Franchise First

22 Aug 2008

Review of Franchising Regulation In New Zealand – If It Ain't Broke, Don't Fix It?

The Ministry of Economic Development (MED) has released a discussion document requesting submissions on whether there is a need for specific franchise regulation in New Zealand. The deadline for submissions is Friday 21 November 2008.

This article outlines the background to the discussion document, the options outlined by MED and our views on the possibility of specific franchise regulation.

Introduction

The term "franchise" has no exact legal meaning in New Zealand and means different things to different people. The discussion document focuses on "business format franchising". This mode of doing business is based on a long term contract and intellectual property licence under which an established business (franchisor) grants a person or company (franchisee) the right (and obligation) to operate a copy of its business system for a specified period. More on this later.

The release of the discussion document comes on the back of the fraud allegations which arose in late 2007/early 2008 involving the sale of bogus Green Acres' ironing franchises by Mr Keith Lapham, a (now former) Green Acres master franchisor. These allegations of fraud are currently being investigated by the Serious Fraud Office (SFO). Ironically, issues of fraud fall outside the scope of MED's review as it considers fraud to be adequately dealt with by existing laws. We agree.

MED has nonetheless taken this opportunity to pick up on suggestions in the marketplace and review whether there is a need for specific franchise regulation in New Zealand. The MED discussion document requests submissions on two principal options to deal with the future regulation of the New Zealand franchise industry:

• maintain the status quo; or
• introduce franchise specific legislation.

Option 1 - Maintain the Status Quo

There are currently no specific laws governing franchising in New Zealand. Franchise agreements are subject to a range of more generic business laws such as contract law, consumer law, intellectual property law and competition law. Voluntary self regulation of franchising is also achieved through the Franchise Association of New Zealand Inc (FANZ).

FANZ has approximately 220 members, covering between 40-50% of active franchise systems in New Zealand. FANZ promotes the growth and development of franchising in New Zealand and regulates this development through a code of practice, code of ethics and franchise review process. A key focus of this self regulation is on the mandatory supply of financial and non-financial information by franchisors to prospective franchisees so they may make informed decisions about whether to enter into a franchise agreement. The FANZ code of practice also provides for a cooling off period and establishes a dispute mediation process for use by franchisors and franchisees.

The combination of generic business laws and self regulation is the approach taken in many countries such as the UK, Singapore and Hong Kong. MED notes that the self regulation achieved in the UK is still considered to be the most effective way of regulating franchising and comments that in the New Zealand context, with few exceptions, the status quo appears to be working well without any evidence of widespread problems. That said, MED notes that the current self regulatory regime only applies to FANZ members and although its membership is growing, there are still a number of franchise systems that are not members of FANZ.

Option 2 - Franchise Specific Regulation

MED has outlined what it considers to be the perceived "problems" with the franchise industry focussing on 3 key areas:

• the information imbalance between franchisors and franchisees, who, in the absence of mandatory disclosure requirements, do not always have the relevant information to enable them to make an informed decision whether to enter into a franchise agreement;
• the barriers to resolving disputes for franchisees, who, in the absence of a mandatory requirement for both parties to mediate or pursue other forms of alternative dispute resolution, may not have the resources to pursue private legal action; and
• the contractual power imbalance between a franchisor and franchisee which may permit a franchisor to terminate a franchise agreement without just cause or unreasonably prevent the transfer of an agreement by a franchisee.

MED notes that there is no common approach to the regulation of franchising overseas. Countries such as Australia, the USA, Canada, Malaysia and China have adopted franchise specific laws to varying degrees. MED concentrates its focus on the Australian system. In response to the perceived "problems", MED highlights three material aspects of the Australian approach to franchise regulation:

• mandatory information disclosure by franchisors to franchisees prior to a franchisee entering into a franchise agreement;
• an enhanced dispute resolution process which provides for mandatory mediation between franchisors and franchisees; and
• statutory minimums for franchise agreements regarding matters such as the termination, renewal or transfer of a franchise agreement by a franchisee.

Our View

We do not consider there is any need for specific laws to govern franchising in New Zealand. Although there could be benefits from legislation for the public perception of franchising as an "industry", there is no compelling reason to single out franchising from other industries.

