On the 14th of March 2019, the Parliamentary Joint Committee on Corporations and Financial Services (“Committee”) issued its long-awaited Report into the operation and effectiveness of the Franchising Code of Conduct (the “Code”).

Since the last inquiry into franchising was conducted in 2008, the Committee indicated that it is no longer the case of there being “a few bad eggs”, but rather, that the problems in franchising are systemic.

To resolve these systemic problems, a much broader and more comprehensive approach is required, and the Committee has proposed substantial changes to the Code, to sections of the Oil Code of Conduct (the “Oil Code”) that relate to franchising as well as suggesting changes to the responsibilities and powers of the Australian Competition and Consumer Commission (ACCC).

The Committee has made over 70 recommendations on topics including disclosure and registration, third line forcing, supplier rebates, unfair contract terms, cooling off periods, exit arrangements, goodwill, restraints of trade, collective action, dispute resolution, industry codes, pre-entry education and access to advice (for franchisees), retail leasing, and financing and lending.  The recommendations are designed to lift standards and conduct across the entire industry, as based on the evidence given at the inquiry, it has become apparent that some franchisors may have been abusing the power imbalance between themselves and their franchisees.

In making their recommendations, the Committee identified three recurring themes, these being the need to develop greater:

• transparency and accountability;
• fairness and protection; and
• education and awareness.

Below are some of the key recommendations from the Report.

For the franchising industry

Establishment of a Franchising Taskforce

The Committee has recommended establishing an inter-agency “Franchising Taskforce” made up of representatives from the Department of the Treasury, the Department of Jobs and Small Business and, where appropriate, the Australian Competition and Consumer Commission to examine the feasibility and implementation of several of the Committee’s recommendations.

Enhancement and alignment of industry codes

The Committee identified that the Code has fallen short of its purpose to strike an appropriate balance of power between franchisors and franchisees.

One of the key recommendations of the Committee relates to the penalty regime associated with both the Code and the Oil Code, where up until now penalties for some breaches have been non-existence or pitiful, while also undermining the ACCC’s ability to ensure franchisors comply with the codes.  On this basis, the Committee considers that civil pecuniary penalties and infringement notices should be made available for all breaches of the Code and Oil Code.  If accepted, this is likely to have a significant impact on franchisors.

Further, the penalty amounts should be on par to the penalties currently available under the Australian Consumer Law to ensure meaningful deterrence.  Importantly, the penalty amounts must be prescribed in legislation, so that the limit on penalties under industry codes do not apply to franchising.  

The Committee also made specific recommendations regarding franchising in the automotive sector, and has recommended that the Franchising Taskforce identify reforms that would support the fair handling of capital intensive stock when franchise agreements between car manufacturers and new car dealers are not renewed.

Dispute resolution

The Committee has recommended reform to the dispute resolution scheme in franchising to include binding arbitration with the capacity to award remedies, compensation, interest and costs.

Further, the Committee recommended that the Code be amended to allow a mediator or arbitrator to undertake multi-franchisee resolutions when disputes relating to similar issues arise.

Churning and burning

Churning refers to the repeated sale at a single site of a failed franchise to a new franchisee.  Outlets that pass through a corporate store stage in between being operated by franchisees can also be counted as site churning.

In contrast, burning refers to franchisors continually opening new outlets, some of which are unlikely to be viable, to profit from upfront fees, while leaving existing outlets to struggle and close.

The Committee has made recommendations that the ACCC be given an intervention power to identify and act on the marketing and sales of franchises where a franchisor shows a track record of systemic churning and/or burning, and that the ACCC target only the most egregious behaviour by franchisors.

For franchisors

Disclosure and Registration

The inquiry has demonstrated that disclosure alone (which has been the focus of previous inquiries) is an insufficient regulatory response to power imbalances and exploitative behaviour by franchisors towards their franchisees.  However, the Committee has made significant recommendations pertaining to disclosure, including:

• a requirement to provide the disclosure document in electronic form; 
• requirements around the provision of earnings and financial information when franchises are sold or transferred; and
• greater clarity, consistency and accountability with respect to the use and reporting of marketing funds.

The Committee also recommended that the Franchising Taskforce investigates options for a public franchise register requiring franchisors to provide updated disclosure documents and template franchise agreements annually and that civil penalties should apply to franchisors for non-compliance.  

