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Fairness in Franchising: What did the inquiry find?

Fairness in Franchising: What did the inquiry find?

Australian Parliament House

The long-awaited final report from the parliamentary Fairness in Franchising inquiry has at last been released, in a scathing review that compared the failures of franchisors to those uncovered by the banking royal commission.

Released late on Thursday (14 March), the report took an in-depth look into the current practices and workings of the industry, with a particular look at the relationship between franchisors and their franchisees.

It was compiled by the Parliamentary Joint Committee on Corporations and Financial Services.

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As the report notes, franchising is a major component of the Australian business landscape, contributing around 9 per cent of the country’s total GDP, making its efficient and effective operation critical to health of the broader economy.

Findings

The committee was overwhelmingly critical of the existing regulatory framework for the franchise industry, stating that it has “manifestly failed to deter systemic poor conduct and exploitative behaviour”, and that current rules had also “entrenched the power imbalance” favouring franchisors.

It likened the situation facing the franchise sector to that of the finance sector and the “serious failures of corporate governance” uncovered during last year’s banking royal commission and other parliamentary inquiries.

“The evidence presented to [this] committee during this inquiry indicates that the extent of poor corporate governance in some areas of franchising is comparable to that in the financial services sector,” it said in the final report.

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It also lamented that “the actions of certain franchisors have caused enormous reputational damage to the sector. This needs to be rectified for the benefit of the entire franchising industry.”

Power imbalance

The report went to great lengths to note the power imbalance weighing on franchisees, regardless of industry.

“As a business structure, franchising exhibits a substantial disparity in power between franchisors and franchisees,” the report stated.

“This power imbalance is inherent to the structure, given the franchisor owns the business model and has control over operations and franchisee contracts, as well as their tenancy in many cases.”

It found that the existing regulatory framework has not achieved the desired outcome of addressing the power imbalance, and “has in some cases further entrenched [it]”.

“Even a franchise agreement that may appear fair and reasonable when the franchise is operated to the mutual benefit of the franchisor and franchisee can, if the circumstances change (such as a change of ownership), be abused by the franchisor to the detriment of the franchisee.

“Indeed, many of the public and confidential submissions received by the committee outlined the significant, and often life-changing, detriment that many franchisees endured as a direct result of being exploited by franchisors.”

Things getting worse over time

Interestingly, the report drew comparisons between this inquiry and the one conducted back in 2008, and found that the fairness of franchise agreements and their conditions had deteriorated markedly over that time.

“Even a franchise agreement that may appear fair and reasonable when the franchise is operated to the mutual benefit of the franchisor and franchisee can, if the circumstances change (such as a change of ownership), be abused by the franchisor to the detriment of the franchisee,” it said.

“Indeed, many of the public and confidential submissions received by the committee outlined the significant, and often life-changing, detriment that many franchisees endured as a direct result of being exploited by franchisors.

“When this committee inquired into franchising in 2008, it appeared that some franchisors were behaving opportunistically, but that the issues were relatively isolated. By contrast, the evidence to this inquiry indicates that the problems, including exploitation in certain franchise systems, are systemic.”

Transparency, education provisions ‘insufficient’

Educating franchisees and providing greater transparency are “certainly important and necessary”, the report noted; however, it was critical of the current parameters in being able to deliver this, describing them as “insufficient”.

This was deemed to be because of the franchise agreement, which as previously stated, “embeds the power disparity between franchisor and franchisee”.

“This report recommends an overarching franchising framework that is fair for all participants and which recognises that, in franchising (just like banking and financial services), disclosure alone is an insufficient regulatory response to power imbalances and exploitative behaviour by powerful corporations,” it said.

ASX listings, private equity ‘added complexity’

Just as a former franchisee criticised the structure of ASX-listed franchise brands, and a business adviser previously outlined a perceived conflict of interest for venture capital-owned brands, the committee determined that such ownership structures have “added further complexity”.

“The entry of a third party, such as shareholders, may shift the franchisor’s focus from its franchisees to its shareholders. For example, if the franchisor cannibalises franchisee territory, increases its fees, reduces its service to franchisees, and introduces costly mandatory training that is unaccredited, the franchisee will find scant relief in the contract and the Franchising Code.”

Franchise model contributing to wage theft

The problem of underpayment of employee wages and entitlements, referred to as wage theft, was found to “occur in many franchises”.

And while the actual payment of wages falls to the responsibility of each franchisee as the actual employer, the report said that franchise brands themselves are partly to blame for the situation. It even found instances of franchisors actually encouraging the practice.

“The committee notes that wage theft continues to occur in many franchises: partly due to the business model franchisors operate and partly due to a range of sociocultural problems,” it said.

“At times, wage theft was occurring as a way for franchisees to extract profits or service payments in order to stay afloat in a financially constrained business model (given wages are one of the greatest costs in the franchisee’s control). In some instances, wage theft was encouraged by franchisors.

“Whilst many franchisors cited greed as the primary motivation for wage theft, the committee notes that the issue is far more complex and partly inherent to the business models’ structural breakdown of power and the imposition of cost controls.”

It said that some of its recommendations, outlined below, “will go a long way to indirectly rectify this issue by mitigating incentives to engage in wage theft”.

