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FRANCHISOR FAILURE: AN ASSESSMENT OF THE ADEQUACY OF REGULATORY RESPONSE Jennifer Mary Buchan LLB (Otago), LLM (Melbourne) Submitted in fulfilment of the requirements for the degree of Doctor of Philosophy School of Law Faculty of Law Queensland University of Technology August 2010

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Page 1: FAILURE AN ASSESSMENT OF THE ADEQUACY OF REGULATORY … · CPA Certified Practicing Accountants, Australia DFV German Franchise Association EFF European Franchise Federation FCA Federal

FRANCHISOR FAILURE: AN ASSESSMENT

OF THE ADEQUACY OF REGULATORY

RESPONSE

Jennifer Mary Buchan

LLB (Otago), LLM (Melbourne)

Submitted in fulfilment of the requirements for the degree of

Doctor of Philosophy

School of Law

Faculty of Law

Queensland University of Technology

August 2010

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Franchisor Failure: An Assessment of the Adequacy of Regulatory Response i

Keywords

administration, asymmetry, Australia, bankruptcy, benchmark, best practice regulation, business consumer, consumer protection, contracts, Corporations Act 2001 (Cth), cost benefit, disclaim, disclosure, due diligence, education, executory contract, exploitative contract, fail, franchise agreement, franchisee, Franchising Code of Conduct, franchisor, incomplete contract, insolvency, ipso facto clause, lease, liquidator, onerous contract, policy, premises, receivership, regulation, relational contract, Retail Leases Act 1995 (NSW), remedies, stakeholder, standard form contract, Trade Marks Act 1995 (Cth), Trade Practices Act 1974 (Cth), unconscionable conduct, winding up.

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ii Franchisor Failure: An Assessment of the Adequacy of Regulatory Response

Abstract

Franchisor failure is one of the most problematic areas of the franchise

relationship. It impacts negatively on landlords and other suppliers, but the

contracting parties that are currently without legal rights to respond when a

franchisor fails, and thus without consumer protection, are its franchisees.

In this thesis I explore the current contractual, regulatory and commercial

environment that franchisees inhabit, within the context of franchisor failure. I

conclude that ex ante there are opportunities to level the playing field through

consumer protection legislation. I also conclude that the task is not one solely for the

consumer protection legislation; the problem should also be addressed ex post

through the Corporations Act.

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Franchisor Failure: An Assessment of the Adequacy of Regulatory Response iii

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 

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3.2.6  Franchisees or employees? ........................................................................................... 123 

3.3  The franchise agreement .......................................................................................................... 146 3.3.1  Addressing the failure of the franchisor’s business ...................................................... 148 3.3.2  The desirability of certainty in contracts ...................................................................... 149 3.3.3  Parties to commercial and consumer contracts act in their own interests ..................... 150 3.3.4  A standard form business consumer contract ............................................................... 153 3.3.5  Relational contract ........................................................................................................ 157 3.3.6  Incomplete contract ...................................................................................................... 159 3.3.7  Exploitative contract ..................................................................................................... 161 3.3.8  Breach of contract ......................................................................................................... 162 3.3.9  Contract and quasi-contract based remedies ................................................................. 166 3.3.10 Contract-related complications ..................................................................................... 167 3.3.11 Conclusion .................................................................................................................... 169 

3.4  Asymmetry issues .................................................................................................................... 173 3.4.1  Information asymmetry ................................................................................................ 173 3.4.2  Adviser and advice asymmetry ..................................................................................... 177 3.4.3  Risk asymmetry ............................................................................................................ 183 3.4.4  Resource asymmetry .................................................................................................... 185 3.4.5  Contract asymmetry ...................................................................................................... 186 3.4.6  Legislative asymmetry .................................................................................................. 186 

3.5  Conclusion ............................................................................................................................... 187 

CHAPTER 4:  IS THE CURRENT REGULATORY RESPONSE ADEQUATE TO DEAL WITH THE PROBLEM? ................................................................................................................. 191 

4.1  Theory of the market-led solution ............................................................................................ 191 

4.2  Policy background ................................................................................................................... 194 4.2.1  The regulators ............................................................................................................... 196 

4.3  Trade Practices Act 1974 (Cth)................................................................................................ 197 4.3.1  Trade Practices Act 1974 (Cth) Section 51AC ............................................................ 198 4.3.2  Trade Practices Act 1974 (Cth) Part V Division 1 ....................................................... 202 4.3.3  Trade Practices (Industry Codes- Franchising) Regulations 1998 (Cth) (‘the

Code’) ........................................................................................................................... 203 

4.4  Corporations Act 2001 (Cth) ................................................................................................... 213 4.4.1  Receivership ................................................................................................................. 213 4.4.2  Administration .............................................................................................................. 213 4.4.3  Winding up in insolvency ............................................................................................. 215 4.4.4  Specific assets and liabilities under the insolvency provisions of the

Corporations Act .......................................................................................................... 220 4.4.5  Impact on suppliers to franchise network ..................................................................... 227 4.4.6  Impact on employees if employer becomes insolvent .................................................. 227 

4.5  Retail leasing legislation .......................................................................................................... 227 

4.6  Statutory remedies ................................................................................................................... 233 

4.7  Conclusion ............................................................................................................................... 233 

CHAPTER 5: THE DEAL FOR FRANCHISEES ........................................................................ 235 

5.1  Consumer protection benchmarks ............................................................................................ 236 5.1.1  Regulation should provide effective protection from serious risks and threats that

franchisees as consumers cannot tackle as individuals (B1) ......................................... 238 5.1.2  There should be accessible, timely and meaningful redress where consumer

detriment has occurred (B2) ......................................................................................... 243 5.1.3  Cost benefit considerations (B3) .................................................................................. 246 

5.2  Conclusion ............................................................................................................................... 250 

CHAPTER 6: CONSUMER PROTECTION TO ADDRESS THE BENCHMARKS ............... 251 

6.1  Potential non-regulatory solutions ........................................................................................... 251 

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6.1.1  Status quo ..................................................................................................................... 251 6.1.2  Education ...................................................................................................................... 251 6.1.3  Franchisee union ........................................................................................................... 253 6.1.4  Insurance ....................................................................................................................... 254 6.1.5  Reconfigure some obligations ...................................................................................... 255 6.1.6  Deem franchisors to be trustees .................................................................................... 255 6.1.7  Legislate solutions ........................................................................................................ 255 

6.2  Regulatory solutions ................................................................................................................ 258 6.2.1  Make franchise agreements accessible ......................................................................... 260 6.2.2  Amend s 51AC Trade Practices Act ............................................................................. 261 6.2.3  Imply terms into all franchise agreements via Franchise Contracts Act ....................... 262 6.2.4  Amend Franchising Code of Conduct .......................................................................... 271 6.2.5  Consequential amendments to State and Territory Retail Leases legislation ............... 276 6.2.6  Amend Corporations Act 2001 (Cth) ............................................................................ 277 

6.3  Evaluation of regulatory solutions against benchmarks B1 and B2 ......................................... 280 

6.4  Costs and Benefits ................................................................................................................... 280 6.4.1  Stakeholders.................................................................................................................. 281 6.4.2  Present regime .............................................................................................................. 281 6.4.3  Proposed solutions ........................................................................................................ 282 6.4.4  Costs and benefits ......................................................................................................... 283 

6.5  Conclusion ............................................................................................................................... 286 

CHAPTER 7: CONCLUSION ........................................................................................................ 287 

7.1  Leading the world in franchise regulation ............................................................................... 287 

7.2  Areas for Future research ......................................................................................................... 290 7.2.1  Database ....................................................................................................................... 290 7.2.2  Conflicts of interest ...................................................................................................... 291 7.2.3  Intellectual property ...................................................................................................... 291 7.2.4  Contracts ....................................................................................................................... 291 7.2.5  The potential liability of lenders ................................................................................... 291 7.2.6  Insolvent master franchisees ......................................................................................... 292 7.2.7  Corporations Act responses .......................................................................................... 292 7.2.8  International insolvency principles ............................................................................... 293 7.2.9  Cross border insolvency ............................................................................................... 294 7.2.10 Franchisees in unions and representative groups .......................................................... 295 7.2.11 Not purely a legal issue ................................................................................................. 295 

APPENDICES ................................................................................................................................... 297 Appendix A: Australian Commonwealth and State legislation ................................................ 297 Division 2—Conditions and warranties in consumer transactions ........................................... 312 Appendix B: Foreign legislation .............................................................................................. 331 Appendix C: Possible categorisation of franchisees’ interests in diverse jurisdictions ............ 333 Appendix D: Franchise network .............................................................................................. 334 

BIBLIOGRAPHY ............................................................................................................................. 335 

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List of Figures

UFigure 1: Number of identified failed franchisors in Australia 1987 – 2009. U ....................................... 40 

UFigure 2: Known number of franchisees affected by their franchisor failing in Australia 1990-2009U ...................................................................................................................................... 41 

UFigure 3: Minimum estimated lost investment by franchisees in Australia 1990 - 2009.U ..................... 69 

The Australian Securities and Investments Commission has approved funding for an

investigation into the collapse of white goods business Kleenmaid.

source: Uwww.news.com.au/perthnowU, 25 September 2009 

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Franchisor Failure: An Assessment of the Adequacy of Regulatory Response vii

List of Tables  UTable 1: Australian failed franchisor dataU ............................................................................................. 30 

UTable 2: National Australia Bank Accredited Franchise Systems 2008 and 2009 U ................................ 51 

UTable 3: Some costs and losses for one franchisee of Danoz DirectionsU .............................................. 61 

UTable 4: Features of Employee, Franchisee and Supplier / Independent Contractor.U .......................... 125 

UTable 5: Additional Features of Employee and Franchisee.U ................................................................ 133 

UTable 6: Franchisees’ position under State and Territory retail tenancy legislation. U ........................... 231 

UTable 7: Risk analysis templateU ........................................................................................................... 241 

UTable 8: Cost benefit tentative summaryU ............................................................................................. 283 

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List of Abbreviations

AC Appeal Cases

ACCC Australian Competition and Consumer Commission

ACLC Australian Company Law Cases

ANZ Australia and New Zealand Bank

ASIC Australian Securities and Investments Commission

ATO Australian Taxation Office

BHG Beach House Fitness Group

CA Chartered Accountants

CLR Commonwealth Law Reports

Code Trade Practices (Industry Codes – Franchising) Regulations 1998 (Cth).

CPA Certified Practicing Accountants, Australia

DFV German Franchise Association

EFF European Franchise Federation

FCA Federal Court of Australia

FCA Franchise Council of Australia

FCP Franchising Code of Practice 1993

FCR Federal Court Reports

GEERS General Employee Entitlements and Redundancy Scheme

Griffith Griffith University, Queensland

ISoF International Society of Franchising

MBE MailBoxes Etc

NAB National Australia Bank

NSW New South Wales

NSWCA New South Wales Court of Appeal

NSWLEC New South Wales Land and Environment Court

NSWSC New South Wales Supreme Court

OBPR Office of Best Practice Regulation

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Franchisor Failure: An Assessment of the Adequacy of Regulatory Response ix

PC Productivity Commission

QLD Queensland

RLA Retail Leases Act 1994 (NSW)

SA South Australia

SGR Superannuation Guarantee Ruling

TM Trade mark

TMA Trade Marks Act 1995 (Cth)

TR Australian Taxation Office Rulings

UK United Kingdom

UNCITRAL United Nations Commission on International Trade Law

USA United States of America

USDOC United States Department of Commerce

VSC Victorian Supreme Court

WASC West Australia Supreme Court

WBC Westpac Banking Corporation

.

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Statement of Original Authorship

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Acknowledgments

Although working on a PhD is a solitary pursuit the project is not completed

without the support and encouragement of many people. I thank my supervisors

Professor Stephen Corones and Dr Bill Dixon for their outstanding guidance. I also

thank my other academic and professional advisers and mentors; Professor Diana

Beal, Associate Professor Dale Boccabella, Bill Butcher, Professor Alan Carsrud,

Professor Bill Duncan, Professor Lorelle Frazer, Associate Professor Anne Junor,

Philip Linacre, Professor Rosalind Mason, Michael Murray, Dr Paul Omar,

Rosemary Pynor, Professor John Piggott, Dr Michael Schaper, Albrecht Schulz,

Professor Tania Sourdin, Dr Elizabeth Spencer, Professor John Taylor and The Rt

Hon Sir EW (Ted) Thomas, LLD for support and encouragement at critical junctures.

I thank Julia Roy for editorial assistance Andre Briel, Caroline Malcolm, Wei Wu,

for research assistance; and Phil Cohen, Jane Malady, Hui Yi Thong and Pernilla

White for administrative assistance.

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, ‘Consumer Protection for Franchisees of Failed Franchisors: Is

There a Need for Statutory Intervention?’ (2010) 9(2) QUT Law and Justice

Journal 232.

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, ‘Franchisor’s Registered Trade Marks – Empirical Surprises’

(2009) 21(7) Australian Intellectual Property Law Bulletin 154.

Jenny Buchan, ‘Ex Ante Information and Ex Post Reality for Franchisees – the

Case of Franchisor Failure’ (2008) 36 Australian Business Law Review 407.

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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, 20-22 June 2008) paper 30.

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, 20-22 June

2008) paper 39.

Jenny Buchan, ‘Challenges that Franchisees of Insolvent Franchisors Pose for

Liquidators’ (2008) 16 Insolvency Law Journal 26.

Jenny Buchan, ‘Square Pegs in Round Holes: Franchisees of Insolvent

Franchisors’ (2008) 9(2) Business Law International 114.

Jenny Buchan, ‘Reducing Collateral Damage in Franchisor Insolvency’ in Paul

Omar (ed), International Insolvency Law: Themes and Perspectives (2008) 367.

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.

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.

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.

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My Sunday morning coffee friends provided words of encouragement when

caffeine alone did not do the trick. The members of the bluemaumau online

community helped me keep my sense of humour.

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.

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Chapter 1: Introduction 1

Chapter 1: Introduction

The issue of the franchisee/franchisor relationship when the franchisor goes

into liquidation is one of the few vulnerabilities in franchising.0F

1

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.

The purpose of this thesis is to critically examine the position of franchisees as

consumers of franchise opportunities. It examines the franchisees’ role in the

franchise network 1F

2 and the options available to them when their franchisor fails. On

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’).

The Benchmarks are:

B1) Regulation should provide effective protection from serious risks and threats that

[franchisees as business] consumers cannot tackle as individuals.2F

3

B2) There should be accessible, timely3F

4 and meaningful redress where consumer

detriment has occurred.

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.

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2 Chapter 1: Introduction

The focus of this thesis is on business format franchising. Business format

franchising is a method of expanding a business via a network. It may be used by any

business that is capable of documenting its operations sufficiently to enable them to

be replicated. The business format franchise model, at its simplest, involves a

franchisor and its successful prototype business, a franchisee, a disclosure document

and a franchise agreement. The franchise agreement is a contract wherein the

franchisor grants the franchisee a licence for typically, a finite number of years to

establish a clone of a successful business that the franchisor has developed. The

franchisee then builds its own business and operates as a franchisee until the licence

contained in the franchise agreement expires. ‘The franchisee is obliged to pay the

franchisor certain fees and royalties in exchange for rights [described in contracts].

The franchisor has the obligation to provide the agreed rights and [to] generally

support the franchisee.’4F

5

The franchisee is neither an employee nor an independent contractor – but

displays many characteristics that are said to be defining of each relationship.

However, if the franchisor becomes insolvent, the franchisee has neither the legal

standing and protection employees enjoy nor the right to lodge a proof of debt for all

money invested, to ‘cut its losses’ and walk away with its own business intact that a

supplier has as an independent contractor.

In 1994 Australia was home to an estimated 555 business format franchisors,

and 16,536 franchised units which provided employment for 142,636 people.5F

6 Over

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.6F

7 The resulting investment by franchisees in start-up costs was

approximately A$7.14 billion in 2008.7F

8

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

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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’.8F

9

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 claim9F

10 in the franchisor’s insolvency, but

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.

1.1 EFFECTIVE PROTECTION FOR FRANCHISEES WHOSE FRANCHISOR FAILS

The franchise environment in Australia is described as ‘…a mature franchise

sector operating within a regulated framework’.10F

11 An inference that is drawn from

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.

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4 Chapter 1: Introduction

franchise business model, franchisors are able to achieve freedom from

statutes11F

12 [and common law liabilities] which would otherwise protect

workers and investors. Franchisees have far more to lose than …

employees. 12F

13

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.

Notwithstanding the significant amount of policy and regulatory attention that

franchising has attracted in Australia, a fundamental problem still exists. The federal

and state government inquiries into franchising, the Review of Australia’s Consumer

Policy Framework conducted by the Productivity Commission (‘PC’) in 2008, and

the amendments to the Trade Practices Act resulting from the PC’s review have not

treated the franchisor’s failure, as a supplier to a franchisee as a business consumer,

as a consumer protection issue. This is the nub of the problem. If a supplier of

another expensive item like a luxury car fails, service people, spare parts and a resale

market for that car continue to exist notwithstanding the supplier’s failure. Where the

franchisor is the supplier and the franchisee’s business is the product, the situation is

different. There are unlikely to be replacement suppliers willing and able to supply

all of the franchisor’s services to franchisees. Further, it is unlikely that there will be

a market for the franchisees’ businesses, unsupported by the now failed franchisor.

The particular vulnerability of franchisees stems from numerous asymmetries

including; the current legislation, the franchisees’ role within the franchise network,

their inability to be a part of major decisions taken by their franchisor that may put

the franchise network at risk, and their own very limited ability to self-protect from

the legal consequences of franchisor failure.

The law’s response to franchisor failure sits awkwardly at the intersection of

contract law, consumer protection law and insolvency law. In all three areas there has 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.

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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.13F

14 In addition there have been significant developments in

consumer protection and an increasingly forgiving attitude towards business failure.

Traditionally parties to commercial contracts were of equal bargaining

strength, and only signed contracts that had genuinely been negotiated. The

franchising contract challenges these assumptions. In franchising, the contract

between the franchisor supplier and franchisee consumer conforms to 21st century

consumer contract norms. These norms include the intrusion of the standard form

into the domain of relational commercial contracts.

On learning of the appointment of an administrator or liquidator to the

franchisor, franchisees turn to their franchise agreement and thence to contract law to

find what their rights are. For reasons that will be explored in chapter 3.3 and 3.4,

franchise agreements do not typically provide for franchisor insolvency.

Occasionally individual franchise agreements do address franchisor insolvency.

Where they do, the clause will typically offer one relatively crude option, an ipso

facto14F

15 clause being a mirror image of the current rights franchisors have under the

Franchising Code of Conduct 15F

16 (‘the Code’) to terminate the agreement if the

franchisee commits an act of bankruptcy. They do not provide avenues for

franchisees to work with the administrator to assess alternatives. Usually franchisees

discover that they are bound to continue performing their contractual obligations, to

wait and see what the administrator or liquidator decides, and obviously to hope for

the best.

Australian consumer protection law has recognised that the franchisee is a

vulnerable business consumer, as demonstrated by the enactment of s51AC of the

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.

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6 Chapter 1: Introduction

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:

a productive mechanism. Business failures are part of a process in which

inefficient and unprofitable businesses are replaced by efficient and

profitable ones. … Economies get better through a process of

experimentation and natural selection.16F

17

Perhaps as a consequence of reframing business failure as a productive

mechanism, neither corporate insolvency not personal bankruptcy carry the stigma

they once did, and strategic insolvency17F

18 is considered to be a valid strategy for some

businesses. US lawyers speaking to an audience of franchise lawyers noted:

Bankruptcy provides a useful business tool for a company to reorganize its

operations, deleverage its balance sheet, accomplish a sale of assets, obtain

new financing or improve its capital structure. For example, bankruptcy may

assist a franchisor in addressing the following challenging business issues;

overexpansion in the market and the need to eliminate units, an unworkable

equity structure, desire to sell or merge with another entity, threat of

franchisee litigation, desire to refinance but the lender has expressed concern

about financial or other issues.18F

19

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.

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Chapter 1: Introduction 7

The strategic insolvency strategy is a variant of the ‘capricious termination’

problem that was identified by Harold Brown19F

20 in 1973 as the ‘Achilles Heel’ of the

entire franchising industry.

Whether the decision by a franchisor to become insolvent was strategic or not,

the franchisees’ situation as vulnerable business consumers is brought into sharp

relief if an administrator or liquidator is appointed to the franchisor. At that point

franchisees must respond to decisions made by third party administrators or

liquidators who do not have the same interest in individual franchisee’s ongoing

viability as the franchisor has. Franchisees have no meaningful protection under

common law or statute once an administrator or liquidator is appointed to their

franchisor.

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.

Franchisors and franchisees view a franchise network in an entirely different

way to the way administrators and liquidators do. The Corporations Act contains the

administrators’ and liquidators’ statutory rights and duties towards parties that are in

a contractual relationship with the failing entity but under Australian insolvency law

franchisees have no specific statutory rights as parties to executory contracts.

Throughout the period of administration franchisees must not only continue to

honour their obligations under the franchise agreement. They must also continue to

meet upstream and downstream contractual obligations under premises sub-lease or

licence, supplier, employment and other contractual arrangements.

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.

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8 Chapter 1: Introduction

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.

1.2 CHALLENGES FOR THE LAW

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.’20F

21

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.

In addition to the theoretical legal issues, the ‘complexity of the operation of

law in practice’21F

22 should be taken into account when looking for solutions to

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.

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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’) 22F

23 being:

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.

A specification of the desired objective(s) (‘OBPR 2’). This is addressed in

chapter 5 by reference to the three consumer protection benchmarks

already identified.

A description of the options (regulatory and/or non regulatory) expressed

as a regulatory form or type that may constitute viable means for achieving

the desired objectives (‘OBPR 3’). These are identified in chapter 6.

An assessment of the impact, including costs and benefits, on consumers,

business, government and community or each option, with each impacted

group identified, noting impacts on competition, small business and trade

(‘OBPR 4’). A start has been made on this in chapter 6.3 but a full cost/

benefit analysis is the work of an economist with an appropriate budget

and falls outside this thesis.

A consultations statement detailing who was consulted, with a summary of

views from the main affected parties, or specific reasons why consultation

is inappropriate (‘OBPR 5’).23F

24 Although a consultations statement also

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’.

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10 Chapter 1: Introduction

Comments about the problem from a range of stakeholders are found

throughout the thesis.

A recommended option, with an explanation of why it was selected and

others were not (‘OBPR 6’). Some recommendations are made in chapter

6.2. Some are made in brief and others more fully. Each would have to be

subjected to a full cost/benefit analysis before being accepted or rejected.

A detailed strategy for the implementation and review of the preferred

option (‘OBPR 7’)’.24F

25 Formulating detailed implementation and review

strategies is the work of regulators and is beyond this thesis.

In addition to the seven OBPR pre-requisites, the UNCITRAL Legislative

Guide on Insolvency Law (‘the Guide’)25F

26 raises a further consideration, the

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’.26F

27

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.

1.3 AIM OF THE RESEARCH

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.

To support the conclusions this dissertation demonstrates why the current

emphasis on solving franchising problems through pre-contractual disclosure by

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.

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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:

Can franchisees as business consumers self-protect against the

consequences of franchisor failure?

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?

How should Australia’s commonwealth consumer protection law be

amended to meet the benchmarks?

1.4 OUTLINE OF THESIS

This thesis is presented in seven chapters in the manner outlined below.

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.

Chapter 3 places the problem in context by identifying the sources of the

problem. The outcome of an individual franchisor’s failure for each of its franchisees

depends on factors which can be loosely attributed to:

the development of the franchise model,

franchise network structural factors,

franchise agreement-related factors based in contract law, and

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

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12 Chapter 1: Introduction

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.

In chapter 3.4 the numerous asymmetries that affect franchisees as a group of

business consumers are identified. The legal relationships between the network’s

entities, levels and nature of delegation, allocation of risk, ownership of the assets

that make up the franchisors’ offering, and the direction of money flow between

franchise and franchisees, all have a strong bearing on the franchisees’ ability to

continue trading if their franchisor’s business fails.

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’,27F

28

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.

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Chapter 1: Introduction 13

The application of the Corporations Act to franchisor insolvency is examined

in chapter 4.4. The limitations posed by the imperfect fit between the consumer

protection and insolvency regimes becomes clearer when the roles and

responsibilities of a receiver, administrator and liquidator under the Corporations Act

are identified. State and territory retail leases legislation are considered in broad

terms in chapter 4.5.

The OBPR writes in terms of ‘desired objectives’. This is interpreted as

objectives that meet appropriate benchmarks. The three identified consumer

protection benchmarks are expanded on in chapter 5. I refer to conclusions drawn in

chapters 3 and 4 to demonstrate that benchmarks B1 and B2 are not met under the

current Australian law.

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.

1.5 INFORMATION BASE

Michael Trebilcock argues that an ‘information-based approach to consumer

protection policy is the appropriate framework for analysing consumer protection

problems’.28F

29 Reliable information is a necessary starting point. There are at least two

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.

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14 Chapter 1: Introduction

franchisor-franchisee relationship, surprisingly little empirical research has

previously been conducted on the legal structure of the entire franchise network. To

understand the impact of insolvency law on the franchisee’s legal contractual,

property-based and consumer protection rights it was necessary to fill this gap. If a

solution is proposed in the absence of a strong understanding of both the factual and

the legal framework within which a problem subsists, it will not satisfy the OBPR

model for the making of sound and informed policy.

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.

1.5.1 EMPIRICAL RESEARCH ON THE FACTS

Initial research was conducted to formulate ‘[a] description of the problem or

issues which give rise to the need for action’.29F

30 The following areas were

investigated:

A pilot study 30F

31 was conducted (‘the CPA Study’) of franchisors that fail in

Australia, the reasons for their failure, the characteristics of failed

franchisors, the number of franchisees impacted and the impact of

franchisor failure on the franchisees in specific networks including the

Ansett Airlines-owned Traveland, travel agency franchise.31F

32

The nexus between the franchisor, the franchisees and the franchisees’

rights in relation to franchisors’ registered trade marks was explored. (‘the

Exploratory Study’)32F

33

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.

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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. 33F

34

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.

Ultimately, the challenges confronting legal researchers in franchising in

Australia is even greater in some ways than those that confront franchisees

attempting to conduct thorough due diligence on a particular franchise network. For

franchisees, it is extremely difficult, expensive, and sometimes impossible, to verify

the information provided by the franchisor in the disclosure statement. The

researcher has no ‘as of right’ access to disclosure documents or franchise

agreements that provide key information such as the legal identity of parties.

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.34F

35 Retail premises-based

franchisees were selected because franchisees establishing in retail premises each

made a high average initial investment of $234,00035F

36 and thus have a strong interest

in the security of their investment.

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.

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16 Chapter 1: Introduction

All 850 franchisors in the known population of franchisors in Australia in 2004

were listed.36F

37 Their websites were searched to identify those having franchisees in

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.

Information about ownership of franchisors’ registered trade marks within the

sample group was gathered from the IP Australia website37F

38 and franchisors’

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’).

1.5.2 RESEARCH ON THE CURRENT LAW

Research conducted on franchise law prior to this dissertation has focussed on

pre-contractual disclosure and on the franchise agreement as a contract. In addition to

disclosure and contract formation, this dissertation required an understanding of:

The legal structure of the franchise network

Trade mark law and practice

Retail lease law and practice

How franchisees compared with employees and independent contractors

37 With the assistance of Professor Lorelle Frazer, Griffith University. 38 IP Australia <www.ipaustralia.gov.au> at 31 May 2010.

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Chapter 1: Introduction 17

How franchisees compared with traditional suppliers

Law and economics, with a focus on asymmetry

Remedies for breach of contract and the Trade Practices Act

The application of the Code to administrators

The legal rights of franchisees of insolvent franchisors under contract law

and under the Corporations Act.

1.6 LIMITATIONS

This research is based on incomplete data in relation to franchisor numbers,

number of franchisees impacted and size of the investments lost. Some of the great

difficulties of conducting robust empirical research into the legal aspects of

Australian franchising are identified more precisely in chapter 2.1.1.

It is acknowledged in chapter 6 that a cost benefit analysis is essential before

any proposed legislative responses to problems are enacted. As the author is not an

economist, the stakeholders are identified and some costs and benefits are identified

but a full cost benefit analysis is left to be conducted by Commonwealth Treasury if

it deems such a step to be appropriate.

1.7 MATTERS BEYOND THE SCOPE OF THIS THESIS

This dissertation does not pursue in depth:

Retail leasing enactments which are part of the problem and part of the

solution.

The situation of franchisee whose franchisor discontinues franchising but

stays solvent.

Tax treatment of franchisees’ sunk costs when the franchisor fails.

The impact of the halo effect referred to in chapter 3 on the depth and

quality of franchisees’ due diligence.

The impact of the franchisor’s insolvency on the contracts entered into by

franchisees as a consequence of becoming franchisees which is raised but

not explored in chapter 3.1.10.

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18 Chapter 1: Introduction

The possibility of deeming franchisors to hold discrete funds paid by

franchisees in trust. This is raised but not pursued in chapter 6.1.6.

The insolvency of master franchisees.

The Corporations Act is part of the solution. Beyond tentative suggestions

in chapter 6.2.5 and identification of issues, this thesis does not address the

Corporations Act.

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Chapter 2: What is the problem and how big is it? 19

Chapter 2: What is the problem and how big is it?

According to the OECD Regulatory Checklist, the problem to be solved

should be precisely stated, giving clear evidence of its nature and magnitude

and explaining why it has arisen.38F

39

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.

2.1 RESEARCH INTO FRANCHISOR FAILURE

The existence of widespread franchisor failure is acknowledged by franchise

lawyers.39F

40 Beyond attempts at establishing how many franchisors fail and when in

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’.40F

41

Academic studies of the number and timing of franchisor failures have been

conducted in the United States, the United Kingdom and France41F

42 but no large-scale

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.

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20 Chapter 2: What is the problem and how big is it?

many franchises [ie franchisors] were failing [in the US]. One study42F

43 identified 54

entire restaurant franchise systems that turned “belly up” over a two-year period’.43F

44

Roger Blair and Francine Lafontaine state:

the USDOC (1988)44F

45 data … reports the number of franchisor failures and

departures… Out of an estimated population of 2,177 franchisors in 1986:

‘A total of 104 franchisors operating 5,423 outlets failed during 1987 … The

volume of 1986 sales represented by failed firms amounted to $[US] 1.7

billion, of which the franchisee-owned portion was $[US]1.5 billion’. 45F

46

Commenting on the timing of the failures:

[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.46F

47

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:

The only systematically compiled statistics on franchise [this could have

been franchisors or franchisees] failures have been provided by the

Franchising in the Economy reports [produced up until the late 1980s by the

US Department of Commerce but since discontinued] and periodic

membership surveys by the International Franchise Association. While these

efforts are commendable and undoubtedly well intentioned, both are based

on potentially incomplete and inaccurate data submitted by franchisors.47F

48

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.

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Chapter 2: What is the problem and how big is it? 21

unqualified success story … over a ten year period. Around half the [UK] sample

was judged to have failed completely and utterly’.48F

49 Blair and Lafontaine conclude

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’.49F

50

Rozenn Perrigot and Gérard Cliquet studied 952 franchising networks in

France during the period 1992-2002 and found that only 42.13 per cent survived.50F

51

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.51F

52 Beyond this small amount of research on the number of franchisor

failures, the actual cost to franchisees and consequences for franchisees of franchisor

failure is under-researched. 52F

53

2.1.1 AUSTRALIAN FRANCHISOR FAILURE DATA

As this thesis is about franchisor failure in Australia, it is important to seek

Australian data rather than assuming that American, British or French patterns are

reproduced in Australia. However, as Colin McCosker and Lorelle Frazer observed

in 1998:

When extending the analysis of business failure to franchising, the problem

of data collection becomes apparent. No comprehensive database of

franchisors or franchisees is available in Australia, so researchers must

develop their own. … it is not possible to access failed franchisors. The

magnitude of such franchise system failures is unknown but may be

disturbingly high. For instance, … the authors found that in the 6-month

period from checking firm details in the Telstra White Pages on the Internet

(updated daily) to follow-up on non-respondents, 13.4 per cent (127 out of

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.

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22 Chapter 2: What is the problem and how big is it?

946 [franchisor] firms) could not be located and were presumed to be no

longer operating.53F

54

Echoing McCosker and Frazer’s observation in 1998, it is still not possible in

2010 to determine from public records which of the 693 franchisors known to be

trading in 1998, the 850 in 2004 and the 1100 in 200854F

55 are still solvent.

Data collected during the CPA Research and subsequently is reproduced in

Table 1 on pages 30 to 39. The data in Table 1 tends to support Lafontaine and

Shaw’s conclusion that young franchisor networks in Australia are not more

vulnerable to failure than the more established ones. By implication, it contradicts

Shane’s research as some Australian franchisors have failed long after their

businesses passed the 10 year mark.

Frazer et al now conduct a biannual franchising Australia survey. Their

database records the franchisors that are not contactable two years later, but the

published survey does not identify them by name or by total number. Frazer is cited

as saying:

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.55F

56

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.

Jason Gehrke writes that his analysis of:

the advertiser list of a 1996 edition of Franchising Magazine indicated that

of 113 franchisors then advertising for franchisees, 34 could no longer be

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.

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Chapter 2: What is the problem and how big is it? 23

found to exist just 10 years later – an attrition rate of 30 per cent. Many of

these were very small, start-up systems with a handful of outlets, but the

consequences of their failure are equally devastating to their franchisees

nonetheless. 56F

57

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.

The biggest impediment to determining what happens to franchisees when their

franchisor fails is identifying failed franchisors and former franchisees. The list in

Table 1 is incomplete. Searches of public records and other sources that are typically

available to intending franchisees or their advisers were conducted. The records

searched were:

Media reports, using the Factiva database and the Australian Financial

Review,

The Australian Securities and Investments Commission 57F

58 (‘ASIC’)

website where administrators and liquidators lodge documents surrounding

corporate insolvency at ASIC,

The Insolvency and Trustee Service Australia that maintains records of

personal bankruptcy (‘ITSA’),

The Australian Competition and Consumer Commission58F

59 (‘ACCC’)

website which contains information about investigations and prosecutions

for breaches of the Trade Practices Act and the Code,

State and territory business name records, and

Federal, state and territory court records.59F

60

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.

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24 Chapter 2: What is the problem and how big is it?

First the identity of the failed franchisor’s legal entity was sought, then the

affected franchisees. Many challenges were encountered.

What was the franchisor entity?

Franchisors exist within complex networks of legal entities. It is difficult to

find a legally meaningful starting point, such as the name of the franchisor entity,

from which to begin an investigation. The franchisor entity may be a public or

proprietary company, a trust or sole trader with a name different to the trading name

of the franchisor. This is apparent by observing the differences in the ‘Trading name’

and the ‘Entity names’ columns in Table 1.

IDENTIFICATION OF FRANCHISOR THROUGH THE MEDIA

If a failed franchisor is named in a media report, the franchisor is referred to by

its trading name. Where the trading name and the legal entity name of the franchisor

are similar it is possible to determine the legal identity of the franchisor (eg The

Furniture Wizard Pty Ltd traded as Furniture Wizard). In cases where there is no

similarity between the legal entity’s name and the trading name (eg Chaste

Corporation Pty Ltd traded as TRIMit) the franchisor cannot be identified from the

media report.

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’.60F

61 BHG was wound up, insolvent, in December 2008.

Thirty four of the franchisors in the CPA Study were initially identified

through media reports. 61F

62

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.

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Chapter 2: What is the problem and how big is it? 25

IDENTIFICATION USING ASIC RECORDS

Once the initial database of likely failed franchise systems was compiled, ASIC

records were searched to verify the status of each corporate franchisor. To identify

franchisees of the former franchisors, franchisees that appeared by name on any

public records were recorded. Franchisees are often proprietary companies, with

contractual obligations supported by the personal guarantees of the directors. The

franchisors are also primarily companies.62F

63 ASIC does not require franchisors or

franchisees to self-identify as being part of a franchise network, so ASIC records are

not a reliable way of identifying participants in the franchise sector, or in a particular

franchise network. Where the franchisor is a public company there is no record of the

franchisees’ identities in the company’s Annual Report.

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.

The insolvency-related ASIC records of two insolvent franchisors63F

64 were

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.

Following a franchisor failure, the administrator or liquidator receives or

compiles a list of franchisees but there is no requirement to lodge that list with ASIC

or ITSA. Without access to these records, it is impossible to ascertain whether all of

the franchisees have been counted, and whether the number of franchisee per

franchisor as reported in the media is accurate.

63 Lorelle Frazer and Scott Weaven, Franchising Australia 2004 (2004) 70. 64 The Furniture Wizard and Traveland.

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26 Chapter 2: What is the problem and how big is it?

ITSA RECORDS

It is not possible to determine from personal bankruptcy records whether the

failed sole proprietor was a franchisor or a franchisee.

IDENTIFYING FAILED FRANCHISORS AND THEIR FRANCHISEES THROUGH COURT RECORDS

Searches of numerous court records yielded very little. The exception is

Synergy in Business which was prosecuted by the ACCC64F

65 in order to establish that

it was a franchise network. A list of franchisees was appended to the judgment.

In court cases involving failed franchisors, it can be impossible to determine

the identity of the franchise network. For example in Rousellis v Maiurano [1998]

NSWCA 196 Fitzgerald AJA referred to the franchisor as ‘two companies, which at

the time were insolvent and were later ordered to be wound up on that ground’65F

66

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. 66F

67

Identifying and finding former franchisees of failed franchisors

Precise information is required for legal research. Having finally identified 39

failed franchisors in the CPA Study67F

68 a bigger challenge proved to be identifying

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.

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Chapter 2: What is the problem and how big is it? 27

As one of the failed systems was a travel agency, Traveland, an advertisement

was placed in a daily electronic newsletter service that circulated to 15,000

individuals in the travel industry.68F

69 This elicited three responses from former

Traveland franchisees.

Advertisements aimed at former franchisees of failed franchisors were placed

in a number of national and state daily newspapers including ‘The Australian’ and

the ‘Daily Telegraph’. It was an expensive exercise and the response rate was very

low. 69F

70 Specific advertisements were not placed in Tasmania, the Northern Territory

or Western Australia because of the relatively low number of franchisees in those

states. A press release sent to one daily newspaper was picked up and used, and led

to one franchisee of a failed franchisor making contact.

An advertisement was posted on the Brisbane bailiff’s office website

http://www.bailiff-sheriffaustralia.com.au. A chat strand was set up on

franchisechat.com http://www.franchise-chat.com/forum, a global franchise chat site

with 736 members. Neither yielded any responses or postings.

IDENTIFYING FRANCHISEES THROUGH STATE AND TERRITORY BUSINESS NAME RECORDS

Businesses that do not trade under their company name or their personal name

are required to register their business name in the state or territory in which they

operate. Many businesses ignore this legal requirement. For example, in the online

lingerie retailing franchise, franchisor No Regrets, of the 600 franchisees, only two

had registered their business names – one in New South Wales and one in Western

Australia. Therefore there are 598 former franchisees that cannot be identified

through the business names public records. In ‘The Furniture Wizard’, a furniture

repair franchise with 35 franchisees, only 21 had registered business names.

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.

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28 Chapter 2: What is the problem and how big is it?

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’.

Where business names had been registered by franchisees, extracts of the

relevant registration were purchased. Although the registration had generally lapsed,

the contact details of the former franchisee are still on the records. They are often no

longer current.

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.

Eighteen former franchisees agreed to complete a survey. Three that were

eligible declined.70F

71 For the CPA Study two survey instruments were used. The first

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.

The human dimension

A further challenge to research on franchisees of failed franchisors is that

former franchisees’ lives have been disrupted by the experience. Former franchisees

71 One who could not face revisiting the issue, one who had signed a confidentiality agreement and

one couple who spoke very broken English.

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Chapter 2: What is the problem and how big is it? 29

are not always willing to participate in research that will cause them to revisit a

difficult time.

Reactions to an invitation to participate in the CPA Study varied from:

… really interested in being involved

to

… not interested in being involved. [S]igned confidentiality agreement with

Synergy and wouldn't want to breach it

… simply doesn't feel up to getting involved in it all again

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.71F

72

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. 72F

73 To comply with the Code, the franchisor is required to supply business

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.

Information from administrator and liquidators

Because franchisees were difficult to find, letters were sent to administrators

and liquidators of specific franchise networks. Five agreed to participate and were

interviewed. In all cases these professionals provided valuable insights, all on the

condition of confidentiality.

Distinguishing franchised businesses from non-franchised businesses

Some businesses do not knowingly establish themselves as a franchise and

only realise that they are operating as a franchise after court action. For instance, in

Australian Competition and Consumer Commission v Ewing [2004] FCA 5 the

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’).

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30 Chapter 2: What is the problem and how big is it?

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.

Interpreting information on franchisors’ websites

On learning that the Australian master franchisor for Canadian popcorn

franchisor Kernel’s Amazing Popcorn was insolvent, the Australian master

franchisor’s website was immediately searched. The website still portrayed a master

franchise in good health. It did not identify the franchisor. The only legal entity

named was Jatora Pty Ltd which, according to the website, had the role of

negotiating and holding the head lease on all the franchised locations. A

contemporaneous search of the ASIC company and business name records name had

a different outcome with 17 business names registered incorporating ‘Kernel’s

Popcorn’, but no names of legal entities. The Australian master franchisor does not

have the word Kernels in its name. An ASIC search reveals Jatora Pty Ltd’s status as

‘under external administration and/or controller appointed’. The administrator was

appointed on 18 March 2005. A resolution that the company be wound up was

recorded by ASIC on 21 April 2005. It was unclear from the master franchisor’s

website, whether Jatora played any other role other than head tenant in the leases.

However, the liquidators’ report to creditors filed with ASIC to comply with

Corporations Act s 239A shows that Jatora Pty Ltd was the Australian master

franchisor.

