FAILURE AN ASSESSMENT OF THE ADEQUACY OF REGULATORY … · CPA Certified Practicing Accountants,...
FRANCHISOR FAILURE: AN ASSESSMENT OF THE ADEQUACY OF REGULATORY RESPONSE Jennifer Mary Buchan LLB (Otago), LLM (Melbourne) Submitted in fulfilment of the requirements for the degree of Doctor of Philosophy School of Law Faculty of Law Queensland University of Technology August 2010
FAILURE AN ASSESSMENT OF THE ADEQUACY OF REGULATORY … · CPA Certified Practicing Accountants, Australia DFV German Franchise Association EFF European Franchise Federation FCA Federal
1.1 Effective protection for franchisees whose franchisor fails ......................................................... 3
1.2 Challenges for the law ................................................................................................................. 8
1.3 Aim of the research .................................................................................................................... 10
1.4 Outline of thesis ......................................................................................................................... 11
1.5 Information base ........................................................................................................................ 13 1.5.1 Empirical research on the facts ....................................................................................... 14 1.5.2 Research on the current law ............................................................................................ 16
1.7 Matters beyond the scope of this thesis ...................................................................................... 17
CHAPTER 2: WHAT IS THE PROBLEM AND HOW BIG IS IT? ............................................. 19
2.1 Research into franchisor failure ................................................................................................. 19 2.1.1 Australian franchisor failure data ................................................................................... 21 2.1.2 Evidence of failed franchisors ........................................................................................ 30 2.1.3 Why franchisors fail ....................................................................................................... 43 2.1.4 Early warning signs ........................................................................................................ 48
2.2 Franchisor failure from other perspectives ................................................................................ 52 2.2.1 Franchisor’s perspective ................................................................................................. 52 2.2.2 The government’s and the regulator’s perspective ......................................................... 52 2.2.3 Industry organisations’ and commentators’ perspectives ............................................... 54
2.3 Franchisor failure from franchisees’ perspective ....................................................................... 55 2.3.1 Additional implications for franchisees structured like a commission agency ............... 67
2.4 Franchisees from the franchisor liquidator’s perspective ........................................................... 68 2.4.1 Franchisee as creditor ..................................................................................................... 69 2.4.2 Franchisee as debtor ....................................................................................................... 71 2.4.3 Franchisee as potential litigant ....................................................................................... 73 2.4.4 Challenges facing the liquidator ..................................................................................... 73
CHAPTER 3: THE PROBLEM IN CONTEXT .............................................................................. 79
3.1 Development of business format franchising ............................................................................. 80
3.2 Components of 21st century franchise networks ........................................................................ 81 3.2.1 Franchisor ....................................................................................................................... 83 3.2.2 Trade marks .................................................................................................................... 90 3.2.3 Leases ........................................................................................................................... 102 3.2.4 Franchisees ................................................................................................................... 112 3.2.5 Franchisees not traditional suppliers ............................................................................. 122
iv Franchisor Failure: An Assessment of the Adequacy of Regulatory Response
3.2.6 Franchisees or employees? ........................................................................................... 123
3.3 The franchise agreement .......................................................................................................... 146 3.3.1 Addressing the failure of the franchisor’s business ...................................................... 148 3.3.2 The desirability of certainty in contracts ...................................................................... 149 3.3.3 Parties to commercial and consumer contracts act in their own interests ..................... 150 3.3.4 A standard form business consumer contract ............................................................... 153 3.3.5 Relational contract ........................................................................................................ 157 3.3.6 Incomplete contract ...................................................................................................... 159 3.3.7 Exploitative contract ..................................................................................................... 161 3.3.8 Breach of contract ......................................................................................................... 162 3.3.9 Contract and quasi-contract based remedies ................................................................. 166 3.3.10 Contract-related complications ..................................................................................... 167 3.3.11 Conclusion .................................................................................................................... 169
4.4 Corporations Act 2001 (Cth) ................................................................................................... 213 4.4.1 Receivership ................................................................................................................. 213 4.4.2 Administration .............................................................................................................. 213 4.4.3 Winding up in insolvency ............................................................................................. 215 4.4.4 Specific assets and liabilities under the insolvency provisions of the
Corporations Act .......................................................................................................... 220 4.4.5 Impact on suppliers to franchise network ..................................................................... 227 4.4.6 Impact on employees if employer becomes insolvent .................................................. 227
CHAPTER 5: THE DEAL FOR FRANCHISEES ........................................................................ 235
5.1 Consumer protection benchmarks ............................................................................................ 236 5.1.1 Regulation should provide effective protection from serious risks and threats that
franchisees as consumers cannot tackle as individuals (B1) ......................................... 238 5.1.2 There should be accessible, timely and meaningful redress where consumer
7.1 Leading the world in franchise regulation ............................................................................... 287
7.2 Areas for Future research ......................................................................................................... 290 7.2.1 Database ....................................................................................................................... 290 7.2.2 Conflicts of interest ...................................................................................................... 291 7.2.3 Intellectual property ...................................................................................................... 291 7.2.4 Contracts ....................................................................................................................... 291 7.2.5 The potential liability of lenders ................................................................................... 291 7.2.6 Insolvent master franchisees ......................................................................................... 292 7.2.7 Corporations Act responses .......................................................................................... 292 7.2.8 International insolvency principles ............................................................................... 293 7.2.9 Cross border insolvency ............................................................................................... 294 7.2.10 Franchisees in unions and representative groups .......................................................... 295 7.2.11 Not purely a legal issue ................................................................................................. 295
APPENDICES ................................................................................................................................... 297 Appendix A: Australian Commonwealth and State legislation ................................................ 297 Division 2—Conditions and warranties in consumer transactions ........................................... 312 Appendix B: Foreign legislation .............................................................................................. 331 Appendix C: Possible categorisation of franchisees’ interests in diverse jurisdictions ............ 333 Appendix D: Franchise network .............................................................................................. 334
vi Franchisor Failure: An Assessment of the Adequacy of Regulatory Response
List of Figures
UFigure 1: Number of identified failed franchisors in Australia 1987 – 2009. U ....................................... 40
UFigure 2: Known number of franchisees affected by their franchisor failing in Australia 1990-2009U ...................................................................................................................................... 41
UFigure 3: Minimum estimated lost investment by franchisees in Australia 1990 - 2009.U ..................... 69
The Australian Securities and Investments Commission has approved funding for an
investigation into the collapse of white goods business Kleenmaid.
source: Uwww.news.com.au/perthnowU, 25 September 2009
Franchisor Failure: An Assessment of the Adequacy of Regulatory Response vii
List of Tables UTable 1: Australian failed franchisor dataU ............................................................................................. 30
UTable 2: National Australia Bank Accredited Franchise Systems 2008 and 2009 U ................................ 51
UTable 3: Some costs and losses for one franchisee of Danoz DirectionsU .............................................. 61
UTable 4: Features of Employee, Franchisee and Supplier / Independent Contractor.U .......................... 125
UTable 5: Additional Features of Employee and Franchisee.U ................................................................ 133
UTable 6: Franchisees’ position under State and Territory retail tenancy legislation. U ........................... 231
GEERS General Employee Entitlements and Redundancy Scheme
Griffith Griffith University, Queensland
ISoF International Society of Franchising
MBE MailBoxes Etc
NAB National Australia Bank
NSW New South Wales
NSWCA New South Wales Court of Appeal
NSWLEC New South Wales Land and Environment Court
NSWSC New South Wales Supreme Court
OBPR Office of Best Practice Regulation
Franchisor Failure: An Assessment of the Adequacy of Regulatory Response ix
PC Productivity Commission
RLA Retail Leases Act 1994 (NSW)
SA South Australia
SGR Superannuation Guarantee Ruling
TM Trade mark
TMA Trade Marks Act 1995 (Cth)
TR Australian Taxation Office Rulings
UK United Kingdom
UNCITRAL United Nations Commission on International Trade Law
USA United States of America
USDOC United States Department of Commerce
VSC Victorian Supreme Court
WASC West Australia Supreme Court
WBC Westpac Banking Corporation
x Franchisor Failure: An Assessment of the Adequacy of Regulatory Response
Statement of Original Authorship
Franchisor Failure: An Assessment of the Adequacy of Regulatory Response xi
Although working on a PhD is a solitary pursuit the project is not completed
without the support and encouragement of many people. I thank my supervisors
Professor Stephen Corones and Dr Bill Dixon for their outstanding guidance. I also
thank my other academic and professional advisers and mentors; Professor Diana
Beal, Associate Professor Dale Boccabella, Bill Butcher, Professor Alan Carsrud,
Professor Bill Duncan, Professor Lorelle Frazer, Associate Professor Anne Junor,
Philip Linacre, Professor Rosalind Mason, Michael Murray, Dr Paul Omar,
Rosemary Pynor, Professor John Piggott, Dr Michael Schaper, Albrecht Schulz,
Professor Tania Sourdin, Dr Elizabeth Spencer, Professor John Taylor and The Rt
Hon Sir EW (Ted) Thomas, LLD for support and encouragement at critical junctures.
I thank Julia Roy for editorial assistance Andre Briel, Caroline Malcolm, Wei Wu,
for research assistance; and Phil Cohen, Jane Malady, Hui Yi Thong and Pernilla
White for administrative assistance.
I have published extensively from this research and extend my thanks to the
anonymous referees who have each made valued comments. The publications are:
Jenny Buchan, ‘Consumer Protection for Franchisees of Failed Franchisors: Is
There a Need for Statutory Intervention?’ (2010) 9(2) QUT Law and Justice
Jenny Buchan and Bill Butcher, ‘Premises Occupancy Models for Franchised
Retail Businesses in Australia: Factors for Consideration’ (2009) 17(2) Australian
Property Law Journal 143.
Jenny Buchan, ‘Can Franchise Agreements Provide for Relief Against Franchisor
Failure in the Context of the Common Law?’ (Paper presented at the 23rd Annual
International Society of Franchising Conference, San Diego, 12-14 February
Jenny Buchan, ‘Franchisor’s Registered Trade Marks – Empirical Surprises’
(2009) 21(7) Australian Intellectual Property Law Bulletin 154.
Jenny Buchan, ‘Ex Ante Information and Ex Post Reality for Franchisees – the
Case of Franchisor Failure’ (2008) 36 Australian Business Law Review 407.
xii Franchisor Failure: An Assessment of the Adequacy of Regulatory Response
Jenny Buchan, ‘Franchisors’ Registered Trade Marks Under Australia’s Trade
Marks Act 1995 (Cth)’ (Paper presented at the 22nd Annual International Society
of Franchising Conference, St Malo, 20-22 June 2008) paper 30.
Jenny Buchan and Bill Butcher, ‘Franchisees’ Retail Premises Occupancy
Models in Australia; the Rights and the Risks’ (Paper presented at the 22nd
Annual International Society of Franchising Conference, St Malo, 20-22 June
2008) paper 39.
Jenny Buchan, ‘Challenges that Franchisees of Insolvent Franchisors Pose for
Liquidators’ (2008) 16 Insolvency Law Journal 26.
Jenny Buchan, ‘Square Pegs in Round Holes: Franchisees of Insolvent
Franchisors’ (2008) 9(2) Business Law International 114.
Jenny Buchan, ‘Reducing Collateral Damage in Franchisor Insolvency’ in Paul
Omar (ed), International Insolvency Law: Themes and Perspectives (2008) 367.
Jenny Buchan and Lorelle Frazer, ‘The Domino Effect – How Ansett’s Failure
Impacted on Traveland Academy of World Business’ (Paper presented at the
Marketing & Management Development Conference, Paris, 10-13 July 2006)
Jenny Buchan, ‘Is There a Basis for Equating Franchisees with Employees in
Priority Ranking on the Insolvency of Franchisors?’ (Paper presented at the 20th
Annual International Society of Franchising Conference, Palm Springs,
California, 24-26 February 2006) 229.
Jenny Buchan, ‘Franchisor Failure in Australia – Impact on Franchisees and
Potential Solutions’ (Paper presented at the 19th Annual International Society of
Franchising Conference, London, UK, 20-22 May 2005) 529.
CPA Australia and its then policy adviser Judy Hartcher, the International Bar
Association and the University of New South Wales funded and assisted the data
collection. On the subject of data, much activity in the world of failing franchisors
happens behind the scenes so I particularly wish to record my appreciation for the
contribution of former franchisees Ben Morris, David Archibald and several former
Traveland franchisees. My colleagues in the International Society of Franchising
have forced me to field searching questions that have improved my research. Their
interest and generosity is much appreciated.
Franchisor Failure: An Assessment of the Adequacy of Regulatory Response xiii
My Sunday morning coffee friends provided words of encouragement when
caffeine alone did not do the trick. The members of the bluemaumau online
community helped me keep my sense of humour.
Finally, and most significantly, my family granted me the time and space to
complete this research so I thank especially Graham, Ian and Tamsin Buchan and my
parents George and Jo Hitchcock. Without them every step would be more difficult.
Chapter 1: Introduction 1
Chapter 1: Introduction
The issue of the franchisee/franchisor relationship when the franchisor goes
into liquidation is one of the few vulnerabilities in franchising.0F
Most franchisees believe they are buying into a proven business model. Very
few have had previous experience with the consequences of franchisor failure and
most do not realise that in this respect, they are largely unprotected by law.
The purpose of this thesis is to critically examine the position of franchisees as
consumers of franchise opportunities. It examines the franchisees’ role in the
franchise network 1F
2 and the options available to them when their franchisor fails. On
concluding that the current situation is unsatisfactory, and that the situation will not
change without statutory intervention, I recommend legal reforms designed to level
the playing field in franchising. The proposed regulatory responses are evaluated
against three consumer protection benchmarks (‘the Benchmarks’).
The Benchmarks are:
B1) Regulation should provide effective protection from serious risks and threats that
[franchisees as business] consumers cannot tackle as individuals.2F
B2) There should be accessible, timely3F
4 and meaningful redress where consumer
detriment has occurred.
B3) The cost to the franchisor and the legal system of meeting B1 and B2 should be
less than the benefit to franchisees whose franchisor fails.
1 Peter Switzer, ‘Stop Losing Franchisees in the FOG’, The Australian (Sydney), 31 January 2002,
quoting Jim McCracken, then CEO of the Franchise Association of Australia, 21. 2 The phrase ‘franchise network’ is used throughout this dissertation. It refers to the entire network
created that supports the franchisor’s business, both the upstream entities related to the franchisor, including for example the franchisor’s premises leasing companies, entities that own the registered trade marks, and patents that franchisees use, and the downstream franchisees. This is differentiated from the widely used phrase ‘franchise system’ that includes only the franchisor and its franchisees.
3 Commission of the European Communities, EU Consumer Policy Strategy 2007 – 2013 Empowering Consumers, Enhancing their Welfare, Effectively Protecting them (2007) European Commission 5 <http://ec.europa.eu/consumers/overview/cons_policy/doc/cps_0713_en.pdf> at 5 March 2010.
4 Australian Government Productivity Commission, Review of Australia’s Consumer Policy Framework, Productivity Commission Report No 45 (2008) vol 2, xv.
2 Chapter 1: Introduction
The focus of this thesis is on business format franchising. Business format
franchising is a method of expanding a business via a network. It may be used by any
business that is capable of documenting its operations sufficiently to enable them to
be replicated. The business format franchise model, at its simplest, involves a
franchisor and its successful prototype business, a franchisee, a disclosure document
and a franchise agreement. The franchise agreement is a contract wherein the
franchisor grants the franchisee a licence for typically, a finite number of years to
establish a clone of a successful business that the franchisor has developed. The
franchisee then builds its own business and operates as a franchisee until the licence
contained in the franchise agreement expires. ‘The franchisee is obliged to pay the
franchisor certain fees and royalties in exchange for rights [described in contracts].
The franchisor has the obligation to provide the agreed rights and [to] generally
support the franchisee.’4F
The franchisee is neither an employee nor an independent contractor – but
displays many characteristics that are said to be defining of each relationship.
However, if the franchisor becomes insolvent, the franchisee has neither the legal
standing and protection employees enjoy nor the right to lodge a proof of debt for all
money invested, to ‘cut its losses’ and walk away with its own business intact that a
supplier has as an independent contractor.
In 1994 Australia was home to an estimated 555 business format franchisors,
and 16,536 franchised units which provided employment for 142,636 people.5F
the next 14 years these numbers grew to 1,100 franchisors, 63,500 franchisee-
operated units, and more than 400,000 people employed in business format franchise
7 The resulting investment by franchisees in start-up costs was
approximately A$7.14 billion in 2008.7F
5 PriceWaterhouse Coopers, ‘Economic Impact of Franchised Businesses’ (2004) International
Franchise Association Educational Foundation iii. 6 Australian Bureau of Statistics, Department of Industry, Science and Technology, Franchising
Sector Survey (1994). Note: this includes petroleum retailers. 7 Lorelle Frazer, Owen Wright and Scott Weaven, Franchising Australia 2008 (2008) 9-10. Note
the total excludes an estimated 10,500 retail fuel and motor vehicle retailers and the total number of employees includes those employed by franchisors.
8 Ibid 29-30. What is the total start-up cost of a new franchised unit (excluding GST)? This data is from a sample of 252 franchisors. ‘A significant difference was found between retail and non-retail systems. In the retail sector the median total start-up cost was $246,250 compared with
Chapter 1: Introduction 3
As franchisees have no clear standing under the Corporations Act 2001 (Cth)
(‘Corporations Act’) compared with other stakeholders in a franchisor’s insolvency
they pose a new challenge for both consumer protection and business failure law.
Franchisees are problematic. One insolvency lawyer observes that ‘[o]f all
insolvency matters, the most difficult is the failure of a franchise group’.8F
Most of the performance by the franchisor occurs after the franchisee has made
its investment. Table 3 shows that the franchisee makes a high sunk investment in the
early stages of the franchise relationship, particularly where the franchised business
is in retail or another sector where the franchisee’s business is conducted from fixed
premises such as hotels, motor fuels or car sales. The reality, if the franchisor
becomes insolvent, is that the sunk costs and other outlays have been expended by
the franchisee, theoretically allowing a claim9F
10 in the franchisor’s insolvency, but
with the reality of no prospect of return from the insolvency process. The reasons for
this will be explored in chapters 2, 3 and 4.
1.1 EFFECTIVE PROTECTION FOR FRANCHISEES WHOSE FRANCHISOR FAILS
The franchise environment in Australia is described as ‘…a mature franchise
sector operating within a regulated framework’.10F
11 An inference that is drawn from
such a claim is that the legal framework supporting the franchise model has evolved
to satisfactorily accommodate the needs of the key stakeholders at all stages of the
The opportunities the franchising model provides for franchisors are well
a multibillion dollar corporation can be built with little regard for the welfare
of the thousands of individuals who invest their life savings to build the
franchisor’s brand. … By accessing the labour and capital markets with a
$51,000 in non-retail. Food retailing start-up costs averaged $280,000, compared with a median of $210,000 in non-food retailing. The 2008 survey excludes motor trades franchisees.
9 D Binning, ‘Code Wars – A Liquidator’s Worst Fears’, The Australian Financial Review (Sydney), 29 June 2006, 13 quoting David Cowling, insolvency partner with law firm Clayton Utz (then Vice-chair of International Bar Association’s Section on Insolvency and Creditors Rights).
10 Contingent on the franchisee being permitted by the court to litigate, and then successfully establishing a claim that the franchisor breached a contract or the Trade Practices Act 1974 (Cth).
11 Lorelle Frazer, Scott Weaven, Owen Wright, Franchising Australia 2006 (2006) 12.
4 Chapter 1: Introduction
franchise business model, franchisors are able to achieve freedom from
12 [and common law liabilities] which would otherwise protect
workers and investors. Franchisees have far more to lose than …
Paul Steinberg and Gerald Lescatre have drawn attention to the somewhat
anomalous situation franchising has created – the opportunity for franchisors to shift
risk and liability without the law having fully adjusted to the consequential
vulnerability of franchisees as adopters of the risk and liability.
Notwithstanding the significant amount of policy and regulatory attention that
franchising has attracted in Australia, a fundamental problem still exists. The federal
and state government inquiries into franchising, the Review of Australia’s Consumer
Policy Framework conducted by the Productivity Commission (‘PC’) in 2008, and
the amendments to the Trade Practices Act resulting from the PC’s review have not
treated the franchisor’s failure, as a supplier to a franchisee as a business consumer,
as a consumer protection issue. This is the nub of the problem. If a supplier of
another expensive item like a luxury car fails, service people, spare parts and a resale
market for that car continue to exist notwithstanding the supplier’s failure. Where the
franchisor is the supplier and the franchisee’s business is the product, the situation is
different. There are unlikely to be replacement suppliers willing and able to supply
all of the franchisor’s services to franchisees. Further, it is unlikely that there will be
a market for the franchisees’ businesses, unsupported by the now failed franchisor.
The particular vulnerability of franchisees stems from numerous asymmetries
including; the current legislation, the franchisees’ role within the franchise network,
their inability to be a part of major decisions taken by their franchisor that may put
the franchise network at risk, and their own very limited ability to self-protect from
the legal consequences of franchisor failure.
The law’s response to franchisor failure sits awkwardly at the intersection of
contract law, consumer protection law and insolvency law. In all three areas there has 12 For example: statutes that impose requirements on employees to provide insurance for injured
workers, superannuation, payroll tax, statutory and common law directors duties in relation to areas such as conflicts of interest that would exist if the franchisees were share holders or employees but do not exist as the franchisees have chosen the franchising method of investment in the franchisor.
13 Paul Steinberg and Gerald Lescatre, ‘Beguiling Heresy: Regulating the Franchise Relationship’ (2004) 109 Pennsylvania State Law Review 105, 121.
Chapter 1: Introduction 5
been a considerable shift in attitude during the time that the franchise business model
has developed. The standard form relational contract is now widely used in business-
14 In addition there have been significant developments in
consumer protection and an increasingly forgiving attitude towards business failure.
Traditionally parties to commercial contracts were of equal bargaining
strength, and only signed contracts that had genuinely been negotiated. The
franchising contract challenges these assumptions. In franchising, the contract
between the franchisor supplier and franchisee consumer conforms to 21st century
consumer contract norms. These norms include the intrusion of the standard form
into the domain of relational commercial contracts.
On learning of the appointment of an administrator or liquidator to the
franchisor, franchisees turn to their franchise agreement and thence to contract law to
find what their rights are. For reasons that will be explored in chapter 3.3 and 3.4,
franchise agreements do not typically provide for franchisor insolvency.
Occasionally individual franchise agreements do address franchisor insolvency.
Where they do, the clause will typically offer one relatively crude option, an ipso
15 clause being a mirror image of the current rights franchisors have under the
Franchising Code of Conduct 15F
16 (‘the Code’) to terminate the agreement if the
franchisee commits an act of bankruptcy. They do not provide avenues for
franchisees to work with the administrator to assess alternatives. Usually franchisees
discover that they are bound to continue performing their contractual obligations, to
wait and see what the administrator or liquidator decides, and obviously to hope for
Australian consumer protection law has recognised that the franchisee is a
vulnerable business consumer, as demonstrated by the enactment of s51AC of the
14 For full discussion of the standard form relational contract, its characteristics in the context of
franchising and its implications in franchising, see Elizabeth C Spencer, The Regulation of the Franchise Relationship in Australia: A Contractual Analysis (PhD Thesis, Bond University, 2007).
15 Trischa Mann (general ed) and Audrey Blunden (consulting ed), Australian Law Dictionary (2010) 322 ‘by that very fact’. In the context of this thesis, an ipso facto clause might state that the act of bankruptcy being committed entitles the innocent party to rescind the contract. It should be noted that termination of a franchise agreement in the United States as a result of filing a bankruptcy petition is unenforceable, even if the agreement contains an ipso facto clause. W Michael Garner, Franchise and Distribution Law and Practice (1990) §13:17.
Trade Practices Act 1974 (Cth) (‘Trade Practices Act’) and the Code in 1998. The
franchisor’s insolvency has not, until now, been cast as a consumer protection issue.
In the realm of business failure, attitudes and expectations have reached a point
where business failures are seen by many in the commercial world as:
a productive mechanism. Business failures are part of a process in which
inefficient and unprofitable businesses are replaced by efficient and
profitable ones. … Economies get better through a process of
experimentation and natural selection.16F
Perhaps as a consequence of reframing business failure as a productive
mechanism, neither corporate insolvency not personal bankruptcy carry the stigma
they once did, and strategic insolvency17F
18 is considered to be a valid strategy for some
businesses. US lawyers speaking to an audience of franchise lawyers noted:
Bankruptcy provides a useful business tool for a company to reorganize its
operations, deleverage its balance sheet, accomplish a sale of assets, obtain
new financing or improve its capital structure. For example, bankruptcy may
assist a franchisor in addressing the following challenging business issues;
overexpansion in the market and the need to eliminate units, an unworkable
equity structure, desire to sell or merge with another entity, threat of
franchisee litigation, desire to refinance but the lender has expressed concern
about financial or other issues.18F
17 Ian Bickerdyke, Ralph Lattimore, and Alan Madge, ‘Business Failure and Change: An Australian
Perspective’ (Productivity Commission Staff Research Paper, 2000) 3. 18 D Noakes, ‘Measuring the Impact of Strategic Insolvency on Employees’ (2003) 11(12)
Insolvency Law Journal 91, fn 5, quoting Peta Spender ‘strategic insolvency arises when the bankruptcy is invoked due to strategic decision-making rather than being a passive response to market forces.’ Rizwaan Jameel Mokal, ‘The Search for Someone to Save: A Defensive Case for the Priority of Secured Credit’ (2002) 22(4) Oxford Journal of Legal Studies 687, suggests at 698 that ‘because a significant part of the [small firm] shareholder-managers’ wealth is likely to be invested in the [small] firm, as an undiversified investment, far from being ready to liquidate them strategically, shareholder-managers can be expected to fight … single-mindedly to keep them afloat.’ Mokal’s proposition may help explain the franchisees’ response to impending failure, but is inapplicable to franchisors that diversify business risks through their franchisees.
19 Sarah B Foster and Carolyn Johnsen, ‘The War of the Worlds: Bankruptcy Versus…’ (Paper presented at the American Bar Association, 28th Annual Forum on Franchising, Florida, 19-21 October 2005) 1. The word bankruptcy is used for both corporate insolvency and personal bankruptcy in the USA. In Australia bankruptcy is personal bankruptcy; insolvency is the corporate equivalent.
Chapter 1: Introduction 7
The strategic insolvency strategy is a variant of the ‘capricious termination’
problem that was identified by Harold Brown19F
20 in 1973 as the ‘Achilles Heel’ of the
entire franchising industry.
Whether the decision by a franchisor to become insolvent was strategic or not,
the franchisees’ situation as vulnerable business consumers is brought into sharp
relief if an administrator or liquidator is appointed to the franchisor. At that point
franchisees must respond to decisions made by third party administrators or
liquidators who do not have the same interest in individual franchisee’s ongoing
viability as the franchisor has. Franchisees have no meaningful protection under
common law or statute once an administrator or liquidator is appointed to their
This dissertation explores the ability of the current contract and consumer
protection laws to address the franchisees’ situation. The limited avenues of redress
currently available to franchisees as business consumers are neither meaningful nor
appropriate once an administrator or liquidator is appointed. Following the failure of
the franchisor, decisions made by the administrators and liquidators will take into
account the size of the debt owed to the franchisor’s creditors, the presence of
secured creditors, the value of franchisor’s saleable assets, the existence of interested
buyers, distribution of assets and liabilities throughout the franchise network and
other factors. Franchisees, as contracting parties have no standing.
Franchisors and franchisees view a franchise network in an entirely different
way to the way administrators and liquidators do. The Corporations Act contains the
administrators’ and liquidators’ statutory rights and duties towards parties that are in
a contractual relationship with the failing entity but under Australian insolvency law
franchisees have no specific statutory rights as parties to executory contracts.
Throughout the period of administration franchisees must not only continue to
honour their obligations under the franchise agreement. They must also continue to
meet upstream and downstream contractual obligations under premises sub-lease or
licence, supplier, employment and other contractual arrangements.
20 Harold Brown, Franchising: Realities and Remedies (1973) 40 cited in Shelby D Hunt,
The franchisees’ problems compound if third parties own assets to which the
franchisees would need uninterrupted access in order to continue their businesses.
These may include for example licences to use trade marks or patents, customer lists
or retail leases. Lack of access to third party owned assets makes it difficult for an
administrator to restructure the franchise network and virtually impossible for the
administrator or liquidator to sell the network intact. It also becomes difficult for
franchisees to continue trading independent of the franchise network. Trade marks
used by and retail leases of premises occupied by franchisees will be examined in
chapters 3.2.1, 3.2.3 and 4.5.
1.2 CHALLENGES FOR THE LAW
Multiple legal issues arise from franchisor failure. It is convenient to say that
franchisees should learn to conduct proper due diligence, or that they should be
better educated about the risks of franchising. It is also convenient to blame
franchisees for not self-protecting as a matter of course by each negotiating a suitable
ipso facto clause into their franchise agreement. In theory it is possible for
franchisees to self-protect through their franchise agreements but in practice there are
impediments to this which are discussed in chapters 3.3 and 3.4. For example, ‘[i]t is
costly, if not impossible, to write contracts representing claims on a firm [franchisor]
which clearly delineate the rights of holders for all possible contingencies.’20F
Even if negotiating an ipso facto clause were possible, the legal relationships
within a franchise network are so numerous and complex that a purely contract-based
solution is unsatisfactory as a sector-wide solution. It may suit a franchisee operating
a pool cleaning business with a well-established customer base that is loyal to their
pool cleaner and will follow him or her regardless of the name on the van but not a
franchisee with high, newly sunk investments and years to run on its franchise
In addition to the theoretical legal issues, the ‘complexity of the operation of
law in practice’21F
22 should be taken into account when looking for solutions to
21 Michael C Jensen and William H Meckling, ‘Theory of the Firm: Managerial Behavior, Agency
Costs and Ownership Structure’ (1976) 3(4) Journal of Financial Economics 305, 340. 22 Gillian K Hadfield, ‘The Many Legal Institutions that Support Contractual Commitment’ in
Claude Menard and Mary Shirley (eds), Handbook of New Institutional Economics (2004) 175, 177.
Chapter 1: Introduction 9
complex problems. In nature ecosystems are most complex at the boundaries of two
or more habitats. The problem of how to treat franchisees of failed franchisors is a
perfect example of this complexity existing in the legal world at the intersection of
the law governing commercial contracts, consumer protection, and insolvency.
Solutions to identified gaps in the law will have the greatest chance of being
acceptable to policy makers if they address the seven pre-requisites for the making of
sound and informed policy adopted by Australia’s Office of Best Practice Regulation
A description of the problem or issues which give rise to the need for
action and broad goal of the proposed regulation (‘OBPR 1’). This is
addressed in chapters 2, 3 and 5.
A specification of the desired objective(s) (‘OBPR 2’). This is addressed in
chapter 5 by reference to the three consumer protection benchmarks
A description of the options (regulatory and/or non regulatory) expressed
as a regulatory form or type that may constitute viable means for achieving
the desired objectives (‘OBPR 3’). These are identified in chapter 6.
An assessment of the impact, including costs and benefits, on consumers,
business, government and community or each option, with each impacted
group identified, noting impacts on competition, small business and trade
(‘OBPR 4’). A start has been made on this in chapter 6.3 but a full cost/
benefit analysis is the work of an economist with an appropriate budget
and falls outside this thesis.
A consultations statement detailing who was consulted, with a summary of
views from the main affected parties, or specific reasons why consultation
is inappropriate (‘OBPR 5’).23F
24 Although a consultations statement also
falls outside this thesis, stakeholder categories are identified in chapter 6.3.
23 Australian Government, Best Practice Regulation Handbook (2007) Department of Finance and
Deregulation A.2 <http://www.finance.gov.au/obpr/docs/handbook.pdf> at 30 May 2010. 24 Gary Banks, ‘Reducing the Regulatory Burden: the Way Forward’ (Inaugural Public Lecture,
Monash Centre for Regulatory Studies, University Law Chambers, Melbourne, 17 May 2006) 12. One of the prerequisites of good regulatory processes is ‘effective consultation with regulated parties at the key stages of regulation-making and administration’.
10 Chapter 1: Introduction
Comments about the problem from a range of stakeholders are found
throughout the thesis.
A recommended option, with an explanation of why it was selected and
others were not (‘OBPR 6’). Some recommendations are made in chapter
6.2. Some are made in brief and others more fully. Each would have to be
subjected to a full cost/benefit analysis before being accepted or rejected.
A detailed strategy for the implementation and review of the preferred
option (‘OBPR 7’)’.24F
25 Formulating detailed implementation and review
strategies is the work of regulators and is beyond this thesis.
In addition to the seven OBPR pre-requisites, the UNCITRAL Legislative
Guide on Insolvency Law (‘the Guide’)25F
26 raises a further consideration, the
relationship between insolvency and other law. The Guide recommends that ‘the
relationship between insolvency law and other laws should be clear and, where
possible, references to the other laws should be included in the insolvency law’.26F
The franchisee, being a part of a business model that evolved after the insolvency
laws were fundamentally settled does not comfortably fit within the insolvency
regime. In the context of consumer protection it is suggested that rather than relying
on the lead coming from insolvency law, the relationship between consumer
protection and insolvency law should be addressed pro-actively. This will be re-
visited in chapters 6.2 and 7.
1.3 AIM OF THE RESEARCH
This dissertation demonstrates why franchisees need protection and why they
are unable to self-protect from the consequences of franchisor failure. It explores and
proposes solutions via a statute-based consumer protection approach. The solutions
will address the three benchmarks and OBPR prerequisites 1, 2, 3, 5 and 6.
To support the conclusions this dissertation demonstrates why the current
emphasis on solving franchising problems through pre-contractual disclosure by
25 Peter Carroll, ‘Rethinking Regulation: An Assessment of the Report of the Taskforce’ (Paper
presented at the Australasian Political Studies Association Conference, University of Newcastle, 25-27 September 2006) 6.
26 UNICITRAL, Legislative Guide on Insolvency Law (2005) 19 <http://www.uncitral.org/pdf/english/texts/insolven/05-80722_Ebook.pdf> at 15 December 2009.
27 Ibid 19.
Chapter 1: Introduction 11
franchisors, improved pre-entry education and due diligence by franchisees and the
level of consumer protection currently contained in the Trade Practices Act and the
Code is inadequate in the context of franchisor failure. This dissertation thus aims to
answer three questions:
Can franchisees as business consumers self-protect against the
consequences of franchisor failure?
Does the current law meet the identified consumer protection benchmarks
and thereby protect franchisees as business consumers in the face of
franchisor failure without imposing undue extra costs on franchisors?
How should Australia’s commonwealth consumer protection law be
amended to meet the benchmarks?
1.4 OUTLINE OF THESIS
This thesis is presented in seven chapters in the manner outlined below.
This chapter 1 highlights the problems franchisor failure creates for franchisees
and introduces the dimensions of the problems that will be addressed. It also
identifies limitations of the research.
Chapter 2 identifies the size and scope of the problem of franchisor failure for
franchisees. The impacts on franchisees, the perspectives of key franchise sector and
insolvent franchisor stakeholders, and the reasons for the particular impacts and
stances are identified.
Chapter 3 places the problem in context by identifying the sources of the
problem. The outcome of an individual franchisor’s failure for each of its franchisees
depends on factors which can be loosely attributed to:
the development of the franchise model,
franchise network structural factors,
franchise agreement-related factors based in contract law, and
The legal structure of the network, the contractual relationship between the
franchisor and four key elements of a franchise network are set out in chapter 3.
These key elements are the franchisors, trade marks that identify the franchise, the
12 Chapter 1: Introduction
legal relationships between landlords, franchisors and the franchisees that conduct
their franchisee businesses from the landlords’ retail premises and, of course, the
The franchisees’ role within the franchisor’s network is examined, and because
there is uncertainty in some people’s minds about the differences between
franchisees and suppliers, the role and legal standing of suppliers to a franchise
network is also set out in the context of franchisor failure. In chapter 3.2.6
franchisees are compared with employees as there are strong similarities and strong
differences in the roles and in the level of protection afforded to them in the event of
their employer’s or franchisor’s insolvency.
Chapter 3.3 provides the theoretical discussion of key aspects of the franchise
agreement. Chapter 3.3 thus demonstrates how difficult it would be for all 71,400
Australian franchisees to be protected by ipso facto clauses in negotiated franchise
agreements. It will demonstrate why franchise agreements will never be drafted
voluntarily to routinely provide effective protection to franchisees whose franchisor
fails. Before moving from the contractual analysis, breach of contract and remedies
for breach of contract are examined.
In chapter 3.4 the numerous asymmetries that affect franchisees as a group of
business consumers are identified. The legal relationships between the network’s
entities, levels and nature of delegation, allocation of risk, ownership of the assets
that make up the franchisors’ offering, and the direction of money flow between
franchise and franchisees, all have a strong bearing on the franchisees’ ability to
continue trading if their franchisor’s business fails.
On concluding that contract law alone cannot protect franchisees, and that the
franchisor failure problem is significant enough to ‘give rise to the need for action’,27F
the question of whether the consumer protection regulatory regime is adequate in its
present form to deal with the problem is addressed in chapter 4. Chapter 4.1 explores
the possibilities of franchisees of failing and failed franchisors receiving protection
as business consumers under the current provisions of the Trade Practices Act.
Chapter 4.3.3 evaluates the adequacy of the Code.
28 Australian Government, Best Practice Regulation Handbook, above n 23, 27.
Chapter 1: Introduction 13
The application of the Corporations Act to franchisor insolvency is examined
in chapter 4.4. The limitations posed by the imperfect fit between the consumer
protection and insolvency regimes becomes clearer when the roles and
responsibilities of a receiver, administrator and liquidator under the Corporations Act
are identified. State and territory retail leases legislation are considered in broad
terms in chapter 4.5.
The OBPR writes in terms of ‘desired objectives’. This is interpreted as
objectives that meet appropriate benchmarks. The three identified consumer
protection benchmarks are expanded on in chapter 5. I refer to conclusions drawn in
chapters 3 and 4 to demonstrate that benchmarks B1 and B2 are not met under the
current Australian law.
On concluding that the current situation fails to attain B1 and B2, this
dissertation proposes solutions in chapter 6. First, non-regulatory solutions are
considered. They are rejected. The proposed regulatory solutions are then introduced.
These include amendments to the Trade Practices Act and to state and territory retail
leasing legislation. The solutions would provide laws that meet B1 and B2. As
previously stated, B3 concerns cost/benefit considerations and is not pursued in
detail in this dissertation.
Chapter 7 brings together the themes and issues explored and exposed in the
previous chapters. The central research question is reconsidered with reference to the
theoretical conclusions, empirical findings and the Benchmarks. Avenues for future
research that have been identified through this research are listed.
1.5 INFORMATION BASE
Michael Trebilcock argues that an ‘information-based approach to consumer
protection policy is the appropriate framework for analysing consumer protection
29 Reliable information is a necessary starting point. There are at least two
categories of information that must be found and understood before concluding that a
legislated solution is required to a problem. Firstly what are the facts, and secondly
what is the current law. While much research has been conducted on aspects of the
29 Michael J Trebilcock, ‘Rethinking Consumer Protection Policy’ in Charles E F Rickett and
Thomas G W Telfer (eds), International Perspectives on Consumers’ Access to Justice (2003) 69 referring to research conducted with Gillian K Hadfield and Robert Howse.
14 Chapter 1: Introduction
franchisor-franchisee relationship, surprisingly little empirical research has
previously been conducted on the legal structure of the entire franchise network. To
understand the impact of insolvency law on the franchisee’s legal contractual,
property-based and consumer protection rights it was necessary to fill this gap. If a
solution is proposed in the absence of a strong understanding of both the factual and
the legal framework within which a problem subsists, it will not satisfy the OBPR
model for the making of sound and informed policy.
The data on which this thesis is based is similar to the depth and amount of
data that a prospective franchisee conducting a very thorough due diligence would be
able to access. It is submitted that it is sufficient to support the conclusions reached.
1.5.1 EMPIRICAL RESEARCH ON THE FACTS
Initial research was conducted to formulate ‘[a] description of the problem or
issues which give rise to the need for action’.29F
30 The following areas were
A pilot study 30F
31 was conducted (‘the CPA Study’) of franchisors that fail in
Australia, the reasons for their failure, the characteristics of failed
franchisors, the number of franchisees impacted and the impact of
franchisor failure on the franchisees in specific networks including the
The nexus between the franchisor, the franchisees and the franchisees’
rights in relation to franchisors’ registered trade marks was explored. (‘the
30 Australian Government, Best Practice Regulation Handbook, above n 23, 27. 31 Jenny Buchan, ‘When the Franchisor Fails’ (2006); Jenny Buchan, ‘Franchisor Failure in
Australia – Impact on Franchisees and Potential Solutions’ (Paper presented at the 19th Annual International Society of Franchising Conference, London, UK, 20-22 May 2005) 529.
32 Jenny Buchan, ‘Reducing Collateral Damage in Franchisor Insolvency’ in Paul Omar (ed), International Insolvency Law: Themes and Perspectives (2008) 367; Joint Committee on Corporations and Financial Services, Parliament of Australia, Department of the Senate, Inquiry into Franchising and Code of Conduct (2008) Jenny Buchan Submission #89. <http://www.aph.gov.au/Senate/committee/corporations_ctte/franchising/submissions/sub89.pdf> at 31 May 2010. Jenny Buchan and Lorelle Frazer, ‘The Domino Effect – How Ansett’s Failure Impacted on Traveland Academy of World Business’ (Paper presented at the Marketing & Management Development Conference, Paris, 10-13 July 2006) 1901.
33 Jenny Buchan, ‘Franchisors’ Registered Trade Marks under Australia’s Trade Marks Act 1995 (Cth)’ (Paper presented at the 22nd Annual International Society of Franchising Conference, St Malo, France, 20-22 June 2008) paper 30; Jenny Buchan, ‘Franchisor’s Registered Trade Marks – Empirical Surprises’ (2009) 21(7) Australian Intellectual Property Law Bulletin 154.
Chapter 1: Introduction 15
The franchisees’ legal rights to occupy the retail premises they trade from
was also examined as part of the Exploratory Study. 33F
Data contained in the Tables throughout this dissertation is the most
comprehensive information that could be assembled, mostly from public records.
The CPA Study was conducted in 2005. It was funded and the final report was
published by CPA Australia, and was the beginning of a now ongoing search for
reliable base information about failing and failed franchisors and their networks. The
many challenges are discussed in chapter 2.1.1.
Ultimately, the challenges confronting legal researchers in franchising in
Australia is even greater in some ways than those that confront franchisees
attempting to conduct thorough due diligence on a particular franchise network. For
franchisees, it is extremely difficult, expensive, and sometimes impossible, to verify
the information provided by the franchisor in the disclosure statement. The
researcher has no ‘as of right’ access to disclosure documents or franchise
agreements that provide key information such as the legal identity of parties.
The Exploratory Study was funded by two research grants from the Australian
School of Business at the University of New South Wales. To obtain the data a
sample group comprising all franchisors with franchisees trading from premises
regulated by the Retail Leases Act 1995 (NSW) (‘Retail Leases Act’) was identified.
New South Wales was chosen because it has the highest number of franchisee-owned
units of any of Australia’s six states and two territories.34F
35 Retail premises-based
franchisees were selected because franchisees establishing in retail premises each
made a high average initial investment of $234,00035F
36 and thus have a strong interest
in the security of their investment.
34 Jenny Buchan and Bill Butcher, ‘Franchisees’ Retail Premises Occupancy Models in Australia;
The Rights and the Risks’ (Paper presented at the 22nd Annual International Society of Franchising Conference, St Malo, France, 20-22 June 2008) paper 39; Jenny Buchan and Bill Butcher, ‘Premises Occupancy Models for Franchised Retail Businesses in Australia: Factors for Consideration’ (2009) 17(2) Australian Property Law Journal 143.
35 Frazer, Weaven and Wright, Franchising Australia 2006, above n 11, 25 shows that franchisors have 34 per cent of their units in NSW, with the next highest percentage being 23.7 per cent in Victoria.
16 Chapter 1: Introduction
All 850 franchisors in the known population of franchisors in Australia in 2004
37 Their websites were searched to identify those having franchisees in
New South Wales (NSW). The addresses of NSW franchisees’ premises were found
from the website and checked in the telephone directory. It was then assessed
whether the franchisees’ premises would be regulated by the Retail Leases Act. This
process identified 350 franchisors as the sample group. For 13 of these, no further
information could be found and they were omitted. Hence, the sample group for the
Exploratory Study on franchisors’ registered trade marks in chapter 3.2.2 and retail
leases in chapter 3.2.3 numbered 337 franchisors.
Information about leasing patterns among the 337 franchisors was sourced
from court reports, the New South Wales Land and Property Management
Authority records, and the franchisor’s websites. Limitations stemmed from that fact
that many franchisees do not register leases or sub-leases on the premises title, and
information on franchisors websites is often loosely worded from a legal researcher’s
Information about ownership of franchisors’ registered trade marks within the
sample group was gathered from the IP Australia website37F
38 and franchisors’
websites. Trade mark registration identification numbers and the identity of the trade
mark owners were recorded and analysed. Information about how public-company-
owned franchisors’ trade marks were recorded in published Annual Reports was
sourced from the Notes to Accompany the Financial Statements (‘NTFS’).
1.5.2 RESEARCH ON THE CURRENT LAW
Research conducted on franchise law prior to this dissertation has focussed on
pre-contractual disclosure and on the franchise agreement as a contract. In addition to
disclosure and contract formation, this dissertation required an understanding of:
The legal structure of the franchise network
Trade mark law and practice
Retail lease law and practice
How franchisees compared with employees and independent contractors
37 With the assistance of Professor Lorelle Frazer, Griffith University. 38 IP Australia <www.ipaustralia.gov.au> at 31 May 2010.
Chapter 1: Introduction 17
How franchisees compared with traditional suppliers
Law and economics, with a focus on asymmetry
Remedies for breach of contract and the Trade Practices Act
The application of the Code to administrators
The legal rights of franchisees of insolvent franchisors under contract law
and under the Corporations Act.
This research is based on incomplete data in relation to franchisor numbers,
number of franchisees impacted and size of the investments lost. Some of the great
difficulties of conducting robust empirical research into the legal aspects of
Australian franchising are identified more precisely in chapter 2.1.1.
It is acknowledged in chapter 6 that a cost benefit analysis is essential before
any proposed legislative responses to problems are enacted. As the author is not an
economist, the stakeholders are identified and some costs and benefits are identified
but a full cost benefit analysis is left to be conducted by Commonwealth Treasury if
it deems such a step to be appropriate.
1.7 MATTERS BEYOND THE SCOPE OF THIS THESIS
This dissertation does not pursue in depth:
Retail leasing enactments which are part of the problem and part of the
The situation of franchisee whose franchisor discontinues franchising but
Tax treatment of franchisees’ sunk costs when the franchisor fails.
The impact of the halo effect referred to in chapter 3 on the depth and
quality of franchisees’ due diligence.
The impact of the franchisor’s insolvency on the contracts entered into by
franchisees as a consequence of becoming franchisees which is raised but
not explored in chapter 3.1.10.
18 Chapter 1: Introduction
The possibility of deeming franchisors to hold discrete funds paid by
franchisees in trust. This is raised but not pursued in chapter 6.1.6.
The insolvency of master franchisees.
The Corporations Act is part of the solution. Beyond tentative suggestions
in chapter 6.2.5 and identification of issues, this thesis does not address the
Chapter 2: What is the problem and how big is it? 19
Chapter 2: What is the problem and how big is it?
According to the OECD Regulatory Checklist, the problem to be solved
should be precisely stated, giving clear evidence of its nature and magnitude
and explaining why it has arisen.38F
The problem is that when a franchisor’s business fails the law does not provide
a clear way for franchisees to respond. In this chapter the evidence of franchisor
failure, its causes, magnitude and impact on franchisees is explored. Reasons behind
the difficulty of creating an accurate and complete Australian database of failed
franchisors and their franchisees are explored. This is followed by a discussion of
franchisor failure research and the causes of franchisor’s failure. The impact is
discussed from various perspectives: that of the franchisor, of commentators such as
industry lobbyists, of the franchisees and the liquidator.
2.1 RESEARCH INTO FRANCHISOR FAILURE
The existence of widespread franchisor failure is acknowledged by franchise
40 Beyond attempts at establishing how many franchisors fail and when in
the franchisor lifecycle the failure occurs ‘the [franchise research] subset of the
implications of franchisor failure and the impact of franchise failure on franchisees
has received very little academic attention’.40F
Academic studies of the number and timing of franchisor failures have been
conducted in the United States, the United Kingdom and France41F
42 but no large-scale
data has yet been published to specifically record the number or timing of Australian
franchisor failures. In 1977 Shelby Hunt wrote that ‘[e]vidence began to mount that 39 Trebilcock, above n 29, 69 citing OECD, Recommendation of the Council of the OECD on
Improving the Quality of Government Regulation (Including the OECD Reference Checklist for Regulatory Decision-Making and Background Notes) Paris: OECD (1995) 9.
40 For example, the Franchise Council of Australia’s annual conference legal day has scheduled a session on franchisor failure every year from 2006 to 2009 inclusive.
41 Benjamin Morris, Franchisor Insolvency (B Laws Honours Thesis, University of Technology Sydney, 2006) 3.
42 French and United States franchising and franchise research are referred to throughout this thesis in addition to Australian. Both France and the United States have strong franchise sectors, active franchise academics and have, either recently (France) or historically (the United States) conducted research or collated statistics on franchisor failure.
20 Chapter 2: What is the problem and how big is it?
many franchises [ie franchisors] were failing [in the US]. One study42F
43 identified 54
entire restaurant franchise systems that turned “belly up” over a two-year period’.43F
Roger Blair and Francine Lafontaine state:
the USDOC (1988)44F
45 data … reports the number of franchisor failures and
departures… Out of an estimated population of 2,177 franchisors in 1986:
‘A total of 104 franchisors operating 5,423 outlets failed during 1987 … The
volume of 1986 sales represented by failed firms amounted to $[US] 1.7
billion, of which the franchisee-owned portion was $[US]1.5 billion’. 45F
Commenting on the timing of the failures:
[Scott] Shane suggests heavy failure rates of new franchise systems in the
first four years, followed then up to the ten year period by only modest
further losses, …. Lafontaine and Shaw, on the other hand, report steady and
sustained failure rates from franchise format adoption onwards.46F
The difficulty of obtaining sound data on failed franchisors was noted in 1994
by James Cross who pointed to an information void with regard to franchise failure:
The only systematically compiled statistics on franchise [this could have
been franchisors or franchisees] failures have been provided by the
Franchising in the Economy reports [produced up until the late 1980s by the
US Department of Commerce but since discontinued] and periodic
membership surveys by the International Franchise Association. While these
efforts are commendable and undoubtedly well intentioned, both are based
on potentially incomplete and inaccurate data submitted by franchisors.47F
Lafontaine and K Shaw cite United Kingdom research by John Stanworth who
concluded that ‘at best, one franchise company in four could be described as an
43 Urban B Ozanne and Shelby D Hunt, The Economic Effects of Franchising (1971) 93. 44 Hunt, ‘Franchising: Promises, Problems, Prospects’, above n 20, 75. 45 Andrew Kostecka, United States Department of Commerce, Franchising in the Economy (1988)
12. 46 Roger D Blair and Francine Lafontaine, The Economics of Franchising (2005) 272. 47 Francine Lafontaine and K L Shaw, ‘Franchising Growth and Franchisor Entry and Exit in the
US Market: Myth and Reality’ (1998) 13(2) Journal of Business Venturing 95, in Frank Hoy and John Stanworth (eds), Franchising: An International Perspective (2003) 163.
48 In John Stanworth, David Purdy and Stuart Price, ‘Franchise Growth and Failure in the USA and the UK: a Troubled Dreamworld Revisited’ (1997) 2(2) Franchising Research: An International Journal 75, 78 citing Janes Cross, ‘Franchising Failures: Definitional and Measurement Issues’ (Paper presented at the International Society of Franchising Conference, Las Vegas, Nevada, 13-14 February 1994) 1.
