Escolar Documentos
Profissional Documentos
Cultura Documentos
School of Law
Faculty of Law
Queensland University of Technology
August 2010
i
Keywords
Abstract
Table of Contents
Keywords .................................................................................................................................................i
Abstract .................................................................................................................................................. ii
List of Figures ........................................................................................................................................vi
List of Tables ....................................................................................................................................... vii
List of Abbreviations........................................................................................................................... viii
Statement of Original Authorship ........................................................................................................... x
Acknowledgments ..................................................................................................................................xi
CHAPTER 1: INTRODUCTION ....................................................................................................... 1
1.1 Effective protection for franchisees whose franchisor fails ......................................................... 3
1.2 Challenges for the law ................................................................................................................. 8
1.3 Aim of the research .................................................................................................................... 10
1.4 Outline of thesis ......................................................................................................................... 11
1.5 Information base ........................................................................................................................ 13
1.5.1 Empirical research on the facts ....................................................................................... 14
1.5.2 Research on the current law ............................................................................................ 16
1.6 Limitations ................................................................................................................................. 17
1.7 Matters beyond the scope of this thesis...................................................................................... 17
CHAPTER 2: WHAT IS THE PROBLEM AND HOW BIG IS IT?............................................. 19
2.1 Research into franchisor failure ................................................................................................. 19
2.1.1 Australian franchisor failure data ................................................................................... 21
2.1.2 Evidence of failed franchisors ........................................................................................ 30
2.1.3 Why franchisors fail ....................................................................................................... 43
2.1.4 Early warning signs ........................................................................................................ 48
2.2 Franchisor failure from other perspectives ................................................................................ 52
2.2.1 Franchisor’s perspective ................................................................................................. 52
2.2.2 The government’s and the regulator’s perspective ......................................................... 52
2.2.3 Industry organisations’ and commentators’ perspectives ............................................... 54
2.3 Franchisor failure from franchisees’ perspective ....................................................................... 55
2.3.1 Additional implications for franchisees structured like a commission agency ............... 67
2.4 Franchisees from the franchisor liquidator’s perspective........................................................... 68
2.4.1 Franchisee as creditor ..................................................................................................... 69
2.4.2 Franchisee as debtor ....................................................................................................... 71
2.4.3 Franchisee as potential litigant ....................................................................................... 73
2.4.4 Challenges facing the liquidator ..................................................................................... 73
2.5 Conclusion ................................................................................................................................. 75
CHAPTER 3: THE PROBLEM IN CONTEXT .............................................................................. 79
3.1 Development of business format franchising ............................................................................. 80
3.2 Components of 21st century franchise networks ........................................................................ 81
3.2.1 Franchisor ....................................................................................................................... 83
3.2.2 Trade marks .................................................................................................................... 90
3.2.3 Leases ........................................................................................................................... 102
3.2.4 Franchisees ................................................................................................................... 112
3.2.5 Franchisees not traditional suppliers............................................................................. 122
List of Figures
Figure 1: Number of identified failed franchisors in Australia 1987 – 2009. ....................................... 40
U U
Figure 2: Known number of franchisees affected by their franchisor failing in Australia 1990-
U
2009...................................................................................................................................... 41
U
Figure 3: Minimum estimated lost investment by franchisees in Australia 1990 - 2009. ..................... 69
U U
The Australian Securities and Investments Commission has approved funding for an
investigation into the collapse of white goods business Kleenmaid.
source: www.news.com.au/perthnow, 25 September 2009
U U
List of Tables
Table 1: Australian failed franchisor data ............................................................................................. 30
U U
Table 2: National Australia Bank Accredited Franchise Systems 2008 and 2009 ................................ 51
U U
Table 3: Some costs and losses for one franchisee of Danoz Directions .............................................. 61
U U
Table 6: Franchisees’ position under State and Territory retail tenancy legislation............................ 231
U U
List of Abbreviations
AC Appeal Cases
CA Chartered Accountants
PC Productivity Commission
QLD Queensland
SA South Australia
TM Trade mark
UK United Kingdom
Acknowledgments
I have published extensively from this research and extend my thanks to the
anonymous referees who have each made valued comments. The publications are:
Jenny Buchan and Bill Butcher, ‘Premises Occupancy Models for Franchised
Retail Businesses in Australia: Factors for Consideration’ (2009) 17(2) Australian
Property Law Journal 143.
Jenny Buchan, ‘Can Franchise Agreements Provide for Relief Against Franchisor
Failure in the Context of the Common Law?’ (Paper presented at the 23rd Annual
International Society of Franchising Conference, San Diego, 12-14 February
2009) 1.
Jenny Buchan, ‘Ex Ante Information and Ex Post Reality for Franchisees – the
Case of Franchisor Failure’ (2008) 36 Australian Business Law Review 407.
Jenny Buchan and Lorelle Frazer, ‘The Domino Effect – How Ansett’s Failure
Impacted on Traveland Academy of World Business’ (Paper presented at the
Marketing & Management Development Conference, Paris, 10-13 July 2006)
1901.
Jenny Buchan, ‘Is There a Basis for Equating Franchisees with Employees in
Priority Ranking on the Insolvency of Franchisors?’ (Paper presented at the 20th
Annual International Society of Franchising Conference, Palm Springs,
California, 24-26 February 2006) 229.
CPA Australia and its then policy adviser Judy Hartcher, the International Bar
Association and the University of New South Wales funded and assisted the data
collection. On the subject of data, much activity in the world of failing franchisors
happens behind the scenes so I particularly wish to record my appreciation for the
contribution of former franchisees Ben Morris, David Archibald and several former
Traveland franchisees. My colleagues in the International Society of Franchising
have forced me to field searching questions that have improved my research. Their
interest and generosity is much appreciated.
Finally, and most significantly, my family granted me the time and space to
complete this research so I thank especially Graham, Ian and Tamsin Buchan and my
parents George and Jo Hitchcock. Without them every step would be more difficult.
Most franchisees believe they are buying into a proven business model. Very
few have had previous experience with the consequences of franchisor failure and
most do not realise that in this respect, they are largely unprotected by law.
concluding that the current situation is unsatisfactory, and that the situation will not
change without statutory intervention, I recommend legal reforms designed to level
the playing field in franchising. The proposed regulatory responses are evaluated
against three consumer protection benchmarks (‘the Benchmarks’).
B1) Regulation should provide effective protection from serious risks and threats that
[franchisees as business] consumers cannot tackle as individuals. 3 2F
B2) There should be accessible, timely 4 and meaningful redress where consumer
3F
B3) The cost to the franchisor and the legal system of meeting B1 and B2 should be
less than the benefit to franchisees whose franchisor fails.
1
Peter Switzer, ‘Stop Losing Franchisees in the FOG’, The Australian (Sydney), 31 January 2002,
quoting Jim McCracken, then CEO of the Franchise Association of Australia, 21.
2
The phrase ‘franchise network’ is used throughout this dissertation. It refers to the entire network
created that supports the franchisor’s business, both the upstream entities related to the franchisor,
including for example the franchisor’s premises leasing companies, entities that own the
registered trade marks, and patents that franchisees use, and the downstream franchisees. This is
differentiated from the widely used phrase ‘franchise system’ that includes only the franchisor
and its franchisees.
3
Commission of the European Communities, EU Consumer Policy Strategy 2007 – 2013
Empowering Consumers, Enhancing their Welfare, Effectively Protecting them (2007) European
Commission 5 <http://ec.europa.eu/consumers/overview/cons_policy/doc/cps_0713_en.pdf> at 5
March 2010.
4
Australian Government Productivity Commission, Review of Australia’s Consumer Policy
Framework, Productivity Commission Report No 45 (2008) vol 2, xv.
Chapter 1: Introduction 1
2
the next 14 years these numbers grew to 1,100 franchisors, 63,500 franchisee-
operated units, and more than 400,000 people employed in business format franchise
organisations. 7 The resulting investment by franchisees in start-up costs was
6F
5
PriceWaterhouse Coopers, ‘Economic Impact of Franchised Businesses’ (2004) International
Franchise Association Educational Foundation iii.
6
Australian Bureau of Statistics, Department of Industry, Science and Technology, Franchising
Sector Survey (1994). Note: this includes petroleum retailers.
7
Lorelle Frazer, Owen Wright and Scott Weaven, Franchising Australia 2008 (2008) 9-10. Note
the total excludes an estimated 10,500 retail fuel and motor vehicle retailers and the total number
of employees includes those employed by franchisors.
8
Ibid 29-30. What is the total start-up cost of a new franchised unit (excluding GST)? This data is
from a sample of 252 franchisors. ‘A significant difference was found between retail and non-
retail systems. In the retail sector the median total start-up cost was $246,250 compared with
2 Chapter 1: Introduction
3
As franchisees have no clear standing under the Corporations Act 2001 (Cth)
(‘Corporations Act’) compared with other stakeholders in a franchisor’s insolvency
they pose a new challenge for both consumer protection and business failure law.
Franchisees are problematic. One insolvency lawyer observes that ‘[o]f all
insolvency matters, the most difficult is the failure of a franchise group’. 9 8F
Most of the performance by the franchisor occurs after the franchisee has made
its investment. Table 3 shows that the franchisee makes a high sunk investment in the
early stages of the franchise relationship, particularly where the franchised business
is in retail or another sector where the franchisee’s business is conducted from fixed
premises such as hotels, motor fuels or car sales. The reality, if the franchisor
becomes insolvent, is that the sunk costs and other outlays have been expended by
the franchisee, theoretically allowing a claim 10 in the franchisor’s insolvency, but
9F
with the reality of no prospect of return from the insolvency process. The reasons for
this will be explored in chapters 2, 3 and 4.
such a claim is that the legal framework supporting the franchise model has evolved
to satisfactorily accommodate the needs of the key stakeholders at all stages of the
relationship.
The opportunities the franchising model provides for franchisors are well
recognised:
a multibillion dollar corporation can be built with little regard for the welfare
of the thousands of individuals who invest their life savings to build the
franchisor’s brand. … By accessing the labour and capital markets with a
$51,000 in non-retail. Food retailing start-up costs averaged $280,000, compared with a median
of $210,000 in non-food retailing. The 2008 survey excludes motor trades franchisees.
9
D Binning, ‘Code Wars – A Liquidator’s Worst Fears’, The Australian Financial Review
(Sydney), 29 June 2006, 13 quoting David Cowling, insolvency partner with law firm Clayton
Utz (then Vice-chair of International Bar Association’s Section on Insolvency and Creditors
Rights).
10
Contingent on the franchisee being permitted by the court to litigate, and then successfully
establishing a claim that the franchisor breached a contract or the Trade Practices Act 1974 (Cth).
11
Lorelle Frazer, Scott Weaven, Owen Wright, Franchising Australia 2006 (2006) 12.
Chapter 1: Introduction 3
4
Paul Steinberg and Gerald Lescatre have drawn attention to the somewhat
anomalous situation franchising has created – the opportunity for franchisors to shift
risk and liability without the law having fully adjusted to the consequential
vulnerability of franchisees as adopters of the risk and liability.
12
For example: statutes that impose requirements on employees to provide insurance for injured
workers, superannuation, payroll tax, statutory and common law directors duties in relation to
areas such as conflicts of interest that would exist if the franchisees were share holders or
employees but do not exist as the franchisees have chosen the franchising method of investment
in the franchisor.
13
Paul Steinberg and Gerald Lescatre, ‘Beguiling Heresy: Regulating the Franchise Relationship’
(2004) 109 Pennsylvania State Law Review 105, 121.
4 Chapter 1: Introduction
5
been a considerable shift in attitude during the time that the franchise business model
has developed. The standard form relational contract is now widely used in business-
to-business transactions. 14 In addition there have been significant developments in
13F
14
For full discussion of the standard form relational contract, its characteristics in the context of
franchising and its implications in franchising, see Elizabeth C Spencer, The Regulation of the
Franchise Relationship in Australia: A Contractual Analysis (PhD Thesis, Bond University,
2007).
15
Trischa Mann (general ed) and Audrey Blunden (consulting ed), Australian Law Dictionary
(2010) 322 ‘by that very fact’. In the context of this thesis, an ipso facto clause might state that
the act of bankruptcy being committed entitles the innocent party to rescind the contract. It should
be noted that termination of a franchise agreement in the United States as a result of filing a
bankruptcy petition is unenforceable, even if the agreement contains an ipso facto clause. W
Michael Garner, Franchise and Distribution Law and Practice (1990) §13:17.
16
Trade Practices (Industry Codes – Franchising) Regulations 1998 (Cth) Appendix A.
Chapter 1: Introduction 5
6
Trade Practices Act 1974 (Cth) (‘Trade Practices Act’) and the Code in 1998. The
franchisor’s insolvency has not, until now, been cast as a consumer protection issue.
In the realm of business failure, attitudes and expectations have reached a point
where business failures are seen by many in the commercial world as:
17
Ian Bickerdyke, Ralph Lattimore, and Alan Madge, ‘Business Failure and Change: An Australian
Perspective’ (Productivity Commission Staff Research Paper, 2000) 3.
18
D Noakes, ‘Measuring the Impact of Strategic Insolvency on Employees’ (2003) 11(12)
Insolvency Law Journal 91, fn 5, quoting Peta Spender ‘strategic insolvency arises when the
bankruptcy is invoked due to strategic decision-making rather than being a passive response to
market forces.’ Rizwaan Jameel Mokal, ‘The Search for Someone to Save: A Defensive Case for
the Priority of Secured Credit’ (2002) 22(4) Oxford Journal of Legal Studies 687, suggests at 698
that ‘because a significant part of the [small firm] shareholder-managers’ wealth is likely to be
invested in the [small] firm, as an undiversified investment, far from being ready to liquidate
them strategically, shareholder-managers can be expected to fight … single-mindedly to keep
them afloat.’ Mokal’s proposition may help explain the franchisees’ response to impending
failure, but is inapplicable to franchisors that diversify business risks through their franchisees.
19
Sarah B Foster and Carolyn Johnsen, ‘The War of the Worlds: Bankruptcy Versus…’ (Paper
presented at the American Bar Association, 28th Annual Forum on Franchising, Florida, 19-21
October 2005) 1. The word bankruptcy is used for both corporate insolvency and personal
bankruptcy in the USA. In Australia bankruptcy is personal bankruptcy; insolvency is the
corporate equivalent.
6 Chapter 1: Introduction
7
This dissertation explores the ability of the current contract and consumer
protection laws to address the franchisees’ situation. The limited avenues of redress
currently available to franchisees as business consumers are neither meaningful nor
appropriate once an administrator or liquidator is appointed. Following the failure of
the franchisor, decisions made by the administrators and liquidators will take into
account the size of the debt owed to the franchisor’s creditors, the presence of
secured creditors, the value of franchisor’s saleable assets, the existence of interested
buyers, distribution of assets and liabilities throughout the franchise network and
other factors. Franchisees, as contracting parties have no standing.
20
Harold Brown, Franchising: Realities and Remedies (1973) 40 cited in Shelby D Hunt,
‘Franchising: Promises, Problems, Prospects’ (1977) 53(3) Journal of Retailing 71, 77.
Chapter 1: Introduction 7
8
The franchisees’ problems compound if third parties own assets to which the
franchisees would need uninterrupted access in order to continue their businesses.
These may include for example licences to use trade marks or patents, customer lists
or retail leases. Lack of access to third party owned assets makes it difficult for an
administrator to restructure the franchise network and virtually impossible for the
administrator or liquidator to sell the network intact. It also becomes difficult for
franchisees to continue trading independent of the franchise network. Trade marks
used by and retail leases of premises occupied by franchisees will be examined in
chapters 3.2.1, 3.2.3 and 4.5.
Multiple legal issues arise from franchisor failure. It is convenient to say that
franchisees should learn to conduct proper due diligence, or that they should be
better educated about the risks of franchising. It is also convenient to blame
franchisees for not self-protecting as a matter of course by each negotiating a suitable
ipso facto clause into their franchise agreement. In theory it is possible for
franchisees to self-protect through their franchise agreements but in practice there are
impediments to this which are discussed in chapters 3.3 and 3.4. For example, ‘[i]t is
costly, if not impossible, to write contracts representing claims on a firm [franchisor]
which clearly delineate the rights of holders for all possible contingencies.’ 21 20F
Even if negotiating an ipso facto clause were possible, the legal relationships
within a franchise network are so numerous and complex that a purely contract-based
solution is unsatisfactory as a sector-wide solution. It may suit a franchisee operating
a pool cleaning business with a well-established customer base that is loyal to their
pool cleaner and will follow him or her regardless of the name on the van but not a
franchisee with high, newly sunk investments and years to run on its franchise
agreement.
21
Michael C Jensen and William H Meckling, ‘Theory of the Firm: Managerial Behavior, Agency
Costs and Ownership Structure’ (1976) 3(4) Journal of Financial Economics 305, 340.
22
Gillian K Hadfield, ‘The Many Legal Institutions that Support Contractual Commitment’ in
Claude Menard and Mary Shirley (eds), Handbook of New Institutional Economics (2004) 175,
177.
8 Chapter 1: Introduction
9
complex problems. In nature ecosystems are most complex at the boundaries of two
or more habitats. The problem of how to treat franchisees of failed franchisors is a
perfect example of this complexity existing in the legal world at the intersection of
the law governing commercial contracts, consumer protection, and insolvency.
Solutions to identified gaps in the law will have the greatest chance of being
acceptable to policy makers if they address the seven pre-requisites for the making of
sound and informed policy adopted by Australia’s Office of Best Practice Regulation
(‘OBPR’) 23 being:
2F
A description of the problem or issues which give rise to the need for
action and broad goal of the proposed regulation (‘OBPR 1’). This is
addressed in chapters 2, 3 and 5.
falls outside this thesis, stakeholder categories are identified in chapter 6.3.
23
Australian Government, Best Practice Regulation Handbook (2007) Department of Finance and
Deregulation A.2 <http://www.finance.gov.au/obpr/docs/handbook.pdf> at 30 May 2010.
24
Gary Banks, ‘Reducing the Regulatory Burden: the Way Forward’ (Inaugural Public Lecture,
Monash Centre for Regulatory Studies, University Law Chambers, Melbourne, 17 May 2006) 12.
One of the prerequisites of good regulatory processes is ‘effective consultation with regulated
parties at the key stages of regulation-making and administration’.
Chapter 1: Introduction 9
10
relationship between insolvency and other law. The Guide recommends that ‘the
relationship between insolvency law and other laws should be clear and, where
possible, references to the other laws should be included in the insolvency law’. 27 26F
The franchisee, being a part of a business model that evolved after the insolvency
laws were fundamentally settled does not comfortably fit within the insolvency
regime. In the context of consumer protection it is suggested that rather than relying
on the lead coming from insolvency law, the relationship between consumer
protection and insolvency law should be addressed pro-actively. This will be re-
visited in chapters 6.2 and 7.
This dissertation demonstrates why franchisees need protection and why they
are unable to self-protect from the consequences of franchisor failure. It explores and
proposes solutions via a statute-based consumer protection approach. The solutions
will address the three benchmarks and OBPR prerequisites 1, 2, 3, 5 and 6.
25
Peter Carroll, ‘Rethinking Regulation: An Assessment of the Report of the Taskforce’ (Paper
presented at the Australasian Political Studies Association Conference, University of Newcastle,
25-27 September 2006) 6.
26
UNICITRAL, Legislative Guide on Insolvency Law (2005) 19
<http://www.uncitral.org/pdf/english/texts/insolven/05-80722_Ebook.pdf> at 15 December 2009.
27
Ibid 19.
10 Chapter 1: Introduction
11
franchisors, improved pre-entry education and due diligence by franchisees and the
level of consumer protection currently contained in the Trade Practices Act and the
Code is inadequate in the context of franchisor failure. This dissertation thus aims to
answer three questions:
Does the current law meet the identified consumer protection benchmarks
and thereby protect franchisees as business consumers in the face of
franchisor failure without imposing undue extra costs on franchisors?
This chapter 1 highlights the problems franchisor failure creates for franchisees
and introduces the dimensions of the problems that will be addressed. It also
identifies limitations of the research.
Chapter 2 identifies the size and scope of the problem of franchisor failure for
franchisees. The impacts on franchisees, the perspectives of key franchise sector and
insolvent franchisor stakeholders, and the reasons for the particular impacts and
stances are identified.
asymmetry issues.
The legal structure of the network, the contractual relationship between the
franchisor and four key elements of a franchise network are set out in chapter 3.
These key elements are the franchisors, trade marks that identify the franchise, the
Chapter 1: Introduction 11
12
legal relationships between landlords, franchisors and the franchisees that conduct
their franchisee businesses from the landlords’ retail premises and, of course, the
franchisees themselves.
The franchisees’ role within the franchisor’s network is examined, and because
there is uncertainty in some people’s minds about the differences between
franchisees and suppliers, the role and legal standing of suppliers to a franchise
network is also set out in the context of franchisor failure. In chapter 3.2.6
franchisees are compared with employees as there are strong similarities and strong
differences in the roles and in the level of protection afforded to them in the event of
their employer’s or franchisor’s insolvency.
Chapter 3.3 provides the theoretical discussion of key aspects of the franchise
agreement. Chapter 3.3 thus demonstrates how difficult it would be for all 71,400
Australian franchisees to be protected by ipso facto clauses in negotiated franchise
agreements. It will demonstrate why franchise agreements will never be drafted
voluntarily to routinely provide effective protection to franchisees whose franchisor
fails. Before moving from the contractual analysis, breach of contract and remedies
for breach of contract are examined.
On concluding that contract law alone cannot protect franchisees, and that the
franchisor failure problem is significant enough to ‘give rise to the need for action’,28 27F
the question of whether the consumer protection regulatory regime is adequate in its
present form to deal with the problem is addressed in chapter 4. Chapter 4.1 explores
the possibilities of franchisees of failing and failed franchisors receiving protection
as business consumers under the current provisions of the Trade Practices Act.
Chapter 4.3.3 evaluates the adequacy of the Code.
28
Australian Government, Best Practice Regulation Handbook, above n 23, 27.
12 Chapter 1: Introduction
13
On concluding that the current situation fails to attain B1 and B2, this
dissertation proposes solutions in chapter 6. First, non-regulatory solutions are
considered. They are rejected. The proposed regulatory solutions are then introduced.
These include amendments to the Trade Practices Act and to state and territory retail
leasing legislation. The solutions would provide laws that meet B1 and B2. As
previously stated, B3 concerns cost/benefit considerations and is not pursued in
detail in this dissertation.
Chapter 7 brings together the themes and issues explored and exposed in the
previous chapters. The central research question is reconsidered with reference to the
theoretical conclusions, empirical findings and the Benchmarks. Avenues for future
research that have been identified through this research are listed.
categories of information that must be found and understood before concluding that a
legislated solution is required to a problem. Firstly what are the facts, and secondly
what is the current law. While much research has been conducted on aspects of the
29
Michael J Trebilcock, ‘Rethinking Consumer Protection Policy’ in Charles E F Rickett and
Thomas G W Telfer (eds), International Perspectives on Consumers’ Access to Justice (2003) 69
referring to research conducted with Gillian K Hadfield and Robert Howse.
Chapter 1: Introduction 13
14
The data on which this thesis is based is similar to the depth and amount of
data that a prospective franchisee conducting a very thorough due diligence would be
able to access. It is submitted that it is sufficient to support the conclusions reached.
investigated:
A pilot study 31 was conducted (‘the CPA Study’) of franchisors that fail in
30F
The nexus between the franchisor, the franchisees and the franchisees’
rights in relation to franchisors’ registered trade marks was explored. (‘the
Exploratory Study’) 33 32F
30
Australian Government, Best Practice Regulation Handbook, above n 23, 27.
31
Jenny Buchan, ‘When the Franchisor Fails’ (2006); Jenny Buchan, ‘Franchisor Failure in
Australia – Impact on Franchisees and Potential Solutions’ (Paper presented at the 19th Annual
International Society of Franchising Conference, London, UK, 20-22 May 2005) 529.
32
Jenny Buchan, ‘Reducing Collateral Damage in Franchisor Insolvency’ in Paul Omar (ed),
International Insolvency Law: Themes and Perspectives (2008) 367; Joint Committee on
Corporations and Financial Services, Parliament of Australia, Department of the Senate, Inquiry
into Franchising and Code of Conduct (2008) Jenny Buchan Submission #89.
<http://www.aph.gov.au/Senate/committee/corporations_ctte/franchising/submissions/sub89.pdf>
at 31 May 2010. Jenny Buchan and Lorelle Frazer, ‘The Domino Effect – How Ansett’s Failure
Impacted on Traveland Academy of World Business’ (Paper presented at the Marketing &
Management Development Conference, Paris, 10-13 July 2006) 1901.
33
Jenny Buchan, ‘Franchisors’ Registered Trade Marks under Australia’s Trade Marks Act 1995
(Cth)’ (Paper presented at the 22nd Annual International Society of Franchising Conference, St
Malo, France, 20-22 June 2008) paper 30; Jenny Buchan, ‘Franchisor’s Registered Trade Marks –
Empirical Surprises’ (2009) 21(7) Australian Intellectual Property Law Bulletin 154.
14 Chapter 1: Introduction
15
The franchisees’ legal rights to occupy the retail premises they trade from
was also examined as part of the Exploratory Study. 34 3F
CPA Study
Data contained in the Tables throughout this dissertation is the most
comprehensive information that could be assembled, mostly from public records.
The CPA Study was conducted in 2005. It was funded and the final report was
published by CPA Australia, and was the beginning of a now ongoing search for
reliable base information about failing and failed franchisors and their networks. The
many challenges are discussed in chapter 2.1.1.
Exploratory Study
The Exploratory Study was funded by two research grants from the Australian
School of Business at the University of New South Wales. To obtain the data a
sample group comprising all franchisors with franchisees trading from premises
regulated by the Retail Leases Act 1995 (NSW) (‘Retail Leases Act’) was identified.
New South Wales was chosen because it has the highest number of franchisee-owned
units of any of Australia’s six states and two territories. 35 Retail premises-based
34F
34
Jenny Buchan and Bill Butcher, ‘Franchisees’ Retail Premises Occupancy Models in Australia;
The Rights and the Risks’ (Paper presented at the 22nd Annual International Society of
Franchising Conference, St Malo, France, 20-22 June 2008) paper 39; Jenny Buchan and Bill
Butcher, ‘Premises Occupancy Models for Franchised Retail Businesses in Australia: Factors for
Consideration’ (2009) 17(2) Australian Property Law Journal 143.
35
Frazer, Weaven and Wright, Franchising Australia 2006, above n 11, 25 shows that franchisors
have 34 per cent of their units in NSW, with the next highest percentage being 23.7 per cent in
Victoria.
36
Ibid.
Chapter 1: Introduction 15
16
New South Wales (NSW). The addresses of NSW franchisees’ premises were found
from the website and checked in the telephone directory. It was then assessed
whether the franchisees’ premises would be regulated by the Retail Leases Act. This
process identified 350 franchisors as the sample group. For 13 of these, no further
information could be found and they were omitted. Hence, the sample group for the
Exploratory Study on franchisors’ registered trade marks in chapter 3.2.2 and retail
leases in chapter 3.2.3 numbered 337 franchisors.
Information about leasing patterns among the 337 franchisors was sourced
from court reports, the New South Wales Land and Property Management
Authority records, and the franchisor’s websites. Limitations stemmed from that fact
that many franchisees do not register leases or sub-leases on the premises title, and
information on franchisors websites is often loosely worded from a legal researcher’s
perspective.
websites. Trade mark registration identification numbers and the identity of the trade
mark owners were recorded and analysed. Information about how public-company-
owned franchisors’ trade marks were recorded in published Annual Reports was
sourced from the Notes to Accompany the Financial Statements (‘NTFS’).
37
With the assistance of Professor Lorelle Frazer, Griffith University.
38
IP Australia <www.ipaustralia.gov.au> at 31 May 2010.
16 Chapter 1: Introduction
17
1.6 LIMITATIONS
Retail leasing enactments which are part of the problem and part of the
solution.
The impact of the halo effect referred to in chapter 3 on the depth and
quality of franchisees’ due diligence.
Chapter 1: Introduction 17
18
18 Chapter 1: Introduction
Chapter 2: What is the problem and how
big is it?
The problem is that when a franchisor’s business fails the law does not provide
a clear way for franchisees to respond. In this chapter the evidence of franchisor
failure, its causes, magnitude and impact on franchisees is explored. Reasons behind
the difficulty of creating an accurate and complete Australian database of failed
franchisors and their franchisees are explored. This is followed by a discussion of
franchisor failure research and the causes of franchisor’s failure. The impact is
discussed from various perspectives: that of the franchisor, of commentators such as
industry lobbyists, of the franchisees and the liquidator.
the franchisor lifecycle the failure occurs ‘the [franchise research] subset of the
implications of franchisor failure and the impact of franchise failure on franchisees
has received very little academic attention’. 41 40F
Academic studies of the number and timing of franchisor failures have been
conducted in the United States, the United Kingdom and France 42 but no large-scale
41F
data has yet been published to specifically record the number or timing of Australian
franchisor failures. In 1977 Shelby Hunt wrote that ‘[e]vidence began to mount that
39
Trebilcock, above n 29, 69 citing OECD, Recommendation of the Council of the OECD on
Improving the Quality of Government Regulation (Including the OECD Reference Checklist for
Regulatory Decision-Making and Background Notes) Paris: OECD (1995) 9.
40
For example, the Franchise Council of Australia’s annual conference legal day has scheduled a
session on franchisor failure every year from 2006 to 2009 inclusive.
41
Benjamin Morris, Franchisor Insolvency (B Laws Honours Thesis, University of Technology
Sydney, 2006) 3.
42
French and United States franchising and franchise research are referred to throughout this thesis
in addition to Australian. Both France and the United States have strong franchise sectors, active
franchise academics and have, either recently (France) or historically (the United States)
conducted research or collated statistics on franchisor failure.
many franchises [ie franchisors] were failing [in the US]. One study 43 identified 54 42F
entire restaurant franchise systems that turned “belly up” over a two-year period’. 44 43F
the USDOC (1988) 45 data … reports the number of franchisor failures and
4F
[Scott] Shane suggests heavy failure rates of new franchise systems in the
first four years, followed then up to the ten year period by only modest
further losses, …. Lafontaine and Shaw, on the other hand, report steady and
sustained failure rates from franchise format adoption onwards. 47 46F
The difficulty of obtaining sound data on failed franchisors was noted in 1994
by James Cross who pointed to an information void with regard to franchise failure:
Lafontaine and K Shaw cite United Kingdom research by John Stanworth who
concluded that ‘at best, one franchise company in four could be described as an
43
Urban B Ozanne and Shelby D Hunt, The Economic Effects of Franchising (1971) 93.
44
Hunt, ‘Franchising: Promises, Problems, Prospects’, above n 20, 75.
45
Andrew Kostecka, United States Department of Commerce, Franchising in the Economy (1988)
12.
46
Roger D Blair and Francine Lafontaine, The Economics of Franchising (2005) 272.
47
Francine Lafontaine and K L Shaw, ‘Franchising Growth and Franchisor Entry and Exit in the
US Market: Myth and Reality’ (1998) 13(2) Journal of Business Venturing 95, in Frank Hoy and
John Stanworth (eds), Franchising: An International Perspective (2003) 163.
48
In John Stanworth, David Purdy and Stuart Price, ‘Franchise Growth and Failure in the USA and
the UK: a Troubled Dreamworld Revisited’ (1997) 2(2) Franchising Research: An International
Journal 75, 78 citing Janes Cross, ‘Franchising Failures: Definitional and Measurement Issues’
(Paper presented at the International Society of Franchising Conference, Las Vegas, Nevada, 13-
14 February 1994) 1.
that ‘there has been no systematic study of the effect of franchisor exits, whether it
be a departure from franchising or a business failure, on the survival or growth of the
franchised units that were tied to it’. 50 49F
Over half of franchisors in France did not survive 10 years. These are franchisors that
have been granting franchisees the right to trade as a franchisee for terms of 0 to 20
years and for which up-front franchise fees would typically have been paid for the
entire term. 52 Beyond this small amount of research on the number of franchisor
51F
failures, the actual cost to franchisees and consequences for franchisees of franchisor
failure is under-researched. 53 52F
49
Lafontaine and Shaw, above n 47, 95-112, in Hoy and Stanworth, above n 47, 164.
50
Blair and Lafontaine, above n 46, 44.
51
Rozenn Perrigot and Gérard Cliquet, ‘Survival of Franchising Networks in France from 1992 to
2002’ (Paper presented at the 18th Annual International Society of Franchising Conference, Las
Vegas, Nevada, 6-7 March 2004).
52
Rozenn Perrigot, ‘Services vs Retail Chains: Are There Any Differences? Evidence from the
French Franchising Industry’ (2006) 34(12) International Journal of Retail & Distribution
Management 925.
53
An exploratory study was conducted by Jenny Buchan in 2004-2005 in Australia and reported in
‘When the Franchisor Fails’, above n 31. The Report focussed on consequences of franchisor
failure.
What the latest study [2008] shows is that many franchise systems are
relatively new and untested in a recession, many are too small to remain
viable long-term, … One-third of systems started up between 2000 and 2005
and one-fifth since 2006. … Between 2004 and 2006, the number of systems
increased by 100. There were 200 new entrants and 100 that ceased
franchising, so for every two new ones, one got out. 56 5F
Not all of the un-contactable franchisors on the Griffith database failed. Some
test the franchise model, decide it is not for them, then buy back the franchisees’
businesses. Others simply stop servicing their franchisees without the franchisor
entering administration.
54
Colin McCosker and Lorelle Frazer, Franchising Australia 1998: A Survey of Franchising
Practices and Performance (1998).
55
Frazer, Weaven and Wright, Franchising Australia 2008, above n 7, 9.
56
John Kavanagh, A Business Out of a Box (2009) Business Day
<http://www.businessday.com.au/small-business/franchising/a-business-out-of-a-box-20090703-
d6zd.html> at 3 July 2009.
Gehrke’s methodology does not support his conclusions to the extent that some
franchisors included in the 30 percent quoted will no longer be advertising for
franchisees because they have moved away from the franchise model. They may still
be operating their core business successfully though company owned stores or other
business models.
Media reports, using the Factiva database and the Australian Financial
Review,
57
Jason Gehrke, When Franchisors Fail (2008) Smart Company Blogs
<http://www.smartcompany.com.au/blogs/when-franchisors-fail/print.html> at 31 May 2010.
58
ASIC <www.asic.gov.au> at 31 May 2010.
59
ACCC <www.accc.gov.au> at 31 May 2010.
60
Using the www.austlii.edu.au and Casebase databases.
First the identity of the failed franchisor’s legal entity was sought, then the
affected franchisees. Many challenges were encountered.
Data may be accurate when published but quickly become inaccurate. The
media faces the same problems that franchisors face in trying to portray accurate and
up to date information. For example, in Business Review Weekly’s 31 January – 5
March 2008 edition ‘The franchisor Beach House Fitness Group [BHG], with 60
outlets at 30 June 2007, was ranked 4th in 2006 [on what measure] and 11th fastest
growing franchises by outlet’. 61 BHG was wound up, insolvent, in December 2008.
60F
Thirty four of the franchisors in the CPA Study were initially identified
through media reports. 62 61F
61
Business Review Weekly (31 January – 5 March 2008) 49.
62
Using the Factiva database of media records in Australia. This identified the following
franchisors that were probably in administration or insolvent: A1 Mobile Radiator Repairs;
Barnacle Bills; BB's Coffee & Bake; BC The Body Club; Boston Markets; Busy Bookkeeping;
Carlovers Carwash; Cheap as Chips; Cut Price Deli; Delifrance (Australian master); Furniture
Wizard; King Pie; Allied Securities; Lloyd Scott Enterprises; Mini Tankers International; Modern
Garages; National Express Transport; Nationwide International (Australia); NoRegrets; On Time
Business Solutions; PC Company; Personal Actions; Renouf Personal Fitness Centres; Simply
No-Knead; Snow Deli; Soils Ain't Soils; Speeds Shoes; Synergy in Business; Tokyo Joe's; Tony
Barlow Menswear; Top Snack Foods; Traveland, United Video Franchising; Wonderland of Pets.
Liquidators file prescribed documents with ASIC or ITSA. Both the lists of
sundry debtors and of unsecured creditors contain names and addresses of people and
companies that owe and are owed money by the failing company, but give no
indication of the nature of the debt or the claim. A franchisee may be characterised as
a sundry debtor or a creditor, depending on the structure of the franchise. In many
cases franchisees are not mentioned in the material filed by the liquidator. Details
must be cross-referenced to court reports, media releases or a business name extract
to determine an individual’s status.
purchased to determine whether franchisees could be identified from the records filed
with ASIC by the liquidator and, if so, how they were categorised. They could not, so
no further records were purchased. Employees’ claims in the insolvency of the
employer by contrast, are identified in a separate schedule – schedule E to the Report
of Affairs filed with ASIC by the liquidator.
63
Lorelle Frazer and Scott Weaven, Franchising Australia 2004 (2004) 70.
64
The Furniture Wizard and Traveland.
ITSA RECORDS
It is not possible to determine from personal bankruptcy records whether the
failed sole proprietor was a franchisor or a franchisee.
without naming the companies or the trading name of the franchise network. The
respondent was a director of the companies.
Sometimes even the courts are unable to identify the franchisor. For example,
in Acer Computer Australia Pty Limited v Carter (No 2) [2007] FCA 1943 Justice
Graham stated:
The relevant franchisor would appear to have been one or other of the
companies in the ‘Betta Group,’ which comprised Betta Stores Limited …,
Betta Stores (Southern) Pty Limited …, Betta Stores (Northern) Pty Limited
…, A.K. Truscott Investments Pty Limited …, Truscott Electronics Pty
Limited …, Truscott Finance Pty Limited …, PGA & Associates Pty
Limited … and BSL Finance Pty Limited. 67 6F
individual former franchisees by name and finding up to date contact details. This
proved almost impossible.
65
Australian Competition and Consumer Commission v Ewing [2004] FCA 5 lists the names of 31
franchisees (called licensees) but not their addresses or the states where they operated.
66
Rousellis v Maiurano [1998] NSWCA 196.
67
Acer Computer Australia Pty Limited v Carter (No 2) [2007] FCA 1943, para 2.
68
Buchan, ‘Franchisor Fails’, above n 31, Appendix 1.
Traveland franchisees.
Once a business name has been registered in compliance with state legislation,
it is added to the centralised, federal, ASIC website. The information generated by
the ASIC search of The Furniture Wizard stated that there is ‘no document list
available for this organisation type’. This implies that there is no further information
available about the business. In fact, an inquiry at the Western Australian Fair
69
<www.Travelblackboard.com.au> at 11 August 2005.
70
In total this elicited eight franchisee subjects, two legal advisers, two insolvency practitioner
accountants.
Trading Office reveals that historical information about the business named
‘Furniture Wizard – Wangara’ is available. Sometimes this historical information
contains the name and residential address details of the former franchisee. As
demonstrated by the above examples, eliciting comprehensive information from
some public records can be ‘hit and miss’.
The electronic white pages directories were searched for a reliable match for
franchisees whose name and address was known. For people with common
Australian names – eg ‘Smith’, it was not attempted.
Searching state and territory business names registers proved to be the most
reliable way of identifying former franchisees of failed franchisors, but it was far
from satisfactory.
Surveyed franchisees
Ultimately only 87 franchisees from 14 failed systems were identified by name.
It was not possible to physically locate many of these. Franchisees were contacted by
telephone before they were sent a survey, in order to verify that the correct individual
had been located.
was tailored for Traveland (46 questions) due to the high proportion of Traveland
respondents whose identity was known and the second (45 questions) was generic.
Completed surveys were returned by 14 former franchisees. This low response rate
means that the survey responses are not statistically valid.
71
One who could not face revisiting the issue, one who had signed a confidentiality agreement and
one couple who spoke very broken English.
to
and
… not interested in being involved. Doesn't want to ‘go through it’ all again,
as it caused … quite a few problems which they are only now putting behind
them. 72
71F
Often franchisees’ only point of connection with each other is via the
franchisor. They may not know each other’s last names or addresses. If the franchisor
fails, franchisees can lose access to the franchisor’s intranet, and with it their only
means of contacting each other. This problem is not overcome by the requirements of
the Code. 73 To comply with the Code, the franchisor is required to supply business
72F
contact details (but not the name of the franchisee) for some or all franchisees in the
system at the time the franchisee obtains the disclosure.
72
Caroline Malcolm, Research Assistant Report after a day of telephoning all known former
franchisees of insolvent franchisors.
73
See Trade Practices (Industry Codes – Franchising) Regulations 1998 (Cth) cl 6.2, 6.3 (‘The
Code’).
ACCC successfully alleged that the licensor, Synergy in Business, was franchising
and had breached the Code. Proceedings had commenced on 22 July 2002. On 6 June
2002 Synergy in Business became insolvent. The 31 franchisees had signed licence
agreements and had not known they were franchisees until the judgment was handed
down 18 months after the franchisor became insolvent.
14
Known Number of Failed Franchisors
12
10
0
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
The numbers in Figure 1 for 2006 and 2007 are low because data was not
actively sought in those years. There is no evidence that the number of franchisor
failures or the number of franchisees affected has reduced since the Code became
mandatory. It appears that the opposite occurred, but there is insufficient data to
franchising [in Australia] for more than 20 years. … says his defunct franchisors file
is bigger than the current franchisors file by a factor of six to one’. 75 On the basis of 74F
Williamson’s statement it is suggested that the data in Table 1and the numbers in
Figures 1 and 2 are the tip of the iceberg.
1,235
1,000 686
399
285 285
150 129
103
100 62
41
27
10
10
3
1
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
In Australia in 2007, the average number of franchise units per franchise
system was 50. 76 To use this median to estimate the number of franchisees impacted
75F
six had over 150. It is not possible to determine the number of franchisees in 53 of
the 98 failed networks identified in Table 1.
The number of franchisees at the time of the franchisor failure is not a true
representation of franchisees affected by the failure as many may have already left
the network, disenchanted at the lack of franchisor support, slow stock deliveries or
74
Australian Franchise Consultant from the Franchising Centre.
75
Emma Connors, ‘The Brave New World of Franchising’, The Weekend Australian Financial
Review (Sydney), 6-7 February 2010, 39.
76
Frazer, Weaven and Wright, Franchising Australia 2008, above n 7, 24.
77
Ibid 25.
other problems symptomatic of impending business failure. For example, pet shop
retail franchise Wonderland of Pets had ten franchisees at its peak, but only three at
the time it failed.
any age and structure can fail. Failed franchisors in Australia include:
Those requiring small sunk costs (Furniture Wizard, conducted from the
franchisees’ suburban residential garages)
Those established post the enactment of the Code (Kleins, Danoz, diet
business Trimit)
78
Lafontaine and Shaw, above n 47, 95-112, in Hoy and Stanworth (eds), above n 47, 163.
2.7 … most vulnerable franchise systems are those that have recently
commenced franchising and have less than, say, 12-15 units. 80 79F
…
2.9 Franchisees are clearly vulnerable to the collapse of the franchisor,
however, even when the franchisor has collapsed, some franchisees are
capable of surviving as independently owned and operated outlets, as with a
number of the Barbara’s House and Garden franchisees. …
2.10 However newer franchisees or franchisees already suffering severe
financial strain are unlikely to survive the complete collapse of a franchise
system. 81
80F
Three years after the Task Force filed its report, Stanworth, Purdy and Price
report that James Cross identified some causes of SME (small and medium-sized
enterprise) failure as being generic and concluded that failures of this type should
actually be remedied or reduced by franchising. 82 These causes are:
81F
undercapitalization
79
Robert W Fitzgerald, Franchising Task Force Final Report to the Minister for Small Business
and Customs (1991) 2.7–2.10.
80
In the light of the data in Table 1 in this thesis this statement is not supported by current data.
81
Here, I have listed only the reasons that are within the control of the franchisor, omitting those
that are a function of the broader economy.
82
Cross, above n 48, 2-4.
For Traveland, failure of the parent company, Ansett, was the beginning of
the end. ‘Air New Zealand’s decision to buy Ansett and absorb the much
larger airline destroyed both. Insufficient due diligence and the need to
upgrade Ansett’s ageing fleet were among Air NZ’s problems’. 86 85F
83
John Stanworth, David Purdy and Stuart Price, above n 48, 78-9.
84
For example Ansett Airlines failed, taking its subsidiaries including Traveland with it.
85
Kath Walters, ‘Fuel for Shareholders Anger’, Business Review Weekly (Sydney), 13 May 2004,
17.
