I decided to lodge a personal submission to the Parliamentary Joint Committee on Corporations and Financial Services enquiry into the operation and effectiveness of the Franchising Code of Conduct. A copy of my submission is below
11 May 2018
Committee Secretary
Parliamentary Joint Committee
on Corporations and Financial Services
PO Box 6100
Parliament House
Parliament House
CANBERRA ACT 2600
By email: corporations.joint@aph.gov.au
Dear Committee Secretary
Terceiro Legal Consulting (TLC) is an incorporated legal practice, which
specialises in competition and consumer law (trade practices law). TLC has been
operating since 2008 and has represented companies, businesses and individuals
in Australian Competition and Consumer Commission (ACCC) matters. TLC has also advised both franchisees and
franchisors in relation to various franchise matters, including in relation to
Breach Notices, marketing funds, terminations and restraint of trade
provisions.
Michael Terceiro, the principal of TLC, formerly worked at
the ACCC for 15 years in a variety of positions, including as a Director of
Enforcement and the Director in charge of the Sydney Mergers and Asset Sales
Branch. In these roles, he was responsible for running investigations and
litigation into alleged breaches of the competition and consumer laws and the Franchising
Code of Conduct. Michael has a great
deal of ACCC enforcement experience, having ran more than than 600
investigations, including more than 100 merger clearances, and 30 court cases
during his time at the ACCC.
Terms of
reference
(a) the operation and
effectiveness of the Franchising Code of Conduct, including the disclosure
document and information statement, and the Oil Code of Conduct, in ensuring
full disclosure to potential franchisees of all information necessary to make a
fully-informed decision when assessing whether to enter a franchise agreement,
including information on:
(i) likely financial performance of a franchise and worse-case
scenarios,
Based on my experience, it is very rare for a franchisor to
provide a prospective franchisee with any meaningful information about the
likely financial performance of a franchisee business. I suspect that the reason for this is due to a
tendency amongst advisors to provide particularly cautious legal advice to
franchisors which encourages them not to take any chances in relation to the
disclosure of financial information.
Rather franchisees are encouraged by the franchisor to speak to
as many other franchisees who are already within the system to gain some
indication of the likely financial performance of their prospective franchise
business. It is arguable that existing
franchisees who assist prospective franchisees in this way may have unwittingly
exposed themselves to legal liability in relation to the accuracy of the
financial information which they have gratuitously provided to the prospective
franchisee.
(ii) the contractual rights and obligations of all parties,
including termination rights and geographical exclusivity
I have come across one particular franchise system which has a
large number of evergreen / perpetual franchise agreements. Given the fact that these franchise
agreements are evergreen / perpetual, the franchisor is under no legal
obligation to amend those agreements to ensure that they are consistent with the
particular provisions of the Code which were introduced to protect franchisees,
such as the prohibition contained in clause 22 of the Code:
22 Costs of settling
disputes
A franchise agreement must not contain a clause that requires the
franchisee to pay to the franchisor costs incurred by the franchisor in
relation to settling a dispute under the agreement, and if it does, the clause
is of no effect.
I believe that some franchisors
sometimes use the dispute recovery cost clauses in their evergreen / perpetual
franchise agreements as a means of pressuring franchisees to resolve legitimate
disputes as quickly as possible and in a manner which is highly advantageous to
the franchisor. In effect, franchisees are concerned that if they decide to
challenge the franchisor about an issue, such as a Breach Notice, they will be
liable not only for their own legal costs, but also for the franchisor’s legal
and other costs incurred in resolving the dispute.
Indeed, I had the unfortunate
experience of dealing with an advisor for a national franchisor in a franchise
dispute involving a franchise agreement which contained just such a dispute
cost recovery clause. Throughout the
dispute the advisor for the national franchisor appeared intent on generating
as much correspondence as possible in relation to the dispute (sometimes
sending two letters in a single day), whilst at the same time continually
pointing out to me the financial effects that the dispute cost recovery clause would
have on my client.
Furthermore, franchisors with evergreen / perpetual franchise
agreements are not required to update those agreements to ensure that they are
consistent with the new Unfair Contract Term laws introduced in November 2016.
(iii) the leasing arrangements and any limitations of the
franchisee’s ability to enforce tenants’ rights, and
No comments.
(iv) the expected running costs, including cost of goods
required to be purchased through prescribed suppliers;
I have come across a situation where a franchisor has apparently
sought to control the retail margins of franchisees so as to prevent them from
purchasing goods from outside of the franchise system, which was permitted
under the franchise agreement.
By way of example, assume that the franchisor supplies
particular products through its preferred suppliers at a wholesale price of
$100 each and that each of these products are resold at the retail level for
$150, at a gross profit margin of $50.