Chapter 2: What is the problem and how big is it? 21
unqualified success story … over a ten year period. Around half the [UK] sample
was judged to have failed completely and utterly’.48F
49 Blair and Lafontaine conclude
that ‘there has been no systematic study of the effect of franchisor exits, whether it
be a departure from franchising or a business failure, on the survival or growth of the
franchised units that were tied to it’.49F
Rozenn Perrigot and Gérard Cliquet studied 952 franchising networks in
France during the period 1992-2002 and found that only 42.13 per cent survived.50F
Over half of franchisors in France did not survive 10 years. These are franchisors that
have been granting franchisees the right to trade as a franchisee for terms of 0 to 20
years and for which up-front franchise fees would typically have been paid for the
52 Beyond this small amount of research on the number of franchisor
failures, the actual cost to franchisees and consequences for franchisees of franchisor
failure is under-researched. 52F
2.1.1 AUSTRALIAN FRANCHISOR FAILURE DATA
As this thesis is about franchisor failure in Australia, it is important to seek
Australian data rather than assuming that American, British or French patterns are
reproduced in Australia. However, as Colin McCosker and Lorelle Frazer observed
When extending the analysis of business failure to franchising, the problem
of data collection becomes apparent. No comprehensive database of
franchisors or franchisees is available in Australia, so researchers must
develop their own. … it is not possible to access failed franchisors. The
magnitude of such franchise system failures is unknown but may be
disturbingly high. For instance, … the authors found that in the 6-month
period from checking firm details in the Telstra White Pages on the Internet
(updated daily) to follow-up on non-respondents, 13.4 per cent (127 out of
49 Lafontaine and Shaw, above n 47, 95-112, in Hoy and Stanworth, above n 47, 164. 50 Blair and Lafontaine, above n 46, 44. 51 Rozenn Perrigot and Gérard Cliquet, ‘Survival of Franchising Networks in France from 1992 to
2002’ (Paper presented at the 18th Annual International Society of Franchising Conference, Las Vegas, Nevada, 6-7 March 2004).
52 Rozenn Perrigot, ‘Services vs Retail Chains: Are There Any Differences? Evidence from the French Franchising Industry’ (2006) 34(12) International Journal of Retail & Distribution Management 925.
53 An exploratory study was conducted by Jenny Buchan in 2004-2005 in Australia and reported in ‘When the Franchisor Fails’, above n 31. The Report focussed on consequences of franchisor failure.
22 Chapter 2: What is the problem and how big is it?
946 [franchisor] firms) could not be located and were presumed to be no
Echoing McCosker and Frazer’s observation in 1998, it is still not possible in
2010 to determine from public records which of the 693 franchisors known to be
trading in 1998, the 850 in 2004 and the 1100 in 200854F
55 are still solvent.
Data collected during the CPA Research and subsequently is reproduced in
Table 1 on pages 30 to 39. The data in Table 1 tends to support Lafontaine and
Shaw’s conclusion that young franchisor networks in Australia are not more
vulnerable to failure than the more established ones. By implication, it contradicts
Shane’s research as some Australian franchisors have failed long after their
businesses passed the 10 year mark.
Frazer et al now conduct a biannual franchising Australia survey. Their
database records the franchisors that are not contactable two years later, but the
published survey does not identify them by name or by total number. Frazer is cited
What the latest study  shows is that many franchise systems are
relatively new and untested in a recession, many are too small to remain
viable long-term, … One-third of systems started up between 2000 and 2005
and one-fifth since 2006. … Between 2004 and 2006, the number of systems
increased by 100. There were 200 new entrants and 100 that ceased
franchising, so for every two new ones, one got out.55F
Not all of the un-contactable franchisors on the Griffith database failed. Some
test the franchise model, decide it is not for them, then buy back the franchisees’
businesses. Others simply stop servicing their franchisees without the franchisor
Jason Gehrke writes that his analysis of:
the advertiser list of a 1996 edition of Franchising Magazine indicated that
of 113 franchisors then advertising for franchisees, 34 could no longer be
54 Colin McCosker and Lorelle Frazer, Franchising Australia 1998: A Survey of Franchising
Practices and Performance (1998). 55 Frazer, Weaven and Wright, Franchising Australia 2008, above n 7, 9. 56 John Kavanagh, A Business Out of a Box (2009) Business Day
<http://www.businessday.com.au/small-business/franchising/a-business-out-of-a-box-20090703-d6zd.html> at 3 July 2009.
Chapter 2: What is the problem and how big is it? 23
found to exist just 10 years later – an attrition rate of 30 per cent. Many of
these were very small, start-up systems with a handful of outlets, but the
consequences of their failure are equally devastating to their franchisees
Gehrke’s methodology does not support his conclusions to the extent that some
franchisors included in the 30 percent quoted will no longer be advertising for
franchisees because they have moved away from the franchise model. They may still
be operating their core business successfully though company owned stores or other
The biggest impediment to determining what happens to franchisees when their
franchisor fails is identifying failed franchisors and former franchisees. The list in
Table 1 is incomplete. Searches of public records and other sources that are typically
available to intending franchisees or their advisers were conducted. The records
Media reports, using the Factiva database and the Australian Financial
The Australian Securities and Investments Commission 57F
website where administrators and liquidators lodge documents surrounding
corporate insolvency at ASIC,
The Insolvency and Trustee Service Australia that maintains records of
personal bankruptcy (‘ITSA’),
The Australian Competition and Consumer Commission58F
website which contains information about investigations and prosecutions
for breaches of the Trade Practices Act and the Code,
State and territory business name records, and
Federal, state and territory court records.59F
57 Jason Gehrke, When Franchisors Fail (2008) Smart Company Blogs
<http://www.smartcompany.com.au/blogs/when-franchisors-fail/print.html> at 31 May 2010. 58 ASIC <www.asic.gov.au> at 31 May 2010. 59 ACCC <www.accc.gov.au> at 31 May 2010. 60 Using the www.austlii.edu.au and Casebase databases.
24 Chapter 2: What is the problem and how big is it?
First the identity of the failed franchisor’s legal entity was sought, then the
affected franchisees. Many challenges were encountered.
What was the franchisor entity?
Franchisors exist within complex networks of legal entities. It is difficult to
find a legally meaningful starting point, such as the name of the franchisor entity,
from which to begin an investigation. The franchisor entity may be a public or
proprietary company, a trust or sole trader with a name different to the trading name
of the franchisor. This is apparent by observing the differences in the ‘Trading name’
and the ‘Entity names’ columns in Table 1.
IDENTIFICATION OF FRANCHISOR THROUGH THE MEDIA
If a failed franchisor is named in a media report, the franchisor is referred to by
its trading name. Where the trading name and the legal entity name of the franchisor
are similar it is possible to determine the legal identity of the franchisor (eg The
Furniture Wizard Pty Ltd traded as Furniture Wizard). In cases where there is no
similarity between the legal entity’s name and the trading name (eg Chaste
Corporation Pty Ltd traded as TRIMit) the franchisor cannot be identified from the
Data may be accurate when published but quickly become inaccurate. The
media faces the same problems that franchisors face in trying to portray accurate and
up to date information. For example, in Business Review Weekly’s 31 January – 5
March 2008 edition ‘The franchisor Beach House Fitness Group [BHG], with 60
outlets at 30 June 2007, was ranked 4th in 2006 [on what measure] and 11th fastest
growing franchises by outlet’.60F
61 BHG was wound up, insolvent, in December 2008.
Thirty four of the franchisors in the CPA Study were initially identified
through media reports. 61F
61 Business Review Weekly (31 January – 5 March 2008) 49. 62 Using the Factiva database of media records in Australia. This identified the following
franchisors that were probably in administration or insolvent: A1 Mobile Radiator Repairs; Barnacle Bills; BB's Coffee & Bake; BC The Body Club; Boston Markets; Busy Bookkeeping; Carlovers Carwash; Cheap as Chips; Cut Price Deli; Delifrance (Australian master); Furniture Wizard; King Pie; Allied Securities; Lloyd Scott Enterprises; Mini Tankers International; Modern Garages; National Express Transport; Nationwide International (Australia); NoRegrets; On Time Business Solutions; PC Company; Personal Actions; Renouf Personal Fitness Centres; Simply No-Knead; Snow Deli; Soils Ain't Soils; Speeds Shoes; Synergy in Business; Tokyo Joe's; Tony Barlow Menswear; Top Snack Foods; Traveland, United Video Franchising; Wonderland of Pets.
Chapter 2: What is the problem and how big is it? 25
IDENTIFICATION USING ASIC RECORDS
Once the initial database of likely failed franchise systems was compiled, ASIC
records were searched to verify the status of each corporate franchisor. To identify
franchisees of the former franchisors, franchisees that appeared by name on any
public records were recorded. Franchisees are often proprietary companies, with
contractual obligations supported by the personal guarantees of the directors. The
franchisors are also primarily companies.62F
63 ASIC does not require franchisors or
franchisees to self-identify as being part of a franchise network, so ASIC records are
not a reliable way of identifying participants in the franchise sector, or in a particular
franchise network. Where the franchisor is a public company there is no record of the
franchisees’ identities in the company’s Annual Report.
Liquidators file prescribed documents with ASIC or ITSA. Both the lists of
sundry debtors and of unsecured creditors contain names and addresses of people and
companies that owe and are owed money by the failing company, but give no
indication of the nature of the debt or the claim. A franchisee may be characterised as
a sundry debtor or a creditor, depending on the structure of the franchise. In many
cases franchisees are not mentioned in the material filed by the liquidator. Details
must be cross-referenced to court reports, media releases or a business name extract
to determine an individual’s status.
The insolvency-related ASIC records of two insolvent franchisors63F
purchased to determine whether franchisees could be identified from the records filed
with ASIC by the liquidator and, if so, how they were categorised. They could not, so
no further records were purchased. Employees’ claims in the insolvency of the
employer by contrast, are identified in a separate schedule – schedule E to the Report
of Affairs filed with ASIC by the liquidator.
Following a franchisor failure, the administrator or liquidator receives or
compiles a list of franchisees but there is no requirement to lodge that list with ASIC
or ITSA. Without access to these records, it is impossible to ascertain whether all of
the franchisees have been counted, and whether the number of franchisee per
franchisor as reported in the media is accurate.
63 Lorelle Frazer and Scott Weaven, Franchising Australia 2004 (2004) 70. 64 The Furniture Wizard and Traveland.
26 Chapter 2: What is the problem and how big is it?
It is not possible to determine from personal bankruptcy records whether the
failed sole proprietor was a franchisor or a franchisee.
IDENTIFYING FAILED FRANCHISORS AND THEIR FRANCHISEES THROUGH COURT RECORDS
Searches of numerous court records yielded very little. The exception is
Synergy in Business which was prosecuted by the ACCC64F
65 in order to establish that
it was a franchise network. A list of franchisees was appended to the judgment.
In court cases involving failed franchisors, it can be impossible to determine
the identity of the franchise network. For example in Rousellis v Maiurano 
NSWCA 196 Fitzgerald AJA referred to the franchisor as ‘two companies, which at
the time were insolvent and were later ordered to be wound up on that ground’65F
without naming the companies or the trading name of the franchise network. The
respondent was a director of the companies.
Sometimes even the courts are unable to identify the franchisor. For example,
in Acer Computer Australia Pty Limited v Carter (No 2)  FCA 1943 Justice
The relevant franchisor would appear to have been one or other of the
companies in the ‘Betta Group,’ which comprised Betta Stores Limited …,
Identifying and finding former franchisees of failed franchisors
Precise information is required for legal research. Having finally identified 39
failed franchisors in the CPA Study67F
68 a bigger challenge proved to be identifying
individual former franchisees by name and finding up to date contact details. This
proved almost impossible.
65 Australian Competition and Consumer Commission v Ewing  FCA 5 lists the names of 31
franchisees (called licensees) but not their addresses or the states where they operated. 66 Rousellis v Maiurano  NSWCA 196. 67 Acer Computer Australia Pty Limited v Carter (No 2)  FCA 1943, para 2. 68 Buchan, ‘Franchisor Fails’, above n 31, Appendix 1.
Chapter 2: What is the problem and how big is it? 27
As one of the failed systems was a travel agency, Traveland, an advertisement
was placed in a daily electronic newsletter service that circulated to 15,000
individuals in the travel industry.68F
69 This elicited three responses from former
Advertisements aimed at former franchisees of failed franchisors were placed
in a number of national and state daily newspapers including ‘The Australian’ and
the ‘Daily Telegraph’. It was an expensive exercise and the response rate was very
70 Specific advertisements were not placed in Tasmania, the Northern Territory
or Western Australia because of the relatively low number of franchisees in those
states. A press release sent to one daily newspaper was picked up and used, and led
to one franchisee of a failed franchisor making contact.
An advertisement was posted on the Brisbane bailiff’s office website
http://www.bailiff-sheriffaustralia.com.au. A chat strand was set up on
franchisechat.com http://www.franchise-chat.com/forum, a global franchise chat site
with 736 members. Neither yielded any responses or postings.
IDENTIFYING FRANCHISEES THROUGH STATE AND TERRITORY BUSINESS NAME RECORDS
Businesses that do not trade under their company name or their personal name
are required to register their business name in the state or territory in which they
operate. Many businesses ignore this legal requirement. For example, in the online
lingerie retailing franchise, franchisor No Regrets, of the 600 franchisees, only two
had registered their business names – one in New South Wales and one in Western
Australia. Therefore there are 598 former franchisees that cannot be identified
through the business names public records. In ‘The Furniture Wizard’, a furniture
repair franchise with 35 franchisees, only 21 had registered business names.
Once a business name has been registered in compliance with state legislation,
it is added to the centralised, federal, ASIC website. The information generated by
the ASIC search of The Furniture Wizard stated that there is ‘no document list
available for this organisation type’. This implies that there is no further information
available about the business. In fact, an inquiry at the Western Australian Fair
69 <www.Travelblackboard.com.au> at 11 August 2005. 70 In total this elicited eight franchisee subjects, two legal advisers, two insolvency practitioner
28 Chapter 2: What is the problem and how big is it?
Trading Office reveals that historical information about the business named
‘Furniture Wizard – Wangara’ is available. Sometimes this historical information
contains the name and residential address details of the former franchisee. As
demonstrated by the above examples, eliciting comprehensive information from
some public records can be ‘hit and miss’.
Where business names had been registered by franchisees, extracts of the
relevant registration were purchased. Although the registration had generally lapsed,
the contact details of the former franchisee are still on the records. They are often no
The electronic white pages directories were searched for a reliable match for
franchisees whose name and address was known. For people with common
Australian names – eg ‘Smith’, it was not attempted.
Searching state and territory business names registers proved to be the most
reliable way of identifying former franchisees of failed franchisors, but it was far
Ultimately only 87 franchisees from 14 failed systems were identified by name.
It was not possible to physically locate many of these. Franchisees were contacted by
telephone before they were sent a survey, in order to verify that the correct individual
had been located.
Eighteen former franchisees agreed to complete a survey. Three that were
71 For the CPA Study two survey instruments were used. The first
was tailored for Traveland (46 questions) due to the high proportion of Traveland
respondents whose identity was known and the second (45 questions) was generic.
Completed surveys were returned by 14 former franchisees. This low response rate
means that the survey responses are not statistically valid.
The human dimension
A further challenge to research on franchisees of failed franchisors is that
former franchisees’ lives have been disrupted by the experience. Former franchisees
71 One who could not face revisiting the issue, one who had signed a confidentiality agreement and
one couple who spoke very broken English.
Chapter 2: What is the problem and how big is it? 29
are not always willing to participate in research that will cause them to revisit a
Reactions to an invitation to participate in the CPA Study varied from:
… really interested in being involved
… not interested in being involved. [S]igned confidentiality agreement with
Synergy and wouldn't want to breach it
… simply doesn't feel up to getting involved in it all again
… not interested in being involved. Doesn't want to ‘go through it’ all again,
as it caused … quite a few problems which they are only now putting behind
Often franchisees’ only point of connection with each other is via the
franchisor. They may not know each other’s last names or addresses. If the franchisor
fails, franchisees can lose access to the franchisor’s intranet, and with it their only
means of contacting each other. This problem is not overcome by the requirements of
the Code. 72F
73 To comply with the Code, the franchisor is required to supply business
contact details (but not the name of the franchisee) for some or all franchisees in the
system at the time the franchisee obtains the disclosure.
Information from administrator and liquidators
Because franchisees were difficult to find, letters were sent to administrators
and liquidators of specific franchise networks. Five agreed to participate and were
interviewed. In all cases these professionals provided valuable insights, all on the
condition of confidentiality.
Distinguishing franchised businesses from non-franchised businesses
Some businesses do not knowingly establish themselves as a franchise and
only realise that they are operating as a franchise after court action. For instance, in
Australian Competition and Consumer Commission v Ewing  FCA 5 the
72 Caroline Malcolm, Research Assistant Report after a day of telephoning all known former
franchisees of insolvent franchisors. 73 See Trade Practices (Industry Codes – Franchising) Regulations 1998 (Cth) cl 6.2, 6.3 (‘The
30 Chapter 2: What is the problem and how big is it?
ACCC successfully alleged that the licensor, Synergy in Business, was franchising
and had breached the Code. Proceedings had commenced on 22 July 2002. On 6 June
2002 Synergy in Business became insolvent. The 31 franchisees had signed licence
agreements and had not known they were franchisees until the judgment was handed
down 18 months after the franchisor became insolvent.
Interpreting information on franchisors’ websites
On learning that the Australian master franchisor for Canadian popcorn
franchisor Kernel’s Amazing Popcorn was insolvent, the Australian master
franchisor’s website was immediately searched. The website still portrayed a master
franchise in good health. It did not identify the franchisor. The only legal entity
named was Jatora Pty Ltd which, according to the website, had the role of
negotiating and holding the head lease on all the franchised locations. A
contemporaneous search of the ASIC company and business name records name had
a different outcome with 17 business names registered incorporating ‘Kernel’s
Popcorn’, but no names of legal entities. The Australian master franchisor does not
have the word Kernels in its name. An ASIC search reveals Jatora Pty Ltd’s status as
‘under external administration and/or controller appointed’. The administrator was
appointed on 18 March 2005. A resolution that the company be wound up was
recorded by ASIC on 21 April 2005. It was unclear from the master franchisor’s
website, whether Jatora played any other role other than head tenant in the leases.
However, the liquidators’ report to creditors filed with ASIC to comply with
Corporations Act s 239A shows that Jatora Pty Ltd was the Australian master
2.1.2 EVIDENCE OF FAILED FRANCHISORS
Given the difficulty in obtaining comprehensive data on franchisor failure,
Table 1 provides a conservative indication of the size of the problem. The gaps are
where the information could not be found.
Table 1: Australian failed franchisor data
Year failed (administrator or liquidator)
Amount owed to creditors, (estimated)
Known number of franchisees
Navis 2010 85
Chapter 2: What is the problem and how big is it? 31
Tokyo Joe’s The Australian Sushi Company Pty Ltd (franchisor + supplier)
2003 $31,000 6
Delifrance (Australian arm)
1995 2003 19
Mini Tankers International
Mini-Tankers International Pty Ltd
1991 2003 $4.4m secured $8m unsecured
Mobile Computer Cleaning
Mobile Computer Cleaning Pty Ltd
1997 2003 56
Chapter 2: What is the problem and how big is it? 37
Year failed (administrator or liquidator)
Amount owed to creditors, (estimated)
Known number of franchisees
Personal Action Pty Limited
1992 2003 $200,000
Roger David Franchising Pty Ltd
Soils Ain’t Soils
Soils Ain’t Soils Pty Ltd
1980 2003 Up to $100m incl. $16m to ATO
King of Croissant
King of Croissant Pty Ltd
Jims Sand Soil & Gravel
In Jims Group
NoRegrets NoRegrets Australia Pty Ltd (and several Norwood-controlled companies)
1998 1998 2002 $13m No assets
Old Papa’s Café
Old Papa’s Franchise Systems Pty Ltd
2000 2002 3
Rugs Galore Rugs Galore Pty Ltd 12 007 343 204
1991 2002 4
Tony Barlow Menswear
Boutique Consolidated Pty Ltd Tony Barlow Australia Ltd (parent)
2002 $4.8m incl. $700k secured to NAB
Stockmans Australian Café
Stockman’s Australian Café Pty Ltd
1990 2002 48
Synergy in Business
Synergy In Business Pty Ltd
1998 1999 2002 31
Cheque Exchange (Aust.) Pty Ltd
1998 2001 58
Personal Training Centres
Lloyd Scott Enterprises
Lloyd Scott Enterprises Pty Ltd ACN002739773
38 Chapter 2: What is the problem and how big is it?
Year failed (administrator or liquidator)
Amount owed to creditors, (estimated)
Known number of franchisees
Traveland Traveland Pty Ltd (in a group of 40 entities including Ansett Australia Limited and 1 trustee company)
1958 1990? 2001 270
TRIMit Chaste Corporation Pty Ltd
1999 2001 70
Arby’s Arby’s Pty Ltd
Jims Motor Vehicle Repair Service
In Jims Group
On Time Copy Centre
On Time Business Solutions
1997 1998 2000 $3m 17
Simply No Knead Franchising Pty Ltd
1985 1989 2000 5
Top Snack Foods
Top Snack Foods Pty Ltd Nick Kritharas Holdings Pty Ltd Adway Holdings Pty Ltd
1994 2000 $800,000 5
A1 Mobile Radiator Repairs
A1 Mobile Radiator Repairs Pty Ltd
? 1997 1999 4
The Furniture Wizard Pty Ltd
1996 maybe 1998 1999 35
Arbin (no 1) Pty Limited (formerly Abrogram Pty Limited, Modern Garages Pty Limited)
1988 1994 1999
Mystic Crystals Franchises (Australia)
1993 1999 2
Chapter 2: What is the problem and how big is it? 39
Year failed (administrator or liquidator)
Amount owed to creditors, (estimated)
Known number of franchisees
Century 21 Pty Ltd
Century 21(South Pacific) Pty Ltd
1988 1988 1998
Great Australian Ice Creamery
Icecreameries of Australia Pty Ltd
1977 1982 1998 62
Wonderland of Pets
Wonderland of Pets Pty Ltd ; Kiltaro Pty Ltd
1994 1996 $860,000 3 (originally 10)
Cut Price Deli
Cut Price Deli Pty Ltd
1974 1984 1995 150
Denny’s Denny’s Pty Ltd
Ozzie Discount Software
Discount Software Pty Limited
Underpinning buildings in NSW
Aizeema (Australia) Pty Ltd; Hy-Jack Superlifting Systems Pty Ltd
Snow Deli Snowdeli Pty Limited
1987 1990 $8.7m 10
Barbara’s House and Garden
Barbaras House & Garden (Retail) Pty Ltd (franchisor) Barbara’s House & Garden Pty Ltd, Barbaras House & Garden (Australia) Pty Ltd Barbaras House & Garden (Wholesale Pty Ltd
1980 1982 1987
40 Chapter 2: What is the problem and how big is it?
Year failed (administrator or liquidator)
Amount owed to creditors, (estimated)
Known number of franchisees
Dinkum Bargains Fuddruckers Fuddruckers
Pty Ltd 1981
Sizzler Bumpa T Bumpa
Described as ‘defunct’ no more information available
The Donut Wheel/ The Chocolate Chip Cookie wheel
Melbourne based, vans delivering choc chip cookies to shops
Figure 1: Number of identified failed franchisors in Australia 1987 – 2009.
The numbers in Figure 1 for 2006 and 2007 are low because data was not
actively sought in those years. There is no evidence that the number of franchisor
failures or the number of franchisees affected has reduced since the Code became
mandatory. It appears that the opposite occurred, but there is insufficient data to
Known Numberof Failed
Chapter 2: What is the problem and how big is it? 41
assess the extent of this problem. Garry Williamson73F
74 who ‘has been tracking
franchising [in Australia] for more than 20 years. … says his defunct franchisors file
is bigger than the current franchisors file by a factor of six to one’.74F
75 On the basis of
Williamson’s statement it is suggested that the data in Table 1and the numbers in
Figures 1 and 2 are the tip of the iceberg.
Figure 2: Known number of franchisees affected by their franchisor failing in
In Australia in 2007, the average number of franchise units per franchise
system was 50.75F
76 To use this median to estimate the number of franchisees impacted
by franchisor failure in Australia is problematic as franchise systems range ‘from 1 to
2,950 total units.’76F
77 While some networks had very few franchisees when they failed,
six had over 150. It is not possible to determine the number of franchisees in 53 of
the 98 failed networks identified in Table 1.
The number of franchisees at the time of the franchisor failure is not a true
representation of franchisees affected by the failure as many may have already left
the network, disenchanted at the lack of franchisor support, slow stock deliveries or 74 Australian Franchise Consultant from the Franchising Centre. 75 Emma Connors, ‘The Brave New World of Franchising’, The Weekend Australian Financial
Review (Sydney), 6-7 February 2010, 39. 76 Frazer, Weaven and Wright, Franchising Australia 2008, above n 7, 24. 77 Ibid 25.
affected (logaithmic scale)
42 Chapter 2: What is the problem and how big is it?
other problems symptomatic of impending business failure. For example, pet shop
retail franchise Wonderland of Pets had ten franchisees at its peak, but only three at
the time it failed.
Consistent with Lafontaine and Shaw’s conclusions,77F
78 franchise networks of
any age and structure can fail. Failed franchisors in Australia include:
Public companies and entities wholly owned by public companies (drive in
car wash business CarLovers, travel agent Traveland, retail gadget shop
Proprietary companies (retail mid-range jewellery franchise Kleins, Top
Long established businesses (Kleins Jewellery had been in business for 25
years, franchising unknown number of years ; Collins Booksellers, 76
years, franchising unknown number of years; and Speeds Shoes, 94 years,
franchising unknown number of years)
Franchisors of short duration (A1 Mobile Radiator Repairs and Danoz
Directions - 2 years)
Franchisors with hundreds of franchisees (No Regrets with 600, Traveland
Businesses requiring franchisees to invest high sunk costs (Kleins,
Kleenmaid ($400,000), Stockmans Australian Café, Cut Price Deli)
Those requiring small sunk costs (Furniture Wizard, conducted from the
franchisees’ suburban residential garages)
Franchisors established before the mandatory Code was introduced in
1998 (Cut Price Deli, Century 21, Great Australian Ice Creamery)
Those established post the enactment of the Code (Kleins, Danoz, diet
Franchisors with franchisees operating as commission agents (gym
business Beach House Group, Kleenmaid)
78 Lafontaine and Shaw, above n 47, 95-112, in Hoy and Stanworth (eds), above n 47, 163.
Chapter 2: What is the problem and how big is it? 43
Franchisees operating on the usual money flow model where franchisees
receive money from their customers and pay royalties to their franchisor
Australian master franchisees of overseas based franchisors (Kernels
popcorn from Canada, Delifrance from Singapore, Midas and Hooters
from the USA).
2.1.3 WHY FRANCHISORS FAIL
Common sense suggests that the franchisors do everything in their power to
make their business a success. This is not always the case. The Franchising Task
Force Report of December 1991 (‘Task Force’) in Australia78F
79 concluded that the:
2.7 … most vulnerable franchise systems are those that have recently
commenced franchising and have less than, say, 12-15 units.79F
2.9 Franchisees are clearly vulnerable to the collapse of the franchisor,
however, even when the franchisor has collapsed, some franchisees are
capable of surviving as independently owned and operated outlets, as with a
number of the Barbara’s House and Garden franchisees. …
2.10 However newer franchisees or franchisees already suffering severe
financial strain are unlikely to survive the complete collapse of a franchise
Three years after the Task Force filed its report, Stanworth, Purdy and Price
report that James Cross identified some causes of SME (small and medium-sized
enterprise) failure as being generic and concluded that failures of this type should
actually be remedied or reduced by franchising.81F
82 These causes are:
absence of economies of scale
lack of business acumen
79 Robert W Fitzgerald, Franchising Task Force Final Report to the Minister for Small Business
and Customs (1991) 2.7–2.10. 80 In the light of the data in Table 1 in this thesis this statement is not supported by current data. 81 Here, I have listed only the reasons that are within the control of the franchisor, omitting those
that are a function of the broader economy. 82 Cross, above n 48, 2-4.
44 Chapter 2: What is the problem and how big is it?
inability to survive intense competition in sectors (such as retailing)
where barriers to entry are low.
Failure as a result of franchising-related factors, is seen by Cross as falling
essentially into five key categories: business fraud, intrasystem competition
involving franchise outlets being located too close, insufficient support of
franchisees, poor franchisee screening and persistent franchisor-franchisee conflict.82F
Failure of the parent company83F
84 should be added to this list.
It is not always possible to identify the underlying cause of insolvency from
public records. Reported court cases that involve a franchisor at about the same time
as it becomes insolvent generally relate to issues with a particular franchisee or group
of franchisees and seek to resolve pre-insolvency matters such as alleged misleading
and deceptive conduct by the franchisor. Only passing reference is made to causes of
The following are specific examples of failed franchisors from Australia:
An unsuccessful attempt at expanding to another country can lead a
franchisor to fail; for example Mini-Tankers International ‘which operated
franchises in Australia, Canada and New Zealand collapsed in September
 owing $10.7million as a result of an unsuccessful attempt to launch
an operation in the United States’.84F
For Traveland, failure of the parent company, Ansett, was the beginning of
the end. ‘Air New Zealand’s decision to buy Ansett and absorb the much
larger airline destroyed both. Insufficient due diligence and the need to
upgrade Ansett’s ageing fleet were among Air NZ’s problems’.85F
83 John Stanworth, David Purdy and Stuart Price, above n 48, 78-9. 84 For example Ansett Airlines failed, taking its subsidiaries including Traveland with it. 85 Kath Walters, ‘Fuel for Shareholders Anger’, Business Review Weekly (Sydney), 13 May 2004,
17. 86 Stathi Paxinos, ‘Ansett from A to T’, Sunday Age (Melbourne), 17 February 2002, 9. The
statement that both airlines were destroyed has turned out to be inaccurate; Air New Zealand is still operating in 2010.
Chapter 2: What is the problem and how big is it? 45
A1 Mobile Radiators breached the consumer protection provisions ss 52
and 59(2) of the Trade Practices Act and became insolvent during the
A similar path to A1 Mobile Radiators was followed by Simply No Knead
which was successfully prosecuted for breaching s 51AC of the Trade
Practices Act and became insolvent during the litigation.87F
No Regrets, an on-line lingerie retail business, established in 1998, enticed
600 franchisees to invest in a virtual franchise store. The franchise ‘was
launched in 1998 as a tax-effective scheme, with the help of prospectuses
that set a new standard in steamy financial documents complete with
pictures of scantily clad women’.88F
89 The franchise was based on an
aggressive tax avoidance scheme where ‘investors put in about [A]
$12,500 cash for each so-called virtual franchise store they bought but
claimed tax deductions of up to $51,000’. 89F
90 It was described as a ‘financial
and operational flop’.90F
91 It is estimated that the 600 franchisees lost ‘in
excess of [A]$7million through a combination of their original franchise
fee, then big bills sent by the tax office as part of a crackdown on tax-
92 Although the dubious wisdom they exhibited in
being attracted to a tax minimisation scheme can be questioned, the
franchisees did not cause the failure of this franchise.
Lloyd Scott Enterprises, a photocopier franchise became insolvent in June
2001 because of the dishonesty of the franchisor, Mr Lloyd Scott. The
the fallout continues from the [A]$40 million fraud that brought down
Newcastle photocopier franchise Lloyd Scott Enterprises. … Businessman
Lloyd Scott had been fraudulently writing multiple leases on photocopier
87 Australian Competition & Consumer Commission v Trayling  FCA 1133. 88 Australian Competition & Consumer Commission v Simply No-Knead (Franchising) Pty Ltd
 FCA 1365; Australian Competition and Consumer Commission v Simply No-Knead (Franchising) Pty Ltd (2000) 104 FCR 25.
89 Neale Prior, ‘Lingerie Firm’s Rescue Looks A Little Scanty’, The Australian Financial Review (Sydney), 22 May 2004, 6.
90 Neale Prior, ‘Investors in Norwood’s NoRegrets Left with Plenty of Them’, The West Australian (Perth), 4 February 2005, 37.
91 Ibid. 92 Ibid.
46 Chapter 2: What is the problem and how big is it?
equipment, a step that had flooded his company with cash, but which had
required him to perpetrate more frauds to keep the various leases paid up.92F
CarLovers Carwash franchise was a public listed company which became
insolvent in 2003. The media report stated:
In the 2002 financial year, according to PricewaterhouseCoopers, from every
[A]$100 in income that CarLovers earned, 20c came from franchise fees. ….
[the franchisor] locked itself into expensive leases of up to 20 years, on sites
where the carwashes didn’t reach expectations and the company made big
write downs. … [I]n 1998 CarLovers’ problems with its leases were
compounded with what became an even greater problem: an increasing
number of franchisees stopped paying franchise fees, claiming that
CarLovers was not providing the services … it had promised. Then there
were the little contretemps CarLovers’ had with its auditors.93F
Failed franchisor, Stockmans Australian Cafes identified what were
believed to be critical mistakes which resulted in the franchisor failing.
Failure to provide sufficient field support to franchisees.
Appointing master franchisees. … this gave third parties the authority to
grow and represent the franchisor but they did not have the requisite skills
No internal compliance standards and a tolerance of non-compliance of
Having a very wide geographical spread of franchisees, but small numbers.
[The franchisor] had all the costs of servicing a national network without
many of the economies.
Failure to invigorate the network with new product and innovation.
Poor communication and complaints management processes.
Growth that was too fast and master franchisees that were too focussed on
selling franchises rather than providing the necessary support to franchisees.
Poor recruitment standards and policies.
93 Greg Ray, ‘Fraud Fallout Action Settled’, The Newcastle Herald (Newcastle), 24 July 2004, 4. 94 Neil Chenoweth, ‘CarLovers is All Washed Up’, The Australian Financial Review (Sydney), 19
Chapter 2: What is the problem and how big is it? 47
Lack of detailed monitoring and bench marking.94F
In 2006, the Signature Brands owned Pulp Franchises’ failure was
attributed to the fact that by ‘mid 2004 the juice bar industry, estimated to
be worth more than $650m by ACNielsen – had become saturated and
recent arrivals [such as Pulp] were struggling under the weight of massive
Instances of franchisor failure are increasingly well publicised. Media attention
tends to highlight the plight of customers and the franchisor’s employees, paying
scant attention to franchisees. For example, the Mercury made no mention of Speeds
Shoes’ franchisees who had invested $180,000 - $300,000 on their outlets, rather
focussing on employees, writing: ‘[m]ore than 60 workers face losing up to $200,000
in wages, superannuationa and holiday pay after the collapse of a discount shoe
97 This failure of the media to include franchisees in the franchisor failure
stories tends to reinforce the mantra that franchising is a safe entry point into small
The tale told in the Barbara’s House & Garden litigation rings true even 20
years later. It could provide a salutary warning to people becoming franchisees of a
franchisor that is not on a sound financial or managerial footing:
In the second half of 1982, when Mrs. Bateman had been working for the
company for some two years, the company became involved in the vigorous
promotion of franchises to operate ‘Barbara's House and Garden’ stores ….
The promotion was portrayed as the natural expansion of an outstandingly
successful business, but financial statements tendered in evidence suggest it
was in fact an attempt to keep a foundering business afloat by getting in
substantial franchise fees. 97F
History repeats itself. Strathfield Car Radio replicated the Barbara’s House and
Garden strategy in 2009, going one step further and embracing franchising as a way
95 Stephen Giles and Rod Young, ‘The Rise and Fall of Stockmans Australian Cafes’, FCA Visions
Newsletter (Melbourne), August 2005. 96 Sue Mitchell, ‘Signature Out of Pulp but Not Out of Juice’, The Australian Financial Review
(Sydney), 1-2 April 2006, 10. 97 Tim Martin and Catherine Hockley The Mercury (Hobart), 2 April 2004, 11. 98 Re Richard Vincent Bateman and Georgina Gay Bateman v Barbara Jean Slatyer; Harvey John
Slatyer; Graham Walter Tiekle and Barbara's House & Garden (Retail) Pty Limited  FCA 58, para 3.
48 Chapter 2: What is the problem and how big is it?
of resurrecting itself out of administration. Strathfield Car Radios’s administrator
adopted a strategy of:
selling franchises in order to rid themselves of unprofitable assets and to
raise capital. [For example] mobile phone and electronics retailer Strathfield,
… collapsed into administration earlier this year but emerged after a major
shareholder injected fresh capital. Strathfield has announced it will pursue a
franchise strategy as it attempts to turn its fortunes around.98F
It is beyond the power of the franchisees to influence the franchisor’s
management choices. As Doug Frazey observes:
While franchisees are typically required to meet a number of conditions in
their franchise agreements (such as sales quotas), franchisors do not share
the same responsibilities. … a franchisee is usually powerless to correct a
poorly managed franchisor, even though the effects may weigh more heavily
on the franchisee. 99F
One striking aspect of these insolvencies is that there is no evidence that any of
them was of a franchisees’ making.
2.1.4 EARLY WARNING SIGNS
Michael Jensen and William Meckling note that ‘[a]s the probability of
bankruptcy increases both the operating costs and the revenues of the firm are
101 The flow-on effects of the franchisor not receiving previously
favourable trading terms will be noticeable to franchisees that are required to source
stock or other services through their franchisor.
Jensen and Meckling use the example of a firm facing possible bankruptcy
having to ‘pay higher salaries to induce executives to accept the higher risk of
99 Jacqui Walker, Franchising Under Pressure (2009) Smartcompany
<http://www.smartcompany.com.au/franchising/20090505-will-franchising-survive-the-recession.html> at 20 August 2009; and see James Thomson, Retail Chain Strathfield Collapses into Administration (2009) Smartcompany <http://www.smartcompany.com.au/retail/retail-chain-strathfield-collapses-into-administration.html> at 31 May 2010.
100 Doug Frazey, ‘Case Note: When ‘Good Cause’ Goes Bad: Minnesota Restricts Protection for Dealers under HUMEDA – River Valley Truck Ctr., Inc V. Interstate Cos’ (2006 - 2007) 33(2) William Mitchell Law Review 711, 728 quoting David Hess, ‘The Iowa Franchise Act: Towards Protecting Reasonable Expectations of Franchisees and Franchisors’ (1995) 80 Iowa Law Review 333, 338-9.
101 Jensen and Meckling, above n 21, 341.
Chapter 2: What is the problem and how big is it? 49
102 Whereas in a traditionally structured firm some of these costs can
be ‘avoided by merger’ 102F
103 the opportunities available to a franchise include
advertising for new franchisees, increasing costs to franchisees and embarking on a
course of strategic insolvency. Consequently, franchisees may find they have to
accept less reliable supply of stock or manage hostile premises landlords or other
suppliers where the franchisor has failed to pay costs incurred in relation to the
franchisees’ business – paid on time by franchisees to franchisor and then not on-
paid to the suppliers on time. For example, a BHG franchisee discovered the
franchisor had failed to pay the local advertiser, so the advertiser refused to deal with
the franchisee until the franchisee got to the bottom of the problem and arranged
direct payment from franchisee to supplier, instead of from franchisee to franchisor
to supplier, for future local advertising.
It is difficult for franchisees to be pro-active if they believe their franchisor is
operating precariously. The franchise agreement and consequential contracts must be
Relevance of type of product or service sold by franchisees
As Jensen and Meckling point out, ‘in certain kinds of durable goods industries
the demand function for the firm’s product will not be independent of the probability
of bankruptcy.’ 103F
104 In franchising, the demand for the early morning take-away coffee
sold by a franchisee where payment and supply is completed within a minute will be
unaffected by the franchisor’s impending or actual financial woes. Customers will
continue to patronise the franchisee so long as they like the coffee. Only if the
franchisee’s business closes, will the customers patronize another cafe. By contrast,
the demand for expensive items supported by long term warranties, such as motor
vehicles, or white ware that will be bailed by the franchisor or franchisee until a
builder needs to take delivery, or products and services like travel, hotel or rental car
bookings made and paid for now with delivery in the future, will be adversely
affected as consumers prefer to deal with solvent suppliers.
In the immediate pre-insolvency phase, the franchisor’s own employees are
likely to become aware of the precarious nature of the franchisor’s business before
102 Ibid. 103 Ibid. 104 Ibid.
50 Chapter 2: What is the problem and how big is it?
the franchisees do because employees notice irregularities in their wages and hear ‘in
house’ whispers. Because the money flows from franchisee to franchisor in most
cases, this unofficial early warning system of cash flow problems being exposed may
not be available to franchisees. Franchisees may not become aware of the
franchisor’s position until a supplier changes the terms of trade, or a landlord locks
them out of their shop because the franchisor has not passed on the rent it has
collected from the franchisee/ licensee or franchisee/sub-tenant or the franchisee
learns of the franchisor’s financial difficulty through the media.
For the franchisee, Canadian insolvency litigator Craig R Colraine states that:
Poor financial performance, including the accumulation of significant debt
when the franchise system is not expanding, growing operating losses, the
writing down of assets and re-financings are obvious indications [to the
financially literate] that a franchise is in difficulty. … Identifying financial
problems in non-publicly traded corporations is more difficult.104F
Colraine’s experience as an insolvency litigator also qualifies him to observe
that ‘[t]he financial difficulties of a closely held franchisor may become apparent
only when the franchisor’s obligation to provide advertising support, equipment and
inventory on a timely basis … are breached’.105F
The role of banks
Banks are a major stakeholder in both franchisors and franchisees through their
role as evaluators and financiers. But, in some cases the early warning signs do not
trigger a response by the franchisor’s bank. Allowing a franchisor to continue signing
up franchisees whilst the franchisor is in default on a large loan is a way of a bank
reducing its exposure by increasing its security.
In the Kleins retail jewellery franchise failure, for example, the franchisor’s
bank continued to endorse the franchise network despite being owed millions of
dollars by the franchisor and being well-positioned to know that the franchisor’s
financial structure was not viable or sustainable. As recently as June 2008, the Kleins
franchise was still listed as one of only 20 National Australia Bank ‘Accredited
105 Craig Robin Colraine, ‘Franchises: Insolvency and Restructuring’ (Unpublished paper presented
at the Distribution Law: Catch the Wave, Avoid the Rocks, Ontario Bar Association Continuing Legal Education, Toronto, Canada, 26 May 2003) 3.
Chapter 2: What is the problem and how big is it? 51
Franchise Systems’. By including Kleins in this list, the bank sent a message to
potential consumers of Kleins franchises, and their advisers, that Kleins was of sound
Table 2: National Australia Bank Accredited Franchise Systems 2008 and 2009
NAB Accredited Franchise Systems
23 May 2008
NAB Accredited Franchise Systems
6 September 2009
Bob Jane T-Marts
Choice Hotels (Flag)
Pizza Hut/Yum! Restaurants
Quest Serviced Apartments
Bob Jane T-Marts
Choice Hotels (Flag)
Pizza Hut/Yum! Restaurants
Quest Serviced Apartments
The Outdoor Furniture Specialists
Kleins was placed into administration on 30 April 2008 while the National
Australia Bank was still demonstrating endorsement on its website.
Litigation against franchisor as an early warning sign
The significance of litigation as an early indicator of failure was identified in a
Dun & Bradstreet Corporate Health Watch survey. It was concluded from the survey
results that ‘[c]ompanies that have had legal action taken against them are nearly
eight times more likely to fail than those that haven’t’.106F
107 ‘Warning Signs of Failure’, The Australian Financial Review (Sydney), 2 May 2006.
52 Chapter 2: What is the problem and how big is it?
In franchising, further research would reveal whether the threat of franchisee
litigation caused the franchisor to consider pre-emptive or strategic bankruptcy107F
whether the litigation caused the subsequent failure of the franchisor.
2.2 FRANCHISOR FAILURE FROM OTHER PERSPECTIVES
2.2.1 FRANCHISOR’S PERSPECTIVE
For a financially troubled business, insolvency may be part of a considered
business strategy. According to US legal advisers, it provides ‘an opportunity … to
solve operational or financial problems and emerge as a more viable company’.108F
One US lawyer writes:
Franchisors file for bankruptcy to escape or postpone the consequences of
mass franchisee litigation, shareholder litigation, and lender enforcement
activities. During the reorganization [in Australia, administration] process,
bankruptcy can modify and suspend the obligations of the parties to a
franchise agreement. Ultimately, the reorganization plan may permanently
modify the rights and obligations of the parties to the franchise agreement. 109F
Anecdotal and deduced evidence of this conduct exists in Australia. For
example, bake your own bread franchisor Simply No Knead became insolvent
between the time the ACCC initiated proceedings and the time the case successfully
alleging the franchisor had breached s51AC Trade Practices Act was concluded.110F
Senior US franchise lawyers Rupert Barkoff and Andrew Selden identify ‘the
risk that ‘your franchisor goes bankrupt’111F
112 as an ‘uncontrollable risk’ in their
practitioner guide on franchise law.
2.2.2 THE GOVERNMENT’S AND THE REGULATOR’S PERSPECTIVE
Several government reviews into the franchise sector have been conducted in
113 Some have examined small business generally; others focus on
108 Foster and Johnsen, above n 19, 1. 109 Ibid. 110 Craig R Tractenberg, ‘What the Franchise Lawyer Needs to Know About Bankruptcy’ (2000–
2001) (3)20 Franchise Law Journal 3. 111 Australian Competition & Consumer Commission v Simply No-Knead (Franchising) Pty Ltd
 FCA 1365. 112 Rupert M Barkoff and Andrew C Selden, Fundamentals of Franchising (3rd ed, 2008) 278.
Chapter 2: What is the problem and how big is it? 53
The Franchising Task Force in 1991 was the first Australian government-
initiated review to comment directly on franchisor failure, noting:
[t]he main internal network reasons for franchisor failure were under-
capitalisation of the franchisor; too rapid expansion of the franchise system,
poor product or service, poor franchisee selection, [and] franchisor greed.113F
The main reasons for franchisor failure external to the franchise network were
identified as: ‘devaluation of the Australian dollar, an increase of import duties, the
withdrawal of an important source of products, an aggressive and cheaper competitor
or a severe downturn in the economy’.114F
115 Franchisor and franchisee failure was
addressed as the same issue by the Task Force and resulted in recommendations that
franchisors should provide better disclosure, and prospective franchisees should
conduct better assessment of the nature of the business being purchased and the risks
as well as opportunities associated with the system.115F
116 Although the 1992
Supplement included a table on franchise failures, the firms counted were almost
No further attention was given to the incidence or impact of franchisor failure
until the Mathews Review in 2006. The Matthews Review reported being: ‘made
aware of a number of situations where the impact of the failure of a franchise or a
franchisor had a major impact on the financial or emotional well being of those
Trade Practices Consultative Committee, Small Business and the Trade Practices Act (Blunt) (1979); Standing Committee on Industry, Science and Technology, Parliament of the Commonwealth of Australia House of Representatives Small Business in Australia: Challenges, Problems and Opportunities (‘Beddall Report’) (1990); Robert Fitzgerald, Franchising Task Force Final Report to the Minister for Small Business and Customs, the Hon David Beddall (‘Task Force 1991’); Franchising – Australia and Abroad, Supplement to the Franchising Task Force Final Report, 1992 (‘1992 Supplement’); Robert Gardini, Review of the Franchising Code of Practice (1994); Peter Reith, New Deal: Fair Deal – Giving Small Business a Fair Go (1997); Graeme Matthews, Review of the Disclosure Provisions of the Franchising Code of Conduct (2006); Government of Western Australia, Inquiry into the Operation of Franchise Businesses in Western Australia, Report to the Western Australian Minister for Small Business (2008); Economic and Finance Committee, Parliament of South Australia, Franchises (2008), Parliamentary Joint Committee on Corporations and Financial Services, Commonwealth, Inquiry into the Franchising Code of Conduct (2008).
114 Task Force above n 113, 21-22. 115 Ibid. 116 Ibid 26. 117 Matthews, above n 113, 17.
54 Chapter 2: What is the problem and how big is it?
More recently, the ACCC as consumer protection regulator has identified that
‘franchisees often lose their business and their livelihood when their franchise system
fails. The 2008 failure of the Kleins Jewellers franchise system highlighted this
118 The ACCC recommended the Parliamentary Joint Committee consider
whether: ‘Some measure might be warranted to protect franchisees in circumstances
where their franchisor fails – for example granting them the right to exit the franchise
2.2.3 INDUSTRY ORGANISATIONS’ AND COMMENTATORS’ PERSPECTIVES
The mantra of some franchise industry groups is that:
Bankruptcy of the franchisor is not necessarily bad for franchise system or
franchisees. There have been cases where bankruptcy and restructuring
actually result in [a] stronger network of operators, with stronger financial
management at corporate headquarters and a stronger brand position.119F
Singing from the same song sheet as the IFA, the media release below was the
only reference to ‘insolvency’ when the FCA’s website was searched in October
2009. It implies that the Ezy DVD franchisees all survived their franchisor’s failure.
Franchise insolvency leads to a ‘rebirth’ for franchisees.
In late December 2008, DVD retailer EzyDVD collapsed under the strain of
debts of around [A]$18 million. However, a white knight appeared in the
form of Franchise Entertainment Group (FEG), the operator of the
Blockbuster and Video Ezy chains in Australia and Asia. FEG bought out
EzyDVD’s brand and online business, the franchise network, as well as
stock, plant and equipment and 11 company-owned EzyDVD stores. The 25
franchised EzyDVD stores will also come under FEG’s control.
This turn of events has given new hope to many of the EzyDVD franchisees
whose futures were uncertain during the Christmas and New Year period. It
is also a clear indication that Franchise insolvency does not necessarily mean
the end of the line for franchisees. In fact, it would appear that the
118 Submission to Parliamentary Joint Committee on Corporations and Financial Services,
Commonwealth, Inquiry into Franchising Code of Conduct, September 2008, 8.4 (ii) a) 27 (Australian Competition and Consumer Commission).
119 Ibid 28. 120 Emma Maltby, Dragged into a Bankruptcy That isn’t Yours (2009) CNN Small Business, quoting
Alisa Harrison, IFA’s spokeswoman <http://money.cnn.com/2009/07/17/smallbusiness/franchise_bankruptcy.smb/> at 2 March 2010.
Chapter 2: What is the problem and how big is it? 55
franchisees may fare better than others affected by the EzyDVD insolvency,
such as unsecured creditors. 120F
Before a company has a chance to attempt ‘rebirth’, it has to go through the
pains of bankruptcy – which can be easy, hard or very hard on the franchisees. In a
best-case scenario, franchisees continue business as usual, perhaps implementing
minor adjustments that the franchisor deems necessary to boost profits or cut
overheads. However, it is
not uncommon for franchisees to be left holding the bag while a
[franchisor’s] bankruptcy is in progress. Bennigan’s franchisees, who had
previously depended on corporate marketing initiatives to advertise their
stores, faced the challenge of publicizing that they were open for business
despite a whirlwind of press implying otherwise.121F
Another perspective was provided to Australian franchising lawyers by Wayne
Jenvey who observed that in general terms:
the effects of franchisor insolvency on the franchise ecosystem translates,
upon insolvency, into myriad interests and competing claims among which
the franchisee is the least protected. The interests of the franchisees are not
protected and franchisees have no control over the business when the
franchisor fails. Franchisees are subject to the decisions of the external
2.3 FRANCHISOR FAILURE FROM FRANCHISEES’ PERSPECTIVE
Each individual franchisee’s personal and financial resilience and negotiating
ability will be factors in how they emerge from franchisor failures. Some can draw
from a deep well of prior experience and a strong personal support network; some
can only attribute the survival of their business to luck or its demise to bad luck.
A 2009 online news piece on franchisor insolvency sums up the predicament
faced by many franchisees:
121 Franchise Council of Australia, Franchise Insolvency Leads to a ‘Rebirth’ for Franchisees
<http://www.franchise.org.au/scripts/cgiip.exe/WService=FCAWWW/ccms.r?PageID=10184> at 7 October 2009.
122 Maltby, above n 120. 123 Wayne Jenvey, ‘Rocky Roads and Rollercoasters – Turnaround Strategies for Distressed
Franchise Systems’ (Paper presented at the Legal Symposium at the Franchise Australia Annual Conference, Gold Coast, 24 October 2006) 2.
56 Chapter 2: What is the problem and how big is it?
Dragged into a bankruptcy that isn’t yours. When a franchise company goes
bankrupt, independent operators face a tsunami of legal tangles and
Matthew Dunckley writes, quoting franchisee Mr Maccartney; ‘We put our life
savings on the line … and these guys [franchisor] get to treat us like credit cards.’124F
Journalist Trevor Sykes followed the Traveland franchise failure story and
described the insolvency of the Traveland franchisor as a tragedy in four acts.125F
Act I. 24 September 2001 … saw the parent company; Ansett’s
administrators sell Traveland to a dot.com company that had not previously
been involved in the travel industry, Internova Travel for $500,000. At this
stage Traveland had 104 branches and 750 staff. Internova Travel
(incorporated specifically for the Traveland purchase) bought the money-
losing business with borrowed money, without tying down its potential
partners and financiers.
Act II. 28 September 2001 saw the Australian Investment Corporation of
Western Samoa (AIC) buy half of Internova Travel for [A]$500,000. … ’the
half a million AIC put up seems to have disappeared straight down the
insatiable maw of Traveland in wages and other costs.