86
Stathi Paxinos, ‘Ansett from A to T’, Sunday Age (Melbourne), 17 February 2002, 9. The
statement that both airlines were destroyed has turned out to be inaccurate; Air New Zealand is
still operating in 2010.
and operational flop’. 91 It is estimated that the 600 franchisees lost ‘in
90F
the fallout continues from the [A]$40 million fraud that brought down
Newcastle photocopier franchise Lloyd Scott Enterprises. … Businessman
Lloyd Scott had been fraudulently writing multiple leases on photocopier
87
Australian Competition & Consumer Commission v Trayling [1999] FCA 1133.
88
Australian Competition & Consumer Commission v Simply No-Knead (Franchising) Pty Ltd
[2000] FCA 1365; Australian Competition and Consumer Commission v Simply No-Knead
(Franchising) Pty Ltd (2000) 104 FCR 25.
89
Neale Prior, ‘Lingerie Firm’s Rescue Looks A Little Scanty’, The Australian Financial Review
(Sydney), 22 May 2004, 6.
90
Neale Prior, ‘Investors in Norwood’s NoRegrets Left with Plenty of Them’, The West Australian
(Perth), 4 February 2005, 37.
91
Ibid.
92
Ibid.
equipment, a step that had flooded his company with cash, but which had
required him to perpetrate more frauds to keep the various leases paid up.93 92F
93
Greg Ray, ‘Fraud Fallout Action Settled’, The Newcastle Herald (Newcastle), 24 July 2004, 4.
94
Neil Chenoweth, ‘CarLovers is All Washed Up’, The Australian Financial Review (Sydney), 19
July 2003.
stories tends to reinforce the mantra that franchising is a safe entry point into small
business.
The tale told in the Barbara’s House & Garden litigation rings true even 20
years later. It could provide a salutary warning to people becoming franchisees of a
franchisor that is not on a sound financial or managerial footing:
In the second half of 1982, when Mrs. Bateman had been working for the
company for some two years, the company became involved in the vigorous
promotion of franchises to operate ‘Barbara's House and Garden’ stores ….
The promotion was portrayed as the natural expansion of an outstandingly
successful business, but financial statements tendered in evidence suggest it
was in fact an attempt to keep a foundering business afloat by getting in
substantial franchise fees. 98
97F
History repeats itself. Strathfield Car Radio replicated the Barbara’s House and
Garden strategy in 2009, going one step further and embracing franchising as a way
95
Stephen Giles and Rod Young, ‘The Rise and Fall of Stockmans Australian Cafes’, FCA Visions
Newsletter (Melbourne), August 2005.
96
Sue Mitchell, ‘Signature Out of Pulp but Not Out of Juice’, The Australian Financial Review
(Sydney), 1-2 April 2006, 10.
97
Tim Martin and Catherine Hockley The Mercury (Hobart), 2 April 2004, 11.
98
Re Richard Vincent Bateman and Georgina Gay Bateman v Barbara Jean Slatyer; Harvey John
Slatyer; Graham Walter Tiekle and Barbara's House & Garden (Retail) Pty Limited [1987] FCA
58, para 3.
One striking aspect of these insolvencies is that there is no evidence that any of
them was of a franchisees’ making.
Michael Jensen and William Meckling note that ‘[a]s the probability of
bankruptcy increases both the operating costs and the revenues of the firm are
adversely affected’. 101 The flow-on effects of the franchisor not receiving previously
10F
favourable trading terms will be noticeable to franchisees that are required to source
stock or other services through their franchisor.
Jensen and Meckling use the example of a firm facing possible bankruptcy
having to ‘pay higher salaries to induce executives to accept the higher risk of
99
Jacqui Walker, Franchising Under Pressure (2009) Smartcompany
<http://www.smartcompany.com.au/franchising/20090505-will-franchising-survive-the-
recession.html> at 20 August 2009; and see James Thomson, Retail Chain Strathfield Collapses
into Administration (2009) Smartcompany <http://www.smartcompany.com.au/retail/retail-chain-
strathfield-collapses-into-administration.html> at 31 May 2010.
100
Doug Frazey, ‘Case Note: When ‘Good Cause’ Goes Bad: Minnesota Restricts Protection for
Dealers under HUMEDA – River Valley Truck Ctr., Inc V. Interstate Cos’ (2006 - 2007) 33(2)
William Mitchell Law Review 711, 728 quoting David Hess, ‘The Iowa Franchise Act: Towards
Protecting Reasonable Expectations of Franchisees and Franchisors’ (1995) 80 Iowa Law Review
333, 338-9.
101
Jensen and Meckling, above n 21, 341.
sold by a franchisee where payment and supply is completed within a minute will be
unaffected by the franchisor’s impending or actual financial woes. Customers will
continue to patronise the franchisee so long as they like the coffee. Only if the
franchisee’s business closes, will the customers patronize another cafe. By contrast,
the demand for expensive items supported by long term warranties, such as motor
vehicles, or white ware that will be bailed by the franchisor or franchisee until a
builder needs to take delivery, or products and services like travel, hotel or rental car
bookings made and paid for now with delivery in the future, will be adversely
affected as consumers prefer to deal with solvent suppliers.
102
Ibid.
103
Ibid.
104
Ibid.
the franchisees do because employees notice irregularities in their wages and hear ‘in
house’ whispers. Because the money flows from franchisee to franchisor in most
cases, this unofficial early warning system of cash flow problems being exposed may
not be available to franchisees. Franchisees may not become aware of the
franchisor’s position until a supplier changes the terms of trade, or a landlord locks
them out of their shop because the franchisor has not passed on the rent it has
collected from the franchisee/ licensee or franchisee/sub-tenant or the franchisee
learns of the franchisor’s financial difficulty through the media.
For the franchisee, Canadian insolvency litigator Craig R Colraine states that:
In the Kleins retail jewellery franchise failure, for example, the franchisor’s
bank continued to endorse the franchise network despite being owed millions of
dollars by the franchisor and being well-positioned to know that the franchisor’s
financial structure was not viable or sustainable. As recently as June 2008, the Kleins
franchise was still listed as one of only 20 National Australia Bank ‘Accredited
105
Craig Robin Colraine, ‘Franchises: Insolvency and Restructuring’ (Unpublished paper presented
at the Distribution Law: Catch the Wave, Avoid the Rocks, Ontario Bar Association Continuing
Legal Education, Toronto, Canada, 26 May 2003) 3.
106
Ibid.
Table 2: National Australia Bank Accredited Franchise Systems 2008 and 2009
Kleins was placed into administration on 30 April 2008 while the National
Australia Bank was still demonstrating endorsement on its website.
107
‘Warning Signs of Failure’, The Australian Financial Review (Sydney), 2 May 2006.
Senior US franchise lawyers Rupert Barkoff and Andrew Selden identify ‘the
risk that ‘your franchisor goes bankrupt’ 112 as an ‘uncontrollable risk’ in their
1F
Several government reviews into the franchise sector have been conducted in
Australia. 113 Some have examined small business generally; others focus on
12F
franchising.
108
Foster and Johnsen, above n 19, 1.
109
Ibid.
110
Craig R Tractenberg, ‘What the Franchise Lawyer Needs to Know About Bankruptcy’ (2000–
2001) (3)20 Franchise Law Journal 3.
111
Australian Competition & Consumer Commission v Simply No-Knead (Franchising) Pty Ltd
[2000] FCA 1365.
112
Rupert M Barkoff and Andrew C Selden, Fundamentals of Franchising (3rd ed, 2008) 278.
[t]he main internal network reasons for franchisor failure were under-
capitalisation of the franchisor; too rapid expansion of the franchise system,
poor product or service, poor franchisee selection, [and] franchisor greed. 114
13F
The main reasons for franchisor failure external to the franchise network were
identified as: ‘devaluation of the Australian dollar, an increase of import duties, the
withdrawal of an important source of products, an aggressive and cheaper competitor
or a severe downturn in the economy’. 115 Franchisor and franchisee failure was
14F
addressed as the same issue by the Task Force and resulted in recommendations that
franchisors should provide better disclosure, and prospective franchisees should
conduct better assessment of the nature of the business being purchased and the risks
as well as opportunities associated with the system. 116 Although the 1992
15F
Supplement included a table on franchise failures, the firms counted were almost
certainly franchisees.
113
Trade Practices Review Committee (Swanson Committee) Report, PP No 228/1976, (1976);
Trade Practices Consultative Committee, Small Business and the Trade Practices Act (Blunt)
(1979); Standing Committee on Industry, Science and Technology, Parliament of the
Commonwealth of Australia House of Representatives Small Business in Australia: Challenges,
Problems and Opportunities (‘Beddall Report’) (1990); Robert Fitzgerald, Franchising Task
Force Final Report to the Minister for Small Business and Customs, the Hon David Beddall
(‘Task Force 1991’); Franchising – Australia and Abroad, Supplement to the Franchising Task
Force Final Report, 1992 (‘1992 Supplement’); Robert Gardini, Review of the Franchising Code
of Practice (1994); Peter Reith, New Deal: Fair Deal – Giving Small Business a Fair Go (1997);
Graeme Matthews, Review of the Disclosure Provisions of the Franchising Code of Conduct
(2006); Government of Western Australia, Inquiry into the Operation of Franchise Businesses in
Western Australia, Report to the Western Australian Minister for Small Business (2008);
Economic and Finance Committee, Parliament of South Australia, Franchises (2008),
Parliamentary Joint Committee on Corporations and Financial Services, Commonwealth, Inquiry
into the Franchising Code of Conduct (2008).
114
Task Force above n 113, 21-22.
115
Ibid.
116
Ibid 26.
117
Matthews, above n 113, 17.
More recently, the ACCC as consumer protection regulator has identified that
‘franchisees often lose their business and their livelihood when their franchise system
fails. The 2008 failure of the Kleins Jewellers franchise system highlighted this
issue’. 118 The ACCC recommended the Parliamentary Joint Committee consider
17F
Singing from the same song sheet as the IFA, the media release below was the
only reference to ‘insolvency’ when the FCA’s website was searched in October
2009. It implies that the Ezy DVD franchisees all survived their franchisor’s failure.
118
Submission to Parliamentary Joint Committee on Corporations and Financial Services,
Commonwealth, Inquiry into Franchising Code of Conduct, September 2008, 8.4 (ii) a) 27
(Australian Competition and Consumer Commission).
119
Ibid 28.
120
Emma Maltby, Dragged into a Bankruptcy That isn’t Yours (2009) CNN Small Business, quoting
Alisa Harrison, IFA’s spokeswoman
<http://money.cnn.com/2009/07/17/smallbusiness/franchise_bankruptcy.smb/> at 2 March 2010.
121
Franchise Council of Australia, Franchise Insolvency Leads to a ‘Rebirth’ for Franchisees
<http://www.franchise.org.au/scripts/cgiip.exe/WService=FCAWWW/ccms.r?PageID=10184> at
7 October 2009.
122
Maltby, above n 120.
123
Wayne Jenvey, ‘Rocky Roads and Rollercoasters – Turnaround Strategies for Distressed
Franchise Systems’ (Paper presented at the Legal Symposium at the Franchise Australia Annual
Conference, Gold Coast, 24 October 2006) 2.
Dragged into a bankruptcy that isn’t yours. When a franchise company goes
bankrupt, independent operators face a tsunami of legal tangles and
marketing challenges. 124
123F
Matthew Dunckley writes, quoting franchisee Mr Maccartney; ‘We put our life
savings on the line … and these guys [franchisor] get to treat us like credit cards.’ 125 124F
Journalist Trevor Sykes followed the Traveland franchise failure story and
described the insolvency of the Traveland franchisor as a tragedy in four acts. 126 125F
Sykes writes:
124
Emily Maltby, above n 120 .
125
Matthew Dunckley, ‘Call to Shield Franchisees’, The Australian Financial Review (Sydney), 17
April 2009, 9.
126
Trevor Sykes, ‘Traveland: Final Tragedy of Errors’, The Australian Financial Review Weekend
(Sydney), 9-10 March 2002, 12.
127
Ibid.
permitted him to terminate the franchise agreement if Traveland failed – and he did
so. For the other franchisees, the Traveland Franchise Council was of the view that
franchisees did not have grounds for terminating franchise agreements.
A liquidator does not have an obligation to sell assets of the failed franchisor to
the purchaser who would be the most suitable from the franchisees’ perspective, nor
to a purchaser who is well motivated towards the franchisees. According to one
former franchisee, the purchasers of Traveland knew nothing about travel or
franchising. There is nothing to stop a liquidator selling the franchisor’s business to a
direct competitor of the franchisor. That direct competitor may elect not to buy the
franchise agreements but, instead, buy the brand in order to shelve it. In the United
States, albeit in a non-franchise context, ‘Disney purchased customer lists of
Toysmart in 2000 so it could ‘retire’ the list (ie. “destroy”)’. 129
128F
The following insights about how their franchisors’ collapse affected its
franchisees were collected in the CPA Study. All 18 former franchisee participants in
the CPA Study lost money as a result of the franchisor’s insolvency. In response to
the question, ‘if you lost money, what caused the loss?’ Sixty four per cent replied
that it was because their investment was now valueless.
To the question: ‘in total, how much money did you lose because of your
franchisor's insolvency? (including in this amount the cost of refurbishing your
premises to remove your franchisor’s image and replace it with another, if relevant).’
128
Buchan, ‘When the Franchisor Fails’, above n 31.
129
Gerald L Baldwin, ‘The Role of Intangibles in Bankruptcy’ (2006) 25-8 American Bankruptcy
Institute Journal 12, 53.
Forty four per cent lost more than A$50,000. Fifty-five per cent lost less than
$50,000. The responses are skewed in favour of smaller losses as only one franchisee
from a retail shopping centre based franchise responded to the survey.
To the question: ‘if your company could not continue trading, why was this?’
Forty per cent of franchisees replied that they had no money left to start a new
business and 20 per cent had other reasons. Some of the franchisees responding ‘not
applicable’ were trading as sole traders, not as corporations.
When asked whether they had any comments to make about the impact of the
insolvency on their franchise business, or about any other aspects of franchising,
none of the CPA Survey participants made any negative comments about franchising
per se. Comments were personal:
I think that the emotional turmoil and lack of assistance from government,
associations and lawyers (due to fear of repercussion) left us weaker and more
vulnerable, which has resulted in many owners selling up or becoming ill from
exhaustion – trying to rescue their business. This even has major impact on staff
sick days too.
Very unhappy with how the whole issue was handled by Traveland, their lawyers
and buyers.
The former Traveland franchisees who were still running travel agencies had to
collect the travel tax levy that the government imposed on all travellers to help fund
employees’ claims in the Ansett insolvency. They report that this ‘rubbed salt in their
wounds’. In addition, because of the discrepancy in income from the years of being a
franchisee to the year following the insolvency, the Australian Taxation Office
audited former franchisees’ tax returns.
130
Michael Murray, Keay’s Insolvency: Personal and Corporate Law and Practice (5th ed, 2005)
340. ‘In some cases liquidators do not wish to retain property because it is too onerous, worth
little or is unsaleable. In such circumstances, liquidators wish to get rid of the property in order to
avoid responsibilities and costs in relation to it. In disclaiming, the liquidator gives notice to
others that he or she wishes to be rid of any interest in the property. If a person suffers loss as a
consequence, those persons to whom notice has been given are required to try to mitigate their
loss. They may lodge a proof of debt in the liquidation in respect of the amount of that loss. The
liquidator may disclaim property referred to in section 568(1) Corporations Act 2001 (Cth)
(including) land burdened with onerous covenants (for example a lease of retail space in the
franchisor’s name that is licensed to a franchisee as occupier with no status on the title and no
privity of contact with the landlord) and contracts (including franchise agreements).’
131
Jacqui Walker, ‘It Pays to Have a Plan B’, Business Review Weekly (Melbourne), 16-22 March
2006, 57.
In Australia, once it became obvious to the franchisees that the new owners of
the Traveland brand did not have the expertise to run a franchised chain of travel
agents, the franchisees moved in several directions. Joining another franchise
network was an exit strategy for many of the former Traveland franchisees.
For some franchisees joining another travel agency franchise was not
appealing. A franchisee who owned a Traveland in a country town pointed out that
prior to buying into Traveland, she and her husband investigated all of the travel
agency franchises available. They decided on Traveland because it had the best
systems. When Traveland failed, the franchisee initially contemplated becoming an
independent travel agent but concluded this was not feasible as her former customers
preferred to deal with a ‘name’ brand. In her words:
Traveland was an excellent franchisor, great to work for but following the
collapse of Traveland if I had rebranded as [my name]’s Travel Agency it
would not have been acceptable [to the town]. The response would have
been “Who does she think she is?” … We were not communicated with at all
when Ansett collapsed. From that day all the [franchisor’s] phones were
Consequently, she had no real choice but to close the travel agency.
Table 3: Some costs and losses for one franchisee of Danoz Directions
132
Interview with former Traveland franchisee (conducted at former franchsiee’s home, country
Victoria, 17 June 2006).
133
Switzer, above n 1.
134
In Cheque One Pty Ltd v Cheque Exchange (Australia) Pty Ltd (in liq) [2002] FCA 593, 12
applicant franchisees sought leave of the court under s 471B Corporations Act 2001 (Cth) to join
proceedings commenced against the franchisor in 2000.
The franchisee in Table 3 was not a creditor of the franchisor and was a debtor
to the extent of the monthly royalty and the rent, which is ultimately owed to the
landlord. This is not a strong negotiating position for a franchisee to be in relation to
the franchisor’s liquidator. Of the estimated total outlaid by the franchisee in Table 3
(excluding professional advice and bank charges):
A$99,000 is sunk costs, spent on fit out. Depending on how portable the
items purchased were, some might have second hand value. Others (eg.
shop window, flooring, most electrical works) become part of the
landowner’s real property upon installation.
A$25,000 charged by the franchisor for supervising the fit out is deemed
earned by the franchisor as soon as the fit out is complete.
135
Corporations Act 2001 (Cth) s 440D, stay of proceedings for company under administration; s
471B, stay of proceedings and suspension of enforcement process for company in liquidation.
Tax issues
Until 1995, from the moment a franchisees’ business closed the interest on the
loans taken out to fund the businesses ceased to be tax deductible. Since 1995 the
position has altered through a line of cases in relation to s 51(1) of the Income Tax
Assessment Act 1936 (Cth) that started with a decision reached by Davies, Hill and
Sackville JJ in the Federal Court, Placer Pacific Management Pty Ltd v Federal
Commissioner of Taxation 95 ATC 4459. A deduction can now be claimed for
interest on loans taken out to fund a business that has ceased generating an
income. 136 135F
136
Federal Commissioner of Taxation v Brown [1999] FCA 721 (Lee, Nicholson and Merkel JJ) The
interest payments were deductible under the second limb of s 51(1). The occasion for the interest
payments was to be found in the loan entered into by the partnership in carrying on business for
the purpose of producing assessable income and that the cessation of the business did not operate
to break the nexus between the carrying on of the business and the incurring of the interest
liability; Federal Commissioner of Taxation v Jones (2002) 117 FCR 95 (Beaumont, Finn and
Sundberg JJ). In this case, refinancing the loan after the business.
137
Income Tax Assessment Act 1997 (Cth) s 40-880.
138
Angela Harper, ‘Liquidators Sell off Kleenmaid Assets’, Sydney Morning Herald (Sydney), 30
June 2009.
its capital losses and thus another avenue of future research identified in this research
is the tax treatment of franchisees’ sunk costs when the franchisor fails.
Without ongoing stock from Kleenmaid to sell, the retail franchisees have no
future under the Kleenmaid brand, and without Kleenmaid to co-ordinate
warranty repairs and maintenance schedules, the service franchisees are
equally challenged. All franchisees will lose. 142
14F
139
Sue Mitchell, ‘Kleenmaid on Comeback Trail’, The Australian Financial Review (Sydney), 31
August 2009, 16.
140
Harper ‘Liquidators Sell off Kleenmaid Assets’, above n 138.
141
ASIC Funds Kleenmaid Probe (2009) Perth Now
<http://www.news.com.au/perthnow/story/0,26122992-5017962,00.html> at 1 October 2009.
Investigation: ASIC has approved funding for an investigation into the collapse of white goods
business Kleenmaid.
142
Jason Gehrke, Why is Kleenmaid Such Big News (2009) Smartcompany
<http://www.smartcompany.com.au/franchise-tips-and-trends/20090421-why-is-kleenmaid-such-
big-news/print.html> at 7 October 2009.
Customers could see the products and pay for them in store, but all payments
were forwarded to the Kleenmaid national office, which would despatch the
products to the customers' homes.
Franchisees would generate their income through commissions paid to them
by Kleenmaid, so long as those commissions were greater than the amounts
franchisees were required to pay to Kleenmaid each month.
Payments to Kleenmaid included advertising ($10,000), training and
computer support ($2000) and rent. A clawback clause in the franchise
agreement would require franchisees to repay commissions if a customer
cancelled an order (if the commission had been previously paid).
Even though sales proceeds went direct to the franchisor, between the
required monthly payments and the potential for commission clawbacks
from cancelled sales, it is possible for Kleenmaid franchisees to still owe the
franchisor money at the end of a month. If this is the case, the administrators
will be duty-bound to pursue all debts owed to Kleenmaid, even if it is from
franchisees who are themselves owed money for sale commissions for a
subsequent month.
In other words, there will be no set-off where franchisees owe money to the
franchisor, and the franchisor owes the franchisee money. The franchisees
will be required to pay their debts to the franchisor in full, while at the same
time standing helplessly in line as unsecured creditors waiting for the money
owed to them. 143
142F
143
Ibid.
144
Anthony Klan, ‘Kleenmaid Kitchen Empire Sinks with $67m Debt’, The Australian (Sydney), 11
April 2009.
This means the landlords have started exercising their rights to terminate the
leases for the retail premises leased by The Jewellery Chain Pty Ltd as the head
lessee entity within the Kleins franchise network. Lacking privity of contract
between themselves and the landlords, franchisees have no right to continue in
occupation under the licences to occupy if the head lease is terminated by reason of
the head lessee’s default.
statement serves to emphasize the lack of standing the franchisee have in insolvency.
Existing franchisees’ responsible for liabilities that are best met by the franchisor
trading well, will certainly be detrimentally affected by any protracted
administration.
Some franchisees do find a way of making the most of the opportunities that a
franchisor’s failure opens to them by forming a buyers group and continuing trading.
This action was taken by former Great Australian Ice Creamery franchisees and
some franchisees of one of the failed juice shop franchisors. Others re-brand and
continue trading under a former competitor’s banner, however this may be difficult if
a territory or suburb is already well serviced by a competitor franchisor.
145
In Stewart, in the Matter of Kleins Franchising Pty Ltd (administrators appointed) (ACN 007 348
236) [2008] FCA 721 (20 May 2008) para [4].
146
Ibid para [10].
the franchisee. The franchisor then pays a commission to the franchisee. This
commission ‘is the only cash flow our [Allphones franchise] business has’. 147 The 146F
All moneys are deposited to the franchisor’s account and three times a
month Hoy Mobile was to receive their percentage of the gross profits. All
stock is supplied by the franchisor. When our second commission cheque
was not forthcoming … 148
147F
Franchise agreements rarely provide for the franchisor to pay the franchisee
interest on late payments, or for the franchisor to provide personal guarantees to
franchisees. Franchisees operating under the commission agency model have no
control over when the franchisor pays commission and minimal control over the
customer base they have generated. They have no control over whether the franchisor
pays its suppliers, which in turn will influence the franchisor’s ability to supply stock
to the franchisees. If the franchisor fails it is the administrator and liquidator that
have a list of each franchisee’s customers, not the individual franchisee.
147
Commonwealth Senate, Opportunity not Opportunism, Joint Parliamentary Inquiry into
Franchising (2008) 1 (Nicole Hoy).
148
Ibid.
$50
$40
$30
$20
$10
$0
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
Losses shown in Table 1 and Figure 3 are probably an order of magnitude
higher. For many franchise networks there is no publicly available data. The data
contained in Table 1 does not include legal fees, and does not take into account
subsequent costs and collateral losses such as franchisees paying franchisors rental
guarantees and meeting the government-imposed travel levy for the Traveland
employees.
In Selim v McGrath 149 Justice Barrett concluded that in the context of a s 148F
439A [Corporations Act] meeting, creditors were all persons who have, as
against the company concerned, “debts” or “claims” provable in a winding
149
(2004) 22 ACLC 112, 128-9.
up. He said the boundaries were those set by s 533 [Corporations Act] which
are very wide. 150
149F
franchisee’s revenue stream is from the sale of airline tickets. If the airline is the
parent company of the franchisor (as Ansett airlines was for the Traveland
franchisees) it will owe the travel agent franchisee commission on ticket sales.
Second, the franchisee may be a creditor if, for example, goods that were
supplied by the franchisor are returned under warranty by the franchisee’s customers.
An example is jewellery supplied by Kleins.
The third instance when the franchisee may be a creditor of the franchisor is for
moneys payable by the franchisor pursuant to a concluded dispute. Where the
conclusion has been that the franchisor owes the franchisee settlement money, the
sums could be substantial.
150
Michael Murray, Keay’s Insolvency: Personal and Corporate Law and Practice, (6th ed, 2008)
531.
151
No empirical research has been conducted on the direction of money flow between franchisors
and franchisees. Most franchisees collect payment from their customers and pay royalties to
franchisors but some franchisor/franchisee relationships are structured like commission agencies
with the franchisor being paid by the franchisees’ customers, and the franchisor then paying
franchisees commission.
The sums of money owed to the franchisee as a creditor under the above
arrangements, with the possible exception of the third instance, are a small
proportion of the franchisees’ total investment. For the remainder of its investment
the franchisee is not a recognised creditor. The question ‘what rights did you have in
the franchisor's liquidation?’ elicited one unexpected response as one franchisee was
a secured creditor of the franchisor. The CPA Study did not permit exploration of
this response. The remainder were unsecured creditors (56 per cent) or had no status
at all in the insolvency (33 per cent). Unsecured creditor status places franchisees
well behind the franchisor’s employees in terms of priority.
franchisee to exercise one vote at the creditors’ meeting where votes are exercisable
by creditors on a pro-rated basis to the size of the debt they are owed. It is not
difficult to see how franchisees would quickly be out voted by secured creditors.
Table 1 shows the amount of money some failed franchisors owed creditors.
152
Interview with Liquidator, (Sydney), 2005.
trading within franchise networks that are structured like commission agencies will
also be debtors – in relation to advertising levies, royalties and other periodic
payments.
moneys owed to the landlord if the franchisor defaulted on its obligations under the
head lease, but would not guarantee the franchisee the right to lease the site if the
head lease was disclaimed by a liquidator.
The CPA Study participants were asked three questions about their borrowing
for the business. To the question: ‘how did you finance the purchase of your
franchise?’ 62 per cent answered that they financed from savings, 25 per cent
borrowed from a bank and the remainder used a combination of savings and loans.
These proportions are probably a reflection of the small sample size in the CPA
Study and the fact that most subjects did not operate from retail shopping centre
premises, rather than being a true reflection of the pattern of funding franchise
purchases in Australia. Questions in relation to borrowings showed that where
franchisees did borrow, 22 per cent borrowed 80–100 per cent of the total investment
cost. These borrowings were secured by a mortgage over the franchisee’s home.
153
For example: Neldue Pty Ltd v Moran & Ors [2004] WASC 100; Loyal No 46 v Miller [2001]
FMCA 30.
154
British Franchise Association United Kingdom, Franchise Survey (2004) 37.
If franchisees are contemplating litigation, or have not yet had their case heard,
they find that ‘[o]n the appointment of an administrator or liquidator, there is a stay
of proceedings so that no action or other civil proceedings may be begun or
continued against the company without the leave of the court’. 155 154F
Franchisees do not want their franchisor to fail. They are aware that litigation
would impose a significant cost burden on the franchisor. There is anecdotal
evidence that, rather than risk making their franchisor financially vulnerable, some
franchisees make a conscious decision not to litigate against their franchisors.
There are often franchisees who will not mutiny against the franchisor, no
matter what level of provocation exists. Most systems contain, amongst the
franchisees, family members, franchisees on ‘special deals’ or who believe
they are on special deals, and some that are financially bound to the
franchisor. 156 15F
155
Above n 89 at pp. 283 and 487. The relevant legislation is Corporations Act ss 440D, 471(2).
(See Ibbco Trading Pty Ltd v HIH Casualty and General Insurance Ltd (2001) 19 ACLC 1093).
156
Interview with Australian Franchise Lawyer/Mediator Philip Linacre (Telephone interview, 11
August 2006).
157
Corporations Act 2001 (Cth) s 471B
158
Binning, above n 9, quoting David Cowling, insolvency partner with law firm Clayton Utz, (then
Vice-chair of the IBA’s Section on Insolvency and Creditors Rights.)
Liquidators have duties under the Corporations Act. This does not include
duties to franchisees. Theoretically, in Australia there is nothing to stop a liquidator
selling the franchisor’s business to a direct competitor 159 of the franchisor. It is
158F
unlikely that an acquisition would meet the threshold merger test of, ‘having the
effect, or be likely to have the effect of substantially lessening competition in a
market, 160 that must be met before a merger of two franchise networks would risk
159F
being closely examined by the ACCC and potentially prevented from occurring. That
direct competitor may elect not to buy the franchise agreements but, instead, to
simply buy the brand and shelve it.
Other factors that impact on how individual franchisees fare include the
financial climate at the time of the failure and the suitability of the buyer:
Sale of the [franchisor’s] business may subject the franchisee to the control
of a company unfamiliar in the area and incapable of running the business
profitably. The dramatic demise of Traveland [franchise subsidiary of
Australia’s former Ansett Airlines] demonstrates the implications of a
buying entity that has little experience in the franchisor’s core business area
and has insufficient expertise or resources to support the business. 161160F
In the short term, the most appropriate way for prospective franchisees to
mitigate against the possible harmful effects of their franchisor becoming insolvent is
to ‘attempt to structure his or her affairs to ensure minimum personal liability and
flexibility in keeping or restructuring the business in the event the franchise business
fails or alternatively the franchisor becomes insolvent’. 162 Realistically, the 16F
159
Trade Practices Act 1974 (Cth) s 50 prohibits acquisitions that would result in a lessening of
competition.
160
Trade Practices Act 1974 (Cth) s 50(1).
161
Jenvey, above n 123, 9.
162
Steven H Goldman, Tackling Troublesome Insolvency Issues for Franchisees (2003) Unpublished
3-6 <http://www.goldmanrosen.com/pdf/franchiseesinsolvency1.pdf> at 29 April 2007.
Goldman’s paper outlines 10 specific strategies franchisees may attempt to put in place.
Colraine suggests:
The intellectual property included the business name and trade mark, without
which the businesses would have to re-brand and may be exposed to competition
from the current owner of the business name and trade mark.
2.5 CONCLUSION
Implicit in the decision to buy a franchise is the belief that the network has a
proven ‘product’. Clearly, though, the network is not always proven, and not all
franchisors are strongly motivated to ensure that their franchisees’ businesses thrive.
163
Jenny Buchan interview (Sydney, face to face interview in liquidator’s office) (2005).
164
Colraine, above n 105, 6.
165
‘Sale Finalised’ Inside Retailing (Sydney), 21 August 2000.
That the government explore avenues to better balance the rights and
liabilities of franchisees and franchisors in the event of franchisor failure. 16716F
Due diligence on the scale a franchisee can realistically conduct can at best
shed light on the past and present – it will not reveal the future.
Franchisees and their legal advisers believe the agreement and the
disclosure document that must be provided by the franchisor to comply
with the Code contain most of the key information they will be basing
their purchasing decision on – it does not.
166
Joint Committee on Corporations and Financial Services, Australian Senate, Opportunity Not
Opportunism: Improving Conduct in Australian Franchising (2008).
167
Ibid Recommendation 4 (para 6.40) xv.
The franchisee has no control over how the franchisor conducts its business.
The franchisor may chose to sell its business, sell parts of its business, encumber
assets or transfer assets such as trade marks into related or unrelated entities beyond
the reach of the franchisees and of liquidators. Franchisors may actively engage in a
course of action that leads to administration or insolvency and neither franchisor, nor
administrator nor liquidator is accountable to the franchisees for consequences that
flow through to the franchisees. The appointment of a liquidator to the franchisor’s
business signals a radical change in the franchisees’ legal position. Unlike
employees, lenders, debtors and shareholders, there is no clear way forward for
franchisees.
We now move to chapter 3 where the problems that flow from franchisor
failure are analysed in the context of the franchise network, the franchise agreement
and contract law, and the numerous asymmetries that impact on the
franchisor/franchisee relationship.
New policy initiatives should flow from a ‘clear identification of the nature and
source of the underlying problem’. 168 Currently, outdated assumptions 169 inform
167F 168F
franchise law and practice and have a detrimental effect on the development of legal
responses to the challenge of levelling the playing field for franchisees as business
consumers. The problems franchisees encounter when their franchisor fails emanate
from several sources. In this chapter the sources of the problem are identified. This is
necessary as describing and treating the 21st century franchise relationship as one
between a franchisor and its franchisees is too simplistic. Until the
franchisor/franchisee relationship is placed in its fuller legal context, any solutions to
the treatment of franchisees whose franchisor fails will miss their mark. This chapter
is set out in the following way.
At 3.1 the recent development of the business format franchising model is set
out. At 3.2, the structure and roles of the component parts of the 21st century
franchise network are identified. Specifically, two significant components of the
franchisees’ business are the registered trade marks, and the premises lease. With
access to the franchise brand and the premises they trade from, the franchisees may
be able to regroup and survive if the franchisor becomes insolvent. Without access to
both elements the survival of the franchisee’s business is unlikely. Research
discussed at 3.2.2 and 3.2.3 reveals significant variations from one franchise network
to another. The variations lead to different possible outcomes in insolvency. At 3.2.4
franchisees, their personal profiles and the roles and risks they accept are
summarised. Finally, at 3.2.5 and 3.2.5 franchisees are compared with suppliers to, or
employees of, a company that is in administration or being wound up. This
168
Australian Government Productivity Commission, vol 2, above n 4, 46.
169
For example: (i) underlying the need for franchisors to disclosure only the health of ‘the
franchisor’ is that the franchisor is the only important franchisor-controlled entity in the network;
(ii) franchisees cause franchisors to fail; (iii) franchisees are able to conduct adequate due
diligence; (iv) franchise agreements are negotiable and are not standard form consumer contracts
– this last assumption was put firmly to rest by Spencer in The Regulation of the Franchise
Relationship in Australia: A Contractual Analysis, above n 14.
comparison with two parties that have long enjoyed defined rights in the franchisor’s
insolvency serves to highlight the fact that consumer protection law nor insolvency
law have not yet adapted to accommodate franchisees as fully as they might.
At 3.3 the inability of contract law to deal with the problem will be addressed
and at 3.4 the asymmetrical environment in which the franchisee gathers and
processes information about the prospective franchise, and then conducts its
business, is examined.
By the end of chapter 3 it will be clear that the franchisee occupies a small but
significant role in a large network. The role includes functions that would be
performed by third parties, such as employees and suppliers that are currently
accommodated in the insolvency regime; but franchisees that occupy these roles are
unwittingly unprotected. Once the problem of providing protection for franchisees
whose franchisors fail is placed in the context of the franchise network, it is clear that
a solution will not evolve through precedent. Further, a solution is required for the
franchise model to remain attractive.
The current business format franchising model grew out of western society’s
changed needs and patterns at the end of World War II. This is demonstrated in the
response in two countries with a strong franchising culture; France and the United
States. In France, the post-war challenge of rebuilding infrastructure led
manufacturers to appoint franchisees to rebuild retail outlets throughout the country,
allowing the manufacturer to focus its resources on rebuilding its manufacturing
capacity. In the United States, the same post war period created the opportunity to
revise work models. Production lines were converted from making tanks to
manufacture of cars. Once cars became common the suburb and ultimately the
suburban shopping mall became commonplace too. ‘Franchising grew out of
servicing these thousands of new suburbs which were coming into existence all over
America. … about 50 years ago, in 1947-48’. 170 169F
170
Standing Committee on Industry, Science and Technology, House of Representatives, Fair
Trading Inquiry (1996) Mr Atchison (Great Australian Ice Creamery franchisor). Mr Atchison
had experienced ‘20 years in ice-cream and 14 in franchising. In fact, we have 87 outlets in
Australia, and one lonely outlet in Beijing’ at the time of this evidence. Great Australian Ice
Creamery started franchising in 1982 and became insolvent in 1998, at which time it had 62
Since the post-1945 development, the business format franchising model has
flourished and expanded globally. As franchisors grow their brand, and opportunities
present themselves, many franchise networks become multi-national. 171 Evidence is 170F
United States, £13 billion in the United Kingdom, US$142 billion in Japan,
US$5billion in Malaysia and AU$111.2 billion in Australia. 174 173F
poorly if the franchisor becomes insolvent one must first ‘unpack’ the franchise
organisation, identify the individual contracting entities and explore their roles. It is
then possible to trace each contract and each obligation into the insolvency and
analyse all from the perspective of the franchisee-consumer.
franchisees.
<http://parlinfo.aph.gov.au/parlInfo/search/display/display.w3p;adv=;db=;group=;holdingType=;i
d=;orderBy=;page=;query=(Dataset%3Acommsen,commrep,commjnt,estimate,commbill%20Sea
rchCategory_Phrase%3A%22committees%22)%20Decade%3A%221990s%22%20CommitteeNa
me_Phrase%3A%22house%20of%20representatives%20standing%20committee%20on%20indus
try,%20science%20and%20technology%22%20Year%3A%221996%22%20Month%3A%2209%
22%20Responder_Phrase%3A%22mr%20atchison%22;querytype=;rec=0;resCount=> at 15 June
2010.
171
Frazer, Weaven and Wright, Franchising Australia 2008, above n 7, Question C5, 9 per cent of
franchisors operating in Australia are overseas-based; Question C7, 27.2 per cent of Australian
domestic franchisors are currently franchising overseas.
172
For example, during February 2010 requests for lawyers in the following jurisdictions were
posted on the American Bar Association Forum on Franchising: Aruba and Bonaire; Brazil;
Estonia; India; Indonesia; Morocco.
173
In the USA, 50 per cent of all retail sales are conducted through a franchise. A Bou et al,
‘Insolvency in International Franchise Relationships’ (Paper presented at the International Bar
Association Annual Conference, San Francisco, 14 - 19 September 2003) ch 2.
174
IBIS World, ‘Franchising in Australia’ (2006) IBIS World Industry Report.
175
Jensen and Meckling, above n 21, 311.
Although franchisees own their own businesses, they are part of a much larger
organisation and are not free to develop their own ideas or to ‘go their own way’ 176 175F
to the extent that an agent, distributor, supplier or even a manager, could. The trade-
off franchisees make for their lack of independence is the opportunity to build a
business and make money in a secure environment. The inter-related nature of the
franchisor’s and franchisee’s business together with the pattern of contractual
relationships that bind the franchise network together are strengths that become
weaknesses for franchisees when a franchisor fails.
Harlee was incorporated in Illinois in February 1950. Mr. L.S. Maranz, its
president … coined the name "Tastee Freez" ... Harlee … built up an
extensive business in a comparatively short time. … Each franchise holder is
assigned a specific territory. In this territory the franchise holder sets up
operators in stores which are in nearly all instances of a specific design that
are built in accordance with plans and specifications supplied by Harlee
Manufacturing Company. Each store carries a roof sign bearing the "Tastee
Freez" mark in the specific logo type adopted by Harlee Manufacturing
Company for its mark. 177
176F
176
Tanya Woker, ‘Franchising – The Need for Legislation’ (2005) 17 South African Mercantile Law
Journal 50.
177
Aston v Harlee Manufacturing Co (‘Tastee Freez’) (1960) 103 CLR 391, 396.
and owned by the franchisor. They were required to purchase a mix made from a
franchisor-owned formula. The dry ingredients for the mix were supplied only by
one source, selected by the franchisor.
structural inevitability of late 20th and early 21st century franchising the fact
that the franchisee may depend on the franchisor not only for materials
essential to the business, which the franchisee can often only purchase
through the franchisor [as was the case in Tastee Freez], but also for
premises and finance. 17817F
When Tastee Freez was formed, the legal structure of the franchisor’s side of
the network was simple. Only two legal entities were involved, Harlee
Manufacturing Company and Tastee Freez International Ltd. This is in contrast to
today’s franchisors which may provide the items identified by Frazey through up to
40 legal entities. 179
178F
[D]espite the degree to which the franchisee depends on the franchisor, the
franchisor is generally not bound to respect the reasonable expectation of the
franchisee that, in return for its dependence, the franchisee can continue to
operate as long as it [does not breach its franchise] agreement. 180
179F
3.2.1 FRANCHISOR
178
Frazey, above n 100, 728 quoting ABA Antitrust Section: Monograph No 17, Franchise
Protection: Laws Against Termination and the Establishment of Additional Franchises 19 (1990).
179
See Appendix A of this thesis.
180
Frazey, above n 100, 728 quoting David Hess, ‘Comment, The Iowa Franchise Act: Towards
Protecting Reasonable Expectations of Franchisees and Franchisors’ (1995) 80 Iowa Law Review
333, 355.
they develop their business following the franchisor’s procedures. Over time the
franchise network evolves, is refined and updated.
the only party being pursued by the franchisee and the franchisees’ directors. The
181
See Appendix A of this thesis.
182
Bakers Delight Media Relaease, Unique Business Opportunity for Young Guns (2009)
<http://www.bakersdelight.com.au/Assets/Files/1994895a-dac3-4386-8a08-cc0a4a5671ee.pdf> at
16 June 2010. ‘Bakers Delight will then help them [new franchisees] purchase a bakery through
a combination of financial assistance - possibly including working capital, vendor finance and
bonus schemes, as well as ongoing advice, training and operational support’. Frazer, Weaven and
Wright, Franchising Australia 2006, above n 11, 54-55, report that 22.2 per cent of franchisors
provide [start-up] finance to franchisees and for 17.7 per cent of franchisees the franchisor is the
major source of finance.
183
Re Richard Vincent Bateman and Georgina Gay Bateman v Barbara Jean Slatyer; Harvey John
Slatyer; Graham Walter Tiekle and Barbara's House & Garden (Retail) Pty Limited [1987] FCA
58.
ASIC records show that there were four companies in the Barbara’s House & Garden
group. 184 Similarly, there were two entities in the Tastee Freez franchise.
183F
The legal structure of failed franchisor Kleenmaid is set out by way of example
in Appendix D. The solvent Pets Paradise franchise network is a network whose
basic structure is an example of a typical 21st century business format franchisor. It is
outlined in Pampered Paws Connection Pty Ltd (ACN 116 460 621) v Pets Paradise
Franchising (Qld) Pty Ltd (ACN 054 406 272) (No 3) [2009] FCA 138 (‘Pets
Paradise’). There, franchisee applicants were each dealing with several of the eight
different legal entities that made up the franchisor and its related entities. In
describing the role of each entity Justice Mansfield stated:
The first to sixth respondents [Pets Paradise Franchising (Qld) Pty Ltd, Pets
Paradise Franchising (SA) Pty Ltd, Pets Paradise Franchising (NSW) Pty
Ltd, Global Pet Productions Pty Ltd, Pets Paradise (Franchising) Pty Ltd,
Pets Paradise Pty Ltd] are said to be trading corporations with their holding
company being the seventh respondent [Paradise Retail Holdings Pty Ltd].
The sole director of all the corporate respondents is the eighth respondent
[Gary Diamond]. The eighth respondent is also said to be the managing
director of each of the respondents. Hence, each of the corporate respondents
184
It is acknowledged that there may have been other related entities whose name did not include the
clause Barbara’s House & Garden and which thus did not appear on the ASIC search.
185
Jensen and Meckling, above n 21, 349.
and
In Pets Paradise, Justice Mansfield outlined the role of each of the eight
entities in the franchisor controlled part of the franchise network:
186
Pampered Paws Connection Pty Ltd (ACN 116 460 621) (on its own behalf and in a
representative capacity) v Pets Paradise Franchising (QLD) Pty Ltd (ACN 054 406 272) (No 3)
[2009] FCA 138 para 14 (Mansfield J).
187
Ibid para 21.
regulator’s consent to require franchisees to acquire certain key products only from
approved suppliers.
Business entities that form part of the franchisor’s group of entities but do not
carry the title ‘franchisor’ do not have to make disclosure to prospective franchisees
(except in relation to intellectual property rights). Yet the failure of any of these
related entities can have an effect on the solvency of the franchisor, and thereby
impact the franchisee. The identity of only two of the 51 entities in the Kleenmaid
network, being the ‘franchisor’ and the owner of the Kleenmaid trade mark, would
have been included in the disclosure provided to incoming Kleenmaid franchisees.
188
Ibid paras 24–30.
189
Notification N92536 under s 47 Trade Practices Act 1974 (Cth) <
http://www.accc.gov.au/content/index.phtml/itemId/750777/fromItemId/729985> at 17 June
2010.