Third Line Forcing and Supplier Rebates

Central to the operation of a franchise network is consistency of products and services offered, and for this reason it is common for franchisors to use third line forcing arrangements to require franchisees to use specified suppliers.  This also allows franchisors to use their bulk buying power to obtain better deals for their franchisees.

The recommendations made by the Committee in relation to third line forcing arrangements are focused on providing greater transparency and accountability to franchisees regarding such arrangements, including mandatory disclosure in percentage terms of all supplier rebates, commissions and other payments in relation to the supply of goods or services to franchisees.

Unfair Contract Terms

The unfair contract terms laws have had limited effect on franchising.  The Committee has therefore recommended that the Franchising Taskforce examine the appropriateness of making unfair contract terms in franchise agreements illegal, and for civil penalties to be established.  It is evident the unfair contract terms are on the radar of the ACCC, and that franchisors should be taking a pro-active approach and have their franchise agreements reviewed and updated (if required) to amend any terms that could be considered to be an unfair contract term.

For franchisees:

Exit Rights and Goodwill

Up until now, the Code has only provided termination rights for franchisors.  The Committee has therefore recommended that a significant addition be made to the Code to give franchisees the right to exit franchise agreements under certain conditions, which will vary according to the situation.  The Committee hopes these recommendations will bring significant cultural change to franchising and help address the power imbalance.  

The committee also recommends the Franchising Taskforce consider greater transparency around the allocation (if any) of goodwill in franchise agreements, as well as protections for franchisees when required to undertake significant capital expenditure near the end of the term of a franchising agreement.  

Education and Advice

The Committee recognised that education is vital in equipping prospective franchisees with the knowledge and skills to better inform themselves about the risks and responsibilities of becoming a franchisee.  The Committee also recognised that many prospective franchisees do not have easy access to services that can help them understand those risks or fail to undertake sufficient due diligence or seek sufficient and appropriate legal or accounting/business advice.

The Committee has proposed a range of improvements to the education and advice available for franchisees, including recommendations for: 

• the ACCC to develop a “FranchiseSmart” website for franchises (like the MoneySmart service provided by the Australian Securities and Investment Commission); and 
• franchisees to develop far greater awareness around the risks and responsibilities of being a franchisee including obtaining pre-entry education and seeking appropriate advice about the franchise agreement, financing arrangement, and the implications of retail lease arrangements.

Industry Associations and Collective Action

To address the power imbalance between franchisors and franchisees, the Committee has recommended that a suitable body exists to represent the interests of franchisees and for the Franchising Taskforce to examine how the consultation process surrounding franchising policy, regulation and legislation can achieve an appropriate level of input from franchisees.  

The Committee also recommends that the Government implement the ACCC’s proposal for a class exemption to make it lawful for all franchisees to collectively bargain with their franchisor regardless of their size or other characteristics.  The committee wants to see franchisees empowered to undertake collective action, such as joint negotiation, mediation and arbitration to resolve problems and disputes.  The implementation of this recommendation would provide a significant mechanism to address the power imbalance between franchisees and franchisors and any intimidatory behaviour by franchisors.

Conclusion

The inquiry revealed that the current regulatory environment in franchising has manifestly failed to deter systemic poor conduct and exploitative behaviour and has entrenched the power imbalance between franchisors and franchisees.  To improve the franchising sector, the Committee in providing its recommendations has taken a two-pronged approach, namely:

1. implement a series of changes to the Code and the Oil Code, including:

• an increase to the penalty amounts to a level similar to the penalties currently available under the Australian Consumer Law;
• prescribed penalty amounts in legislation, so that the limit on penalties under industry codes does not apply to franchising; and

2. provide the ACCC with more responsibilities, and in certain instances, greater enforcement powers.  However, the Committee notes that the ACCC is not the only regulator with responsibility for franchising and that other government departments and agencies also have a role to play.

The proposed reforms outlined by the Committee are substantial, and many elements are interdependent.  The Committee has sought to strike an appropriate balance between the legitimate business interests of both franchisors and franchisees and has taken a holistic approach to address the systemic problems.  The Committee has asked the government to “avoid cherry picking”, and instead implement all their recommendations as soon as possible, however with a Federal election looming it will at first be a case of seeing which side of politics gets into office and whether franchising forms part of the new government’s agenda.

This article provides a high-level summary of the Committee’s recommendations – in upcoming articles, our franchising team will be undertaking a closer examination of the recommendations.  If you would like to speak with a lawyer in Coleman Greig’s Franchising team either with regard to any of the information in this article, or your own franchising matter, please don’t hesitate to get in touch today.