Call for Australian Parliament to Inquire Into Franchising

Author's note: Below is an open letter to the Honourable Peter Costello MP, the Treasurer in the Australian Government. Mr Costello has amongst his portfolio responsibilities the administering of the Franchising Code of Conduct. This Call for a Parliamentary Committee of Enquiry has been made due to the disturbing number of similiar stories that I have received following the mentioning of the conduct of Bakers Delight in the Australian Parliament by the Honourable Joanna Gash, MP.

The Australian media has recognised that there is an imbalance in the franchise relationship with franchisors and financial institutions colluding and profiting from the franchisee. As one Australian jounalist recently said to me "where there is smoke, there is fire - we are all watching the issue closely" An Enquiry will encourage open discussion of these issues enabling informed decisions on future legislation to be made.

An Open Letter to the Hon. Peter Costello, MP 

Re: Call for Parliamentary Committee of Enquiry 

The benefits of franchising have been strongly advocated for years, and there can be no disputing the enormous growth of the industry.  The Griffith University Survey 2006 writes that there are now approximately 960 franchise systems in Australia with a sales turnover estimated at $128 billion in 2005, representing roughly 14% of the GDP. 

Unfortunately there is growing evidence of some franchisors breaching both the Trade Practices Act and The Franchising Code of Conduct, with devastating consequences to their franchisees.  An enquiry into this franchisor opportunism and franchising in general in Australia is urgently needed.  This will ensure the exposure and understanding of the issues currently facing franchisees within Australia.  It will also enable a legislative response to be determined and enacted in order to ensure the protection of Australian franchisees. 

I base my call for an enquiry on the following points: 

The Promise

The financial outlay for a franchise is far greater than for a conventional small business.  People buy a franchise to be part of a ‘proven’ system, as represented to them by the franchisor. Despite the waivers and disclaimers written into the contracts, the franchisor is selling proven expertise and charges for this expertise through the ongoing advertising and royalty payments.  Through the premium advertising percentage charged, the franchisee pays for the franchisors expertise in market research and for the franchisor to market and grow their businesses. Through this market research the franchisor is in control of all the facts regarding a franchised business at all times. Because of the mandatory financial reports supplied by the franchisees in addition to their own research, the franchisor knows if and when a franchised business will fail.   

The franchisor promises many things, including business and marketing support. Many of the potential franchisees are looking to this type of business model as they have no prior business experience and are prepared to pay for it through the premium they pay the franchisor to use their systems and brands.  How often do we hear the catch-cry associated with franchising “In business for yourself, not by yourself”?  This is the promise of franchising. Unfortunately there is widespread belief that franchising must be profitable because what you see is success and profits. The franchisor has fostered the belief that as the franchisor makes money when the franchisee does, it is a win/win relationship with few risks as the franchisor has a vested interest in seeing that the franchisee is successful. This is not always the case. 

A parliamentary enquiry would be able to determine the requirement, and if necessary set up regulations that administer this requirement, for franchisors to submit and actually prove that their system works, before being able to on-sell it to potential franchisees.  There is also a need for this information to be provided on a regular basis, and a parliamentary enquiry could investigate the frequency and manner in which a franchisors business plan should be submitted.  A public company must prove their system and solvency to their investors.  Franchisors should be made to comply with the same type of regulations. 

Ability to Conduct Due Diligence

In Australia there is no requirement to produce information regarding the success or failure of a franchise system to anyone. This results in unprofitable systems continuing to operate. As there is no one to check the failure rate of individual franchises, and through the use of strict confidentiality agreements with exiting franchisees, the franchisors can keep the true franchise failure rate statistics hidden.  With the actual independent franchise data only held by the franchisor, any attempt to conduct due diligence by a potential franchisee is pointless.   

