Options
Option 1: Status quo – generic legislation and self-regulation
50 With a few exceptions, the status quo appears to be working well and there is no evidence of widespread problems with the current framework. The generic law prohibits people from things such as making false and misleading claims, and FANZ offers a higher level of supervision. People buying a FANZ franchise know that they are covered by Codes of Practice and Ethics and that they have access to good information about the nature of the arrangements they are entering into.
What are the likely impacts?
51 If the status quo were to continue, the sector would be allowed to develop its own solutions to address the issues identified and the franchise sector would continue to be regulated by those that know it best. FANZ has reported an increase in the number of applications for membership it has received following the cases of alleged fraud. This indicates that franchise businesses are already taking steps to protect and promote their reputation. If a central government agency were to take over the core function of a voluntary organisation like FANZ, there is a sense of potentially reinventing the wheel. There is also a risk that the quality of the regulation would be reduced because of the lack of specialist knowledge of franchising.
52 Another benefit of this option is that it would not impose additional compliance costs on the industry and it would avoid the risk that regulation could slow the growth of franchising in New Zealand. Also, there would be no increase in cost for the government as there would not need to be mechanisms for sanctioning non-compliance.
53 However, the current self-regulatory regime only applies to FANZ members and, although its membership is growing, there are a significant number of franchise systems that are not members. Franchisees of those systems only have the protections provided by generic law and may face high costs to resolve disputes. Furthermore, even in the case of FANZ franchises, FANZ essentially has ‘no teeth' to enforce its Codes. It can only sanction (e.g. through some form of publicity), suspend or expel a member for not complying with its rules, which may not be enough of a deterrent for some franchisors.
54 This option is also unlikely to address any adverse perceptions the public has of franchising.
Option 2: Education
55 A non-regulatory option is to launch education initiatives. These could be targeted at franchisees to make them aware of the things to look for and the questions to ask when purchasing a franchise, as well as the importance of seeking advice from professionals experienced in franchising. Education initiatives could also be aimed at franchisors, on the importance of correctly structuring a franchise business and having established systems and procedures in place. The education of immigrants who have English as a second language, and/or may be unaware of New Zealand laws could be another element of this option.
What are the likely impacts?
56 A benefit of this option is that it would increase the awareness among potential franchisees on the steps they should take before purchasing a franchise, and increase the knowledge of franchisors on how to structure and manage a franchise system. As with Option 1, this option would not impose extra compliance requirements on the sector and would avoid the risk that regulation could slow the growth of the franchising.
57 One question this option raises is who would be responsible for designing and carrying out such education initiatives. This leads to another issue regarding whether the government or the sector would bear the costs of this option.
58 FANZ already has a wide range of information on its website advising potential franchisees what to do if they are considering buying a franchise. This information includes the questions that should be asked and the importance of seeking professional advice, and has recently been translated into Korean, Chinese and Hindi.
59 This option could be implemented either alone or in combination with any of the other sub-options outlined in Option 3 below.
Option 3: Franchise-specific regulation
60 Option 3 is to implement some form of franchise-specific regulation. Those that support franchise-specific regulation tend to focus on the need for full disclosure, independent advice and dispute resolution. The following sub-options have been identified as potential forms of regulation and have been grouped in relation to the issue that they address. These sub-options are not mutually exclusive and any, some, or all of the following could be adopted.
Information imbalance
Option 3.1: Mandatory information disclosure
61 This option would require franchisors to give certain information to potential franchisees before an agreement can be entered into to ensure that potential franchisees have the information needed to do their due diligence.
62 Information disclosure is a key aspect of the FANZ Code and the mandatory code in Australia. However, the Australian regime requires considerably more information to be disclosed and information must also be disclosed annually, if requested, to any franchisee, not just to potential franchisees before a contract is signed. The information that members of FANZ are required to disclose is outlined in clauses 14 and 15 of the Code of Practice (see Appendix 1).
What are the likely impacts?
63 The benefits of this option are that it would help to address the problem of the information imbalance, as potential franchisees would be supplied with the information they need to do their due diligence and make informed business decisions. This could then have flow-on effects, possibly reducing the number of contractual disputes that may arise and the need to go to court.
