Keynote Address to the BRW Franchising Conference, Sydney
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Welcome and introduction
That you have kindly asked me to speak at this event is testament to the increasing importance of franchising to the Australian economy.
Franchising is both a domestic and international phenomenon.
In Australia, the estimated annual turnover in the franchising industry is $130 billion, with approximately 71,000 franchise agreements in place, employing more than 400,000 people.
The Government is a strong supporter of small business and welcomes the opportunities that franchising affords the business community.
Through franchising, many Australians have been able to realise their aspiration of self-employment and, as new business owners, they have had the opportunity to leverage off the resources, knowledge and reputation of established commercial franchise operations.
The Rudd Government believes it is vital that regulatory arrangements enable people in the franchising community to operate with confidence and we have been working hard to achieve this goal.
In this respect, the Government supports the Franchising Code of Conduct and the Office of the Mediation Adviser, which were both established in 1998.
However, more needs to be done to ensure the Franchising Code continues to operate effectively.
To this end, in November last year, I announced a package of measures in response to the recommendations from two inquiries: the inquiry into franchising conducted by the Parliamentary Joint Committee on Corporations and Financial Services, and the inquiry into the unconscionable conduct provisions of the Trade Practices Act undertaken by the Senate Standing Committee on Economics.
The final Government response to those inquiries, which I am announcing here today, entails the most sweeping reform of the Franchising Code of Conduct since its inception 12 years ago.
But in making these reforms the Government is not throwing the baby out with the bath water.
The reforms will put franchisees in a better position to understand the risks of going into franchising by giving them clearer information up front about the terms and conditions on offer.
The reforms will also better protect franchisees from unconscionable conduct and false and misleading representations from unscrupulous franchisors while retaining for good, honest franchisors the flexibility they need to make franchising a commercial success for themselves and their franchisees.
In the last couple of years I have received strong demands that I effectively tear up the franchising model or make it so onerous and prescriptive as to destroy its commercial viability. I have not and will not succumb to these pressures. Franchising is a good business model that can be made even better – and that’s what the reforms I am announcing today are designed to do.
Government response to the committee reports
The Parliamentary Joint Committee’s Report made a number of recommendations for improving the operation of the Franchising Code of Conduct.
And the recommendations of the Senate Standing Committee on Economics concerning unconscionable conduct are equally as important to franchisors and franchisees alike.
Following those recommendations, the Government will amend the Trade Practices Act to make it clear that protection from unconscionable conduct relates not only to the process of settling a contract, but also to the terms and conditions of the contract and the ongoing behaviour of the parties to the contract.
Many of the behaviours that franchisees complain about occur while the contract is underway.
Making it clear that the unconscionable conduct provisions apply to behaviour that occurs during the course of the contract, as well as to the terms and conditions of that contract, is an important reform designed to better protect franchisees and other small businesses.
We are also augmenting the investigative powers of the ACCC.
We will amend the Trade Practices Act to allow the ACCC to conduct random audits under the Franchising Code and the other mandatory codes of conduct.
Franchisees wishing to complain about franchisors not complying with the Franchising Code may fear reprisal.
These new random audit powers will help strengthen franchisor compliance with the Code, while relieving franchisees of the fear of retaliation against them for complaining to the ACCC about franchisor behaviour.
The Government will also extend the public warning power available under the Australian Consumer Law Bill currently before the Parliament to include breaches of the Franchising Code and other mandatory industry codes.
This warning – or naming and shaming – power will alert the public to rogue or unscrupulous franchisors.
Also under this package of reforms, where a large number of franchisees are harmed by the behaviour of a franchisor in breach of the Franchising Code, the ACCC will be able to apply for an order providing redress to all the franchisees, without requiring every franchisee to be party to the legal proceedings.
And, in addition to existing remedies, breaches of the unconscionable conduct provisions of the Trade Practices Act will attract penalties of up to $1.1 million for corporations and $220,000 for individuals.
Behaviours
As well as beefing up the penalties and adding to the ACCC’s powers, as part of the Government’s response to these two Senate inquiries we looked at whether there were specific behaviours that would reasonably be considered to be inappropriate in a franchising arrangement.
During the course of the consultations undertaken as a part of the Joint Committee inquiry into franchising, and discussions held after the Joint Committee handed down its report, a number of behaviours were identified as commonly causing difficulties for franchisees.
Concerns were raised about end-of-term arrangements between franchisees and franchisors and about dispute resolution procedures.
In some cases, unforeseen capital expenditure or the unilateral variation of contracts had led to disputes.
Other areas of contention included provisions about the attribution of legal costs to the franchisee in disputes, confidentiality agreements, and changes to franchise agreements when a franchisee is trying to sell the business.
In November, I announced that the Government will amend the Franchising Code to deal with end-of-term arrangements and dispute resolution.
And I asked an expert panel to consider the others in more detail.
End-of-term arrangements
In respect of end-of-term arrangements, the Government will amend the Franchising Code to require franchisors to disclose to franchisees the processes that will apply in determining end-of-term arrangements, including whether or not there is some right of renewal beyond the term of the agreement.