The imbalance of information provided by a franchisor is of particular relevance when discussing already operating sites.  The franchisor knows the risks involved with these particular sites, and the end result of the previous franchisee that owned and operated the store.  The franchisor known risk of success or failure of any of these franchises should be disclosed under law to potential franchisees to enable them to conduct proper due diligence, including contacting the previous franchisee to discuss the true reasons for the success or failure of any business. The idea that a franchisor knowingly sells the same failed franchised business repeatedly is criminal, unconscionable and deceptive.  Franchisors should have to disclose the details of any of their franchises that have failed.  At present a franchise is not deemed to have ‘failed’ until it closes; if a franchisee fails due to a business being unprofitable, this needs to be disclosed to any potential purchaser.  This will prevent the usual platitudes so commonly used such as ‘bad operator’, ‘poor financial manager’ and place the blame firmly where it belongs – on the franchisor, whose system or chosen site does not work.  It will also go a long way to prevent this same franchise being sold repeatedly to unsuspecting franchisees. 

The review into the disclosure provisions of the Disclosure Document was positive, but it did not go far enough to protect potential franchisees. In essence, as the Franchising Code of Conduct currently does not require a franchisor to disclose the sales figures of their stores, nor the success or failure rates of their individual stores, franchisors have been allowed to operate with immunity and to keep these failure rates, and churning practices, hidden through the lack of disclosure.   

The current disclosure provisions allow a franchisor to obscure the actual percentage of failed or churned franchises by using words like ‘terminations’ and ‘transfers’.  These statistics do not offer any reasons behind the end results, so they do not assist a potential franchisee to understand whether a store they are looking at buying is profitable. Through failing to provide full disclosure, the franchisor can provide the appearance of a viable business, hide a business model that depends on churning to remain in operation, and allow the continued exploitation of franchisees via kickbacks received from third parties.   

Currently there is no requirement under the Code for franchisors to provide information on disputes with franchisees that have not resulted in litigation, or court judgements.  This can be misleading for a potential franchisee undertaking their due diligence.  There is also no requirement to provide records of the number of breaches issued to franchisees.  This type of information provides an insight into the true culture of the franchisors business. The main concern is the lack of transparency regarding internal compliance and/or dispute resolution processes of a franchisor, which prevents a franchisee from truly understanding the conduct of the franchisor towards its franchisees. 

There is a need for the establishment of an independent Franchise Authority which can administer franchising legislation. A parliamentary enquiry could consider the type of authority required by gaining a good understanding of the size of the problems facing franchisees, determining the benefits of establishing an independent Authority and consider the appropriate way to implement such an authority in order to protect franchising into the future. 

Level of Disputes

The idea that ‘everything is fine’ in franchising has been cultivated by biased self-interested franchisor lobby groups.  Franchising suffers from inaccurate reporting and then the misleading interpretation of any research actually conducted.  The self-proclaimed ‘peak’ body, the Franchise Council of Australia, pushes the line that there is nothing wrong in franchising, but the increasing numbers of failed franchisees are contradicting this strongly guarded position. 

This is particularly true regarding the level of disputes within the franchising industry.  The Griffith University study ‘Franchising in Australia 2006’ showed “some 35% of franchisors reported that they had been involved in a substantial dispute over the previous 12 month period”.  This result is distorted due to the fact that only 212 franchisors out of the 960 in Australia actually took part in this part of the survey; only 22%.  Of that 22%, 35% were in dispute with their franchisees.  How can this be interpreted to mean that there is nothing wrong in franchising? 

To highlight this point, let’s look at one section only in the survey.  The survey results regarding ‘franchised unit changes’ are based on the franchisors own Disclosure Documents, so the information again is not independent.  We will use the results for 2005, with only 213 respondents. 

Franchise business ceased to operate – 201

Franchise Agreement Terminated by franchisor – 80

Franchise Agreement not renewed when expired – 48

Franchise Agreement terminated and business bought back by the franchisor – 51 

This adds up to 380 franchisees out of business.  Potentially 380 families financially destroyed.  380 franchisees failed from only 213 franchised systems.  This does not include any obscure ‘transfers’ of a franchised business.  The overall success rate is irrelevant if 380 families have lost their homes.  The lack of transparency in the business transactions between franchisor and franchisees allows franchisor opportunism to run rampant without threat of repercussions.  This cannot be acceptable. 

