Franchising and the ACCC

Speakers: 
Mr Mick Keogh, Commissioner
Conference: 
Franchise Council of Australia Law Symposium
14 October 2018

ACCC Deputy Chair Mick Keogh addresses the Franchise Council of Australia’s National Conference regarding the ACCC’s role in franchising, its submission to the Franchise Inquiry and some recent enforcement actions.

Transcript: 

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Introduction

Good morning, and thank you for the invitation to speak at your conference today.

Franchises are an important part of the Australian economy. Some of our most iconic Australian businesses are franchised, and a multitude of Australians are employed by franchises. What would the Australian retail landscape look like without the presence of Australian franchises like Baker’s Delight, Fernwood, or The Coffee Club? There would be a lot less Cheesymite Scrolls, that is for sure, and we would be all the poorer for it.

The famous management consultant, Peter Drucker, once said:

‘Whenever you see a successful business, someone once made a courageous decision.’

This is true for all businesses, from family stores to global franchises: business is about managed risk, and engaging with risk requires courage. Owning a franchise business is a fantastic way to leverage off the existing brand recognition of a major brand and set up your own successful business, but people often only see the brand, and forget that franchises are still small businesses, with all the attendant risks, stresses and vulnerabilities that entails.

The ACCC recognises the benefits associated with franchise business models, while also recognising the inherent vulnerability of franchisees due to the significant personal and financial investment they commonly make, paired with the imbalance of power that can exist between franchisee and franchisor.

Today, I will outline the role of the ACCC in franchising, briefly touch on our submission to the Parliamentary Joint Committee on Corporations and Financial Services Inquiry into the Franchising Code of Conduct, highlight our position on possible class exemptions for collective bargaining, discuss the interaction of unfair contract terms and the Franchise Code, and finally, note some recent enforcement actions that may be of interest to your members.

The role of the ACCC

The ACCC is Australia’s competition and consumer regulator. One of our responsibilities is for the regulation of mandatory industry codes that are prescribed under the Competition and Consumer Act 2010, or CCA, including the Franchising Code of Conduct—a mandatory national code that regulates the conduct of franchising participants towards each other.

The activities of the ACCC in franchise matters include;

  • the provision of comprehensive franchise education and guidance materials,
  • an active Franchise Code compliance program, and
  • enforcement activities, including the issuing of penalties and court action in cases when breaches of the law are sufficiently serious.

Our education and information activities include a section of our website that is dedicated to franchising, separate manuals for franchisors and franchisees, and a guide to help franchisees and prospective franchisees understand their rights and responsibilities under the Franchising Code. We also support a free online education program for prospective franchisees provided by FranchiseEd.

We also have many thousands of people signed up to our Franchise Information Network. Subscribers receive regular email bulletins about current franchising issues, including changes to the law, information for franchisors about compliance, and information about our enforcement activities aimed to highlight examples of conduct that would be in breach of the code. If you are not subscribed already, I would highly recommend.

We proactively conduct a code compliance program each year, which requires selected franchisors to provide copies of documents relating to requirements under the Franchising Code and other legislation we administer, such as the Business-to-Business unfair contract terms law.

The Franchising Code Inquiry

As many of you may know, the ACCC recently appeared before the Parliamentary Joint Committee on Corporations and Financial Services Inquiry into the Franchising Code of Conduct. I am aware that the Franchise Council have made your own supplementary submission as well, including some recommendations that are different to those made by the ACCC.

The Franchising Code is designed to minimise the need for regulatory and legal intervention. It requires important disclosures to allow informed choices, establishes expectations of transparency and fairness, and facilitates dispute resolution through mediation.

The frontline mechanism for dispute resolution between franchisees and franchisors is through engagement, mediation or private action, supported by the Franchising Code. Government agencies also play a vital role in these processes, including the Australian Small Business and Family Enterprise Ombudsman, the Office of Franchise Mediation Advisor and the state small business commissioners.