Act III. 8 October 2001 Financial Options Group Inc (FOGI), a company
owned by the two Sydney entrepreneurs who controlled AIC, paid
[A]$2million for the balance of Traveland. Possession of the business passed
on 8 October but settlement was not required until 24 October. The money
was not paid and on 26 November 2001 Internova Travel’s directors put it
into administration, which quickly turned into liquidation. The Australian
Securities and Investment Commission put FOGI into liquidation on 18
Act IV. 23 December 2001. FOGI’s liquidator sold Traveland to
Travelworld for $250,000. Travelworld now has all Traveland’s staff and
licenses. Finally, Traveland was vanishing like the Cheshire cat. 126F
124 Emily Maltby, above n 120 . 125 Matthew Dunckley, ‘Call to Shield Franchisees’, The Australian Financial Review (Sydney), 17
April 2009, 9. 126 Trevor Sykes, ‘Traveland: Final Tragedy of Errors’, The Australian Financial Review Weekend
(Sydney), 9-10 March 2002, 12. 127 Ibid.
Chapter 2: What is the problem and how big is it? 57
Throughout the drama recounted by Sykes, there is little mention of the
estimated 270 to 285 Traveland franchisees. The Traveland business was an asset in
the Ansett insolvency. The CPA Study tracked down some of the former
128 One Traveland franchisee did have a clause in his agreement that
permitted him to terminate the franchise agreement if Traveland failed – and he did
so. For the other franchisees, the Traveland Franchise Council was of the view that
franchisees did not have grounds for terminating franchise agreements.
A liquidator does not have an obligation to sell assets of the failed franchisor to
the purchaser who would be the most suitable from the franchisees’ perspective, nor
to a purchaser who is well motivated towards the franchisees. According to one
former franchisee, the purchasers of Traveland knew nothing about travel or
franchising. There is nothing to stop a liquidator selling the franchisor’s business to a
direct competitor of the franchisor. That direct competitor may elect not to buy the
franchise agreements but, instead, buy the brand in order to shelve it. In the United
States, albeit in a non-franchise context, ‘Disney purchased customer lists of
Toysmart in 2000 so it could ‘retire’ the list (ie. “destroy”)’.128F
The following insights about how their franchisors’ collapse affected its
franchisees were collected in the CPA Study. All 18 former franchisee participants in
the CPA Study lost money as a result of the franchisor’s insolvency. In response to
the question, ‘if you lost money, what caused the loss?’ Sixty four per cent replied
that it was because their investment was now valueless.
The insolvency of a franchisor affects many relationships beyond that of
franchisor/franchisee. The franchisee’s own creditors will be unsure about the
franchisee’s ability to meet its ongoing payments. With this in mind, participants in
the CPA Study were asked: ‘did the insolvency of your franchisor mean you could
not pay business related liabilities?’ Forty-four per cent were able pay all business
related liabilities, while the balance defaulted or could only pay some.
To the question: ‘in total, how much money did you lose because of your
franchisor's insolvency? (including in this amount the cost of refurbishing your
premises to remove your franchisor’s image and replace it with another, if relevant).’ 128 Buchan, ‘When the Franchisor Fails’, above n 31. 129 Gerald L Baldwin, ‘The Role of Intangibles in Bankruptcy’ (2006) 25-8 American Bankruptcy
Institute Journal 12, 53.
58 Chapter 2: What is the problem and how big is it?
Forty four per cent lost more than A$50,000. Fifty-five per cent lost less than
$50,000. The responses are skewed in favour of smaller losses as only one franchisee
from a retail shopping centre based franchise responded to the survey.
To the question: ‘if your company could not continue trading, why was this?’
Forty per cent of franchisees replied that they had no money left to start a new
business and 20 per cent had other reasons. Some of the franchisees responding ‘not
applicable’ were trading as sole traders, not as corporations.
When asked whether they had any comments to make about the impact of the
insolvency on their franchise business, or about any other aspects of franchising,
none of the CPA Survey participants made any negative comments about franchising
per se. Comments were personal:
I lost a lot of money, reputation and health.
I think that the emotional turmoil and lack of assistance from government,
associations and lawyers (due to fear of repercussion) left us weaker and more
vulnerable, which has resulted in many owners selling up or becoming ill from
exhaustion – trying to rescue their business. This even has major impact on staff
sick days too.
Very unhappy with how the whole issue was handled by Traveland, their lawyers
The former Traveland franchisees who were still running travel agencies had to
collect the travel tax levy that the government imposed on all travellers to help fund
employees’ claims in the Ansett insolvency. They report that this ‘rubbed salt in their
wounds’. In addition, because of the discrepancy in income from the years of being a
franchisee to the year following the insolvency, the Australian Taxation Office
audited former franchisees’ tax returns.
Decisions the administrator or liquidator takes in relation to disclaiming
onerous contracts will impact significantly on the options available to franchisees.129F
130 Michael Murray, Keay’s Insolvency: Personal and Corporate Law and Practice (5th ed, 2005)
340. ‘In some cases liquidators do not wish to retain property because it is too onerous, worth little or is unsaleable. In such circumstances, liquidators wish to get rid of the property in order to avoid responsibilities and costs in relation to it. In disclaiming, the liquidator gives notice to others that he or she wishes to be rid of any interest in the property. If a person suffers loss as a consequence, those persons to whom notice has been given are required to try to mitigate their loss. They may lodge a proof of debt in the liquidation in respect of the amount of that loss. The
Chapter 2: What is the problem and how big is it? 59
If the liquidator disclaims the lease, the franchisee will lose the value of the sunk
costs unless it is able to negotiate a new lease. Even then, the franchisee may find
that the lack of the power of the brand, or the loss of group bargaining power, may
make trade unviable as an independent. For example:
James Rixon was a franchisee in the failed [Australian master franchisee
owned] Kernel’s Popcorn chain. He sold his business at a loss nine months
after his franchisor went into administration in 2005. … Rixon, a shop-fitter
by trade, renegotiated a lease with his landlord, formed direct relationships
with his suppliers and got together with other Kernel’s Popcorn franchisees
to trade under a new brand, Pop n Go, when his franchisor failed. But the
business was not as profitable as he would have liked. Rixon says he did not
have the marketing expertise to run the operations without a franchisor…. 130F
Franchisees who do not weather the storm of franchisor failure successfully
may be those that have only recently established their franchise when the franchisor
failed, they may not have established personal credibility with their landlord, their
working life may be nearing its end as the franchise may have been purchased with
redundancy money or with retirement savings, and they may be stretched to the limit.
Franchisor failure is a tipping point from which some franchisees have little chance
of recovering financially.
The physical whereabouts of a franchisee’s business will have a bearing on the
exit strategies available to the franchisee. For example, if the buyer of the network
already has an outlet in the same area it may decline to adopt the franchise agreement
as it does not want to cannibalize an existing market. Proximity to the end of the term
of the franchise agreement and premises lease are also relevant; the nearer to the end,
the more of the franchisees’ original investment has been recouped and the more
likely they are to have started to think of their future after franchising.
As is documented in Appendix C, insolvency regimes the world over give
special recognition to creditors and employees, but almost uniformly exclude
franchisees as stakeholders. The franchisee is likely to be contractually bound to
liquidator may disclaim property referred to in section 568(1) Corporations Act 2001 (Cth) (including) land burdened with onerous covenants (for example a lease of retail space in the franchisor’s name that is licensed to a franchisee as occupier with no status on the title and no privity of contact with the landlord) and contracts (including franchise agreements).’
131 Jacqui Walker, ‘It Pays to Have a Plan B’, Business Review Weekly (Melbourne), 16-22 March 2006, 57.
60 Chapter 2: What is the problem and how big is it?
remain in the franchise relationship while the administrator or liquidator explores
options for the future of the system and then pursues the best option for the creditors,
which can take months.
In Australia, once it became obvious to the franchisees that the new owners of
the Traveland brand did not have the expertise to run a franchised chain of travel
agents, the franchisees moved in several directions. Joining another franchise
network was an exit strategy for many of the former Traveland franchisees.
Twenty franchisees switched to UTAG travel.
Several franchisees switched to Harvey World Travel.
One hundred and fifty Traveland franchisees joined Travelworld.
One franchisee became an employee of another agency, having lost so
much that he could not continue as a franchisee.
At least three franchisees re-branded as independent travel agents.
The fate of the remaining 100 or so other former Traveland franchisees is
unknown. Some will have continued trading as an independent businesses, unaligned
to any particular group.
For some franchisees joining another travel agency franchise was not
appealing. A franchisee who owned a Traveland in a country town pointed out that
prior to buying into Traveland, she and her husband investigated all of the travel
agency franchises available. They decided on Traveland because it had the best
systems. When Traveland failed, the franchisee initially contemplated becoming an
independent travel agent but concluded this was not feasible as her former customers
preferred to deal with a ‘name’ brand. In her words:
Traveland was an excellent franchisor, great to work for but following the
collapse of Traveland if I had rebranded as [my name]’s Travel Agency it
would not have been acceptable [to the town]. The response would have
been “Who does she think she is?” … We were not communicated with at all
when Ansett collapsed. From that day all the [franchisor’s] phones were
Chapter 2: What is the problem and how big is it? 61
switched off. We could only call other franchisees. At no stage were the
Traveland franchisees offered the opportunity of buying the franchisor. 131F
Consequently, she had no real choice but to close the travel agency.
As was noted in The Australian:
...when it comes to liquidation, the laws are stacked in favour of the
franchisors. This is seen in the way that franchisors have the right to sell
their brand name and franchisees to another buyer, which sounds fair and
okay in terms of business law as it pertains to administration and liquidation,
but it could ruin the innocent parties, namely the franchisees. This is what
happened to 270 Traveland travel-agent franchisees[;] ... one-time solid
Traveland agents effectively lost.132F
Dollar cost of franchisor failure to a franchisee.
This varies greatly from one franchise network to another, and from one
franchisee to another. Table 3 outlines the costs and some of the losses incurred by
one franchisee who signed a franchise agreement with Danoz Directions in February
2004. The Danoz franchisor became insolvent eight months after this franchisee
signed his franchise agreement.
Table 3: Some costs and losses for one franchisee of Danoz Directions
Item paid by franchisee
Franchisee’s investment in $AUD
Franchisee paid to
Outcome for franchisee in insolvency of franchisor
Initial franchise fee paid to secure rights for 5 years
$60,000 plus additional $20,000 training
Franchise agreement between franchisee and franchisor signed early 2004
Franchisor in full before commence business
Franchisee no statutory right to claim from administrator.
Franchisee will be a creditor for an amount in damages for breach of the franchise agreement. The franchisee may seek leave to bring proceedings against the insolvent franchisor in order to quantify its claim133F
132 Interview with former Traveland franchisee (conducted at former franchsiee’s home, country
Victoria, 17 June 2006). 133 Switzer, above n 1. 134 In Cheque One Pty Ltd v Cheque Exchange (Australia) Pty Ltd (in liq)  FCA 593, 12
applicant franchisees sought leave of the court under s 471B Corporations Act 2001 (Cth) to join proceedings commenced against the franchisor in 2000.
62 Chapter 2: What is the problem and how big is it?
Item paid by franchisee
Franchisee’s investment in $AUD
Franchisee paid to
Outcome for franchisee in insolvency of franchisor
Sunk Fit out costs
$99,000 Disclosure document
Franchisor for payment on to independent shop fitter
Lease (in franchisor's name) disclaimed by administrator. Landlord would negotiate with franchisee for a continued tenancy agreement if franchisee gave up value of fit out. Lost $99,000 sunk cost of fit out
Franchisor's fit out supervision
$25,000 Franchise agreement between franchisee and franchisor
Franchisor as a 25per cent fee on top of invoiced fit out cost
Service fully performed by franchisor; franchisee no right to claim. Lost $25,000
$45,000 Supplier agreements
Supplier Return, sell, depends on terms of supply
Security deposit on franchisor's head lease
Bank guarantee - 3 months' rent = approx $15,000
Franchise agreement between franchisee and franchisor
Provided direct to landlord
Franchisee negotiated with landlord to be released - no loss
Monthly premises rental
Approx $4,000 pm
Lease between franchisor and landlord. Sublease/ licence between franchisor and franchisee
Franchisor for forwarding to landlord.
Franchisee debtor of franchisor. Franchisor in breach of lease because of appointment of administrator
Training costs $20,000 Franchise agreement between franchisee and franchisor
To general revenue of franchisor or franchisor related company on day paid
Franchisee not creditor or debtor. No claim possible
Other costs $6,000 Franchise agreement between franchisee and franchisor
Paid to franchisor up front
Franchisee not creditor or debtor. No claim possible
Options to open 3 future franchisee owned stores @ $20,000 per option
$60,000 Agreement between franchisor and franchisee
Paid to franchisor up front
No statute-based claim possible.
Franchisee not a creditor for $60,000 unless could claim breach of contract or quasi-contract at common law re the $60,000 if court consents to civil proceedings normally prevented under ss 440D or
Chapter 2: What is the problem and how big is it? 63
Item paid by franchisee
Franchisee’s investment in $AUD
Franchisee paid to
Outcome for franchisee in insolvency of franchisor
471B Corporations Act 2001 Unlikely
The franchisee in Table 3 was not a creditor of the franchisor and was a debtor
to the extent of the monthly royalty and the rent, which is ultimately owed to the
landlord. This is not a strong negotiating position for a franchisee to be in relation to
the franchisor’s liquidator. Of the estimated total outlaid by the franchisee in Table 3
(excluding professional advice and bank charges):
A pro-rated amount of the A$60,000 (initial franchise fee) could be the
subject of an equitable claim for unjust enrichment. Any action against the
liquidator would need to be approved by the court.134F
A$99,000 is sunk costs, spent on fit out. Depending on how portable the
items purchased were, some might have second hand value. Others (eg.
shop window, flooring, most electrical works) become part of the
landowner’s real property upon installation.
A$25,000 charged by the franchisor for supervising the fit out is deemed
earned by the franchisor as soon as the fit out is complete.
A$45,000 inventory is returned to suppliers or sold or thrown away by the
franchisee, depending on the relevant terms of trade.
A$15,000 bank guarantee provided by the franchisee to guarantee the
franchisor’s obligations under the head lease. Depending on the landlord’s
attitude towards the franchisee as a replacement tenant and the amount of
rent the now insolvent franchisor owes, this guarantee may be called up by
the landlord, or, as in the case described in Table 3, used to support the
replacement lease to the former franchisee.
135 Corporations Act 2001 (Cth) s 440D, stay of proceedings for company under administration; s
471B, stay of proceedings and suspension of enforcement process for company in liquidation.
64 Chapter 2: What is the problem and how big is it?
A$26,000 training costs and other amounts deemed earned by the
franchisor pursuant to the franchise agreement. No claim possible.
A$60,000 to secure options to ‘own’ three future territories. This, also, is
potentially the subject of a claim for unjust enrichment.
Until 1995, from the moment a franchisees’ business closed the interest on the
loans taken out to fund the businesses ceased to be tax deductible. Since 1995 the
position has altered through a line of cases in relation to s 51(1) of the Income Tax
Assessment Act 1936 (Cth) that started with a decision reached by Davies, Hill and
Sackville JJ in the Federal Court, Placer Pacific Management Pty Ltd v Federal
Commissioner of Taxation 95 ATC 4459. A deduction can now be claimed for
interest on loans taken out to fund a business that has ceased generating an
Possible tax-related consequences
All income from the business is taxed, but from the time of the collapse of the
franchisor, if the franchisee’s business has stopped trading all new expenses incurred
after the collapse may not be deductible.136F
Tax and sunk costs
Perhaps a more compelling issue than interest deductibility is whether the
franchisee’s sunk costs are deductible if the franchisor fails and the franchisee is
unable to trade on. Take, for example, a Kleenmaid franchisee. The franchise
network was established in Queensland in 1985 to sell and maintain whitegoods
under the Kleenmaid brand. By the time the administrator was appointed in 2009
there were ‘20 retail outlets of which 15 [were] franchised and 5 [were] wholly
owned by the company’.137F
138 While ‘[l]iquidators have been selling the products on
136 Federal Commissioner of Taxation v Brown  FCA 721 (Lee, Nicholson and Merkel JJ) The
interest payments were deductible under the second limb of s 51(1). The occasion for the interest payments was to be found in the loan entered into by the partnership in carrying on business for the purpose of producing assessable income and that the cessation of the business did not operate to break the nexus between the carrying on of the business and the incurring of the interest liability; Federal Commissioner of Taxation v Jones (2002) 117 FCR 95 (Beaumont, Finn and Sundberg JJ). In this case, refinancing the loan after the business.
137 Income Tax Assessment Act 1997 (Cth) s 40-880. 138 Angela Harper, ‘Liquidators Sell off Kleenmaid Assets’, Sydney Morning Herald (Sydney), 30
Chapter 2: What is the problem and how big is it? 65
Grays Online for very good prices’138F
139 and ‘30 service van franchisees [are] to
continue to operate and provide maintenance and repairs to support existing
140 what becomes of the investment in sunk costs made by the
franchisees? A Kleenmaid franchisee will have invested tens of thousands of dollars
in sunk costs to open its business. For example, it had to purchase demonstration
models of the white goods on display and keep them up–to-date as styles in white
goods change. Had Kleenmaid failed six months after a franchisee set up its store,
the franchisee would probably have to write off investment in items such as white
goods as capital items. 140F
141 An individual small business is unlikely to be able to sell
its capital losses and thus another avenue of future research identified in this research
is the tax treatment of franchisees’ sunk costs when the franchisor fails.
Commenting on the predicaments of Kleenmaid franchisees Jason Gehrke
Without ongoing stock from Kleenmaid to sell, the retail franchisees have no
future under the Kleenmaid brand, and without Kleenmaid to co-ordinate
warranty repairs and maintenance schedules, the service franchisees are
equally challenged. All franchisees will lose.141F
Franchisees’ ability to source alternative suppliers
Some of the Kleins franchisees continue to occupy their sites, and are able to
source alternative supplies. Finding alternative suppliers for fashion jewellery
accessories, previously supplied to franchisees by a Kleins-related entity, is more
feasible than contracting with alternative suppliers for Kleenmaid-branded products.
Because Kleenmaid has its own brand of products, franchisees cannot source
Kleenmaid goods from other suppliers.
Under Kleenmaid's franchise agreement, franchisees did not stock products
in their stores, but operated showrooms featuring only display items.
139 Sue Mitchell, ‘Kleenmaid on Comeback Trail’, The Australian Financial Review (Sydney), 31
August 2009, 16. 140 Harper ‘Liquidators Sell off Kleenmaid Assets’, above n 138. 141 ASIC Funds Kleenmaid Probe (2009) Perth Now
<http://www.news.com.au/perthnow/story/0,26122992-5017962,00.html> at 1 October 2009. Investigation: ASIC has approved funding for an investigation into the collapse of white goods business Kleenmaid.
142 Jason Gehrke, Why is Kleenmaid Such Big News (2009) Smartcompany <http://www.smartcompany.com.au/franchise-tips-and-trends/20090421-why-is-kleenmaid-such-big-news/print.html> at 7 October 2009.
66 Chapter 2: What is the problem and how big is it?
Customers could see the products and pay for them in store, but all payments
were forwarded to the Kleenmaid national office, which would despatch the
products to the customers' homes.
Franchisees would generate their income through commissions paid to them
by Kleenmaid, so long as those commissions were greater than the amounts
franchisees were required to pay to Kleenmaid each month.
Payments to Kleenmaid included advertising ($10,000), training and
computer support ($2000) and rent. A clawback clause in the franchise
agreement would require franchisees to repay commissions if a customer
cancelled an order (if the commission had been previously paid).
Even though sales proceeds went direct to the franchisor, between the
required monthly payments and the potential for commission clawbacks
from cancelled sales, it is possible for Kleenmaid franchisees to still owe the
franchisor money at the end of a month. If this is the case, the administrators
will be duty-bound to pursue all debts owed to Kleenmaid, even if it is from
franchisees who are themselves owed money for sale commissions for a
In other words, there will be no set-off where franchisees owe money to the
franchisor, and the franchisor owes the franchisee money. The franchisees
will be required to pay their debts to the franchisor in full, while at the same
time standing helplessly in line as unsecured creditors waiting for the money
owed to them.142F
Communication between franchisees and administrators
One Sydney-based Kleenmaid franchisee told [radio] 2GB's Ray Hadley he
bought the franchise in November 2008, and became suspicious about the financial
health of the group in December, only one month after the purchase. ‘I'm probably
down $270,000 plus expenses’ he said. ‘I've heard nothing verbally from them since
November ... we still have not got official notification (of the collapse)’.143F
Franchisees’ ability to remain in premises
In Stewart, in the matter of Kleins Franchising Pty Ltd (administrators
appointed) (ACN 007 348 236)  FCA 721 in support of an application to
extend the time for the administration, the Administrator stated:
143 Ibid. 144 Anthony Klan, ‘Kleenmaid Kitchen Empire Sinks with $67m Debt’, The Australian (Sydney), 11
Chapter 2: What is the problem and how big is it? 67
In Australia there are 132 franchised stores … Each store is leased by TJC
[The Jewellery Chain] from third parties. Each franchisee holds a licence
from TJC in respect of their franchised store. Under each of the leases, the
landlords are permitted to terminate and re-enter the properties on an event
of insolvency, such as administration of the lessee. Some of the lessors have
issued notices to remedy the breach.144F
This means the landlords have started exercising their rights to terminate the
leases for the retail premises leased by The Jewellery Chain Pty Ltd as the head
lessee entity within the Kleins franchise network. Lacking privity of contract
between themselves and the landlords, franchisees have no right to continue in
occupation under the licences to occupy if the head lease is terminated by reason of
the head lessee’s default.
The administrators stated ‘[n]o party (including employees, franchisees, lessors
and retention of title claimants) will be detrimentally affected by granting an
extension of the convening period for the second meeting of creditors’.145F
statement serves to emphasize the lack of standing the franchisee have in insolvency.
Existing franchisees’ responsible for liabilities that are best met by the franchisor
trading well, will certainly be detrimentally affected by any protracted
Some franchisees do find a way of making the most of the opportunities that a
franchisor’s failure opens to them by forming a buyers group and continuing trading.
This action was taken by former Great Australian Ice Creamery franchisees and
some franchisees of one of the failed juice shop franchisors. Others re-brand and
continue trading under a former competitor’s banner, however this may be difficult if
a territory or suburb is already well serviced by a competitor franchisor.
2.3.1 ADDITIONAL IMPLICATIONS FOR FRANCHISEES STRUCTURED LIKE A COMMISSION AGENCY
The franchisees of Kleenmaid and BHG were structured as commission
agencies. In a commission agency the franchisee makes a sale to its customer; the
customer then pays the franchisor and takes delivery of the product or service from
145 In Stewart, in the Matter of Kleins Franchising Pty Ltd (administrators appointed) (ACN 007 348
236)  FCA 721 (20 May 2008) para . 146 Ibid para .
68 Chapter 2: What is the problem and how big is it?
the franchisee. The franchisor then pays a commission to the franchisee. This
commission ‘is the only cash flow our [Allphones franchise] business has’.146F
franchisees’ vulnerability is expressed in the words of a director of franchisee Hoy
Mobile Pty Ltd:
All moneys are deposited to the franchisor’s account and three times a
month Hoy Mobile was to receive their percentage of the gross profits. All
stock is supplied by the franchisor. When our second commission cheque
was not forthcoming …147F
Franchise agreements rarely provide for the franchisor to pay the franchisee
interest on late payments, or for the franchisor to provide personal guarantees to
franchisees. Franchisees operating under the commission agency model have no
control over when the franchisor pays commission and minimal control over the
customer base they have generated. They have no control over whether the franchisor
pays its suppliers, which in turn will influence the franchisor’s ability to supply stock
to the franchisees. If the franchisor fails it is the administrator and liquidator that
have a list of each franchisee’s customers, not the individual franchisee.
2.4 FRANCHISEES FROM THE FRANCHISOR LIQUIDATOR’S PERSPECTIVE
The appointment of the franchisor’s liquidator triggers a change in the
franchisee’s status from being an essential component of the franchisor’s business
network, to a party to contracts that are evaluated by the liquidator as being either
assets or liabilities. While the franchisor is solvent the franchisee has contractually
enforceable rights backstopped by a range of other legal rights flowing from their
standing as a consumer. The franchisee has no clear rights under insolvency
An administrator may be faced with tens, or sometimes hundreds of franchisees
that see themselves as key stakeholders of the failed franchisor. Franchisees are
widely dispersed geographically. Each is at a different stage in their business life-
cycle and faces the prospect of a loss of a different magnitude. Each is a party to
consequential contracts. Not all of these contracts are with the franchisor. 147 Commonwealth Senate, Opportunity not Opportunism, Joint Parliamentary Inquiry into
Franchising (2008) 1 (Nicole Hoy). 148 Ibid.
Chapter 2: What is the problem and how big is it? 69
Franchisees will often be both creditors and debtors and may also have a contract or
Trade Practices Act based claim they can bring against the franchisor.
Figure 3: Minimum estimated lost investment by franchisees in Australia 1990 -
Losses shown in Table 1 and Figure 3 are probably an order of magnitude
higher. For many franchise networks there is no publicly available data. The data
contained in Table 1 does not include legal fees, and does not take into account
subsequent costs and collateral losses such as franchisees paying franchisors rental
guarantees and meeting the government-imposed travel levy for the Traveland
2.4.1 FRANCHISEE AS CREDITOR
‘Creditor’ is not defined in the Corporations Act.
In Selim v McGrath 148F
149 Justice Barrett concluded that in the context of a s
439A [Corporations Act] meeting, creditors were all persons who have, as
against the company concerned, “debts” or “claims” provable in a winding
149 (2004) 22 ACLC 112, 128-9.
t by franchises ($m
70 Chapter 2: What is the problem and how big is it?
up. He said the boundaries were those set by s 533 [Corporations Act] which
are very wide. 149F
Traditional suppliers of debt finance such as banks are categorised as creditors
in insolvency and have had the opportunity to take security, and to price their loans
accordingly. Traditional suppliers of equity finance, shareholders, have taken the risk
of the entity becoming insolvent knowingly and on the basis of information supplied
in a prospectus that has met rigorous standards.
Unless a franchisee is a creditor, there is no room in Australia’s insolvency
regime for the franchisee to have a voice in the franchisor’s insolvency, far less a
share of the insolvent’s estate. Typically, there are four situations that might place a
franchisee into the position of being a creditor, generally unsecured, in a franchisor’s
insolvent estate. These are:
First, in some franchise networks the franchisee is remunerated by commission
payable by the franchisor.150F
151 For example, in travel agency franchises part of the
franchisee’s revenue stream is from the sale of airline tickets. If the airline is the
parent company of the franchisor (as Ansett airlines was for the Traveland
franchisees) it will owe the travel agent franchisee commission on ticket sales.
Second, the franchisee may be a creditor if, for example, goods that were
supplied by the franchisor are returned under warranty by the franchisee’s customers.
An example is jewellery supplied by Kleins.
The third instance when the franchisee may be a creditor of the franchisor is for
moneys payable by the franchisor pursuant to a concluded dispute. Where the
conclusion has been that the franchisor owes the franchisee settlement money, the
sums could be substantial.
A fourth category when a franchisee may be a creditor of a franchisor is where
the franchisee has to pay its premises rent to the franchisor, that then pays the
landlord. On receiving the rent from the franchisee the franchisor is the trustee of the
150 Michael Murray, Keay’s Insolvency: Personal and Corporate Law and Practice, (6th ed, 2008)
531. 151 No empirical research has been conducted on the direction of money flow between franchisors
and franchisees. Most franchisees collect payment from their customers and pay royalties to franchisors but some franchisor/franchisee relationships are structured like commission agencies with the franchisor being paid by the franchisees’ customers, and the franchisor then paying franchisees commission.
Chapter 2: What is the problem and how big is it? 71
funds pending payment to the landlord. This is common, as shown in models 3, 4, 5,
7 and 9 at 3.1.3.
The sums of money owed to the franchisee as a creditor under the above
arrangements, with the possible exception of the third instance, are a small
proportion of the franchisees’ total investment. For the remainder of its investment
the franchisee is not a recognised creditor. The question ‘what rights did you have in
the franchisor's liquidation?’ elicited one unexpected response as one franchisee was
a secured creditor of the franchisor. The CPA Study did not permit exploration of
this response. The remainder were unsecured creditors (56 per cent) or had no status
at all in the insolvency (33 per cent). Unsecured creditor status places franchisees
well behind the franchisor’s employees in terms of priority.
If the franchisee is not a creditor in relation to a specific sum, liquidators
sometimes ‘put franchisees in for a dollar each’.151F
152 This secures the right for each
franchisee to exercise one vote at the creditors’ meeting where votes are exercisable
by creditors on a pro-rated basis to the size of the debt they are owed. It is not
difficult to see how franchisees would quickly be out voted by secured creditors.
Table 1 shows the amount of money some failed franchisors owed creditors.
If a franchisee is invited to a creditors’ meeting this puts them in direct
communication with the liquidator. Anecdotal evidence from discussions with
liquidators is that they do include franchisees in early creditors meetings. The
response to the question: ‘were you invited to the creditors' meeting of your
franchisor?’ was that the 33 per cent who had no recognized status answered ‘not
applicable’. Fifty seven per cent answered ‘no’. These experiences contradict the
liquidator’s account of their approach and merit further investigation.
2.4.2 FRANCHISEE AS DEBTOR
The appointment of an administrator to a franchisor signals a sea change in the
franchisor/franchisee relationship. The franchisor becomes a debtor to its creditors
and the franchise agreements become assets or liabilities. Franchisees remain parties
to the franchise agreements. Payments due by the franchisee to the franchisor
continue to be payable, as do payments by the franchisee to third parties. Franchisees
152 Interview with Liquidator, (Sydney), 2005.
72 Chapter 2: What is the problem and how big is it?
trading within franchise networks that are structured like commission agencies will
also be debtors – in relation to advertising levies, royalties and other periodic
In some situations the franchisee guarantees the performance of the franchisor
under the head lease.152F
153 Being a guarantor would make the franchisee liable for
moneys owed to the landlord if the franchisor defaulted on its obligations under the
head lease, but would not guarantee the franchisee the right to lease the site if the
head lease was disclaimed by a liquidator.
With franchisees’ collateral liabilities in mind, it is interesting to see what
approach financiers take to their franchisee customers’ funding needs. In the UK:
Typically 3 in 5 franchisees needed to borrow money when starting up their
business. Needless to say, the amounts borrowed vary greatly between
different franchises. The mean amount borrowed in this year’s study is
£44,700. … As might be expected, the need for specific business premises is
a significant driver of borrowing. Those who require specific premises for
their operation needed an average of £54,500 compared to the £14,000
among those not needing specific premises. By far the most common source
of finance is retail banks, which provided finance to 85 per cent of those
The CPA Study participants were asked three questions about their borrowing
for the business. To the question: ‘how did you finance the purchase of your
franchise?’ 62 per cent answered that they financed from savings, 25 per cent
borrowed from a bank and the remainder used a combination of savings and loans.
These proportions are probably a reflection of the small sample size in the CPA
Study and the fact that most subjects did not operate from retail shopping centre
premises, rather than being a true reflection of the pattern of funding franchise
purchases in Australia. Questions in relation to borrowings showed that where
franchisees did borrow, 22 per cent borrowed 80–100 per cent of the total investment
cost. These borrowings were secured by a mortgage over the franchisee’s home.
153 For example: Neldue Pty Ltd v Moran & Ors  WASC 100; Loyal No 46 v Miller 
FMCA 30. 154 British Franchise Association United Kingdom, Franchise Survey (2004) 37.
Chapter 2: What is the problem and how big is it? 73
2.4.3 FRANCHISEE AS POTENTIAL LITIGANT
If franchisees are contemplating litigation, or have not yet had their case heard,
they find that ‘[o]n the appointment of an administrator or liquidator, there is a stay
of proceedings so that no action or other civil proceedings may be begun or
continued against the company without the leave of the court’. 154F
Franchisees do not want their franchisor to fail. They are aware that litigation
would impose a significant cost burden on the franchisor. There is anecdotal
evidence that, rather than risk making their franchisor financially vulnerable, some
franchisees make a conscious decision not to litigate against their franchisors.
There are often franchisees who will not mutiny against the franchisor, no
matter what level of provocation exists. Most systems contain, amongst the
franchisees, family members, franchisees on ‘special deals’ or who believe
they are on special deals, and some that are financially bound to the
A contract is executed at the conclusion of successful mediation. The contract
may be disclaimed by a liquidator. If litigation has been concluded and a judgment
entered against the franchisor, but the judgment debt is not yet paid, creditors cannot
enforce any judgments or orders they may have obtained against the debtor (being a
corporation operated by a voluntary administrator or liquidator); and other legal
proceedings many not be brought or pursued against the corporation without the
leave of the court.156F
2.4.4 CHALLENGES FACING THE LIQUIDATOR
When it comes to companies going bust, the insolvency of a franchise is
usually about as shambolic as you can get. Of all insolvency matters, the
most difficult is the failure of a franchise group… There are always
problems with the Franchise Code, always leasing problems and unforeseen
third party issues. 157F
155 Above n 89 at pp. 283 and 487. The relevant legislation is Corporations Act ss 440D, 471(2).
(See Ibbco Trading Pty Ltd v HIH Casualty and General Insurance Ltd (2001) 19 ACLC 1093). 156 Interview with Australian Franchise Lawyer/Mediator Philip Linacre (Telephone interview, 11
August 2006). 157 Corporations Act 2001 (Cth) s 471B
158 Binning, above n 9, quoting David Cowling, insolvency partner with law firm Clayton Utz, (then Vice-chair of the IBA’s Section on Insolvency and Creditors Rights.)
74 Chapter 2: What is the problem and how big is it?
Liquidators have duties under the Corporations Act. This does not include
duties to franchisees. Theoretically, in Australia there is nothing to stop a liquidator
selling the franchisor’s business to a direct competitor158F
159 of the franchisor. It is
unlikely that an acquisition would meet the threshold merger test of, ‘having the
effect, or be likely to have the effect of substantially lessening competition in a
160 that must be met before a merger of two franchise networks would risk
being closely examined by the ACCC and potentially prevented from occurring. That
direct competitor may elect not to buy the franchise agreements but, instead, to
simply buy the brand and shelve it.
Other factors that impact on how individual franchisees fare include the
financial climate at the time of the failure and the suitability of the buyer:
Sale of the [franchisor’s] business may subject the franchisee to the control
of a company unfamiliar in the area and incapable of running the business
profitably. The dramatic demise of Traveland [franchise subsidiary of
Australia’s former Ansett Airlines] demonstrates the implications of a
buying entity that has little experience in the franchisor’s core business area
and has insufficient expertise or resources to support the business. 160F
In the short term, the most appropriate way for prospective franchisees to
mitigate against the possible harmful effects of their franchisor becoming insolvent is
to ‘attempt to structure his or her affairs to ensure minimum personal liability and
flexibility in keeping or restructuring the business in the event the franchise business
fails or alternatively the franchisor becomes insolvent’.161F
162 Realistically, the
opportunity to do so depends on the franchisor’s willingness to negotiate, the
franchisors policies regarding matters such as whose name the premises lease is in,
and the franchisee’s ability to negotiate.
159 Trade Practices Act 1974 (Cth) s 50 prohibits acquisitions that would result in a lessening of
competition. 160 Trade Practices Act 1974 (Cth) s 50(1). 161 Jenvey, above n 123, 9. 162 Steven H Goldman, Tackling Troublesome Insolvency Issues for Franchisees (2003) Unpublished
3-6 <http://www.goldmanrosen.com/pdf/franchiseesinsolvency1.pdf> at 29 April 2007. Goldman’s paper outlines 10 specific strategies franchisees may attempt to put in place.
Chapter 2: What is the problem and how big is it? 75
One liquidator’s experience led him to observe: ‘I am only guessing, but very
few [franchisor] companies survive the administration, whereas many franchise
systems would survive in a new company set-up’. 162F
Renegotiating the franchise agreements in order to support the franchise and
preserve goodwill may be a possibility. Financing the franchisor could be
considered if the franchisor’s primary lenders were willing to engage in
reorganizations outside formal proceedings.163F
Intellectual property rights, as noted at 3.2.2, can pose problems for
administrators selling a franchise network. For example:
[t]he sale of Queensland-based On Time Business Solutions, [with 17
franchised stores] trading as On Time Copy Centres … was subject to the
delivery of intellectual property rights which had been assigned last
December. On Time Business Solutions (On Time) had sold the rights to on
Time Business Holdings. … On Time which entered into voluntary
administration in February was sold to Ausdoc on Demand in May for
$1.1m. AusDoc managed the chain while the administrators sought to regain
the intellectual property rights.164F
The intellectual property included the business name and trade mark, without
which the businesses would have to re-brand and may be exposed to competition
from the current owner of the business name and trade mark.
Implicit in the decision to buy a franchise is the belief that the network has a
proven ‘product’. Clearly, though, the network is not always proven, and not all
franchisors are strongly motivated to ensure that their franchisees’ businesses thrive.
163 Jenny Buchan interview (Sydney, face to face interview in liquidator’s office) (2005). 164 Colraine, above n 105, 6. 165 ‘Sale Finalised’ Inside Retailing (Sydney), 21 August 2000.
76 Chapter 2: What is the problem and how big is it?
The Government report titled ‘Opportunity not opportunism: improving
conduct in Australian franchising’ (‘Opportunity not opportunism’)’ 165F
acknowledged that this may not be satisfactory and has recommended:
That the government explore avenues to better balance the rights and
liabilities of franchisees and franchisors in the event of franchisor failure.166F
As a result of the numerous assumptions on which franchise law is currently
founded, the market fails franchisees of franchisors that are in administration for a
number of reasons. These include that:
It is impossible in some franchise networks for franchisees to conduct
adequate pre-commitment due diligence – because of the structure of the
franchise network and gaps in the publicly available data.
Due diligence on the scale a franchisee can realistically conduct can at best
shed light on the past and present – it will not reveal the future.
Franchisees and their legal advisers believe the agreement and the
disclosure document that must be provided by the franchisor to comply
with the Code contain most of the key information they will be basing
their purchasing decision on – it does not.
The franchisee starts down its path to franchising as a business consumer. On
signing the franchise agreement, most of its rights to receive consumer protection are
derived from pre-contractual conduct by the franchisor. At that point the franchisor
was probably, though not invariably, solvent.
Franchisor failure is common enough, as the list of failed franchisors in Table 1
demonstrates, and it has a profound effect on the parties to be included in the
template franchise agreement as originally drafted, but seldom is. Franchise
agreements are standard form, exploitative contracts and thus not negotiated. They
are assumed to be able to adapt to the evolving franchisor/franchisee relationship.
Trusting a contract to adapt to administration or insolvency is naïve.
166 Joint Committee on Corporations and Financial Services, Australian Senate, Opportunity Not
Opportunism: Improving Conduct in Australian Franchising (2008). 167 Ibid Recommendation 4 (para 6.40) xv.
Chapter 2: What is the problem and how big is it? 77
The failure to accommodate a franchisee in insolvency is at odds with the
ability to self protect and the recognition accorded by the business failure laws to
other parties that take the same risks in a non franchised business.
Behavioural economic issues weigh adversely on prospective franchisees.
These include the environment of selling the franchise, the timing of the provision of
information to prospective franchisees, the fact that franchisees are psychologically
committed to one franchise opportunity before they have signed a franchise
agreement and could still walk away, the lack of emphasis on the level of
commitment that accompanies signed franchise agreements and ancillary contracts,
and the over-emphasis by the franchisor on the benefits of being part of a winning
team. Some of these issues are pursued in chapter 3.
The franchisee has no control over how the franchisor conducts its business.
The franchisor may chose to sell its business, sell parts of its business, encumber
assets or transfer assets such as trade marks into related or unrelated entities beyond
the reach of the franchisees and of liquidators. Franchisors may actively engage in a
course of action that leads to administration or insolvency and neither franchisor, nor
administrator nor liquidator is accountable to the franchisees for consequences that
flow through to the franchisees. The appointment of a liquidator to the franchisor’s
business signals a radical change in the franchisees’ legal position. Unlike
employees, lenders, debtors and shareholders, there is no clear way forward for
We now move to chapter 3 where the problems that flow from franchisor
failure are analysed in the context of the franchise network, the franchise agreement
and contract law, and the numerous asymmetries that impact on the
Chapter 3: The problem in context 79
Chapter 3: The problem in context
New policy initiatives should flow from a ‘clear identification of the nature and
source of the underlying problem’.167F
168 Currently, outdated assumptions 168F
franchise law and practice and have a detrimental effect on the development of legal
responses to the challenge of levelling the playing field for franchisees as business
consumers. The problems franchisees encounter when their franchisor fails emanate
from several sources. In this chapter the sources of the problem are identified. This is
necessary as describing and treating the 21st century franchise relationship as one
between a franchisor and its franchisees is too simplistic. Until the
franchisor/franchisee relationship is placed in its fuller legal context, any solutions to
the treatment of franchisees whose franchisor fails will miss their mark. This chapter
is set out in the following way.
At 3.1 the recent development of the business format franchising model is set
out. At 3.2, the structure and roles of the component parts of the 21st century
franchise network are identified. Specifically, two significant components of the
franchisees’ business are the registered trade marks, and the premises lease. With
access to the franchise brand and the premises they trade from, the franchisees may
be able to regroup and survive if the franchisor becomes insolvent. Without access to
both elements the survival of the franchisee’s business is unlikely. Research
discussed at 3.2.2 and 3.2.3 reveals significant variations from one franchise network
to another. The variations lead to different possible outcomes in insolvency. At 3.2.4
franchisees, their personal profiles and the roles and risks they accept are
summarised. Finally, at 3.2.5 and 3.2.5 franchisees are compared with suppliers to, or
employees of, a company that is in administration or being wound up. This
168 Australian Government Productivity Commission, vol 2, above n 4, 46. 169 For example: (i) underlying the need for franchisors to disclosure only the health of ‘the
franchisor’ is that the franchisor is the only important franchisor-controlled entity in the network; (ii) franchisees cause franchisors to fail; (iii) franchisees are able to conduct adequate due diligence; (iv) franchise agreements are negotiable and are not standard form consumer contracts – this last assumption was put firmly to rest by Spencer in The Regulation of the Franchise Relationship in Australia: A Contractual Analysis, above n 14.
80 Chapter 3: The problem in context
comparison with two parties that have long enjoyed defined rights in the franchisor’s
insolvency serves to highlight the fact that consumer protection law nor insolvency
law have not yet adapted to accommodate franchisees as fully as they might.
At 3.3 the inability of contract law to deal with the problem will be addressed
and at 3.4 the asymmetrical environment in which the franchisee gathers and
processes information about the prospective franchise, and then conducts its
business, is examined.
By the end of chapter 3 it will be clear that the franchisee occupies a small but
significant role in a large network. The role includes functions that would be
performed by third parties, such as employees and suppliers that are currently
accommodated in the insolvency regime; but franchisees that occupy these roles are
unwittingly unprotected. Once the problem of providing protection for franchisees
whose franchisors fail is placed in the context of the franchise network, it is clear that
a solution will not evolve through precedent. Further, a solution is required for the
franchise model to remain attractive.
3.1 DEVELOPMENT OF BUSINESS FORMAT FRANCHISING
The current business format franchising model grew out of western society’s
changed needs and patterns at the end of World War II. This is demonstrated in the
response in two countries with a strong franchising culture; France and the United
States. In France, the post-war challenge of rebuilding infrastructure led
manufacturers to appoint franchisees to rebuild retail outlets throughout the country,
allowing the manufacturer to focus its resources on rebuilding its manufacturing
capacity. In the United States, the same post war period created the opportunity to
revise work models. Production lines were converted from making tanks to
manufacture of cars. Once cars became common the suburb and ultimately the
suburban shopping mall became commonplace too. ‘Franchising grew out of
servicing these thousands of new suburbs which were coming into existence all over
America. … about 50 years ago, in 1947-48’.169F
170 Standing Committee on Industry, Science and Technology, House of Representatives, Fair
Trading Inquiry (1996) Mr Atchison (Great Australian Ice Creamery franchisor). Mr Atchison had experienced ‘20 years in ice-cream and 14 in franchising. In fact, we have 87 outlets in Australia, and one lonely outlet in Beijing’ at the time of this evidence. Great Australian Ice Creamery started franchising in 1982 and became insolvent in 1998, at which time it had 62
Chapter 3: The problem in context 81
Since the post-1945 development, the business format franchising model has
flourished and expanded globally. As franchisors grow their brand, and opportunities
present themselves, many franchise networks become multi-national.170F
171 Evidence is
supplied by the ever-increasing number of international jurisdictions in which
franchise lawyer members of the American Bar Association (ABA) request local
franchise counsel recommendations through the ABA’s forum on franchising.171F
A sizeable contribution to a nation’s economy may be made by businesses
conducted through the business format franchising model. Over the 2004-5 financial
year, estimated sales through franchise systems reached US$1.53 trillion172F
173 in the
United States, £13 billion in the United Kingdom, US$142 billion in Japan,
US$5billion in Malaysia and AU$111.2 billion in Australia.173F
3.2 COMPONENTS OF 21ST CENTURY FRANCHISE NETWORKS
Franchise networks are perfect examples of ‘organizations [being] simply legal
fictions which serve as a nexus for a set of contracting relationships among
175 To gain a clear understanding of how and why franchisees fare so
poorly if the franchisor becomes insolvent one must first ‘unpack’ the franchise
organisation, identify the individual contracting entities and explore their roles. It is
then possible to trace each contract and each obligation into the insolvency and
analyse all from the perspective of the franchisee-consumer.
franchisees. <http://parlinfo.aph.gov.au/parlInfo/search/display/display.w3p;adv=;db=;group=;holdingType=;id=;orderBy=;page=;query=(Dataset%3Acommsen,commrep,commjnt,estimate,commbill%20SearchCategory_Phrase%3A%22committees%22)%20Decade%3A%221990s%22%20CommitteeName_Phrase%3A%22house%20of%20representatives%20standing%20committee%20on%20industry,%20science%20and%20technology%22%20Year%3A%221996%22%20Month%3A%2209%22%20Responder_Phrase%3A%22mr%20atchison%22;querytype=;rec=0;resCount=> at 15 June 2010.
171 Frazer, Weaven and Wright, Franchising Australia 2008, above n 7, Question C5, 9 per cent of franchisors operating in Australia are overseas-based; Question C7, 27.2 per cent of Australian domestic franchisors are currently franchising overseas.
172 For example, during February 2010 requests for lawyers in the following jurisdictions were posted on the American Bar Association Forum on Franchising: Aruba and Bonaire; Brazil; Estonia; India; Indonesia; Morocco.
173 In the USA, 50 per cent of all retail sales are conducted through a franchise. A Bou et al, ‘Insolvency in International Franchise Relationships’ (Paper presented at the International Bar Association Annual Conference, San Francisco, 14 - 19 September 2003) ch 2.
174 IBIS World, ‘Franchising in Australia’ (2006) IBIS World Industry Report. 175 Jensen and Meckling, above n 21, 311.
82 Chapter 3: The problem in context
Although franchisees own their own businesses, they are part of a much larger
organisation and are not free to develop their own ideas or to ‘go their own way’175F
to the extent that an agent, distributor, supplier or even a manager, could. The trade-
off franchisees make for their lack of independence is the opportunity to build a
business and make money in a secure environment. The inter-related nature of the
franchisor’s and franchisee’s business together with the pattern of contractual
relationships that bind the franchise network together are strengths that become
weaknesses for franchisees when a franchisor fails.
Franchise relationships that begin simply rapidly become complex. Complexity
arises as the franchisor expands to other jurisdictions, is bought by a larger entity, or
as specific functions are transferred to related entities in the franchisor’s network.
Tastee Freez provides an American/Australian example of the speedy growth of a
franchise network and its accompanying complexity. The franchisor’s failure to
register its trade mark in Australia in a timely way led to Aston v Harlee
Manufacturing Co (‘Tastee Freez’)  HCA 47; (1960) 103 CLR 391. In Tastee
Freez, Fullagar J documented the growth of Tastee Freez, a typical franchise and
identified some of the constraints placed on franchisees:
Harlee was incorporated in Illinois in February 1950. Mr. L.S. Maranz, its
president … coined the name "Tastee Freez" ... Harlee … built up an
extensive business in a comparatively short time. … Each franchise holder is
assigned a specific territory. In this territory the franchise holder sets up
operators in stores which are in nearly all instances of a specific design that
are built in accordance with plans and specifications supplied by Harlee
Manufacturing Company. Each store carries a roof sign bearing the "Tastee
Freez" mark in the specific logo type adopted by Harlee Manufacturing
Company for its mark. 176F
As Harlee, through Tastee Freez demonstrates, franchising is a way of building
an extensive business quickly, under a common brand and format. Within two years
of incorporation of the franchisor there were 315 Tastee Freez stores, and within
seven years, 1778 franchised stores in the USA. Franchisees were required to adopt
common trade dress in their stores and to lease freezers and feeding devices patented 176 Tanya Woker, ‘Franchising – The Need for Legislation’ (2005) 17 South African Mercantile Law
Journal 50. 177 Aston v Harlee Manufacturing Co (‘Tastee Freez’) (1960) 103 CLR 391, 396.
Chapter 3: The problem in context 83
and owned by the franchisor. They were required to purchase a mix made from a
franchisor-owned formula. The dry ingredients for the mix were supplied only by
one source, selected by the franchisor.
The franchisor thus has a ‘captive’ market of franchisees contractually bound
to purchase and sell its products and to use its inventions. Doug Frazey identifies the
‘captive’ market role that franchisees experience as a
structural inevitability of late 20th and early 21st century franchising the fact
that the franchisee may depend on the franchisor not only for materials
essential to the business, which the franchisee can often only purchase
through the franchisor [as was the case in Tastee Freez], but also for
premises and finance.177F
When Tastee Freez was formed, the legal structure of the franchisor’s side of
the network was simple. Only two legal entities were involved, Harlee
Manufacturing Company and Tastee Freez International Ltd. This is in contrast to
today’s franchisors which may provide the items identified by Frazey through up to
40 legal entities.178F
Franchisees depend on the continued sound operation of their franchisor.
[D]espite the degree to which the franchisee depends on the franchisor, the
franchisor is generally not bound to respect the reasonable expectation of the
franchisee that, in return for its dependence, the franchisee can continue to
operate as long as it [does not breach its franchise] agreement.179F
Before starting the franchise network, the franchisor identifies a business
opportunity and pilots and documents the business that will be offered to franchisees.
The franchisor prepares a disclosure document and drafts a franchise agreement. The
franchisor then recruits and appoints franchisees. It makes disclosure to the
franchisees, who then sign the franchise agreement. It also supports franchisees as
178 Frazey, above n 100, 728 quoting ABA Antitrust Section: Monograph No 17, Franchise
Protection: Laws Against Termination and the Establishment of Additional Franchises 19 (1990). 179 See Appendix A of this thesis. 180 Frazey, above n 100, 728 quoting David Hess, ‘Comment, The Iowa Franchise Act: Towards
Protecting Reasonable Expectations of Franchisees and Franchisors’ (1995) 80 Iowa Law Review 333, 355.
84 Chapter 3: The problem in context
they develop their business following the franchisor’s procedures. Over time the
franchise network evolves, is refined and updated.
The franchisor establishes a business that performs many functions. It is
possible for the franchisor entity itself to conduct all functions that support the
franchisees. The only network function that is not able to be performed by a
franchisor or one of its related entities, is ‘franchisee.’ It is common, however, for
the ‘franchisor’ functions to be spread across several legal entities. Some of the
entities may be truly independent of the franchisor; others may meet the test of
related entities under Corporations Act s 50.180F
These franchise network support functions may include: recruiting franchisees,
conducting franchisee training, exploring future directions for the network, owning
and managing the intellectual property assets that the franchisees are licensed to use,
negotiating and entering into leases of premises the franchisee will occupy, designing
and fitting out the franchisees’ premises, providing franchisee finance181F
negotiating relationships with financiers who will offer preferred treatment to
franchisee applicants They also include sourcing and negotiating contracts for the
supply of items of plant such as pizza ovens or cash registers, and stationery such as
pre-printed courier package labels, sourcing and supplying via import, manufacture
or distribution, the stock that the franchisees will sell to customers, and delivering
stock to franchisees.
Each franchise network is uniquely configured. Anecdotal evidence suggests
that in the early days of franchising, the franchisor’s related entities were not nearly
as numerous and the franchise networks not as complex as they are today. For
example, in the Barbara’s House and Garden litigation182F
183 in 1987, the franchisor was
the only party being pursued by the franchisee and the franchisees’ directors. The
181 See Appendix A of this thesis. 182 Bakers Delight Media Relaease, Unique Business Opportunity for Young Guns (2009)
<http://www.bakersdelight.com.au/Assets/Files/1994895a-dac3-4386-8a08-cc0a4a5671ee.pdf> at 16 June 2010. ‘Bakers Delight will then help them [new franchisees] purchase a bakery through a combination of financial assistance - possibly including working capital, vendor finance and bonus schemes, as well as ongoing advice, training and operational support’. Frazer, Weaven and Wright, Franchising Australia 2006, above n 11, 54-55, report that 22.2 per cent of franchisors provide [start-up] finance to franchisees and for 17.7 per cent of franchisees the franchisor is the major source of finance.
