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34 As mentioned earlier, reports of alleged fraud involving franchises have recently surfaced. Fraud is a matter which is sufficiently addressed by current laws and these reports in themselves are not evidence of a widespread problem in New Zealand's franchising sector.

35 However, it has been suggested that these events show that the current regulatory framework around franchising may be open to abuse. This has brought the debate about whether there is a case for franchise-specific regulation into the spotlight.

36 Officials are not aware of any systemic problems within the franchising sector. But as a contract with commercial risks, there may be aspects of franchising that warrant a strengthening of the legal framework which surrounds it.

37 To identify the aspects of franchising that may need further investigation, officials have considered the different elements of contracting, being the negotiation stage pre-agreement; the post-agreement stage when parties are giving effect to the contract; and arrangements for enforcing rights and resolving disputes. When thinking about these different elements, consideration has been given to the extent to which the franchising arrangement is different from other business models and exposes the franchisee to risk that is not present in other contractual business relationships.

Information imbalance

38 The purchase of a new franchise (as opposed to an existing franchise business) differs from that of an existing business as it usually involves intangible assets – it is a mode of doing business that is being purchased, not the business itself. That means that a potential franchisee will have to evaluate the likely success of the business based on the success of other franchisees in different locations, rather than looking at the financial statements of an existing business.

39 However, there is an information imbalance between franchisors and franchisees who do not always have the relevant information to make an informed decision. Franchisors that are not members of FANZ are not obliged to disclose certain important information to a potential franchisee. There is thus a risk that some franchisees will not be provided with enough information to enable them to do the appropriate due diligence (thoroughly research and evaluate the contract, the system and the franchise opportunity), obtain meaningful advice and make an informed decision when purchasing a franchise.

40 This information imbalance also gives rise to the risk that some poorly structured franchises will go undetected. Anecdotal evidence suggests that some franchisors begin franchising without having good systems or the right structure in place to be profitable. Without the appropriate information, it would be difficult for franchisees to distinguish between these franchisors and those with established and proven systems.

Barriers to resolving disputes

41 Participants in the franchise sector indicate that the existing options for resolving disputes may not always be suitable or accessible, particularly for franchisees. Although complaints can be lodged with the Commerce Commission in certain circumstances, often the only option available to parties is to take private action. Disputes can be taken to the Disputes Tribunal, but if disputes exceed the Tribunal's thresholds,² parties must look at contractual dispute resolution or going to court. The cost of taking this private legal action can be substantial, involving court costs, legal advice and representation, although these costs may be justified depending on the scale of the dispute. Often, these options can be too expensive for franchisees who, as companies, are not eligible for legal aid (although individuals may be eligible).

42 The nature and length of arbitration or litigation mean that these dispute resolution processes can also be costly and harmful to the franchising relationship. These processes are adversarial and can damage the relationship between the franchisor and franchisee, which relies on collaboration and cooperation. The relationship is also often going to continue after the dispute has been resolved and these existing options for dispute resolution may not work to preserve this.

43 FANZ rules require a member to have an alternative dispute resolution clause in its franchise agreements requiring mediation if either party wants the mediation process to apply. However, there is an exception where injunctive relief is needed to avoid irreversible damage to a party. The mediation process also does not apply to events which justify immediate termination, if such events are clearly specified in the franchise agreement. FANZ has a panel of mediators that have gone through training to ensure they are equipped to deal with franchise disputes. FANZ's mediation model is further discussed in paragraph 86.

Contractual power imbalance

44 Another issue that has been raised relates to contractual power imbalance. In particular, concern has been raised over the ability of franchisors to exercise powers such as cancelling of a franchise agreement without just cause, or unreasonably preventing the transfer of an agreement.

45 This issue has been raised specifically in relation to the petrol retail and motor vehicle dealing industries, which typically use ‘product franchising' agreements. There is concern over the ability for large motor vehicle and petrol companies to unilaterally terminate contracts without just cause, imposing significant distress on a franchisee. However, others in the franchise sector indicate that this issue may be specific to the petrol and motor vehicle industries, and is not something that affects the franchise sector or business format franchising as a whole.

46 Common law principles may apply in such cases and officials do not yet have sufficient evidence that contractual power imbalance is an aspect of franchising that needs to be considered. Furthermore, it may be that it is captured by the issue of information imbalance and the lack of full disclosure by some franchisors.

Public perception

47 These issues, combined with the reports of alleged fraud, may affect the public's confidence in the franchising sector. The whole sector must deal with reputational issues and a perception that franchising may have broader problems could be a harmful one.

48 This uncertainty can impact the decision by a prospective franchisee not only in relation to purchasing a particular business operation but to a franchise generally, affecting the growth of the sector. On the other hand, if potential franchisees have the confidence to invest in a franchise and feel secure that they are not exposed to risk beyond normal business risk, the sector is more likely to grow and develop.

49 Thus there is an argument that regulation may help the growth and innovation of franchising by contributing to high public confidence and attracting a stream of quality recruits to the sector.