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Regulating Franchising, Part 2

Capitol Building in Washington D.C.
The U.S. Capitol Building from Pennsylvania Avenue. photo/bmm

LEXINGTON, Ky. – Associate Professor Elizabeth Crawford Spencer discusses why a revision of franchise regulation is necessary in this final part of her two-part interview. Spencer's timely book comes out as major legislation to curb franchising abuse has emerged from New England to California, from Canada's Manitoba to South Australia.

A member of the state bar of Texas since 1996, Elizabeth Spencer has worked in law in various parts of the world. She practiced law in Dallas and served on the staff of Southern Methodist University. She was the editor for Kluwer Law International at The Hague. Assistant Professor Spencer has lectured on business and franchise law since 2001 at Bond University, just outside of Brisbane, Australia. Last year she finished writing The Regulation of Franchising in the New Global Economy, a book that regulators, lobbyists, attorneys and franchise advocates will no doubt be poring over.

While visiting with family in Connecticut, Spencer spoke with Blue MauMau.

BMM: Franchise Disclosure Documents depend on a sort of franchisor honor code. What can be done to better the trustworthiness of these documents for prospective franchise investors [buyers]?

Spencer: Registration [where franchisors would be required to file their Disclosure Documents with the government and buyers could freely access those filings, such as the online database CalEasi of California] would be really useful. On the other side, franchisees often don't read or understand the information they receive. I think disclosure in Australia, similar to the U.S., honestly is too detailed. Regulators try to specify all the information that should be provided, but the focus really should have shifted a while ago to enable franchisees receiving the information to understand it and use it, instead of continuing to require more and more information dump, which creates overload on the part of the franchisee.

Registration is important [because it better allows transparency, scrutiny and comparison]. The Franchise Council of Australia, the Australian Competition & Consumer Commission, and the International Franchise Association in the U.S. have embarked on education programs. But in my view, these programs are biased to [favor] sellers of franchises. These groups are not providing prospective franchise owners with the kind of information they need, or even really want. The advertising on behalf of franchisors just needs to be clear for the prospective franchise owner.

BMM: Are you saying that these Disclosure Documents are really sales materials that at its worst can be false advertisements? It reminds me of something a franchise attorney once said to me: "Why doesn't the Federal Trade Commission use their own truth-in-advertisement laws, which it has considerable authority to pursue, and go after some of these franchisors for making false claims?" Does Australia have the same problem, that franchisees cannot be sure of the reliability of franchisors' information?

Spencer: Yes, it does. That's happening in Australia. If you look at franchisee claims against franchisors, which is nowhere near the level of litigation that is in the United States, one key piece is mandatory mediation. In Australia, if one party asks for mediation, the other party has to go to mediation.

In theory that sounds good but the problem is that when they mediate none of the results are made public. So we don't get the benefit of knowing what the outcomes are of the dispute.

BMM: When mediation and settlements of lawsuits are completed here in the U.S., franchisors are spared the embarrassment of having the results publicly declared. Moreover, franchisees sign gag clauses as a condition for the settlement. So those contemplating investing in a franchise are clueless as to what happened.

Canberra Senate, Aus. photo/Proimos

Spencer: To the extent in Australia that there is information about litigation and the nature of the claims that are brought, we see that misleading or deceptive conduct is the most litigated provision of our trade practice. Actually, it is no longer just a trade practice. In fact, in Australia's larger competition and consumer law, Section 18 simply states that a person — it used to say corporation — a person must not, in trade or commerce, engage in conduct that is misleading or deceptive or is likely to mislead or deceive, period.

That is the most litigated provision in Australia's consumer law today.

I think the original intent of Section 18 was meant to be a bit of a catchall. Regulators didn't think it was going to be used much. They thought, oh, we'll just throw this in. I can't say how much franchisees actually get relief from that provision, but it is heavily used. It is one of the differences between Australia and United States. I don't think you have a similar provision that franchisees can rely on, do you? Rather, the U.S. focuses on executing contracts in good faith and fair dealing. But is using good faith and fair dealing clauses effective there?