183 Re Richard Vincent Bateman and Georgina Gay Bateman v Barbara Jean Slatyer; Harvey John Slatyer; Graham Walter Tiekle and Barbara's House & Garden (Retail) Pty Limited  FCA 58.
Chapter 3: The problem in context 85
ASIC records show that there were four companies in the Barbara’s House & Garden
184 Similarly, there were two entities in the Tastee Freez franchise.
In contrast, franchise networks have now become complex webs of
interdependent companies. The franchisor benefits from its ability to structure the
network through a number of entities. ‘Diversification on the part of owner-managers
[directors of the franchisor] can be explained by risk aversion and optimal portfolio
185 The franchisor’s directors take legal advice that it is desirable to protect
some business or personal assets, for instance a suite of registered intellectual
property assets, or the franchisor’s family home, from the risk of having to be sold to
meet a judgment against the franchisor. They structure the franchise network and
manage their personal exposure to loss accordingly.
The legal structure of failed franchisor Kleenmaid is set out by way of example
in Appendix D. The solvent Pets Paradise franchise network is a network whose
basic structure is an example of a typical 21st century business format franchisor. It is
outlined in Pampered Paws Connection Pty Ltd (ACN 116 460 621) v Pets Paradise
Ltd, Global Pet Productions Pty Ltd, Pets Paradise (Franchising) Pty Ltd,
Pets Paradise Pty Ltd] are said to be trading corporations with their holding
company being the seventh respondent [Paradise Retail Holdings Pty Ltd].
The sole director of all the corporate respondents is the eighth respondent
[Gary Diamond]. The eighth respondent is also said to be the managing
director of each of the respondents. Hence, each of the corporate respondents
184 It is acknowledged that there may have been other related entities whose name did not include the
clause Barbara’s House & Garden and which thus did not appear on the ASIC search. 185 Jensen and Meckling, above n 21, 349.
86 Chapter 3: The problem in context
is a related corporation for the purposes of s 50 of the Corporations Act 2001
Each of the respondents, that is the corporate respondents, is said to be
implementing part of a system through the instruction of its director, the
eighth respondent, and as part of the overall system of which they are a
member through their proprietorship by the seventh respondent and the
control over all of the eighth respondent. 186F
In Pets Paradise, Justice Mansfield outlined the role of each of the eight
entities in the franchisor controlled part of the franchise network:
Each of the first three respondents is said to carry on business in
Queensland, South Australia and the Northern Territory, and New South
Wales respectively … granting Pets Paradise franchises – and each also
operated retail businesses providing pets and pet accessories under that
The fourth respondent is the supplier of goods to operators of Pets Paradise
The fifth respondent is the author and proprietor of intellectual property
rights … and provides support services by way of legal services, copies of
documents … to prospective franchisees and franchisees, and from time to
time receives payment of franchise fees and legal fees.
The sixth respondent is said to be the proprietor of a series of four registered
trade marks in relation to categories of pets and pet accessories, and licenses
the use of those trade marks to the first, second and third respondents to
enable them to sub-license the use of those trade marks to franchisees. It also
assumes liability pursuant to hire purchase agreements to make payments in
respect of fixtures and fittings used in the operation of retail businesses
which are guaranteed by one or some of the other respondents. It also
receives, and presumably assesses, preliminary franchise agreements from
186 Pampered Paws Connection Pty Ltd (ACN 116 460 621) (on its own behalf and in a
representative capacity) v Pets Paradise Franchising (QLD) Pty Ltd (ACN 054 406 272) (No 3)  FCA 138 para 14 (Mansfield J).
187 Ibid para 21.
Chapter 3: The problem in context 87
The seventh respondent operates, it appears, as a form of head office. It is
said to provide legal services, accounts and management staff for the group,
including for the purposes of making representations to and dealing with
franchisees on its own behalf and on behalf of the first, second, third and
…, the eighth respondent directly manages the carrying on of the business of
each of those corporate respondents by means of daily control and direction
of, and participation in, their respective business activities.’187F
There are up to 100 Pets Paradise franchisees throughout Australia. The
franchisee executes a franchise agreement with the entity named as franchisor. In a
network such as Pets Paradise, the franchisee will subsequently be required by the
franchisor to enter contracts with several of the entities related to the franchisor. This
will be demonstrated through an explanation of retail leases within the franchise
network in chapter 3.2.3.
In addition to related entities, the franchisor will have negotiated arrangements
with non-related entities that the franchisee must deal with. For example, Budget
Shop Fitting fits out Pets Paradise franchisee shops. The franchisees are required to
pay an ongoing royalty for use of the shop fitters’ pet pens. Similarly, in the Bakers
Delight Holdings Ltd franchise network (‘Bakers Delight’), franchisees are required
to order key products from entities unrelated to Bakers Delight as is described in the
Bakers Delight notification to the ACCC188F
189 by which Bakers Delight secured the
regulator’s consent to require franchisees to acquire certain key products only from
Business entities that form part of the franchisor’s group of entities but do not
carry the title ‘franchisor’ do not have to make disclosure to prospective franchisees
(except in relation to intellectual property rights). Yet the failure of any of these
related entities can have an effect on the solvency of the franchisor, and thereby
impact the franchisee. The identity of only two of the 51 entities in the Kleenmaid
network, being the ‘franchisor’ and the owner of the Kleenmaid trade mark, would
have been included in the disclosure provided to incoming Kleenmaid franchisees.
188 Ibid paras 24–30. 189 Notification N92536 under s 47 Trade Practices Act 1974 (Cth) <
http://www.accc.gov.au/content/index.phtml/itemId/750777/fromItemId/729985> at 17 June 2010.
88 Chapter 3: The problem in context
This demonstrates what little information a franchisor must provide to a franchisee
about a network in order to satisfy the disclosure provisions of the Code.
Moving the focus from the franchise network to the specific franchisor, in
2006, 70 per cent of the entities identified as the ‘franchisor’ in Australia were
proprietary companies, 14 per cent public companies and 10 per cent trusts.189F
Where a franchisor is owned by a public company, the company’s published
reports do not contain meaningful information about the franchise division. This is
exemplified by the limited amount of information about franchisors’ intangible
assets, discussed at 3.2.2.
If the franchisor or some of the entities in the franchisor’s network are set up as
trusts, the issue confronting a prospective franchisee becomes not one of the
prohibitive cost of obtaining information about the franchisor and its related entities,
but the impossibility of obtaining information about the true identity of the
franchisor. For example in Australian Competition and Consumer Commission v
Chaste Corporation Pty Ltd (In Liquidation) (ACN 089 837 329), Braddon Ralph
Webb, Orlawood Pty Ltd (ACN 059 294 334), Peter Clarence Foster, Sean Petrie
Allen Cousins, Kevin Anthony McMullan, Alan Kenneth Cooper, Stephen D’alton,
Qud 252 of 2001, Lander J in the Federal Court in Queensland observed:
Chaste was entirely controlled by the fourth respondent, Mr Foster and the
second respondent, Mr Webb, and those two gentlemen, through the [trusts]
which they controlled, namely WMMT and WFDT would receive
respectively 75 per cent and 25 per cent of the profits. As far as a bystander
[eg: franchisee] was concerned, Chaste was entirely controlled by Mr Webb.
No bystander could have known that there were agreements in place between
the second and third respondents and the fourth respondent, and an entity
controlled by the fourth respondent which gave control of Chaste to Mr
190 Frazer, Weaven and Wright, Franchising Australia 2006, above n 11, 34. 191 Australian Competition and Consumer Commission v Chaste Corporation Pty Ltd (In
Liquidation) (ACN 089 837 329), Braddon Ralph Webb, Orlawood Pty Ltd (ACN 059 294 334), Peter Clarence Foster, Sean Petrie Allen Cousins, Kevin Anthony McMullan, Alan Kenneth Cooper, Stephen D’alton, Qud 252 of 2001 , .
Chapter 3: The problem in context 89
Performing due diligence
It is assumed that a franchisor issuing a disclosure document under the Code
will be solvent. Of concern for incoming franchisees is that several of the franchisors
in Table 1 were subsequently found to have been offering franchises for sale despite
the directors knowing the franchise network was insolvent.191F
It is also assumed that before committing to the purchase, franchisees will
double-check any important statement the franchisor has made, including the
solvency statement provided as disclosure Item 20. A popular view of due diligence
propounded by non-lawyer industry figures like Jason Gehrke192F
193 is that:
… franchisees … don't know what due diligence is and may have never
heard the term before. They may figure due diligence is something that is
expensive and complicated and therefore done by the lawyers or other
professional advisors that they might engage to handle "the paperwork" of
the sale. … Due diligence is no more complicated than looking at the facts of
a deal from all angles to make sure they stack up.193F
A franchisee reading Gehrke’s comments would be excused for concluding that
conducting effective due diligence is lay person’s work, and is quick, easy, cheap
and will reveal all that needs to be known about a franchise investment. This
prejudices the intending franchisee against being prepared to pay their legal and
accounting advisers to conduct thorough due diligence.
Thorough due diligence is expensive and will reveal areas where the
information to substantiate the material disclosed cannot readily be obtained, and if
obtained, cannot be objectively tested. It will give rise to further questions that the
franchisor should be prepared to answer candidly. Attempts to obfuscate by the
192 For example, Dan Minchin, ‘Pets Chain Creditors out in Cold’, The West Australian (Perth), 2
December 1996 reported of Wonderland of pets franchisor that ‘the companies value of assets is estimated to total $A62,216 while the combined liabilities is $853,277; Mr. Conlan’s report also states that both the companies were trading while they were insolvent’. Nick Butterly, ‘Northbridge Gym Fails Fiscal Test’, Sunday Times (Perth), 11 July 2004, 55. ‘I think the company has been insolvent for quite a while prior to appointing administrators’ [administrator] Mr. Lopez says.
193 Director of franchise advisory and training company The Franchise Advisory Centre, Franchise Media Commentator on smartcompany.com, then Member of the Board of the Franchise Council of Australia, Adjunct Lecturer in Franchising at Griffith University.
194 Jason Gehrke, Franchise Tips and Trends (2009) Smartcompany <http://www.smartcompany.com.au/franchise-tips-and-trends/20090929-what-is-due-diligence.html> at 29 September 2009.
90 Chapter 3: The problem in context
franchisor should ring alarm bells for the franchisee, but by this time many are
It can be difficult, if not impossible for the franchisee to conduct thorough due
diligence to test or verify what the franchisor has told them, or to provide context for
the information provided in the Code-mandated disclosure. For example when
franchisors and their shareholders are structured as trusts; the nature of a trust means
that it is impossible to conduct independent due diligence about it. The only source
of further information available to the intending franchisee is the franchisor itself.
Regardless of the number of entities in the franchisor’s network, the franchisor
is the key entity that makes disclosure. Limited disclosure is provided in relation to
intellectual property rights and retail leases. The number of entities in some of the
failed networks is recorded in Table 1: Australian failed franchisor data. Even if the
franchisee became aware of others, the more entities there are, the more expensive,
difficult and possibly meaningless it becomes for prospective franchisees to conduct
robust due diligence.
Because of the difficulty and cost of accessing more information, the
franchisee has either to accept what the franchisor discloses at face value, ask more
questions and hope the franchisor provides full answers, or walk away.
In Australia, franchise networks range in size from one to 2,950 units.194F
franchisee buying into a large and well established franchise network could be
forgiven for relying heavily on the reputation of the brand rather than conducting
thorough due diligence. This theme is revisited in chapter 3.2.2 under the heading
‘overseas brands and due diligence’.
As discussed in chapter 3.3, regardless of what the franchisee’s advisers
discover about the franchise network, no amount of due diligence will enable the
franchisee to have the franchise agreement amended.
3.2.2 TRADE MARKS
Trade marks are the most visible of the franchisor’s intellectual property assets,
providing ‘information to the consumer [both franchisees and their customers]
195 Frazer, Weaven and Wright, Franchising Australia 2008, above n 7, 25.
Chapter 3: The problem in context 91
regarding the quality and source of the product that reduces search costs’.195F
franchise law practitioners and former Subway franchisees, Steinberg and Lescatre,
the nature of franchising is that the franchisee is “buying” something that the
franchisee can never sell, specifically, the trade marked “name on the door”
and such support as the franchisor chooses to provide. Unsophisticated
buyers of franchises fail to realize the implications of the fact that they are
licensing a trade mark. 196F
Franchisees rely on the licence purchased from the franchisor to use, amongst
other things, the franchisors’ trade marks, further adding to the brand’s recognition
and value. Given the importance of brand recognition, it would be logical for
franchisors to register their trade marks. Some franchisors also register patents and
designs. These are not as universally recognised as part of the franchisor’s brand. An
examination of the property rights aspects of trade marks is sufficient to demonstrate
the franchisees’ vulnerability, especially in the franchisor failure scenario.
Registration under the Trade Marks Act 1995 (Cth)
The Commonwealth (of Australia) has enacted a number of statutes to regulate
intellectual property pursuant to x 51(xviii) of the Constitution. The Trade Marks Act
1995 (Cth) (‘Trade Marks Act’) is the legislation concerned with the identification
and registration of, and dealing in, trade marks. Section 6 states that any:
letter, word, name, signature, numeral, device, brand, heading, label, ticket,
aspect of packaging, shape, colour, sound or scent or combination thereof’ 197F
may be registered as a trade mark.
The registered trade mark is recognised as personal property by s 21 Trade
Marks Act’ and the registered owner is given extensive, exclusive rights to use it and
to authorise others (for instance franchisees) to use it under ss 20, 22. Section 26
Trade Marks Act provides a number of additional statutory rights, including the right
to bring an action for infringement (s 26(1)(b)) and to grant others, for instance
franchisees, the right to use the mark (s 26(1)(f)).
196 Blair and Lafontaine, above n 46, 147. 197 Steinberg and Lescatre, above n 13, 116. 198 Guidelines are available on the IP Australia website. <
http://www.ipaustralia.gov.au/trademarks/index.shtml> at 17 June 2010.
92 Chapter 3: The problem in context
Trade marks under Franchising Code of Conduct
Franchisees are entitled to be provided with certain details about the
intellectual property that is ‘material to the franchise system’.198F
199 The Code requires
pre-contractual, and periodic disclosure of the matters listed in s 7.199F
4.1.1(c) and 7 acknowledge that the franchisor itself may not own the intellectual
property, and that the intellectual property may be unregistered.
Trade mark research and literature
Gillian K Hadfield refers to a 1971 study conducted by Ozanne and Hunt200F
clauses in fast food industry franchise contracts which found that 77 per cent of
franchise agreements granted the franchisee no ownership rights in the trade mark.201F
What is surprising is that 23 per cent did grant ownership rights. A comparable study
has not been conducted on Australian franchise agreements.
Bruce Schaeffer and Susan Robbins have written about the valuation of
intangible assets in franchise companies and multinational groups drawing on the
experience in the United States.202F
203 Whilst their article addresses franchises as a
category, the authors do not differentiate between the various types of intellectual
property – trade marks, patents and designs.
A description of the consumer protection franchisees gain from the registration
of trade marks is found in Australian Competition & Consumer Commission v 4WD
Systems Pty Ltd  FCA 850. In this case, the franchisor told prospective
The 4WD Systems name is a registered and protected name, unauthorised
use of the name and associated trade marks is illegal …. This means your
business is protected from any unauthorised use of the name within your
199 Trade Practices (Industry Codes – Franchising) Regulations 1998 (Cth) s 7.1. 200 See Appendix A of this thesis for wording. 201 Ozanne and Hunt, above n 43, ch 5. 202 Gillian K Hadfield, ‘Problematic Relations: Franchising and the Law of Incomplete Contracts’
(1990) 42 Stanford Law Review 927, 942. 203 Bruce S Schaeffer and Susan J Robbins, ‘Valuation of Intangible Assets in Franchise Companies
and Multinational Groups: A Current Issue’ (2008) 27(3) Franchise Law Journal 185. 204 Australian Competition & Consumer Commission v 4WD Systems Pty Ltd  FCA 850, para
Chapter 3: The problem in context 93
As the franchise agreement usually grants a license to use the franchise trade
marks, the franchisor is expected to own the network’s trade marks, or to be able to
satisfy its franchisees that it has the right to grant the franchisees a licence to use
them. An Australian master licensee of a foreign-based franchisor (regarded by the
Australian unit franchisees as ‘the franchisor’) would be expected to have a licence
granting it sole and exclusive rights to develop the franchise network using the
franchisor’s registered trade marks in Australia. It can then confidently grant
To understand the options an administrator or liquidator has when faced with a
failing franchisor, it is necessary to know the extent to which they can claim the
benefit of contractual rights to permit franchisees to use the franchisor’s registered
trade marks. Franchisees would, for example, become vulnerable if the Australian
master licensee breached the master licence agreement and lost the right to be the
Australian ‘franchisor’ unless there was a contractual obligation requiring the
overseas franchisor to permit the individual franchisees to continue to use the trade
marks. Because no studies could be found that specifically report on ownership and
use of trade marks by franchisors and franchise network stakeholders in Australia, I
conducted the Exploratory Study on the trade marks registered under the Trade
Marks Act used by franchisors in 2005.204F
Exploratory Study findings
The Exploratory Study revealed a diversity of trade mark ownership and
registration strategies adopted in Australian franchising. The implications of this
situation for franchisees of insolvent franchisors are discussed in chapter 4.4.4.
The 337 franchise networks in the sample group together owned at least 1,308
registered trade marks. For 14.24 per cent of franchise systems (48 in total) it was not
possible to determine the legal identity of the franchisor entity from the franchisor’s
website or from other public records. This meant that it was not possible to take more
than an educated guess at whether the trade marks relating to the network were
owned by the franchisor. Given the importance of brand protection in franchising, it
was surprising to find that 13.65 per cent (46) of franchise networks in the sample
205 Jenny Buchan, Investigation of Real and Intellectual Property Rights under Franchise Systems
Operating from Retail Premises in New South Wales (2005). Research funded by University of New South Wales.
94 Chapter 3: The problem in context
did not have any registered trade marks. Between 72.1 per cent and 86.5 per cent of
franchise networks did register trade marks. The remainder probably use unregistered
trade marks that would be defendable through common law or a statutory passing off
action under the Trade Practices Act. The franchisor was the sole trade mark owner
in 26.11 per cent of networks in the sample (88). In 28.78 per cent of networks the
franchisor was one of the trade mark owners. For example in the bedding retailer
Forty Winks franchise network, Forty Winks Pty Ltd owned all six registered trade
marks and was the franchisor, whereas in the tyre retail Bob Jane network, Bob Jane
Corporation Pty Ltd was the franchisor and owned 19 of the 21 trade marks. Bob
Jane Telecommunications Pty Ltd and Bob Jane T-Marts Pty Ltd jointly owned the
It was found that 15.73 per cent (53) of the franchisors in the sample were
foreign-based in such diverse jurisdictions as the Bahamas, Germany, Hong Kong,
Japan, Mauritius, the Netherlands and the USA.205F
206 Of these 53, only one (1.88 per
cent) Australian master licensee had registered an interest as an authorised user under
s 26. That one, an entity that is presumably the Australian master licensee of
Coldwell Banker Corporation, Australian Real Estate Systems Pty registered an
interest in nine of the 10 trade marks owned by franchisor Coldwell Banker 206 7-Eleven, Inc (USA); Athletes Foot Brands, Inc (USA); Bartercard International Ltd (Bermuda);
Baskin-Robbins International Co (USA); Blockbuster Inc (USA); Bridgestone Corporation (Japan); Candleman Corporation (USA); Dannic IP Holdings Inc (Bahamas); Century 21 Real Estate LLC (USA); Hanic Publishing LLC (USA) Company; Chipmunks IP Limited (New Zealand); Coldwell Banker Corporation (USA); Italtile Mauritius (Proprietary) Limited (Mauritius); Italtile Franchising (Proprietary) Limited (Mauritius); Discount Car & Truck Rentals Ltd (Canada); Domino's Pizza, PMC, Inc a Michigan corporation (USA); Produits Ella Bache Laboratoire Suzy (France); Europcar International (France); Express Services, Inc (USA); Fastway Limited (NZ); Voith Turbo GmbH & Co KG (Germany); Gloria Jean's Gourmet Coffees Corp (USA); The Goodyear Tyre & Rubber Company an Ohio corporation (USA); HRB Royalty, Inc (Bahamas); H2O Plus, LP; A Delaware Corporation (USA); Hertz System Inc, a Delaware Corporation (USA); Arana Ltd (Hong Kong); Burger King Corporation (USA); IGA, Inc (USA); Kernels Popcorn Limited (Canada); Yum! Australia Holdings I LLC and Yum! Australia Holdings II LLC (Both USA); Kumon Institute of Education Co Limited (Japan); ICED Management, Inc, a Delaware Corporation (USA); LPNZ Limited (New Zealand); Madame Et Monsieur LLC a Californian Corporation (USA); United Parcel Service of America, Inc a Delaware Corporation (USA); McDonald's Corporation a Delaware Corporation (USA); Medicine Shoppe International Inc a Delaware Corporation (USA); Pinnacle Intellectual Property Services - International, Inc a Nevada Corporation (USA); Mend-A-Bath International (Pty) Ltd (Cape Province); Midas International Corporation (USA); Mrs. Fields' Original Cookies, Inc, a Delaware Corporation (USA); Nando's International Ltd (Republic of Ireland); Number Works Ltd (New Zealand); Pizza Hut International LLC a Delaware Corporation (USA); Quik International a Nevada Corporation (USA); The Quizno's Master LLC (USA); Sign*A*Rama, Inc (USA); Fastsigns International Inc, A Texas Corporation (USA); International Spar Centrale BV (The Netherlands); Doctor's Associates Inc (USA); SureSlim International Limited (UK); Mascolo Limited (UK); Warner Bros Entertainment Inc (USA).
Chapter 3: The problem in context 95
Corporation (USA), a real estate franchise. The Australian licensee has registered its
interest pursuant to a licensed user agreement on the trade mark registry. No unit
franchisees in the sample group had registered their interest as authorised users of
any franchisor’s trade mark.
In 3.26 per cent of all identified networks (11 in total), there was more than one
owner of certain trade marks. In 8.01 per cent of networks (27 in total), there were
several individual owners of several individual trade marks. Typically, this was two
or three individuals where the franchisor was a corporation. For example Margaret
Kerr Kent Sasse and Harry Arthur Sasse owned the franchise Gymbaroo trade marks.
The franchisor is a corporation called Toddler Kindy Gymbaroo Pty Ltd. In some
instances the first trade mark registered by a franchisor was found to be owned by
two individuals, but subsequent trade marks in the network were owned by the
franchisor or a corporate entity related to the franchisor. For example, D Williams
and J Clow were registered as the owner of one trade mark and Fernwood Fitness
Centre Pty Ltd was the owner of all subsequently registered trade marks for the
Fernwood Women's Health Club. The franchisor entity was Fernwood Womens
Health Clubs Pty Ltd.
An alternative to registration as an ‘authorised user’ is that all levels of
franchisee, could record their interests as licensees on the TM Register by relying on
the provisions of Trade Marks Act Part 11.206F
207 This would be useful protection if they
are prohibited by their franchise agreement from registering their interest as an
‘authorised user’. However, there is no evidence that franchisees register their
interest as licensees under the Trade Marks Act.
Trade marks and franchise agreements
One of the key functions of the franchise agreement is to grant the franchisee a
licence to use the franchisor’s intellectual property, including its trade marks. Based
on the Trade Mark Research it appears that franchisees rely solely on the contractual
rights granted to them in the licence agreements with the franchisor. There is
therefore a strong incentive for the franchisee to ensure that they have a contractual
nexus with the owner of the trade mark.
207 See Appendix A of this thesis.
96 Chapter 3: The problem in context
A valid franchise agreement does not require the trade marks to be registered
or for the franchisor to own them. For example, the precedent franchise agreement in
the Australian Encyclopaedia of Forms and Precedents207F
208refers to the trade marks as
being part of the franchisor’s image. In it, the franchisor grants the franchisee the
right, under clause 2(1)(a):
to operate the franchised business within the territory using the image, and
‘marks’ means the trade marks or logos and trade names described at Item 4
of the Schedule and any variations or modifications thereto.
In relation to the trade mark, the franchisor, in clause 12 of the precedent
agreement, is contractually bound to:
12(1)(a) make the image and the system available to the franchisee;
12(1)(b) actively develop and promote the image and system;
and, at 12(5), the: Franchisor shall take reasonable steps to maintain the
integrity of the system and to protect the marks against any action or
infringement by any person.
By agreeing to clause 15(6):
The franchisee acknowledges that franchisor is the owner of the marks and
that the franchisee's sole right to use them is derived from this agreement.
The franchisee shall not use any other trade marks, trade names, business
names, logos, designs or colour schemes in connection with the franchised
The requirement in relation to the trade marks in the Traveland franchise
6.1 Use of Marks and Corporate Identity.
The Franchisee must:
Display the marks in and on the Premises and on all signs, fixtures, fittings,
display stands, stationery, uniforms and other items used in relation to the
Business; … Strictly in accordance with the operations manual or as the
Franchisor may require from time to time.
6.3 The Marks
208 LexisNexis Butterworths, Australian Encyclopaedia of Forms and Precedent, Form 40.1. 209 Ibid.
Chapter 3: The problem in context 97
The franchisee must, if requested by the franchisor, execute a registered user
agreement in relation to the Marks.
The Franchisee and the Guarantors:
Acknowledge the franchisor’s exclusive ownership of all intellectual
property rights and goodwill accrued in the marks at the date of this
(b) acknowledge that any goodwill accruing to the marks, the Business name
or the business during the term and any copyright materials produced by the
Franchisee during the Term relating to the Business will be the exclusive
property of the franchisor; and
Will not contest or challenge the franchisor’s exclusive ownership of these
intellectual property rights and this goodwill.
11.1 Immediate Termination
The franchisor may terminate this Agreement immediately by notice in
writing to the Franchisee if:
The franchisee makes improper or unauthorized use of the Marks … or is
involved in any act or conduct which, in the Franchisor’s opinion, is likely to
adversely affect the Mark …209F
Clearly, both franchisors and franchisees regard the trade marks as an
important and valuable part of what the franchisee as a business consumer and
investor is paying for. Also clear is that Australian master franchisees and
franchisees’ and franchisors’ financiers are generally lax about accessing the
statutory rights available under the Trade Marks Act to register their interest in trade
Overseas Brands and due diligence
The law cannot protect all consumers from their own perceptions. Paul
Steinberg and Gerald Lescatre describe the ‘halo effect’ that can result where
franchisees are unsophisticated investors:
… ownership of a household-name franchise conveys a degree of status and
may result in a non-rational purchase decision. … A powerful franchise
brand further distorts analysis of the franchise investment. ... Trade mark
owners are acutely aware of reputational risk as applied to the brand value of
210 Copy of Traveland franchise agreement on author’s file.
98 Chapter 3: The problem in context
the retailed product but inefficient dissemination of reputational data with
regard to the wholesaled product (franchises) means that the franchisors can
benefit from an unsophisticated consumer’s perception that if Dunkin’ has
quality donuts and if Burger King is concerned about the humane treatment
of cattle, then the consumer’s positive perceptions of the brand carry over to
the consumer’s positive perception of the franchise. 210F
Unsophisticated investors possibly overvalue a known franchise brand
emotionally rather than objectively assessing their forthcoming investment. It is
speculated that the notion of ‘cultural cringe’211F
212 may be a version of the halo effect,
resulting in franchisees exercising less due diligence in purchasing into an overseas
based franchise than would be exercised in relation to a local franchisor.
For instance, as the trade mark research shows, only one Australian master
licensee has registered its authorised user status at the trade marks office. Cultural
cringe may lead less sophisticated franchisee consumers to favour one of the 53
overseas brands over a home grown Australian brand. A conclusion that can be
drawn from the Trade Mark Research concerning the use of registration and
authorisation opportunities under the Trade Marks Act is that overseas franchisors
are not necessarily models of best practice. The idea that the overseas brand is a
more secure, better organised investment, may be ill founded. The list in Table 1
contains the failed Australian master franchisees of several franchisors of overseas
Taking into account the halo effect and the fact that some well known
franchisor brands with registered trade marks fail completely, for example Australian
based Traveland and Australian master licensees of Canadian based Kernel’s
Popcorn, Singapore based Deli France and US based Midas, it is suggested that
concluding that having a widely recognised trade mark is indicative of a ‘good’
franchisor is a flawed indicator of franchisor quality for a potential franchisee.
211 Steinberg and Lescatre, above n 13, 155. 212 An attitude characterised by deference to the cultural achievements of other countries and
disparagement of Australian (ie ones own) culture. The Australian Oxford Dictionary (2nd ed, 2004) 307.
213 For example, the Australian master franchisees Kernel’s Popcorn, Priority Management Systems Pty Ltd, of Canadian franchisors.
Chapter 3: The problem in context 99
Due diligence should extend beyond verifying the existence of the owner of the
trade mark to verifying the ‘chain of title’, so the franchisee can be confident it will
have an ongoing right to use the trade marks if the franchisor becomes insolvent.
Valuation – security
Bruce Schaeffer and Susan Robbins argue that ‘intangibles [registered and
unregistered intellectual property] often account for more than 80 per cent of the total
214 and write that:
The value of the trade mark gauges the success of the franchisor in assuring
that franchisees provide an otherwise valuable product or service or system
according to the franchisor’s plan. The more valuable the trade mark, the
greater the price at which franchises can be sold and the greater the royalties
Access to property rights as security is fundamental to lenders and to
liquidators. Much of the asset base of the franchisor is ‘personal’ property (including
intellectual property) which may pose greater difficulties for liquidators to sell than
does real property.
As trade marks are a recognised item of property, franchisors are able to offer
them to lenders as security for loans. As trade marks are an essential asset of the
network lenders may want security over them. However, their value is notoriously
difficult to quantify. A multitude of valuation methods can be applied to intellectual
216 and the technique chosen will be influenced by the context. It is
also believed by economists that ‘the greater the volume of sales under the trade
mark, the greater is the likelihood that a consumer has had direct or indirect contact
with the trade mark, increasing its value’.216F
From the perspective of accountants, however, discrepancies in the
presentation of trade mark valuation in the reports of public companies arise through
214 Bruce S Schaeffer and Susan J Robbins, ‘Valuation of Intangible Assets in Franchise Companies
and Multinational Groups: A Current Issue’ (2008) 27(3) Franchise Law Journal 185. 215 Hadfield, ‘Problematic Relations: Franchising and the Law of Incomplete Contracts’, above n
202, 949. 216 See Paul McGuinness, Intellectual Property Commercialisation: a Business Manager’s
Companion (2003) ch 23. 217 Hadfield, ‘Problematic Relations: Franchising and the Law of Incomplete Contracts’, above n
100 Chapter 3: The problem in context
standard accounting and audit practices.217F
218 The rules of accounting do not permit the
creation of an entry that recognises what is known as ‘internally generated goodwill’,
because it is an intangible. Accountants are only allowed to recognise ‘purchased
goodwill’. Purchased goodwill arises in two ways. First, by purchasing a trade mark,
in which case the accountant can record the purchase price. Second, by purchasing a
company. The excess paid over the net value of the assets is deemed to be the
goodwill that has been purchased. Items such as registered trade marks are included
in the goodwill. In the case of Harvey World Travel for example, the A$5,000 value
attributed to intangibles is likely the administrative cost of applying for the trade
As several of the franchisors in the Exploratory Study were Australian public
companies their annual accounts could be accessed via the internet. Although this
sample is small, it is useful to demonstrate the range of approaches public company
franchisors take to expressing the value and identity of their trade mark assets in the
Depending on whether the purpose is simply to comply with accounting
standards (as appears to be the case for most companies including Domino’s, Rebel
Sport and Harvey World Travel in the Exploratory Study) or to attract franchisees to
a fledgling franchisor (as appears to be the case in the light of subsequent litigation
with Danoz Direct); trade mark values in 2005 were entered as either the ‘cost of
acquisition’ or as a ‘directors’ valuation’. The lack of standardisation increases the
uncertainty of the franchisees’ pre-purchase due diligence. It also makes the
administrator’s or liquidator’s task of accurately assessing the value of trade marks
for the purpose of deciding whether to advertise them for sale or not, difficult. Four
In 2005, Domino’s Pizza Australia New Zealand Ltd, included its ‘Intangibles’
in the Notes to Accompany the Financial Statements under ‘goodwill’ and ‘franchise
distribution network’. The 21 registered trade marks that Dominos Pizza franchisees
were licensed to use were not included as they were owned by the US parent
company. Dominos Pizza Australia New Zealand Ltd had not registered its licence to
218 As described also by Ahmad Sujan and Indra Abeysekera, ‘Intellectual Capital Reporting
Practices of the Top Australian Firms’ (2007) 17(2) Australian Accounting Review 71.
Chapter 3: The problem in context 101
use the trade marks at the time of the research. Even though the trade marks were
owned by the US parent, there seemed to be no way in the accounting standards of
expressing the value of the registered user licenses for the 21 registered Dominos
Pizza trade marks to the Australia and New Zealand master licensee. This
theoretically leaves the Australian and New Zealand Dominos franchisees exposed to
not being allowed to use the trade marks if the US parent failed. The franchisor’s
liquidators could disclaim the licences as onerous contracts.
Rebel Sport Ltd did not list any of the five registered trade marks that it owned
on its 2005 balance sheet.
Harvey World Travel Ltd, with over 500 offices internationally, a turnover in
excess of A$1.7 billion218F
219 and at least six registered trade marks, included a heading
‘Patents and Trade Marks’ in its 2004 Notes to and Forming Part of the Financial
Statement as above (‘NTFS’). It stated: ‘Patents and Trade marks are valued in the
financial statements at cost of acquisition ($5,000) and are amortised over the period
in which their benefits are expected to be realised’.219F
That incoming franchisees should not necessarily place reliance on the stated
value of the trade marks is underscored by the experience of the franchisees of
Danoz Direct. TVSN Ltd, the parent company of franchisor Danoz Direct, was
formed in 2003. It became insolvent in 2005. It reported in relation to intangible
assets in the 2004 Notes to and Forming Part of the Financial Statements (NTFS)
The identifiable intangible asset of the company comprises the name
‘Danoz’. No amortisation is provided against this asset as the life of the asset
is of such duration and the residual value is such that the amortisation
charge, if any, would not be material. The carrying value of $8million is in
accordance with a valuation by Directors. At each reporting date, assessment
of the carrying value will be made by the Directors.220F
219 Harvey World Travel, Franchise Information
<http://www.harveyworld.com.au/FranchiseInfo.aspx> at 12 December 2007. 220 Harvey World Travel NTFS. 221 This value was ascribed under ASB 138, the predecessor to accounting standard AASB 138.
AASB 138 is an accounting standard relating to intangible assets. It requires an entity to recognise an intangible asset if, and only if, specified criteria are met. The Standard also specifies how to measure the carrying amount of intangible assets and requires specified disclosures about
102 Chapter 3: The problem in context
Danoz Direct paid A$8 million more than the value of the assets because the
parent company, TVSN Ltd, self-assessed that this represented the value of the
customers and the brand. Franchisees therefore believed they were buying into a
valuable name, without realising that the value was self-generated by the franchisor’s
A public company’s published annual reports are an unreliable source of
information about the existence and value of its trade marks. When trade marks are
specifically mentioned, their value(s) are given in order to comply with accounting
standards and are not objectively verifiable.
Trademarks are an asset categorised in the company’s accounts as an
‘intangible’ asset. The effective life221F
222 of standard patents is a maximum period of 20
223 For tax purposes, trade marks do not fall within s40-30(2)(c) Income Tax
Assessment Act 1997 (Cth) as ‘items of intellectual property’ as ‘intellectual
property’ is defined in s995-1 Income Tax Assessment Act in terms that do not
include trade marks. Debt finance is a common form of finance for a business in
Australia. The debt is secured over assets owned by the borrower. Yet this valuable
asset is rarely used as security for loans in Australian franchises.223F
If the creditor has to sell the franchisor’s business in a mortgagee’s sale, the
value would potentially be much greater if the trade mark were also available for
Many franchisees trade from retail premises. The presence of premises owners
as stakeholders in a franchise network can be a significant factor in how the
administration or insolvency is resolved. ‘Of the 960 business format franchises
operating in Australia in 2006, 44.7 per cent had franchisees operating from a retail
intangible assets. For more information see Catherine Pozzi and Mark Shyling (eds) Accounting Handbook (2010) 747 – 775.
222 The effective life of a depreciating asset determines the rate at which the asset declines in value Income Tax Assessment Act 1997 (Cth) ss 40-70, 40-75 in RL Deutsch et al, Australian Tax Handbook, Tax Return Edition (2009) 681.
223 Deutsch et al, above n 222, 685. 224 But see Darin Neumyer, ‘Future of Using Intellectual Property and Intangible Assets as
Collateral’ (2008) 64(1) The Secured Lender New York 42.
Chapter 3: The problem in context 103
225 This numbered nearly 2,900 individual retail premises’ (2,887).225F
costs payable by franchisees range from $0 to $550,000.226F
Franchisors shed or manage risk through the legal relationships created with
the owners of franchisees’ retail premises. Franchisees may be required to enter a
retail premises lease, sub-lease or licence with the franchisor or with third parties, or
to fit out premises with no security of tenure. The consequences of these choices will
be expanded on under the heading ‘Legal relationships and management of premises
related risks’ on page 109.
Property interests in a retail site can take many different forms as was
recognised in the 1991 Franchising Task Force’s Final Report to the Minister for
Small Business and Customs:
some franchisors insist on taking the head lease while others allow the
Franchisees to take the lease of the premises. … there is a diverse range of
arrangements that can successfully exist under the franchising umbrella.227F
The consequences of the franchisor’s failure for the franchisees’ site will vary
depending on the leasing model. Twelve common franchisee premises occupancy
models are outlined below. The ramifications for the franchisees if the franchisor
becomes insolvent are discussed in chapter 4.2.4.
225 Frazer, Weaven, and Wright, Franchising Australia 2006, above n 11, 28. The concept ‘retail
premises’ was not defined in the survey so the figure does not equate perfectly with the definitions of ‘retail premises’ in the Australian legislative instruments. The data for the Franchising Australia 2008 survey was not analysed by reference to location of franchisees’ business but by business type. In 2008, 28 per cent of the 1100 franchisors were identified as being in ‘retail trade’. This figure excluded cafes and other food services, travel agencies, financial services and postal services. The figure for the separate categories of franchise can not simply be added to the retail figure to provide a 2008 total as the café category includes accommodation, which is not retail and travel agencies, financial services and postal services may be conducted from retail or from non-retail premises. The mismatch between the 2008 survey data and the legal definitions of retail highlights the difficulty of using data that was collected for one purpose for another.
226 Buchan and Butcher, ‘Premises Occupancy Models for Franchised Retail Businesses in Australia: Factors for Consideration’, above n 34, 143-4.
227 Frazer, Weaven, and Wright, Franchising Australia 2008, above n 7, 30. Note, some franchisors answering this question would have franchisees without fixed premises, hence $0.
228 Franchising Task Force, Final Report to the Minister for Small Business and Customs (1991) 87.
104 Chapter 3: The problem in context
Model 1: The franchisor owns the premises and leases them to the franchisee.
Model 2: A legal entity related to the franchisor owns the premises and leases them
to the franchisee.
Franchisor related landlord
Lessee = Franchisee
Landlord = Franchisor
Lessee = Franchisee
Chapter 3: The problem in context 105
Model 3: The franchisor leases the premises from a landlord and sub leases to the
Model 4: A legal entity related to the franchisor leases the premises from a landlord
and sub leases them to the franchisee.
Landlord Lessee = Franchisor related entity
Franchisor Sub lessee = Franchisee
Landlord Lessee = Franchisor
Sub lessee = Franchisee
Sublease Franchise agreement
106 Chapter 3: The problem in context
Model 5: The franchisor leases the premises from premises owner and grants a
licence to occupy to the franchisee.
……………….. Model 6: An entity related to the franchisor leases the premises and licenses them to
Landlord Lessee = Franchisor related entity
Franchisor Sub lessee/ Licensee = Franchisee
Landlord Lessee = Franchisor
Licensee = Franchisee
License Franchise agreement
Chapter 3: The problem in context 107
Model 7: A master franchisee leases the premises from a landlord and sub leases
them to the franchisee.
Model 8: A legal entity related to a master franchisee leases the premises from a
landlord and sub leases them to the franchisee.
Sublease Franchise agreement
Australian subsidiary = master franchisee
Sublease Franchise agreement
Australian master franchisee
108 Chapter 3: The problem in context
Model 9: A master franchisee leases the premises from a landlord and grants a
licence to occupy them to the franchisee.
………………… Model 10: The franchisee or an entity related to the franchisee leases the premises
direct from a landlord.
Guaranteed by Franchisee’s directors Franchisee = Tenant
Landlord Master franchisee = Lessee
Franchisor Licensee = Franchisee
Licence Franchise agreement
Master franchise agreement
Chapter 3: The problem in context 109
Model 11: The franchisee or franchisee related entity owns the premises.
…………….. Model 12: There are no formal occupancy arrangements.
Legal relationships and management of premises related risks
Typically the premises leasing model is dictated by the franchisor’s
229 and tempered by the amount of control the landlord wishes to assert in
230 In some networks more than one model is chosen.
Australian research has shown that where the franchise unit operates from a
specific site, the head lease is held by the franchisee in 64 per cent of cases. Twenty
six per cent of franchisors hold the head lease. Franchisors are more likely to hold
the head lease in retail (food and non food) systems. 230F
229 In an unpublished NSW Government Retail Tenancy Survey (2008), 33 per cent of landlords
required the franchisor to be the head tenant. 230 Barkoff and Selden, above n 112, 67. 231 Frazer, Weaven and Wright, Franchising Australia 2006, above n 11, Question A15, 30. Thus,
No written premises agreement
Franchisor Owner = franchisee Franchise agreement
110 Chapter 3: The problem in context
Depending on the occupancy model that is adopted, there may not be any
contractual relationship between the landlord and the franchisee tenant prior to the
franchisee fitting out the premises.231F
232 The franchisee may have protection as a lessee
under the State or Territory retail leasing legislation, but this is not uniform across
As occurs in models 4, 6, 7 and 10, it is increasingly common in Australia
when the franchisor takes a head lease of retail premises, for the franchisee to
provide a personal guarantee or the security deposit to back the franchisor’s
performance under the head lease. The relevant clause in the franchise agreement
The franchisor shall hold the head lease to the store site. The franchisee shall
make available the security deposit upon signing the sub-lease.233F
The franchisee, thus, takes ultimate financial risk on the premises, while the
franchisor retains the full benefit of the site lease being in the franchisor’s name.
Contracts may be made between franchisee and landlord, as in models 1, 10
and 11. Alternatively, the franchisee’s contractual relationship may not be with the
landlord; rather, the landlord is in a direct contractual relationship with the franchisor
or its related entity, as in models 3, 4, 5, 6. The franchisee then enters a sub-lease,
licence or has an informal verbal agreement with the franchisor concerning the
Master franchisees may be contractually bound through their own franchise
agreements with the franchisor to ensure the head leases in their territory are under
their control. As there is no public database of franchise agreements or master
franchise agreements, or franchise disclosure documents in Australia it is not
possible to conduct quantitative research.234F
235 It is a common practice in franchising
232 In the case of a shopping centre, the franchisor commonly negotiates the lease agreement - or
heads of agreement - with the owner's leasing manager. The franchisee then fits out the shop under the scrutiny of the centre manager. The centre manager is an employee of the shopping centre management company, which is normally a subsidiary of the shopping centre owner.
233 See Buchan and Butcher, ‘Premises Cccupancy Models for Franchised Retail Businesses in Australia: Factors for Consideration’, above n 34, 143–78 for discussion of the situation State by State. And see Table E of this thesis.
234 Danoz Directions Franchise Agreement (2004) cl 3. 235 Matthews, above n 113, Recommendation 23; Inquiry into the Operation of Franchise Businesses
in Western Australia, Report to the Western Australian Minister for Small Business (2008) Recommendation 2.5; Economic and Finance Committee, Parliament of South Australia,
Chapter 3: The problem in context 111
for the franchisor to take a head lease on a retail site, and then sublet (usually on the
same terms) to the franchisee. This enables the franchisor to maintain control of the
outlets through which the franchise operates, and it also assists in negotiating a better
deal with large retail centre managers that would not otherwise be available to a
In the 2004 version of the Danoz Directions Franchise Agreement, which used
a Model 5 structure, Clause 8 states that:
8.1 The franchisor will on or before the Commencement Date enter into a
lease of the Premises from which the Franchised Business is to be carried on.
8.2 The franchisee must, on the date this agreement is executed, enter into a
licence agreement to occupy the premises on those terms and conditions
contained in the Franchisor’s Standard Occupation Licence.
In model 6 the franchisee’s tenure is secured only by a licence. The following
passage by a former Bakers Delight, franchisee describes model 6 from a
When a franchisee signs their franchisor’s licence agreement, they are
binding themselves to the lease, without having any of the protections
offered by the lease. Neither the landlord nor the franchisor is required to
provide the franchisee/licensee with any information about their negotiation
process, nor does the franchisee see the landlord’s disclosure document – if
they even know it exists. As a Bakers Delight franchisee, I did not even see a
copy of the leases for two of my stores until after I had signed the licence
agreement. The third one I never saw.235F
It is difficult for a researcher to identify the preferred model for specific
franchisors as there is no requirement to place such details on a public database.
However, a clause such as the following in the Traveland Franchise Agreement
provides clues as to the franchisor’s preference, in this case for a Model 10
arrangement, by providing:
Franchises (2008) Recommendation 7.2.1; Parliamentary Joint Committee on Corporations and Financial Services, Commonwealth, Opportunity not Opportunism: Improving Conduct in Australian Franchising, above n 166, Recommendation 2; all state that franchise disclosure documents should be registered on a centralised database.
236 Evidence to Retail Tenancies Inquiry, Retail Tenancy Unit, New South Wales Government (Sydney) (2008) 3. Report embargoed. (Deanne de Leeuw former Bakers Delight franchisee) quoted with permission of the author.
112 Chapter 3: The problem in context
Lease. The Franchisee must provide the Franchisor with details of its
existing lease or licence of the premises and of any proposed new lease or
licence of the Premises. 236F
The franchisee is at risk at several junctures before and after a franchisor fails.
The franchisor’s conduct in relation to its obligations under a head lease can result in
the franchisee losing the right to occupy retail premises. Even if the franchisor is not
directly involved in the premises lease, its insolvency can still cause great difficulties
for the franchisee tenant.
Franchisees, as consumers of the franchisor supplier’s vision typified the
enterprise worker the then Prime Minister of Australia, who observed:
…‘white collar’ and ‘blue collar’, even ‘knowledge worker’ are no longer
adequate to properly encapsulate a growing number of people, some of
whom own their own businesses …as franchisees … [W]orking together for
our future … is the dominant consideration, and working in an environment
where the success of the enterprise is indistinguishable from your own
personal success. [T]here are now more Australians who are self employed
as owner-managers at 1.91 million than there are members of a registered
The success of the enterprise is indistinguishable from the individual
franchisee’s own personal success, but so is the failure of the franchisor part of the
enterprise often indistinguishable from its franchisees’ failure.
As enterprise workers, 21st century franchisees replace the labour and capital
the franchisor would otherwise have to carry on its own books and, as exemplified in
relation to trade marks and retail leases. Franchisees accept levels of commercial,
financial and legal risk that an employer would not be able to require an employee or
an independent contractor to accept.
Franchisors are aware of the divesting of legal and financial responsibility that
follows a move into franchising. This was acknowledged by Commander
Communications in 2007 which ‘says the effect of franchising will be an increase in
237 Draft Individual Unit Traveland Pty Ltd Franchise Agreement (undated) 14. 238 The Hon John Howard MP Prime Minister of Australia, ‘Opening address’ (Speech delivered at
the Franchise Council of Australia's 2005 Annual Convention, Canberra, 10 October 2005).
Chapter 3: The problem in context 113
sales, movement of costs from fixed to variable and a reduction in direct labour costs
with an increase in commissions’.238F
A group with diverse skills and motivation
In South Africa:
the Government has identified franchising as a means of encouraging the
development of small businesses, creating jobs, alleviating poverty and
creating black empowerment because it has the capacity to address many of
the problems which make it difficult for a new business to get off the
For example a stand-alone start up business owner would usually not have the
credibility to negotiate a lease with one of the large shopping centre owners in
Australia or the ability to generate the consumption of supplies required to obtain the
benefits of economies of scale which franchising can offer.
Franchising provides an opportunity for immediate gainful work and standing
in the community for immigrants who may be unable to earn an income using the
qualifications gained in their country of origin. The franchisee may be fluent in
English and accustomed to local culture or may be a new migrant with limited
English language skills but with access to funds. Franchisees may be self-funded or
borrowing money from family or commercial lenders to fund their franchise. Both
the well educated and those with little formal education become franchisees.
Franchisees may be embarking on their first career, or be older workers using
their superannuation as funding.240F
241 They may be using a retrenchment pay-out to
fund the purchase, as were franchisees Peter and Sandra of whom Ambrose J noted:
239 Jacqui Walker, Small Business Does it Tough … Hardie Trio Quit … Economists Tip Wages to
Firm … Gloria Jean’s Tax Trouble … Domino’s Setback … Small Biz Stats … Commander to Franchise … Economic Roundup (2007) Smartcompany <http://www.smartcompany.com.au/retail/small-business-does-it-tough-hardie-trio-quit-economists-tip-wages-to-firm-gloria-jean-s-tax-trouble-domino-s-setback-small-biz-stats-commander-to-franchise-economic-roundup.html> at 17 September 2009.
240 Tanya Woker, ‘Franchising – the Need for Legislation’ (2005) 17 South African Mercantile Law Journal 49, citing Lindiwe Hendricks [Deputy Minister of Trade and Industry, South Africa] The Franchise Book of South Africa (2003) 8.
241 The average age of a franchisee in France was 44 years old in 2007. Banque Populaire, Fédération Française de la Franchise, CSA, Resultats 2007, Enquete Annuelle sur la franchise, 9; the average franchisee in Australia is in their forties (male, 47; female, 43), perhaps indicative of people seeking a career change or of the desire to be master of one’s destiny. Deloitte, Franchisee Satisfaction Survey Benchmark 2004 (2004) 6.
114 Chapter 3: The problem in context
… neither … had any experience in conducting a business. …Peter had spent
most of his life in the public service and had latterly been a purchasing
officer ... Sandra had worked as a bus driver.
In 1995 Peter, then aged about 46 years, was retrenched and received about
$225,000 as severance pay. He had been taking a business training course
for some time at a university ... [Peter and Sandra] decided between them
that they would try to buy a business that they could manage and which
would allow them to work together, produce an income to support their
family and give them an interest.241F
Through franchising, many former employees make their first foray into self-
243 Peter and Sandra, on purchasing a Spud Mulligan’s franchise, were
buying what they believe to be:
A business out of a box. …[Often] one of the family's breadwinners has lost
his or her job and is wondering what to do with the redundancy payout. On
the list of options are paying off a chunk of the mortgage and other debts,
putting money into super, taking a holiday or buying into a franchise and
becoming a small-business owner. 243F
The franchise might be the principal source of income for the family. One in
four franchisees in Australia in 2004 was female. 244F
245 The franchisees’ education may
be specific to the franchise business (such as travel agencies) or may be in an
unrelated field. The franchisee may be a city dweller or may be establishing a
business in a country town. Some franchisees are engaged in ‘cross border
246 as they have purchased the right to be the master licensee of an overseas
People wanting to own a small to medium sized business choose franchising
partly because, in the words of one liquidator, ‘[t]he start up costs for a similar
242 Neilson Investments (Qld) P/L & Ors v Spud Mulligan's P/L & Ors  QSC 258. 243 Frazer, Weaven and Wright, Franchising Australia 2008, above n 7, Question B6 on page 35
reported that immediately prior to entering the franchise, according to information supplied by their franchisor 52.6 per cent of new franchisees had been in salaried work and 4 per cent had ‘other experience’ (eg unemployed, parental duties, etc). Forty three per cent had independent business experience immediately prior to becoming a franchisee.
244 Kavanagh, above n 56. 245 Deloitte, above n 241, 6. 246 Commission of the European Communities, above n 3, 2.
Chapter 3: The problem in context 115
business in the same industry that is not a franchise are remarkably dearer, unless the
person already has a strong knowledge in a particular field’.246F
‘In legal terms, there is no relationship quite like that between a franchisor and
its franchisees. The execution of the franchise agreement often triggers a significant
commitment from the franchisee in the form of sunk investments in premises’,247F
hire of staff and entry into long term contracts with parties other than the franchisor
for finance, premises rental, vehicle rental, and stock purchase.