However, the franchisee can also buy these same products from an outside
supplier at a wholesale price of $75, which would net the franchisee a net
profit margin of $75, based on the same retail price of $150.
However, franchisors are able to discourage this practice (in
order to safeguard their own preferred supplier arrangements) by forcing the
franchisees to sell outside purchases at low retail margins. Using the above
example, a franchisor may decide to set a maximum retail margin of 20% on the
outside purchases meaning that the franchisee would only be able to sell the
outside purchase which they had purchased at a wholesale price of $75 for $90
retail, with a $15 gross profit margin.
The effect of the franchisor’s conduct in this situation would be to make
the outside purchases uneconomic for the franchisee and to force the franchisee
to only make sales through preferred suppliers.
(b) the effectiveness of
dispute resolution under the Franchising Code of Conduct and the Oil Code of
Conduct;
I understand that there are a number of differences in
terminology between the Code and the Oil Code.
It is important to address these differences to reduce the level of
confusion which can arise.
(c) the impact of the
Australian consumer law unfair contract provisions on new, renewed and
terminated franchise agreements entered into since 12 November 2016, including
whether changes to standard franchise agreements have resulted;
As stated above, franchisors with evergreen / perpetual
franchise agreement have no legal obligation to update their agreements to
ensure that they are consistent with the new Unfair Contract Terms legislation
introduced on 12 November 2016.
(d) whether the provisions of other mandatory industry codes of
conduct, such as the Oil Code, contain advantages or disadvantages relevant to
franchising relationships in comparison with terms of the Franchising Code of
Conduct;
No comments.
(e) the adequacy and operation of termination provisions in the
Franchising Code of Conduct and the Oil Code of Conduct;
I have come across situations where franchisors have incorrectly
alleged that a franchisee has engaged in fraudulent conduct in a Notice of
Breach. When asked to advise on these Notices of Breach it has been clear to me
that whilst the franchisee may have engaging is false or misleading conduct,
the alleged conduct did not satisfy the elements of fraud.
In order to address this particular problem, it make be worthwhile
for the Code to be amended to include some further guidance at to the legal
meaning of the words “act fraudulently” in clause 29(1)(g) of the Code.
(f) the imposition of restraints of trade on former franchisees
following the termination of a franchise agreement;
No comments.
(g) the enforcement of breaches of the Franchising Code of
Conduct and the Oil Code of Conduct and other applicable laws, such as
the Competition and Consumer Act 2010, and franchisors; and
ACCC’s
enforcement of the Code
An issue which will no doubt be front and centre of the enquiry is the
effectiveness of the Australian Competition and Consumer Commission (ACCC) as
an enforcer of the provisions of the Franchising Code of Conduct.
Unfortunately, in my view, the ACCC’s enforcement of the Code has not been
effective.
The following table outlines the ACCC’s record in terms of enforcing the
provisions of the Code. This table is based on information currently available
on the ACCC’s website and the ACCC Annual Reports.
Table 1: ACCC Franchising
Code litigation and undertakings 2004 – 2018
Year
|
ACCC investigations litigation
|
Matters
|
2004
|
2
|
Synergy, Chaste
|
2005
|
3
|
Bon Levi, Office Support Services, You Can Bake It
|
2006
|
4
|
Archem, Contact Plus, Scotty’s Premium Pet Foods, Photo Safe/Data Vault/ie Networks
|
2007
|
3
|
JV Mobile, Kyloe (dismissed), Quizno’s
|
2008
|
2
|
Duco Magic, Awesome Water
|
2009
|
1
|
ALM/Active Money
|
2010
|
5
|
Allphones, Ray White, Seal-a-Fridge, Mailpost,
Refund Home Loans
|
2011
|
0
|
|
2012
|
0
|
|
2013
|
0
|
|
2014
|
2
|
Express Mobile, Taxsmart
|
2015
|
2
|
Coverall, Electrodry
|
2016
|
1
|
Sensaslim
|
2017
|
5
|
Fastway, Pastacup, Geowash, Domino’s, UltraTune
|
2018
|
0
|
|
Total
|
30
|
In other words, over the last fifteen years, the ACCC has pursued 30 formal
outcomes in relation to the Franchising Code. The ACCC has been successful in
29 of these cases, with only the Kyloe case having been dismissed as not
disclosing a breach of the Code.
The above figures are somewhat misleading, as a number of these
Franchising Code investigations and outcomes listed on the ACCC website as
franchising outcomes did not in fact allege any Code breaches. For example:
- the Chaste case did not allege any contraventions of the Franchising Code - rather, the focus of that case was on false representations, misleading and deceptive conduct and resale price maintenance.
