How will major changes to the Franchising Code affect the sector?

The recent release of the Review of the Franchising Code of Conduct provides a valuable insight into what the future of franchising in Australia might look like.

The 18 recommendations made by reviewer Alan Wein offer a range of proposed changes and improvements that have the potential to substantially influence the nature of relationships between franchisors and franchisees.

There is something for everyone in the review, with franchisor, franchisee, legal practitioner, regulator and other stakeholder perspectives taken into account in framing the various recommendations.

Chief among these recommendations is the proposal to introduce fines of up to $50,000 for a breach of the Code, the inclusion of an express obligation of good faith, greater definition around the management of marketing funds, and recognition of franchisees as creditors in the event of a franchisor insolvency.

While the Minister for Small Business, Gary Gray, is yet to announce the government’s official response to the recommendations, Parliamentary Secretary for Small Business and chairman of the last franchise inquiry in 2008, Bernie Ripoll, has been quick to promote the report since its release on May 17 via media release and radio interviews.

For Ripoll, the current Code review represents an opportunity to deal with some unfinished business.

He was chairman of the 2008 Parliamentary Joint Committee on Corporations and Financial Services, which independently of the then small business minister Craig Emerson, conducted a comprehensive review of the Franchising Code of Conduct following state-based inquiries earlier that year in South Australia and Western Australia.

The 2008 inquiry took longer than the current inquiry, and included public hearings which sought personal testimony from participants across the franchise sector, as well as received more than 140 written submissions. (By comparison, the current inquiry did not conduct public hearings, although the reviewer did meet with a variety of stakeholders to discuss their views, and received 73 submissions).

Following the 2008 inquiry (which made 11 recommendations) Emerson took nearly a year to consider the government’s official response, which resulted in full or partial acceptance of eight of the recommendations. These were adopted into the Code from July 1, 2010, and were criticised by advocates of increased franchisee rights that they did not go far enough, while franchisor stakeholders accepted that the changes may require more effort to comply with the new requirements.

A key recommendation of the 2008 inquiry was that the Code not be reviewed again within three years, in order to give time for the latest changes to be properly evaluated. While the timeframe has been slightly less than three years, the scope of the current review and its recommendations appears to be significantly broader than any previous review. (Indeed the current review recommends a period of five years before any further review).

The key recommendations regarding fines, good faith, marketing funds and franchisees as creditors represent potentially the most significant changes to the Code since it was first introduced in 1998.

Although the Australian Competition and Consumer Commission (ACCC) have had the role of enforcing the Franchising Code since its commencement, the range of enforcement tools available to it have been limited largely to outcomes derived from court proceedings. This enforcement methodology has been criticised by some stakeholders as slow, expensive and inefficient.

If fines are introduced for breaches of the Code in future, it is likely that enforcement responses will be faster and potentially more specific to the relevant breach.

The devil is in the detail and it remains to be seen how this recommendation may translate into a scale of Code breaches, and what size fine may be applicable to each. This will require extensive consideration due to the complexity of the Code and its requirement to disclose information to franchisees upfront, and may also require a transitional period to allow the franchise sector to adjust to any changes before fines are levied.

Recommendations regarding marketing funds in the Code Review go further than in any previous review. Franchisees in most systems make a contribution to a central fund that then pays for communal promotions, such as catalogue production, major media advertising, and online promotions.

The management of these marketing funds has not been a particular focus of reviews in the past, but now is subject to recommendations that, if adopted, would require the fund to be operated like a trust account, with an annual audit, and compulsory contributions from franchisor-owned outlets, among other requirements. At a practical, commercial level, the operation of a marketing fund as a trust account may require a fundamental change in the way these funds are managed, and the cost and complexity of doing so. Again, the devil is in the detail and it depends on whether or not this recommendation is accepted, and if so, how this may be worded in a future version of the Code.

Good faith was considered in the 2008 review of the Code, and again in the current review. Its existence was acknowledged for the first time by changes to the Code which commenced in 2010. The current review seeks to include a specific requirement to act in good faith (as opposed to just acknowledging that good faith might exist), but does not seek to include a definition of good faith, instead leaving it to the courts to define on a case-by-case basis in a similar manner to the concept of unconscionable conduct.

Another key recommendation is the recognition of franchisees as creditors by apportioning the franchise fee paid up-front over the term of the franchise, thus creating a debt owed to the franchisee in the event of a franchisor insolvency. This addresses an issue that has occurred in recent high-profile franchisor insolvencies such as Angus & Robertson and others, where franchisees have not been owed money by the franchisor, and therefore are entitled to less information than creditors or staff in the administration process, despite having the most invested in the future of the franchisor as a going concern.

As mentioned earlier, there are 18 recommendations arising from the current review of the Franchising Code, and this article has provided an overview of the review’s background and four key recommendations. As with the previous Code review, it is likely that a majority of the recommendations will be accepted, although an implementation and transitional timeframe is unclear.

To read the full list of 18 recommended changes, see the summary list at the front of the Code review report by clicking here.

To learn more in person at a special event to be held on June 5 about the impact of potential changes from key figures whose submissions were influential in shaping the Code review recommendations, click here for details.

Jason Gehrke is the director of the Franchise Advisory Centre and has been involved in franchising for 20 years at franchisee, franchisor and advisor level.