Franchisees from the franchisor’s perspective
Some franchisors have a clear profile of the type of franchisee they want. For
example, in 1994 McDonald’s identified ‘owner-operators whose livelihoods are
dependent on their units’ as ideal franchisees.248F
249 Other less discerning franchisors
seek only warm bodies and the willingness to write cheques.
The appeal of granting licences to franchisees as opposed to pursuing organic
growth is described by franchisor, Commander Communications:
...the effect of (moving from a traditional business structure and into)
franchising will be an increase in sales, movement of costs from fixed to
variable and a reduction in direct labour costs with an increase in
The legal liabilities the franchisee potentially assumes on signing the franchise
agreement compare starkly with the rights (many) and liabilities (few) that accrue to
parties that perform the equivalent functions in a non-franchised network. ‘The
relationship between franchisor and franchisee is akin to a partnership, wider and
more complicated in fact than any document could contain’. 250F
247 Telephone Survey conducted by Jenny Buchan on 6 December 2004. 248 Frazer, Weaven and Wright, Franchising Australia 2006, above n 11, 35. The total start up cost
of a new franchised unit (excluding GST) was $78,000 with the range being $2,100 to $960,000 in 2006.
249 Patrick J Kaufmann and Francine Lafontaine, ‘Costs of Control: The Sources of Economic Rents for McDonald’s Franchisees’ (1994) XXXVII Journal of Law and Economics 417, 444 in (ed) Francine Lafontaine, Franchise Contracting and Organization (2005) 303.
250 Jacqui Walker, IT News - Commander to Franchise (2007) Smartcompany <www.smartcompany.com.au> at 20 February 2007.
251 American Bar Association Antitrust Section, ‘Franchisee Protection: Laws against Termination and Establishment of Additional Franchises’ (1990) 19 Monograph No 17 55.
116 Chapter 3: The problem in context
As Commander Communications acknowledged above, franchisees are a
saving on labour costs, borrowed and equity finance, and a risk devolving
mechanism, not available to a non-franchised business owner.
Credit is the lifeblood of the modern industrialized economy. The employee
who is paid at the end of the working week gives credit to his employer.251F
The NatWest March 2004 United Kingdom Franchise Survey asked
franchisees what their working status was immediately before taking out their
253 Sixty-two per cent were former employees. In 2006, 64 per cent were in
salaried employment immediately before taking out their franchise.253F
254 There is no
reason to expect Australian franchisees to differ significantly.
A non-franchised business sources labour by hiring employees or contractors.
Both categories of worker have well defined legal rights. Employees derive their
rights in relation to remuneration, entitlements, leave and work conditions from
specific legislation and may be assisted by trade unions representing them in
negotiations and disputes with their employers. Contractors, including suppliers,
negotiate the terms on which they will perform a job and are remunerated
The role the franchisees play as the franchisor’s labour force was
acknowledged by the New South Wales Court of Appeal in Majik Markets Pty Ltd v
Brake and Service Centre Drummoyne Pty Ltd and ors where Kirby P observed on
behalf of himself and Mahoney and Handley JJA:
While the franchisees, if natural persons are working for themselves, they
are also in a very real sense working for the franchisor. If the business was
not operated by some franchisee, the franchisor would either have to employ
staff of its own or sell or lease the site to an independent purchaser or
252 Sir Kenneth Cork, Great Britain Insolvency Law and Practice Report of the Review Committee
(1982) 10. 253 NatWest bfa United Kingdom, Franchise Survey (2004) Question 5.2. 254 NatWest bfa United Kingdom, Franchise Survey (2006) 29. 255 Majik Markets Pty Ltd v Brake and Service Centre Drummoyne Pty Ltd and ors (1991) 28
NSWLR 443, 465.
Chapter 3: The problem in context 117
In legal terms, an incorporated franchisee cannot be an employee, but in
numerous other aspects the franchisee and the employee are functionally
256 A more detailed analysis of the franchisees’ role compared to
the employee and the independent contractor will be conducted in chapter 3.1.6.
The franchisee supplies capital in the form of the initial franchisee fee, and it
funds the establishment of its franchisee business, to help grow the franchisor’s
brand. For example, the franchisor of Boost Juice, Janine Allis, ‘was able to roll out
[a juice bar concept] around Australia at an extraordinary pace and with limited
[franchisor] capital by developing a franchise system … [commenting that] [w]e
have been able to grow using other people’s capital’.256F
A franchisee makes a significant financial investment in the franchisor. For
instance, ‘on average it costs $380,000 to open a Baker’s Delight franchise’.257F
working capital required is approximately 30 per cent of the business or $120,000
whichever is the greater’.258F
259 The franchisor does not offer the franchisee security for
its investment. The same reliance on the franchisees’ access to funds is
acknowledged by Australia Post that:
is planning to franchise 150 PostShops as part of its plan to gain revenue and
offset the steady decline of its snail mail business. … [A]nother 50 will be
created by buying out licensees and reselling those sites as franchises. …
[T]he plan will allow Australia post to retain control over its network and
allow it to gain initial franchise fees and a potential share of capital gains
when the franchises are sold. Franchises also provide greater contractual
flexibility than the present licence and branch systems, as well as reducing
Australia Post’s direct exposure to rising wages, retail downturns and further
slowing in demand for traditional mailing methods. … To secure a franchise,
256 Penelope Ward, ‘Can Franchisees be Treated as Employees?’ (Paper presented at the 22nd Annual
IBA/IFA Conference, Washington DC, 18-19 May 2006). 257 Virginia Marsh, ‘Entrepreneur Enjoys Fruits of Fast-Expanding Juice Chain – Janine Allis
Squeezed her Way to Success from Humble Beginnings’, Financial Times (London) 24 June 2005, 5 quoting Boost’s chief operating officer, Simon McNamara.
258 Amber Plum, ‘Bakers Delight to Help Fund New Franchisees’ Smartcompany (Melbourne), 11 September 2009. <www.smartcompany.com.au> at 14 September 2009.
259 Bakers Delight, Buyafranchise.com.au <http://www.buyafranchise.com.au/searches/franchdetails.asp?listing_id=2749> at 15 September 2009.
118 Chapter 3: The problem in context
a candidate will need access to investment capital, typically $250,000 to
Jim Cohen states that: ‘A bad business model will not be saved by franchising
261 How the franchisees investing in the PostShops are going to recoup their
investments and make money in an environment where there is a steady decline in
the core business product of the PostShop, snail mail, is not obvious.
Access to its franchisees’ capital resources and individual borrowing capacity,
unencumbered by reciprocal legal obligations beyond what is in the franchisor-
controlled franchise agreement, is also reportedly acknowledged by franchisors of
Australian telecommunications franchise Telcoinabox:
The biggest challenge to date for [the franchisor] has been access to capital.
None of the banks would lend to them (directors of the franchisor) because
they unanimously refused to put their houses on the line. ''Banks don't want
to invest in a concept or idea,'' [the franchisor] says.
They were never interested in seeking venture capital because of the hefty
chunk of equity demanded in return for the investment.
''We did speak to a number of people but they basically want the soul of your
first-born son. Equity is the most expensive form of finance you can get,'' Mr
Kay says. Telcoinabox relied heavily on franchising fees ($50,000 per
franchisee) in the first year. ([T]he franchisor) says not being answerable to
investors is liberating …261F
James Brickley and Frederick Dark described the risk/reward trade-offs in
franchising in noting that:
[f]ranchising has its own set of potential costs and incentive problems….
One such cost is that associated with inefficient risk-bearing. If the manager
[ie the franchisee owner] of a franchised unit has a large proportion of his [or
her] wealth and income tied to the performance of the unit, his [or her]
investment portfolio will be relatively undiversified. This inefficient risk-
260 Damien Lynch, ‘Postal Franchisees Sought’, The Australian Financial Review (Sydney), 8
November 2005, 56. 261 Jim Cohen, Franchise Statistics Debunked Again! (2008) Blue Maumau
<http://www.bluemaumau.org/franchise_statistics_debunked_again> at 18 September 2008. 262 Kristen Le Mesurier, ‘Damian Score Double Hit’, Sydney Morning Herald (Sydney) 8 February
Chapter 3: The problem in context 119
bearing generates at least two types of agency costs. First, the manager is
likely to make less ideal investment decisions than an efficiently diversified
decision maker… The franchisee is more likely to be concerned with the
total risk of the project than a diversified decision maker who is concerned
only with the systematic risk. Second inefficient risk-bearing can lead to
higher required rates of expected compensation because of increased risk.262F
A traditional analysis of a franchisee as a contracting party with the ability to
fully understand and assess a range of risks and then factor them into price and
contract terms is incomplete because of the nature of the franchise agreement. This is
explored in detail at 3.3.
franchisor can manage risk through contract, a franchisee cannot. … the
‘contract as commodity’ approach of the standard form as opposed to a
‘contract as relationship’ approach of the relational … contract creates a
conflict where the standard form prevails. A franchisee takes on qualities of
consumer of product, rather than an equal party to negotiation of terms.263F
The risk taking in franchising is relatively one-sided. Franchisees are typically
required to supply all financial details to a franchisor prior to being accepted as a
franchisee, and accept that a cost of being allowed to become a franchisee is
providing personal guarantees by directors and their spouses. This makes it difficult
for franchisees to diversify their risk.
When negotiating a contract on behalf of a client one approach is to ask them
to identify the main commercial areas that, if not addressed properly, would radically
compromise the deal for them. If the client is the franchisor, the franchisee’s death or
the administration, insolvency or bankruptcy of the franchisee would appear in this
list. If representing a franchisee, the converse should apply. However, in my
experience as a franchisee adviser, franchisees typically identify only their own, but
not the franchisor’s potential death or failure. It is very rare for a franchisee to
identify franchisor failure as a potential risk. In the course of my research only three
263 James A Brickley and Frederick H Dark, ‘The Choice of Organizational Form: The Case of
Franchising’ (1987) 18 Journal of Financial Economics 401, 405 in Francine Lafontaine (ed) Franchise Contracting and Organization (2005) 57.
264 Spencer, The Regulation of the Franchise Relationship in Australia: A Contractual Analysis, above n 14, 170.
120 Chapter 3: The problem in context
franchisees were found to have a clause inserted into their franchise agreement that
permitted the franchisee to terminate the contract if the franchisor became insolvent;
one Traveland franchisee of 270 and one of the 60 or so BHG franchisees and one
master franchisee of a network that remains solvent.
In the absence of franchisees, all risks associated with conducting the business
would be taken directly by the franchisor or indirectly by financiers. The ability to
devolve risk is an under-acknowledged, but significant, benefit to the franchisor. The
amount of risk franchisees take, compared with the amount the franchisor takes, and
their respective ability to manage it by closing the store, is highlighted by the
observation, especially when read with the insight added by the last sentence:
[A]fter Bennigan’s restaurants filed for Chapter 7 in July 2008, the corporate
locations shuttered while nearly 140 franchisees remained open. “One
problem with Bennigan’s was that they had too many company-owned
stores. When the economics changed, the company-owned stores were no
longer profitable and they were losing money faster than the franchisees
were paying royalties” explains iFranchise’s Siebert. ‘But even if they’re not
that profitable it’s hard [for a franchisor] to actually lose money on a
Franchisees knowingly take on the risk of their own business failing. They pay
for their premises fit out, the franchise fee, ongoing royalties, hire employees, insure
their business, pay their employees’ payroll tax, and sign contracts with suppliers. At
its most extreme, the franchisee also accepts, unwittingly, the risk that the franchisor
might become insolvent.
The franchisee is sometimes portrayed as a willing and aware risk taker. One
theory is that a
risk averse franchisee would clearly prefer to invest in a portfolio of shares
in all franchise outlets, rather than confining his investment to a single store.
This means, essentially, that the franchisee will require a higher rate of
return on his capital if he is required to invest in one outlet than in a
portfolio. Conversely the franchisor, by forcing a relatively large risk on the
franchisee, will himself earn a lower rate of return. This argument thus
appears to make sense only if we assume that franchisors are more risk 265 Maltby, above n 120.
Chapter 3: The problem in context 121
averse than franchisees. But since franchisees commonly invest a large share
of their assets in acquiring the franchise, it is unlikely that this will be the
The underlying assumption is that franchisors do not have control over the
amount of risk they take. However, franchisors have ultimate control through a range
of mechanisms including:
their ability to configure the ownership of their personal and business
assets ex ante to protect their personal assets from subsequent claims,
control of the separate entities that own the trade marks,
prescribing the nature of premises lease arrangements,
managing supplier relationships,
the ultimate power of being able to force a franchisee to breach the
franchise agreement, thus giving the franchisor the right to terminate, or to
refuse to renew.
Ultimately, franchisees assume all of their own, plus some of the franchisor’s
business risk. In the absence of franchisees, the franchisor’s business risk would be
taken directly by the franchisor, indirectly by the franchisor’s financiers, or not taken
Jensen and Meckling note that
[w]e don’t find many large firms financed almost entirely with debt-type
claims (ie non-residual claims) because of the effect such a financial
structure would have on the owner-manager’s behaviour. Potential creditors
will not loan $100,000 to a firm in which the entrepreneur has an investment
of $10,000. With that financial structure the owner-manager will have a
strong incentive to engage in activities (investments) which promise very
high payoffs if successful even if they have a very low probability of
266 Paul H Rubin, ‘The Theory of the Firm and the Structure of the Franchise Contract’ (1978) XXI
(1) The Journal of law and Economics 223, 225 in Francine Lafontaine’s (ed), Franchise Contracting and Organization (2005) 20.
122 Chapter 3: The problem in context
success. If they turn out well, he captures most of the gains. If they turn out
badly, the creditors bear most of the costs.266F
Franchisors have solved the problem of accessing more capital than their core
business could support as debt by appointing franchisees and incorporating the equity
and debt raising capacity of those franchisees into the franchisor’s business structure.
By reporting the income of franchisees as part of the income of the network, and
describing the franchise agreements as income generating assets of the franchisor,
the franchisor can both receive initial franchise fees from the franchises and convince
the franchisor’s own lenders that its business is capable of bearing more debt than an
objective analysis of the franchisor would support. In this way when a franchisor
becomes insolvent they fail with few assets and with secured creditors claiming
many millions of dollars. 267F
Franchisees, whilst assuming some of the franchisor’s business risk, have no
right to receive a corresponding reward, as the venture capital providers or
shareholders typically would, if the franchisor entity is sold for a profit.
It is suggested that franchisees are, in effect, taking quasi equity risk in the
franchisor, often for returns more typically associated with employment or fixed
3.2.5 FRANCHISEES NOT TRADITIONAL SUPPLIERS
Some advisers and academics struggle to see the difference between
franchisees and traditional suppliers. Indeed, the contracting parties most severely
affected by a franchisor’s insolvency, other than its franchisees, are its suppliers, and
sometimes the franchise network’s customers. Its franchisees are generally exposed
to greater loss and are less able to protect against such loss than is a supplier for a
number of reasons.
First; even though a supplier may have taken significant steps, such as
retooling a production line, or committing to grow a particular crop in reliance on its
contract with the franchisor, it would normally have done so in the context of an
already-established business. For example, a farmer will negotiate a supply
267 Jensen and Meckling, above n 21, 334. Compare with anecdotal evidence which suggests that in
New Zealand at least one major trading bank will lend franchisees $25,000 unsecured, of the $30,000 required to purchase a home cleaning franchise, in 2009.
268 See Table 1 column headed ‘Amount owed to creditors (estimated)’ of this thesis.
Chapter 3: The problem in context 123
agreement to grow potatoes or a printer will negotiate to print labels to specific
standards for a franchisor.
Second; a traditional supplier is viewed by the franchisor as a strategic partner
that is, effectively, making an investment in the whole network. The supplier
relationship may have begun by the supplier successfully tendering. The franchisor
and supplier negotiate and agree the terms of their contract. These are likely to
include retention of title clauses and penalty provisions for late payment by the
franchisor. They may include franchisors directors’ guarantees. The supply
agreement is relational but is not a standard form contract.
Third; while both suppliers and franchisees commit their own capital to the
franchisor’s brand, franchisees must then build a business along lines tightly
prescribed by the franchisor. Unlike a supplier, the franchisee that sees its franchisor
is in financial trouble has little flexibility to prepare for continuing its business with
another partner in the event of the franchisor’s insolvency. Suppliers have their own
business that they can adapt to supply other buyers if the business with the franchisor
Fourth; both franchisee and supplier to some extent put themselves at the
mercy of the franchisor’s ongoing viability but because of the standard form of the
franchise agreement, the franchisee does so to a greater extent and with less capacity
to protect itself either legally or practically. Suppliers are not 'owned' by the
Fifth; suppliers own their own customer lists but not all franchisees do so.
Anecdotal evidence suggests that an increasing number of franchisors operate as
commission agencies. This means the franchisor has all of the franchisees’
customers’ details and the franchisee is likely to have difficulty convincing the
customer to continue to have faith in the franchisee where the franchisor has failed to
deliver a purchased product. An example is the Australian whitegoods franchise
3.2.6 FRANCHISEES OR EMPLOYEES?
The relevance of comparing franchisees with employees is that they are
sometimes indistinguishable in function, but are each treated differently if the
employer/ franchisor becomes insolvent. The employee, whose role the franchisee
124 Chapter 3: The problem in context
has assumed in many organisations, is provided with significant protection in
Australia’s regulatory regime. This is pursued in chapter 4.4.3. The franchisee has no
protection from legislation or government.
Dependence and control are the major features of the employer-employee
relationship. Franchisees undeniably experience a relationship of dependence and
control with their franchisors. These features are put in place through the franchise
agreement and maintained in numerous ways through the administration of the
franchise network. From their customers’ perspective, a franchisee, an employee and
an independent contractor are indistinguishable. Depending on nuances of the precise
franchise model used by the network, the differences, however, may be numerous
There is far more than dependence and control to an employer- employee
relationship. Franchisors are aware of the relative cost of staff compared to shedding
the staff in favour of franchisees, as demonstrated by the words of a franchisor:
The other big challenge is just the cost of employing staff in Australia.
Having a company-owned network of stores is just so expensive, and too
expensive to own all our stores with payroll tax, and so on. That's obviously
part of the reason we've moved to a franchise system.268F
It is, however, useful to identify the characteristics of an employee and a
franchisee and thereby to understand why they are sometimes indistinguishable and
at other times a franchisee is clearly not an employee. Useful sources on which to
found this analysis are:
Australian Taxation Office (ATO) Rulings (TR) identifying
characteristics of an employee,
franchise agreements and
The ATO has not been asked for a ruling to distinguish an employee from a
franchisee but it has had to distinguish an employee from an independent contractor.
The features of an employment contract were presented in table form in ATO Ruling
269 Patrick Stafford quoting Homschek in A Bigger Slice of the Pie (2009) SmartCompany
<http://www.smartcompany.com.au/food-and-beverages/20090821-a-bigger-slice-of-the-pie.html> at 22 September 2009.
Chapter 3: The problem in context 125
2000/14. Whilst this ruling has now been superseded by TR 2005/16 and
Superannuation Guarantee Ruling SGR 2005/1, the features of employment that were
compared with independent contracting remain valid. The column headed
‘Franchisee’ in Table 4 has been added to demonstrate in which respects the
franchisee exhibits features of the employee or the independent contractor.
Table 4: Features of Employee, Franchisee and Supplier / Independent Contractor.
The nearest relationships are identified in ‘Franchisee is more like …’ column for
employee Under a contract of service, the payer usually has the right to direct the manner of performance. Where the nature of the work involves the professional skill or judgment of the worker, the degree of control over the manner of performance is diminished. What is important is the lawful authority to command that rests with the payer
Method of conducting franchise is set out in detail in Operating Manual(s). Franchisor has right to require the franchisee to work in a certain way and to terminate the franchise if franchisee does not follow system270F
The hallmark of a contract for services is said to be that the contract is one for a given result. The contractor works to achieve the result in terms of the contract. The contractor works on his/her own account
270 Adapted from Schedule B in ATO TR 2000/14. 271 Zuijs v Wirth Bros Pty Ltd (1955) 93 CLR 561; Australian Mutual Provident Society v Chaplin
(1978) 18 ALR 385; Glambed v FCT (1989) 20 ATR 428; Sgobino v South Australia (1987) 46 SASR 292; Re Clothing Trades Award 1982 (1987) 19 IR 416; City Motors (1981) Pty Ltd v Commissioner of State Taxation (WA) (1993) 26 ATR 291; Samrani v Roads and Traffic Authority of New South Wales (1994) Aust Torts Reports ¶81-314; Climaze Holdings Pty Ltd v Dyson (1995) 13 WAR 487; Australian Building Construction Employees and Building Labourers Federation (WA Branch) v Pacesetter Homes Pty Ltd (1994) 56 IR 51; Humberstone v Northern Timber Mills (1949) 79 CLR 389; Stevens v Brodribb Sawmilling Co Pty Ltd (1986) 160 CLR 16; Ready Mixed Concrete (South East) Ltd v Minister of Pensions and National Insurance  2 QB 497 (list sourced from CCH).
employee Tasks are performed at the request of the employer. The worker is said to be working in the business of the payer
Tasks are performed following the method prescribed by the franchisor. Franchisee typically has little discretion in how and whether they perform the work. The franchisee is working in own business within the parameters mandated by the franchisor
Enters into a contract for a specific task or series of tasks. Maintains a high level of discretion and flexibility as to how the work is to be performed. Contract may contain precise terms as to materials used and methods of performance and still be one for services
Risk independent contractor
Bears little or no risk. Employee is not exposed to any commercial risk. This is borne by the employer.
The employer is generally responsible for any loss occasioned by poor workmanship or negligence of the employee
Bears all risk for own performance. Franchisee bears risk of the franchisor failing or underperforming.
Franchisor may be liable in tort for injury caused by franchisee271F
272 or under workcover legislation for injury to franchisee’s employee272F
Stands to make a profit or loss on the task. Bears the commercial risk and the responsibility and liability for any poor workmanship or injury sustained in performance of the task. Generally, would be expected to carry their own insurance
272 The 1996 (US) court decisions in the Foodmaker and Ely cases both held that the franchisors
were not vicariously liable for franchisees' acts. In Ely, General Motors was not liable for a wrongful death caused by a dealer's employee since GM did not have specific control over the test drive or employee involved in the death. In Foodmaker, the franchisor was not vicariously liable for a franchisee-employee's murder by a co-worker; the plaintiffs had alleged liability due to inadequate security or negligent hiring. In a Dairy Queen case the franchisor was liable for a tort that occurred on a franchisee’s site because the injury was sustained by the plaintiff as a result of the franchisee complying with franchisor’s prescribed construction requirements. The franchisor had control of the process.
273 For example WorkCover Authority of New South Wales (Insector Petar Ankucic) v McDonald's Australia Limited and Another  NSWIRComm 277; and Workcover Authority of NSW (Inspector Ankucic) v McDonald's Australia Limited and anor matter  NSWIRComm 1123 where franchisor was held liable for death of franchsiees’ employees at franchisee’s outlets.
Appointment employee Generally recruited through an advertisement by the employer
Recruited by franchisor or its agent.274F
275 Once franchisee’s business established, franchisee and franchisor market the system’s services or products to the public
Likely to advertise their services to the public at large
Termination employee Employer reserves the right to dismiss an employee at any time (subject to State or Federal legislation)
Franchise Agreement typically for a fixed term.275F
Franchise agreement and Code contain termination possibilities exercisable by franchisor 276F
Contracted to complete a set task. The payer may only terminate the contract without penalty where contractor has not fulfilled the conditions of contract. Insolvency of either party a specified event of default
275 Franchisor is required to supply intending franchisee with a disclosure that complies with the
Franchising Code of Conduct 1998. Failure to do so gives franchisee rights under Trade Practices Act 1974 (Cth) s 51AC but currently there is no right to damages.
276 Both an employee and a franchisee expect to be in the particular work relationship for a number of years; for an employee this will vary with the nature of the job. For a franchisee, there is an expectation that the franchisee will be in the relationship for the term of the franchise agreement, or will sell at a profit before then. Frazer, Weaven and Wright, Franchising Australia 2008, above n 7, 23 report the initial terms of the current franchise agreement of the 264 franchisors that responded ranged from 1 to 50 years. Of these, 67 per cent of franchisees have an initial term of 5 years.
277 Hadfield, ‘Problematic Relations: Franchising and the Law of Incomplete Contracts’, above n 202, 940 reports that in the US, all franchise contracts contain termination rights for franchisors and 79 per cent state that [the franchsiee’s] bankruptcy automatically terminates the contract and all rights revert to franchisor. In Australia, clauses 21, 22 and 23 of the Franchising Code of Conduct stipulate when a franchisor may terminate a franchise agreement (see chapter 4.2.3 and for full wording see Appendix A – of this thesis). This is in addition to contractual provisions.
Delegation employee Employee has no inherent right to delegate tasks to another. However, there may be a power to delegate some duties to other employees
Typically may not delegate management role except with franchisor’s express consent. Most franchisees have employees. Franchise agreement contains provisions for familial succession on death/ incapacity of franchisor
May delegate all or some of the tasks to another person, and may employ other persons277F
Against the criteria in Table 4, over half of the identified features of the
business relationship place the franchisee nearer to having an employment
relationship with its franchisor than an independent contractor relationship. Only a
third locate the franchisee nearer to an independent contractor.
In answering the question ‘who is an employee?’278F
279 the 2005 rulings examine
the features of employment and independent contracting relationships under the six
headings; control, results contracts, whether the work can be delegated or sub-
contracted, risk, provision of tools and equipment and payment of business expenses,
and other indicators. Each is expanded on below in the context of franchisees.
The notion of control encompasses features 1, 2, 4 and 5 of TR 2000/14. It
includes both degree of control and the ability to dictate what, how and where work
is to be done. Essentially, the question here is whether the worker operates on his or
her own account or in the business of the payee. ‘In Hollis v Vabu (2001) 207 CLR
280 (Vabu) the majority of the High Court quoted the following statement made
by Windeyer J in Marshall v Whittaker's Building Supply Co (1963) 109 CLR 210.
278 ATO TR 2000/14, Attachment B. 279 For the purposes of interpreting the word ‘employee’ as it appears in Taxation Administration Act
1953 (Cth) pt IVAAA and Superannuation Guarantee (Administration) Act 1992 (Cth) s 12. 280 (2001) 207 CLR 21, 39 (Gleeson CJ, Gaudron, Gummow, Kirby and Hayne JJ) (McHugh and
Callinan JJ dissenting).
130 Chapter 3: The problem in context
... the distinction between an employee and independent contractor is 'rooted
fundamentally in the difference between a person who serves his employer
in his, the employer's business, and a person who carries on a trade or
business of his own. 280F
This distinction is also referred to as the integration or organisation test.281F
Vabu, the majority in the High Court found that a bicycle courier was a common law
employee of Vabu and stated that ‘[v]iewed as a practical matter, the bicycle couriers
were not running their own business or enterprise, nor did they have independence in
the conduct of their operations’.282F
In the franchising context, McDonald's Australia Holdings Ltd & Anor v
Industrial Relations Commission of NSW & 2 Ors  NSWCA 286 the
expectations on McDonald’s licensee (ie: franchisees) are set out:
The foundation and essence of the McDonald’s System is the adherence by
licensees to standards and policies of McDonald’s and its related
corporations providing for the uniform operation of all McDonald’s
restaurants within the McDonald’s System including, but not limited to,
serving designated food and beverage products; the use only of prescribed
equipment and building layout and designs; and strict adherence to
designated food and beverage specifications and to prescribed standards of
quality, service and cleanliness in restaurant operation. Compliance by
licensees with the foregoing standards and policies in conjunction with
McDonald’s trade marks, service marks and trade names provides the basis
for the valuable goodwill and wide acceptance of the McDonald’s System.
Moreover the establishment and maintenance of a close personal relationship
with Licensee in the conduct of his McDonald’s restaurant business, his
accountability for performance of the obligations contained in this
agreement, and his adherence to the tenets of the McDonald’s system
constitute the essence of the licence provided for herein. 283F
281 [FN 25 in TR 2005/16]; Hollis v Vabu (2001) 207 CLR 21, 39. 282 [FN 26 in TR 2005/16]. The notion of an 'integration' test arose in Montreal v Montreal
Locomotive Works (1947) 1 DLR 161, 169 and was affirmed by Lord Denning in Stevenson Jordan and Harrison Ltd v MacDonald and Evans  1 TLR 101, 111 and reaffirmed in Bank Voor Handel En Scheepvaart NV v Slatford  1 QB 248, 295.
283 [FN 27 in TR 2005/16]; Hollis v Vabu (2001) 207 CLR 21, 41 and TR 2005/15 para 32, 33. 284 McDonald's Australia Holdings Ltd & Anor v Industrial Relations Commission of NSW & 2 Ors
dissenting). 292 Australian Taxation Office TR 2005/16, 12, para 52.
136 Chapter 3: The problem in context
OWNS EMPLOYEE’S OR FRANCHISEE’S IMPROVEMENTS TO INTELLECTUAL PROPERTY
In both the employer-employee and the franchisor – franchisee relationship, the
employer and the franchisor own the intellectual property and all improvements to it
unless the parties have made a specific contract to the contrary. Intellectual property
typically includes registered and unregistered trade marks, patents and registered
designs and any improvements to systems and products. A clause from the Australian
Autobarn franchise agreement is typical of the relevant clause in franchise
2.9.4 All rights in and to the Marks and the Industrial [ie intellectual]
Property and any part thereof and any addition thereto shall be and remain
the property of the franchisor and the Franchise Holder shall not acquire any
right, title or interest therein except as provided in this agreement.292F
Thus, again, employment and franchising are the same.
SUBJECT TO ONGOING PERFORMANCE REVIEWS
Performance reviews are an entrenched aspect of employment. They do not
disappear if an employee becomes a franchisee. They help ensure franchisees
maintain the standards set by the franchisor. For both employees, and for franchisees,
the performance review may be comprehensive. For example, for franchisees in the
McDonald’s network, as described in Far Horizons Pty Ltd v McDonald's Australia
Ltd  VSC 310 (‘Far Horizons’):
The Store Owner must have a positive, co-operative and contributive attitude
towards the McDonald's System. He/she must have demonstrated a pro-
active record of sales building and involvement in their local community; an
attitude which is in tune with today's competitive market place for good solid
business rationale and one that will enhance the future growth of their store
and the development of the McDonald's System.293F
This was explained by the McDonald's witnesses as having two components:
first an appropriate attitude towards the McDonald’s organisation including
other licensees, and, second, an appropriate attitude to the conduct of the
293 Copy of franchise agreement in researcher’s possession. 294 Far Horizons Pty Ltd v McDonald's Australia Ltd  VSC 310, para 5(f).
Chapter 3: The problem in context 137
business, including a readiness to engage in local activities which would
promote the image of the business and of McDonald’s’.294F
Being subject to ongoing performance reviews is not a meaningful way of
distinguishing employees from franchisees.
Choice of suppliers
The employee is motivated by job description and ideally by loyalty to the firm
to choose the best suppliers. Ideally, there is no conflict of interest between an
employee and their employer. Where a director is also a supplier there may be a
breach of director’s equitable duties if a conflict of interest is not disclosed. 295F
Ideally there will be no conflict of interest between franchisor and franchisee in
relation to choice of suppliers or treatment of franchisees stemming from supplier
issues. In theory, the franchisor’s ability to negotiate on the basis of the combined
buying power of the franchisees will secure better terms from suppliers than the
franchisee could negotiate as sole operators.
The choice of suppliers to franchisees can, however, be a source of
considerable franchisee dissatisfaction if the franchisor is perceived to be taking
undisclosed commissions from the supplier, or if the franchisee would be able to
source the same product elsewhere if it were not contractually bound to the
franchisor. The potential for conflict of interest is significant when the franchisor or a
related entity is the supplier. Three typical positions franchisors have in relation to
suppliers are exemplified by excerpts from Australian individual unit franchise
At the least controlling level, the franchise agreement in Jax Franchising
Systems Pty Limited v State Rail Authority (New South Wales); Jax Tyres Pty Limited
v State Rail Authority (New South Wales)  NSWLEC 397 leaves Jax Tyres
franchisees free to secure supplies from any supplier. This avoids conflicts of interest
between franchisor and franchisee. The Jax Tyres franchise agreement stipulates:
295 Ibid para 32. 296 For extensive discussion on directors duties and conflicts of interest see RP Austin and IM
Ramsay, Ford’s Principles of Corporations Law (13th ed, 2007) ch 8, 9.
138 Chapter 3: The problem in context
The franchisor shall not limit the suppliers from which such items may be
A middle position existed in the Mail Boxes Etc (MBE) single unit franchise
agreement that stipulated, in Clause 9.1 that:
During this agreement the franchisee must not:
Purchase those products, materials, equipment or services required by the
Operating Manual to be purchased from suppliers approved by the
Franchisor from any person other than those suppliers without the written
consent of the Franchisor: 297F
For McDonald’s franchisees Justice Byrne noted:
The McDonald’s System is a comprehensive restaurant system for the
retailing of a limited menu of uniform and quality food products. The
foundation and essence of the McDonald’s System is the adherence by
licensees [ie: franchisees] to standards and policies of McDonald’s and its
related corporations providing for the uniform operation of all McDonald’s
restaurants within the McDonald’s System including, but not limited to,
serving designated food and beverage products; the use of only prescribed
equipment and building layout and designs; and strict adherence to
designated food and beverage specifications and to prescribed standards of
quality, service and cleanliness in restaurant operation. Compliance by
licensees with the foregoing standards and policies in conjunction with
McDonald’s trade marks, service marks and trade names provides the basis
for the valuable goodwill and wide acceptance of the McDonald’s System. 298F
In comparison with the franchise systems mentioned above, the case of
Australian Competition & Consumer Commission v Simply No-Knead (Franchising)
Pty Ltd  FCA 1365 (‘SKN’) provides a glimpse into supply chain abuse by a
franchisor. There, the franchisor required the franchisee to purchase most supplies
through the franchisor, then refused to deliver the products ordered to the
franchisees. This provided the first test case of the business-to-business
297 Jax Franchise Agreement, cl 9.6. 298 This agreement has possibly been superseded as MBE was taken over by UPS, but it is not
possible to be sure because of the absence of a franchise agreement database in Australia. 299 Far Horizons Pty Ltd v McDonald's Australia Ltd  VSC 310.
Chapter 3: The problem in context 139
unconscionable conduct provisions of the Trade Practices Act, s 51AC, introduced in
1998. SKN is now insolvent.
Clearly issues around sourcing and dealing with suppliers are one significant
area where employment and franchising differ.
The relationship is recognised specifically by law
Both employment and franchise relationships are created by contract, both are
recognised by statutes that need to be adhered to before a business fails. Clause 10.16
of the Jax Tyres franchise agreement is replicated in similar words in the boilerplate
clauses of all single unit franchise agreements:
The relationship between the franchisor and the franchisee is strictly that of
franchisor and franchisee. This agreement does not constitute either party a
joint venturer, partner, agent, employee or fiduciary of the other. 299F
The employment relationship is the subject of a comprehensive statutory
regime that provides employees with ‘cradle to grave’ rights in relation to their
employers. These include statutory rights to accurate job advertisements, employer
funded superannuation, paid leave, recourse in the event of discrimination and
recognised status and rights under the Corporations Act if the employer becomes
insolvent. The impact of an employer’s insolvency on employees is addressed in
Recognition of franchisees by the law stops if the franchisor enters
administration or becomes insolvent. Aspects of the resulting problems are addressed
in detail in chapters 2.3 and 4.4.1 – 4.4.4.
Duty of confidentiality/secrecy
Employees and franchisees both have obligations to keep some matters
confidential. In both situations termination of the relationship may result from a
breach of this obligation.
Employment entails confidentiality obligations that stem from the employment
contract, professional codes of ethics, or specific confidentiality agreements such as
those many franchisors require that their franchisees’ employees sign.
300 Jax Franchising Systems Pty Limited v State Rail Authority (New South Wales); Jax Tyres Pty
Limited v State Rail Authority (New South Wales)  NSWLEC 397.
140 Chapter 3: The problem in context
The contractual obligation in Clause 6.12 of the Donut King franchise
agreement typifies the franchisees’ confidentiality obligations towards its franchisor:
Secrecy: The Franchisee and the Guarantors hereby covenant and agree that
(a) maintain, and ensure that their employees maintain, strict secrecy about
the modes and methods of business of the Franchisor and the System,
including but without limiting the foregoing, any manuals … issued by the
Franchisor, the Franchisor’s trade secrets, advertising and publicity material.
The Franchisee shall take all reasonable steps to ensure that its employees
observe the Franchisor’s requirements for secrecy, including, if required by
the Franchisor, the Franchisee’ procuring the execution of a deed of
confidentiality in favour of the Franchisor by each employee;
(b) not and will procure that their employees shall not, during the Term of
this Agreement, or after its termination or expiration, disclose any
Confidential Information, including all manuals …, communications,
marketing programs, products under development and methods of operations
received by any of them during the Term hereof unless disclosure is required
( c) not, and shall procure that their employees shall not , after the expiration
or earlier determination of this Agreement use any of the Confidential
Information without the written consent of the Franchisor first had and
Employment and franchising respond in a very similar way to this issue.
Restraints on other work that may be done during term of contract
An employer expects an employee to devote the agreed amount of time to their
work. An employer adopts policies to ensure this occurs, including policies for
managing conflicts of interest. The situation is very similar for franchisees. For
example franchisor MBE mandates that:
During this agreement the franchisee must not:
9.1(q) without the Franchisor’s prior written consent in any capacity
whatsoever be directly or indirectly engaged in any business or undertaking
301 Copy of franchise agreement is in researcher’s possession.
Chapter 3: The problem in context 141
which in the sole opinion of the Franchisor is considered competitive to the
The equivalent clause in a McDonald’s licence agreement is:
6.05 Best Efforts
Licensee or, where Licensee is a company, Principal shall … personally
devote… his full time and attention to and exercising his best efforts in the
operation of the Restaurant. Licensee [etc] … shall keep free from
conflicting enterprises or any other activities which would be detrimental to
or interfere with the business of the Restaurant. 302F
Where a single franchisee operates multiple units of the same or a diversified
portfolio of franchise units with more than one franchisor, they do so with the
consent of their franchisors. Thus, in-term restraints are not a reliable distinguishing
characteristic of the relationships.
VULNERABLE TO CAPRICIOUS BEHAVIOUR BY EMPLOYER OR FRANCHISOR
Employees and franchisees are potentially affected by capricious or
unreasonable behaviour by their employer or franchisor. In both situations, despite
the existence of fair work and anti-discrimination legislation for employment, and
statutory prohibitions against unconscionable conduct and discrimination for
franchisees, in practical terms the employer/franchisor has the ‘upper hand.’
If their employer abuses its stronger position, employees may have recourse to
a trade union for assistance.
Franchisees in Australia do not have a representative body that functions in the
same way a trade union does.303F
304 Franchisees sometimes feel vulnerable and
disempowered and may have to go to court to attempt to assert legal rights.
302 Copy of franchise agreement is in researcher’s possession. 303 McDonald's Australia Holdings Ltd & Anor v Industrial Relations Commission of NSW & 2 Ors
 NSWCA 286, para 23 of Judgment of Spigelman CJ. 304 A Franchisees Association of Australia Incorporated was established in 1983 but lacked funding
and did not function like a trade union; the Franchise Council of Australia claims to represent franchisors and franchisees but ‘current figures suggest that only 200 franchisors of 1100 in total are members, which represents less than 20 per cent while the percentage of franchisees who are members is even lower.’ Elizabeth Crawford Spencer, ‘All for One and One for All: A Survey of Franchise Trade Associations’ Roles in the Governance of the Franchise Relationship.’ (Paper presented at the 23rd Annual International Society of Franchising Conference, San Diego, California, 12-14 February 2009) 15.
142 Chapter 3: The problem in context
For example, in Far Horizons Mr Hackett, director of a McDonald’s franchise,
vulnerability as a franchisee is obvious in the words of his witness statement:
Mr Xipolitos appeared to me to be determined and insistent on grading me as
… I came to realise that my future security and prospects in the McDonald's
System, being my $2 million plus investment in my restaurants and my
desire to expand, were ultimately in the hands of a very subjective evaluation
of my restaurants by one or two people and the personal relationship
between myself as licensee and my Consultant. 304F
The increased vulnerability for a franchisee over an employee is that
franchisees like Mr Hackett have sunk investments, their own employees, ongoing
contractual obligations to the franchisor and third parties and consequential liabilities
secured in contractual relationships. The franchisee does not have the option of
finding another job.
Thus, while both employees and franchisees are potentially victims of
capricious behaviour, the franchisee is arguably more vulnerable and less able to
retaliate appropriately because of lack of a representative body to turn to, numerous
contingent contractual relationships requiring ongoing performance and an
investment in sunk costs to protect.
MAY JOIN A UNION TO ENFORCE RIGHTS
Employees are legally permitted to join trade unions in Australia. During the
Ansett insolvency in 2001 the trade union provided assistance to the employees in
the form of representation at the creditors’ meetings, up to date information on a
designated website, and its ‘weight’ in negotiations with the federal government.
This resulted in especially favourable treatment for employees.
One enduring, effective, and widely respected franchisee association is the
Motor Traders Association of Australia. It represents vehicle dealers and associated
franchisees, licensees of vehicle and oil companies and independent operators in the
motor trades. For franchisees outside motor trades, several franchisee representative
groups have formed and been disbanded over the years. The possible benefit of
franchisees joining unions is discussed in chapter 6.1.3.
305 Far Horizons Pty Ltd v McDonald's Australia Ltd  VSC 310, para 42.
Chapter 3: The problem in context 143
Accordingly, the possibility of joining a trade union is a significant point of
difference between employees with access to union membership and franchisees.
PERSONALLY ASSUME FINANCIAL RISK OF EMPLOYER/ FRANCHISOR’S FAILURE
This is another area where the outcomes for employees and franchisees starkly
differ. The employee loses his or her job if the employer’s business fails. Some ‘read
the writing on the wall’ and leave before the administrator is appointed. For example,
Vicky Kay, employee manager of the franchisor owned store Traveland Bondi
Junction, is reported as saying that she resigned on 20 November 2001 as manager
after 29 years of working for Traveland, fed up with being paid late.
They kept saying the money’s coming. 305F
Vicky’s employer, Traveland, was a travel agency with 100 non-franchised and
270 franchisee owned agencies. It was wholly owned by Australia’s failed Ansett
Airlines. Being paid wages fortnightly or monthly … employees would quickly
know if they did not receive wages.
Key staff may be retained by, and paid by, the administrator whilst the
administrator reorganises the business structure. The financial risk the employee
assumes is in relation to unpaid wages and bonuses. However, statutory protection
exists for some wages and allowances, and a government backed GEERS scheme
compensates for some wages that cannot be paid from the insolvent estate.
The franchisees may be at a significant disadvantage compared with the
franchisor’s employees when it comes to detecting early warning signs of the
franchisor’s financial woes. The difference between employees and franchisees was
also demonstrated when the Kleins jewellery franchisor failed. It was reported that
… collapsed with debts of approximately $20-25 million in May 2008. It
became readily apparent that Kleins could never be returned to its former
glory and was simply a ‘tired’ business. … all employees would be likely to
306 Alison Rehn and David Penberthy, ‘Traveland liquidators to be paid $1m’, Daily Telegraph
(Australia) 15 March 2002, 15.
144 Chapter 3: The problem in context
receive their entitlements, under the GEERS scheme, but unsecured creditors
[and franchisees] should expect nothing.306F
Franchisee may not become aware of the franchisor’s position until a supplier
changed the terms of trade, or they hear about the franchisor’s demise through the
MAY SELL THE ROLE
This is a significant point of difference. An employee is not at liberty to sell
their job. The franchisee, on the other hand, expects to be able to sell their business.
Strong re-sales of franchisees’ businesses by incumbent franchisees is one indicator
of a successful franchise network.
After relationship ends
OPPORTUNITY TO MAKE CAPITAL GAINS IF ENTERPRISE SUCCEEDS
An employee in a middle or senior management position in a public company
may be rewarded in the form of a bonus package of options or shares. They would
then be free to trade these on the stock exchange at future dates.
Ideally, franchisees also make capital gains if their business succeeds. This is
available to the franchisee if they can sell the business during the term of franchise.
A longer franchise term provides more opportunity for the franchisee to recover its
initial investment while building the franchise, and ideally leaving a residual term to
WHO OWNS THE GOODWILL AT THE END?
Goodwill is a complex issue, and is a clear point of differentiation between an
employee and a franchisee. An employer owns the goodwill in its business. Its
employees do not own the goodwill.
The franchisee situation opens the door for a debate about the type of goodwill
that is being sold: is it goodwill that attaches to the person (the franchisee), or the
brand (the franchisor) or the location (potentially either or both)? In ATO ruling
‘PCD 8 Capital Gains: Goodwill’307F
308 possible viewpoints on the question of whether a
307 Alexander Samson, Alicia Hill and Derek Sutherland, Back to Basics – Insolvency and
Franchising (2009) Dibbsbarker < http://www.dibbsbarker.com/industry/Franchising/Recent_Publications.aspx?publicationid=d835666ba19cfd1d> at 18 February 2010.
308 Australian Taxation Office, PCD 8 Capital Gains: Goodwill (1995).
Chapter 3: The problem in context 145
franchisee can own goodwill are discussed. There is authority for the view that in the
absence of a specific contractual provision to the contrary, on the termination of a
franchise, the benefit of the goodwill remains in the franchisor. The amount of time
still to run under the franchise agreement will be relevant to the conclusion.
Some franchise agreements state the matter clearly. For instance, clause 17.2 of
the MBE individual franchise agreement states:
Consequences of Termination
The Franchisee shall have no claim against the Franchisor for …
compensation for the loss of the business, loss of goodwill or any similar
It would be usual for a franchisee to expect to receive some of the goodwill on
the sale of a franchise during the term, particularly where the franchisor has not
terminated the franchise agreement for franchisee misconduct.308F
Post-contract restraints apply to franchisees and less commonly to employees
in Australia. The validity of the restraint depends on how reasonable it is – in time,
scope and distance. Franchise related restraint cases in Australia include The
Cheesecake Shop v A & A Shah Enterprises  NSWSC 625 which discussed the
following clause in the franchise agreement:
16. Post Termination Covenant Not To Compete
16.5 The Franchisee, Nominated Manager and the Guarantors shall
not during the term or the period, after the expiration or earlier termination
of this Agreement, as specified in the Schedule conduct on his own account
or be concerned or interested in whether directly or indirectly as agent,
shareholder, or director in any firm or corporation conducting a business
similar to the Franchised Operation or in any cake manufacturing or cake
retail or cake wholesale enterprise, within the distance [stipulated in the
agreement] from the location specified in the Schedule.309F
309 Goodwill is discussed by Ian Tregoning in ‘Goodwill in the Context of Licensing, Leasing and
Franchising: Some Considerations’ (2009) 37 Australian Business Law Review 296. 310 The Cheesecake Shop v A & A Shah Enterprises  NSWSC 625.
146 Chapter 3: The problem in context
Justice Windeyer was not prepared to enforce a post-term non-compete
I cannot see how the restraint could be justified. It is really a prohibition
against competition without any evidence to establish anything being
competed against. There is no evidence that The Cheesecake Shop (TCS)
wished to open a Cheesecake Shop within the postcode referred to or
anywhere near Bonnyrigg or anywhere within the restrained area. Thus there
is no evidence of disadvantage to TCS if a shop selling cheesecake products
operated from the premises. In the absence of evidence the covenant would
seem to operate to preserve an area for TCS operations which do not
presently exist and may never exist. … such a restraint could not be upheld
as it could not be shown to be necessary or reasonable to preserve the
goodwill of TCS. 310F
ON TERMINATION OF RELATIONSHIP EMPLOYEE OR FRANCHISEE HAS FINANCIAL OBLIGATIONS RE THE BUSINESS.
While an employee would expect to have an ongoing obligation not to disclose
confidential information obtained during a period of employment, some franchisors
impose a more onerous obligation through their franchise agreements. The
independent contractor or the employee is free to look for new work as soon as the
administrator is appointed. At the time of the franchisor’s insolvency a key
difference between employees and franchisees is that the employees are supported by
government policy, franchisees are not.
The differences between franchisees and employees are often as striking as the
similarities, especially when the franchisor fails. The implications for employees are
discussed in chapter 4.4.6.
3.3 THE FRANCHISE AGREEMENT
The first question when considering any problem from a legal perspective is:
can the problem be addressed within the existing law? Is anything preventing
franchisees from protecting themselves against the consequences of franchisor failure
by negotiating contracts better? Intuitively, it would seem that franchisors and
franchisees should be able to incorporate provisions into the contract that address the
possibility of the franchisor’s business failing, and thereby provide franchisees with 311 Ibid para 36
Chapter 3: The problem in context 147
appropriate consequential rights. New York franchise lawyer Craig Tractenberg
The best protection against the risks inherent in the bankruptcy process is to
terminate the franchise agreement before bankruptcy is filed. If the franchise
agreement is terminated before bankruptcy is filed, it is not protected by the
automatic stay and the franchise is not property of the estate.311F
Tractenberg also advises that ‘[c]omplete termination is required’.312F
313 Similarly, the
best protection for franchisees is for them to be legally entitled to terminate the
franchise agreement during the period of administration before the franchisor’s
liquidator is appointed.
‘Contracts are fundamental to commerce. Contract law determines how a
contract is made, whether it is enforceable, whether it has been breached, and what
remedies are available for its breach’.313F
314 Blair and Lafontaine summarise a franchise
agreement as being:
…most often understood as a contractual arrangement between two legally
independent firms in which one firm, the franchisee, pays the other firm, the
franchisor, for the right to sell the franchisor’s product and/or the right to use
its trademarks and business format in a given location for a specified period
of time. 314F
Franchise agreements perform the same role everywhere. In South Africa, for
example, the franchise agreement has been described in Cacun Trading No 24 CC &
312 Tractenberg, above n 110, end note 8; See, for example, Moody v Amoco Oil Company 734 F 2d
1200 (7th Cir) cert denied, 469 US 982 (1984). Tractenberg is writing for an audience of lawyers whose clients are franchisors whose franchisees are becoming bankrupt but the same applies to franchisees. Whilst being a high-risk strategy for franchisees in Australia, termination for anticipatory breach is the avenue that gives individual franchisees the quickest exit from a doomed franchise agreement; see ch 3.3 of this thesis.
313 Tractenberg, above n 110, end note 9. If the franchise agreement expired prepetition or is otherwise not in existence because of having been completely terminated prepetition it is not property of the estate. See, for example, Days In v Gainesville P-H Properties, Inc 77 BR 285 (Bankr MD Pa 1993); But compare with Baskin Robbins Inc v Neiberg 161 BR 606 (Bankr BD Pa 1993) (no waiver by franchisor of termination rights) with In re Karfakis, 162 BR 719 (Bankr BD Pa 1993) (franchise agreement and real property lease were indivisible contracts and purported termination of franchise agreement without taking possession of real estate was incomplete termination of the integrated franchise rights of the debtor).
314 M P Ellinghaus, E W Wright and M Karras, Models of Contract Law an Empirical Evaluation of Their Utility (2005).
315 Blair and Lafontaine, above n 46, 3-4.
148 Chapter 3: The problem in context
Others v Seven-Eleven Corporation SA (Pty) Ltd unreported case no 18/IR/Dec 99
[a] franchise agreement is neither an employment relationship nor an
independent contracting relationship. It rather combines elements of
integration and delegation, control and independence and is thus a
multifaceted vertical structure that paves the way for endless relational and
commitment problems. 315F
Any problems are ideally addressed to the satisfaction of both parties as the
relationship develops. After conducting an inquiry into franchising in 2008, the
Economics and Finance Committee of the South Australian Parliament writes:
The basic premise on which the principles of freedom of contract and
sanctity of contract rest is that contracts are negotiated at arm’s length by
equally positioned participants in the bargaining process. That premise is not
fulfilled in the typical franchise arrangement.316F
‘Contractual relations are the essence of the firm, not only with employees but
with suppliers, customers, creditors’ 317F
318 and franchisees. The franchise agreement is
also the starting point for the courts, administrators and liquidators determining the
parties’ rights. The franchise agreement will now be examined as the record of a
bargain, and in the context of the franchisor failing.
3.3.1 ADDRESSING THE FAILURE OF THE FRANCHISOR’S BUSINESS
The franchise agreement documents a relationship that is commercial and
consumer. The subject of the contract is a commercial relationship. The parties are
the franchisor as a business supplier and a franchisee as a business consumer. Once
executed, like all commercial agreements, it sits in the proverbial ‘bottom drawer’
until one party needs to invoke legal rights. Then, it commands the undivided
Because there is no public register of franchise agreements in Australia, 70
franchise agreements … were chosen from the US website FreeFranchise
316 Tanya Woker, ‘Franchising – The Need for Legislation’ (2005) 17 South African Mercantile Law
Journal 49, 51. 317 Economics and Finance Committee, Parliament of South Australia, Franchises (2008) 17. 318 Jensen and Meckling, above n 21, 311.