2.1.2 EVIDENCE OF FAILED FRANCHISORS

Given the difficulty in obtaining comprehensive data on franchisor failure,

Table 1 provides a conservative indication of the size of the problem. The gaps are

where the information could not be found.

Table 1: Australian failed franchisor data

Trading name

Entity names

Started business

Started franchising

Year failed (administrator or liquidator)

Amount owed to creditors, (estimated)

Known number of franchisees

Worldwide Online

Navis 2010 85

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Chapter 2: What is the problem and how big is it? 31

Trading name

Entity names

Started business

Started franchising

Year failed (administrator or liquidator)

Amount owed to creditors, (estimated)

Known number of franchisees

Printing

Mailpost Australia

Mailpost Postie Network Pty Ltd (franchisor) Mailpost Australia Limited (master franchisee = insolvent)

2007 2007 2010

Firepower 2009 $100m secured

City Pacific Finance

City Pacific Limited Wengor Pty Ltd First Chartered Capital 11 subsidiaries in total.

2009 40+

Storm Financial Group

Storm Financial Limited, + 22 other companies, not EXAD on 3/12/09

2009

Hooters Wings-Aus Holdings Pty Ltd

Failed twice in Australia

2009

LPGas 1 franchising

LPGas 1 Franchising Pty Ltd

2007 2009 8

Samsara Samsara Wholesaling Pty Ltd Samsara Furniture and Café Pty Ltd Samsara Furniture and Homewares Pty Ltd Samsara Exotic Wares and Café Pty Ltd Samsara

1993 2009 10

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32 Chapter 2: What is the problem and how big is it?

Trading name

Entity names

Started business

Started franchising

Year failed (administrator or liquidator)

Amount owed to creditors, (estimated)

Known number of franchisees

Licensing Pty Ltd

Jims Pool Care Retail

In Jims Group

2003 2009

Kleenmaid Group 1 Lifestyle Appliance Corporation Pty Ltd (franchisor) Kleenmaid Corporate Pty Ltd Lifestyle Appliance Sales Pty Ltd Kleenmaid Property Pty Ltd EDIS Service Logistics Pty Ltd, Kleenmaid Customer Solutions Pty Ltd Bizco Retail Pty Ltd Kleenmaid Holdings Pty Ltd KM Intellectual Reserves Pty Ltd Orchard KM Pty Ltd Kleenmaid Retail Pty Ltd Manlyvale Pty Ltd Kleenmaid Pty Ltd Kleenmaid Appliances Pty Limited (“the Kleenmaid Group”)

1985 2009

$102m including $28m secured

15 retail + 30 van

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Chapter 2: What is the problem and how big is it? 33

Trading name

Entity names

Started business

Started franchising

Year failed (administrator or liquidator)

Amount owed to creditors, (estimated)

Known number of franchisees

(All Administrators Appointed) Group 2 (Orchid Group) (24 entities in total)

Beach House Group

Beach House Group Pty Ltd BHFC (Australasia) Pty Ltd Skinsama Pty Ltd Skinsama Debt Collections Pty Ltd Skinsama Investments Pty Ltd Skinsama Mentone Pty Ltd Sroll Pty Ltd BH Utilities Pty Ltd Kilbara Pty Ltd Broadbeach Beach House Pty Ltd Simafa Pty Ltd; Beach House Fitness Centre Pty Ltd 3D Commercial Pty Ltd (possibly related) Micklan Pty Ltd

2001 2008 $8m secured; $47m unsecured.

60

Jims Appliance Repairs

In Jims Group

2001 2008

Jims Graffiti Solutions

In Jims Group

2007 2008

Jims In Jims

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34 Chapter 2: What is the problem and how big is it?

Trading name

Entity names

Started business

Started franchising

Year failed (administrator or liquidator)

Amount owed to creditors, (estimated)

Known number of franchisees

Heating & Cooling

Group

EzyDVD EzyDVD Pty Ltd

2008 $18m secured.

32

Midas Midas Australia

1976 (Australia)

$30m secured

43

The Base Warehouse

Zafco 2008

Kleins Kleins Franchising Pty Ltd The Jewellery Chain Pty Ltd (franchisor) JDA Imports Pty Ltd

2008 $20-25m secured

150 in Australia, South Africa and New Zealand

Priority Management

Priority Management Systems Pty Ltd (master of Canadian system)

? 2001 2007

Jims Road Training

In Jims Group

2000 2007

Betta Electrical

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 BSL Finance Pty Limited

2007

PC Masters 2007 Pulp juice bars

Signature Brands Ltd

2004 2006 $200,000 + unsecured to landlords

19 in Australia 2 in Middle East

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Chapter 2: What is the problem and how big is it? 35

Trading name

Entity names

Started business

Started franchising

Year failed (administrator or liquidator)

Amount owed to creditors, (estimated)

Known number of franchisees

GoManGo juice bars

Signature Brands Ltd (floated in 2004)

2006 5 (est)

Sureslim Sureslim Australia Pty Ltd

2006

Jims irrigation

In Jims Group

2002 2006

Jims Mobile BBQ

In Jims Group

1999 2006

Jims Wardrobes

In Jims Group

1999 2006

DC Corporation Australia Pty Ltd

2000 2006

Collins Booksellers

Collins Booksellers Pty Ltd

1929 ? 2005 20

Jims Alarms In Jims Group

2000 2005

Jims Concreting

In Jims Group

2003 2005

Jims Earthworks

In Jims Group

2004 2005

Jims Garden Edge

In Jims Group

2003 2005

Marie’s Mobile Hair

In Jims Group

2003 2005

Danoz Direct

Danoz Direct Retail Pty Ltd TVSN Limited Danoz Directions Pty Ltd Danoz Direct Pty Ltd

1998 2005 6

ie Networks IE Networks Pty Ltd

2004 2005

Juice Station

The Juice Station Pty Ltd

1996 2005 17

Kernels Popcorn

Jatora Pty Ltd

1996 2005 25

Nrgize Nrgize Australia Pty Ltd

2005 $2m 17

Only $2 Only $2 Pty Ltd

1999 2005 25

Party Land Partyland Australia Pty

2000 2005 3

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36 Chapter 2: What is the problem and how big is it?

Trading name

Entity names

Started business

Started franchising

Year failed (administrator or liquidator)

Amount owed to creditors, (estimated)

Known number of franchisees

Ltd Sam's Seafood

Sam's Seafood Holdings Ltd

2005 $17m 16

Allied Securities

Liquid Engineering Industrial Pty Ltd Servcom

2004 1160

Data Vault Data Vault Services Pty Ltd

2002 2004

Office Support Services

Office Support Services International Pty Ltd

2001 2004

Photo Safe Photo Safe Australia Pty Ltd

2002 2004

Speeds Shoes

Speeds Shoes Pty Ltd 326SS Pty Ltd Speeds Shoes Group Pty Ltd

1910 2004 $1m 75

Jims Preggi Bellies

In Jims Group

2004

The Keg Keg (Albert Park) Pty Ltd

1998 2004

CarLovers carwash

Carlovers International Ltd

Pre-1998 Pre-1998 2003 30

Tokyo Joe’s The Australian Sushi Company Pty Ltd (franchisor + supplier)

2003 $31,000 6

Delifrance (Australian arm)

Delifrance Australia

1995 2003 19

Mini Tankers International

Mini-Tankers International Pty Ltd

1991 2003 $4.4m secured $8m unsecured

200

Mobile Computer Cleaning

Mobile Computer Cleaning Pty Ltd

1997 2003 56

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Chapter 2: What is the problem and how big is it? 37

Trading name

Entity names

Started business

Started franchising

Year failed (administrator or liquidator)

Amount owed to creditors, (estimated)

Known number of franchisees

Personal Actions

Personal Action Pty Limited

1992 2003 $200,000

Roger David

Roger David Franchising Pty Ltd

2003

Soils Ain’t Soils

Soils Ain’t Soils Pty Ltd

1980 2003 Up to $100m incl. $16m to ATO

4

King of Croissant

King of Croissant Pty Ltd

1997 2002

Jims Sand Soil & Gravel

In Jims Group

2001 2002

NoRegrets NoRegrets Australia Pty Ltd (and several Norwood-controlled companies)

1998 1998 2002 $13m No assets

600

Old Papa’s Café

Old Papa’s Franchise Systems Pty Ltd

2000 2002 3

Rugs Galore Rugs Galore Pty Ltd 12 007 343 204

1991 2002 4

Tony Barlow Menswear

Boutique Consolidated Pty Ltd Tony Barlow Australia Ltd (parent)

2002 $4.8m incl. $700k secured to NAB

5

Stockmans Australian Café

Stockman’s Australian Café Pty Ltd

1990 2002 48

Synergy in Business

Synergy In Business Pty Ltd

1998 1999 2002 31

Cheque Exchange

Cheque Exchange (Aust.) Pty Ltd

1998 2001 58

Renouf Fitness

Personal Training Centres

2001 $200,000

Lloyd Scott Enterprises

Lloyd Scott Enterprises Pty Ltd ACN002739773

1984 2001

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38 Chapter 2: What is the problem and how big is it?

Trading name

Entity names

Started business

Started franchising

Year failed (administrator or liquidator)

Amount owed to creditors, (estimated)

Known number of franchisees

Traveland Traveland Pty Ltd (in a group of 40 entities including Ansett Australia Limited and 1 trustee company)

1958 1990? 2001 270

TRIMit Chaste Corporation Pty Ltd

1999 2001 70

Arby’s Arby’s Pty Ltd

1995 2000

Jims Motor Vehicle Repair Service

In Jims Group

1999 2000

On Time Copy Centre

On Time Business Solutions

1997 1998 2000 $3m 17

Simply No-Knead

Simply No Knead Franchising Pty Ltd

1985 1989 2000 5

Top Snack Foods

Top Snack Foods Pty Ltd Nick Kritharas Holdings Pty Ltd Adway Holdings Pty Ltd

1994 2000 $800,000 5

A1 Mobile Radiator Repairs

A1 Mobile Radiator Repairs Pty Ltd

? 1997 1999 4

Furniture Wizard

The Furniture Wizard Pty Ltd

1996 maybe 1998 1999 35

Modern Garages

Arbin (no 1) Pty Limited (formerly Abrogram Pty Limited, Modern Garages Pty Limited)

1988 1994 1999

Mystic Crystals

Mystic Crystals Franchises (Australia)

1993 1999 2

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Chapter 2: What is the problem and how big is it? 39

Trading name

Entity names

Started business

Started franchising

Year failed (administrator or liquidator)

Amount owed to creditors, (estimated)

Known number of franchisees

Pty Ltd

Century 21 Pty Ltd

Century 21(South Pacific) Pty Ltd

1988 1988 1998

Great Australian Ice Creamery

Icecreameries of Australia Pty Ltd

1977 1982 1998 62

Wonderland of Pets

Wonderland of Pets Pty Ltd ; Kiltaro Pty Ltd

1994 1996 $860,000 3 (originally 10)

Cut Price Deli

Cut Price Deli Pty Ltd

1974 1984 1995 150

Denny’s Denny’s Pty Ltd

1986 1994

Ozzie Discount Software

Discount Software Pty Limited

1992

Underpinning buildings in NSW

Aizeema (Australia) Pty Ltd; Hy-Jack Superlifting Systems Pty Ltd

1990 1991

1993

Snow Deli Snowdeli Pty Limited

1987 1990 $8.7m 10

Brumby’s (survived)

1988

Barbara’s House and Garden

Barbaras House & Garden (Retail) Pty Ltd (franchisor) Barbara’s House & Garden Pty Ltd, Barbaras House & Garden (Australia) Pty Ltd Barbaras House & Garden (Wholesale Pty Ltd

1980 1982 1987

Cassidy’s Fair

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40 Chapter 2: What is the problem and how big is it?

Trading name

Entity names

Started business

Started franchising

Year failed (administrator or liquidator)

Amount owed to creditors, (estimated)

Known number of franchisees

Dinkum Bargains Fuddruckers Fuddruckers

Pty Ltd 1981

Mermaid’s Catch

Sizzler Bumpa T Bumpa

Described as ‘defunct’ no more information available

The Donut Wheel/ The Chocolate Chip Cookie wheel

Melbourne based, vans delivering choc chip cookies to shops

LJ Hooker

Figure 1: Number of identified failed franchisors in Australia 1987 – 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

0

2

4

6

8

10

12

14

16

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

Known Numberof Failed

 Franchisors

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Chapter 2: What is the problem and how big is it? 41

assess the extent of this problem. Garry Williamson73F

74 who ‘has been tracking

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’.74F

75 On the basis of

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.

Figure 2: Known number of franchisees affected by their franchisor failing in

Australia 1990-2009

In Australia in 2007, the average number of franchise units per franchise

system was 50.75F

76 To use this median to estimate the number of franchisees impacted

by franchisor failure in Australia is problematic as franchise systems range ‘from 1 to

2,950 total units.’76F

77 While some networks had very few franchisees when they failed,

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.

10 

150 

62 41 

27 

399 686 

285 

1,235 

129 

285 

103 

10 

100 

1,000 

10,000 

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

Known fran

chisees

affected (logaithmic scale)

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42 Chapter 2: What is the problem and how big is it?

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.

Consistent with Lafontaine and Shaw’s conclusions,77F

78 franchise networks of

any age and structure can fail. Failed franchisors in Australia include:

Public companies and entities wholly owned by public companies (drive in

car wash business CarLovers, travel agent Traveland, retail gadget shop

Danoz)

Proprietary companies (retail mid-range jewellery franchise Kleins, Top

Snack Foods)

Long established businesses (Kleins Jewellery had been in business for 25

years, franchising unknown number of years ; Collins Booksellers, 76

years, franchising unknown number of years; and Speeds Shoes, 94 years,

franchising unknown number of years)

Franchisors of short duration (A1 Mobile Radiator Repairs and Danoz

Directions - 2 years)

Franchisors with hundreds of franchisees (No Regrets with 600, Traveland

with 270)

Businesses requiring franchisees to invest high sunk costs (Kleins,

Kleenmaid ($400,000), Stockmans Australian Café, Cut Price Deli)

Those requiring small sunk costs (Furniture Wizard, conducted from the

franchisees’ suburban residential garages)

Franchisors established before the mandatory Code was introduced in

1998 (Cut Price Deli, Century 21, Great Australian Ice Creamery)

Those established post the enactment of the Code (Kleins, Danoz, diet

business Trimit)

Franchisors with franchisees operating as commission agents (gym

business Beach House Group, Kleenmaid)

78 Lafontaine and Shaw, above n 47, 95-112, in Hoy and Stanworth (eds), above n 47, 163.

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Chapter 2: What is the problem and how big is it? 43

Franchisees operating on the usual money flow model where franchisees

receive money from their customers and pay royalties to their franchisor

Australian master franchisees of overseas based franchisors (Kernels

popcorn from Canada, Delifrance from Singapore, Midas and Hooters

from the USA).

2.1.3 WHY FRANCHISORS FAIL

Common sense suggests that the franchisors do everything in their power to

make their business a success. This is not always the case. The Franchising Task

Force Report of December 1991 (‘Task Force’) in Australia78F

79 concluded that the:

2.7 … most vulnerable franchise systems are those that have recently

commenced franchising and have less than, say, 12-15 units.79F

80

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. 80F

81

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.81F

82 These causes are:

undercapitalization

absence of economies of scale

lack of business acumen

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.

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44 Chapter 2: What is the problem and how big is it?

inability to survive intense competition in sectors (such as retailing)

where barriers to entry are low.

Failure as a result of franchising-related factors, is seen by Cross as falling

essentially into five key categories: business fraud, intrasystem competition

involving franchise outlets being located too close, insufficient support of

franchisees, poor franchisee screening and persistent franchisor-franchisee conflict.82F

83

Failure of the parent company83F

84 should be added to this list.

It is not always possible to identify the underlying cause of insolvency from

public records. Reported court cases that involve a franchisor at about the same time

as it becomes insolvent generally relate to issues with a particular franchisee or group

of franchisees and seek to resolve pre-insolvency matters such as alleged misleading

and deceptive conduct by the franchisor. Only passing reference is made to causes of

franchisor failure.

The following are specific examples of failed franchisors from Australia:

An unsuccessful attempt at expanding to another country can lead a

franchisor to fail; for example Mini-Tankers International ‘which operated

franchises in Australia, Canada and New Zealand collapsed in September

[2003] owing $10.7million as a result of an unsuccessful attempt to launch

an operation in the United States’.84F

85

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’.85F

86

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.

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Chapter 2: What is the problem and how big is it? 45

A1 Mobile Radiators breached the consumer protection provisions ss 52

and 59(2) of the Trade Practices Act and became insolvent during the

litigation.86F

87

A similar path to A1 Mobile Radiators was followed by Simply No Knead

which was successfully prosecuted for breaching s 51AC of the Trade

Practices Act and became insolvent during the litigation.87F

88

No Regrets, an on-line lingerie retail business, established in 1998, enticed

600 franchisees to invest in a virtual franchise store. The franchise ‘was

launched in 1998 as a tax-effective scheme, with the help of prospectuses

that set a new standard in steamy financial documents complete with

pictures of scantily clad women’.88F

89 The franchise was based on an

aggressive tax avoidance scheme where ‘investors put in about [A]

$12,500 cash for each so-called virtual franchise store they bought but

claimed tax deductions of up to $51,000’. 89F

90 It was described as a ‘financial

and operational flop’.90F

91 It is estimated that the 600 franchisees lost ‘in

excess of [A]$7million through a combination of their original franchise

fee, then big bills sent by the tax office as part of a crackdown on tax-

effective schemes’.91F

92 Although the dubious wisdom they exhibited in

being attracted to a tax minimisation scheme can be questioned, the

franchisees did not cause the failure of this franchise.

Lloyd Scott Enterprises, a photocopier franchise became insolvent in June

2001 because of the dishonesty of the franchisor, Mr Lloyd Scott. The

media reported:

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.

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46 Chapter 2: What is the problem and how big is it?

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.92F

93

CarLovers Carwash franchise was a public listed company which became

insolvent in 2003. The media report stated:

In the 2002 financial year, according to PricewaterhouseCoopers, from every

[A]$100 in income that CarLovers earned, 20c came from franchise fees. ….

[the franchisor] locked itself into expensive leases of up to 20 years, on sites

where the carwashes didn’t reach expectations and the company made big

write downs. … [I]n 1998 CarLovers’ problems with its leases were

compounded with what became an even greater problem: an increasing

number of franchisees stopped paying franchise fees, claiming that

CarLovers was not providing the services … it had promised. Then there

were the little contretemps CarLovers’ had with its auditors.93F

94

Failed franchisor, Stockmans Australian Cafes identified what were

believed to be critical mistakes which resulted in the franchisor failing.

These were:

Failure to provide sufficient field support to franchisees.

Appointing master franchisees. … this gave third parties the authority to

grow and represent the franchisor but they did not have the requisite skills

and passion.

No internal compliance standards and a tolerance of non-compliance of

franchisees.

Having a very wide geographical spread of franchisees, but small numbers.

[The franchisor] had all the costs of servicing a national network without

many of the economies.

Failure to invigorate the network with new product and innovation.

Poor communication and complaints management processes.

Growth that was too fast and master franchisees that were too focussed on

selling franchises rather than providing the necessary support to franchisees.

Poor recruitment standards and policies.

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.

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Chapter 2: What is the problem and how big is it? 47

Lack of detailed monitoring and bench marking.94F

95

In 2006, the Signature Brands owned Pulp Franchises’ failure was

attributed to the fact that by ‘mid 2004 the juice bar industry, estimated to

be worth more than $650m by ACNielsen – had become saturated and

recent arrivals [such as Pulp] were struggling under the weight of massive

leases’.95F

96

Instances of franchisor failure are increasingly well publicised. Media attention

tends to highlight the plight of customers and the franchisor’s employees, paying

scant attention to franchisees. For example, the Mercury made no mention of Speeds

Shoes’ franchisees who had invested $180,000 - $300,000 on their outlets, rather

focussing on employees, writing: ‘[m]ore than 60 workers face losing up to $200,000

in wages, superannuationa and holiday pay after the collapse of a discount shoe

chain’.96F

97 This failure of the media to include franchisees in the franchisor failure

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. 97F

98

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.

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48 Chapter 2: What is the problem and how big is it?

of resurrecting itself out of administration. Strathfield Car Radios’s administrator

adopted a strategy of:

selling franchises in order to rid themselves of unprofitable assets and to

raise capital. [For example] mobile phone and electronics retailer Strathfield,

… collapsed into administration earlier this year but emerged after a major

shareholder injected fresh capital. Strathfield has announced it will pursue a

franchise strategy as it attempts to turn its fortunes around.98F

99

It is beyond the power of the franchisees to influence the franchisor’s

management choices. As Doug Frazey observes:

While franchisees are typically required to meet a number of conditions in

their franchise agreements (such as sales quotas), franchisors do not share

the same responsibilities. … a franchisee is usually powerless to correct a

poorly managed franchisor, even though the effects may weigh more heavily

on the franchisee. 99F

100

One striking aspect of these insolvencies is that there is no evidence that any of

them was of a franchisees’ making.

2.1.4 EARLY WARNING SIGNS

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’.100F

101 The flow-on effects of the franchisor not receiving previously

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.

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Chapter 2: What is the problem and how big is it? 49

unemployment’.101F

102 Whereas in a traditionally structured firm some of these costs can

be ‘avoided by merger’ 102F

103 the opportunities available to a franchise include

advertising for new franchisees, increasing costs to franchisees and embarking on a

course of strategic insolvency. Consequently, franchisees may find they have to

accept less reliable supply of stock or manage hostile premises landlords or other

suppliers where the franchisor has failed to pay costs incurred in relation to the

franchisees’ business – paid on time by franchisees to franchisor and then not on-

paid to the suppliers on time. For example, a BHG franchisee discovered the

franchisor had failed to pay the local advertiser, so the advertiser refused to deal with

the franchisee until the franchisee got to the bottom of the problem and arranged

direct payment from franchisee to supplier, instead of from franchisee to franchisor

to supplier, for future local advertising.

It is difficult for franchisees to be pro-active if they believe their franchisor is

operating precariously. The franchise agreement and consequential contracts must be

adhered to.

Relevance of type of product or service sold by franchisees

As Jensen and Meckling point out, ‘in certain kinds of durable goods industries

the demand function for the firm’s product will not be independent of the probability

of bankruptcy.’ 103F

104 In franchising, the demand for the early morning take-away coffee

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.

In the immediate pre-insolvency phase, the franchisor’s own employees are

likely to become aware of the precarious nature of the franchisor’s business before

102 Ibid. 103 Ibid. 104 Ibid.

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50 Chapter 2: What is the problem and how big is it?

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:

Poor financial performance, including the accumulation of significant debt

when the franchise system is not expanding, growing operating losses, the

writing down of assets and re-financings are obvious indications [to the

financially literate] that a franchise is in difficulty. … Identifying financial

problems in non-publicly traded corporations is more difficult.104F

105

Colraine’s experience as an insolvency litigator also qualifies him to observe

that ‘[t]he financial difficulties of a closely held franchisor may become apparent

only when the franchisor’s obligation to provide advertising support, equipment and

inventory on a timely basis … are breached’.105F

106

The role of banks

Banks are a major stakeholder in both franchisors and franchisees through their

role as evaluators and financiers. But, in some cases the early warning signs do not

trigger a response by the franchisor’s bank. Allowing a franchisor to continue signing

up franchisees whilst the franchisor is in default on a large loan is a way of a bank

reducing its exposure by increasing its security.

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.

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Chapter 2: What is the problem and how big is it? 51

Franchise Systems’. By including Kleins in this list, the bank sent a message to

potential consumers of Kleins franchises, and their advisers, that Kleins was of sound

financial standing.

Table 2: National Australia Bank Accredited Franchise Systems 2008 and 2009

NAB Accredited Franchise Systems

23 May 2008

NAB Accredited Franchise Systems

6 September 2009

Australia Post

Autobarn

Bakers Delight

Bob Jane T-Marts

Choice Hotels (Flag)

Clarke Rubber

Fernwood

Gloria Jeans

Hungry Jacks

KFC/Yum! Restaurants

Kleins Jewellery

McDonald’s

Michels Patisserie

National Foods

Natrad

Pizza Hut/Yum! Restaurants

Quest Serviced Apartments

Red Rooster

Subway

Australia Post

Autobarn

Bakers Delight

Bob Jane T-Marts

Choice Hotels (Flag)

Clarke Rubber

Fernwood

Gloria Jeans

Hungry Jacks

KFC/Yum! Restaurants

McDonald’s

Michels Patisserie

National Foods

Natrad

Pizza Hut/Yum! Restaurants

Quest Serviced Apartments

Red Rooster

Subway

The Outdoor Furniture Specialists

Kleins was placed into administration on 30 April 2008 while the National

Australia Bank was still demonstrating endorsement on its website.

Litigation against franchisor as an early warning sign

The significance of litigation as an early indicator of failure was identified in a

Dun & Bradstreet Corporate Health Watch survey. It was concluded from the survey

results that ‘[c]ompanies that have had legal action taken against them are nearly

eight times more likely to fail than those that haven’t’.106F

107

107 ‘Warning Signs of Failure’, The Australian Financial Review (Sydney), 2 May 2006.

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52 Chapter 2: What is the problem and how big is it?

In franchising, further research would reveal whether the threat of franchisee

litigation caused the franchisor to consider pre-emptive or strategic bankruptcy107F

108 or

whether the litigation caused the subsequent failure of the franchisor.

2.2 FRANCHISOR FAILURE FROM OTHER PERSPECTIVES

2.2.1 FRANCHISOR’S PERSPECTIVE

For a financially troubled business, insolvency may be part of a considered

business strategy. According to US legal advisers, it provides ‘an opportunity … to

solve operational or financial problems and emerge as a more viable company’.108F

109

One US lawyer writes:

Franchisors file for bankruptcy to escape or postpone the consequences of

mass franchisee litigation, shareholder litigation, and lender enforcement

activities. During the reorganization [in Australia, administration] process,

bankruptcy can modify and suspend the obligations of the parties to a

franchise agreement. Ultimately, the reorganization plan may permanently

modify the rights and obligations of the parties to the franchise agreement. 109F

110

Anecdotal and deduced evidence of this conduct exists in Australia. For

example, bake your own bread franchisor Simply No Knead became insolvent

between the time the ACCC initiated proceedings and the time the case successfully

alleging the franchisor had breached s51AC Trade Practices Act was concluded.110F

111

Senior US franchise lawyers Rupert Barkoff and Andrew Selden identify ‘the

risk that ‘your franchisor goes bankrupt’111F

112 as an ‘uncontrollable risk’ in their

practitioner guide on franchise law.

2.2.2 THE GOVERNMENT’S AND THE REGULATOR’S PERSPECTIVE

Several government reviews into the franchise sector have been conducted in

Australia.112F

113 Some have examined small business generally; others focus on

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.

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Chapter 2: What is the problem and how big is it? 53

The Franchising Task Force in 1991 was the first Australian government-

initiated review to comment directly on franchisor failure, noting:

[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.113F

114

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’.114F

115 Franchisor and franchisee failure was

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.115F

116 Although the 1992

Supplement included a table on franchise failures, the firms counted were almost

certainly franchisees.

No further attention was given to the incidence or impact of franchisor failure

until the Mathews Review in 2006. The Matthews Review reported being: ‘made

aware of a number of situations where the impact of the failure of a franchise or a

franchisor had a major impact on the financial or emotional well being of those

involved’.116F

117

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.

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54 Chapter 2: What is the problem and how big is it?

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’.117F

118 The ACCC recommended the Parliamentary Joint Committee consider

whether: ‘Some measure might be warranted to protect franchisees in circumstances

where their franchisor fails – for example granting them the right to exit the franchise

agreement’.118F

119

2.2.3 INDUSTRY ORGANISATIONS’ AND COMMENTATORS’ PERSPECTIVES

The mantra of some franchise industry groups is that:

Bankruptcy of the franchisor is not necessarily bad for franchise system or

franchisees. There have been cases where bankruptcy and restructuring

actually result in [a] stronger network of operators, with stronger financial

management at corporate headquarters and a stronger brand position.119F

120

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.

Franchise insolvency leads to a ‘rebirth’ for franchisees.

In late December 2008, DVD retailer EzyDVD collapsed under the strain of

debts of around [A]$18 million. However, a white knight appeared in the

form of Franchise Entertainment Group (FEG), the operator of the

Blockbuster and Video Ezy chains in Australia and Asia. FEG bought out

EzyDVD’s brand and online business, the franchise network, as well as

stock, plant and equipment and 11 company-owned EzyDVD stores. The 25

franchised EzyDVD stores will also come under FEG’s control.

This turn of events has given new hope to many of the EzyDVD franchisees

whose futures were uncertain during the Christmas and New Year period. It

is also a clear indication that Franchise insolvency does not necessarily mean

the end of the line for franchisees. In fact, it would appear that the

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.

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Chapter 2: What is the problem and how big is it? 55

franchisees may fare better than others affected by the EzyDVD insolvency,

such as unsecured creditors. 120F

121

Before a company has a chance to attempt ‘rebirth’, it has to go through the

pains of bankruptcy – which can be easy, hard or very hard on the franchisees. In a

best-case scenario, franchisees continue business as usual, perhaps implementing

minor adjustments that the franchisor deems necessary to boost profits or cut

overheads. However, it is

not uncommon for franchisees to be left holding the bag while a

[franchisor’s] bankruptcy is in progress. Bennigan’s franchisees, who had

previously depended on corporate marketing initiatives to advertise their

stores, faced the challenge of publicizing that they were open for business

despite a whirlwind of press implying otherwise.121F

122

Another perspective was provided to Australian franchising lawyers by Wayne

Jenvey who observed that in general terms:

the effects of franchisor insolvency on the franchise ecosystem translates,

upon insolvency, into myriad interests and competing claims among which

the franchisee is the least protected. The interests of the franchisees are not

protected and franchisees have no control over the business when the

franchisor fails. Franchisees are subject to the decisions of the external

controller.122F

123

2.3 FRANCHISOR FAILURE FROM FRANCHISEES’ PERSPECTIVE

Each individual franchisee’s personal and financial resilience and negotiating

ability will be factors in how they emerge from franchisor failures. Some can draw

from a deep well of prior experience and a strong personal support network; some

can only attribute the survival of their business to luck or its demise to bad luck.

A 2009 online news piece on franchisor insolvency sums up the predicament

faced by many franchisees:

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.

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56 Chapter 2: What is the problem and how big is it?

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.123F

124

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.’124F

125

Journalist Trevor Sykes followed the Traveland franchise failure story and

described the insolvency of the Traveland franchisor as a tragedy in four acts.125F

126

Sykes writes:

Act I. 24 September 2001 … saw the parent company; Ansett’s

administrators sell Traveland to a dot.com company that had not previously

been involved in the travel industry, Internova Travel for $500,000. At this

stage Traveland had 104 branches and 750 staff. Internova Travel

(incorporated specifically for the Traveland purchase) bought the money-

losing business with borrowed money, without tying down its potential

partners and financiers.

Act II. 28 September 2001 saw the Australian Investment Corporation of

Western Samoa (AIC) buy half of Internova Travel for [A]$500,000. … ’the

half a million AIC put up seems to have disappeared straight down the

insatiable maw of Traveland in wages and other costs.

Act III. 8 October 2001 Financial Options Group Inc (FOGI), a company

owned by the two Sydney entrepreneurs who controlled AIC, paid

[A]$2million for the balance of Traveland. Possession of the business passed

on 8 October but settlement was not required until 24 October. The money

was not paid and on 26 November 2001 Internova Travel’s directors put it

into administration, which quickly turned into liquidation. The Australian

Securities and Investment Commission put FOGI into liquidation on 18

February 2002.

Act IV. 23 December 2001. FOGI’s liquidator sold Traveland to

Travelworld for $250,000. Travelworld now has all Traveland’s staff and

licenses. Finally, Traveland was vanishing like the Cheshire cat. 126F

127

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.

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Chapter 2: What is the problem and how big is it? 57

Throughout the drama recounted by Sykes, there is little mention of the

estimated 270 to 285 Traveland franchisees. The Traveland business was an asset in

the Ansett insolvency. The CPA Study tracked down some of the former

franchisees.127F

128 One Traveland franchisee did have a clause in his agreement that

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”)’.128F

129

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.

The insolvency of a franchisor affects many relationships beyond that of

franchisor/franchisee. The franchisee’s own creditors will be unsure about the

franchisee’s ability to meet its ongoing payments. With this in mind, participants in

the CPA Study were asked: ‘did the insolvency of your franchisor mean you could

not pay business related liabilities?’ Forty-four per cent were able pay all business

related liabilities, while the balance defaulted or could only pay some.

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.

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58 Chapter 2: What is the problem and how big is it?

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 lost a lot of money, reputation and health.

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.

Decisions the administrator or liquidator takes in relation to disclaiming

onerous contracts will impact significantly on the options available to franchisees.129F

130

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

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If the liquidator disclaims the lease, the franchisee will lose the value of the sunk

costs unless it is able to negotiate a new lease. Even then, the franchisee may find

that the lack of the power of the brand, or the loss of group bargaining power, may

make trade unviable as an independent. For example:

James Rixon was a franchisee in the failed [Australian master franchisee

owned] Kernel’s Popcorn chain. He sold his business at a loss nine months

after his franchisor went into administration in 2005. … Rixon, a shop-fitter

by trade, renegotiated a lease with his landlord, formed direct relationships

with his suppliers and got together with other Kernel’s Popcorn franchisees

to trade under a new brand, Pop n Go, when his franchisor failed. But the

business was not as profitable as he would have liked. Rixon says he did not

have the marketing expertise to run the operations without a franchisor…. 130F

131

Franchisees who do not weather the storm of franchisor failure successfully

may be those that have only recently established their franchise when the franchisor

failed, they may not have established personal credibility with their landlord, their

working life may be nearing its end as the franchise may have been purchased with

redundancy money or with retirement savings, and they may be stretched to the limit.

Franchisor failure is a tipping point from which some franchisees have little chance

of recovering financially.

The physical whereabouts of a franchisee’s business will have a bearing on the

exit strategies available to the franchisee. For example, if the buyer of the network

already has an outlet in the same area it may decline to adopt the franchise agreement

as it does not want to cannibalize an existing market. Proximity to the end of the term

of the franchise agreement and premises lease are also relevant; the nearer to the end,

the more of the franchisees’ original investment has been recouped and the more

likely they are to have started to think of their future after franchising.

As is documented in Appendix C, insolvency regimes the world over give

special recognition to creditors and employees, but almost uniformly exclude

franchisees as stakeholders. The franchisee is likely to be contractually bound to

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.

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60 Chapter 2: What is the problem and how big is it?

remain in the franchise relationship while the administrator or liquidator explores

options for the future of the system and then pursues the best option for the creditors,

which can take months.

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.

Twenty franchisees switched to UTAG travel.

Several franchisees switched to Harvey World Travel.

One hundred and fifty Traveland franchisees joined Travelworld.

One franchisee became an employee of another agency, having lost so

much that he could not continue as a franchisee.

At least three franchisees re-branded as independent travel agents.

The fate of the remaining 100 or so other former Traveland franchisees is

unknown. Some will have continued trading as an independent businesses, unaligned

to any particular group.

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

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switched off. We could only call other franchisees. At no stage were the

Traveland franchisees offered the opportunity of buying the franchisor. 131F

132

Consequently, she had no real choice but to close the travel agency.

As was noted in The Australian:

...when it comes to liquidation, the laws are stacked in favour of the

franchisors. This is seen in the way that franchisors have the right to sell

their brand name and franchisees to another buyer, which sounds fair and

okay in terms of business law as it pertains to administration and liquidation,

but it could ruin the innocent parties, namely the franchisees. This is what

happened to 270 Traveland travel-agent franchisees[;] ... one-time solid

Traveland agents effectively lost.132F

133

Dollar cost of franchisor failure to a franchisee.

This varies greatly from one franchise network to another, and from one

franchisee to another. Table 3 outlines the costs and some of the losses incurred by

one franchisee who signed a franchise agreement with Danoz Directions in February

2004. The Danoz franchisor became insolvent eight months after this franchisee

signed his franchise agreement.

Table 3: Some costs and losses for one franchisee of Danoz Directions

Item paid by franchisee

Franchisee’s investment in $AUD

Relevant contract

Franchisee paid to

Outcome for franchisee in insolvency of franchisor

Initial franchise fee paid to secure rights for 5 years

$60,000 plus additional $20,000 training

Franchise agreement between franchisee and franchisor signed early 2004

Franchisor in full before commence business

Franchisee no statutory right to claim from administrator.

Franchisee will be a creditor for an amount in damages for breach of the franchise agreement. The franchisee may seek leave to bring proceedings against the insolvent franchisor in order to quantify its claim133F

134

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.

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62 Chapter 2: What is the problem and how big is it?

Item paid by franchisee

Franchisee’s investment in $AUD

Relevant contract

Franchisee paid to

Outcome for franchisee in insolvency of franchisor

Sunk Fit out costs

$99,000 Disclosure document

Franchisor for payment on to independent shop fitter

Lease (in franchisor's name) disclaimed by administrator. Landlord would negotiate with franchisee for a continued tenancy agreement if franchisee gave up value of fit out. Lost $99,000 sunk cost of fit out

Franchisor's fit out supervision

$25,000 Franchise agreement between franchisee and franchisor

Franchisor as a 25per cent fee on top of invoiced fit out cost

Service fully performed by franchisor; franchisee no right to claim. Lost $25,000

Inventory/ stock

$45,000 Supplier agreements

Supplier Return, sell, depends on terms of supply

Security deposit on franchisor's head lease

Bank guarantee - 3 months' rent = approx $15,000

Franchise agreement between franchisee and franchisor

Provided direct to landlord

Franchisee negotiated with landlord to be released - no loss

Monthly premises rental

Approx $4,000 pm

Lease between franchisor and landlord. Sublease/ licence between franchisor and franchisee

Franchisor for forwarding to landlord.

Franchisee debtor of franchisor. Franchisor in breach of lease because of appointment of administrator

Training costs $20,000 Franchise agreement between franchisee and franchisor

To general revenue of franchisor or franchisor related company on day paid

Franchisee not creditor or debtor. No claim possible

Other costs $6,000 Franchise agreement between franchisee and franchisor

Paid to franchisor up front

Franchisee not creditor or debtor. No claim possible

Options to open 3 future franchisee owned stores @ $20,000 per option

$60,000 Agreement between franchisor and franchisee

Paid to franchisor up front

No statute-based claim possible.

Franchisee not a creditor for $60,000 unless could claim breach of contract or quasi-contract at common law re the $60,000 if court consents to civil proceedings normally prevented under ss 440D or

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Item paid by franchisee

Franchisee’s investment in $AUD

Relevant contract

Franchisee paid to

Outcome for franchisee in insolvency of franchisor

471B Corporations Act 2001 Unlikely

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 pro-rated amount of the A$60,000 (initial franchise fee) could be the

subject of an equitable claim for unjust enrichment. Any action against the

liquidator would need to be approved by the court.134F

135

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.

A$45,000 inventory is returned to suppliers or sold or thrown away by the

franchisee, depending on the relevant terms of trade.

A$15,000 bank guarantee provided by the franchisee to guarantee the

franchisor’s obligations under the head lease. Depending on the landlord’s

attitude towards the franchisee as a replacement tenant and the amount of

rent the now insolvent franchisor owes, this guarantee may be called up by

the landlord, or, as in the case described in Table 3, used to support the

replacement lease to the former franchisee.

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.

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64 Chapter 2: What is the problem and how big is it?

A$26,000 training costs and other amounts deemed earned by the

franchisor pursuant to the franchise agreement. No claim possible.

A$60,000 to secure options to ‘own’ three future territories. This, also, is

potentially the subject of a claim for unjust enrichment.

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.135F

136

Possible tax-related consequences

All income from the business is taxed, but from the time of the collapse of the

franchisor, if the franchisee’s business has stopped trading all new expenses incurred

after the collapse may not be deductible.136F

137

Tax and sunk costs

Perhaps a more compelling issue than interest deductibility is whether the

franchisee’s sunk costs are deductible if the franchisor fails and the franchisee is

unable to trade on. Take, for example, a Kleenmaid franchisee. The franchise

network was established in Queensland in 1985 to sell and maintain whitegoods

under the Kleenmaid brand. By the time the administrator was appointed in 2009

there were ‘20 retail outlets of which 15 [were] franchised and 5 [were] wholly

owned by the company’.137F

138 While ‘[l]iquidators have been selling the products on

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.

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Chapter 2: What is the problem and how big is it? 65

Grays Online for very good prices’138F

139 and ‘30 service van franchisees [are] to

continue to operate and provide maintenance and repairs to support existing

Kleenmaid customers’,139F

140 what becomes of the investment in sunk costs made by the

franchisees? A Kleenmaid franchisee will have invested tens of thousands of dollars

in sunk costs to open its business. For example, it had to purchase demonstration

models of the white goods on display and keep them up–to-date as styles in white

goods change. Had Kleenmaid failed six months after a franchisee set up its store,

the franchisee would probably have to write off investment in items such as white

goods as capital items. 140F

141 An individual small business is unlikely to be able to sell

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.

Commenting on the predicaments of Kleenmaid franchisees Jason Gehrke

writes:

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.141F

142

Franchisees’ ability to source alternative suppliers

Some of the Kleins franchisees continue to occupy their sites, and are able to

source alternative supplies. Finding alternative suppliers for fashion jewellery

accessories, previously supplied to franchisees by a Kleins-related entity, is more

feasible than contracting with alternative suppliers for Kleenmaid-branded products.

Because Kleenmaid has its own brand of products, franchisees cannot source

Kleenmaid goods from other suppliers.

Under Kleenmaid's franchise agreement, franchisees did not stock products

in their stores, but operated showrooms featuring only display items.

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.

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66 Chapter 2: What is the problem and how big is it?

