BENCHMARKS
A benchmark is ‘a standard or point of reference; a means of evaluating by 575 comparison with a benchmark’.574F Following its evaluation of Australia’s consumer protection laws, Australia’s PC recommended that the:
Australian Government should adopt a common overarching objective for consumer policy, being: To improve consumer wellbeing by fostering effective competition and enabling the confident participation of consumers in markets in which both 576 consumers and suppliers trade fairly and in good faith. 57F
The PC concludes that ‘fairness’ and ‘good faith’ are the appropriate benchmarks for measuring markets in which consumers can participate confidently. The PC’s recommendation led to the drafting of the Trade Practices Amendment (Australian Consumer Law) Bill 2009 (‘2009 Bill’) and the Trade Practices Amendment (Australian Consumer Law) Bill (No. 2) 2010 (‘2010 Bill’). The 2009 Bill does not include consumer protection for franchisees whose franchisor fails because the PC confined its inquiry to consumers that currently fall under the definition in s 4B Trade Practices Act. The PC did not appreciate that while there may be effective competition, confident (albeit under-informed) participation in the market by franchisee consumers and good faith on the part of both franchisors and franchisees, nonetheless franchisors will fail. While a franchisor’s strategic insolvency certainly indicates lack of fairness and good faith towards franchisees, in many franchisor failure situations there is no lack of good faith on the part of any
575 Bruce Moore (ed), The Australian Oxford Dictionary (2nd ed, 2010) 117. 576 Australian Government Productivity Commission, vol 2, above 4, 42.
236 Chapter 5: The deal for franchisees 237 party. Good faith is not a suitable benchmark in this context. In relation to fairness the Commonwealth Government concludes:
The Franchising Code is designed to ensure franchisees and franchisors treat each other at least with a certain minimum standard of fairness, and the Government’s [2009] proposed changes to the Franchising Code will 577 improve its effectiveness in promoting fairness and good practice.576F
Until the problem of franchisor failure is addressed, an acceptable level of fairness will not have been achieved.
In chapter 2 it was demonstrated that franchisor failure is a sizeable problem for franchisees. In chapter 3 we gained an understanding of why franchisees are unable to self-protect through negotiating better contracts and that they could not rely on an action for breach of contract against an insolvent franchisor delivering redress. Chapter 3.4 demonstrated that issues of asymmetry in six spheres mitigate against franchisees being able to self-protect via contract law.
In chapter 4 it was concluded that current remedies for breach of the Trade Practices Act are unhelpful to franchisee consumers where their franchisor supplier is insolvent. The franchisees’ position under the insolvency provisions of the Corporations Act is extremely vulnerable.
On concluding that fairness and good faith are inappropriate benchmarks for evaluating the adequacy of the response of consumer protection regulation to franchisor failure, more meaningful benchmarks are selected. They are:
B1) Regulation should provide effective protection from serious risks and threats that franchisees as business consumers cannot tackle as individuals.
B2) There should be accessible, timely and meaningful redress where consumer detriment has occurred.
B3) The cost to the franchisor and legal system of meeting B1 and B2 should be less than the benefit to franchisees whose franchisor fails.
577 Commonwealth Government Response to the Report of the Parliamentary Joint Committee on Corporations and Financial Services, above n 166, 11.
Chapter 5: The deal for franchisees 237 238
Australian legislation will succeed in providing adequate protection to 578 franchisees as business consumers when it ‘credibly demonstrates’57F to all franchisees that they can enter a franchise agreement knowing that if their franchisor goes into administration or becomes insolvent they will:
have had the opportunity to assess and prepare for this risk before they sign the franchise agreement,
have a legislated exit strategy.
5.1.1 REGULATION SHOULD PROVIDE EFFECTIVE PROTECTION FROM SERIOUS RISKS AND THREATS THAT FRANCHISEES AS CONSUMERS CANNOT TACKLE AS INDIVIDUALS (B1) Of the national consumer policy objectives identified by Australia’s 579 580 Productivity Commission,578F following a review of those of New Zealand,579F the 581 582 583 United States,580F the United Kingdom,581F Canada582F the fourth objective espoused by the European Union; [t]o protect consumers effectively from the serious risks and 584 threats that they cannot tackle as individuals 583F best articulates one of the specific issues that confronts franchisees – the risk of franchisor failure is a serious risk and
578 Commission of the European Communities, EU Consumer Policy Strategy 2007–2013, (2007) 2
238 Chapter 5: The deal for franchisees 239 threat that individual franchisees, or even group of franchisees cannot tackle by themselves.
The EU Consumer Policy strategy 2007 – 2013 states:
Confident, informed and empowered consumers are the motor of economic change as their choices drive innovation and efficiency. The response to these challenges lies in equipping the consumer with the skills and tools to fulfil their role in the modern economy; in making markets deliver for them and in ensuring effective protection from the risks and threats they cannot 585 tackle as individuals. 584F
This inability of franchisees to address the risks or threats of franchisor failure as individuals is the core of their problem.
Firms incur obligations daily to suppliers, to employees and to different classes of investors. So long as the firm is prospering the adjudication of claims is seldom a problem. When the firm has difficulty meeting some of its obligations, however, the issue of the priority of those claims can pose serious problems. This is most obvious in the extreme case where the firm is forced into bankruptcy. If bankruptcy [administration or insolvency] were costless the reorganization would be accompanied by an adjustment of the claims of various parties and the business could, if that proved to be in the 586 interests of the claimants, simply go on.58F
587 Where the firm is a franchisor, not only will the ‘total value of the firm fall’586F but the franchisees to an arguably greater degree than the franchisor ‘bear [almost] 588 the entire wealth effect of the bankruptcy cost’.587F
What type of protection is possible within the consumer regime? Ex ante, the protection should be in place before the franchisees sign the agreement. This allows them to factor the possibility of the franchisor failing into their financial models and make a more accurate evaluation of how much risk they are taking. Thus, ex ante protection should exist in the form of both an improved disclosure document, and implied terms in the franchise agreement. An important
585 Commission of the European Communities, EU Consumer Policy strategy 2007 - 2013, above n 578, 2. 586 Jensen and Meckling, above n 21, 340. 587 Ibid 341. 588 Ibid.
Chapter 5: The deal for franchisees 239 240 further component of consumer protection is for the business consumer of a failed product, the franchise business, to have rights under the Corporations Act. This aspect of the solution does not form part of this thesis.
IMPROVED PRE-CONTRACT DISCLOSURE The improved disclosure should address recommendation 21 in the Matthews Committee Proposal:
The Risk Statement [to be provided to all franchisees associated with failure of this particular franchise and its structure before they are committed to the franchise] and the ACCC educational material should clearly describe the 589 risks and consequences associated with franchisor failure.58F
Improved disclosure does not mean longer disclosure. It is disclosure that is differently structured so it is more meaningful. This will be addressed more fully in chapter 6.2.4.
IMPLIED TERMS The second response should occur at franchise agreement level. All franchise agreements should contain implied terms including ratcheted provisions enabling franchisees to exit the network following the appointment of an administrator or liquidator. These are addressed in chapter 6.2.2.
What are the risks and threats? The greatest risk to fulfilment of the promise that franchising offers franchisees and the unmitigated threat to the viability of the franchisee’s business is that the franchisor will fail. As has been demonstrated in chapter 2, this is a real risk and a real threat. It is clear from 2.1.3 that franchisors may fail for a wide variety of reasons. Few if any franchisor failures can be attributed to franchisees. None could have been anticipated by a franchisee conducting better due diligence on the basis of the current disclosure document, being better educated on the basis of information currently available to intending franchisees, or receiving better legal or financial advice before signing the franchise agreement.
It is reasonable to expect that the major legal and commercial risks that a franchisee faces as a consequence of signing the contract could be addressed in the standard contract. The Australian Risk Standard, AS/NZ 4360/2004 (‘Risk
589 Matthews, above 113, 44.
240 Chapter 5: The deal for franchisees 241
Standard’) provides a methodology for identifying and managing risk in a business that could be used by both franchisors and franchisees to determine whether a given franchise agreement addresses the key risk items. An aspect of the methodology is to categorise events in tabular form as in Table 7 as ‘known knowns’, events which will occur, such as the franchise agreement will terminate at the end of the term; ‘known unknown’ events which are known to be possible but their effect is not fully knowable; and ‘unknowns’. The category each event is placed in determines its treatment in the franchise agreement.
Table 7: Risk analysis template
Event Solution
Known Day to day events Address in contract knowns
Known Franchisor might fail – genuine If impact would be severe on either party, unknowns failure. include, if not, leave to future negotiation. Franchisor might decide to become Weight with respect to impact on network and insolvent. on individual franchisee. Parent company might decide to Provide contract based strategy. close franchise division/ strategic insolvency.
Unknowns Far fetched events that are never Address through ‘motherhood’ clauses; ie: likely to impact on the network. general obligations such as to cooperate, act
reasonably, act in good faith.
In the context of the Risk Standard, franchisor insolvency is a risk that should be evaluated and planned for as a ‘known/ unknown’ i.e. – it is known that it could occur, but unknown if or when it will occur. If it does occur, it is serious enough to be addressed in the franchise agreement.
Why are franchisees unable to tackle these risks and threats as individuals? The Australian Government argues that ‘the parties to the contract are best 590 placed to determine commercial matters’.589F There are eight broad reasons why
590 Commonwealth Government Response to the Report of the Parliamentary Joint Committee on Corporations and Financial Services, above n 166, 21.
Chapter 5: The deal for franchisees 241 242 franchisees are unable to accurately measure and factor in the commercial risk of franchisor failure, even if they do identify it as a possibility. In summary:
The franchise network is a complex set of legal structures. The retail lease models in chapter 3.2.3, and diagrams and charts in Appendix D depict the legal environment in which the franchisor operates.
Pre contract disclosure:
o Fails to put franchisees on notice about the significant threat which is beyond their ability to research, and beyond their control – the franchisor’s survival. It provides only a small amount of information about the current financial standing of the franchise network. In 2009 it was announced that:
The Government will introduce amendments to clause 1.1(d) of Annexure 1 and clause 1.1(e) of Annexure 2 of the Franchising Code to state that franchising is a business and that like any business the franchise (or 591 franchisor) could fail during the franchise term.590F
This is a step towards better consumer protection but its impact is diluted by the emphasis on the franchise. Franchisees have always accepted that their own business might fail. It is franchisor failure that is the less manageable risk. o Fails to disclose specific information about the direction of money flows within the network and the risks and threats thus accepted by franchisees operating as commission agents. o Does not require franchisors to provide sufficient timely information about premises. This is particularly the case if the franchisee is a sub- lessee or a short term licensee that does not fit within the relevant statutory definition of tenant/lessee.
Franchisees are unable to conduct affordable and effective due diligence as previously discussed.
591 Ibid 22.
242 Chapter 5: The deal for franchisees 243
The franchise agreement is drafted by the franchisor. Because it is not negotiable the information provided in the disclosure and acquired through due diligence, is of limited value.
Asymmetries abound, as described in 3.4. They contribute to the franchisees’ inability to evaluate the risk of franchisor failure, or plan for it.
The Code offers no rights and no protection to franchisees in this situation.
The winding up process provides liquidators with rights that are the antithesis of franchisees’ needs. Franchisees have no right to negotiate with the receiver or administrator. When the liquidator is appointed, they have no franchisee-specific rights in the creditors’ pool. Strategic insolvency cannot be anticipated.
There is no lobby group or union that represents the interests of all franchisees whereas franchisors interests are strongly represented by the FCA.
5.1.2 THERE SHOULD BE ACCESSIBLE, TIMELY AND MEANINGFUL REDRESS WHERE CONSUMER DETRIMENT HAS OCCURRED (B2) Currently, where the franchisor enters administration or becomes insolvent, each of its franchisees enters a legal minefield. The legal options franchisees can consider are:
Terminate the franchise agreement for anticipatory breach, but this is accompanied by the risk that the liquidator might initiate proceedings.
Pursue quasi-contractual remedies.
Commence action under the Trade Practices Act if any of the directors or another solvent party is identified that falls within s 75B Trade Practices Act.
Any post-appointment action commenced by the franchisee requires the consent of the court and would almost certainly be opposed by the liquidator. If the franchisee successfully navigates the minefield it arrives at a regulatory vacuum in relation to its rights in the administration or the insolvency. This is not satisfactory.
Chapter 5: The deal for franchisees 243 244
Accessible redress Hadfield writes:
[c]ontract law makes its own promises to contracting parties: it promises to be available to accurately interpret the agreement the contracting parties have made, to impartially judge the performances rendered, and to reliably implement the appropriate remedies. … Courts must be accessible at relatively low cost in geographic and linguistic terms to contracting 592 parties.591F
Hadfield also states that:
[d]elay in the resolution of contract disputes is an important impediment to the effectiveness of contract law – not only does the value of payment decrease with time but so too does the probability of recovery diminish as the potential for assets to be dissipated increases and circumstances change 593 to make performance more difficult and/or less valuable.592F
As was demonstrated in chapter 4, justice extracted from a solvent franchisor through the courts was very expensive and very slow for the Hoys whose alternative to litigation was to have their franchise terminated by their franchisor. The 594 franchisees ultimately won their case, and won again on appeal.593F
Hadfield’s thoughts are also valid when the redress is to come from the diminishing assets of an insolvent estate. Accessing redress through an administrator or liquidator is far more problematic, at any cost. Specific issues were identified in chapters 3.3, 4.3 and 4.4.
Timely redress The possibility of timely redress is particularly significant where the parties to the dispute are in an ongoing contractual relationship. This is recognised in franchising and addressed through the opportunity to request mediation through the Code if the franchisor is solvent.
Timeliness is especially important for the franchisee whose right to profit from the relationship ends on the termination date of the franchise agreement. Examples of
592 Hadfield, ‘The Many Legal Institutions that Support Contractual Commitment’, above n 22, 181. 593 Ibid 182. 594 Hoy Mobile Pty Ltd v Allphones Retail Pty Ltd (No 2) [2008] FCA 810.
244 Chapter 5: The deal for franchisees 245 lack of timeliness are common where one party has an interest in not settling a dispute. The franchisor may be reluctant to settle for fear of setting a precedent. For example, in Hoy, following the franchisor’s refusal to mediate the franchisee had to litigate or accept defeat. The franchisee said:
I was told the proceeding were likely to cost me around [A]$300,000 … and that my matter stood a good chance of succeeding … but more importantly there was no other way of restraining the franchisor from acting upon the termination notice without an injunction. Our business was worth … about the same amount. At the time we thought it was commercially sensible to begin proceedings to prevent the termination and to protect our asset. By … the end of 2006 the costs had reached $140,000. The court ordered mediation which we attended to no avail in November 2006. The franchisor had made it clear from the beginning that they were going to fight us all the way … We had to subpoena [telecommunications] carriers to obtain the evidence we required and even this process was not easy and cheap. We had to provide an undertaking to the court that we would not disclose the information we read before we were allowed to view the documents. Once I viewed the documents I was certain our issue had merit and was an issue that affected every [Allphones] franchisee and I was not allowed to tell my fellow franchisees or the ACCC. The carriers each charged between [A] $1000 to 595 over [A] $3000 for producing the documents.594F
In the failed Danoz Directions franchise network one franchisee signed a franchise agreement for a five year term with a five year renewal in February 2004, the franchisor failed in October 2004. The franchisee instituted proceedings against the franchisor’s solvent directors alleging breaches of parts IAV and V of the Trade Practices Act. In September 2009 two days of hearing time were allocated and in April 2010 a further two weeks of hearing time are allocated for the litigation
595 Evidence to Parliament of Australia Joint Committee on Corporations and Financial Services, Senate of Australia, Inquiry into Franchising Code of Conduct, undated, 4 (Nicole Hoy)
Chapter 5: The deal for franchisees 245 246 initiated by the franchisee under the Trade Practices Act to be heard in the Federal 596 Court of Australia. 59F This is not timely.
Timely redress is also important where the franchisees whose businesses are required by the administrator to continue operating must keep paying staff, meeting commitments under premises agreements (even those that involve paying money to the failed franchisor) and meeting franchise agreement commitments while the administrator and then the liquidator decide on the future of the franchisor.
‘Accessible and timely’ are not sufficient measures of redress where one party is insolvent. Meaningful redress is also vitally important.
Meaningful redress Meaningful redress leaves the franchisee able to move ahead with their life unencumbered by debts and bad relationships accumulated through the conduct of the franchisor. Franchisor-transmitted debt and franchisor-transmitted poor supplier relationships should not be a consequence of being a franchisee.
Meaningful redress is also cost-effective. The trials in the Danoz and the Hoy matter above are expensive. Few franchisees can afford to litigate. In addition to money, the human resources in the court room on each hearing day, in Danoz, are one Special Counsel, one junior barrister, one solicitor for each party plus the judge, the Judge’s Associate and a court officer plus the parties and expert witnesses. All of these people have other ways they can spend their time.
Legal options should extend beyond the theoretical and should be meaningful, accessible and timely. This is especially where consumer loss is significant and is brought about by failure of the monopoly supplier. The current situation fails against these measures.
5.1.3 COST BENEFIT CONSIDERATIONS (B3) These problems [i.e. those sought to be addressed by enacting s 51AC Trade Practices Act and the Code in 1998] have considerable economic and social costs in that they contribute significantly to business failure. The social costs identified included stress, marriage breakdown, poor health and suicide. The economic costs of the business conduct issues … include an inability by
596 Hearing 2 (P) NSD1313/2008 Benjamin Morris & Anor v Danoz Directions Pty Ltd (ACN 092 832 534) (in Liquidation) & Ors.
246 Chapter 5: The deal for franchisees 247
small firms to gain a return on sunk costs and market inefficiencies arising out of exploitative conduct. The overall costs of small business failure in 597 terms of its implications for employment and growth are also relevant.596F
The OBPR identifies as its fourth criteria the need for:
An assessment of the impact, including costs and benefits, on consumers, business, government and community or each option, with each impacted 598 group identified, noting impacts on competition, small business and trade.597F
B3 is thus that the cost of the franchisor supplying and the franchisee assimilating the information should not outweigh the benefit to the franchisee business consumer in the newly framed regime.
‘The primary objective of cost-benefit analysis is to determine whether the overall wellbeing (termed ‘welfare’ by economists) of society is likely to increase or 599 decrease as a result of implementing a specific policy’.598F A comprehensive cost benefit analysis (‘CBA’) relies on adequate base data. There is no such data available in franchising. This partly stems from unwillingness by the government to require franchisors to place their franchise disclosure materials on a publicly searchable database as a pre-condition of allowing them to sell franchises. Even with a useful set of base data, conducting a cost benefit analysis is primarily the work of an economist.
Theory Banks writes that ‘an effective regulation making and administrative system should mediate the impact of the increasing demands that arise from an increasingly 600 risk averse society’.59F As we have observed in the way franchisors shift risk to franchisees, the franchisees are the unwitting mediators of a wide range of the franchisors’ risks.
Leo Dobes reminds us that ‘[w]hen economists refer to cost-benefit analysis, they mean social cost-benefit analysis: reflecting the fact that the analysis is not
597 The Parliament of the Commonwealth of Australia House of Representatives, Explanatory Memorandum, Trade Practices Amendment (Fair Trading) Bill 1997 (Circulated by the authority of the Minister for Customs and Consumer Affairs, Senator the Honourable Christopher Ellison). 598 Australian Government, Best Practice Regulation Handbook (2007) 27.
Chapter 5: The deal for franchisees 247 248 limited to the standpoint of a government budget, a firm’s profits, or an individual’s 601 interests’.60F
Stakeholders The impact on all stakeholders must be included in a cost benefit analysis. In the context of this thesis, they are identified in 6.3.
The cost of franchisor failure
602 Benefits of intervention cannot be considered in isolation from its costs… 601F
The economic cost of franchise failure is not counted in studies such as the ‘Economic Impact of Franchised Business’ conducted for the International Franchise 603 Association Educational Foundation,602F and is generally below the regulators’ 604 radar.603F As well as the cost of franchisor failure being hidden:
[t]he real costs of regulation are ‘hidden’ from view as they are the ‘off- budget’ costs of business and society compliance with regulation. The cumulative cost of regulation is not often considered as most departments and agencies have responsibility only for specific regulation, 605 and little concern for its cumulative nature. 604F
This is the case in franchisor insolvency where, as was outlined in chapter 4, different governments and within the governments, different departments have responsibility for the Trade Practices Act, the Corporations Act and the states’ and territories’ retail tenancies legislation.
Limitations of cost benefit analysis Richard Zerbe states:
CBA attempts to solve collective action problems, which arise when individuals or groups pursuing narrow self-interest without coordination
601 Dobes, above n 599, 69. 602 Australian Government Productivity Commission, vol 2, above n 4, [2], [42]. 603 PriceWaterhouse Coopers, Franchise Business Growth Outpaces Other Buiness Sectors (2004) International Franchise Association
248 Chapter 5: The deal for franchisees 249
arrive at outcomes that are collectively inferior to those that could be 606 achieved with coordination.605F
‘There are two issues raised here. One is the value of the use of benefit-cost analysis (CBA) and the other is to what extent to which its use can be protected from 607 destructive effects of the political process’.60F Zerbe’s paper addresses the value of CBA but equally important in franchising policy, where some sectors have a strong vested interest in the status quo, is the second question. The world of business format franchising includes numerous individuals and groups with different agendas, a sizeable amount of self-interest stemming from ego, a wish to retain power, an unwillingness to see the big picture and factors as mundane as the constraints of the 6-minute time sheet. To objectivise the problem of franchisor failure as it impacts on franchisees, to repackage it in a CBA is a useful step towards a solution in that the focus can thereby shift from the individual problem to a collective solution.
Steps in cost benefit analysis A CBA may include the following steps, following identification of the stakeholders:
Forecast impact on franchise purchases Estimate cost to franchisors Estimate benefits to franchisees Estimate impact on government Estimate other [consequential] effects Aggregate costs and benefits into an estimated total net benefit effect Assess policy risks and uncertainties 608 Consider incidence of the policy on different social groups.607F
606 Richard O Zerbe, Jr, ‘An Ethical Benefit-Cost Analysis’ (Paper presented at The Searle Centre Cost-benefit Analysis of Regulations: Lessons Learned, Future Challenges Conference at Northwestern University School of Law, September 2007) citing at fn 31 Theodore M Porter, Trust in Numbers: The Pursuit of Objectivity in Science and Public Life (1995) 187. 607 Ibid, 4. 608 Adapted from
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5.2 CONCLUSION
The currently favoured consumer protection benchmarks of fairness and good faith, and accessible and timely are insufficient when evaluating the sufficiency of consumer protection response for franchisees of failed franchisors.
The benchmarks proposed; B1, B2 and B3 do get to the heart of the problem. Until the problem is understood any solutions will be patchy and unsatisfactory. They will not protect franchisee consumers at their most vulnerable time.
All current possible contract and quasi contract based actions fail to address the problem and fail to measure up to benchmarks B1 and B2. The statutory avenues currently available to franchisees are equally unusable in practice.