Franchise Council of Australia (FCA) lacks balance, industry oversight

The peak body for franchising, the Franchise Council of Australia (FCA), was singled out as being “captive” to the interests of franchisors, rather than providing balanced oversight, which the committee said was likely the result of its membership base being almost exclusively franchisors.

“There are almost no franchisee members of the FCA, and membership of the FCA is dominated by franchisors. In effect, the FCA is captive to the interests of franchisors,” the report said.

Not all bad

Of course, attention is generally drawn to the worst-case scenarios and most radical, perhaps controversial, findings. But the report did note that some franchises have achieved the right mix of balancing the interests and power balance of both franchisor and franchisee.

“The committee acknowledges that many franchisors have developed franchise systems that operate to the mutual benefit of the franchisor and their franchisees. Indeed, the committee heard from a franchisor whose business model explicitly recognises the mutual importance of the franchisor, franchisees and suppliers,” it said.

“Further, that franchisor has commitment to resolving challenges in collaboration with its franchisees. Therefore, in developing its recommendations, the committee has been mindful to avoid imposing unnecessary burdens on franchisors who treat franchisees fairly.”

Industry-wide recommendations

In response to these findings, the committee has proposed “substantial changes” be made to the Franchising Code of Conduct, as well as to “the responsibilities and powers of the regulator”.

“The recommendations are designed to lift standards and conduct across the entire industry because, on the balance of evidence given to the committee in public and in confidence, far too many franchisors are abusing the power imbalance between themselves and their franchisees,” the report said.

These include, but are not limited to:

  • The creation of a Franchising Taskforce — including representatives from Treasury, the Department of Jobs and Small Business, and the ACCC, where relevant — to oversee the implementation of the committee’s recommendations.
  • Stopping short of formally pushing for a new or additional industry body, the committee did recommend government be alert to the apparent franchisor bias of the Franchise Council when considering its input into policy and regulation.
  • Improving disclosure: including by requiring disclosure documents to be provided in electronic form, forcing franchisors to provide earnings and financial information — in the form of two years’ prior BAS, profit and loss statements, balance sheets and labour cost assessment — when franchises are sold or transferred; and better “clarity, consistency and accountability” around the use and reporting of marketing funds.
  • Mandatory disclosure — in percentage terms — of all supplier rebates, commissions and payments relating to the supply of goods and services to franchisees.
  • The creation of a public franchise register, incorporating annually updated disclosure documents and template franchise agreements.
  • The recommendation of the recently introduced Whistleblower Protections laws be extended to cover franchisees and their employees.
  • Franchising Taskforce investigates, among other things, making unfair contract terms within franchise agreements illegal, with attached civil penalties, and also conflicts of interest in supplier rebates.
  • Better clarification around the triggering and timing of the seven-day cooling-off period for franchisees after signing a franchise agreement, and specifically stipulating that these periods are measured in calendar days.
  • Changing the cooling-off period to 14 days after the last of these is done: the signing of the agreement; payment made; required disclosure documents and a copy of the lease are received by the franchisee.
  • Amending the Franchising Code to allow franchisees to unilaterally exit a franchise agreement under certain circumstances, and protections for franchisees in instances where they are required to make sizeable capital investment towards the end of an agreement’s term.
  • Also amending the Code to stipulate that a majority of franchisees must agree with a change to the franchise agreement that would constitute unilateral variation of the terms of the agreement.
  • Adoption of the ACCC’s proposal to allow all franchisees to collectively bargain with their franchisor, regardless of size, and that franchisees be empowered to undertake such bargaining.
  • Changing the dispute resolution process under the Franchising Code to make arbitration binding.
  • New laws to introduce civil pecuniary penalties and infringement notices for breaches of the Franchising Code and the Oil Code, with penalties linked to those of the Australian Consumer Law.
  • New powers for the ACCC to investigate and act upon “burning and churning” by franchisors looking to profit from upfront fees to the detriment of established franchisees, and to prohibit the marketing and sale of franchises by brands with a history of such practices.
  • The launch of a new FranchiseSmart website, by the ACCC, to provide information to franchisees in a similar fashion to ASIC’s consumer-oriented MoneySmart website.

Changes have also been recommended to the Oil Code of Conduct that specifically relate to franchising.

Retail Food Group singled out for further scrutiny

Retail Food Group — owner of brands including Donut King, Gloria Jean’s, Michel’s Pattiserie, Crust Gourmet Pizza Bar and Brumby’s Bakery — was used as a case study by the inquiry. And it was single out for particular scorn by the committee.

“The committee recommends that the Australian Competition and Consumer Commission, the Australian Securities and Investments Commission and the Australian Tax Office conduct investigations into the operations and dealings of Retail Food Group, its former and current directors and senior executives and companies and trusts they own, direct, manage or hold a beneficial interest in,” the report said.

“With regard to matters including, but not limited to, the Australian Consumer Law, the Franchising Code of Conduct, insider trading, short selling, market disclosure obligations (including related party obligations), compliance with directors’ duties, audit quality, valuation of assets (including goodwill) and tax avoidance.”

The more than 300-page report — including its 18 pages of recommendations — can be downloaded from the Australian Parliament’s website.

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