These amendments will assist in mitigating disputes where one party has an expectation, not shared by the other party, that a franchise agreement will be renewed.
Franchisors will also be required to inform franchisees at least six months before the end of the franchise agreement of their decision either to renew or to end a franchise agreement.
It is the Government’s clear intention that these new end-of-term arrangements will apply to franchise agreements signed after the date of amendments to the Franchising Code.
For agreements already in existence, the end-of-term arrangements can be included by the voluntary agreement of both parties but will not be obligatory.
Dispute resolution
Where disputes arise in a franchising relationship, the Government recognises the need to encourage the parties to approach their dispute in a conciliatory manner.
We will amend the Franchising Code to include a list of behaviours expected under the Code that will help facilitate dispute resolution.
The Code will require parties to a franchising agreement who are engaged in dispute resolution processes to attend and participate in meetings at reasonable times and the parties will be required to make their intentions clear at the outset of the mediation.
For example, if the aim of the franchisor is to negotiate an exit arrangement, rather than a resolution to enable continued trading, this should be made clear from the outset.
The parties will be required to observe confidentiality obligations during and after the mediation process, and both parties will be required act in a way that does not damage the franchise brand during the dispute, for example, by providing inferior goods, services and support.
These changes set up the ground rules in a way which will encourage outcomes to be achieved when entering into dispute resolution processes.
Good Faith
Before I go on to talk about the work I asked the expert panel to undertake over the Christmas and New Year period, I would like to take this opportunity to say a few words on good faith in franchising.
The Joint Committee on franchising recommended the inclusion of a broad and general reference to good faith in the Franchising Code.
Prior to the last election, the Government said that the Franchising Code would be amended to include a good-faith obligation as long as the scope of this obligation could be well defined.
After extensive investigation, the Government has concluded that a well-defined good-faith obligation is not achievable.
The law on good faith is still evolving and there is not a single definition or an agreed, standard set of behaviours that constitute good faith.
Because of this, the inclusion of a general obligation of good faith in the Franchising Code would increase uncertainty in franchising.
Neither franchisors nor franchisees would be certain of the occurrence of a breach.
In fact, court proceedings would be required to establish whether or not a breach had occurred.
The extra uncertainty created by the inclusion in the Franchising Code of a general, undefined good-faith obligation could be expected to have adverse commercial consequences for franchisees.
And franchisors may well seek compensation for the extra risk they face through larger franchise fees and more onerous terms and conditions in other parts of the agreement.
Further, banks and other financiers would be more reluctant to provide credit to franchisees and franchisors in these more risky commercial circumstances – the last thing the Government wants to do when small business organisations are claiming that banks are being too harsh in their small business lending practices.
Our difficulty is not with the principle of good faith, or indeed with the parties acting honourably in their dealings with each other. Our difficulty is with the inability to define good faith clearly enough for it to be inserted into a mandatory code of conduct.
Instead, the Government will amend the Franchising Code to provide that nothing in the Code limits any common law requirement of good faith in relation to a franchise agreement to which the Code applies.
Expert panel report
Earlier, I mentioned that the Government had referred five behaviours that could be unacceptable in a franchising situation to an expert panel.
That panel reported to me last month.
I am pleased to be able to release that report publicly here today and to announce that the Government supports and will adopt the findings of the expert panel.
I would like to publicly thank the members of the expert panel – Professor Bryan Horrigan, Mr David Lieberman and Mr Ray Steinwall – for their thoughtful and well-considered work.
With respect to those five behaviours, the expert panel considered that there may be legitimate business reasons for such behaviours by franchisors, including market and regulatory demands.
Therefore they did not recommend outright prohibition. Instead, they made a number of findings and recommendations to enhance the Franchising Code.
On the basis of the expert panel’s findings, the Government will strengthen the disclosure requirements under the Franchising Code to address the five behaviours.
Under this enhanced disclosure regime, information will need to be provided to prospective franchisees at a time in the decision-making process that enables them to undertake their due diligence and make informed decisions about whether or not to enter into the franchise agreement.
But the enhanced disclosure regime will not be unduly burdensome on franchisors.
The expert panel considered that disclosure was important, noting that if prospective franchisees are armed with the information necessary to undertake their due diligence, they should be better able to weigh the risks and rewards of entering a particular franchise system.
Unilateral contract variation
Turning to those behaviours, in relation to unilateral changes to a franchise arrangement, the expert panel noted that this may be a necessary feature of the franchising system.
That is, there may be legitimate business reasons for such variations to occur.
The panel considered that unilateral contract variations may be dealt with through better disclosure up front, together with better education for franchisees, to make prospective franchisees more aware of the possibility of unilateral variation of their franchise agreements.
The Government will amend the Franchising Code to require franchisors to disclose the circumstances in which unilateral variation to an agreement may take place, and the circumstances in which the franchisor has unilaterally varied a franchise agreement in the past three financial years.
Unforeseen capital expenditure
In relation to unforeseen capital expenditure, the panel found such expenditure may be required of franchisees in order to maintain the competitiveness and responsiveness of the franchise business, and that such outlays are not always foreseeable.