In chapter 6 a number of possible non-regulatory and then regulatory responses are proposed. The regulatory responses are evaluated against B1 and B2
250 Chapter 5: The deal for franchisees
Chapter 6: Consumer protection to address the benchmarks
If franchisor failure is a hidden risk, what is the best way of protecting the franchisee’s business from the effects of franchisor failure? How can the situation be addressed more satisfactorily, predictably, efficiently and economically? In 6.1 non- regulatory solutions are canvassed. In 6.2.1 and 6.2.3 consumer protection strategies that do not involve amending insolvency laws are identified.
6.1 POTENTIAL NON-REGULATORY SOLUTIONS
6.1.1 STATUS QUO In the ‘do nothing’ solution requires all franchisors to continue preparing, updating and delivering extensive Code compliant disclosure that fails to place the franchise offering in an accurate context from the perspective of franchisees being able to evaluate commercial or legal risk. Franchisees will continue to pay for legal and financial advice on the inadequate information and to be unable to objectively verify much of that information. Most franchisees will not negotiate ipso facto clauses into their agreements and will not be able to protect their own assets as well as franchisors can. Franchisees will continue to be unnecessarily vulnerable to the franchisor’s failure.
6.1.2 EDUCATION It has been acknowledged that more education is needed for prospective and incumbent franchisees, and also for franchisors. Australian Government sponsored reports on franchising have identified education as an essential part of the solution to 609 short comings of the franchise model.608F The Reid Report identified ‘the inadequacy 610 of advice and education for small businesses’609F as a matter for concern. The
609 Task Force above n Recommendation 41; Committee on Industry, Science and Technology (the Reid Committee) Finding a balance; Towards fair trading in Australia (1997) Recommendation 7.3 and 7.4; Matthews, above n 113, Recommendation 21 ; Economic and Finance Committee, Parliament of South Australia, Franchises (2008) 38 and 87; Chris Bothams, Inquiry into the Operation of Franchise Businesses in Western Australia (2008) 14. 610 Committee on Industry, Science and Technology (Reid Committee), above n 609, 1.
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611 Matthews Review’s Report610F contained 15 references to education. The South Australian Parliament Report in 2008 contained 42 references to education. It did not 612 directly identify education as a solution to franchisor failure.61F
The West Australian report, also in 2008, referred to education 38 times, including the following observation about franchisee failure:
The risk of business failure [impliedly a franchisee’s business, not a franchisor’s] will always exist. This risk can be reduced by undertaking thorough business feasibility assessment and planning prior to entering into any commercial arrangement. …The importance of pre-entry education for franchisees has emerged as a key issue. … It has been reported anecdotally that in many cases, prospective franchisees do not educate themselves prior 613 to entering into a franchise arrangement.612F
It was demonstrated in chapter 3 that the operating in the perfect world of thorough business feasibility assessment and prior planning is impossible in some cases and ultimately of no benefit if a franchisor fails.
Pre-contractual education was placed in context in Opportunity not opportunism where it was noted that ‘[a]lthough education, advice, disclosure and due diligence generate important information about the potential for success, the true 614 nature of franchising cannot be appreciated until the relationship is under way’.613F
The commonwealth Government responded by writing:
the Government has explored avenues to better balance the rights and liabilities of franchisees and franchisors in the event of franchisor failure (Recommendation 4). The Government supports the development, by the ACCC, of additional educational information on the potential consequences and liabilities franchisees could be exposed to in the event of franchisor 615 failure.614F
The importance of education cannot be discounted. Education will make
611 Matthews, above n 113. 612 Economic and Finance Committee, South Australian Parliament, Franchises (2008). 613 Government of Western Australia, Inquiry into the Operation of Franchise Businesses in Western Australia, Report to the Western Australian Minister for Small Business (2008) 14. 614 Commonwealth Government Response to the Report of the Parliamentary Joint Committee on Corporations and Financial Services, above n 166, 7. 615 Ibid 21.
252 Chapter 6: Consumer protection to address the benchmarks 253 franchisees and their advisers more aware of the possibility of franchisors failing. Education cannot protect franchisees if their franchisor does fail.
It should also be noted that it is difficult for the ACCC to provide meaningful educational material that would alert a franchisee within a network that their situation is worse than that of others in the network because the franchisor has chosen to shift more risk onto them specifically. For example if the franchisor usually uses leasing model 4 or 5 but on this occasion has selected model 10 because there is a demolition clause in the lease. Only the franchisor will know this is an aberration from its usual practice.
6.1.3 FRANCHISEE UNION Franchisees face significant impediments to self-representation as lobbyists or as litigants. Franchisees do not join trade unions in Australia. As individuals they do not have resources to involve themselves personally in politics at a national level in addition to running their own business and in some cases participating in their own franchise network’s advisory council. They risk alienating their franchisor if they express views that the franchisor or the FCA find threatening or inconvenient. Franchisees may fear that if, hypothetically, they were seen to be devoting time to union affairs, their franchisor would build a case to terminate for breach of a term of the franchise agreement that requires the franchisee to devote all time and energy to its business.
The problem of whether a franchisee union could be established and how it would be funded has been overcome in Japan. There, individual owners of franchised convenience stores were permitted to become members of an existing union in 616 2009.615F
In Europe, recognising the difficulties of finding time and money for consumers to self-represent effectively:
[t]he EU has subsidised consumer group representation through the European Consumers’ Organisation (BEUC) and the European Consumer Law Group (ECLG) as well as specialised groups such as European
616 Anderson Mori and Tomotsune, Formation of Labour Union by Convenience Store Franchisees (2009)
Chapter 6: Consumer protection to address the benchmarks 253 254
Association for the coordination of Consumer Representation in 617 Standardisation (ANEC).61F
While franchisors and franchisees do have matters of common interest where the FCA can provide adequate representation, the areas where their interests are in conflict should not rely on academics or individual franchisees with sufficient motivation and courage to make a submission to a government inquiry, to be aired. The argument for union membership has appeal. It is easy to dismiss one franchisee’s voice as non-representative, but would be difficult to dismiss a union representing the 71,000 franchisees in Australia.
6.1.4 INSURANCE It should be possible for franchisees to insure against the consequences of their 618 franchisor failing.617F In a submission to the 2009-10 Senate Economics Committee Inquiry into Liquidators and Administrators, Greg Crook, a director of a supplier adversely affected by the insolvency of a mining company wrote:
[s]uppliers to industry have few options … Take out their own insurance [debtor insurance] at rates that are up there with the insolvency practitioners themselves. …The cost of this insurance is … becoming even more out of reach as the risk to the insurers book escalates as insolvencies are becoming more and more common. There is no way that suppliers can be secured … 619 they have no choice but to be unsecured creditors.618F
Crook proposes that:
ASIC’s charter should be to ensure protection for all stakeholders and this could be achieved by writing into AS 4000 that there should be reciprocal insurance rights for all stakeholders. If premiums were gathered by the insurance industry on every contract then the overall premium would be 620 drastically reduced.619F
The insurance solution is appealing but in the franchising sector the absence of reliable comprehensive data about franchisor failure would make it difficult for
617 Ramsay, above n 329, 18. 618 The author is not aware of any such insurance but theoretically the risk and potential loss are measurable so the possibility of insurance should not be ruled out. 619 Submission to Economics Committee, Australian Commonwealth Senate, Inquiry into Liquidators and Administrators, 3 December 2009, Submission Number 1 (Greg Crook). 620 Ibid.
254 Chapter 6: Consumer protection to address the benchmarks 255 actuaries to assess the likelihood of failure or the magnitude of loss, and therefore to set premiums accurately. Further, the absence of a mandatory requirement that franchisors register would make it extremely difficult to achieve widespread compliance with any requirement to pay into an insurance fund.
6.1.5 RECONFIGURE SOME OBLIGATIONS Requiring franchisors to provide their own security deposits for retail premises could help mitigate the effects of their failure on their franchisees. This would mean that if the franchisor failed, a franchisee in a model 3, 4, 6, 7 or 10 leasing situation would not be called on to meet the franchisor’s liability for unpaid rent or outgoings. This is a partial solution, limited to franchisees conducting their franchise under the specific models.
Requiring franchisors that operate through the commission agency model to supply personal guarantees from the franchisor’s directors to franchisees is also possible, though ad hoc and seldom agreed to by franchisors. Personal guarantees would remain actionable if the principal debtor, the franchisor, became insolvent.
6.1.6 DEEM FRANCHISORS TO BE TRUSTEES An option would be for some of the funds received by franchisors to be deemed to be held on trust for the franchisee. For example, currently, the sums like the $60,000 option fees in Table 3 charged for future sites are currently treated as general revenue and are not traceable in the franchisor’s insolvency. Ideally, these sums should be held by franchisors on trust for the franchisees until the paid-for options are exercised. The moneys franchisees pay to a central advertising fund would also be easy to hold in a separate account with the franchisees as beneficial owners until the moneys are spent for legitimate advertising purposes.
Which moneys franchisors should be holding on trust would be a topic for future research.
6.1.7 LEGISLATE SOLUTIONS [T]here are three fundamental questions surrounding the debate about consumer protection: Why do consumers need protection? When ought the state intervene to protect them?
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621 How ought the government to intervene? 620F
Andromachi Georgosouli adds that:
consumer protection policies have as an overarching objective to improve economic efficiency by remedying market failures and preserving the 622 fairness of the process and outcomes of the transactions.621F
Consumer protection does not exist in a regulatory vacuum. Thus, a fourth fundamental question should be added:
What is the context in which consumer protection functions?
623 This leads to the question; why do consumer protection inquiries,62F economic 624 models created by franchise academics623F and regulatory responses assume that the supplier, in this case the franchisor, will be solvent at the time the product or service, the franchise business support, is supplied?
‘[C]onsumer protection has an ancient genesis, dating back at least to Roman times with the adoption in Roman law of various implied warranties against latent 625 defects in the sale of goods’.624F Trebilcock identifies two sources of pressure on traditional consumer protection regulation, being:
the rapidity of technological change, globalisation and deregulation of formerly regulated monopolies have dramatically expanded the range of consumer products and services available in any given jurisdiction, making product and service-specific regulation increasingly problematic and 626 intensifying the informational challenges faced by consumers.625F and:
a veritable revolution in industrial organisation theory … particularly as it relates to market structure, bargaining power and information, has rendered simplistic structure-conduct-performance paradigms that keyed on a small
621 Iain D C Ramsey, ‘Rationales for Intervention in the Consumer Marketplace’ (1984) Occasional Paper for the Office of Fair Trading 1, in fn 24 of Georgosouli, above n 338. 622 Georgosouli, above n 338, 7. 623 For example Australia’s Productivity Commission Review of Australia’s Consumer Policy Framework, vol 2, above n 4. 624 For example Francine Lafontaine; K Shaw; and Gillian K Hadfield. 625 Trebilcock, above n 29, 68. 626 Ibid.
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number of variables and that underpin many aspects of contemporary 627 consumer protection policy also increasingly problematic.62F
Trebilcock’s conclusion that the true focus of consumer protection is in the quality and cost of information falls short. He concludes, by implication, that with sufficient of the right information provided at the right time and the right price, the consumer can be adequately protected. This may be true where goods and services are not designed to last for decades, or where ongoing servicing is provided by replacement suppliers. It does not apply when the business of the franchisor supplier fails.
Further, Trebilcock et al’s analysis starts with the assumption that the consumer market is competitive and, by implication, that it remains competitive even once a product has been acquired by a consumer. They suggest that ‘where a market is very imperfectly competitive or non-competitive, problems of consumer protection 628 may have to be addressed through competition policy or economic regulation’627F rather than through consumer protection.
The sale of franchises is a hybrid. Before the franchise agreement is executed the market is competitive. Once the agreement has been executed the franchisee is committed to dealing with a monopoly. This is demonstrated through the network of contractual relationships that is shown in relation to retail premises and trade marks in chapter 3.2. Franchisees have purchased a bundle of products, services and use rights from the franchisor.
If the franchisor’s business fails, there is no alternative franchisor to step into the insolvent franchisor’s shoes. A competitor may potentially take over the company owned and franchisee owned sites but may not wish to enter contracts with the existing franchisees. A purchaser purchasing even an expensive item such as a car is not obliged to return to the manufacturer for driving lessons, servicing, all routine future suppliers of parts, petrol and oil, and ultimately to sell the vehicle only through the manufacturer. The purchaser of the vehicle may get it serviced anywhere, buy petrol anywhere and can sell it on the open market long after the manufacturer has ceased to exist. The insolvency of the manufacturer is not going to
627 Ibid. 628 Ibid 69.
Chapter 6: Consumer protection to address the benchmarks 257 258 prevent the consumer from gaining full use and enjoyment out of the car. Franchisees are different because the bundle of products, services and use rights only stays intact while the franchisor is solvent. The insolvency of the franchisor almost without exception deprives the franchisee of what it has purchased.
In answer to Ramsey, Georgosouli and Trebilcock, here is a situation when the state ought to intervene to protect consumers. The forces of the competitive marketplace have failed franchisees. Consumer protection policy is an appropriate vehicle to correct this market failure. In conclusion, the problems will not go away, and they will not be resolved without parliamentary intervention. A range of regulatory interventions is now proposed.
6.2 REGULATORY SOLUTIONS
An essential step when amending legislation is being considered in Australia is 629 to conduct a Best Practice Regulation Preliminary Assessment using the procedure628F provided by the Australian Government Department of Finance and Deregulation. In line with this process, the problems were identified in chapters 2, 3 and 4. Solutions are proposed in 6.2.
These solutions are designed to:
provide franchisees and their advisers with more meaningful pre-contract disclosure
level the playing field for franchisees before they sign a franchise agreement, during the franchisor’s administration and after the franchisor’s business is wound up
keep the franchise network intact long enough to determine whether it may be sold as a viable network rather than being dismantled.
A cost benefit analysis that would be needed to satisfy B3 will demonstrate the solutions will reduce disclosure and documentation costs for franchisors
In Australia, pre-contractual disclosure under the Code is fundamentally modelled on the North American disclosure requirements. This focus has not served
629 Australian Government, Department of Finance and Deregulation, Regulatory Impact Analysis Guidance Material
258 Chapter 6: Consumer protection to address the benchmarks 259 franchisees as well as a more global or Europe centric focus would have done. As Iain Ramsey observes:
[t]here is now a significant difference between the substantive rules and institutional approach to standard form consumer contracts in Europe and North America. Standard form consumer contracts that are used in North America would not be permitted in Europe and the proactive approach adopted by the Office of Fair Trading is currently unknown in North 630 America.629F
Australia tends to have taken its lead from North America. Franchise agreements are standard form consumer contracts, as was demonstrated in chapter 3.3.4. The supply of a franchise business to the franchisee business consumer is similar, theoretically, to any other product that is supplied with a standard form contract, and with a projected life span of the number of years denoted in the franchise agreement. Stephen Corones and Philip Clarke state that:
Part V divs 2 and 2A [Trade Practices Act]… focuses on transactions rather than on the structure of markets. Its aim is to regulate market failure arising from information asymmetry … The consumer protection provisions are designed to ensure that there is sufficient information available to potential 631 consumers so that consumers will get “value for money.”630F
A fundamental assumption is that the franchise system will work, to the standard described, through to the end of the term.
Part V addresses information asymmetry in relation to transactions in three different ways … in relation to supply of goods and services, liability for false representations is imposed on the supplier who is in the best position to 632 know the characteristics of those goods and services.631F
The supply of a franchise business to the franchisee business consumer is similar, theoretically, to any other product that is supplied with a standard form contract, and with a projected fixed life span denoted in the sale agreement.
630 Ramsay, above n 329, 34. 631 Stephen Corones and Philip H Clarke, Consumer Protection and Product Liability Law (2nd ed, 2002) 5. 632 Ibid.
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Franchisors need franchisees to make significant investments of both time and [equity and borrowed] money in their businesses. But, of course, such investments are only worth making if the franchisee can expect to earn some reasonable return on these investments over a sufficiently long period of time. If it takes five years, for example, to fully recoup ones investment in a franchise, then no franchisee should invest unless the relationship is 633 expected to last for at least five years.632F
When a consumer purchases a product or service in Australia, and the product or service does not meet standards, the person has rights to claim against the supplier or manufacturer. These options are currently not available to franchisees that purchase into a franchise network that turns out to be faulty and to fail.
6.2.1 MAKE FRANCHISE AGREEMENTS ACCESSIBLE Every franchisor should be required to post all versions of their standard pro forma franchise agreements on a publicly accessible, free, website. This would mean that franchisees and their advisors could:
Compare the document they have been asked to sign with the franchisor’s pro forma agreement. This would enable them to identify differences that may then require explanation. It would also enable them to identify how the agreement has changed over time. This will be particularly helpful to a franchisee purchasing in a re-sale. They will be able to identify whether the agreement differs from the one the current franchisee operates under in any material way. It will also assist advisers who are not familiar with the nuances of franchising as opposed to transactions concerning non- franchised businesses.
Compare the document with others operating in the same sector of the market.
Making the database publicly available would be a step further than the recommendation of the Matthews Review that recommended ‘[t]he Government implement a mandatory process of franchisor registration and annual lodgement of 634 the most current disclosure document and other prescribed information’.63F
633 Blair and Lafontaine, above n 46, 264. 634 Matthews, above n 113, Recommendation 23, 13.
260 Chapter 6: Consumer protection to address the benchmarks 261
6.2.2 AMEND S 51AC TRADE PRACTICES ACT Three options for reforming s 51AC were examined by Bryan Horrigan, David Lierberman and Ray Steinwall in ‘Strengthening Statutory Unconscionable Conduct 635 and the Franchising Code of Conduct’.634F These were, to provide a list of examples, or a statement of principles, and to pursue non-legislative options.
The list of examples proposal was rejected. It was considered ‘legislatively and 636 administratively burdensome’635F and potentially ‘requiring numerous 637 amendments’.63F It was also considered to be something which the regulators can achieve outside the rigid framework of legislation by developing effective guidance 638 material.637F
The statement of principles received more favourable consideration than the list of examples. It was accepted that principles which ‘lower the standard to one of fairness and justness would dilute the concept … in addition to overtaking the 639 proposed unfair terms provisions of the Australian Consumer Law’.638F
One option may be to redraft the events listed in Trade Practices Act s 51AC (a) – (k) and to add a statement of principles as a new section. Thus, s 51AC and the new section would operate together as do ss 51A and 52. Section 52 sets out a broad statement of principle in relation to misleading and deceptive conduct, s 51A shifts the burden of proving the conduct was not misleading under s 52 to the party that made the representation if the representation was with respect to any future matter. If one party to a franchise agreement, say, the franchisee, establishes that any of events occur, the other party, say the franchisor, has to satisfy court the events are not unconscionable. This places the burden of proof on the party that has set up the unconscionable situation, being the party that has the evidence to rebut if the conduct is not unconscionable.
635 Bryan Horrigan, David Lieberman and Ray Steinwall, ‘Strengthening Statutory Unconscionable Conduct and the Franchising Code of Conduct’, Australian Government, The Treasury, Department of Innovation, Industry, Science and Research (2010) 18. 636 Ibid 26. 637 Ibid. 638 Ibid 28. 639 The Nature and Application of Unconscionable Conduct Regulation, Issues Paper 2009 (Submission Professors Christensen and Duncan) 6 cited in Horrigan, Lieberman and Steinwall, above n 642, fn 118, 31.
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6.2.3 IMPLY TERMS INTO ALL FRANCHISE AGREEMENTS VIA FRANCHISE CONTRACTS ACT The Australian Government concluded, after receiving Opportunity not opportunism that:
If potential franchisees can identify and access the information needed informed business decision, they should have a better basis with which to negotiate a contract that meets their requirements. Parties engaged in trade 640 and commerce should have a high degree of freedom to contract. 639F
Two aspects of this statement are fundamentally flawed. Firstly, the paragraph starts with the powerful little word ‘if’. It was demonstrated in this dissertation that franchisees cannot identify the information needed to make an informed business decision. When they can identify it access becomes an insurmountable hurdle in some situations. Structure of the franchise network, deficient disclosure requirements, deficient publicly accessible information and prohibitive costs lead to the response – if they could, they would, but very often they cannot!
Secondly, the notion of franchisees being able ‘to negotiate a contract’ is flawed. For the reasons discussed in chapter 3, the contents of most franchise agreements are not negotiable. At best the franchisee can understand it as a legal document. Even this understanding will leave them without context. It is like getting married without meeting, far less getting to know, ones intended spouse’s family first.
A solution is to protect franchisees from the worst results of franchisor failure through new legislation. The idea of specific franchising legislation is not new. It was proposed in 1997 in the Reid report whose recommendations were adopted by making adhesion to the Code compulsory.
Under the more far reaching franchise law now proposed, terms would be implied into all franchise agreements by incorporating the Code and implied terms into legislation modelled on the Insurance Contracts Act 1984 (Cth) whose purpose is:
640 Commonwealth Government Response to the Report of the Parliamentary Joint Committee on Corporations and Financial Services, above n 166, 21.
262 Chapter 6: Consumer protection to address the benchmarks 263
to reform and modernise the law relating to certain contracts of insurance so that a fair balance is struck between the interests of insurers, insureds and other members of the public and so that the provisions included in such contracts, and the practices of insurers in relation to such contracts, operate 641 fairly, and for related purposes.640F
The Insurance Contracts Act did not protect insureds from the sometimes devastating results of the failure of HIH insurance group so it is not a perfect template. It does provide an example of a statute having been enacted to regulate an area that is traditionally mainly regulated by common law – the law of contract. It 642 also accepts the notion of fairness, which echoes the sentiment express in 1997641F before the Code was made mandatory.
The purpose of a Franchise Contracts Act would be to reform the law relating to business format franchise agreements so that a fair balance is struck between the interests of franchisors, franchisees and other stakeholders so that the provisions included in such contracts, and the practices of franchisors in relation to such contracts, operate fairly, and for related purposes.
To achieve the objectives a wide range of implied terms are proposed below. An overwhelming benefit of legislation over all obligations being contained in individual franchise agreements as is the case now is that franchise agreements would be shorter. This would help reduce the time and expense devoted to generating agreements. This would save both franchisors and franchisees money.
In proposing that terms be implied into all franchise agreements it must be acknowledged that franchise agreements can be disclaimed as onerous contracts by liquidators. They would, however, apply to the franchisor and the administrator.
Product or service warranty When a consumer purchases a product or service in Australia, and the product 643 or service does not meet standards, the person has statute based642F rights to claim
641 Australian Government, Attorney General’s Department, Insurance Contracts Act 1984 (Cth)
Chapter 6: Consumer protection to address the benchmarks 263 264 against the supplier or manufacturer. These avenues are currently not available to franchisees that purchase a franchise that turns out to be faulty and to fail – not fit for its purpose. The Trade Practices Act does not provide redress if a manufacturer becomes insolvent, but the Corporations Act classifies consumers of defective products as unsecured creditors. The franchisor failing before the end of the franchise term is arguably analogous to a product or service failing.
The Trade Practices Act implies terms into consumer agreements but 644 franchisees do not fit the definition of ‘consumer’ in the Trade Practices Act s 4B.643F Nor will franchisees fit within the new Australian Consumer Law (‘ACL’). They do not fit the ACL’s definition of ‘consumer’.
