Australian Code Changes Will Expose Franchise Frauds

The changes to Australia's Franchising Code of Conduct announced on November 5 by Federal Small Business Minister should send shivers down the spines of some participants in the franchise sector.

But it probably hasn’t, because those who stand to be most affected by the changes to the Code deny that that they are franchisors. That’s right. The people who are likely to be most impacted by the new regulation of franchising don’t believe that they are involved in franchising.

Instead, such business operators call themselves licensors or distributors, when on closer examination, they may well be found to be a franchise under the definition given under the Code.

The Minister’s belated response to the 2008 federal franchising inquiry did not accept the recommendation to require all franchisors in Australia to be registered, which might have forced some franchise-deniers out of the shadows. However, the changes announced last week will have a similar effect without the requirement for every franchisor to renew their credentials every 12 months.

The reason for this is that so-called licensors or distributors of “business opportunities” who strenuously deny that they have any involvement in franchising will soon find that changes in the Code will make it harder for regulating bodies to take their word for it.

Currently, under the Franchising Code of Conduct, a franchise is defined as the “rights and obligations under a franchise agreement”. Further clarification of what constitutes a franchise agreement is offered in clause 4 of the Code which generally states that four key elements must be present for a franchise agreement to exist. These are:

1. That there is an agreement, which can be written, oral or implied;
2. The franchisor grants to the franchisee the right to carry on the business of offering, supplying or distributing goods or services under a system or marketing plan substantially determined, controlled or suggested by the franchisor, or an associate of the franchisor;
3. The business is substantially or materially associated with a trademark owned, licensed or specified by the franchisor;
4. Before starting or to continue the business, the franchisee must pay an upfront fee, or payment for goods or services, or a fee based on gross or net income, or a training fee.

Application of the Code to franchisors currently is similar to the application of the road speed limit to motorists – you’re considered to be compliant until such time as a radar or speed camera finds otherwise. For franchisors, this usually means that unless there is a complaint – or a number of complaints to the Australian Competition and Consumer Commission (ACCC), it is unlikely they will be subject to scrutiny of their franchising practices.

A problem with this approach is that those “licensed business opportunities” and “distributorships” which call themselves anything but a franchise (but which to all intents and purposes are franchises under the four-point definition provided in the Code) often escape the scrutiny they deserve as they seek to avoid their obligations under the Code.

In other words, if it walks like a duck, quacks like a duck and looks like a duck, it’s a duck, no matter what other label might be put on it.

Under the new changes to the Code, these “licensed business opportunities” and “distributorships” which have until now fooled themselves into thinking that the Code doesn’t apply to them and therefore they are not required to provide a disclosure document, cooling-off period, recourse to mediation, etc, will soon have a rude awakening.

The rude awakening may be that they could well find themselves at the receiving end of an ACCC random audit, and be required to prove that they are NOT a franchise.

In the Government’s official 23-page response to the 2008 Franchising Inquiry, the Government notes that:

The ACCC will be given the power to request copies of documents or other information from persons subject to an industry Code.

It further states that the “ACCC will not be required to have any belief about compliance with the Code before conducting an audit”. In other words, where there’s smoke, or even where there’s no smoke, franchisors can be audited. For franchise deniers which dress themselves up as “licenses” or “distributorships”, this is a clear message that their charade will be unmasked.

The ACCC has already commenced a crackdown on such operators, with its recent prosecution of a finance broking franchise that claimed it was a licence, and therefore did not provide a disclosure document and misled its “licensees”.

Prior to the upcoming changes, such a prosecution would be a considerably time-consuming and expensive exercise for the ACCC, and most likely prompted by a series of complaints from disaffected “licensees” (franchisees). Under the new changes, the ACCC need not wait for such complaints, or can use the random audit power to act on such complaints to identify and stop non-compliant behaviour before it causes greater damage.

Once a random audit is conducted, the ACCC’s normal investigative powers apply if the audit uncovers issues warranting further action, including a new power to issue substantiation notices. Under this power, the ACCC can require businesses to provide information to substantiate claims that they have made in promoting their goods and services. It is entirely possible that simply advertising a business as a “licence” or “distributorship” could trigger the issue of a substantiation notice requiring the business to substantiate its claim that it is NOT a franchise.

If a franchise-denier is found to be a franchise, they can be subject to the current enforcement provisions available under the Trade Practice Act as it stands currently, but soon may face more onerous repercussions with the introduction of financial penalties up to $1.1 million for organisations who engage in unconscionable conduct, or make false or misleading representations.

For “licenses” or “distributorships” who wilfully attempt to avoid complying with the Franchising Code of Conduct, the risk of random audits, substantiation notices, and fines up to $1.1 million must surely give pause for thought about the wisdom of continuing to deny that they are a franchise.

For any such “licenses” or “distributorships”, now is the time to review their positioning as non-franchises before the Code changes come into effect and the risks of non-compliance escalate. Advice should be sought from experienced franchise advisors as a matter of urgency and if need be, changes made to the business model accordingly.

This article has covered just one example of the impact of the forthcoming changes to the Franchising Code of Conduct. There will be many other issues arising from the Code changes worth exploring in detail in future articles.

Jason Gehrke is the director of the Franchise Advisory Centre and has been involved in franchising for 18 years at franchisee, franchisor and advisor level. He advises both existing and potential franchisors and franchisees, and conducts franchise education programs throughout Australia. He has been awarded for his franchise achievements, and publishes Franchise News & Events, Australia’s only fortnightly electronic news bulletin on franchising issues. In his spare time, Jason is a passionate collector of military antiques.

Copyright © Jason Gehrke, 2009.