64 The costs of this option could be relatively low. Once the franchisor has set up the basic information, it would not be too costly to keep it up to date for release to other prospective franchisees. This however depends on the nature of the information to be disclosed and whether disclosure is only required before a contract is entered into, or if disclosure is on-going. In Australia, the disclosure requirements have grown significantly from when the code was first introduced and concerns have been expressed that the compliance costs for franchisors are onerous.3
65 For example, a member of the Franchise Council of Australia has indicated that when disclosure was voluntary, his company's disclosure document was around ten pages. After the introduction of the Franchising Code it was around 20 pages, and following the latest review of the code, it is now almost 50 pages.
66 In the case of multi-tiered franchise systems, there would be questions around who would be responsible to disclose the information (i.e. the franchisor or the master franchisee) and who would be liable if there was a failure to comply with the disclosure requirements. If the franchisor held the responsibility for disclosure and the liability, this could undermine the purpose of the master franchising model – allowing the franchisor to concentrate on strategic issues while the master franchisee focuses on regional expansion, recruitment and support. One option is for the obligation and liability to fall on whoever is party to the franchise agreement. That means that if a master franchisee grants a franchise, it would be their obligation to meet the disclosure requirements, and they would be liable if they did not comply, not the franchisor. The master franchisee could also be required to disclose information regarding the master licence arrangement.
67 Another issue to consider is that overseas franchisors, who already comply with disclosure requirements in other jurisdictions, are not deterred from selling franchises in New Zealand because of a different set of disclosure requirements. Thought needs to be given to the extent to which these franchisors can use the disclosure documents they already prepare to comply with any requirements in New Zealand. One option to address this issue could be to empower the New Zealand regulator to recognise overseas disclosure documents which have a New Zealand supplement.
68 Although this option would help to address the information imbalance, there is still a risk that franchisees will be given all the relevant information but not understand what it means or do their due diligence and use it to make an educated decision. One way of looking at this is that the government should go no further than correcting the information imbalance, and if potential franchisees fail to use the disclosed information effectively then they must take responsibility for that failure. In this sense, this option is related to Option 3.2 below, requiring franchisees to seek professional advice.
Option 3.2: Mandatory professional advice
69 This option would require franchisors to require of their franchisees that they obtain professional advice (from a lawyer, accountant, business consultant or franchise advisor for example) on a contract before entering into a franchise agreement, unless the franchisee waives this requirement.
70 This is a feature of the Australian Code. Under the Code, before an agreement can be entered into, a franchisor must receive statements signed by an independent legal adviser, business adviser or accountant certifying that the prospective franchisee has been given advice about the franchise agreement. Alternatively, the prospective franchisee can sign a statement saying that they have been given professional advice on the agreement, or that they have been told that they should seek advice but have decided not to.
71 FANZ also has a similar provision in its Code of Practice (see clause 11.2 of the Code and FANZ's recommended statement for franchisors to include in the disclosure document regarding independent advice).
72 A variation of this option would be to require the party to the contract (the franchisor or the master franchisee) to advise the franchisee to obtain professional advice from franchise experts before signing an agreement.
What are the likely impacts?
73 The benefits of this option are that potential franchisees would be encouraged to do their due diligence before entering into a franchise agreement. An independent third-party would be able to review the contract and explain how it would affect the potential franchisee. This would help to address the problem of information imbalance.
74 If franchisees understand more fully the terms of the contract and how it will affect them, this could possibly prevent some disputes from arising and in turn would help to address the problem of the high cost of going to court.
75 The costs of this option would be those borne by the franchisee in getting professional advice. Sector participants estimate that the cost of obtaining legal advice for example could range from $1000 to $2000, although this could be higher depending on several factors such as the size of the documents, the complexity of the franchise, or if the franchise is a multi-tiered system.
76 This requirement would not prevent people seeking advice from the wrong sources. Some professionals may not have the suitable experience with or specialist knowledge of the franchising sector to give appropriate advice and franchisees could end up making poor decisions as a result.
77 Another aspect to consider is that while some franchisees may be vulnerable groups and do not have the sufficient business knowledge, other franchisees may be experienced enough to not need professional advice. For example, they could have purchased a franchise before, or they could be a lawyer and are fully qualified to make their own assessment. Therefore, a requirement to seek professional advice may not be suitable for all franchisees. However, these problems would be overcome under the variation of this option described in paragraph 72.