Moving the focus from the franchise network to the specific franchisor, in
2006, 70 per cent of the entities identified as the ‘franchisor’ in Australia were
proprietary companies, 14 per cent public companies and 10 per cent trusts. 190 189F
If the franchisor or some of the entities in the franchisor’s network are set up as
trusts, the issue confronting a prospective franchisee becomes not one of the
prohibitive cost of obtaining information about the franchisor and its related entities,
but the impossibility of obtaining information about the true identity of the
franchisor. For example in Australian Competition and Consumer Commission v
Chaste Corporation Pty Ltd (In Liquidation) (ACN 089 837 329), Braddon Ralph
Webb, Orlawood Pty Ltd (ACN 059 294 334), Peter Clarence Foster, Sean Petrie
Allen Cousins, Kevin Anthony McMullan, Alan Kenneth Cooper, Stephen D’alton,
Qud 252 of 2001, Lander J in the Federal Court in Queensland observed:
Chaste was entirely controlled by the fourth respondent, Mr Foster and the
second respondent, Mr Webb, and those two gentlemen, through the [trusts]
which they controlled, namely WMMT and WFDT would receive
respectively 75 per cent and 25 per cent of the profits. As far as a bystander
[eg: franchisee] was concerned, Chaste was entirely controlled by Mr Webb.
No bystander could have known that there were agreements in place between
the second and third respondents and the fourth respondent, and an entity
controlled by the fourth respondent which gave control of Chaste to Mr
Foster. 191
190F
190
Frazer, Weaven and Wright, Franchising Australia 2006, above n 11, 34.
191
Australian Competition and Consumer Commission v Chaste Corporation Pty Ltd (In
Liquidation) (ACN 089 837 329), Braddon Ralph Webb, Orlawood Pty Ltd (ACN 059 294 334),
Peter Clarence Foster, Sean Petrie Allen Cousins, Kevin Anthony McMullan, Alan Kenneth
Cooper, Stephen D’alton, Qud 252 of 2001 [22], [24].
… franchisees … don't know what due diligence is and may have never
heard the term before. They may figure due diligence is something that is
expensive and complicated and therefore done by the lawyers or other
professional advisors that they might engage to handle "the paperwork" of
the sale. … Due diligence is no more complicated than looking at the facts of
a deal from all angles to make sure they stack up. 194
193F
Thorough due diligence is expensive and will reveal areas where the
information to substantiate the material disclosed cannot readily be obtained, and if
obtained, cannot be objectively tested. It will give rise to further questions that the
franchisor should be prepared to answer candidly. Attempts to obfuscate by the
192
For example, Dan Minchin, ‘Pets Chain Creditors out in Cold’, The West Australian (Perth), 2
December 1996 reported of Wonderland of pets franchisor that ‘the companies value of assets is
estimated to total $A62,216 while the combined liabilities is $853,277; Mr. Conlan’s report also
states that both the companies were trading while they were insolvent’. Nick Butterly,
‘Northbridge Gym Fails Fiscal Test’, Sunday Times (Perth), 11 July 2004, 55. ‘I think the
company has been insolvent for quite a while prior to appointing administrators’ [administrator]
Mr. Lopez says.
193
Director of franchise advisory and training company The Franchise Advisory Centre, Franchise
Media Commentator on smartcompany.com, then Member of the Board of the Franchise Council
of Australia, Adjunct Lecturer in Franchising at Griffith University.
194
Jason Gehrke, Franchise Tips and Trends (2009) Smartcompany
<http://www.smartcompany.com.au/franchise-tips-and-trends/20090929-what-is-due-
diligence.html> at 29 September 2009.
franchisor should ring alarm bells for the franchisee, but by this time many are
psychologically committed.
It can be difficult, if not impossible for the franchisee to conduct thorough due
diligence to test or verify what the franchisor has told them, or to provide context for
the information provided in the Code-mandated disclosure. For example when
franchisors and their shareholders are structured as trusts; the nature of a trust means
that it is impossible to conduct independent due diligence about it. The only source
of further information available to the intending franchisee is the franchisor itself.
In Australia, franchise networks range in size from one to 2,950 units. 195 A 194F
franchisee buying into a large and well established franchise network could be
forgiven for relying heavily on the reputation of the brand rather than conducting
thorough due diligence. This theme is revisited in chapter 3.2.2 under the heading
‘overseas brands and due diligence’.
Trade marks are the most visible of the franchisor’s intellectual property assets,
providing ‘information to the consumer [both franchisees and their customers]
195
Frazer, Weaven and Wright, Franchising Australia 2008, above n 7, 25.
regarding the quality and source of the product that reduces search costs’.196 US 195F
franchise law practitioners and former Subway franchisees, Steinberg and Lescatre,
write:
the nature of franchising is that the franchisee is “buying” something that the
franchisee can never sell, specifically, the trade marked “name on the door”
and such support as the franchisor chooses to provide. Unsophisticated
buyers of franchises fail to realize the implications of the fact that they are
licensing a trade mark. 197
196F
Franchisees rely on the licence purchased from the franchisor to use, amongst
other things, the franchisors’ trade marks, further adding to the brand’s recognition
and value. Given the importance of brand recognition, it would be logical for
franchisors to register their trade marks. Some franchisors also register patents and
designs. These are not as universally recognised as part of the franchisor’s brand. An
examination of the property rights aspects of trade marks is sufficient to demonstrate
the franchisees’ vulnerability, especially in the franchisor failure scenario.
letter, word, name, signature, numeral, device, brand, heading, label, ticket,
aspect of packaging, shape, colour, sound or scent or combination thereof’ 198
197F
196
Blair and Lafontaine, above n 46, 147.
197
Steinberg and Lescatre, above n 13, 116.
198
Guidelines are available on the IP Australia website. <
http://www.ipaustralia.gov.au/trademarks/index.shtml> at 17 June 2010.
pre-contractual, and periodic disclosure of the matters listed in s 7. 200 Sections 19F
4.1.1(c) and 7 acknowledge that the franchisor itself may not own the intellectual
property, and that the intellectual property may be unregistered.
clauses in fast food industry franchise contracts which found that 77 per cent of
franchise agreements granted the franchisee no ownership rights in the trade mark. 202 201F
What is surprising is that 23 per cent did grant ownership rights. A comparable study
has not been conducted on Australian franchise agreements.
Bruce Schaeffer and Susan Robbins have written about the valuation of
intangible assets in franchise companies and multinational groups drawing on the
experience in the United States. 203 Whilst their article addresses franchises as a
20F
category, the authors do not differentiate between the various types of intellectual
property – trade marks, patents and designs.
199
Trade Practices (Industry Codes – Franchising) Regulations 1998 (Cth) s 7.1.
200
See Appendix A of this thesis for wording.
201
Ozanne and Hunt, above n 43, ch 5.
202
Gillian K Hadfield, ‘Problematic Relations: Franchising and the Law of Incomplete Contracts’
(1990) 42 Stanford Law Review 927, 942.
203
Bruce S Schaeffer and Susan J Robbins, ‘Valuation of Intangible Assets in Franchise Companies
and Multinational Groups: A Current Issue’ (2008) 27(3) Franchise Law Journal 185.
204
Australian Competition & Consumer Commission v 4WD Systems Pty Ltd [2003] FCA 850, para
78.
As the franchise agreement usually grants a license to use the franchise trade
marks, the franchisor is expected to own the network’s trade marks, or to be able to
satisfy its franchisees that it has the right to grant the franchisees a licence to use
them. An Australian master licensee of a foreign-based franchisor (regarded by the
Australian unit franchisees as ‘the franchisor’) would be expected to have a licence
granting it sole and exclusive rights to develop the franchise network using the
franchisor’s registered trade marks in Australia. It can then confidently grant
franchises.
The 337 franchise networks in the sample group together owned at least 1,308
registered trade marks. For 14.24 per cent of franchise systems (48 in total) it was not
possible to determine the legal identity of the franchisor entity from the franchisor’s
website or from other public records. This meant that it was not possible to take more
than an educated guess at whether the trade marks relating to the network were
owned by the franchisor. Given the importance of brand protection in franchising, it
was surprising to find that 13.65 per cent (46) of franchise networks in the sample
205
Jenny Buchan, Investigation of Real and Intellectual Property Rights under Franchise Systems
Operating from Retail Premises in New South Wales (2005). Research funded by University of
New South Wales.
did not have any registered trade marks. Between 72.1 per cent and 86.5 per cent of
franchise networks did register trade marks. The remainder probably use unregistered
trade marks that would be defendable through common law or a statutory passing off
action under the Trade Practices Act. The franchisor was the sole trade mark owner
in 26.11 per cent of networks in the sample (88). In 28.78 per cent of networks the
franchisor was one of the trade mark owners. For example in the bedding retailer
Forty Winks franchise network, Forty Winks Pty Ltd owned all six registered trade
marks and was the franchisor, whereas in the tyre retail Bob Jane network, Bob Jane
Corporation Pty Ltd was the franchisor and owned 19 of the 21 trade marks. Bob
Jane Telecommunications Pty Ltd and Bob Jane T-Marts Pty Ltd jointly owned the
other two.
It was found that 15.73 per cent (53) of the franchisors in the sample were
foreign-based in such diverse jurisdictions as the Bahamas, Germany, Hong Kong,
Japan, Mauritius, the Netherlands and the USA. 206 Of these 53, only one (1.88 per
205F
cent) Australian master licensee had registered an interest as an authorised user under
s 26. That one, an entity that is presumably the Australian master licensee of
Coldwell Banker Corporation, Australian Real Estate Systems Pty registered an
interest in nine of the 10 trade marks owned by franchisor Coldwell Banker
206
7-Eleven, Inc (USA); Athletes Foot Brands, Inc (USA); Bartercard International Ltd (Bermuda);
Baskin-Robbins International Co (USA); Blockbuster Inc (USA); Bridgestone Corporation
(Japan); Candleman Corporation (USA); Dannic IP Holdings Inc (Bahamas); Century 21 Real
Estate LLC (USA); Hanic Publishing LLC (USA) Company; Chipmunks IP Limited (New
Zealand); Coldwell Banker Corporation (USA); Italtile Mauritius (Proprietary) Limited
(Mauritius); Italtile Franchising (Proprietary) Limited (Mauritius); Discount Car & Truck Rentals
Ltd (Canada); Domino's Pizza, PMC, Inc a Michigan corporation (USA); Produits Ella Bache
Laboratoire Suzy (France); Europcar International (France); Express Services, Inc (USA);
Fastway Limited (NZ); Voith Turbo GmbH & Co KG (Germany); Gloria Jean's Gourmet Coffees
Corp (USA); The Goodyear Tyre & Rubber Company an Ohio corporation (USA); HRB Royalty,
Inc (Bahamas); H2O Plus, LP; A Delaware Corporation (USA); Hertz System Inc, a Delaware
Corporation (USA); Arana Ltd (Hong Kong); Burger King Corporation (USA); IGA, Inc (USA);
Kernels Popcorn Limited (Canada); Yum! Australia Holdings I LLC and Yum! Australia
Holdings II LLC (Both USA); Kumon Institute of Education Co Limited (Japan); ICED
Management, Inc, a Delaware Corporation (USA); LPNZ Limited (New Zealand); Madame Et
Monsieur LLC a Californian Corporation (USA); United Parcel Service of America, Inc a
Delaware Corporation (USA); McDonald's Corporation a Delaware Corporation (USA);
Medicine Shoppe International Inc a Delaware Corporation (USA); Pinnacle Intellectual Property
Services - International, Inc a Nevada Corporation (USA); Mend-A-Bath International (Pty) Ltd
(Cape Province); Midas International Corporation (USA); Mrs. Fields' Original Cookies, Inc, a
Delaware Corporation (USA); Nando's International Ltd (Republic of Ireland); Number Works
Ltd (New Zealand); Pizza Hut International LLC a Delaware Corporation (USA); Quik
International a Nevada Corporation (USA); The Quizno's Master LLC (USA); Sign*A*Rama, Inc
(USA); Fastsigns International Inc, A Texas Corporation (USA); International Spar Centrale BV
(The Netherlands); Doctor's Associates Inc (USA); SureSlim International Limited (UK);
Mascolo Limited (UK); Warner Bros Entertainment Inc (USA).
Corporation (USA), a real estate franchise. The Australian licensee has registered its
interest pursuant to a licensed user agreement on the trade mark registry. No unit
franchisees in the sample group had registered their interest as authorised users of
any franchisor’s trade mark.
In 3.26 per cent of all identified networks (11 in total), there was more than one
owner of certain trade marks. In 8.01 per cent of networks (27 in total), there were
several individual owners of several individual trade marks. Typically, this was two
or three individuals where the franchisor was a corporation. For example Margaret
Kerr Kent Sasse and Harry Arthur Sasse owned the franchise Gymbaroo trade marks.
The franchisor is a corporation called Toddler Kindy Gymbaroo Pty Ltd. In some
instances the first trade mark registered by a franchisor was found to be owned by
two individuals, but subsequent trade marks in the network were owned by the
franchisor or a corporate entity related to the franchisor. For example, D Williams
and J Clow were registered as the owner of one trade mark and Fernwood Fitness
Centre Pty Ltd was the owner of all subsequently registered trade marks for the
Fernwood Women's Health Club. The franchisor entity was Fernwood Womens
Health Clubs Pty Ltd.
207
See Appendix A of this thesis.
A valid franchise agreement does not require the trade marks to be registered
or for the franchisor to own them. For example, the precedent franchise agreement in
the Australian Encyclopaedia of Forms and Precedents 208refers to the trade marks as
207F
being part of the franchisor’s image. In it, the franchisor grants the franchisee the
right, under clause 2(1)(a):
to operate the franchised business within the territory using the image, and
the system;
‘marks’ means the trade marks or logos and trade names described at Item 4
of the Schedule and any variations or modifications thereto.
12(1)(a) make the image and the system available to the franchisee;
12(1)(b) actively develop and promote the image and system;
and, at 12(5), the: Franchisor shall take reasonable steps to maintain the
integrity of the system and to protect the marks against any action or
infringement by any person.
The franchisee acknowledges that franchisor is the owner of the marks and
that the franchisee's sole right to use them is derived from this agreement.
The franchisee shall not use any other trade marks, trade names, business
names, logos, designs or colour schemes in connection with the franchised
business. 209
208F
208
LexisNexis Butterworths, Australian Encyclopaedia of Forms and Precedent, Form 40.1.
209
Ibid.
210
Copy of Traveland franchise agreement on author’s file.
For instance, as the trade mark research shows, only one Australian master
licensee has registered its authorised user status at the trade marks office. Cultural
cringe may lead less sophisticated franchisee consumers to favour one of the 53
overseas brands over a home grown Australian brand. A conclusion that can be
drawn from the Trade Mark Research concerning the use of registration and
authorisation opportunities under the Trade Marks Act is that overseas franchisors
are not necessarily models of best practice. The idea that the overseas brand is a
more secure, better organised investment, may be ill founded. The list in Table 1
contains the failed Australian master franchisees of several franchisors of overseas
origin. 213
21F
Taking into account the halo effect and the fact that some well known
franchisor brands with registered trade marks fail completely, for example Australian
based Traveland and Australian master licensees of Canadian based Kernel’s
Popcorn, Singapore based Deli France and US based Midas, it is suggested that
concluding that having a widely recognised trade mark is indicative of a ‘good’
franchisor is a flawed indicator of franchisor quality for a potential franchisee.
211
Steinberg and Lescatre, above n 13, 155.
212
An attitude characterised by deference to the cultural achievements of other countries and
disparagement of Australian (ie ones own) culture. The Australian Oxford Dictionary (2nd ed,
2004) 307.
213
For example, the Australian master franchisees Kernel’s Popcorn, Priority Management Systems
Pty Ltd, of Canadian franchisors.
Due diligence should extend beyond verifying the existence of the owner of the
trade mark to verifying the ‘chain of title’, so the franchisee can be confident it will
have an ongoing right to use the trade marks if the franchisor becomes insolvent.
Valuation – security
Bruce Schaeffer and Susan Robbins argue that ‘intangibles [registered and
unregistered intellectual property] often account for more than 80 per cent of the total
enterprise value’, 214 and write that:
213F
The value of the trade mark gauges the success of the franchisor in assuring
that franchisees provide an otherwise valuable product or service or system
according to the franchisor’s plan. The more valuable the trade mark, the
greater the price at which franchises can be sold and the greater the royalties
collected. 215 214F
As trade marks are a recognised item of property, franchisors are able to offer
them to lenders as security for loans. As trade marks are an essential asset of the
network lenders may want security over them. However, their value is notoriously
difficult to quantify. A multitude of valuation methods can be applied to intellectual
property assets 216 and the technique chosen will be influenced by the context. It is
215F
also believed by economists that ‘the greater the volume of sales under the trade
mark, the greater is the likelihood that a consumer has had direct or indirect contact
with the trade mark, increasing its value’. 217 216F
214
Bruce S Schaeffer and Susan J Robbins, ‘Valuation of Intangible Assets in Franchise Companies
and Multinational Groups: A Current Issue’ (2008) 27(3) Franchise Law Journal 185.
215
Hadfield, ‘Problematic Relations: Franchising and the Law of Incomplete Contracts’, above n
202, 949.
216
See Paul McGuinness, Intellectual Property Commercialisation: a Business Manager’s
Companion (2003) ch 23.
217
Hadfield, ‘Problematic Relations: Franchising and the Law of Incomplete Contracts’, above n
202, 950.
standard accounting and audit practices. 218 The rules of accounting do not permit the
217F
In 2005, Domino’s Pizza Australia New Zealand Ltd, included its ‘Intangibles’
in the Notes to Accompany the Financial Statements under ‘goodwill’ and ‘franchise
distribution network’. The 21 registered trade marks that Dominos Pizza franchisees
were licensed to use were not included as they were owned by the US parent
company. Dominos Pizza Australia New Zealand Ltd had not registered its licence to
218
As described also by Ahmad Sujan and Indra Abeysekera, ‘Intellectual Capital Reporting
Practices of the Top Australian Firms’ (2007) 17(2) Australian Accounting Review 71.
use the trade marks at the time of the research. Even though the trade marks were
owned by the US parent, there seemed to be no way in the accounting standards of
expressing the value of the registered user licenses for the 21 registered Dominos
Pizza trade marks to the Australia and New Zealand master licensee. This
theoretically leaves the Australian and New Zealand Dominos franchisees exposed to
not being allowed to use the trade marks if the US parent failed. The franchisor’s
liquidators could disclaim the licences as onerous contracts.
Rebel Sport Ltd did not list any of the five registered trade marks that it owned
on its 2005 balance sheet.
Harvey World Travel Ltd, with over 500 offices internationally, a turnover in
excess of A$1.7 billion 219 and at least six registered trade marks, included a heading
218F
‘Patents and Trade Marks’ in its 2004 Notes to and Forming Part of the Financial
Statement as above (‘NTFS’). It stated: ‘Patents and Trade marks are valued in the
financial statements at cost of acquisition ($5,000) and are amortised over the period
in which their benefits are expected to be realised’. 220 219F
That incoming franchisees should not necessarily place reliance on the stated
value of the trade marks is underscored by the experience of the franchisees of
Danoz Direct. TVSN Ltd, the parent company of franchisor Danoz Direct, was
formed in 2003. It became insolvent in 2005. It reported in relation to intangible
assets in the 2004 Notes to and Forming Part of the Financial Statements (NTFS)
that:
219
Harvey World Travel, Franchise Information
<http://www.harveyworld.com.au/FranchiseInfo.aspx> at 12 December 2007.
220
Harvey World Travel NTFS.
221
This value was ascribed under ASB 138, the predecessor to accounting standard AASB 138.
AASB 138 is an accounting standard relating to intangible assets. It requires an entity to
recognise an intangible asset if, and only if, specified criteria are met. The Standard also specifies
how to measure the carrying amount of intangible assets and requires specified disclosures about
Danoz Direct paid A$8 million more than the value of the assets because the
parent company, TVSN Ltd, self-assessed that this represented the value of the
customers and the brand. Franchisees therefore believed they were buying into a
valuable name, without realising that the value was self-generated by the franchisor’s
parent entity.
years. 223 For tax purposes, trade marks do not fall within s40-30(2)(c) Income Tax
2F
If the creditor has to sell the franchisor’s business in a mortgagee’s sale, the
value would potentially be much greater if the trade mark were also available for
sale.
3.2.3 LEASES
Many franchisees trade from retail premises. The presence of premises owners
as stakeholders in a franchise network can be a significant factor in how the
administration or insolvency is resolved. ‘Of the 960 business format franchises
operating in Australia in 2006, 44.7 per cent had franchisees operating from a retail
intangible assets. For more information see Catherine Pozzi and Mark Shyling (eds) Accounting
Handbook (2010) 747 – 775.
222
The effective life of a depreciating asset determines the rate at which the asset declines in value
Income Tax Assessment Act 1997 (Cth) ss 40-70, 40-75 in RL Deutsch et al, Australian Tax
Handbook, Tax Return Edition (2009) 681.
223
Deutsch et al, above n 222, 685.
224
But see Darin Neumyer, ‘Future of Using Intellectual Property and Intangible Assets as
Collateral’ (2008) 64(1) The Secured Lender New York 42.
site. 225 This numbered nearly 2,900 individual retail premises’ (2,887). 226 Fit-out
24F 25F
Franchisors shed or manage risk through the legal relationships created with
the owners of franchisees’ retail premises. Franchisees may be required to enter a
retail premises lease, sub-lease or licence with the franchisor or with third parties, or
to fit out premises with no security of tenure. The consequences of these choices will
be expanded on under the heading ‘Legal relationships and management of premises
related risks’ on page 109.
Property interests in a retail site can take many different forms as was
recognised in the 1991 Franchising Task Force’s Final Report to the Minister for
Small Business and Customs:
some franchisors insist on taking the head lease while others allow the
Franchisees to take the lease of the premises. … there is a diverse range of
arrangements that can successfully exist under the franchising umbrella. 228 27F
The consequences of the franchisor’s failure for the franchisees’ site will vary
depending on the leasing model. Twelve common franchisee premises occupancy
models are outlined below. The ramifications for the franchisees if the franchisor
becomes insolvent are discussed in chapter 4.2.4.
225
Frazer, Weaven, and Wright, Franchising Australia 2006, above n 11, 28. The concept ‘retail
premises’ was not defined in the survey so the figure does not equate perfectly with the
definitions of ‘retail premises’ in the Australian legislative instruments. The data for the
Franchising Australia 2008 survey was not analysed by reference to location of franchisees’
business but by business type. In 2008, 28 per cent of the 1100 franchisors were identified as
being in ‘retail trade’. This figure excluded cafes and other food services, travel agencies,
financial services and postal services. The figure for the separate categories of franchise can not
simply be added to the retail figure to provide a 2008 total as the café category includes
accommodation, which is not retail and travel agencies, financial services and postal services may
be conducted from retail or from non-retail premises. The mismatch between the 2008 survey
data and the legal definitions of retail highlights the difficulty of using data that was collected for
one purpose for another.
226
Buchan and Butcher, ‘Premises Occupancy Models for Franchised Retail Businesses in Australia:
Factors for Consideration’, above n 34, 143-4.
227
Frazer, Weaven, and Wright, Franchising Australia 2008, above n 7, 30. Note, some franchisors
answering this question would have franchisees without fixed premises, hence $0.
228
Franchising Task Force, Final Report to the Minister for Small Business and Customs (1991) 87.
Models
Model 1: The franchisor owns the premises and leases them to the franchisee.
……………..
Model 2: A legal entity related to the franchisor owns the premises and leases them
to the franchisee.
Franchise
agreement
Lease
Lessee = Franchisee
……………………
Model 3: The franchisor leases the premises from a landlord and sub leases to the
franchisee.
Sub lessee =
Franchisee
…………………..
Model 4: A legal entity related to the franchisor leases the premises from a landlord
and sub leases them to the franchisee.
Guarantee
………………
Model 5: The franchisor leases the premises from premises owner and grants a
licence to occupy to the franchisee.
Licensee =
Franchisee
………………..
Model 6: An entity related to the franchisor leases the premises and licenses them to
the franchisee.
Guarantee
……………….
Model 7: A master franchisee leases the premises from a landlord and sub leases
them to the franchisee.
Master
Franchisor franchise Franchisee
……………….
Model 8: A legal entity related to a master franchisee leases the premises from a
landlord and sub leases them to the franchisee.
Sublease
Franchise
Lease agreement
………………
Model 9: A master franchisee leases the premises from a landlord and grants a
licence to occupy them to the franchisee.
Franchisor Licensee =
Franchisee
…………………
Model 10: The franchisee or an entity related to the franchisee leases the premises
direct from a landlord.
Landlord Franchisor
Franchise
agreement
Lease
Guaranteed by
Franchisee’s directors
Franchisee = Tenant
……………..
Model 11: The franchisee or franchisee related entity owns the premises.
……………..
Model 12: There are no formal occupancy arrangements.
Landlord Franchisor
Franchise
agreement
No written
premises
agreement
Franchisee
each instance. 230 In some networks more than one model is chosen.
29F
Australian research has shown that where the franchise unit operates from a
specific site, the head lease is held by the franchisee in 64 per cent of cases. Twenty
six per cent of franchisors hold the head lease. Franchisors are more likely to hold
the head lease in retail (food and non food) systems. 231 230F
229
In an unpublished NSW Government Retail Tenancy Survey (2008), 33 per cent of landlords
required the franchisor to be the head tenant.
230
Barkoff and Selden, above n 112, 67.
231
Frazer, Weaven and Wright, Franchising Australia 2006, above n 11, Question A15, 30. Thus,
Models 1–6.
Depending on the occupancy model that is adopted, there may not be any
contractual relationship between the landlord and the franchisee tenant prior to the
franchisee fitting out the premises. 232 The franchisee may have protection as a lessee
231F
under the State or Territory retail leasing legislation, but this is not uniform across
Australia. 233
23F
The franchisor shall hold the head lease to the store site. The franchisee shall
make available the security deposit upon signing the sub-lease. 234 23F
The franchisee, thus, takes ultimate financial risk on the premises, while the
franchisor retains the full benefit of the site lease being in the franchisor’s name.
232
In the case of a shopping centre, the franchisor commonly negotiates the lease agreement - or
heads of agreement - with the owner's leasing manager. The franchisee then fits out the shop
under the scrutiny of the centre manager. The centre manager is an employee of the shopping
centre management company, which is normally a subsidiary of the shopping centre owner.
233
See Buchan and Butcher, ‘Premises Cccupancy Models for Franchised Retail Businesses in
Australia: Factors for Consideration’, above n 34, 143–78 for discussion of the situation State by
State. And see Table E of this thesis.
234
Danoz Directions Franchise Agreement (2004) cl 3.
235
Matthews, above n 113, Recommendation 23; Inquiry into the Operation of Franchise Businesses
in Western Australia, Report to the Western Australian Minister for Small Business (2008)
Recommendation 2.5; Economic and Finance Committee, Parliament of South Australia,
for the franchisor to take a head lease on a retail site, and then sublet (usually on the
same terms) to the franchisee. This enables the franchisor to maintain control of the
outlets through which the franchise operates, and it also assists in negotiating a better
deal with large retail centre managers that would not otherwise be available to a
single tenant.
In the 2004 version of the Danoz Directions Franchise Agreement, which used
a Model 5 structure, Clause 8 states that:
8.1 The franchisor will on or before the Commencement Date enter into a
lease of the Premises from which the Franchised Business is to be carried on.
8.2 The franchisee must, on the date this agreement is executed, enter into a
licence agreement to occupy the premises on those terms and conditions
contained in the Franchisor’s Standard Occupation Licence.
Lease. The Franchisee must provide the Franchisor with details of its
existing lease or licence of the premises and of any proposed new lease or
licence of the Premises. 237
236F
The franchisee is at risk at several junctures before and after a franchisor fails.
The franchisor’s conduct in relation to its obligations under a head lease can result in
the franchisee losing the right to occupy retail premises. Even if the franchisor is not
directly involved in the premises lease, its insolvency can still cause great difficulties
for the franchisee tenant.
3.2.4 FRANCHISEES
…‘white collar’ and ‘blue collar’, even ‘knowledge worker’ are no longer
adequate to properly encapsulate a growing number of people, some of
whom own their own businesses …as franchisees … [W]orking together for
our future … is the dominant consideration, and working in an environment
where the success of the enterprise is indistinguishable from your own
personal success. [T]here are now more Australians who are self employed
as owner-managers at 1.91 million than there are members of a registered
trade union. 238
237F
As enterprise workers, 21st century franchisees replace the labour and capital
the franchisor would otherwise have to carry on its own books and, as exemplified in
relation to trade marks and retail leases. Franchisees accept levels of commercial,
financial and legal risk that an employer would not be able to require an employee or
an independent contractor to accept.
Franchisors are aware of the divesting of legal and financial responsibility that
follows a move into franchising. This was acknowledged by Commander
Communications in 2007 which ‘says the effect of franchising will be an increase in
237
Draft Individual Unit Traveland Pty Ltd Franchise Agreement (undated) 14.
238
The Hon John Howard MP Prime Minister of Australia, ‘Opening address’ (Speech delivered at
the Franchise Council of Australia's 2005 Annual Convention, Canberra, 10 October 2005).
sales, movement of costs from fixed to variable and a reduction in direct labour costs
with an increase in commissions’. 239 238F
For example a stand-alone start up business owner would usually not have the
credibility to negotiate a lease with one of the large shopping centre owners in
Australia or the ability to generate the consumption of supplies required to obtain the
benefits of economies of scale which franchising can offer.
fund the purchase, as were franchisees Peter and Sandra of whom Ambrose J noted:
239
Jacqui Walker, Small Business Does it Tough … Hardie Trio Quit … Economists Tip Wages to
Firm … Gloria Jean’s Tax Trouble … Domino’s Setback … Small Biz Stats … Commander to
Franchise … Economic Roundup (2007) Smartcompany
<http://www.smartcompany.com.au/retail/small-business-does-it-tough-hardie-trio-quit-
economists-tip-wages-to-firm-gloria-jean-s-tax-trouble-domino-s-setback-small-biz-stats-
commander-to-franchise-economic-roundup.html> at 17 September 2009.
240
Tanya Woker, ‘Franchising – the Need for Legislation’ (2005) 17 South African Mercantile Law
Journal 49, citing Lindiwe Hendricks [Deputy Minister of Trade and Industry, South Africa] The
Franchise Book of South Africa (2003) 8.
241
The average age of a franchisee in France was 44 years old in 2007. Banque Populaire,
Fédération Française de la Franchise, CSA, Resultats 2007, Enquete Annuelle sur la franchise, 9;
the average franchisee in Australia is in their forties (male, 47; female, 43), perhaps indicative of
people seeking a career change or of the desire to be master of one’s destiny. Deloitte, Franchisee
Satisfaction Survey Benchmark 2004 (2004) 6.
Through franchising, many former employees make their first foray into self-
employment. 243 Peter and Sandra, on purchasing a Spud Mulligan’s franchise, were
24F
A business out of a box. …[Often] one of the family's breadwinners has lost
his or her job and is wondering what to do with the redundancy payout. On
the list of options are paying off a chunk of the mortgage and other debts,
putting money into super, taking a holiday or buying into a franchise and
becoming a small-business owner. 244 243F
The franchise might be the principal source of income for the family. One in
four franchisees in Australia in 2004 was female. 245 The franchisees’ education may
24F
based franchise.
242
Neilson Investments (Qld) P/L & Ors v Spud Mulligan's P/L & Ors [2002] QSC 258.
243
Frazer, Weaven and Wright, Franchising Australia 2008, above n 7, Question B6 on page 35
reported that immediately prior to entering the franchise, according to information supplied by
their franchisor 52.6 per cent of new franchisees had been in salaried work and 4 per cent had
‘other experience’ (eg unemployed, parental duties, etc). Forty three per cent had independent
business experience immediately prior to becoming a franchisee.
244
Kavanagh, above n 56.
245
Deloitte, above n 241, 6.
246
Commission of the European Communities, above n 3, 2.
business in the same industry that is not a franchise are remarkably dearer, unless the
person already has a strong knowledge in a particular field’. 247 246F
‘In legal terms, there is no relationship quite like that between a franchisor and
its franchisees. The execution of the franchise agreement often triggers a significant
commitment from the franchisee in the form of sunk investments in premises’, 248 247F
hire of staff and entry into long term contracts with parties other than the franchisor
for finance, premises rental, vehicle rental, and stock purchase.
The legal liabilities the franchisee potentially assumes on signing the franchise
agreement compare starkly with the rights (many) and liabilities (few) that accrue to
parties that perform the equivalent functions in a non-franchised network. ‘The
relationship between franchisor and franchisee is akin to a partnership, wider and
more complicated in fact than any document could contain’. 251 250F
247
Telephone Survey conducted by Jenny Buchan on 6 December 2004.
248
Frazer, Weaven and Wright, Franchising Australia 2006, above n 11, 35. The total start up cost
of a new franchised unit (excluding GST) was $78,000 with the range being $2,100 to $960,000
in 2006.
249
Patrick J Kaufmann and Francine Lafontaine, ‘Costs of Control: The Sources of Economic Rents
for McDonald’s Franchisees’ (1994) XXXVII Journal of Law and Economics 417, 444 in (ed)
Francine Lafontaine, Franchise Contracting and Organization (2005) 303.
250
Jacqui Walker, IT News - Commander to Franchise (2007) Smartcompany
<www.smartcompany.com.au> at 20 February 2007.
251
American Bar Association Antitrust Section, ‘Franchisee Protection: Laws against Termination
and Establishment of Additional Franchises’ (1990) 19 Monograph No 17 55.
Labour Force
Credit is the lifeblood of the modern industrialized economy. The employee
who is paid at the end of the working week gives credit to his employer. 252
251F
salaried employment immediately before taking out their franchise. 254 There is no
253F
The role the franchisees play as the franchisor’s labour force was
acknowledged by the New South Wales Court of Appeal in Majik Markets Pty Ltd v
Brake and Service Centre Drummoyne Pty Ltd and ors where Kirby P observed on
behalf of himself and Mahoney and Handley JJA:
While the franchisees, if natural persons are working for themselves, they
are also in a very real sense working for the franchisor. If the business was
not operated by some franchisee, the franchisor would either have to employ
staff of its own or sell or lease the site to an independent purchaser or
lessee. 255
254F
252
Sir Kenneth Cork, Great Britain Insolvency Law and Practice Report of the Review Committee
(1982) 10.
253
NatWest bfa United Kingdom, Franchise Survey (2004) Question 5.2.
254
NatWest bfa United Kingdom, Franchise Survey (2006) 29.
255
Majik Markets Pty Ltd v Brake and Service Centre Drummoyne Pty Ltd and ors (1991) 28
NSWLR 443, 465.
the employee and the independent contractor will be conducted in chapter 3.1.6.
Financier
The franchisee supplies capital in the form of the initial franchisee fee, and it
funds the establishment of its franchisee business, to help grow the franchisor’s
brand. For example, the franchisor of Boost Juice, Janine Allis, ‘was able to roll out
[a juice bar concept] around Australia at an extraordinary pace and with limited
[franchisor] capital by developing a franchise system … [commenting that] [w]e
have been able to grow using other people’s capital’. 257 256F
is planning to franchise 150 PostShops as part of its plan to gain revenue and
offset the steady decline of its snail mail business. … [A]nother 50 will be
created by buying out licensees and reselling those sites as franchises. …
[T]he plan will allow Australia post to retain control over its network and
allow it to gain initial franchise fees and a potential share of capital gains
when the franchises are sold. Franchises also provide greater contractual
flexibility than the present licence and branch systems, as well as reducing
Australia Post’s direct exposure to rising wages, retail downturns and further
slowing in demand for traditional mailing methods. … To secure a franchise,
256
Penelope Ward, ‘Can Franchisees be Treated as Employees?’ (Paper presented at the 22nd Annual
IBA/IFA Conference, Washington DC, 18-19 May 2006).
257
Virginia Marsh, ‘Entrepreneur Enjoys Fruits of Fast-Expanding Juice Chain – Janine Allis
Squeezed her Way to Success from Humble Beginnings’, Financial Times (London) 24 June
2005, 5 quoting Boost’s chief operating officer, Simon McNamara.
258
Amber Plum, ‘Bakers Delight to Help Fund New Franchisees’ Smartcompany (Melbourne), 11
September 2009. <www.smartcompany.com.au> at 14 September 2009.
259
Bakers Delight, Buyafranchise.com.au
<http://www.buyafranchise.com.au/searches/franchdetails.asp?listing_id=2749> at 15 September
2009.
Jim Cohen states that: ‘A bad business model will not be saved by franchising
it’. 261 How the franchisees investing in the PostShops are going to recoup their
260F
The biggest challenge to date for [the franchisor] has been access to capital.
None of the banks would lend to them (directors of the franchisor) because
they unanimously refused to put their houses on the line. ''Banks don't want
to invest in a concept or idea,'' [the franchisor] says.
They were never interested in seeking venture capital because of the hefty
chunk of equity demanded in return for the investment.
''We did speak to a number of people but they basically want the soul of your
first-born son. Equity is the most expensive form of finance you can get,'' Mr
Kay says. Telcoinabox relied heavily on franchising fees ($50,000 per
franchisee) in the first year. ([T]he franchisor) says not being answerable to
investors is liberating … 262
261F
Risk taker
James Brickley and Frederick Dark described the risk/reward trade-offs in
franchising in noting that:
[f]ranchising has its own set of potential costs and incentive problems….
One such cost is that associated with inefficient risk-bearing. If the manager
[ie the franchisee owner] of a franchised unit has a large proportion of his [or
her] wealth and income tied to the performance of the unit, his [or her]
investment portfolio will be relatively undiversified. This inefficient risk-
260
Damien Lynch, ‘Postal Franchisees Sought’, The Australian Financial Review (Sydney), 8
November 2005, 56.
261
Jim Cohen, Franchise Statistics Debunked Again! (2008) Blue Maumau
<http://www.bluemaumau.org/franchise_statistics_debunked_again> at 18 September 2008.
262
Kristen Le Mesurier, ‘Damian Score Double Hit’, Sydney Morning Herald (Sydney) 8 February
2008.
bearing generates at least two types of agency costs. First, the manager is
likely to make less ideal investment decisions than an efficiently diversified
decision maker… The franchisee is more likely to be concerned with the
total risk of the project than a diversified decision maker who is concerned
only with the systematic risk. Second inefficient risk-bearing can lead to
higher required rates of expected compensation because of increased risk. 263 26F
Whereas a
263
James A Brickley and Frederick H Dark, ‘The Choice of Organizational Form: The Case of
Franchising’ (1987) 18 Journal of Financial Economics 401, 405 in Francine Lafontaine (ed)
Franchise Contracting and Organization (2005) 57.
264
Spencer, The Regulation of the Franchise Relationship in Australia: A Contractual Analysis,
above n 14, 170.
franchisees were found to have a clause inserted into their franchise agreement that
permitted the franchisee to terminate the contract if the franchisor became insolvent;
one Traveland franchisee of 270 and one of the 60 or so BHG franchisees and one
master franchisee of a network that remains solvent.
In the absence of franchisees, all risks associated with conducting the business
would be taken directly by the franchisor or indirectly by financiers. The ability to
devolve risk is an under-acknowledged, but significant, benefit to the franchisor. The
amount of risk franchisees take, compared with the amount the franchisor takes, and
their respective ability to manage it by closing the store, is highlighted by the
observation, especially when read with the insight added by the last sentence:
[A]fter Bennigan’s restaurants filed for Chapter 7 in July 2008, the corporate
locations shuttered while nearly 140 franchisees remained open. “One
problem with Bennigan’s was that they had too many company-owned
stores. When the economics changed, the company-owned stores were no
longer profitable and they were losing money faster than the franchisees
were paying royalties” explains iFranchise’s Siebert. ‘But even if they’re not
that profitable it’s hard [for a franchisor] to actually lose money on a
franchisee’. 265
264F
Franchisees knowingly take on the risk of their own business failing. They pay
for their premises fit out, the franchise fee, ongoing royalties, hire employees, insure
their business, pay their employees’ payroll tax, and sign contracts with suppliers. At
its most extreme, the franchisee also accepts, unwittingly, the risk that the franchisor
might become insolvent.
The franchisee is sometimes portrayed as a willing and aware risk taker. One
theory is that a
265
Maltby, above n 120.
averse than franchisees. But since franchisees commonly invest a large share
of their assets in acquiring the franchise, it is unlikely that this will be the
case. 266
265F
The underlying assumption is that franchisors do not have control over the
amount of risk they take. However, franchisors have ultimate control through a range
of mechanisms including:
Ultimately, franchisees assume all of their own, plus some of the franchisor’s
business risk. In the absence of franchisees, the franchisor’s business risk would be
taken directly by the franchisor, indirectly by the franchisor’s financiers, or not taken
at all.
Reward sharer
Jensen and Meckling note that
[w]e don’t find many large firms financed almost entirely with debt-type
claims (ie non-residual claims) because of the effect such a financial
structure would have on the owner-manager’s behaviour. Potential creditors
will not loan $100,000 to a firm in which the entrepreneur has an investment
of $10,000. With that financial structure the owner-manager will have a
strong incentive to engage in activities (investments) which promise very
high payoffs if successful even if they have a very low probability of
266
Paul H Rubin, ‘The Theory of the Firm and the Structure of the Franchise Contract’ (1978) XXI
(1) The Journal of law and Economics 223, 225 in Francine Lafontaine’s (ed), Franchise
Contracting and Organization (2005) 20.
success. If they turn out well, he captures most of the gains. If they turn out
badly, the creditors bear most of the costs. 267
26F
Franchisors have solved the problem of accessing more capital than their core
business could support as debt by appointing franchisees and incorporating the equity
and debt raising capacity of those franchisees into the franchisor’s business structure.
By reporting the income of franchisees as part of the income of the network, and
describing the franchise agreements as income generating assets of the franchisor,
the franchisor can both receive initial franchise fees from the franchises and convince
the franchisor’s own lenders that its business is capable of bearing more debt than an
objective analysis of the franchisor would support. In this way when a franchisor
becomes insolvent they fail with few assets and with secured creditors claiming
many millions of dollars. 268 267F
It is suggested that franchisees are, in effect, taking quasi equity risk in the
franchisor, often for returns more typically associated with employment or fixed
interest debt.
First; even though a supplier may have taken significant steps, such as
retooling a production line, or committing to grow a particular crop in reliance on its
contract with the franchisor, it would normally have done so in the context of an
already-established business. For example, a farmer will negotiate a supply
267
Jensen and Meckling, above n 21, 334. Compare with anecdotal evidence which suggests that in
New Zealand at least one major trading bank will lend franchisees $25,000 unsecured, of the
$30,000 required to purchase a home cleaning franchise, in 2009.
268
See Table 1 column headed ‘Amount owed to creditors (estimated)’ of this thesis.
Third; while both suppliers and franchisees commit their own capital to the
franchisor’s brand, franchisees must then build a business along lines tightly
prescribed by the franchisor. Unlike a supplier, the franchisee that sees its franchisor
is in financial trouble has little flexibility to prepare for continuing its business with
another partner in the event of the franchisor’s insolvency. Suppliers have their own
business that they can adapt to supply other buyers if the business with the franchisor
becomes unviable.
Fourth; both franchisee and supplier to some extent put themselves at the
mercy of the franchisor’s ongoing viability but because of the standard form of the
franchise agreement, the franchisee does so to a greater extent and with less capacity
to protect itself either legally or practically. Suppliers are not 'owned' by the
franchisor.
Fifth; suppliers own their own customer lists but not all franchisees do so.
Anecdotal evidence suggests that an increasing number of franchisors operate as
commission agencies. This means the franchisor has all of the franchisees’
customers’ details and the franchisee is likely to have difficulty convincing the
customer to continue to have faith in the franchisee where the franchisor has failed to
deliver a purchased product. An example is the Australian whitegoods franchise
Kleenmaid.
The other big challenge is just the cost of employing staff in Australia.
Having a company-owned network of stores is just so expensive, and too
expensive to own all our stores with payroll tax, and so on. That's obviously
part of the reason we've moved to a franchise system. 269
268F
reported judgments.
The ATO has not been asked for a ruling to distinguish an employee from a
franchisee but it has had to distinguish an employee from an independent contractor.
The features of an employment contract were presented in table form in ATO Ruling
269
Patrick Stafford quoting Homschek in A Bigger Slice of the Pie (2009) SmartCompany
<http://www.smartcompany.com.au/food-and-beverages/20090821-a-bigger-slice-of-the-
pie.html> at 22 September 2009.