There urgently needs to be an enquiry into the failure rates and level of disputes within franchising.  Due to the lack of reporting requirements, a franchisor can breach the Trade Practices Act and the Franchising Code of Conduct without fear of retribution.  The suspected failure rate alone should be reason enough to call an enquiry into franchising to determine the true size of the problem, and a more accurate accounting of former franchisees that have lost financially through their association with franchising.   

Assets – Ownership vs. Control

There is a great difference between the ownership and control of the assets belonging to a franchisee. The franchisee ‘owns’ the assets of the business, often through a loan provided by a recommended lender. The franchisor however knows that those assets of the franchisees whose businesses fail, or whose businesses the franchisor choses to churn, or recycle, will eventually be acquired by the franchisor, or their chosen third party. It should not be a surprise that the franchisor is the one who sets the ‘Market Value’ of the franchisee’s assets. It should be concerning to the government that the banks are willing to re-lend on the assets of a failed franchise business to a new franchisee. The often ridiculously small ‘market value’ offer for the assets of the franchisee is accepted by the bank that holds the guaranteed loan, with often no discussion with the franchisee. Clear title of the assets is then given to the franchisor, or third party. The bank then forecloses on the franchisees other assets; their homes and investment properties, to clear the remaining debt. This process often leaves the franchisee bankrupt within a matter of weeks – even if their franchise was profitable. In this manner the franchisor and the bank always win. The franchisee always loses - everything.   

When a sale transfer of the franchised business is signed by the failed or ‘exited’ franchisee, it is accompanied by ‘confidentiality’ terms that cover the terms of the relationship of the parties involved, the terms of the sale, and a release of liability to the franchisor and new franchisee. Again, the failed franchisee loses – this time it is the freedom to speak out and warn others, under threat of being sued for breach of contract.  

A parliamentary enquiry could look into the relationship between the franchisor and the banks, with the view of determining the degree of control a franchisor should be able to hold over a franchisee’s assets in the event of the franchisee’s business failing.    New laws protecting the franchisee in this circumstance would go a long way in preventing opportunism occurring to the detriment of the franchisee. 

Fraudulent Activity and Breaches of Confidentiality

There are indications that fraudulent activity may exist within the franchise industry; between franchisors, suppliers, lenders. 

The Australian franchise industry is also characterised by breaches of confidentiality by franchisors and interested third parties.  This occurs at levels that have serious repercussions for the franchisee, without the franchisee’s knowledge.  These breaches of confidentiality can lead to inappropriate business dealings, from breaches of the privacy act, to fraud. 

These areas need further independent investigation to expose the true size of this issue. 

The Contract

There is an acknowledged interdependence or ‘relational contract’ between a franchisor and a franchisee. This has allowed substantial imbalance into the business model that does not exist in other areas of business. The very nature of the contract suggests that between the franchisor and franchisee, each have an implied obligation of co-operation under the contract – this is the very nature of an interdependent or ‘relational contract’. Unfortunately this is not the experience of many former and current franchisees. 

The Contract, or Franchise Agreement as it is more commonly known, is written to provide significant benefits only to the franchisor. In particular, the often substantial setup and development costs associated with building the physical business and operational side of the business are solely at the franchisee’s cost, including the often high supplier rebates to the franchisor. All costs associated with the operation of the business remain the responsibility of the franchisee. As the franchisee builds the business, the franchisor again benefits as the franchisee builds the brand in their local area through local marketing and promotion of the brand. In addition to all of these benefits, they are also entitled to ongoing royalties. The franchisee is prepared to pay top dollar in exchange for the proven system, ongoing support and proven expertise of the franchisor and the ‘system’ they are selling.    

The contracts allow the franchisor to breach a franchisee for any perceived default in carrying out their business in accordance with the franchise agreement. It is possible for a franchisee to be breached for a completely fabricated, trivial or induced default.  If this breach cannot be rectified by the franchisee the result is that the franchise agreement can be terminated by the franchisor, fully protected by ‘contract law’.  Also of concern is the situation where a breach can be issued and without allowing the franchisee time to rectify the breach, the franchisor can terminate the agreement, also protected by the ‘contract’.  Some franchise agreements also contain clauses where a franchisor can terminate without the need to provide any reason.  These are serious breaches of the terms of good faith within a franchise relationship. 