78 A possible concern with this option is a situation that has occurred in Australia where in one franchise agreement, there was a minor technical fault in the certificate confirming the franchisee obtained advice and this created an opening for a legal dispute. The recent Australian judgement in Ketchell vs. Master of Education Services Pty Ltd ([2007] NSWCA 161) found that a franchise agreement was illegal and unenforceable as a result of a franchisor's non-compliance with this requirement. This has created uncertainty for the sector in Australia and the matter is now before the Australian High Court.
Option 3.3: Cooling off period
79 A cooling off period is a safeguard designed to allow someone the opportunity to change their mind after entering into a contract. This would mean that a franchisee could withdraw from a contract within a certain time after signing a franchise agreement if they decided that the agreement was not suitable for them.
80 A seven-day cooling off period is a feature of both the FANZ Code of Practice and the mandatory code in Australia.
What are the likely impacts?
81 A benefit of this option would be that it would help prevent pressure sales, offering potential franchisees protection from high pressure sales and negotiations. In this respect, it would add a layer of protection to franchisees in response to the information imbalance between franchisors and franchisees.
82 Another benefit is that the compliance costs would be relatively low. It is already standard practice for FANZ members to include a cooling off period in their contracts and it would be relatively simple for other franchisors to include this in their agreements.
83 A possible cost of this option is that a franchisee may be subject to restraint of trade provisions following the termination of the agreement which could be harsh in effect, although if these are unreasonable the generic law will usually hold them unenforceable. Another situation to consider is where a franchisee has already paid a fee and decides to withdraw from the contract as issues may arise around the refunding of money. In Australia, the franchisor must fully refund all payments made by the franchisee within 14 days, less any reasonable expenses if the expenses or their method of calculation have been set out in the agreement. FANZ has a similar provision (see Clause 8 of the Code of Practice).
Barriers to resolving disputes
Option 3.4: Enhanced dispute resolution
84 As mentioned, the current options available to resolve disputes are not always suitable or accessible for franchises. Not only can arbitration or litigation be expensive, but the interdependent nature of a franchising relationship means that these adversarial processes are not always the best way to resolve disputes.
85 Providing for an alternative dispute resolution process, a feature of both the FANZ and the Australian Codes, is one option which could offer a low cost way for disputes to be settled. FANZ requires mediation as a prerequisite if either party wants it before turning to arbitration or litigation, although there is an exception for urgent injunctive relief where needed. There is also an exception if the events in question justify immediate termination of the agreement, if these events are spelt out in the agreement. FANZ has a panel of mediators that have gone through training to ensure they are equipped to deal with franchise disputes.
86 Clause 9 of FANZ's Code of Practice outlines the mediation process. In summary:
- Where a dispute arises, the complainant must set out in writing the nature of the dispute and both parties must make every effort to resolve it by mutual negotiation.
- If they are unable to reach a resolution within 21 days, either party may notify the other that it seeks to have the party resolved by mediation.
- If a mediator cannot be agreed upon within 10 days, then either party can apply to FANZ or the New Zealand Law Society for them to nominate one.
- The proceedings are intended to be informal, confidential and on a "without prejudice" basis (i.e. statements made between the parties cannot subsequently be used as evidence in Court). The mediator is required to act fairly, in good faith and without bias and must have regard to the fairness and reasonableness of all matters.
- The mediation must be determined within 14 days after referral to the mediator and the parties must report back within 14 days of the end of the hearings on the actions taken as a result.
- If the dispute is not resolved within 45 days of referral to mediation, a party may then commence court proceedings and/or take other action as it sees fit.
The costs of this process are split equally between the parties. FANZ estimates that this is around $3000 for each party, plus legal costs. Mediation that extends into a second day can incur higher costs.
87 Those systems outside of FANZ can also go through mediation, but only if both parties agree. Otherwise, they can arbitrate or litigate without first going through a mediation process.
What are the likely impacts?
