by Ceclia Do

The Franchising Industry has been highly important in the Australian economy, making up to 9 per cent of the country’s GDP, according to the Parliamentary Joint Committee on Corporations and Financial Services (“the Committee”).

The recent string of scandals involving major franchisors such as Domino’s Pizza, 7-Eleven, Caltex and Retail Food Group which owns Michel Pastisserie, Brumby's, Gloria Jeans, Donut King and the Crust Pizza brand, and the financial difficulties faced mostly by Franchisees as a result of the failure of the business they heavily invested in, have triggered the Committee to conduct an inquiry into the franchise industry.

On 14 March 2019, the Committee released a report on Fairness in Franchising inquiry, looking in-depth into the current practices and workings of the industry, particularly into the relationship between Franchisors and their Franchisees.

Major findings from the Committee’s inquiry revealed that there is a power imbalance favouring the Franchisor, and that Australia’s current regulatory framework for the franchise industry contributes to entrenching the power imbalance between Franchisors and Franchisees.

The power imbalance, weighing on Franchisees, is partially caused by the structure giving the Franchisors excessive power and control, including ownership of the business model, control over operations, franchisee contracts and in some instances, tenancy contracts.

The current disclosure and transparency requirements in most franchise agreements have been found to be insufficient to help achieve fairness and avoid exploitative behaviour by Franchisors. The franchise agreements embed the power disparity in a way that gives Franchisees minimal negotiating power and exit opportunity, while providing Franchisors with abusive power.

Adding to the lack of protection for Franchisees, is the head body for franchising, the Franchise Council of Australia (FCA), which is supposed to act mutually in supervising the practices of the franchise industry, appears to be biased toward Franchisors’ interests, which is likely to be a result of the dominating number of Franchisor members in the FCA.

The issue becomes further complicated among the listed franchises. The Committee found that the entrance of a third party, such as shareholders, may shift the Franchisors’ focus from its Franchisees to its shareholders.

Another common issue in the Franchise Industry is ‘wage theft’, which is the underpayment of employees’ wages and entitlements. This was found to be caused by an emphasis in the industry on cost control. More often than not, with wages being one of the main costs in the franchise industry, the focus on costs control gives Franchisees an incentive to engage in ‘wage theft’. Also, some Franchisors have advised Franchisees on what payments to employees are required.

The Committee made numerous industry-wide recommendations, which can be found in the 300-page report which can be downloaded from the Australian Parliament website.  

In summary, the major recommendations include the following:

  • To establish a Franchising Taskforce to include representatives from the Department of Treasury, Departments of Jobs and Small Business, and the Australian Competition and Consumer Commission (ACCC), to monitor the feasibility and implementation of the recommendations in the Report.
  • To implement changes to the law to afford the ACCC greater powers of enforcement and investigation, including granting the ACCC the power to intervene and prevent Franchisors from marketing and selling franchises where they have a record of repeated sale of failed franchises, and to prevent Franchisors from continually opening new unsuccessful franchises in order to benefit from upfront fees.
  • Introducing greater protection for the Franchisees against third line forcing, being a Franchisors’ requirements that Franchisees to purchase goods and services only from either the Franchisor or a restricted source of supply. Franchisors will be obliged to disclose in percentage terms the financial incentives received from its suppliers.
  • Improved disclosure requiring vendors in sales of franchises to provide prospective purchasers the prior two years’ Business Activity Statements, Financial statements and an assessment of labour costs for that particular franchise.
  • To make substantial amendments to the Franchising Code of Conduct. These amendments include Franchisees’ termination rights under certain circumstances, the requirement for the majority of franchisees to agree with a change to the franchise agreement in order to cause a variation of the term of the franchise agreement.
  • The ACCC to launch a new FranchiseSmart website, similar to ASIC’s MoneySmart website, to provide information to franchises.

Accordingly, it appears that Franchisors will be most significantly impacted by the Committee’s proposed changes to the law and to the Code.

It may still take some time to see positive improvements in the franchise industry after implementations of the recommendations. However, it is expected that the introduction of the Committee’s recommendations and especially a new supervisory body, will force Franchisors to review their operational model for the mutual benefit of the Franchisor and their Franchisees and be less inclined to engage in unethical conduct.  

At Veritas Advisory, our advisory and insolvency specialists have a strong understanding of the issues both franchisors and franchisees face. We will work with you through the financial difficulty, endeavour to assist your company to preserve the value of the business whether you are a Franchisor or a Franchisee. We also ensure we stay informed with regard to the regulatory changes in the franchising market in order to provide you the best available resolution for your specific circumstance.

 

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