Some common examples are where the franchisor undertakes to offer a new product range or embarks on a national rebranding exercise.
While these activities may require capital expenditure which was not foreseen at the commencement of the franchising agreement, they may in fact improve the competitiveness of the franchisees’ businesses.
On this point, the panel supported disclosure of whether significant capital expenditure would be a factor to be considered in deciding to renew the franchise agreement, and whether that has been a factor in the past three financial years.
The Government has already recognised that prospective franchisees’ expectations about renewal need to be better managed, and the financial implications of non-renewal need to be better understood before fixed-term franchise agreements are entered into.
Other changes will also be made to disclosure statements.
Information will be provided on whether or not the prospective franchisee would be entitled to an exit payment at the end of the term and, if so, how the exit payment would be determined.
Details will need to be provided on what arrangements would apply at the end of the agreement to unsold stock or to equipment purchased at the beginning of the term.
Details will be provided on whether or not the prospective franchisee would have the right to sell the business at the end of the term, whether the franchisor would have first right of refusal, and on how market value would be determined.
The disclosure statement will also need to state whether a franchise agreement may be amended, even when the franchisee is seeking to sell the franchise, and whether the franchisor will attribute their legal costs to a franchisee in the event of dispute resolution.
Prospective franchisees will also need to be alerted to the categories of information that cannot be discussed with existing and former franchisees, such as the outcomes of mediation, settlements, intellectual property and trade secrets.
Franchisor initiated changes when a franchisee is trying to sell the business
In relation to cases where a franchisor amends a franchise agreement when a franchisee is trying to sell the business, the expert panel found that there may be legitimate commercial and regulatory reasons for amendments during the course of a franchise agreement.
However, changes to a franchise agreement when a franchisee is trying to sell the business may affect the franchisee’s ability to maximise the return on the investment.
For this reason, the Government will require that the potential for any changes at the time when the franchisee is selling a business will be disclosed upfront, before the agreement is signed.
The Government will also adopt the recommendation of the panel to amend the Franchising Code so that the transfer of an existing franchise agreement will also include the novation of the current franchisee’s agreement, where the prospective franchisee signs a new franchise agreement.
Short, simple, ‘Plain English’ document
The expert panel also recommended the development of a short, simple, plain English document, which could be provided to prospective franchisees before they are committed to a franchise system.
This short document would be additional to the current disclosure requirements under the Franchising Code and would emphasise the key costs, benefits and risks of the franchise system.
The Government is seeking the support of the franchising community in voluntarily producing a short, simple document.
However, the panel has suggested the Government should consider mandating a short document of this kind if evidence emerges to indicate that franchisees remain unaware of the nature of the franchise relationship and the potential key costs, benefits and risks of the franchise business model in general.
Views of the expert panel on unconscionable conduct
To ensure that the Government’s package of measures was complete, I also asked the expert panel to consider measures that could be taken to make the unconscionable conduct provisions of the Trade Practices Act more easily understood and more easily applied by the courts.
The Senate Select Committee on Economics recommended that the Government consider whether a list of clear examples of behaviour which constitutes unconscionable conduct could be included in the Trade Practices Act.
The expert panel looked carefully at this recommendation but concluded that a list of examples would not help the understanding or implementation of the unconscionable conduct provisions.
Instead, the panel recommended that a set of principles be added to the Trade Practices Act.
The panel was of the view that these principles would help courts interpret the provisions, help regulators enforce them, and help people better understand them.
The panel has suggested that four principles be added to the Trade Practices Act.
The first will confirm that the courts may examine both the terms of a contract and behaviour during the life a contract.
As I have said earlier, the Government had already agreed to amend the unconscionable conduct provisions to ensure that the courts could look at these matters.
The panel also recommended that the principles confirm that the courts may look at systemic conduct or patterns of behaviour in order to determine whether unconscionable conduct has occurred.
The principles will also confirm that there is no need to establish a special disadvantage between the parties, for example language difficulties on the part of one of the parties to the contract, to prove that there has been unconscionable conduct.
Finally, and this is a very technical point, the principles will indicate to the courts that unconscionable conduct under the Trade Practices Act can be interpreted more broadly than under existing case law.
The Government will adopt these recommendations of the expert panel.
We will introduce these interpretive principles into the unconscionable conduct provisions of the Trade Practices Act to ensure the way the law applies is clear and to increase contractual certainty for franchisees and franchisors alike.
Conclusion
The Government is committed to comprehensive changes to the Franchising Code, along with the amendments to the unconscionable conduct provisions of the Trade Practices Act.
Given the comprehensive nature of these changes, the expert panel has recommended that once they are enacted, they be allowed to operate for a period of three to five years to provide sufficient time to evaluate their effectiveness.
The Government will formally adopt the expert panel’s recommendation as it believes that franchisors and franchisees deserve the stability and confidence that this will provide.
Franchising is an important business model for the Australian economy.
The changes the Government announced last year, and the changes I have announced here this morning, will help provide certainty for both franchisees and franchisors and help to ensure that franchising continues to be a major contributor to jobs and prosperity into the future.
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