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.142F

143

Communication between franchisees and administrators

One Sydney-based Kleenmaid franchisee told [radio] 2GB's Ray Hadley he

bought the franchise in November 2008, and became suspicious about the financial

health of the group in December, only one month after the purchase. ‘I'm probably

down $270,000 plus expenses’ he said. ‘I've heard nothing verbally from them since

November ... we still have not got official notification (of the collapse)’.143F

144

Franchisees’ ability to remain in premises

In Stewart, in the matter of Kleins Franchising Pty Ltd (administrators

appointed) (ACN 007 348 236) [2008] FCA 721 in support of an application to

extend the time for the administration, the Administrator stated:

143 Ibid. 144 Anthony Klan, ‘Kleenmaid Kitchen Empire Sinks with $67m Debt’, The Australian (Sydney), 11

April 2009.

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In Australia there are 132 franchised stores … Each store is leased by TJC

[The Jewellery Chain] from third parties. Each franchisee holds a licence

from TJC in respect of their franchised store. Under each of the leases, the

landlords are permitted to terminate and re-enter the properties on an event

of insolvency, such as administration of the lessee. Some of the lessors have

issued notices to remedy the breach.144F

145

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.

The administrators stated ‘[n]o party (including employees, franchisees, lessors

and retention of title claimants) will be detrimentally affected by granting an

extension of the convening period for the second meeting of creditors’.145F

146 This

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.

2.3.1 ADDITIONAL IMPLICATIONS FOR FRANCHISEES STRUCTURED LIKE A COMMISSION AGENCY

The franchisees of Kleenmaid and BHG were structured as commission

agencies. In a commission agency the franchisee makes a sale to its customer; the

customer then pays the franchisor and takes delivery of the product or service from

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].

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68 Chapter 2: What is the problem and how big is it?

the franchisee. The franchisor then pays a commission to the franchisee. This

commission ‘is the only cash flow our [Allphones franchise] business has’.146F

147 The

franchisees’ vulnerability is expressed in the words of a director of franchisee Hoy

Mobile Pty Ltd:

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 …147F

148

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.

2.4 FRANCHISEES FROM THE FRANCHISOR LIQUIDATOR’S PERSPECTIVE

The appointment of the franchisor’s liquidator triggers a change in the

franchisee’s status from being an essential component of the franchisor’s business

network, to a party to contracts that are evaluated by the liquidator as being either

assets or liabilities. While the franchisor is solvent the franchisee has contractually

enforceable rights backstopped by a range of other legal rights flowing from their

standing as a consumer. The franchisee has no clear rights under insolvency

legislation.

An administrator may be faced with tens, or sometimes hundreds of franchisees

that see themselves as key stakeholders of the failed franchisor. Franchisees are

widely dispersed geographically. Each is at a different stage in their business life-

cycle and faces the prospect of a loss of a different magnitude. Each is a party to

consequential contracts. Not all of these contracts are with the franchisor. 147 Commonwealth Senate, Opportunity not Opportunism, Joint Parliamentary Inquiry into

Franchising (2008) 1 (Nicole Hoy). 148 Ibid.

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Chapter 2: What is the problem and how big is it? 69

Franchisees will often be both creditors and debtors and may also have a contract or

Trade Practices Act based claim they can bring against the franchisor.

Figure 3: Minimum estimated lost investment by franchisees in Australia 1990 -

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.

2.4.1 FRANCHISEE AS CREDITOR

‘Creditor’ is not defined in the Corporations Act.

In Selim v McGrath 148F

149 Justice Barrett concluded that in the context of a s

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.

$0

$10

$20

$30

$40

$50

$60

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

Estim

atedlost  investmen

t by franchises  ($m

illion)

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70 Chapter 2: What is the problem and how big is it?

up. He said the boundaries were those set by s 533 [Corporations Act] which

are very wide. 149F

150

Traditional suppliers of debt finance such as banks are categorised as creditors

in insolvency and have had the opportunity to take security, and to price their loans

accordingly. Traditional suppliers of equity finance, shareholders, have taken the risk

of the entity becoming insolvent knowingly and on the basis of information supplied

in a prospectus that has met rigorous standards.

Unless a franchisee is a creditor, there is no room in Australia’s insolvency

regime for the franchisee to have a voice in the franchisor’s insolvency, far less a

share of the insolvent’s estate. Typically, there are four situations that might place a

franchisee into the position of being a creditor, generally unsecured, in a franchisor’s

insolvent estate. These are:

First, in some franchise networks the franchisee is remunerated by commission

payable by the franchisor.150F

151 For example, in travel agency franchises part of the

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.

A fourth category when a franchisee may be a creditor of a franchisor is where

the franchisee has to pay its premises rent to the franchisor, that then pays the

landlord. On receiving the rent from the franchisee the franchisor is the trustee of the

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.

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funds pending payment to the landlord. This is common, as shown in models 3, 4, 5,

7 and 9 at 3.1.3.

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.

If the franchisee is not a creditor in relation to a specific sum, liquidators

sometimes ‘put franchisees in for a dollar each’.151F

152 This secures the right for each

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.

If a franchisee is invited to a creditors’ meeting this puts them in direct

communication with the liquidator. Anecdotal evidence from discussions with

liquidators is that they do include franchisees in early creditors meetings. The

response to the question: ‘were you invited to the creditors' meeting of your

franchisor?’ was that the 33 per cent who had no recognized status answered ‘not

applicable’. Fifty seven per cent answered ‘no’. These experiences contradict the

liquidator’s account of their approach and merit further investigation.

2.4.2 FRANCHISEE AS DEBTOR

The appointment of an administrator to a franchisor signals a sea change in the

franchisor/franchisee relationship. The franchisor becomes a debtor to its creditors

and the franchise agreements become assets or liabilities. Franchisees remain parties

to the franchise agreements. Payments due by the franchisee to the franchisor

continue to be payable, as do payments by the franchisee to third parties. Franchisees

152 Interview with Liquidator, (Sydney), 2005.

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trading within franchise networks that are structured like commission agencies will

also be debtors – in relation to advertising levies, royalties and other periodic

payments.

In some situations the franchisee guarantees the performance of the franchisor

under the head lease.152F

153 Being a guarantor would make the franchisee liable for

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.

With franchisees’ collateral liabilities in mind, it is interesting to see what

approach financiers take to their franchisee customers’ funding needs. In the UK:

Typically 3 in 5 franchisees needed to borrow money when starting up their

business. Needless to say, the amounts borrowed vary greatly between

different franchises. The mean amount borrowed in this year’s study is

£44,700. … As might be expected, the need for specific business premises is

a significant driver of borrowing. Those who require specific premises for

their operation needed an average of £54,500 compared to the £14,000

among those not needing specific premises. By far the most common source

of finance is retail banks, which provided finance to 85 per cent of those

borrowing.153F

154

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.

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Chapter 2: What is the problem and how big is it? 73

2.4.3 FRANCHISEE AS POTENTIAL LITIGANT

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’. 154F

155

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. 155F

156

A contract is executed at the conclusion of successful mediation. The contract

may be disclaimed by a liquidator. If litigation has been concluded and a judgment

entered against the franchisor, but the judgment debt is not yet paid, creditors cannot

enforce any judgments or orders they may have obtained against the debtor (being a

corporation operated by a voluntary administrator or liquidator); and other legal

proceedings many not be brought or pursued against the corporation without the

leave of the court.156F

157

2.4.4 CHALLENGES FACING THE LIQUIDATOR

When it comes to companies going bust, the insolvency of a franchise is

usually about as shambolic as you can get. Of all insolvency matters, the

most difficult is the failure of a franchise group… There are always

problems with the Franchise Code, always leasing problems and unforeseen

third party issues. 157F

158

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.)

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74 Chapter 2: What is the problem and how big is it?

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 competitor158F

159 of the franchisor. It is

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,159F

160 that must be met before a merger of two franchise networks would risk

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. 160F

161

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’.161F

162 Realistically, the

opportunity to do so depends on the franchisor’s willingness to negotiate, the

franchisors policies regarding matters such as whose name the premises lease is in,

and the franchisee’s ability to negotiate.

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.

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Chapter 2: What is the problem and how big is it? 75

One liquidator’s experience led him to observe: ‘I am only guessing, but very

few [franchisor] companies survive the administration, whereas many franchise

systems would survive in a new company set-up’. 162F

163

Colraine suggests:

Renegotiating the franchise agreements in order to support the franchise and

preserve goodwill may be a possibility. Financing the franchisor could be

considered if the franchisor’s primary lenders were willing to engage in

reorganizations outside formal proceedings.163F

164

Intellectual property rights, as noted at 3.2.2, can pose problems for

administrators selling a franchise network. For example:

[t]he sale of Queensland-based On Time Business Solutions, [with 17

franchised stores] trading as On Time Copy Centres … was subject to the

delivery of intellectual property rights which had been assigned last

December. On Time Business Solutions (On Time) had sold the rights to on

Time Business Holdings. … On Time which entered into voluntary

administration in February was sold to Ausdoc on Demand in May for

$1.1m. AusDoc managed the chain while the administrators sought to regain

the intellectual property rights.164F

165

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.

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76 Chapter 2: What is the problem and how big is it?

The Government report titled ‘Opportunity not opportunism: improving

conduct in Australian franchising’ (‘Opportunity not opportunism’)’ 165F

166 has

acknowledged that this may not be satisfactory and has recommended:

That the government explore avenues to better balance the rights and

liabilities of franchisees and franchisors in the event of franchisor failure.166F

167

As a result of the numerous assumptions on which franchise law is currently

founded, the market fails franchisees of franchisors that are in administration for a

number of reasons. These include that:

It is impossible in some franchise networks for franchisees to conduct

adequate pre-commitment due diligence – because of the structure of the

franchise network and gaps in the publicly available data.

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.

The franchisee starts down its path to franchising as a business consumer. On

signing the franchise agreement, most of its rights to receive consumer protection are

derived from pre-contractual conduct by the franchisor. At that point the franchisor

was probably, though not invariably, solvent.

Franchisor failure is common enough, as the list of failed franchisors in Table 1

demonstrates, and it has a profound effect on the parties to be included in the

template franchise agreement as originally drafted, but seldom is. Franchise

agreements are standard form, exploitative contracts and thus not negotiated. They

are assumed to be able to adapt to the evolving franchisor/franchisee relationship.

Trusting a contract to adapt to administration or insolvency is naïve.

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.

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Chapter 2: What is the problem and how big is it? 77

The failure to accommodate a franchisee in insolvency is at odds with the

ability to self protect and the recognition accorded by the business failure laws to

other parties that take the same risks in a non franchised business.

Behavioural economic issues weigh adversely on prospective franchisees.

These include the environment of selling the franchise, the timing of the provision of

information to prospective franchisees, the fact that franchisees are psychologically

committed to one franchise opportunity before they have signed a franchise

agreement and could still walk away, the lack of emphasis on the level of

commitment that accompanies signed franchise agreements and ancillary contracts,

and the over-emphasis by the franchisor on the benefits of being part of a winning

team. Some of these issues are pursued in chapter 3.

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.

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Chapter 3: The problem in context 79

Chapter 3: The problem in context

New policy initiatives should flow from a ‘clear identification of the nature and

source of the underlying problem’.167F

168 Currently, outdated assumptions 168F

169 inform

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.

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80 Chapter 3: The problem in context

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.

3.1 DEVELOPMENT OF BUSINESS FORMAT FRANCHISING

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’.169F

170

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

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Chapter 3: The problem in context 81

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.170F

171 Evidence is

supplied by the ever-increasing number of international jurisdictions in which

franchise lawyer members of the American Bar Association (ABA) request local

franchise counsel recommendations through the ABA’s forum on franchising.171F

172

A sizeable contribution to a nation’s economy may be made by businesses

conducted through the business format franchising model. Over the 2004-5 financial

year, estimated sales through franchise systems reached US$1.53 trillion172F

173 in the

United States, £13 billion in the United Kingdom, US$142 billion in Japan,

US$5billion in Malaysia and AU$111.2 billion in Australia.173F

174

3.2 COMPONENTS OF 21ST CENTURY FRANCHISE NETWORKS

Franchise networks are perfect examples of ‘organizations [being] simply legal

fictions which serve as a nexus for a set of contracting relationships among

individuals’.174F

175 To gain a clear understanding of how and why franchisees fare so

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=;id=;orderBy=;page=;query=(Dataset%3Acommsen,commrep,commjnt,estimate,commbill%20SearchCategory_Phrase%3A%22committees%22)%20Decade%3A%221990s%22%20CommitteeName_Phrase%3A%22house%20of%20representatives%20standing%20committee%20on%20industry,%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.

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82 Chapter 3: The problem in context

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’175F

176

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.

Franchise relationships that begin simply rapidly become complex. Complexity

arises as the franchisor expands to other jurisdictions, is bought by a larger entity, or

as specific functions are transferred to related entities in the franchisor’s network.

Tastee Freez provides an American/Australian example of the speedy growth of a

franchise network and its accompanying complexity. The franchisor’s failure to

register its trade mark in Australia in a timely way led to Aston v Harlee

Manufacturing Co (‘Tastee Freez’) [1960] HCA 47; (1960) 103 CLR 391. In Tastee

Freez, Fullagar J documented the growth of Tastee Freez, a typical franchise and

identified some of the constraints placed on franchisees:

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. 176F

177

As Harlee, through Tastee Freez demonstrates, franchising is a way of building

an extensive business quickly, under a common brand and format. Within two years

of incorporation of the franchisor there were 315 Tastee Freez stores, and within

seven years, 1778 franchised stores in the USA. Franchisees were required to adopt

common trade dress in their stores and to lease freezers and feeding devices patented 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.

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Chapter 3: The problem in context 83

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.

The franchisor thus has a ‘captive’ market of franchisees contractually bound

to purchase and sell its products and to use its inventions. Doug Frazey identifies the

‘captive’ market role that franchisees experience as a

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.177F

178

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.178F

179

Franchisees depend on the continued sound operation of their franchisor.

[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.179F

180

3.2.1 FRANCHISOR

Before starting the franchise network, the franchisor identifies a business

opportunity and pilots and documents the business that will be offered to franchisees.

The franchisor prepares a disclosure document and drafts a franchise agreement. The

franchisor then recruits and appoints franchisees. It makes disclosure to the

franchisees, who then sign the franchise agreement. It also supports franchisees as

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.

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84 Chapter 3: The problem in context

they develop their business following the franchisor’s procedures. Over time the

franchise network evolves, is refined and updated.

The franchisor establishes a business that performs many functions. It is

possible for the franchisor entity itself to conduct all functions that support the

franchisees. The only network function that is not able to be performed by a

franchisor or one of its related entities, is ‘franchisee.’ It is common, however, for

the ‘franchisor’ functions to be spread across several legal entities. Some of the

entities may be truly independent of the franchisor; others may meet the test of

related entities under Corporations Act s 50.180F

181

These franchise network support functions may include: recruiting franchisees,

conducting franchisee training, exploring future directions for the network, owning

and managing the intellectual property assets that the franchisees are licensed to use,

negotiating and entering into leases of premises the franchisee will occupy, designing

and fitting out the franchisees’ premises, providing franchisee finance181F

182 or

negotiating relationships with financiers who will offer preferred treatment to

franchisee applicants They also include sourcing and negotiating contracts for the

supply of items of plant such as pizza ovens or cash registers, and stationery such as

pre-printed courier package labels, sourcing and supplying via import, manufacture

or distribution, the stock that the franchisees will sell to customers, and delivering

stock to franchisees.

Each franchise network is uniquely configured. Anecdotal evidence suggests

that in the early days of franchising, the franchisor’s related entities were not nearly

as numerous and the franchise networks not as complex as they are today. For

example, in the Barbara’s House and Garden litigation182F

183 in 1987, the franchisor was

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.

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ASIC records show that there were four companies in the Barbara’s House & Garden

group. 183F

184 Similarly, there were two entities in the Tastee Freez franchise.

In contrast, franchise networks have now become complex webs of

interdependent companies. The franchisor benefits from its ability to structure the

network through a number of entities. ‘Diversification on the part of owner-managers

[directors of the franchisor] can be explained by risk aversion and optimal portfolio

selection’.184F

185 The franchisor’s directors take legal advice that it is desirable to protect

some business or personal assets, for instance a suite of registered intellectual

property assets, or the franchisor’s family home, from the risk of having to be sold to

meet a judgment against the franchisor. They structure the franchise network and

manage their personal exposure to loss accordingly.

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.

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86 Chapter 3: The problem in context

is a related corporation for the purposes of s 50 of the Corporations Act 2001

(Cth). 185F

186

and

Each of the respondents, that is the corporate respondents, is said to be

implementing part of a system through the instruction of its director, the

eighth respondent, and as part of the overall system of which they are a

member through their proprietorship by the seventh respondent and the

control over all of the eighth respondent. 186F

187

In Pets Paradise, Justice Mansfield outlined the role of each of the eight

entities in the franchisor controlled part of the franchise network:

Each of the first three respondents is said to carry on business in

Queensland, South Australia and the Northern Territory, and New South

Wales respectively … granting Pets Paradise franchises – and each also

operated retail businesses providing pets and pet accessories under that

name.

The fourth respondent is the supplier of goods to operators of Pets Paradise

businesses.

The fifth respondent is the author and proprietor of intellectual property

rights … and provides support services by way of legal services, copies of

documents … to prospective franchisees and franchisees, and from time to

time receives payment of franchise fees and legal fees.

The sixth respondent is said to be the proprietor of a series of four registered

trade marks in relation to categories of pets and pet accessories, and licenses

the use of those trade marks to the first, second and third respondents to

enable them to sub-license the use of those trade marks to franchisees. It also

assumes liability pursuant to hire purchase agreements to make payments in

respect of fixtures and fittings used in the operation of retail businesses

which are guaranteed by one or some of the other respondents. It also

receives, and presumably assesses, preliminary franchise agreements from

prospective franchisees.

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.

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Chapter 3: The problem in context 87

The seventh respondent operates, it appears, as a form of head office. It is

said to provide legal services, accounts and management staff for the group,

including for the purposes of making representations to and dealing with

franchisees on its own behalf and on behalf of the first, second, third and

fourth respondents.

…, the eighth respondent directly manages the carrying on of the business of

each of those corporate respondents by means of daily control and direction

of, and participation in, their respective business activities.’187F

188

There are up to 100 Pets Paradise franchisees throughout Australia. The

franchisee executes a franchise agreement with the entity named as franchisor. In a

network such as Pets Paradise, the franchisee will subsequently be required by the

franchisor to enter contracts with several of the entities related to the franchisor. This

will be demonstrated through an explanation of retail leases within the franchise

network in chapter 3.2.3.

In addition to related entities, the franchisor will have negotiated arrangements

with non-related entities that the franchisee must deal with. For example, Budget

Shop Fitting fits out Pets Paradise franchisee shops. The franchisees are required to

pay an ongoing royalty for use of the shop fitters’ pet pens. Similarly, in the Bakers

Delight Holdings Ltd franchise network (‘Bakers Delight’), franchisees are required

to order key products from entities unrelated to Bakers Delight as is described in the

Bakers Delight notification to the ACCC188F

189 by which Bakers Delight secured the

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.

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88 Chapter 3: The problem in context

This demonstrates what little information a franchisor must provide to a franchisee

about a network in order to satisfy the disclosure provisions of the Code.

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.189F

190

Where a franchisor is owned by a public company, the company’s published

reports do not contain meaningful information about the franchise division. This is

exemplified by the limited amount of information about franchisors’ intangible

assets, discussed at 3.2.2.

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. 190F

191

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].

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Chapter 3: The problem in context 89

Performing due diligence

It is assumed that a franchisor issuing a disclosure document under the Code

will be solvent. Of concern for incoming franchisees is that several of the franchisors

in Table 1 were subsequently found to have been offering franchises for sale despite

the directors knowing the franchise network was insolvent.191F

192

It is also assumed that before committing to the purchase, franchisees will

double-check any important statement the franchisor has made, including the

solvency statement provided as disclosure Item 20. A popular view of due diligence

propounded by non-lawyer industry figures like Jason Gehrke192F

193 is that:

… 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.193F

194

A franchisee reading Gehrke’s comments would be excused for concluding that

conducting effective due diligence is lay person’s work, and is quick, easy, cheap

and will reveal all that needs to be known about a franchise investment. This

prejudices the intending franchisee against being prepared to pay their legal and

accounting advisers to conduct thorough due diligence.

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.

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90 Chapter 3: The problem in context

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.

Regardless of the number of entities in the franchisor’s network, the franchisor

is the key entity that makes disclosure. Limited disclosure is provided in relation to

intellectual property rights and retail leases. The number of entities in some of the

failed networks is recorded in Table 1: Australian failed franchisor data. Even if the

franchisee became aware of others, the more entities there are, the more expensive,

difficult and possibly meaningless it becomes for prospective franchisees to conduct

robust due diligence.

Because of the difficulty and cost of accessing more information, the

franchisee has either to accept what the franchisor discloses at face value, ask more

questions and hope the franchisor provides full answers, or walk away.

In Australia, franchise networks range in size from one to 2,950 units.194F

195 A

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’.

As discussed in chapter 3.3, regardless of what the franchisee’s advisers

discover about the franchise network, no amount of due diligence will enable the

franchisee to have the franchise agreement amended.

3.2.2 TRADE MARKS

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.

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Chapter 3: The problem in context 91

regarding the quality and source of the product that reduces search costs’.195F

196 US

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. 196F

197

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.

Registration under the Trade Marks Act 1995 (Cth)

The Commonwealth (of Australia) has enacted a number of statutes to regulate

intellectual property pursuant to x 51(xviii) of the Constitution. The Trade Marks Act

1995 (Cth) (‘Trade Marks Act’) is the legislation concerned with the identification

and registration of, and dealing in, trade marks. Section 6 states that any:

letter, word, name, signature, numeral, device, brand, heading, label, ticket,

aspect of packaging, shape, colour, sound or scent or combination thereof’ 197F

198

may be registered as a trade mark.

The registered trade mark is recognised as personal property by s 21 Trade

Marks Act’ and the registered owner is given extensive, exclusive rights to use it and

to authorise others (for instance franchisees) to use it under ss 20, 22. Section 26

Trade Marks Act provides a number of additional statutory rights, including the right

to bring an action for infringement (s 26(1)(b)) and to grant others, for instance

franchisees, the right to use the mark (s 26(1)(f)).

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.

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92 Chapter 3: The problem in context

Trade marks under Franchising Code of Conduct

Franchisees are entitled to be provided with certain details about the

intellectual property that is ‘material to the franchise system’.198F

199 The Code requires

pre-contractual, and periodic disclosure of the matters listed in s 7.199F

200 Sections

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.

Trade mark research and literature

Gillian K Hadfield refers to a 1971 study conducted by Ozanne and Hunt200F

201 on

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.201F

202

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.202F

203 Whilst their article addresses franchises as a

category, the authors do not differentiate between the various types of intellectual

property – trade marks, patents and designs.

A description of the consumer protection franchisees gain from the registration

of trade marks is found in Australian Competition & Consumer Commission v 4WD

Systems Pty Ltd [2003] FCA 850. In this case, the franchisor told prospective

franchisees:

The 4WD Systems name is a registered and protected name, unauthorised

use of the name and associated trade marks is illegal …. This means your

business is protected from any unauthorised use of the name within your

region. 203F

204

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.

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Chapter 3: The problem in context 93

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.

To understand the options an administrator or liquidator has when faced with a

failing franchisor, it is necessary to know the extent to which they can claim the

benefit of contractual rights to permit franchisees to use the franchisor’s registered

trade marks. Franchisees would, for example, become vulnerable if the Australian

master licensee breached the master licence agreement and lost the right to be the

Australian ‘franchisor’ unless there was a contractual obligation requiring the

overseas franchisor to permit the individual franchisees to continue to use the trade

marks. Because no studies could be found that specifically report on ownership and

use of trade marks by franchisors and franchise network stakeholders in Australia, I

conducted the Exploratory Study on the trade marks registered under the Trade

Marks Act used by franchisors in 2005.204F

205

Exploratory Study findings

The Exploratory Study revealed a diversity of trade mark ownership and

registration strategies adopted in Australian franchising. The implications of this

situation for franchisees of insolvent franchisors are discussed in chapter 4.4.4.

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.

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94 Chapter 3: The problem in context

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.205F

206 Of these 53, only one (1.88 per

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).

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Chapter 3: The problem in context 95

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.

An alternative to registration as an ‘authorised user’ is that all levels of

franchisee, could record their interests as licensees on the TM Register by relying on

the provisions of Trade Marks Act Part 11.206F

207 This would be useful protection if they

are prohibited by their franchise agreement from registering their interest as an

‘authorised user’. However, there is no evidence that franchisees register their

interest as licensees under the Trade Marks Act.

Trade marks and franchise agreements

One of the key functions of the franchise agreement is to grant the franchisee a

licence to use the franchisor’s intellectual property, including its trade marks. Based

on the Trade Mark Research it appears that franchisees rely solely on the contractual

rights granted to them in the licence agreements with the franchisor. There is

therefore a strong incentive for the franchisee to ensure that they have a contractual

nexus with the owner of the trade mark.

207 See Appendix A of this thesis.

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96 Chapter 3: The problem in context

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 Precedents207F

208refers to the trade marks as

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.

In relation to the trade mark, the franchisor, in clause 12 of the precedent

agreement, is contractually bound to:

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.

By agreeing to clause 15(6):

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. 208F

209

The requirement in relation to the trade marks in the Traveland franchise

agreement was:

6.1 Use of Marks and Corporate Identity.

The Franchisee must:

Display the marks in and on the Premises and on all signs, fixtures, fittings,

display stands, stationery, uniforms and other items used in relation to the

Business; … Strictly in accordance with the operations manual or as the

Franchisor may require from time to time.

6.3 The Marks

208 LexisNexis Butterworths, Australian Encyclopaedia of Forms and Precedent, Form 40.1. 209 Ibid.

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Chapter 3: The problem in context 97

The franchisee must, if requested by the franchisor, execute a registered user

agreement in relation to the Marks.

6.3 Ownership

The Franchisee and the Guarantors:

Acknowledge the franchisor’s exclusive ownership of all intellectual

property rights and goodwill accrued in the marks at the date of this

Agreement;

(b) acknowledge that any goodwill accruing to the marks, the Business name

or the business during the term and any copyright materials produced by the

Franchisee during the Term relating to the Business will be the exclusive

property of the franchisor; and

Will not contest or challenge the franchisor’s exclusive ownership of these

intellectual property rights and this goodwill.

11.1 Immediate Termination

The franchisor may terminate this Agreement immediately by notice in

writing to the Franchisee if:

The franchisee makes improper or unauthorized use of the Marks … or is

involved in any act or conduct which, in the Franchisor’s opinion, is likely to

adversely affect the Mark …209F

210

Clearly, both franchisors and franchisees regard the trade marks as an

important and valuable part of what the franchisee as a business consumer and

investor is paying for. Also clear is that Australian master franchisees and

franchisees’ and franchisors’ financiers are generally lax about accessing the

statutory rights available under the Trade Marks Act to register their interest in trade

marks.

Overseas Brands and due diligence

The law cannot protect all consumers from their own perceptions. Paul

Steinberg and Gerald Lescatre describe the ‘halo effect’ that can result where

franchisees are unsophisticated investors:

… ownership of a household-name franchise conveys a degree of status and

may result in a non-rational purchase decision. … A powerful franchise

brand further distorts analysis of the franchise investment. ... Trade mark

owners are acutely aware of reputational risk as applied to the brand value of

210 Copy of Traveland franchise agreement on author’s file.

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98 Chapter 3: The problem in context

the retailed product but inefficient dissemination of reputational data with

regard to the wholesaled product (franchises) means that the franchisors can

benefit from an unsophisticated consumer’s perception that if Dunkin’ has

quality donuts and if Burger King is concerned about the humane treatment

of cattle, then the consumer’s positive perceptions of the brand carry over to

the consumer’s positive perception of the franchise. 210F

211

Unsophisticated investors possibly overvalue a known franchise brand

emotionally rather than objectively assessing their forthcoming investment. It is

speculated that the notion of ‘cultural cringe’211F

212 may be a version of the halo effect,

resulting in franchisees exercising less due diligence in purchasing into an overseas

based franchise than would be exercised in relation to a local franchisor.

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.212F

213

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.

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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’,213F

214 and write that:

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.214F

215

Access to property rights as security is fundamental to lenders and to

liquidators. Much of the asset base of the franchisor is ‘personal’ property (including

intellectual property) which may pose greater difficulties for liquidators to sell than

does real property.

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 assets215F

216 and the technique chosen will be influenced by the context. It is

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’.216F

217

From the perspective of accountants, however, discrepancies in the

presentation of trade mark valuation in the reports of public companies arise through

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.

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100 Chapter 3: The problem in context

standard accounting and audit practices.217F

218 The rules of accounting do not permit the

creation of an entry that recognises what is known as ‘internally generated goodwill’,

because it is an intangible. Accountants are only allowed to recognise ‘purchased

goodwill’. Purchased goodwill arises in two ways. First, by purchasing a trade mark,

in which case the accountant can record the purchase price. Second, by purchasing a

company. The excess paid over the net value of the assets is deemed to be the

goodwill that has been purchased. Items such as registered trade marks are included

in the goodwill. In the case of Harvey World Travel for example, the A$5,000 value

attributed to intangibles is likely the administrative cost of applying for the trade

marks.

As several of the franchisors in the Exploratory Study were Australian public

companies their annual accounts could be accessed via the internet. Although this

sample is small, it is useful to demonstrate the range of approaches public company

franchisors take to expressing the value and identity of their trade mark assets in the

accounts.

Depending on whether the purpose is simply to comply with accounting

standards (as appears to be the case for most companies including Domino’s, Rebel

Sport and Harvey World Travel in the Exploratory Study) or to attract franchisees to

a fledgling franchisor (as appears to be the case in the light of subsequent litigation

with Danoz Direct); trade mark values in 2005 were entered as either the ‘cost of

acquisition’ or as a ‘directors’ valuation’. The lack of standardisation increases the

uncertainty of the franchisees’ pre-purchase due diligence. It also makes the

administrator’s or liquidator’s task of accurately assessing the value of trade marks

for the purpose of deciding whether to advertise them for sale or not, difficult. Four

examples follow.

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.

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Chapter 3: The problem in context 101

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 billion218F

219 and at least six registered trade marks, included a heading

‘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’.219F

220

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:

The identifiable intangible asset of the company comprises the name

‘Danoz’. No amortisation is provided against this asset as the life of the asset

is of such duration and the residual value is such that the amortisation

charge, if any, would not be material. The carrying value of $8million is in

accordance with a valuation by Directors. At each reporting date, assessment

of the carrying value will be made by the Directors.220F

221

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

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102 Chapter 3: The problem in context

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.

A public company’s published annual reports are an unreliable source of

information about the existence and value of its trade marks. When trade marks are

specifically mentioned, their value(s) are given in order to comply with accounting

standards and are not objectively verifiable.

Trademarks are an asset categorised in the company’s accounts as an

‘intangible’ asset. The effective life221F

222 of standard patents is a maximum period of 20

years.222F

223 For tax purposes, trade marks do not fall within s40-30(2)(c) Income Tax

Assessment Act 1997 (Cth) as ‘items of intellectual property’ as ‘intellectual

property’ is defined in s995-1 Income Tax Assessment Act in terms that do not

include trade marks. Debt finance is a common form of finance for a business in

Australia. The debt is secured over assets owned by the borrower. Yet this valuable

asset is rarely used as security for loans in Australian franchises.223F

224

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.

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Chapter 3: The problem in context 103

site.224F

225 This numbered nearly 2,900 individual retail premises’ (2,887).225F

226 Fit-out

costs payable by franchisees range from $0 to $550,000.226F

227

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.227F

228

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.

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104 Chapter 3: The problem in context

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.

……………………

Franchisor related landlord

Franchisor

Lessee = Franchisee

Lease

Franchise agreement

Landlord = Franchisor

Lessee = Franchisee

Lease

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Chapter 3: The problem in context 105

Model 3: The franchisor leases the premises from a landlord and sub leases to the

franchisee.

…………………..

Model 4: A legal entity related to the franchisor leases the premises from a landlord

and sub leases them to the franchisee.

………………

Landlord Lessee = Franchisor related entity

Franchisor Sub lessee = Franchisee

Lease

Sublease

Guarantee

Franchise agreement

Landlord Lessee = Franchisor

Sub lessee = Franchisee

Lease

Sublease Franchise agreement

Guarantee

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106 Chapter 3: The problem in context

Model 5: The franchisor leases the premises from premises owner and grants a

licence to occupy to the franchisee.

……………….. Model 6: An entity related to the franchisor leases the premises and licenses them to

the franchisee.

……………….

Landlord Lessee = Franchisor related entity

Franchisor Sub lessee/ Licensee = Franchisee

Lease

Licence

Guarantee

Franchise agreement

Landlord Lessee = Franchisor

Licensee = Franchisee

Lease

License Franchise agreement

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Chapter 3: The problem in context 107

Model 7: A master franchisee leases the premises from a landlord and sub leases

them to the franchisee.

……………….

Model 8: A legal entity related to a master franchisee leases the premises from a

landlord and sub leases them to the franchisee.

………………

Landlord

Overseas franchisor

Franchisee

Lease

Sublease Franchise agreement

Australian subsidiary = master franchisee

License

Landlord

Franchisor Franchisee

Guarantee

Sublease Franchise agreement

Australian master franchisee

Lease

Master franchise

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108 Chapter 3: The problem in context

Model 9: A master franchisee leases the premises from a landlord and grants a

licence to occupy them to the 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

Landlord Master franchisee = Lessee

Franchisor Licensee = Franchisee

Lease

Licence Franchise agreement

Master franchise agreement

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Chapter 3: The problem in context 109

Model 11: The franchisee or franchisee related entity owns the premises.

…………….. Model 12: There are no formal occupancy arrangements.

Legal relationships and management of premises related risks

Typically the premises leasing model is dictated by the franchisor’s

preference228F

229 and tempered by the amount of control the landlord wishes to assert in

each instance.229F

230 In some networks more than one model is chosen.

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. 230F

231

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.

Landlord Franchisor

Franchisee

Franchise agreement

No written premises agreement

Franchisor Owner = franchisee Franchise agreement

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110 Chapter 3: The problem in context

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.231F

232 The franchisee may have protection as a lessee

under the State or Territory retail leasing legislation, but this is not uniform across

Australia.232F

233

As occurs in models 4, 6, 7 and 10, it is increasingly common in Australia

when the franchisor takes a head lease of retail premises, for the franchisee to

provide a personal guarantee or the security deposit to back the franchisor’s

performance under the head lease. The relevant clause in the franchise agreement

might read:

The franchisor shall hold the head lease to the store site. The franchisee shall

make available the security deposit upon signing the sub-lease.233F

234

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.

Contracts may be made between franchisee and landlord, as in models 1, 10

and 11. Alternatively, the franchisee’s contractual relationship may not be with the

landlord; rather, the landlord is in a direct contractual relationship with the franchisor

or its related entity, as in models 3, 4, 5, 6. The franchisee then enters a sub-lease,

licence or has an informal verbal agreement with the franchisor concerning the

premises.

Master franchisees may be contractually bound through their own franchise

agreements with the franchisor to ensure the head leases in their territory are under

their control. As there is no public database of franchise agreements or master

franchise agreements, or franchise disclosure documents in Australia it is not

possible to conduct quantitative research.234F

235 It is a common practice in franchising

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,

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Chapter 3: The problem in context 111

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.

In model 6 the franchisee’s tenure is secured only by a licence. The following

passage by a former Bakers Delight, franchisee describes model 6 from a

franchisee’s perspective:

When a franchisee signs their franchisor’s licence agreement, they are

binding themselves to the lease, without having any of the protections

offered by the lease. Neither the landlord nor the franchisor is required to

provide the franchisee/licensee with any information about their negotiation

process, nor does the franchisee see the landlord’s disclosure document – if

they even know it exists. As a Bakers Delight franchisee, I did not even see a

copy of the leases for two of my stores until after I had signed the licence

agreement. The third one I never saw.235F

236

It is difficult for a researcher to identify the preferred model for specific

franchisors as there is no requirement to place such details on a public database.

However, a clause such as the following in the Traveland Franchise Agreement

provides clues as to the franchisor’s preference, in this case for a Model 10

arrangement, by providing:

Franchises (2008) Recommendation 7.2.1; Parliamentary Joint Committee on Corporations and Financial Services, Commonwealth, Opportunity not Opportunism: Improving Conduct in Australian Franchising, above n 166, Recommendation 2; all state that franchise disclosure documents should be registered on a centralised database.

236 Evidence to Retail Tenancies Inquiry, Retail Tenancy Unit, New South Wales Government (Sydney) (2008) 3. Report embargoed. (Deanne de Leeuw former Bakers Delight franchisee) quoted with permission of the author.

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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. 236F

237

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

Franchisees, as consumers of the franchisor supplier’s vision typified the

enterprise worker the then Prime Minister of Australia, who observed:

…‘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.237F

238

The success of the enterprise is indistinguishable from the individual

franchisee’s own personal success, but so is the failure of the franchisor part of the

enterprise often indistinguishable from its franchisees’ failure.

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).

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Chapter 3: The problem in context 113

sales, movement of costs from fixed to variable and a reduction in direct labour costs

with an increase in commissions’.238F

239

A group with diverse skills and motivation

In South Africa:

the Government has identified franchising as a means of encouraging the

development of small businesses, creating jobs, alleviating poverty and

creating black empowerment because it has the capacity to address many of

the problems which make it difficult for a new business to get off the

ground.239F

240

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.

Franchising provides an opportunity for immediate gainful work and standing

in the community for immigrants who may be unable to earn an income using the

qualifications gained in their country of origin. The franchisee may be fluent in

English and accustomed to local culture or may be a new migrant with limited

English language skills but with access to funds. Franchisees may be self-funded or

borrowing money from family or commercial lenders to fund their franchise. Both

the well educated and those with little formal education become franchisees.

Franchisees may be embarking on their first career, or be older workers using

their superannuation as funding.240F

241 They may be using a retrenchment pay-out to

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.

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… neither … had any experience in conducting a business. …Peter had spent

most of his life in the public service and had latterly been a purchasing

officer ... Sandra had worked as a bus driver.

In 1995 Peter, then aged about 46 years, was retrenched and received about

$225,000 as severance pay. He had been taking a business training course

for some time at a university ... [Peter and Sandra] decided between them

that they would try to buy a business that they could manage and which

would allow them to work together, produce an income to support their

family and give them an interest.241F

242

Through franchising, many former employees make their first foray into self-

employment.242F

243 Peter and Sandra, on purchasing a Spud Mulligan’s franchise, were

buying what they believe to be:

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. 243F

244

The franchise might be the principal source of income for the family. One in

four franchisees in Australia in 2004 was female. 244F

245 The franchisees’ education may

be specific to the franchise business (such as travel agencies) or may be in an

unrelated field. The franchisee may be a city dweller or may be establishing a

business in a country town. Some franchisees are engaged in ‘cross border

shopping’245F

246 as they have purchased the right to be the master licensee of an overseas

based franchise.

People wanting to own a small to medium sized business choose franchising

partly because, in the words of one liquidator, ‘[t]he start up costs for a similar

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.

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Chapter 3: The problem in context 115

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’.246F

247

‘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’,247F

248

hire of staff and entry into long term contracts with parties other than the franchisor

for finance, premises rental, vehicle rental, and stock purchase.

Franchisees from the franchisor’s perspective

Some franchisors have a clear profile of the type of franchisee they want. For

example, in 1994 McDonald’s identified ‘owner-operators whose livelihoods are

dependent on their units’ as ideal franchisees.248F

249 Other less discerning franchisors

seek only warm bodies and the willingness to write cheques.

The appeal of granting licences to franchisees as opposed to pursuing organic

growth is described by franchisor, Commander Communications:

...the effect of (moving from a traditional business structure and into)

franchising will be an increase in sales, movement of costs from fixed to

variable and a reduction in direct labour costs with an increase in

commissions. 249F

250

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’. 250F

251

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.

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116 Chapter 3: The problem in context

As Commander Communications acknowledged above, franchisees are a

saving on labour costs, borrowed and equity finance, and a risk devolving

mechanism, not available to a non-franchised business owner.

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.251F

252

The NatWest March 2004 United Kingdom Franchise Survey asked

franchisees what their working status was immediately before taking out their

franchise.252F

253 Sixty-two per cent were former employees. In 2006, 64 per cent were in

salaried employment immediately before taking out their franchise.253F

254 There is no

reason to expect Australian franchisees to differ significantly.

A non-franchised business sources labour by hiring employees or contractors.

Both categories of worker have well defined legal rights. Employees derive their

rights in relation to remuneration, entitlements, leave and work conditions from

specific legislation and may be assisted by trade unions representing them in

negotiations and disputes with their employers. Contractors, including suppliers,

negotiate the terms on which they will perform a job and are remunerated

accordingly.

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. 254F

255

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.

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Chapter 3: The problem in context 117

In legal terms, an incorporated franchisee cannot be an employee, but in

numerous other aspects the franchisee and the employee are functionally

indistinguishable.255F

256 A more detailed analysis of the franchisees’ role compared to

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’.256F

257

A franchisee makes a significant financial investment in the franchisor. For

instance, ‘on average it costs $380,000 to open a Baker’s Delight franchise’.257F

258 ‘The

working capital required is approximately 30 per cent of the business or $120,000

whichever is the greater’.258F

259 The franchisor does not offer the franchisee security for

its investment. The same reliance on the franchisees’ access to funds is

acknowledged by Australia Post that:

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.

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118 Chapter 3: The problem in context

a candidate will need access to investment capital, typically $250,000 to

$500,000.259F

260

Jim Cohen states that: ‘A bad business model will not be saved by franchising

it’.260F

261 How the franchisees investing in the PostShops are going to recoup their

investments and make money in an environment where there is a steady decline in

the core business product of the PostShop, snail mail, is not obvious.

Access to its franchisees’ capital resources and individual borrowing capacity,

unencumbered by reciprocal legal obligations beyond what is in the franchisor-

controlled franchise agreement, is also reportedly acknowledged by franchisors of

Australian telecommunications franchise Telcoinabox:

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 …261F

262

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.