BMM: Probably not because what exactly is "fair dealing?" A franchisor and franchisee might deem a deal as chicken soup for the soul, while the rest of us consider it snake venom for the soon damned. Franchisor apologists argue who are we to judge if someone wants to risk jumping off the bridge or wants to buy into a deceptive franchise deal?

You wrote in your book that even in a completely free market there is regulation of one type or another. Can you tell us a little bit about that?

Spencer: Regulation is really just the control of people's interactions. On a private level, you regulate your own actions. In fact, if you read Hugh Collins' book, Regulating Contracts, he talks about different layers of regulation. There is regulation of our own interactions at the private layer of governance, and he talks about regulation of market interaction. When another party tries to cheat us, we have the choice of going back for more or going to someone else. So you have that repeat, the repeat deal is one way of looking at a type of regulation of the private interaction at the level of the marketplace.

The Regulation of Franchising and the New Global Economy by Prof. Liz SpencerThe contract itself is also a means of parties regulating their interactions privately for themselves. You agree to do X, Y and Z and I agree to do A, B and C. We then have sanctions that we can apply. We both agree how much we're going to pay each other and what we're going to do. That's actually regulating our interaction. And to say that those are purer [forms compared to other types of regulation] is, I think, to miss the point. It boils down to what your own philosophy is of when government should intervene in private interactions. But whether acknowledged or not, we all are always regulating our interactions.

There are generally two fundamental reasons for regulating commercial interactions.

Someone has control at a given time and someone else has another type of control at another given time. We adjust those levers of control to appropriately regulate our interactions. If you agree with John Stuart Mill [British philosopher and economist], for example, when one party harms another in a private interaction, Mill would say according to the Harm Principle, government should intervene. Governments need to provide some sort of provision to prevent abusive control and to protect parties and members of society from harming each other.

The other is to promote efficiency of markets. And, of course, then you have to agree on what's your philosophy on how an efficient market works, on how much insolvency and bankruptcy is acceptable. So you have to ask yourself two questions: how much pain on the individual level is okay and how much inefficiency at the market level is okay, and where do you want to strike the balance?

BMM: So the balance in regulation slides between two principles of not allowing society to be harmed but also respecting the liberty of an individual to do what he wants: for example, the right to pursue a prospective franchise owner's money.

Spencer: I've gone off track, but it is to make the point that all interactions are governed at various levels. Franchisees and franchisors have a contractual agreement. They are regulated when they go to court and ask the government to intervene because one party or the other isn't doing what it agreed to do. It's a quasi-public means of governing the interaction because you're going outside the sanctions that the parties can apply to each other, and you're asking the public entity to become involved and to weigh in on the situation.

There is another regulation layer, which is legislation. The enacted law impacts on the relationship to ensure that something happens or doesn't happen. If it is not complied with, parties and administrative arms of government may have recourse to the courts.

With respect to legislation, the light touch is always the preferred one. We go for the light touch, the procedural regulation, the less interventionist regulation — like disclosure — to start with. But sometimes that may not be the most effective or appropriate tool. You always have to monitor regulation. And one thing that tends to be lacking worldwide is the monitoring of regulation.

Where countries perceive franchising pain, they tend to cut and paste regulation from elsewhere to solve it. Let's use disclosure. Everybody else is using disclosure. But let's not require registration. That's expensive for us regulators. No one else seems to think it's good. We'd be criticized for implementing registration and not doing it right. So let's just do the light touch. Let's just do the least intervention. Let's do what everyone else is doing.

And then regulators fail to monitor the disclosures. So that's why my big message is that governments need a proper regulatory process, and they need the right participants involved in that process.

I don't think we have that in place anywhere, to be honest. I think we're maybe inching closer in the States and Australia.