88 This option could help to address the costs of resolving disputes, potentially providing a cost-effective mechanism to settle disputes as well as a more flexible process than arbitration or litigation. This offers a better chance that the relationship between the franchisor and the franchisee will remain intact after the dispute.
89 A mandatory mediation process has been quite successful in overseas jurisdictions. Both the ACCC and the Franchise Council of Australia confirm that the mediation process is effective.
90 However, the success of the mediation process is not guaranteed. Mediation only settles disputes if the parties can both agree – no binding decision is imposed on them without their agreement. This is different from arbitration and litigation where decisions can be imposed on the parties.
91 Establishing a new process and institutional framework for mediation could also be complex. The FANZ mediation process provides a potential model to work from, but this is only one model. A number of issues would need to be addressed, including:
- when mediation is required to take place, whether it is mandatory and if there are exceptions where parties may go directly to court;
- what time frames would apply;
- who can be eligible to be a mediator;
- what happens if the parties cannot agree on a mediator;
- where the mediation is to take place;
- where the costs lie; and
- the relationship to FANZ's existing mediation process and/or any dispute resolution provisions specified in existing franchise agreements.
92 In its recent announcements relating to tribunal reform, the government has also expressed some concerns with ad hoc statutory approaches to resolving certain types of disputes.
93 Given these issues, it may be that the issue of the costs of resolving disputes is better addressed by improving access to existing options for dispute resolution. This could be done through exploring the possibility of providing targeted subsidies for franchisees, similar to legal aid, or by looking at the current thresholds for the Disputes Tribunal for example.
Contractual power imbalance
Option 3.5: Rules for franchising contracts
94 This option would require statutory minimum requirements regarding matters such as the transfer, termination or renewal of a franchise agreement.
95 The Australian legislation contains provisions to regulate conduct in this way. It clarifies the rights of the parties on termination, prevents consent to transfer from being unreasonably withheld, prohibits waivers of liability and ensures the capacity of franchisees to freely associate. See Appendix 2 for an outline of these requirements.
What are the likely impacts?
96 This is an option to be considered if there is sufficient evidence that there is a problem of contractual power imbalance with franchise agreements generally, not just in certain industries or with certain types of franchising. If there were certain statutory requirements, this may help to balance the power between franchisors and franchisees as all franchise agreements would have to meet certain minimum standards. This in turn may reduce the number of disputes that arise over franchise agreements.
97 However, there is a risk that a ‘one size fits all' approach to franchise contracts in legislation would be inappropriate. For example, what is suitable for a larger franchisor to include in its contracts may not be suitable or necessary for a smaller franchisor, and could create unnecessary and high compliance costs. Also, what may be suitable for a product or manufacturing franchise may not be suitable for a business format franchise.
98 There are already implied duties in law for a party to act reasonably in certain circumstances within the terms of a contract. This can include giving reasonable notice of the termination of a contract if no notice period is outlined in the agreement.
Option 3.6: Good faith
99 This option would impose an obligation of good faith on franchisors in relation to their post-contractual conduct. What this would require would depend upon the specific circumstances in question. However, a good faith obligation would be likely to have the effect of, amongst other things, requiring a franchisor to have regard to or take into consideration a franchisee's interests when it came to issues such as the termination or renewal of a franchise agreement.
100 Some franchise agreements already contain good faith provisions, and it is a term which is not unusual in relational contracts.
What are the likely impacts?
101 The benefit of this option is that it could provide an additional safeguard for franchisees in relation to the conduct by franchisors after a contract has been signed. A general obligation of good faith may also have the advantage of being flexible enough to cover a broad range of circumstances, and could go someway towards addressing any circumstances, to the extent that they exist, that are not expressly covered by other aspects of the law.
102 However, good faith is a term which is both difficult to define and identify in practice and to date, the courts in New Zealand have been cautious about implying a general duty of good faith into contracts. If such an obligation was introduced, it would be unclear for many franchisors what this obligation would mean, and it would be likely to take some time before the court established the key principles that would underpin a good faith obligation in the context of franchising. In the meantime, there is a risk that this could create uncertainty and confusion in the law, rather than providing protection for franchisees. It may be that it is more appropriate to allow this area of law to develop on a case by case basis as part of existing established principles of law and equity.