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Chapter 3: The problem in context 119

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.262F

263

A traditional analysis of a franchisee as a contracting party with the ability to

fully understand and assess a range of risks and then factor them into price and

contract terms is incomplete because of the nature of the franchise agreement. This is

explored in detail at 3.3.

Whereas a

franchisor can manage risk through contract, a franchisee cannot. … the

‘contract as commodity’ approach of the standard form as opposed to a

‘contract as relationship’ approach of the relational … contract creates a

conflict where the standard form prevails. A franchisee takes on qualities of

consumer of product, rather than an equal party to negotiation of terms.263F

264

The risk taking in franchising is relatively one-sided. Franchisees are typically

required to supply all financial details to a franchisor prior to being accepted as a

franchisee, and accept that a cost of being allowed to become a franchisee is

providing personal guarantees by directors and their spouses. This makes it difficult

for franchisees to diversify their risk.

When negotiating a contract on behalf of a client one approach is to ask them

to identify the main commercial areas that, if not addressed properly, would radically

compromise the deal for them. If the client is the franchisor, the franchisee’s death or

the administration, insolvency or bankruptcy of the franchisee would appear in this

list. If representing a franchisee, the converse should apply. However, in my

experience as a franchisee adviser, franchisees typically identify only their own, but

not the franchisor’s potential death or failure. It is very rare for a franchisee to

identify franchisor failure as a potential risk. In the course of my research only three

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.

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120 Chapter 3: The problem in context

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’. 264F

265

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

risk averse franchisee would clearly prefer to invest in a portfolio of shares

in all franchise outlets, rather than confining his investment to a single store.

This means, essentially, that the franchisee will require a higher rate of

return on his capital if he is required to invest in one outlet than in a

portfolio. Conversely the franchisor, by forcing a relatively large risk on the

franchisee, will himself earn a lower rate of return. This argument thus

appears to make sense only if we assume that franchisors are more risk 265 Maltby, above n 120.

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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. 265F

266

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:

their ability to configure the ownership of their personal and business

assets ex ante to protect their personal assets from subsequent claims,

control of the separate entities that own the trade marks,

prescribing the nature of premises lease arrangements,

managing supplier relationships,

the ultimate power of being able to force a franchisee to breach the

franchise agreement, thus giving the franchisor the right to terminate, or to

refuse to renew.

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.

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122 Chapter 3: The problem in context

success. If they turn out well, he captures most of the gains. If they turn out

badly, the creditors bear most of the costs.266F

267

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. 267F

268

Franchisees, whilst assuming some of the franchisor’s business risk, have no

right to receive a corresponding reward, as the venture capital providers or

shareholders typically would, if the franchisor entity is sold for a profit.

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.

3.2.5 FRANCHISEES NOT TRADITIONAL SUPPLIERS

Some advisers and academics struggle to see the difference between

franchisees and traditional suppliers. Indeed, the contracting parties most severely

affected by a franchisor’s insolvency, other than its franchisees, are its suppliers, and

sometimes the franchise network’s customers. Its franchisees are generally exposed

to greater loss and are less able to protect against such loss than is a supplier for a

number of reasons.

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.

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agreement to grow potatoes or a printer will negotiate to print labels to specific

standards for a franchisor.

Second; a traditional supplier is viewed by the franchisor as a strategic partner

that is, effectively, making an investment in the whole network. The supplier

relationship may have begun by the supplier successfully tendering. The franchisor

and supplier negotiate and agree the terms of their contract. These are likely to

include retention of title clauses and penalty provisions for late payment by the

franchisor. They may include franchisors directors’ guarantees. The supply

agreement is relational but is not a standard form contract.

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.

3.2.6 FRANCHISEES OR EMPLOYEES?

The relevance of comparing franchisees with employees is that they are

sometimes indistinguishable in function, but are each treated differently if the

employer/ franchisor becomes insolvent. The employee, whose role the franchisee

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124 Chapter 3: The problem in context

has assumed in many organisations, is provided with significant protection in

Australia’s regulatory regime. This is pursued in chapter 4.4.3. The franchisee has no

protection from legislation or government.

Dependence and control are the major features of the employer-employee

relationship. Franchisees undeniably experience a relationship of dependence and

control with their franchisors. These features are put in place through the franchise

agreement and maintained in numerous ways through the administration of the

franchise network. From their customers’ perspective, a franchisee, an employee and

an independent contractor are indistinguishable. Depending on nuances of the precise

franchise model used by the network, the differences, however, may be numerous

and significant.

There is far more than dependence and control to an employer- employee

relationship. Franchisors are aware of the relative cost of staff compared to shedding

the staff in favour of franchisees, as demonstrated by the words of a franchisor:

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.268F

269

It is, however, useful to identify the characteristics of an employee and a

franchisee and thereby to understand why they are sometimes indistinguishable and

at other times a franchisee is clearly not an employee. Useful sources on which to

found this analysis are:

Australian Taxation Office (ATO) Rulings (TR) identifying

characteristics of an employee,

franchise agreements and

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.

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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.

Table 4: Features of Employee, Franchisee and Supplier / Independent Contractor.

The nearest relationships are identified in ‘Franchisee is more like …’ column for

each feature.

Features of relationship269F

270 Franchisee is more like ...

Employee Franchisee Supplier/ independent contractor

Lawful authority to command

employee Under a contract of service, the payer usually has the right to direct the manner of performance. Where the nature of the work involves the professional skill or judgment of the worker, the degree of control over the manner of performance is diminished. What is important is the lawful authority to command that rests with the payer

Method of conducting franchise is set out in detail in Operating Manual(s). Franchisor has right to require the franchisee to work in a certain way and to terminate the franchise if franchisee does not follow system270F

271

The hallmark of a contract for services is said to be that the contract is one for a given result. The contractor works to achieve the result in terms of the contract. The contractor works on his/her own account

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).

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Features of relationship269F

270 Franchisee is more like ...

Employee Franchisee Supplier/ independent contractor

How is the work performed?

employee Tasks are performed at the request of the employer. The worker is said to be working in the business of the payer

Tasks are performed following the method prescribed by the franchisor. Franchisee typically has little discretion in how and whether they perform the work. The franchisee is working in own business within the parameters mandated by the franchisor

Enters into a contract for a specific task or series of tasks. Maintains a high level of discretion and flexibility as to how the work is to be performed. Contract may contain precise terms as to materials used and methods of performance and still be one for services

Risk independent contractor

Bears little or no risk. Employee is not exposed to any commercial risk. This is borne by the employer.

The employer is generally responsible for any loss occasioned by poor workmanship or negligence of the employee

Bears all risk for own performance. Franchisee bears risk of the franchisor failing or underperforming.

Franchisor may be liable in tort for injury caused by franchisee271F

272 or under workcover legislation for injury to franchisee’s employee272F

273

Stands to make a profit or loss on the task. Bears the commercial risk and the responsibility and liability for any poor workmanship or injury sustained in performance of the task. Generally, would be expected to carry their own insurance

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.

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Features of relationship269F

270 Franchisee is more like ...

Employee Franchisee Supplier/ independent contractor

Place of performance

employee Worker under a contract of service will generally perform the tasks on the payer's premises using the payer's assets and equipment

Provides own assets and equipment and own premises. May sub-lease premises from franchisor and be required to place orders through a centralized ordering system owned and operated by franchisor

Generally provides all own assets and equipment

Hours of work employee Generally works standard or set hours

Works the hours dictated by franchisor273F

274

Generally sets own hours of work

Leave entitlements

independent contractor

The contract generally provides for annual leave, long service leave, sick leave and other benefits or allowance

Franchisee does not receive benefit of statutory leave provisions. Sometime franchise systems require franchisees to obtain franchisor’s consent to be absent from franchise

Generally, an independent contract does not contain leave provisions

Payment independent contractor but if structured like commission agency, employee

Generally paid an hourly rate, piece rates or award rates

Payment usually by franchisee’s company;

Some franchisees receive commission from franchisor

Payment is based upon performance of the contract

Expenses independent contractor

Generally reimbursed for expenses incurred in the course of employment

Meets own expenses; if required to deal with suppliers mandated by franchisor may be unable to negotiate terms or price

Generally incurs own expenses

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.

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128 Chapter 3: The problem in context

Features of relationship269F

270 Franchisee is more like ...

Employee Franchisee Supplier/ independent contractor

Appointment employee Generally recruited through an advertisement by the employer

Recruited by franchisor or its agent.274F

275 Once franchisee’s business established, franchisee and franchisor market the system’s services or products to the public

Likely to advertise their services to the public at large

Termination employee Employer reserves the right to dismiss an employee at any time (subject to State or Federal legislation)

Franchise Agreement typically for a fixed term.275F

276

Franchise agreement and Code contain termination possibilities exercisable by franchisor 276F

277

Contracted to complete a set task. The payer may only terminate the contract without penalty where contractor has not fulfilled the conditions of 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.

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Chapter 3: The problem in context 129

Features of relationship269F

270 Franchisee is more like ...

Employee Franchisee Supplier/ independent contractor

Delegation employee Employee has no inherent right to delegate tasks to another. However, there may be a power to delegate some duties to other employees

Typically may not delegate management role except with franchisor’s express consent. Most franchisees have employees. Franchise agreement contains provisions for familial succession on death/ incapacity of franchisor

May delegate all or some of the tasks to another person, and may employ other persons277F

278

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?’278F

279 the 2005 rulings examine

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, 39279F

280 (Vabu) the majority of the High Court quoted the following statement made

by Windeyer J in Marshall v Whittaker's Building Supply Co (1963) 109 CLR 210.

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).

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130 Chapter 3: The problem in context

... the distinction between an employee and independent contractor is 'rooted

fundamentally in the difference between a person who serves his employer

in his, the employer's business, and a person who carries on a trade or

business of his own. 280F

281

This distinction is also referred to as the integration or organisation test.281F

282 In

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’.282F

283

In the franchising context, McDonald's Australia Holdings Ltd & Anor v

Industrial Relations Commission of NSW & 2 Ors [2005] NSWCA 286 the

expectations on McDonald’s licensee (ie: franchisees) are set out:

The foundation and essence of the McDonald’s System is the adherence by

licensees to standards and policies of McDonald’s and its related

corporations providing for the uniform operation of all McDonald’s

restaurants within the McDonald’s System including, but not limited to,

serving designated food and beverage products; the use only of prescribed

equipment and building layout and designs; and strict adherence to

designated food and beverage specifications and to prescribed standards of

quality, service and cleanliness in restaurant operation. Compliance by

licensees with the foregoing standards and policies in conjunction with

McDonald’s trade marks, service marks and trade names provides the basis

for the valuable goodwill and wide acceptance of the McDonald’s System.

Moreover the establishment and maintenance of a close personal relationship

with Licensee in the conduct of his McDonald’s restaurant business, his

accountability for performance of the obligations contained in this

agreement, and his adherence to the tenets of the McDonald’s system

constitute the essence of the licence provided for herein. 283F

284

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).

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Chapter 3: The problem in context 131

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.284F

285 This

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.

Risk of liability for injury or for substandard work

This feature of the relationships takes up point 3 of TR 2000/14 which focuses

on the consequences of the risk of physical injury or of liability for substandard

product or workmanship. Whilst franchisees are widely assumed to be liable for the

physical injury occurring on their premises a franchisor has, on occasion, been found

liable for the death of a franchisee’s employee.285F

286 In such cases, the franchisees and

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.

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132 Chapter 3: The problem in context

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.

Provision of tools and equipment and payment of business expenses

In this category, the franchisee is more like an independent contractor. TR

2005/16 286F

287 compares the employee and the independent contractor.

The weight or emphasis given to this indicator … depends on the particular

circumstances and the context and nature of the contractual work. All the

other facts must be considered to determine the nature of the contractual

relationship.

Other indicators

These include:

Right to suspend or dismiss

Right to exclusive service

Provision of statutory or award mandated benefits

Requirement that the worker wear a uniform bearing the employer’s logo.

Ultimately it is concluded that the TR are of limited assistance in defining a

franchisee. The answer to the question: ‘What differentiates an employee or an

independent contractor from a franchisee?’ is far from uniform and far from clear.

It is therefore helpful to examine the differences from other perspectives. The

features listed in Table 5 have been categorized to reflect widespread norms. It

should be noted that not all franchise networks exhibit all features. In Table 5 the

issues are approached in a different way to that of the Australian Taxation Office and

case law. The relationships are looked at in time sequence – the pre-engagement

phase, followed by the time when the employee is working for the employer or the

franchisee is operating under a franchise agreement. Finally, the period after the end

of the relationship is examined. The analysis that follows Table 5 expands on

significant features.

287 Paras 49, 50.

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Chapter 3: The problem in context 133

Table 5: Additional Features of Employee and Franchisee. (Bolded features are common to both)

Feature of Relationship Employee Franchisee

Prior to commencement of relationship

Invest money in activity to get started No Yes

Some money invested in sunk costs No Yes

Decides where business will be located No No

Contract is the basis of the relationship Yes Yes

Consumer protection under Trade Practices Act if advertisement misleading or deceptive

Yes Yes

Once committed to relationship

Personal responsibility for premises costs No Yes

Wear uniform; adopt prescribed “trade dress” Yes Yes

Right to choose suppliers No No

Owns improvements to intellectual property made by employees or franchisee

No No

Subject to ongoing performance reviews by employer/ franchisor Yes Yes

Relationship recognized specifically by law Yes Yes

Duty of confidentiality Yes Yes

Restraints on other work that may be done during term of contract

Yes Yes

Vulnerable to capricious behaviour by employer/ franchisor Yes Yes

Duties owed to employer/ franchisor – fidelity, good faith, care and skill, confidentiality, obedience and cooperation, render service

Yes Yes

May join a trade union to enforce rights Yes No

Personally assumes financial risk on behalf of employer/ franchisor No Yes

May sell the role No Yes

If employer/franchisor becomes insolvent, right to sue under Trade Practices Act, subject to liquidators rights under Corporations Act

Yes Yes

If employer/franchisor becomes insolvent, specific rights under Corporations Act

Yes No

After relationship ends

Opportunity to make capital gain if enterprise succeeds No Yes

Owns the goodwill at the end Employer Franchisor

Post-relationship restraints Sometimes Sometimes

On termination of relationship employee or franchisee usually has No Yes

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134 Chapter 3: The problem in context

Feature of Relationship Employee Franchisee

financial obligations re the employer/ franchisors business

Clear statutory rights if employer/ franchisor becomes insolvent Yes No

Contract may be terminated without consulting employee or franchisee on liquidation of employer/ franchisor

Yes Yes

Prior to commencement of relationship

INVEST MONEY IN ACTIVITY TO GET STARTED

An employee does not invest money in the employer as a pre-requisite to being

employed. A franchisee in Australia pays between $5,000 and $1,402,500 for the

right and then the cost of starting up a new franchised unit.287F

288 To quote the Lenard’s

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’.288F

289

SOME MONEY INVESTED IS SUNK COSTS

The issue of sunk costs is not relevant to employees, but it is very real to

franchisees. The amount of sunk costs depends on the type of franchise. Where, for

example, a franchisee is required to fit out a hotel or a café, the sunk costs are high;

where it operates a lawn mowing, house cleaning or courier franchise, the sunk costs

are relatively low. The opportunity to recover sunk costs following the franchisor’s

insolvency varies greatly – a franchisee establishing a retail outlet will not be able to

recover sunk costs if the franchisor fails and the premises lease is disclaimed,

whereas a franchisee will find a market for a second hand vehicle or lawn mower

more readily. A franchisee with low exposure to fixed premises or other purpose-

built branded assets will be in a better position to mitigate its losses in relation to

sunk costs.

DECIDES WHERE BUSINESS WILL BE LOCATED

Having decided to commit to a particular employer or franchise system, an

employee or franchisee requiring fixed premises may not have a genuine choice of

location. This is exemplified in the judgment of Justice Ryan in Kaytonruby Pty Ltd

& Ors v Glev Franchisees Pty Ltd & Ors (1998) VG 438 of 1993, who noted:

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.

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Chapter 3: The problem in context 135

He [the prospective franchisee] was … given several maps…on which were

delineated “territories” … to be allocated to franchisees. … It was further

indicated … that no franchise had by then been allocated in Victoria but Mr

Leong would have to be quick. … After a … short lapse of time [the

franchisor’s agent’s observed that]…‘I think Noble Park is a better area any

way you look at it’. Eventually, the franchisor could not find suitable

premises in Noble Park and the franchisor’s agent suggested that Mr Leong

should consider taking a franchise in Malvern which [until] then had not

been offered to prospective franchisees but had been reserved as a company

shop.289F

290

The only option for the franchisee was the suburb of Malvern.

CONSUMER PROTECTION UNDER TRADE PRACTICES ACT IF ADVERTISEMENT MISLEADING OR DECEPTIVE

Employees and franchisees both have specific recourse to Trade Practices Act

in relation to pre-contractual claims made to them and relied on that turned out to be

misleading or deceptive. Employees can rely on Trade Practices Act ss 51A, 52 and

53B and franchisees on ss 51A, 52 and 59.

Once committed to relationship

WEAR UNIFORM / ADOPT PRESCRIBED TRADE DRESS

The requirement that a worker wear a company uniform is an indicator of an

employment relationship existing between the contracting parties. In Vabu290F

291

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.291F

292

The franchisee’s business is often distinguished by the franchisor’s prescribed

trade dress. A failure to adopt correct trade dress is a breach of the franchise

agreement. The trade dress may include a uniform, as is the case in many fast food

networks, or an emblem or colour scheme to identify the business as belonging to the

franchise brand. In this regard employment and franchising are indistinguishable.

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.

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136 Chapter 3: The problem in context

OWNS EMPLOYEE’S OR FRANCHISEE’S IMPROVEMENTS TO INTELLECTUAL PROPERTY

In both the employer-employee and the franchisor – franchisee relationship, the

employer and the franchisor own the intellectual property and all improvements to it

unless the parties have made a specific contract to the contrary. Intellectual property

typically includes registered and unregistered trade marks, patents and registered

designs and any improvements to systems and products. A clause from the Australian

Autobarn franchise agreement is typical of the relevant clause in franchise

agreements:

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.292F

293

Thus, again, employment and franchising are the same.

SUBJECT TO ONGOING PERFORMANCE REVIEWS

Performance reviews are an entrenched aspect of employment. They do not

disappear if an employee becomes a franchisee. They help ensure franchisees

maintain the standards set by the franchisor. For both employees, and for franchisees,

the performance review may be comprehensive. For example, for franchisees in the

McDonald’s network, as described in Far Horizons Pty Ltd v McDonald's Australia

Ltd [2000] VSC 310 (‘Far Horizons’):

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.293F

294

This was explained by the McDonald's witnesses as having two components:

first an appropriate attitude towards the McDonald’s organisation including

other licensees, and, second, an appropriate attitude to the conduct of the

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).

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Chapter 3: The problem in context 137

business, including a readiness to engage in local activities which would

promote the image of the business and of McDonald’s’.294F

295

Being subject to ongoing performance reviews is not a meaningful way of

distinguishing employees from franchisees.

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. 295F

296

Ideally there will be no conflict of interest between franchisor and franchisee in

relation to choice of suppliers or treatment of franchisees stemming from supplier

issues. In theory, the franchisor’s ability to negotiate on the basis of the combined

buying power of the franchisees will secure better terms from suppliers than the

franchisee could negotiate as sole operators.

The choice of suppliers to franchisees can, however, be a source of

considerable franchisee dissatisfaction if the franchisor is perceived to be taking

undisclosed commissions from the supplier, or if the franchisee would be able to

source the same product elsewhere if it were not contractually bound to the

franchisor. The potential for conflict of interest is significant when the franchisor or a

related entity is the supplier. Three typical positions franchisors have in relation to

suppliers are exemplified by excerpts from Australian individual unit franchise

agreements.

At the least controlling level, the franchise agreement in 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 leaves Jax Tyres

franchisees free to secure supplies from any supplier. This avoids conflicts of interest

between franchisor and franchisee. The Jax Tyres franchise agreement stipulates:

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.

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138 Chapter 3: The problem in context

The franchisor shall not limit the suppliers from which such items may be

purchased. 296F

297

A middle position existed in the Mail Boxes Etc (MBE) single unit franchise

agreement that stipulated, in Clause 9.1 that:

During this agreement the franchisee must not:

Purchase those products, materials, equipment or services required by the

Operating Manual to be purchased from suppliers approved by the

Franchisor from any person other than those suppliers without the written

consent of the Franchisor: 297F

298

For McDonald’s franchisees Justice Byrne noted:

The McDonald’s System is a comprehensive restaurant system for the

retailing of a limited menu of uniform and quality food products. The

foundation and essence of the McDonald’s System is the adherence by

licensees [ie: franchisees] to standards and policies of McDonald’s and its

related corporations providing for the uniform operation of all McDonald’s

restaurants within the McDonald’s System including, but not limited to,

serving designated food and beverage products; the use of only prescribed

equipment and building layout and designs; and strict adherence to

designated food and beverage specifications and to prescribed standards of

quality, service and cleanliness in restaurant operation. Compliance by

licensees with the foregoing standards and policies in conjunction with

McDonald’s trade marks, service marks and trade names provides the basis

for the valuable goodwill and wide acceptance of the McDonald’s System. 298F

299

In comparison with the franchise systems mentioned above, the case of

Australian Competition & Consumer Commission v Simply No-Knead (Franchising)

Pty Ltd [2000] FCA 1365 (‘SKN’) provides a glimpse into supply chain abuse by a

franchisor. There, the franchisor required the franchisee to purchase most supplies

through the franchisor, then refused to deliver the products ordered to the

franchisees. This provided the first test case of the business-to-business

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.

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Chapter 3: The problem in context 139

unconscionable conduct provisions of the Trade Practices Act, s 51AC, introduced in

1998. SKN is now insolvent.

Clearly issues around sourcing and dealing with suppliers are one significant

area where employment and franchising differ.

The relationship is recognised specifically by law

Both employment and franchise relationships are created by contract, both are

recognised by statutes that need to be adhered to before a business fails. Clause 10.16

of the Jax Tyres franchise agreement is replicated in similar words in the boilerplate

clauses of all single unit franchise agreements:

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. 299F

300

The employment relationship is the subject of a comprehensive statutory

regime that provides employees with ‘cradle to grave’ rights in relation to their

employers. These include statutory rights to accurate job advertisements, employer

funded superannuation, paid leave, recourse in the event of discrimination and

recognised status and rights under the Corporations Act if the employer becomes

insolvent. The impact of an employer’s insolvency on employees is addressed in

chapter 4.4.6.

Recognition of franchisees by the law stops if the franchisor enters

administration or becomes insolvent. Aspects of the resulting problems are addressed

in detail in chapters 2.3 and 4.4.1 – 4.4.4.

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.

Employment entails confidentiality obligations that stem from the employment

contract, professional codes of ethics, or specific confidentiality agreements such as

those many franchisors require that their franchisees’ employees sign.

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.

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140 Chapter 3: The problem in context

The contractual obligation in Clause 6.12 of the Donut King franchise

agreement typifies the franchisees’ confidentiality obligations towards its franchisor:

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.300F

301

Employment and franchising respond in a very similar way to this issue.

Restraints on other work that may be done during term of contract

An employer expects an employee to devote the agreed amount of time to their

work. An employer adopts policies to ensure this occurs, including policies for

managing conflicts of interest. The situation is very similar for franchisees. For

example franchisor MBE mandates that:

During this agreement the franchisee must not:

9.1(q) without the Franchisor’s prior written consent in any capacity

whatsoever be directly or indirectly engaged in any business or undertaking

301 Copy of franchise agreement is in researcher’s possession.

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Chapter 3: The problem in context 141

which in the sole opinion of the Franchisor is considered competitive to the

Business. 301F

302

The equivalent clause in a McDonald’s licence agreement is:

6.05 Best Efforts

Licensee or, where Licensee is a company, Principal shall … personally

devote… his full time and attention to and exercising his best efforts in the

operation of the Restaurant. Licensee [etc] … shall keep free from

conflicting enterprises or any other activities which would be detrimental to

or interfere with the business of the Restaurant. 302F

303

Where a single franchisee operates multiple units of the same or a diversified

portfolio of franchise units with more than one franchisor, they do so with the

consent of their franchisors. Thus, in-term restraints are not a reliable distinguishing

characteristic of the relationships.

VULNERABLE TO CAPRICIOUS BEHAVIOUR BY EMPLOYER OR FRANCHISOR

Employees and franchisees are potentially affected by capricious or

unreasonable behaviour by their employer or franchisor. In both situations, despite

the existence of fair work and anti-discrimination legislation for employment, and

statutory prohibitions against unconscionable conduct and discrimination for

franchisees, in practical terms the employer/franchisor has the ‘upper hand.’

If their employer abuses its stronger position, employees may have recourse to

a trade union for assistance.

Franchisees in Australia do not have a representative body that functions in the

same way a trade union does.303F

304 Franchisees sometimes feel vulnerable and

disempowered and may have to go to court to attempt to assert legal rights.

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.

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142 Chapter 3: The problem in context

For example, in Far Horizons Mr Hackett, director of a McDonald’s franchise,

vulnerability as a franchisee is obvious in the words of his witness statement:

Mr Xipolitos appeared to me to be determined and insistent on grading me as

operationally unsatisfactory….

… I came to realise that my future security and prospects in the McDonald's

System, being my $2 million plus investment in my restaurants and my

desire to expand, were ultimately in the hands of a very subjective evaluation

of my restaurants by one or two people and the personal relationship

between myself as licensee and my Consultant. 304F

305

The increased vulnerability for a franchisee over an employee is that

franchisees like Mr Hackett have sunk investments, their own employees, ongoing

contractual obligations to the franchisor and third parties and consequential liabilities

secured in contractual relationships. The franchisee does not have the option of

finding another job.

Thus, while both employees and franchisees are potentially victims of

capricious behaviour, the franchisee is arguably more vulnerable and less able to

retaliate appropriately because of lack of a representative body to turn to, numerous

contingent contractual relationships requiring ongoing performance and an

investment in sunk costs to protect.

MAY JOIN A UNION TO ENFORCE RIGHTS

Employees are legally permitted to join trade unions in Australia. During the

Ansett insolvency in 2001 the trade union provided assistance to the employees in

the form of representation at the creditors’ meetings, up to date information on a

designated website, and its ‘weight’ in negotiations with the federal government.

This resulted in especially favourable treatment for employees.

One enduring, effective, and widely respected franchisee association is the

Motor Traders Association of Australia. It represents vehicle dealers and associated

franchisees, licensees of vehicle and oil companies and independent operators in the

motor trades. For franchisees outside motor trades, several franchisee representative

groups have formed and been disbanded over the years. The possible benefit of

franchisees joining unions is discussed in chapter 6.1.3.

305 Far Horizons Pty Ltd v McDonald's Australia Ltd [2000] VSC 310, para 42.

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Chapter 3: The problem in context 143

Accordingly, the possibility of joining a trade union is a significant point of

difference between employees with access to union membership and franchisees.

PERSONALLY ASSUME FINANCIAL RISK OF EMPLOYER/ FRANCHISOR’S FAILURE

This is another area where the outcomes for employees and franchisees starkly

differ. The employee loses his or her job if the employer’s business fails. Some ‘read

the writing on the wall’ and leave before the administrator is appointed. For example,

Vicky Kay, employee manager of the franchisor owned store Traveland Bondi

Junction, is reported as saying that she resigned on 20 November 2001 as manager

after 29 years of working for Traveland, fed up with being paid late.

They kept saying the money’s coming. 305F

306

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.

The franchisees may be at a significant disadvantage compared with the

franchisor’s employees when it comes to detecting early warning signs of the

franchisor’s financial woes. The difference between employees and franchisees was

also demonstrated when the Kleins jewellery franchisor failed. It was reported that

Kleins:

… collapsed with debts of approximately $20-25 million in May 2008. It

became readily apparent that Kleins could never be returned to its former

glory and was simply a ‘tired’ business. … all employees would be likely to

306 Alison Rehn and David Penberthy, ‘Traveland liquidators to be paid $1m’, Daily Telegraph

(Australia) 15 March 2002, 15.

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144 Chapter 3: The problem in context

receive their entitlements, under the GEERS scheme, but unsecured creditors

[and franchisees] should expect nothing.306F

307

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.

MAY SELL THE ROLE

This is a significant point of difference. An employee is not at liberty to sell

their job. The franchisee, on the other hand, expects to be able to sell their business.

Strong re-sales of franchisees’ businesses by incumbent franchisees is one indicator

of a successful franchise network.

After relationship ends

OPPORTUNITY TO MAKE CAPITAL GAINS IF ENTERPRISE SUCCEEDS

An employee in a middle or senior management position in a public company

may be rewarded in the form of a bonus package of options or shares. They would

then be free to trade these on the stock exchange at future dates.

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.

WHO OWNS THE GOODWILL AT THE END?

Goodwill is a complex issue, and is a clear point of differentiation between an

employee and a franchisee. An employer owns the goodwill in its business. Its

employees do not own the goodwill.

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’307F

308 possible viewpoints on the question of whether a

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=d835666ba19cfd1d> at 18 February 2010.

308 Australian Taxation Office, PCD 8 Capital Gains: Goodwill (1995).

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Chapter 3: The problem in context 145

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.

It would be usual for a franchisee to expect to receive some of the goodwill on

the sale of a franchise during the term, particularly where the franchisor has not

terminated the franchise agreement for franchisee misconduct.308F

309

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:

16. Post Termination Covenant Not To Compete

16.5 The Franchisee, Nominated Manager and the Guarantors shall

not during the term or the period, after the expiration or earlier termination

of this Agreement, as specified in the Schedule conduct on his own account

or be concerned or interested in whether directly or indirectly as agent,

representative, consultant, adviser, servant, employee, trustee, partner,

shareholder, or director in any firm or corporation conducting a business

similar to the Franchised Operation or in any cake manufacturing or cake

retail or cake wholesale enterprise, within the distance [stipulated in the

agreement] from the location specified in the Schedule.309F

310

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.

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146 Chapter 3: The problem in context

Justice Windeyer was not prepared to enforce a post-term non-compete

covenant, writing:

I cannot see how the restraint could be justified. It is really a prohibition

against competition without any evidence to establish anything being

competed against. There is no evidence that The Cheesecake Shop (TCS)

wished to open a Cheesecake Shop within the postcode referred to or

anywhere near Bonnyrigg or anywhere within the restrained area. Thus there

is no evidence of disadvantage to TCS if a shop selling cheesecake products

operated from the premises. In the absence of evidence the covenant would

seem to operate to preserve an area for TCS operations which do not

presently exist and may never exist. … such a restraint could not be upheld

as it could not be shown to be necessary or reasonable to preserve the

goodwill of TCS. 310F

311

ON TERMINATION OF RELATIONSHIP EMPLOYEE OR FRANCHISEE HAS FINANCIAL OBLIGATIONS RE THE BUSINESS.

While an employee would expect to have an ongoing obligation not to disclose

confidential information obtained during a period of employment, some franchisors

impose a more onerous obligation through their franchise agreements. The

independent contractor or the employee is free to look for new work as soon as the

administrator is appointed. At the time of the franchisor’s insolvency a key

difference between employees and franchisees is that the employees are supported by

government policy, franchisees are not.

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.

3.3 THE FRANCHISE AGREEMENT

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

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Chapter 3: The problem in context 147

appropriate consequential rights. New York franchise lawyer Craig Tractenberg

recommends:

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.311F

312

Tractenberg also advises that ‘[c]omplete termination is required’.312F

313 Similarly, the

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.

‘Contracts are fundamental to commerce. Contract law determines how a

contract is made, whether it is enforceable, whether it has been breached, and what

remedies are available for its breach’.313F

314 Blair and Lafontaine summarise a franchise

agreement as being:

…most often understood as a contractual arrangement between two legally

independent firms in which one firm, the franchisee, pays the other firm, the

franchisor, for the right to sell the franchisor’s product and/or the right to use

its trademarks and business format in a given location for a specified period

of time. 314F

315

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.

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148 Chapter 3: The problem in context

Others v Seven-Eleven Corporation SA (Pty) Ltd unreported case no 18/IR/Dec 99

thus:

[a] franchise agreement is neither an employment relationship nor an

independent contracting relationship. It rather combines elements of

integration and delegation, control and independence and is thus a

multifaceted vertical structure that paves the way for endless relational and

commitment problems. 315F

316

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:

The basic premise on which the principles of freedom of contract and

sanctity of contract rest is that contracts are negotiated at arm’s length by

equally positioned participants in the bargaining process. That premise is not

fulfilled in the typical franchise arrangement.316F

317

‘Contractual relations are the essence of the firm, not only with employees but

with suppliers, customers, creditors’ 317F

318 and franchisees. The franchise agreement is

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.

3.3.1 ADDRESSING THE FAILURE OF THE FRANCHISOR’S BUSINESS

The franchise agreement documents a relationship that is commercial and

consumer. The subject of the contract is a commercial relationship. The parties are

the franchisor as a business supplier and a franchisee as a business consumer. Once

executed, like all commercial agreements, it sits in the proverbial ‘bottom drawer’

until one party needs to invoke legal rights. Then, it commands the undivided

attention.

Because there is no public register of franchise agreements in Australia, 70

franchise agreements … were chosen from the US website FreeFranchise

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.

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Chapter 3: The problem in context 149

docs. 318F

319 [We] examined [them] to determine what a typical franchise

agreement might say about insolvency of one of the signatories. None of

these agreements mentioned franchisor bankruptcy … In the same

agreements, 23.5 per cent were silent on the right for franchisors to terminate

the agreement if the franchisee became bankrupt. Seventy six per cent

permitted the franchisor to terminate the franchise agreement, usually with

no notice and no right to cure if the franchisee became bankrupt.319F

320

In Australia, the ex post experience of a Traveland travel agency franchisee is

consistent with the US findings above:

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.320F

321

This failure to provide for an event which is demonstrably common is

problematic. The ideal world where ‘negotiations between two … parties, … are

designed to advance the wants and needs of each of those contracting parties’ 321F

322 does

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.

3.3.2 THE DESIRABILITY OF CERTAINTY IN CONTRACTS

Notwithstanding that one would assume for all stakeholders that certainty is an

outcome of the contracting process and

[t]he classical theory of contract was seen to offer predictability and

certainty, although, as Sir Anthony Mason has observed; “It later emerged,

as is the case with many legal concepts rooted in formalism, that the element

of certainty was illusory”322F

323

Acknowledging that the franchise agreement is a relational contract is also to

acknowledge that whilst procedural certainty may be achieved, substantial certainty

need not be an outcome of the contracting process. Certainty in all dimensions is

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.

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150 Chapter 3: The problem in context

widely accepted as being desirable in commercial relationships. Heather Ridout

points out that ‘uncertainty is death for business’323F

324 in the context of the carbon

trading debate. Hadfield observes:

… incomplete contracts (such as franchise agreements) often exist deeply

embedded in an ongoing relationship. The parties are not strangers; much of

their interaction takes place “off the contract” mediated not by visible terms

enforceable by a court, but by a particular balance of cooperation and

coercion, communication and strategy.324F

325

There is an assumption underlying a relational contract that the major

foreseeable events which could fundamentally change the relationship, are addressed

in the contract. Other events are foreseeable but seem so unlikely to one or both

parties that they are not included. The parties acknowledge, by implication, that some

events are not foreseeable and will be the subject of negotiation if and when they

occur. Where certainty is not possible, a balanced contract would be a desirable

outcome.

3.3.3 PARTIES TO COMMERCIAL AND CONSUMER CONTRACTS ACT IN THEIR OWN INTERESTS

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’.325F

326 Parties to commercial contracts should act in their

own interests but, as K M Sharma writes:

… 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.326F

327

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.

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Chapter 3: The problem in context 151

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.

That franchisors do act in their own interest is demonstrated by franchisors’

responses to compliance with the voluntary Franchising Code of Practice (FCP). The

FCP was ‘introduced in 1993 to address significant problems in franchising

identified in the 1991 report by the Franchising Task Force’.327F

328 The FCP was a form

of ‘soft law’ 328F

329 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’.329F

330

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 publishers330F

331 would increase the pressure on

franchisors to register’.331F

332 Those that did register may also have been motivated by

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.

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152 Chapter 3: The problem in context

However, ‘…the motor vehicle industry … decided not to participate in the

Code, as [did] significant areas in the real estate sector’.332F

333 Those that did not register

also acted in their own interest for reasons which included:

lawyers advising franchisor clients not to voluntarily expose themselves to

the obligations the FCP imposed on signatories,

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

a few franchisors claimed not to know of the existence of the FCP.

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.333F

334

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.

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Chapter 3: The problem in context 153

own interests, is debateable. If they want to become a franchisee of a specific

network they have no ability to act in their own interests; in order to be approved as a

franchisee they hand the franchisor all of their financial information, then prior to

becoming a franchisee they execute the standard form, non-negotiated agreement

drafted by the franchisor.

3.3.4 A STANDARD FORM BUSINESS CONSUMER CONTRACT

In its submission to The Australian Consumer Law Consultation on Draft

Provisions on Unfair Contract Terms, the Law Society of NSW provides examples of

‘standard form contracts’ frequently used in conveyancing transactions and states

that:

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. 334F

335

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.

Franchisors use standard form franchise agreements drafted to maximize their

position. For example:

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. 335F

336

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.

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154 Chapter 3: The problem in context

be resolved by arbitration or litigation in the location nominated by the franchisor,

Connecticut, USA. 336F

337 Such a strategy is beneficial to the franchisor but is a

significant disincentive to robust dispute resolution for Subway franchisees in

Australia.

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.

Nevertheless franchise agreements are:

long-term contracts [that] involve continuing financial commitment in the

course of which the consumer, being imperfectly informed and not fully

aware about his needs – is largely reliant on the advice, guidance and skills

of his counter-party.337F

338

In addition to being a contract concerning the purchase and operation of a

business the franchise agreement is a contract between a supplier and a business

consumer. It places a franchisee in a position of dependence on the franchisor in

relation to services provided by both the franchisor and by third parties. Despite all

the words about support and nurturing that have resulted in the franchisee purchasing

the business, the franchisor’s position is clearly stated in the wording of the franchise

agreement, as is shown for example in a typical Australian franchise agreement.

‘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.

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Chapter 3: The problem in context 155

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’.338F

339

Elizabeth Spencer observes:

The inherent dynamic in franchisor/franchisee relationship … involves

maintaining the franchisee in a subordinate position. This increases the

franchisee’s motivation to provide assurances of performance, among them

taking on risk. … Despite being overburdened with risk, because of the

standard form the franchisee is faced with the choice of accepting the

contract terms or giving up on the deal entirely.339F

340

But, as Rick Bigwood points out, ‘standardized [as manifested by standard

form] contracts are mostly to be endured as beneficial in complex free market

economies. This is largely because they reduce transaction costs’.340F

341 Bigwood

acknowledges that ‘consumer protection through market forces alone is weak’.341F

342

The inability of market forces to remodel franchise agreements to accommodate

franchisor failure is an aspect of extreme one sidedness that is not to be endured. For

example, franchise agreements always provide for the death or insolvency of the

franchisee. There are no statistics available for the number of franchisees who die

while being a party to a franchise agreement. In the author’s experience acting for

franchisors of large networks, a franchisee died on two occasions. On both occasions

the death affected one outlet and the transition to a new owner was managed by the

franchisor without interruption to any other franchisees. By way of contrast, a

‘standard form contract … does not anticipate [the franchisor equivalent of the

franchisee’s death] insolvency of the franchisor. This limits the ability of the

franchisee to self protect’.342F

343

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.

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156 Chapter 3: The problem in context

Another way of expressing the problems caused by the standard form is that:

[c]onflicts of interest may, and do, create counter-incentives for [creating

and] complying with contractual obligations. Especially in long term

contracts and in conditions of asymmetric information, the possibility of

opportunistic behaviour appears considerably increased not least because the

value of the contract and the investment depends on the firm’s performance

after the point of purchase.343F

344 Contracting out would be a way in which

consumers could avoid being exposed to the risk of their counter-party’s

misconduct, nevertheless the costs involved discourage them from doing

so. 344F

345

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. 345F

346

Willmott et al add that

[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. 346F

347

The franchise agreement is an example of such a contract negotiation process.

The franchisor supplier drafts the franchise agreement. The franchisee business

consumer takes it or leaves it, seldom having the opportunity to vary the standard

form. Experience of legal practitioners suggests that the only franchisees in the

position to negotiate non-standard terms into their franchise agreement may be the

first franchisees of a new network or the first master franchisee entering a new state

or country where a franchisor is very keen to establish a presence.

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.

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Chapter 3: The problem in context 157

3.3.5 RELATIONAL CONTRACT

Franchise agreements are relational contracts, and are necessarily incomplete.

Underlying a relational contract is the assumption that the major foreseeable events

that could fundamentally change the relationship have been addressed in the contract.

As Hadfield observes

incomplete contracts [such as franchise agreements] often exist deeply

embedded in an ongoing relationship. The parties are not strangers; much of

their interaction takes place ‘off the contract’ mediated not by visible terms

enforceable by a court, but by a particular balance of cooperation and

coercion, communication and strategy.347F

348

‘In contract theory, incompleteness is [also] due to the cost and sometimes

unavailability of information’.348F

349 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’.349F

350 ‘Both

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’.350F

351

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’.351F

352

As Hadfield points out, once the contract moves beyond negotiation or

performance to litigation:

[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.

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158 Chapter 3: The problem in context

which is part of that commitment, incomplete contracts cannot fully function

in their role as anchor for many complex transactions.352F

353

The franchise agreement is necessarily incomplete because of its long term353F

354

and the unpredictability of human relationships and commercial environments.

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. 354F

355

‘To a lawyer, a contract may be incomplete in failing to describe the

obligations of the parties in each possible state of the world’.355F

356 It is thus difficult to

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’.356F

357 A flaw in applying the theory of trading off ‘front-end and back-end

costs’357F

358 to justify not providing for franchisor failure ‘up front’ is that franchisors

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.