2000/14. Whilst this ruling has now been superseded by TR 2005/16 and
Superannuation Guarantee Ruling SGR 2005/1, the features of employment that were
compared with independent contracting remain valid. The column headed
‘Franchisee’ in Table 4 has been added to demonstrate in which respects the
franchisee exhibits features of the employee or the independent contractor.
The nearest relationships are identified in ‘Franchisee is more like …’ column for
each feature.
270
Adapted from Schedule B in ATO TR 2000/14.
271
Zuijs v Wirth Bros Pty Ltd (1955) 93 CLR 561; Australian Mutual Provident Society v Chaplin
(1978) 18 ALR 385; Glambed v FCT (1989) 20 ATR 428; Sgobino v South Australia (1987) 46
SASR 292; Re Clothing Trades Award 1982 (1987) 19 IR 416; City Motors (1981) Pty Ltd v
Commissioner of State Taxation (WA) (1993) 26 ATR 291; Samrani v Roads and Traffic
Authority of New South Wales (1994) Aust Torts Reports ¶81-314; Climaze Holdings Pty Ltd v
Dyson (1995) 13 WAR 487; Australian Building Construction Employees and Building
Labourers Federation (WA Branch) v Pacesetter Homes Pty Ltd (1994) 56 IR 51; Humberstone v
Northern Timber Mills (1949) 79 CLR 389; Stevens v Brodribb Sawmilling Co Pty Ltd (1986)
160 CLR 16; Ready Mixed Concrete (South East) Ltd v Minister of Pensions and National
Insurance [1968] 2 QB 497 (list sourced from CCH).
How is the employee Tasks are performed Tasks are performed Enters into a
work at the request of the following the method contract for a
performed? employer. The prescribed by the specific task or
worker is said to be franchisor. Franchisee series of tasks.
working in the typically has little Maintains a high
business of the discretion in how and level of discretion
payer whether they perform and flexibility as
the work. The to how the work is
franchisee is working to be performed.
in own business Contract may
within the parameters contain precise
mandated by the terms as to
franchisor materials used and
methods of
performance and
still be one for
services
Risk independent Bears little or no Bears all risk for own Stands to make a
contractor risk. Employee is performance. profit or loss on
not exposed to any Franchisee bears risk the task. Bears the
commercial risk. of the franchisor commercial risk
This is borne by the failing or and the
employer. underperforming. responsibility and
liability for any
The employer is Franchisor may be
poor workmanship
generally liable in tort for injury
or injury sustained
responsible for any caused by
in performance of
loss occasioned by franchisee 272 or under
the task.
271F
272
The 1996 (US) court decisions in the Foodmaker and Ely cases both held that the franchisors
were not vicariously liable for franchisees' acts. In Ely, General Motors was not liable for a
wrongful death caused by a dealer's employee since GM did not have specific control over the
test drive or employee involved in the death. In Foodmaker, the franchisor was not vicariously
liable for a franchisee-employee's murder by a co-worker; the plaintiffs had alleged liability due
to inadequate security or negligent hiring. In a Dairy Queen case the franchisor was liable for a
tort that occurred on a franchisee’s site because the injury was sustained by the plaintiff as a
result of the franchisee complying with franchisor’s prescribed construction requirements. The
franchisor had control of the process.
273
For example WorkCover Authority of New South Wales (Insector Petar Ankucic) v McDonald's
Australia Limited and Another [2000] NSWIRComm 277; and Workcover Authority of NSW
(Inspector Ankucic) v McDonald's Australia Limited and anor matter [2000] NSWIRComm 1123
where franchisor was held liable for death of franchsiees’ employees at franchisee’s outlets.
274
Hadfield, ‘Problematic Relations: Franchising and the Law of Incomplete Contracts’, above n
202, 943. Twelve per cent of franchisors require franchisee to manage full time. Nine per cent
require approval of manager.
contract.
Insolvency of
either party a
specified event of
default
275
Franchisor is required to supply intending franchisee with a disclosure that complies with the
Franchising Code of Conduct 1998. Failure to do so gives franchisee rights under Trade Practices
Act 1974 (Cth) s 51AC but currently there is no right to damages.
276
Both an employee and a franchisee expect to be in the particular work relationship for a number
of years; for an employee this will vary with the nature of the job. For a franchisee, there is an
expectation that the franchisee will be in the relationship for the term of the franchise agreement,
or will sell at a profit before then. Frazer, Weaven and Wright, Franchising Australia 2008,
above n 7, 23 report the initial terms of the current franchise agreement of the 264 franchisors
that responded ranged from 1 to 50 years. Of these, 67 per cent of franchisees have an initial term
of 5 years.
277
Hadfield, ‘Problematic Relations: Franchising and the Law of Incomplete Contracts’, above n
202, 940 reports that in the US, all franchise contracts contain termination rights for franchisors
and 79 per cent state that [the franchsiee’s] bankruptcy automatically terminates the contract and
all rights revert to franchisor. In Australia, clauses 21, 22 and 23 of the Franchising Code of
Conduct stipulate when a franchisor may terminate a franchise agreement (see chapter 4.2.3 and
for full wording see Appendix A – of this thesis). This is in addition to contractual provisions.
Delegation employee Employee has no Typically may not May delegate all
inherent right to delegate management or some of the
delegate tasks to role except with tasks to another
another. However, franchisor’s express person, and may
there may be a consent. Most employ other
power to delegate franchisees have persons 278
27F
Against the criteria in Table 4, over half of the identified features of the
business relationship place the franchisee nearer to having an employment
relationship with its franchisor than an independent contractor relationship. Only a
third locate the franchisee nearer to an independent contractor.
In answering the question ‘who is an employee?’ 279 the 2005 rulings examine
278F
the features of employment and independent contracting relationships under the six
headings; control, results contracts, whether the work can be delegated or sub-
contracted, risk, provision of tools and equipment and payment of business expenses,
and other indicators. Each is expanded on below in the context of franchisees.
Control
The notion of control encompasses features 1, 2, 4 and 5 of TR 2000/14. It
includes both degree of control and the ability to dictate what, how and where work
is to be done. Essentially, the question here is whether the worker operates on his or
her own account or in the business of the payee. ‘In Hollis v Vabu (2001) 207 CLR
21, 39 280 (Vabu) the majority of the High Court quoted the following statement made
279F
278
ATO TR 2000/14, Attachment B.
279
For the purposes of interpreting the word ‘employee’ as it appears in Taxation Administration Act
1953 (Cth) pt IVAAA and Superannuation Guarantee (Administration) Act 1992 (Cth) s 12.
280
(2001) 207 CLR 21, 39 (Gleeson CJ, Gaudron, Gummow, Kirby and Hayne JJ) (McHugh and
Callinan JJ dissenting).
This distinction is also referred to as the integration or organisation test. 282 In 281F
Vabu, the majority in the High Court found that a bicycle courier was a common law
employee of Vabu and stated that ‘[v]iewed as a practical matter, the bicycle couriers
were not running their own business or enterprise, nor did they have independence in
the conduct of their operations’. 283 28F
281
[FN 25 in TR 2005/16]; Hollis v Vabu (2001) 207 CLR 21, 39.
282
[FN 26 in TR 2005/16]. The notion of an 'integration' test arose in Montreal v Montreal
Locomotive Works (1947) 1 DLR 161, 169 and was affirmed by Lord Denning in Stevenson
Jordan and Harrison Ltd v MacDonald and Evans [1952] 1 TLR 101, 111 and reaffirmed in
Bank Voor Handel En Scheepvaart NV v Slatford [1953] 1 QB 248, 295.
283
[FN 27 in TR 2005/16]; Hollis v Vabu (2001) 207 CLR 21, 41 and TR 2005/15 para 32, 33.
284
McDonald's Australia Holdings Ltd & Anor v Industrial Relations Commission of NSW & 2 Ors
[2005] NSWCA 286, para 19 (Spigelman CJ, Mason P, Handley JA).
Given the prescriptive nature of the business environment for the McDonald’s
franchisee, it would arguably be open for the High Court to find a McDonald’s
franchisee is an employee if it applied Vabu without considering additional
distinguishing traits.
Results contracts
While the notion of 'payment for a result' is expected in a contract for services,
it is not necessarily inconsistent with a contract of service. Stephen J in the High
Court in Federal Commissioner of Taxation v Barrett & Ors [1973] HCA 49; (1973)
129 CLR 395 found that land salesmen who were engaged by a firm of land agents to
find purchasers for land entrusted to the firm for sale and who were remunerated by
commission only were employees and not independent contractors. Likewise, the
High Court in Vabu considered that payment to the bicycle couriers per delivery,
rather than per time period engaged, was a natural means to remunerate employees
whose sole purpose is to perform deliveries. Further, the Full Court of the Supreme
Court of South Australia in The Commissioner of State Taxation v The Roy Morgan
Research Centre Pty Ltd [2004] SASC 288 Mullighan, Nyland and Anderson JJ
found that interviewers who were only paid on the completion of each assignment,
not on an hourly basis, were employees and not independent contractors. 285 This 284F
analysis poses challenges for those franchisors whose franchisees are effectively
commission agents. Such franchisees may be found to be employees. In the majority
of franchise relationships, however, the franchisee does not receive commission from
the franchisor but pays the franchisor a periodical royalty, regardless of results.
their employees followed the franchisor’s methods and instructions to the letter, for
example by employing the franchisor’s prescribed tradespeople to conduct work on
285
SGR 2005/16 para 46; TR 2005/16 para 39.
286
For example: WorkCover Authority of New South Wales (Insector Petar Ankucic) v McDonald's
Australia Limited and Another [2000] NSWIRComm 277.
the franchisees site. The franchisor’s prescribed methods or instructions were found
by the courts to be flawed, resulting in the court attributing liability to the franchisor.
Other indicators
These include:
Requirement that the worker wear a uniform bearing the employer’s logo.
287
Paras 49, 50.
poultry franchisor, Lenard Poulter, ‘[u]nless you [as franchisor] pile up a lot of debt,
franchising is the only way to expand retail operations. It means that other people
supply the capital’. 289
28F
288
Frazer, Weaven and Wright, Franchising Australia 2008, above n 7, 30.
289
Derek Parker, ‘Counting on His Chickens’, The Australian (Sydney), 24 June 2005.
The only option for the franchisee was the suburb of Malvern.
the fact that the couriers were presented to the public and to those using the
courier services as emanations of Vabu (the couriers were wearing uniforms
bearing Vabu’s logo) was an important factor supporting the majority’s
decision that the bicycle couriers were employees. 292
291F
290
Kaytonruby Pty Ltd & Ors v Glev Franchisees Pty Ltd & Ors (1998) VG 438 of 1993, para 24.
291
(2001) 207 CLR 21, 42 (Gleeson CJ, Gaudron, McHugh, Gummow, Kirby, Hayne JJ). (Callinan J
dissenting).
292
Australian Taxation Office TR 2005/16, 12, para 52.
2.9.4 All rights in and to the Marks and the Industrial [ie intellectual]
Property and any part thereof and any addition thereto shall be and remain
the property of the franchisor and the Franchise Holder shall not acquire any
right, title or interest therein except as provided in this agreement. 293
29F
The Store Owner must have a positive, co-operative and contributive attitude
towards the McDonald's System. He/she must have demonstrated a pro-
active record of sales building and involvement in their local community; an
attitude which is in tune with today's competitive market place for good solid
business rationale and one that will enhance the future growth of their store
and the development of the McDonald's System. 294 293F
293
Copy of franchise agreement in researcher’s possession.
294
Far Horizons Pty Ltd v McDonald's Australia Ltd [2000] VSC 310, para 5(f).
Choice of suppliers
The employee is motivated by job description and ideally by loyalty to the firm
to choose the best suppliers. Ideally, there is no conflict of interest between an
employee and their employer. Where a director is also a supplier there may be a
breach of director’s equitable duties if a conflict of interest is not disclosed. 296295F
295
Ibid para 32.
296
For extensive discussion on directors duties and conflicts of interest see RP Austin and IM
Ramsay, Ford’s Principles of Corporations Law (13th ed, 2007) ch 8, 9.
The franchisor shall not limit the suppliers from which such items may be
purchased. 297
296F
A middle position existed in the Mail Boxes Etc (MBE) single unit franchise
agreement that stipulated, in Clause 9.1 that:
297
Jax Franchise Agreement, cl 9.6.
298
This agreement has possibly been superseded as MBE was taken over by UPS, but it is not
possible to be sure because of the absence of a franchise agreement database in Australia.
299
Far Horizons Pty Ltd v McDonald's Australia Ltd [2000] VSC 310.
Clearly issues around sourcing and dealing with suppliers are one significant
area where employment and franchising differ.
The relationship between the franchisor and the franchisee is strictly that of
franchisor and franchisee. This agreement does not constitute either party a
joint venturer, partner, agent, employee or fiduciary of the other. 300
29F
Duty of confidentiality/secrecy
Employees and franchisees both have obligations to keep some matters
confidential. In both situations termination of the relationship may result from a
breach of this obligation.
300
Jax Franchising Systems Pty Limited v State Rail Authority (New South Wales); Jax Tyres Pty
Limited v State Rail Authority (New South Wales) [2003] NSWLEC 397.
Secrecy: The Franchisee and the Guarantors hereby covenant and agree that
they shall:
(a) maintain, and ensure that their employees maintain, strict secrecy about
the modes and methods of business of the Franchisor and the System,
including but without limiting the foregoing, any manuals … issued by the
Franchisor, the Franchisor’s trade secrets, advertising and publicity material.
The Franchisee shall take all reasonable steps to ensure that its employees
observe the Franchisor’s requirements for secrecy, including, if required by
the Franchisor, the Franchisee’ procuring the execution of a deed of
confidentiality in favour of the Franchisor by each employee;
(b) not and will procure that their employees shall not, during the Term of
this Agreement, or after its termination or expiration, disclose any
Confidential Information, including all manuals …, communications,
marketing programs, products under development and methods of operations
received by any of them during the Term hereof unless disclosure is required
by law;
( c) not, and shall procure that their employees shall not , after the expiration
or earlier determination of this Agreement use any of the Confidential
Information without the written consent of the Franchisor first had and
obtained. 301
30F
301
Copy of franchise agreement is in researcher’s possession.
If their employer abuses its stronger position, employees may have recourse to
a trade union for assistance.
302
Copy of franchise agreement is in researcher’s possession.
303
McDonald's Australia Holdings Ltd & Anor v Industrial Relations Commission of NSW & 2 Ors
[2005] NSWCA 286, para 23 of Judgment of Spigelman CJ.
304
A Franchisees Association of Australia Incorporated was established in 1983 but lacked funding
and did not function like a trade union; the Franchise Council of Australia claims to represent
franchisors and franchisees but ‘current figures suggest that only 200 franchisors of 1100 in total
are members, which represents less than 20 per cent while the percentage of franchisees who are
members is even lower.’ Elizabeth Crawford Spencer, ‘All for One and One for All: A Survey of
Franchise Trade Associations’ Roles in the Governance of the Franchise Relationship.’ (Paper
presented at the 23rd Annual International Society of Franchising Conference, San Diego,
California, 12-14 February 2009) 15.
305
Far Horizons Pty Ltd v McDonald's Australia Ltd [2000] VSC 310, para 42.
Vicky’s employer, Traveland, was a travel agency with 100 non-franchised and
270 franchisee owned agencies. It was wholly owned by Australia’s failed Ansett
Airlines. Being paid wages fortnightly or monthly … employees would quickly
know if they did not receive wages.
Key staff may be retained by, and paid by, the administrator whilst the
administrator reorganises the business structure. The financial risk the employee
assumes is in relation to unpaid wages and bonuses. However, statutory protection
exists for some wages and allowances, and a government backed GEERS scheme
compensates for some wages that cannot be paid from the insolvent estate.
306
Alison Rehn and David Penberthy, ‘Traveland liquidators to be paid $1m’, Daily Telegraph
(Australia) 15 March 2002, 15.
receive their entitlements, under the GEERS scheme, but unsecured creditors
[and franchisees] should expect nothing. 307
306F
Franchisee may not become aware of the franchisor’s position until a supplier
changed the terms of trade, or they hear about the franchisor’s demise through the
media.
Ideally, franchisees also make capital gains if their business succeeds. This is
available to the franchisee if they can sell the business during the term of franchise.
A longer franchise term provides more opportunity for the franchisee to recover its
initial investment while building the franchise, and ideally leaving a residual term to
sell.
The franchisee situation opens the door for a debate about the type of goodwill
that is being sold: is it goodwill that attaches to the person (the franchisee), or the
brand (the franchisor) or the location (potentially either or both)? In ATO ruling
‘PCD 8 Capital Gains: Goodwill’ 308 possible viewpoints on the question of whether a
307F
307
Alexander Samson, Alicia Hill and Derek Sutherland, Back to Basics – Insolvency and
Franchising (2009) Dibbsbarker <
http://www.dibbsbarker.com/industry/Franchising/Recent_Publications.aspx?publicationid=d835
666ba19cfd1d> at 18 February 2010.
308
Australian Taxation Office, PCD 8 Capital Gains: Goodwill (1995).
franchisee can own goodwill are discussed. There is authority for the view that in the
absence of a specific contractual provision to the contrary, on the termination of a
franchise, the benefit of the goodwill remains in the franchisor. The amount of time
still to run under the franchise agreement will be relevant to the conclusion.
Some franchise agreements state the matter clearly. For instance, clause 17.2 of
the MBE individual franchise agreement states:
Consequences of Termination
The Franchisee shall have no claim against the Franchisor for …
compensation for the loss of the business, loss of goodwill or any similar
loss.
POST-RELATIONSHIP RESTRAINTS
Post-contract restraints apply to franchisees and less commonly to employees
in Australia. The validity of the restraint depends on how reasonable it is – in time,
scope and distance. Franchise related restraint cases in Australia include The
Cheesecake Shop v A & A Shah Enterprises [2004] NSWSC 625 which discussed the
following clause in the franchise agreement:
309
Goodwill is discussed by Ian Tregoning in ‘Goodwill in the Context of Licensing, Leasing and
Franchising: Some Considerations’ (2009) 37 Australian Business Law Review 296.
310
The Cheesecake Shop v A & A Shah Enterprises [2004] NSWSC 625.
The differences between franchisees and employees are often as striking as the
similarities, especially when the franchisor fails. The implications for employees are
discussed in chapter 4.4.6.
The first question when considering any problem from a legal perspective is:
can the problem be addressed within the existing law? Is anything preventing
franchisees from protecting themselves against the consequences of franchisor failure
by negotiating contracts better? Intuitively, it would seem that franchisors and
franchisees should be able to incorporate provisions into the contract that address the
possibility of the franchisor’s business failing, and thereby provide franchisees with
311
Ibid para 36
The best protection against the risks inherent in the bankruptcy process is to
terminate the franchise agreement before bankruptcy is filed. If the franchise
agreement is terminated before bankruptcy is filed, it is not protected by the
automatic stay and the franchise is not property of the estate. 312
31F
Tractenberg also advises that ‘[c]omplete termination is required’. 313 Similarly, the
312F
best protection for franchisees is for them to be legally entitled to terminate the
franchise agreement during the period of administration before the franchisor’s
liquidator is appointed.
agreement as being:
Franchise agreements perform the same role everywhere. In South Africa, for
example, the franchise agreement has been described in Cacun Trading No 24 CC &
312
Tractenberg, above n 110, end note 8; See, for example, Moody v Amoco Oil Company 734 F 2d
1200 (7th Cir) cert denied, 469 US 982 (1984). Tractenberg is writing for an audience of lawyers
whose clients are franchisors whose franchisees are becoming bankrupt but the same applies to
franchisees. Whilst being a high-risk strategy for franchisees in Australia, termination for
anticipatory breach is the avenue that gives individual franchisees the quickest exit from a
doomed franchise agreement; see ch 3.3 of this thesis.
313
Tractenberg, above n 110, end note 9. If the franchise agreement expired prepetition or is
otherwise not in existence because of having been completely terminated prepetition it is not
property of the estate. See, for example, Days In v Gainesville P-H Properties, Inc 77 BR 285
(Bankr MD Pa 1993); But compare with Baskin Robbins Inc v Neiberg 161 BR 606 (Bankr BD
Pa 1993) (no waiver by franchisor of termination rights) with In re Karfakis, 162 BR 719 (Bankr
BD Pa 1993) (franchise agreement and real property lease were indivisible contracts and
purported termination of franchise agreement without taking possession of real estate was
incomplete termination of the integrated franchise rights of the debtor).
314
M P Ellinghaus, E W Wright and M Karras, Models of Contract Law an Empirical Evaluation of
Their Utility (2005).
315
Blair and Lafontaine, above n 46, 3-4.
Any problems are ideally addressed to the satisfaction of both parties as the
relationship develops. After conducting an inquiry into franchising in 2008, the
Economics and Finance Committee of the South Australian Parliament writes:
‘Contractual relations are the essence of the firm, not only with employees but
with suppliers, customers, creditors’ 318 and franchisees. The franchise agreement is
317F
also the starting point for the courts, administrators and liquidators determining the
parties’ rights. The franchise agreement will now be examined as the record of a
bargain, and in the context of the franchisor failing.
316
Tanya Woker, ‘Franchising – The Need for Legislation’ (2005) 17 South African Mercantile Law
Journal 49, 51.
317
Economics and Finance Committee, Parliament of South Australia, Franchises (2008) 17.
318
Jensen and Meckling, above n 21, 311.
We’d just renewed the franchise agreements on our 4 [Traveland] outlets for
5 years when the franchisor’s administrator was appointed. We went to see a
QC to see if we could get out of the agreements and there was no way. 321 320F
not describe the experience of franchisees. Contract theory helps explain how this
imbalance arises and why it has not been redressed by the common law.
Notwithstanding that one would assume for all stakeholders that certainty is an
outcome of the contracting process and
319
Free Franchise Docs <http://www.freefranchisedocs.com/index.html> at 5 June 2008.
320
Buchan and Butcher, ‘Premises Occupancy Models for Franchised Retail Businesses in Australia:
Factors for Consideration’, above n 34, 170.
321
Jenny Buchan and Lorelle Frazer, above n 32, 1906.
322
Lindy Willmott et al, Contract Law (3rd ed, 2009) 16.
323
In Bobux Marketing Limited v Raynor Marketing Limited [2001] NZCA 348, para 34 (Thomas J
dissenting), citing AF Mason, ‘Contract, Good Faith and Equitable Standards in Fair Dealing’
(2000) 116 Law Quarterly Review 66, 70.
As E W Thomas observes, ‘[i]t is the law of contract that has the greatest
impact on interactions where freedom of choice and action and freedom from
interference are most coveted’. 326 Parties to commercial contracts should act in their
325F
… the liberal fiction that all the effects of a contract should be attributed to
the will of those who made it still persists though contract law today even
though the overwhelming majority of contracts are the product of the will of
only one of the contracting parties. 327
326F
Parties to contracts act in their own interest. In franchising, though, the will of
the franchisor dominates the franchise agreement. Franchisors draft the agreement
324
Sky News, ‘Australian Industry Group, Heather Ridout, with Kieran Gilbert’, Agenda (5 May
2009).
325
Hadfield, ‘Problematic Relations: Franchising and the Law of Incomplete Contracts’, above n
202, footnote 28 at 928.
326
E W Thomas, The Judicial Process: Realism, Pragmatism, Practical Reasoning and Principles
(2005) 382.
327
K M Sharma, ‘From Sanctity to Fairness’ (1999) 18 New York Law School Journal of
International and Comparative Law 95, 115.
acting in their own interest. This makes sense to the extent that franchisors can
thereby ensure that the major risks for the future integrity of their network are
addressed, and can achieve administrative efficiency through standardisation.
329
of ‘soft law’ 328F recognised within the franchising community as being a final
opportunity for the franchising sector in Australia to prove to the Australian
Government that it could self-regulate. The alternative to demonstrated, sector-wide,
voluntary compliance was that the Government would enact legislation to regulate
franchising. After one year of proactive, government funded promotion of the
benefits of the FCP it was perceived that the FCP was not delivering on hopes, and
the Gardini Review was commissioned. Robert Gardini wrote that ‘[a]s at 30
September 1994, 376 franchisors had registered with the FCAC [the body
administering the FCP]. … it appears that approximately 50 – 60 per cent of
franchisors are registered’. 330 329F
Both the franchisors that did register and those that did not, acted in their own
interest. Some registered because most banks required registration as a pre condition
of lending to franchisees. It was considered at the time that ‘restraints contained in
the Code on financial institutions and publishers331 would increase the pressure on
30F
franchisors to register’. 332 Those that did register may also have been motivated by
31F
the credibility that they hoped the ‘FCP compliant’ by-line lent to their businesses.
328
Robert Gardini, Review of the Franchising Code of Practice (1994) v.
329
Iain Ramsay, ‘Consumer Law, Regulatory Capitalism and the ‘New Learning’ in Regulation’
(2006) 28(1) Sydney Law Review 9.
330
Gardini, above n 328, 15.
331
‘Publisher’ was included under the definition of ‘Service Provider’ in clause 3(e) of the
Franchising Code of Practice 1993 but the definition did not expand on who would be considered
to be a ‘publisher’. Clause 16.2 of the Code of Practice stated: Service Providers which are
publishers and advertising media providers who register with the Code will comply with the Code
by agreeing not to take or place advertisements from persons purporting to sell or provide
Franchise opportunities unless those persons are able to provide a current Code Registration
Number.
332
Gardini, above n 328, v.
that the franchisor had nothing to hide and concluded that compliance
would impose a financial and administrative cost that they would pass on
to franchisees while not generating any greater security for their
franchisees,
that the franchisor did have something to hide and did not want to risk
exposing themselves to a random audit, and
Each franchisor, thus, acted in its own interest. This rational approach helps
explain why franchisors make no mention of franchisor failure in franchise
agreements. They believe they are acting in their own interest. The franchise sector’s
equivocal response to complying with the FCP is likely to be an indication of how
they would respond to the suggestion that all franchise agreements voluntarily
include provisions addressing franchisees’ rights if the franchisor failed.
A further example of the stronger party acting in its own interest is the way
issues of risk and reward are addressed in franchise agreements. A contract
negotiated between parties of equal weight and with a mutual interest in the success
of the venture would result in the contract addressing both risk and gain in a balanced
way. For example, despite having assumed a considerable amount of the franchisor’s
business risk franchisees have no right to receive the corresponding reward that a
franchisor’s venture capital providers or shareholders typically would be entitled to if
the franchisor entity is sold for a profit. 334
3F
Thus the assumption that franchisors will act in their own interests is correct.
The assumption that the weaker party to the contract, the franchisee, will act in their
333
Ibid.
334
For example S Mitchell, ‘Cartridge Refiller Tops up With $60m’, The Australian Financial
Review (Melbourne), 2 August 2007, reports on a private equity led management buyout of 80
per cent of the franchisor’s business for an estimated $60m.
the Committee believes that the use of these forms has significant consumer
benefits: [being] familiarity, comprehensiveness, compliance with legislative
provisions, frequently updates, flexibility, efficiency, risk management,
balance between the parties to the transactions. 335
34F
Whilst all of these points are valid in respect of standard form contracts drafted
by an impartial party, standard form agreements such as franchise agreements are
drafted by the overwhelmingly more powerful party in a commercial relationship.
The Law Society’s thinking about standard form contracts is inaccurate in the
context of standard form franchise agreements.
Thus, in the Subway franchise network the franchisor maximizes its position
by requiring disputes that are not able to be resolved by mediation at national level to
335
Law Society of New South Wales, Australian Consumer Law – Consultation on Draft Provisions
on Unfair Contract Terms (2009) Australian Government, The Treasury
<http://www.treasury.gov.au/contentitem.asp?NavId=037&ContentID=1537> at 4 June 2010.
336
Timic v Hammock [2001] FCA 74, para 6.
Franchisees are encouraged to read the franchise agreement and ask questions,
but any requests for changes are typically rejected by the franchisor. Standardisation
of outcome is a more important result for a franchisor than letting a new franchisee
enter the relationship in the mistaken belief that he or she has any bargaining power.
The franchisee accepts the franchisor’s unwillingness to negotiate because
standardisation reinforces the franchisor’s mantra – we know how to do it, trust us
and sign on with us and you will be successful before you know it.
‘Clause 10.1 of the [Lenard’s] retail chicken shop franchise agreement reads as
follows:
337
‘Doctor's Associates Inc, an American corporation, is the owner of proprietary and other rights
and interests in various service marks, trade marks, trade names and goodwill used in its business
including the trade name and trade mark ‘Subway’. Subway Systems is the Australian licensee of
Doctor's Associates. … Clauses identical or substantially similar to clause 10 appear in franchise
agreements for over 14,000 Subway franchises throughout the world. The reason Subway
Systems and Doctor's Associates require disputes with franchisees to be resolved in accordance
with clause 10 is that they want to develop an internationally consistent approach to dispute
resolution with franchisees.’ In Timic v Hammock [2001] FCA 74.
338
Andromachi Georgosouli, ‘Investor Protection Regulation: Economically Rational?’ (2006)
Working Paper Series, University of London, Centre for Commercial Law Studies 10
<http://ssrn.com/abstract=893451> at 4 June 2010.
The National Franchisor, the Master Franchisee and the Franchisee are each
independent contractors. They are not and shall not be considered as joint
venturers, partners or agents of each other and no fiduciary relationship shall
be deemed to exist between them’. 339 38F
acknowledges that ‘consumer protection through market forces alone is weak’. 342 341F
339
Poulet Frais Pty Ltd v The Silver Fox Company Pty Ltd [2005] FCAFC 131 (Branson, Nicholson
and Jacobson JJ).
340
Elizabeth Spencer, ‘Standard Form and Relational Aspects of Franchise Contracts’ (Paper
presented at the 20th International Society of Franchising Conference, Palm Springs, California,
24-26 February 2006) 21, quoting Silvana Sciarra, ‘Franchising and Contract of Employment:
Notes on a Still Impossible Assimilation’ in Christian Joerges (ed), Franchising and the Law:
Theoretical and Comparative Approaches in Europe and the United States (1996) in Journal
Institutional & Theoretical Economics, 152, 297-324.
341
Rick Bigwood, Exploitative Contracts (2003) 274.
342
Ibid 274-5.
343
Jenvey, above n 123.
Another way of expressing the problems caused by the standard form is that:
It is easy to suggest that, having observed that other franchisees have already
made the investment in the franchise business, franchisee consumers free ride and do
not conduct extensive due diligence. Even if adequate due diligence were possible
the contract is not negotiable. As Carter et al state:
the assumption that will and intention form the substratum of every contract
is heavily attenuated by inequality of bargaining power between individual
and corporation whose power is marked by common use of standard form
contracts. 346
345F
[s]tandard form contracts are typically used by parties who are in such a
strong bargaining position … that they are able to prescribe the terms on
which they are prepared to contract on a ‘take or leave it’ basis. 347
346F
344
Georgosouli, above n 338, 10-11, fn 40 citing I D C Ramsey, ‘Rationales for Intervention in the
Consumer Marketplace’ (1984) Occasional Paper for the Office of Fair Trading 28.
345
Ibid 11.
346
J W Carter, Elisabeth Peden and G J Tolhurst, Contract Law in Australia (5th ed, 2007) 8.
347
Willmott et al, above n 322, 583.
‘In contract theory, incompleteness is [also] due to the cost and sometimes
unavailability of information’. 349 During the initial contract negotiations ‘parties
348F
ex ante and ex post contracting costs prevent parties from writing complete contracts
and give rise to what economists refer to as the problem of incomplete contracts’. 351 350F
Ex ante, the parties might not foresee all possible contingencies or they would
have to incur prohibitively high negotiation and drafting costs to partition all
contingencies sufficiently to provide for efficient obligations in each case. The
contingency that the franchisor’s business might fail is the least likely from a
franchisees’ perspective, as most believe they are buying a proven concept. ‘A
challenge for parties designing contracts is to preordain or at least constrain the
course of future renegotiation so as to yield both ex ante and ex post efficiency’. 352 351F
[t]o the extent that courts cannot distinguish between the derogation of a
commitment in an incomplete contract, and an exercise of the flexibility
348
Hadfield, ‘Problematic Relations: Franchising and the Law of Incomplete Contracts’, above n
202, 928.
349
Robert E Scott and George G Triantis, ‘Incomplete Contracts and the Theory of Contract Design’
(2005) 56(1) Case Western Reserve Law Review, 187, 191.
350
Ibid 190.
351
Ibid.
352
Ibid 194.
The franchise agreement is necessarily incomplete because of its long term 354 35F
the legal system is likely to be a poor venue for specifying the substantive
terms of the [long term franchise] contract. It would be unrealistic to expect
a relational contract to cover all contingencies. From a franchisee’s
perspective, then, perhaps the biggest problem with franchising lies not so
much in what it is, but rather what it is not and yet sometimes appears to
be. 355
354F
explain why franchisors would knowingly leave gaps around the possibility of
franchisor failure when ‘the cost of making contracts complete in this sense is
trivial’. 357 A flaw in applying the theory of trading off ‘front-end and back-end
356F
costs’ 358 to justify not providing for franchisor failure ‘up front’ is that franchisors
357F
fail sufficiently often for the risk to be eligible for inclusion in the franchise
agreement from the outset. It would be relatively inexpensive to insert provisions
about franchisor failure into the franchise agreement, and the traditional justification
that issues left for the back end will be resolved by the courts is not justifiable where
the trigger event is the insolvency of one party.
353
Hadfield, ‘Problematic Relations: Franchising and the Law of Incomplete Contracts’, above n
202, 928.
354
Shelby D Hunt, ‘The Trend Towards Company-Operated Units in Franchise Chains’ (1973) 49(2)
Journal of Retailing 3, 10 reported that typically fast food franchisors in the US granted terms
with a median length of 15 years, and that frequently the franchisee had an option to renew.
Frazer, Weaven and Wright, Franchising Australia 2008, above n 7, 23 found the initial term of a
franchise agreement in Australia across all sectors except motor vehicles varied from one to 50
years, with a median term of 5 years.
355
Blair and Lafontaine, above n 46, 221.
356
Scott and Triantis, above n 349, 187, 190.
357
Ibid.
358
Ibid 196.
accord to each party to a contract of this kind, reasonable security for the
protection of his or her justified expectations. 359 358F
situations merit implying terms into contracts’. 361 These may be implied to give
360F
effect to the ‘presumed intentions of the parties’. 362 The presumed intentions of the
361F
parties could rarely be proven, to the satisfaction of a court, to have included the
franchisor’s failure. It is thus not open to the franchisee to argue that clauses
providing the franchisee with contract-based rights on the franchisor’s insolvency
were omitted because the contract did not reflect the intentions of the parties.
Alternatively terms are implied into contracts ‘regardless of intention’ 363 362F
because the type of contract or a specific statute mandates inclusion of that term.
Currently no terms are implied into franchise agreements to fit the second category
following the appointment of a receiver, administrator or liquidator. The possibility
of implying terms into franchise agreements by statute is addressed in chapter 6.2.
[i]t would be quite wrong to think that a contract that omits a provision to
deal with a particular contingency is due to an oversight or the finite capacity
of business people and their legal advisers to predict future events with
accuracy. … there are sound commercial and economic reasons why the
parties may deliberately choose to enter into agreements in which no
provision is made for known contingencies. 364 36F
359
Dymocks Franchise Systems v Bilgola Enterprises Ltd 8 TCLR 612, 630.
360
Carter, Peden, Tolhurst, above n 348, 8.
361
See Des Butler et al, Contract Law Casebook (2009) 73.
362
Ibid 73–4.
363
Ibid 77.
364
Thomas, above n 326, 296.
[t]he decision as to what is the most efficient will be made having regard to
… the time available for further negotiations, the cost of more
comprehensive drafting, the risk that the core bargain will be lost, the
chances of the contingency actually occurring, and the consequences or
alternatives available if the contingency does not occur. Further, with long-
term or relational contracts … the parties can anticipate that some terms of
the contract will be renegotiated and developed in the light of experience or
necessity. 365
364F
But, by taking each of the factors identified by Thomas and placing them in the
context of the franchise sale and purchase process it can be concluded that franchise
contracts are not the result of typical commercial negotiations. There is, in theory,
ample time. The franchisee has a 14-day cooling off period in which to consider the
deal. By this time the franchise agreement has already been settled through a process
of franchisor centric drafting and it is likely that no amendments will be agreed to.
Cost is not the issue. The additional cost of drafting to provide a termination
right for franchisees would be negligible, especially once that provision had been
incorporated as standard into the franchisor’s usual franchise agreement. However,
the franchisee is required to sign the standard franchise agreement for the network.
There is a perceived risk that the core bargain – the sale of the franchise to the
franchisee – will be lost if the franchisee insists on additional terms. However, once a
franchisee has decided which franchise to buy, it is very difficult to dissuade them.
This is explored further in chapter 3.4.
The damage resulting from franchisor failure is more widespread than that
caused by the failure of an individual franchisee. When a franchisor fails, all of its
365
Ibid 296-7.
What is crucial is that the vulnerability that gives rise to the asymmetric
power relation between the parties is such that P ought to be excused …
from having to exercise that level of responsibility or self-reliance expected
and required of the generality of contracting parties. … the exploitable
circumstances condition presupposes a weakness or vulnerability that, in the
circumstances, removes P from the normal assumptions made about the
bargaining ‘game’… the crux of the exploitable circumstances criterion lie
in the nature and extent of the power relation existing between the parties.
What matters is that P’s interests have become peculiarly sensitive to – that
is, they can be directly, strongly and adversely affected by – D’s choices and
actions and this resultant vulnerability becomes the source of D’s bargaining
power. 366
365F
[implying] a term [of good faith], whatever the basis of its implication and
whatever its precise content, may validly operate to protect a vulnerable or
366
Bigwood, above n 341, 143.
Frustration
Events may occur after a contract has been made which makes its
performance pointless, more difficult or more costly, or even impossible.
Such events may result in the termination of the contract by operation of
law, on the basis that it has been frustrated. 368 367F
Frustration of a contract can only arise if the following conditions are met:
a. The supervening event must cause a fundamental or radical change to the nature
of the contractual rights and obligations;
b. Neither party should have caused or brought about the supervening event;
c. The supervening event must be such that it was not contemplated by the parties
when they entered the contract. It follows, therefore that there should be no
provision in the contract designed to deal with it; and
367
Meridian Retail Pty Ltd v Australian Unity Retail Network Pty Ltd [2006] VSC 223, para 210 at
[4] citing Warren CJ in Esso Australia Resources Pty Ltd v Southern Pacific Petroleum NL
(receiver and manager appointed) [2004] VSC 477, who contemplated that only protection of a
‘particularly vulnerable’ party or a party ‘at a substantial disadvantage’ may justify curial
interference. In Meridian, the franchisor’s conduct was not considered to be exploitative.
368
NC Seddon and M F Ellinghaus, Cheshire and Fifoot’s Law of Contract (8th Australian ed, 2002)
881.
d. It must be unjust to hold the parties to the contract to its terms as originally
agreed upon. 369368F
The failure of the franchisor will meet the first condition. The fundamental
change from the franchisees’ perspective is that the franchisor becomes unable to
deliver on its side of the bargain. It may have lost the right to grant licences to
franchisees to use the trade marks. It may have breached head leases that, in turn,
deprive franchisees of their premises.
369
D Khoury and YS Yamouni, Understanding Contract Law (7th ed, 2007) 419.
Football Club Ltd v Bradley Scott Fittler BC9600163 NSWSC is applied. In that
case, competition under a new league was found to be radically different from that
contemplated by the contracts signed by Bradley Fittler and Matthew Sing (‘the
players’). A proposal to enter into new competitions and to transfer club's assets to
new competition licensee discharged parties from further performance of contracts
and the innocent party (in this case the players) were not responsible for bringing
about circumstances frustrating the contract. The contracts were held to have been
frustrated.
Frustration has not been raised in any Australian franchise cases. In Canada, a
plaintiff franchisee:
Unjust enrichment
Alternatively, franchisees could make out a claim in quasi-contract 373 against 372F
the administrator or liquidator, for unjust enrichment. This action would theoretically
be available to franchisees in Australia, though it has not been tested in the context of
insolvency in Australian courts. It depends firstly on the court granting consent to
370
Magnetic Marketing Ltd v Print Three Franchising Corp et al (1991) 38 CPR (3d) 540.
371
Goldman, above n 162, 11.
372
Ibid 12.
373
Bruce Moore (ed), The Australian Oxford Dictionary (2nd ed, 2010) 479. ‘Quasi-contract (implied
contract) a form of the equitable remedy of restitution to restore an innocent party to his previous
position.’
cohesively enough to succeed, the court did not rule out unjust enrichment as a
possible cause of action for future franchisor insolvency cases.
374
P Davenport and C Harris, Unjust Enrichment (1997) 34.
375
Country Style Food Services Cases: Country Style Food Services Inc v 1304271 Ontario Ltd
Ontario Superior Court of Justice Chapnik J, Judgement: 11 February 2003; in the matter of the
Companies Creditors Arrangement Act, RSC 1985 C c-36, As amended AND In the matter of the
Courts of Justice Act RSO 1990 c-43, As amended AND in the matter of a plan of compromise or
arrangement of Country Style Food Services Inc, Country Style Food Services Holdings Inc,
Country Style Realty Limited, Melody Farms Specialty Foods and Equipment Limited, Buns
Master Bakery Systems Inc and Buns Master Bakery Realty Inc 15 April 2002 Court of Appeal
for Ontario Docket M28458 (Unreported decision).
Both the action for frustration and the action for unjust enrichment may have
the best chance of success where the franchise term has only just begun, as the
franchisee will have paid all upfront costs but derived minimal benefit from the
investment.
Anticipatory breach
Anticipatory breach
… occurs where a party, prior to the time for performance under the
contract, evinces an intention no longer to be bound by the contract. … [I]f
the anticipatory breach relates to a breach of an essential term or the
repudiation goes to the root of the contract, the promisee [in this case,
franchisee] may terminate prior to the time for actual performance. 376
375F
Consideration of anticipatory breach raises the issues of exactly what terms the
franchisor breached. Typically the franchisor has few contractual obligations, while
the franchisee has many. It can be difficult to identify an actual contract term on
which to found the claim of anticipatory breach following the appointment of an
administrator.
Currently all remedies accessed through the law of contract and the Trade
Practices Act assume the supplier is able to deliver the prescribed solution, or that an
insurer could meet a claim. But, if the supplier is insolvent this assumption is fatally
376
Willmott et al, above n 322, 677.
flawed. Franchisees’ access to remedies for breach of contract brought about by the
failure of the franchisor is hindered by a number of factors.
First, contract law remedies rely on the doctrine of privity of contract. The law
presumes that franchisees and franchisors have a contractual relationship with each
other and that this contract is the source of the breach. 377 This does not acknowledge
376F
the complex matrix of contracts and entities that underpin the franchise relationship,
as was demonstrated here and in Appendix D. The commitments that a franchisee
has under third party contracts are not contingent on the franchisors remaining
solvent.
Where the franchisor is insolvent, there is not enough money available to meet
a judgment debt to put the ‘innocent’ party back into their pre-contractual situation.
The problems are exacerbated when the number of franchisees affected by one
franchisor insolvency are counted; the ‘innocent parties’ may include as many as 600
franchisees, their families and employees. 379 Any litigated or mediated victory by the
378F
Consequential contracts
The execution of the franchise agreement also means that the franchisee is
entering a number of consequential contractual commitments. This was demonstrated
in chapters 3.2.2 and 3.2.3 by examinations of the franchisor and franchisees’
377
The Franchising Code of Conduct requires the franchisor to make disclosure, but only requires
limited information about the other franchisor’s controlled entities that the franchisee must do
business with. Appendix D of this thesis graphically demonstrates the numerous possible
relationships.
378
Hadfield, ‘The Many Legal Institutions that Support Contractual Commitment’, above n 22, 194.
379
See Table 1 of this thesis.
contractual or lack of contractual, relationships with the owners of the trade marks
that identify the franchise network and its products, and the premises that franchisees
trade from. The franchisor:
First: Contracts entered into with the franchisor; including such agreements as
licences to use intellectual property, software and premises, and various finance
arrangements. 381 380F
Second: Contracts entered into with third parties, related to the franchisor such
as supplier agreements concerning stock, licence to use intellectual property, lease of
premises and finance arrangements. 382 381F
Third: Contracts entered into with third parties unrelated to the franchisor such
as supplier contracts, vehicle leases, lease or licence of premises, 383 equipment 382F
leases, loan agreements – secured over real property or shares owned by the
franchisee before it becomes a franchisee and employment contracts with the
franchisee’s employees.
380
Jensen and Meckling, above n 21, 311.
381
Frazer and Weaven, Franchising Australia 2004, above n 63, found that 29 per cent of
franchisors provide finance to franchisees, with the most popular being direct finance supplied by
the franchisor (59 per cent).