Under the Trade Practices Act protection is provided for ‘consumers’ from manufacturing defects, acknowledging that one defectively manufactured product can cause damage to hundreds of consumers.
Terms are implied into contracts for the supply of goods and services by statutes. Currently this occurs through the Trade Practices Act, Part V div 2. In relation to sale of goods where state or territory legislation applies, terms are implied into contracts for sale of goods and for supply of services necessarily ancillary to the supply of the goods through state legislation.
A potential response would be for the wording in the Trade Practices Act to be incorporated into a Franchise Contracts Act so a franchisee could claim the failed franchisor had breached new equivalents of the terms currently implied by the Trade Practices Act:
An equivalent to s 69 would imply undertakings as to title, encumbrances and quiet possession. It would become relevant where the franchisor has not secured premises leasing rights but requires the franchisee to commence trading, such as in Shakespeares case.
An equivalent to s 70 that concerns supply of goods by description would apply, for example, to protect the franchisee purchasing a greenfields
Australia
264 Chapter 6: Consumer protection to address the benchmarks 265
business based on its description and the franchisor’s evaluation of its potential.
Importantly for franchisees whose franchisor fails, an equivalent to s 71 would imply undertakings as to quality and fitness. The specific franchise business being sold, and the franchisor supporting it, would have to measure up to the undertakings as to quality and fitness for purpose for the duration of the licence being granted.
The franchisee relies on the existing businesses it sees, and on the appearance the franchisor maintains that it will remain solvent and will continue to deliver the aspects of the business it holds itself out to be providing. Thus a clause similar to s 72 of the Trade Practices Act that concerns supply of goods by sample should be implied;
A term similar to s74 which addresses supply of services should be implied. This would, as the current legislation does for consumer purchases, extend to both those services that have not been supplied with the requisite due care and skill (Trade Practices Act s 74(1)) and services that are not fit for their purpose (Trade Practices Act s 74(2)).
Franchisees are clear about their purpose – they are buying a business that is currently viable or that will become viable once they have established it. Franchisors should not, therefore, have difficulty implying a term like s 74B Trade Practices Act which addresses goods not fit for a purpose made clear at the time of purchase;
A term that achieves the same result as the current s 74C Trade Practices Act would provide consumer protection in respect of false descriptions and could be applied to franchises that are sold as licences and thereby avoid complying with the Code.
74D Trade Practices Act addresses goods of unmerchantable quality which turns out to be the case with franchise businesses sold by franchisors that were already insolvent when the franchisee paid its franchise fee; or finally
74E Trade Practices Act (non- correspondence with sample).
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The remedies currently provided in the Trade Practices Act are inappropriate as they depend on the breaching entity being able to make good the breach in one of a range of ways; the franchisor is insolvent and cannot do this.
The Trade Practices Act Part VA concerns damages for defective goods. Under current law, franchisees would be ineligible to claim under Trade Practices Act pt V div 2 or 2A as, again, they are not a ‘consumer’ under Trade Practices Act s 4B or they are not purchasing ‘goods’.
Franchisees are, however arguably purchasing ‘services’ for the purposes of the Trade Practices Act s 4(1). For pts V 2 and 2A to apply to franchisees of failed franchisors a definition of ‘business consumers’ would need to be added to the Trade Practices Act and several consequential amendments would be required including expressly extending pt V div 2 and 2A to include business consumers.
Implied terms re franchisor duties The franchisor currently has a duty under item 18(2) of the Code disclosure to tell franchisees about a breach of the Corporations Act within 14 days of becoming aware of it. There is no evidence as to whether they do so, or not. However, even if they do, the moment the franchisee has executed the franchise agreement and the 14 day cooling off period has expired, it is too late for the franchisee to protect itself from a franchisor’s breach of the Corporations Act. The franchisor’s breach of the Corporations Act is not a breach of the franchise agreement and does not give the franchisees the right to terminate the franchise agreement and all ancillary commitments.
645 Where the franchisor is a corporation the franchisor directors’ duties64F should be expanded so the directors owe to franchisees the same duties as directors currently have to a company. The rationale behind this is that franchisees provide a significant amount of the operational infrastructure that, absent franchisees, the franchisor would have to supply, and franchisees assume a significant amount of the franchisors business risk. The issue of franchisors duties to franchisees could usefully be pursued in the future.
645 Directors have statuory duties under Corporations Act 2001 (Cth) ss 180 (care and diligence), 181 (good faith), 182 (use of position), 183 (use of information), 184 (good faith, use of position and use of information – criminal offences), 190 (responsibility for actions of a delegate), 191 (disclosure of material personal interests) and 588G (insolvent trading).
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Imply term requiring franchisor to obey all relevant law The franchisor should have an implied contractual obligation consistent with the franchisees’ current obligation to carry on business activities in compliance with all laws, regulations and Codes of conduct. A statutory obligation should exist to require the franchisor to meet all contractual and statutory obligations between;
itself and the franchisee
itself and third parties (for example franchisor obligations in the head lease, and other supplier agreements on which the franchisee and its commercial reputation rely)
itself and ASIC, the ATO and other levels and arms of government relevant to the franchise network where a breach would cause harm to the franchisee. A breach of this implied term, depending on its seriousness, could give rise to a right for the franchisee to terminate the franchise agreement and sue for damages for breach of contract.
The term would need to be drafted widely enough to acknowledge that it might not be the franchisor that fails – it might be the parent company or another critical entity in franchisor’s network that fails, taking the franchisor with it.
Implied term that franchisor will comply with all contractual or statutory obligations towards third-parties The franchisor should be required to comply with all collateral contract obligations and all obligations that arise under statute. A breach of any of the third- party or collateral contractual obligations that impacted detrimentally on franchisees would enable the affected franchisees to terminate their agreements and seek damages from the franchisor.
This term would be used by franchisees whose franchisor did not pay the rent, outgoings or other third-party payments that it had received from the franchisee in a timely way. In failing to do so, the franchisor has put the franchisees’ businesses and reputation at risk.
Requiring franchisee consent to changes that would have a material effect on franchisees The Matthews Review recommended that ‘[c]onsideration be given to prohibiting unilateral changes by franchisors to arrangements with franchisees which
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646 have materially adverse effects on the franchisee without franchisee consent’.645F The government responded by stating that:
this will be addressed through reform to section 51AC of the Trade Practices Act in relation to unconscionable conduct where unilateral variation clauses will be a factor that may indicate a corporation has engaged 647 in unconscionable conduct.64F
The theme of unilateral contract variation is being addressed. In 2010 the Small Business Minister Dr Emerson announced, in announcing amendments to the Code:
Franchisors would have to make it clear to prospective franchisees that there 648 may be unilateral contract variations, unforseen capital expenditure …647F
When the causes of franchisor administration and insolvency are taken into consideration, it is clear that an even more problematic area of material change is the franchisor adopting strategies that put the entire network at risk. Franchisees have no right to know about the franchisors plans that are implemented by the franchisors’ related entities. The feasibility of requiring that franchisors disclose, and possibly secure franchisees’ consent to, major strategic changes that could put the network at risk, should be explored.
No contracting out Legislated consumer protection for franchisees must not be able to be avoided by contracting out.
Implied term to take effect on appointment of administrator A term would be implied into all franchise agreements that if an administrator is appointed to the franchisor or to any of the entities in the franchisor’s network that threaten the viability of the franchisee’s business, a 2 step process will be triggered:
Step 1: when an administrator is appointed to their franchisor any franchisee may give notice to the administrator that if a satisfactory resolution (restructuring that takes into account the franchisee’s interests as well as
646 Matthews, above n 113, 42. 647 Australian Government Response to the Review of the Discolsure Provisions of the Franchising Code of Conduct (2007) 6. 648 The Hon Dr Craig Emerson MP, ‘Better Protection for Franchisees’ (Media Release, 3 March 2010)
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those of the franchisor’s creditors, or sale to appropriate buyer) is not found within x days, it will terminate the agreement, Step 2: if the administrator does not meet the requirements in x days, the franchisee have the right to terminate the franchise agreement, without this being a deemed breach by the franchisee and without it compromising any other rights the franchisee may pursue. The franchisees may express their losses as unsecured creditors for an amount of their initial investment, adjusted by depreciation and other appropriate considerations, plus any amounts currently owed in the franchisor’s administration/ subsequent insolvency.
This approach could be adopted in relation to both franchisor and franchisee failure. This would mean the current asymmetrical provisions in the Code and all franchise agreements favouring franchisors in the event of franchisee failure could be removed from franchise agreements, thus making them shorter. It would also eliminate the risk of franchisees being sued by the administrator or liquidator for anticipatory breach.
There is currently debate in insolvency law about the merit of ipso facto clauses. Step 1 above is a refined ipso facto clause:
The IPA argue[s] that the ability of the non-insolvent party to terminate these contracts destroyed enterprise value and, if businesses could be provided with some limited protection from these automatic terminations the 649 potential for restructuring businesses would be significantly improved.648F
Currently franchisor give themselves, but not the franchisees ipso facto clauses in the franchise agreement. Arguably the IPA’s wish is not as valid in the franchising context as it may be in, for example, a supplier contract.
For franchisee consumers to be given statutory protection in the form of a modified ipso facto clause would be consistent with the approach in jurisdictions such as Canada that recognise parties to executory contracts as meriting special consideration in insolvency of one of the parties.
649 Morgan Kelly, ‘Failing Businesses Can be Saved’, The Australian Financial Review’ (Sydney), 30 November 2009, 55.
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Consequential amendments as additional implied terms The franchisees’ option to terminate their franchise agreement would have a secondary right attached to it – on the appointment of the administrator, all payments (eg, royalties, advertising, rent) falling due from the franchisee to the franchisor or any franchisor-related entity that was also under administration would cease to be payable. Payment obligations – without arrears – would resume if the franchise network was successfully revived. This would mean the vulnerable business consumers, the franchisees, were not funding the administration.
The tenancy contract between the landlord and the franchisor would be novated.
A novation occurs when two parties to a contract enter into an agreement with a third party under which, in consideration of the first party [the landlord] releasing the second party [the franchisor] from the contract, the third party [franchisee] undertakes to assume responsibility for performance in place of the second party. A transaction … is not effective as a novation unless an intention is clearly shown that the second party’s obligations are to 650 be extinguished.649F
The franchisee would step into the shoes of the failed franchisor but would not take on the liabilities accrued by the under-performing franchisor. Premises rent formerly collected by the franchisor for on-payment to landlords would thus become payable direct to the landlord. This would not disadvantage the administrator or the franchisee’s landlord, but would enable the franchisee to demonstrate to the landlord whether the franchisee has a viable business as an independent operator.
These provisions would provide an incentive for the administrator to acknowledge franchisees as parties with rights, not merely to categorise franchise agreements and premises leases as assets or liabilities of the franchisor. They would enable the administrator to keep the franchise network together if a viable buyer was found quickly, but not leave franchisees in limbo for extended periods while the administration proceeds.
The drafting would have to be done with careful attention to incentives. It is important not to incentivise the administrator from acting too hastily in proposing the
650 NC Seddon and MP Ellinghaus, above n 368, 360.
270 Chapter 6: Consumer protection to address the benchmarks 271 administration proceed quickly to liquidation to prevent the franchisees from exercising their option to terminate.
6.2.4 AMEND FRANCHISING CODE OF CONDUCT Prospective franchisees do not currently have access to all information they need to make an accurate assessment of the risk of the franchise network failing and the impact that failure could have on their future business.
In economic terms the duty to disclose is formulated on the following basis:
[I]n general a person has a property right to information when it is costly to gain such information, but the person does not have a property right and therefore cannot take advantage of this information when the information is 651 obtained at a very low cost.650F
An application of this principle means franchisors would provide franchisees with less disclosure that is of greater value; information the franchisee could not gain access to otherwise, or only at great cost. This is also recognised in Opportunity not opportunism:
Better disclosure does not necessarily mean more disclosure; disclosure documentation should be in line with Code requirements and should focus on the provision of information which is difficult and/or expensive for the 652 franchisee to obtain through other means.651F
Four aspects of the Code could usefully be amended. They are the Code’s application to administrators, the scope of entities that the franchisor has to disclose, the form and content of the disclosure document and the public accessibility of the disclosure document.
Application of Code to administrators If the Code does apply to administrators, franchisees are ‘business consumers’ and entitled to remedies available under the Trade Practices Act for breaches of the Code. If it does not apply, the administrator is regulated only by the IPA’s Code of Professional Conduct and by its obligations under the Corporations Act. As was explained in 4.3.2, the current, untested view held by some administrators that the
651 D Wittman, Economic Foundations of Law and Organization (2006) 194, 104. 652 Commonwealth Government Response to the Report of the Parliamentary Joint Committee on Corporations and Financial Services, above n 166, xiii.
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Code does not apply to administrators is abused by some administrators. This results in administrators denying franchisees the right to request mediation during the administration. Mediation might not be the disastrous waste of time and resources that administrators claim – it may be a way of opening a meaningful dialogue between administrators and franchisees and provide the administrators with a loyal franchisee base whose contracts can be sold.
Power and funds imbalances, the tight time lines surrounding all aspects of the winding up procedure, the embargo on commencing litigation against the party in administration, mean it is unlikely that franchisees would ever be able to mount an effective challenge, so the incorrect view prevails. To resolve this, a statement should be inserted in the Code to clarify that it does apply to administrators.
Entities making disclosure The franchisee needs to base its purchasing decision on full, specific and accurate information. The franchisee should be given information that is specific to its actual business. Even franchisors that have invariable rules about specific aspects of business do make exceptions for particular sites, so generic information is not necessarily accurate.
It was shown in 3.2.1, Table 1 and Appendix D that ‘the franchisor’ is typically 653 only one of a group of numerous corporate and trustee entities.652F The franchisor is not necessarily the entity whose failure will trigger the failure of the group. In chapters 3.2.2 and 3.2.3 two of the key ‘assets’ of the franchisor, registered trade marks and head leases, provided numerous examples of the range of business structuring models franchisors use. The fragmentation of ownership of vital assets means that the current form of disclosure by and of the franchisor exposes only a very small part of the franchise network to scrutiny by the franchisees’ advisers.
654 The Matthews Review recommended653F and the Australian Government accepted that:
653 For example there were approximately 40 entities in the Ansett group of which Traveland was a franchisor casualty; 51 entities in the two corporate groups and their related entities that made up the Kleenmaid empire. Fifteen franchisor and related entities in BHG. 654 Matthews, above n 113, 44-5.
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[t]he requirement under item 20 of Annexure 1 [of the disclosure under the code] to disclosure financial details [should] be extended, where applicable, 655 to include the consolidated entity to which the franchisor belongs.654F
To achieve fuller, more telling information a credit rating agency report on the franchisor entity should be required to be provided by the franchisor. This would be more meaningful to the franchisee than a very full and potentially confusing mass of numbers supplied under the amended item 20. The item 20 information is attached to entities whose function in the network the franchisee would not be aware of.
A credit rating agency provides context for the franchisor entity’s operations. Such a report shows related entities and individual directors which are not presently a feature of disclosure. It reports on their credit history which, if one believes that history repeats itself, is significant information to an incoming franchisee interested in assessing risk. The information provided would enable an accountant to analyse the franchisor’s attitude to risk, debt, and creditors and would provide a far more comprehensive picture of the franchise network than is provided through the current disclosure.
It should be noted that credit rating agencies do obtain some of their information from the subject entity. To avoid this being misleading, the information that was supplied by franchisor or related entity should be identified so the franchisee will not be misled into believing the report is entirely objective.
Form and Content of the Disclosure
656 Recommendation 1 of Opportunity not opportunism65F proposes the current absence of warnings about franchisor failure should be addressed thus:
The … Code [should] be amended to require that disclosure documents include a clear statement by franchisors of the liabilities and consequences 657 applying to franchisees in the event of franchisor failure.65F
655 Australian Government Response to the Review of the Discolsure Provisions of the Franchising Code of Conduct, above n 415, 8. 656 Parliament of Australia, Joint Committee, Inquiry Into the Franchising Code of Conduct (2008) submissions and final report para 4.80
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This would not be a total solution, but it would put franchisees on notice that the franchisor may fail. The government responded that:
individual franchisees, rather than franchisors, would be better placed to assess the liabilities and consequences applying to them in the event of their franchisor failing. In addition, such a statement may induce a belief among franchisees that, in the event of franchisor failure, they will not be exposed 658 to any risks other than those noted in the disclosure document.657F
The government’s preference for generic information to be supplied by the ACCC is problematic. Information without context can be very misleading. Because of considerable variation of risk shifting within each franchise network, any risk statement would be most valuable if it were tailored to each specific franchisee’s situation. Only the franchisor could do this, and only in relation to assets/ contracts to which the franchisor or a related entity was a party. Franchisors should set out in plain English specific possible contractual and statutory consequences of their own failure for their franchisees. They would include information such as:
The franchisor’s liquidator may disclaim (i.e. terminate) the premises lease. This could result in you losing your right to trade from the premises.
If you provided a guarantee for the franchisor’s head lease, you would lose the amount of the guarantee as it would be paid to your landlord. You could not claim it back from the franchisor’s liquidator.
If the landlord would not grant you a new lease you would lose the entire fit-out and could not trade from your premises any longer.
The franchisor’s liquidator may disclaim your franchise agreement. This would mean you could no longer trade as a franchisee of [franchisor].
If your lease was not disclaimed but the franchise agreement was disclaimed you would have to continue paying rent and outgoings on your premises, but would have to change the name of your shop and may not be able to buy the same stock as you did while you were a franchisee.
above n 113, 13 and agreed to in principle in the Australian Government Response (2007) 7-8 which placed the responsibility, inappropriately, with the ACCC. 658 Commonwealth Government Response to the Report of the Parliamentary Joint Committee on Corporations and Financial Services, above n 166, 21.
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If the franchisor does not own the trade marks, patents or designs that you need access to for your business, you are most likely to lose the right to use these if the franchisor becomes insolvent. You may also lose access to these if an administrator finds a buyer for the franchisor. That buyer may not accept you as a franchisee.
This franchise is a commission agency. If the franchisor fails, you will not receive any commission from the administrator or liquidator. Please consider the impact of receiving no commission on your cash-flow and make provision for it.
If you reach a mediated settlement where the franchisor has agreed to pay you money, you would become an unsecured creditor for as much of that sum as remains unpaid if the franchisor fails. This should put franchisees on notice to require security from the franchisor or its directors for any agreed compensation.
Over time ex ante warnings may lead to franchisors being more open to amend their standard franchise contracts to level the failure part of the playing field. It may also lead to banks that fund both a franchisor and its franchisees being more diligent about managing the franchisor side of the ledger, preventing the franchisor from excessive borrowing that might jeopardise the viability of the network.
A reconfigured disclosure would be valuable. It would enable franchisees to assess their risk more accurately and would make lenders more aware of the risks in lending to franchisors and franchisees. It should be noted that even if enough information was supplied, franchisees would still be unable to self protect if franchise agreements did not allow them to terminate the contract and deal satisfactorily with all of their collateral obligations when the franchisor failed.
Early, free access Intending franchisees do not have accurate information early enough or cheaply enough. Disclosure documents should be accessible on public databases. Despite the reservations expressed by the government as to cost and usefulness of a 659 registration process658F it is the only way of monitoring the sector and obtaining
659 Ibid 11.
Chapter 6: Consumer protection to address the benchmarks 275 276 meaningful, publicly accessible, longitudinal and contextual data about franchisors. This would enable intending franchisees to compare offerings more readily at an earlier stage in their path towards small business ownership.
6.2.5 CONSEQUENTIAL AMENDMENTS TO STATE AND TERRITORY RETAIL LEASES LEGISLATION In some states, under some of the tenancy models outlined in chapter 3.2.3 the tenant may have the protection of retail leasing legislation while the franchisor is solvent. Statutory protection is not uniform in existence or scope across Australia. A franchisee will encounter the problems identified in chapter 3.2.3 and 4.4 if the franchisor has not met its commitments to the landlord.
After a franchisor fails, the franchisee’s business may be viable on a stand- alone basis as long as the franchisee can retain its premises. However, the franchisee may not have right to remain in premises if franchisor fails. The liquidator has a 660 statutory right to disclaim the franchisor’s head lease as an onerous contract.659F
Alternatively, the landlord may have the terminated lease for non-payment of the rent by franchisor. When the franchisee is a licensee or sub-lessee of the franchisor, the franchisee pays its rent to the franchisor. The franchisor then pays its rent to the landlord. In some situations the franchisor has received the franchisees’ rent, not paid it to the landlord, and the franchisee is unaware of this until the landlord locks the franchisee out, after terminating the head lease for non-payment of rent.
A possible solution is to amend all State and Territory retail leasing legislation to follow the Ontario, Canada, approach that affords franchisees in such situations 661 the right to elect to become the lessee.60F This situation is exemplified in the 662 Canadian case, Majdpour v M & B Acquisition Corp:61F
Not all franchisees’ tenancy arrangements are covered by State/Territory Retail leasing legislation. This is a problem because the franchisee relies on continuing tenure of the premises tenure. The issue arises because the definitions of “lease” and “tenant” in the legislation may not include the
660 For example: in Kleins and Kernel’s Popcorn. 661 See Appendix A of this thesis. 662 2001 CanLII 28457 (ON SC)
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arrangement between the franchisee and the franchisor. The franchisor could deprive franchisees of any statutory rights by, for example, taking a head lease for five years, and then granting a licence to the franchisee for a short term that would then deprive the franchisee of the protection offered to tenants under the relevant state legislation. One way of resolving these problems would be to redraft definitions in retail leasing legislation to provide rights to premises to franchisees that can prove they have paid the rent and outgoings in a timely way, even if the franchisor or other 663 intermediary has not passed the moneys on to the landlord.62F
In addition, the justification for exempting short-term tenancies from legislative protection should be reconsidered. In particular, franchisor head tenants should be required to extend the protection intended for the tenant to the franchisee 664 regardless of the term or the contractual basis for the franchisee’s tenure’.63F
6.2.6 AMEND CORPORATIONS ACT 2001 (CTH) A solution that addresses the problem only through the Trade Practices Act will be incomplete. It cannot provide adequate redress for franchisees whose franchisor failed before franchisees had time to recoup their investment. It will not bind liquidators. It also risks incentivising creditors to force administrators to quickly pass through the administration stage and to propose the franchisor be wound up so as to deprive franchisees of their newfound implied terms.
Expand directors general duties
665 Section 172 of the Companies Act (UK)64F can be read broadly enough to give directors the duty/ability to consider franchisees in their decision making. This is an
663 Buchan and Butcher, ‘Franchisees’ Retail Premises Occupancy Models in Australia: Factors for Consideration’, above n 34, 175. 664 Ibid. 665 Companies Act 2006 (UK) ch 46, pt 10 A, Company's Directors, ch 2 General Duties of Directors, The General Duties, In-Force Date: 1 October 2007; s 172 duty to promote the success of the company. (1) A director of a company must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, and in doing so have regard (amongst other matters) to- (a) the likely consequences of any decision in the long term, (b) the interests of the company's employees, (c) the need to foster the company's business relationships with suppliers, customers and others, (d) the impact of the company's operations on the community and the environment, (e) the desirability of the company maintaining a reputation for high standards of business conduct, and (f) the need to act fairly as between members of the company.