Justice Hammond in Dymocks Franchise Systems v Bilgola Enterprises Ltd 8

TCLR 612 recognised that the

underlying recognition is that a relational contract is of an ongoing, and

often relatively open-ended, character; and that it is in society’s interest to

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.

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Chapter 3: The problem in context 159

accord to each party to a contract of this kind, reasonable security for the

protection of his or her justified expectations.358F

359

A franchisee’s ‘justified expectations’ are unmet if the franchisor fails.

3.3.6 INCOMPLETE CONTRACT

Carter et al identify that ‘The absence of genuine [pre-contractual] negotiation

can result in the weaker party signing an unfavourable contract. Partly in response to

this, the law of contract implies terms into certain commonly occurring contractual

relationships to complete the parties’ bargain’.359F

360 Under the common law some

situations merit implying terms into contracts’.360F

361 These may be implied to give

effect to the ‘presumed intentions of the parties’.361F

362 The presumed intentions of the

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’362F

363

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.

E W Thomas adds a judicial perspective to the conclusions drawn by Carter

writing that:

[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.363F

364

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.

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160 Chapter 3: The problem in context

Contracts may not be complete because they were never intended to be

complete. In the franchising arena, for example, franchisors may negotiate directly

with a landlord to reach heads of agreement in relation to the franchisees’ premises,

then both franchisor and landlord may hand the negotiations over to the landlord’s

shopping centre manager or lawyer to complete the lease details with the franchisee.

The heads of agreement may constitute a binding contract, but it is incomplete.

Thomas accurately observes that in a typical commercial negotiation

[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. 364F

365

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.

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Chapter 3: The problem in context 161

franchisees are affected, most adversely. If an individual franchisee fails the

franchisor will not fail, and nor will any other franchisees. Damage resulting from

franchisor failure was explored in chapter 2.3.

3.3.7 EXPLOITATIVE CONTRACT

A franchisor has no incentive to include terms to protect the franchisee from

the consequences of the franchisors’ administration or insolvency. The franchisor has

every incentive to put itself into a contractual position where it can exploit its

franchisees if the relationship does not evolve as the franchisor expected. The

concept of exploitative contracts has been investigated in depth by Bigwood, who

describes the power imbalance between the franchisee (Plaintiff) and franchisor

(Defendant) that creates the environment for exploitation:

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. 365F

366

The nature of the franchise agreement as a standard form contract means a

franchisee is typically unable to effectively negotiate amendments to provide it with

rights if the franchisor fails. Consequently, the supplier franchisor is entering a

franchise agreement that potentially exploits the franchisee consumer.

In Meridian Madam Justice Dodds-Streeton acknowledged that:

[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.

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162 Chapter 3: The problem in context

disadvantaged party “from exploitative conduct which subverts the original

purpose for which the contract was made. 366F

367

If protection of franchisees from the consequences of franchisor failure is not

achievable through the franchise agreement, how has the legislature responded? This

will be explored in chapters 4.3, 4.4 and 4.5.

3.3.8 BREACH OF CONTRACT

In theory, franchisees whose franchisor failed could claim breach of the

franchise agreement by the franchisor and make out a contract law based claim, or a

quasi-contract claim. In practice, it is difficult for a franchisor to breach a franchise

agreement as the agreement imposes so few obligations on the franchisor. In the

absence of a breach of a term of the contract, a contract-based claim against a

franchisor could be based on the doctrine of frustration or on unjust enrichment or

anticipatory breach.

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.367F

368

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.

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Chapter 3: The problem in context 163

d. It must be unjust to hold the parties to the contract to its terms as originally

agreed upon.368F

369

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.

The franchise agreement is re-categorised as an asset or a liability and, whereas

prior to the franchisor’s liquidator being appointed the franchisee was entitled to rely

on the franchise agreement as a source of franchisor’s obligations, from the time the

liquidator is appointed the franchisee has no right of access to remedies for breach of

contract and the liquidator is entitled to disclaim the franchise agreement as an

onerous contract.

Condition b. may preclude franchisees of some failed franchisors from

accessing frustration as a cause of action. If, for example, the franchisor brought

about its own failure by acting strategically, or caused it by failing to manage its

finances prudently, it is possible that franchisees may be prevented from claiming

frustration.

Condition c. is met in almost all franchise agreements. Solutions proposed in

chapter 6.2.2 would lead to franchisees being unable to access the remedy of

frustration because all franchise agreements would address franchisor failure.

Whether condition d. is met will depend on whose perspective is taken into

account. From the administrator’s perspective, it would be reasonable for the

franchisee to be held to the contract, whereas for the franchisee, it may be unjust.

It is suggested that an Australian franchisee could not successfully argue

frustration while the franchisor was under administration because the franchise

agreement is between the franchisor or its assigns (which includes the administrator)

and the franchisee.

It is also possible that the sale of the franchise network by a liquidator to an

unsuitable buyer could frustrate the contract if Penrith District Rugby League

369 D Khoury and YS Yamouni, Understanding Contract Law (7th ed, 2007) 419.

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164 Chapter 3: The problem in context

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:

… sought rescission of its franchise agreement based upon fundamental

breach. 369F

370 It also sought the return of the franchise fee, royalty fees and

advertising fees paid to the franchisor. In considering the issue of

fundamental breach and the numerous alleged breaches of the franchise

agreement by the franchisor, the [British Columbia Supreme] Court found

that the franchisee had obtained substantially what it bargained for under the

franchise agreement, and accordingly found that there was no fundamental

breach of the agreement.370F

371

Goldman explains this particular decision stating:

Whether a fundamental breach argument has any chance of success is fact

dependent. The greater the benefit that the franchisee has already received

from being part of the franchised system, the less likely that the franchisor’s

bankruptcy will be found to have fundamentally breached the franchise

agreement. 371F

372

Unjust enrichment

Alternatively, franchisees could make out a claim in quasi-contract372F

373 against

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.’

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franchisees to embark on litigation against the administrator or liquidator or against

the directors or solvent related entities of the failed franchisor. Success in

a restitutionary claim based on unjust enrichment depends upon the plaintiff

establishing the following elements:

Benefit or enrichment [defendant has been enriched by the receipt of a

benefit – in the case of the franchisor, upfront fee that was charged for the

right to conduct a franchise for, say, 5 years, but the franchisor became

insolvent after 2 years – 3/5 of the initial franchise fee could be the starting

point]

At the plaintiff’s expense

Unjust factor (unjust to allow the defendant to retain the benefit); and

No bars to the restitutionary claim (no other consideration barring the claim,

such as a subsisting valid and enforceable contract between the parties).

To succeed in a restitutionary claim all these elements must be satisfied. In

the first instance, the plaintiff must prove elements 1-3 on the balance of

probabilities. In many cases this would be sufficient. Generally speaking it is

up to the defendant [liquidator] to raise the issue of a bar to restitution. Then

the plaintiff must prove element 4. If, on the balance of probabilities, the

court is not satisfied that there is no bar to a restitutionary claim, then the

plaintiff fails.373F

374

The use of an unjust enrichment action could be considered by franchisees that

recently paid a franchise fee but derived very little benefit prior to the franchisor’s

failure. The pool of money available to the liquidator to pay creditors is artificially

expanded by the franchise fee; thus the liquidator is ‘unjustly enriched’. This was

pleaded by a group of franchisees in Ontario, Canada in one of the Country Style

Food Services cases.374F

375 There, whilst the franchisees did not act quickly or

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).

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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.375F

376

The alternative to repudiation relying on anticipatory breach is for the

franchisee to wait for the franchisor to fail to perform an obligation under the

franchise agreement, and then terminate for actual breach.

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.

Franchisees without the appropriate ipso facto termination trigger in their

franchise agreements have to decide whether to adopt the high-risk strategy of

terminating their agreements or remaining bound to the failed franchisor in a legal

‘holding pattern’. To pursue any of the three responses to breach of contract by the

franchisor outlined in chapter 3.2.8 would tax an individual franchisee’s resources.

Litigation would be best undertaken by a group of franchisees.

3.3.9 CONTRACT AND QUASI-CONTRACT BASED REMEDIES

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.

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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.376F

377 This does not acknowledge

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.

Second, Hadfield observes, limitations in effectiveness ‘when contract law is

limited to the awarding of damages, a remedy that may be inadequate to deter

deliberate fraud and that may be no deterrence at all against those who have no

assets’.377F

378

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.378F

379 Any litigated or mediated victory by the

franchisees will be hollow.

Third, the powers given to administrators and liquidators under the

Corporations Act render franchisees’ consumer protection and contract law rights

impotent. This is explored in chapter 4.

3.3.10 CONTRACT-RELATED COMPLICATIONS

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.

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168 Chapter 3: The problem in context

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:

serves as a nexus for contracting relationships and … is also characterized

by the existence of divisible residual claims on the assets and cash flows of

the [franchisor] which can generally be sold without permission of the other

contracting individuals. … emphasizing the essential contractual nature of

[franchise networks] … [This] focuses attention on a crucial set of questions

– [including] and how [the contractual relationships] are affected by changes

exogenous to the organization.379F

380

These legally binding contract-based commitments will be noted and

identified, but not explored in detail here. Their fate following the franchisor’s

insolvency is an area for future research. Consequential contracts in this context

occupy three categories:

First: Contracts entered into with the franchisor; including such agreements as

licences to use intellectual property, software and premises, and various finance

arrangements.380F

381

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.381F

382

Third: Contracts entered into with third parties unrelated to the franchisor such

as supplier contracts, vehicle leases, lease or licence of premises,382F

383 equipment

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.

All of the contracts in the three categories above are executory. 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.

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Chapter 3: The problem in context 169

Pending assumption or rejection [by the liquidator] the debtor [here,

franchisor] is technically not required to perform the obligations under the

executory contract, whereas the non-debtor party [here, the franchisee] is

still required to perform.383F

384

Typically, none of the consequential contracts in the three categories above

contemplates the franchisee’s rights and obligations when the franchisor becomes

insolvent. They assume the franchisor will remain solvent. While this thesis

concentrates on the relationship between a franchisor and its franchisees, the

franchisee’s situation under any of the above consequential contracts will also be

impacted by the franchisor’s failure.

International dimensions of franchise agreements

Franchise relationships and agreements often contain international dimensions.

This was identified in the pattern of trade mark ownership at 3.2.2, and in Subway’s

standard franchise agreement referred to earlier in this chapter. International law may

have an impact on the jurisdiction and forum in which a franchise agreement is

judged. Importantly, cross border insolvency issues may become relevant to

domestic franchisees by virtue of the franchisor, the parent company, the owner of

trade marks or the franchisor’s financier being outside Australia. This is touched on

again in chapter 4.5 but not explored in depth as it is substantial enough to constitute

a significant research project on its own.

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’.384F

385

When the franchisor/ franchisee relationship is placed in jeopardy through the

appointment of an administrator or liquidator to the franchisor, the franchise

agreement is the first place an administrator or liquidator looks to determine what

responsibilities the franchisor has and what rights its franchisees have. At that point

it is too late for the franchisor and franchisee to negotiate a change in the terms of the

franchise agreement. It is thus important to understand whether franchise

384 Tractenberg, above n 110, end note 22–5. 385 Scott above n 349,190.

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170 Chapter 3: The problem in context

agreements, as a genre, can realistically be expected to contain provisions relating to

franchisor failure.

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]385F

386 rulings as a framework for structuring their business methods.

Consumers have rarely been able to harness private law to have such systemic

effects.386F

387

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’.387F

388

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’.388F

389 Rohrbacher explains that ‘the troublesome issue in

executory contracts is not that property and contracts are treated so differently but

that debtors and creditors are treated so differently’.389F

390

The franchise agreement purports to be a complete package of rights, distilling

the franchisors and franchisees rights and obligations for the duration of the term.

Nevertheless, almost without exception, franchise contracts make no reference to

franchisees’ rights on franchisor failure. This cannot be justified on the basis that it is

so unlikely to occur that no provision needs to be made.

The [franchisor] is a legal fiction which serves as a focus for a complex

process in which the conflicting objectives of individuals (some of whom

may ‘represent’ other organizations) are brought into equilibrium within a

framework of contractual relations. In this sense the ‘behaviour’ of the firm

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.

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Chapter 3: The problem in context 171

[the franchisor] is like the behaviour of a market, that is, the outcome of a

complex equilibrium process.390F

391

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 justifications for a contract not to be comprehensive in its terms - that it is

relational, too expensive to include all possible future contingencies, that the

franchise agreement needs to be standardised for ease of administration - do not

support the omission of terms about franchisor failure; an event whose possibility is

real, and whose consequences can be devastating for the franchisee consumer. It can

be concluded that relational contracts are not well equipped to deal with franchisor

failure as the event that triggers a need to renegotiate, franchisor failure, also signals

the end of the relationship between the franchisor and its franchisees.

Ultimately there is no equitable, logical or cost-based justification for the

franchise agreement making extensive provision for some known possible events that

would have a relatively minor effect on the network, such as the possibility of a

franchisee dying, while failing to provide for known and potentially network-

debilitating events, such as franchisor failure.

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’.391F

392 This is exemplified

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.

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172 Chapter 3: The problem in context

avenues to better balance the rights and liabilities of franchisees and franchisors in

the event of franchisor failure’.392F

393

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.

It is concluded that the franchise agreement, in its current form, is unable to

address franchisor failure satisfactorily. If protection of franchisees from the

consequences of franchisor failure cannot be achieved through the standard franchise

agreement, it is logical to ask how the legislature has responded. In chapter 4.1 the

effectiveness of legislative initiatives in providing consumer protection for

franchisees of failed franchisors is considered. However, before moving to the

legislature, I will explore the asymmetry of the franchisees’ world in chapter 3.3. As

Thomas J wrote in relation to a distributorship agreement, ‘The sheer commercial

absurdity of this lopsided bargain prompts the question as to how it could have come

about. There is an explanation’.393F

394

In relation to franchisor failure, the explanation lies partly in the franchise

agreement, as discussed in chapter 3.3, and partly in economic and legal

considerations. These will now be explored.

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).

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Chapter 3: The problem in context 173

3.4 ASYMMETRY ISSUES

The problems franchisees experience when their franchisor fails are

particularly difficult to address ex ante because they are unanticipated by franchisees,

who enter the relationship unprepared for franchisor failure. The lack of preparation

by franchisees is contributed to by numerous asymmetrical features of franchising.

Asymmetry exists in every aspect of franchising; in the structure of the

franchise network, the timing of events, the contents of contracts, and the legislation

designed to protect consumers. It compromises the parties’ awareness of the need to

self-protect and on their so opportunity to do so. Franchisees make, and re-make their

investment based on fatally flawed information. This devalues the due diligence

process, reduces the effectiveness of the Code and limits franchisees’ ability to plan

an effective exit strategy from a failing or insolvent franchisor.

Despite the requirement of pre contractual disclosure, franchisees as consumers

seldom anticipate the possibility of the franchisor’s business failing or the effect that

event may have on their rights and obligations as a franchisee. The franchisee is a

typical consumer functioning in an environment where Iain Ramsay observes:

The ‘responsibilisation’ of the consumer is being pursued … governments

are investing heavily in projects to ensure that individuals become

responsible consumers through the use of information … These programs

often make heroic assumptions about the ability of consumers to use and

process information on market choices and their ultimate results remain

uncertain and difficult to measure.394F

395

The exploration of asymmetry between franchisor and franchisee that follows

demonstrates areas where the information supplied to educate franchisee consumers

to become more responsible may serve to mislead them about the risks they should

consider before signing the franchise agreement. It also helps underscore Ramsay’s

concerns that the ‘heroic assumptions’ made by governments are flawed.

3.4.1 INFORMATION ASYMMETRY

It is assumed that parties to a long-term contract will perform comprehensive

due diligence on each other as prospective business associates and on the business

395 Ramsay, above n 329, 13.

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174 Chapter 3: The problem in context

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’.395F

396 Such a dismissive response to a serious issue by an industry

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.

When it comes to disclosing the possibility of franchisor failure the franchise

market is a little like ‘the market for cigarettes: manufacturers compete among

themselves for market share but have a common incentive not to disclose

information about the risks from smoking so long as these risks apply to all

cigarettes’.396F

397 Similarly, any franchisor may fail. All franchisors have an interest in

holding the line that they will succeed.

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. 397F

398

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.398F

399 In the United Kingdom, information about a specific

franchisor came from magazines (18 per cent) and exhibitions (20 per cent).399F

400 None

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.

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Chapter 3: The problem in context 175

of these are objective information sources. Such information is often not capable of

being objectively verified.

‘A consumer protection problem is more likely to be present where there is no

obvious reason for consumers to doubt their general expectation of safety, so their

expectation can easily be exploited’.400F

401 ‘An important implication of this focus on

general consumer expectation is that the more obvious a consumer protection

problem has become the less of a problem it may come to be’.401F

402

Rights and liabilities recorded in the franchise agreement are asymmetrical. So

too is the opportunity for franchisors and franchisees to shelter their assets from

creditors.

[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.402F

403

A franchisee conducting due diligence to verify information disclosed by the

franchisor is potentially confronted with numerous impediments to obtaining full

information.

Franchisees often do not register their business names. It is thus impossible to

verify from the public record, the identity of the owners and former owners of

franchisees of franchised outlets. The 2008 Amendments to the Disclosure Document

under the Code partially rectified this problem by S 11.2 of Annexure 1 (the

Disclosure).403F

404

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.

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176 Chapter 3: The problem in context

insolvency. Any disclosure document is a snapshot of the franchisor’s business at the

date it is made. It is always going to be of limited value for that reason.

Franchise agreements last from a short term of 1 year404F

405 to, in some cases, (eg

Signwave) 35 years and in rare cases (eg Fastway couriers) indefinitely. It is

unrealistic to expect a franchisee to conduct due diligence that sees far into the

future, even if infinite resources were available for the task.

Information asymmetry includes the difference between what is written in the

contracts and what is the ‘culture’ of a particular franchise. This has been expressed

as: ‘Each contract says what it says, but the culture underlying the way parties

choose to operate the levers that contract gives them may be producing quite a

different effect than appears to a superficial or even a close reading’.405F

406

In Australia neither disclosure documents nor a network’s pro forma franchise

agreements are available to the public. This means that the franchisee’s advisers

cannot compare the offering before them with either the usual documentation for

franchisees in the network or with the franchise agreements of other comparable

franchisors. This limits the value of professional advice as it is unable to be

contextualized. This issue was raised in several of the submissions to the inquiry that

culminated in the Opportunity not opportunism report. The government has partly

accepted that the problem causes a real impediment to the creation of responsive

policy. Recommendation 2 starts to address a solution by recommending:

…that the government investigate the benefits of developing a simple online

registration system for Australian franchisors, requiring them on an annual

basis to lodge a statement confirming the nature and extent of their

franchising network and providing a guarantee that they are meeting their

obligations under the Franchising Code of Conduct and the Trade Practices

Act.

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).

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Chapter 3: The problem in context 177

Recommendation 2 represents incremental progress, but if it is adopted

franchisees and their advisers will still not have a means of establishing a context for

the specific franchise agreement being advised on and signed.406F

407

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.

3.4.2 ADVISER AND ADVICE ASYMMETRY

The calibre and expertise of their advisers has a bearing on a franchisee’s

understanding of what they are signing. It also has a bearing on whether any

meaningful pre-purchase or post failure negotiation occurs.

Legal and accounting advice

Franchisors frequently use professional advisers who have created numerous

franchise agreements for a range of franchise models. For example, Stephen Giles, of

Norton Rose law firm, says: ‘[m]y firm would represent over 300 franchisors (due to

our size we do not have a large franchisee constituency)’.407F

408 Large legal and

accounting firms also have experience in advising franchisors on how to shelter

personal assets from franchisees.

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.408F

409 Lawyers with specific areas of expertise can be found through the state or

territory law society. The ‘business law expert’ is superficially the ideal lawyer to

provide franchisee advice. But, as Solomon observes:

knowledge of business law may enable someone to 'read' a contract

competently, but that isn't really the due diligence on the transaction itself.

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.

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178 Chapter 3: The problem in context

… a business lawyer who is not up to date on what is happening in the

franchise industry most probably will not 'spot' many of the contract

language traps. 409F

410

Solomon continues, ‘[t]he franchise industry … uses that lack of available

[legal and also accounting] expertise to enable rampant misrepresentation’.410F

411

Franchisees will seek an accountant’s advice in relation to the feasibility of the

business opportunity described in the disclosure document. Australian accountants

are either Chartered Accountants (‘CAs’) or members of CPA Australia (‘CPAs’).

As a generalization, the CAs advise larger commercial clients (franchisors and

master franchisors), work in the city, include liquidators in their number, and may be

members of the FCA. The CPAs are more often suburban or country town

accountants who would typically advise franchisees and would be less likely to join

the FCA as their practices would not specialise on franchising and could not justify

the expense.

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.

The regulator as educator

The Matthews Report identified that:

[t]he ACCC and peak industry associations undertake an important role in

providing education and information resources for franchisees and

franchisors. These resources should strengthen the message to prospective

franchisees in particular that they should seek advice from suitable and

independent franchise sector advisors.411F

412

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_integration_clauses> at 15 May 2008.

411 Ibid. 412 Matthews, above n 113, 37, Recommendation 9.

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Chapter 3: The problem in context 179

The Government agreed with this recommendation.412F

413 However two years

later, the ACCC published Franchisee Manual,413F

414 made no mention of the care that

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)?’414F

415

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,415F

416 Commonwealth Bank of Australia (CBA), National

Australia Bank (NAB), and Westpac (WBC) 416F

417 - are ‘service provider’ members of

the FCA. 417F

418

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.

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180 Chapter 3: The problem in context

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. 418F

419

The CBA website publishes a list of 35 accredited franchises419F

420 but does not

mention protecting franchisee customers against the risk of franchisor failure.

NAB publishes a list of approved franchise systems, stating:

For franchisees, ‘Joining a NAB Accredited Franchise System means that

you may be able to borrow up to 70 per cent of the total set up cost of a new

franchise, or purchase cost of an existing franchise, without necessarily

providing your home as collateral for the loan. 420F

421

The message to prospective franchisees is that each of these Accredited

franchisors is a reputable, secure investment in the eyes of the NAB. The list of NAB

Accredited Franchise Systems included Kleins on 23 May 2008. 421F

422 As at May 2008,

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.

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Chapter 3: The problem in context 181

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. 422F

423

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:

What's the franchisor’s track record (financial and management)?

How much control do you (and the franchisor) have?

What are the renewal and termination terms and conditions?

Do you see your investment in a franchise as a long-term commitment? 423F

424

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.

Additional sources of advice

Governments and banks direct prospective franchisees to additional sources of

general franchise information. These additional sources of general information are

423 Westpac Bank Website <www.westpac.com.au> at 1 May 2008 424 Ibid.

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182 Chapter 3: The problem in context

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 FCA is an influential industry group. It provides information through its

website, its publication The Franchise Review, and its education programs. None of

these provide any information about franchisor insolvency. The FCA website also

states:

… the nature of the franchise relationship was open to exploitation prior to

1998 in Australia, when franchising operated in a de-regulated environment.

As a consequence the public perception of franchising was tarnished by

several high profile franchise failures … Behaviour in the sector was not

universally appropriate, and franchisees had far less investment security.

Since 1998 the sector has not only grown, but matured and developed into

one of the primary engines for economic growth in Australia.424F

425

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.

The first introduction to a specific franchise network may be at a franchise

business opportunity expo. These are held in major population centres annually and

are a widely accepted franchise promotion method. Regardless of the source of

information,425F

426 there is a ‘sameness’ about all franchise opportunity advertising. In

the words of American franchise lawyer and commentator Richard Solomon:

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.426F

427

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.

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Chapter 3: The problem in context 183

Prospective franchisees reading franchise advertisements feel secure buying

into a long-established franchise, believing them to be well-proven. They trust the

information supplied by the franchisor and have difficulty obtaining objective third

party perspectives. There is no incentive for anyone involved in the franchise sales

process, nor for any current franchisee of the network, to mention the risk of the

franchisor failing.

3.4.3 RISK ASYMMETRY

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’.427F

428

The franchise agreement is effectively a contract uberrimae fidei 428F

429 for the

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.429F

430 For example, as was seen in chapter 3.2.3, when the franchisor takes a

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.

Another example of risk shifting is the practice of structuring a franchise

relationship to function like a commission agency. Here, the franchisee attracts the

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.

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184 Chapter 3: The problem in context

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.

Research on approaches to risk in franchising has been carried out by Paul

Rubin and by Lafontaine and Bhattacharyya. Neither factored the failure of the

franchisor into their risk research. Looking at the franchise investment as a

proportion of an individual’s entire portfolio of assets, Rubin’s view is that ‘since

franchisees commonly invest a large share of their assets in acquiring the franchise, it

is unlikely that’430F

431 franchisors are more risk averse than franchisees.

Lafontaine and Bhattacharyya consider the role of risk in franchising431F

432 from

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:

… failure rates will still be sensitive to franchisor moral hazard; if a

franchisor shirks, or behaves opportunistically, this will increase the

probability of failure for all units in the chain and is likely to show up in the

discontinuation statistics. 432F

433

Lafontaine and Bhattacharyya conclude 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.

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Chapter 3: The problem in context 185

franchisees, a conclusion we find unappealing given their respective sizes

and differential access to capital markets.433F

434

3.4.4 RESOURCE ASYMMETRY

The FCA acknowledges that there are disadvantages to the franchise model

including:

3. The prospective franchisee may find it difficult to assess the quality

of the franchisor. This factor must be weighed very carefully by the

potential franchisee for it can affect the franchisee in two ways.

A. Firstly, the franchisor's offer of a business-format package may not

amount to what it appears to be on the surface.

B. Secondly, the franchisor may be unable to maintain the continuing

services which the franchisee is likely to need in order to sustain their

business.

6. The franchisor's policies may affect the franchisee's profitability. For

example, the franchisor may wish to see his franchisee build up to a

higher turnover from which he gets his continuing franchise fee, while

the franchisee may be more concerned with increasing his profitability,

which does not always necessarily follow from increased turnover.

7. The franchisor may make mistakes in their policies. They may arrive

at decisions, relating to innovations in the business which turn out to be

unsuccessful and detrimental to the franchisee.

8. The good name of the franchised business and its brand image may

become less reputable for reasons beyond their own control.434F

435

Prospective franchisees would have difficulty assessing whether a specific

franchisor has any of the possible flaws listed above. Disadvantages 6, 7 and 8, like

insolvency, refer to future matters. Even with unlimited resources, it is impossible for

a franchisee to make an informed assessment about these issues.

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.

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186 Chapter 3: The problem in context

3.4.5 CONTRACT ASYMMETRY

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’.435F

436

‘Standardised contract terms are … [a] regulatory instrument’ 436F

437 that places all

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’.437F

438 In franchising, the marginal incentives created within the franchise

agreement do not outweigh the disadvantages to the franchisees whose franchisor

operates its business so poorly or recklessly that an administrator or liquidator is

appointed. In theory franchisees can negotiate some protection into the franchise

agreement. In practice, most cannot.

At negligible extra cost a franchisor can include a provision to give franchisees

the right to terminate the franchise agreement if an administrator is appointed. Yet

anecdotal evidence suggests that only one franchisee in each of the 270-franchisee

Traveland and the 60-franchisee BHG networks had a clause in their agreements

permitting them to terminate the agreement if the franchisor fails.438F

439 Franchisors

have no incentive to write contracts that fully acknowledge both parties’ risks.

3.4.6 LEGISLATIVE ASYMMETRY

[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.439F

440

A risk that is currently addressed in both franchisor agreements and the

Code 440F

441 is the risk of the franchisee’s business failing - there is no reciprocal 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.

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Chapter 3: The problem in context 187

statutory protection if the franchisor fails. As we saw in 3.4.5 contracts remain

asymmetrical to the disadvantage of franchisees. The legislation does not provide the

level playing field it was enacted to provide in response.

Hadfield observes that ‘[e]ither because current regulation is piecemeal or

more fundamentally, because franchise relationships are too complex to reduce to

precise statutory terms, the heart of franchising’s legal structure is still contract’.441F

442

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.

The nature of the franchise agreement, the difficulty of conducting adequate

affordable due diligence, the possibility of strategic insolvency, the fact that the Code

may not bind administrators and the stay on proceedings during administration and

insolvency mean that the most solid avenue forward for fair franchise contracts is for

terms to be implied into all franchise agreements via a Franchise Contract Act along

the lines of the Insurance Contracts Act 1984 (Cth). This option will be examined in

chapter 6.2.2.

Steven Kennedy also identifies that ‘in many cases government actions tend to

reallocate risk between different groups’.442F

443 This reallocation is partly a result of

lobbying. At least one researcher has suggested that:

the dearth of information on franchisor failure is largely a reflection on the

strength of the franchise lobby constituted by franchisors and their

representatives. Similar franchisor biased representation is prevalent in the

Australia, American, Canadian and British context. This lobby has an

interest in promoting the franchise cause, and hence has resisted (and

perhaps limited) published research on franchisor failure. 443F

444

3.5 CONCLUSION

The franchisee investigates the franchise opportunity believing the business is

sound and viable. It may be impossible to conduct due diligence much beyond what 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.

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188 Chapter 3: The problem in context

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,444F

445 whose roles are not identified or

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’.445F

446

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.

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Chapter 3: The problem in context 189

It was shown, at 3.2.4–3.2.6 that franchisees occupy a unique space in the

business world, being neither employees nor independent contractors/suppliers.

Other players that would perform the roles in a non-franchised business that

franchisees perform in the franchise network would negotiate appropriate protection

from identified legal and business risks before signing contracts. Chapter 3.3

explored the franchise contract and demonstrated three key aspects of franchise

agreements: they are not traditional commercial contracts between two business

people, a few individual franchise agreements may contain ipso facto clauses relating

to the franchisor’s insolvency, but most of the 11,000 or so do not, and even if they

did include clauses to protect franchisees, the remedies available for breach of

contract are inappropriate as a means of compensating franchisees.

Some of the asymmetries in franchise relationship were introduced in chapter

3.4. From every perspective explored; information, risk, resource, contract and

legislation, franchisees experience significant asymmetry, always to their detriment.

Franchisees are vulnerable as business consumers.

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Chapter 4: Is the current regulatory response adequate to deal with the problem?

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.

Consumer protection policy and legislation is designed to moderate the effects

of the free market. For Australian franchisees consumer protection is provided

through the Trade Practices Act and the Code. If current consumer protection

regulation is up to the task of addressing the challenges presented by franchisor

failure in a way that meets benchmarks B1 and B2 and B3 that were introduced in

chapter 1, the current law should remain unamended.

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.446F

447

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.

4.1 THEORY OF THE MARKET-LED SOLUTION

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).

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192 Chapter 4: Is the current regulatory response adequate to deal with the problem?

to emerge.’ 447F

448 Trebilcock identifies five characteristics that are all relevant to the

market for the sale of franchise businesses to franchisee consumers.

First, ‘[r]epeat transactions are rare, and consequently the performance

incentives created by the possibility of repeat business from satisfied customers are

blunted.’ 448F

449 Franchisees as consumers of the franchisor’s business opportunity would

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’.449F

450 Trebilcock is referring to franchisors and

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.450F

451

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.

Third, ‘[m]any sellers or producers are extra jurisdictional, making redress

through private law more difficult for customers. Sellers characteristically have few

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.

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Chapter 4: Is the current regulatory response adequate to deal with the problem? 193

assets against which a judgment may be enforced’.451F

452 In franchising up to 25 per cent

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,452F

453 the language in the franchisor’s jurisdiction, distance to travel

to court,453F

454 the size of the dispute and the amount of time away from the business

that litigation will necessitate.

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.

Fourth, ‘[t]he costs to consumers of a ‘bad’ transaction are delayed or

potentially catastrophic, making ex post relief an inadequate or unsatisfactory

solution’.454F

455 The costs to franchisees of a failed franchisor are often catastrophic,

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.

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194 Chapter 4: Is the current regulatory response adequate to deal with the problem?

Finally, ‘[t]he small size of a typical transaction creates significant disincentive

to seeking ex post relief through the courts’.455F

456 Regardless of whether a franchisee

has made a million dollar investment or an A$15,000 investment, administrators

claim the Code, with its cost effective dispute resolution provisions, does not bind

them. This leaves a franchisee that wishes to terminate its franchise agreement with

the choice of walking away from the investment, and thereby risking action by the

administrator or liquidator for breach of contract, or litigating. Litigation is often

prohibitively expensive. For example, in relation to costs leading up to the appeal

that was reported in Hoy Mobile Pty Ltd v Allphones Retail Pty Ltd (No 2) [2008]

FCA 810 and Hoy Mobile Pty Ltd v Allphones Retail Pty Ltd (No 3) [2008] FCA 967,

the franchisee wrote:

July 2006, my barrister began preparing to file an injunction. On the same

day without notice our franchisor released our commission payment…. [the

matter eventually went to court]. We received judgment in our favour on the

30 May 2008. [Allphones, franchisor] has appealed the entire judgment. …

The matter will most likely be heard in February or March 2009, three years

and over $650,000 after Hoy Mobile requested mediation. … Our five year

agreement will expire before the appeal is heard.456F

457

4.2 POLICY BACKGROUND

As early as 1976, the Swanson Committee, while not specifically considering

franchisor failure:

… identified two broad value judgments as providing the foundation upon

which the body of trade practices legislation in Australia has been

constructed. The first of these is the acceptance of competitive capitalism as

a socio-economic system based upon the institution of private enterprise.

The second is that the economically weak should be protected against the

unfair or predatory acts of the economically strong, a belief that is derived

from notions of human dignity and acceptable norms in the conduct of

human affairs. [The Committee acknowledged that] [a]ttitudes as to what

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.

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Chapter 4: Is the current regulatory response adequate to deal with the problem? 195

constitute norms in human affairs will change from generation to generation

and the change will show in the practical expression they receive in

legislative enactment and administrative enforcement; exercises of economic

power which were accepted by society a generation ago are no longer

tolerated today. Thus trade practices legislation looks not only to the

preservation of competition but also to the regulation of potential misuse of

economic power which is inimical to the public interest of the public

benefit. 457F

458

It was in an environment in which a simple franchisor corporate structure, as

described in chapter 3.2.1, was the norm, that the initial moves to regulate business

format franchising were made in Australia. Voluntary regulation of the sector under

the Franchising Code of Practice (‘FCP’) in 1993 was the first step. It failed.

By the time the Trade Practices Act s 51AC and the mandatory Code were

enacted Parliament acknowledged that there were:

… particular problems for small firms in:

obtaining full information on a venture prior to entering into it;

understanding complex documentation;

having terms and conditions of contracts imposed rather than being

given an opportunity to negotiate them;

harsh business conduct within a commercial relationship; and

accessing the justice system.

These problems were found to be most prevalent in the franchising and retail

tenancies sectors. 458F

459

In 1997, The Hon Peter Reith introduced s 51AC and the Code to ‘give small

business protection in its dealings with big business.’459F

460 At this time business failure

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.

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196 Chapter 4: Is the current regulatory response adequate to deal with the problem?

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.460F

461

In December 2006 Australia’s Productivity Commission (‘PC’) was asked to

report on … ‘ways to improve the consumer policy framework to assist and empower

consumers, including disadvantaged and vulnerable consumers, to operate effectively

in increasingly complex markets’.461F

462 The PC reported the:

[k]ey considerations [included]: The need to ensure that consumers and

businesses, including small businesses, are not burdened by unnecessary

regulation or complexity … the need for consumer policy to be based on

evidence from the operation of consumer produce markets, … and the

importance of promoting certainty and consistency for businesses and

consumers in the operation of Australia’s consumer protection laws.

The Commission proposes … common [Australia-wide] objectives for

consumer policy, with the overarching objective being to ‘improve consumer

wellbeing by fostering effective competition and enabling the confident

participation of consumers in markets in which both consumers and

suppliers can trade fairly and in good faith.462F

463

No mention was made of ‘business consumers’ in the brief to the PC or in its

subsequent report. This was an unfortunate omission as business consumers, the

‘small firms’ above have been acknowledged as an especially vulnerable group of

consumers in government policy since 1997 and have received protection under

Australian consumer protection law since 1998.

4.2.1 THE REGULATORS

The ACCC has responsibility for consumer protection insofar as it relates to

franchisees, ASIC has responsibility for regulating corporations and the ITSA has

responsibility for personal bankruptcy matters that arise under the Bankruptcy Act

1966 (Cth). The existence of separate regulators for different parts of the business

continuum makes it difficult for any one agency to achieve a macro perspective.

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.

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A consequence of this is that issues such as franchisor failure do not appear

significant to any of the three regulators. The ACCC does not maintain a database of

franchisors so has no way of knowing, other than anecdotally, that so many fail.

ASIC and ITSA, as agencies that regulate the failure end of the spectrum do not

know which failed entities are franchisors or franchisees. In addition, as already

discussed at 3.2.1 and demonstrated in Table 1 and Appendix D, a franchise network

might consist of numerous entities and none may have the trading name of the

franchise in its legal name. This makes it virtually impossible to ‘join the dots’ when

attempting to research which franchisors have failed.

4.3 TRADE PRACTICES ACT 1974 (CTH)

Globally, franchisees are variously categorized as consumers,463F

464 business

consumers, entrepreneurs, business entities, and in some litigation, employees. In

Australia they are recognised as ‘business consumers’ under the Trade Practices Act

s 51AC by virtue of their status as vulnerable small firms for whose protection s

51AC and the Code were enacted. Specific franchising legislation including

mandatory disclosure obligations has been enacted in numerous jurisdictions,

including Australia, to facilitate pre-contractual due diligence for intending

franchisees. In-term issues receive less franchise-specific attention, often being

addressed under generic fair trading laws.

The object of the Trade Practices Act, stated in s 2 is:

to enhance the welfare of Australians through the promotion of competition and fair trading and provision for consumer protection.

In Canada, Côté J discussed the interpretation of protective legislation, in Hi

Hotel Limited Partnership and Holiday Hospitality Franchising Inc and ors. 2008

ABCA 276 (Hi Hotel), concluding:

[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.

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198 Chapter 4: Is the current regulatory response adequate to deal with the problem?

[20] … Whatever the bargaining power of a prospective franchisee, large or

small, he or she will rarely know much about the franchisor, its officers and

its actual practices (absent full disclosure).464F

465

To an extent, the statutory legal framework has evolved to accommodate the

needs of franchisees. We now turn to the parts of the Trade Practices Act that

provide consumer protection for franchisees.

4.3.1 TRADE PRACTICES ACT 1974 (CTH) SECTION 51AC

‘Dubious conduct which may be detrimental to consumers will not always’465F

466

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.’466F

467 The

conduct may be unconscionable. To enable business consumers to challenge

unconscionable conduct by business suppliers the Trade Practices Act was amended

in 1998 by the addition of s 51AC. This was statutory acknowledgement of the

particular vulnerability of business consumers. The phrase ‘business consumers’ is

used in s 51AC but the term is not defined.

In announcing [the introduction of s 51AC], the Government has accepted

the principle that small business people are entitled to a legal protection

against unfair business conduct comparable with that which consumers

already have against corporations. 467F

468

Both procedural and substantive unconscionable conduct may be caught by s

51AC.

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.

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[I]f sellers cannot easily distinguish informed and uninformed consumers,

they cannot exploit the latter by charging a higher price. Thus, information

deficiency alone does not justify judicial intervention on the basis of

unconscionable conduct.468F

469

However in franchising the seller can reasonably readily distinguish between

informed and uninformed consumers. The seller (franchisor) may chose to keep

franchisees uninformed about its decision to take on a high debt load that threatens

the network, or to become insolvent to meet its own strategic objectives. The lack of

information is a fundamental problem ex ante for franchisee consumers.

If it became apparent that the franchisor had chosen to keep franchisees

uninformed about significant risky behaviour, well-funded franchisees, sufficiently

incentivised, may be able to secure redress under s 51AC. Franchisees might be able

to make out a case that s 51AC (3) (i), (j) or (k) was breached. The basis of the

argument under s 51AC(3)(i):

(i) the extent to which the supplier [franchisor] unreasonably failed to

disclose to the business consumer [franchisee]:

(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.

An argument based on s 51AC(3)(j);

(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.

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200 Chapter 4: Is the current regulatory response adequate to deal with the problem?

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.

The third possible avenue under s 51AC (3) is:

(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’.469F

470

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’.470F

471

In practice, however, an action against the franchisor for breach of s 51AC

Trade Practices Act would only result in meaningful relief to the franchisees if they

were able to include the failed franchisor’s solvent directors as defendants. As

already noted in chapters 3.4.1 and 4.1 directors are likely to have sheltered their

personal assets.

On a theoretical level, Eric Posner writes:

[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. 471F

472

It is suggested that a franchisor’s future intentions are an example of a variable

that is intrinsically impossible for a franchisee to measure before the franchisee

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.

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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.

Bigwood recognises limitations of arguments based on unconscionability,

albeit in the context of common law, as being that:

No matter how attractive the precept of unconscionability is as a judicial

matter, the number of transactions that can be reached and controlled is too

small to have a social impact, and the reluctance of courts to review

countless arguments is too strong.472F

473

From a practical perspective the unconscionable conduct provisions of the

Trade Practices Act are not useful to all franchisees in the situation of franchisor

administration and insolvency. It may be possible to establish that the franchisor

behaved unconscionably. If the insolvency was not ‘strategic’, however, it will be

difficult to establish that the franchisor acted unconscionably. Taking the decision to

become insolvent is also a decision to withhold supply. Franchisees, like many

consumers, are widely dispersed geographically. This makes working cohesively to

litigate against the franchisor or negotiate with the administrator, while concurrently

(as required by administrators) continuing to meet obligations under the franchise

agreement, extremely difficult.

Recently legislation was:

… introduced into Parliament to enhance the range of enforcement

mechanisms for unconscionable conduct. The amendments will increase the

punitive consequences for engaging in statutory unconscionable conduct.