- the Archem and Refund Home Loans case also did not allege any breaches of the Franchising Code; and
- finally, the Electrodry case
was focused solely on the making of false testimonials.
Accordingly, the ACCC has actually had 25 successful outcomes in
relation to Code breaches in the last 15 years.
In my view this is a very low
level of enforcement activity given the size of the franchising sector in
Australia and the number of franchising complaints received by the ACCC over
that period.
Table 2: Franchising
complaints
Year
|
Number of
complaints
|
2003-2004
|
1557
|
2004-2005
|
1235
|
2005-2006
|
747
|
2006-2007
|
853
|
2007-2008
|
715
|
2008-2009
|
949
|
2009-2010
|
765
|
2010-2011
|
990*
|
2011-2012
|
861
|
2012-2013
|
802
|
2013-2014
|
818
|
2014-2015
|
809
|
2015-2016
|
931
|
2016-2017
|
608
|
Total
|
12640
|
* estimate
While it is probable that the ACCC received multiple complaints about
each of the franchisors against which it took enforcement action over the last
fifteen years, even if we assume 15 complaints against each of those
franchisors, that means that the ACCC took enforcement action in relation to 3.5%
of all franchising complaints received – ie
- 30 x 15 = 450 divided by
12,640 x 100 = 3.56%.
In addition, many of the franchisors against which the ACCC has taken
enforcement action are relatively small operators with both limited market share
and low brand recognition. Accordingly,
one is left to question the effectiveness of these enforcement actions in terms
of achieving general deterrence, particularly in the boardrooms of larger,
national franchisors.
While the ACCC’s record in the enforcement of both the Competition and Consumer Act 2010 and
the Australian Consumer Law 2010 has
been nothing short of sensational in recent years, the ACCC continues to
struggle in the franchising area. Put
simply I believe that there is a significant degree of serious non-compliance
occurring in the franchising sector which the ACCC is simply not addressing.
(h) any related matter
Marketing
funds
I believe that there are a number of large franchisors that are not
complying with their obligations under the Code in relation to marketing and
cooperative funds. Not only are
significant expenditures not being approved by the franchisees, but audit
reports are not being sent to franchisees.
Franchise
associations
Some franchisors actively discourage franchisees from establishing
franchisee associations. I am aware of a
situation where a large national franchisor simply refused to meet with the
duly elected representatives of a franchisee association for no good reason.
Fear of
franchisor
Many franchisees are quite fearful of challenging the franchisor on any
legitimate issues because of their concern about the possibility of reprisals
and victimisation. It is clear from my
engagement in the franchising sector that some franchisors adopt a divide and
conquer strategy when dealing with their franchisees. Franchisees who are perceived to be
trouble-makers are subject to additional scrutiny, including having to respond
to questionable Breach Notices.
Small Business Code Authority
An idea which may be worth considering
is the establishment of a specialist Small Business Code Authority (SBCA)
modelled in the newly created Australian Financial Complaints Authority.
A significant issue for many small
businesses, particularly franchisees which are engaged in a dispute with their
franchisor, are the costs of pursuing their dispute through the courts, in the
event that mandatory mediation does not result in a resolution.
Currently, small businesses have the
option of commencing proceedings in the Federal Court or the Federal Circuit
Court which is a very costly exercise. A
more cost-effective option may be to establish a specialist agency with
jurisdiction to both mediate and adjudicate disputes arising under various
Codes.
The purpose of the new SBCA would be to
mediate and adjudicate various small business disputes arising under various
mandatory Codes, including the Franchising Code of Conduct, Oil Code and the
Horticulture Code. The jurisdiction of
the SBCA could also be extended as new mandatory codes are introduced, for
example the Grocery Code, if a decision is made to make that Code mandatory,
and the recently proposed Dairy Code.
I acknowledge that the establishment
of a new federal Authority to deal exclusively with small business code
disputes, particularly franchise disputes, may appear to be a costly exercise
for the government to consider. However, there are a number of arguments in
favour of such an approach, particularly in relation to franchising:
- franchising is a very large sector in Australia with approximately 1100 franchising systems, employing many hundreds of thousands of employees;
- the costs of pursuing a legitimate grievance against a franchisor are currently cost prohibitive;
- often franchisees have invested their entire savings in their business and as such risk losing everything unless the dispute is resolved in a quick and cost-effective manner; and
- franchising is a complex area, best dealt with by specialists with expertise in franchising.
Many of the above arguments would also
apply in relation to other mandatory Codes, particularly points (2), (3) and
(4).
If you have any questions about this submission, please contact me on
(02) 8086 2005.
Yours sincerely
Michael Terceiro
Competition and Consumer Lawyer
Terceiro Legal Consulting
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