Both the Franchising and Oil Codes—the latter of which relates to service stations—are not as effective as they could be. Our detailed submission to the Inquiry makes a strong case for changes that would result in a substantial increase in penalties for breaches of the Code, improved and more meaningful information disclosure to franchisees, and stronger unfair contract terms law—the last of which I will discuss later in this address.

We’d also like to see actions that will create more incentive for prospective franchisees to seek independent advice before investing in a franchise, and changes that make unfair contract terms illegal.

We are aware of systematic conduct within the franchising industry involving underpayment of employees. While we have deep sympathy for the individuals affected by this situation, we need to be clear that we do not have the power to intervene in response to breaches of workplace laws. This power sits with the Fair Work Ombudsman.

We note proposals—including from the Franchise Council of Australia—to address some of the problems heard by the Inquiry by requiring franchise documentation to be registered on a public register, or in some cases, proposals to register these documents with the ACCC.

We don’t think this will solve the problem.

In fact, our concern is that this may lead to a perverse outcome by creating the perception that information provided by franchisors has been audited and verified, or ‘accredited’ by the ACCC. This would increase the potential for franchisees to believe that the ACCC has done the work for them, and that their risks in taking on the business have been minimised. The result would be a lessening of the amount of due diligence investigations carried out by potential franchisees—thus making the problem of ill-informed franchisees worse than is already the case.

We noted in our submission that we believe due diligence investigations are an essential step in considering a franchise, and the ACCC remains concerned that many franchisees do not seek independent professional advice as part of this process. Recent research commissioned by the Department of Jobs, for example, has indicated this may be driven by an assumption by prospective franchisees that franchise systems are proven business models. I am sure there are many in this room that know from bitter experience that is not always the case.

There is also a misplaced assumption that the Franchising Code and/or regulators can guard against business failure, which of course we can’t. The job of the ACCC is not to ensure your business is successful: it is to ensure that it operates on an even playing field.

Our full submission is available on the ACCC website.

The Class Exemption for Collective Bargaining for Small Businesses

As I am sure many in this audience will be aware, collective bargaining by a group of businesses who would otherwise be competitors is currently not allowed under Australian competition law, unless the group first obtains approval from the ACCC through an authorisation or notification process.

The process can involve paying a lodgement fee and perhaps paying a lawyer, and in complex cases can also take up to six months to be finalised. However, the Government’s recent changes to the CCA offer a way for the ACCC to streamline this process for many small businesses and franchisees.

Under these changes, the ACCC now has the power to make ‘class exemptions’—meaning we can grant certain categories of businesses an exemption from competition law for certain ‘classes of conduct’ that may otherwise carry a risk of breaching competition laws, but do not substantially lessen competition, or are likely to result in an overall public benefit.

For example, a collective bargaining class exemption for certain types of businesses could provide a ‘safe harbour’, so that qualifying businesses could engage in collective bargaining with a common electricity supplier, without the risk of breaching competition law.

We are now seeking feedback about a potential ‘class exemption’ to allow small businesses, including franchisees, to negotiate collectively. We recently launched a discussion paper to this effect—which considers how a collective bargaining class exemption for small businesses and franchisees could operate, which businesses might qualify, and what conditions would apply.

Over the years the ACCC has considered many collective bargaining arrangements. Most come from groups of primary producers or other small businesses wanting to collectively bargain with a larger business; for example, farmers wanting to bargain with the company who buys their produce.

This has given us a good evidence base about the types of collective bargaining that produce public benefits and are unlikely to harm competition, and are therefore likely to be suitable for this exemption. Watch this space for future developments about class exemptions for small businesses and franchisees.

Unfair Contract Terms and the Franchise Code

The Business to Business UCT law is a valuable law that works to protect small businesses from being forced to accept overly onerous or unfair terms in standard form contracts they are offered by other businesses. In most cases these are large businesses, but that is not always the case and the law does not require one party to be a large businesses in order for it to be engaging in unfair contract terms. This law was first enacted in November 2016, and at the time the Government committed to review it within two years.

As part of the review, the Government will draw upon the experiences of the ACCC in administering this law, as well as the views of other key stakeholders.