Chapter 6: Consumer protection to address the benchmarks 277 278 avenue of legislative change that could be investigated in Australia. Franchisees would need to be included in a definition of ‘members as a whole’. If they were not specifically included they could be denied the right to litigate to clarify the intention of the legislature for the same reasons that impede franchisees wishing to litigate currently.
Specific fiduciary duties A further future inquiry is whether the directors of the franchisor do or should owe any fiduciary duty to franchisees. The issue of franchisors as fiduciaries was addressed in Germany where guidelines have been developed by the German Franchise Association to interpret Article 3.3 of the European Franchise Federation (‘EFF’) Code of Ethics.
[Article] 3.3 [states] In order to allow prospective Individual Franchisees to enter into any binding document with full knowledge, they shall be given a copy of the present Code of Ethics as well as full and accurate written disclosure of all information material to the franchise relationship, within a 666 reasonable time prior to the execution of these binding documents.65F
The guidelines are consistent with German case law. Before it was amended to express duties more generally, Guideline (1) stated:
During the initial phase, when a franchisor starts to explain its franchise opportunity, and during contract negotiations a pre-contractual relationship with fiduciary duties emerges which obliges the parities to disclose whatever 667 information is essential for their future relationship.6F
By way of contrast, in the USA ‘[f]ranchisors owe no fiduciary duty to 668 franchisees,67F and no other duty to honor the franchisee's expectations is likely to 669 670 come from the franchise agreement itself68F or from contract law governing it’.69F
(2) Where or to the extent that the purposes of the company consist of or include purposes other than the benefit of its members, subsection (1) has effect as if the reference to promoting the success of the company for the benefit of its members were to achieving those purposes. (3) The duty imposed by this section has effect subject to any enactment or rule of law requiring directors, in certain circumstances, to consider or act in the interests of creditors of the company. 666 European Franchise Federation, European Code of Ethics for Franchising
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The issue was raised but not resolved in the context of a solvent franchisor 671 Australia in Hoy Mobile Pty Ltd v Allphones Retail Pty Ltd (No 2).670F
It would be addressed if franchisors were required to exercise the same duty towards franchisees as directors do towards shareholders.
Franchisee representative committee during administration and insolvency In the United States:
[t]he UST [United States Trustee] may also appoint additional committees of creditors or equity security holders as the UST ‘deems appropriate.’ (11 U.S.C. 1102(a)(1)). This is important in a franchisor bankruptcy if franchisees believe their interests are not adequately represented on the Committee. Because franchisees may not have an actual liquidated claim against the franchisor at the time of filing, they may not be included on the list of twenty largest creditors and may not be solicited to serve on the Committee. Yet, they have a large stake in the bankruptcy. Franchisees may urge the UST to appoint a separate committee or petition the court to allow 672 the formation of a franchisee committee.671F
The merits of all franchisees being officially recognised and represented in creditors meetings, whether they are creditors or debtors, should be examined at the time review of the Corporations Act to address franchisor failure is undertaken.
Expand liquidators’ duty of care A statutory duty of care should be imposed on administrators and liquidators dealing with a failed franchisor towards franchisees. Under the expanded duty, administrators and liquidators would owe a duty of care to the franchisees to consider their legitimate needs as consumers. This includes the possibility for franchisees to continue operating their businesses if the cause of the failure is not related to the viability of the individual franchisee businesses. It would also mean that any
669 Ibid 728 quoting Robert W Emerson, ‘Franchising and the Collective Rights of Franchisees’ (1990) 43 Vanerbildt Law Review 1503, 1509, n 21 (noting the franchisor usually drafts the franchise agreement and that most obligations fall on the franchisee). 670 Ibid 729. 671 [2008] FCA 810. 672 Foster and Johnsen, above n 19, 20. Cases in which franchisee committees have been appointed: In re Nutri/System, Inc, 169 BR 854 (Bankr EDPa 1994); In re First International Services Corp, 25 BR 66 (Bankr D Conn 1982); In re Rusty Jones, Inc, 128 BR 1001 (Bankr ND Ill 1991).
Chapter 6: Consumer protection to address the benchmarks 279 280 purchaser of the franchisees’ business would be required to satisfy the administrator or liquidator that it was competent to run the franchise system.
6.3 EVALUATION OF REGULATORY SOLUTIONS AGAINST BENCHMARKS B1 AND B2
To recap, benchmarks 1 and 2 are:
B1) Regulation should provide effective protection from serious risks and threats that [franchisees as business] consumers cannot tackle as individuals.
B2) There should be accessible, timely and meaningful redress where consumer detriment has occurred.
6.4 COSTS AND BENEFITS
Benchmark B3 requires that the cost to the franchisor and the legal system of meeting B1 and B2 should be less than the benefit to franchisees whose franchisor fails. In order to assess this, a cost benefit analysis would be conducted.
[Cost benefit analysis] CBA is an analytical tool that can be used to assess the benefits and costs of regulatory proposals. CBA involves examining costs and benefits from the perspective of the community as a whole to help identify the proposal with the highest net benefit. Where regulation is designed to reduce the risk of physical or economic harm, a CBA should include a risk analysis detailing how the regulation will change the 673 likelihood, frequency or consequences of an adverse event occurring.672F
In summary, ‘[c]ost-benefit tells us the menu of trade-offs which policymakers 674 face’.673F As part of the Best Practice Regulation Preliminary Assessment, Australian government policy requires that a CBA should be conducted, and identified that:
[f]or a Regulation Impact Statement (RIS) to be assessed as adequate, it should demonstrate that: the benefits of the proposal to the community outweigh the costs; and
673 Australian Government, Department of Finance and Deregulation, Cost Benefit Analysis
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the preferred option has the greatest net benefit for the community, 675 taking into account all the impacts (Australian Government 2007).674F
The Australian government evaluates projects by assessing their Benefit Cost 676 Ratio (BCR).675F
6.4.1 STAKEHOLDERS An early step in conducting CBA is to identify all stakeholders in the problem. The stakeholders affected when a franchisor fails are some or all of the following; the franchisor and its related legal entities, franchisor’s employees, franchisor’s shareholders, franchisors secured and unsecured creditors, landlords, franchisees, franchisee’s guarantors, employees, creditors, families, policy makers, ACCC, ASIC, administrators, liquidators, master franchisees, other suppliers, owners of registered intellectual property rights used by the franchise network, and courts. They may be affected directly and invariably, or the effect may be as a consequence of a course of action adopted by an individual franchisee.
6.4.2 PRESENT REGIME The features of the present regime are, in summary:
Disclosure contains approximately 250 items of information and is supplied to every franchisee before purchase, and annually on request.
Disclosure is made only of the franchisor entity and the owner of the intellectual property.
Lease:
o Franchisee is often required to pay rental guarantee for franchisor’s head lease; the franchisor is often the head lessee and franchisees thus
675 Australian Government, Department of Finance and Regulation, Best Practice Regulation Guidance Note: Decision Rules in Regulatory Cost-Benefit Analysis 1
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lose the right to occupy premises because of head lessee (franchisor’s) default, or o Franchisee keeps lease with no income because franchise agreement disclaimed and franchisee loses access to franchisor-controlled network of IP, suppliers, customer database, etc.
Franchisees have no legal rights per se on franchisor failure.
The franchisor entity and related entities are dealt with separately on franchisor insolvency.
Franchisee can risk breach of contract action or undertake Trade Practices Act action with consent of court but the provisions of the Corporations Act make action against an insolvent entity problematic.
6.4.3 PROPOSED SOLUTIONS The proposed solutions comprise a more streamlined but accurate disclosure, and amendments to the Code, amendments to the Trade Practices Act or a separate Franchise Contracts Act that contained terms implied into all franchise agreements. The provisions designed to protect franchisees, such as ipso facto rights on franchisor failure, could not be contracted out of. The legislation would include all provisions that are currently included in all franchise agreements, such as the grant of the licence to use the intellectual property, a minimum term that reflected the franchisee’s right to amortize its investment in sunk costs.
Disclosure would contain fewer items provided by franchisor, plus data about the franchisor that set it in its full context, provided by a credit agency such as Dunn and Bradstreet. It would be more meaningful. Through improved disclosure, the franchisor and its business would be placed in a meaningful context as whole network would be demonstrated by chart with name and function of each entity.
Retail leasing legislation would be consequentially amended by requiring franchisors to pay the guarantee for head leases that are not in the franchisees’ name. Franchisee may keep premises if head lessee-franchisor defaults or they may surrender the lease without penalty if they are unable to continue trading without the support of the franchisor.
282 Chapter 6: Consumer protection to address the benchmarks 283
6.4.4 COSTS AND BENEFITS Leo Dobes states ‘[t]here is no reason why the results of a [CBA]should not be presented in a way that shows how various stakeholders are likely to be affected by a 677 government project or policy’.67F As already stated, conducting a full regulatory cost benefit analysis is also beyond the scope of this thesis.
My proposal for addressing B3 is that the stakeholders could be listed and the costs and benefits of the present and the proposed ex ante regulatory solutions summarised in a series of tables such as Table 8. Initially, separate tables would be created for each strategy identified in Chapter 6 from ‘status quo through to amend Corporations Act. Strategies could then be evaluated using the decision rules identified in note 676.
It should be noted that draft Table 8 is intentionally incomplete. Entries are indicative of the type of things that would be considered in a full analysis. A comprehensive analysis of B3 is beyond the scope of this dissertation.
Table 8: Cost benefit tentative summary
Present Proposed Stakeholders Type of impact Benchmark Affected (s)
addressed Benefits Benefits
Federal Fewer government B2 government inquiries would be B3 State and territory needed. governments Better stakeholder representation would meet OBPR criteria. Submissions would not need to be made. FCA Insignificant Standard form More mirror/ Franchisors Significant: B1 contract, free reciprocal terms Franchisees Fairer contracts that B2 market addressing risk State governments assign risks more approach. areas. Federal efficiently between government More clearly franchisors as ACCC defined rights on suppliers and
failure of franchisor franchisee as consumers. More timely and cost- effective redress if
677 Dobes, above n 599, 69.
Chapter 6: Consumer protection to address the benchmarks 283 284
Present Proposed Stakeholders Type of impact Benchmark Affected (s)
addressed franchisor went into administration. Can reorganise Reduced risk of Franchisors and Risk reduced B1 without having being accused of parent company to factor in misleading B2 franchisees franchisees Disclosure of More contextualised Franchisees and Clearer understanding B1 ‘the franchisor’ disclosure. franchisees of risk because have B2 shareholders and information they guarantors could not previously get. Can insulate personal assets and assess risk in more informed way. Risk reduced. Improved rent Landlords Would still have B1 payment structure ability to terminate when franchisor in lease if party failed to B2 administration. perform. Easier to evaluate possibility of franchisee remaining a tenant without being part of the franchise network. More accurate Lenders to B1 picture of franchisors and franchisor’s and franchisees franchisees’ assets, liabilities and contingent liabilities Franchisors and GEERS / no impact franchisees’ employees Stand-off as to Clear statement that Administrators Clarified position B1 whether Code Code applies B2 applicable Powerless, Clear Franchisees Improved knowledge B1 rudderless understanding, families and thus ability to standing and rights plan. Costs Costs New full Much of franchise Franchisor Cost at each step B2 franchise agreement significantly reduced Franchisee B3 agreement for contained in new each franchisee Franchise Franchisee’s legal Contracts Act and financial advisers
284 Chapter 6: Consumer protection to address the benchmarks 285
Present Proposed Stakeholders Type of impact Benchmark Affected (s)
addressed Keeping Franchisor Reduced B3 disclosure up to date Code + s 51AC Amended Code + ACCC Would be nearer to B1 amended Trade delivering on the level Practices Act OR playing field that is as new Franchise aspect of consumer Contracts Act protection. incorporating Code provisions. Sense of ACCC Numerous complaints frustration that they cannot deal with can’t do anything except issue statements. Disclosure of More contextualised Franchisor and May have difficulty ‘the franchisor’ disclosure. shareholders getting capital from bank if have to take more of risk themselves. Lose business Ipso facto clause Franchisee, Inability to gain a and premises if franchisee’s return on sunk costs Amendment to franchisor fails guarantors and of investment. leasing legislation without legal financier Lose house to right to manage mortgagee sale. own response. Opportunity cost of time. Opportunity cost of money. Tax audit. Social costs (eg divorce) Illness; stress, depression, suicide. Franchisees Financial stress, families Social costs (eg divorce) Illness; stress, depression, suicide.
Tyler Cowen notes, however, that ‘[g]iving cost-benefit analysis a greater voice in policy may lead to fewer bad regulations than otherwise, but cost-benefit 678 analysis is not up to serving as a centrepiece for regulatory reform’.67F
678 Cowen, above n 674.
Chapter 6: Consumer protection to address the benchmarks 285 286
6.5 CONCLUSION
Non regulatory solutions such as providing better education for more people at more stages of the business process, funding the foundation of a franchise union and so on will not result in sufficient change to protect all franchisees whose franchisor fails. Changes will only be effective at a legislated level. The changes proposed in chapter 6.2 would meet the benchmarks and would require very little expenditure once they were established. In the long run, franchise documents would be shorter and yet more informative if a federal Franchise Contract Act were enacted that contained the clauses recommended in 6.2.3.
It would benefit franchisees and their financiers if the relationship between insolvency and consumer law was clearer and accordingly if a reference to the specific legal consequences for the franchisee being given the disclosure of the 679 specific franchisor’s insolvency were included in all pre contract disclosure.678F Currently, in so far as franchisees are concerned, Australia’s insolvency regime and the consumer protection legislation acknowledging franchisees as business consumers are out of step with each other. Rohrbacher writes that ‘[i]mproving the bankruptcy system is important because property and contractual rights are keys to 680 the smooth functioning of our (US) economic enterprises’.679F
Franchising, and the loss of wealth by franchisees who sign on with the wrong franchisor, is a clear demonstration of property and contractual rights that are not handled optimally by insolvency law.
679 The UNCITRAL Guide, above n 26, 19 recommends that the relationship between insolvency law and other laws should be clear and, where possible, references to the other laws should be included in the insolvency law. 680 Rohrbacher, above n 537.
286 Chapter 6: Consumer protection to address the benchmarks
Chapter 7: Conclusion
7.1 LEADING THE WORLD IN FRANCHISE REGULATION
The issue of franchisor failure remains ‘one of the few vulnerabilities in 681 franchising’680F but as a result of this research its impact on franchisees and the reasons for the impact is now better understood.
To an extent this thesis is a response to Iain Ramsay’s 2005 call ‘for future 682 research on consumer law and policy’.681F It demonstrates that the legal and economic context in which consumers operate needs to be fully understood before policy is formulated. Accordingly, it is only when frames of the commercial, legal and regulatory environment impacting on franchisees of failed franchisors are each expanded to the point where they overlap that the problems that franchisees of failed franchisors experience can be understood. Now that the problem has been placed in context, it is time for policy makers to take remedial action. As a result, Australia would genuinely lead the world in franchise regulation.
A regulatory response would recognise that
[i]n the three and a half decades that have passed since the Trade Practices Act transformed Australia’s consumer policy landscape, there have been a range of new and significant contributions to economic, political and psychological thinking that can usefully inform the way we engage in 683 consumer policy.682F
684 This thesis build on Elizabeth Spencer’s683F thesis where she demonstrated that franchise contracts are by and large not negotiable, relational, standard form contracts. The findings here suggest that the approaches to consumer policy that should change in the future are that:
681 Switzer, above n 1. 682 Ramsay, above n 329, 34. 683 Kennedy, above n 405, 10. 684 Spencer, The Regulation of the Franchise Relationship in Australia: A Contractual Analysis, above n 14.
Chapter 7: Conclusion 287 288
The commercial and economic frame needs to be enlarged beyond the immediate consumer (the franchisee) to acknowledge that the franchisor and franchisee are components of an entire franchise network.
The legal frame needs to be expanded beyond the separate laws of contract, consumer protection and insolvency.
The regulatory frame then needs to be expanded to include both the consumer protection and the insolvency regulators.
Any discrete frame does not present a full context. Viewed together, they are compelling.
Whilst the consumer protection aspect of the solution proposed in this dissertation may stand alone, it is acknowledged that consumer protection laws are capable of providing only a partial solution. An optimal solution can only be devised if consumer protection and business failure laws work together.
Final outcomes for consumers in economic and non-economic terms are the ultimate arbiter of whether markets are failing or succeeding in terms of citizens’ expectations. Whilst it is undeniable that ‘the law cannot seek to correct all the 685 inequalities that inevitably affect contracting parties’,684F policy makers credit franchisees with more foresight, power and negotiation skill than any single unit franchisee has.
Business failure law does not acknowledge the franchisee, per se, as a legitimate stakeholder, independent of its categorisation as a creditor in the franchisor’s insolvency. The law currently provides no meaningful redress to franchisees whose franchisor fails. This situation has arisen for a number of reasons;
The most fundamental reason why franchisor failure has not been addressed in the context of consumer law is consumer policy is created on the assumption that suppliers do not fail. Thus the consequences of a supplier’s business entity’s failure do not become a consideration in formulating consumer policy.
685 Thomas, above n 326, 383.
288 289
Building on this assumption is a second, equally flawed assumption, that if suppliers do fail, another supplier, or an insurance company, will pick up where the supplier left off and will supply the services, such as car repair, that mean that the consumer will not be unduly disadvantaged. In the case of franchisor suppliers of franchise businesses to franchisee consumers, it turns out to be a flawed assumption.
There is also an entrenched notion that business persons are able to negotiate their contracts and thus cannot be vulnerable consumers. Both notions have been demonstrated to be incorrect.
Former franchisees of failed franchisors are invisible on government databases and are rarely the subject of academic research because they are difficult to find and to research.
The fact that consumer protection and small business are dealt with by one federal ministry and corporations and insolvency and personal bankruptcy with another contributes to the respective regulators’ failure to understand the complexity, causes, scope and results of the problem, and their ability to deal with it.
Lobby groups in Australia have traditionally deflected the regulators’ attention away from failure.
Hadfield also makes observations about the disproportionate influence of 686 lobby groups, citing Martin Bailey and Rubin685F who observe that ‘the bureaucratic and legislative processes involved in drafting legislation, however, may face other distortions in information and incentives arising 687 from interest group politics’.68F This theme is repeated by Michael Le Page who writes:
The effectiveness of policies … can be empirically determined. … the best evidence comes from randomised controlled trials; better still, a systematic review of randomised trials. “Common sense” and good intentions are no substitute for hard evidence. … The big challenge is to get politicians and
686 Martin J Bailey and Paul H Rubin, ‘A Positive Theory of Legal Change’ (1994) 14 International Review of Law and Economics, 467-77. 687 Hadfield, ‘The Many Legal Institutions that Support Contractual Commitment’, above n 22, 198.
289 290
policy-makers to understand what constitutes rigorous evidence and to base their decisions on it, rather than on the urgings of lobbyists. The only alternative is to spend vast sums on programmes and policies that, far from 688 achieving their aims, may be making matters worse.687F
Periodic government reviews of insolvency policy have not received submissions from franchise interests.
Where franchising is the subject of specific national legislation, the focus is typically on pre-contract disclosure. This ignores that fact that even if the disclosure is perfect, and the franchisees’ due diligence is thorough, some franchisors will still fail, or will choose insolvency to deliver commercial benefits to themselves and their shareholders. At that point, the best disclosure and due diligence prove useless to the franchisee.
Any proposals put to the liquidator by groups of franchisees must be measured enough to permit the value of the brand to be retained if possible. Solutions should address the potential for the franchisee to continue in business with or without the brand. The franchisees as a group may be able to buy the brand. Every concession secured by franchisees in relation to every contractual commitment will be as a result of their ability as negotiators.
Timing is critical so that the individual franchisees remain motivated, their customers remain loyal, and so they can put constructive solutions to their own financiers and landlords, and do not suffer too great a loss of brand value.
7.2 AREAS FOR FUTURE RESEARCH
7.2.1 DATABASE It would be useful to have accurate numbers of franchisors that fail. They could then be categorised, and specific effects of franchisor failure on franchisees of specific categories could be identified. This would help not only future franchisees in making purchasing decisions but also suppliers such as banks to price loan products with greater precision. Currently no ‘risk profile’ exists of a franchisor that is likely to fail. Until this is in place it will not be possible for possible effects to be predicted
688 Michael Le Page, ‘Beware of Common Sense’ (2009) 203(2725) New Scientist 32.
290 291 other than on a case by case basis. With better base data it might be possible for insurers to offer insurance products based on informed analysis.
7.2.2 CONFLICTS OF INTEREST Researchers have often noted the conflicts of interest that arise between the franchisor and its franchisees. The Code attempts to mitigate the effects of conflicts of interest, but they still exist. Conflicts that exist pre and post insolvency, and ways of addressing them satisfactorily, would be a worthwhile research project in law and economics.
7.2.3 INTELLECTUAL PROPERTY As was seen in chapter 3.2.2, the current way of expressing the value of registered intellectual property rights in company accounts can be misleading and inaccurate for business consumers such as franchisees who are attempting to test the franchisors’ claims about the value of specific trade marks. There is room for the accounting profession to revisit the methodology for valuing trade marks and other items of intellectual property for the purposes of reporting in annual returns.
It was also speculated that cultural cringe and the ‘halo effect’ impact on eh amount and depth of due diligence conducted by prospective franchisees on foreign based or well established local brands. This would be an interesting topic for future research.
7.2.4 CONTRACTS The rights of the franchisees as parties to consequential contracts between themselves and third parties that are, in practical if not legal terms, frustrated by the franchisor’s failing, is under-researched.
7.2.5 THE POTENTIAL LIABILITY OF LENDERS This issue arose in the context of the Kleins insolvency in chapter 2.1.4. Here, the bank that actively promoted Kleins to franchisees as an accredited franchise system possibly knew of the parlous state of the Kleins franchisor’s finances. If it did, it is arguable that it was unconscionable for the bank to continue to lend to new franchisees as the bank is thereby spreading its own risk in a situation where the franchisees trusted the bank’s evaluation of the system. Internal bank processes could be studied to promote improved communication between the people conducting accreditation of franchisors and the people making lending decisions.
291 292
7.2.6 INSOLVENT MASTER FRANCHISEES Whether the ‘franchisor’ that becomes insolvent is the franchisor or is actually a national or state master franchisee is significant for its franchisees. If the franchisor is really a national or state master franchisee, the master franchisee’s insolvency will most likely be an event that gives the ‘parent’ franchisor the right to terminate the master licence agreement. This can render the franchisees’ agreements with the master meaningless. At law, one can only grant a right that is equal to or smaller than the rights one enjoys oneself.
This research has not specifically explored the implications of franchisor failure for international franchising or for franchise networks that include master licensees.