382
Ibid, found that of the franchisors providing finance in Australia, 4.9 per cent did so through a
company related to the franchisor.
383
In Australia, 47.1 per cent of franchsiees conduct their business from a retail site or kiosk, 29.3
per cent from mobile unit, van or trailer, 26.8 per cent home based (office or garage), 21.8 per
cent of franchisees operate from specific commercial sites, and 4 per cent operate from an
industrial site, Frazer, Weaven and Wright Franchising Australia 2008, above n 7, 27.
3.3.11 CONCLUSION
During the initial contract negotiations ‘parties incur ex ante transaction costs,
including the costs of anticipating future contingencies and writing a contract that
specifies an outcome for each one’. 385 384F
384
Tractenberg, above n 110, end note 22–5.
385
Scott above n 349,190.
Private law does matter to those who can use it effectively, for example
businesses that incorporate judicial rulings in standard terms or that seek judicial [or
regulator] 386 rulings as a framework for structuring their business methods.
385F
Consumers have rarely been able to harness private law to have such systemic
effects. 387
386F
Private contract law is, however, unable to provide solutions to the problem.
‘The franchise situation is a classic example of an unresolved treatment of contracts.
Executory contracts, of which franchise agreements are an example, are not
specifically considered in the UNCITRAL Legislative Guide on Insolvency Law’. 388 387F
Countryman defines an executory contract as ‘one under which the obligation of both
the bankrupt and the other party … are so far underperformed that the failure of
either to complete performance would constitute a material breach excusing the
performance of the other’. 389 Rohrbacher explains that ‘the troublesome issue in
38F
executory contracts is not that property and contracts are treated so differently but
that debtors and creditors are treated so differently’. 390 389F
386
For example Bakers Delight’s successful application under Trade Practices Act 1974 (Cth) s 47.
387
Ramsay, above n 329, 33.
388
United Nations Commission on International Trade Law, UNCITRAL Legislative Guide on
Insolvency Law (2004)
<http://www.uncitral.org/uncitral/en/uncitral_texts/insolvency/2004Guide.html> at 5 June 2010.
389
Vern Countryman, ‘Executory Contracts in Bankruptcy’ (1973) 57(1) Minnesota Law Review
439, 460 cited in B Rohrbacher, ‘More Equal than Others: Defending Property-Contract Parity in
Bankruptcy’ (2005) 114(5) The Yale Law Journal 1099, 1127.
390
Rohrbacher, above n 391, 1128.
[the franchisor] is like the behaviour of a market, that is, the outcome of a
complex equilibrium process. 391
390F
The insolvency of the nexus triggers a move to a new equilibrium in which the
administrator, and then the liquidator, controls the destiny of the franchisees through
the twin mechanisms of the franchise agreement and the Corporations Act.
The franchise agreement is, in theory, negotiable. It may be possible for the
franchisee to insert a provision in the contract that gives the franchisee the right to
‘walk away’ from the franchise system, and to retain the right to use the premises, if
the franchisor fails. In reality the possibility of the franchisor failing is generally the
furthest thing from the new franchisee’s mind, and the franchise agreement is not
negotiable.
Woker observes that ‘the law of contract is wholly inadequate for the purpose
of regulating modern franchise relationships and practices’. 392 This is exemplified
391F
clearly when the franchisor fails. The report ‘Opportunity not opportunism’
acknowledged that the current contractual arrangements between franchisor and
franchisee are not satisfactory and recommended ‘that the government explore
391
Jensen and Meckling, above n 21, 311.
392
Tanya Woker, ‘Franchising – The Need for Legislation’ (2005) 17 South African Mercantile Law
Journal 49.
avenues to better balance the rights and liabilities of franchisees and franchisors in
the event of franchisor failure’. 393
392F
An action for breach of contract presupposes that there has been a breach.
Franchise agreements always permit the franchisor to terminate the franchise
agreement if the franchisee commits an act of bankruptcy, but seldom makes
provision for franchisees’ rights following the administration or insolvency of the
franchisor. Franchise agreements also require franchisees to obey all relevant laws,
failure to do so constitutes a breach of the franchise agreement and entitles the
franchisor to terminate. Franchise agreements only require the franchisor, as a term
of the contract, to comply with the Code, not with the Corporations Act. Thus a
breach of the Corporations Act or of any other financial regulation by the franchisor
does not pave the way for the franchisee to argue that the franchisor has breached the
franchise agreement.
393
Joint Committee on Corporations and Financial Services, Australian Senate, Opportunity Not
Opportunism: Improving Conduct in Australian Franchising, above n 166, Recommendation 4
[6.40] xv.
394
Bobux Marketing Limited v Raynor Marketing Limited [2001] NZCA 348, para 18 (Thomas J,
dissenting).
395
Ramsay, above n 329, 13.
offering. The franchisor provides the franchisee with the information that it wants the
franchisee to know, and complies with the disclosure requirements of the Trade
Practices Act.
Franchisees are advised to conduct their own due diligence beyond the Code
disclosure. Franchisees are routinely blamed by courts, commentators and
franchisors for failure to conduct adequate pre-purchase due diligence. For example a
delegate of the FCA, when asked to comment on a report about franchisor failure
replied that ‘[f]ranchising is risky and some people might not be adhering to the
correct process’. 396 Such a dismissive response to a serious issue by an industry
395F
representative tends to make prospective franchisees think that as long as they follow
the process established by their franchisor, they will not be part of a franchisor
failure. The facts do not support this.
Given the high costs of investigating the safety of a given unfamiliar product
prior to purchasing, it is not surprising that a general expectation that
products on the market are acceptably safe is a crucial assumption of most
consumer behaviour, influencing the value that consumers place on
information. 398397F
The 2006 UK franchise survey reports that its initial source of information
about the franchise industry was equally (20 - 21 per cent) magazines, newspapers
and friends/relatives. 399 In the United Kingdom, information about a specific
398F
franchisor came from magazines (18 per cent) and exhibitions (20 per cent). 400 None 39F
396
Jacqui Walker, ‘Help for Squeezed Business’, Business Review Weekly (Melbourne), 30 March
2006, 24.
397
Trebilcock, above n 29, 70.
398
Ibid.
399
NatWest bfa United Kingdom, Franchise Survey 2006, above n 254, 30.
400
Ibid 20.
of these are objective information sources. Such information is often not capable of
being objectively verified.
[I]ndividuals have preferences that change through time, are concerned for
others, have varying attitudes to risk depending on how risks are framed and
what reference points are available, violate rationality by overestimating
their skills, over-project the current state, use rules of thumb or heuristics to
solve problems and make decisions affected by transient emotion. 403 402F
Due diligence cannot anticipate the events that precede some franchisor
administrations or insolvencies and no franchisee or franchisee’s professional adviser
could reliably anticipate when a franchisor might to embark on a course of strategic
401
Trebilcock, above n 29, 70.
402
Ibid.
403
Steven Kennedy, ‘The Future of Consumer Policy: Should we Regulate to Protect Homo
Economicus?’ (Accord Industry Leaders Briefing, Old Parliament House, Canberra 13 August
2009) 10 citing Stefano Della Vigna, ‘Psychology and Economics: Evidence from the Field’
(2009) 47(2) Journal of Economic Literature 315, 316.
404
Appendix A of this thesis.
Franchise agreements last from a short term of 1 year 405 to, in some cases, (eg
40F
405
Frazer, Weaven, Wright Franchising Australia 2008, above n 7.
406
Evidence to Economic and Finance Committee, Parliament of South Australia, Official Hansard
Report, 6 February 2008, 38 (JR Rau MP).
Typically, the franchise agreement does not provide any specific rights to the
franchisee on the franchisor’s insolvency. Thus, neither the Disclosure Document nor
the franchise agreement would direct a legal adviser to consider franchisor failure or
its consequences unless the lawyer or accountant providing advice also happens to
work in the highly specialised field of insolvency.
The franchisee will, ideally, also engage advisers with franchise expertise. The
identity of these professional advisers is found through advertisements in franchise
magazines, their presence at trade shows, ‘asking around’ or searching the
internet. 409 Lawyers with specific areas of expertise can be found through the state or
408F
territory law society. The ‘business law expert’ is superficially the ideal lawyer to
provide franchisee advice. But, as Solomon observes:
407
Joint Committee on Corporations and Financial Services, Australian Senate, Opportunity Not
Opportunism: Improving Conduct in Australian Franchising, above n 166, para 4.81.
408
Evidence to Economic and Finance Committee, Parliament of South Australia, Official Hansard
Report, 6 February 2008, 33 (Stephen Giles).
409
For example, unsing the Findlaw website http://www.findlaw.com.au/wld/QuickSearch.asp
lawyers are searchable under the specialty area ‘franchises’. No lawyers possessing franchise
expertise are listed for the Northern Territory or Tasmania.
Accountants are not necessarily able to predict the future solvency of the
franchisor, even with access to the disclosure document. In testing the return on
investment, the accountant is unlikely to model the return based on the franchisor
itself failing one or two years into the relationship. If they did, they would be quick
to tell their client to select another form of investment.
410
Richard Solomon, ‘License to Lie, Cheat and Steal: Impact of Acknowledgement & Integration
Clauses’ (2008) Blue Maumau
<http://www.bluemaumau.org/license_lie_cheat_and_steal_impact_acknowledgement_integratio
n_clauses> at 15 May 2008.
411
Ibid.
412
Matthews, above n 113, 37, Recommendation 9.
The Government agreed with this recommendation. 413 However two years
412F
later, the ACCC published Franchisee Manual, 414 made no mention of the care that
413F
should be taken to ensure advice comes from advisers who understand franchising. In
2009 the ACCC finally added information to its website under the heading ‘What if
the franchisor becomes insolvent (fails)?’ 415 41F
In its role as educator the ACCC can do more to make franchisees aware of the
fact that franchisors fail more often than the rhetoric suggests. However their ability
to warn franchisees of risks of specific networks will always be hampered by the
differences among franchisors’ legal structures, and their varying approaches and
attitudes to risk sharing. Each individual franchisor is thus the only party that can
adequately predict the possible effect of its failure on its own franchisees.
Trading banks
Although 21.2 per cent of franchisors ranked ‘difficulty in finding franchisee
finance’ as the third greatest hindrance to growth in 2006, all four major trading
banks in Australia have specific policies to assist in the purchase of franchisee
businesses. All four - ANZ, 416 Commonwealth Bank of Australia (CBA), National
415F
Australia Bank (NAB), and Westpac (WBC) 417 - are ‘service provider’ members of
416F
None of the four mentions the risk of franchisor failure on their websites. This
tends to indicate one of two things. Either, the area of the bank dealing with loans
that have ‘gone bad’ and the business lending and the marketing areas of the banks
do not communicate with each other about specific customers. Or, banks decide that
because they have adequate security from franchisees they are not worried that their
policies of lending to the franchising sector will trigger awkward questions at
shareholders meetings.
413
Australian Government Response to the Review of the Disclosure Provisions of the Franchising
Code of Conduct (2007) 4.
414
ACCC, Franchisee Manual (7th ed, 2008).
415
ACCC, What if the Franchisor Becomes Insolvent (fails)?
<http://www.accc.gov.au/content/index.phtml/itemId/861040> at 1 February 2010.
416
ANZ Bank Website <www.anz.com.au> at 5 June 2010.
417
Westpac Bank Website <www.westpac.com.au> at 23 May 2008.
418
Franchise Business <http://www.franchisebusiness.com.au/FAMemberList.aspx?> at 3 June
2008.
The situation of failed jewellery retail franchisor Kleins and the NAB is a clear
reason why banks need to monitor the ongoing viability of the franchisors they
approve. Failure to do so places them at risk of misleading franchisees that the
franchisors business is still a sound investment.
Turning to each of the banks to see what their customers might be able to learn
from them about the franchisors whose franchisees they will fund, and about
franchisor failure. The ANZ does not publicise the names of those franchisors to
which it has accorded preferred status. It states:
We work from the basic belief that franchise businesses are different and
usually inherit some strengths and capabilities from the franchisor. ANZ
offers ANZ Preferred status to selected franchisors to reflect the value of
their franchise system. 419
418F
The CBA website publishes a list of 35 accredited franchises 420 but does not419F
there was no public record that any of the three central companies that make up the
Kleins group had filed any documents with ASIC since January 2003. On seeing
Kleins on the NAB list, between KFC and McDonald’s, prospective franchisees
would have been entitled to conclude, as late as 23 May 2008 that NAB had
confidence in Kleins as an investment. NAB was identified in May 2008 as the
419
ANZ, ANZ Franchising
<http://www.anz.com/australia/business/IndustrySpecialisation/Franchising.asp> at 2 June 2008.
420
Commonwealth Bank, Franchise Banking <http://www.commbank.com.au/corporate/your-
industry/franchising/default.aspx> at 1 February 2010.
421
NAB, NAB Accredited Franchise Systems
<http://www.nab.com.au/wps/wcm/connect/nab/nab/home/business_solutions/8/6/4> at 1
February 2010.
422
NAB Website <www.nab.com.au> at 23 May 2008.
biggest secured creditor of the Kleins group (in administration), being owed
approximately A$15million. This raises issues that will not be dealt with here of a
bank’s duties to its Kleins franchisee customers, and the extent to which it exposes
itself to claims by Kleins’ disenfranchised franchisees.
In WBC
[f]ranchise lending is one of the four core business units in the TPD [Third
Party Distribution] system. ... The business maximises Westpac's share of
the franchising market by developing profitable relationships with
franchisors, providing referrals and expert advice to Business Banking sales
people; and also providing input into WBC's franchising policies and
systems. 423
42F
This indicates that WBC manages its risk exposure by securing loans to
franchisees over the franchisees’ home. This protects the bank from losing money if
a franchisor fails, but exposes the franchisee to the risk of significant loss. Westpac
also recommends that prospective franchisees should consider the following
questions:
These questions are generic and are not supported by examples or placed
within a context. They will not make a franchisee ask questions about the
consequences of franchisor failure.
The banks go no further than to hint in oblique terms that one of the
considerations for an intending franchisee should be the consequence to the
franchisee of franchisor failure.
423
Westpac Bank Website <www.westpac.com.au> at 1 May 2008
424
Ibid.
the FCA, franchise magazines and Do-It-Yourself or primer books. None is sufficient
to put the franchisee on notice that the franchisor might fail.
The inference to be drawn from this statement is that prior to 1998, when pre-
contract disclosure was voluntary for franchisors, there were some unprofitable
franchisors and some of them failed but that this does not happen any more. Table 1
demonstrates that numerous franchisors’ businesses have failed since 1998.
If you look at all the franchise adverts for franchise opportunities in any
business category, they all say the same thing -- we know how to do it -- we
can show you how to do it -- you save a lot of money and reduce risk of
failure if you do it with us -- we have the 'secret' to success -- we will
support you to achieve success -- we have the proven system -- we have the
name recognition -- we get you up and running quickly. In actual fact, most
of this is not even remotely true. 427
426F
425
Franchise Council of Australia, above n 121, 7.
426
Be it a broker, the FCA, or the franchisor’s website.
427
Solomon, above n 412.
In reply to the question ‘Are there risks the [intending franchisee’s] business
plan cannot address?’ the ACCC wrote in 2009: ‘[e]very business faces risk. One
risk to franchisees is the franchisor becoming insolvent, which can sometimes
happen unexpectedly’. 428 427F
The franchise agreement is effectively a contract uberrimae fidei 429 for the
428F
franchisee, but not for the franchisor as the franchisor entity has only specific
disclosure requirements. The shifting of risk that is achieved by appointing
franchisees is a significant benefit to the franchisor. A fundamental aspect of
franchising is the separation of ownership, by the franchisees, from control, which
remains with the franchisor. This can also be expressed as a separation of risk
bearing, again by the franchisees, and decision functions, which rest with the
franchisor. 430 For example, as was seen in chapter 3.2.3, when the franchisor takes a
429F
head lease of retail premises in its own name, it is common for the franchisee to
become the guarantor of the franchisor’s performance under the head lease. The
franchisee, thus, takes almost all the risk on the premises, while the franchisor retains
the full benefit of the site lease being in the franchisor’s name. The franchisor
executes the franchise agreement and requires the franchisee, and if the franchisee is
a corporation, its guarantors, to sign, whereas the franchisor’s directors rarely
provide personal guarantees to franchisees.
428
Australian Competition and Consumer Commission, ‘Understanding the Issues in Franchising’
(2009) Franchise Review 65.
429
Mann and Blunden, above n 15, 585, Utmost Good Faith.
430
See Eugene F Farma and Michael C Jensen, ‘Separation of Ownership and Control’ (1983)
XXVI(2) Journal of Law and Economics 301, 304 who do not include franchise networks in the
spectrum of organizations discussed.
customers, but payment by the customers for the products or services they purchase
is made directly to the franchisor. The franchisor then pays a commission to the
franchisee. The two risks that the franchisee assumes in this scenario are that the
franchisor will be prepared to chase the customer for payment and that the franchisor
will remit the commission to the franchisee, both in a timely manner.
Lafontaine and Bhattacharyya consider the role of risk in franchising 432 from 431F
the perspective of the investment in the single franchise unit rather than as a
component of an individual’s entire investment portfolio. After examining a number
of factors in the franchisor/franchisee relationship they conclude that franchising is
not necessarily selected for its risk shedding potential.
One of the factors evaluated by Lafontaine and Bhattacharyya was failure rates.
They confined their inquiry to the failure of franchisees and of franchisor-owned
outlets, and did not extend their inquiry to entire networks. They note that:
… there are patterns in the data that seem to imply that franchisees bear
more risk than franchisors. Under models based on efficient risk allocation
this leads to the conclusion that franchisors are more risk averse than
431
Paul H Rubin, ‘The Theory of the Firm and the Structure of the Franchise Contract’ (1978)
XXI(1) The Journal of Law and Economics 223, 225 in Francine Lafontaine (ed), Franchise
Contracting and Organization (2005) 18, 20.
432
Francine Lafontaine and Sugato Bhattacharyya, ‘The Role of Risk in Franchising’ (1995) 2
Journal of Corporate Finance 39, 55 in Francine Lafontaine (ed), Franchise Contracting and
Organization (2005) 164, 180.
433
Ibid.
The FCA acknowledges that there are disadvantages to the franchise model
including:
434
Ibid 193.
435
Franchise Council of Australia
http://www.franchise.org.au/scripts/cgiip.exe/WService=FCAWWW/ccms.r?PageId=10111 at 22
Juen 2010.
In economic terms, the ‘role of contract law is to minimize the cost of the
parties writing contracts + the cost of the courts writing contracts + the cost of
inefficient behaviour arising from poorly written or incomplete contracts’. 436 435F
‘Standardised contract terms are … [a] regulatory instrument’ 437 that places all
436F
of the power to regulate the difficult times the relationship will experience, in the
hands of the drafter, the franchisor.
In the context of economics, contract terms play a dual role; ‘creating the
correct marginal incentives on a contractually specified measure of (or proxy for)
performance, and ... the creation of rents sufficient to make the relationship self-
enforcing’. 438 In franchising, the marginal incentives created within the franchise
437F
have no incentive to write contracts that fully acknowledge both parties’ risks.
[R]isk is a key concern for policymakers. All other things being equal and
where possible, we aim to reduce the overall level of risk and complexity in
society. 440
439F
436
D Wittman, Economic Foundations of Law and Organization (2006) 194.
437
Trebilcock, above n 29, 77.
438
Benjamin Klein, ‘The Economics of Franchise Contracts’ (1995) 2 Journal of Corporate Finance
9, 19 in Francine Lafontaine (ed), Franchise Contracting and Organization 2005, 323.
439
Liquidator appointed by the court 18 December 2008, ASIC, National Names Index
<http://www.search.asic.gov.au/cgi-
bin/gns030c?acn=098_577_667&juris=9&hdtext=ACN&srchsrc=1> at 19 December 2008.
440
Kennedy, above n 403, 15.
The contract could, theoretically, provide protection for franchisees from some of the
consequences of their franchisor’s failure. In reality, because of asymmetry, they
cannot routinely do so.
Steven Kennedy also identifies that ‘in many cases government actions tend to
reallocate risk between different groups’. 443 This reallocation is partly a result of
42F
3.5 CONCLUSION
441
Trade Practices (Industry Codes – Franchising) Regulations 1998 (Cth) s 23. See Appendix A of
this thesis.
442
Hadfield, ‘Problematic Relations: Franchising and the Law of Incomplete Contracts’, above n
202, 939.
443
Kennedy, above n 403, 15.
444
Morris, above n 41, 3.
the franchisor has disclosed. This may be for any of numerous reasons. In chapter 3.2
we saw that franchisors are more diverse, and in some cases far more complex than
many franchisees, financiers, regulators and franchisee advisers recognise.
Franchisors are becoming more complex as the model evolves. The franchisor
may not be a corporation; it may, as Kleenmaid was, be one of 14 interdependent
entities sitting alongside another related corporate group of 10 corporations that dealt
directly with the ‘franchisees’ customers, 445 whose roles are not identified or
4F
explained to the franchisee. The franchisees’ money may flow freely among the
franchisors’ entities, it may not be used for the purposes the franchisees paid it for.
The cost of the due diligence may be prohibitive, or the franchisee may decide to
save money on advisers and believe the layman’s rhetoric that due diligence requires
only that that they have looked ‘at the facts of [the] deal from all angles to make sure
they stack up’. 446
45F
The franchisee’s ongoing contractual liabilities to third parties assume, but are
not contingent on, the franchisor’s solvency. The franchisor may, for example, may
control all head leases on franchisees’ premises. If the franchisor has breached the
head leases by failing to pay rent or committing an act of bankruptcy, landlords may
terminate leases and evict the franchisees even though the franchisees are up to date
with rental payments to the franchisor. At the level of state and territory legislation,
if the franchisor breaches the head lease, even a franchisee sub-lessee or licensee that
could trade strongly without the franchisor’s brand has no statutory rights to become
head lessee. Although the existence of the trade marks and other intellectual property
used by franchisees will be identified in the disclosure document, they may not be
owned by the franchisor. This was explored in chapter 3.2.2. The consequences of
the franchisees’ lack of rights will be visited in chapter 4.4.
Similarly, where franchisees need to trade from retail premises, there is a wide
range of possible models, as was demonstrated in chapter 3.2.3. Not all of these
provide suitable options for franchisees if the franchisor fails. This will be explored
in chapter 4.4.4 and 4.5.
445
See Appendix D of this thesis.
446
Jason Gehrke, What is Due Diligence (2009) Smartcompany
<http://www.smartcompany.com.au/franchise-tips-and-trends/20090929-what-is-due-
diligence.html> at 5 June 2010.
In chapter 2 the problem of franchisor failure, and some of its impacts, together
with some of the challenges that liquidators face were identified. In chapter 3.2 it
was demonstrated that franchisees cannot self protect against the consequences of
franchisor failure through contract law. In this chapter the efficacy of the current
consumer protection regime for franchisees whose franchisor fails will be examined.
On realising that neither their franchise agreement nor the common law of
contract provides them with legal rights to respond to their franchisor’s failure,
franchisees turn to the Trade Practices Act, the Code and the Corporations Act. If the
franchisee traded from retail premises they may also turn to their lease, sub-lease or
licence agreement and the relevant state or territory retail tenancies legislation.447 46F
The potential avenues under the Trade Practices Act, the Code, the Corporations Act
and the Retail Leases Act 1994 (NSW) will be explored in chapters 4.3 to 4.5.
The traditional view in the late 20th century was that markets worked things out
over time, but ‘[i]n the case of a competitive market, there are a number of
characteristics that may lead to a hypothesis that a market-based solution is unlikely
447
Leases (Commercial and Retail) Act 2001 (ACT); Retail Leases Act 1994 (NSW); Business
Tenancies (Fair Dealings) Act 2003 (NT); Retail Shop Leases Act 1994 (Qld); Retail and
Commercial Leases Act 1995 (SA); Fair Trading (Code of Practice for Retail Tenancies)
Regulations 1998 (Tas); Retail Leases Act 2003 (Vic); Commercial Tenancy (Retail Shops)
Agreements Act 1985 (WA).
Chapter 4: Is the current regulatory response adequate to deal with the problem? 191
192
to emerge.’ 448 Trebilcock identifies five characteristics that are all relevant to the
47F
typically only purchase one franchise. If they purchase into a second franchise
network after the first franchisor fails they are likely to insist on the franchise
agreement containing an ipso facto clause – this explains the presence of an ipso
facto clause in the agreements of one of the 270 Traveland franchise agreements and
one of the 60 BHG franchise agreements.
Second, ‘[e]ntry and exit costs in the industry are low, leading to the possibility
of a large number of fly by night operators with few sunk costs and only modest
investments in reputational capital’. 450 Trebilcock is referring to franchisors and
49F
national master franchisors. Sometimes entry costs in franchising are relatively low,
even where the franchisee is required to pay a high franchise fee. However, even
where entry and exit costs are very high for the franchisee business consumer, fly-
by-night operators at franchisor and national master franchisee level still exist.
Reputational capital may indeed be only a modest investment for some franchisors;
many trade through companies with forgettable names, in large markets, and can
easily disassociate their own name and reputation from that of the failed entry.451 450F
Alternately they are able to hide their true identify by using trusts, as occurred in
Australian Competition and Consumer Commission v Chaste Corporation Pty Ltd (in
liquidation) [2005] FCA 1212. Because the failure of a franchisor is not specifically
identified by a bank or by ASIC as being linked to all of its franchisees the
magnitude of the fallout is easy to under-estimate.
448
Trebilcock, above n 29, 72.
449
Ibid.
450
Ibid.
451
Although, one director of a now failed Australian franchisor went so far as to change his name by
deed poll to distance his identity from his past as a solicitor who had been jailed for fraud
following misuse of his firm’s trust account.
192 Chapter 4: Is the current regulatory response adequate to deal with the problem?
193
of franchisors are foreign based and many more are based within Australia, but in a
different state or territory from the franchisee. This extra jurisdictional dimension to
franchise relationships potentially hamper franchisees’ ability to conduct due
diligence, and to resolve disputes.
The franchisees’ ability to conduct pre contractual ‘soft’ due diligence beyond
what can be found on the public record is much easier if the franchise network is
locally based. Soft due diligence consists, for example, of speaking with suppliers to
the network and existing and former franchisees to discover what is the franchisor
really like and what is being a franchisee of this network really like?
The existence of an overseas franchisor may make it difficult and expensive for
franchisees to access redress through private law. Contributing factors include
jurisdictional issues, 453 the language in the franchisor’s jurisdiction, distance to travel
452F
to court, 454 the size of the dispute and the amount of time away from the business
453F
In addition, the franchisor entity is likely to have few assets, as the individuals
involved have the opportunity to shelter assets from the franchisor’s creditors.
extending beyond loss of the franchised business to loss of their home (because of
personal guarantees and loans secured over the franchisee’s personal assets) and
relationships. This is a strong example of Trebilcock’s fourth characteristic as the
franchisor’s administrator or liquidator is not appointed until after the franchisee has
made the whole of its sunk investment. Satisfactory ex post relief is not available
from an insolvent, asset-poor, debt-burdened franchisor.
452
Trebilcock, above n 29, 72.
453
For example, disputes must ultimately be resolved in Connecticut under all ‘Subway’ franchise
agreements.
454
Even within Australia litigation may be between one party based in NSW and the other in
Western Australia, three time zones and several hours by air from each other.
455
Trebilcock, above n 29, 72.
Chapter 4: Is the current regulatory response adequate to deal with the problem? 193
194
456
Ibid.
457
Senate Standing Committee for Corporations and Financial Services, [Commonwealth of
Australia], Joint Parliamentary Inquiry into Franchising (2008), Submission Number 8, (Nicole
Hoy). This submission details the cost of litigation for franchisees whose franchisor refuses to
mediate.
194 Chapter 4: Is the current regulatory response adequate to deal with the problem?
195
By the time the Trade Practices Act s 51AC and the mandatory Code were
enacted Parliament acknowledged that there were:
In 1997, The Hon Peter Reith introduced s 51AC and the Code to ‘give small
business protection in its dealings with big business.’ 460 At this time business failure
459F
implied a failure of the business that had been the consumer of deficient information
- here, franchisees - not a failure of the supplier of the information, the franchisor.
Failure was also not understood to have any greater impact on franchisees than on
458
The Trade Practices Review Committee (Swanson Committee) Report, above n 113, paras 10.40-
49.
459
The Parliament of the Commonwealth of Australia House of Representatives, Explanatory
Memorandum, Trade Practices Amendment (Fair Trading) Bill (Cth) 1997, (Circulated by the
authority of the Minister for Customs and Consumer Affairs, Senator the Honourable Christopher
Ellison).
460
Statement by the then Minister for Workplace Relations and Small Business, the Hon Peter Reith,
MP ‘New Deal: Fair Deal – Giving Small Business a Fair Go’, above n 113.
Chapter 4: Is the current regulatory response adequate to deal with the problem? 195
196
independent small business people. It was not considered that the failure of a supplier
franchisor’s business might have intractable consequences for the franchisee-
business consumers. There is now a better picture of the scope, magnitude and cost
of the failure of a single franchisor’s business. 461 460F
461
See Table 1 and Appendix D of this thesis.
462
Australian Government Productivity Commission, Review of Australia’s Consumer Policy
Framework, Report No 45 (2008) Volume 1, summary vii, viii.
463
Australian Government Productivity Commission, vol 2, above n 4, ix.
196 Chapter 4: Is the current regulatory response adequate to deal with the problem?
197
to enhance the welfare of Australians through the promotion of competition and fair
trading and provision for consumer protection.
[19] the latest authority says that protective consumer legislation should not
be interpreted narrowly, nor ‘through the lens of freedom of contract and
competition’: Assoc. des courtiers et agents immobiliers du Québec v
Proprio Direct, 2008 SCC 32 (para 34).
464
For example under Consumer Protection Act 2008 (South Africa) s 6 ‘the following transactions
must be regarded as a transaction between a supplier and consumer within the meaning of this
Act: (d) a franchise agreement or an agreement supplementary to a franchise agreement.’ The
Consumer Protection Act is estimated to become law in October 2010.
Chapter 4: Is the current regulatory response adequate to deal with the problem? 197
198
‘Dubious conduct which may be detrimental to consumers will not always’ 466 465F
fit within the statutory notion of misleading or deceptive contained in the Trade
Practices Act Part V Division 1. Despite not meeting the statutory tests of misleading
or deceptive, the conduct may be ‘harsh, unfair or even dishonest … and may offend
community-held standards as to apposite standards of business conduct.’ 467 The 46F
Posner explores the lack of information versus the lack of sophistication, and
concedes that lack of information seems to play a role in unconscionable conduct
cases. He argues, in mitigation, that consumers who lack information have incentives
to acquire information. Posner says:
465
Hi Hotel Limited Partnership and Holiday Hospitality Franchising Inc and ors 2008 ABCA 276.
Reasons for the Judgment reserved of the Honourable Mr Justice Côté.
466
Lynden Griggs, Eileen Webb and Aviva Freilich, Consumer Protection Law (2008) 97.
467
Ibid.
468
Reith, above n 113.
198 Chapter 4: Is the current regulatory response adequate to deal with the problem?
199
(i) any intended conduct of the supplier that might affect the interests of the
business consumer; and
(ii) any risks to the business consumer arising from the supplier’s intended
conduct (being risks that the supplier should have foreseen would not be
apparent to the business consumer)
would be that the franchisees would have no inkling of the impending voluntary
administration or strategic insolvency, and no ability to predict it or prepare their
own businesses to deal with the consequences of the franchisor’s strategic
insolvency. The franchisor’s conduct was deliberate. The franchisor is able to foresee
clearly the consequences for all of its franchisees.
(j) the extent to which the supplier was willing to negotiate the terms and
conditions of any contract for supply of the goods or services with the
business consumer;
may be able to be made out if the franchisee had sought amendment to the standard
form agreement to include an ipso facto termination on franchisor insolvency clause;
469
Eric A Posner, Economic Analysis of Contract Law after Three Decades: Success or Failure
(Working Paper No 146, (2d series) (2002)) 14.
Chapter 4: Is the current regulatory response adequate to deal with the problem? 199
200
but that request had been denied. The franchisor’s administrator may counter with a
claim that the franchisee was not misled, that they subsequently signed the agreement
with their eyes wide open.
(k) the extent to which the supplier and the business consumer acted in good
faith.
Although the concept of ‘good faith’ is not defined in the Trade Practices Act,
‘parties to a relational contract are not expected to break the relational rules’. 470 469F
These include the rule that ‘a [franchisee] party to this type of [franchise] contract
does not (rationally) intend to assume the risk of [the franchisor’s] opportunistic
behaviour’. 471
470F
[a] simple model of the consumer goods market implies that courts should
not use the unconscionability doctrine to strike down contracts. More
complex models that take account of asymmetric information and bargaining
power imply that such contracts should be struck down only in particular
circumstances, when courts have information about variables that are
intrinsically difficult to measure. 472
471F
470
William Michael Dixon, An Examination of the Common Law Obligation of Good Faith in the
Performance and Enforcement of Commercial Contracts in Australia (Thesis (SJD), Queensland
University of Technology, Brisbane, 2005) 77 citing NC Seddon, ‘Australian Contract Law:
Malestrom or Measured Mutation?’ (1994) 7 Journal of Contract Law 93, 96.
471
Ibid, citing G Hadfield who has suggested an interpretation of ‘good faith’ as fidelity to an
implicit obligation not to use discretion opportunistically: G Hadfield, ‘The Second Wave of Law
and Economics: Learning to Surf’ in M Richardson and G Hadfield (eds), The Second Wave of
Law and Economics (1990) 60 as referred to by JM Paterson, ‘Good Faith in Commercial
Contracts? A Franchising Case Study’ (2002) 29 Australian Business Law Review 270, 290.
472
Posner, above n 469, 15.
200 Chapter 4: Is the current regulatory response adequate to deal with the problem?
201
commits to the investment. This would leave the way open for courts to strike down
franchise agreements if the franchisor behaved unconscionably by pursuing
voluntary administration or strategic insolvency.
473
Bigwood, above n 341, 277, citing R A Epstein, ‘The Social Consequences of Common Law
Rules’ (1982) 95 Harvard Law Review 1717, 1750.
Chapter 4: Is the current regulatory response adequate to deal with the problem? 201
202
These changes will not make any difference to franchisees whose franchisor is
in administration or being wound up.
Franchisees may take action under Trade Practices Act ss 52, 53A or 59
against a franchisor, or other ‘persons involved in a contravention’ 475 who misled 47F
them before the franchise agreement was signed, or in relation to any matter not
addressed in contracts that occurred subsequently. 476 Section 75B lists by role the
475F
Actions against the insolvent franchise systems A1 Mobile Radiator Repairs477 476F
474
Australian Government, the Treasury, The Nature and Application of Unconscionable Conduct
Regulation, Issues Paper November (2009)
<http://www.treasury.gov.au/contentitem.asp?NavId=037&ContentID=1676> at 11 December
2009.
475
See full wording of s 75B Trade Practices Act 1974 (Cth) in Appendix A of this thesis.
476
See Appendix A of this thesis.
477
The Australian Competition and Consumer Commission successfully took the director of the
insolvent franchisor to court on behalf of 4 franchisees in ACCC v Trayling [1999] FCA 1133.
The court held there had been breaches of ss 52 and 59(2) Trade Practices Act 1974 (Cth). The
action against the franchisor was discontinued because of the franchisor’s insolvency.
478
Eleven franchisees were involved in four court cases against Furniture Wizard and one of its
directors, Mr Grant. Breaches of s 52 and 59 Trade Practices Act 1974 (Cth) were established:
ACCC v Grant [2000] FCA 567; Grant v Eddington [2000] FCA 1550; ACCC v Grant [2000]
FCA1564; Lawrence v Furniture Wizard [2000] NSWSC 1107.
202 Chapter 4: Is the current regulatory response adequate to deal with the problem?
203
Disclosure
In Côté J’s assessment in Hi Hotel the Canadian legislature was of the view
that: ‘Someone soliciting such an investment [ie a franchisor selling a franchise] or
the fees for a franchise must put into the investor’s or franchisee’s hands accurate
complete written information.’ 481 480F
franchisees. However, it is shown in chapter 3.1, Table 1, and Appendix D, that the
franchise system 483 is only part of the larger franchise network. The purposes of the
482F
The content and format of the disclosure are dictated by the Code. The
franchisor’s duty to disclose extends only to matters listed in the Code. Franchisees
479
Trade Practices (Industry Codes—Franchising) Regulations 1998 (Cth) s 2.
480
As outlined in ch 2.2.3 of this thesis.
481
Hi Hotel Limited Partnership and Holiday Hospitality Franchising Inc and ors 2008 ABCA 276.
482
Franchise system is defined very loosely in s 3 of the Trade Practices (Industry Codes –
Franchising) Regulations 1998 (Cth)]. See Appendix A of this thesis.
483
The franchise system is the franchisor, its master franchisees and franchisees, but not the
franchisor’s related entities.
484
See Appendix A of this thesis.
Chapter 4: Is the current regulatory response adequate to deal with the problem? 203
204
may be forgiven for not looking beyond the 250 items that are addressed in the
disclosure and the numerous clauses in the ancillary documentation including the
franchise agreement. Because these documents refer to the consequences of
franchisee failure, but not of franchisor failure, franchisees are unlikely to consider
franchisor failure and its possible consequences.
In relation to insolvency and personal bankruptcy, item 4.2 of the Code dictates
that disclosure should provide relevant information concerning the franchisors’
directors’ involvement in previous business failures. 485 In a situation that is disclosed
48F
under item 4 (2)(c) there is almost never an accompanying case report from which a
franchisee can objectively verify information supplied by the franchisor, so the
franchisee is reliant on the information supplied in the disclosure document. 486 485F
485
See Appendix A of this thesis for full wording.
486
If there was a case that had ended in a judgment the franchisee could obtain a copy of the
judgment, or even be aware of it by searching the court records electronically
(<www.austlii.edu.au> at 6 June 2010). Insolvencies are filed at the Australian Securities and
Investment Commission and personal bankruptcy information at ITSA (Insolvency Trustees
Association of Australia) <http://www.itsa.gov.au/> at 6 June 2010.
487
See Appendix A of this thesis. Trade Practices (Industry Codes – Franchising) Regulations 1998
(the Franchising Code of Conduct 1998) cl 10.
488
Cor Cordis Liquidators Report (19 October 2009) 13.
489
Ibid.
204 Chapter 4: Is the current regulatory response adequate to deal with the problem?
205
Implied terms
In an attempt to prevent dependence from becoming a form of predation or
servitude 490 Part 3 of the Code implies terms into the franchise agreement. The
489F
terms:
490
Elizabeth C Spencer, ‘Conditions for effective disclosure in the regulation of franchising’
(2008) 22(4) International Review of Applied Economics 509.
Chapter 4: Is the current regulatory response adequate to deal with the problem? 205
206
The Code sets out three situations when a franchisor may terminate a franchise
agreement. The trigger events are:
a range of events where there has been no breach by franchisee (22), and
The franchisees, in legislation that is supposed to level the playing field and provide
them with protection, have no mirror rights. In defence its decision not to amend the
Code to extend the rights provided for franchisors in regulation 23 to franchisees, the
Government commented in 2009 that:
The government fails to appreciate that the franchisors already have the right to
automatically terminate franchisees to which receivers or administrators are
appointed. They give it to themselves in the standard franchise agreements. They do
not need legislative protection.
The early identification of problems within the franchise may be aided by the
franchisees’ rights of association under s 15 of the Code.
491
Commonwealth Government Response to the Report of the Parliamentary Joint Committee on
Corporations and Financial Services, Opportunity Not Opportunism: Improving Conduct in
Australian Franchising (2009) above n 166, 22.
206 Chapter 4: Is the current regulatory response adequate to deal with the problem?
207
This, combined with the right each franchisee has under s 19 of the Code 492 to 491F
request and receive a copy of the disclosure document every 12 months would enable
a well coordinated franchisee group to access a moving annual picture of the
franchise system, but still not of the whole network. A well organized franchisee
group may thus, be able to detect that a franchisor is experiencing financial
difficulties before it is too late for the franchisees to work out how to protect their
collective interest in the brand. This assumes that it is the franchisor itself
experiencing solvency problems, not related entities or its parent – being entities that
are exempt from the ongoing disclosure requirement.
Under s 437B 493 the Corporations Act the administrator’s role to act as the
492F
company’s agent. An agent is typically able to enter contracts and bind the principal
so long as it is acting within its authority. The authority of the administrator as agent
could be taken to be the performance of the role ad outlined in s 437A Corporations
Act. This is a broad enough authority to permit the administrator to attend mediation
and to execute a contract recording a mediated settlement.
The ACCC approaches the problem from another perspective. The ACCC
issued an undated ‘Release for distribution to Insolvency Practitioners Association of
Australia’ in which it advised that, in its view:
492
See Appendix A of this thesis.
493
See ibid.
Chapter 4: Is the current regulatory response adequate to deal with the problem? 207
208
through the inexpensive and quick mechanism provided in the Code is consistent
with survival of the franchise.
Administrators, however, cite the Corporations Act part 5.3 and argue that an
administrator does not have to involve itself in substantive responses to a dispute
notice issued under the Code. To become involved would, they say, distract from
carrying out the tasks of an administrator. Administrators claim Brian Rochford Ltd
(Administrator appointed) v Textile Clothing & Footwear Union of NSW (‘Brian
Rochford’) (1998) 47 NSWLR 47; (1998) 149 FLR 125 supports their argument. In
Brian Rochford, Austin J considered an application under s 440D of the
Corporations Act for leave to allow proceedings against a company under
administration.
The key words of s 440D were: ‘proceedings in a court’. Despite the definition
of the word ‘court’ in Corporations Act s 58AA, Justice Austin held that the
Industrial Relations Commission was a ‘court’. For Brian Rochford to be applied to
administrators refusing to mediate with franchisees, the mediation process set up
under the Code to resolve disputes would have to be analogous to ‘proceedings in a
court’. Leave under s 440D is not required for arbitration 496 proceedings. 497
495F 496F
494
ACCC Submission to the Parliamentary Joint Committee on Corporations and Financial Services
Inquiry into Franchising Code of Conduct (2008) 8.4(ii) d)
495
Foxcroft v The Ink Group Pty Ltd (1994) 12 ACLC 1063; see R Fisher, Corporate Insolvency
Law (2000) 142.
496
Auburn Council v Austin Australia Pty Ltd (2004) 22 ACLC 766.
497
Murray, above n 150, 536.
208 Chapter 4: Is the current regulatory response adequate to deal with the problem?
209
498
Warren Pengilley, ‘The Franchising Code of Conduct: Does its Coverage Address the Need?’
(1998-99) 1(3) Newcastle Law Review 32.
Chapter 4: Is the current regulatory response adequate to deal with the problem? 209
210
AM I A FRANCHISOR?
Some franchisors do not recognise that they are franchising, and thus do not
adhere to the Code. For example law firm Freehills reminded clients involved in
‘commercial agreements such as intellectual property licences and distributorship
agreements’ 500 of:
49F
the need to carefully consider whether the Code governs [the arrangement].
The directors of Synergy in Business Pty Ltd and Lawsons Trading Co Pty
Ltd found out the hard way that the requirements of the Code cannot be
avoided simply by describing a franchise relationship as a licence. 501 50F
TIMING OF DISCLOSURE
The timing of the disclosure is problematic from three perspectives.
499
For example Australia and Vietnam.
500
David Sarkin, Franchise Follies: Lessons From the ACCC (2004) <www.freehills.com> at 19
July 2004.
501
Ibid.
210 Chapter 4: Is the current regulatory response adequate to deal with the problem?
211
causing delay that would only add to the cost of the transaction. ... Mr
Muriniti told his client … that there was something seriously wrong with the
deal ... Amongst the unresolved matters was absence of consent to
Multipye’s occupation by Westfield, the landlord. 502 501F
Third, disclosure of current and past facts is not a guarantee of the franchisor’s
future performance, or policies.
SCOPE OF DISCLOSURE
It is widely assumed that the Code protects franchisees in key risk areas. Or,
that it provides franchisees with the information they need to structure their affairs so
as to protect themselves. However, the disclosure provided under the Code is no
more than current information, predominantly concerned with the financial and legal
fitness of the entity identified as the franchisor. ‘The primary focus of disclosure is
contract formation’. 503 502F
Further, the Code’s narrow focus on ‘the franchisor’ and ‘the franchisee’
means it is ineffective if the franchisor fails. There are many stakeholders in the
franchise network whose conduct may impact on the network and ultimately on the
franchisee. These may include entities related to the franchisor, the franchisor’s
administrator, and unrelated landlords or master franchisees. Franchisees are required
to enter contracts with some of these entities. Problems can be hidden elsewhere in
the network, where they incubate until they destroy the franchisor.