The ACCC believes there are a number of problems with this law , and in particular I want to focus today on two fundamental problems.

The biggest limitation that the ACCC has identified within the current legislation is that it does not make unfair contract terms illegal in standard form contracts. What it does is enable a potentially unfair contract term to be challenged in a court, and if it is judged to be unfair the court can declare that term to be void, and not enforceable under that contract.

The second biggest limitation to the current law is that the ACCC cannot seek civil pecuniary penalties when a term in a contract is declared unfair and void by the court. Nor can we issue infringement notices for contract terms that are likely to be unfair.

So, lacking a legal impediment, and without fear of financial penalties, businesses could be considered to have an added incentive to include potentially unfair terms in their contracts. The worst that can happen under the law is that if some of the terms are subject to legal challenge, the might be declared unfair and effectively struck out of the contract, but the contracts otherwise remains in force.

The ACCC wants to see this changed to more adequately protect small businesses from UCTs—including franchisees.

Enforcement Actions

Consistent with our Compliance and Enforcement Policy, the ACCC undertakes enforcement action when serious breaches of the Franchising Code are identified, either through our code compliance program or following reports made directly to the ACCC.

As an economy-wide regulator, the ACCC has to prioritise our activities across all sectors through its Compliance and Enforcement Policy. We seek to identify matters that have broad impact in terms of persons harmed, financial detriment, or conduct that highlights broader systemic issues within the industry or economy. We leverage off successful interventions through compliance and education activities, to encourage broader compliance.

Our recent franchise enforcement actions have included Domino’s Pizza, West Aust Couriers Pty Ltd, trading as Fastway Couriers (Perth), Pastacup franchisor Morild, and Husqvarna. The ACCC is also currently involved in two separate proceedings before the Federal Court against Ultratune and Geowash (a former national franchisor) and we have material investigations underway into several others.

I’ll briefly expand on three of those cases—Husqvarna, Pastacup and Luxottica—as they are instructive examples.

Husqvarna

Husqvarna is a subsidiary of the Swedish based Husqvarna Group, which is a global power tool manufacturer. Husqvarna has 343 dealers throughout Australia.

The ACCC took action against Husqvarna, alleging breaches of the Franchise Code and the unfair contract terms law. We agreed to settle the matter on the basis of Husqvarna entering into an enforceable undertaking.

Husqvarna cooperated with the ACCC, and has acknowledged in the undertaking that:

  1. it is likely it engaged in misleading conduct by representing to its dealers that their dealership agreements were not franchising agreements, when it is likely that they were franchise agreements
  2. it is likely to have terminated one or more dealers in breach of the Franchising Code of Conduct and
  3. one or more of the agreements it entered into with dealers are likely to contain unfair contract terms.

Husqvarna has undertaken to:

  1. offer any new dealers a new agreement that complies with the FCC and does not contain unfair terms
  2. provide all existing dealers a written notification, in a form approved by the ACCC, that the FCC applies to their current dealer agreement, as well as the opportunity to transition to the new agreement
  3. not enforce any of the unfair terms in the old agreement, and
  4. implement and maintain an ACL compliance program for a period of three years.

This action ensures that Husqvarna’s dealers receive the protections they are entitled to under the FCC. Ensuring small businesses receive the protection of the FCC and unfair contract terms laws is a priority for the ACCC.

Pastacup

On 21 September 2016 the ACCC instituted proceedings against Pastacup’s current franchisor, Morild Pty Ltd, and former director Stuart Bernstein for alleged breaches of the Competition and Consumer Act 2010 (the Act) and the Competition and Consumer (Industry Codes – Franchising) Regulation 2014 (the Code). The issue of concern in this instance was alleged deficiencies in the information disclosed to potential franchisees.

The Court found that Morild failed to provide a disclosure document which complied with the Franchising Code to franchisees, because the document provided failed to disclose Mr Bernstein’s previous directorship of the insolvent Pastacup franchisors. The Court held that this was relevant business experience that was required to be disclosed to prospective franchisees in Morild’s disclosure document. The Court also found that Mr Bernstein was knowingly concerned in Morild’s conduct.