Franchise renewal should also be an issue of concern.  All Franchise Agreements are for a set term, say 10 years, with the provision for the renewal of the same term.  The franchisee believes that this offers them security – of both their tenure and their business goodwill.  This is however, no guarantee at all.  I have been told of intimidation towards franchisees, ordering them to undertake expensive refurbishments or their agreement will not be renewed.  Sometimes after the refurbishment is completed, the agreement is not renewed anyway, so the franchisor has a newly refurbished store to re-sell, and the franchisee has nothing but more debt.  I have seen a letter from the Bakers Delight franchisor to a franchisee that stated that because the franchisee did not attend an overseas conference the franchisor “will not be renewing the deed” ignoring that the franchisee had given prior notice that they could not afford to go.  Bakers Delight used this non-attendance to cite that the franchisee was not ‘following the system’. 

The establishment of a Franchising Authority that could administer franchise agreements, ensuring a more balanced agreement, will prevent a rogue franchisor from seeking to profit by using the contract law provisions in an unfair contract to legally ‘churn’ their franchisees.   

Trade Practices Act

In most disputes between franchisees and franchisors, the Franchise Agreement and the Disclosure Documents are not relevant.  The issues are generally related to conduct, and therefore it becomes a Trade Practices Act issue.  The Trade Practices Act law 51AC and 51AD are designed to look at behaviour, specifically unconscionable, misleading and deceptive conduct. The provisions of the TPA appear adequate, although that said; the laws remain relatively untested, due to the high cost of mounting a case through the Federal Court.  This in turn encourages some franchisors to continue with their behaviour unchecked.   

The Franchising Code of Conduct

The Code in its present form does not offer protection to franchisees.   

The Dispute Resolution provisions of the code are too easily ignored by the franchisor. When I was issued three breach notices, one for each of my three franchised businesses, with only 7 days to rectify, I served Notices of Disputes on my franchisor. These were ignored, and my agreements were terminated. There is no protection within the Code for this type of behaviour.  There is no independent organisation for a franchisee to seek assistance from, and no independent agency to enforce any breaches of the Code.   

When faced with this situation, a franchisee has only two options – mediation and litigation.  Both are expensive.  In my case, my franchisor refused to attend mediation with me.  I had no choice but to begin the expensive process of litigation.   

The Mediation provisions of the Code are expensive and cannot deliver court enforceable decisions.  They can also offer the franchisor another opportunity to lie, threaten, and intimidate a franchisee into accepting a poor offer. 

If the outcome of mediation is unacceptable for whatever reason, the franchisees’ (former or current) only remaining avenue for relief is litigation.  This is usually not financially viable.  Franchisee’s when they reach this point are usually broken from months of financial and emotional duress.   

The lack of penalties prescribed for breaches of the Code ensures that no franchisor takes the Code seriously.  This needs to be rectified.  There needs to be substantial penalties for breaching any provision in the Code.   

There are no statistics available that can show that mediation is an effective way to solve a franchise dispute.  The confidentiality clauses in the mediation agreement effectively keep quiet the true nature of any mediation results.  There is a need for a tribunal, or Franchising Authority, to capture the true outcome of franchising disputes.  This type of authority would ensure that franchisees can gain the benefits of a low cost mediation process and level the playing field.  A parliamentary enquiry could investigate the benefits of this tribunal, taking comment from all parties to franchising. 

The Bank

Franchise lending is a lucrative business.  This type of business loan generates continuing business and healthy profits for a bank. The acceptance of the franchising model by the banks in Australia has meant that franchising, and franchisors, have grown quickly.  Franchisees borrow the money from the bank in order to rent the franchisors brand, whilst operating what they believe is their ‘own’ business.   

I believe, through personal experience, that the banks are fully aware and complicit with some franchisors, assisting the churning process through their own policies of re-lending, and foreclosing.  The churn model greatly benefits the banks as well as the franchisor as the bank gets to re-write the loan for the same business every few years, instead of waiting for the term of the contract to end.  It is mutually beneficial for the banks and the franchisors to work together.    