7.2.7 CORPORATIONS ACT RESPONSES Sir Kenneth Cork wrote: ‘changes in ... the commercial life of the community since the Nineteenth Century require the law of insolvency to be reviewed and 689 refashioned to meet the needs of our own time’.68F A solution to the problems raised by franchisor insolvency that is based only on ex ante consumer protection is not sufficient.
The opportunities for amending the Corporations Act to recognise franchisees appropriately in the franchisors’ insolvency to be explored in depth in the future include;
The franchise agreement as an executory contract under the Corporations Act. The issues of the treatment of ipso facto clauses proposed as part of the solution in chapter 6.2.3 would be addressed here.
Pooling identified in chapter 4.3.3.
Insolvency of a national master franchisee.
Directors duties and the duties of administrators and liquidators towards franchisees of both solvent and insolvent franchisors.
689 Cork, above n 252, 9.
292 293
7.2.8 INTERNATIONAL INSOLVENCY PRINCIPLES This thesis does not explore the franchisees’ optimal place within the insolvency regime. Nevertheless, it provides an opportunity to examine the position of franchisees from the viewpoint of insolvency law principles. These are broadly stated in the UNCITRAL Guide which states that;
[s]ince an insolvency regime cannot fully protect the interests of all parties, some of the key policy choices to be made when designing an insolvency law relate to defining the goals of the insolvency law and achieving the 690 desired balance between its eight key objectives.689F
Each jurisdiction places different weight on the claims of different stakeholders as should be apparent from Appendix C.
The UNCITRAL principles are listed below with comments on how those goals fit with the circumstances of franchisor insolvency.
Maximizing the value of the assets. In the franchisor’s business the significant assets are its intellectual property and the franchise contracts. They are often owned by different entities, and the franchise agreements are likely to be the only asset owned by the franchisor.
Striking a balance between reorganization and liquidation While many liquidators recognise that the existing franchisees might be prospective purchasers of the franchisor’s business and its network, there is no obligation to offer that business to the franchisees. Reorganisation may be unsatisfactory from a consumer protection perspective as the franchise agreements may, as occurred in Brumby’s, be disclaimed in the process of the restructuring.
Providing for timely, efficient and impartial resolution of insolvency Meeting this objective makes it difficult, if not impossible, for franchisees to have time to seek leave of the court to pursue the insolvent franchisor for breach of contract or to prove a breach of consumer protection legislation, and thus to re-claim the moneys paid to the franchisor in return for what turns out to be much less than payment of the franchise fee entitled the franchisee to receive.
690 United Nations Commission on International Trade Law, Draft Legislative Guide on Insolvency Law (2003) 1-2, 6.
293 294
The franchisee in Table 3 contracted to receive, amongst other things, five years of franchisor support and the right to trade under the franchisor’s marks for five years out of premises held in the franchisor’s name, plus the right to open three future sites. Instead, within six months of paying $60,000 for franchise fees and a further $60,000 for the rights to open future territories, the franchisor was insolvent and the liquidator had disclaimed the lease of the franchisee’s premises. It could be argued that ‘the creditors of the debtor [franchisor] receive[d] a windfall and [were 691 unjustly] enriched at the expense of the hapless real owner.’690F The policy choice to favour a timely resolution of the insolvency means that franchisees’ potential claims cannot realistically be pursued through the courts.
Preventing premature dismemberment of the debtor’s assets Without the ability to exploit the franchise, the ability of the franchisee to trade profitably is destroyed. Franchise systems, by their nature, involve a complex network of business relations. The effects of franchisor insolvency on the franchise ecosystem translates … into a myriad of interests and 692 competing claims among which the franchisee is the least protected.691F
As the insolvent franchisor is usually part of an interdependent group of entities it would be appropriate to include a consideration of franchise networks in future research into the insolvency of corporate groups.
7.2.9 CROSS BORDER INSOLVENCY As 27 per cent ‘of Australian based franchisors are currently franchising 693 overseas’692F there are numerous instances of successful overseas expansion by Australian franchisors. Although being exposed to more than one economy can be a sound risk management strategy for a franchisor, operating across national borders does not guarantee the franchisor will remain solvent. Cross border insolvency issues arise if the franchisor or a national master franchisor, or the owner of the trade marks becomes insolvent. This leaves individual franchisees vulnerable. They are potentially unable to protect their investment and without rights under the franchise agreement. The franchise agreement between the franchisee and the national master franchisee does not have to be novated to the overseas franchisor.
691 Philip R Wood, Principles of International Insolvency (1995) 41. 692 Jenvey, above n 123, 2. 693 Frazer, Weaven and Wright Franchising Australia 2006, above n 11, 66.
294 295
A survey was conducted of legal practitioners specialising in either creditors’ 694 rights or franchising in 26 countries.693F It was an attempt to discover whether the problem of franchisees in their franchisors insolvency had been resolved within the law elsewhere, and might provide guidance for Australia. It was found that there is no consistency, and in most jurisdictions, no provision for these franchisees. The responses are shown in Appendix C. The lack of a consistent approach is not of overwhelming concern if a franchise network stays within one jurisdiction; it becomes an issue when issues like the law of the contract are necessary to resolve.
7.2.10 FRANCHISEES IN UNIONS AND REPRESENTATIVE GROUPS The effectiveness for Japanese franchisees of union membership and the European subsidised consumer representation groups provide models to be evaluated in the future. These were raised in chapter 6.1.3.
Franchisees appointing committees of franchisees as recognised stakeholders with voting power should also be considered and possibly trialled as part of any research conducted under the Corporations Act.
7.2.11 NOT PURELY A LEGAL ISSUE This research has been conducted through the lens of the law. The law alone cannot provide an understanding of or a solution to all of the problems franchisees whose franchisor has failed will experience. Future research areas leading from this basic research are numerous. Researchers in the fields of psychology, economics, and accounting can add texture to this legal analysis.
694 Appendix C of this thesis was created from a survey conducted for the author by the International Bar Association (IBA). The IBA distributed the survey by email to all members of its Creditors Rights and International Franchising Committees. Legal practitioners and law academics from the following countries responded: Argentina; Australia; Belgium; British Virgin Islands; Canada; Colombia; Denmark; England; Finland; France; Germany; Greece; India; Republic of Ireland; Republic of Korea; Mexico; the Netherlands; New Zealand; Nigeria; Spain; Sweden; Switzerland; Syria; United Kingdom; United States of America and Vietnam. The responses have not been verified and should be regarded as indicative only.
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Appendices
APPENDIX A: AUSTRALIAN COMMONWEALTH AND STATE LEGISLATION Bankruptcy Act 1996 (Cth) http://www.comlaw.gov.au/comlaw/Legislation/ActCompilation1.nsf/0/ADAB54284 4770FC1CA25766C000E289A?OpenDocument
______Corporations Act 2001 (Cth) http://www.comlaw.gov.au/ComLaw/Legislation/ActCompilation1.nsf/0/084B0D33 FA61F4BCCA25766D000D8A4F?OpenDocument
50 Related bodies corporate
Where a body corporate is: (a) a holding company of another body corporate; or (b) a subsidiary of another body corporate; or (c) a subsidiary of a holding company of another body corporate; the first-mentioned body and the other body are related to each other.
50AAA Associated entities
(1) One entity (the associate) is an associated entity of another entity (the principal) if subsection (2), (3), (4), (5), (6) or (7) is satisfied.
(2) This subsection is satisfied if the associate and the principal are related bodies corporate.
(3) This subsection is satisfied if the principal controls the associate.
(4) This subsection is satisfied if: (a) the associate controls the principal; and (b) the operations, resources or affairs of the principal are material to the associate.
(5) This subsection is satisfied if: (a) the associate has a qualifying investment (see subsection (8)) in the principal; and (b) the associate has significant influence over the principal; and (c) the interest is material to the associate.
(6) This subsection is satisfied if: (a) the principal has a qualifying investment (see subsection (8)) in the associate; and (b) the principal has significant influence over the associate; and (c) the interest is material to the principal.
(7) This subsection is satisfied if: (a) an entity (the third entity) controls both the principal and the associate; and (b) the operations, resources or affairs of the principal and the associate are both material to the third entity.
Chapter 7: ConclusionAppendices 297 298
(8) For the purposes of this section, one entity (the first entity) has a qualifying investment in another entity (the second entity) if the first entity: (a) has an asset that is an investment in the second entity; or (b) has an asset that is the beneficial interest in an investment in the second entity and has control over that asset.
50AA Control
(1) For the purposes of this Act, an entity controls a second entity if the first entity has the capacity to determine the outcome of decisions about the second entity’s financial and operating policies.
(2) In determining whether the first entity has this capacity: (a) the practical influence the first entity can exert (rather than the rights it can enforce) is the issue to be considered; and (b) any practice or pattern of behaviour affecting the second entity’s financial or operating policies is to be taken into account (even if it involves a breach of an agreement or a breach of trust).
(3) The first entity does not control the second entity merely because the first entity and a third entity jointly have the capacity to determine the outcome of decisions about the second entity’s financial and operating policies.
(4) If the first entity: (a) has the capacity to influence decisions about the second entity’s financial and operating policies; and (b) is under a legal obligation to exercise that capacity for the benefit of someone other than the first entity’s members; the first entity is taken not to control the second entity.
95A Solvency and insolvency
(1) A person is solvent if, and only if, the person is able to pay all the person’s debts, as and when they become due and payable.
(2) A person who is not solvent is insolvent.
295 Contents of annual financial report
Basic contents
(1) The financial report for a financial year consists of: (a) the financial statements for the year; and (b) the notes to the financial statements; and (c) the directors’ declaration about the statements and notes.
Financial statements
(2) The financial statements for the year are: (a) the financial statements in relation to the entity reported on that are required by the accounting standards; and (b) if required by the accounting standards—the financial statements in relation to the consolidated entity that are required by the accounting standards.
Notes to financial statements
(3) The notes to the financial statements are: (a) disclosures required by the regulations; and (b) notes required by the accounting standards; and
298 Appendices 299
(c) any other information necessary to give a true and fair view (see section 297).
Directors’ declaration
(4) The directors’ declaration is a declaration by the directors: (c) whether, in the directors’ opinion, there are reasonable grounds to believe that the company, registered scheme or disclosing entity will be able to pay its debts as and when they become due and payable; and (d) whether, in the directors’ opinion, the financial statement and notes are in accordance with this Act, including: (i) section 296 (compliance with accounting standards); and (ii) section 297 (true and fair view); and (e) if the company, disclosing entity or registered scheme is listed—that the directors have been given the declarations required by section 295A. Note: See paragraph 285(3)(c) for the reference to the debts of a registered scheme.
(5) The declaration must: (a) be made in accordance with a resolution of the directors; and (b) specify the date on which the declaration is made; and (c) be signed by a director.
295A Declaration in relation to listed entity’s financial statements by chief executive officer and chief financial officer
(1) If the company, disclosing entity or registered scheme is listed, the directors’ declaration under subsection 295(4) must be made only after each person who performs: (a) a chief executive function; or (b) a chief financial officer function; in relation to the company, disclosing entity or registered scheme has given the directors a declaration under subsection (2) of this section.
(2) The declaration is a declaration whether, in the person’s opinion: (a) the financial records of the company, disclosing entity or registered scheme for the financial year have been properly maintained in accordance with section 286; and (b) the financial statements, and the notes referred to in paragraph 295(3)(b), for the financial year comply with the accounting standards; and (c) the financial statements and notes for the financial year give a true and fair view (see section 297); and (d) any other matters that are prescribed by the regulations for the purposes of this paragraph in relation to the financial statements and the notes for the financial year are satisfied.
(3) The declaration must: (a) be made in writing; and (b) specify the date on which the declaration is made; and (c) specify the capacity in which the person is making the declaration; and (d) be signed by the person making the declaration. A person who performs both a chief executive function and a chief financial officer function may make a single declaration in both capacities.
(4) A person performs a chief executive function in relation to the company, disclosing entity or registered scheme if the person is the person who is primarily and directly responsible to the directors for the general and overall management of the company, disclosing entity or registered scheme.
(5) If there is no one person who performs a chief executive function in relation to the company, disclosing entity or registered scheme under subsection (4), a person performs
Appendices 299 300
a chief executive function in relation to the company, disclosing entity or registered scheme if the person is one of a number of people who together are primarily and directly responsible to the directors for the general and overall management of the company, disclosing entity or registered scheme.
(6) A person performs a chief financial officer function in relation to the company, disclosing entity or registered scheme if that person is the person who is: (a) primarily responsible for financial matters in relation to the company, disclosing entity or registered scheme; and (b) directly responsible for those matters to either: (i) the directors; or (ii) the person or persons who perform the chief executive function in relation to the company.
(7) If there is no one person who performs a chief financial officer function in relation to the company, disclosing entity or registered scheme under subsection (6), a person performs a chief financial officer function in relation to the company, disclosing entity or registered scheme if the person is one of a number of people who together are: (a) primarily responsible for financial matters in relation to the company, disclosing entity or registered scheme; and (b) directly responsible for those matters to either: (i) the directors; or (ii) the person or persons who perform the chief executive function in relation to the company.
(8) Nothing in this section derogates from the responsibility that a director has for ensuring that financial statements comply with this Act.
296 Compliance with accounting standards and regulations
(1) The financial report for a financial year must comply with the accounting standards. However, a small proprietary company’s report does not have to comply with particular accounting standards if: (a) the report is prepared in response to a shareholder direction under section 293; and (b) the direction specifies that the report does not have to comply with those accounting standards.
(2) The financial report must comply with any further requirements in the regulations.
297 True and fair view
The financial statements and notes for a financial year must give a true and fair view of: (a) the financial position and performance of the company, registered scheme or disclosing entity; and (b) if consolidated financial statements are required—the financial position and performance of the consolidated entity. This section does not affect the obligation under section 296 for a financial report to comply with accounting standards. Note: If the financial statements and notes prepared in compliance with the accounting standards would not give a true and fair view, additional information must be included in the notes to the financial statements under paragraph 295(3)(c).
437A Role of administrator (1) While a company is under administration, the administrator: (a) has control of the company’s business, property and affairs; and
300 Appendices 301
(b) may carry on that business and manage that property and those affairs; and (c) may terminate or dispose of all or part of that business, and may dispose of any of that property; and (d) may perform any function, and exercise any power, that the company or any of its officers could perform or exercise if the company were not under administration. (2) Nothing in subsection (1) limits the generality of anything else in it.
437 B When performing a function, or exercising a power, as administrator of a company under administration, the administrator is taken to be acting as the company’s agent.
439A Administrator to convene meeting and inform creditors
(1) The administrator of a company under administration must convene a meeting of the company’s creditors within the convening period as fixed by subsection (5) or extended under subsection (6). Note: For body corporate representatives’ powers at a meeting of the company’s creditors, see section 250D.
(2) The meeting must be held within 5 business days before, or within 5 business days after, the end of the convening period.
(3) The administrator must convene the meeting by: (a) giving written notice of the meeting to as many of the company’s creditors as reasonably practicable; and (b) causing notice of the meeting to be published: (i) in a national newspaper; or (ii) in each State or Territory in which the company has its registered office or carries on business, in a daily newspaper that circulates generally in that State or Territory; at least 5 business days before the meeting. Note: For electronic notification under paragraph (a), see section 600G.
(4) The notice given to a creditor under paragraph (3)(a) must be accompanied by a copy of: (a) a report by the administrator about the company’s business, property, affairs and financial circumstances; and (b) a statement setting out the administrator’s opinion about each of the following matters: (i) whether it would be in the creditors’ interests for the company to execute a deed of company arrangement; (ii) whether it would be in the creditors’ interests for the administration to end; (iii) whether it would be in the creditors’ interests for the company to be wound up; and also setting out: (iv) his or her reasons for those opinions; and (v) such other information known to the administrator as will enable the creditors to make an informed decision about each matter covered by subparagraph (i), (ii) or (iii); and (c) if a deed of company arrangement is proposed—a statement setting out details of the proposed deed. Note: For electronic notification, see section 600G.
Appendices 301 302
(5) The convening period is: (a) if the day after the administration begins is in December, or is less than 25 business days before Good Friday—the period of 25 business days beginning on: (i) that day; or (ii) if that day is not a business day—the next business day; or (b) otherwise—the period of 20 business days beginning on: (i) the day after the administration begins; or (ii) if that day is not a business day—the next business day.
(6) The Court may extend the convening period on an application made during or after the period referred to in paragraph (5)(a) or (b), as the case requires.
(7) If an application is made under subsection (6) after the period referred to in paragraph (5)(a) or (b), as the case may be, the Court may only extend the convening period if the Court is satisfied that it would be in the best interests of the creditors if the convening period were extended in accordance with the application.
(8) If an application is made under subsection (6) after the period referred to in paragraph (5)(a) or (b), as the case may be, then, in making an order about the costs of the application, the Court must have regard to: (a) the fact that the application was made after that period; and (b) any other conduct engaged in by the administrator; and (c) any other relevant matters.
439B Conduct of meeting
(1) At a meeting convened under section 439A, the administrator is to preside.
(2) A meeting convened under section 439A may be adjourned from time to time, but the period of the adjournment, or the total of the periods of adjournment, must not exceed 45 business days.
439C What creditors may decide
At a meeting convened under section 439A, the creditors may resolve: (a) that the company execute a deed of company arrangement specified in the resolution (even if it differs from the proposed deed (if any) details of which accompanied the notice of meeting); or (b) that the administration should end; or (c) that the company be wound up.
440D Stay of proceedings
(1) During the administration of a company, a proceeding in a court against the company or in relation to any of its property cannot be begun or proceeded with, except: (a) with the administrator’s written consent; or (b) with the leave of the Court and in accordance with such terms (if any) as the Court imposes.
(2) Subsection (1) does not apply to: (a) a criminal proceeding; or (b) a prescribed proceeding.
471B Stay of proceedings and suspension of enforcement process
While a company is being wound up in insolvency or by the Court, or a provisional liquidator of a company is acting, a person cannot begin or proceed with: (a) a proceeding in a court against the company or in relation to property of the company; or
302 Appendices 303
(b) enforcement process in relation to such property; except with the leave of the Court and in accordance with such terms (if any) as the Court imposes.
533 Reports by liquidator
(1) If it appears to the liquidator of a company, in the course of a winding up of the company, that: (a) a past or present officer or employee, or a member or contributory, of the company may have been guilty of an offence under a law of the Commonwealth or a State or Territory in relation to the company; or (b) a person who has taken part in the formation, promotion, administration, management or winding up of the company: (i) may have misapplied or retained, or may have become liable or accountable for, any money or property of the company; or (ii) may have been guilty of any negligence, default, breach of duty or breach of trust in relation to the company; or (c) the company may be unable to pay its unsecured creditors more than 50 cents in the dollar; the liquidator must: (d) as soon as practicable, and in any event within 6 months, after it so appears to him or her, lodge a report with respect to the matter and state in the report whether he or she proposes to make an application for an examination or order under section 597; and (e) give ASIC such information, and give to it such access to and facilities for inspecting and taking copies of any documents, as ASIC requires.
(2) The liquidator may also, if he or she thinks fit, lodge further reports specifying any other matter that, in his or her opinion, it is desirable to bring to the notice of ASIC.
(3) If it appears to the Court, in the course of winding up a company: (a) that a past or present officer or employee, or a contributory or member, of the company has been guilty of an offence under a law referred to in paragraph (1)(a) in relation to the company; or (b) that a person who has taken part in the formation, promotion, administration, management or winding up of the company has engaged in conduct referred to in paragraph (1)(b) in relation to the company; and that the liquidator has not lodged with ASIC a report with respect to the matter, the Court may, on the application of a person interested in the winding up, direct the liquidator so to lodge such a report.
558 Debts due to employees
(1) Where a contract of employment with a company being wound up was subsisting immediately before the relevant date, the employee under the contract is, whether or not he or she is a person referred to in subsection (2), entitled to payment under section 556 as if his or her services with the company had been terminated by the company on the relevant date.
(2) Where, for the purposes of the winding up of a company, a liquidator employs a person whose services with the company had been terminated by reason of the winding up, that person is, for the purpose of calculating any entitlement to payment for leave of absence, or any entitlement to a retrenchment amount in respect of employment, taken, while the liquidator employs him or her for those purposes, to be employed by the company.
(3) Subject to subsection (4), where, after the relevant date, an amount in respect of long service leave or extended leave, or a retrenchment amount, becomes payable to a person
Appendices 303 304
referred to in subsection (2) in respect of the employment so referred to, the amount is a cost of the winding up.
(4) Where, at the relevant date, the length of qualifying service of a person employed by a company that is being wound up is insufficient to entitle him or her to any amount in respect of long service leave or extended leave, or to any retrenchment amount in respect of employment by the company, but, by the operation of subsection (2) he or she becomes entitled to such an amount after that date, that amount: (a) is a cost of the winding up to the extent of an amount that bears to that amount the same proportion as the length of his or her qualifying service after that relevant date bears to the total length of his or her qualifying service; and (b) is, to the extent of the balance of that amount, taken, for the purposes of section 556, to be an amount referred to in paragraph 556(1)(g), or a retrenchment payment payable to the person, as the case may be.
(5) In this section, retrenchment amount, in relation to employment of a person, means an amount payable to the person, by virtue of an industrial instrument, in respect of termination of the employment.
______Income Tax Assessment Act 1997 (Cth)
40-880 Business related costs
Object
(1) The object of this section is to make certain business capital expenditure deductible over 5 years if: (a) the expenditure is not otherwise taken into account; and (b) a deduction is not denied by some other provision; and (c) the business is, was or is proposed to be carried on for a taxable purpose. Note: If Division 250 applies to you and an asset: (a) if section 250-150 applies—you can deduct an amount for capital expenditure you incur in relation to the asset to the extent specified in a determination made under subsection 250-150(3); or (b) otherwise—you cannot deduct an amount for such expenditure.
Deduction
(2) You can deduct, in equal proportions over a period of 5 income years starting in the year in which you incur it, capital expenditure you incur: (a) in relation to your business; or (b) in relation to a business that used to be carried on; or (c) in relation to a business proposed to be carried on; or (d) to liquidate or deregister a company of which you were a member, to wind up a partnership of which you were a partner or to wind up a trust of which you were a beneficiary, that carried on a business.
Limitations and exceptions
(3) You can only deduct the expenditure, for a business that you carry on, used to carry on or propose to carry on, to the extent that the business is carried on, was carried on or is proposed to be carried on for a taxable purpose.
(4) You can only deduct the expenditure, for a business that another entity used to carry on or proposes to carry on, to the extent that: (a) the business was carried on or is proposed to be carried on for a taxable purpose; and
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(b) the expenditure is in connection with: (i) your deriving assessable income from the business; and (ii) the business that was carried on or is proposed to be carried on.