COST OF DISCLOSURE
For franchisors the disclosure is an expensive document to create and maintain.
Revising the structure of the disclosure could result in considerable cost savings for
franchisors while resulting in a more informative document for the business
consumer franchisees.
502
Shakespeares Pie Co v Multipye [2006] NSWSC 930, para 36.
503
Elizabeth C Spencer, ‘The Efficacy of Disclosure in the Regulation of the Franchise Sector in
Australia’, (Paper presented at the third meeting of the European Network on the Economics of
the Firm, France, September 2006) 7.
Chapter 4: Is the current regulatory response adequate to deal with the problem? 211
212
franchisee. From franchisors that are not trading strongly this may be of limited
value. Usually, only public companies are required to be audited. Even if the auditor
has identified a situation that casts doubt on an entity’s ‘going concern’ status, the
directors may have been able to satisfy the auditor that there are mitigating
circumstances and all will be well for the franchisor. Such mitigating circumstances,
for instance new franchisees committed to investing, may or may not eventuate.
Thus, a Code compliant audit may present an inaccurate and misleading picture of
the franchisor’s solvency.
The government responded with a watered down requirement that the Code be
amended to alert franchisees that ‘franchising is a business and like any business the
504
See Appendix A of the thesis for full wording, of 20.1 of the Trade Practices (Industry Codes -
Franchising) Regulations 1998.
505
Parliament of Australia, Joint Committee, Inquiry into the Franchising Code of Conduct (2008)
para 4.80
<http://www.aph.gov.au/SENATE/COMMITTEE/corporations_ctte/franchising/index.htm> at 6
June 2010.
212 Chapter 4: Is the current regulatory response adequate to deal with the problem?
213
franchise (or franchisor) could fail’. 506 This response will be discussed in chapter
50F
6.2.3.
4.4.1 RECEIVERSHIP
4.4.2 ADMINISTRATION
The administration process allows the company to evaluate its options. On the
appointment, the administrator exercises the rights and fulfils the responsibilities of
the franchisor to the extent prescribed in s 437A Corporations Act. The administrator
‘has effective control of the [franchisor] company and may decide to discontinue the
company’s business and dispose of any of its property, [including franchise
506
Commonwealth Government Response to the report of the Parliamentary Joint Committee on
Corporations and Financial Services, above n 166, 22.
Chapter 4: Is the current regulatory response adequate to deal with the problem? 213
214
agreements, supplier contracts and leases] subject to the restrictions under s 442c
Corporations Act’. 507 506F
The administrator becomes personally liable for new debts, all existing debts
are frozen and all actions for recovery against the debtor, in this case the franchisor,
are frozen. The administrator is not indemnified for decisions taken during the
administration. There are three possible outcomes of the administration process:
the company may be declared solvent and returned to the directors. In his
experience as an administrator and liquidator Richard Hughes states that in
his experience ‘this never happens with franchisors in administration in
Australia’. 510 509F
The creditors may vote that the company is insolvent and it should be
wound up. This was the outcome for Kleenmaid, which was ‘incredibly
insolvent’. 511 510F
507
Murray, above n 150, 528.
508
Tolcher v National Australia Bank (2004) 22 ACLC 397, 401 (Barnett J) (cited in Murray, above
n 150).
509
Interview with Franchisee of an Insolvent Franchisor (Telephone interview, 28 September 2006).
510
Richard Hughes, (Speech delivered at the Griffith University Franchising Seminar, Southbank,
Brisbane, 18 November 2009) about the Kleenmaid insolvency.
511
Ibid. Kleenmaid was an asset-less administration. ‘The liquidator successfully applied to ASIC
for funds to carry out its work. Kavanagh, above n 56.
214 Chapter 4: Is the current regulatory response adequate to deal with the problem?
215
the court (Young J) said that leave under s 440D should only be granted
rarely, so as to ensure that administrator is not deflected from the necessary
tasks in having to defend litigation and in having to incur costs. 514 513F
The final step along the continuum from solvent to insolvent is the appointment
of a liquidator. This appointment recognises that there is no hope of the company
continuing trading or re-structuring its way into solvency. The general policy
objective of the insolvency provisions in the Corporations Act is to allow for the
orderly winding up and ultimate deregistration of insolvent companies.
512
Hughes, above n 510.
513
(1994) 15 ACSR 203.
514
Murray, above n 150, 536.
515
Ibid 538.
516
Corporations Act 2001 (Cth) pt 5.3A, div 7, for example the rule is relaxed under s 441G in
relation to perishable property.
Chapter 4: Is the current regulatory response adequate to deal with the problem? 215
216
This era has witnessed a marked change in the attitude towards bankruptcy.
No longer is bankruptcy considered the last desperate act of a financially
defeated person or entity. Bankruptcy 518 is now viewed as a viable business
517F
If a corporation cannot pay its debts as and when they fall due (that is, the
corporation is insolvent), 520 an application may be made to the Court to
519F
Once the liquidation has commenced, the directors no longer manage the
affairs of the corporation; the liquidator manages them. The liquidator is
the only person empowered to dispose of company property.
517
A Keay and Michael Murray, Keay’s Insolvency: Personal and Corporate Law and Practice (4th
ed, 2002) 17–18, cited in Michael Murray, Submission CAP 10 (31 August 2002) 2.
518
The US term generically used for personal bankruptcy and corporate insolvency.
519
K Freed, D Gurnick and E Honesty, ‘Bankruptcy Issues’ (Paper presented at the International
Franchise Association 29th Annual Legal Symposium, Washington, May 1996) 2.
520
Corporations Act 2001 (Cth) s 95A.
521
Corporations Act 2001 (Cth) s 459P.
522
Corporations Act 2001 (Cth) ss 468(4), 500(1); this includes franchisees who have obtained
judgments in their favour.
216 Chapter 4: Is the current regulatory response adequate to deal with the problem?
217
The assets of the corporation are realised and the proceeds distributed by
the liquidator proportionately to those creditors who are able to prove
debts in the corporate insolvency.524 523F
Whilst insolvency policies and priorities vary from one country to another, 525 524F
Corporations Act:
As early as 1988, the Cork Report recognised that there were potential
problems for small traders who depended on the insolvent party for their livelihood.
Franchisees were not expressly contemplated but they fit within the category
contemplated by the Cork Report, which reads:
523
Corporations Act 2001 (Cth) ss 471B, 500(2).
524
Some creditors may be granted priority by the Corporations Act 2001 (Cth) for some of the
moneys owed to them.
525
As is demonstrated in part in Appendix D of this thesis.
526
Corporations Act 2001(Cth) s 558 deals with ‘debts due to employees’.
527
Australian Law Reform Commission, General Insolvency Inquiry (1988) para 722, quoting the
Cork Report, para 1428. The [employee] priority was introduced into insolvency legislation for
social welfare reasons ‘to ease the financial hardship caused to a relatively poor and defenceless
section of the community by the insolvency of their employer.’
528
Ibid, quoting the Cork Report, para 723.
Chapter 4: Is the current regulatory response adequate to deal with the problem? 217
218
be explored in this thesis as it would entail a major deviation from the consumer
protection focus.
The liquidator has a statutory right to disclaim onerous assets pursuant to the
Corporations Act s 568. 531 In the franchise situation this may include a lease of the
530F
529
Murray, above n 150, 258.
530
Ibid 385.
531
Onerous assets are referred to as ‘burdensome assets’ in the UNCITRAL Legislative Guide on
Insolvency, above n 26, 4, and defined as ‘assets that may have no value or an insignificant value
to the insolvency estate or that are burdened in such a way that retention would require
expenditure that would exceed the proceeds of realization of the asset or give rise to an onerous
obligation or a liability to pay money’.
218 Chapter 4: Is the current regulatory response adequate to deal with the problem?
219
franchisee has entered with third parties will also be directly impacted by the
liquidator’s decisions. Regardless of the way the liquidator elects to treat each
franchise agreement, the event of insolvency does not provide the franchisee any
statutory rights to terminate the franchise agreement or consequential contracts
between itself and third parties. Franchisees must continue to meet their obligations
under all contracts.
When the franchisor was solvent, the franchisee was an essential component of
the franchisor’s business network. It had contractually enforceable rights to use real,
personal and intellectual property, backstopped by a range of other legal rights
flowing from its standing as consumer. The appointment of a liquidator or
administrator to the franchisor’s business signals a significant change in the
franchisee’s legal position.
the former franchisor Traveland Pty Ltd, but not the 270 former franchisees or their
employees.
When a franchisor fails the franchisee has no legal right to respond – it has to
‘sit tight’, continue complying with the franchise agreement and hope for a
satisfactory outcome. The franchise agreement is an asset or a liability when seen
through the eyes of the administrator or liquidator. If the liquidator assesses that a
contract is ‘too onerous, worth little or is unsaleable’ 534 they have a statutory right
53F
532
Corporations Act 2001 (Cth) s 568(1).
533
Australian Government, Employee Entitlement Schemes
<http://www.workplace.gov.au/employeeentitlements> at 27 October 2005.
534
Michael Murray, (5th ed), above n 130, 340.
Chapter 4: Is the current regulatory response adequate to deal with the problem? 219
220
under the Corporations Act s 568 to disclaim that contract. At that point all of the
insolvent franchisor’s liabilities and rights under the disclaimed contract cease. In
deciding whether a contract is eligible to be disclaimed liquidators are guided by
Chesterman J who concluded in Re Real Investments Pty Ltd [2000] 2 Qd R 555 that:
franchisee finds the liquidator can at the same time have the right to exercise quasi
ownership rights over the franchisee’s business and to disclaim the franchise
agreement as an onerous contract.
535
Re Real Investments Pty Ltd [2000] 2 Qd R 555, para 21.
536
B Rohrbacher, ‘More Equal Than Others: Defending Property-Contract Parity in Bankruptcy’
(2005) 114(5) Yale Law Journal 1099, 1101.
220 Chapter 4: Is the current regulatory response adequate to deal with the problem?
221
Retail Leases
First, the franchisor or master franchisor may breach the head-lease. Breaches
give the lessor a right to remedy the breach, or to terminate the lease. If the
franchisor fails to pay the rent there is typically a remedy period. The problem for the
franchisee in models 3, 4, 5, 6, 7, 8, 9 and possibly 12 in chapter 3.2.3 is that the
franchisor is contractually positioned between the franchisee and the landlord. The
franchisee becomes vulnerable if the franchisor breaches the head lease in a way that
permits the landlord to terminate it. The franchisee in this situation pays its premises
rent to the franchisor, that is meant to then pay it to the landlord. The franchisee
does not enjoy privity of contract with the landlord. If the franchisor does not pay the
rent, the franchisee does not necessarily learn of the default under the head lease until
the rent is in arrears. The franchisee has been used by the franchisor as a free line of
credit.
In exercising his or her statutory duty the liquidator will determine whether
each contract is a liability or an asset. If the franchisor holds the head lease, the
liquidator’s right to disclaim onerous property has implications for the franchisee.
The result of disclaiming is that: ‘[a]fter disclaiming 17 leases on the loss-making
bars [ie. the leases of premises occupied by Pulp franchisees], the only assets the
liquidators had available to sell were ‘fridges, blenders and mixers’. 537 The 536F
The franchisee would have the best claim to retain the premises if it occupied
its premises pursuant to models 1, 2, 10 or 11. Under all other models, the franchisee
would have, at best, a tenuous right to remain in the premises.
In both models 1 and 2 the franchisee is able to verify the premises’ ownership
and determine the extent of other registered interests by conducting a search of the
title. For greater security, the franchisee could register its lease on the title. It would
not, however, preserve the franchisee’s leasehold interest if a liquidator decided the
premises would fetch a better return for creditors if sold with vacant possession. In
that case, the liquidator of an insolvent franchisor-premises owner could disclaim the
lease.
537
Mitchell, ‘Signature Out of Pulp But Not Out of Juice’, above n 96, 10.
Chapter 4: Is the current regulatory response adequate to deal with the problem? 221
222
In models 2, 4 and 6, the implications for the franchisee if the franchisor entity
fails depend on whether the related entity was in the pool of failed companies, or
survives the franchisor’s insolvency without being wound up. If the franchisee still
has a valid lease, but the franchise agreement has been disclaimed, the franchisee
may find itself with a liability to pay rent to the end of the term, but no right to
operate the business.
In model 10, while the benefits of leasing direct from the landlord are obvious
for the franchisee, there may be a significant disadvantage. If the franchisor becomes
insolvent, the franchisee has ongoing legal obligations under the lease but the
liquidator may disclaim the franchise agreement. If that were to occur, the franchisee
would no longer be entitled to trade under the former franchisor’s brand and would
have to re-fit the premises. Disclaiming disentitles the franchisee to any benefits it
was entitled to under the contract.
222 Chapter 4: Is the current regulatory response adequate to deal with the problem?
223
only been on foot for one or two years. The franchisees would be very vulnerable.
They would not have had an opportunity to trade long enough to recoup the cost
before the franchisor became insolvent.
One of the biggest problems for Kleins was the structural issues with the
franchise system. The franchisor entered into the lease arrangements for
every franchise premises and in some cases provided income guarantees and
rent subsidies to franchisees. … [who] have lost their right of occupation of
their sites being locked out by landlords whose leases were with the
franchisor, who had defaulted despite the franchisees paying to the
franchisor the monthly rent payments 538 537F
An advantage for the franchisee in the model 10 leasing structure became clear
when the ‘Carlovers’ carwash franchisor was placed into voluntary administration on
10 July, 2003. In Carlovers, ‘after the construction of the structural plant by the
Landowner [sic] the property [would] be leased to the Car Wash Operator (ie the
franchisee), who [would] then install items of operating plant’. 539 538F
The franchisees would not have been able to confidently predict their futures if
the franchisor had been the head lessor.
538
Samson, Hill and Sutherland, above n 307.
539
Re Taxation Appeals No NT95/211 AAT No 10709.
540
N Chenowerth, ‘Car Lovers Is All Washed Up’, The Australian Financial Review (Sydney), 19
July 2003.
541
‘Car Wash Sites Still Running’, The Newcastle Herald (Newcastle), 15 July 2003.
Chapter 4: Is the current regulatory response adequate to deal with the problem? 223
224
In the Danoz Directions franchise, the franchisee did not have any security of
tenure as a licensee and bore all of the premises risk. In Danoz Directions the
franchisor/lessee was placed into voluntary administration only a few weeks after
one franchisee’s franchise agreement had been signed. The franchisor lessee’s
voluntary administration constituted a breach of the lease. Thus, the franchisees, as
licensee of the franchisor, found itself in the position of negotiating directly with the
landlord or closing the newly opened shop. One Danoz Directions franchisee:
…almost lost the lease on the store because the franchisor held the head
lease. …[the franchisee] was able to negotiate with his landlord to keep the
site, but he had to bargain away ownership of his store fit-out. 544 543F
The fit out bargained away had cost $125,000.00 a few weeks prior. This figure
includes fit out supervision claimed by the franchisor.
Because fitting out retail premises is a significant sunk investment for many
franchisees, the solutions proposed in this dissertation include proposed amendments
to retail leasing legislation. This is addressed at 6.2.4.
Title to stock
Kleenmaid did not transfer title in the goods sold by its franchisees until the
goods were delivered to the customer. This is a departure from the usual arrangement
under the state sale of goods legislation in which title can pass on the receipt of full
payment by the supplier. 545 As many of the suites of whitegoods purchased from
54F
542
Refer to 11 April 2005, ASIC Form 535 Formal Proof of Debt or Claim filed by the
Administrators pursuant to Corporations Act 2001 (Cth) s 439A re Jatora Pty Ltd, formerly T/A
Kernels Extraordinary Popcorn.
543
Ibid 5.
544
Walker, ‘It Pays to Have a Plan B’, above n 131, 56.
545
See, for example, Appendix A of this thesis, Sale of Goods Act 1896 (Qld).
224 Chapter 4: Is the current regulatory response adequate to deal with the problem?
225
Kleenmaid warehoused the purchased whitegoods until it suited the customer to take
delivery. Once the franchisor failed, the warehouses exercised a lien to sell the stock
so the warehouse would be paid before handing the balance of the money to the
liquidators. This meant the only stock available for franchisees to sell once the
administrator was appointed was their own demonstration/floor stock.
Trade Marks
‘Much of a company’s goodwill is associated with its name, which may be the
subject of trade mark protection. … [T]he crystallizing event’ 546 of franchisor 54F
insolvency is likely to damage the value of that name. Franchisees assume that they
will continue to have the right to use the franchisors’ trade marks so long as they
adhere to their contractual obligations. In the case of franchisor insolvency, this
assumption is incorrect. If the trade mark was owned by the failed franchisor
company, it is a task of the liquidator to sell that trade mark, or maintain the goodwill
of the name, if possible, in order to realize value for creditors. Trade marks provide
an example of the difficulties liquidators face when trying to retain the franchise
network as a cohesive trading entity. If any of the 88 franchisors identified in the
Exploratory Study in chapter 3.2.2 that owned their trade marks became insolvent the
trade mark would be an asset the liquidator could sell without needing to consult co-
owners or franchisees. Where the franchisor does not own the trade marks the
liquidator must decide whether it is worthwhile negotiating with the owner(s) for
ongoing rights for use of the trade marks.
Compass Capital will now set up a new kitchen and laundry goods business
using the Kleenmaid name. The Kleenmaid website will be updated by early
next week with details about how people can buy products… Compass
546
McGuinness, above n 216, 328.
Chapter 4: Is the current regulatory response adequate to deal with the problem? 225
226
An asset is only available for sale if it belongs to the debtor or another pooled
entity controlled by the franchisor. If it is merely licensed to the debtor then the act
of bankruptcy will trigger a default in the licence agreement and entitle the trade
mark owner to terminate the licence. A third party owner of the franchised trade
marks may not wish to continue licensing to a franchisor that is demonstrably in
financial difficulty. This leaves the liquidator in a position of having to decide
whether to negotiate with the trade mark owner for the right to continue using the
trade marks. Where trade mark owners live in foreign jurisdictions it is inevitably
more expensive for liquidators to negotiate ongoing use rights for franchisees, even if
a buyer wanted to keep the network together.
The implication of using trade marks as securities for loans is that they might
be repossessed and on-sold to a new owner if the franchisor defaults on the loan. At
the time the searches of the trade mark registry were conducted 2.38 per cent (8
franchisors) of the franchisor trade mark owners had failed. 548 Kleins, which failed
547F
since the research on trade marks was conducted, owed the National Australia Bank
$20 million at the time it failed. The administrator said the Kleins trade mark was
part of the loan security by way of a fixed and floating charge. 549 Three of the 337548F
franchisors in the sample analysed in chapter 3.1.2 had security interests registered
against their trade marks. 550 This would mean the secured party would be a priority
549F
Even if the administrator or liquidator is able to retain the right for the
franchisees to use the trade marks,
the greatest difficulty for a financier in taking a security interest over a trade
mark is whether the trade mark will retain its value once it has ceased to be
associated with the original business or company… If the crystallizing event
547
AAP, ‘Compass Deal a Fresh Start for Kleenmaid’, The Australian Financial Review (Sydney), 7
January 2010, 7.
548
Australian Master Licensee for Kernels, Australian Master Licensee for Midas, Sure Slim, Danoz
Directions, Collins.
549
Interview with liquidator James Stewart of Ferrier Hodgson (Sydney, 7 August 2008).
550
The Athlete's Foot Australia P/L; Coldwell Banker Corporation (USA); Rams Home Loans P/L.
226 Chapter 4: Is the current regulatory response adequate to deal with the problem?
227
for the transfer of the trade mark is insolvency then it is likely that the value
of the trade mark will be severely damaged. 551 50F
For a master franchisee that has not registered its interest as an authorised user
under the procedures established in the Trade Marks Act, the process of defending
the trade marks that they in turn are licensing franchisees to use, is more
cumbersome. A greater degree of initiative will be required from the liquidator
wishing to negotiate the right to ongoing use of the trade marks.
Unregistered trade marks almost certainly prove more difficult, expensive and
time consuming than registered trademarks for liquidators to value, assert ownership
over, and sell.
Property law recognises that several legal entities may have concurrent rights
in the same premises, the most obvious example being under a lease, where an owner
551
McGinness, above n 216, 328.
Chapter 4: Is the current regulatory response adequate to deal with the problem? 227
228
grants to a lessee/tenant the right to occupy the premises to the exclusion of all
others, including the owner itself, for a specified period. Retail leases are legally
binding contracts that define the relationship between a lessor (the landlord) and a
retailer (the lessee or tenant). The lease contract addresses a range of matters
including identifying the parties and the lettable space, the rent and permitted uses,
relocation, redevelopment, quality and maintenance, rent reviews, fit-outs and
expiry. 552 51F
All Australian states have adopted the Torrens system of land registration,
issuing a title to each identified parcel of land. 555 Part 6 of the Real Property Act
54F
1900 (NSW) 556 provides for interests in land to be registered on the title. The effect
5F
552
Productivity Commission, The Market for Retail Tenancy Leases in Australia’ Draft Report
(2007) xvii.
553
For example Real Property Act 1900 (NSW) s 42 states that the estate of the registered proprietor
is paramount.
554
Land may also be subject to restrictions at common law; for example nuisance, right of support,
and rights reserved to the Crown such as mining rights.
555
B J Edgeworth, C J Rossiter, M A Stone and P A O”Connor, Sackville and Neave, Australian
Property Law (8th ed, 2008) 460.
556
Similarly, in other States and Territories, Land Titles Act 1925 (ACT); Land Title Act (NT) part 3;
Real Property Act 1861 (Qld); Real Property Act 1886 (SA); Land Titles Act 1980 (TAS);
Transfer of Land Act 1958 (Vic); Transfer of Land Act 1874 (WA).
557
For example under Real Property Act 1900 (NSW) s 74F.
228 Chapter 4: Is the current regulatory response adequate to deal with the problem?
229
An owner may borrow money against the security of the land. If the owner (the
‘mortgagor’) defaults on its payments the land can be sold by the lender (the
‘mortgagee’) to fund repayment of the loan. 558 If there is a lessee over premises on
57F
the land, the mortgagee, and subsequently the buyer, has to allow the tenant to
remain in the premises for the term of its lease, or to pay it out, provided the Real
Property Act 1900 (NSW) s53 or its equivalent 559 has been complied with. Section
58F
53 provides:
53 (1) When any land under the provisions of this Act is intended to
be leased or demised for a life or lives or for any term of years exceeding
three years, the proprietor shall execute a lease in the approved form.
53 (4) A lease of land which is subject to a mortgage, charge or
covenant charge is not valid or binding on the mortgagee, chargee or
covenant chargee unless the mortgagee, chargee or covenant chargee has
consented to the lease before it is registered.
Even if the lease is unregistered, the lessee’s rights are preserved as long as any
mortgagee of the premises has consented to the lease or any buyer of the premises
has notice of it. 560
59F
Premises leases must comply with the Retail Leases Act 1994 (NSW) (‘RLA’)
or its equivalent in other states and territories. 561 If a lessee wishes to grant
560F
occupation of the premises to another party, it may, subject to the terms of the lease,
assign or novate the lease or grant a sub lease or a licence to that other party. In all
cases, the consent of the landlord is required. Where a sub lease or licence is granted,
the original lease between landlord and lessee continues and is referred to as the head
lease. For the lessee, subleasing or licensing provides a continuing connection to the
occupancy that would be lost in the case of assignment or novation of the lease. A
sub lease must be consistent with the terms of the head lease in its key parameters. It
558
The power of sale is conferred in NSW by Real Property Act 1900 (NSW) s 58. Each State and
Territory has similar legislation.
559
Land Title Act (NT) s 67.
560
Figgins Holdings Pty Ltd v SEAA Enterprises Pty Ltd [1999] HCA 20; and see Joycey Tooher,
‘Let Mortgagees and their Buyers Beware: Figgins Holdings Pty Ltd v SEAA Enterprises Pty Ltd’
(2000) 26(1) Monash Law Review 216; Peter Butt, ‘Variation of Lease Binding Purchaser from
Mortgagee’ (1999) 73(12) Australian Law Journal 861.
561
Leases (Commercial and Retail) Act 2001 (ACT); Business Tenancies (Fair Dealings) Act 2003
(NT); Retail Shop Leases Act 1994 (Qld); Retail and Commercial Leases Act 1995 (SA); Fair
Trading (Code of Practice for Retail Tenancies) Regulations 1998 (Tas); Retail Leases Act 2003
(Vic); Commercial Tenancy (Retail Shops) Agreements Act 1985 (WA).
Chapter 4: Is the current regulatory response adequate to deal with the problem? 229
230
is possible to register a sub lease on title, but in the context of retail leasing this is not
common. Retail tenancy legislation enables the lessor to refuse to allow a tenant to
grant a sub lease. 562561F
A lessee that has assigned the lease may not be relieved of all of the underlying
contractual liabilities. A would be assignor-lessee that wants no ongoing rights may
ask the landlord to novate the lease to a replacement tenant who will replace the
original tenant in respect of all of its rights and obligations.
Alternatively, the landlord or the lessee may grant a licence. Fewer rights
accrue to a licensee than to a sub lessee or assignee. Property laws do not provide for
a licensee to register its interest on the title to the premises, nor can the licensee
protect its interest by registering a caveat as a licence is a personal property interest,
not an interest in real property. The fewest rights accrue to a mere occupier with no
contract to define its rights.
For example, the Western Australia legislation563 defines ‘lease’ broadly but
562F
contains an additional definition of ‘retail shop lease’ that may deprive some
franchisees of protection if their franchisor is a public corporation or a subsidiary of
one. The legislation in some states does not apply to tenancy arrangements of shorter
than 12, 6 or 1 months’ duration. 564 Only the legislation of Western Australia
563F
562
For example Retail Leases Act 1994 (NSW) s 42, see Appendix A of this thesis.
563
Commercial Tenancy (Retail Shops) Agreements Act 1985 (WA) s 3.
564
Retail Leases Act 2003 (Vic) s 12 (1) exempts some leases of shorter than 1 year duration.
Business Tenancies (Fair Dealings) Act 2003 (NT) s 7(1); s 13(8) exempts short term leases from
the provisions of the Retail Shop Leases Act 1994 (Qld) and s 13(9) defines ‘short term’; licences
of six months or less for parts of common area in shopping centres are excluded from the Fair
Trading (Code of Practice for Retail Tenancies) Regulations (1998) (Tas) under Reg 1(b) and
from the Retail Leases Act 1994 (NSW) by s 6A. Retail and Commercial Leases Act 1995 (SA) s
4(2)(ab).
230 Chapter 4: Is the current regulatory response adequate to deal with the problem?
231
State and territory laws permit the lessee or sub lessee to register its interest on the
title. 565 Registration puts a third party dealing with the title, such as a purchaser,
564F
Table 6: Franchisees’ position under State and Territory retail tenancy legislation. 568 567F
Australia Western
New South Northern Queenslan South Tasmani
Model n Capital
568F Victoria Australi
569 Wales Territory d Australia a
Territory a
1 Covered Covered Covered Covered Covered Probably Covered Covered
2 Covered Covered Covered Covered Covered covered. Covered Covered
3 Covered Covered Covered Covered Covered Lessor Covered Covered
4 Covered Covered Covered Covered Covered and Covered Covered
lessee
not
defined
5 Not Arrangeme Arrangeme Covered so Arrangeme Probably Not Covered
covered nt covered nt covered long as nt covered covered. covered
in in premises in Lessor
definition definition owner definition and
of lease: of lease: consents to of retail lessee
franchisee franchisee franchisee shop lease; not
may not be may not be occupation franchisee defined
565
Real Property Act 1900 (NSW) s 53(1); Land Title Act 1994 (QLD) s 64; Real Property Act 1886
(SA) ss 116-17; Land Titles Act 1925 (ACT) s 82; Land Titles Act 1980 (Tas) s 64(1); Transfer of
Land Act 1958 (Vic) s 661(1); Transfer of Land Act 1893 (WA) s 91; see Edgeworth, above n
556, 870-871.
566
Licensees and franchisees are, however, specifically included under the definition of ‘lease’ in the
Duties Act 1997 (NSW).
567
Buchan and Butcher, ‘Premises Occupancy Models for Franchised Retail Businesses in Australia:
Factors for Consideration’, above n 34, 178.
568
Relevant tenancy legislation is: Leases (Commercial and Retail) Act 2001 (ACT); Retail Leases
Act 1994 (NSW); Business Tenancies (Fair Dealings) Act 2003 (NT); Retail Shop Leases Act
1994 (Qld); Retail and Commercial Leases Act 1995 (SA); Fair Trading (Code of Practice for
Retail Tenancies) Regulations 1998 (Tas), Retail Leases Act 2003 (Vic); Commercial Tenancy
(Retail Shops) Agreements Act 1985 (WA).
569
See ch 3.2.3 of this thesis.
Chapter 4: Is the current regulatory response adequate to deal with the problem? 231
232
The parties to a retail lease are free to negotiate and include a response to
franchisor insolvency in their lease contract. As was demonstrated in chapter 3.1.3,
franchisees may not have privity of contract with the owner of the premises. This
increases the franchisees’ vulnerability if the franchisor becomes insolvent in three
ways:
If they were a guarantor, the landlord will have made a legitimate call on
the guarantee when the franchisor breached the lease; thereby depleting the
franchisees’ financial resources, and
232 Chapter 4: Is the current regulatory response adequate to deal with the problem?
233
They have lost the right to trade from the premises as result of the
franchisor breaching the lease.
As was seen in 4.4, even if remedies were available to franchisees, the stay of
proceedings under Corporations Act s 440D means they are not able to pursue any
remedies through the courts while the franchisor entity is in administration. Nor are
franchisees able to initiate proceedings without the consent of the court 570 if a 569F
liquidator is appointed. ‘While legal proceedings against the company are stayed,
existing proceedings by the company are not stayed…The liquidator has to decide
whether to continue such proceedings’.571 Thus, the franchisees are vulnerable if they
570F
decide, for example, to stop paying franchise fees following the appointment of the
administrator. The administrator may issue proceedings for anticipatory breach
without seeking leave of the court.
4.7 CONCLUSION
As has been shown in chapter 4, once the franchisor is controlled by a liquidator, the
consumer protection provisions of the Trade Practices Act and the Code cease for
practical purposes, to protect franchisees. Enforcing contractual and statutory rights
through litigation is slow and expensive. Even if litigation were affordable, the
570
Corporations Act 2001 (Cth) s 471B.
571
Murray, above n 150, 318.
Chapter 4: Is the current regulatory response adequate to deal with the problem? 233
234
The current solutions available to franchisees are too fact-specific, expensive, slow
and uncertain. More elegant solutions than the law currently provides require
analysis along the lines of the OBPR’s model 573 for the making of sound and
572F
informed policy.
572
Corporations Act 2001 (Cth) s 568D(2).
573
Introduced in ch 1 of this thesis.
234 Chapter 4: Is the current regulatory response adequate to deal with the problem?
Chapter 5: The deal for franchisees
In this chapter the current ‘fair and in good faith’ Australian benchmark for
evaluating consumer protection laws will be discussed briefly. Then, the three more
appropriate consumer protection benchmarks identified in chapter 1 will be put
forward as a basis for evaluating proposed consumer protection for franchisees
whose franchisor fails.
the past, lack of collated evidence on how failed franchisor suppliers and their
liquidators behave towards franchisee consumers has meant that the regulators have
not regarded the situation as one requiring attention. Since the Matthews Inquiry in
2006 the government and the ACCC have become more aware that they could play a
role ex ante in alleviating the effects of franchisor insolvency on franchisees. Ex
post, the consequences of franchisors failure for franchisees are still dealt with on an
ad hoc basis by individual insolvency practitioners.
In chapter 3 the problem was placed in the context of an issue that is influenced
by:
574
Australian Government Productivity Commission, vol 2, above n 4, 42.
It was concluded that contract law will not evolve, unaided, to provide an adequate
solution.
The current statutory framework was discussed in chapter 4. It is concluded
that the law in its current form cannot deliver consumer protection to franchisees in
the event of franchisor failure. Rather, it lulls franchisees, as well as financiers and
franchisee advisers into a false sense that the franchisee’s future is secure in the
franchise model.
The PC concludes that ‘fairness’ and ‘good faith’ are the appropriate
benchmarks for measuring markets in which consumers can participate confidently.
The PC’s recommendation led to the drafting of the Trade Practices Amendment
(Australian Consumer Law) Bill 2009 (‘2009 Bill’) and the Trade Practices
Amendment (Australian Consumer Law) Bill (No. 2) 2010 (‘2010 Bill’). The 2009
Bill does not include consumer protection for franchisees whose franchisor fails
because the PC confined its inquiry to consumers that currently fall under the
definition in s 4B Trade Practices Act. The PC did not appreciate that while there
may be effective competition, confident (albeit under-informed) participation in the
market by franchisee consumers and good faith on the part of both franchisors and
franchisees, nonetheless franchisors will fail. While a franchisor’s strategic
insolvency certainly indicates lack of fairness and good faith towards franchisees, in
many franchisor failure situations there is no lack of good faith on the part of any
575
Bruce Moore (ed), The Australian Oxford Dictionary (2nd ed, 2010) 117.
576
Australian Government Productivity Commission, vol 2, above 4, 42.
party. Good faith is not a suitable benchmark in this context. In relation to fairness
the Commonwealth Government concludes:
In chapter 4 it was concluded that current remedies for breach of the Trade
Practices Act are unhelpful to franchisee consumers where their franchisor supplier
is insolvent. The franchisees’ position under the insolvency provisions of the
Corporations Act is extremely vulnerable.
On concluding that fairness and good faith are inappropriate benchmarks for
evaluating the adequacy of the response of consumer protection regulation to
franchisor failure, more meaningful benchmarks are selected. They are:
B1) Regulation should provide effective protection from serious risks and
threats that franchisees as business consumers cannot tackle as individuals.
B3) The cost to the franchisor and legal system of meeting B1 and B2
should be less than the benefit to franchisees whose franchisor fails.
577
Commonwealth Government Response to the Report of the Parliamentary Joint Committee on
Corporations and Financial Services, above n 166, 11.
franchisees that they can enter a franchise agreement knowing that if their franchisor
goes into administration or becomes insolvent they will:
have had the opportunity to assess and prepare for this risk before they
sign the franchise agreement,
United States, 581 the United Kingdom, 582 Canada 583 the fourth objective espoused by
580F 581F 582F
the European Union; [t]o protect consumers effectively from the serious risks and
584
threats that they cannot tackle as individuals 583F best articulates one of the specific
issues that confronts franchisees – the risk of franchisor failure is a serious risk and
578
Commission of the European Communities, EU Consumer Policy Strategy 2007–2013, (2007) 2
<http://ec.europa.eu/consumers/overview/cons_policy/doc/EN_99.pdf> at 5 March 2010.
579
Summarised in the Review of Australia’s Consumer Policy Framework Productivity Commission
Inquiry Report, vol 2, above n 4, 52.
580
To create an environment that is conducive to good and accurate information flows between
suppliers and consumers so that consumers can transact with confidence. New Zealand Ministry
of Economic Development 2003, Creating Confident Consumers — the Role of the Ministry of
Consumer Affairs in a Dynamic Modern Economy, (2003) 7. Ibid, 29.
581
To prevent business practices that are anticompetitive or deceptive or unfair to consumers; to
enhance informed consumer choice and public understanding of the competitive process; and to
accomplish these missions without unduly burdening legitimate business activity. Federal Trade
Commission (2006) ‘Strategic Plan Fiscal Years 2006-2011’, Washington, 1. Ibid, 29.
582
To place empowered consumers at the heart of an effective competition regime, bringing UK
levels of competition, consumer empowerment and protection up to the level of the best by 2006.
UK Competition Commission 2007, ‘The roles of the Competition Commission and Department
of Trade and Industry in promoting competition’, from www.competition-commission.org.uk.
583
Building trust in the marketplace so that consumers can protect themselves and be able to
confidently and knowledgeably drive demand for innovative products and services at competitive
prices. (Office of Consumer Affairs, Canada 2007). www.ic.gc.ca
584
To empower EU consumers. (i) Putting consumers in the driving seat benefits citizens but also
boost competition significantly. (ii) Empowered consumers need real choices, accurate
information, market transparency and the confidence that comes from effective protection and
solid rights. (iii) To enhance consumer welfare in terms of price, choice, quality, diversity,
affordability and safety. Consumer welfare is at the heart of well-functioning markets. (iv) To
protect consumers effectively from the serious risks and threats that they cannot tackle as
individuals. (v) A high level of protection against these threats is essential to consumer
confidence. Commission of the European Communities above n 578, 5-6.
Where the firm is a franchisor, not only will the ‘total value of the firm fall’ 587586F
but the franchisees to an arguably greater degree than the franchisor ‘bear [almost]
the entire wealth effect of the bankruptcy cost’. 588 587F
585
Commission of the European Communities, EU Consumer Policy strategy 2007 - 2013, above n
578, 2.
586
Jensen and Meckling, above n 21, 340.
587
Ibid 341.
588
Ibid.
The Risk Statement [to be provided to all franchisees associated with failure
of this particular franchise and its structure before they are committed to the
franchise] and the ACCC educational material should clearly describe the
risks and consequences associated with franchisor failure. 589
58F
IMPLIED TERMS
The second response should occur at franchise agreement level. All franchise
agreements should contain implied terms including ratcheted provisions enabling
franchisees to exit the network following the appointment of an administrator or
liquidator. These are addressed in chapter 6.2.2.
It is reasonable to expect that the major legal and commercial risks that a
franchisee faces as a consequence of signing the contract could be addressed in the
standard contract. The Australian Risk Standard, AS/NZ 4360/2004 (‘Risk
589
Matthews, above 113, 44.
Event Solution
Known Franchisor might fail – genuine If impact would be severe on either party,
unknowns failure. include, if not, leave to future negotiation.
Franchisor might decide to become Weight with respect to impact on network and
insolvent. on individual franchisee.
Parent company might decide to Provide contract based strategy.
close franchise division/ strategic
insolvency.
Unknowns Far fetched events that are never Address through ‘motherhood’ clauses; ie:
likely to impact on the network. general obligations such as to cooperate, act
reasonably, act in good faith.
In the context of the Risk Standard, franchisor insolvency is a risk that should
be evaluated and planned for as a ‘known/ unknown’ i.e. – it is known that it could
occur, but unknown if or when it will occur. If it does occur, it is serious enough to
be addressed in the franchise agreement.
Why are franchisees unable to tackle these risks and threats as individuals?
The Australian Government argues that ‘the parties to the contract are best
placed to determine commercial matters’.590 There are eight broad reasons why
589F
590
Commonwealth Government Response to the Report of the Parliamentary Joint Committee on
Corporations and Financial Services, above n 166, 21.
franchisees are unable to accurately measure and factor in the commercial risk of
franchisor failure, even if they do identify it as a possibility. In summary:
The franchise network is a complex set of legal structures. The retail lease
models in chapter 3.2.3, and diagrams and charts in Appendix D depict the
legal environment in which the franchisor operates.
This is a step towards better consumer protection but its impact is diluted by
the emphasis on the franchise. Franchisees have always accepted that their
own business might fail. It is franchisor failure that is the less manageable
risk.
o Fails to disclose specific information about the direction of money
flows within the network and the risks and threats thus accepted by
franchisees operating as commission agents.
o Does not require franchisors to provide sufficient timely information
about premises. This is particularly the case if the franchisee is a sub-
lessee or a short term licensee that does not fit within the relevant
statutory definition of tenant/lessee.
591
Ibid 22.
The winding up process provides liquidators with rights that are the
antithesis of franchisees’ needs. Franchisees have no right to negotiate
with the receiver or administrator. When the liquidator is appointed, they
have no franchisee-specific rights in the creditors’ pool. Strategic
insolvency cannot be anticipated.
Commence action under the Trade Practices Act if any of the directors or
another solvent party is identified that falls within s 75B Trade Practices
Act.
Accessible redress
Hadfield writes:
Hadfield’s thoughts are also valid when the redress is to come from the
diminishing assets of an insolvent estate. Accessing redress through an administrator
or liquidator is far more problematic, at any cost. Specific issues were identified in
chapters 3.3, 4.3 and 4.4.
Timely redress
The possibility of timely redress is particularly significant where the parties to
the dispute are in an ongoing contractual relationship. This is recognised in
franchising and addressed through the opportunity to request mediation through the
Code if the franchisor is solvent.
Timeliness is especially important for the franchisee whose right to profit from
the relationship ends on the termination date of the franchise agreement. Examples of
592
Hadfield, ‘The Many Legal Institutions that Support Contractual Commitment’, above n 22, 181.
593
Ibid 182.
594
Hoy Mobile Pty Ltd v Allphones Retail Pty Ltd (No 2) [2008] FCA 810.
lack of timeliness are common where one party has an interest in not settling a
dispute. The franchisor may be reluctant to settle for fear of setting a precedent. For
example, in Hoy, following the franchisor’s refusal to mediate the franchisee had to
litigate or accept defeat. The franchisee said:
I was told the proceeding were likely to cost me around [A]$300,000 … and
that my matter stood a good chance of succeeding … but more importantly
there was no other way of restraining the franchisor from acting upon the
termination notice without an injunction. Our business was worth … about
the same amount. At the time we thought it was commercially sensible to
begin proceedings to prevent the termination and to protect our asset. By …
the end of 2006 the costs had reached $140,000. The court ordered
mediation which we attended to no avail in November 2006. The franchisor
had made it clear from the beginning that they were going to fight us all the
way …
We had to subpoena [telecommunications] carriers to obtain the evidence we
required and even this process was not easy and cheap. We had to provide an
undertaking to the court that we would not disclose the information we read
before we were allowed to view the documents. Once I viewed the
documents I was certain our issue had merit and was an issue that affected
every [Allphones] franchisee and I was not allowed to tell my fellow
franchisees or the ACCC. The carriers each charged between [A] $1000 to
over [A] $3000 for producing the documents. 595
594F
595
Evidence to Parliament of Australia Joint Committee on Corporations and Financial Services,
Senate of Australia, Inquiry into Franchising Code of Conduct, undated, 4 (Nicole Hoy)
<http://www.aph.gov.au/SENATE/COMMITTEE/corporations_ctte/franchising/submissions/sub
08.pdf> at 17 January 2010.
initiated by the franchisee under the Trade Practices Act to be heard in the Federal
Court of Australia. 596 This is not timely.
59F
Timely redress is also important where the franchisees whose businesses are
required by the administrator to continue operating must keep paying staff, meeting
commitments under premises agreements (even those that involve paying money to
the failed franchisor) and meeting franchise agreement commitments while the
administrator and then the liquidator decide on the future of the franchisor.
‘Accessible and timely’ are not sufficient measures of redress where one party
is insolvent. Meaningful redress is also vitally important.
Meaningful redress
Meaningful redress leaves the franchisee able to move ahead with their life
unencumbered by debts and bad relationships accumulated through the conduct of
the franchisor. Franchisor-transmitted debt and franchisor-transmitted poor supplier
relationships should not be a consequence of being a franchisee.
Meaningful redress is also cost-effective. The trials in the Danoz and the Hoy
matter above are expensive. Few franchisees can afford to litigate. In addition to
money, the human resources in the court room on each hearing day, in Danoz, are
one Special Counsel, one junior barrister, one solicitor for each party plus the judge,
the Judge’s Associate and a court officer plus the parties and expert witnesses. All of
these people have other ways they can spend their time.
Legal options should extend beyond the theoretical and should be meaningful,
accessible and timely. This is especially where consumer loss is significant and is
brought about by failure of the monopoly supplier. The current situation fails against
these measures.
596
Hearing 2 (P) NSD1313/2008 Benjamin Morris & Anor v Danoz Directions Pty Ltd (ACN 092
832 534) (in Liquidation) & Ors.
small firms to gain a return on sunk costs and market inefficiencies arising
out of exploitative conduct. The overall costs of small business failure in
terms of its implications for employment and growth are also relevant. 597596F
B3 is thus that the cost of the franchisor supplying and the franchisee
assimilating the information should not outweigh the benefit to the franchisee
business consumer in the newly framed regime.
benefit analysis (‘CBA’) relies on adequate base data. There is no such data available
in franchising. This partly stems from unwillingness by the government to require
franchisors to place their franchise disclosure materials on a publicly searchable
database as a pre-condition of allowing them to sell franchises. Even with a useful set
of base data, conducting a cost benefit analysis is primarily the work of an
economist.
Theory
Banks writes that ‘an effective regulation making and administrative system
should mediate the impact of the increasing demands that arise from an increasingly
risk averse society’. 600 As we have observed in the way franchisors shift risk to
59F
franchisees, the franchisees are the unwitting mediators of a wide range of the
franchisors’ risks.