103 It is possible that the desired effect of an obligation of good faith could be better achieved by upfront disclosure and a cost-effective mediation process. Pre-contractual disclosure would make a franchisee aware of the terms of termination and renewal and if they were unhappy with these terms, they could reject the contract. A cost-effective mediation process could provide an avenue for franchisees to seek a resolution if they believe that the post-contractual behaviour of a franchisor goes against the franchise agreement.
Institutional options
104 With all of the sub-options of Option 3, options relating to which institution should be responsible for rule-making, enforcement and mediation need to be considered.
Option 3.7: Co-regulatory regime
105 As outlined, the current self-regulatory model operated by FANZ is operating well for its members. Most of the features discussed above can already be found in the FANZ Code of Ethics and Code of Practice. In considering institutional arrangements, an option is to give statutory backing to this model and create a co-regulatory regime. This could be achieved in one or more of the following ways:
- making membership of FANZ mandatory;
- making the FANZ code mandatory (for example as a mandatory ISO standard); and/or
- creating a statutory franchising body, with membership from the franchising sector, to oversee franchising arrangements (for example, based on the New Zealand Institute of Chartered Accountants model, which is discussed in Appendix 3).
106 A co-regulatory model may be preferred where the technical expertise is held outside of government, where there is a high level of coherence within the sector and flexibility of rules is important. However, such models may suffer if they enable anticompetitive conduct through rule-making by private parties or the public sector has a significant comparative advantage in enforcement. Any co-regulatory regime must ensure alignment of public and private interests, including protection for natural justice of individual parties.
107 Ensuring the quality of regulation provided by a co-regulatory model through funding and the expertise available is also important. Funding of co-regulatory bodies is likely to be through cost recovery on the sector (see ‘Costs of Regulation' section below). Having a sufficient pool of available experienced people to draw from is also important to ensure the quality of regulation provided under this model.
Option 3.8: Other institutional options
108 Other institutional options include that a public agency or department could be responsible for enforcing and monitoring all or part of any legislative requirements. This would most likely be the Commerce Commission, as any franchise-specific regulation would be closely linked with the Commission's fair trading enforcement responsibilities. The Commission also has a lot of experience in monitoring information disclosure regimes, although it does not have specific experience with franchising. This raises institutional and funding issues regarding the Commission's capacity to fulfil such a role.
109 Private enforcement is another option, allowing parties to take private action against non-compliance with any legislative requirements. A mixture of public and private enforcement could also be considered.
110 For some of the options, thought could be given to how existing regulatory structures could be used. For example, if mandatory mediation were to be introduced, the possibility of using FANZ's panel of mediators on a cost-recovery basis could be explored.
Costs of regulation
111 As well as the costs mentioned for particular options, there are also general costs associated with any form of regulation. These relate to monitoring and enforcing compliance, or the costs of maintaining a tribunal. This raises the issue of who would meet these ongoing costs. Options for meeting the costs of regulation include government funding or potentially cost recovering on the sector either by franchisee, franchisor or franchise contract for example.
Transitional issues
112 How any legislation applies to new and existing franchise contracts will need to be considered. If it were only to apply to new contracts, this may cause problems for franchisors having one set of contracts that comply with the legislation and another set that do not. However, as franchise contracts are usually set for a specific term, it is likely that all contracts would eventually come under any new legislation.
Compliance cost implications
113 The compliance cost implications for each option and how would they impact on the growth of the franchising sector need to be considered. After the introduction of the mandatory code in Australia, there was a decline in the growth of the franchising sector. Franchising has since recovered and continues to grow steadily. However, it is unlikely that the New Zealand sector could afford an even temporary decline, given the size of the sector is considerably smaller than in Australia.
Questions
Q 4 Which of the options above do you favour? Why?
Q 5 Have all of the options (and sub-options) been identified? Are there other options (and/or sub-options) that should be considered?
Q 6 If information disclosure is to be introduced, which classes of information should be included?
Q 7 What are the benefits of each of the options (including any further options)?
Q 8 What are the costs and risks of each of the options?
Q 9 Can you give any estimates of the compliance costs associated with the options?
Q 10 With any of the regulatory options discussed are there potential conflicts with any existing law, such as securities law or company law?
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