(5) You cannot deduct anything under this section for an amount of expenditure you incur to the extent that: (a) it forms part of the cost of a depreciating asset that you hold, used to hold or will hold; or (b) you can deduct an amount for it under a provision of this Act other than this section; or (c) it forms part of the cost of land; or (d) it is in relation to a lease or other legal or equitable right; or (e) it would, apart from this section, be taken into account in working out: (i) a profit that is included in your assessable income (for example, under section 6-5 or 15-15); or (ii) a loss that you can deduct (for example, under section 8-1 or 25-40); or (f) it could, apart from this section, be taken into account in working out the amount of a capital gain or capital loss from a CGT event; or (g) a provision of this Act other than this section would expressly make the expenditure non-deductible if it were not of a capital nature; or (h) a provision of this Act other than this section expressly prevents the expenditure being taken into account as described in paragraphs (a) to (f) for a reason other than the expenditure being of a capital nature; or (i) it is expenditure of a private or domestic nature; or (j) it is incurred in relation to gaining or producing exempt income or non-assessable non-exempt income.
(6) The exceptions in paragraphs (5)(d) and (f) do not apply to expenditure you incur to preserve (but not enhance) the value of goodwill if the expenditure you incur is in relation to a legal or equitable right and the value to you of the right is solely attributable to the effect that the right has on goodwill.
(7) You cannot deduct an amount under paragraph (2)(c) in relation to a business proposed to be carried on unless, having regard to any relevant circumstances, it is reasonable to conclude that the business is proposed to be carried on within a reasonable time.
(8) You cannot deduct anything under this section for an amount of expenditure that, because of a market value substitution rule, was excluded from the cost of a depreciating asset or the cost base or reduced cost base of a CGT asset. Note: Some examples of market value substitution rules are subsection 40-180(2) (table item 8), subsection 40-190(3) (table item 1) and sections 40-765 and 112-20.
(9) You cannot deduct anything under this section for an amount of expenditure you incur: (a) by way of returning an amount you have received (except to the extent that the amount was included in your assessable income or taken into account in working out an amount so included); or (b) to the extent that, for another entity, the amount is a return on or of: (i) an equity interest; or (ii) a debt interest that is an obligation of yours.
______
Appendices 305 306
Trade Marks Act 1995 (Cth)
s 8 ‘authorised users’ 8 (1) … uses the trade mark in relation to goods or services under the control of the owner of the trade mark 20 Rights given by registration of trade mark (1) If a trade mark is registered, the registered owner of the trade mark has, subject to this Part, the exclusive rights: (a) to use the trade mark; and (b) to authorise other persons to use the trade mark; in relation to the goods and/or services in respect of which the trade mark is registered. (2) The registered owner of a trade mark has also the right to obtain relief under this Act if the trade mark has been infringed. (3) omitted (4) If the trade mark is registered subject to conditions or limitations, the rights of the registered owner are restricted by those conditions or limitations. (5) If the trade mark is registered in the name of 2 or more persons as joint owners of the trade mark, the rights granted to those persons under this section are to be exercised by them as if they were the rights of a single person
21 Nature of registered trade mark as property (1) A registered trade mark is personal property. (2) Equities in respect of a registered trade mark may be enforced in the same way as equities in respect of any other personal property.
S 22 Power of registered owner to deal with trade mark (1) The registered owner of a trade mark may, subject only to any rights appearing in the Register to be vested in another person, deal with the trade mark as its absolute owner and give in good faith discharges for any consideration for that dealing
26 Powers of authorised user of registered trade mark (1) Subject to any agreement between the registered owner of a registered trade mark and an authorised user of the trade mark, the authorised user may do any of the following: (a) the authorised user may use the trade mark in relation to the goods and/or services in respect of which the trade mark is registered, subject to any condition or limitation subject to which the trade mark is registered; (b) the authorised user may (subject to subsection (2)) bring an action for infringement of the trade mark: (i) at any time, with the consent of the registered owner; or (ii) during the prescribed period, if the registered owner refuses to bring such an action on a particular occasion during the prescribed period; or (iii) after the end of the prescribed period, if the registered owner has failed to bring such an action during the prescribed period; (c) the authorised user may cause to be displayed on goods in respect of which the trade mark is registered, or on their package, or on the container in which they are offered to the public, a notice prohibiting any act that is under subsection 121(2) a prohibited act in relation to the goods; (d) the authorised user may: (i) give to the Customs CEO a notice under section 132 objecting to the importation of goods that infringe the trade mark; or (ii) revoke such a notice; (e) an authorised user may give permission to any person:
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(i) to alter or deface; or (ii) to make any addition to; or (iii) to remove, erase or obliterate, wholly or partly; a registered trade mark that is applied to any goods, or in relation to any goods or services, in respect of which the trade mark is registered; (f) the authorised user may give permission to any person to apply the trade mark to goods, or in relation to goods or services, in respect of which the trade mark is registered. Note 1: For registered owner and registered trade mark see section 6. Note 2: For authorised user see section 8. Note 3: For what amounts to an infringement of a trade mark see Part 12. Note 4: For apply to and apply in relation to see section 9. (2) If the authorised user brings an action for infringement of the trade mark, the authorised user must make the registered owner of the trade mark a defendant in the action. However, the registered owner is not liable for costs if he or she does not take part in the proceedings. Part 10—Assignment and transmission of trade marks S 106 Assignment etc. of trade mark (1) A registered trade mark, or a trade mark whose registration is being sought, may be assigned or transmitted in accordance with this section. (2) The assignment or transmission may be partial, that is, it may apply to some only of the goods and/or services in respect of which registration is sought or the trade mark is registered, but it may not be partial in relation to the use of a trade mark in a particular area. (3) The assignment or transmission may be with or without the goodwill of the business concerned in the relevant goods and/or services. 107 Applications for record to be made of assignment etc. of trade mark whose registration is sought (1) If a trade mark whose registration is being sought is assigned or transmitted: (a) the applicant for the registration of the trade mark; or (b) the person to whom it has been assigned or transmitted; must apply to the Registrar for the assignment or transmission to be recorded. (2) The application must: (a) be in an approved form; and (b) be filed, together with any prescribed document, in accordance with the regulations. Part 11—Voluntary recording of claims to interests in and rights in respect of trade marks Div 1—Preliminary 112 Object of Part: This Part makes provision: (a) for recording in the Register claims to interests in, and rights in respect of, registered trade marks that may not be so recorded under another Part; and (b) for the Registrar to keep a record of claims to interests in, and rights in respect of, trade marks for which registration is sought.
Appendices 307 308
Trade Practices Act 1974 (Cth) http://www.comlaw.gov.au/ComLaw/Legislation/ActCompilation1.nsf/0/C7F0 8B8A219DB518CA2575FC0082807A?OpenDocument
2 Object of this Act
The object of this Act is to enhance the welfare of Australians through the promotion of competition and fair trading and provision for consumer protection.
4B Consumers
(1) For the purposes of this Act, unless the contrary intention appears: (a) a person shall be taken to have acquired particular goods as a consumer if, and only if: (i) the price of the goods did not exceed the prescribed amount; or (ii) where that price exceeded the prescribed amount—the goods were of a kind ordinarily acquired for personal, domestic or household use or consumption or the goods consisted of a commercial road vehicle; and the person did not acquire the goods, or hold himself or herself out as acquiring the goods, for the purpose of re-supply or for the purpose of using them up or transforming them, in trade or commerce, in the course of a process of production or manufacture or of repairing or treating other goods or fixtures on land; and (b) a person shall be taken to have acquired particular services as a consumer if, and only if: (i) the price of the services did not exceed the prescribed amount; or (ii) where that price exceeded the prescribed amount—the services were of a kind ordinarily acquired for personal, domestic or household use or consumption.
(2) For the purposes of subsection (1): (a) the prescribed amount is $40,000 or, if a greater amount is prescribed for the purposes of this paragraph, that greater amount; (b) subject to paragraph (c), the price of goods or services purchased by a person shall be taken to have been the amount paid or payable by the person for the goods or services; (c) where a person purchased goods or services together with other property or services, or with both other property and services, and a specified price was not allocated to the goods or services in the contract under which they were purchased, the price of the goods or services shall be taken to have been: (i) the price at which, at the time of the acquisition, the person could have purchased from the supplier the goods or services without the other property or services; (ii) if, at the time of the acquisition, the goods or services were not available for purchase from the supplier except together with the other property or services but, at that time, goods or services of the kind acquired were available for purchase from another supplier without other property or services—the lowest price at which the person could, at that time, reasonably have purchased goods or services of that kind from another supplier; or (iii) if, at the time of the acquisition, goods or services of the kind acquired were not available for purchase from any supplier except together with other property or services—the value of the goods or services at that time; (d) where a person acquired goods or services otherwise than by way of purchase, the price of the goods or services shall be taken to have been: (i) the price at which, at the time of the acquisition, the person could have purchased the goods or services from the supplier;
308 Appendices 309
(ii) if, at the time of the acquisition, the goods or services were not available for purchase from the supplier or were so available only together with other property or services but, at that time, goods or services of the kind acquired were available for purchase from another supplier—the lowest price at which the person could, at that time, reasonably have purchased goods or services of that kind from another supplier; or (iii) if goods or services of the kind acquired were not available, at the time of the acquisition, for purchase from any supplier or were not so available except together with other property or services—the value of the goods or services at that time; and (e) without limiting by implication the meaning of the expression services in subsection 4(1), the obtaining of credit by a person in connection with the acquisition of goods or services by him or her shall be deemed to be the acquisition by him or her of a service and any amount by which the amount paid or payable by him or her for the goods or services is increased by reason of his or her so obtaining credit shall be deemed to be paid or payable by him or her for that service.
(3) Where it is alleged in any proceeding under this Act or in any other proceeding in respect of a matter arising under this Act that a person was a consumer in relation to particular goods or services, it shall be presumed, unless the contrary is established, that the person was a consumer in relation to those goods or services.
(4) In this section, commercial road vehicle means a vehicle or trailer acquired for use principally in the transport of goods on public roads.
4C Acquisition, supply and re-supply
In this Act, unless the contrary intention appears: (a) a reference to the acquisition of goods includes a reference to the acquisition of property in, or rights in relation to, goods in pursuance of a supply of the goods; (b) a reference to the supply or acquisition of goods or services includes a reference to agreeing to supply or acquire goods or services; (c) a reference to the supply or acquisition of goods includes a reference to the supply or acquisition of goods together with other property or services, or both; (d) a reference to the supply or acquisition of services includes a reference to the supply or acquisition of services together with property or other services, or both; (e) a reference to the re-supply of goods acquired from a person includes a reference to: (i) a supply of the goods to another person in an altered form or condition; and (ii) a supply to another person of goods in which the first-mentioned goods have been incorporated; (f) a reference to the re-supply of services (the original services) acquired from a person (the original supplier) includes a reference to: (i) a supply of the original services to another person in an altered form or condition; and (ii) a supply to another person of other services that are substantially similar to the original services, and could not have been supplied if the original services had not been acquired by the person who acquired them from the original supplier.
51AC Unconscionable conduct in business transactions
(1) A corporation must not, in trade or commerce, in connection with: (a) the supply or possible supply of goods or services to a person (other than a listed public company); or (b) the acquisition or possible acquisition of goods or services from a person (other than a listed public company);
Appendices 309 310
engage in conduct that is, in all the circumstances, unconscionable.
(2) A person must not, in trade or commerce, in connection with: (a) the supply or possible supply of goods or services to a corporation (other than a listed public company); or (b) the acquisition or possible acquisition of goods or services from a corporation (other than a listed public company); engage in conduct that is, in all the circumstances, unconscionable.
(3) Without in any way limiting the matters to which the court may have regard for the purpose of determining whether a corporation or a person (the supplier) has contravened subsection (1) or (2) in connection with the supply or possible supply of goods or services to a person or a corporation (the business consumer), the court may have regard to: (a) the relative strengths of the bargaining positions of the supplier and the business consumer; and (b) whether, as a result of conduct engaged in by the supplier, the business consumer was required to comply with conditions that were not reasonably necessary for the protection of the legitimate interests of the supplier; and (c) whether the business consumer was able to understand any documents relating to the supply or possible supply of the goods or services; and (d) whether any undue influence or pressure was exerted on, or any unfair tactics were used against, the business consumer or a person acting on behalf of the business consumer by the supplier or a person acting on behalf of the supplier in relation to the supply or possible supply of the goods or services; and (e) the amount for which, and the circumstances under which, the business consumer could have acquired identical or equivalent goods or services from a person other than the supplier; and (f) the extent to which the supplier’s conduct towards the business consumer was consistent with the supplier’s conduct in similar transactions between the supplier and other like business consumers; and (g) the requirements of any applicable industry code; and (h) the requirements of any other industry code, if the business consumer acted on the reasonable belief that the supplier would comply with that code; and (i) the extent to which the supplier unreasonably failed to disclose to the business consumer: (i) any intended conduct of the supplier that might affect the interests of the business consumer; and (ii) any risks to the business consumer arising from the supplier’s intended conduct (being risks that the supplier should have foreseen would not be apparent to the business consumer); and (j) the extent to which the supplier was willing to negotiate the terms and conditions of any contract for supply of the goods or services with the business consumer; and (ja) whether the supplier has a contractual right to vary unilaterally a term or condition of a contract between the supplier and the business consumer for the supply of the goods or services; and (k) the extent to which the supplier and the business consumer acted in good faith.
(4) Without in any way limiting the matters to which the court may have regard for the purpose of determining whether a corporation or a person (the acquirer) has contravened subsection (1) or (2) in connection with the acquisition or possible acquisition of goods or services from a person or corporation (the small business supplier), the court may have regard to: (a) the relative strengths of the bargaining positions of the acquirer and the small business supplier; and
310 Appendices 311
(b) whether, as a result of conduct engaged in by the acquirer, the small business supplier was required to comply with conditions that were not reasonably necessary for the protection of the legitimate interests of the acquirer; and (c) whether the small business supplier was able to understand any documents relating to the acquisition or possible acquisition of the goods or services; and (d) whether any undue influence or pressure was exerted on, or any unfair tactics were used against, the small business supplier or a person acting on behalf of the small business supplier by the acquirer or a person acting on behalf of the acquirer in relation to the acquisition or possible acquisition of the goods or services; and (e) the amount for which, and the circumstances in which, the small business supplier could have supplied identical or equivalent goods or services to a person other than the acquirer; and (f) the extent to which the acquirer’s conduct towards the small business supplier was consistent with the acquirer’s conduct in similar transactions between the acquirer and other like small business suppliers; and (g) the requirements of any applicable industry code; and (h) the requirements of any other industry code, if the small business supplier acted on the reasonable belief that the acquirer would comply with that code; and (i) the extent to which the acquirer unreasonably failed to disclose to the small business supplier: (i) any intended conduct of the acquirer that might affect the interests of the small business supplier; and (ii) any risks to the small business supplier arising from the acquirer’s intended conduct (being risks that the acquirer should have foreseen would not be apparent to the small business supplier); and (j) the extent to which the acquirer was willing to negotiate the terms and conditions of any contract for the acquisition of the goods and services with the small business supplier; and (ja) whether the acquirer has a contractual right to vary unilaterally a term or condition of a contract between the acquirer and the small business supplier for the acquisition of the goods or services; and (k) the extent to which the acquirer and the small business supplier acted in good faith.
(5) A person is not to be taken for the purposes of this section to engage in unconscionable conduct in connection with: (a) the supply or possible supply of goods or services to another person; or (b) the acquisition or possible acquisition of goods or services from another person; by reason only that the first-mentioned person institutes legal proceedings in relation to that supply, possible supply, acquisition or possible acquisition or refers to arbitration a dispute or claim in relation to that supply, possible supply, acquisition or possible acquisition.
(6) For the purpose of determining whether a corporation has contravened subsection (1) or whether a person has contravened subsection (2): (a) the court must not have regard to any circumstances that were not reasonably foreseeable at the time of the alleged contravention; and (b) the court may have regard to circumstances existing before the commencement of this section but not to conduct engaged in before that commencement.
(7) A reference in this section to the supply or possible supply of goods or services is a reference to the supply or possible supply of goods or services to a person whose acquisition or possible acquisition of the goods or services is or would be for the purpose of trade or commerce.
(8) A reference in this section to the acquisition or possible acquisition of goods or services is a reference to the acquisition or possible acquisition of goods or services by a person
Appendices 311 312
whose acquisition or possible acquisition of the goods or services is or would be for the purpose of trade or commerce.
(12) Section 51A applies for the purposes of this section in the same way as it applies for the purposes of Division 1 of Part V.
(13) Expressions used in this section that are defined for the purpose of Part IVB have the same meaning in this section as they do in Part IVB.
(14) In this section, listed public company has the same meaning as it has in the Income Tax Assessment Act 1997.
51A Interpretation
(1) For the purposes of this Division, where a corporation makes a representation with respect to any future matter (including the doing of, or the refusing to do, any act) and the corporation does not have reasonable grounds for making the representation, the representation shall be taken to be misleading.
(2) For the purposes of the application of subsection (1) in relation to a proceeding concerning a representation made by a corporation with respect to any future matter, the corporation shall, unless it adduces evidence to the contrary, be deemed not to have had reasonable grounds for making the representation.
(3) Subsection (1) shall be deemed not to limit by implication the meaning of a reference in this Division to a misleading representation, a representation that is misleading in a material particular or conduct that is misleading or is likely or liable to mislead.
52 Misleading or deceptive conduct
(1) A corporation shall not, in trade or commerce, engage in conduct that is misleading or deceptive or is likely to mislead or deceive.
(2) Nothing in the succeeding provisions of this Division shall be taken as limiting by implication the generality of subsection (1). Note: For rules relating to representations as to the country of origin of goods, see Division 1AA (sections 65AA to 65AN).
59 Misleading representations about certain business activities
(1) A corporation shall not, in trade or commerce, make a representation that is false or misleading in a material particular concerning the profitability or risk or any other material aspect of any business activity that the corporation has represented as one that can be, or can be to a considerable extent, carried on at or from a person’s place of residence.
(2) Where a corporation, in trade or commerce, invites, whether by advertisement or otherwise, persons to engage or participate, or to offer or apply to engage or participate, in a business activity requiring the performance by the persons concerned of work, or the investment of moneys by the persons concerned and the performance by them of work associated with the investment, the corporation shall not make, with respect to the profitability or risk or any other material aspect of the business activity, a representation that is false or misleading in a material particular.
Division 2—Conditions and warranties in consumer transactions 66 Interpretation
(1) In this Division: (a) a reference to the quality of goods includes a reference to the state or condition of the goods;
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(b) a reference to a contract does not include a reference to a contract made before the commencing date; (c) a reference to antecedent negotiations in relation to a contract for the supply by a corporation of goods to a consumer is a reference to any negotiations or arrangements conducted or made with the consumer by another person in the course of a business carried on by the other person whereby the consumer was induced to make the contract or which otherwise promoted the transaction to which the contract relates; and (d) a reference to the person by whom any antecedent negotiations were conducted is a reference to the person by whom the negotiations or arrangements concerned were conducted or made.
(2) Goods of any kind are of merchantable quality within the meaning of this Division if they are as fit for the purpose or purposes for which goods of that kind are commonly bought as it is reasonable to expect having regard to any description applied to them, the price (if relevant) and all the other relevant circumstances.
69 Implied undertakings as to title, encumbrances and quiet possession
(1) In every contract for the supply of goods by a corporation to a consumer, other than a contract to which subsection (3) applies, there is: (a) an implied condition that, in the case of a supply by way of sale, the supplier has a right to sell the goods, and, in the case of an agreement to sell or a hire-purchase agreement, the supplier will have a right to sell the goods at the time when the property is to pass; (b) an implied warranty that the consumer will enjoy quiet possession of the goods except so far as it may lawfully be disturbed by the supplier or by another person who is entitled to the benefit of any charge or encumbrance disclosed or known to the consumer before the contract is made; and (c) in the case of a contract for the supply of goods under which the property is to pass or may pass to the consumer—an implied warranty that the goods are free, and will remain free until the time when the property passes, from any charge or encumbrance not disclosed or known to the consumer before the contract is made.
(2) A corporation is not, in relation to a contract for the supply of goods, in breach of the implied warranty referred to in paragraph (1)(c) by reason only of the existence of a floating charge over assets of the corporation unless and until the charge becomes fixed and enforceable by the person to whom the charge is given.
(3) In a contract for the supply of goods by a corporation to a consumer in the case of which there appears from the contract or is to be inferred from the circumstances of the contract an intention that the supplier should transfer only such title as he or she or a third person may have, there is: (a) an implied warranty that all charges or encumbrances known to the supplier and not known to the consumer have been disclosed to the consumer before the contract is made; and (b) an implied warranty that: (i) the supplier; (ii) in a case where the parties to the contract intend that the supplier should transfer only such title as a third person may have—that person; and (iii) anyone claiming through or under the supplier or that third person otherwise than under a charge or encumbrance disclosed or known to the consumer before the contract is made; will not disturb the consumer’s quiet possession of the goods.
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70 Supply by description
(1) Where there is a contract for the supply (otherwise than by way of sale by auction) by a corporation in the course of a business of goods to a consumer by description, there is an implied condition that the goods will correspond with the description, and, if the supply is by reference to a sample as well as by description, it is not sufficient that the bulk of the goods corresponds with the sample if the goods do not also correspond with the description.
(2) A supply of goods is not prevented from being a supply by description for the purposes of subsection (1) by reason only that, being exposed for sale or hire, they are selected by the consumer.
71 Implied undertakings as to quality or fitness
(1) Where a corporation supplies (otherwise than by way of sale by auction) goods to a consumer in the course of a business, there is an implied condition that the goods supplied under the contract for the supply of the goods are of merchantable quality, except that there is no such condition by virtue only of this section: (a) as regards defects specifically drawn to the consumer’s attention before the contract is made; or (b) if the consumer examines the goods before the contract is made, as regards defects which that examination ought to reveal.
(2) Where a corporation supplies (otherwise than by way of sale by auction) goods to a consumer in the course of a business and the consumer, expressly or by implication, makes known to the corporation or to the person by whom any antecedent negotiations are conducted any particular purpose for which the goods are being acquired, there is an implied condition that the goods supplied under the contract for the supply of the goods are reasonably fit for that purpose, whether or not that is a purpose for which such goods are commonly supplied, except where the circumstances show that the consumer does not rely, or that it is unreasonable for him or her to rely, on the skill or judgment of the corporation or of that person.
(3) Subsections (1) and (2) apply to a contract for the supply of goods made by a person who in the course of a business is acting as agent for a corporation as they apply to a contract for the supply of goods made by a corporation in the course of a business, except where that corporation is not supplying in the course of a business and either the consumer knows that fact or reasonable steps are taken to bring it to the notice of the consumer before the contract is made.
72 Supply by sample
Where in a contract for the supply (otherwise than by way of sale by auction) by a corporation in the course of a business of goods to a consumer there is a term in the contract, expressed or implied, to the effect that the goods are supplied by reference to a sample: (a) there is an implied condition that the bulk will correspond with the sample in quality; (b) there is an implied condition that the consumer will have a reasonable opportunity of comparing the bulk with the sample; and (c) there is an implied condition that the goods will be free from any defect, rendering them unmerchantable, that would not be apparent on reasonable examination of the sample.
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74 Warranties in relation to the supply of services
(1) In every contract for the supply by a corporation in the course of a business of services to a consumer there is an implied warranty that the services will be rendered with due care and skill and that any materials supplied in connexion with those services will be reasonably fit for the purpose for which they are supplied.