The critical background to this review is that it has arisen as a result of the allegations of fraud levelled against a rogue individual. This issue is being dealt with by the SFO within the framework of current laws and, as MED itself notes in the discussion document, is not evidence of any widespread problem in New Zealand's franchising sector.

Our view is that the "status quo" system of regulation through New Zealand's existing business laws and FANZ adequately protects New Zealand's franchising sector. In particular:

• mandatory information disclosure can provide benefits of transparency and allow a franchisee the opportunity to (in principle) better understand the franchise system and the proposed franchise arrangement before it enters into the franchise agreement. However, this will not in itself deal with the root cause of many disputes between franchisors and franchisees. In many cases, the key issue is not whether the information has been provided but rather what information has been provided and whether it is accurate. In other words, whether the franchisor has made any misrepresentations concerning the franchise system or any misleading or deceptive claims. In the worst cases, this involves issues of fraud which can be dealt with by the SFO. In other cases, New Zealand's contract law (including the Contractual Remedies Act 1979) and the Fair Trading Act 1986 provide a robust form of protection for franchisees. There are a number of instances where the New Zealand courts have found in favour of franchisees in respect of misrepresentations which may have been made by franchisors in respect of their franchise system. This includes cases where a disclosure document has been prepared and provided to a prospective franchisee. A mandatory system of disclosure will not in itself deal with these underlying issues;
• issues of access to justice and methods of alternative dispute resolution are of general application to New Zealand SME's and are not peculiar to franchising. There is no concrete evidence of any widespread or systemic inability for franchisees to obtain access to justice for contractual disputes (which is borne out by the number of franchise related disputes which have been considered by our court system) or from appropriate authorities such as the SFO. Methods of alternative dispute resolution such as mediation are also no "silver bullet" and successful mediation will still require agreement by both parties to any negotiated settlement - a decision will not be imposed on them by a mediator; and
• the imposition of statutory requirements for franchise agreements is contrary to the principle of freedom of contract. Any perceived issues of "contractual imbalance" are something which should be dealt with by the courts on a case by case basis and it is in our view unnecessary and inappropriate to impose a "one size fits all" approach to this issue. In our experience, it is uncommon for franchise agreements to be open to termination by a franchisor at any time "without cause" and almost all franchise agreements we review deal with issues of renewal and transferability in a sensible manner. Further, issues of "unconscionable conduct" are currently being reviewed by the Ministry of Consumer Affairs as part of its review of the Fair Trading Act in a wider context than just franchising. This review should be left to run its course and there is no current justification for statutory requirements for franchise agreements.

More generally, as with any form of new regulation, a key issue is to determine who would be affected by the regulation. We believe care needs to be taken to ensure the term "franchise" is not incorrectly used to describe what are in effect pure distribution arrangements or licences to manufacture that do not involve the use of a "business format". This issue has been hotly debated in Australia and, even with a detailed definition of "franchise agreement", there is still uncertainty there as to when a distribution arrangement ends and a franchise begins. MED's discussion document provides evidence of this confusion. MED highlights a focus on "business format franchising" but also refers to examples of "product franchising" (where a manufacturer grants a right to a retailer to "re-sell" the manufacturer's product e.g. motor vehicles or petrol) and "manufacturing franchising" (where intellectual property may be licensed and/or technical information supplied by a person to a manufacturer for the manufacturer to make and sell a product e.g. a soft drink). In our view, these arrangements do not (and should not) be considered "franchises". Even if steps were taken to implement franchise specific regulation, any attempt to include these arrangements as "franchises" would need to be vigorously opposed.

Further Information

If you would like a copy of the discussion document or would like to make submissions to MED, please contact Patrick Casey.

Authors

Earl Gray

Partner - Intellectual Property

DDI: +64 9 977 5002

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Richard Watts

Partner - Intellectual Property

DDI: +64 9 977 5182

Mobile: +64 21 895 931

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Alex Campbell

Senior Associate - Corporate & Commercial

DDI: +64 9 977 5177

Mobile: +64 21 918 311

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Lisa Carbines

Senior Associate - Corporate & Commercial

DDI: +64 9 977 5219

Mobile: +64 21 498 626

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Sarah Chapman

Senior Associate - Intellectual Property

DDI: +64 9 977 5167

Mobile: +64 21 498 965

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