Chapter 3: The problem in context 149
319 [We] examined [them] to determine what a typical franchise
agreement might say about insolvency of one of the signatories. None of
these agreements mentioned franchisor bankruptcy … In the same
agreements, 23.5 per cent were silent on the right for franchisors to terminate
the agreement if the franchisee became bankrupt. Seventy six per cent
permitted the franchisor to terminate the franchise agreement, usually with
no notice and no right to cure if the franchisee became bankrupt.319F
In Australia, the ex post experience of a Traveland travel agency franchisee is
consistent with the US findings above:
We’d just renewed the franchise agreements on our 4 [Traveland] outlets for
5 years when the franchisor’s administrator was appointed. We went to see a
QC to see if we could get out of the agreements and there was no way.320F
This failure to provide for an event which is demonstrably common is
problematic. The ideal world where ‘negotiations between two … parties, … are
designed to advance the wants and needs of each of those contracting parties’ 321F
not describe the experience of franchisees. Contract theory helps explain how this
imbalance arises and why it has not been redressed by the common law.
3.3.2 THE DESIRABILITY OF CERTAINTY IN CONTRACTS
Notwithstanding that one would assume for all stakeholders that certainty is an
outcome of the contracting process and
[t]he classical theory of contract was seen to offer predictability and
certainty, although, as Sir Anthony Mason has observed; “It later emerged,
as is the case with many legal concepts rooted in formalism, that the element
of certainty was illusory”322F
Acknowledging that the franchise agreement is a relational contract is also to
acknowledge that whilst procedural certainty may be achieved, substantial certainty
need not be an outcome of the contracting process. Certainty in all dimensions is
319 Free Franchise Docs <http://www.freefranchisedocs.com/index.html> at 5 June 2008. 320 Buchan and Butcher, ‘Premises Occupancy Models for Franchised Retail Businesses in Australia:
Factors for Consideration’, above n 34, 170. 321 Jenny Buchan and Lorelle Frazer, above n 32, 1906. 322 Lindy Willmott et al, Contract Law (3rd ed, 2009) 16. 323 In Bobux Marketing Limited v Raynor Marketing Limited  NZCA 348, para 34 (Thomas J
dissenting), citing AF Mason, ‘Contract, Good Faith and Equitable Standards in Fair Dealing’ (2000) 116 Law Quarterly Review 66, 70.
150 Chapter 3: The problem in context
widely accepted as being desirable in commercial relationships. Heather Ridout
points out that ‘uncertainty is death for business’323F
324 in the context of the carbon
trading debate. Hadfield observes:
… incomplete contracts (such as franchise agreements) often exist deeply
embedded in an ongoing relationship. The parties are not strangers; much of
their interaction takes place “off the contract” mediated not by visible terms
enforceable by a court, but by a particular balance of cooperation and
coercion, communication and strategy.324F
There is an assumption underlying a relational contract that the major
foreseeable events which could fundamentally change the relationship, are addressed
in the contract. Other events are foreseeable but seem so unlikely to one or both
parties that they are not included. The parties acknowledge, by implication, that some
events are not foreseeable and will be the subject of negotiation if and when they
occur. Where certainty is not possible, a balanced contract would be a desirable
3.3.3 PARTIES TO COMMERCIAL AND CONSUMER CONTRACTS ACT IN THEIR OWN INTERESTS
As E W Thomas observes, ‘[i]t is the law of contract that has the greatest
impact on interactions where freedom of choice and action and freedom from
interference are most coveted’.325F
326 Parties to commercial contracts should act in their
own interests but, as K M Sharma writes:
… the liberal fiction that all the effects of a contract should be attributed to
the will of those who made it still persists though contract law today even
though the overwhelming majority of contracts are the product of the will of
only one of the contracting parties.326F
Parties to contracts act in their own interest. In franchising, though, the will of
the franchisor dominates the franchise agreement. Franchisors draft the agreement
324 Sky News, ‘Australian Industry Group, Heather Ridout, with Kieran Gilbert’, Agenda (5 May
2009). 325 Hadfield, ‘Problematic Relations: Franchising and the Law of Incomplete Contracts’, above n
202, footnote 28 at 928. 326 E W Thomas, The Judicial Process: Realism, Pragmatism, Practical Reasoning and Principles
(2005) 382. 327 K M Sharma, ‘From Sanctity to Fairness’ (1999) 18 New York Law School Journal of
International and Comparative Law 95, 115.
Chapter 3: The problem in context 151
acting in their own interest. This makes sense to the extent that franchisors can
thereby ensure that the major risks for the future integrity of their network are
addressed, and can achieve administrative efficiency through standardisation.
That franchisors do act in their own interest is demonstrated by franchisors’
responses to compliance with the voluntary Franchising Code of Practice (FCP). The
FCP was ‘introduced in 1993 to address significant problems in franchising
identified in the 1991 report by the Franchising Task Force’.327F
328 The FCP was a form
of ‘soft law’ 328F
329 recognised within the franchising community as being a final
opportunity for the franchising sector in Australia to prove to the Australian
Government that it could self-regulate. The alternative to demonstrated, sector-wide,
voluntary compliance was that the Government would enact legislation to regulate
franchising. After one year of proactive, government funded promotion of the
benefits of the FCP it was perceived that the FCP was not delivering on hopes, and
the Gardini Review was commissioned. Robert Gardini wrote that ‘[a]s at 30
September 1994, 376 franchisors had registered with the FCAC [the body
administering the FCP]. … it appears that approximately 50 – 60 per cent of
franchisors are registered’.329F
Both the franchisors that did register and those that did not, acted in their own
interest. Some registered because most banks required registration as a pre condition
of lending to franchisees. It was considered at the time that ‘restraints contained in
the Code on financial institutions and publishers330F
331 would increase the pressure on
franchisors to register’.331F
332 Those that did register may also have been motivated by
the credibility that they hoped the ‘FCP compliant’ by-line lent to their businesses.
328 Robert Gardini, Review of the Franchising Code of Practice (1994) v. 329 Iain Ramsay, ‘Consumer Law, Regulatory Capitalism and the ‘New Learning’ in Regulation’
(2006) 28(1) Sydney Law Review 9. 330 Gardini, above n 328, 15. 331 ‘Publisher’ was included under the definition of ‘Service Provider’ in clause 3(e) of the
Franchising Code of Practice 1993 but the definition did not expand on who would be considered to be a ‘publisher’. Clause 16.2 of the Code of Practice stated: Service Providers which are publishers and advertising media providers who register with the Code will comply with the Code by agreeing not to take or place advertisements from persons purporting to sell or provide Franchise opportunities unless those persons are able to provide a current Code Registration Number.
332 Gardini, above n 328, v.
152 Chapter 3: The problem in context
However, ‘…the motor vehicle industry … decided not to participate in the
Code, as [did] significant areas in the real estate sector’.332F
333 Those that did not register
also acted in their own interest for reasons which included:
lawyers advising franchisor clients not to voluntarily expose themselves to
the obligations the FCP imposed on signatories,
that the franchisor had nothing to hide and concluded that compliance
would impose a financial and administrative cost that they would pass on
to franchisees while not generating any greater security for their
that the franchisor did have something to hide and did not want to risk
exposing themselves to a random audit, and
a few franchisors claimed not to know of the existence of the FCP.
Each franchisor, thus, acted in its own interest. This rational approach helps
explain why franchisors make no mention of franchisor failure in franchise
agreements. They believe they are acting in their own interest. The franchise sector’s
equivocal response to complying with the FCP is likely to be an indication of how
they would respond to the suggestion that all franchise agreements voluntarily
include provisions addressing franchisees’ rights if the franchisor failed.
A further example of the stronger party acting in its own interest is the way
issues of risk and reward are addressed in franchise agreements. A contract
negotiated between parties of equal weight and with a mutual interest in the success
of the venture would result in the contract addressing both risk and gain in a balanced
way. For example, despite having assumed a considerable amount of the franchisor’s
business risk franchisees have no right to receive the corresponding reward that a
franchisor’s venture capital providers or shareholders typically would be entitled to if
the franchisor entity is sold for a profit.333F
Thus the assumption that franchisors will act in their own interests is correct.
The assumption that the weaker party to the contract, the franchisee, will act in their
333 Ibid. 334 For example S Mitchell, ‘Cartridge Refiller Tops up With $60m’, The Australian Financial
Review (Melbourne), 2 August 2007, reports on a private equity led management buyout of 80 per cent of the franchisor’s business for an estimated $60m.
Chapter 3: The problem in context 153
own interests, is debateable. If they want to become a franchisee of a specific
network they have no ability to act in their own interests; in order to be approved as a
franchisee they hand the franchisor all of their financial information, then prior to
becoming a franchisee they execute the standard form, non-negotiated agreement
drafted by the franchisor.
3.3.4 A STANDARD FORM BUSINESS CONSUMER CONTRACT
In its submission to The Australian Consumer Law Consultation on Draft
Provisions on Unfair Contract Terms, the Law Society of NSW provides examples of
‘standard form contracts’ frequently used in conveyancing transactions and states
the Committee believes that the use of these forms has significant consumer
benefits: [being] familiarity, comprehensiveness, compliance with legislative
balance between the parties to the transactions. 334F
Whilst all of these points are valid in respect of standard form contracts drafted
by an impartial party, standard form agreements such as franchise agreements are
drafted by the overwhelmingly more powerful party in a commercial relationship.
The Law Society’s thinking about standard form contracts is inaccurate in the
context of standard form franchise agreements.
Franchisors use standard form franchise agreements drafted to maximize their
position. For example:
Clauses identical or substantially similar to clause 10 appear in franchise
agreements for over 14,000 Subway franchises throughout the world. The
reason Subway Systems and Doctor's Associates require disputes with
franchisees to be resolved in accordance with clause 10 is that they want to
develop an internationally consistent approach to dispute resolution with
Thus, in the Subway franchise network the franchisor maximizes its position
by requiring disputes that are not able to be resolved by mediation at national level to
335 Law Society of New South Wales, Australian Consumer Law – Consultation on Draft Provisions
on Unfair Contract Terms (2009) Australian Government, The Treasury <http://www.treasury.gov.au/contentitem.asp?NavId=037&ContentID=1537> at 4 June 2010.
336 Timic v Hammock  FCA 74, para 6.
154 Chapter 3: The problem in context
be resolved by arbitration or litigation in the location nominated by the franchisor,
Connecticut, USA. 336F
337 Such a strategy is beneficial to the franchisor but is a
significant disincentive to robust dispute resolution for Subway franchisees in
Franchisees are encouraged to read the franchise agreement and ask questions,
but any requests for changes are typically rejected by the franchisor. Standardisation
of outcome is a more important result for a franchisor than letting a new franchisee
enter the relationship in the mistaken belief that he or she has any bargaining power.
The franchisee accepts the franchisor’s unwillingness to negotiate because
standardisation reinforces the franchisor’s mantra – we know how to do it, trust us
and sign on with us and you will be successful before you know it.
Nevertheless franchise agreements are:
long-term contracts [that] involve continuing financial commitment in the
course of which the consumer, being imperfectly informed and not fully
aware about his needs – is largely reliant on the advice, guidance and skills
of his counter-party.337F
In addition to being a contract concerning the purchase and operation of a
business the franchise agreement is a contract between a supplier and a business
consumer. It places a franchisee in a position of dependence on the franchisor in
relation to services provided by both the franchisor and by third parties. Despite all
the words about support and nurturing that have resulted in the franchisee purchasing
the business, the franchisor’s position is clearly stated in the wording of the franchise
agreement, as is shown for example in a typical Australian franchise agreement.
‘Clause 10.1 of the [Lenard’s] retail chicken shop franchise agreement reads as
337 ‘Doctor's Associates Inc, an American corporation, is the owner of proprietary and other rights
and interests in various service marks, trade marks, trade names and goodwill used in its business including the trade name and trade mark ‘Subway’. Subway Systems is the Australian licensee of Doctor's Associates. … Clauses identical or substantially similar to clause 10 appear in franchise agreements for over 14,000 Subway franchises throughout the world. The reason Subway Systems and Doctor's Associates require disputes with franchisees to be resolved in accordance with clause 10 is that they want to develop an internationally consistent approach to dispute resolution with franchisees.’ In Timic v Hammock  FCA 74.
338 Andromachi Georgosouli, ‘Investor Protection Regulation: Economically Rational?’ (2006) Working Paper Series, University of London, Centre for Commercial Law Studies 10 <http://ssrn.com/abstract=893451> at 4 June 2010.
Chapter 3: The problem in context 155
The National Franchisor, the Master Franchisee and the Franchisee are each
independent contractors. They are not and shall not be considered as joint
venturers, partners or agents of each other and no fiduciary relationship shall
be deemed to exist between them’.338F
Elizabeth Spencer observes:
The inherent dynamic in franchisor/franchisee relationship … involves
maintaining the franchisee in a subordinate position. This increases the
franchisee’s motivation to provide assurances of performance, among them
taking on risk. … Despite being overburdened with risk, because of the
standard form the franchisee is faced with the choice of accepting the
contract terms or giving up on the deal entirely.339F
But, as Rick Bigwood points out, ‘standardized [as manifested by standard
form] contracts are mostly to be endured as beneficial in complex free market
economies. This is largely because they reduce transaction costs’.340F
acknowledges that ‘consumer protection through market forces alone is weak’.341F
The inability of market forces to remodel franchise agreements to accommodate
franchisor failure is an aspect of extreme one sidedness that is not to be endured. For
example, franchise agreements always provide for the death or insolvency of the
franchisee. There are no statistics available for the number of franchisees who die
while being a party to a franchise agreement. In the author’s experience acting for
franchisors of large networks, a franchisee died on two occasions. On both occasions
the death affected one outlet and the transition to a new owner was managed by the
franchisor without interruption to any other franchisees. By way of contrast, a
‘standard form contract … does not anticipate [the franchisor equivalent of the
franchisee’s death] insolvency of the franchisor. This limits the ability of the
franchisee to self protect’.342F
339 Poulet Frais Pty Ltd v The Silver Fox Company Pty Ltd  FCAFC 131 (Branson, Nicholson
and Jacobson JJ). 340 Elizabeth Spencer, ‘Standard Form and Relational Aspects of Franchise Contracts’ (Paper
presented at the 20th International Society of Franchising Conference, Palm Springs, California, 24-26 February 2006) 21, quoting Silvana Sciarra, ‘Franchising and Contract of Employment: Notes on a Still Impossible Assimilation’ in Christian Joerges (ed), Franchising and the Law: Theoretical and Comparative Approaches in Europe and the United States (1996) in Journal Institutional & Theoretical Economics, 152, 297-324.
341 Rick Bigwood, Exploitative Contracts (2003) 274. 342 Ibid 274-5. 343 Jenvey, above n 123.
156 Chapter 3: The problem in context
Another way of expressing the problems caused by the standard form is that:
[c]onflicts of interest may, and do, create counter-incentives for [creating
and] complying with contractual obligations. Especially in long term
contracts and in conditions of asymmetric information, the possibility of
opportunistic behaviour appears considerably increased not least because the
value of the contract and the investment depends on the firm’s performance
after the point of purchase.343F
344 Contracting out would be a way in which
consumers could avoid being exposed to the risk of their counter-party’s
misconduct, nevertheless the costs involved discourage them from doing
It is easy to suggest that, having observed that other franchisees have already
made the investment in the franchise business, franchisee consumers free ride and do
not conduct extensive due diligence. Even if adequate due diligence were possible
the contract is not negotiable. As Carter et al state:
the assumption that will and intention form the substratum of every contract
is heavily attenuated by inequality of bargaining power between individual
and corporation whose power is marked by common use of standard form
Willmott et al add that
[s]tandard form contracts are typically used by parties who are in such a
strong bargaining position … that they are able to prescribe the terms on
which they are prepared to contract on a ‘take or leave it’ basis. 346F
The franchise agreement is an example of such a contract negotiation process.
The franchisor supplier drafts the franchise agreement. The franchisee business
consumer takes it or leaves it, seldom having the opportunity to vary the standard
form. Experience of legal practitioners suggests that the only franchisees in the
position to negotiate non-standard terms into their franchise agreement may be the
first franchisees of a new network or the first master franchisee entering a new state
or country where a franchisor is very keen to establish a presence.
344 Georgosouli, above n 338, 10-11, fn 40 citing I D C Ramsey, ‘Rationales for Intervention in the
Consumer Marketplace’ (1984) Occasional Paper for the Office of Fair Trading 28. 345 Ibid 11. 346 J W Carter, Elisabeth Peden and G J Tolhurst, Contract Law in Australia (5th ed, 2007) 8. 347 Willmott et al, above n 322, 583.
Chapter 3: The problem in context 157
3.3.5 RELATIONAL CONTRACT
Franchise agreements are relational contracts, and are necessarily incomplete.
Underlying a relational contract is the assumption that the major foreseeable events
that could fundamentally change the relationship have been addressed in the contract.
As Hadfield observes
incomplete contracts [such as franchise agreements] often exist deeply
embedded in an ongoing relationship. The parties are not strangers; much of
their interaction takes place ‘off the contract’ mediated not by visible terms
enforceable by a court, but by a particular balance of cooperation and
coercion, communication and strategy.347F
‘In contract theory, incompleteness is [also] due to the cost and sometimes
unavailability of information’.348F
349 During the initial contract negotiations ‘parties
incur ex ante transaction costs, including the costs of anticipating future
contingencies and writing a contract that specifies an outcome for each one’.349F
ex ante and ex post contracting costs prevent parties from writing complete contracts
and give rise to what economists refer to as the problem of incomplete contracts’.350F
Ex ante, the parties might not foresee all possible contingencies or they would
have to incur prohibitively high negotiation and drafting costs to partition all
contingencies sufficiently to provide for efficient obligations in each case. The
contingency that the franchisor’s business might fail is the least likely from a
franchisees’ perspective, as most believe they are buying a proven concept. ‘A
challenge for parties designing contracts is to preordain or at least constrain the
course of future renegotiation so as to yield both ex ante and ex post efficiency’.351F
As Hadfield points out, once the contract moves beyond negotiation or
performance to litigation:
[t]o the extent that courts cannot distinguish between the derogation of a
commitment in an incomplete contract, and an exercise of the flexibility
348 Hadfield, ‘Problematic Relations: Franchising and the Law of Incomplete Contracts’, above n
202, 928. 349 Robert E Scott and George G Triantis, ‘Incomplete Contracts and the Theory of Contract Design’
(2005) 56(1) Case Western Reserve Law Review, 187, 191. 350 Ibid 190. 351 Ibid. 352 Ibid 194.
158 Chapter 3: The problem in context
which is part of that commitment, incomplete contracts cannot fully function
in their role as anchor for many complex transactions.352F
The franchise agreement is necessarily incomplete because of its long term353F
and the unpredictability of human relationships and commercial environments.
the legal system is likely to be a poor venue for specifying the substantive
terms of the [long term franchise] contract. It would be unrealistic to expect
a relational contract to cover all contingencies. From a franchisee’s
perspective, then, perhaps the biggest problem with franchising lies not so
much in what it is, but rather what it is not and yet sometimes appears to
‘To a lawyer, a contract may be incomplete in failing to describe the
obligations of the parties in each possible state of the world’.355F
356 It is thus difficult to
explain why franchisors would knowingly leave gaps around the possibility of
franchisor failure when ‘the cost of making contracts complete in this sense is
357 A flaw in applying the theory of trading off ‘front-end and back-end
358 to justify not providing for franchisor failure ‘up front’ is that franchisors
fail sufficiently often for the risk to be eligible for inclusion in the franchise
agreement from the outset. It would be relatively inexpensive to insert provisions
about franchisor failure into the franchise agreement, and the traditional justification
that issues left for the back end will be resolved by the courts is not justifiable where
the trigger event is the insolvency of one party.
Justice Hammond in Dymocks Franchise Systems v Bilgola Enterprises Ltd 8
TCLR 612 recognised that the
underlying recognition is that a relational contract is of an ongoing, and
often relatively open-ended, character; and that it is in society’s interest to
353 Hadfield, ‘Problematic Relations: Franchising and the Law of Incomplete Contracts’, above n
202, 928. 354 Shelby D Hunt, ‘The Trend Towards Company-Operated Units in Franchise Chains’ (1973) 49(2)
Journal of Retailing 3, 10 reported that typically fast food franchisors in the US granted terms with a median length of 15 years, and that frequently the franchisee had an option to renew. Frazer, Weaven and Wright, Franchising Australia 2008, above n 7, 23 found the initial term of a franchise agreement in Australia across all sectors except motor vehicles varied from one to 50 years, with a median term of 5 years.
355 Blair and Lafontaine, above n 46, 221. 356 Scott and Triantis, above n 349, 187, 190. 357 Ibid. 358 Ibid 196.
Chapter 3: The problem in context 159
accord to each party to a contract of this kind, reasonable security for the
protection of his or her justified expectations.358F
A franchisee’s ‘justified expectations’ are unmet if the franchisor fails.
3.3.6 INCOMPLETE CONTRACT
Carter et al identify that ‘The absence of genuine [pre-contractual] negotiation
can result in the weaker party signing an unfavourable contract. Partly in response to
this, the law of contract implies terms into certain commonly occurring contractual
relationships to complete the parties’ bargain’.359F
360 Under the common law some
situations merit implying terms into contracts’.360F
361 These may be implied to give
effect to the ‘presumed intentions of the parties’.361F
362 The presumed intentions of the
parties could rarely be proven, to the satisfaction of a court, to have included the
franchisor’s failure. It is thus not open to the franchisee to argue that clauses
providing the franchisee with contract-based rights on the franchisor’s insolvency
were omitted because the contract did not reflect the intentions of the parties.
Alternatively terms are implied into contracts ‘regardless of intention’362F
because the type of contract or a specific statute mandates inclusion of that term.
Currently no terms are implied into franchise agreements to fit the second category
following the appointment of a receiver, administrator or liquidator. The possibility
of implying terms into franchise agreements by statute is addressed in chapter 6.2.
E W Thomas adds a judicial perspective to the conclusions drawn by Carter
[i]t would be quite wrong to think that a contract that omits a provision to
deal with a particular contingency is due to an oversight or the finite capacity
of business people and their legal advisers to predict future events with
accuracy. … there are sound commercial and economic reasons why the
parties may deliberately choose to enter into agreements in which no
provision is made for known contingencies.363F
359 Dymocks Franchise Systems v Bilgola Enterprises Ltd 8 TCLR 612, 630. 360 Carter, Peden, Tolhurst, above n 348, 8. 361 See Des Butler et al, Contract Law Casebook (2009) 73. 362 Ibid 73–4. 363 Ibid 77. 364 Thomas, above n 326, 296.
160 Chapter 3: The problem in context
Contracts may not be complete because they were never intended to be
complete. In the franchising arena, for example, franchisors may negotiate directly
with a landlord to reach heads of agreement in relation to the franchisees’ premises,
then both franchisor and landlord may hand the negotiations over to the landlord’s
shopping centre manager or lawyer to complete the lease details with the franchisee.
The heads of agreement may constitute a binding contract, but it is incomplete.
Thomas accurately observes that in a typical commercial negotiation
[t]he decision as to what is the most efficient will be made having regard to
… the time available for further negotiations, the cost of more
comprehensive drafting, the risk that the core bargain will be lost, the
chances of the contingency actually occurring, and the consequences or
alternatives available if the contingency does not occur. Further, with long-
term or relational contracts … the parties can anticipate that some terms of
the contract will be renegotiated and developed in the light of experience or
But, by taking each of the factors identified by Thomas and placing them in the
context of the franchise sale and purchase process it can be concluded that franchise
contracts are not the result of typical commercial negotiations. There is, in theory,
ample time. The franchisee has a 14-day cooling off period in which to consider the
deal. By this time the franchise agreement has already been settled through a process
of franchisor centric drafting and it is likely that no amendments will be agreed to.
Cost is not the issue. The additional cost of drafting to provide a termination
right for franchisees would be negligible, especially once that provision had been
incorporated as standard into the franchisor’s usual franchise agreement. However,
the franchisee is required to sign the standard franchise agreement for the network.
There is a perceived risk that the core bargain – the sale of the franchise to the
franchisee – will be lost if the franchisee insists on additional terms. However, once a
franchisee has decided which franchise to buy, it is very difficult to dissuade them.
This is explored further in chapter 3.4.
The damage resulting from franchisor failure is more widespread than that
caused by the failure of an individual franchisee. When a franchisor fails, all of its
365 Ibid 296-7.
Chapter 3: The problem in context 161
franchisees are affected, most adversely. If an individual franchisee fails the
franchisor will not fail, and nor will any other franchisees. Damage resulting from
franchisor failure was explored in chapter 2.3.
3.3.7 EXPLOITATIVE CONTRACT
A franchisor has no incentive to include terms to protect the franchisee from
the consequences of the franchisors’ administration or insolvency. The franchisor has
every incentive to put itself into a contractual position where it can exploit its
franchisees if the relationship does not evolve as the franchisor expected. The
concept of exploitative contracts has been investigated in depth by Bigwood, who
describes the power imbalance between the franchisee (Plaintiff) and franchisor
(Defendant) that creates the environment for exploitation:
What is crucial is that the vulnerability that gives rise to the asymmetric
power relation between the parties is such that P ought to be excused …
from having to exercise that level of responsibility or self-reliance expected
and required of the generality of contracting parties. … the exploitable
circumstances condition presupposes a weakness or vulnerability that, in the
circumstances, removes P from the normal assumptions made about the
bargaining ‘game’… the crux of the exploitable circumstances criterion lie
in the nature and extent of the power relation existing between the parties.
What matters is that P’s interests have become peculiarly sensitive to – that
is, they can be directly, strongly and adversely affected by – D’s choices and
actions and this resultant vulnerability becomes the source of D’s bargaining
The nature of the franchise agreement as a standard form contract means a
franchisee is typically unable to effectively negotiate amendments to provide it with
rights if the franchisor fails. Consequently, the supplier franchisor is entering a
franchise agreement that potentially exploits the franchisee consumer.
In Meridian Madam Justice Dodds-Streeton acknowledged that:
[implying] a term [of good faith], whatever the basis of its implication and
whatever its precise content, may validly operate to protect a vulnerable or
366 Bigwood, above n 341, 143.
162 Chapter 3: The problem in context
disadvantaged party “from exploitative conduct which subverts the original
purpose for which the contract was made. 366F
If protection of franchisees from the consequences of franchisor failure is not
achievable through the franchise agreement, how has the legislature responded? This
will be explored in chapters 4.3, 4.4 and 4.5.
3.3.8 BREACH OF CONTRACT
In theory, franchisees whose franchisor failed could claim breach of the
franchise agreement by the franchisor and make out a contract law based claim, or a
quasi-contract claim. In practice, it is difficult for a franchisor to breach a franchise
agreement as the agreement imposes so few obligations on the franchisor. In the
absence of a breach of a term of the contract, a contract-based claim against a
franchisor could be based on the doctrine of frustration or on unjust enrichment or
Events may occur after a contract has been made which makes its
performance pointless, more difficult or more costly, or even impossible.
Such events may result in the termination of the contract by operation of
law, on the basis that it has been frustrated.367F
Frustration of a contract can only arise if the following conditions are met:
a. The supervening event must cause a fundamental or radical change to the nature
of the contractual rights and obligations;
b. Neither party should have caused or brought about the supervening event;
c. The supervening event must be such that it was not contemplated by the parties
when they entered the contract. It follows, therefore that there should be no
provision in the contract designed to deal with it; and
367 Meridian Retail Pty Ltd v Australian Unity Retail Network Pty Ltd  VSC 223, para 210 at
 citing Warren CJ in Esso Australia Resources Pty Ltd v Southern Pacific Petroleum NL (receiver and manager appointed)  VSC 477, who contemplated that only protection of a ‘particularly vulnerable’ party or a party ‘at a substantial disadvantage’ may justify curial interference. In Meridian, the franchisor’s conduct was not considered to be exploitative.
368 NC Seddon and M F Ellinghaus, Cheshire and Fifoot’s Law of Contract (8th Australian ed, 2002) 881.
Chapter 3: The problem in context 163
d. It must be unjust to hold the parties to the contract to its terms as originally
The failure of the franchisor will meet the first condition. The fundamental
change from the franchisees’ perspective is that the franchisor becomes unable to
deliver on its side of the bargain. It may have lost the right to grant licences to
franchisees to use the trade marks. It may have breached head leases that, in turn,
deprive franchisees of their premises.
The franchise agreement is re-categorised as an asset or a liability and, whereas
prior to the franchisor’s liquidator being appointed the franchisee was entitled to rely
on the franchise agreement as a source of franchisor’s obligations, from the time the
liquidator is appointed the franchisee has no right of access to remedies for breach of
contract and the liquidator is entitled to disclaim the franchise agreement as an
Condition b. may preclude franchisees of some failed franchisors from
accessing frustration as a cause of action. If, for example, the franchisor brought
about its own failure by acting strategically, or caused it by failing to manage its
finances prudently, it is possible that franchisees may be prevented from claiming
Condition c. is met in almost all franchise agreements. Solutions proposed in
chapter 6.2.2 would lead to franchisees being unable to access the remedy of
frustration because all franchise agreements would address franchisor failure.
Whether condition d. is met will depend on whose perspective is taken into
account. From the administrator’s perspective, it would be reasonable for the
franchisee to be held to the contract, whereas for the franchisee, it may be unjust.
It is suggested that an Australian franchisee could not successfully argue
frustration while the franchisor was under administration because the franchise
agreement is between the franchisor or its assigns (which includes the administrator)
and the franchisee.
It is also possible that the sale of the franchise network by a liquidator to an
unsuitable buyer could frustrate the contract if Penrith District Rugby League
369 D Khoury and YS Yamouni, Understanding Contract Law (7th ed, 2007) 419.
164 Chapter 3: The problem in context
Football Club Ltd v Bradley Scott Fittler BC9600163 NSWSC is applied. In that
case, competition under a new league was found to be radically different from that
contemplated by the contracts signed by Bradley Fittler and Matthew Sing (‘the
players’). A proposal to enter into new competitions and to transfer club's assets to
new competition licensee discharged parties from further performance of contracts
and the innocent party (in this case the players) were not responsible for bringing
about circumstances frustrating the contract. The contracts were held to have been
Frustration has not been raised in any Australian franchise cases. In Canada, a
… sought rescission of its franchise agreement based upon fundamental
370 It also sought the return of the franchise fee, royalty fees and
advertising fees paid to the franchisor. In considering the issue of
fundamental breach and the numerous alleged breaches of the franchise
agreement by the franchisor, the [British Columbia Supreme] Court found
that the franchisee had obtained substantially what it bargained for under the
franchise agreement, and accordingly found that there was no fundamental
breach of the agreement.370F
Goldman explains this particular decision stating:
Whether a fundamental breach argument has any chance of success is fact
dependent. The greater the benefit that the franchisee has already received
from being part of the franchised system, the less likely that the franchisor’s
bankruptcy will be found to have fundamentally breached the franchise
Alternatively, franchisees could make out a claim in quasi-contract372F
the administrator or liquidator, for unjust enrichment. This action would theoretically
be available to franchisees in Australia, though it has not been tested in the context of
insolvency in Australian courts. It depends firstly on the court granting consent to 370 Magnetic Marketing Ltd v Print Three Franchising Corp et al (1991) 38 CPR (3d) 540. 371 Goldman, above n 162, 11. 372 Ibid 12. 373 Bruce Moore (ed), The Australian Oxford Dictionary (2nd ed, 2010) 479. ‘Quasi-contract (implied
contract) a form of the equitable remedy of restitution to restore an innocent party to his previous position.’
Chapter 3: The problem in context 165
franchisees to embark on litigation against the administrator or liquidator or against
the directors or solvent related entities of the failed franchisor. Success in
a restitutionary claim based on unjust enrichment depends upon the plaintiff
establishing the following elements:
Benefit or enrichment [defendant has been enriched by the receipt of a
benefit – in the case of the franchisor, upfront fee that was charged for the
right to conduct a franchise for, say, 5 years, but the franchisor became
insolvent after 2 years – 3/5 of the initial franchise fee could be the starting
At the plaintiff’s expense
Unjust factor (unjust to allow the defendant to retain the benefit); and
No bars to the restitutionary claim (no other consideration barring the claim,
such as a subsisting valid and enforceable contract between the parties).
To succeed in a restitutionary claim all these elements must be satisfied. In
the first instance, the plaintiff must prove elements 1-3 on the balance of
probabilities. In many cases this would be sufficient. Generally speaking it is
up to the defendant [liquidator] to raise the issue of a bar to restitution. Then
the plaintiff must prove element 4. If, on the balance of probabilities, the
court is not satisfied that there is no bar to a restitutionary claim, then the
The use of an unjust enrichment action could be considered by franchisees that
recently paid a franchise fee but derived very little benefit prior to the franchisor’s
failure. The pool of money available to the liquidator to pay creditors is artificially
expanded by the franchise fee; thus the liquidator is ‘unjustly enriched’. This was
pleaded by a group of franchisees in Ontario, Canada in one of the Country Style
Food Services cases.374F
375 There, whilst the franchisees did not act quickly or
cohesively enough to succeed, the court did not rule out unjust enrichment as a
possible cause of action for future franchisor insolvency cases.
374 P Davenport and C Harris, Unjust Enrichment (1997) 34. 375 Country Style Food Services Cases: Country Style Food Services Inc v 1304271 Ontario Ltd
Ontario Superior Court of Justice Chapnik J, Judgement: 11 February 2003; in the matter of the Companies Creditors Arrangement Act, RSC 1985 C c-36, As amended AND In the matter of the Courts of Justice Act RSO 1990 c-43, As amended AND in the matter of a plan of compromise or arrangement of Country Style Food Services Inc, Country Style Food Services Holdings Inc, Country Style Realty Limited, Melody Farms Specialty Foods and Equipment Limited, Buns Master Bakery Systems Inc and Buns Master Bakery Realty Inc 15 April 2002 Court of Appeal for Ontario Docket M28458 (Unreported decision).
166 Chapter 3: The problem in context
Both the action for frustration and the action for unjust enrichment may have
the best chance of success where the franchise term has only just begun, as the
franchisee will have paid all upfront costs but derived minimal benefit from the
… occurs where a party, prior to the time for performance under the
contract, evinces an intention no longer to be bound by the contract. … [I]f
the anticipatory breach relates to a breach of an essential term or the
repudiation goes to the root of the contract, the promisee [in this case,
franchisee] may terminate prior to the time for actual performance.375F
The alternative to repudiation relying on anticipatory breach is for the
franchisee to wait for the franchisor to fail to perform an obligation under the
franchise agreement, and then terminate for actual breach.
Consideration of anticipatory breach raises the issues of exactly what terms the
franchisor breached. Typically the franchisor has few contractual obligations, while
the franchisee has many. It can be difficult to identify an actual contract term on
which to found the claim of anticipatory breach following the appointment of an
Franchisees without the appropriate ipso facto termination trigger in their
franchise agreements have to decide whether to adopt the high-risk strategy of
terminating their agreements or remaining bound to the failed franchisor in a legal
‘holding pattern’. To pursue any of the three responses to breach of contract by the
franchisor outlined in chapter 3.2.8 would tax an individual franchisee’s resources.
Litigation would be best undertaken by a group of franchisees.
3.3.9 CONTRACT AND QUASI-CONTRACT BASED REMEDIES
Currently all remedies accessed through the law of contract and the Trade
Practices Act assume the supplier is able to deliver the prescribed solution, or that an
insurer could meet a claim. But, if the supplier is insolvent this assumption is fatally
376 Willmott et al, above n 322, 677.
Chapter 3: The problem in context 167
flawed. Franchisees’ access to remedies for breach of contract brought about by the
failure of the franchisor is hindered by a number of factors.
First, contract law remedies rely on the doctrine of privity of contract. The law
presumes that franchisees and franchisors have a contractual relationship with each
other and that this contract is the source of the breach.376F
377 This does not acknowledge
the complex matrix of contracts and entities that underpin the franchise relationship,
as was demonstrated here and in Appendix D. The commitments that a franchisee
has under third party contracts are not contingent on the franchisors remaining
Second, Hadfield observes, limitations in effectiveness ‘when contract law is
limited to the awarding of damages, a remedy that may be inadequate to deter
deliberate fraud and that may be no deterrence at all against those who have no
Where the franchisor is insolvent, there is not enough money available to meet
a judgment debt to put the ‘innocent’ party back into their pre-contractual situation.
The problems are exacerbated when the number of franchisees affected by one
franchisor insolvency are counted; the ‘innocent parties’ may include as many as 600
franchisees, their families and employees.378F
379 Any litigated or mediated victory by the
franchisees will be hollow.
Third, the powers given to administrators and liquidators under the
Corporations Act render franchisees’ consumer protection and contract law rights
impotent. This is explored in chapter 4.
3.3.10 CONTRACT-RELATED COMPLICATIONS
The execution of the franchise agreement also means that the franchisee is
entering a number of consequential contractual commitments. This was demonstrated
in chapters 3.2.2 and 3.2.3 by examinations of the franchisor and franchisees’
377 The Franchising Code of Conduct requires the franchisor to make disclosure, but only requires
limited information about the other franchisor’s controlled entities that the franchisee must do business with. Appendix D of this thesis graphically demonstrates the numerous possible relationships.
378 Hadfield, ‘The Many Legal Institutions that Support Contractual Commitment’, above n 22, 194. 379 See Table 1 of this thesis.
168 Chapter 3: The problem in context
contractual or lack of contractual, relationships with the owners of the trade marks
that identify the franchise network and its products, and the premises that franchisees
trade from. The franchisor:
serves as a nexus for contracting relationships and … is also characterized
by the existence of divisible residual claims on the assets and cash flows of
the [franchisor] which can generally be sold without permission of the other
contracting individuals. … emphasizing the essential contractual nature of
[franchise networks] … [This] focuses attention on a crucial set of questions
– [including] and how [the contractual relationships] are affected by changes
exogenous to the organization.379F
These legally binding contract-based commitments will be noted and
identified, but not explored in detail here. Their fate following the franchisor’s
insolvency is an area for future research. Consequential contracts in this context
occupy three categories:
First: Contracts entered into with the franchisor; including such agreements as
licences to use intellectual property, software and premises, and various finance
Second: Contracts entered into with third parties, related to the franchisor such
as supplier agreements concerning stock, licence to use intellectual property, lease of
premises and finance arrangements.381F
Third: Contracts entered into with third parties unrelated to the franchisor such
as supplier contracts, vehicle leases, lease or licence of premises,382F
leases, loan agreements – secured over real property or shares owned by the
franchisee before it becomes a franchisee and employment contracts with the
All of the contracts in the three categories above are executory. 380 Jensen and Meckling, above n 21, 311. 381 Frazer and Weaven, Franchising Australia 2004, above n 63, found that 29 per cent of
franchisors provide finance to franchisees, with the most popular being direct finance supplied by the franchisor (59 per cent).
382 Ibid, found that of the franchisors providing finance in Australia, 4.9 per cent did so through a company related to the franchisor.
383 In Australia, 47.1 per cent of franchsiees conduct their business from a retail site or kiosk, 29.3 per cent from mobile unit, van or trailer, 26.8 per cent home based (office or garage), 21.8 per cent of franchisees operate from specific commercial sites, and 4 per cent operate from an industrial site, Frazer, Weaven and Wright Franchising Australia 2008, above n 7, 27.
Chapter 3: The problem in context 169
Pending assumption or rejection [by the liquidator] the debtor [here,
franchisor] is technically not required to perform the obligations under the
executory contract, whereas the non-debtor party [here, the franchisee] is
still required to perform.383F
Typically, none of the consequential contracts in the three categories above
contemplates the franchisee’s rights and obligations when the franchisor becomes
insolvent. They assume the franchisor will remain solvent. While this thesis
concentrates on the relationship between a franchisor and its franchisees, the
franchisee’s situation under any of the above consequential contracts will also be
impacted by the franchisor’s failure.
International dimensions of franchise agreements
Franchise relationships and agreements often contain international dimensions.
This was identified in the pattern of trade mark ownership at 3.2.2, and in Subway’s
standard franchise agreement referred to earlier in this chapter. International law may
have an impact on the jurisdiction and forum in which a franchise agreement is
judged. Importantly, cross border insolvency issues may become relevant to
domestic franchisees by virtue of the franchisor, the parent company, the owner of
trade marks or the franchisor’s financier being outside Australia. This is touched on
again in chapter 4.5 but not explored in depth as it is substantial enough to constitute
a significant research project on its own.
During the initial contract negotiations ‘parties incur ex ante transaction costs,
including the costs of anticipating future contingencies and writing a contract that
specifies an outcome for each one’.384F
When the franchisor/ franchisee relationship is placed in jeopardy through the
appointment of an administrator or liquidator to the franchisor, the franchise
agreement is the first place an administrator or liquidator looks to determine what
responsibilities the franchisor has and what rights its franchisees have. At that point
it is too late for the franchisor and franchisee to negotiate a change in the terms of the
franchise agreement. It is thus important to understand whether franchise
384 Tractenberg, above n 110, end note 22–5. 385 Scott above n 349,190.
170 Chapter 3: The problem in context
agreements, as a genre, can realistically be expected to contain provisions relating to
Private law does matter to those who can use it effectively, for example
businesses that incorporate judicial rulings in standard terms or that seek judicial [or
386 rulings as a framework for structuring their business methods.
Consumers have rarely been able to harness private law to have such systemic
Private contract law is, however, unable to provide solutions to the problem.
‘The franchise situation is a classic example of an unresolved treatment of contracts.
Executory contracts, of which franchise agreements are an example, are not
specifically considered in the UNCITRAL Legislative Guide on Insolvency Law’.387F
Countryman defines an executory contract as ‘one under which the obligation of both
the bankrupt and the other party … are so far underperformed that the failure of
either to complete performance would constitute a material breach excusing the
performance of the other’.388F
389 Rohrbacher explains that ‘the troublesome issue in
executory contracts is not that property and contracts are treated so differently but
that debtors and creditors are treated so differently’.389F
The franchise agreement purports to be a complete package of rights, distilling
the franchisors and franchisees rights and obligations for the duration of the term.
Nevertheless, almost without exception, franchise contracts make no reference to
franchisees’ rights on franchisor failure. This cannot be justified on the basis that it is
so unlikely to occur that no provision needs to be made.
The [franchisor] is a legal fiction which serves as a focus for a complex
process in which the conflicting objectives of individuals (some of whom
may ‘represent’ other organizations) are brought into equilibrium within a
framework of contractual relations. In this sense the ‘behaviour’ of the firm
386 For example Bakers Delight’s successful application under Trade Practices Act 1974 (Cth) s 47. 387 Ramsay, above n 329, 33. 388 United Nations Commission on International Trade Law, UNCITRAL Legislative Guide on
Insolvency Law (2004) <http://www.uncitral.org/uncitral/en/uncitral_texts/insolvency/2004Guide.html> at 5 June 2010.
389 Vern Countryman, ‘Executory Contracts in Bankruptcy’ (1973) 57(1) Minnesota Law Review 439, 460 cited in B Rohrbacher, ‘More Equal than Others: Defending Property-Contract Parity in Bankruptcy’ (2005) 114(5) The Yale Law Journal 1099, 1127.
390 Rohrbacher, above n 391, 1128.
Chapter 3: The problem in context 171
[the franchisor] is like the behaviour of a market, that is, the outcome of a
complex equilibrium process.390F
The insolvency of the nexus triggers a move to a new equilibrium in which the
administrator, and then the liquidator, controls the destiny of the franchisees through
the twin mechanisms of the franchise agreement and the Corporations Act.
The justifications for a contract not to be comprehensive in its terms - that it is
relational, too expensive to include all possible future contingencies, that the
franchise agreement needs to be standardised for ease of administration - do not
support the omission of terms about franchisor failure; an event whose possibility is
real, and whose consequences can be devastating for the franchisee consumer. It can
be concluded that relational contracts are not well equipped to deal with franchisor
failure as the event that triggers a need to renegotiate, franchisor failure, also signals
the end of the relationship between the franchisor and its franchisees.
Ultimately there is no equitable, logical or cost-based justification for the
franchise agreement making extensive provision for some known possible events that
would have a relatively minor effect on the network, such as the possibility of a
franchisee dying, while failing to provide for known and potentially network-
debilitating events, such as franchisor failure.
The franchise agreement is, in theory, negotiable. It may be possible for the
franchisee to insert a provision in the contract that gives the franchisee the right to
‘walk away’ from the franchise system, and to retain the right to use the premises, if
the franchisor fails. In reality the possibility of the franchisor failing is generally the
furthest thing from the new franchisee’s mind, and the franchise agreement is not
Woker observes that ‘the law of contract is wholly inadequate for the purpose
of regulating modern franchise relationships and practices’.391F
392 This is exemplified
clearly when the franchisor fails. The report ‘Opportunity not opportunism’
acknowledged that the current contractual arrangements between franchisor and
franchisee are not satisfactory and recommended ‘that the government explore
391 Jensen and Meckling, above n 21, 311. 392 Tanya Woker, ‘Franchising – The Need for Legislation’ (2005) 17 South African Mercantile Law
172 Chapter 3: The problem in context
avenues to better balance the rights and liabilities of franchisees and franchisors in
the event of franchisor failure’.392F
An action for breach of contract presupposes that there has been a breach.
Franchise agreements always permit the franchisor to terminate the franchise
agreement if the franchisee commits an act of bankruptcy, but seldom makes
provision for franchisees’ rights following the administration or insolvency of the
franchisor. Franchise agreements also require franchisees to obey all relevant laws,
failure to do so constitutes a breach of the franchise agreement and entitles the
franchisor to terminate. Franchise agreements only require the franchisor, as a term
of the contract, to comply with the Code, not with the Corporations Act. Thus a
breach of the Corporations Act or of any other financial regulation by the franchisor
does not pave the way for the franchisee to argue that the franchisor has breached the
It is concluded that the franchise agreement, in its current form, is unable to
address franchisor failure satisfactorily. If protection of franchisees from the
consequences of franchisor failure cannot be achieved through the standard franchise
agreement, it is logical to ask how the legislature has responded. In chapter 4.1 the
effectiveness of legislative initiatives in providing consumer protection for
franchisees of failed franchisors is considered. However, before moving to the
legislature, I will explore the asymmetry of the franchisees’ world in chapter 3.3. As
Thomas J wrote in relation to a distributorship agreement, ‘The sheer commercial
absurdity of this lopsided bargain prompts the question as to how it could have come
about. There is an explanation’.393F
In relation to franchisor failure, the explanation lies partly in the franchise
agreement, as discussed in chapter 3.3, and partly in economic and legal
considerations. These will now be explored.
393 Joint Committee on Corporations and Financial Services, Australian Senate, Opportunity Not
Opportunism: Improving Conduct in Australian Franchising, above n 166, Recommendation 4 [6.40] xv.
394 Bobux Marketing Limited v Raynor Marketing Limited  NZCA 348, para 18 (Thomas J, dissenting).
Chapter 3: The problem in context 173
3.4 ASYMMETRY ISSUES
The problems franchisees experience when their franchisor fails are
particularly difficult to address ex ante because they are unanticipated by franchisees,
who enter the relationship unprepared for franchisor failure. The lack of preparation
by franchisees is contributed to by numerous asymmetrical features of franchising.
Asymmetry exists in every aspect of franchising; in the structure of the
franchise network, the timing of events, the contents of contracts, and the legislation
designed to protect consumers. It compromises the parties’ awareness of the need to
self-protect and on their so opportunity to do so. Franchisees make, and re-make their
investment based on fatally flawed information. This devalues the due diligence
process, reduces the effectiveness of the Code and limits franchisees’ ability to plan
an effective exit strategy from a failing or insolvent franchisor.
Despite the requirement of pre contractual disclosure, franchisees as consumers
seldom anticipate the possibility of the franchisor’s business failing or the effect that
event may have on their rights and obligations as a franchisee. The franchisee is a
typical consumer functioning in an environment where Iain Ramsay observes:
The ‘responsibilisation’ of the consumer is being pursued … governments
are investing heavily in projects to ensure that individuals become
responsible consumers through the use of information … These programs
often make heroic assumptions about the ability of consumers to use and
process information on market choices and their ultimate results remain
uncertain and difficult to measure.394F
The exploration of asymmetry between franchisor and franchisee that follows
demonstrates areas where the information supplied to educate franchisee consumers
to become more responsible may serve to mislead them about the risks they should
consider before signing the franchise agreement. It also helps underscore Ramsay’s
concerns that the ‘heroic assumptions’ made by governments are flawed.
3.4.1 INFORMATION ASYMMETRY
It is assumed that parties to a long-term contract will perform comprehensive
due diligence on each other as prospective business associates and on the business
395 Ramsay, above n 329, 13.
174 Chapter 3: The problem in context
offering. The franchisor provides the franchisee with the information that it wants the
franchisee to know, and complies with the disclosure requirements of the Trade
Franchisees are advised to conduct their own due diligence beyond the Code
disclosure. Franchisees are routinely blamed by courts, commentators and
franchisors for failure to conduct adequate pre-purchase due diligence. For example a
delegate of the FCA, when asked to comment on a report about franchisor failure
replied that ‘[f]ranchising is risky and some people might not be adhering to the
396 Such a dismissive response to a serious issue by an industry
representative tends to make prospective franchisees think that as long as they follow
the process established by their franchisor, they will not be part of a franchisor
failure. The facts do not support this.
When it comes to disclosing the possibility of franchisor failure the franchise
market is a little like ‘the market for cigarettes: manufacturers compete among
themselves for market share but have a common incentive not to disclose
information about the risks from smoking so long as these risks apply to all
397 Similarly, any franchisor may fail. All franchisors have an interest in
holding the line that they will succeed.
Given the high costs of investigating the safety of a given unfamiliar product
prior to purchasing, it is not surprising that a general expectation that
products on the market are acceptably safe is a crucial assumption of most
consumer behaviour, influencing the value that consumers place on
The 2006 UK franchise survey reports that its initial source of information
about the franchise industry was equally (20 - 21 per cent) magazines, newspapers
399 In the United Kingdom, information about a specific
franchisor came from magazines (18 per cent) and exhibitions (20 per cent).399F
396 Jacqui Walker, ‘Help for Squeezed Business’, Business Review Weekly (Melbourne), 30 March
2006, 24. 397 Trebilcock, above n 29, 70. 398 Ibid. 399 NatWest bfa United Kingdom, Franchise Survey 2006, above n 254, 30. 400 Ibid 20.
Chapter 3: The problem in context 175
of these are objective information sources. Such information is often not capable of
being objectively verified.
‘A consumer protection problem is more likely to be present where there is no
obvious reason for consumers to doubt their general expectation of safety, so their
expectation can easily be exploited’.400F
401 ‘An important implication of this focus on
general consumer expectation is that the more obvious a consumer protection
problem has become the less of a problem it may come to be’.401F
Rights and liabilities recorded in the franchise agreement are asymmetrical. So
too is the opportunity for franchisors and franchisees to shelter their assets from
[I]ndividuals have preferences that change through time, are concerned for
others, have varying attitudes to risk depending on how risks are framed and
what reference points are available, violate rationality by overestimating
their skills, over-project the current state, use rules of thumb or heuristics to
solve problems and make decisions affected by transient emotion.402F
A franchisee conducting due diligence to verify information disclosed by the
franchisor is potentially confronted with numerous impediments to obtaining full
Franchisees often do not register their business names. It is thus impossible to
verify from the public record, the identity of the owners and former owners of
franchisees of franchised outlets. The 2008 Amendments to the Disclosure Document
under the Code partially rectified this problem by S 11.2 of Annexure 1 (the
Due diligence cannot anticipate the events that precede some franchisor
administrations or insolvencies and no franchisee or franchisee’s professional adviser
could reliably anticipate when a franchisor might to embark on a course of strategic
401 Trebilcock, above n 29, 70. 402 Ibid. 403 Steven Kennedy, ‘The Future of Consumer Policy: Should we Regulate to Protect Homo
Economicus?’ (Accord Industry Leaders Briefing, Old Parliament House, Canberra 13 August 2009) 10 citing Stefano Della Vigna, ‘Psychology and Economics: Evidence from the Field’ (2009) 47(2) Journal of Economic Literature 315, 316.
404 Appendix A of this thesis.
176 Chapter 3: The problem in context
insolvency. Any disclosure document is a snapshot of the franchisor’s business at the
date it is made. It is always going to be of limited value for that reason.
Franchise agreements last from a short term of 1 year404F
405 to, in some cases, (eg
Signwave) 35 years and in rare cases (eg Fastway couriers) indefinitely. It is
unrealistic to expect a franchisee to conduct due diligence that sees far into the
future, even if infinite resources were available for the task.