(2) Where a corporation supplies services (other than services of a professional nature provided by a qualified architect or engineer) to a consumer in the course of a business and the consumer, expressly or by implication, makes known to the corporation any particular purpose for which the services are required or the result that he or she desires the services to achieve, there is an implied warranty that the services supplied under the contract for the supply of the services and any materials supplied in connexion with those services will be reasonably fit for that purpose or are of such a nature and quality that they might reasonably be expected to achieve that result, except where the circumstances show that the consumer does not rely, or that it is unreasonable for him or her to rely, on the corporation’s skill or judgment.
(2A) If: (a) there is a breach of an implied warranty that exists because of this section in a contract made after the commencement of this subsection; and (b) the law of a State or Territory is the proper law of the contract; the law of the State or Territory applies to limit or preclude liability for the breach, and recovery of that liability (if any), in the same way as it applies to limit or preclude liability, and recovery of a liability, for breach of another term of the contract.
(3) A reference in this section to services does not include a reference to services that are, or are to be, provided, granted or conferred under: (a) a contract for or in relation to the transportation or storage of goods for the purposes of a business, trade, profession or occupation carried on or engaged in by the person for whom the goods are transported or stored; or (b) a contract of insurance. Division 2A—Actions against manufacturers and importers of goods
74A Interpretation
(1) In this Division:
express warranty, in relation to goods, means an undertaking, assertion or representation in relation to: (a) the quality, performance or characteristics of the goods; (b) the provision of services that are or may at any time be required in respect of the goods; (c) the supply of parts that are or may at any time be required for the goods; or (d) the future availability of identical goods, or of goods constituting or forming part of a set of which the goods in relation to which the undertaking, assertion or representation is given or made form part; given or made in connection with the supply of the goods or in connection with the promotion by any means of the supply or use of the goods, the natural tendency of which is to induce persons to acquire the goods.
manufactured includes grown, extracted, produced, processed and assembled.
(2) In this Division: (a) a reference to goods shall, unless the contrary intention appears, be read as a reference to goods of a kind ordinarily acquired for personal, domestic or household use or consumption; (aa) a reference to a person who acquires goods from a consumer does not include a reference to a person who acquires goods for the purpose of re-supply;
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(b) a reference to the quality of goods includes a reference to the state or condition of the goods; (c) a reference to antecedent negotiations in relation to the acquisition of goods by a consumer shall be read as a reference to any negotiations or arrangements conducted or made with the consumer by another person in the course of a business carried on by the other person whereby the consumer was induced to acquire the goods or which otherwise promoted the acquisition of the goods by the consumer; and (d) a reference to the person by whom any antecedent negotiations were conducted shall be read as a reference to the person by whom the negotiations or arrangements concerned were conducted or made.
(3) If: (a) a corporation holds itself out to the public as the manufacturer of goods; (b) a corporation causes or permits the name of the corporation, a name by which the corporation carries on business or a brand or mark of the corporation to be applied to goods supplied by the corporation; or (c) a corporation causes or permits another person, in connexion with the supply or possible supply of goods by that other person, or in connexion with the promotion by that other person by any means of the supply or use of goods, to hold out the corporation to the public as the manufacturer of the goods; the corporation shall be deemed, for the purposes of this Division, to have manufactured the goods.
(4) If: (a) goods are imported into Australia by a corporation that was not the manufacturer of the goods; and (b) at the time of the importation the manufacturer of the goods does not have a place of business in Australia; the corporation shall be deemed, for the purposes of this Division, to have manufactured the goods.
(5) For the purposes of paragraph (3)(b): (a) a name, brand or mark shall be deemed to be applied to goods if it: (i) is woven in, impressed on, worked into or annexed or affixed to the goods; or (ii) is applied to a covering, label, reel or thing in or with which the goods are supplied; and (b) if the name of a corporation, a name in which a corporation carries on business or a brand or mark of a corporation is applied to goods, it shall be presumed, unless the contrary is established, that the corporation caused or permitted the name, brand or mark to be applied to the goods.
(6) The reference in subsection (5) to a covering includes a reference to a stopper, glass, bottle, vessel, box, capsule, case, frame or wrapper and the reference in that subsection to a label includes a reference to a band or ticket.
(7) If goods are imported into Australia on behalf of a corporation, the corporation shall be deemed, for the purposes of this Division, to have imported the goods into Australia.
(8) For the purposes of this Division, goods shall be taken to be supplied to a consumer notwithstanding that, at the time of the supply, they are affixed to land or premises.
74B Actions in respect of unsuitable goods
(1) Where:
(a) a corporation, in trade or commerce, supplies goods manufactured by the corporation to another person who acquires the goods for re-supply;
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(b) a person (whether or not the person who acquired the goods from the corporation) supplies the goods (otherwise than by way of sale by auction) to a consumer; (c) the goods are acquired by the consumer for a particular purpose that was, expressly or by implication, made known to the corporation, either directly, or through the person from whom the consumer acquired the goods or a person by whom any antecedent negotiations in connexion with the acquisition of the goods were conducted; (d) the goods are not reasonably fit for that purpose, whether or not that is a purpose for which such goods are commonly supplied; and (e) the consumer or a person who acquires the goods from, or derives title to the goods through or under, the consumer suffers loss or damage by reason that the goods are not reasonably fit for that purpose; the corporation is liable to compensate the consumer or that other person for the loss or damage and the consumer or that other person may recover the amount of the compensation by action against the corporation in a court of competent jurisdiction. (2) Subsection (1) does not apply:
(a) if the goods are not reasonably fit for the purpose referred to in that subsection by reason of: (i) an act or default of any person (not being the corporation or a servant or agent of the corporation); or (ii) a cause independent of human control; occurring after the goods have left the control of the corporation; or (b) where the circumstances show that the consumer did not rely, or that it was unreasonable for the consumer to rely, on the skill or judgment of the corporation.
74C Actions in respect of false descriptions
(1) Where: (a) a corporation, in trade or commerce, supplies goods manufactured by the corporation to another person who acquires the goods for re-supply; (b) a person (whether or not the person who acquired the goods from the corporation) supplies the goods (otherwise than by way of sale by auction) to a consumer by description; (c) the goods do not correspond with the description; and (d) the consumer or a person who acquires the goods from, or derives title to the goods through or under, the consumer suffers loss or damage by reason that the goods do not correspond with the description; the corporation is liable to compensate the consumer or that other person for the loss or damage and the consumer or that other person may recover the amount of the compensation by action against the corporation in a court of competent jurisdiction.
(2) Subsection (1) does not apply if the goods do not correspond with the description referred to in that subsection by reason of: (a) an act or default of any person (not being the corporation or a servant or agent of the corporation); or (b) a cause independent of human control; occurring after the goods have left the control of the corporation.
(3) A corporation is not liable to compensate a person for loss or damage suffered by the person by reason that goods do not correspond with a description unless the description was applied to the goods: (a) by or on behalf of the corporation; or (b) with the consent of the corporation, whether express or implied.
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(4) If the goods referred to in subsection (1) are supplied to the consumer by reference to a sample as well as by description, it is not a defence to an action under this section that the bulk of the goods corresponds with the sample if the goods do not also correspond with the description.
(5) A supply of goods is not prevented from being a supply by description for the purposes of subsection (1) by reason only that, being exposed for sale or hire, they are selected by the consumer.
75B Interpretation
(1) A reference in this Part to a person involved in a contravention of a provision of Part IV, IVA, IVB, V or VC, or of section 75AU, 75AYA or 95AZN, shall be read as a reference to a person who: (a) has aided, abetted, counselled or procured the contravention; (b) has induced, whether by threats or promises or otherwise, the contravention; (c) has been in any way, directly or indirectly, knowingly concerned in, or party to, the contravention; or (d) has conspired with others to effect the contravention.
(2) In this Part, unless the contrary intention appears: (a) a reference to the Court in relation to a matter is a reference to any court having jurisdiction in the matter; (b) a reference to the Federal Court is a reference to the Federal Court of Australia; and (c) a reference to a judgment is a reference to a judgment, decree or order, whether final or interlocutory. ______Trade Practices (Industry Codes - Franchising) Regulations 1998 (Franchising Code of Conduct) (Cth) Part 1 Preliminary
2 Purpose of code The purpose of this code is to regulate the conduct of participants in franchising towards other participants in franchising
3 Definitions associate, for a franchisor, means a person: (a) who: (i) is a director or related body corporate, or a director of a related body corporate, of the franchisor; or (ii) for a franchisor that is a proprietary company — directly or indirectly owns, controls, or holds with power to vote, at least 15% of the issued voting shares in the franchisor; or (iii) is a partner of the franchisor; and (b) whose relationship with the franchisor is relevant to the franchise system, including supplying goods, real property or services to a franchisee. disclosure document has the meaning given by clause 6. franchise includes the following:
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(a) the rights and obligations under a franchise agreement; (b) a master franchise; (c) a subfranchise; (d) an interest in a franchise. franchise agreement has the meaning given by clause 4. franchisee includes the following: (a) a person to whom a franchise is granted; (b) a person who otherwise participates in a franchise as a franchisee; (c) a subfranchisor in its relationship with a franchisor; (d) a subfranchisee in its relationship with a subfranchisor. franchise system includes a business system in which a franchisor grants a franchise to a franchisee. franchisor includes the following: (a) a person who grants a franchise; (b) a person who otherwise participates in a franchise as a franchisor; (c) a subfranchisor in its relationship with a subfranchisee; (d) a master franchisee in a master franchise system; (e) a master franchisee in its relationship with a franchisee. interest in a franchise includes a legal or beneficial interest in: (a) a franchise agreement or a franchised business; or (b) shares or voting rights in a corporation, not being a listed corporation that owns a franchised business; or (c) units or voting rights in a unit or other trust that owns a franchised business; or (d) the capital or income of a partnership that owns a franchised business.
4 Meaning of franchise agreement (1) A franchise agreement is an agreement: (a) that takes the form, in whole or part, of any of the following: (i) a written agreement; (ii) an oral agreement; (iii) an implied agreement; and (b) in which a person (the franchisor) grants to another person (the franchisee) the right to carry on the business of offering, supplying or distributing goods or services in Australia under a system or marketing plan substantially determined, controlled or suggested by the franchisor or an associate of the franchisor; and (c) under which the operation of the business will be substantially or materially associated with a trade mark, advertising or a commercial symbol: (i) owned, used or licensed by the franchisor or an associate of the franchisor; or (ii) specified by the franchisor or an associate or the franchisor; and (d) under which, before starting business or continuing the business, the franchisee must pay or agree to pay to the franchisor or an associate of the franchisor an amount including, for example: (i) an initial capital investment fee; or
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(ii) a payment for goods or services; or (iii) a fee based on a percentage of gross or net income whether or not called a royalty or franchise service fee; or (iv) a training fee or training school fee; but excluding:
(v) payment for goods and services at or below their usual wholesale price; or (vi) repayment by the franchisee of a loan from the franchisor; or (vii) payment of the usual wholesale price for goods taken on consignment; or (viii) payment of market value for purchase or lease of real property, fixtures, equipment or supplies needed to start business or to continue business under the franchise agreement.
(2) For subclause (1), each of the following is taken to be a franchise agreement: (a) transfer, renewal or extension of a franchise agreement; (b) a motor vehicle dealership agreement.
(3) However, any of the following does not in itself constitute a franchise agreement: (a) an employer and employee relationship; (b) a partnership relationship; (c) a landlord and tenant relationship; (d) a mortgagor and mortgagee relationship; (e) a lender and borrower relationship; (f) the relationship between the members of a cooperative that is registered, incorporated or formed under any of the following laws: (i) Co-operatives Act 1992 of New South Wales; (ii) Co-operatives Act 1996 of Victoria; (iii) Cooperatives Act 1997 of Queensland; (iv) Co-operative and Provident Societies Act 1903 of Western Australia; (v) Co-operatives Act 1997 of South Australia; (vi) Co-operative Industrial Societies Act 1928 of Tasmania; (vii) Co-operative Societies Act 1939 of the Australian Capital Territory; (viii) Co-operatives Act 1997 of the Northern Territory; (ix) the Corporations Act 2001.
Part 2 Disclosure
Division 2.1 Disclosure document
6 Franchisor must maintain a disclosure document (1) A franchisor must, before entering into a franchise agreement, and within 4 months after the end of each financial year after entering into a franchise agreement, create a document (a disclosure document) for the franchise in accordance with this Division.
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(2) A disclosure document: (a) must be: (i) if the franchised business has an expected annual turnover at any time during the term of the franchise agreement of $50 000 or more — in accordance with Annexure 1; or (ii) if the franchised business has an expected annual turnover of less than $50 000 — in accordance with Annexure 1 or 2; and (b) may include additional information under the heading ‘Other relevant disclosure information’; and (c) must be signed by a director or other officer of the franchisor.
6A Purpose of disclosure document The purposes of a disclosure document are: (a) to give to a prospective franchisee, or a franchisee proposing to enter into, renew or extend a franchise agreement, information from the franchisor to help the franchisee to make a reasonably informed decision about the franchise; and (b) to give a franchisee current information from the franchisor that is material to the running of the franchised business.
6B Requirement to give disclosure document (1) A franchisor must give a current disclosure document to: (a) a prospective franchisee; or (b) a franchisee proposing to: (i) renew a franchise agreement; or (ii) extend the scope or term of a franchise agreement. (2) If a subfranchisor proposes to grant a subfranchise to a prospective subfranchisee: (a) the franchisor and subfranchisor must: (i) give separate disclosure documents, in relation to the master franchise and the subfranchise respectively, to the prospective subfranchisee; or (ii) give to the prospective subfranchisee a joint disclosure document that addresses the respective obligations of the franchisor and the subfranchisor; and (b) the subfranchisor must comply with the requirements imposed on a franchisor by this Part. Note A subfranchisor is also sometimes referred to as a master franchisee: see subclause 3 (1).
6C Additional information If a franchisee or prospective franchisee who is given a disclosure document in accordance with Annexure 2 asks the franchisor for the information referred to in sections 3, 5, 6, 9, 10, 11, 14, 17, 18, 19, 21 and 22 of Annexure 1, the franchisor must give that information.
Division 2.2 Before franchise agreement
8 Application This Division applies to a disclosure document in accordance with Annexure 1 or 2 for:
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(a) a prospective franchisee; or (b) a franchisee proposing to enter into, renew or extend a franchise agreement.
10 Franchisor obligations A franchisor must give: (a) a copy of this code; and (b) a disclosure document; and (c) a copy of the franchise agreement, in the form in which it is to be executed; to:
(d) a prospective franchisee at least 14 days before the prospective franchisee: (i) enters into a franchise agreement or an agreement to enter into a franchise agreement; or (ii) makes a non-refundable payment (whether of money or of other valuable consideration) to the franchisor or an associate of the franchisor in connection with the proposed franchise agreement; or (e) a franchisee at least 14 days before renewal or extension of the franchise agreement. Note Subsection 9 (1) of the Electronic Transactions Act 1999 provides that a requirement under a law of the Commonwealth to give information in writing is satisfied by giving the information electronically if it is reasonable to expect that the information will be readily accessible so as to be useable for subsequent reference, and the person to whom the information is given consents to it being provided electronically.
11 Advice before entering into franchise agreement (1) The franchisor must not: (a) enter into, renew or extend a franchise agreement; or (b) enter into an agreement to enter into, renew or extend a franchise agreement; or (c) receive a non-refundable payment (whether of money or of other valuable consideration) under a franchise agreement or an agreement to enter into a franchise agreement; unless the franchisor has received from the franchisee or prospective franchisee a written statement that the franchisee or prospective franchisee has received, read and had a reasonable opportunity to understand the disclosure document and this code.
(2) Before a franchise agreement is entered into, the franchisor must have received from the prospective franchisee: (a) signed statements, that the prospective franchisee has been given advice about the proposed franchise agreement or franchised business, by any of: (i) an independent legal adviser; (ii) an independent business adviser: (iii) an independent accountant; or (b) for each kind of statement not received under paragraph (a), a signed statement by the prospective franchisee that the prospective franchisee: (i) has been given that kind of advice about the proposed franchise agreement or franchised business; or (ii) has been told that that kind of advice should be sought but has decided not to seek it.
(3) Subclause (2):
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(a) does not apply to the renewal or extension of a franchise agreement with a franchisor; and (b) does not prevent the franchisor from requiring any or all of the statements mentioned in paragraph (2) (a).
14 Copy of lease (1) If a franchisee leases premises from the franchisor or an associate of the franchisor for the purposes of a franchised business, the franchisor or the associate from which the premises are leased must give to the franchisee 1 of the documents mentioned in subclause (2) within 1 month after the lease or agreement to lease is signed by the parties.
(2) For subclause (1), the documents are: (a) a copy of the agreement to lease; (b) a copy of the lease.
(3) If the franchisee occupies, without a lease, premises leased by the franchisor or an associate of the franchisor, the franchisor or the associate who leases the premises must give to the franchisee 1 of the documents mentioned in subclause (4) within 1 month after: (a) the occupation commences; or (b) for the documents mentioned in paragraph (4) (b) — the documents are signed by the parties.
(4) For subclause (3), the documents are: (a) a copy of the franchisor’s or associate’s lease or agreement to lease; (b) a copy of the documents that give the franchisee rights to occupy the premises; (c) written details of the conditions of occupation.
15 Association of franchisees or prospective franchisees A franchisor must not induce a franchisee or prospective franchisee: (a) not to form an association; or (b) not to associate with other franchisees or prospective franchisees for a lawful purpose.
18 Disclosure of materially relevant facts
(1) If a disclosure document does not mention a matter mentioned in subclause (2), the franchisor must tell a franchisee or prospective franchisee about the matter, in writing, within a reasonable time (but not more than 14 days) after the franchisor becomes aware of it.
(2) For subclause (1), the matters are the following: (a) change in majority ownership or control of the franchisor; (b) proceedings by a public agency, a judgment in criminal or civil proceedings or an award in an arbitration against the franchisor or a franchisor director in Australia alleging: (i) breach of a franchise agreement; or (ii) contravention of trade practices law; or (iii) contravention of the Corporations Act 2001; or (iv) unconscionable conduct; or (v) misconduct; or
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(vi) an offence of dishonesty; (c) a judgment against the franchisor, other than for unfair dismissal of an employee, under: (i) section 127A or 127B of the Workplace Relations Act 1996; or (ii) section 106 of the Industrial Relations Act 1996 of New South Wales; or (iii) section 276 of the Industrial Relations Act 1999 of Queensland; (d) civil proceedings in Australia against the franchisor or a franchisor director by at least 10%, or 10, of the franchisees in Australia of the franchisor (whichever is the lower); (e) any judgment that is entered against the franchisor in Australia, and is not discharged within 28 days, for at least: (i) for a small proprietary company — $100,000; or (ii) for any other company — $1,000,000; (f) any judgment that is entered against the franchisor in a matter mentioned in item 4.2 of Annexure 1 or item 3.2 of Annexure 2; (g) the franchisor becoming an externally-administered body corporate; (h) a change in the intellectual property, or ownership or control of the intellectual property, that is material to the franchise system; (i) the existence and content of any undertaking or order under section 87B of the Act.
(3) For paragraphs (2) (b), (c), (d), (e) and (f), the franchisor must tell the franchisee: (a) the names of the parties to the proceedings; and (b) the name of the court or tribunal; and (c) the case number; and (d) the general nature of the proceedings.
(4) For paragraph (2) (g), the franchisor must tell the franchisee the name and address of the administrator, controller or liquidator.
(5) For paragraph 18 (2) (i), this information must be disclosed within a reasonable time (but not more than 14 days) after the undertaking or order is given. Note Nothing in this code affects the operation of Part VIIC of the Crimes Act 1914 (which includes provisions that, in certain circumstances, relieve persons from the requirement to disclose spent convictions and require persons aware of such convictions to disregard them).
23 Termination — special circumstances A franchisor does not have to comply with clause 21 or 22 if the franchisee: (a) no longer holds a licence that the franchisee must hold to carry on the franchised business; or (b) becomes bankrupt, insolvent under administration or an externally-administered body corporate; or (c) voluntarily abandons the franchised business or the franchise relationship; or (d) is convicted of a serious offence; or (e) operates the franchised business in a way that endangers public health or safety; or (f) is fraudulent in connection with operation of the franchised business; or (g) agrees to termination of the franchise agreement.
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27 Code complaint handling procedure A party to a franchise agreement who has a dispute with another party to the franchise agreement may start the procedure under clause 29.
Franchising Code of Conduct Annexure 1 Disclosure document for franchisee or prospective franchisee
1 First page 1.1 On the first page: (a) in bold upper case: DISCLOSURE DOCUMENT FOR FRANCHISEE OR PROSPECTIVE FRANCHISEE; and (b) the franchisor’s: (i) name; and (ii) business address and phone number; and (iii) ABN, ACN or ARBN (or foreign equivalent if the franchisor is a foreign franchisor); and (ba) the signature of the franchisor, or of a director, officer or authorised agent of the franchisor; and (c) the preparation date of the disclosure document; and (d) the following statement: This disclosure document contains some of the information you need in order to make an informed decision about whether to enter into a franchise agreement. Entering into a franchise agreement is a serious undertaking. A franchise agreement is legally binding on you if you sign it. (omitted) Take your time, read all the documents carefully, talk to other franchisees and assess your own financial resources and capabilities to deal with the requirements of the franchised business. You should make your own enquiries about the franchise and about the business of the franchise. You should get independent legal, accounting and business advice before signing the franchise agreement. It is often prudent to prepare a business plan and projections for profit and cash flow. You should also consider educational courses, particularly if you have not operated a business before.
2 Franchisor details
2.1 The franchisor’s: (a) name; and (b) address, or addresses, of registered office and principal place of business in Australia; and (c) ABN, ACN or ARBN (or foreign equivalent if the franchisor is a foreign franchisor).
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2.2 The name under which the franchisor carries on business in Australia relevant to the franchise.
2.3 A description of the kind of business operated under the franchise.
2.4 The name, ABN, ACN or ARBN, address of registered office and principal place of business of each associate of the franchisor that is a body corporate (if any).
2.5 The name and address of each associate of the franchisor that is not a body corporate (if any).
2.6 For each officer of the franchisor — name, position held and qualifications (if any).
3 Business experience
3.1 A summary of the relevant business experience in the last 10 years of each person mentioned in item 2.6.
3.2 A summary of relevant business experience of the franchisor in the last 10 years, including: (a) length of experience in: (i) operating a business that is substantially the same as that of the franchise; and (ii) offering other franchises that are substantially the same as the franchise; and (b) whether the franchisor has offered franchises for other businesses and, if so: (i) a description of each such business; and (ii) for how long the franchisor offered franchises for each such business.
4 Litigation 4.1 Details of: (a) current proceedings by a public agency, criminal or civil proceedings or arbitration, relevant to the franchise, against the franchisor or a franchisor director in Australia alleging: (i) breach of a franchise agreement; or (ii) contravention of trade practices law; or (iii) contravention of the Corporations Act 2001; or (iv) unconscionable conduct; or (v) misconduct; or (vi) an offence of dishonesty; and (b) proceedings against the franchisor under: (i) section 127A or 127B of the Workplace Relations Act 1996; or (ii) section 106 of the Industrial Relations Act 1996 of New South Wales; or (iii) section 276 of the Industrial Relations Act 1999 of Queensland.