The Trade Practices Amendment (Australian Consumer Law) Bill 2009

includes provisions to introduce:

pecuniary penalties of up to [A]$1.1million for corporations and

$220,000 for individuals for contraventions of the unconscionable

conduct provisions;

infringement notices, which the Australian Competition and

Consumer Commission (ACCC) may issue for alleged

contraventions of the unconscionable conduct provisions;

473 Bigwood, above n 341, 277, citing R A Epstein, ‘The Social Consequences of Common Law

Rules’ (1982) 95 Harvard Law Review 1717, 1750.

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202 Chapter 4: Is the current regulatory response adequate to deal with the problem?

disqualification orders, allowing the Court to ban those involved in a

contravention of the unconscionable conduct provisions from

managing corporations;

public warning notices, which the ACCC may issue about

corporations it has reasonable grounds to suspect have contravened

an unconscionable conduct provision; and

Court orders to redress loss or damage suffered by non-party

consumers as a result of a contravention of an unconscionable

conduct provision.473F

474

These changes will not make any difference to franchisees whose franchisor is

in administration or being wound up.

4.3.2 TRADE PRACTICES ACT 1974 (CTH) PART V DIVISION 1

Franchisees may take action under Trade Practices Act ss 52, 53A or 59

against a franchisor, or other ‘persons involved in a contravention’474F

475 who misled

them before the franchise agreement was signed, or in relation to any matter not

addressed in contracts that occurred subsequently.475F

476 Section 75B lists by role the

potential ‘person[s] involved in a contravention’ who may be prosecuted if, for

example, the franchisor breaches parts of the Trade Practices Act.

Actions against the insolvent franchise systems A1 Mobile Radiator Repairs476F

477

and Furniture Wizard provide examples of franchisees proceeding under ss 52 and

59.477F

478

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.

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4.3.3 TRADE PRACTICES (INDUSTRY CODES- FRANCHISING) REGULATIONS 1998 (CTH) (‘THE CODE’)

The Code was enacted as a mandatory industry code of conduct pursuant to

Trade Practices Act s 51AE. Its overall objective is to ‘to regulate the conduct of

participants in franchising towards other participants in franchising’478F

479 by levelling

the playing field between franchisors and franchisees.

Regulation is achieved under the Code through three avenues: by requiring

franchisors to provide disclosure (Part 2), by implying terms into franchise

agreements (Part 3),479F

480 and by mandating a dispute resolution process (Part 4).

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.’480F

481

In Australia, compliance with the Code by franchisors should mean that

complete, accurate information about the franchise system481F

482 is given to prospective

franchisees. However, it is shown in chapter 3.1, Table 1, and Appendix D, that the

franchise system482F

483 is only part of the larger franchise network. The purposes of the

disclosure document are set out in s 6A:

(a) to give to a prospective franchisee, or a franchisee proposing to enter

into, renew or extend a franchise agreement, information from the franchisor

to help the franchisee to make a reasonably informed decision about the

franchise; and

(b) to give a franchisee current information from the franchisor that is

material to the running of the franchised business. 483F

484

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.

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204 Chapter 4: Is the current regulatory response adequate to deal with the problem?

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.484F

485 In a situation that is disclosed

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.485F

486

Shortcomings of the Code

Section 10 of the Code sets out the requirement for a statement about the

financial details that have been supplied to the franchisee. It is effectively a statement

of current solvency.486F

487 This is taken literally by franchisors whose ‘franchisor’ entity

is the solvent face of an insolvent or soon to be insolvent network. Some franchisors

are willing to sign a statement of solvency, despite knowing their business is

insolvent. For example, BHG was still accepting franchise fees from new franchisees

in the third quarter of 2006. The liquidator wrote that ‘in my opinion the company

became insolvent in 2005 and remained insolvent from that time’.487F

488 The liquidator

also reported having

discovered an email prepared by one of the company directors dated 7 May

2007 admitting the company was insolvent and that the company should be

wound up. There is no evidence to show the relevant director took any steps

to prevent the company from incurring further debts.488F

489

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.

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No franchisee could have uncovered this information through due diligence in

time to avoid investing. Discovering post investment that the franchisor is insolvent

is unhelpful. A franchisee would compound the fraud if it decided to sell its business

without disclosing its knowledge of the franchisor’s insolvency.

In addition to being open to compromise by the lack of personal integrity of the

franchisors’ directors, the value of the information provided by the franchisor is

limited by the prospective franchisee’s advisers’ experience and by budget. This was

addressed at 3.4.

Implied terms

In an attempt to prevent dependence from becoming a form of predation or

servitude489F

490 Part 3 of the Code implies terms into the franchise agreement. The

terms:

provide a 14 day cooling off period for franchisees (13),

require franchisors to provide a copy of the premises lease in some

circumstances (14),

forbid the franchisor from preventing franchisees or prospective

franchisees to associate with each other (15),

prohibit the franchisor from requiring franchisees to sign a general release

from liability (16),

mandate audit and reporting requirements in relation to franchise network

marketing and other cooperative funds (17),

require disclosure of materially relevant facts by the franchisor to the

franchisees within 14 days of the franchisor becoming aware, including

contravention of the Corporations Act by the franchisor and the franchisor

becoming an externally administered body corporate (18),

require the franchisor to provide a current disclosure document if the

franchisee requests it (19),

490 Elizabeth C Spencer, ‘Conditions for effective disclosure in the regulation of franchising’ (2008) 22(4) International Review of Applied Economics 509.

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forbid the franchisor from unreasonably withholding a franchisee’s request

to be permitted to transfer its franchise (20).

The Code sets out three situations when a franchisor may terminate a franchise

agreement. The trigger events are:

a breach by the franchisee (21),

a range of events where there has been no breach by franchisee (22), and

if the franchisee becomes bankrupt, insolvent under administration or an

externally administered body corporate, the franchisor does not have to

give the franchisee notice of its intention to exercise the franchisor’s right

to terminate that is contained in franchise agreements. This is considered

to be ‘special circumstances’ (Regulation 23).

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 inclusion of an automatic right of termination for franchisees (in the

Franchising Code) in the event of franchisor failure would give one area of

small business an advantage over others (preferential treatment). It would

also provide franchisees with an automatic right under the Franchising Code

that is not available to franchisors.490F

491

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.

A franchisor must not induce a franchisee not to form an association or not

to associate with other franchisees for a lawful purpose.

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.

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This, combined with the right each franchisee has under s 19 of the Code 491F

492 to

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.

ADMINISTRATORS AND CODE DISPUTE RESOLUTION

When the administrator is appointed to investigate the franchisor’s business the

applicability of the Code become contentious.

Mediators are unsure as to whether administrators are ‘a party to a franchise

agreement’, a threshold requirement for the purposes of mediation under Part 4 s 27

of the Code. In the franchise contract the franchisor is typically described thus; ‘the

term [franchisor] includes it successors in title and its assigns’. This raises the

question of whether an administrator fits within the wording of ‘a successor in title or

an assign’?

Under s 437B492F

493 the Corporations Act the administrator’s role to act as the

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:

The franchisor company continues to be bound by the Code during the

administration period. As an administrator, you are obliged to continue to

492 See Appendix A of this thesis. 493 See ibid.

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comply with the franchising Code of Conduct on behalf of the franchisor

company.

It cites Smith v Federal Commissioner of Taxation (1996) 71 FCR 150 in

support of the proposition that the Code does cover administrators, arguing:

the appointment of an administrator for a franchise system under Part 5.3A

of the Corporations Act does not, of itself, terminate or constitute a

repudiation of the franchise agreement. 493F

494

The third argument in favour of the Code applying to administrators is that,

from a policy perspective, the purpose of the administration process is to maximise

the survival prospects of a flagging company.494F

495 Attempting to resolve disputes

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 arbitration495F

496 proceedings.496F

497

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.

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Consistent with the interpretation of arbitration proceedings, Professor Warren

Pengilley distinguished mediation under the Code from ‘proceedings in a court’

writing that:

… proper mediation procedures are possible only if there is legislation with

the relevant procedures and safeguards embedded into it. The Government’s

regulatory path (Code created by Regulation) means that the essential

elements of mediation are not law.497F

498

The consequences of refusing to mediate, where the franchisor’s alleged

breaches of the franchise agreement are the cause of the dispute, may be that the

franchisees will become entitled to abandon their contracts. If the Code does apply to

administrators, and they refuse to adhere to it, franchisees become entitled to seek

leave of the court to litigate, and would be entitled to remedies available under the

Trade Practices Act for breaches of the Code. These remedies would be available

against the franchisor, but of greater value is that through the application of s 75B

Trade Practices Act remedies should also available from the administrator.

On balance it is concluded that the Code does apply to franchisors under

administration. The lack of funds for court action during the administration process,

however, mean it is unlikely that franchisees will be able to litigate to force

administrators to adhere to the Code. Because of the power imbalance during the

administration, the fact that franchisees tend not to operate as a cohesive group, and

the lack of time available it is concluded that the only way to make administrators

adhere to the Code is by legislating the need for compliance.

CODE DOES NOT APPLY TO LIQUIDATORS

Transition from administration to winding up on the appointment of the

liquidator signals a change in focus. From the time the liquidator is appointed the

Corporations Act ‘trumps’ the Trade Practices Act and the Code. As a consequence,

the Code should not, and does not apply to liquidators.

Weaknesses of the Code.

The Code has weaknesses, which are especially prominent in the context of

franchisor entity failure.

498 Warren Pengilley, ‘The Franchising Code of Conduct: Does its Coverage Address the Need?’

(1998-99) 1(3) Newcastle Law Review 32.

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SNAPSHOT, NOT CRYSTAL BALL

The disclosure is a snapshot of the current status of the franchise network,

focusing on the financial and legal fitness of the entity called the franchisor. Even in

jurisdictions where the franchisees have a recurring right to receive updated

disclosure documents 498F

499 this will not enable a franchisee to predict the franchisor or

the franchisor network’s future prosperity or insolvency.

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’499F

500 of:

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. 500F

501

TIMING OF DISCLOSURE

The timing of the disclosure is problematic from three perspectives.

First, a potential franchisee is psychologically committed to become a

franchisee of the particular franchise network before receiving the disclosure.

Franchisees in Australia tend not to compare several disclosure documents as they

have to pay a deposit before being given the document. Second, when a franchise

offering does not withstand due diligence investigation by the potential franchisee’s

pre-purchase professional advisers, it can be difficult for the advisers to dissuade the

potential franchisee. The experience of a retail pie shop franchisee, detailed below,

illustrates this problem.

Mr Thadani [franchisee of failed pie franchise outlet in Sydney CBD] gave

evidence of negotiations conducted by him and Mr Muriniti [franchisee’s

lawyer], with Mr Gualdi and others, during September 2003. According to

his evidence, Mr Gualdi [franchisor] told him more than once not to listen to

Mr Muriniti because Mr Muriniti was not a franchise lawyer and was

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.

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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.501F

502

The franchisee ignored his solicitor, preferring to be seen as cooperative by the

franchisor. Obviously, things did not go well thereafter.

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’. 502F

503

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.

INTERPRETATION OF THE AUDIT REQUIREMENT

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.

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212 Chapter 4: Is the current regulatory response adequate to deal with the problem?

A director of the franchisor is required to sign a statement that complies with

clause 20.1 of the Code by providing a statement that in the director’s opinion the

franchisor is solvent,503F

504 as part of the pre-purchase disclosure supplied to the

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.

Attempted action on weaknesses

In 2006, the Mathews Report recommended that disclosure should include

specific information about what would happen to it if the franchisor became

insolvent. This recommendation was loosely adapted by the Federal Government, in

the form of a request to the ACCC to provide general information about the

consequences of franchisor failure.

‘Opportunity not opportunism’ recommended that the continued absence of

specific warnings about franchisor failure should be addressed:

Recommendation 1 The committee recommends that the Franchising Code

of Conduct be amended to require that disclosure documents include a clear

statement by franchisors of the liabilities and consequences applying to

franchisees in the event of franchisor failure. 504F

505

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.

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franchise (or franchisor) could fail’.505F

506 This response will be discussed in chapter

6.2.3.

4.4 CORPORATIONS ACT 2001 (CTH)

In Australia an external party can be appointed to take control of a company

from its directors by three broad mechanisms; a creditor can appoint a receiver, the

directors or the court can appoint an administrator, or the court can appoint a

liquidator. Receivers, administrators and liquidators must act within strict statutory

time limits prescribed by the Corporations Act. This does not allow parties such as

franchisees time to attempt to protect their interests by bringing court actions to test

prospective consumer protection, contract or equity based rights. Each status will

now be summarised.

4.4.1 RECEIVERSHIP

Receivership status may lead to the administration or winding up of an

insolvent entity. In receivership, a receiver is appointed by one creditor. The

receiver’s role is to recover debts owed to that creditor. The receiver is indemnified

for all decisions.

For example, a receiver was appointed to manage the Brumby’s bread

franchisor in 1988. By 1991, the receiver had sold the company owned stores,

reducing the overall number of Brumby’s outlets from 76 to 54. In the process the

receiver satisfied the needs of the creditor that appointed it. The company was sold to

a new owner formed from the original franchisor and a group of the remaining

franchisees. From 1991 on the reinvigorated Brumby’s operated as a successful

franchise network.

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.

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agreements, supplier contracts and leases] subject to the restrictions under s 442c

Corporations Act’.506F

507

This enables the creditors, guided by the administrator, to make a decision

about the company’s fate. …Recovery, protection and preservation of the

company’s property are not of themselves the direct concern of the

administrator. 507F

508

There is no legal obligation for an administrator or creditors to consult

franchisees or take the interests of franchisees into account. From the franchisees’

perspective, the administration process ‘only serves to protect directors by putting up

endless barriers to accountability’.508F

509 If franchisees are not creditors they have no

statutory right to attend a creditors meeting.

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’.509F

510

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’.510F

511

A Deed of Company Arrangement (DOCA) may be entered into. This is a

compromise arrangement where creditors agree to allow the company to

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.

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pay debts by instalments. The DOCA is very flexible. It is useful as a tool

to ‘cut off stores that are not working’. 511F

512

Franchisees whose franchisor is in administration are unlikely to have

resources to fight administrator decisions and in any event the Corporations Act s

440D

… establishes a moratorium on civil actions against the company: Court

proceedings in relation to company property or against the company cannot

proceed or be commenced unless the administrator gives written consent or

the leave of the court is obtained…. In Foxcraft v The Ink Group Pty Ltd,512F

513

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.513F

514

Not only is there a stay on commencing actions, the appointment of an

administrator also serves to suspend enforcement and execution actions. Under the

Corporations Act, s 440F and 440G, ‘during the administration no enforcement

process in relation to company property can proceed or be commenced except with

the leave of the court’.514F

515 There are exceptions to this rule.515F

516

4.4.3 WINDING UP IN INSOLVENCY

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.

The general purposes of bankruptcy law [including corporate insolvency] are

to provide a protective and ordered process in the event of financial distress;

to facilitate the equal access by creditors to a debtor’s property in order to

compensate them for their loss; and to allow individuals who find

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.

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216 Chapter 4: Is the current regulatory response adequate to deal with the problem?

themselves in financial difficulties to be given a fresh start, freed from the

financial obligations that were the subject of the bankruptcy.516F

517

As mentioned in chapter 1, attitudes to business failure have changed as it is

recognised that any business can fail and that events beyond the immediate control of

the debtor can impact severely on solvency. Of the late 1980s and early 1990s, K

Freed, D Gurnick and E Honesty write:

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. Bankruptcy517F

518 is now viewed as a viable business

option and financial planning tool.518F

519

This attitude to insolvency is pragmatic. The Global Financial Crisis of late

2008 – 2010 will have cemented the pragmatism. Franchisors are business people

and are not exempt.

The basic components of the legislative corporate insolvency scheme in

Australia are:

If a corporation cannot pay its debts as and when they fall due (that is, the

corporation is insolvent),519F

520 an application may be made to the Court to

appoint a liquidator. The application may be made by a creditor, the

corporation, a director or member of the corporation, ASIC or a

liquidator.520F

521

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.

A corporation in liquidation is given some protection; creditors cannot

enforce any judgments or orders they may have obtained521F

522 and other legal

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.

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proceedings may not be brought or pursued against the corporation without

the leave of the court.522F

523

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.523F

524

Whilst insolvency policies and priorities vary from one country to another,524F

525

the insolvency regime in Australia generally tends to favour creditors over

shareholders. Apart from claims by liquidators, employees,525F

526 and other listed in the

Corporations Act:

Insolvency law tries to encompass all ‘creditors’ by having a wide definition

of that term, including contingent claims damages claims, future claims as

set out in s 553. Insolvency law … does alter the priorities of certain groups,

for example employee creditors. 526F

527

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:

[T]he effect of the [employee] priority is to deprive other unsecured creditors

of their claim to a share of the available assets. Included in that class of

unsecured creditors may be small traders who were substantially dependent

upon the insolvent for their business and persons who were in an employee-

like relationship with the insolvent but who are classified (in a strict legal

sense) as independent contractors. There, creditors may be as vulnerable as

employees in the event of bankruptcy or liquidation but enjoy no

protection.527F

528

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.

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The functions of a liquidator of an insolvent company are threefold: to wind up

the affairs of the company; to distribute equitably the company’s assets among its

creditors; and to examine the circumstances which precipitated the liquidation and

which may reveal improper dispositions of property and criminal offences.528F

529

When a liquidator is appointed to one of the parties to a contract, contract law

is ‘trumped’ by rights given to liquidators under the Corporations Act. This would be

appropriate if the franchisor operated a standalone business, but it is highly

problematic in franchising where the franchisor is the lynchpin of a network of

dependent entities. The franchisee’s contract-based rights are in the franchise

agreement. Once the liquidator is appointed the franchise agreement becomes an

asset or a liability in the franchisor’s insolvent estate. The franchisee has no separate

rights as a consumer or a contracting party. As was seen in chapter 4.1, the Trade

Practices Act does not provide any avenues for relief. The franchisee is not a

stakeholder in the franchisor’s insolvency unless it has rights as a creditor. This was

explored in chapter 3.6.1. Consequently, in relation to the majority of its exposure, it

has no standing under the Corporations Act.

A ‘company is a separate legal entity and if it is in liquidation must be treated

as such. In some cases however, the company’s affairs are inextricably bound with

other companies in liquidation in a group. In such cases, since the Corporations

Amendment (Insolvency) Act 2007, a statutory pooling regime is available to

facilitate the winding up of companies in corporate groups – see Div 8, Pt 5.5

Corporations Act’.529F

530 Pooling is obviously relevant in franchise networks. It will not

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 568.530F

531 In the franchise situation this may include a lease of the

premises a franchisee trades from, an agreement with a supplier, an agreement

between the insolvent master franchisee and the international franchisor, or the unit 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’.

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franchise agreement. Because the franchisee is a party to a contract with the

franchisor, the franchisor’s liquidator has the right to disclaim the franchise

agreement as an onerous contract.531F

532 The viability of each of the agreements that the

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 effect of a winding up order is that contracts of employment are

terminated. Employees have safety nets in the form of statutory priority and the

government scheme, the General Employee Entitlements and Redundancy Scheme

(GEERS). Additionally, in response to the Ansett failure, the Special Employee

Entitlements Scheme for Ansett (‘SEESA’) was established for people whose

employment was terminated from an Ansett group company (while under

administration) on or after 12 September 2001.532F

533 The latter includes employees of

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’533F

534 they have a statutory right

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.

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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:

A contract is unprofitable for the purpose of section 568 [Corporations Act

2001] if it imposes on the company continuing financial obligations which

may be regarded as detrimental to the creditors, which presumably means

that the contract confers no sufficient reciprocal benefit.

Before a contract may be unprofitable for the purposes of the section it must

give rise to prospective liabilities.

Contracts which will delay the winding-up of the company's affairs because

they are to be performed over a substantial period of time and will involve

expenditure that may not be recovered are unprofitable.

No case has decided that a contract is unprofitable merely because it is

financially disadvantageous. The cases focus upon the nature and cause of

the disadvantage.

A contract is not unprofitable merely because the company could have made

or could make a better bargain.534F

535

4.4.4 SPECIFIC ASSETS AND LIABILITIES UNDER THE INSOLVENCY PROVISIONS OF THE CORPORATIONS ACT

A fundamental difficulty, identified by Rohrbacher, in developing legal

policies around contract based property rights is that ‘[f]or executory contracts in

bankruptcy, the debtor’s [ie franchisor/liquidator’s] right to performance is treated as

property, but the debtor’s obligation to perform is treated as contract’.535F

536 Thus, the

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.

The problem of categorisation and the consequences of splitting up the

franchisor’s business along ‘asset’ and ‘liability’ lines will be demonstrated through

retail leases, title to stock and the franchisor’s trade marks.

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.

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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’.536F

537 The

franchisees have lost their right to trade from the premises.

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.

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222 Chapter 4: Is the current regulatory response adequate to deal with the problem?

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.

Even if the franchisee under model 10 or 11 is not evicted as a consequence of

the franchisor’s failure, they can still suffer financially. Having renovated the

premises to accommodate the franchisor’s specific fit-out requirements, if the

franchise agreement is disclaimed by the liquidator the premises would have to be

de-identified before the franchisee could continue trading from them.

In the worst-case scenario, a franchise may have recently bought into a

franchise network that requires it to trade in a shopping centre with significant

investment sunk in the shop fit-out. It may also have provided a personal guarantee

for the franchisor’s head lease. The failing franchisor is likely to have used the

franchisee’s rent payments as a line of credit to prefer creditors other than the

landlord. The landlord will simultaneously call on the franchisee’s guarantee, and

terminate the head lease on two grounds – arrears of rent and outgoings (owed by the

franchisor, paid to the franchisor by the franchisee but not passed on to the landlord)

and administration or insolvency of the tenant (the franchisor).

Implications – specific facts and figures

Franchisees who participated in the 2004/05 CPA Study were asked ‘How

many years did the lease of business premises have still to run when administrator or

liquidator was appointed?’ Forty four per cent answered two-three years and 11 per

cent, four-five years. Where a lease has four-five years remaining it has probably

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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 payments537F

538

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’.538F

539

Commitment to lease payments [in CarLovers] appears to have been a

contributing factor to the financial distress of the franchisor that had ‘locked

itself into expensive leases of up to 20 years, on sites where the carwashes

didn’t reach expectations and the [franchisor] company made big

writedowns. 539F

540

A few days earlier, franchisees reported being unaffected by the

administration. “The day to day operations of the individual franchisees

would continue as normal.”540F

541

The franchisees would not have been able to confidently predict their futures if

the franchisor had been the head lessor.

The Kernels Popcorn Australian master franchisee’s insolvency, operating

retail premises through model 7, provides an example of the impact of a

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.

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224 Chapter 4: Is the current regulatory response adequate to deal with the problem?

franchisor/lessee’s insolvency on franchisees. Kernel’s became insolvent in 2005.541F

542

In the report to creditors the administrator wrote:

There were 24 Kernel’s Extraordinary Popcorn stores, of which 20 operated

pursuant to franchise agreements. The company was also lessor of the 20

franchisee-owned stores and four franchisor owned stores. [The liquidator

reports] I was without funds … it was necessary for me to disclaim all of the

company’s leases on 24 March 2005.542F

543

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.543F

544

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.544F

545 As many of the suites of whitegoods purchased from

Kleenmaid were to be installed after customers’ renovations had been completed,

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).

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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’545F

546 of franchisor

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.

The franchisor’s intellectual property becomes an asset in the franchisor’s

liquidation. It is an asset, in the same way as franchise agreements are an asset – both

are available to be sold by the liquidator for the best possible price, but they do not

need not be sold to the same buyer. A buyer of the trade marks may elect not to

purchase the franchise agreements. For example the liquidator of Kleenmaid sold the

name ‘Kleenmaid’, to an entity that did not buy any other part of the former

Kleenmaid business.

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.

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226 Chapter 4: Is the current regulatory response adequate to deal with the problem?

Capital acquired the right to Kleenmaid’s brand and logo following

[Kleenmaid’s] collapse last year. 546F

547

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.547F

548 Kleins, which failed

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.548F

549 Three of the 337

franchisors in the sample analysed in chapter 3.1.2 had security interests registered

against their trade marks.549F

550 This would mean the secured party would be a priority

creditor in the franchisor’s insolvency.

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.

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for the transfer of the trade mark is insolvency then it is likely that the value

of the trade mark will be severely damaged.550F

551

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.

4.4.5 IMPACT ON SUPPLIERS TO FRANCHISE NETWORK

Suppliers were discussed in 3.2.5. If a liquidator is appointed to the franchisor,

the supplier becomes a creditor or debtor. At that point, the franchisor has breached

the particular supplier agreement and the supplier can access remedies and mitigate

losses. Unlike franchisees, suppliers do not have their entire businesses reclassified

as franchisor’s assets or liabilities in the franchisor’s insolvency following the

appointment of the liquidator.

4.4.6 IMPACT ON EMPLOYEES IF EMPLOYER BECOMES INSOLVENT

As many franchisees were formerly employees they are used to having

statutory rights if their employer’s business fails. Some franchisees can be likened to

a middle or senior manager in a corporation. Others are more accurately compared to

junior employees. The incorporated franchisee that employs hundreds of staff and

invests hundreds of thousands of dollars in premises and stock is in a very different

position in the franchisor insolvency to an unincorporated sole trader franchisee who

has paid less than A$50,000 for the licence to conduct a dog wash business, do

domestic ironing or mow lawns. In each situation, and all variables in between, the

franchisee will fare differently to an employee if the franchisor becomes insolvent.

4.5 RETAIL LEASING LEGISLATION

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.

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228 Chapter 4: Is the current regulatory response adequate to deal with the problem?

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.551F

552

In addition to contract terms, real property in Australia is regulated by state and

territory laws. Ownership, the strongest real property right, enables the owner (also

known as the registered proprietor) to do anything it wishes with the land,552F

553 subject

to any restrictions specifically imposed by statute. These restrictions can include

planning requirements and laws that permit the government to compulsorily acquire

land.553F

554

All Australian states have adopted the Torrens system of land registration,

issuing a title to each identified parcel of land.554F

555 Part 6 of the Real Property Act

1900 (NSW) 555F

556 provides for interests in land to be registered on the title. The effect

of registration is that it identifies the registered proprietor (owner) of the property

and alerts third parties as to who, in addition to the owner, has a legal claim to an

interest in the property. The information on the title is recognised as being conclusive

in the absence of fraud. If the landowner provides its land as security for a loan, the

mortgagee may register its interest. Lessees may also register their interests.

Registered interests take priority over unregistered interests if an issue arises such as

the financial distress of the landowner. If a party has a registrable interest but decides

not to register, it may lodge a caveat on the title.556F

557

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.

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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.557F

558 If there is a lessee over premises on

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 equivalent558F

559 has been complied with. Section

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.559F

560

Premises leases must comply with the Retail Leases Act 1994 (NSW) (‘RLA’)

or its equivalent in other states and territories.560F

561 If a lessee wishes to grant

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).

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230 Chapter 4: Is the current regulatory response adequate to deal with the problem?

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.561F

562

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.

A pre-requisite for protection under retail leasing legislation is that the

franchisor’s occupancy situation falls under the legislation. As demonstrated in Table

E, a review of the definitions of ‘landlord’/’lessor’, ‘tenant’/’lessee’ and ‘lease’ in

each of the Acts reveals that none of the state and territory retail tenancy legislation

covers all 12 models of franchisee occupancy described in chapter 3.1.3.

For example, the Western Australia legislation562F

563 defines ‘lease’ broadly but

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.563F

564 Only the legislation of Western Australia

designates minimum tenancy terms before becoming applicable.

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).

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State and territory laws permit the lessee or sub lessee to register its interest on the

title.564F

565 Registration puts a third party dealing with the title, such as a purchaser,

mortgagee or a liquidator, on notice of the property interest. Even when a franchisee

has property interests recognised by the legislation, they may not be able to be

registered on the landlord’s title. And, where interests are registrable, registration is

not always customary. Franchisees occupying premises as licensees are not protected

by most jurisdictions’ legislation.565F

566

In practice, whether a lease is registered on the title will depend on the

practice in the state or territory where the premises are located. For example,

it is usual for a tenant to register a lease of three years duration or longer on

the title in New South Wales, but neither registration of a lease nor lodging a

caveat to protect the tenant’s interest is necessary or usual for retail premises

in Victoria.566F

567

Table 6: Franchisees’ position under State and Territory retail tenancy legislation.567F

568

Model568F

569

Australian Capital Territory

New South Wales

Northern Territory

Queensland

South Australia

Tasmania

Victoria Western Australia

1 Covered Covered Covered Covered Covered Probably covered. Lessor and lessee not defined

Covered Covered2 Covered Covered Covered Covered Covered Covered Covered3 Covered Covered Covered Covered Covered Covered Covered4 Covered Covered Covered Covered Covered Covered Covered

5 Not covered

Arrangement covered in definition of lease: franchisee may not be

Arrangement covered in definition of lease: franchisee may not be

Covered so long as premises owner consents to franchisee occupation

Arrangement covered in definition of retail shop lease; franchisee

Probably covered. Lessor and lessee not defined

Not covered

Covered

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.

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232 Chapter 4: Is the current regulatory response adequate to deal with the problem?

covered by definition of lessee

covered by definition of lessee

may not be covered by definition of lessee

6 Covered Covered if term longer than six months with right of renewal

Covered if term longer than six months with right to extend term

Covered Covered if term longer than one month

Covered unless related to common area of shopping centre and term shorter than six months

Covered if ‘lease’ interpreted broadly

Covered

7 Covered Covered Covered Covered Covered Probably covered - lessor and lessee not defined

Covered Covered 8 Covered Covered Covered Covered Covered Covered Covered 9 Not

covered Not covered for same reason as model 5

Not covered for same reason as model 5

Covered so long as premises owner consents to franchisee occupation

Not covered for same reason as model 5

Not covered

Covered

10 Covered Covered Covered Covered Covered Covered Covered 11 N/A N/A N/A N/A N/A N/A N/A N/A 12 Not

covered Not covered

Not covered

May be covered

May be covered if prospective lessee

Not covered, no agreement

Not covered

Not covered

‘Covered' means the franchisee's occupancy arrangement fits within the retail tenancy legislation ‘Not covered' means the franchisee fails to qualify because it or its occupancy arrangement does not fit under the definitions in the relevant legislation N/A applies where the franchisee owns the premises

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:

Franchisees will not be recognised as creditors in relation to their lost

premises interests as there will be no contractual rights to connect their

loss to the insolvency;

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

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They have lost the right to trade from the premises as result of the

franchisor breaching the lease.

4.6 STATUTORY REMEDIES

Benchmark 2 is that there should be accessible, timely and meaningful redress

where consumer detriment has occurred. Up until the time an administrator is

appointed to their franchisor, franchisees have access to protection and redress under

Trade Practices Act parts IVA, and V division 1 and through the Code.

In practical terms however none of the remedies available in Trade Practices

Act pt IV are applicable to the franchisor administration/insolvency situation.

Damages, injunctions, deleting the offending words of a contract, enforceable

undertakings, and advertisements are all remedies based on the assumption that the

breaching party is still solvent. As mentioned in 4.2.3 administrators reject

franchisees’ requests that they attend mandatory mediation under the Code and the

Code does not apply to liquidators.

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 court569F

570 if a

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’.570F

571 Thus, the franchisees are vulnerable if they

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.

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234 Chapter 4: Is the current regulatory response adequate to deal with the problem?

Corporations Act imposes barriers on commencing or continuing litigation during

the insolvency process, as discussed in chapters 2.4 and 4.4.

Whilst a franchisee whose franchise agreement or premises lease has been

disclaimed has a right to lodge a proof of debt in the liquidation as an unsecured

creditor for its loss,571F

572 this is a deficient form of consumer protection.

From the time an administrator is appointed to the franchisor, franchisees have

no meaningful voice, let alone any control over their future in the insolvency process.

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 model572F

573 for the making of sound and

informed policy.

572 Corporations Act 2001 (Cth) s 568D(2). 573 Introduced in ch 1 of this thesis.

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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 Productivity Commission (‘PC’) recommends that ‘policy makers should

have regard to the evidence on how consumers and businesses actually behave.’573F

574 In

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.

The actual behaviour of franchisors as suppliers and franchisees as business

consumers was addressed in chapter 2 where the causes and magnitude of the

problem were identified. It was shown that franchisors fail in greater numbers and

with more serious consequences for franchisees than rhetoric suggests. It was also

shown that the failure is seldom caused by franchisees.

In chapter 3 the problem was placed in the context of an issue that is influenced

by:

choices made by the franchisor about structuring the franchise network

the franchise agreement as a contract, for which traditional breach of

contract remedies are ill-fitted when the monopoly supplier becomes

insolvent

asymmetries of information, adviser, risk, resource, contract and

legislation

574 Australian Government Productivity Commission, vol 2, above n 4, 42.

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236 Chapter 5: The deal for franchisees

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.

5.1 CONSUMER PROTECTION BENCHMARKS

A benchmark is ‘a standard or point of reference; a means of evaluating by

comparison with a benchmark’.574F

575 Following its evaluation of Australia’s consumer

protection laws, Australia’s PC recommended that the:

Australian Government should adopt a common overarching objective

for consumer policy, being:

To improve consumer wellbeing by fostering effective competition and

enabling the confident participation of consumers in markets in which both

consumers and suppliers trade fairly and in good faith. 575F

576

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.

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party. Good faith is not a suitable benchmark in this context. In relation to fairness

the Commonwealth Government concludes:

The Franchising Code is designed to ensure franchisees and franchisors treat

each other at least with a certain minimum standard of fairness, and the

Government’s [2009] proposed changes to the Franchising Code will

improve its effectiveness in promoting fairness and good practice.576F

577

Until the problem of franchisor failure is addressed, an acceptable level of

fairness will not have been achieved.

In chapter 2 it was demonstrated that franchisor failure is a sizeable problem

for franchisees. In chapter 3 we gained an understanding of why franchisees are

unable to self-protect through negotiating better contracts and that they could not rely

on an action for breach of contract against an insolvent franchisor delivering redress.

Chapter 3.4 demonstrated that issues of asymmetry in six spheres mitigate against

franchisees being able to self-protect via contract law.

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.

B2) There should be accessible, timely and meaningful redress where

consumer detriment has occurred.

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.

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Australian legislation will succeed in providing adequate protection to

franchisees as business consumers when it ‘credibly demonstrates’577F

578 to all

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,

have a legislated exit strategy.

5.1.1 REGULATION SHOULD PROVIDE EFFECTIVE PROTECTION FROM SERIOUS RISKS AND THREATS THAT FRANCHISEES AS CONSUMERS CANNOT TACKLE AS INDIVIDUALS (B1)

Of the national consumer policy objectives identified by Australia’s

Productivity Commission, 578F

579 following a review of those of New Zealand,579F

580 the

United States,580F

581 the United Kingdom,581F

582 Canada 582F

583 the fourth objective espoused by

the European Union; [t]o protect consumers effectively from the serious risks and

threats that they cannot tackle as individuals 583F

584best 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.

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threat that individual franchisees, or even group of franchisees cannot tackle by

themselves.

The EU Consumer Policy strategy 2007 – 2013 states:

Confident, informed and empowered consumers are the motor of economic

change as their choices drive innovation and efficiency. The response to

these challenges lies in equipping the consumer with the skills and tools to

fulfil their role in the modern economy; in making markets deliver for them

and in ensuring effective protection from the risks and threats they cannot

tackle as individuals. 584F

585

This inability of franchisees to address the risks or threats of franchisor failure

as individuals is the core of their problem.

Firms incur obligations daily to suppliers, to employees and to different

classes of investors. So long as the firm is prospering the adjudication of

claims is seldom a problem. When the firm has difficulty meeting some of

its obligations, however, the issue of the priority of those claims can pose

serious problems. This is most obvious in the extreme case where the firm is

forced into bankruptcy. If bankruptcy [administration or insolvency] were

costless the reorganization would be accompanied by an adjustment of the

claims of various parties and the business could, if that proved to be in the

interests of the claimants, simply go on.585F

586

Where the firm is a franchisor, not only will the ‘total value of the firm fall’586F

587

but the franchisees to an arguably greater degree than the franchisor ‘bear [almost]

the entire wealth effect of the bankruptcy cost’.587F

588

What type of protection is possible within the consumer regime?

Ex ante, the protection should be in place before the franchisees sign the

agreement. This allows them to factor the possibility of the franchisor failing into

their financial models and make a more accurate evaluation of how much risk they

are taking. Thus, ex ante protection should exist in the form of both an improved

disclosure document, and implied terms in the franchise agreement. An important

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.

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240 Chapter 5: The deal for franchisees

further component of consumer protection is for the business consumer of a failed

product, the franchise business, to have rights under the Corporations Act. This

aspect of the solution does not form part of this thesis.

IMPROVED PRE-CONTRACT DISCLOSURE

The improved disclosure should address recommendation 21 in the Matthews

Committee Proposal:

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.588F

589

Improved disclosure does not mean longer disclosure. It is disclosure that is

differently structured so it is more meaningful. This will be addressed more fully in

chapter 6.2.4.

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.

What are the risks and threats?

The greatest risk to fulfilment of the promise that franchising offers franchisees

and the unmitigated threat to the viability of the franchisee’s business is that the

franchisor will fail. As has been demonstrated in chapter 2, this is a real risk and a

real threat. It is clear from 2.1.3 that franchisors may fail for a wide variety of

reasons. Few if any franchisor failures can be attributed to franchisees. None could

have been anticipated by a franchisee conducting better due diligence on the basis of

the current disclosure document, being better educated on the basis of information

currently available to intending franchisees, or receiving better legal or financial

advice before signing the franchise agreement.

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.

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Standard’) provides a methodology for identifying and managing risk in a business

that could be used by both franchisors and franchisees to determine whether a given

franchise agreement addresses the key risk items. An aspect of the methodology is to

categorise events in tabular form as in Table 7 as ‘known knowns’, events which will

occur, such as the franchise agreement will terminate at the end of the term; ‘known

unknown’ events which are known to be possible but their effect is not fully

knowable; and ‘unknowns’. The category each event is placed in determines its

treatment in the franchise agreement.

Table 7: Risk analysis template

Event Solution

Known knowns

Day to day events Address in contract

Known unknowns

Franchisor might fail – genuine failure.

Franchisor might decide to become insolvent.

Parent company might decide to close franchise division/ strategic insolvency.

If impact would be severe on either party, include, if not, leave to future negotiation.

Weight with respect to impact on network and on individual franchisee.

Provide contract based strategy.

Unknowns

Far fetched events that are never likely to impact on the network.

Address through ‘motherhood’ clauses; ie: 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’.589F

590 There are eight broad reasons why

590 Commonwealth Government Response to the Report of the Parliamentary Joint Committee on

Corporations and Financial Services, above n 166, 21.

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242 Chapter 5: The deal for franchisees

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.

Pre contract disclosure:

o Fails to put franchisees on notice about the significant threat which is

beyond their ability to research, and beyond their control – the

franchisor’s survival. It provides only a small amount of information

about the current financial standing of the franchise network. In 2009

it was announced that:

The Government will introduce amendments to clause 1.1(d) of Annexure 1

and clause 1.1(e) of Annexure 2 of the Franchising Code to state that

franchising is a business and that like any business the franchise (or

franchisor) could fail during the franchise term.590F

591

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.

Franchisees are unable to conduct affordable and effective due diligence as

previously discussed.

591 Ibid 22.

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The franchise agreement is drafted by the franchisor. Because it is not

negotiable the information provided in the disclosure and acquired through

due diligence, is of limited value.

Asymmetries abound, as described in 3.4. They contribute to the

franchisees’ inability to evaluate the risk of franchisor failure, or plan for

it.

The Code offers no rights and no protection to franchisees in this situation.

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.

There is no lobby group or union that represents the interests of all

franchisees whereas franchisors interests are strongly represented by the

FCA.

5.1.2 THERE SHOULD BE ACCESSIBLE, TIMELY AND MEANINGFUL REDRESS WHERE CONSUMER DETRIMENT HAS OCCURRED (B2)

Currently, where the franchisor enters administration or becomes insolvent,

each of its franchisees enters a legal minefield. The legal options franchisees can

consider are:

Terminate the franchise agreement for anticipatory breach, but this is

accompanied by the risk that the liquidator might initiate proceedings.

Pursue quasi-contractual remedies.

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.

Any post-appointment action commenced by the franchisee requires the

consent of the court and would almost certainly be opposed by the liquidator. If the

franchisee successfully navigates the minefield it arrives at a regulatory vacuum in

relation to its rights in the administration or the insolvency. This is not satisfactory.

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Accessible redress

Hadfield writes:

[c]ontract law makes its own promises to contracting parties: it promises to

be available to accurately interpret the agreement the contracting parties

have made, to impartially judge the performances rendered, and to reliably

implement the appropriate remedies. … Courts must be accessible at

relatively low cost in geographic and linguistic terms to contracting

parties. 591F

592

Hadfield also states that:

[d]elay in the resolution of contract disputes is an important impediment to

the effectiveness of contract law – not only does the value of payment

decrease with time but so too does the probability of recovery diminish as

the potential for assets to be dissipated increases and circumstances change

to make performance more difficult and/or less valuable.592F

593

As was demonstrated in chapter 4, justice extracted from a solvent franchisor

through the courts was very expensive and very slow for the Hoys whose alternative

to litigation was to have their franchise terminated by their franchisor. The

franchisees ultimately won their case, and won again on appeal.593F

594

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.

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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. 594F

595

In the failed Danoz Directions franchise network one franchisee signed a

franchise agreement for a five year term with a five year renewal in February 2004,

the franchisor failed in October 2004. The franchisee instituted proceedings against

the franchisor’s solvent directors alleging breaches of parts IAV and V of the Trade

Practices Act. In September 2009 two days of hearing time were allocated and in

April 2010 a further two weeks of hearing time are allocated for the litigation

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/sub08.pdf> at 17 January 2010.

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initiated by the franchisee under the Trade Practices Act to be heard in the Federal

Court of Australia. 595F

596 This is not timely.

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.