597
The Parliament of the Commonwealth of Australia House of Representatives, Explanatory
Memorandum, Trade Practices Amendment (Fair Trading) Bill 1997 (Circulated by the authority
of the Minister for Customs and Consumer Affairs, Senator the Honourable Christopher Ellison).
598
Australian Government, Best Practice Regulation Handbook (2007) 27.
<http://www.finance.gov.au/obpr/docs/handbook.pdf > at 17 June 2010.
599
Leo Dobes, ‘A Practical Guide to Cost-Benefit Analysis’ in George Argyrous (ed), Evidence for
Policy and Decision-Making (2009) 45, 69.
600
Banks above n 24, 15.
Stakeholders
The impact on all stakeholders must be included in a cost benefit analysis. In
the context of this thesis, they are identified in 6.3.
The economic cost of franchise failure is not counted in studies such as the
‘Economic Impact of Franchised Business’ conducted for the International Franchise
Association Educational Foundation, 603 and is generally below the regulators’
602F
604
radar. 603F As well as the cost of franchisor failure being hidden:
[t]he real costs of regulation are ‘hidden’ from view as they are the ‘off-
budget’ costs of business and society compliance with regulation.
The cumulative cost of regulation is not often considered as most
departments and agencies have responsibility only for specific regulation,
and little concern for its cumulative nature. 605
604F
601
Dobes, above n 599, 69.
602
Australian Government Productivity Commission, vol 2, above n 4, [2], [42].
603
PriceWaterhouse Coopers, Franchise Business Growth Outpaces Other Buiness Sectors (2004)
International Franchise Association
<http://www.franchise.org/franchiseesecondary.aspx?id=37842> at 7 March 2010.
604
An exception is the exploratory Australian study funded and published by CPA Australia. The
resulting report When the Franchisor Fails (2006) <http://www.cpaaustralia.com.au> at 17 June
2010.
605
Carroll, above n 25, 4.
‘There are two issues raised here. One is the value of the use of benefit-cost
analysis (CBA) and the other is to what extent to which its use can be protected from
destructive effects of the political process’. 607 Zerbe’s paper addresses the value of
60F
CBA but equally important in franchising policy, where some sectors have a strong
vested interest in the status quo, is the second question. The world of business format
franchising includes numerous individuals and groups with different agendas, a
sizeable amount of self-interest stemming from ego, a wish to retain power, an
unwillingness to see the big picture and factors as mundane as the constraints of the
6-minute time sheet. To objectivise the problem of franchisor failure as it impacts on
franchisees, to repackage it in a CBA is a useful step towards a solution in that the
focus can thereby shift from the individual problem to a collective solution.
606
Richard O Zerbe, Jr, ‘An Ethical Benefit-Cost Analysis’ (Paper presented at The Searle Centre
Cost-benefit Analysis of Regulations: Lessons Learned, Future Challenges Conference at
Northwestern University School of Law, September 2007) citing at fn 31 Theodore M Porter,
Trust in Numbers: The Pursuit of Objectivity in Science and Public Life (1995) 187.
607
Ibid, 4.
608
Adapted from <http://www.treasury.gov.au/documents/790/PDF/Cost_Benefit_Analysis.pdf> at
7 March 2010.
5.2 CONCLUSION
The benchmarks proposed; B1, B2 and B3 do get to the heart of the problem.
Until the problem is understood any solutions will be patchy and unsatisfactory.
They will not protect franchisee consumers at their most vulnerable time.
All current possible contract and quasi contract based actions fail to address the
problem and fail to measure up to benchmarks B1 and B2. The statutory avenues
currently available to franchisees are equally unusable in practice.
If franchisor failure is a hidden risk, what is the best way of protecting the
franchisee’s business from the effects of franchisor failure? How can the situation be
addressed more satisfactorily, predictably, efficiently and economically? In 6.1 non-
regulatory solutions are canvassed. In 6.2.1 and 6.2.3 consumer protection strategies
that do not involve amending insolvency laws are identified.
6.1.2 EDUCATION
It has been acknowledged that more education is needed for prospective and
incumbent franchisees, and also for franchisors. Australian Government sponsored
reports on franchising have identified education as an essential part of the solution to
short comings of the franchise model. 609 The Reid Report identified ‘the inadequacy
608F
of advice and education for small businesses’ 610 as a matter for concern. The
609F
609
Task Force above n Recommendation 41; Committee on Industry, Science and Technology (the
Reid Committee) Finding a balance; Towards fair trading in Australia (1997) Recommendation
7.3 and 7.4; Matthews, above n 113, Recommendation 21 ; Economic and Finance Committee,
Parliament of South Australia, Franchises (2008) 38 and 87; Chris Bothams, Inquiry into the
Operation of Franchise Businesses in Western Australia (2008) 14.
610
Committee on Industry, Science and Technology (Reid Committee), above n 609, 1.
<http://www.aph.gov.au/house/committee/isr/fairtrad/report/CHAP1.PDF > at 22 June 2010.
It was demonstrated in chapter 3 that the operating in the perfect world of thorough
business feasibility assessment and prior planning is impossible in some cases and
ultimately of no benefit if a franchisor fails.
the Government has explored avenues to better balance the rights and
liabilities of franchisees and franchisors in the event of franchisor failure
(Recommendation 4). The Government supports the development, by the
ACCC, of additional educational information on the potential consequences
and liabilities franchisees could be exposed to in the event of franchisor
failure. 615
614F
611
Matthews, above n 113.
612
Economic and Finance Committee, South Australian Parliament, Franchises (2008).
613
Government of Western Australia, Inquiry into the Operation of Franchise Businesses in Western
Australia, Report to the Western Australian Minister for Small Business (2008) 14.
614
Commonwealth Government Response to the Report of the Parliamentary Joint Committee on
Corporations and Financial Services, above n 166, 7.
615
Ibid 21.
franchisees and their advisers more aware of the possibility of franchisors failing.
Education cannot protect franchisees if their franchisor does fail.
It should also be noted that it is difficult for the ACCC to provide meaningful
educational material that would alert a franchisee within a network that their
situation is worse than that of others in the network because the franchisor has
chosen to shift more risk onto them specifically. For example if the franchisor
usually uses leasing model 4 or 5 but on this occasion has selected model 10 because
there is a demolition clause in the lease. Only the franchisor will know this is an
aberration from its usual practice.
616
Anderson Mori and Tomotsune, Formation of Labour Union by Convenience Store Franchisees
(2009)
<https://www.internationallawoffice.com%2fNewsletters%2fDetail.aspx%3fg%3d4ca4add7-
f8bd-4530-a6eb-82b0fa183729> at 5 January 2010.
6.1.4 INSURANCE
[s]uppliers to industry have few options … Take out their own insurance
[debtor insurance] at rates that are up there with the insolvency practitioners
themselves. …The cost of this insurance is … becoming even more out of
reach as the risk to the insurers book escalates as insolvencies are becoming
more and more common. There is no way that suppliers can be secured …
they have no choice but to be unsecured creditors. 619 618F
ASIC’s charter should be to ensure protection for all stakeholders and this
could be achieved by writing into AS 4000 that there should be reciprocal
insurance rights for all stakeholders. If premiums were gathered by the
insurance industry on every contract then the overall premium would be
drastically reduced. 620619F
The insurance solution is appealing but in the franchising sector the absence of
reliable comprehensive data about franchisor failure would make it difficult for
617
Ramsay, above n 329, 18.
618
The author is not aware of any such insurance but theoretically the risk and potential loss are
measurable so the possibility of insurance should not be ruled out.
619
Submission to Economics Committee, Australian Commonwealth Senate, Inquiry into
Liquidators and Administrators, 3 December 2009, Submission Number 1 (Greg Crook).
620
Ibid.
actuaries to assess the likelihood of failure or the magnitude of loss, and therefore to
set premiums accurately. Further, the absence of a mandatory requirement that
franchisors register would make it extremely difficult to achieve widespread
compliance with any requirement to pay into an insurance fund.
Requiring franchisors to provide their own security deposits for retail premises
could help mitigate the effects of their failure on their franchisees. This would mean
that if the franchisor failed, a franchisee in a model 3, 4, 6, 7 or 10 leasing situation
would not be called on to meet the franchisor’s liability for unpaid rent or outgoings.
This is a partial solution, limited to franchisees conducting their franchise under the
specific models.
621
How ought the government to intervene? 620F
This leads to the question; why do consumer protection inquiries, 623 economic 62F
models created by franchise academics 624 and regulatory responses assume that the
623F
supplier, in this case the franchisor, will be solvent at the time the product or service,
the franchise business support, is supplied?
and:
621
Iain D C Ramsey, ‘Rationales for Intervention in the Consumer Marketplace’ (1984) Occasional
Paper for the Office of Fair Trading 1, in fn 24 of Georgosouli, above n 338.
622
Georgosouli, above n 338, 7.
623
For example Australia’s Productivity Commission Review of Australia’s Consumer Policy
Framework, vol 2, above n 4.
624
For example Francine Lafontaine; K Shaw; and Gillian K Hadfield.
625
Trebilcock, above n 29, 68.
626
Ibid.
Further, Trebilcock et al’s analysis starts with the assumption that the
consumer market is competitive and, by implication, that it remains competitive even
once a product has been acquired by a consumer. They suggest that ‘where a market
is very imperfectly competitive or non-competitive, problems of consumer protection
may have to be addressed through competition policy or economic regulation’ 628 627F
627
Ibid.
628
Ibid 69.
prevent the consumer from gaining full use and enjoyment out of the car. Franchisees
are different because the bundle of products, services and use rights only stays intact
while the franchisor is solvent. The insolvency of the franchisor almost without
exception deprives the franchisee of what it has purchased.
level the playing field for franchisees before they sign a franchise
agreement, during the franchisor’s administration and after the franchisor’s
business is wound up
keep the franchise network intact long enough to determine whether it may
be sold as a viable network rather than being dismantled.
A cost benefit analysis that would be needed to satisfy B3 will demonstrate the
solutions will reduce disclosure and documentation costs for franchisors
629
Australian Government, Department of Finance and Deregulation, Regulatory Impact Analysis
Guidance Material <http://www.finance.gov.au/obpr/proposal/ria-guidance.html> at 7 March
2010.
franchisees as well as a more global or Europe centric focus would have done. As
Iain Ramsey observes:
Australia tends to have taken its lead from North America. Franchise
agreements are standard form consumer contracts, as was demonstrated in chapter
3.3.4. The supply of a franchise business to the franchisee business consumer is
similar, theoretically, to any other product that is supplied with a standard form
contract, and with a projected life span of the number of years denoted in the
franchise agreement. Stephen Corones and Philip Clarke state that:
630
Ramsay, above n 329, 34.
631
Stephen Corones and Philip H Clarke, Consumer Protection and Product Liability Law (2nd ed,
2002) 5.
632
Ibid.
Every franchisor should be required to post all versions of their standard pro
forma franchise agreements on a publicly accessible, free, website. This would mean
that franchisees and their advisors could:
Compare the document they have been asked to sign with the franchisor’s
pro forma agreement. This would enable them to identify differences that
may then require explanation. It would also enable them to identify how
the agreement has changed over time. This will be particularly helpful to a
franchisee purchasing in a re-sale. They will be able to identify whether
the agreement differs from the one the current franchisee operates under in
any material way. It will also assist advisers who are not familiar with the
nuances of franchising as opposed to transactions concerning non-
franchised businesses.
Compare the document with others operating in the same sector of the
market.
Making the database publicly available would be a step further than the
recommendation of the Matthews Review that recommended ‘[t]he Government
implement a mandatory process of franchisor registration and annual lodgement of
the most current disclosure document and other prescribed information’. 634 63F
633
Blair and Lafontaine, above n 46, 264.
634
Matthews, above n 113, Recommendation 23, 13.
Three options for reforming s 51AC were examined by Bryan Horrigan, David
Lierberman and Ray Steinwall in ‘Strengthening Statutory Unconscionable Conduct
and the Franchising Code of Conduct’. 635 These were, to provide a list of examples,
634F
The list of examples proposal was rejected. It was considered ‘legislatively and
administratively burdensome’ 636 635F and potentially ‘requiring numerous
amendments’. 637 It was also considered to be something which the regulators can
63F
One option may be to redraft the events listed in Trade Practices Act s 51AC
(a) – (k) and to add a statement of principles as a new section. Thus, s 51AC and the
new section would operate together as do ss 51A and 52. Section 52 sets out a broad
statement of principle in relation to misleading and deceptive conduct, s 51A shifts
the burden of proving the conduct was not misleading under s 52 to the party that
made the representation if the representation was with respect to any future matter. If
one party to a franchise agreement, say, the franchisee, establishes that any of events
occur, the other party, say the franchisor, has to satisfy court the events are not
unconscionable. This places the burden of proof on the party that has set up the
unconscionable situation, being the party that has the evidence to rebut if the conduct
is not unconscionable.
635
Bryan Horrigan, David Lieberman and Ray Steinwall, ‘Strengthening Statutory Unconscionable
Conduct and the Franchising Code of Conduct’, Australian Government, The Treasury,
Department of Innovation, Industry, Science and Research (2010) 18.
636
Ibid 26.
637
Ibid.
638
Ibid 28.
639
The Nature and Application of Unconscionable Conduct Regulation, Issues Paper 2009
(Submission Professors Christensen and Duncan) 6 cited in Horrigan, Lieberman and Steinwall,
above n 642, fn 118, 31.
Two aspects of this statement are fundamentally flawed. Firstly, the paragraph
starts with the powerful little word ‘if’. It was demonstrated in this dissertation that
franchisees cannot identify the information needed to make an informed business
decision. When they can identify it access becomes an insurmountable hurdle in
some situations. Structure of the franchise network, deficient disclosure
requirements, deficient publicly accessible information and prohibitive costs lead to
the response – if they could, they would, but very often they cannot!
Under the more far reaching franchise law now proposed, terms would be
implied into all franchise agreements by incorporating the Code and implied terms
into legislation modelled on the Insurance Contracts Act 1984 (Cth) whose purpose
is:
640
Commonwealth Government Response to the Report of the Parliamentary Joint Committee on
Corporations and Financial Services, above n 166, 21.
The Insurance Contracts Act did not protect insureds from the sometimes
devastating results of the failure of HIH insurance group so it is not a perfect
template. It does provide an example of a statute having been enacted to regulate an
area that is traditionally mainly regulated by common law – the law of contract. It
also accepts the notion of fairness, which echoes the sentiment express in 1997 642 641F
The purpose of a Franchise Contracts Act would be to reform the law relating
to business format franchise agreements so that a fair balance is struck between the
interests of franchisors, franchisees and other stakeholders so that the provisions
included in such contracts, and the practices of franchisors in relation to such
contracts, operate fairly, and for related purposes.
To achieve the objectives a wide range of implied terms are proposed below.
An overwhelming benefit of legislation over all obligations being contained in
individual franchise agreements as is the case now is that franchise agreements
would be shorter. This would help reduce the time and expense devoted to generating
agreements. This would save both franchisors and franchisees money.
641
Australian Government, Attorney General’s Department, Insurance Contracts Act 1984 (Cth)
<http://www.comlaw.gov.au/comlaw/Legislation/ActCompilation1.nsf/0/8993B3C6A1DDA189
CA25749000200A9B?OpenDocument> at 7 March 2010.
642
Reith, above n 113; Reid Committee, above n 616.
643
Under the Trade Practices Act at national level, or the state and territory Sale of Goods Acts. Note
these rights will be replaced with new statutory consumer protection rights under Trade Practices
Amendment (Australian Consumer Law) Bill (No 2) (Cth) 2010 available at Parliament of
against the supplier or manufacturer. These avenues are currently not available to
franchisees that purchase a franchise that turns out to be faulty and to fail – not fit for
its purpose. The Trade Practices Act does not provide redress if a manufacturer
becomes insolvent, but the Corporations Act classifies consumers of defective
products as unsecured creditors. The franchisor failing before the end of the franchise
term is arguably analogous to a product or service failing.
The Trade Practices Act implies terms into consumer agreements but
franchisees do not fit the definition of ‘consumer’ in the Trade Practices Act s 4B. 644 643F
Nor will franchisees fit within the new Australian Consumer Law (‘ACL’). They do
not fit the ACL’s definition of ‘consumer’.
Under the Trade Practices Act protection is provided for ‘consumers’ from
manufacturing defects, acknowledging that one defectively manufactured product
can cause damage to hundreds of consumers.
Terms are implied into contracts for the supply of goods and services by
statutes. Currently this occurs through the Trade Practices Act, Part V div 2. In
relation to sale of goods where state or territory legislation applies, terms are implied
into contracts for sale of goods and for supply of services necessarily ancillary to the
supply of the goods through state legislation.
A potential response would be for the wording in the Trade Practices Act to be
incorporated into a Franchise Contracts Act so a franchisee could claim the failed
franchisor had breached new equivalents of the terms currently implied by the Trade
Practices Act:
Australia
<http://parlinfo.aph.gov.au/parlInfo/search/display/display.w3p;query=Id%3A%22legislation%2
Fbillhome%2Fr4335%22> at 6 June 2010.
644
See Appendix A of this thesis for wording of s 4B.
Franchisees are clear about their purpose – they are buying a business that
is currently viable or that will become viable once they have established it.
Franchisors should not, therefore, have difficulty implying a term like s
74B Trade Practices Act which addresses goods not fit for a purpose made
clear at the time of purchase;
A term that achieves the same result as the current s 74C Trade Practices
Act would provide consumer protection in respect of false descriptions and
could be applied to franchises that are sold as licences and thereby avoid
complying with the Code.
The remedies currently provided in the Trade Practices Act are inappropriate
as they depend on the breaching entity being able to make good the breach in one of
a range of ways; the franchisor is insolvent and cannot do this.
The Trade Practices Act Part VA concerns damages for defective goods. Under
current law, franchisees would be ineligible to claim under Trade Practices Act pt V
div 2 or 2A as, again, they are not a ‘consumer’ under Trade Practices Act s 4B or
they are not purchasing ‘goods’.
Where the franchisor is a corporation the franchisor directors’ duties 645 should 64F
be expanded so the directors owe to franchisees the same duties as directors currently
have to a company. The rationale behind this is that franchisees provide a significant
amount of the operational infrastructure that, absent franchisees, the franchisor
would have to supply, and franchisees assume a significant amount of the franchisors
business risk. The issue of franchisors duties to franchisees could usefully be pursued
in the future.
645
Directors have statuory duties under Corporations Act 2001 (Cth) ss 180 (care and diligence),
181 (good faith), 182 (use of position), 183 (use of information), 184 (good faith, use of position
and use of information – criminal offences), 190 (responsibility for actions of a delegate), 191
(disclosure of material personal interests) and 588G (insolvent trading).
itself and third parties (for example franchisor obligations in the head
lease, and other supplier agreements on which the franchisee and its
commercial reputation rely)
itself and ASIC, the ATO and other levels and arms of government
relevant to the franchise network
where a breach would cause harm to the franchisee. A breach of this implied term,
depending on its seriousness, could give rise to a right for the franchisee to terminate
the franchise agreement and sue for damages for breach of contract.
The term would need to be drafted widely enough to acknowledge that it might
not be the franchisor that fails – it might be the parent company or another critical
entity in franchisor’s network that fails, taking the franchisor with it.
Implied term that franchisor will comply with all contractual or statutory
obligations towards third-parties
The franchisor should be required to comply with all collateral contract
obligations and all obligations that arise under statute. A breach of any of the third-
party or collateral contractual obligations that impacted detrimentally on franchisees
would enable the affected franchisees to terminate their agreements and seek
damages from the franchisor.
This term would be used by franchisees whose franchisor did not pay the rent,
outgoings or other third-party payments that it had received from the franchisee in a
timely way. In failing to do so, the franchisor has put the franchisees’ businesses and
reputation at risk.
have materially adverse effects on the franchisee without franchisee consent’. 646 The 645F
The theme of unilateral contract variation is being addressed. In 2010 the Small
Business Minister Dr Emerson announced, in announcing amendments to the Code:
When the causes of franchisor administration and insolvency are taken into
consideration, it is clear that an even more problematic area of material change is the
franchisor adopting strategies that put the entire network at risk. Franchisees have no
right to know about the franchisors plans that are implemented by the franchisors’
related entities. The feasibility of requiring that franchisors disclose, and possibly
secure franchisees’ consent to, major strategic changes that could put the network at
risk, should be explored.
No contracting out
Legislated consumer protection for franchisees must not be able to be avoided
by contracting out.
646
Matthews, above n 113, 42.
647
Australian Government Response to the Review of the Discolsure Provisions of the Franchising
Code of Conduct (2007) 6.
648
The Hon Dr Craig Emerson MP, ‘Better Protection for Franchisees’ (Media Release, 3 March
2010) <http://minister.innovation.gov.au/Emerson/Pages/default.aspx> at 23 May 2010.
There is currently debate in insolvency law about the merit of ipso facto
clauses. Step 1 above is a refined ipso facto clause:
The IPA argue[s] that the ability of the non-insolvent party to terminate
these contracts destroyed enterprise value and, if businesses could be
provided with some limited protection from these automatic terminations the
potential for restructuring businesses would be significantly improved. 649
648F
Currently franchisor give themselves, but not the franchisees ipso facto clauses
in the franchise agreement. Arguably the IPA’s wish is not as valid in the franchising
context as it may be in, for example, a supplier contract.
649
Morgan Kelly, ‘Failing Businesses Can be Saved’, The Australian Financial Review’ (Sydney),
30 November 2009, 55.
The tenancy contract between the landlord and the franchisor would be
novated.
The franchisee would step into the shoes of the failed franchisor but would not
take on the liabilities accrued by the under-performing franchisor. Premises rent
formerly collected by the franchisor for on-payment to landlords would thus become
payable direct to the landlord. This would not disadvantage the administrator or the
franchisee’s landlord, but would enable the franchisee to demonstrate to the landlord
whether the franchisee has a viable business as an independent operator.
650
NC Seddon and MP Ellinghaus, above n 368, 360.
Four aspects of the Code could usefully be amended. They are the Code’s
application to administrators, the scope of entities that the franchisor has to disclose,
the form and content of the disclosure document and the public accessibility of the
disclosure document.
651
D Wittman, Economic Foundations of Law and Organization (2006) 194, 104.
652
Commonwealth Government Response to the Report of the Parliamentary Joint Committee on
Corporations and Financial Services, above n 166, xiii.
Code does not apply to administrators is abused by some administrators. This results
in administrators denying franchisees the right to request mediation during the
administration. Mediation might not be the disastrous waste of time and resources
that administrators claim – it may be a way of opening a meaningful dialogue
between administrators and franchisees and provide the administrators with a loyal
franchisee base whose contracts can be sold.
Power and funds imbalances, the tight time lines surrounding all aspects of the
winding up procedure, the embargo on commencing litigation against the party in
administration, mean it is unlikely that franchisees would ever be able to mount an
effective challenge, so the incorrect view prevails. To resolve this, a statement should
be inserted in the Code to clarify that it does apply to administrators.
It was shown in 3.2.1, Table 1 and Appendix D that ‘the franchisor’ is typically
only one of a group of numerous corporate and trustee entities. 653 The franchisor is
652F
not necessarily the entity whose failure will trigger the failure of the group. In
chapters 3.2.2 and 3.2.3 two of the key ‘assets’ of the franchisor, registered trade
marks and head leases, provided numerous examples of the range of business
structuring models franchisors use. The fragmentation of ownership of vital assets
means that the current form of disclosure by and of the franchisor exposes only a
very small part of the franchise network to scrutiny by the franchisees’ advisers.
accepted that:
653
For example there were approximately 40 entities in the Ansett group of which Traveland was a
franchisor casualty; 51 entities in the two corporate groups and their related entities that made up
the Kleenmaid empire. Fifteen franchisor and related entities in BHG.
654
Matthews, above n 113, 44-5.
[t]he requirement under item 20 of Annexure 1 [of the disclosure under the
code] to disclosure financial details [should] be extended, where applicable,
to include the consolidated entity to which the franchisor belongs. 655 654F
To achieve fuller, more telling information a credit rating agency report on the
franchisor entity should be required to be provided by the franchisor. This would be
more meaningful to the franchisee than a very full and potentially confusing mass of
numbers supplied under the amended item 20. The item 20 information is attached to
entities whose function in the network the franchisee would not be aware of.
A credit rating agency provides context for the franchisor entity’s operations.
Such a report shows related entities and individual directors which are not presently a
feature of disclosure. It reports on their credit history which, if one believes that
history repeats itself, is significant information to an incoming franchisee interested
in assessing risk. The information provided would enable an accountant to analyse
the franchisor’s attitude to risk, debt, and creditors and would provide a far more
comprehensive picture of the franchise network than is provided through the current
disclosure.
655
Australian Government Response to the Review of the Discolsure Provisions of the Franchising
Code of Conduct, above n 415, 8.
656
Parliament of Australia, Joint Committee, Inquiry Into the Franchising Code of Conduct (2008)
submissions and final report para 4.80
<http://www.aph.gov.au/SENATE/COMMITTEE/corporations_ctte/franchising/index.htm> at 6
June 2010.
657
Commonwealth Government Response to the Report of the Parliamentary Joint Committee on
Corporations and Financial Services, above n 166, xiii. This was also recommended in Matthews,
This would not be a total solution, but it would put franchisees on notice that
the franchisor may fail. The government responded that:
If you provided a guarantee for the franchisor’s head lease, you would lose
the amount of the guarantee as it would be paid to your landlord. You
could not claim it back from the franchisor’s liquidator.
If the landlord would not grant you a new lease you would lose the entire
fit-out and could not trade from your premises any longer.
If your lease was not disclaimed but the franchise agreement was
disclaimed you would have to continue paying rent and outgoings on your
premises, but would have to change the name of your shop and may not be
able to buy the same stock as you did while you were a franchisee.
above n 113, 13 and agreed to in principle in the Australian Government Response (2007) 7-8
which placed the responsibility, inappropriately, with the ACCC.
658
Commonwealth Government Response to the Report of the Parliamentary Joint Committee on
Corporations and Financial Services, above n 166, 21.
If the franchisor does not own the trade marks, patents or designs that you
need access to for your business, you are most likely to lose the right to
use these if the franchisor becomes insolvent. You may also lose access to
these if an administrator finds a buyer for the franchisor. That buyer may
not accept you as a franchisee.
This franchise is a commission agency. If the franchisor fails, you will not
receive any commission from the administrator or liquidator. Please
consider the impact of receiving no commission on your cash-flow and
make provision for it.
If you reach a mediated settlement where the franchisor has agreed to pay
you money, you would become an unsecured creditor for as much of that
sum as remains unpaid if the franchisor fails. This should put franchisees
on notice to require security from the franchisor or its directors for any
agreed compensation.
Over time ex ante warnings may lead to franchisors being more open to amend
their standard franchise contracts to level the failure part of the playing field. It may
also lead to banks that fund both a franchisor and its franchisees being more diligent
about managing the franchisor side of the ledger, preventing the franchisor from
excessive borrowing that might jeopardise the viability of the network.
659
Ibid 11.
In some states, under some of the tenancy models outlined in chapter 3.2.3 the
tenant may have the protection of retail leasing legislation while the franchisor is
solvent. Statutory protection is not uniform in existence or scope across Australia. A
franchisee will encounter the problems identified in chapter 3.2.3 and 4.4 if the
franchisor has not met its commitments to the landlord.
Alternatively, the landlord may have the terminated lease for non-payment of
the rent by franchisor. When the franchisee is a licensee or sub-lessee of the
franchisor, the franchisee pays its rent to the franchisor. The franchisor then pays its
rent to the landlord. In some situations the franchisor has received the franchisees’
rent, not paid it to the landlord, and the franchisee is unaware of this until the
landlord locks the franchisee out, after terminating the head lease for non-payment of
rent.
A possible solution is to amend all State and Territory retail leasing legislation
to follow the Ontario, Canada, approach that affords franchisees in such situations
the right to elect to become the lessee. 661 This situation is exemplified in the
60F
660
For example: in Kleins and Kernel’s Popcorn.
661
See Appendix A of this thesis.
662
2001 CanLII 28457 (ON SC)
<http://www.canlii.org/en/on/onsc/doc/2001/2001canlii28457/2001canlii28457.html> at 6 June
2010.
arrangement between the franchisee and the franchisor. The franchisor could
deprive franchisees of any statutory rights by, for example, taking a head
lease for five years, and then granting a licence to the franchisee for a short
term that would then deprive the franchisee of the protection offered to
tenants under the relevant state legislation. One way of resolving these
problems would be to redraft definitions in retail leasing legislation to
provide rights to premises to franchisees that can prove they have paid the
rent and outgoings in a timely way, even if the franchisor or other
intermediary has not passed the moneys on to the landlord. 663 62F
A solution that addresses the problem only through the Trade Practices Act
will be incomplete. It cannot provide adequate redress for franchisees whose
franchisor failed before franchisees had time to recoup their investment. It will not
bind liquidators. It also risks incentivising creditors to force administrators to quickly
pass through the administration stage and to propose the franchisor be wound up so
as to deprive franchisees of their newfound implied terms.
663
Buchan and Butcher, ‘Franchisees’ Retail Premises Occupancy Models in Australia: Factors for
Consideration’, above n 34, 175.
664
Ibid.
665
Companies Act 2006 (UK) ch 46, pt 10 A, Company's Directors, ch 2 General Duties of
Directors, The General Duties, In-Force Date: 1 October 2007; s 172 duty to promote the success
of the company.
(1) A director of a company must act in the way he considers, in good faith, would be most likely to
promote the success of the company for the benefit of its members as a whole, and in doing so
have regard (amongst other matters) to-
(a) the likely consequences of any decision in the long term,
(b) the interests of the company's employees,
(c) the need to foster the company's business relationships with suppliers, customers and others,
(d) the impact of the company's operations on the community and the environment,
(e) the desirability of the company maintaining a reputation for high standards of business conduct,
and
(f) the need to act fairly as between members of the company.
The guidelines are consistent with German case law. Before it was amended to
express duties more generally, Guideline (1) stated:
During the initial phase, when a franchisor starts to explain its franchise
opportunity, and during contract negotiations a pre-contractual relationship
with fiduciary duties emerges which obliges the parities to disclose whatever
information is essential for their future relationship. 6676F
come from the franchise agreement itself669 or from contract law governing it’. 670
68F 69F
(2) Where or to the extent that the purposes of the company consist of or include purposes other than
the benefit of its members, subsection (1) has effect as if the reference to promoting the success
of the company for the benefit of its members were to achieving those purposes.
(3) The duty imposed by this section has effect subject to any enactment or rule of law requiring
directors, in certain circumstances, to consider or act in the interests of creditors of the company.
666
European Franchise Federation, European Code of Ethics for Franchising <http://www.eff-
franchise.com/spip.php?rubrique13> at 6 March 2010.
667
DFV, DFV-Disclosure Guidelines
<http://www.franchiseverband.com/fileadmin/user_upload/MAIN-dateien/English/4-documents-
for-downloads-12_Disclosure_Guidelines.pdf> at 6 March 2010.
668
Frazey, above n 100, 728 quoting Steinberg and Lescatre, above note 13, 174, and fn 133.
The issue was raised but not resolved in the context of a solvent franchisor
Australia in Hoy Mobile Pty Ltd v Allphones Retail Pty Ltd (No 2). 671 670F
[t]he UST [United States Trustee] may also appoint additional committees of
creditors or equity security holders as the UST ‘deems appropriate.’ (11
U.S.C. 1102(a)(1)). This is important in a franchisor bankruptcy if
franchisees believe their interests are not adequately represented on the
Committee. Because franchisees may not have an actual liquidated claim
against the franchisor at the time of filing, they may not be included on the
list of twenty largest creditors and may not be solicited to serve on the
Committee. Yet, they have a large stake in the bankruptcy. Franchisees may
urge the UST to appoint a separate committee or petition the court to allow
the formation of a franchisee committee. 672 671F
669
Ibid 728 quoting Robert W Emerson, ‘Franchising and the Collective Rights of Franchisees’
(1990) 43 Vanerbildt Law Review 1503, 1509, n 21 (noting the franchisor usually drafts the
franchise agreement and that most obligations fall on the franchisee).
670
Ibid 729.
671
[2008] FCA 810.
672
Foster and Johnsen, above n 19, 20. Cases in which franchisee committees have been appointed:
In re Nutri/System, Inc, 169 BR 854 (Bankr EDPa 1994); In re First International Services Corp,
25 BR 66 (Bankr D Conn 1982); In re Rusty Jones, Inc, 128 BR 1001 (Bankr ND Ill 1991).
B1) Regulation should provide effective protection from serious risks and threats that
[franchisees as business] consumers cannot tackle as individuals.
B2) There should be accessible, timely and meaningful redress where consumer
detriment has occurred.
Benchmark B3 requires that the cost to the franchisor and the legal system of
meeting B1 and B2 should be less than the benefit to franchisees whose franchisor
fails. In order to assess this, a cost benefit analysis would be conducted.
[Cost benefit analysis] CBA is an analytical tool that can be used to assess
the benefits and costs of regulatory proposals. CBA involves examining
costs and benefits from the perspective of the community as a whole to help
identify the proposal with the highest net benefit. Where regulation is
designed to reduce the risk of physical or economic harm, a CBA should
include a risk analysis detailing how the regulation will change the
likelihood, frequency or consequences of an adverse event occurring. 673 672F
government policy requires that a CBA should be conducted, and identified that:
673
Australian Government, Department of Finance and Deregulation, Cost Benefit Analysis
<http://www.finance.gov.au/obpr/cost-benefit-analysis.html> at 7 March 2010.
674
Tyler Cowen, Using Cost-Benefit Analysis to Review Regulation (1998) George Mason
University Draft 2.
<http://www.gmu.edu/centers/publicchoice/faculty%20pages/Tyler/Cowen%20on%20cost%20be
nefit.pdf> at 8 March 2010.
the preferred option has the greatest net benefit for the community,
taking into account all the impacts (Australian Government 2007). 675
674F
6.4.1 STAKEHOLDERS
Disclosure is made only of the franchisor entity and the owner of the
intellectual property.
Lease:
675
Australian Government, Department of Finance and Regulation, Best Practice Regulation
Guidance Note: Decision Rules in Regulatory Cost-Benefit Analysis 1
<http://www.finance.gov.au/obpr/cost-benefit-analysis.html> at 7 March 2010.
676
Ibid. The benefit-cost ratio (BCR) of a project or regulation is the present value of the estimated
benefits divided by the present value of the estimated costs. In mathematical terms, it is expressed
as:
n n
BCR Bt 1 r C 1 r
t t
t
t 1 t 1
The decision rule when using BCR is:
accept a policy only if BCR>1; and
in deciding between alternative policies, select the one with the highest BCR.
The franchisor entity and related entities are dealt with separately on
franchisor insolvency.
Disclosure would contain fewer items provided by franchisor, plus data about
the franchisor that set it in its full context, provided by a credit agency such as Dunn
and Bradstreet. It would be more meaningful. Through improved disclosure, the
franchisor and its business would be placed in a meaningful context as whole
network would be demonstrated by chart with name and function of each entity.
Leo Dobes states ‘[t]here is no reason why the results of a [CBA]should not be
presented in a way that shows how various stakeholders are likely to be affected by a
government project or policy’. 677 As already stated, conducting a full regulatory cost
67F
My proposal for addressing B3 is that the stakeholders could be listed and the
costs and benefits of the present and the proposed ex ante regulatory solutions
summarised in a series of tables such as Table 8. Initially, separate tables would be
created for each strategy identified in Chapter 6 from ‘status quo through to amend
Corporations Act. Strategies could then be evaluated using the decision rules
identified in note 676.
677
Dobes, above n 599, 69.
678
Cowen, above n 674.
6.5 CONCLUSION
Non regulatory solutions such as providing better education for more people at
more stages of the business process, funding the foundation of a franchise union and
so on will not result in sufficient change to protect all franchisees whose franchisor
fails. Changes will only be effective at a legislated level. The changes proposed in
chapter 6.2 would meet the benchmarks and would require very little expenditure
once they were established. In the long run, franchise documents would be shorter
and yet more informative if a federal Franchise Contract Act were enacted that
contained the clauses recommended in 6.2.3.
Franchising, and the loss of wealth by franchisees who sign on with the wrong
franchisor, is a clear demonstration of property and contractual rights that are not
handled optimally by insolvency law.
679
The UNCITRAL Guide, above n 26, 19 recommends that the relationship between insolvency law
and other laws should be clear and, where possible, references to the other laws should be
included in the insolvency law.
680
Rohrbacher, above n 537.
To an extent this thesis is a response to Iain Ramsay’s 2005 call ‘for future
research on consumer law and policy’. 682 It demonstrates that the legal and economic
681F
[i]n the three and a half decades that have passed since the Trade Practices
Act transformed Australia’s consumer policy landscape, there have been a
range of new and significant contributions to economic, political and
psychological thinking that can usefully inform the way we engage in
consumer policy. 683
682F
This thesis build on Elizabeth Spencer’s 684 thesis where she demonstrated that
683F
franchise contracts are by and large not negotiable, relational, standard form
contracts. The findings here suggest that the approaches to consumer policy that
should change in the future are that:
681
Switzer, above n 1.
682
Ramsay, above n 329, 34.
683
Kennedy, above n 405, 10.
684
Spencer, The Regulation of the Franchise Relationship in Australia: A Contractual Analysis,
above n 14.
Any discrete frame does not present a full context. Viewed together, they are
compelling.
Final outcomes for consumers in economic and non-economic terms are the
ultimate arbiter of whether markets are failing or succeeding in terms of citizens’
expectations. Whilst it is undeniable that ‘the law cannot seek to correct all the
inequalities that inevitably affect contracting parties’, 685 policy makers credit
684F
franchisees with more foresight, power and negotiation skill than any single unit
franchisee has.
Business failure law does not acknowledge the franchisee, per se, as a
legitimate stakeholder, independent of its categorisation as a creditor in the
franchisor’s insolvency. The law currently provides no meaningful redress to
franchisees whose franchisor fails. This situation has arisen for a number of reasons;
The most fundamental reason why franchisor failure has not been
addressed in the context of consumer law is consumer policy is created on
the assumption that suppliers do not fail. Thus the consequences of a
supplier’s business entity’s failure do not become a consideration in
formulating consumer policy.
685
Thomas, above n 326, 383.
288
289
The fact that consumer protection and small business are dealt with by one
federal ministry and corporations and insolvency and personal bankruptcy
with another contributes to the respective regulators’ failure to understand
the complexity, causes, scope and results of the problem, and their ability
to deal with it.
who writes:
686
Martin J Bailey and Paul H Rubin, ‘A Positive Theory of Legal Change’ (1994) 14 International
Review of Law and Economics, 467-77.
687
Hadfield, ‘The Many Legal Institutions that Support Contractual Commitment’, above n 22, 198.
289
290
It would be useful to have accurate numbers of franchisors that fail. They could
then be categorised, and specific effects of franchisor failure on franchisees of
specific categories could be identified. This would help not only future franchisees in
making purchasing decisions but also suppliers such as banks to price loan products
with greater precision. Currently no ‘risk profile’ exists of a franchisor that is likely
to fail. Until this is in place it will not be possible for possible effects to be predicted
688
Michael Le Page, ‘Beware of Common Sense’ (2009) 203(2725) New Scientist 32.
290
291
other than on a case by case basis. With better base data it might be possible for
insurers to offer insurance products based on informed analysis.
Researchers have often noted the conflicts of interest that arise between the
franchisor and its franchisees. The Code attempts to mitigate the effects of conflicts
of interest, but they still exist. Conflicts that exist pre and post insolvency, and ways
of addressing them satisfactorily, would be a worthwhile research project in law and
economics.
As was seen in chapter 3.2.2, the current way of expressing the value of
registered intellectual property rights in company accounts can be misleading and
inaccurate for business consumers such as franchisees who are attempting to test the
franchisors’ claims about the value of specific trade marks. There is room for the
accounting profession to revisit the methodology for valuing trade marks and other
items of intellectual property for the purposes of reporting in annual returns.
It was also speculated that cultural cringe and the ‘halo effect’ impact on eh
amount and depth of due diligence conducted by prospective franchisees on foreign
based or well established local brands. This would be an interesting topic for future
research.
7.2.4 CONTRACTS
This issue arose in the context of the Kleins insolvency in chapter 2.1.4. Here,
the bank that actively promoted Kleins to franchisees as an accredited franchise
system possibly knew of the parlous state of the Kleins franchisor’s finances. If it
did, it is arguable that it was unconscionable for the bank to continue to lend to new
franchisees as the bank is thereby spreading its own risk in a situation where the
franchisees trusted the bank’s evaluation of the system. Internal bank processes could
be studied to promote improved communication between the people conducting
accreditation of franchisors and the people making lending decisions.
291
292
Sir Kenneth Cork wrote: ‘changes in ... the commercial life of the community
since the Nineteenth Century require the law of insolvency to be reviewed and
refashioned to meet the needs of our own time’. 689 A solution to the problems raised
68F
689
Cork, above n 252, 9.
292
293
This thesis does not explore the franchisees’ optimal place within the
insolvency regime. Nevertheless, it provides an opportunity to examine the position
of franchisees from the viewpoint of insolvency law principles. These are broadly
stated in the UNCITRAL Guide which states that;
[s]ince an insolvency regime cannot fully protect the interests of all parties,
some of the key policy choices to be made when designing an insolvency
law relate to defining the goals of the insolvency law and achieving the
desired balance between its eight key objectives. 690
689F
The UNCITRAL principles are listed below with comments on how those
goals fit with the circumstances of franchisor insolvency.
690
United Nations Commission on International Trade Law, Draft Legislative Guide on Insolvency
Law (2003) 1-2, 6.
293
294
favour a timely resolution of the insolvency means that franchisees’ potential claims
cannot realistically be pursued through the courts.
Australian franchisors. Although being exposed to more than one economy can be a
sound risk management strategy for a franchisor, operating across national borders
does not guarantee the franchisor will remain solvent. Cross border insolvency issues
arise if the franchisor or a national master franchisor, or the owner of the trade marks
becomes insolvent. This leaves individual franchisees vulnerable. They are
potentially unable to protect their investment and without rights under the franchise
agreement. The franchise agreement between the franchisee and the national master
franchisee does not have to be novated to the overseas franchisor.
691
Philip R Wood, Principles of International Insolvency (1995) 41.
692
Jenvey, above n 123, 2.
693
Frazer, Weaven and Wright Franchising Australia 2006, above n 11, 66.
294
295
problem of franchisees in their franchisors insolvency had been resolved within the
law elsewhere, and might provide guidance for Australia. It was found that there is
no consistency, and in most jurisdictions, no provision for these franchisees. The
responses are shown in Appendix C. The lack of a consistent approach is not of
overwhelming concern if a franchise network stays within one jurisdiction; it
becomes an issue when issues like the law of the contract are necessary to resolve.
This research has been conducted through the lens of the law. The law alone
cannot provide an understanding of or a solution to all of the problems franchisees
whose franchisor has failed will experience. Future research areas leading from this
basic research are numerous. Researchers in the fields of psychology, economics,
and accounting can add texture to this legal analysis.
694
Appendix C of this thesis was created from a survey conducted for the author by the International
Bar Association (IBA). The IBA distributed the survey by email to all members of its Creditors
Rights and International Franchising Committees. Legal practitioners and law academics from the
following countries responded: Argentina; Australia; Belgium; British Virgin Islands; Canada;
Colombia; Denmark; England; Finland; France; Germany; Greece; India; Republic of Ireland;
Republic of Korea; Mexico; the Netherlands; New Zealand; Nigeria; Spain; Sweden;
Switzerland; Syria; United Kingdom; United States of America and Vietnam. The responses have
not been verified and should be regarded as indicative only.
295
Appendices
_______________________________________________________________
Corporations Act 2001 (Cth)
http://www.comlaw.gov.au/ComLaw/Legislation/ActCompilation1.nsf/0/084B0D33
FA61F4BCCA25766D000D8A4F?OpenDocument
(1) One entity (the associate) is an associated entity of another entity (the principal) if
subsection (2), (3), (4), (5), (6) or (7) is satisfied.
(2) This subsection is satisfied if the associate and the principal are related bodies
corporate.
(8) For the purposes of this section, one entity (the first entity) has a qualifying investment
in another entity (the second entity) if the first entity:
(a) has an asset that is an investment in the second entity; or
(b) has an asset that is the beneficial interest in an investment in the second entity and
has control over that asset.
50AA Control
(1) For the purposes of this Act, an entity controls a second entity if the first entity has the
capacity to determine the outcome of decisions about the second entity’s financial and
operating policies.
(3) The first entity does not control the second entity merely because the first entity and a
third entity jointly have the capacity to determine the outcome of decisions about the
second entity’s financial and operating policies.