4.2 Whether the franchisor or a director of the franchisor has been: (a) in the last 10 years — convicted of a serious offence, or an equivalent offence outside Australia; or (b) in the last 5 years — subject to final judgment in civil proceedings for a matter mentioned in paragraph 4.1 (a); or (c) in the last 10 years — bankrupt, insolvent under administration or an externally-administered body corporate in Australia or elsewhere.
326 Appendices 327
4.3 For items 4.1 and 4.2 — the following details (where relevant): (a) the names of the parties to the proceedings; (b) the name of the court, tribunal or arbitrator; (c) the case number; (d) the general nature of the proceedings; (e) the current status of the proceedings; (f) the date and content of any undertaking or order under section 87B of the Act; (g) the penalty or damages assessed or imposed; (h) the names of the persons who are bankrupt, insolvent under administration or externally administered; (i) the period of the bankruptcy, insolvency under administration or external administration.
7 Intellectual property 7.1 For any trade mark used to identify, and for any patent, design or copyright that is material to, the franchise system (intellectual property): (a) description of the intellectual property; and (b) details of the franchisee’s rights and obligations in connection with the use of the intellectual property; and (c) whether the intellectual property is registered in Australia, and if so, the registration date, registration number and place of registration; and (d) any judgment or pending proceedings that could significantly affect ownership or use of the intellectual property, including: (i) name of court or tribunal; and (ii) matter number; and (iii) summary of the claim or judgment; and (e) if the intellectual property is not owned by the franchisor — who owns it; and (f) details of any agreement that significantly affects the franchisor’s rights to use, or to give others the right to use, the intellectual property, including: (i) parties to the agreement; and (ii) nature and extent of any limitation; and (iii) duration of the agreement; and (iv) conditions under which the agreement may be terminated.
7.2 The franchisor is taken to comply with item 7.1 for any information that is confidential if the franchisor gives: (a) a general description of the subject matter; and (b) a summary of conditions for use by the franchisee.
8 Franchise site or territory 8.1 Whether the franchise is: (a) for an exclusive or non-exclusive territory; or (b) limited to a particular site.
8.2 For the territory of the franchise:
Appendices 327 328
(a) whether other franchisees may operate a business that is substantially the same as the franchised business; and (b) whether the franchisor or an associate of the franchisor may operate a business that is substantially the same as the franchised business; and (c) whether the franchisor or an associate of the franchisor may establish other franchises that are substantially the same as the franchise; and (d) whether the franchisee may operate a business that is substantially the same as the franchised business outside the territory of the franchise; and (e) whether the franchisor may change the territory of the franchise.
18 Obligation to sign related agreements 18.1 Summary of any requirements under the franchise agreement for the franchisee or directors, shareholders, beneficiaries, owners or partners of the franchisee to enter into any of the following agreements: (a) a lease, sublease, licence or other agreement under which the franchisee can occupy the premises of the franchised business; (b) a chattel lease or hire purchase agreement; (ba) an agreement under which the franchisee gains ownership of, or is authorised to use, any intellectual property; (c) a security agreement, including a guarantee, mortgage, security deposit, indemnity, loan agreement or obligation to provide a bank guarantee to a third party; (d) a confidentiality agreement; (e) an agreement not to carry on business within an area or for a time after the franchise agreement is terminated.
18.2 All documents mentioned in item 18.1 must be provided to the franchisee: (a) at least 14 days before the day on which the franchise agreement is signed, if they are available at that time; or (b) if they are not available at that time — when they become available.
20 Financial details 20.1 A statement as at the end of the last financial year, signed by at least 1 director of the franchisor, whether in its directors’ opinion there are reasonable grounds to believe that the franchisor will be able to pay its debts as and when they fall due.
20.2 Financial reports for each of the last 2 completed financial years in accordance with sections 295 to 297 of the Corporations Act 2001, or the foreign equivalent for a foreign franchisor, prepared by: (a) the franchisor; and (b) any consolidated entity to which the franchisor belongs; if:
(c) the franchisor is part of a consolidated entity that is required to provide audited financial reports under the Corporations Act 2001; and (d) a franchisee requests the reports.
20.3 Item 20.2 does not apply if: (a) the statement under item 20.1 is supported by an independent audit provided by: (i) a registered company auditor; or
328 Appendices 329
(ii) if the franchisor is a foreign franchisor — a foreign equivalent for that franchisor; within 12 months after the end of the financial year to which the statement relates; and (b) a copy of the independent audit is provided with the statement under item 20.1.
21 Updates 21.1 Any information given under clause 18 of the code that has changed between the date of the disclosure document and the date the disclosure document is given under the code. ______Retail Leases Act 1995 (NSW) s 42 Lessor may reserve right to refuse sub lease, mortgage. A retail shop lease may contain a provision which allows the lessor to refuse in the lessor’s absolute discretion: (a) consent to the grant of a sub lease, licence or concession in respect of the whole or any part of the shop, or (b) consent to the lessee parting with possession of the whole or any part of the shop, or (c) consent to the lessee mortgaging or otherwise charging or encumbering the lessee’s estate or interest in the lease. ______Sale of Goods Act 1896 (Qld) http://www.legislation.qld.gov.au/LEGISLTN/CURRENT/S/SaleGoodA1896. pdf 20 Property passes when intended to pass (1) When there is a contract for the sale of specific or ascertained goods the property in them is transferred to the buyer at such time as the parties to the contract intended it to be transferred. (2) For the purpose of ascertaining the intention of the parties regard is to be had to the terms of the contract, the conduct of the parties, and the circumstances of the case. 21 Rules for ascertaining intention Unless a different intention appears, the following are rules for ascertaining the intention of the parties as to the time at which the property in the goods is to pass to the buyer— Rule 1: When there is an unconditional contract for the sale of specific goods in a deliverable state, the property in the goods passes to the buyer when the contract is made, and it is immaterial whether the time of payment or the time of delivery, or both, is or are postponed. Rule 2: When there is a contract for the sale of specific goods and the seller is bound to do something to the goods for the purpose of putting them into a deliverable state, the property does not pass until such thing is done and the buyer has notice thereof. Rule 3: When there is a contract for the sale of specific goods in a deliverable state, but the seller is bound to weigh, measure, test, or do some other act or thing with reference to the goods for the purpose of ascertaining the price, the property does not pass until such act or thing is done and the buyer has notice thereof. Rule 4: (1) When goods are delivered to the buyer on approval or ‘on sale or return’ or other similar terms the property therein passes to the buyer— (a) when the buyer signifies the buyer’s approval or acceptance to the seller, or does any other act adopting the transaction; (b) if the buyer does not signify the buyer’s approval or acceptance to the seller but retains the goods without giving notice of rejection, then, if a time has been fixed for the return of the goods, on the expiration of such time, and, if no time has been fixed, on the expiration of a reasonable time.
Appendices 329 330
(2) What is a reasonable time is a question of fact. Rule 5: (1) When there is a contract for the sale of unascertained or future goods by description, and goods of that description and in a deliverable state are unconditionally appropriated to the contract, either by the seller with the assent of the buyer, or by the buyer with the assent of the seller, the property in the goods thereupon passes to the buyer. (1A) Such assent may be express or implied, and may be given either before or after the appropriation is made. (2) When, in pursuance of the contract, the seller delivers the goods to the buyer or to a carrier or other bailee (whether named by the buyer or not) for the purpose of transmission to the buyer, and does not reserve the right of disposal, the seller is deemed to have unconditionally appropriated the goods to the contract. 22 Reservation of right of disposal (1) When there is a contract for the sale of specific goods or when goods are subsequently appropriated to the contract, the seller may, by the terms of the contract or appropriation, reserve the right of disposal of the goods until certain conditions are fulfilled. (1A) In such case, notwithstanding the delivery of the goods to the buyer, or to a carrier or other bailee for the purpose of transmission to the buyer, the property in the goods does not pass to the buyer until the conditions imposed by the seller are fulfilled. (2) When goods are shipped, and by the bill of lading the goods are deliverable to the order of the seller or the seller’s agent, the seller is prima facie deemed to reserve the right of disposal. (3) When the seller of goods draws on the buyer for the price, and transmits the bill of exchange and bill of lading to the buyer together to secure acceptance or payment of the bill of exchange, the buyer is bound to return the bill of lading if the buyer does not honour the bill of exchange, and if the buyer wrongfully retains the bill of lading the property in the goods does not pass to the buyer.
330 Appendices 331
APPENDIX B: FOREIGN LEGISLATION Canada
In Ontario, Canada franchisees as sub-tenants have the right under Commercial Tenancies Act RSO 1990, c L7, s 39(2) to elect to become the lessee, http://www.canlii.org/on/laws/sta/l-7/20080515/whole.html viewed 15 May 2008.
Lien of landlord in bankruptcy, etc., further provisions Election to surrender 39 (1) The person who is assignee, liquidator or trustee has the further right, at any time before so electing, by notice in writing to the landlord, to surrender possession or disclaim any such lease, and the person’s entry into possession of the leased premises and their occupation by the person, while required for the purposes of the trust estate, shall not be deemed to be evidence of an intention on the person’s part to elect to retain possession under section 38 RSO 1990, cL7, s39(1). Rights of sub-tenants (2) Where the assignor, or person or firm against whom a receiving order has been made in bankruptcy, or a winding up order has been made, being a lessee, has, before the making of the assignment or such order demised any premises by way of under-lease, approved or consented to in writing by the landlord, and the assignee, liquidator or trustee surrenders, disclaims or elects to assign the lease, the under-lessee, if the under-lessee so elects in writing within three months of such assignment or order, stands in the same position with the landlord as though the under-lessee were a direct lessee from the landlord but subject, except as to rental payable, to the same liabilities and obligations as the assignor, bankrupt or insolvent company was subject to under the lease at the date of the assignment or order, but the under-lessee shall in such event be required to covenant to pay to the landlord a rental not less than that payable by the under-lessee to the debtor, and if such last mentioned rental was greater than that payable by the debtor to the said landlord, the under-lessee shall be required to covenant to pay to the landlord the like greater rental. RSO 1990, c L7, s 39 (2). An example of the section being applied is in Majdpour v M & B Acquisition Corp 2001 CanLII 28457 (ON SC); (2001) 25 CBR (4th) 62
Appendices 331 332
(2) Where or to the extent that the purposes of the company consist of or include purposes other than the benefit of its members, subsection (1) has effect as if the reference to promoting the success of the company for the benefit of its members were to achieving those purposes. (3) The duty imposed by this section has effect subject to any enactment or rule of law requiring directors, in certain circumstances, to consider or act in the interests of creditors of the company.
332 Appendices 333
APPENDIX C: POSSIBLE CATEGORISATION OF FRANCHISEES’ INTERESTS IN DIVERSE JURISDICTIONS
Country Possible categorisation of franchisees’ interests by franchisor’s liquidator Asset Liability Creditor Debtor Franchisee Other Do not know Australia √ √ √ √ Belgium √ √ British Virgin Is √ Canada √ √ √ √ √ Colombia √ Denmark √ √ √ √ √ England √ √ Finland √ √ √ France √ Germany √ √ √ √ Greece √ √ √ √ India √ Ireland √ √ Mexico √ √ Netherlands √ New Zealand √ √ √ √ Nigeria √ √ √ √ Republic of Ireland √ Republic of Korea √ √ √ √ Spain √ Sweden √ √ √ Switzerland √ √ √ UK √ √ √ √ √ Syria √ √ USA √ Vietnam √
Appendices 333 334
APPENDIX D: FRANCHISE NETWORK Kleenmaid Franchise network where franchisees trade from retail premises, and franchisees are operated on commission agency model.
(insert scanned Appendix D here)
334 Appendices
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B, Klein, ‘The Economics of Franchise Contracts’ (1995) 2 Journal of Corporate Finance 9, 19 reprinted in Francine Lafontaine (ed), Franchise Contracting and Organization (2005) 323. Baer, John R F, Beyer, David A and Weber, Scott P, ‘When are Sales Representatives also Franchisees?’ (2008) 27 Franchise Law Journal 151. Baldwin, Gerald L and Horwitz, Matt, ‘The Role of Intangibles in Bankruptcy’ (2006) 12 American Bankruptcy Institute Journal 25. Barkoff, Rupert M and Selden, Andrew C, Fundamentals of Franchising (3rd ed, 2008, American Bar Association, Chicago). Bigwood, Rick, Exploitative Contracts (2003, Oxford University Press). Blair, Roger D and Lafontaine, Francine, The Economics of Franchising (2005). Brickley, James A and Dark, Frederick H, ‘The Choice of Organizational Form: The Case of Franchising’ (1987) 18 Journal of Financial Economics 401, in Francine Lafontaine (ed), Franchise Contracting and Organization (2005) 57. Buchan, Jenny, ‘Challenges That Franchisees of Insolvent Franchisors Pose for Liquidators’ (2008) 16 Insolvency Law Journal 26. Buchan, Jenny, ‘Consumer Protection for Franchisees of Failed Franchisors: Is There a Need for Statutory Intervention?’ (2010) 9(2) QUT Law and Justice Journal 232. Buchan, Jenny, ‘Ex Ante Information and Ex Post Reality for Franchisees – The Case of Franchisor Failure’ (2008) 36 Australian Business Law Review 407. Buchan, Jenny, ‘Franchisor’s Registered Trade Marks – Empirical Surprises’ (2009) Australian Intellectual Property Law Bulletin 154. Buchan, Jenny and Butcher, Bill, ‘Premises Occupancy Models for Franchised Retail Businesses in Australia: Factors for Consideration’ (2009) 17(2) Australian Property Law Journal 143. Buchan, Jenny, ‘Reducing Collateral Damage in Franchisor Insolvency’ in Paul Omar (ed), International Insolvency Law: Themes and Perspectives (2008) 367.
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Case Law
Australian
Acer Computer Australia Pty Limited v Carter (No 2) [2007] FCA 1943 Aston v Harlee Manufacturing Co [1960] HCA 47 Australian Building Construction Employees and Building Labourers Federation (WA Branch) v Pacesetter Homes Pty Ltd (1994) 56 IR 51 Australian Competition and Consumer Commission v Imagine Essential Services Limited [2008] FCA 349 (Gordon J) Australian Competition and Consumer Commission v Ewing [2004] FCA 5 Australian Competition and Consumer Commission v 4WD Systems Pty Ltd [2003] FCA 850 Australian Competition and Consumer Commission v Grant [2000] FCA 567 Australian Competition & Consumer Commission v Simply No-Knead (Franchising) Pty Ltd [2000] FCA 1365 Australian Competition & Consumer Commission v Trayling [1999] FCA 1133 Australian Mutual Provident Society v Chaplin (1978) 18 ALR 385 Bamco Villa Pty Ltd v Montedeen Pty Ltd; Delta Car Rentals Aust Pty Ltd v Bamco Villa Pty Ltd [2001] VSC 192 Benjamin Morris & Anor v Danoz Directions Pty Ltd (ACN 092 832 534) (in liquidation) & Ors Hearing 2 (P) NSD1313/2008 Cheque One Pty Ltd v Cheque Exchange (Australia) Pty Ltd (in liq) [2002] FCA 593 Chief Commissioner of State Revenue v Zafco Franchise Co Pty Ltd [2006] NSWSC 1085 (Young CJ in Eq) City Motors (1981) Pty Ltd v Commissioner of State Taxation (WA) (1993) 26 ATR 291 Climaze Holdings Pty Ltd v Dyson (1995) 13 WAR 487 Codelfa Construction Pty Ltd v SRA of NSW (1982) 149 CLR 337 Dymocks Franchise Systems v Bilgola Enterprises Ltd 8 TCLR Enviro Systems Renewable Resources Pty Ltd v Australian Securities & Investments Commission [2001] SASC 11 Far Horizons Pty Ltd v McDonald's Australia Ltd [2000] VSC 310 Federal Commissioner of Taxation v Brown [1999] FCA 721 Federal Commissioner of Taxation v Jones (2002) 117 FCR 9 Figgins Holdings Pty Ltd v SEAA Enterprises Pty Ltd [1999] HCA 20 Glambed v FCT (1989) 20 ATR 428 Grant v Eddington [2000] FCA 1550
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Gregory John King v Cake It Away Pty Ltd and ors [2003] NSWIRComm 242 (Walton Boland and Staunton JJ) Hollis v Vabu (2001) 207 CLR 21 Hoy Mobile Pty Ltd v Allphones Retail Pty Ltd (No 2) [2008] FCA 810 Humberstone v Northern Timber Mills (1949) 79 CLR 389 Ibbco Trading Pty Ltd v HIH Casualty and General Insurance Ltd (2001) 19 ACLC 1093 Impressionable Kids Aust Pty Ltd v Karen Cornwall t/as Impressionable Kids Keilor (Civil Claims) [2007] VCAT 2431 Jax Tyres: Jax Franchising Systems Pty Limited v State Rail Authority (New South Wales); Jax Tyres Pty Limited v State Rail Authority (New South Wales) [2003] NSWLEC 397 J F Keir Pty Ltd v Priority Management Systems Pty Ltd (administrators appointed) [2007] NSWSC 789 (Rein AJ) J F Keir Pty Limited v Sparks [2008] FCA 611 (Graham J) Kaytonruby Pty Ltd & Ors v Glev Franchisees Pty Ltd & Ors (1998) VG 438 of 1993 Lawrence v Furniture Wizard [2000] NSWSC 1107 Loyal No 46 v Miller [2001] FMCA 30 Majik Markets Pty Ltd v Brake and Service Centre Drummoyne Pty Ltd and ors [1991] 39 IR, 169 Marshall v Whittaker's Building Supply Co (1963) 109 CLR 210 McDonald's Australia Holdings Ltd & Anor v Industrial Relations Commission of NSW & 2 Ors [2005] NSWCA 286 Meridian Retail Pty Ltd v Australian Unity Retail Network Pty Ltd [2006] VSC 223 Neilson Investments (Qld) P/L & Ors v Spud Mulligan's P/L & Ors [2002] QSC 258 Neldue Pty Ltd v Moran & Ors [2004] WASC 100 Pampered Paws Connection Pty Ltd (ACN 116 460 621) v Pets Paradise Franchising (Qld) Pty Ltd (ACN 054 406 272) (No 3) [2009] FCA 138 Placer Pacific Management Pty Ltd v Federal Commissioner of Taxation 95 ATC 4459 Poulet Frais Pty Ltd v The Silver Fox Company Pty Ltd [2005] FCAFC 131 Re Clothing Trades Award 1982 (1987) 19 IR 416 Re Real Investments Pty Ltd (in liq) [1999] QSC 89 Re Richard Vincent Bateman and Georgina Gay Bateman v Barbara Jean Slatyer; Harvey John Slatyer; Graham Walter Tiekle and Barbara's House & Garden (Retail) Pty Limited [1987] FCA 58 Ready Mixed Concrete (South East) Ltd v Minister of Pensions and National Insurance [1968] 2 QB 497 Rousellis v Maiurano [1998] NSWCA 196 Samrani v Roads and Traffic Authority of New South Wales (1994) Aust Torts Reports ¶81- 314 Scanlan's New Neon Ltd v Tooheys Ltd (1943) 67 CLR 169 Selim v McGrath (2004) 22 ACLC 112 Sgobino v South Australia (1987) 46 SASR 292
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Smith & Ors v DCM Coffee & Donuts Limited, Charles Lee, Wayne Douglas Plant, Brian’s Systems Australia Pty Limited (Administrator Appointed) Industrial Relations Commission of New South Wales 5 November 1997 (Marks J) Stevens v Brodribb Sawmilling Co Pty Ltd (1986) 160 CLR 16 Stewart, in the matter of Kleins Franchising Pty Ltd (administrators appointed) (ACN 007 348 236) [2008] FCA 721 The Cheesecake Shop v A & A Shah Enterprises [2004] NSWSC 625 Timic v Hammock [2001] FCA 74 WorkCover Authority of New South Wales (Insector Petar Ankucic) v McDonald 's Australia Limited and Another [2000] NSWIRComm 277 Workcover Authority of NSW (Inspector Ankucic) v McDonald 's Australia Limited and anor matter [2000] NSWIRComm 1123 (Walton J, Vice-President) Zuijs v Wirth Bros Pty Ltd (1955) 93 CLR 561
Canadian
Country Style Food Services Cases: Country Style Food Services Inc v 1304271 Ontario Ltd Ontario Superior Court of Justice Chapnik J, Judgement: 11 February 2003; in the matter of the Companies Creditors Arrangement Act, RSC 1985 C c-36, As amended AND In the matter of the Courts of Justice Act RSO 1990 c-43, As amended AND in the matter of a plan of compromise or arrangement of Country Style Food Services Inc, Country Style Food Services Holdings Inc, Country Style Realty Limited, Melody Farms Specialty Foods and Equipment Limited, Buns Master Bakery Systems Inc and Buns Master Bakery Realty Inc 15 April 2002 Court of Appeal for Ontario Docket M28458 (Unreported decision)
Hi Hotel Limited Partnership and Holiday Hospitality Franchising Inc and ors 2008 ABCA 276
Magnetic Marketing Ltd v Print Three Franchising Corp et al (1991), 38 CPR (3d) 540
New Zealand
Bobux Marketing Limited v Raynor Marketing Limited [2001] NZCA 348
South African
Cacun Trading No 24 CC & Others v Seven-Eleven Corporation SA (Pty) Ltd South Africa: unreported case no 18/IR/Dec 99
UK
Montreal v Montreal Locomotive Works (1947) 1 DLR 161
Stevenson Jordan and Harrison Ltd v MacDonald and Evans [1952] 1 TLR 101
Bank Voor Handel En Scheepvaart NV v Slatford [1953] 1 QB 248
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USA
Days In v Gainesville P-H Properties, Inc 77 BR 285 (Bankr MD Pa 1993)
Baskin Robbins Inc v Neiberg 161 BR 606 (Bankr BD Pa 1993)
In re Karfakis, 162 BR 719 (Bankr BD Pa 1993)
In re Nutri/System, Inc, 169 BR 854 (Bankr ED Pa 1994)
In re First International Services Corp, 25 BR 66 (Bankr D Conn 1982)
In re Rusty Jones, Inc, 128 BR 1001 (Bankr ND Ill 1991)
Legislation
Bankruptcy Act 1966 (Cth)
Corporations Act 2001 (Cth)
Insurance Contracts Act 1984 (Cth)
Trade Practices Act 1974 (Cth)
Leases (Commercial and Retail) Act 2001 (ACT)
Retail Leases Act 1994 (NSW)
Business Tenancies (Fair Dealings) Act 2003 (NT)
Retail Shop Leases Act 1994 (Qld)
Retail and Commercial Leases Act 1995 (SA)
Fair Trading (Code of Practice for Retail Tenancies) Regulations 1998 (Tas)
Retail Leases Act 2003 (Vic)
Commercial Tenancy (Retail Shops) Agreements Act 1985 (WA)
Other sources
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