A parliamentary enquiry would be able to get hold of the true statistics of franchise lending, and the associated default rates of these franchised businesses.  These statistics will assist in understanding the true rate of failure of franchised business, not just the figures produced by biased industry groups.   

The Consequences of non-action

Due to the increasing media coverage franchising is experiencing at present, the numbers of former, and current, franchisees who have suffered significant losses are coming to light.  The numbers are truly unacceptable; their losses devastating. 

These hard-working Australian families have suffered terribly through the lack of true disclosure and the lack of protections afforded them, along with the intentional conduct of their franchisors determined to make a mockery of the system in its current form. Former franchisees have told me personally of their emotional losses, relationship breakdowns, severe depression, and financial collapse. I hear the same stories of the loss of homes and investments, stress related illnesses due to these losses and the continual pressure caused by intimidation and threats. In some franchises, there have been suicides.  These people will come to rely on the welfare system into the future as their life savings are gone, and many will continue to suffer life-long debilitating illnesses.  How can this be allowed to continue without investigation? 

This is verging on a national crisis.  This is conduct that can be stopped; some retrospective laws made, and new reforms introduced.  The end result will be better business, with people confident to enter back into franchises, secure in the knowledge that the government is administering and introducing laws designed to protect them and their assets.  

Summary

In summary, I am calling for an enquiry into franchising based on the following areas of concern: 

1. The lack of truly independent statistics in any area of franchising;

2. The concern that the ability of potential franchisees to conduct due diligence is flawed due to the imbalance in information provided by the franchisor;

3. The unknown level of disputes within franchising;

4. The issue surrounding the ownership of a franchisees’ assets, and how easy the franchisor and the bank can work together, stripping a franchisee of those assets;

5. The incidence of fraudulent activity;

6. The imbalance in the franchise agreement;

7. The high cost of litigation under the Trade Practices Act, makes it unaffordable and therefore not usually option for franchisees;

8. The failure of the Franchising Code of Conduct to protect franchisee interests;

9. The role of the banks;

10. And the consequences of non-action on the growing number of franchisees who are left emotionally and financially devastated at the end of their ‘relationship’ with their franchisor. 

In conclusion, I restate my call for an enquiry into franchisor opportunism and franchising in general in Australia.  It is urgently needed.  Franchisees; former, current, and potential all need to feel confident that the franchising industry is strong and that there are harsh penalties for those rogue franchisors who seek to deliberately breach the law for their own profit.   

As a former franchisee of Bakers Delight, I have personally suffered devastating financial losses through their conduct and misrepresentations. I know that the franchising system has let me and many others down through lack of legal protection. From personal experience I also know that the Franchising Code of Conduct is not working and for that reason I seek your assistance in supporting the setting up of a House of Representatives Committee of Enquiry into all aspects of the Australian franchise industry. 

I reiterate that an enquiry will enable the correct legislative response to be determined and enacted in order to ensure the protection of Australian franchisees, and Australian franchising. 

Deanne de Leeuw
PO Box 243
Vincentia, NSW 2540 
M: 0405 244 013 

23 October 2007 

Note: Deanne de Leeuw is a former franchisee of Bakers Delight, currently in litigation due to the termination of her three franchised bakeries.  She received a B.A from the University of NSW (ADFA) in Information Systems.     

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References  

• CSBFA Review 2005, Submission by Les Stewart, 2005 
• Franchising Australia 2006 Survey, Griffith University, 2006 
• Burger King Corporation v Hungry Jack’s Pty Limited (2001) NSWCA 187 
• Illawarra Breads Pty Ltd and ors v Bakers Delight Holdings Limited (2007) NSW IRComm 6076 of 2005 
• Disclosure Document, Bakers Delight Holdings Limited, 2001 and 2002 
• Franchise Agreement, Bakers Delight Holdings Limited, 2001 and 2003 
• Letter from Bakers Delight dated 07 September 2006  
• Problematic Relations: Franchising and the Law of Incomplete Contracts, Gillian K. Hadfield, Stanford Law Review, 1990