Mr Bernstein co-founded the Pastacup franchise in 2008 and has managed and been a director of two previous franchisors of the Pastacup franchise system that each became insolvent.

The Federal Court ordered Pastacup franchisor Morild Pty Ltd (Morild) to pay penalties of $100,000 for breaches of the Franchising Code of Conduct (Franchising Code), following ACCC proceedings. The company’s co-founder and former director, Mr Stuart Bernstein, was also ordered to pay $50,000 for being knowingly concerned in the breaches.

Luxottica

The Luxottica Group is the world’s largest supplier of eyewear, with net sales of over €9 billion in 2017. Luxottica is the franchisor of OPSM and Laubman and Pank optometry stores in Australia. A related entity, Luxottica Retail Australia Pty Limited (Luxottica Retail), owns and operates the company-owned OPSM and Laubman and Pank stores in Australia.

A complaint was lodged with the ACCC concerning information disclosed by Luxottica to it’s franchisees about its marketing fund and related disclosure documents. In particular, it was alleged that Luxottica failed to disclose the extent of marketing fund contributions by corporate stores, and failed to provide sufficient detail about how the marketing fund was expended.

The ACCC investigation that found Luxottica’s marketing fund financial statement and disclosure document were unlikely to comply with the Franchising Code of Conduct.

Luxottica cooperated with the ACCC’s inquiries and voluntarily committed to change the documents to give franchisees a more open and transparent account of the business. In particular, Luxottica has committed to be more transparent about the structure and operation of its franchise system to franchisees, and provide them with marketing fund information that complies with the requirements of the Franchise Code.

The ACCC receives about 400 reports each year in relation to franchises out of a total of about 250,000 reports and enquiries. These reports on franchise issues are a priority for the ACCC, reflected in the resources we dedicate through our Small Business and Industry Codes team and in our enforcement division, and in other areas of the Commission. However, the cost of investigation and litigation imposes limits on how many matters can be pursued.

The reality is we do not have the power to make findings ourselves, so in order to proceed, we need to go to court, or at least be prepared to do so.

However, we recognise that taking court action can cause injury to the brand reputation of the franchise, can damage relationships between the parties involved, and as a consequence can also cause considerable financial damage to franchisees over time. Consequently, as is evidenced by the previous examples, we will seek to resolve matters in a cooperative manner if at all possible, and for some lesser code transgressions can also impose penalties via infringement notices.

That said, it is worth noting that while we are able to issue infringement notices without going to court, if those notices are not paid we must proceed to court with the substantive action.

Enforcement challenges exist in all areas of our responsibility, but the franchising industry presents some unique complexities of its own. Obtaining evidence can be challenging in situations where there are often quite different accounts of events and limited documentation. Ultimately, the ACCC is not the final arbiter, and therefore must meet court-established evidentiary standards.

Conclusion

Franchisees occupy a unique position in the small business world, bearing different risk and vulnerabilities from ordinary small businesses for various reasons, with the relationship between the small business franchisee and the large business franchisor being the most significant point of difference.

Starting a new franchise is never risk free, and even when the franchisor and the franchisee get along and adhere to the franchise agreement, they can still fail.

It is our view that the Franchise Code provides an appropriate framework within which franchise business can grow and prosper, but that improvements are necessary.

The ACCC wants to see the Franchising Code strengthened, and supported by stronger penalty provisions, to ensure franchise systems operate well for all parties involved, to encourage compliance with franchise agreements, and to keep competition on an even keel.

The ACCC will continue its work providing education and information about franchises, will maintain an active code compliance program, and will also continue to take enforcement action when it is deemed necessary.

It is in the interests of all involved in the sector to have a clear understanding of what is required by law, so that businesses focus on becoming more competitive and growing market share, rather than being tempted to take shortcuts that will ultimately damage the business, but also the reputation of the franchise sector as a whole.