BMM: There is a growing body of franchisees and their associations that think the regulatory landscape right now is insufficient. Franchise owners are pushing for franchise relationship laws rather than tighter disclosure laws.

Spencer: The franchisor argument is, well, if prospective franchisees don't catch misinformation or disinformation, it's their own damn fault. They're not doing their due diligence. Then they have the natural consequence of having to pay the price down the road. But is it really reasonable to expect franchise owners to go through all the expense of vetting reams of information that they don't understand?

BMM: One criticism of franchise relationship laws is that it is hard to measure and regulate an ongoing relationship.

Spencer: That's also a disadvantage of disclosure regulation too because the franchisor-franchisee arrangement is an ongoing relationship. Not everything can be solved with upfront disclosure. Moreover, there are many things that are difficult to disclose. Don't forget that franchisors have provisions where they can unilaterally vary the contract. It's not just a problem for relationship laws. It is also a problem for disclosure, and the limited nature of the contract. I mean, how does a franchisor disclose things that aren't known yet, but that it will do in the future to compete better?

We need to step back and look at franchising and really start at ground zero to understand the fundamentals of what is the nature of this interaction. Franchise regulation needs to be pulled back to its most fundamental issues. We don't have an adequate taxonomy in franchising. We don't even have good settled legal definitions of what is franchising, master franchising and area developers. Once we get those nuances right and say well, here are the advantages and disadvantages, here are the roles that people are playing, they're like employees in this way in this type of relationship; they're like consumers in this way in this type of relationship; they're business partners in this way, but they're not agents for each other in these ways, but they are in this way.

There are so many different elements and levels to the relationship that I think first of all we need to get that straight and then say what are the issues that arise and then develop a consensus on what's the best way to deal with that problem, what's the best way to deal with this other problem?

The truth is we're not going to do that. Regulators and the industry are not going to scrap disclosure. Everyone will keep using disclosure. But we need to get more people involved in the process.

BMM: Actually, the problems from the franchisee point of view have already been distilled down to a few fundamental issues. The Coalition of Franchisee Associations has its Universal Franchisee Bill of Rights – e.g., the right to pass down your business to your posterity, to provide at least a few days to cure issues before the termination of your franchise, or to not have the franchisor set up shop next door. Hotel franchisees have their twelve points of fair franchising, so do other franchisee groups. There actually seems to be wide consensus on what the fundamental franchising problems are. But how do you bring the other side of the industry to consensus, without franchisors obstructing franchisees?

Spencer: There will always be friction between the two. And the politicians are never going to understand the complexities of franchises.

Relational Rights and Responsibilities: Perspectives on Contractual Arrangements in FranchisingA couple of years ago Bond University and the University of New South Wales hosted a franchise law colloquium in Australia. (The collection of papers has been published as Relational Rights and Responsibilities: Perspectives on Contractual Arrangements in Franchising, 2011).

What we were trying to do with the colloquium was bring the legal community in Australia slightly closer to what the U.S. has here with the American Bar Association's Forum on Franchising, where lawyers and lawmakers and any interested parties actually share information in a collegial way, not just one party asserting that things are fine and the other side saying, no, they're not.  I believe that we could benefit from this sort of discourse in Australia.

Although regulatory bodies invite outside advisers and public discussion for new initiatives, the people affected by the type of regulatory process that I am discussing need to come together in great numbers and diversity [e.g., lots of franchisee advocates] to have a real conversation on an on-going basis under which the regulators are not subject to regulatory capture by franchisors.

BMM: "Regulatory capture" what is that?

Spencer: Regulatory capture is when the regulator is too involved with a sector, with a business or a commercial sector. A regulator can get so involved with a sector that they start to know the players. They know the leaders, the lawyers involved and the business leaders involved. They get so involved with them, they get to know them well and they're soon lunching together. The next thing you know they're good friends, which is natural. The problem is that they begin to believe what they're told by certain interests and they lose their objectivity.

That is a big problem.


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