Information asymmetry includes the difference between what is written in the
contracts and what is the ‘culture’ of a particular franchise. This has been expressed
as: ‘Each contract says what it says, but the culture underlying the way parties
choose to operate the levers that contract gives them may be producing quite a
different effect than appears to a superficial or even a close reading’.405F
In Australia neither disclosure documents nor a network’s pro forma franchise
agreements are available to the public. This means that the franchisee’s advisers
cannot compare the offering before them with either the usual documentation for
franchisees in the network or with the franchise agreements of other comparable
franchisors. This limits the value of professional advice as it is unable to be
contextualized. This issue was raised in several of the submissions to the inquiry that
culminated in the Opportunity not opportunism report. The government has partly
accepted that the problem causes a real impediment to the creation of responsive
policy. Recommendation 2 starts to address a solution by recommending:
…that the government investigate the benefits of developing a simple online
registration system for Australian franchisors, requiring them on an annual
basis to lodge a statement confirming the nature and extent of their
franchising network and providing a guarantee that they are meeting their
obligations under the Franchising Code of Conduct and the Trade Practices
405 Frazer, Weaven, Wright Franchising Australia 2008, above n 7. 406 Evidence to Economic and Finance Committee, Parliament of South Australia, Official Hansard
Report, 6 February 2008, 38 (JR Rau MP).
Chapter 3: The problem in context 177
Recommendation 2 represents incremental progress, but if it is adopted
franchisees and their advisers will still not have a means of establishing a context for
the specific franchise agreement being advised on and signed.406F
Typically, the franchise agreement does not provide any specific rights to the
franchisee on the franchisor’s insolvency. Thus, neither the Disclosure Document nor
the franchise agreement would direct a legal adviser to consider franchisor failure or
its consequences unless the lawyer or accountant providing advice also happens to
work in the highly specialised field of insolvency.
3.4.2 ADVISER AND ADVICE ASYMMETRY
The calibre and expertise of their advisers has a bearing on a franchisee’s
understanding of what they are signing. It also has a bearing on whether any
meaningful pre-purchase or post failure negotiation occurs.
Legal and accounting advice
Franchisors frequently use professional advisers who have created numerous
franchise agreements for a range of franchise models. For example, Stephen Giles, of
Norton Rose law firm, says: ‘[m]y firm would represent over 300 franchisors (due to
our size we do not have a large franchisee constituency)’.407F
408 Large legal and
accounting firms also have experience in advising franchisors on how to shelter
personal assets from franchisees.
The franchisee will, ideally, also engage advisers with franchise expertise. The
identity of these professional advisers is found through advertisements in franchise
magazines, their presence at trade shows, ‘asking around’ or searching the
409 Lawyers with specific areas of expertise can be found through the state or
territory law society. The ‘business law expert’ is superficially the ideal lawyer to
provide franchisee advice. But, as Solomon observes:
knowledge of business law may enable someone to 'read' a contract
competently, but that isn't really the due diligence on the transaction itself.
407 Joint Committee on Corporations and Financial Services, Australian Senate, Opportunity Not
Opportunism: Improving Conduct in Australian Franchising, above n 166, para 4.81. 408 Evidence to Economic and Finance Committee, Parliament of South Australia, Official Hansard
Report, 6 February 2008, 33 (Stephen Giles). 409 For example, unsing the Findlaw website http://www.findlaw.com.au/wld/QuickSearch.asp
lawyers are searchable under the specialty area ‘franchises’. No lawyers possessing franchise expertise are listed for the Northern Territory or Tasmania.
178 Chapter 3: The problem in context
… a business lawyer who is not up to date on what is happening in the
franchise industry most probably will not 'spot' many of the contract
language traps. 409F
Solomon continues, ‘[t]he franchise industry … uses that lack of available
[legal and also accounting] expertise to enable rampant misrepresentation’.410F
Franchisees will seek an accountant’s advice in relation to the feasibility of the
business opportunity described in the disclosure document. Australian accountants
are either Chartered Accountants (‘CAs’) or members of CPA Australia (‘CPAs’).
As a generalization, the CAs advise larger commercial clients (franchisors and
master franchisors), work in the city, include liquidators in their number, and may be
members of the FCA. The CPAs are more often suburban or country town
accountants who would typically advise franchisees and would be less likely to join
the FCA as their practices would not specialise on franchising and could not justify
Accountants are not necessarily able to predict the future solvency of the
franchisor, even with access to the disclosure document. In testing the return on
investment, the accountant is unlikely to model the return based on the franchisor
itself failing one or two years into the relationship. If they did, they would be quick
to tell their client to select another form of investment.
The regulator as educator
The Matthews Report identified that:
[t]he ACCC and peak industry associations undertake an important role in
providing education and information resources for franchisees and
franchisors. These resources should strengthen the message to prospective
franchisees in particular that they should seek advice from suitable and
independent franchise sector advisors.411F
410 Richard Solomon, ‘License to Lie, Cheat and Steal: Impact of Acknowledgement & Integration
Clauses’ (2008) Blue Maumau <http://www.bluemaumau.org/license_lie_cheat_and_steal_impact_acknowledgement_integration_clauses> at 15 May 2008.
411 Ibid. 412 Matthews, above n 113, 37, Recommendation 9.
Chapter 3: The problem in context 179
The Government agreed with this recommendation.412F
413 However two years
later, the ACCC published Franchisee Manual,413F
414 made no mention of the care that
should be taken to ensure advice comes from advisers who understand franchising. In
2009 the ACCC finally added information to its website under the heading ‘What if
the franchisor becomes insolvent (fails)?’414F
In its role as educator the ACCC can do more to make franchisees aware of the
fact that franchisors fail more often than the rhetoric suggests. However their ability
to warn franchisees of risks of specific networks will always be hampered by the
differences among franchisors’ legal structures, and their varying approaches and
attitudes to risk sharing. Each individual franchisor is thus the only party that can
adequately predict the possible effect of its failure on its own franchisees.
Although 21.2 per cent of franchisors ranked ‘difficulty in finding franchisee
finance’ as the third greatest hindrance to growth in 2006, all four major trading
banks in Australia have specific policies to assist in the purchase of franchisee
businesses. All four - ANZ,415F
416 Commonwealth Bank of Australia (CBA), National
Australia Bank (NAB), and Westpac (WBC) 416F
417 - are ‘service provider’ members of
the FCA. 417F
None of the four mentions the risk of franchisor failure on their websites. This
tends to indicate one of two things. Either, the area of the bank dealing with loans
that have ‘gone bad’ and the business lending and the marketing areas of the banks
do not communicate with each other about specific customers. Or, banks decide that
because they have adequate security from franchisees they are not worried that their
policies of lending to the franchising sector will trigger awkward questions at
413 Australian Government Response to the Review of the Disclosure Provisions of the Franchising
Code of Conduct (2007) 4. 414 ACCC, Franchisee Manual (7th ed, 2008). 415 ACCC, What if the Franchisor Becomes Insolvent (fails)?
<http://www.accc.gov.au/content/index.phtml/itemId/861040> at 1 February 2010. 416 ANZ Bank Website <www.anz.com.au> at 5 June 2010. 417 Westpac Bank Website <www.westpac.com.au> at 23 May 2008. 418 Franchise Business <http://www.franchisebusiness.com.au/FAMemberList.aspx?> at 3 June
180 Chapter 3: The problem in context
The situation of failed jewellery retail franchisor Kleins and the NAB is a clear
reason why banks need to monitor the ongoing viability of the franchisors they
approve. Failure to do so places them at risk of misleading franchisees that the
franchisors business is still a sound investment.
Turning to each of the banks to see what their customers might be able to learn
from them about the franchisors whose franchisees they will fund, and about
franchisor failure. The ANZ does not publicise the names of those franchisors to
which it has accorded preferred status. It states:
We work from the basic belief that franchise businesses are different and
usually inherit some strengths and capabilities from the franchisor. ANZ
offers ANZ Preferred status to selected franchisors to reflect the value of
their franchise system. 418F
The CBA website publishes a list of 35 accredited franchises419F
420 but does not
mention protecting franchisee customers against the risk of franchisor failure.
NAB publishes a list of approved franchise systems, stating:
For franchisees, ‘Joining a NAB Accredited Franchise System means that
you may be able to borrow up to 70 per cent of the total set up cost of a new
franchise, or purchase cost of an existing franchise, without necessarily
providing your home as collateral for the loan. 420F
The message to prospective franchisees is that each of these Accredited
franchisors is a reputable, secure investment in the eyes of the NAB. The list of NAB
Accredited Franchise Systems included Kleins on 23 May 2008. 421F
422 As at May 2008,
there was no public record that any of the three central companies that make up the
Kleins group had filed any documents with ASIC since January 2003. On seeing
Kleins on the NAB list, between KFC and McDonald’s, prospective franchisees
would have been entitled to conclude, as late as 23 May 2008 that NAB had
confidence in Kleins as an investment. NAB was identified in May 2008 as the
419 ANZ, ANZ Franchising
<http://www.anz.com/australia/business/IndustrySpecialisation/Franchising.asp> at 2 June 2008. 420 Commonwealth Bank, Franchise Banking <http://www.commbank.com.au/corporate/your-
industry/franchising/default.aspx> at 1 February 2010. 421 NAB, NAB Accredited Franchise Systems
<http://www.nab.com.au/wps/wcm/connect/nab/nab/home/business_solutions/8/6/4> at 1 February 2010.
422 NAB Website <www.nab.com.au> at 23 May 2008.
Chapter 3: The problem in context 181
biggest secured creditor of the Kleins group (in administration), being owed
approximately A$15million. This raises issues that will not be dealt with here of a
bank’s duties to its Kleins franchisee customers, and the extent to which it exposes
itself to claims by Kleins’ disenfranchised franchisees.
[f]ranchise lending is one of the four core business units in the TPD [Third
Party Distribution] system. ... The business maximises Westpac's share of
the franchising market by developing profitable relationships with
franchisors, providing referrals and expert advice to Business Banking sales
people; and also providing input into WBC's franchising policies and
This indicates that WBC manages its risk exposure by securing loans to
franchisees over the franchisees’ home. This protects the bank from losing money if
a franchisor fails, but exposes the franchisee to the risk of significant loss. Westpac
also recommends that prospective franchisees should consider the following
What's the franchisor’s track record (financial and management)?
How much control do you (and the franchisor) have?
What are the renewal and termination terms and conditions?
Do you see your investment in a franchise as a long-term commitment? 423F
These questions are generic and are not supported by examples or placed
within a context. They will not make a franchisee ask questions about the
consequences of franchisor failure.
The banks go no further than to hint in oblique terms that one of the
considerations for an intending franchisee should be the consequence to the
franchisee of franchisor failure.
Additional sources of advice
Governments and banks direct prospective franchisees to additional sources of
general franchise information. These additional sources of general information are
423 Westpac Bank Website <www.westpac.com.au> at 1 May 2008 424 Ibid.
182 Chapter 3: The problem in context
the FCA, franchise magazines and Do-It-Yourself or primer books. None is sufficient
to put the franchisee on notice that the franchisor might fail.
The FCA is an influential industry group. It provides information through its
website, its publication The Franchise Review, and its education programs. None of
these provide any information about franchisor insolvency. The FCA website also
… the nature of the franchise relationship was open to exploitation prior to
1998 in Australia, when franchising operated in a de-regulated environment.
As a consequence the public perception of franchising was tarnished by
several high profile franchise failures … Behaviour in the sector was not
universally appropriate, and franchisees had far less investment security.
Since 1998 the sector has not only grown, but matured and developed into
one of the primary engines for economic growth in Australia.424F
The inference to be drawn from this statement is that prior to 1998, when pre-
contract disclosure was voluntary for franchisors, there were some unprofitable
franchisors and some of them failed but that this does not happen any more. Table 1
demonstrates that numerous franchisors’ businesses have failed since 1998.
The first introduction to a specific franchise network may be at a franchise
business opportunity expo. These are held in major population centres annually and
are a widely accepted franchise promotion method. Regardless of the source of
426 there is a ‘sameness’ about all franchise opportunity advertising. In
the words of American franchise lawyer and commentator Richard Solomon:
If you look at all the franchise adverts for franchise opportunities in any
business category, they all say the same thing -- we know how to do it -- we
can show you how to do it -- you save a lot of money and reduce risk of
failure if you do it with us -- we have the 'secret' to success -- we will
support you to achieve success -- we have the proven system -- we have the
name recognition -- we get you up and running quickly. In actual fact, most
of this is not even remotely true.426F
425 Franchise Council of Australia, above n 121, 7. 426 Be it a broker, the FCA, or the franchisor’s website. 427 Solomon, above n 412.
into a long-established franchise, believing them to be well-proven. They trust the
information supplied by the franchisor and have difficulty obtaining objective third
party perspectives. There is no incentive for anyone involved in the franchise sales
process, nor for any current franchisee of the network, to mention the risk of the
3.4.3 RISK ASYMMETRY
In reply to the question ‘Are there risks the [intending franchisee’s] business
plan cannot address?’ the ACCC wrote in 2009: ‘[e]very business faces risk. One
risk to franchisees is the franchisor becoming insolvent, which can sometimes
The franchise agreement is effectively a contract uberrimae fidei 428F
429 for the
franchisee, but not for the franchisor as the franchisor entity has only specific
disclosure requirements. The shifting of risk that is achieved by appointing
franchisees is a significant benefit to the franchisor. A fundamental aspect of
franchising is the separation of ownership, by the franchisees, from control, which
remains with the franchisor. This can also be expressed as a separation of risk
bearing, again by the franchisees, and decision functions, which rest with the
430 For example, as was seen in chapter 3.2.3, when the franchisor takes a
head lease of retail premises in its own name, it is common for the franchisee to
become the guarantor of the franchisor’s performance under the head lease. The
franchisee, thus, takes almost all the risk on the premises, while the franchisor retains
the full benefit of the site lease being in the franchisor’s name. The franchisor
executes the franchise agreement and requires the franchisee, and if the franchisee is
a corporation, its guarantors, to sign, whereas the franchisor’s directors rarely
provide personal guarantees to franchisees.
Another example of risk shifting is the practice of structuring a franchise
relationship to function like a commission agency. Here, the franchisee attracts the
428 Australian Competition and Consumer Commission, ‘Understanding the Issues in Franchising’
(2009) Franchise Review 65. 429 Mann and Blunden, above n 15, 585, Utmost Good Faith. 430 See Eugene F Farma and Michael C Jensen, ‘Separation of Ownership and Control’ (1983)
XXVI(2) Journal of Law and Economics 301, 304 who do not include franchise networks in the spectrum of organizations discussed.
184 Chapter 3: The problem in context
customers, but payment by the customers for the products or services they purchase
is made directly to the franchisor. The franchisor then pays a commission to the
franchisee. The two risks that the franchisee assumes in this scenario are that the
franchisor will be prepared to chase the customer for payment and that the franchisor
will remit the commission to the franchisee, both in a timely manner.
Research on approaches to risk in franchising has been carried out by Paul
Rubin and by Lafontaine and Bhattacharyya. Neither factored the failure of the
franchisor into their risk research. Looking at the franchise investment as a
proportion of an individual’s entire portfolio of assets, Rubin’s view is that ‘since
franchisees commonly invest a large share of their assets in acquiring the franchise, it
is unlikely that’430F
431 franchisors are more risk averse than franchisees.
Lafontaine and Bhattacharyya consider the role of risk in franchising431F
the perspective of the investment in the single franchise unit rather than as a
component of an individual’s entire investment portfolio. After examining a number
of factors in the franchisor/franchisee relationship they conclude that franchising is
not necessarily selected for its risk shedding potential.
One of the factors evaluated by Lafontaine and Bhattacharyya was failure rates.
They confined their inquiry to the failure of franchisees and of franchisor-owned
outlets, and did not extend their inquiry to entire networks. They note that:
… failure rates will still be sensitive to franchisor moral hazard; if a
franchisor shirks, or behaves opportunistically, this will increase the
probability of failure for all units in the chain and is likely to show up in the
discontinuation statistics. 432F
Lafontaine and Bhattacharyya conclude that:
… there are patterns in the data that seem to imply that franchisees bear
more risk than franchisors. Under models based on efficient risk allocation
this leads to the conclusion that franchisors are more risk averse than
431 Paul H Rubin, ‘The Theory of the Firm and the Structure of the Franchise Contract’ (1978)
XXI(1) The Journal of Law and Economics 223, 225 in Francine Lafontaine (ed), Franchise Contracting and Organization (2005) 18, 20.
432 Francine Lafontaine and Sugato Bhattacharyya, ‘The Role of Risk in Franchising’ (1995) 2 Journal of Corporate Finance 39, 55 in Francine Lafontaine (ed), Franchise Contracting and Organization (2005) 164, 180.
Chapter 3: The problem in context 185
franchisees, a conclusion we find unappealing given their respective sizes
and differential access to capital markets.433F
3.4.4 RESOURCE ASYMMETRY
The FCA acknowledges that there are disadvantages to the franchise model
3. The prospective franchisee may find it difficult to assess the quality
of the franchisor. This factor must be weighed very carefully by the
potential franchisee for it can affect the franchisee in two ways.
A. Firstly, the franchisor's offer of a business-format package may not
amount to what it appears to be on the surface.
B. Secondly, the franchisor may be unable to maintain the continuing
services which the franchisee is likely to need in order to sustain their
6. The franchisor's policies may affect the franchisee's profitability. For
example, the franchisor may wish to see his franchisee build up to a
higher turnover from which he gets his continuing franchise fee, while
the franchisee may be more concerned with increasing his profitability,
which does not always necessarily follow from increased turnover.
7. The franchisor may make mistakes in their policies. They may arrive
at decisions, relating to innovations in the business which turn out to be
unsuccessful and detrimental to the franchisee.
8. The good name of the franchised business and its brand image may
become less reputable for reasons beyond their own control.434F
Prospective franchisees would have difficulty assessing whether a specific
franchisor has any of the possible flaws listed above. Disadvantages 6, 7 and 8, like
insolvency, refer to future matters. Even with unlimited resources, it is impossible for
a franchisee to make an informed assessment about these issues.
434 Ibid 193. 435 Franchise Council of Australia
http://www.franchise.org.au/scripts/cgiip.exe/WService=FCAWWW/ccms.r?PageId=10111 at 22 Juen 2010.
186 Chapter 3: The problem in context
3.4.5 CONTRACT ASYMMETRY
In economic terms, the ‘role of contract law is to minimize the cost of the
parties writing contracts + the cost of the courts writing contracts + the cost of
inefficient behaviour arising from poorly written or incomplete contracts’.435F
‘Standardised contract terms are … [a] regulatory instrument’ 436F
437 that places all
of the power to regulate the difficult times the relationship will experience, in the
hands of the drafter, the franchisor.
In the context of economics, contract terms play a dual role; ‘creating the
correct marginal incentives on a contractually specified measure of (or proxy for)
performance, and ... the creation of rents sufficient to make the relationship self-
438 In franchising, the marginal incentives created within the franchise
agreement do not outweigh the disadvantages to the franchisees whose franchisor
operates its business so poorly or recklessly that an administrator or liquidator is
appointed. In theory franchisees can negotiate some protection into the franchise
agreement. In practice, most cannot.
At negligible extra cost a franchisor can include a provision to give franchisees
the right to terminate the franchise agreement if an administrator is appointed. Yet
anecdotal evidence suggests that only one franchisee in each of the 270-franchisee
Traveland and the 60-franchisee BHG networks had a clause in their agreements
permitting them to terminate the agreement if the franchisor fails.438F
have no incentive to write contracts that fully acknowledge both parties’ risks.
3.4.6 LEGISLATIVE ASYMMETRY
[R]isk is a key concern for policymakers. All other things being equal and
where possible, we aim to reduce the overall level of risk and complexity in
A risk that is currently addressed in both franchisor agreements and the
441 is the risk of the franchisee’s business failing - there is no reciprocal 436 D Wittman, Economic Foundations of Law and Organization (2006) 194. 437 Trebilcock, above n 29, 77. 438 Benjamin Klein, ‘The Economics of Franchise Contracts’ (1995) 2 Journal of Corporate Finance
9, 19 in Francine Lafontaine (ed), Franchise Contracting and Organization 2005, 323. 439 Liquidator appointed by the court 18 December 2008, ASIC, National Names Index
<http://www.search.asic.gov.au/cgi-bin/gns030c?acn=098_577_667&juris=9&hdtext=ACN&srchsrc=1> at 19 December 2008.
440 Kennedy, above n 403, 15.
Chapter 3: The problem in context 187
statutory protection if the franchisor fails. As we saw in 3.4.5 contracts remain
asymmetrical to the disadvantage of franchisees. The legislation does not provide the
level playing field it was enacted to provide in response.
Hadfield observes that ‘[e]ither because current regulation is piecemeal or
more fundamentally, because franchise relationships are too complex to reduce to
precise statutory terms, the heart of franchising’s legal structure is still contract’.441F
The contract could, theoretically, provide protection for franchisees from some of the
consequences of their franchisor’s failure. In reality, because of asymmetry, they
cannot routinely do so.
The nature of the franchise agreement, the difficulty of conducting adequate
affordable due diligence, the possibility of strategic insolvency, the fact that the Code
may not bind administrators and the stay on proceedings during administration and
insolvency mean that the most solid avenue forward for fair franchise contracts is for
terms to be implied into all franchise agreements via a Franchise Contract Act along
the lines of the Insurance Contracts Act 1984 (Cth). This option will be examined in
Steven Kennedy also identifies that ‘in many cases government actions tend to
reallocate risk between different groups’.442F
443 This reallocation is partly a result of
lobbying. At least one researcher has suggested that:
the dearth of information on franchisor failure is largely a reflection on the
strength of the franchise lobby constituted by franchisors and their
representatives. Similar franchisor biased representation is prevalent in the
Australia, American, Canadian and British context. This lobby has an
interest in promoting the franchise cause, and hence has resisted (and
perhaps limited) published research on franchisor failure. 443F
The franchisee investigates the franchise opportunity believing the business is
sound and viable. It may be impossible to conduct due diligence much beyond what 441 Trade Practices (Industry Codes – Franchising) Regulations 1998 (Cth) s 23. See Appendix A of
this thesis. 442 Hadfield, ‘Problematic Relations: Franchising and the Law of Incomplete Contracts’, above n
202, 939. 443 Kennedy, above n 403, 15. 444 Morris, above n 41, 3.
188 Chapter 3: The problem in context
the franchisor has disclosed. This may be for any of numerous reasons. In chapter 3.2
we saw that franchisors are more diverse, and in some cases far more complex than
many franchisees, financiers, regulators and franchisee advisers recognise.
Franchisors are becoming more complex as the model evolves. The franchisor
may not be a corporation; it may, as Kleenmaid was, be one of 14 interdependent
entities sitting alongside another related corporate group of 10 corporations that dealt
directly with the ‘franchisees’ customers,444F
445 whose roles are not identified or
explained to the franchisee. The franchisees’ money may flow freely among the
franchisors’ entities, it may not be used for the purposes the franchisees paid it for.
The cost of the due diligence may be prohibitive, or the franchisee may decide to
save money on advisers and believe the layman’s rhetoric that due diligence requires
only that that they have looked ‘at the facts of [the] deal from all angles to make sure
they stack up’.445F
The franchisee’s ongoing contractual liabilities to third parties assume, but are
not contingent on, the franchisor’s solvency. The franchisor may, for example, may
control all head leases on franchisees’ premises. If the franchisor has breached the
head leases by failing to pay rent or committing an act of bankruptcy, landlords may
terminate leases and evict the franchisees even though the franchisees are up to date
with rental payments to the franchisor. At the level of state and territory legislation,
if the franchisor breaches the head lease, even a franchisee sub-lessee or licensee that
could trade strongly without the franchisor’s brand has no statutory rights to become
head lessee. Although the existence of the trade marks and other intellectual property
used by franchisees will be identified in the disclosure document, they may not be
owned by the franchisor. This was explored in chapter 3.2.2. The consequences of
the franchisees’ lack of rights will be visited in chapter 4.4.
Similarly, where franchisees need to trade from retail premises, there is a wide
range of possible models, as was demonstrated in chapter 3.2.3. Not all of these
provide suitable options for franchisees if the franchisor fails. This will be explored
in chapter 4.4.4 and 4.5.
445 See Appendix D of this thesis. 446 Jason Gehrke, What is Due Diligence (2009) Smartcompany
<http://www.smartcompany.com.au/franchise-tips-and-trends/20090929-what-is-due-diligence.html> at 5 June 2010.
Chapter 3: The problem in context 189
It was shown, at 3.2.4–3.2.6 that franchisees occupy a unique space in the
business world, being neither employees nor independent contractors/suppliers.
Other players that would perform the roles in a non-franchised business that
franchisees perform in the franchise network would negotiate appropriate protection
from identified legal and business risks before signing contracts. Chapter 3.3
explored the franchise contract and demonstrated three key aspects of franchise
agreements: they are not traditional commercial contracts between two business
people, a few individual franchise agreements may contain ipso facto clauses relating
to the franchisor’s insolvency, but most of the 11,000 or so do not, and even if they
did include clauses to protect franchisees, the remedies available for breach of
contract are inappropriate as a means of compensating franchisees.
Some of the asymmetries in franchise relationship were introduced in chapter
3.4. From every perspective explored; information, risk, resource, contract and
legislation, franchisees experience significant asymmetry, always to their detriment.
Franchisees are vulnerable as business consumers.
Chapter 4: Is the current regulatory response adequate to deal with the problem? 191
Chapter 4: Is the current regulatory response adequate to deal with the problem?
In chapter 2 the problem of franchisor failure, and some of its impacts, together
with some of the challenges that liquidators face were identified. In chapter 3.2 it
was demonstrated that franchisees cannot self protect against the consequences of
franchisor failure through contract law. In this chapter the efficacy of the current
consumer protection regime for franchisees whose franchisor fails will be examined.
Consumer protection policy and legislation is designed to moderate the effects
of the free market. For Australian franchisees consumer protection is provided
through the Trade Practices Act and the Code. If current consumer protection
regulation is up to the task of addressing the challenges presented by franchisor
failure in a way that meets benchmarks B1 and B2 and B3 that were introduced in
chapter 1, the current law should remain unamended.
On realising that neither their franchise agreement nor the common law of
contract provides them with legal rights to respond to their franchisor’s failure,
franchisees turn to the Trade Practices Act, the Code and the Corporations Act. If the
franchisee traded from retail premises they may also turn to their lease, sub-lease or
licence agreement and the relevant state or territory retail tenancies legislation.446F
The potential avenues under the Trade Practices Act, the Code, the Corporations Act
and the Retail Leases Act 1994 (NSW) will be explored in chapters 4.3 to 4.5.
4.1 THEORY OF THE MARKET-LED SOLUTION
The traditional view in the late 20th century was that markets worked things out
over time, but ‘[i]n the case of a competitive market, there are a number of
characteristics that may lead to a hypothesis that a market-based solution is unlikely
447 Leases (Commercial and Retail) Act 2001 (ACT); Retail Leases Act 1994 (NSW); Business
192 Chapter 4: Is the current regulatory response adequate to deal with the problem?
to emerge.’ 447F
448 Trebilcock identifies five characteristics that are all relevant to the
market for the sale of franchise businesses to franchisee consumers.
First, ‘[r]epeat transactions are rare, and consequently the performance
incentives created by the possibility of repeat business from satisfied customers are
449 Franchisees as consumers of the franchisor’s business opportunity would
typically only purchase one franchise. If they purchase into a second franchise
network after the first franchisor fails they are likely to insist on the franchise
agreement containing an ipso facto clause – this explains the presence of an ipso
facto clause in the agreements of one of the 270 Traveland franchise agreements and
one of the 60 BHG franchise agreements.
Second, ‘[e]ntry and exit costs in the industry are low, leading to the possibility
of a large number of fly by night operators with few sunk costs and only modest
investments in reputational capital’.449F
450 Trebilcock is referring to franchisors and
national master franchisors. Sometimes entry costs in franchising are relatively low,
even where the franchisee is required to pay a high franchise fee. However, even
where entry and exit costs are very high for the franchisee business consumer, fly-
by-night operators at franchisor and national master franchisee level still exist.
Reputational capital may indeed be only a modest investment for some franchisors;
many trade through companies with forgettable names, in large markets, and can
easily disassociate their own name and reputation from that of the failed entry.450F
Alternately they are able to hide their true identify by using trusts, as occurred in
Australian Competition and Consumer Commission v Chaste Corporation Pty Ltd (in
liquidation)  FCA 1212. Because the failure of a franchisor is not specifically
identified by a bank or by ASIC as being linked to all of its franchisees the
magnitude of the fallout is easy to under-estimate.
Third, ‘[m]any sellers or producers are extra jurisdictional, making redress
through private law more difficult for customers. Sellers characteristically have few
448 Trebilcock, above n 29, 72. 449 Ibid. 450 Ibid. 451 Although, one director of a now failed Australian franchisor went so far as to change his name by
deed poll to distance his identity from his past as a solicitor who had been jailed for fraud following misuse of his firm’s trust account.
Chapter 4: Is the current regulatory response adequate to deal with the problem? 193
assets against which a judgment may be enforced’.451F
452 In franchising up to 25 per cent
of franchisors are foreign based and many more are based within Australia, but in a
different state or territory from the franchisee. This extra jurisdictional dimension to
franchise relationships potentially hamper franchisees’ ability to conduct due
diligence, and to resolve disputes.
The franchisees’ ability to conduct pre contractual ‘soft’ due diligence beyond
what can be found on the public record is much easier if the franchise network is
locally based. Soft due diligence consists, for example, of speaking with suppliers to
the network and existing and former franchisees to discover what is the franchisor
really like and what is being a franchisee of this network really like?
The existence of an overseas franchisor may make it difficult and expensive for
franchisees to access redress through private law. Contributing factors include
453 the language in the franchisor’s jurisdiction, distance to travel
454 the size of the dispute and the amount of time away from the business
that litigation will necessitate.
In addition, the franchisor entity is likely to have few assets, as the individuals
involved have the opportunity to shelter assets from the franchisor’s creditors.
Fourth, ‘[t]he costs to consumers of a ‘bad’ transaction are delayed or
potentially catastrophic, making ex post relief an inadequate or unsatisfactory
455 The costs to franchisees of a failed franchisor are often catastrophic,
extending beyond loss of the franchised business to loss of their home (because of
personal guarantees and loans secured over the franchisee’s personal assets) and
relationships. This is a strong example of Trebilcock’s fourth characteristic as the
franchisor’s administrator or liquidator is not appointed until after the franchisee has
made the whole of its sunk investment. Satisfactory ex post relief is not available
from an insolvent, asset-poor, debt-burdened franchisor.
452 Trebilcock, above n 29, 72. 453 For example, disputes must ultimately be resolved in Connecticut under all ‘Subway’ franchise
agreements. 454 Even within Australia litigation may be between one party based in NSW and the other in
Western Australia, three time zones and several hours by air from each other. 455 Trebilcock, above n 29, 72.
194 Chapter 4: Is the current regulatory response adequate to deal with the problem?
Finally, ‘[t]he small size of a typical transaction creates significant disincentive
to seeking ex post relief through the courts’.455F
456 Regardless of whether a franchisee
has made a million dollar investment or an A$15,000 investment, administrators
claim the Code, with its cost effective dispute resolution provisions, does not bind
them. This leaves a franchisee that wishes to terminate its franchise agreement with
the choice of walking away from the investment, and thereby risking action by the
administrator or liquidator for breach of contract, or litigating. Litigation is often
prohibitively expensive. For example, in relation to costs leading up to the appeal
that was reported in Hoy Mobile Pty Ltd v Allphones Retail Pty Ltd (No 2) 
FCA 810 and Hoy Mobile Pty Ltd v Allphones Retail Pty Ltd (No 3)  FCA 967,
the franchisee wrote:
July 2006, my barrister began preparing to file an injunction. On the same
day without notice our franchisor released our commission payment…. [the
matter eventually went to court]. We received judgment in our favour on the
30 May 2008. [Allphones, franchisor] has appealed the entire judgment. …
The matter will most likely be heard in February or March 2009, three years
and over $650,000 after Hoy Mobile requested mediation. … Our five year
agreement will expire before the appeal is heard.456F
4.2 POLICY BACKGROUND
As early as 1976, the Swanson Committee, while not specifically considering
… identified two broad value judgments as providing the foundation upon
which the body of trade practices legislation in Australia has been
constructed. The first of these is the acceptance of competitive capitalism as
a socio-economic system based upon the institution of private enterprise.
The second is that the economically weak should be protected against the
unfair or predatory acts of the economically strong, a belief that is derived
from notions of human dignity and acceptable norms in the conduct of
human affairs. [The Committee acknowledged that] [a]ttitudes as to what
456 Ibid. 457 Senate Standing Committee for Corporations and Financial Services, [Commonwealth of
Australia], Joint Parliamentary Inquiry into Franchising (2008), Submission Number 8, (Nicole Hoy). This submission details the cost of litigation for franchisees whose franchisor refuses to mediate.
Chapter 4: Is the current regulatory response adequate to deal with the problem? 195
constitute norms in human affairs will change from generation to generation
and the change will show in the practical expression they receive in
legislative enactment and administrative enforcement; exercises of economic
power which were accepted by society a generation ago are no longer
tolerated today. Thus trade practices legislation looks not only to the
preservation of competition but also to the regulation of potential misuse of
economic power which is inimical to the public interest of the public
It was in an environment in which a simple franchisor corporate structure, as
described in chapter 3.2.1, was the norm, that the initial moves to regulate business
format franchising were made in Australia. Voluntary regulation of the sector under
the Franchising Code of Practice (‘FCP’) in 1993 was the first step. It failed.
By the time the Trade Practices Act s 51AC and the mandatory Code were
enacted Parliament acknowledged that there were:
… particular problems for small firms in:
obtaining full information on a venture prior to entering into it;
understanding complex documentation;
having terms and conditions of contracts imposed rather than being
given an opportunity to negotiate them;
harsh business conduct within a commercial relationship; and
accessing the justice system.
These problems were found to be most prevalent in the franchising and retail
tenancies sectors. 458F
In 1997, The Hon Peter Reith introduced s 51AC and the Code to ‘give small
business protection in its dealings with big business.’459F
460 At this time business failure
implied a failure of the business that had been the consumer of deficient information
- here, franchisees - not a failure of the supplier of the information, the franchisor.
Failure was also not understood to have any greater impact on franchisees than on
458 The Trade Practices Review Committee (Swanson Committee) Report, above n 113, paras 10.40-
49. 459 The Parliament of the Commonwealth of Australia House of Representatives, Explanatory
Memorandum, Trade Practices Amendment (Fair Trading) Bill (Cth) 1997, (Circulated by the authority of the Minister for Customs and Consumer Affairs, Senator the Honourable Christopher Ellison).
460 Statement by the then Minister for Workplace Relations and Small Business, the Hon Peter Reith, MP ‘New Deal: Fair Deal – Giving Small Business a Fair Go’, above n 113.
196 Chapter 4: Is the current regulatory response adequate to deal with the problem?
independent small business people. It was not considered that the failure of a supplier
franchisor’s business might have intractable consequences for the franchisee-
business consumers. There is now a better picture of the scope, magnitude and cost
of the failure of a single franchisor’s business.460F
In December 2006 Australia’s Productivity Commission (‘PC’) was asked to
report on … ‘ways to improve the consumer policy framework to assist and empower
consumers, including disadvantaged and vulnerable consumers, to operate effectively
in increasingly complex markets’.461F
462 The PC reported the:
[k]ey considerations [included]: The need to ensure that consumers and
businesses, including small businesses, are not burdened by unnecessary
regulation or complexity … the need for consumer policy to be based on
evidence from the operation of consumer produce markets, … and the
importance of promoting certainty and consistency for businesses and
consumers in the operation of Australia’s consumer protection laws.
The Commission proposes … common [Australia-wide] objectives for
consumer policy, with the overarching objective being to ‘improve consumer
wellbeing by fostering effective competition and enabling the confident
participation of consumers in markets in which both consumers and
suppliers can trade fairly and in good faith.462F
No mention was made of ‘business consumers’ in the brief to the PC or in its
subsequent report. This was an unfortunate omission as business consumers, the
‘small firms’ above have been acknowledged as an especially vulnerable group of
consumers in government policy since 1997 and have received protection under
Australian consumer protection law since 1998.
4.2.1 THE REGULATORS
The ACCC has responsibility for consumer protection insofar as it relates to
franchisees, ASIC has responsibility for regulating corporations and the ITSA has
responsibility for personal bankruptcy matters that arise under the Bankruptcy Act
1966 (Cth). The existence of separate regulators for different parts of the business
continuum makes it difficult for any one agency to achieve a macro perspective.
461 See Table 1 and Appendix D of this thesis. 462 Australian Government Productivity Commission, Review of Australia’s Consumer Policy
Framework, Report No 45 (2008) Volume 1, summary vii, viii. 463 Australian Government Productivity Commission, vol 2, above n 4, ix.
Chapter 4: Is the current regulatory response adequate to deal with the problem? 197
A consequence of this is that issues such as franchisor failure do not appear
significant to any of the three regulators. The ACCC does not maintain a database of
franchisors so has no way of knowing, other than anecdotally, that so many fail.
ASIC and ITSA, as agencies that regulate the failure end of the spectrum do not
know which failed entities are franchisors or franchisees. In addition, as already
discussed at 3.2.1 and demonstrated in Table 1 and Appendix D, a franchise network
might consist of numerous entities and none may have the trading name of the
franchise in its legal name. This makes it virtually impossible to ‘join the dots’ when
attempting to research which franchisors have failed.
4.3 TRADE PRACTICES ACT 1974 (CTH)
Globally, franchisees are variously categorized as consumers,463F
consumers, entrepreneurs, business entities, and in some litigation, employees. In
Australia they are recognised as ‘business consumers’ under the Trade Practices Act
s 51AC by virtue of their status as vulnerable small firms for whose protection s
51AC and the Code were enacted. Specific franchising legislation including
mandatory disclosure obligations has been enacted in numerous jurisdictions,
including Australia, to facilitate pre-contractual due diligence for intending
franchisees. In-term issues receive less franchise-specific attention, often being
addressed under generic fair trading laws.
The object of the Trade Practices Act, stated in s 2 is:
to enhance the welfare of Australians through the promotion of competition and fair trading and provision for consumer protection.
In Canada, Côté J discussed the interpretation of protective legislation, in Hi
Hotel Limited Partnership and Holiday Hospitality Franchising Inc and ors. 2008
ABCA 276 (Hi Hotel), concluding:
 the latest authority says that protective consumer legislation should not
be interpreted narrowly, nor ‘through the lens of freedom of contract and
competition’: Assoc. des courtiers et agents immobiliers du Québec v
Proprio Direct, 2008 SCC 32 (para 34).
464 For example under Consumer Protection Act 2008 (South Africa) s 6 ‘the following transactions
must be regarded as a transaction between a supplier and consumer within the meaning of this Act: (d) a franchise agreement or an agreement supplementary to a franchise agreement.’ The Consumer Protection Act is estimated to become law in October 2010.
198 Chapter 4: Is the current regulatory response adequate to deal with the problem?
 … Whatever the bargaining power of a prospective franchisee, large or
small, he or she will rarely know much about the franchisor, its officers and
its actual practices (absent full disclosure).464F
To an extent, the statutory legal framework has evolved to accommodate the
needs of franchisees. We now turn to the parts of the Trade Practices Act that
provide consumer protection for franchisees.
4.3.1 TRADE PRACTICES ACT 1974 (CTH) SECTION 51AC
‘Dubious conduct which may be detrimental to consumers will not always’465F
fit within the statutory notion of misleading or deceptive contained in the Trade
Practices Act Part V Division 1. Despite not meeting the statutory tests of misleading
or deceptive, the conduct may be ‘harsh, unfair or even dishonest … and may offend
community-held standards as to apposite standards of business conduct.’466F
conduct may be unconscionable. To enable business consumers to challenge
unconscionable conduct by business suppliers the Trade Practices Act was amended
in 1998 by the addition of s 51AC. This was statutory acknowledgement of the
particular vulnerability of business consumers. The phrase ‘business consumers’ is
used in s 51AC but the term is not defined.
In announcing [the introduction of s 51AC], the Government has accepted
the principle that small business people are entitled to a legal protection
against unfair business conduct comparable with that which consumers
already have against corporations. 467F
Both procedural and substantive unconscionable conduct may be caught by s
Posner explores the lack of information versus the lack of sophistication, and
concedes that lack of information seems to play a role in unconscionable conduct
cases. He argues, in mitigation, that consumers who lack information have incentives
to acquire information. Posner says:
465 Hi Hotel Limited Partnership and Holiday Hospitality Franchising Inc and ors 2008 ABCA 276.
Reasons for the Judgment reserved of the Honourable Mr Justice Côté. 466 Lynden Griggs, Eileen Webb and Aviva Freilich, Consumer Protection Law (2008) 97. 467 Ibid. 468 Reith, above n 113.
Chapter 4: Is the current regulatory response adequate to deal with the problem? 199
[I]f sellers cannot easily distinguish informed and uninformed consumers,
they cannot exploit the latter by charging a higher price. Thus, information
deficiency alone does not justify judicial intervention on the basis of
However in franchising the seller can reasonably readily distinguish between
informed and uninformed consumers. The seller (franchisor) may chose to keep
franchisees uninformed about its decision to take on a high debt load that threatens
the network, or to become insolvent to meet its own strategic objectives. The lack of
information is a fundamental problem ex ante for franchisee consumers.
If it became apparent that the franchisor had chosen to keep franchisees
uninformed about significant risky behaviour, well-funded franchisees, sufficiently
incentivised, may be able to secure redress under s 51AC. Franchisees might be able
to make out a case that s 51AC (3) (i), (j) or (k) was breached. The basis of the
argument under s 51AC(3)(i):
(i) the extent to which the supplier [franchisor] unreasonably failed to
disclose to the business consumer [franchisee]:
(i) any intended conduct of the supplier that might affect the interests of the business consumer; and
(ii) any risks to the business consumer arising from the supplier’s intended conduct (being risks that the supplier should have foreseen would not be apparent to the business consumer)
would be that the franchisees would have no inkling of the impending voluntary
administration or strategic insolvency, and no ability to predict it or prepare their
own businesses to deal with the consequences of the franchisor’s strategic
insolvency. The franchisor’s conduct was deliberate. The franchisor is able to foresee
clearly the consequences for all of its franchisees.
An argument based on s 51AC(3)(j);
(j) the extent to which the supplier was willing to negotiate the terms and
conditions of any contract for supply of the goods or services with the
may be able to be made out if the franchisee had sought amendment to the standard
form agreement to include an ipso facto termination on franchisor insolvency clause;
469 Eric A Posner, Economic Analysis of Contract Law after Three Decades: Success or Failure
(Working Paper No 146, (2d series) (2002)) 14.
200 Chapter 4: Is the current regulatory response adequate to deal with the problem?
but that request had been denied. The franchisor’s administrator may counter with a
claim that the franchisee was not misled, that they subsequently signed the agreement
with their eyes wide open.
The third possible avenue under s 51AC (3) is:
(k) the extent to which the supplier and the business consumer acted in good
Although the concept of ‘good faith’ is not defined in the Trade Practices Act,
‘parties to a relational contract are not expected to break the relational rules’.469F
These include the rule that ‘a [franchisee] party to this type of [franchise] contract
does not (rationally) intend to assume the risk of [the franchisor’s] opportunistic
In practice, however, an action against the franchisor for breach of s 51AC
Trade Practices Act would only result in meaningful relief to the franchisees if they
were able to include the failed franchisor’s solvent directors as defendants. As
already noted in chapters 3.4.1 and 4.1 directors are likely to have sheltered their
On a theoretical level, Eric Posner writes:
[a] simple model of the consumer goods market implies that courts should
not use the unconscionability doctrine to strike down contracts. More
complex models that take account of asymmetric information and bargaining
power imply that such contracts should be struck down only in particular
circumstances, when courts have information about variables that are
intrinsically difficult to measure. 471F
It is suggested that a franchisor’s future intentions are an example of a variable
that is intrinsically impossible for a franchisee to measure before the franchisee
470 William Michael Dixon, An Examination of the Common Law Obligation of Good Faith in the
Performance and Enforcement of Commercial Contracts in Australia (Thesis (SJD), Queensland University of Technology, Brisbane, 2005) 77 citing NC Seddon, ‘Australian Contract Law: Malestrom or Measured Mutation?’ (1994) 7 Journal of Contract Law 93, 96.
471 Ibid, citing G Hadfield who has suggested an interpretation of ‘good faith’ as fidelity to an implicit obligation not to use discretion opportunistically: G Hadfield, ‘The Second Wave of Law and Economics: Learning to Surf’ in M Richardson and G Hadfield (eds), The Second Wave of Law and Economics (1990) 60 as referred to by JM Paterson, ‘Good Faith in Commercial Contracts? A Franchising Case Study’ (2002) 29 Australian Business Law Review 270, 290.
472 Posner, above n 469, 15.
Chapter 4: Is the current regulatory response adequate to deal with the problem? 201
commits to the investment. This would leave the way open for courts to strike down
franchise agreements if the franchisor behaved unconscionably by pursuing
voluntary administration or strategic insolvency.
Bigwood recognises limitations of arguments based on unconscionability,
albeit in the context of common law, as being that:
No matter how attractive the precept of unconscionability is as a judicial
matter, the number of transactions that can be reached and controlled is too
small to have a social impact, and the reluctance of courts to review
countless arguments is too strong.472F
From a practical perspective the unconscionable conduct provisions of the
Trade Practices Act are not useful to all franchisees in the situation of franchisor
administration and insolvency. It may be possible to establish that the franchisor
behaved unconscionably. If the insolvency was not ‘strategic’, however, it will be
difficult to establish that the franchisor acted unconscionably. Taking the decision to
become insolvent is also a decision to withhold supply. Franchisees, like many
consumers, are widely dispersed geographically. This makes working cohesively to
litigate against the franchisor or negotiate with the administrator, while concurrently
(as required by administrators) continuing to meet obligations under the franchise
agreement, extremely difficult.
Recently legislation was:
… introduced into Parliament to enhance the range of enforcement
mechanisms for unconscionable conduct. The amendments will increase the
punitive consequences for engaging in statutory unconscionable conduct.
The Trade Practices Amendment (Australian Consumer Law) Bill 2009
includes provisions to introduce:
pecuniary penalties of up to [A]$1.1million for corporations and
$220,000 for individuals for contraventions of the unconscionable
infringement notices, which the Australian Competition and
Consumer Commission (ACCC) may issue for alleged
contraventions of the unconscionable conduct provisions;
473 Bigwood, above n 341, 277, citing R A Epstein, ‘The Social Consequences of Common Law
Rules’ (1982) 95 Harvard Law Review 1717, 1750.
202 Chapter 4: Is the current regulatory response adequate to deal with the problem?
disqualification orders, allowing the Court to ban those involved in a
contravention of the unconscionable conduct provisions from
public warning notices, which the ACCC may issue about
corporations it has reasonable grounds to suspect have contravened
an unconscionable conduct provision; and
Court orders to redress loss or damage suffered by non-party
consumers as a result of a contravention of an unconscionable
These changes will not make any difference to franchisees whose franchisor is
in administration or being wound up.
4.3.2 TRADE PRACTICES ACT 1974 (CTH) PART V DIVISION 1
Franchisees may take action under Trade Practices Act ss 52, 53A or 59
against a franchisor, or other ‘persons involved in a contravention’474F
475 who misled
them before the franchise agreement was signed, or in relation to any matter not
addressed in contracts that occurred subsequently.475F
476 Section 75B lists by role the
potential ‘person[s] involved in a contravention’ who may be prosecuted if, for
example, the franchisor breaches parts of the Trade Practices Act.
Actions against the insolvent franchise systems A1 Mobile Radiator Repairs476F
and Furniture Wizard provide examples of franchisees proceeding under ss 52 and
474 Australian Government, the Treasury, The Nature and Application of Unconscionable Conduct
Regulation, Issues Paper November (2009) <http://www.treasury.gov.au/contentitem.asp?NavId=037&ContentID=1676> at 11 December 2009.
475 See full wording of s 75B Trade Practices Act 1974 (Cth) in Appendix A of this thesis. 476 See Appendix A of this thesis. 477 The Australian Competition and Consumer Commission successfully took the director of the
insolvent franchisor to court on behalf of 4 franchisees in ACCC v Trayling  FCA 1133. The court held there had been breaches of ss 52 and 59(2) Trade Practices Act 1974 (Cth). The action against the franchisor was discontinued because of the franchisor’s insolvency.
478 Eleven franchisees were involved in four court cases against Furniture Wizard and one of its directors, Mr Grant. Breaches of s 52 and 59 Trade Practices Act 1974 (Cth) were established: ACCC v Grant  FCA 567; Grant v Eddington  FCA 1550; ACCC v Grant  FCA1564; Lawrence v Furniture Wizard  NSWSC 1107.
Chapter 4: Is the current regulatory response adequate to deal with the problem? 203
The Code was enacted as a mandatory industry code of conduct pursuant to
Trade Practices Act s 51AE. Its overall objective is to ‘to regulate the conduct of
participants in franchising towards other participants in franchising’478F
479 by levelling
the playing field between franchisors and franchisees.
Regulation is achieved under the Code through three avenues: by requiring
franchisors to provide disclosure (Part 2), by implying terms into franchise
agreements (Part 3),479F
480 and by mandating a dispute resolution process (Part 4).
In Côté J’s assessment in Hi Hotel the Canadian legislature was of the view
that: ‘Someone soliciting such an investment [ie a franchisor selling a franchise] or
the fees for a franchise must put into the investor’s or franchisee’s hands accurate
complete written information.’480F
In Australia, compliance with the Code by franchisors should mean that
complete, accurate information about the franchise system481F
482 is given to prospective
franchisees. However, it is shown in chapter 3.1, Table 1, and Appendix D, that the
483 is only part of the larger franchise network. The purposes of the
disclosure document are set out in s 6A:
(a) to give to a prospective franchisee, or a franchisee proposing to enter
into, renew or extend a franchise agreement, information from the franchisor
to help the franchisee to make a reasonably informed decision about the
(b) to give a franchisee current information from the franchisor that is
material to the running of the franchised business. 483F
The content and format of the disclosure are dictated by the Code. The
franchisor’s duty to disclose extends only to matters listed in the Code. Franchisees
479 Trade Practices (Industry Codes—Franchising) Regulations 1998 (Cth) s 2. 480 As outlined in ch 2.2.3 of this thesis. 481 Hi Hotel Limited Partnership and Holiday Hospitality Franchising Inc and ors 2008 ABCA 276. 482 Franchise system is defined very loosely in s 3 of the Trade Practices (Industry Codes –
Franchising) Regulations 1998 (Cth)]. See Appendix A of this thesis. 483 The franchise system is the franchisor, its master franchisees and franchisees, but not the
franchisor’s related entities. 484 See Appendix A of this thesis.
204 Chapter 4: Is the current regulatory response adequate to deal with the problem?
may be forgiven for not looking beyond the 250 items that are addressed in the
disclosure and the numerous clauses in the ancillary documentation including the
franchise agreement. Because these documents refer to the consequences of
franchisee failure, but not of franchisor failure, franchisees are unlikely to consider
franchisor failure and its possible consequences.
In relation to insolvency and personal bankruptcy, item 4.2 of the Code dictates
that disclosure should provide relevant information concerning the franchisors’
directors’ involvement in previous business failures.484F
485 In a situation that is disclosed
under item 4 (2)(c) there is almost never an accompanying case report from which a
franchisee can objectively verify information supplied by the franchisor, so the
franchisee is reliant on the information supplied in the disclosure document.485F
Shortcomings of the Code
Section 10 of the Code sets out the requirement for a statement about the
financial details that have been supplied to the franchisee. It is effectively a statement
of current solvency.486F
487 This is taken literally by franchisors whose ‘franchisor’ entity
is the solvent face of an insolvent or soon to be insolvent network. Some franchisors
are willing to sign a statement of solvency, despite knowing their business is
insolvent. For example, BHG was still accepting franchise fees from new franchisees
in the third quarter of 2006. The liquidator wrote that ‘in my opinion the company
became insolvent in 2005 and remained insolvent from that time’.487F
488 The liquidator
also reported having
discovered an email prepared by one of the company directors dated 7 May
2007 admitting the company was insolvent and that the company should be
wound up. There is no evidence to show the relevant director took any steps
to prevent the company from incurring further debts.488F
485 See Appendix A of this thesis for full wording. 486 If there was a case that had ended in a judgment the franchisee could obtain a copy of the
judgment, or even be aware of it by searching the court records electronically (<www.austlii.edu.au> at 6 June 2010). Insolvencies are filed at the Australian Securities and Investment Commission and personal bankruptcy information at ITSA (Insolvency Trustees Association of Australia) <http://www.itsa.gov.au/> at 6 June 2010.