5.1.3 COST BENEFIT CONSIDERATIONS (B3)

These problems [i.e. those sought to be addressed by enacting s 51AC Trade

Practices Act and the Code in 1998] have considerable economic and social

costs in that they contribute significantly to business failure. The social costs

identified included stress, marriage breakdown, poor health and suicide. The

economic costs of the business conduct issues … include an inability by

596 Hearing 2 (P) NSD1313/2008 Benjamin Morris & Anor v Danoz Directions Pty Ltd (ACN 092

832 534) (in Liquidation) & Ors.

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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.596F

597

The OBPR identifies as its fourth criteria the need for:

An assessment of the impact, including costs and benefits, on consumers,

business, government and community or each option, with each impacted

group identified, noting impacts on competition, small business and trade.597F

598

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.

‘The primary objective of cost-benefit analysis is to determine whether the

overall wellbeing (termed ‘welfare’ by economists) of society is likely to increase or

decrease as a result of implementing a specific policy’.598F

599 A comprehensive cost

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’.599F

600 As we have observed in the way franchisors shift risk to

franchisees, the franchisees are the unwitting mediators of a wide range of the

franchisors’ risks.

Leo Dobes reminds us that ‘[w]hen economists refer to cost-benefit analysis,

they mean social cost-benefit analysis: reflecting the fact that the analysis is not 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.

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248 Chapter 5: The deal for franchisees

limited to the standpoint of a government budget, a firm’s profits, or an individual’s

interests’.600F

601

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 cost of franchisor failure

Benefits of intervention cannot be considered in isolation from its costs… 601F

602

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, 602F

603 and is generally below the regulators’

radar.603F

604 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. 604F

605

This is the case in franchisor insolvency where, as was outlined in chapter 4,

different governments and within the governments, different departments have

responsibility for the Trade Practices Act, the Corporations Act and the states’ and

territories’ retail tenancies legislation.

Limitations of cost benefit analysis

Richard Zerbe states:

CBA attempts to solve collective action problems, which arise when

individuals or groups pursuing narrow self-interest without coordination

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.

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Chapter 5: The deal for franchisees 249

arrive at outcomes that are collectively inferior to those that could be

achieved with coordination.605F

606

‘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’.606F

607 Zerbe’s paper addresses the value of

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.

Steps in cost benefit analysis

A CBA may include the following steps, following identification of the

stakeholders:

Forecast impact on franchise purchases

Estimate cost to franchisors

Estimate benefits to franchisees

Estimate impact on government

Estimate other [consequential] effects

Aggregate costs and benefits into an estimated total net benefit

effect

Assess policy risks and uncertainties

Consider incidence of the policy on different social groups.607F

608

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.

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5.2 CONCLUSION

The currently favoured consumer protection benchmarks of fairness and good

faith, and accessible and timely are insufficient when evaluating the sufficiency of

consumer protection response for franchisees of failed franchisors.

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.

In chapter 6 a number of possible non-regulatory and then regulatory responses

are proposed. The regulatory responses are evaluated against B1 and B2

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Chapter 6: Consumer protection to address the benchmarks

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 POTENTIAL NON-REGULATORY SOLUTIONS

6.1.1 STATUS QUO

In the ‘do nothing’ solution requires all franchisors to continue preparing,

updating and delivering extensive Code compliant disclosure that fails to place the

franchise offering in an accurate context from the perspective of franchisees being

able to evaluate commercial or legal risk. Franchisees will continue to pay for legal

and financial advice on the inadequate information and to be unable to objectively

verify much of that information. Most franchisees will not negotiate ipso facto

clauses into their agreements and will not be able to protect their own assets as well

as franchisors can. Franchisees will continue to be unnecessarily vulnerable to the

franchisor’s failure.

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.608F

609 The Reid Report identified ‘the inadequacy

of advice and education for small businesses’609F

610 as a matter for concern. The

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.

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Matthews Review’s Report610F

611 contained 15 references to education. The South

Australian Parliament Report in 2008 contained 42 references to education. It did not

directly identify education as a solution to franchisor failure.611F

612

The West Australian report, also in 2008, referred to education 38 times,

including the following observation about franchisee failure:

The risk of business failure [impliedly a franchisee’s business, not a

franchisor’s] will always exist. This risk can be reduced by undertaking

thorough business feasibility assessment and planning prior to entering into

any commercial arrangement. …The importance of pre-entry education for

franchisees has emerged as a key issue. … It has been reported anecdotally

that in many cases, prospective franchisees do not educate themselves prior

to entering into a franchise arrangement. 612F

613

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.

Pre-contractual education was placed in context in Opportunity not

opportunism where it was noted that ‘[a]lthough education, advice, disclosure and

due diligence generate important information about the potential for success, the true

nature of franchising cannot be appreciated until the relationship is under way’.613F

614

The commonwealth Government responded by writing:

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. 614F

615

The importance of education cannot be discounted. Education will make

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.

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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.

6.1.3 FRANCHISEE UNION

Franchisees face significant impediments to self-representation as lobbyists or

as litigants. Franchisees do not join trade unions in Australia. As individuals they do

not have resources to involve themselves personally in politics at a national level in

addition to running their own business and in some cases participating in their own

franchise network’s advisory council. They risk alienating their franchisor if they

express views that the franchisor or the FCA find threatening or inconvenient.

Franchisees may fear that if, hypothetically, they were seen to be devoting time to

union affairs, their franchisor would build a case to terminate for breach of a term of

the franchise agreement that requires the franchisee to devote all time and energy to

its business.

The problem of whether a franchisee union could be established and how it

would be funded has been overcome in Japan. There, individual owners of franchised

convenience stores were permitted to become members of an existing union in

2009.615F

616

In Europe, recognising the difficulties of finding time and money for

consumers to self-represent effectively:

[t]he EU has subsidised consumer group representation through the

European Consumers’ Organisation (BEUC) and the European Consumer

Law Group (ECLG) as well as specialised groups such as European

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.

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Association for the coordination of Consumer Representation in

Standardisation (ANEC).616F

617

While franchisors and franchisees do have matters of common interest where

the FCA can provide adequate representation, the areas where their interests are in

conflict should not rely on academics or individual franchisees with sufficient

motivation and courage to make a submission to a government inquiry, to be aired.

The argument for union membership has appeal. It is easy to dismiss one

franchisee’s voice as non-representative, but would be difficult to dismiss a union

representing the 71,000 franchisees in Australia.

6.1.4 INSURANCE

It should be possible for franchisees to insure against the consequences of their

franchisor failing.617F

618 In a submission to the 2009-10 Senate Economics Committee

Inquiry into Liquidators and Administrators, Greg Crook, a director of a supplier

adversely affected by the insolvency of a mining company wrote:

[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. 618F

619

Crook proposes that:

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.619F

620

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.

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Chapter 6: Consumer protection to address the benchmarks 255

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.

6.1.5 RECONFIGURE SOME OBLIGATIONS

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.

Requiring franchisors that operate through the commission agency model to

supply personal guarantees from the franchisor’s directors to franchisees is also

possible, though ad hoc and seldom agreed to by franchisors. Personal guarantees

would remain actionable if the principal debtor, the franchisor, became insolvent.

6.1.6 DEEM FRANCHISORS TO BE TRUSTEES

An option would be for some of the funds received by franchisors to be

deemed to be held on trust for the franchisee. For example, currently, the sums like

the $60,000 option fees in Table 3 charged for future sites are currently treated as

general revenue and are not traceable in the franchisor’s insolvency. Ideally, these

sums should be held by franchisors on trust for the franchisees until the paid-for

options are exercised. The moneys franchisees pay to a central advertising fund

would also be easy to hold in a separate account with the franchisees as beneficial

owners until the moneys are spent for legitimate advertising purposes.

Which moneys franchisors should be holding on trust would be a topic for

future research.

6.1.7 LEGISLATE SOLUTIONS

[T]here are three fundamental questions surrounding the debate about

consumer protection:

Why do consumers need protection?

When ought the state intervene to protect them?

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How ought the government to intervene? 620F

621

Andromachi Georgosouli adds that:

consumer protection policies have as an overarching objective to improve

economic efficiency by remedying market failures and preserving the

fairness of the process and outcomes of the transactions. 621F

622

Consumer protection does not exist in a regulatory vacuum. Thus, a fourth

fundamental question should be added:

What is the context in which consumer protection functions?

This leads to the question; why do consumer protection inquiries,622F

623 economic

models created by franchise academics623F

624 and regulatory responses assume that the

supplier, in this case the franchisor, will be solvent at the time the product or service,

the franchise business support, is supplied?

‘[C]onsumer protection has an ancient genesis, dating back at least to Roman

times with the adoption in Roman law of various implied warranties against latent

defects in the sale of goods’.624F

625 Trebilcock identifies two sources of pressure on

traditional consumer protection regulation, being:

the rapidity of technological change, globalisation and deregulation of

formerly regulated monopolies have dramatically expanded the range of

consumer products and services available in any given jurisdiction, making

product and service-specific regulation increasingly problematic and

intensifying the informational challenges faced by consumers.625F

626

and:

a veritable revolution in industrial organisation theory … particularly as it

relates to market structure, bargaining power and information, has rendered

simplistic structure-conduct-performance paradigms that keyed on a small

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.

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number of variables and that underpin many aspects of contemporary

consumer protection policy also increasingly problematic.626F

627

Trebilcock’s conclusion that the true focus of consumer protection is in the

quality and cost of information falls short. He concludes, by implication, that with

sufficient of the right information provided at the right time and the right price, the

consumer can be adequately protected. This may be true where goods and services

are not designed to last for decades, or where ongoing servicing is provided by

replacement suppliers. It does not apply when the business of the franchisor supplier

fails.

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’627F

628

rather than through consumer protection.

The sale of franchises is a hybrid. Before the franchise agreement is executed

the market is competitive. Once the agreement has been executed the franchisee is

committed to dealing with a monopoly. This is demonstrated through the network of

contractual relationships that is shown in relation to retail premises and trade marks

in chapter 3.2. Franchisees have purchased a bundle of products, services and use

rights from the franchisor.

If the franchisor’s business fails, there is no alternative franchisor to step into

the insolvent franchisor’s shoes. A competitor may potentially take over the

company owned and franchisee owned sites but may not wish to enter contracts with

the existing franchisees. A purchaser purchasing even an expensive item such as a

car is not obliged to return to the manufacturer for driving lessons, servicing, all

routine future suppliers of parts, petrol and oil, and ultimately to sell the vehicle only

through the manufacturer. The purchaser of the vehicle may get it serviced

anywhere, buy petrol anywhere and can sell it on the open market long after the

manufacturer has ceased to exist. The insolvency of the manufacturer is not going to

627 Ibid. 628 Ibid 69.

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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.

In answer to Ramsey, Georgosouli and Trebilcock, here is a situation when the

state ought to intervene to protect consumers. The forces of the competitive

marketplace have failed franchisees. Consumer protection policy is an appropriate

vehicle to correct this market failure. In conclusion, the problems will not go away,

and they will not be resolved without parliamentary intervention. A range of

regulatory interventions is now proposed.

6.2 REGULATORY SOLUTIONS

An essential step when amending legislation is being considered in Australia is

to conduct a Best Practice Regulation Preliminary Assessment using the procedure628F

629

provided by the Australian Government Department of Finance and Deregulation. In

line with this process, the problems were identified in chapters 2, 3 and 4. Solutions

are proposed in 6.2.

These solutions are designed to:

provide franchisees and their advisers with more meaningful pre-contract

disclosure

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

In Australia, pre-contractual disclosure under the Code is fundamentally

modelled on the North American disclosure requirements. This focus has not served

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.

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franchisees as well as a more global or Europe centric focus would have done. As

Iain Ramsey observes:

[t]here is now a significant difference between the substantive rules and

institutional approach to standard form consumer contracts in Europe and

North America. Standard form consumer contracts that are used in North

America would not be permitted in Europe and the proactive approach

adopted by the Office of Fair Trading is currently unknown in North

America. 629F

630

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:

Part V divs 2 and 2A [Trade Practices Act]… focuses on transactions rather

than on the structure of markets. Its aim is to regulate market failure arising

from information asymmetry … The consumer protection provisions are

designed to ensure that there is sufficient information available to potential

consumers so that consumers will get “value for money.”630F

631

A fundamental assumption is that the franchise system will work, to the

standard described, through to the end of the term.

Part V addresses information asymmetry in relation to transactions in three

different ways … in relation to supply of goods and services, liability for

false representations is imposed on the supplier who is in the best position to

know the characteristics of those goods and services. 631F

632

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 fixed life span denoted in the sale agreement.

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.

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Franchisors need franchisees to make significant investments of both time

and [equity and borrowed] money in their businesses. But, of course, such

investments are only worth making if the franchisee can expect to earn some

reasonable return on these investments over a sufficiently long period of

time. If it takes five years, for example, to fully recoup ones investment in a

franchise, then no franchisee should invest unless the relationship is

expected to last for at least five years.632F

633

When a consumer purchases a product or service in Australia, and the product

or service does not meet standards, the person has rights to claim against the supplier

or manufacturer. These options are currently not available to franchisees that

purchase into a franchise network that turns out to be faulty and to fail.

6.2.1 MAKE FRANCHISE AGREEMENTS ACCESSIBLE

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’.633F

634

633 Blair and Lafontaine, above n 46, 264. 634 Matthews, above n 113, Recommendation 23, 13.

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6.2.2 AMEND S 51AC TRADE PRACTICES ACT

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’.634F

635 These were, to provide a list of examples,

or a statement of principles, and to pursue non-legislative options.

The list of examples proposal was rejected. It was considered ‘legislatively and

administratively burdensome’ 635F

636 and potentially ‘requiring numerous

amendments’.636F

637 It was also considered to be something which the regulators can

achieve outside the rigid framework of legislation by developing effective guidance

material.637F

638

The statement of principles received more favourable consideration than the

list of examples. It was accepted that principles which ‘lower the standard to one of

fairness and justness would dilute the concept … in addition to overtaking the

proposed unfair terms provisions of the Australian Consumer Law’.638F

639

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.

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6.2.3 IMPLY TERMS INTO ALL FRANCHISE AGREEMENTS VIA FRANCHISE CONTRACTS ACT

The Australian Government concluded, after receiving Opportunity not

opportunism that:

If potential franchisees can identify and access the information needed

informed business decision, they should have a better basis with which to

negotiate a contract that meets their requirements. Parties engaged in trade

and commerce should have a high degree of freedom to contract. 639F

640

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!

Secondly, the notion of franchisees being able ‘to negotiate a contract’ is

flawed. For the reasons discussed in chapter 3, the contents of most franchise

agreements are not negotiable. At best the franchisee can understand it as a legal

document. Even this understanding will leave them without context. It is like getting

married without meeting, far less getting to know, ones intended spouse’s family

first.

A solution is to protect franchisees from the worst results of franchisor failure

through new legislation. The idea of specific franchising legislation is not new. It

was proposed in 1997 in the Reid report whose recommendations were adopted by

making adhesion to the Code compulsory.

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.

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to reform and modernise the law relating to certain contracts of insurance so

that a fair balance is struck between the interests of insurers, insureds and

other members of the public and so that the provisions included in such

contracts, and the practices of insurers in relation to such contracts, operate

fairly, and for related purposes.640F

641

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 641F

642

before the Code was made mandatory.

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.

In proposing that terms be implied into all franchise agreements it must be

acknowledged that franchise agreements can be disclaimed as onerous contracts by

liquidators. They would, however, apply to the franchisor and the administrator.

Product or service warranty

When a consumer purchases a product or service in Australia, and the product

or service does not meet standards, the person has statute based642F

643 rights to claim

641 Australian Government, Attorney General’s Department, Insurance Contracts Act 1984 (Cth)

<http://www.comlaw.gov.au/comlaw/Legislation/ActCompilation1.nsf/0/8993B3C6A1DDA189CA25749000200A9B?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

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264 Chapter 6: Consumer protection to address the benchmarks

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.643F

644

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:

An equivalent to s 69 would imply undertakings as to title, encumbrances

and quiet possession. It would become relevant where the franchisor has

not secured premises leasing rights but requires the franchisee to

commence trading, such as in Shakespeares case.

An equivalent to s 70 that concerns supply of goods by description would

apply, for example, to protect the franchisee purchasing a greenfields

Australia <http://parlinfo.aph.gov.au/parlInfo/search/display/display.w3p;query=Id%3A%22legislation%2Fbillhome%2Fr4335%22> at 6 June 2010.

644 See Appendix A of this thesis for wording of s 4B.

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business based on its description and the franchisor’s evaluation of its

potential.

Importantly for franchisees whose franchisor fails, an equivalent to s 71

would imply undertakings as to quality and fitness. The specific franchise

business being sold, and the franchisor supporting it, would have to

measure up to the undertakings as to quality and fitness for purpose for the

duration of the licence being granted.

The franchisee relies on the existing businesses it sees, and on the

appearance the franchisor maintains that it will remain solvent and will

continue to deliver the aspects of the business it holds itself out to be

providing. Thus a clause similar to s 72 of the Trade Practices Act that

concerns supply of goods by sample should be implied;

A term similar to s74 which addresses supply of services should be

implied. This would, as the current legislation does for consumer

purchases, extend to both those services that have not been supplied with

the requisite due care and skill (Trade Practices Act s 74(1)) and services

that are not fit for their purpose (Trade Practices Act s 74(2)).

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.

74D Trade Practices Act addresses goods of unmerchantable quality

which turns out to be the case with franchise businesses sold by

franchisors that were already insolvent when the franchisee paid its

franchise fee; or finally

74E Trade Practices Act (non- correspondence with sample).

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266 Chapter 6: Consumer protection to address the benchmarks

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’.

Franchisees are, however arguably purchasing ‘services’ for the purposes of

the Trade Practices Act s 4(1). For pts V 2 and 2A to apply to franchisees of failed

franchisors a definition of ‘business consumers’ would need to be added to the Trade

Practices Act and several consequential amendments would be required including

expressly extending pt V div 2 and 2A to include business consumers.

Implied terms re franchisor duties

The franchisor currently has a duty under item 18(2) of the Code disclosure to

tell franchisees about a breach of the Corporations Act within 14 days of becoming

aware of it. There is no evidence as to whether they do so, or not. However, even if

they do, the moment the franchisee has executed the franchise agreement and the 14

day cooling off period has expired, it is too late for the franchisee to protect itself

from a franchisor’s breach of the Corporations Act. The franchisor’s breach of the

Corporations Act is not a breach of the franchise agreement and does not give the

franchisees the right to terminate the franchise agreement and all ancillary

commitments.

Where the franchisor is a corporation the franchisor directors’ duties644F

645 should

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).

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Imply term requiring franchisor to obey all relevant law

The franchisor should have an implied contractual obligation consistent with

the franchisees’ current obligation to carry on business activities in compliance with

all laws, regulations and Codes of conduct. A statutory obligation should exist to

require the franchisor to meet all contractual and statutory obligations between;

itself and the franchisee

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.

Requiring franchisee consent to changes that would have a material effect on franchisees

The Matthews Review recommended that ‘[c]onsideration be given to

prohibiting unilateral changes by franchisors to arrangements with franchisees which

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268 Chapter 6: Consumer protection to address the benchmarks

have materially adverse effects on the franchisee without franchisee consent’.645F

646 The

government responded by stating that:

this will be addressed through reform to section 51AC of the Trade

Practices Act in relation to unconscionable conduct where unilateral

variation clauses will be a factor that may indicate a corporation has engaged

in unconscionable conduct.646F

647

The theme of unilateral contract variation is being addressed. In 2010 the Small

Business Minister Dr Emerson announced, in announcing amendments to the Code:

Franchisors would have to make it clear to prospective franchisees that there

may be unilateral contract variations, unforseen capital expenditure … 647F

648

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.

Implied term to take effect on appointment of administrator

A term would be implied into all franchise agreements that if an administrator

is appointed to the franchisor or to any of the entities in the franchisor’s network that

threaten the viability of the franchisee’s business, a 2 step process will be triggered:

Step 1: when an administrator is appointed to their franchisor any franchisee

may give notice to the administrator that if a satisfactory resolution

(restructuring that takes into account the franchisee’s interests as well as

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.

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those of the franchisor’s creditors, or sale to appropriate buyer) is not found

within x days, it will terminate the agreement,

Step 2: if the administrator does not meet the requirements in x days, the

franchisee have the right to terminate the franchise agreement, without this

being a deemed breach by the franchisee and without it compromising any

other rights the franchisee may pursue. The franchisees may express their

losses as unsecured creditors for an amount of their initial investment,

adjusted by depreciation and other appropriate considerations, plus any

amounts currently owed in the franchisor’s administration/ subsequent

insolvency.

This approach could be adopted in relation to both franchisor and franchisee

failure. This would mean the current asymmetrical provisions in the Code and all

franchise agreements favouring franchisors in the event of franchisee failure could be

removed from franchise agreements, thus making them shorter. It would also

eliminate the risk of franchisees being sued by the administrator or liquidator for

anticipatory breach.

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.648F

649

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.

For franchisee consumers to be given statutory protection in the form of a

modified ipso facto clause would be consistent with the approach in jurisdictions

such as Canada that recognise parties to executory contracts as meriting special

consideration in insolvency of one of the parties.

649 Morgan Kelly, ‘Failing Businesses Can be Saved’, The Australian Financial Review’ (Sydney),

30 November 2009, 55.

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Consequential amendments as additional implied terms

The franchisees’ option to terminate their franchise agreement would have a

secondary right attached to it – on the appointment of the administrator, all payments

(eg, royalties, advertising, rent) falling due from the franchisee to the franchisor or

any franchisor-related entity that was also under administration would cease to be

payable. Payment obligations – without arrears – would resume if the franchise

network was successfully revived. This would mean the vulnerable business

consumers, the franchisees, were not funding the administration.

The tenancy contract between the landlord and the franchisor would be

novated.

A novation occurs when two parties to a contract enter into an agreement

with a third party under which, in consideration of the first party [the

landlord] releasing the second party [the franchisor] from the contract, the

third party [franchisee] undertakes to assume responsibility for performance

in place of the second party. A transaction … is not effective as a novation

unless an intention is clearly shown that the second party’s obligations are to

be extinguished. 649F

650

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.

These provisions would provide an incentive for the administrator to

acknowledge franchisees as parties with rights, not merely to categorise franchise

agreements and premises leases as assets or liabilities of the franchisor. They would

enable the administrator to keep the franchise network together if a viable buyer was

found quickly, but not leave franchisees in limbo for extended periods while the

administration proceeds.

The drafting would have to be done with careful attention to incentives. It is

important not to incentivise the administrator from acting too hastily in proposing the

650 NC Seddon and MP Ellinghaus, above n 368, 360.

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administration proceed quickly to liquidation to prevent the franchisees from

exercising their option to terminate.

6.2.4 AMEND FRANCHISING CODE OF CONDUCT

Prospective franchisees do not currently have access to all information they

need to make an accurate assessment of the risk of the franchise network failing and

the impact that failure could have on their future business.

In economic terms the duty to disclose is formulated on the following basis:

[I]n general a person has a property right to information when it is costly to

gain such information, but the person does not have a property right and

therefore cannot take advantage of this information when the information is

obtained at a very low cost.650F

651

An application of this principle means franchisors would provide franchisees

with less disclosure that is of greater value; information the franchisee could not gain

access to otherwise, or only at great cost. This is also recognised in Opportunity not

opportunism:

Better disclosure does not necessarily mean more disclosure; disclosure

documentation should be in line with Code requirements and should focus

on the provision of information which is difficult and/or expensive for the

franchisee to obtain through other means.651F

652

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.

Application of Code to administrators

If the Code does apply to administrators, franchisees are ‘business consumers’

and entitled to remedies available under the Trade Practices Act for breaches of the

Code. If it does not apply, the administrator is regulated only by the IPA’s Code of

Professional Conduct and by its obligations under the Corporations Act. As was

explained in 4.3.2, the current, untested view held by some administrators that the

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.

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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.

Entities making disclosure

The franchisee needs to base its purchasing decision on full, specific and

accurate information. The franchisee should be given information that is specific to

its actual business. Even franchisors that have invariable rules about specific aspects

of business do make exceptions for particular sites, so generic information is not

necessarily accurate.

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.652F

653 The franchisor is

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.

The Matthews Review recommended653F

654 and the Australian Government

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.

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[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. 654F

655

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.

It should be noted that credit rating agencies do obtain some of their

information from the subject entity. To avoid this being misleading, the information

that was supplied by franchisor or related entity should be identified so the franchisee

will not be misled into believing the report is entirely objective.

Form and Content of the Disclosure

Recommendation 1 of Opportunity not opportunism655F

656 proposes the current

absence of warnings about franchisor failure should be addressed thus:

The … Code [should] be amended to require that disclosure documents

include a clear statement by franchisors of the liabilities and consequences

applying to franchisees in the event of franchisor failure.656F

657

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,

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This would not be a total solution, but it would put franchisees on notice that

the franchisor may fail. The government responded that:

individual franchisees, rather than franchisors, would be better placed to

assess the liabilities and consequences applying to them in the event of their

franchisor failing. In addition, such a statement may induce a belief among

franchisees that, in the event of franchisor failure, they will not be exposed

to any risks other than those noted in the disclosure document. 657F

658

The government’s preference for generic information to be supplied by the

ACCC is problematic. Information without context can be very misleading. Because

of considerable variation of risk shifting within each franchise network, any risk

statement would be most valuable if it were tailored to each specific franchisee’s

situation. Only the franchisor could do this, and only in relation to assets/ contracts to

which the franchisor or a related entity was a party. Franchisors should set out in

plain English specific possible contractual and statutory consequences of their own

failure for their franchisees. They would include information such as:

The franchisor’s liquidator may disclaim (i.e. terminate) the premises

lease. This could result in you losing your right to trade from the premises.

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.

The franchisor’s liquidator may disclaim your franchise agreement. This

would mean you could no longer trade as a franchisee of [franchisor].

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.

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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.

A reconfigured disclosure would be valuable. It would enable franchisees to

assess their risk more accurately and would make lenders more aware of the risks in

lending to franchisors and franchisees. It should be noted that even if enough

information was supplied, franchisees would still be unable to self protect if

franchise agreements did not allow them to terminate the contract and deal

satisfactorily with all of their collateral obligations when the franchisor failed.

Early, free access

Intending franchisees do not have accurate information early enough or

cheaply enough. Disclosure documents should be accessible on public databases.

Despite the reservations expressed by the government as to cost and usefulness of a

registration process658F

659 it is the only way of monitoring the sector and obtaining

659 Ibid 11.

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meaningful, publicly accessible, longitudinal and contextual data about franchisors.

This would enable intending franchisees to compare offerings more readily at an

earlier stage in their path towards small business ownership.

6.2.5 CONSEQUENTIAL AMENDMENTS TO STATE AND TERRITORY RETAIL LEASES LEGISLATION

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.

After a franchisor fails, the franchisee’s business may be viable on a stand-

alone basis as long as the franchisee can retain its premises. However, the franchisee

may not have right to remain in premises if franchisor fails. The liquidator has a

statutory right to disclaim the franchisor’s head lease as an onerous contract.659F

660

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.660F

661 This situation is exemplified in the

Canadian case, Majdpour v M & B Acquisition Corp:661F

662

Not all franchisees’ tenancy arrangements are covered by State/Territory

Retail leasing legislation. This is a problem because the franchisee relies on

continuing tenure of the premises tenure. The issue arises because the

definitions of “lease” and “tenant” in the legislation may not include the

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.

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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. 662F

663

In addition, the justification for exempting short-term tenancies from

legislative protection should be reconsidered. In particular, franchisor head tenants

should be required to extend the protection intended for the tenant to the franchisee

regardless of the term or the contractual basis for the franchisee’s tenure’.663F

664

6.2.6 AMEND CORPORATIONS ACT 2001 (CTH)

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.

Expand directors general duties

Section 172 of the Companies Act (UK) 664F

665 can be read broadly enough to give

directors the duty/ability to consider franchisees in their decision making. This is an

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.

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avenue of legislative change that could be investigated in Australia. Franchisees

would need to be included in a definition of ‘members as a whole’. If they were not

specifically included they could be denied the right to litigate to clarify the intention

of the legislature for the same reasons that impede franchisees wishing to litigate

currently.

Specific fiduciary duties

A further future inquiry is whether the directors of the franchisor do or should

owe any fiduciary duty to franchisees. The issue of franchisors as fiduciaries was

addressed in Germany where guidelines have been developed by the German

Franchise Association to interpret Article 3.3 of the European Franchise Federation

(‘EFF’) Code of Ethics.

[Article] 3.3 [states] In order to allow prospective Individual Franchisees to

enter into any binding document with full knowledge, they shall be given a

copy of the present Code of Ethics as well as full and accurate written

disclosure of all information material to the franchise relationship, within a

reasonable time prior to the execution of these binding documents.665F

666

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.666F

667

By way of contrast, in the USA ‘[f]ranchisors owe no fiduciary duty to

franchisees,667F

668 and no other duty to honor the franchisee's expectations is likely to

come from the franchise agreement itself668F

669 or from contract law governing it’.669F

670

(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.

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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). 670F

671

It would be addressed if franchisors were required to exercise the same duty

towards franchisees as directors do towards shareholders.

Franchisee representative committee during administration and insolvency

In the United States:

[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.671F

672

The merits of all franchisees being officially recognised and represented in

creditors meetings, whether they are creditors or debtors, should be examined at the

time review of the Corporations Act to address franchisor failure is undertaken.

Expand liquidators’ duty of care

A statutory duty of care should be imposed on administrators and liquidators

dealing with a failed franchisor towards franchisees. Under the expanded duty,

administrators and liquidators would owe a duty of care to the franchisees to consider

their legitimate needs as consumers. This includes the possibility for franchisees to

continue operating their businesses if the cause of the failure is not related to the

viability of the individual franchisee businesses. It would also mean that any

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).

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purchaser of the franchisees’ business would be required to satisfy the administrator

or liquidator that it was competent to run the franchise system.

6.3 EVALUATION OF REGULATORY SOLUTIONS AGAINST BENCHMARKS B1 AND B2

To recap, benchmarks 1 and 2 are:

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.

6.4 COSTS AND BENEFITS

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.672F

673

In summary, ‘[c]ost-benefit tells us the menu of trade-offs which policymakers

face’.673F

674 As part of the Best Practice Regulation Preliminary Assessment, Australian

government policy requires that a CBA should be conducted, and identified that:

[f]or a Regulation Impact Statement (RIS) to be assessed as adequate, it

should demonstrate that:

the benefits of the proposal to the community outweigh the costs;

and

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%20benefit.pdf> at 8 March 2010.

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the preferred option has the greatest net benefit for the community,

taking into account all the impacts (Australian Government 2007).674F

675

The Australian government evaluates projects by assessing their Benefit Cost

Ratio (BCR).675F

676

6.4.1 STAKEHOLDERS

An early step in conducting CBA is to identify all stakeholders in the problem.

The stakeholders affected when a franchisor fails are some or all of the following;

the franchisor and its related legal entities, franchisor’s employees, franchisor’s

shareholders, franchisors secured and unsecured creditors, landlords, franchisees,

franchisee’s guarantors, employees, creditors, families, policy makers, ACCC, ASIC,

administrators, liquidators, master franchisees, other suppliers, owners of registered

intellectual property rights used by the franchise network, and courts. They may be

affected directly and invariably, or the effect may be as a consequence of a course of

action adopted by an individual franchisee.

6.4.2 PRESENT REGIME

The features of the present regime are, in summary:

Disclosure contains approximately 250 items of information and is

supplied to every franchisee before purchase, and annually on request.

Disclosure is made only of the franchisor entity and the owner of the

intellectual property.

Lease:

o Franchisee is often required to pay rental guarantee for franchisor’s

head lease; the franchisor is often the head lessee and franchisees thus

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

t

tt

n

t

tt rCrBBCR

11

11

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.

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lose the right to occupy premises because of head lessee (franchisor’s)

default, or

o Franchisee keeps lease with no income because franchise agreement

disclaimed and franchisee loses access to franchisor-controlled

network of IP, suppliers, customer database, etc.

Franchisees have no legal rights per se on franchisor failure.

The franchisor entity and related entities are dealt with separately on

franchisor insolvency.

Franchisee can risk breach of contract action or undertake Trade Practices

Act action with consent of court but the provisions of the Corporations Act

make action against an insolvent entity problematic.

6.4.3 PROPOSED SOLUTIONS

The proposed solutions comprise a more streamlined but accurate disclosure,

and amendments to the Code, amendments to the Trade Practices Act or a separate

Franchise Contracts Act that contained terms implied into all franchise agreements.

The provisions designed to protect franchisees, such as ipso facto rights on franchisor

failure, could not be contracted out of. The legislation would include all provisions

that are currently included in all franchise agreements, such as the grant of the

licence to use the intellectual property, a minimum term that reflected the

franchisee’s right to amortize its investment in sunk costs.

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.

Retail leasing legislation would be consequentially amended by requiring

franchisors to pay the guarantee for head leases that are not in the franchisees’ name.

Franchisee may keep premises if head lessee-franchisor defaults or they may

surrender the lease without penalty if they are unable to continue trading without the

support of the franchisor.

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6.4.4 COSTS AND BENEFITS

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’.676F

677 As already stated, conducting a full regulatory cost

benefit analysis is also beyond the scope of this thesis.

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.

It should be noted that draft Table 8 is intentionally incomplete. Entries are

indicative of the type of things that would be considered in a full analysis. A

comprehensive analysis of B3 is beyond the scope of this dissertation.

Table 8: Cost benefit tentative summary Present Proposed

Stakeholders Affected

Type of impact Benchmark(s) addressed

Benefits Benefits

Federal government

Fewer government inquiries would be needed.

Better stakeholder representation would meet OBPR criteria.

Submissions would not need to be made.

B2

B3 State and territory

governments

FCA Insignificant

Standard form contract, free market approach.

More mirror/ reciprocal terms addressing risk areas.

More clearly defined rights on failure of franchisor

Franchisors Franchisees State governments Federal government ACCC

Significant:

Fairer contracts that assign risks more efficiently between franchisors as suppliers and franchisee as consumers.

More timely and cost-effective redress if

B1

B2

677 Dobes, above n 599, 69.

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Present Proposed

Stakeholders Affected

Type of impact Benchmark(s) addressed

franchisor went into administration.

Can reorganise without having to factor in franchisees

Reduced risk of being accused of misleading franchisees

Franchisors and parent company

Risk reduced B1

B2

Disclosure of ‘the franchisor’

More contextualised disclosure.

Franchisees and franchisees shareholders and guarantors

Clearer understanding of risk because have information they could not previously get.

Can insulate personal assets and assess risk in more informed way.

Risk reduced.

B1

B2

Improved rent payment structure when franchisor in administration.

Easier to evaluate possibility of franchisee remaining a tenant without being part of the franchise network.

Landlords Would still have ability to terminate lease if party failed to perform.

B1

B2

More accurate picture of franchisor’s and franchisees’ assets, liabilities and contingent liabilities

Lenders to franchisors and franchisees

B1

Franchisors and franchisees’ employees

GEERS / no impact

Stand-off as to whether Code applicable

Clear statement that Code applies

Administrators Clarified position B1

B2

Powerless, rudderless

Clear understanding, standing and rights

Franchisees families

Improved knowledge and thus ability to plan.

B1

Costs Costs

New full franchise agreement for each franchisee

Much of franchise agreement contained in new Franchise Contracts Act

Franchisor

Franchisee

Franchisee’s legal and financial advisers

Cost at each step significantly reduced

B2

B3

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Present Proposed

Stakeholders Affected

Type of impact Benchmark(s) addressed

Keeping disclosure up to date

Franchisor Reduced B3

Code + s 51AC Amended Code + amended Trade Practices Act OR new Franchise Contracts Act incorporating Code provisions.

ACCC Would be nearer to delivering on the level playing field that is as aspect of consumer protection.

B1

Sense of frustration that can’t do anything except issue statements.

ACCC Numerous complaints they cannot deal with

Disclosure of ‘the franchisor’

More contextualised disclosure.

Franchisor and shareholders

May have difficulty getting capital from bank if have to take more of risk themselves.

Lose business and premises if franchisor fails without legal right to manage own response.

Ipso facto clause

Amendment to leasing legislation

Franchisee, franchisee’s guarantors and financier

Inability to gain a return on sunk costs of investment. Lose house to mortgagee sale. Opportunity cost of time. Opportunity cost of money.

Tax audit.

Social costs (eg divorce)

Illness; stress, depression, suicide.

Franchisees families

Financial stress,

Social costs (eg divorce)

Illness; stress, depression, suicide.

Tyler Cowen notes, however, that ‘[g]iving cost-benefit analysis a greater

voice in policy may lead to fewer bad regulations than otherwise, but cost-benefit

analysis is not up to serving as a centrepiece for regulatory reform’.677F

678

678 Cowen, above n 674.

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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.

It would benefit franchisees and their financiers if the relationship between

insolvency and consumer law was clearer and accordingly if a reference to the

specific legal consequences for the franchisee being given the disclosure of the

specific franchisor’s insolvency were included in all pre contract disclosure.678F

679

Currently, in so far as franchisees are concerned, Australia’s insolvency regime and

the consumer protection legislation acknowledging franchisees as business

consumers are out of step with each other. Rohrbacher writes that ‘[i]mproving the

bankruptcy system is important because property and contractual rights are keys to

the smooth functioning of our (US) economic enterprises’.679F

680

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.

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Chapter 7: Conclusion

7.1 LEADING THE WORLD IN FRANCHISE REGULATION

The issue of franchisor failure remains ‘one of the few vulnerabilities in

franchising’680F

681 but as a result of this research its impact on franchisees and the

reasons for the impact is now better understood.

To an extent this thesis is a response to Iain Ramsay’s 2005 call ‘for future

research on consumer law and policy’. 681F

682 It demonstrates that the legal and economic

context in which consumers operate needs to be fully understood before policy is

formulated. Accordingly, it is only when frames of the commercial, legal and

regulatory environment impacting on franchisees of failed franchisors are each

expanded to the point where they overlap that the problems that franchisees of failed

franchisors experience can be understood. Now that the problem has been placed in

context, it is time for policy makers to take remedial action. As a result, Australia

would genuinely lead the world in franchise regulation.

A regulatory response would recognise that

[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.682F

683

This thesis build on Elizabeth Spencer’s683F

684 thesis where she demonstrated that

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.

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288

The commercial and economic frame needs to be enlarged beyond the

immediate consumer (the franchisee) to acknowledge that the franchisor

and franchisee are components of an entire franchise network.

The legal frame needs to be expanded beyond the separate laws of

contract, consumer protection and insolvency.

The regulatory frame then needs to be expanded to include both the

consumer protection and the insolvency regulators.

Any discrete frame does not present a full context. Viewed together, they are

compelling.

Whilst the consumer protection aspect of the solution proposed in this

dissertation may stand alone, it is acknowledged that consumer protection laws are

capable of providing only a partial solution. An optimal solution can only be devised

if consumer protection and business failure laws work together.

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’,684F

685 policy makers credit

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.

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Building on this assumption is a second, equally flawed assumption, that if

suppliers do fail, another supplier, or an insurance company, will pick up

where the supplier left off and will supply the services, such as car repair,

that mean that the consumer will not be unduly disadvantaged. In the case

of franchisor suppliers of franchise businesses to franchisee consumers, it

turns out to be a flawed assumption.

There is also an entrenched notion that business persons are able to

negotiate their contracts and thus cannot be vulnerable consumers. Both

notions have been demonstrated to be incorrect.

Former franchisees of failed franchisors are invisible on government

databases and are rarely the subject of academic research because they are

difficult to find and to research.

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.

Lobby groups in Australia have traditionally deflected the regulators’

attention away from failure.

Hadfield also makes observations about the disproportionate influence of

lobby groups, citing Martin Bailey and Rubin685F

686 who observe that ‘the

bureaucratic and legislative processes involved in drafting legislation,

however, may face other distortions in information and incentives arising

from interest group politics’.686F

687 This theme is repeated by Michael Le Page

who writes:

The effectiveness of policies … can be empirically determined. … the best

evidence comes from randomised controlled trials; better still, a systematic

review of randomised trials. “Common sense” and good intentions are no

substitute for hard evidence. … The big challenge is to get politicians and

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.

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policy-makers to understand what constitutes rigorous evidence and to base

their decisions on it, rather than on the urgings of lobbyists. The only

alternative is to spend vast sums on programmes and policies that, far from

achieving their aims, may be making matters worse.687F

688

Periodic government reviews of insolvency policy have not received

submissions from franchise interests.

Where franchising is the subject of specific national legislation, the focus is

typically on pre-contract disclosure. This ignores that fact that even if the disclosure

is perfect, and the franchisees’ due diligence is thorough, some franchisors will still

fail, or will choose insolvency to deliver commercial benefits to themselves and their

shareholders. At that point, the best disclosure and due diligence prove useless to the

franchisee.

Any proposals put to the liquidator by groups of franchisees must be measured

enough to permit the value of the brand to be retained if possible. Solutions should

address the potential for the franchisee to continue in business with or without the

brand. The franchisees as a group may be able to buy the brand. Every concession

secured by franchisees in relation to every contractual commitment will be as a result

of their ability as negotiators.

Timing is critical so that the individual franchisees remain motivated, their

customers remain loyal, and so they can put constructive solutions to their own

financiers and landlords, and do not suffer too great a loss of brand value.

7.2 AREAS FOR FUTURE RESEARCH

7.2.1 DATABASE

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.

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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.

7.2.2 CONFLICTS OF INTEREST

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.

7.2.3 INTELLECTUAL PROPERTY

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

The rights of the franchisees as parties to consequential contracts between

themselves and third parties that are, in practical if not legal terms, frustrated by the

franchisor’s failing, is under-researched.

7.2.5 THE POTENTIAL LIABILITY OF LENDERS

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.

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7.2.6 INSOLVENT MASTER FRANCHISEES

Whether the ‘franchisor’ that becomes insolvent is the franchisor or is actually

a national or state master franchisee is significant for its franchisees. If the franchisor

is really a national or state master franchisee, the master franchisee’s insolvency will

most likely be an event that gives the ‘parent’ franchisor the right to terminate the

master licence agreement. This can render the franchisees’ agreements with the

master meaningless. At law, one can only grant a right that is equal to or smaller than

the rights one enjoys oneself.