(1) A person is solvent if, and only if, the person is able to pay all the person’s debts, as and
when they become due and payable.
Basic contents
Financial statements
298 Appendices
299
(c) any other information necessary to give a true and fair view (see section 297).
Directors’ declaration
295A Declaration in relation to listed entity’s financial statements by chief executive officer and
chief financial officer
(1) If the company, disclosing entity or registered scheme is listed, the directors’
declaration under subsection 295(4) must be made only after each person who performs:
(a) a chief executive function; or
(b) a chief financial officer function;
in relation to the company, disclosing entity or registered scheme has given the directors
a declaration under subsection (2) of this section.
(4) A person performs a chief executive function in relation to the company, disclosing
entity or registered scheme if the person is the person who is primarily and directly
responsible to the directors for the general and overall management of the company,
disclosing entity or registered scheme.
(5) If there is no one person who performs a chief executive function in relation to the
company, disclosing entity or registered scheme under subsection (4), a person performs
Appendices 299
300
(6) A person performs a chief financial officer function in relation to the company,
disclosing entity or registered scheme if that person is the person who is:
(a) primarily responsible for financial matters in relation to the company, disclosing
entity or registered scheme; and
(b) directly responsible for those matters to either:
(i) the directors; or
(ii) the person or persons who perform the chief executive function in relation
to the company.
(7) If there is no one person who performs a chief financial officer function in relation to
the company, disclosing entity or registered scheme under subsection (6), a person
performs a chief financial officer function in relation to the company, disclosing entity
or registered scheme if the person is one of a number of people who together are:
(a) primarily responsible for financial matters in relation to the company, disclosing
entity or registered scheme; and
(b) directly responsible for those matters to either:
(i) the directors; or
(ii) the person or persons who perform the chief executive function in relation
to the company.
(8) Nothing in this section derogates from the responsibility that a director has for ensuring
that financial statements comply with this Act.
(1) The financial report for a financial year must comply with the accounting standards.
However, a small proprietary company’s report does not have to comply with particular
accounting standards if:
(a) the report is prepared in response to a shareholder direction under section 293;
and
(b) the direction specifies that the report does not have to comply with those
accounting standards.
(2) The financial report must comply with any further requirements in the regulations.
The financial statements and notes for a financial year must give a true and fair view of:
(a) the financial position and performance of the company, registered scheme or
disclosing entity; and
(b) if consolidated financial statements are required—the financial position and
performance of the consolidated entity.
This section does not affect the obligation under section 296 for a financial report to
comply with accounting standards.
Note: If the financial statements and notes prepared in compliance with the
accounting standards would not give a true and fair view, additional
information must be included in the notes to the financial statements under
paragraph 295(3)(c).
300 Appendices
301
(b) may carry on that business and manage that property and those affairs; and
(c) may terminate or dispose of all or part of that business, and may dispose of any
of that property; and
(d) may perform any function, and exercise any power, that the company or any of
its officers could perform or exercise if the company were not under administration.
(2) Nothing in subsection (1) limits the generality of anything else in it.
437 B
When performing a function, or exercising a power, as administrator of a company
under administration, the administrator is taken to be acting as the company’s agent.
(1) The administrator of a company under administration must convene a meeting of the
company’s creditors within the convening period as fixed by subsection (5) or extended
under subsection (6).
Note: For body corporate representatives’ powers at a meeting of the company’s
creditors, see section 250D.
(2) The meeting must be held within 5 business days before, or within 5 business days after,
the end of the convening period.
(4) The notice given to a creditor under paragraph (3)(a) must be accompanied by a copy
of:
(a) a report by the administrator about the company’s business, property, affairs and
financial circumstances; and
(b) a statement setting out the administrator’s opinion about each of the following
matters:
(i) whether it would be in the creditors’ interests for the company to execute a
deed of company arrangement;
(ii) whether it would be in the creditors’ interests for the administration to end;
(iii) whether it would be in the creditors’ interests for the company to be wound
up;
and also setting out:
(iv) his or her reasons for those opinions; and
(v) such other information known to the administrator as will enable the
creditors to make an informed decision about each matter covered by
subparagraph (i), (ii) or (iii); and
(c) if a deed of company arrangement is proposed—a statement setting out details of
the proposed deed.
Note: For electronic notification, see section 600G.
Appendices 301
302
(6) The Court may extend the convening period on an application made during or after the
period referred to in paragraph (5)(a) or (b), as the case requires.
(7) If an application is made under subsection (6) after the period referred to in
paragraph (5)(a) or (b), as the case may be, the Court may only extend the convening
period if the Court is satisfied that it would be in the best interests of the creditors if the
convening period were extended in accordance with the application.
(8) If an application is made under subsection (6) after the period referred to in
paragraph (5)(a) or (b), as the case may be, then, in making an order about the costs of
the application, the Court must have regard to:
(a) the fact that the application was made after that period; and
(b) any other conduct engaged in by the administrator; and
(c) any other relevant matters.
(2) A meeting convened under section 439A may be adjourned from time to time, but the
period of the adjournment, or the total of the periods of adjournment, must not exceed
45 business days.
(1) During the administration of a company, a proceeding in a court against the company or
in relation to any of its property cannot be begun or proceeded with, except:
(a) with the administrator’s written consent; or
(b) with the leave of the Court and in accordance with such terms (if any) as the
Court imposes.
302 Appendices
303
(2) The liquidator may also, if he or she thinks fit, lodge further reports specifying any
other matter that, in his or her opinion, it is desirable to bring to the notice of ASIC.
(1) Where a contract of employment with a company being wound up was subsisting
immediately before the relevant date, the employee under the contract is, whether or not
he or she is a person referred to in subsection (2), entitled to payment under section 556
as if his or her services with the company had been terminated by the company on the
relevant date.
(2) Where, for the purposes of the winding up of a company, a liquidator employs a person
whose services with the company had been terminated by reason of the winding up, that
person is, for the purpose of calculating any entitlement to payment for leave of
absence, or any entitlement to a retrenchment amount in respect of employment, taken,
while the liquidator employs him or her for those purposes, to be employed by the
company.
(3) Subject to subsection (4), where, after the relevant date, an amount in respect of long
service leave or extended leave, or a retrenchment amount, becomes payable to a person
Appendices 303
304
referred to in subsection (2) in respect of the employment so referred to, the amount is a
cost of the winding up.
(4) Where, at the relevant date, the length of qualifying service of a person employed by a
company that is being wound up is insufficient to entitle him or her to any amount in
respect of long service leave or extended leave, or to any retrenchment amount in
respect of employment by the company, but, by the operation of subsection (2) he or she
becomes entitled to such an amount after that date, that amount:
(a) is a cost of the winding up to the extent of an amount that bears to that amount the
same proportion as the length of his or her qualifying service after that relevant
date bears to the total length of his or her qualifying service; and
(b) is, to the extent of the balance of that amount, taken, for the purposes of
section 556, to be an amount referred to in paragraph 556(1)(g), or a retrenchment
payment payable to the person, as the case may be.
_________________________________________________________________________________
Object
(1) The object of this section is to make certain business capital expenditure deductible over
5 years if:
(a) the expenditure is not otherwise taken into account; and
(b) a deduction is not denied by some other provision; and
(c) the business is, was or is proposed to be carried on for a taxable purpose.
Note: If Division 250 applies to you and an asset:
(a) if section 250-150 applies—you can deduct an amount for capital
expenditure you incur in relation to the asset to the extent specified in a
determination made under subsection 250-150(3); or
(b) otherwise—you cannot deduct an amount for such expenditure.
Deduction
(2) You can deduct, in equal proportions over a period of 5 income years starting in the
year in which you incur it, capital expenditure you incur:
(a) in relation to your business; or
(b) in relation to a business that used to be carried on; or
(c) in relation to a business proposed to be carried on; or
(d) to liquidate or deregister a company of which you were a member, to wind up a
partnership of which you were a partner or to wind up a trust of which you were a
beneficiary, that carried on a business.
(3) You can only deduct the expenditure, for a business that you carry on, used to carry on
or propose to carry on, to the extent that the business is carried on, was carried on or is
proposed to be carried on for a taxable purpose.
(4) You can only deduct the expenditure, for a business that another entity used to carry on
or proposes to carry on, to the extent that:
(a) the business was carried on or is proposed to be carried on for a taxable purpose;
and
304 Appendices
305
(5) You cannot deduct anything under this section for an amount of expenditure you incur
to the extent that:
(a) it forms part of the cost of a depreciating asset that you hold, used to hold or will
hold; or
(b) you can deduct an amount for it under a provision of this Act other than this
section; or
(c) it forms part of the cost of land; or
(d) it is in relation to a lease or other legal or equitable right; or
(e) it would, apart from this section, be taken into account in working out:
(i) a profit that is included in your assessable income (for example, under
section 6-5 or 15-15); or
(ii) a loss that you can deduct (for example, under section 8-1 or 25-40); or
(f) it could, apart from this section, be taken into account in working out the amount
of a capital gain or capital loss from a CGT event; or
(g) a provision of this Act other than this section would expressly make the
expenditure non-deductible if it were not of a capital nature; or
(h) a provision of this Act other than this section expressly prevents the expenditure
being taken into account as described in paragraphs (a) to (f) for a reason other
than the expenditure being of a capital nature; or
(i) it is expenditure of a private or domestic nature; or
(j) it is incurred in relation to gaining or producing exempt income or non-assessable
non-exempt income.
(6) The exceptions in paragraphs (5)(d) and (f) do not apply to expenditure you incur to
preserve (but not enhance) the value of goodwill if the expenditure you incur is in
relation to a legal or equitable right and the value to you of the right is solely
attributable to the effect that the right has on goodwill.
(7) You cannot deduct an amount under paragraph (2)(c) in relation to a business proposed
to be carried on unless, having regard to any relevant circumstances, it is reasonable to
conclude that the business is proposed to be carried on within a reasonable time.
(8) You cannot deduct anything under this section for an amount of expenditure that,
because of a market value substitution rule, was excluded from the cost of a
depreciating asset or the cost base or reduced cost base of a CGT asset.
Note: Some examples of market value substitution rules are subsection 40-180(2)
(table item 8), subsection 40-190(3) (table item 1) and sections 40-765 and
112-20.
(9) You cannot deduct anything under this section for an amount of expenditure you incur:
(a) by way of returning an amount you have received (except to the extent that the
amount was included in your assessable income or taken into account in working
out an amount so included); or
(b) to the extent that, for another entity, the amount is a return on or of:
(i) an equity interest; or
(ii) a debt interest that is an obligation of yours.
__________________________________________________________________________________
Appendices 305
306
306 Appendices
307
Appendices 307
308
The object of this Act is to enhance the welfare of Australians through the promotion of
competition and fair trading and provision for consumer protection.
4B Consumers
(1) For the purposes of this Act, unless the contrary intention appears:
(a) a person shall be taken to have acquired particular goods as a consumer if, and
only if:
(i) the price of the goods did not exceed the prescribed amount; or
(ii) where that price exceeded the prescribed amount—the goods were of a kind
ordinarily acquired for personal, domestic or household use or consumption
or the goods consisted of a commercial road vehicle;
and the person did not acquire the goods, or hold himself or herself out as
acquiring the goods, for the purpose of
re-supply or for the purpose of using them up or transforming them, in trade or
commerce, in the course of a process of production or manufacture or of repairing
or treating other goods or fixtures on land; and
(b) a person shall be taken to have acquired particular services as a consumer if, and
only if:
(i) the price of the services did not exceed the prescribed amount; or
(ii) where that price exceeded the prescribed amount—the services were of a
kind ordinarily acquired for personal, domestic or household use or
consumption.
308 Appendices
309
(ii) if, at the time of the acquisition, the goods or services were not available for
purchase from the supplier or were so available only together with other
property or services but, at that time, goods or services of the kind acquired
were available for purchase from another supplier—the lowest price at
which the person could, at that time, reasonably have purchased goods or
services of that kind from another supplier; or
(iii) if goods or services of the kind acquired were not available, at the time of
the acquisition, for purchase from any supplier or were not so available
except together with other property or services—the value of the goods or
services at that time; and
(e) without limiting by implication the meaning of the expression services in
subsection 4(1), the obtaining of credit by a person in connection with the
acquisition of goods or services by him or her shall be deemed to be the
acquisition by him or her of a service and any amount by which the amount paid
or payable by him or her for the goods or services is increased by reason of his or
her so obtaining credit shall be deemed to be paid or payable by him or her for
that service.
(3) Where it is alleged in any proceeding under this Act or in any other proceeding in
respect of a matter arising under this Act that a person was a consumer in relation to
particular goods or services, it shall be presumed, unless the contrary is established, that
the person was a consumer in relation to those goods or services.
(4) In this section, commercial road vehicle means a vehicle or trailer acquired for use
principally in the transport of goods on public roads.
Appendices 309
310
(3) Without in any way limiting the matters to which the court may have regard for the
purpose of determining whether a corporation or a person (the supplier) has
contravened subsection (1) or (2) in connection with the supply or possible supply of
goods or services to a person or a corporation (the business consumer), the court may
have regard to:
(a) the relative strengths of the bargaining positions of the supplier and the business
consumer; and
(b) whether, as a result of conduct engaged in by the supplier, the business consumer
was required to comply with conditions that were not reasonably necessary for
the protection of the legitimate interests of the supplier; and
(c) whether the business consumer was able to understand any documents relating to
the supply or possible supply of the goods or services; and
(d) whether any undue influence or pressure was exerted on, or any unfair tactics
were used against, the business consumer or a person acting on behalf of the
business consumer by the supplier or a person acting on behalf of the supplier in
relation to the supply or possible supply of the goods or services; and
(e) the amount for which, and the circumstances under which, the business consumer
could have acquired identical or equivalent goods or services from a person other
than the supplier; and
(f) the extent to which the supplier’s conduct towards the business consumer was
consistent with the supplier’s conduct in similar transactions between the supplier
and other like business consumers; and
(g) the requirements of any applicable industry code; and
(h) the requirements of any other industry code, if the business consumer acted on the
reasonable belief that the supplier would comply with that code; and
(i) the extent to which the supplier unreasonably failed to disclose to the business
consumer:
(i) any intended conduct of the supplier that might affect the interests of the
business consumer; and
(ii) any risks to the business consumer arising from the supplier’s intended
conduct (being risks that the supplier should have foreseen would not be
apparent to the business consumer); and
(j) the extent to which the supplier was willing to negotiate the terms and conditions
of any contract for supply of the goods or services with the business consumer;
and
(ja) whether the supplier has a contractual right to vary unilaterally a term or
condition of a contract between the supplier and the business consumer for the
supply of the goods or services; and
(k) the extent to which the supplier and the business consumer acted in good faith.
(4) Without in any way limiting the matters to which the court may have regard for the
purpose of determining whether a corporation or a person (the acquirer) has
contravened subsection (1) or (2) in connection with the acquisition or possible
acquisition of goods or services from a person or corporation (the small business
supplier), the court may have regard to:
(a) the relative strengths of the bargaining positions of the acquirer and the small
business supplier; and
310 Appendices
311
(b) whether, as a result of conduct engaged in by the acquirer, the small business
supplier was required to comply with conditions that were not reasonably
necessary for the protection of the legitimate interests of the acquirer; and
(c) whether the small business supplier was able to understand any documents
relating to the acquisition or possible acquisition of the goods or services; and
(d) whether any undue influence or pressure was exerted on, or any unfair tactics
were used against, the small business supplier or a person acting on behalf of the
small business supplier by the acquirer or a person acting on behalf of the
acquirer in relation to the acquisition or possible acquisition of the goods or
services; and
(e) the amount for which, and the circumstances in which, the small business supplier
could have supplied identical or equivalent goods or services to a person other
than the acquirer; and
(f) the extent to which the acquirer’s conduct towards the small business supplier
was consistent with the acquirer’s conduct in similar transactions between the
acquirer and other like small business suppliers; and
(g) the requirements of any applicable industry code; and
(h) the requirements of any other industry code, if the small business supplier acted
on the reasonable belief that the acquirer would comply with that code; and
(i) the extent to which the acquirer unreasonably failed to disclose to the small
business supplier:
(i) any intended conduct of the acquirer that might affect the interests of the
small business supplier; and
(ii) any risks to the small business supplier arising from the acquirer’s intended
conduct (being risks that the acquirer should have foreseen would not be
apparent to the small business supplier); and
(j) the extent to which the acquirer was willing to negotiate the terms and conditions
of any contract for the acquisition of the goods and services with the small
business supplier; and
(ja) whether the acquirer has a contractual right to vary unilaterally a term or
condition of a contract between the acquirer and the small business supplier for
the acquisition of the goods or services; and
(k) the extent to which the acquirer and the small business supplier acted in good
faith.
(5) A person is not to be taken for the purposes of this section to engage in unconscionable
conduct in connection with:
(a) the supply or possible supply of goods or services to another person; or
(b) the acquisition or possible acquisition of goods or services from another person;
by reason only that the first-mentioned person institutes legal proceedings in relation to
that supply, possible supply, acquisition or possible acquisition or refers to arbitration a
dispute or claim in relation to that supply, possible supply, acquisition or possible
acquisition.
(6) For the purpose of determining whether a corporation has contravened subsection (1) or
whether a person has contravened subsection (2):
(a) the court must not have regard to any circumstances that were not reasonably
foreseeable at the time of the alleged contravention; and
(b) the court may have regard to circumstances existing before the commencement of
this section but not to conduct engaged in before that commencement.
(7) A reference in this section to the supply or possible supply of goods or services is a
reference to the supply or possible supply of goods or services to a person whose
acquisition or possible acquisition of the goods or services is or would be for the
purpose of trade or commerce.
(8) A reference in this section to the acquisition or possible acquisition of goods or services
is a reference to the acquisition or possible acquisition of goods or services by a person
Appendices 311
312
whose acquisition or possible acquisition of the goods or services is or would be for the
purpose of trade or commerce.
(12) Section 51A applies for the purposes of this section in the same way as it applies for the
purposes of Division 1 of Part V.
(13) Expressions used in this section that are defined for the purpose of Part IVB have the
same meaning in this section as they do in Part IVB.
(14) In this section, listed public company has the same meaning as it has in the Income Tax
Assessment Act 1997.
51A Interpretation
(1) For the purposes of this Division, where a corporation makes a representation with
respect to any future matter (including the doing of, or the refusing to do, any act) and
the corporation does not have reasonable grounds for making the representation, the
representation shall be taken to be misleading.
(2) For the purposes of the application of subsection (1) in relation to a proceeding
concerning a representation made by a corporation with respect to any future matter, the
corporation shall, unless it adduces evidence to the contrary, be deemed not to have had
reasonable grounds for making the representation.
(3) Subsection (1) shall be deemed not to limit by implication the meaning of a reference in
this Division to a misleading representation, a representation that is misleading in a
material particular or conduct that is misleading or is likely or liable to mislead.
(1) A corporation shall not, in trade or commerce, engage in conduct that is misleading or
deceptive or is likely to mislead or deceive.
(2) Nothing in the succeeding provisions of this Division shall be taken as limiting by
implication the generality of subsection (1).
Note: For rules relating to representations as to the country of origin of goods, see
Division 1AA (sections 65AA to 65AN).
(1) A corporation shall not, in trade or commerce, make a representation that is false or
misleading in a material particular concerning the profitability or risk or any other
material aspect of any business activity that the corporation has represented as one that
can be, or can be to a considerable extent, carried on at or from a person’s place of
residence.
312 Appendices
313
(b) a reference to a contract does not include a reference to a contract made before
the commencing date;
(c) a reference to antecedent negotiations in relation to a contract for the supply by a
corporation of goods to a consumer is a reference to any negotiations or
arrangements conducted or made with the consumer by another person in the
course of a business carried on by the other person whereby the consumer was
induced to make the contract or which otherwise promoted the transaction to
which the contract relates; and
(d) a reference to the person by whom any antecedent negotiations were conducted is
a reference to the person by whom the negotiations or arrangements concerned
were conducted or made.
(2) Goods of any kind are of merchantable quality within the meaning of this Division if
they are as fit for the purpose or purposes for which goods of that kind are commonly
bought as it is reasonable to expect having regard to any description applied to them, the
price (if relevant) and all the other relevant circumstances.
(1) In every contract for the supply of goods by a corporation to a consumer, other than a
contract to which subsection (3) applies, there is:
(a) an implied condition that, in the case of a supply by way of sale, the supplier has
a right to sell the goods, and, in the case of an agreement to sell or a hire-purchase
agreement, the supplier will have a right to sell the goods at the time when the
property is to pass;
(b) an implied warranty that the consumer will enjoy quiet possession of the goods
except so far as it may lawfully be disturbed by the supplier or by another person
who is entitled to the benefit of any charge or encumbrance disclosed or known to
the consumer before the contract is made; and
(c) in the case of a contract for the supply of goods under which the property is to
pass or may pass to the consumer—an implied warranty that the goods are free,
and will remain free until the time when the property passes, from any charge or
encumbrance not disclosed or known to the consumer before the contract is made.
(2) A corporation is not, in relation to a contract for the supply of goods, in breach of the
implied warranty referred to in paragraph (1)(c) by reason only of the existence of a
floating charge over assets of the corporation unless and until the charge becomes fixed
and enforceable by the person to whom the charge is given.
(3) In a contract for the supply of goods by a corporation to a consumer in the case of which
there appears from the contract or is to be inferred from the circumstances of the
contract an intention that the supplier should transfer only such title as he or she or a
third person may have, there is:
(a) an implied warranty that all charges or encumbrances known to the supplier and
not known to the consumer have been disclosed to the consumer before the
contract is made; and
(b) an implied warranty that:
(i) the supplier;
(ii) in a case where the parties to the contract intend that the supplier should
transfer only such title as a third person may have—that person; and
(iii) anyone claiming through or under the supplier or that third person otherwise
than under a charge or encumbrance disclosed or known to the consumer
before the contract is made;
will not disturb the consumer’s quiet possession of the goods.
Appendices 313
314
70 Supply by description
(1) Where there is a contract for the supply (otherwise than by way of sale by auction) by a
corporation in the course of a business of goods to a consumer by description, there is
an implied condition that the goods will correspond with the description, and, if the
supply is by reference to a sample as well as by description, it is not sufficient that the
bulk of the goods corresponds with the sample if the goods do not also correspond with
the description.
(2) A supply of goods is not prevented from being a supply by description for the purposes
of subsection (1) by reason only that, being exposed for sale or hire, they are selected by
the consumer.
(1) Where a corporation supplies (otherwise than by way of sale by auction) goods to a
consumer in the course of a business, there is an implied condition that the goods
supplied under the contract for the supply of the goods are of merchantable quality,
except that there is no such condition by virtue only of this section:
(a) as regards defects specifically drawn to the consumer’s attention before the
contract is made; or
(b) if the consumer examines the goods before the contract is made, as regards
defects which that examination ought to reveal.
(2) Where a corporation supplies (otherwise than by way of sale by auction) goods to a
consumer in the course of a business and the consumer, expressly or by implication,
makes known to the corporation or to the person by whom any antecedent negotiations
are conducted any particular purpose for which the goods are being acquired, there is an
implied condition that the goods supplied under the contract for the supply of the goods
are reasonably fit for that purpose, whether or not that is a purpose for which such
goods are commonly supplied, except where the circumstances show that the consumer
does not rely, or that it is unreasonable for him or her to rely, on the skill or judgment of
the corporation or of that person.
(3) Subsections (1) and (2) apply to a contract for the supply of goods made by a person
who in the course of a business is acting as agent for a corporation as they apply to a
contract for the supply of goods made by a corporation in the course of a business,
except where that corporation is not supplying in the course of a business and either the
consumer knows that fact or reasonable steps are taken to bring it to the notice of the
consumer before the contract is made.
72 Supply by sample
Where in a contract for the supply (otherwise than by way of sale by auction) by a
corporation in the course of a business of goods to a consumer there is a term in the
contract, expressed or implied, to the effect that the goods are supplied by reference to a
sample:
(a) there is an implied condition that the bulk will correspond with the sample in
quality;
(b) there is an implied condition that the consumer will have a reasonable opportunity
of comparing the bulk with the sample; and
(c) there is an implied condition that the goods will be free from any defect,
rendering them unmerchantable, that would not be apparent on reasonable
examination of the sample.
314 Appendices
315
(1) In every contract for the supply by a corporation in the course of a business of services
to a consumer there is an implied warranty that the services will be rendered with due
care and skill and that any materials supplied in connexion with those services will be
reasonably fit for the purpose for which they are supplied.
(2) Where a corporation supplies services (other than services of a professional nature
provided by a qualified architect or engineer) to a consumer in the course of a business
and the consumer, expressly or by implication, makes known to the corporation any
particular purpose for which the services are required or the result that he or she desires
the services to achieve, there is an implied warranty that the services supplied under the
contract for the supply of the services and any materials supplied in connexion with
those services will be reasonably fit for that purpose or are of such a nature and quality
that they might reasonably be expected to achieve that result, except where the
circumstances show that the consumer does not rely, or that it is unreasonable for him
or her to rely, on the corporation’s skill or judgment.
(2A) If:
(a) there is a breach of an implied warranty that exists because of this section in a
contract made after the commencement of this subsection; and
(b) the law of a State or Territory is the proper law of the contract;
the law of the State or Territory applies to limit or preclude liability for the breach, and
recovery of that liability (if any), in the same way as it applies to limit or preclude
liability, and recovery of a liability, for breach of another term of the contract.
(3) A reference in this section to services does not include a reference to services that are,
or are to be, provided, granted or conferred under:
(a) a contract for or in relation to the transportation or storage of goods for the
purposes of a business, trade, profession or occupation carried on or engaged in
by the person for whom the goods are transported or stored; or
(b) a contract of insurance.
Division 2A—Actions against manufacturers and importers of goods
74A Interpretation
Appendices 315
316
(b) a reference to the quality of goods includes a reference to the state or condition of
the goods;
(c) a reference to antecedent negotiations in relation to the acquisition of goods by a
consumer shall be read as a reference to any negotiations or arrangements
conducted or made with the consumer by another person in the course of a
business carried on by the other person whereby the consumer was induced to
acquire the goods or which otherwise promoted the acquisition of the goods by
the consumer; and
(d) a reference to the person by whom any antecedent negotiations were conducted
shall be read as a reference to the person by whom the negotiations or
arrangements concerned were conducted or made.
(3) If:
(a) a corporation holds itself out to the public as the manufacturer of goods;
(b) a corporation causes or permits the name of the corporation, a name by which the
corporation carries on business or a brand or mark of the corporation to be
applied to goods supplied by the corporation; or
(c) a corporation causes or permits another person, in connexion with the supply or
possible supply of goods by that other person, or in connexion with the promotion
by that other person by any means of the supply or use of goods, to hold out the
corporation to the public as the manufacturer of the goods;
the corporation shall be deemed, for the purposes of this Division, to have manufactured
the goods.
(4) If:
(a) goods are imported into Australia by a corporation that was not the manufacturer
of the goods; and
(b) at the time of the importation the manufacturer of the goods does not have a place
of business in Australia;
the corporation shall be deemed, for the purposes of this Division, to have manufactured
the goods.
(6) The reference in subsection (5) to a covering includes a reference to a stopper, glass,
bottle, vessel, box, capsule, case, frame or wrapper and the reference in that subsection
to a label includes a reference to a band or ticket.
(7) If goods are imported into Australia on behalf of a corporation, the corporation shall be
deemed, for the purposes of this Division, to have imported the goods into Australia.
(8) For the purposes of this Division, goods shall be taken to be supplied to a consumer
notwithstanding that, at the time of the supply, they are affixed to land or premises.
(1) Where:
316 Appendices
317
(b) a person (whether or not the person who acquired the goods from the corporation)
supplies the goods (otherwise than by way of sale by auction) to a consumer;
(c) the goods are acquired by the consumer for a particular purpose that was,
expressly or by implication, made known to the corporation, either directly, or
through the person from whom the consumer acquired the goods or a person by
whom any antecedent negotiations in connexion with the acquisition of the goods
were conducted;
(d) the goods are not reasonably fit for that purpose, whether or not that is a purpose
for which such goods are commonly supplied; and
(e) the consumer or a person who acquires the goods from, or derives title to the
goods through or under, the consumer suffers loss or damage by reason that the
goods are not reasonably fit for that purpose;
the corporation is liable to compensate the consumer or that other person for the loss or
damage and the consumer or that other person may recover the amount of the
compensation by action against the corporation in a court of competent jurisdiction.
(2) Subsection (1) does not apply:
(a) if the goods are not reasonably fit for the purpose referred to in that subsection by
reason of:
(i) an act or default of any person (not being the corporation or a servant or
agent of the corporation); or
(ii) a cause independent of human control;
occurring after the goods have left the control of the corporation; or
(b) where the circumstances show that the consumer did not rely, or that it was
unreasonable for the consumer to rely, on the skill or judgment of the corporation.
(1) Where:
(a) a corporation, in trade or commerce, supplies goods manufactured by the
corporation to another person who acquires the goods for re-supply;
(b) a person (whether or not the person who acquired the goods from the corporation)
supplies the goods (otherwise than by way of sale by auction) to a consumer by
description;
(c) the goods do not correspond with the description; and
(d) the consumer or a person who acquires the goods from, or derives title to the
goods through or under, the consumer suffers loss or damage by reason that the
goods do not correspond with the description;
the corporation is liable to compensate the consumer or that other person for the loss or
damage and the consumer or that other person may recover the amount of the
compensation by action against the corporation in a court of competent jurisdiction.
(2) Subsection (1) does not apply if the goods do not correspond with the description
referred to in that subsection by reason of:
(a) an act or default of any person (not being the corporation or a servant or agent of
the corporation); or
(b) a cause independent of human control;
occurring after the goods have left the control of the corporation.
(3) A corporation is not liable to compensate a person for loss or damage suffered by the
person by reason that goods do not correspond with a description unless the description
was applied to the goods:
(a) by or on behalf of the corporation; or
(b) with the consent of the corporation, whether express or implied.
Appendices 317
318
(4) If the goods referred to in subsection (1) are supplied to the consumer by reference to a
sample as well as by description, it is not a defence to an action under this section that
the bulk of the goods corresponds with the sample if the goods do not also correspond
with the description.
(5) A supply of goods is not prevented from being a supply by description for the purposes
of subsection (1) by reason only that, being exposed for sale or hire, they are selected by
the consumer.
75B Interpretation
(1) A reference in this Part to a person involved in a contravention of a provision of Part IV,
IVA, IVB, V or VC, or of section 75AU, 75AYA or 95AZN, shall be read as a
reference to a person who:
(a) has aided, abetted, counselled or procured the contravention;
(b) has induced, whether by threats or promises or otherwise, the contravention;
(c) has been in any way, directly or indirectly, knowingly concerned in, or party to,
the contravention; or
(d) has conspired with others to effect the contravention.
2 Purpose of code
The purpose of this code is to regulate the conduct of participants in franchising towards
other participants in franchising
3 Definitions
associate, for a franchisor, means a person:
(a) who:
(i) is a director or related body corporate, or a director of a related body
corporate, of the franchisor; or
(ii) for a franchisor that is a proprietary company — directly or indirectly owns,
controls, or holds with power to vote, at least 15% of the issued voting shares
in the franchisor; or
(iii) is a partner of the franchisor; and
(b) whose relationship with the franchisor is relevant to the franchise system, including
supplying goods, real property or services to a franchisee.
disclosure document has the meaning given by clause 6.
franchise includes the following:
318 Appendices
319
Appendices 319
320
(v) payment for goods and services at or below their usual wholesale price; or
(vi) repayment by the franchisee of a loan from the franchisor; or
(vii) payment of the usual wholesale price for goods taken on consignment; or
(viii) payment of market value for purchase or lease of real property, fixtures,
equipment or supplies needed to start business or to continue business under
the franchise agreement.
(2) For subclause (1), each of the following is taken to be a franchise agreement:
(a) transfer, renewal or extension of a franchise agreement;
(b) a motor vehicle dealership agreement.
(3) However, any of the following does not in itself constitute a franchise agreement:
(a) an employer and employee relationship;
(b) a partnership relationship;
(c) a landlord and tenant relationship;
(d) a mortgagor and mortgagee relationship;
(e) a lender and borrower relationship;
(f) the relationship between the members of a cooperative that is registered,
incorporated or formed under any of the following laws:
(i) Co-operatives Act 1992 of New South Wales;
(ii) Co-operatives Act 1996 of Victoria;
(iii) Cooperatives Act 1997 of Queensland;
(iv) Co-operative and Provident Societies Act 1903 of Western Australia;
(v) Co-operatives Act 1997 of South Australia;
(vi) Co-operative Industrial Societies Act 1928 of Tasmania;
(vii) Co-operative Societies Act 1939 of the Australian Capital Territory;
(viii) Co-operatives Act 1997 of the Northern Territory;
(ix) the Corporations Act 2001.
Part 2 Disclosure
320 Appendices
321
6C Additional information
If a franchisee or prospective franchisee who is given a disclosure document in
accordance with Annexure 2 asks the franchisor for the information referred to in sections
3, 5, 6, 9, 10, 11, 14, 17, 18, 19, 21 and 22 of Annexure 1, the franchisor must give that
information.
8 Application
This Division applies to a disclosure document in accordance with Annexure 1 or 2 for:
Appendices 321
322
10 Franchisor obligations
A franchisor must give:
(a) a copy of this code; and
(b) a disclosure document; and
(c) a copy of the franchise agreement, in the form in which it is to be executed;
to:
(2) Before a franchise agreement is entered into, the franchisor must have received from the
prospective franchisee:
(a) signed statements, that the prospective franchisee has been given advice about the
proposed franchise agreement or franchised business, by any of:
(i) an independent legal adviser;
(ii) an independent business adviser:
(iii) an independent accountant; or
(b) for each kind of statement not received under paragraph (a), a signed statement by
the prospective franchisee that the prospective franchisee:
(i) has been given that kind of advice about the proposed franchise agreement or
franchised business; or
(ii) has been told that that kind of advice should be sought but has decided not to
seek it.
322 Appendices
323
(a) does not apply to the renewal or extension of a franchise agreement with a
franchisor; and
(b) does not prevent the franchisor from requiring any or all of the statements
mentioned in paragraph (2) (a).
14 Copy of lease
(1) If a franchisee leases premises from the franchisor or an associate of the franchisor for the
purposes of a franchised business, the franchisor or the associate from which the premises
are leased must give to the franchisee 1 of the documents mentioned in subclause (2)
within 1 month after the lease or agreement to lease is signed by the parties.
(3) If the franchisee occupies, without a lease, premises leased by the franchisor or an
associate of the franchisor, the franchisor or the associate who leases the premises must
give to the franchisee 1 of the documents mentioned in subclause (4) within 1 month after:
(a) the occupation commences; or
(b) for the documents mentioned in paragraph (4) (b) — the documents are signed by
the parties.
(1) If a disclosure document does not mention a matter mentioned in subclause (2), the
franchisor must tell a franchisee or prospective franchisee about the matter, in writing,
within a reasonable time (but not more than 14 days) after the franchisor becomes aware
of it.
Appendices 323
324
(3) For paragraphs (2) (b), (c), (d), (e) and (f), the franchisor must tell the franchisee:
(a) the names of the parties to the proceedings; and
(b) the name of the court or tribunal; and
(c) the case number; and
(d) the general nature of the proceedings.
(4) For paragraph (2) (g), the franchisor must tell the franchisee the name and address of the
administrator, controller or liquidator.
(5) For paragraph 18 (2) (i), this information must be disclosed within a reasonable time (but
not more than 14 days) after the undertaking or order is given.
Note Nothing in this code affects the operation of Part VIIC of the Crimes Act 1914
(which includes provisions that, in certain circumstances, relieve persons from the
requirement to disclose spent convictions and require persons aware of such convictions
to disregard them).
324 Appendices
325
1 First page
1.1 On the first page:
(a) in bold upper case:
DISCLOSURE DOCUMENT FOR FRANCHISEE OR PROSPECTIVE
FRANCHISEE; and
(b) the franchisor’s:
(i) name; and
(ii) business address and phone number; and
(iii) ABN, ACN or ARBN (or foreign equivalent if the franchisor is a foreign
franchisor); and
(ba) the signature of the franchisor, or of a director, officer or authorised agent of the
franchisor; and
(c) the preparation date of the disclosure document; and
(d) the following statement:
This disclosure document contains some of the information you need in order to
make an informed decision about whether to enter into a franchise agreement.
Entering into a franchise agreement is a serious undertaking.
A franchise agreement is legally binding on you if you sign it.
(omitted)
Take your time, read all the documents carefully, talk to other franchisees and assess
your own financial resources and capabilities to deal with the requirements of the
franchised business.
You should make your own enquiries about the franchise and about the business of
the franchise.
You should get independent legal, accounting and business advice before signing the
franchise agreement.
It is often prudent to prepare a business plan and projections for profit and cash
flow.
You should also consider educational courses, particularly if you have not operated
a business before.
2 Franchisor details
Appendices 325
326
2.2 The name under which the franchisor carries on business in Australia relevant to the
franchise.
2.4 The name, ABN, ACN or ARBN, address of registered office and principal place of
business of each associate of the franchisor that is a body corporate (if any).
2.5 The name and address of each associate of the franchisor that is not a body corporate (if
any).
2.6 For each officer of the franchisor — name, position held and qualifications (if any).
3 Business experience
3.1 A summary of the relevant business experience in the last 10 years of each person
mentioned in item 2.6.
3.2 A summary of relevant business experience of the franchisor in the last 10 years,
including:
(a) length of experience in:
(i) operating a business that is substantially the same as that of the franchise; and
(ii) offering other franchises that are substantially the same as the franchise; and
(b) whether the franchisor has offered franchises for other businesses and, if so:
(i) a description of each such business; and
(ii) for how long the franchisor offered franchises for each such business.
4 Litigation
4.1 Details of:
(a) current proceedings by a public agency, criminal or civil proceedings or arbitration,
relevant to the franchise, against the franchisor or a franchisor director in Australia
alleging:
(i) breach of a franchise agreement; or
(ii) contravention of trade practices law; or
(iii) contravention of the Corporations Act 2001; or
(iv) unconscionable conduct; or
(v) misconduct; or
(vi) an offence of dishonesty; and
(b) proceedings against the franchisor under:
(i) section 127A or 127B of the Workplace Relations Act 1996; or
(ii) section 106 of the Industrial Relations Act 1996 of New South Wales; or
(iii) section 276 of the Industrial Relations Act 1999 of Queensland.
326 Appendices
327
4.3 For items 4.1 and 4.2 — the following details (where relevant):
(a) the names of the parties to the proceedings;
(b) the name of the court, tribunal or arbitrator;
(c) the case number;
(d) the general nature of the proceedings;
(e) the current status of the proceedings;
(f) the date and content of any undertaking or order under section 87B of the Act;
(g) the penalty or damages assessed or imposed;
(h) the names of the persons who are bankrupt, insolvent under administration or
externally administered;
(i) the period of the bankruptcy, insolvency under administration or external
administration.
7 Intellectual property
7.1 For any trade mark used to identify, and for any patent, design or copyright that is
material to, the franchise system (intellectual property):
(a) description of the intellectual property; and
(b) details of the franchisee’s rights and obligations in connection with the use of the
intellectual property; and
(c) whether the intellectual property is registered in Australia, and if so, the registration
date, registration number and place of registration; and
(d) any judgment or pending proceedings that could significantly affect ownership or
use of the intellectual property, including:
(i) name of court or tribunal; and
(ii) matter number; and
(iii) summary of the claim or judgment; and
(e) if the intellectual property is not owned by the franchisor — who owns it; and
(f) details of any agreement that significantly affects the franchisor’s rights to use, or to
give others the right to use, the intellectual property, including:
(i) parties to the agreement; and
(ii) nature and extent of any limitation; and
(iii) duration of the agreement; and
(iv) conditions under which the agreement may be terminated.
7.2 The franchisor is taken to comply with item 7.1 for any information that is confidential if
the franchisor gives:
(a) a general description of the subject matter; and
(b) a summary of conditions for use by the franchisee.
Appendices 327
328
(a) whether other franchisees may operate a business that is substantially the same as
the franchised business; and
(b) whether the franchisor or an associate of the franchisor may operate a business that
is substantially the same as the franchised business; and
(c) whether the franchisor or an associate of the franchisor may establish other
franchises that are substantially the same as the franchise; and
(d) whether the franchisee may operate a business that is substantially the same as the
franchised business outside the territory of the franchise; and
(e) whether the franchisor may change the territory of the franchise.
18.2 All documents mentioned in item 18.1 must be provided to the franchisee:
(a) at least 14 days before the day on which the franchise agreement is signed, if they
are available at that time; or
(b) if they are not available at that time — when they become available.
20 Financial details
20.1 A statement as at the end of the last financial year, signed by at least 1 director of the
franchisor, whether in its directors’ opinion there are reasonable grounds to believe that
the franchisor will be able to pay its debts as and when they fall due.
20.2 Financial reports for each of the last 2 completed financial years in accordance with
sections 295 to 297 of the Corporations Act 2001, or the foreign equivalent for a foreign
franchisor, prepared by:
(a) the franchisor; and
(b) any consolidated entity to which the franchisor belongs;
if:
(c) the franchisor is part of a consolidated entity that is required to provide audited
financial reports under the Corporations Act 2001; and
(d) a franchisee requests the reports.
328 Appendices
329
21 Updates
21.1 Any information given under clause 18 of the code that has changed between the date of
the disclosure document and the date the disclosure document is given under the code.
___________________________________________________
Retail Leases Act 1995 (NSW)
s 42 Lessor may reserve right to refuse sub lease, mortgage. A retail shop lease may contain a
provision which allows the lessor to refuse in the lessor’s absolute discretion:
(a) consent to the grant of a sub lease, licence or concession in respect of the whole or any
part of the shop, or
(b) consent to the lessee parting with possession of the whole or any part of the shop, or
(c) consent to the lessee mortgaging or otherwise charging or encumbering the lessee’s estate
or interest in the lease.
___________________________________________________
Sale of Goods Act 1896 (Qld)
http://www.legislation.qld.gov.au/LEGISLTN/CURRENT/S/SaleGoodA1896.
pdf
20 Property passes when intended to pass
(1) When there is a contract for the sale of specific or ascertained goods the property in them is
transferred to the buyer at such time as the parties to the contract intended it to be transferred.
(2) For the purpose of ascertaining the intention of the parties regard is to be had to the terms
of the contract, the conduct of the parties, and the circumstances of the case.
21 Rules for ascertaining intention
Unless a different intention appears, the following are rules for ascertaining the intention of the
parties as to the time at which the property in the goods is to pass to the buyer—
Rule 1: When there is an unconditional contract for the sale of specific goods in a deliverable
state, the property in the goods passes to the buyer when the contract is made, and it is
immaterial whether the time of payment or the time of delivery, or both, is or are postponed.
Rule 2: When there is a contract for the sale of specific goods and the seller is bound to do
something to the goods for the purpose of putting them into a deliverable state, the property
does not pass until such thing is done and the buyer has notice thereof.
Rule 3: When there is a contract for the sale of specific goods in a deliverable state, but the
seller is bound to weigh, measure, test, or do some other act or thing with reference to the
goods for the purpose of ascertaining the price, the property does not pass until such act or
thing is done and the buyer has notice thereof.
Rule 4: (1) When goods are delivered to the buyer on approval or ‘on sale or return’ or other
similar terms the property therein passes to the buyer—
(a) when the buyer signifies the buyer’s approval or acceptance to the seller, or does any other
act adopting the transaction;
(b) if the buyer does not signify the buyer’s approval or
acceptance to the seller but retains the goods without giving notice of rejection, then, if a time
has been fixed for the return of the goods, on the expiration of such time, and, if no time has
been fixed, on the expiration of a reasonable time.
Appendices 329
330
330 Appendices
331
Appendices 331
332
(2) Where or to the extent that the purposes of the company consist of or include purposes other than
the benefit of its members, subsection (1) has effect as if the reference to promoting the success
of the company for the benefit of its members were to achieving those purposes.
(3) The duty imposed by this section has effect subject to any enactment or rule of law requiring
directors, in certain circumstances, to consider or act in the interests of creditors of the company.
332 Appendices
333
Appendices 333
334
334 Appendices
Bibliography
Butterworths, Franchise Law and Practice (loose-leaf) Standard Form Franchise Agreement
FP: 1030.
Buchan, Jenny, ‘Square Pegs in Round Holes: Franchisees of Insolvent Franchisors’ (2008)
(9)2 Business Law International 114.
Carter, J W, Peden, Elisabeth and Tolhurst, G J, Contract Law in Australia (5th ed, 2007).
Commission of the European Communities, EU Consumer Policy Strategy 2007 – 2013
Empowering Consumers, Enhancing their Welfare, Effectively Protecting them (2007)
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