This research has not specifically explored the implications of franchisor

failure for international franchising or for franchise networks that include master

licensees.

7.2.7 CORPORATIONS ACT RESPONSES

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’. 688F

689 A solution to the problems raised

by franchisor insolvency that is based only on ex ante consumer protection is not

sufficient.

The opportunities for amending the Corporations Act to recognise franchisees

appropriately in the franchisors’ insolvency to be explored in depth in the future

include;

The franchise agreement as an executory contract under the Corporations

Act. The issues of the treatment of ipso facto clauses proposed as part of

the solution in chapter 6.2.3 would be addressed here.

Pooling identified in chapter 4.3.3.

Insolvency of a national master franchisee.

Directors duties and the duties of administrators and liquidators towards

franchisees of both solvent and insolvent franchisors.

689 Cork, above n 252, 9.

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7.2.8 INTERNATIONAL INSOLVENCY PRINCIPLES

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.689F

690

Each jurisdiction places different weight on the claims of different stakeholders

as should be apparent from Appendix C.

The UNCITRAL principles are listed below with comments on how those

goals fit with the circumstances of franchisor insolvency.

Maximizing the value of the assets.

In the franchisor’s business the significant assets are its intellectual property

and the franchise contracts. They are often owned by different entities, and the

franchise agreements are likely to be the only asset owned by the franchisor.

Striking a balance between reorganization and liquidation

While many liquidators recognise that the existing franchisees might be

prospective purchasers of the franchisor’s business and its network, there is no

obligation to offer that business to the franchisees. Reorganisation may be

unsatisfactory from a consumer protection perspective as the franchise agreements

may, as occurred in Brumby’s, be disclaimed in the process of the restructuring.

Providing for timely, efficient and impartial resolution of insolvency

Meeting this objective makes it difficult, if not impossible, for franchisees to

have time to seek leave of the court to pursue the insolvent franchisor for breach of

contract or to prove a breach of consumer protection legislation, and thus to re-claim

the moneys paid to the franchisor in return for what turns out to be much less than

payment of the franchise fee entitled the franchisee to receive.

690 United Nations Commission on International Trade Law, Draft Legislative Guide on Insolvency

Law (2003) 1-2, 6.

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The franchisee in Table 3 contracted to receive, amongst other things, five

years of franchisor support and the right to trade under the franchisor’s marks for

five years out of premises held in the franchisor’s name, plus the right to open three

future sites. Instead, within six months of paying $60,000 for franchise fees and a

further $60,000 for the rights to open future territories, the franchisor was insolvent

and the liquidator had disclaimed the lease of the franchisee’s premises. It could be

argued that ‘the creditors of the debtor [franchisor] receive[d] a windfall and [were

unjustly] enriched at the expense of the hapless real owner.’690F

691 The policy choice to

favour a timely resolution of the insolvency means that franchisees’ potential claims

cannot realistically be pursued through the courts.

Preventing premature dismemberment of the debtor’s assets

Without the ability to exploit the franchise, the ability of the franchisee to

trade profitably is destroyed. Franchise systems, by their nature, involve a

complex network of business relations. The effects of franchisor insolvency

on the franchise ecosystem translates … into a myriad of interests and

competing claims among which the franchisee is the least protected.691F

692

As the insolvent franchisor is usually part of an interdependent group of

entities it would be appropriate to include a consideration of franchise networks in

future research into the insolvency of corporate groups.

7.2.9 CROSS BORDER INSOLVENCY

As 27 per cent ‘of Australian based franchisors are currently franchising

overseas’692F

693 there are numerous instances of successful overseas expansion by

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.

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A survey was conducted of legal practitioners specialising in either creditors’

rights or franchising in 26 countries.693F

694 It was an attempt to discover whether the

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.

7.2.10 FRANCHISEES IN UNIONS AND REPRESENTATIVE GROUPS

The effectiveness for Japanese franchisees of union membership and the

European subsidised consumer representation groups provide models to be evaluated

in the future. These were raised in chapter 6.1.3.

Franchisees appointing committees of franchisees as recognised stakeholders

with voting power should also be considered and possibly trialled as part of any

research conducted under the Corporations Act.

7.2.11 NOT PURELY A LEGAL ISSUE

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.

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Appendices

APPENDIX A: AUSTRALIAN COMMONWEALTH AND STATE LEGISLATION

Bankruptcy Act 1996 (Cth)

http://www.comlaw.gov.au/comlaw/Legislation/ActCompilation1.nsf/0/ADAB54284

4770FC1CA25766C000E289A?OpenDocument

_______________________________________________________________

Corporations Act 2001 (Cth)

http://www.comlaw.gov.au/ComLaw/Legislation/ActCompilation1.nsf/0/084B0D33

FA61F4BCCA25766D000D8A4F?OpenDocument

50 Related bodies corporate

Where a body corporate is: (a) a holding company of another body corporate; or (b) a subsidiary of another body corporate; or (c) a subsidiary of a holding company of another body corporate;

the first-mentioned body and the other body are related to each other.

50AAA Associated entities

(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.

(3) This subsection is satisfied if the principal controls the associate.

(4) This subsection is satisfied if: (a) the associate controls the principal; and (b) the operations, resources or affairs of the principal are material to the associate.

(5) This subsection is satisfied if: (a) the associate has a qualifying investment (see subsection (8)) in the principal; and (b) the associate has significant influence over the principal; and (c) the interest is material to the associate.

(6) This subsection is satisfied if: (a) the principal has a qualifying investment (see subsection (8)) in the associate; and (b) the principal has significant influence over the associate; and (c) the interest is material to the principal.

(7) This subsection is satisfied if: (a) an entity (the third entity) controls both the principal and the associate; and (b) the operations, resources or affairs of the principal and the associate are both

material to the third entity.

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(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.

(2) In determining whether the first entity has this capacity: (a) the practical influence the first entity can exert (rather than the rights it can

enforce) is the issue to be considered; and (b) any practice or pattern of behaviour affecting the second entity’s financial or

operating policies is to be taken into account (even if it involves a breach of an agreement or a breach of trust).

(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.

(4) If the first entity: (a) has the capacity to influence decisions about the second entity’s financial and

operating policies; and (b) is under a legal obligation to exercise that capacity for the benefit of someone

other than the first entity’s members; the first entity is taken not to control the second entity.

95A Solvency and insolvency

(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.

(2) A person who is not solvent is insolvent.

295 Contents of annual financial report

Basic contents

(1) The financial report for a financial year consists of: (a) the financial statements for the year; and (b) the notes to the financial statements; and (c) the directors’ declaration about the statements and notes.

Financial statements

(2) The financial statements for the year are: (a) the financial statements in relation to the entity reported on that are required by

the accounting standards; and (b) if required by the accounting standards—the financial statements in relation to the

consolidated entity that are required by the accounting standards.

Notes to financial statements

(3) The notes to the financial statements are: (a) disclosures required by the regulations; and (b) notes required by the accounting standards; and

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(c) any other information necessary to give a true and fair view (see section 297).

Directors’ declaration

(4) The directors’ declaration is a declaration by the directors: (c) whether, in the directors’ opinion, there are reasonable grounds to believe that the

company, registered scheme or disclosing entity will be able to pay its debts as and when they become due and payable; and

(d) whether, in the directors’ opinion, the financial statement and notes are in accordance with this Act, including:

(i) section 296 (compliance with accounting standards); and (ii) section 297 (true and fair view); and (e) if the company, disclosing entity or registered scheme is listed—that the directors

have been given the declarations required by section 295A.

Note: See paragraph 285(3)(c) for the reference to the debts of a registered scheme.

(5) The declaration must: (a) be made in accordance with a resolution of the directors; and (b) specify the date on which the declaration is made; and (c) be signed by a director.

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.

(2) The declaration is a declaration whether, in the person’s opinion: (a) the financial records of the company, disclosing entity or registered scheme for

the financial year have been properly maintained in accordance with section 286; and

(b) the financial statements, and the notes referred to in paragraph 295(3)(b), for the financial year comply with the accounting standards; and

(c) the financial statements and notes for the financial year give a true and fair view (see section 297); and

(d) any other matters that are prescribed by the regulations for the purposes of this paragraph in relation to the financial statements and the notes for the financial year are satisfied.

(3) The declaration must: (a) be made in writing; and (b) specify the date on which the declaration is made; and (c) specify the capacity in which the person is making the declaration; and (d) be signed by the person making the declaration.

A person who performs both a chief executive function and a chief financial officer function may make a single declaration in both capacities.

(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

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a chief executive function in relation to the company, disclosing entity or registered scheme if the person is one of a number of people who together are primarily and directly responsible to the directors for the general and overall management of the company, disclosing entity or registered scheme.

(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.

296 Compliance with accounting standards and regulations

(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.

297 True and fair view

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).

437A Role of administrator

(1) While a company is under administration, the administrator:

(a) has control of the company’s business, property and affairs; and

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(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.

439A Administrator to convene meeting and inform creditors

(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.

(3) The administrator must convene the meeting by: (a) giving written notice of the meeting to as many of the company’s creditors as

reasonably practicable; and (b) causing notice of the meeting to be published: (i) in a national newspaper; or (ii) in each State or Territory in which the company has its registered office or

carries on business, in a daily newspaper that circulates generally in that State or Territory;

at least 5 business days before the meeting.

Note: For electronic notification under paragraph (a), see section 600G.

(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.

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(5) The convening period is: (a) if the day after the administration begins is in December, or is less than 25

business days before Good Friday—the period of 25 business days beginning on: (i) that day; or (ii) if that day is not a business day—the next business day; or (b) otherwise—the period of 20 business days beginning on: (i) the day after the administration begins; or (ii) if that day is not a business day—the next business day.

(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.

439B Conduct of meeting

(1) At a meeting convened under section 439A, the administrator is to preside.

(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.

439C What creditors may decide

At a meeting convened under section 439A, the creditors may resolve: (a) that the company execute a deed of company arrangement specified in the

resolution (even if it differs from the proposed deed (if any) details of which accompanied the notice of meeting); or

(b) that the administration should end; or (c) that the company be wound up.

440D Stay of proceedings

(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.

(2) Subsection (1) does not apply to: (a) a criminal proceeding; or (b) a prescribed proceeding.

471B Stay of proceedings and suspension of enforcement process

While a company is being wound up in insolvency or by the Court, or a provisional liquidator of a company is acting, a person cannot begin or proceed with:

(a) a proceeding in a court against the company or in relation to property of the company; or

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(b) enforcement process in relation to such property; except with the leave of the Court and in accordance with such terms (if any) as the Court imposes.

533 Reports by liquidator

(1) If it appears to the liquidator of a company, in the course of a winding up of the company, that:

(a) a past or present officer or employee, or a member or contributory, of the company may have been guilty of an offence under a law of the Commonwealth or a State or Territory in relation to the company; or

(b) a person who has taken part in the formation, promotion, administration, management or winding up of the company:

(i) may have misapplied or retained, or may have become liable or accountable for, any money or property of the company; or

(ii) may have been guilty of any negligence, default, breach of duty or breach of trust in relation to the company; or

(c) the company may be unable to pay its unsecured creditors more than 50 cents in the dollar;

the liquidator must: (d) as soon as practicable, and in any event within 6 months, after it so appears to

him or her, lodge a report with respect to the matter and state in the report whether he or she proposes to make an application for an examination or order under section 597; and

(e) give ASIC such information, and give to it such access to and facilities for inspecting and taking copies of any documents, as ASIC requires.

(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.

(3) If it appears to the Court, in the course of winding up a company: (a) that a past or present officer or employee, or a contributory or member, of the

company has been guilty of an offence under a law referred to in paragraph (1)(a) in relation to the company; or

(b) that a person who has taken part in the formation, promotion, administration, management or winding up of the company has engaged in conduct referred to in paragraph (1)(b) in relation to the company;

and that the liquidator has not lodged with ASIC a report with respect to the matter, the Court may, on the application of a person interested in the winding up, direct the liquidator so to lodge such a report.

558 Debts due to employees

(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

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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.

(5) In this section, retrenchment amount, in relation to employment of a person, means an amount payable to the person, by virtue of an industrial instrument, in respect of termination of the employment.

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Income Tax Assessment Act 1997 (Cth)

40-880 Business related costs

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.

Limitations and exceptions

(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

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(b) the expenditure is in connection with: (i) your deriving assessable income from the business; and (ii) the business that was carried on or is proposed to be carried on.

(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.

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Trade Marks Act 1995 (Cth)

s 8 ‘authorised users’

8 (1) … uses the trade mark in relation to goods or services under the control of the owner of the trade mark

20 Rights given by registration of trade mark (1) If a trade mark is registered, the registered owner of the trade mark has, subject to this Part, the exclusive rights:

(a) to use the trade mark; and (b) to authorise other persons to use the trade mark; in relation to the goods and/or services in respect of which the trade mark is registered. (2) The registered owner of a trade mark has also the right to obtain relief under this

Act if the trade mark has been infringed. (3) omitted (4) If the trade mark is registered subject to conditions or limitations, the rights of the

registered owner are restricted by those conditions or limitations. (5) If the trade mark is registered in the name of 2 or more persons as joint owners of

the trade mark, the rights granted to those persons under this section are to be exercised by them as if they were the rights of a single person

21 Nature of registered trade mark as property (1) A registered trade mark is personal property. (2) Equities in respect of a registered trade mark may be enforced in the same way as

equities in respect of any other personal property. S 22 Power of registered owner to deal with trade mark

(1) The registered owner of a trade mark may, subject only to any rights appearing in the Register to be vested in another person, deal with the trade mark as its absolute owner and give in good faith discharges for any consideration for that dealing

26 Powers of authorised user of registered trade mark

(1) Subject to any agreement between the registered owner of a registered trade mark and an authorised user of the trade mark, the authorised user may do any of the following:

(a) the authorised user may use the trade mark in relation to the goods and/or services in respect of which the trade mark is registered, subject to any condition or limitation subject to which the trade mark is registered;

(b) the authorised user may (subject to subsection (2)) bring an action for infringement of the trade mark:

(i) at any time, with the consent of the registered owner; or

(ii) during the prescribed period, if the registered owner refuses to bring such an action on a particular occasion during the prescribed period; or

(iii) after the end of the prescribed period, if the registered owner has failed to bring such an action during the prescribed period;

(c) the authorised user may cause to be displayed on goods in respect of which the trade mark is registered, or on their package, or on the container in which they are offered to the public, a notice prohibiting any act that is under subsection 121(2) a prohibited act in relation to the goods;

(d) the authorised user may:

(i) give to the Customs CEO a notice under section 132 objecting to the importation of goods that infringe the trade mark; or

(ii) revoke such a notice;

(e) an authorised user may give permission to any person:

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(i) to alter or deface; or

(ii) to make any addition to; or

(iii) to remove, erase or obliterate, wholly or partly;

a registered trade mark that is applied to any goods, or in relation to any goods or services, in respect of which the trade mark is registered;

(f) the authorised user may give permission to any person to apply the trade mark to goods, or in relation to goods or services, in respect of which the trade mark is registered.

Note 1: For registered owner and registered trade mark see section 6.

Note 2: For authorised user see section 8.

Note 3: For what amounts to an infringement of a trade mark see Part 12.

Note 4: For apply to and apply in relation to see section 9.

(2) If the authorised user brings an action for infringement of the trade mark, the authorised user must make the registered owner of the trade mark a defendant in the action. However, the registered owner is not liable for costs if he or she does not take part in the proceedings.

Part 10—Assignment and transmission of trade marks

S 106 Assignment etc. of trade mark

(1) A registered trade mark, or a trade mark whose registration is being sought, may be assigned or transmitted in accordance with this section.

(2) The assignment or transmission may be partial, that is, it may apply to some only of the goods and/or services in respect of which registration is sought or the trade mark is registered, but it may not be partial in relation to the use of a trade mark in a particular area.

(3) The assignment or transmission may be with or without the goodwill of the business concerned in the relevant goods and/or services.

107 Applications for record to be made of assignment etc. of trade mark whose registration is sought

(1) If a trade mark whose registration is being sought is assigned or transmitted:

(a) the applicant for the registration of the trade mark; or

(b) the person to whom it has been assigned or transmitted;

must apply to the Registrar for the assignment or transmission to be recorded.

(2) The application must:

(a) be in an approved form; and

(b) be filed, together with any prescribed document, in accordance with the regulations.

Part 11—Voluntary recording of claims to interests in and rights in respect of trade marks Div 1—Preliminary 112 Object of Part: This Part makes provision: (a) for recording in the Register claims to interests in, and rights in respect of, registered trade marks that may not be so recorded under another Part; and (b) for the Registrar to keep a record of claims to interests in, and rights in respect of, trade marks for which registration is sought.

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Trade Practices Act 1974 (Cth)

http://www.comlaw.gov.au/ComLaw/Legislation/ActCompilation1.nsf/0/C7F08B8A219DB518CA2575FC0082807A?OpenDocument

2 Object of this Act

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.

(2) For the purposes of subsection (1): (a) the prescribed amount is $40,000 or, if a greater amount is prescribed for the

purposes of this paragraph, that greater amount; (b) subject to paragraph (c), the price of goods or services purchased by a person

shall be taken to have been the amount paid or payable by the person for the goods or services;

(c) where a person purchased goods or services together with other property or services, or with both other property and services, and a specified price was not allocated to the goods or services in the contract under which they were purchased, the price of the goods or services shall be taken to have been:

(i) the price at which, at the time of the acquisition, the person could have purchased from the supplier the goods or services without the other property or services;

(ii) if, at the time of the acquisition, the goods or services were not available for purchase from the supplier except together with the other property or services but, at that time, goods or services of the kind acquired were available for purchase from another supplier without other property or services—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, at the time of the acquisition, goods or services of the kind acquired were not available for purchase from any supplier except together with other property or services—the value of the goods or services at that time;

(d) where a person acquired goods or services otherwise than by way of purchase, the price of the goods or services shall be taken to have been:

(i) the price at which, at the time of the acquisition, the person could have purchased the goods or services from the supplier;

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(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.

4C Acquisition, supply and re-supply

In this Act, unless the contrary intention appears: (a) a reference to the acquisition of goods includes a reference to the acquisition of

property in, or rights in relation to, goods in pursuance of a supply of the goods; (b) a reference to the supply or acquisition of goods or services includes a reference

to agreeing to supply or acquire goods or services; (c) a reference to the supply or acquisition of goods includes a reference to the

supply or acquisition of goods together with other property or services, or both; (d) a reference to the supply or acquisition of services includes a reference to the

supply or acquisition of services together with property or other services, or both; (e) a reference to the re-supply of goods acquired from a person includes a reference

to: (i) a supply of the goods to another person in an altered form or condition; and (ii) a supply to another person of goods in which the first-mentioned goods

have been incorporated; (f) a reference to the re-supply of services (the original services) acquired from a

person (the original supplier) includes a reference to: (i) a supply of the original services to another person in an altered form or

condition; and (ii) a supply to another person of other services that are substantially similar to

the original services, and could not have been supplied if the original services had not been acquired by the person who acquired them from the original supplier.

51AC Unconscionable conduct in business transactions

(1) A corporation must not, in trade or commerce, in connection with: (a) the supply or possible supply of goods or services to a person (other than a listed

public company); or (b) the acquisition or possible acquisition of goods or services from a person (other

than a listed public company);

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engage in conduct that is, in all the circumstances, unconscionable.

(2) A person must not, in trade or commerce, in connection with: (a) the supply or possible supply of goods or services to a corporation (other than a

listed public company); or (b) the acquisition or possible acquisition of goods or services from a corporation

(other than a listed public company); engage in conduct that is, in all the circumstances, unconscionable.

(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

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(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

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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.

52 Misleading or deceptive conduct

(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).

59 Misleading representations about certain business activities

(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.

(2) Where a corporation, in trade or commerce, invites, whether by advertisement or otherwise, persons to engage or participate, or to offer or apply to engage or participate, in a business activity requiring the performance by the persons concerned of work, or the investment of moneys by the persons concerned and the performance by them of work associated with the investment, the corporation shall not make, with respect to the profitability or risk or any other material aspect of the business activity, a representation that is false or misleading in a material particular.

Division 2—Conditions and warranties in consumer transactions

66 Interpretation

(1) In this Division: (a) a reference to the quality of goods includes a reference to the state or condition of

the goods;

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(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.

69 Implied undertakings as to title, encumbrances and quiet possession

(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.

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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.

71 Implied undertakings as to quality or fitness

(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.

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74 Warranties in relation to the supply of services

(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

(1) In this Division:

express warranty, in relation to goods, means an undertaking, assertion or representation in relation to:

(a) the quality, performance or characteristics of the goods; (b) the provision of services that are or may at any time be required in respect of the

goods; (c) the supply of parts that are or may at any time be required for the goods; or (d) the future availability of identical goods, or of goods constituting or forming part

of a set of which the goods in relation to which the undertaking, assertion or representation is given or made form part;

given or made in connection with the supply of the goods or in connection with the promotion by any means of the supply or use of the goods, the natural tendency of which is to induce persons to acquire the goods.

manufactured includes grown, extracted, produced, processed and assembled.

(2) In this Division: (a) a reference to goods shall, unless the contrary intention appears, be read as a

reference to goods of a kind ordinarily acquired for personal, domestic or household use or consumption;

(aa) a reference to a person who acquires goods from a consumer does not include a reference to a person who acquires goods for the purpose of re-supply;

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(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.

(5) For the purposes of paragraph (3)(b): (a) a name, brand or mark shall be deemed to be applied to goods if it: (i) is woven in, impressed on, worked into or annexed or affixed to the goods;

or (ii) is applied to a covering, label, reel or thing in or with which the goods are

supplied; and (b) if the name of a corporation, a name in which a corporation carries on business or

a brand or mark of a corporation is applied to goods, it shall be presumed, unless the contrary is established, that the corporation caused or permitted the name, brand or mark to be applied to 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.

74B Actions in respect of unsuitable goods

(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;

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(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.

74C Actions in respect of false descriptions

(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.

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(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) In this Part, unless the contrary intention appears: (a) a reference to the Court in relation to a matter is a reference to any court having

jurisdiction in the matter; (b) a reference to the Federal Court is a reference to the Federal Court of Australia;

and (c) a reference to a judgment is a reference to a judgment, decree or order, whether

final or interlocutory. __________________________________________________

Trade Practices (Industry Codes - Franchising) Regulations 1998 (Franchising Code of Conduct) (Cth)

Part 1 Preliminary

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:

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(a) the rights and obligations under a franchise agreement;

(b) a master franchise;

(c) a subfranchise;

(d) an interest in a franchise.

franchise agreement has the meaning given by clause 4.

franchisee includes the following:

(a) a person to whom a franchise is granted;

(b) a person who otherwise participates in a franchise as a franchisee;

(c) a subfranchisor in its relationship with a franchisor;

(d) a subfranchisee in its relationship with a subfranchisor.

franchise system includes a business system in which a franchisor grants a franchise to a franchisee.

franchisor includes the following:

(a) a person who grants a franchise;

(b) a person who otherwise participates in a franchise as a franchisor;

(c) a subfranchisor in its relationship with a subfranchisee;

(d) a master franchisee in a master franchise system;

(e) a master franchisee in its relationship with a franchisee.

interest in a franchise includes a legal or beneficial interest in:

(a) a franchise agreement or a franchised business; or

(b) shares or voting rights in a corporation, not being a listed corporation that owns a franchised business; or

(c) units or voting rights in a unit or other trust that owns a franchised business; or

(d) the capital or income of a partnership that owns a franchised business.

4 Meaning of franchise agreement

(1) A franchise agreement is an agreement:

(a) that takes the form, in whole or part, of any of the following:

(i) a written agreement;

(ii) an oral agreement;

(iii) an implied agreement; and

(b) in which a person (the franchisor) grants to another person (the franchisee) the right to carry on the business of offering, supplying or distributing goods or services in Australia under a system or marketing plan substantially determined, controlled or suggested by the franchisor or an associate of the franchisor; and

(c) under which the operation of the business will be substantially or materially associated with a trade mark, advertising or a commercial symbol:

(i) owned, used or licensed by the franchisor or an associate of the franchisor; or

(ii) specified by the franchisor or an associate or the franchisor; and

(d) under which, before starting business or continuing the business, the franchisee must pay or agree to pay to the franchisor or an associate of the franchisor an amount including, for example:

(i) an initial capital investment fee; or

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(ii) a payment for goods or services; or

(iii) a fee based on a percentage of gross or net income whether or not called a royalty or franchise service fee; or

(iv) a training fee or training school fee;

but excluding:

(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 

Division 2.1 Disclosure document

6 Franchisor must maintain a disclosure document

(1) A franchisor must, before entering into a franchise agreement, and within 4 months after the end of each financial year after entering into a franchise agreement, create a document (a disclosure document) for the franchise in accordance with this Division.

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(2) A disclosure document:

(a) must be:

(i) if the franchised business has an expected annual turnover at any time during the term of the franchise agreement of $50 000 or more — in accordance with Annexure 1; or

(ii) if the franchised business has an expected annual turnover of less than $50 000 — in accordance with Annexure 1 or 2; and

(b) may include additional information under the heading ‘Other relevant disclosure information’; and

(c) must be signed by a director or other officer of the franchisor.

6A Purpose of disclosure document

The purposes of a disclosure document are:

(a) to give to a prospective franchisee, or a franchisee proposing to enter into, renew or extend a franchise agreement, information from the franchisor to help the franchisee to make a reasonably informed decision about the franchise; and

(b) to give a franchisee current information from the franchisor that is material to the running of the franchised business.

6B Requirement to give disclosure document

(1) A franchisor must give a current disclosure document to:

(a) a prospective franchisee; or

(b) a franchisee proposing to:

(i) renew a franchise agreement; or

(ii) extend the scope or term of a franchise agreement.

(2) If a subfranchisor proposes to grant a subfranchise to a prospective subfranchisee:

(a) the franchisor and subfranchisor must:

(i) give separate disclosure documents, in relation to the master franchise and the subfranchise respectively, to the prospective subfranchisee; or

(ii) give to the prospective subfranchisee a joint disclosure document that addresses the respective obligations of the franchisor and the subfranchisor; and

(b) the subfranchisor must comply with the requirements imposed on a franchisor by this Part.

Note A subfranchisor is also sometimes referred to as a master franchisee: see subclause 3 (1).

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.

Division 2.2 Before franchise agreement

8 Application

This Division applies to a disclosure document in accordance with Annexure 1 or 2 for:

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(a) a prospective franchisee; or

(b) a franchisee proposing to enter into, renew or extend a franchise agreement.

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:

(d) a prospective franchisee at least 14 days before the prospective franchisee:

(i) enters into a franchise agreement or an agreement to enter into a franchise agreement; or

(ii) makes a non-refundable payment (whether of money or of other valuable consideration) to the franchisor or an associate of the franchisor in connection with the proposed franchise agreement; or

(e) a franchisee at least 14 days before renewal or extension of the franchise agreement.

Note Subsection 9 (1) of the Electronic Transactions Act 1999 provides that a requirement under a law of the Commonwealth to give information in writing is satisfied by giving the information electronically if it is reasonable to expect that the information will be readily accessible so as to be useable for subsequent reference, and the person to whom the information is given consents to it being provided electronically.

11 Advice before entering into franchise agreement

(1) The franchisor must not:

(a) enter into, renew or extend a franchise agreement; or

(b) enter into an agreement to enter into, renew or extend a franchise agreement; or

(c) receive a non-refundable payment (whether of money or of other valuable consideration) under a franchise agreement or an agreement to enter into a franchise agreement;

unless the franchisor has received from the franchisee or prospective franchisee a written statement that the franchisee or prospective franchisee has received, read and had a reasonable opportunity to understand the disclosure document and this code.

(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.

(3) Subclause (2):

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(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.

(2) For subclause (1), the documents are:

(a) a copy of the agreement to lease;

(b) a copy of the lease.

(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.

(4) For subclause (3), the documents are:

(a) a copy of the franchisor’s or associate’s lease or agreement to lease;

(b) a copy of the documents that give the franchisee rights to occupy the premises;

(c) written details of the conditions of occupation.

15 Association of franchisees or prospective franchisees

A franchisor must not induce a franchisee or prospective franchisee:

(a) not to form an association; or

(b) not to associate with other franchisees or prospective franchisees for a lawful purpose.

18 Disclosure of materially relevant facts

(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.

(2) For subclause (1), the matters are the following:

(a) change in majority ownership or control of the franchisor;

(b) proceedings by a public agency, a judgment in criminal or civil proceedings or an award in an arbitration 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

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(vi) an offence of dishonesty;

(c) a judgment against the franchisor, other than for unfair dismissal of an employee, 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;

(d) civil proceedings in Australia against the franchisor or a franchisor director by at least 10%, or 10, of the franchisees in Australia of the franchisor (whichever is the lower);

(e) any judgment that is entered against the franchisor in Australia, and is not discharged within 28 days, for at least:

(i) for a small proprietary company — $100,000; or

(ii) for any other company — $1,000,000;

(f) any judgment that is entered against the franchisor in a matter mentioned in item 4.2 of Annexure 1 or item 3.2 of Annexure 2;

(g) the franchisor becoming an externally-administered body corporate;

(h) a change in the intellectual property, or ownership or control of the intellectual property, that is material to the franchise system;

(i) the existence and content of any undertaking or order under section 87B of the Act.

(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).

23 Termination — special circumstances

A franchisor does not have to comply with clause 21 or 22 if the franchisee:

(a) no longer holds a licence that the franchisee must hold to carry on the franchised business; or

(b) becomes bankrupt, insolvent under administration or an externally-administered body corporate; or

(c) voluntarily abandons the franchised business or the franchise relationship; or

(d) is convicted of a serious offence; or

(e) operates the franchised business in a way that endangers public health or safety; or

(f) is fraudulent in connection with operation of the franchised business; or

(g) agrees to termination of the franchise agreement.

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27 Code complaint handling procedure

A party to a franchise agreement who has a dispute with another party to the franchise agreement may start the procedure under clause 29.

 

Franchising Code of Conduct Annexure 1 Disclosure document for franchisee or prospective franchisee

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

2.1 The franchisor’s:

(a) name; and

(b) address, or addresses, of registered office and principal place of business in Australia; and

(c) ABN, ACN or ARBN (or foreign equivalent if the franchisor is a foreign franchisor).

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2.2 The name under which the franchisor carries on business in Australia relevant to the franchise.

2.3 A description of the kind of business operated under 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.

4.2 Whether the franchisor or a director of the franchisor has been:

(a) in the last 10 years — convicted of a serious offence, or an equivalent offence outside Australia; or

(b) in the last 5 years — subject to final judgment in civil proceedings for a matter mentioned in paragraph 4.1 (a); or

(c) in the last 10 years — bankrupt, insolvent under administration or an externally-administered body corporate in Australia or elsewhere.

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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.

8 Franchise site or territory

8.1 Whether the franchise is:

(a) for an exclusive or non-exclusive territory; or

(b) limited to a particular site.

8.2 For the territory of the franchise:

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(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 Obligation to sign related agreements

18.1 Summary of any requirements under the franchise agreement for the franchisee or directors, shareholders, beneficiaries, owners or partners of the franchisee to enter into any of the following agreements:

(a) a lease, sublease, licence or other agreement under which the franchisee can occupy the premises of the franchised business;

(b) a chattel lease or hire purchase agreement;

(ba) an agreement under which the franchisee gains ownership of, or is authorised to use, any intellectual property;

(c) a security agreement, including a guarantee, mortgage, security deposit, indemnity, loan agreement or obligation to provide a bank guarantee to a third party;

(d) a confidentiality agreement;

(e) an agreement not to carry on business within an area or for a time after the franchise agreement is terminated.

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.

20.3 Item 20.2 does not apply if:

(a) the statement under item 20.1 is supported by an independent audit provided by:

(i) a registered company auditor; or

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(ii) if the franchisor is a foreign franchisor — a foreign equivalent for that franchisor;

within 12 months after the end of the financial year to which the statement relates; and

(b) a copy of the independent audit is provided with the statement under item 20.1.

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.

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(2) What is a reasonable time is a question of fact.

Rule 5: (1) When there is a contract for the sale of unascertained or future goods by description, and goods of that description and in a deliverable state are unconditionally appropriated to the contract, either by the seller with the assent of the buyer, or by the buyer with the assent of the seller, the property in the goods thereupon passes to the buyer.

(1A) Such assent may be express or implied, and may be given either before or after the appropriation is made.

(2) When, in pursuance of the contract, the seller delivers the goods to the buyer or to a carrier or other bailee (whether named by the buyer or not) for the purpose of transmission to the buyer, and does not reserve the right of disposal, the seller is deemed to have unconditionally appropriated the goods to the contract.

22 Reservation of right of disposal

(1) When there is a contract for the sale of specific goods or when goods are subsequently appropriated to the contract, the seller may, by the terms of the contract or appropriation, reserve the right of disposal of the goods until certain conditions are fulfilled.

(1A) In such case, notwithstanding the delivery of the goods to the buyer, or to a carrier or other bailee for the purpose of transmission to the buyer, the property in the goods does not pass to the buyer until the conditions imposed by the seller are fulfilled.

(2) When goods are shipped, and by the bill of lading the goods are deliverable to the order of the seller or the seller’s agent, the seller is prima facie deemed to reserve the right of disposal.

(3) When the seller of goods draws on the buyer for the price, and transmits the bill of exchange and bill of lading to the buyer together to secure acceptance or payment of the bill of exchange, the buyer is bound to return the bill of lading if the buyer does not honour the bill of exchange, and if the buyer wrongfully retains the bill of lading the property in the goods does not pass to the buyer.

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APPENDIX B: FOREIGN LEGISLATION

Canada

In Ontario, Canada franchisees as sub-tenants have the right under Commercial

Tenancies Act RSO 1990, c L7, s 39(2) to elect to become the lessee,

http://www.canlii.org/on/laws/sta/l-7/20080515/whole.html viewed 15 May 2008.

Lien of landlord in bankruptcy, etc., further provisions

Election to surrender

39 (1) The person who is assignee, liquidator or trustee has the further right, at any time before so electing, by notice in writing to the landlord, to surrender possession or disclaim any such lease, and the person’s entry into possession of the leased premises and their occupation by the person, while required for the purposes of the trust estate, shall not be deemed to be evidence of an intention on the person’s part to elect to retain possession under section 38 RSO 1990, cL7, s39(1).

Rights of sub-tenants

(2) Where the assignor, or person or firm against whom a receiving order has been made in bankruptcy, or a winding up order has been made, being a lessee, has, before the making of the assignment or such order demised any premises by way of under-lease, approved or consented to in writing by the landlord, and the assignee, liquidator or trustee surrenders, disclaims or elects to assign the lease, the under-lessee, if the under-lessee so elects in writing within three months of such assignment or order, stands in the same position with the landlord as though the under-lessee were a direct lessee from the landlord but subject, except as to rental payable, to the same liabilities and obligations as the assignor, bankrupt or insolvent company was subject to under the lease at the date of the assignment or order, but the under-lessee shall in such event be required to covenant to pay to the landlord a rental not less than that payable by the under-lessee to the debtor, and if such last mentioned rental was greater than that payable by the debtor to the said landlord, the under-lessee shall be required to covenant to pay to the landlord the like greater rental. RSO 1990, c L7, s 39 (2).

An example of the section being applied is in Majdpour v M & B Acquisition Corp 2001 CanLII 28457 (ON SC); (2001) 25 CBR (4th) 62 <http://www.canlii.org/en/on/onsc/doc/2001/2001canlii28457/2001canlii28457.html> at June 2008.

______________________________________

UK

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.

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(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.

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APPENDIX C: POSSIBLE CATEGORISATION OF FRANCHISEES’ INTERESTS IN DIVERSE JURISDICTIONS

Country Possible categorisation of franchisees’ interests by franchisor’s liquidator

Asset Liability Creditor Debtor Franchisee Other Do not know

Australia √ √ √ √

Belgium √ √

British Virgin Is √

Canada √ √ √ √ √

Colombia √

Denmark √ √ √ √ √

England √ √

Finland √ √ √

France √

Germany √ √ √ √

Greece √ √ √ √

India √

Ireland √ √

Mexico √ √

Netherlands √

New Zealand √ √ √ √

Nigeria √ √ √ √

Republic of Ireland √

Republic of Korea √ √ √ √

Spain √

Sweden √ √ √

Switzerland √ √ √

UK √ √ √ √ √

Syria √ √

USA √

Vietnam √

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APPENDIX D: FRANCHISE NETWORK

Kleenmaid Franchise network where franchisees trade from retail premises, and

franchisees are operated on commission agency model.

(insert scanned Appendix D here)

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Chapter 7: ConclusionBibliography 335

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Case Law

Australian

Acer Computer Australia Pty Limited v Carter (No 2) [2007] FCA 1943

Aston v Harlee Manufacturing Co [1960] HCA 47

Australian Building Construction Employees and Building Labourers Federation (WA Branch) v Pacesetter Homes Pty Ltd (1994) 56 IR 51

Australian Competition and Consumer Commission v Imagine Essential Services Limited [2008] FCA 349 (Gordon J)

Australian Competition and Consumer Commission v Ewing [2004] FCA 5

Australian Competition and Consumer Commission v 4WD Systems Pty Ltd [2003] FCA 850

Australian Competition and Consumer Commission v Grant [2000] FCA 567

Australian Competition & Consumer Commission v Simply No-Knead (Franchising) Pty Ltd [2000] FCA 1365

Australian Competition & Consumer Commission v Trayling [1999] FCA 1133

Australian Mutual Provident Society v Chaplin (1978) 18 ALR 385

Bamco Villa Pty Ltd v Montedeen Pty Ltd; Delta Car Rentals Aust Pty Ltd v Bamco Villa Pty Ltd [2001] VSC 192

Benjamin Morris & Anor v Danoz Directions Pty Ltd (ACN 092 832 534) (in liquidation) & Ors Hearing 2 (P) NSD1313/2008

Cheque One Pty Ltd v Cheque Exchange (Australia) Pty Ltd (in liq) [2002] FCA 593

Chief Commissioner of State Revenue v Zafco Franchise Co Pty Ltd [2006] NSWSC 1085 (Young CJ in Eq)

City Motors (1981) Pty Ltd v Commissioner of State Taxation (WA) (1993) 26 ATR 291

Climaze Holdings Pty Ltd v Dyson (1995) 13 WAR 487

Codelfa Construction Pty Ltd v SRA of NSW (1982) 149 CLR 337

Dymocks Franchise Systems v Bilgola Enterprises Ltd 8 TCLR

Enviro Systems Renewable Resources Pty Ltd v Australian Securities & Investments Commission [2001] SASC 11

Far Horizons Pty Ltd v McDonald's Australia Ltd [2000] VSC 310

Federal Commissioner of Taxation v Brown [1999] FCA 721

Federal Commissioner of Taxation v Jones (2002) 117 FCR 9

Figgins Holdings Pty Ltd v SEAA Enterprises Pty Ltd [1999] HCA 20

Glambed v FCT (1989) 20 ATR 428

Grant v Eddington [2000] FCA 1550

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Hollis v Vabu (2001) 207 CLR 21

Hoy Mobile Pty Ltd v Allphones Retail Pty Ltd (No 2) [2008] FCA 810

Humberstone v Northern Timber Mills (1949) 79 CLR 389

Ibbco Trading Pty Ltd v HIH Casualty and General Insurance Ltd (2001) 19 ACLC 1093

Impressionable Kids Aust Pty Ltd v Karen Cornwall t/as Impressionable Kids Keilor (Civil Claims) [2007] VCAT 2431

Jax Tyres: 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

J F Keir Pty Ltd v Priority Management Systems Pty Ltd (administrators appointed) [2007] NSWSC 789 (Rein AJ)

J F Keir Pty Limited v Sparks [2008] FCA 611 (Graham J)

Kaytonruby Pty Ltd & Ors v Glev Franchisees Pty Ltd & Ors (1998) VG 438 of 1993

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Loyal No 46 v Miller [2001] FMCA 30

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Meridian Retail Pty Ltd v Australian Unity Retail Network Pty Ltd [2006] VSC 223

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Placer Pacific Management Pty Ltd v Federal Commissioner of Taxation 95 ATC 4459

Poulet Frais Pty Ltd v The Silver Fox Company Pty Ltd [2005] FCAFC 131

Re Clothing Trades Award 1982 (1987) 19 IR 416

Re Real Investments Pty Ltd (in liq) [1999] QSC 89

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

Ready Mixed Concrete (South East) Ltd v Minister of Pensions and National Insurance [1968] 2 QB 497

Rousellis v Maiurano [1998] NSWCA 196

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Scanlan's New Neon Ltd v Tooheys Ltd (1943) 67 CLR 169

Selim v McGrath (2004) 22 ACLC 112

Sgobino v South Australia (1987) 46 SASR 292

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Stewart, in the matter of Kleins Franchising Pty Ltd (administrators appointed) (ACN 007 348 236) [2008] FCA 721

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Timic v Hammock [2001] FCA 74

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Canadian

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New Zealand

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South African

Cacun Trading No 24 CC & Others v Seven-Eleven Corporation SA (Pty) Ltd South Africa:

unreported case no 18/IR/Dec 99

UK

Montreal v Montreal Locomotive Works (1947) 1 DLR 161 Stevenson Jordan and Harrison Ltd v MacDonald and Evans [1952] 1 TLR 101 Bank Voor Handel En Scheepvaart NV v Slatford [1953] 1 QB 248

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Days In v Gainesville P-H Properties, Inc 77 BR 285 (Bankr MD Pa 1993)

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In re Nutri/System, Inc, 169 BR 854 (Bankr ED Pa 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)

Legislation

Bankruptcy Act 1966 (Cth)

Corporations Act 2001 (Cth)

Insurance Contracts Act 1984 (Cth)

Trade Practices Act 1974 (Cth)

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)

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