487 See Appendix A of this thesis. Trade Practices (Industry Codes – Franchising) Regulations 1998 (the Franchising Code of Conduct 1998) cl 10.
Chapter 4: Is the current regulatory response adequate to deal with the problem? 205
No franchisee could have uncovered this information through due diligence in
time to avoid investing. Discovering post investment that the franchisor is insolvent
is unhelpful. A franchisee would compound the fraud if it decided to sell its business
without disclosing its knowledge of the franchisor’s insolvency.
In addition to being open to compromise by the lack of personal integrity of the
franchisors’ directors, the value of the information provided by the franchisor is
limited by the prospective franchisee’s advisers’ experience and by budget. This was
addressed at 3.4.
In an attempt to prevent dependence from becoming a form of predation or
490 Part 3 of the Code implies terms into the franchise agreement. The
provide a 14 day cooling off period for franchisees (13),
require franchisors to provide a copy of the premises lease in some
forbid the franchisor from preventing franchisees or prospective
franchisees to associate with each other (15),
prohibit the franchisor from requiring franchisees to sign a general release
from liability (16),
mandate audit and reporting requirements in relation to franchise network
marketing and other cooperative funds (17),
require disclosure of materially relevant facts by the franchisor to the
franchisees within 14 days of the franchisor becoming aware, including
contravention of the Corporations Act by the franchisor and the franchisor
becoming an externally administered body corporate (18),
require the franchisor to provide a current disclosure document if the
franchisee requests it (19),
490 Elizabeth C Spencer, ‘Conditions for effective disclosure in the regulation of franchising’ (2008) 22(4) International Review of Applied Economics 509.
206 Chapter 4: Is the current regulatory response adequate to deal with the problem?
forbid the franchisor from unreasonably withholding a franchisee’s request
to be permitted to transfer its franchise (20).
The Code sets out three situations when a franchisor may terminate a franchise
agreement. The trigger events are:
a breach by the franchisee (21),
a range of events where there has been no breach by franchisee (22), and
if the franchisee becomes bankrupt, insolvent under administration or an
externally administered body corporate, the franchisor does not have to
give the franchisee notice of its intention to exercise the franchisor’s right
to terminate that is contained in franchise agreements. This is considered
to be ‘special circumstances’ (Regulation 23).
The franchisees, in legislation that is supposed to level the playing field and provide
them with protection, have no mirror rights. In defence its decision not to amend the
Code to extend the rights provided for franchisors in regulation 23 to franchisees, the
Government commented in 2009 that:
The inclusion of an automatic right of termination for franchisees (in the
Franchising Code) in the event of franchisor failure would give one area of
small business an advantage over others (preferential treatment). It would
also provide franchisees with an automatic right under the Franchising Code
that is not available to franchisors.490F
The government fails to appreciate that the franchisors already have the right to
automatically terminate franchisees to which receivers or administrators are
appointed. They give it to themselves in the standard franchise agreements. They do
not need legislative protection.
The early identification of problems within the franchise may be aided by the
franchisees’ rights of association under s 15 of the Code.
A franchisor must not induce a franchisee not to form an association or not
to associate with other franchisees for a lawful purpose.
491 Commonwealth Government Response to the Report of the Parliamentary Joint Committee on
Corporations and Financial Services, Opportunity Not Opportunism: Improving Conduct in Australian Franchising (2009) above n 166, 22.
Chapter 4: Is the current regulatory response adequate to deal with the problem? 207
This, combined with the right each franchisee has under s 19 of the Code 491F
request and receive a copy of the disclosure document every 12 months would enable
a well coordinated franchisee group to access a moving annual picture of the
franchise system, but still not of the whole network. A well organized franchisee
group may thus, be able to detect that a franchisor is experiencing financial
difficulties before it is too late for the franchisees to work out how to protect their
collective interest in the brand. This assumes that it is the franchisor itself
experiencing solvency problems, not related entities or its parent – being entities that
are exempt from the ongoing disclosure requirement.
ADMINISTRATORS AND CODE DISPUTE RESOLUTION
When the administrator is appointed to investigate the franchisor’s business the
applicability of the Code become contentious.
Mediators are unsure as to whether administrators are ‘a party to a franchise
agreement’, a threshold requirement for the purposes of mediation under Part 4 s 27
of the Code. In the franchise contract the franchisor is typically described thus; ‘the
term [franchisor] includes it successors in title and its assigns’. This raises the
question of whether an administrator fits within the wording of ‘a successor in title or
Under s 437B492F
493 the Corporations Act the administrator’s role to act as the
company’s agent. An agent is typically able to enter contracts and bind the principal
so long as it is acting within its authority. The authority of the administrator as agent
could be taken to be the performance of the role ad outlined in s 437A Corporations
Act. This is a broad enough authority to permit the administrator to attend mediation
and to execute a contract recording a mediated settlement.
The ACCC approaches the problem from another perspective. The ACCC
issued an undated ‘Release for distribution to Insolvency Practitioners Association of
Australia’ in which it advised that, in its view:
The franchisor company continues to be bound by the Code during the
administration period. As an administrator, you are obliged to continue to
492 See Appendix A of this thesis. 493 See ibid.
208 Chapter 4: Is the current regulatory response adequate to deal with the problem?
comply with the franchising Code of Conduct on behalf of the franchisor
It cites Smith v Federal Commissioner of Taxation (1996) 71 FCR 150 in
support of the proposition that the Code does cover administrators, arguing:
the appointment of an administrator for a franchise system under Part 5.3A
of the Corporations Act does not, of itself, terminate or constitute a
repudiation of the franchise agreement. 493F
The third argument in favour of the Code applying to administrators is that,
from a policy perspective, the purpose of the administration process is to maximise
the survival prospects of a flagging company.494F
495 Attempting to resolve disputes
through the inexpensive and quick mechanism provided in the Code is consistent
with survival of the franchise.
Administrators, however, cite the Corporations Act part 5.3 and argue that an
administrator does not have to involve itself in substantive responses to a dispute
notice issued under the Code. To become involved would, they say, distract from
carrying out the tasks of an administrator. Administrators claim Brian Rochford Ltd
(Administrator appointed) v Textile Clothing & Footwear Union of NSW (‘Brian
Rochford’) (1998) 47 NSWLR 47; (1998) 149 FLR 125 supports their argument. In
Brian Rochford, Austin J considered an application under s 440D of the
Corporations Act for leave to allow proceedings against a company under
The key words of s 440D were: ‘proceedings in a court’. Despite the definition
of the word ‘court’ in Corporations Act s 58AA, Justice Austin held that the
Industrial Relations Commission was a ‘court’. For Brian Rochford to be applied to
administrators refusing to mediate with franchisees, the mediation process set up
under the Code to resolve disputes would have to be analogous to ‘proceedings in a
court’. Leave under s 440D is not required for arbitration495F
494 ACCC Submission to the Parliamentary Joint Committee on Corporations and Financial Services
Inquiry into Franchising Code of Conduct (2008) 8.4(ii) d) 495 Foxcroft v The Ink Group Pty Ltd (1994) 12 ACLC 1063; see R Fisher, Corporate Insolvency
Law (2000) 142. 496 Auburn Council v Austin Australia Pty Ltd (2004) 22 ACLC 766. 497 Murray, above n 150, 536.
Chapter 4: Is the current regulatory response adequate to deal with the problem? 209
Consistent with the interpretation of arbitration proceedings, Professor Warren
Pengilley distinguished mediation under the Code from ‘proceedings in a court’
… proper mediation procedures are possible only if there is legislation with
the relevant procedures and safeguards embedded into it. The Government’s
regulatory path (Code created by Regulation) means that the essential
elements of mediation are not law.497F
The consequences of refusing to mediate, where the franchisor’s alleged
breaches of the franchise agreement are the cause of the dispute, may be that the
franchisees will become entitled to abandon their contracts. If the Code does apply to
administrators, and they refuse to adhere to it, franchisees become entitled to seek
leave of the court to litigate, and would be entitled to remedies available under the
Trade Practices Act for breaches of the Code. These remedies would be available
against the franchisor, but of greater value is that through the application of s 75B
Trade Practices Act remedies should also available from the administrator.
On balance it is concluded that the Code does apply to franchisors under
administration. The lack of funds for court action during the administration process,
however, mean it is unlikely that franchisees will be able to litigate to force
administrators to adhere to the Code. Because of the power imbalance during the
administration, the fact that franchisees tend not to operate as a cohesive group, and
the lack of time available it is concluded that the only way to make administrators
adhere to the Code is by legislating the need for compliance.
CODE DOES NOT APPLY TO LIQUIDATORS
Transition from administration to winding up on the appointment of the
liquidator signals a change in focus. From the time the liquidator is appointed the
Corporations Act ‘trumps’ the Trade Practices Act and the Code. As a consequence,
the Code should not, and does not apply to liquidators.
Weaknesses of the Code.
The Code has weaknesses, which are especially prominent in the context of
franchisor entity failure.
498 Warren Pengilley, ‘The Franchising Code of Conduct: Does its Coverage Address the Need?’
(1998-99) 1(3) Newcastle Law Review 32.
210 Chapter 4: Is the current regulatory response adequate to deal with the problem?
SNAPSHOT, NOT CRYSTAL BALL
The disclosure is a snapshot of the current status of the franchise network,
focusing on the financial and legal fitness of the entity called the franchisor. Even in
jurisdictions where the franchisees have a recurring right to receive updated
disclosure documents 498F
499 this will not enable a franchisee to predict the franchisor or
the franchisor network’s future prosperity or insolvency.
AM I A FRANCHISOR?
Some franchisors do not recognise that they are franchising, and thus do not
adhere to the Code. For example law firm Freehills reminded clients involved in
‘commercial agreements such as intellectual property licences and distributorship
the need to carefully consider whether the Code governs [the arrangement].
The directors of Synergy in Business Pty Ltd and Lawsons Trading Co Pty
Ltd found out the hard way that the requirements of the Code cannot be
avoided simply by describing a franchise relationship as a licence. 500F
TIMING OF DISCLOSURE
The timing of the disclosure is problematic from three perspectives.
First, a potential franchisee is psychologically committed to become a
franchisee of the particular franchise network before receiving the disclosure.
Franchisees in Australia tend not to compare several disclosure documents as they
have to pay a deposit before being given the document. Second, when a franchise
offering does not withstand due diligence investigation by the potential franchisee’s
pre-purchase professional advisers, it can be difficult for the advisers to dissuade the
potential franchisee. The experience of a retail pie shop franchisee, detailed below,
illustrates this problem.
Mr Thadani [franchisee of failed pie franchise outlet in Sydney CBD] gave
evidence of negotiations conducted by him and Mr Muriniti [franchisee’s
lawyer], with Mr Gualdi and others, during September 2003. According to
his evidence, Mr Gualdi [franchisor] told him more than once not to listen to
Mr Muriniti because Mr Muriniti was not a franchise lawyer and was
499 For example Australia and Vietnam. 500 David Sarkin, Franchise Follies: Lessons From the ACCC (2004) <www.freehills.com> at 19
July 2004. 501 Ibid.
Chapter 4: Is the current regulatory response adequate to deal with the problem? 211
causing delay that would only add to the cost of the transaction. ... Mr
Muriniti told his client … that there was something seriously wrong with the
deal ... Amongst the unresolved matters was absence of consent to
Multipye’s occupation by Westfield, the landlord.501F
The franchisee ignored his solicitor, preferring to be seen as cooperative by the
franchisor. Obviously, things did not go well thereafter.
Third, disclosure of current and past facts is not a guarantee of the franchisor’s
future performance, or policies.
SCOPE OF DISCLOSURE
It is widely assumed that the Code protects franchisees in key risk areas. Or,
that it provides franchisees with the information they need to structure their affairs so
as to protect themselves. However, the disclosure provided under the Code is no
more than current information, predominantly concerned with the financial and legal
fitness of the entity identified as the franchisor. ‘The primary focus of disclosure is
contract formation’. 502F
Further, the Code’s narrow focus on ‘the franchisor’ and ‘the franchisee’
means it is ineffective if the franchisor fails. There are many stakeholders in the
franchise network whose conduct may impact on the network and ultimately on the
franchisee. These may include entities related to the franchisor, the franchisor’s
administrator, and unrelated landlords or master franchisees. Franchisees are required
to enter contracts with some of these entities. Problems can be hidden elsewhere in
the network, where they incubate until they destroy the franchisor.
COST OF DISCLOSURE
For franchisors the disclosure is an expensive document to create and maintain.
Revising the structure of the disclosure could result in considerable cost savings for
franchisors while resulting in a more informative document for the business
INTERPRETATION OF THE AUDIT REQUIREMENT
502 Shakespeares Pie Co v Multipye  NSWSC 930, para 36. 503 Elizabeth C Spencer, ‘The Efficacy of Disclosure in the Regulation of the Franchise Sector in
Australia’, (Paper presented at the third meeting of the European Network on the Economics of the Firm, France, September 2006) 7.
212 Chapter 4: Is the current regulatory response adequate to deal with the problem?
A director of the franchisor is required to sign a statement that complies with
clause 20.1 of the Code by providing a statement that in the director’s opinion the
franchisor is solvent,503F
504 as part of the pre-purchase disclosure supplied to the
franchisee. From franchisors that are not trading strongly this may be of limited
value. Usually, only public companies are required to be audited. Even if the auditor
has identified a situation that casts doubt on an entity’s ‘going concern’ status, the
directors may have been able to satisfy the auditor that there are mitigating
circumstances and all will be well for the franchisor. Such mitigating circumstances,
for instance new franchisees committed to investing, may or may not eventuate.
Thus, a Code compliant audit may present an inaccurate and misleading picture of
the franchisor’s solvency.
Attempted action on weaknesses
In 2006, the Mathews Report recommended that disclosure should include
specific information about what would happen to it if the franchisor became
insolvent. This recommendation was loosely adapted by the Federal Government, in
the form of a request to the ACCC to provide general information about the
consequences of franchisor failure.
‘Opportunity not opportunism’ recommended that the continued absence of
specific warnings about franchisor failure should be addressed:
Recommendation 1 The committee recommends that the Franchising Code
of Conduct be amended to require that disclosure documents include a clear
statement by franchisors of the liabilities and consequences applying to
franchisees in the event of franchisor failure. 504F
The government responded with a watered down requirement that the Code be
amended to alert franchisees that ‘franchising is a business and like any business the
504 See Appendix A of the thesis for full wording, of 20.1 of the Trade Practices (Industry Codes -
Franchising) Regulations 1998. 505 Parliament of Australia, Joint Committee, Inquiry into the Franchising Code of Conduct (2008)
para 4.80 <http://www.aph.gov.au/SENATE/COMMITTEE/corporations_ctte/franchising/index.htm> at 6 June 2010.
Chapter 4: Is the current regulatory response adequate to deal with the problem? 213
franchise (or franchisor) could fail’.505F
506 This response will be discussed in chapter
4.4 CORPORATIONS ACT 2001 (CTH)
In Australia an external party can be appointed to take control of a company
from its directors by three broad mechanisms; a creditor can appoint a receiver, the
directors or the court can appoint an administrator, or the court can appoint a
liquidator. Receivers, administrators and liquidators must act within strict statutory
time limits prescribed by the Corporations Act. This does not allow parties such as
franchisees time to attempt to protect their interests by bringing court actions to test
prospective consumer protection, contract or equity based rights. Each status will
now be summarised.
Receivership status may lead to the administration or winding up of an
insolvent entity. In receivership, a receiver is appointed by one creditor. The
receiver’s role is to recover debts owed to that creditor. The receiver is indemnified
for all decisions.
For example, a receiver was appointed to manage the Brumby’s bread
franchisor in 1988. By 1991, the receiver had sold the company owned stores,
reducing the overall number of Brumby’s outlets from 76 to 54. In the process the
receiver satisfied the needs of the creditor that appointed it. The company was sold to
a new owner formed from the original franchisor and a group of the remaining
franchisees. From 1991 on the reinvigorated Brumby’s operated as a successful
The administration process allows the company to evaluate its options. On the
appointment, the administrator exercises the rights and fulfils the responsibilities of
the franchisor to the extent prescribed in s 437A Corporations Act. The administrator
‘has effective control of the [franchisor] company and may decide to discontinue the
company’s business and dispose of any of its property, [including franchise
506 Commonwealth Government Response to the report of the Parliamentary Joint Committee on
Corporations and Financial Services, above n 166, 22.
214 Chapter 4: Is the current regulatory response adequate to deal with the problem?
agreements, supplier contracts and leases] subject to the restrictions under s 442c
This enables the creditors, guided by the administrator, to make a decision
about the company’s fate. …Recovery, protection and preservation of the
company’s property are not of themselves the direct concern of the
There is no legal obligation for an administrator or creditors to consult
franchisees or take the interests of franchisees into account. From the franchisees’
perspective, the administration process ‘only serves to protect directors by putting up
endless barriers to accountability’.508F
509 If franchisees are not creditors they have no
statutory right to attend a creditors meeting.
The administrator becomes personally liable for new debts, all existing debts
are frozen and all actions for recovery against the debtor, in this case the franchisor,
are frozen. The administrator is not indemnified for decisions taken during the
administration. There are three possible outcomes of the administration process:
the company may be declared solvent and returned to the directors. In his
experience as an administrator and liquidator Richard Hughes states that in
his experience ‘this never happens with franchisors in administration in
The creditors may vote that the company is insolvent and it should be
wound up. This was the outcome for Kleenmaid, which was ‘incredibly
A Deed of Company Arrangement (DOCA) may be entered into. This is a
compromise arrangement where creditors agree to allow the company to
507 Murray, above n 150, 528. 508 Tolcher v National Australia Bank (2004) 22 ACLC 397, 401 (Barnett J) (cited in Murray, above
n 150). 509 Interview with Franchisee of an Insolvent Franchisor (Telephone interview, 28 September 2006). 510 Richard Hughes, (Speech delivered at the Griffith University Franchising Seminar, Southbank,
Brisbane, 18 November 2009) about the Kleenmaid insolvency. 511 Ibid. Kleenmaid was an asset-less administration. ‘The liquidator successfully applied to ASIC
for funds to carry out its work. Kavanagh, above n 56.
Chapter 4: Is the current regulatory response adequate to deal with the problem? 215
pay debts by instalments. The DOCA is very flexible. It is useful as a tool
to ‘cut off stores that are not working’. 511F
Franchisees whose franchisor is in administration are unlikely to have
resources to fight administrator decisions and in any event the Corporations Act s
… establishes a moratorium on civil actions against the company: Court
proceedings in relation to company property or against the company cannot
proceed or be commenced unless the administrator gives written consent or
the leave of the court is obtained…. In Foxcraft v The Ink Group Pty Ltd,512F
the court (Young J) said that leave under s 440D should only be granted
rarely, so as to ensure that administrator is not deflected from the necessary
tasks in having to defend litigation and in having to incur costs.513F
Not only is there a stay on commencing actions, the appointment of an
administrator also serves to suspend enforcement and execution actions. Under the
Corporations Act, s 440F and 440G, ‘during the administration no enforcement
process in relation to company property can proceed or be commenced except with
the leave of the court’.514F
515 There are exceptions to this rule.515F
4.4.3 WINDING UP IN INSOLVENCY
The final step along the continuum from solvent to insolvent is the appointment
of a liquidator. This appointment recognises that there is no hope of the company
continuing trading or re-structuring its way into solvency. The general policy
objective of the insolvency provisions in the Corporations Act is to allow for the
orderly winding up and ultimate deregistration of insolvent companies.
The general purposes of bankruptcy law [including corporate insolvency] are
to provide a protective and ordered process in the event of financial distress;
to facilitate the equal access by creditors to a debtor’s property in order to
compensate them for their loss; and to allow individuals who find
512 Hughes, above n 510. 513 (1994) 15 ACSR 203. 514 Murray, above n 150, 536. 515 Ibid 538. 516 Corporations Act 2001 (Cth) pt 5.3A, div 7, for example the rule is relaxed under s 441G in
relation to perishable property.
216 Chapter 4: Is the current regulatory response adequate to deal with the problem?
themselves in financial difficulties to be given a fresh start, freed from the
financial obligations that were the subject of the bankruptcy.516F
As mentioned in chapter 1, attitudes to business failure have changed as it is
recognised that any business can fail and that events beyond the immediate control of
the debtor can impact severely on solvency. Of the late 1980s and early 1990s, K
Freed, D Gurnick and E Honesty write:
This era has witnessed a marked change in the attitude towards bankruptcy.
No longer is bankruptcy considered the last desperate act of a financially
defeated person or entity. Bankruptcy517F
518 is now viewed as a viable business
option and financial planning tool.518F
This attitude to insolvency is pragmatic. The Global Financial Crisis of late
2008 – 2010 will have cemented the pragmatism. Franchisors are business people
and are not exempt.
The basic components of the legislative corporate insolvency scheme in
If a corporation cannot pay its debts as and when they fall due (that is, the
corporation is insolvent),519F
520 an application may be made to the Court to
appoint a liquidator. The application may be made by a creditor, the
corporation, a director or member of the corporation, ASIC or a
Once the liquidation has commenced, the directors no longer manage the
affairs of the corporation; the liquidator manages them. The liquidator is
the only person empowered to dispose of company property.
A corporation in liquidation is given some protection; creditors cannot
enforce any judgments or orders they may have obtained521F
522 and other legal
517 A Keay and Michael Murray, Keay’s Insolvency: Personal and Corporate Law and Practice (4th
ed, 2002) 17–18, cited in Michael Murray, Submission CAP 10 (31 August 2002) 2. 518 The US term generically used for personal bankruptcy and corporate insolvency. 519 K Freed, D Gurnick and E Honesty, ‘Bankruptcy Issues’ (Paper presented at the International
Franchise Association 29th Annual Legal Symposium, Washington, May 1996) 2. 520 Corporations Act 2001 (Cth) s 95A. 521 Corporations Act 2001 (Cth) s 459P. 522 Corporations Act 2001 (Cth) ss 468(4), 500(1); this includes franchisees who have obtained
judgments in their favour.
Chapter 4: Is the current regulatory response adequate to deal with the problem? 217
proceedings may not be brought or pursued against the corporation without
the leave of the court.522F
The assets of the corporation are realised and the proceeds distributed by
the liquidator proportionately to those creditors who are able to prove
debts in the corporate insolvency.523F
Whilst insolvency policies and priorities vary from one country to another,524F
the insolvency regime in Australia generally tends to favour creditors over
shareholders. Apart from claims by liquidators, employees,525F
526 and other listed in the
Insolvency law tries to encompass all ‘creditors’ by having a wide definition
of that term, including contingent claims damages claims, future claims as
set out in s 553. Insolvency law … does alter the priorities of certain groups,
for example employee creditors. 526F
As early as 1988, the Cork Report recognised that there were potential
problems for small traders who depended on the insolvent party for their livelihood.
Franchisees were not expressly contemplated but they fit within the category
contemplated by the Cork Report, which reads:
[T]he effect of the [employee] priority is to deprive other unsecured creditors
of their claim to a share of the available assets. Included in that class of
unsecured creditors may be small traders who were substantially dependent
upon the insolvent for their business and persons who were in an employee-
like relationship with the insolvent but who are classified (in a strict legal
sense) as independent contractors. There, creditors may be as vulnerable as
employees in the event of bankruptcy or liquidation but enjoy no
523 Corporations Act 2001 (Cth) ss 471B, 500(2). 524 Some creditors may be granted priority by the Corporations Act 2001 (Cth) for some of the
moneys owed to them. 525 As is demonstrated in part in Appendix D of this thesis. 526 Corporations Act 2001(Cth) s 558 deals with ‘debts due to employees’. 527 Australian Law Reform Commission, General Insolvency Inquiry (1988) para 722, quoting the
Cork Report, para 1428. The [employee] priority was introduced into insolvency legislation for social welfare reasons ‘to ease the financial hardship caused to a relatively poor and defenceless section of the community by the insolvency of their employer.’
528 Ibid, quoting the Cork Report, para 723.
218 Chapter 4: Is the current regulatory response adequate to deal with the problem?
The functions of a liquidator of an insolvent company are threefold: to wind up
the affairs of the company; to distribute equitably the company’s assets among its
creditors; and to examine the circumstances which precipitated the liquidation and
which may reveal improper dispositions of property and criminal offences.528F
When a liquidator is appointed to one of the parties to a contract, contract law
is ‘trumped’ by rights given to liquidators under the Corporations Act. This would be
appropriate if the franchisor operated a standalone business, but it is highly
problematic in franchising where the franchisor is the lynchpin of a network of
dependent entities. The franchisee’s contract-based rights are in the franchise
agreement. Once the liquidator is appointed the franchise agreement becomes an
asset or a liability in the franchisor’s insolvent estate. The franchisee has no separate
rights as a consumer or a contracting party. As was seen in chapter 4.1, the Trade
Practices Act does not provide any avenues for relief. The franchisee is not a
stakeholder in the franchisor’s insolvency unless it has rights as a creditor. This was
explored in chapter 3.6.1. Consequently, in relation to the majority of its exposure, it
has no standing under the Corporations Act.
A ‘company is a separate legal entity and if it is in liquidation must be treated
as such. In some cases however, the company’s affairs are inextricably bound with
other companies in liquidation in a group. In such cases, since the Corporations
Amendment (Insolvency) Act 2007, a statutory pooling regime is available to
facilitate the winding up of companies in corporate groups – see Div 8, Pt 5.5
530 Pooling is obviously relevant in franchise networks. It will not
be explored in this thesis as it would entail a major deviation from the consumer
The liquidator has a statutory right to disclaim onerous assets pursuant to the
Corporations Act s 568.530F
531 In the franchise situation this may include a lease of the
premises a franchisee trades from, an agreement with a supplier, an agreement
between the insolvent master franchisee and the international franchisor, or the unit 529 Murray, above n 150, 258. 530 Ibid 385. 531 Onerous assets are referred to as ‘burdensome assets’ in the UNCITRAL Legislative Guide on
Insolvency, above n 26, 4, and defined as ‘assets that may have no value or an insignificant value to the insolvency estate or that are burdened in such a way that retention would require expenditure that would exceed the proceeds of realization of the asset or give rise to an onerous obligation or a liability to pay money’.
Chapter 4: Is the current regulatory response adequate to deal with the problem? 219
franchise agreement. Because the franchisee is a party to a contract with the
franchisor, the franchisor’s liquidator has the right to disclaim the franchise
agreement as an onerous contract.531F
532 The viability of each of the agreements that the
franchisee has entered with third parties will also be directly impacted by the
liquidator’s decisions. Regardless of the way the liquidator elects to treat each
franchise agreement, the event of insolvency does not provide the franchisee any
statutory rights to terminate the franchise agreement or consequential contracts
between itself and third parties. Franchisees must continue to meet their obligations
under all contracts.
When the franchisor was solvent, the franchisee was an essential component of
the franchisor’s business network. It had contractually enforceable rights to use real,
personal and intellectual property, backstopped by a range of other legal rights
flowing from its standing as consumer. The appointment of a liquidator or
administrator to the franchisor’s business signals a significant change in the
franchisee’s legal position.
The effect of a winding up order is that contracts of employment are
terminated. Employees have safety nets in the form of statutory priority and the
government scheme, the General Employee Entitlements and Redundancy Scheme
(GEERS). Additionally, in response to the Ansett failure, the Special Employee
Entitlements Scheme for Ansett (‘SEESA’) was established for people whose
employment was terminated from an Ansett group company (while under
administration) on or after 12 September 2001.532F
533 The latter includes employees of
the former franchisor Traveland Pty Ltd, but not the 270 former franchisees or their
When a franchisor fails the franchisee has no legal right to respond – it has to
‘sit tight’, continue complying with the franchise agreement and hope for a
satisfactory outcome. The franchise agreement is an asset or a liability when seen
through the eyes of the administrator or liquidator. If the liquidator assesses that a
contract is ‘too onerous, worth little or is unsaleable’533F
534 they have a statutory right
532 Corporations Act 2001 (Cth) s 568(1). 533 Australian Government, Employee Entitlement Schemes
<http://www.workplace.gov.au/employeeentitlements> at 27 October 2005. 534 Michael Murray, (5th ed), above n 130, 340.
220 Chapter 4: Is the current regulatory response adequate to deal with the problem?
under the Corporations Act s 568 to disclaim that contract. At that point all of the
insolvent franchisor’s liabilities and rights under the disclaimed contract cease. In
deciding whether a contract is eligible to be disclaimed liquidators are guided by
Chesterman J who concluded in Re Real Investments Pty Ltd  2 Qd R 555 that:
A contract is unprofitable for the purpose of section 568 [Corporations Act
2001] if it imposes on the company continuing financial obligations which
may be regarded as detrimental to the creditors, which presumably means
that the contract confers no sufficient reciprocal benefit.
Before a contract may be unprofitable for the purposes of the section it must
give rise to prospective liabilities.
Contracts which will delay the winding-up of the company's affairs because
they are to be performed over a substantial period of time and will involve
expenditure that may not be recovered are unprofitable.
No case has decided that a contract is unprofitable merely because it is
financially disadvantageous. The cases focus upon the nature and cause of
A contract is not unprofitable merely because the company could have made
or could make a better bargain.534F
4.4.4 SPECIFIC ASSETS AND LIABILITIES UNDER THE INSOLVENCY PROVISIONS OF THE CORPORATIONS ACT
A fundamental difficulty, identified by Rohrbacher, in developing legal
policies around contract based property rights is that ‘[f]or executory contracts in
bankruptcy, the debtor’s [ie franchisor/liquidator’s] right to performance is treated as
property, but the debtor’s obligation to perform is treated as contract’.535F
536 Thus, the
franchisee finds the liquidator can at the same time have the right to exercise quasi
ownership rights over the franchisee’s business and to disclaim the franchise
agreement as an onerous contract.
The problem of categorisation and the consequences of splitting up the
franchisor’s business along ‘asset’ and ‘liability’ lines will be demonstrated through
retail leases, title to stock and the franchisor’s trade marks.
535 Re Real Investments Pty Ltd  2 Qd R 555, para 21. 536 B Rohrbacher, ‘More Equal Than Others: Defending Property-Contract Parity in Bankruptcy’
(2005) 114(5) Yale Law Journal 1099, 1101.
Chapter 4: Is the current regulatory response adequate to deal with the problem? 221
First, the franchisor or master franchisor may breach the head-lease. Breaches
give the lessor a right to remedy the breach, or to terminate the lease. If the
franchisor fails to pay the rent there is typically a remedy period. The problem for the
franchisee in models 3, 4, 5, 6, 7, 8, 9 and possibly 12 in chapter 3.2.3 is that the
franchisor is contractually positioned between the franchisee and the landlord. The
franchisee becomes vulnerable if the franchisor breaches the head lease in a way that
permits the landlord to terminate it. The franchisee in this situation pays its premises
rent to the franchisor, that is meant to then pay it to the landlord. The franchisee
does not enjoy privity of contract with the landlord. If the franchisor does not pay the
rent, the franchisee does not necessarily learn of the default under the head lease until
the rent is in arrears. The franchisee has been used by the franchisor as a free line of
In exercising his or her statutory duty the liquidator will determine whether
each contract is a liability or an asset. If the franchisor holds the head lease, the
liquidator’s right to disclaim onerous property has implications for the franchisee.
The result of disclaiming is that: ‘[a]fter disclaiming 17 leases on the loss-making
bars [ie. the leases of premises occupied by Pulp franchisees], the only assets the
liquidators had available to sell were ‘fridges, blenders and mixers’.536F
franchisees have lost their right to trade from the premises.
The franchisee would have the best claim to retain the premises if it occupied
its premises pursuant to models 1, 2, 10 or 11. Under all other models, the franchisee
would have, at best, a tenuous right to remain in the premises.
In both models 1 and 2 the franchisee is able to verify the premises’ ownership
and determine the extent of other registered interests by conducting a search of the
title. For greater security, the franchisee could register its lease on the title. It would
not, however, preserve the franchisee’s leasehold interest if a liquidator decided the
premises would fetch a better return for creditors if sold with vacant possession. In
that case, the liquidator of an insolvent franchisor-premises owner could disclaim the
537 Mitchell, ‘Signature Out of Pulp But Not Out of Juice’, above n 96, 10.
222 Chapter 4: Is the current regulatory response adequate to deal with the problem?
In models 2, 4 and 6, the implications for the franchisee if the franchisor entity
fails depend on whether the related entity was in the pool of failed companies, or
survives the franchisor’s insolvency without being wound up. If the franchisee still
has a valid lease, but the franchise agreement has been disclaimed, the franchisee
may find itself with a liability to pay rent to the end of the term, but no right to
operate the business.
In model 10, while the benefits of leasing direct from the landlord are obvious
for the franchisee, there may be a significant disadvantage. If the franchisor becomes
insolvent, the franchisee has ongoing legal obligations under the lease but the
liquidator may disclaim the franchise agreement. If that were to occur, the franchisee
would no longer be entitled to trade under the former franchisor’s brand and would
have to re-fit the premises. Disclaiming disentitles the franchisee to any benefits it
was entitled to under the contract.
Even if the franchisee under model 10 or 11 is not evicted as a consequence of
the franchisor’s failure, they can still suffer financially. Having renovated the
premises to accommodate the franchisor’s specific fit-out requirements, if the
franchise agreement is disclaimed by the liquidator the premises would have to be
de-identified before the franchisee could continue trading from them.
In the worst-case scenario, a franchise may have recently bought into a
franchise network that requires it to trade in a shopping centre with significant
investment sunk in the shop fit-out. It may also have provided a personal guarantee
for the franchisor’s head lease. The failing franchisor is likely to have used the
franchisee’s rent payments as a line of credit to prefer creditors other than the
landlord. The landlord will simultaneously call on the franchisee’s guarantee, and
terminate the head lease on two grounds – arrears of rent and outgoings (owed by the
franchisor, paid to the franchisor by the franchisee but not passed on to the landlord)
and administration or insolvency of the tenant (the franchisor).
Implications – specific facts and figures
Franchisees who participated in the 2004/05 CPA Study were asked ‘How
many years did the lease of business premises have still to run when administrator or
liquidator was appointed?’ Forty four per cent answered two-three years and 11 per
cent, four-five years. Where a lease has four-five years remaining it has probably
Chapter 4: Is the current regulatory response adequate to deal with the problem? 223
only been on foot for one or two years. The franchisees would be very vulnerable.
They would not have had an opportunity to trade long enough to recoup the cost
before the franchisor became insolvent.
One of the biggest problems for Kleins was the structural issues with the
franchise system. The franchisor entered into the lease arrangements for
every franchise premises and in some cases provided income guarantees and
rent subsidies to franchisees. … [who] have lost their right of occupation of
their sites being locked out by landlords whose leases were with the
franchisor, who had defaulted despite the franchisees paying to the
franchisor the monthly rent payments537F
An advantage for the franchisee in the model 10 leasing structure became clear
when the ‘Carlovers’ carwash franchisor was placed into voluntary administration on
10 July, 2003. In Carlovers, ‘after the construction of the structural plant by the
Landowner [sic] the property [would] be leased to the Car Wash Operator (ie the
franchisee), who [would] then install items of operating plant’.538F
Commitment to lease payments [in CarLovers] appears to have been a
contributing factor to the financial distress of the franchisor that had ‘locked
itself into expensive leases of up to 20 years, on sites where the carwashes
didn’t reach expectations and the [franchisor] company made big
A few days earlier, franchisees reported being unaffected by the
administration. “The day to day operations of the individual franchisees
would continue as normal.”540F
The franchisees would not have been able to confidently predict their futures if
the franchisor had been the head lessor.
The Kernels Popcorn Australian master franchisee’s insolvency, operating
retail premises through model 7, provides an example of the impact of a
538 Samson, Hill and Sutherland, above n 307. 539 Re Taxation Appeals No NT95/211 AAT No 10709. 540 N Chenowerth, ‘Car Lovers Is All Washed Up’, The Australian Financial Review (Sydney), 19
July 2003. 541 ‘Car Wash Sites Still Running’, The Newcastle Herald (Newcastle), 15 July 2003.
224 Chapter 4: Is the current regulatory response adequate to deal with the problem?
franchisor/lessee’s insolvency on franchisees. Kernel’s became insolvent in 2005.541F
In the report to creditors the administrator wrote:
There were 24 Kernel’s Extraordinary Popcorn stores, of which 20 operated
pursuant to franchise agreements. The company was also lessor of the 20
franchisee-owned stores and four franchisor owned stores. [The liquidator
reports] I was without funds … it was necessary for me to disclaim all of the
company’s leases on 24 March 2005.542F
In the Danoz Directions franchise, the franchisee did not have any security of
tenure as a licensee and bore all of the premises risk. In Danoz Directions the
franchisor/lessee was placed into voluntary administration only a few weeks after
one franchisee’s franchise agreement had been signed. The franchisor lessee’s
voluntary administration constituted a breach of the lease. Thus, the franchisees, as
licensee of the franchisor, found itself in the position of negotiating directly with the
landlord or closing the newly opened shop. One Danoz Directions franchisee:
…almost lost the lease on the store because the franchisor held the head
lease. …[the franchisee] was able to negotiate with his landlord to keep the
site, but he had to bargain away ownership of his store fit-out.543F
The fit out bargained away had cost $125,000.00 a few weeks prior. This figure
includes fit out supervision claimed by the franchisor.
Because fitting out retail premises is a significant sunk investment for many
franchisees, the solutions proposed in this dissertation include proposed amendments
to retail leasing legislation. This is addressed at 6.2.4.
Title to stock
Kleenmaid did not transfer title in the goods sold by its franchisees until the
goods were delivered to the customer. This is a departure from the usual arrangement
under the state sale of goods legislation in which title can pass on the receipt of full
payment by the supplier.544F
545 As many of the suites of whitegoods purchased from
Kleenmaid were to be installed after customers’ renovations had been completed,
542 Refer to 11 April 2005, ASIC Form 535 Formal Proof of Debt or Claim filed by the
Administrators pursuant to Corporations Act 2001 (Cth) s 439A re Jatora Pty Ltd, formerly T/A Kernels Extraordinary Popcorn.
543 Ibid 5. 544 Walker, ‘It Pays to Have a Plan B’, above n 131, 56. 545 See, for example, Appendix A of this thesis, Sale of Goods Act 1896 (Qld).
Chapter 4: Is the current regulatory response adequate to deal with the problem? 225
Kleenmaid warehoused the purchased whitegoods until it suited the customer to take
delivery. Once the franchisor failed, the warehouses exercised a lien to sell the stock
so the warehouse would be paid before handing the balance of the money to the
liquidators. This meant the only stock available for franchisees to sell once the
administrator was appointed was their own demonstration/floor stock.
‘Much of a company’s goodwill is associated with its name, which may be the
subject of trade mark protection. … [T]he crystallizing event’545F
546 of franchisor
insolvency is likely to damage the value of that name. Franchisees assume that they
will continue to have the right to use the franchisors’ trade marks so long as they
adhere to their contractual obligations. In the case of franchisor insolvency, this
assumption is incorrect. If the trade mark was owned by the failed franchisor
company, it is a task of the liquidator to sell that trade mark, or maintain the goodwill
of the name, if possible, in order to realize value for creditors. Trade marks provide
an example of the difficulties liquidators face when trying to retain the franchise
network as a cohesive trading entity. If any of the 88 franchisors identified in the
Exploratory Study in chapter 3.2.2 that owned their trade marks became insolvent the
trade mark would be an asset the liquidator could sell without needing to consult co-
owners or franchisees. Where the franchisor does not own the trade marks the
liquidator must decide whether it is worthwhile negotiating with the owner(s) for
ongoing rights for use of the trade marks.
The franchisor’s intellectual property becomes an asset in the franchisor’s
liquidation. It is an asset, in the same way as franchise agreements are an asset – both
are available to be sold by the liquidator for the best possible price, but they do not
need not be sold to the same buyer. A buyer of the trade marks may elect not to
purchase the franchise agreements. For example the liquidator of Kleenmaid sold the
name ‘Kleenmaid’, to an entity that did not buy any other part of the former
Compass Capital will now set up a new kitchen and laundry goods business
using the Kleenmaid name. The Kleenmaid website will be updated by early
next week with details about how people can buy products… Compass
546 McGuinness, above n 216, 328.
226 Chapter 4: Is the current regulatory response adequate to deal with the problem?
Capital acquired the right to Kleenmaid’s brand and logo following
[Kleenmaid’s] collapse last year. 546F
An asset is only available for sale if it belongs to the debtor or another pooled
entity controlled by the franchisor. If it is merely licensed to the debtor then the act
of bankruptcy will trigger a default in the licence agreement and entitle the trade
mark owner to terminate the licence. A third party owner of the franchised trade
marks may not wish to continue licensing to a franchisor that is demonstrably in
financial difficulty. This leaves the liquidator in a position of having to decide
whether to negotiate with the trade mark owner for the right to continue using the
trade marks. Where trade mark owners live in foreign jurisdictions it is inevitably
more expensive for liquidators to negotiate ongoing use rights for franchisees, even if
a buyer wanted to keep the network together.
The implication of using trade marks as securities for loans is that they might
be repossessed and on-sold to a new owner if the franchisor defaults on the loan. At
the time the searches of the trade mark registry were conducted 2.38 per cent (8
franchisors) of the franchisor trade mark owners had failed.547F
548 Kleins, which failed
since the research on trade marks was conducted, owed the National Australia Bank
$20 million at the time it failed. The administrator said the Kleins trade mark was
part of the loan security by way of a fixed and floating charge.548F
549 Three of the 337
franchisors in the sample analysed in chapter 3.1.2 had security interests registered
against their trade marks.549F
550 This would mean the secured party would be a priority
creditor in the franchisor’s insolvency.
Even if the administrator or liquidator is able to retain the right for the
franchisees to use the trade marks,
the greatest difficulty for a financier in taking a security interest over a trade
mark is whether the trade mark will retain its value once it has ceased to be
associated with the original business or company… If the crystallizing event
547 AAP, ‘Compass Deal a Fresh Start for Kleenmaid’, The Australian Financial Review (Sydney), 7
January 2010, 7. 548 Australian Master Licensee for Kernels, Australian Master Licensee for Midas, Sure Slim, Danoz
Directions, Collins. 549 Interview with liquidator James Stewart of Ferrier Hodgson (Sydney, 7 August 2008). 550 The Athlete's Foot Australia P/L; Coldwell Banker Corporation (USA); Rams Home Loans P/L.
Chapter 4: Is the current regulatory response adequate to deal with the problem? 227
for the transfer of the trade mark is insolvency then it is likely that the value
of the trade mark will be severely damaged.550F
For a master franchisee that has not registered its interest as an authorised user
under the procedures established in the Trade Marks Act, the process of defending
the trade marks that they in turn are licensing franchisees to use, is more
cumbersome. A greater degree of initiative will be required from the liquidator
wishing to negotiate the right to ongoing use of the trade marks.
Unregistered trade marks almost certainly prove more difficult, expensive and
time consuming than registered trademarks for liquidators to value, assert ownership
over, and sell.
4.4.5 IMPACT ON SUPPLIERS TO FRANCHISE NETWORK
Suppliers were discussed in 3.2.5. If a liquidator is appointed to the franchisor,
the supplier becomes a creditor or debtor. At that point, the franchisor has breached
the particular supplier agreement and the supplier can access remedies and mitigate
losses. Unlike franchisees, suppliers do not have their entire businesses reclassified
as franchisor’s assets or liabilities in the franchisor’s insolvency following the
appointment of the liquidator.
4.4.6 IMPACT ON EMPLOYEES IF EMPLOYER BECOMES INSOLVENT
As many franchisees were formerly employees they are used to having
statutory rights if their employer’s business fails. Some franchisees can be likened to
a middle or senior manager in a corporation. Others are more accurately compared to
junior employees. The incorporated franchisee that employs hundreds of staff and
invests hundreds of thousands of dollars in premises and stock is in a very different
position in the franchisor insolvency to an unincorporated sole trader franchisee who
has paid less than A$50,000 for the licence to conduct a dog wash business, do
domestic ironing or mow lawns. In each situation, and all variables in between, the
franchisee will fare differently to an employee if the franchisor becomes insolvent.
4.5 RETAIL LEASING LEGISLATION
Property law recognises that several legal entities may have concurrent rights
in the same premises, the most obvious example being under a lease, where an owner
551 McGinness, above n 216, 328.
228 Chapter 4: Is the current regulatory response adequate to deal with the problem?
grants to a lessee/tenant the right to occupy the premises to the exclusion of all
others, including the owner itself, for a specified period. Retail leases are legally
binding contracts that define the relationship between a lessor (the landlord) and a
retailer (the lessee or tenant). The lease contract addresses a range of matters
including identifying the parties and the lettable space, the rent and permitted uses,
relocation, redevelopment, quality and maintenance, rent reviews, fit-outs and
In addition to contract terms, real property in Australia is regulated by state and
territory laws. Ownership, the strongest real property right, enables the owner (also
known as the registered proprietor) to do anything it wishes with the land,552F
to any restrictions specifically imposed by statute. These restrictions can include
planning requirements and laws that permit the government to compulsorily acquire
All Australian states have adopted the Torrens system of land registration,
issuing a title to each identified parcel of land.554F
555 Part 6 of the Real Property Act
1900 (NSW) 555F
556 provides for interests in land to be registered on the title. The effect
of registration is that it identifies the registered proprietor (owner) of the property
and alerts third parties as to who, in addition to the owner, has a legal claim to an
interest in the property. The information on the title is recognised as being conclusive
in the absence of fraud. If the landowner provides its land as security for a loan, the
mortgagee may register its interest. Lessees may also register their interests.
Registered interests take priority over unregistered interests if an issue arises such as
the financial distress of the landowner. If a party has a registrable interest but decides
not to register, it may lodge a caveat on the title.556F
552 Productivity Commission, The Market for Retail Tenancy Leases in Australia’ Draft Report
(2007) xvii. 553 For example Real Property Act 1900 (NSW) s 42 states that the estate of the registered proprietor
is paramount. 554 Land may also be subject to restrictions at common law; for example nuisance, right of support,
and rights reserved to the Crown such as mining rights. 555 B J Edgeworth, C J Rossiter, M A Stone and P A O”Connor, Sackville and Neave, Australian
Property Law (8th ed, 2008) 460. 556 Similarly, in other States and Territories, Land Titles Act 1925 (ACT); Land Title Act (NT) part 3;
Real Property Act 1861 (Qld); Real Property Act 1886 (SA); Land Titles Act 1980 (TAS); Transfer of Land Act 1958 (Vic); Transfer of Land Act 1874 (WA).
557 For example under Real Property Act 1900 (NSW) s 74F.
Chapter 4: Is the current regulatory response adequate to deal with the problem? 229
An owner may borrow money against the security of the land. If the owner (the
‘mortgagor’) defaults on its payments the land can be sold by the lender (the
‘mortgagee’) to fund repayment of the loan.557F
558 If there is a lessee over premises on
the land, the mortgagee, and subsequently the buyer, has to allow the tenant to
remain in the premises for the term of its lease, or to pay it out, provided the Real
Property Act 1900 (NSW) s53 or its equivalent558F
559 has been complied with. Section
53 (1) When any land under the provisions of this Act is intended to
be leased or demised for a life or lives or for any term of years exceeding
three years, the proprietor shall execute a lease in the approved form.
53 (4) A lease of land which is subject to a mortgage, charge or
covenant charge is not valid or binding on the mortgagee, chargee or
covenant chargee unless the mortgagee, chargee or covenant chargee has
consented to the lease before it is registered.
Even if the lease is unregistered, the lessee’s rights are preserved as long as any
mortgagee of the premises has consented to the lease or any buyer of the premises
has notice of it.559F
Premises leases must comply with the Retail Leases Act 1994 (NSW) (‘RLA’)
or its equivalent in other states and territories.560F
561 If a lessee wishes to grant
occupation of the premises to another party, it may, subject to the terms of the lease,
assign or novate the lease or grant a sub lease or a licence to that other party. In all
cases, the consent of the landlord is required. Where a sub lease or licence is granted,
the original lease between landlord and lessee continues and is referred to as the head
lease. For the lessee, subleasing or licensing provides a continuing connection to the
occupancy that would be lost in the case of assignment or novation of the lease. A
sub lease must be consistent with the terms of the head lease in its key parameters. It
558 The power of sale is conferred in NSW by Real Property Act 1900 (NSW) s 58. Each State and
Territory has similar legislation. 559 Land Title Act (NT) s 67. 560 Figgins Holdings Pty Ltd v SEAA Enterprises Pty Ltd  HCA 20; and see Joycey Tooher,
‘Let Mortgagees and their Buyers Beware: Figgins Holdings Pty Ltd v SEAA Enterprises Pty Ltd’ (2000) 26(1) Monash Law Review 216; Peter Butt, ‘Variation of Lease Binding Purchaser from Mortgagee’ (1999) 73(12) Australian Law Journal 861.
561 Leases (Commercial and Retail) Act 2001 (ACT); Business Tenancies (Fair Dealings) Act 2003 (NT); Retail Shop Leases Act 1994 (Qld); Retail and Commercial Leases Act 1995 (SA); Fair Trading (Code of Practice for Retail Tenancies) Regulations 1998 (Tas); Retail Leases Act 2003 (Vic); Commercial Tenancy (Retail Shops) Agreements Act 1985 (WA).
230 Chapter 4: Is the current regulatory response adequate to deal with the problem?
is possible to register a sub lease on title, but in the context of retail leasing this is not
common. Retail tenancy legislation enables the lessor to refuse to allow a tenant to
grant a sub lease.561F
A lessee that has assigned the lease may not be relieved of all of the underlying
contractual liabilities. A would be assignor-lessee that wants no ongoing rights may
ask the landlord to novate the lease to a replacement tenant who will replace the
original tenant in respect of all of its rights and obligations.
Alternatively, the landlord or the lessee may grant a licence. Fewer rights
accrue to a licensee than to a sub lessee or assignee. Property laws do not provide for
a licensee to register its interest on the title to the premises, nor can the licensee
protect its interest by registering a caveat as a licence is a personal property interest,
not an interest in real property. The fewest rights accrue to a mere occupier with no
contract to define its rights.
A pre-requisite for protection under retail leasing legislation is that the
franchisor’s occupancy situation falls under the legislation. As demonstrated in Table
E, a review of the definitions of ‘landlord’/’lessor’, ‘tenant’/’lessee’ and ‘lease’ in
each of the Acts reveals that none of the state and territory retail tenancy legislation
covers all 12 models of franchisee occupancy described in chapter 3.1.3.
For example, the Western Australia legislation562F
563 defines ‘lease’ broadly but
contains an additional definition of ‘retail shop lease’ that may deprive some
franchisees of protection if their franchisor is a public corporation or a subsidiary of
one. The legislation in some states does not apply to tenancy arrangements of shorter
than 12, 6 or 1 months’ duration.563F
564 Only the legislation of Western Australia
designates minimum tenancy terms before becoming applicable.
562 For example Retail Leases Act 1994 (NSW) s 42, see Appendix A of this thesis. 563 Commercial Tenancy (Retail Shops) Agreements Act 1985 (WA) s 3. 564 Retail Leases Act 2003 (Vic) s 12 (1) exempts some leases of shorter than 1 year duration.
Business Tenancies (Fair Dealings) Act 2003 (NT) s 7(1); s 13(8) exempts short term leases from the provisions of the Retail Shop Leases Act 1994 (Qld) and s 13(9) defines ‘short term’; licences of six months or less for parts of common area in shopping centres are excluded from the Fair Trading (Code of Practice for Retail Tenancies) Regulations (1998) (Tas) under Reg 1(b) and from the Retail Leases Act 1994 (NSW) by s 6A. Retail and Commercial Leases Act 1995 (SA) s 4(2)(ab).
Chapter 4: Is the current regulatory response adequate to deal with the problem? 231
State and territory laws permit the lessee or sub lessee to register its interest on the
565 Registration puts a third party dealing with the title, such as a purchaser,
mortgagee or a liquidator, on notice of the property interest. Even when a franchisee
has property interests recognised by the legislation, they may not be able to be
registered on the landlord’s title. And, where interests are registrable, registration is
not always customary. Franchisees occupying premises as licensees are not protected
by most jurisdictions’ legislation.565F
In practice, whether a lease is registered on the title will depend on the
practice in the state or territory where the premises are located. For example,
it is usual for a tenant to register a lease of three years duration or longer on
the title in New South Wales, but neither registration of a lease nor lodging a
caveat to protect the tenant’s interest is necessary or usual for retail premises
Table 6: Franchisees’ position under State and Territory retail tenancy legislation.567F
Australian Capital Territory
New South Wales
Victoria Western Australia
1 Covered Covered Covered Covered Covered Probably covered. Lessor and lessee not defined
‘Covered' means the franchisee's occupancy arrangement fits within the retail tenancy legislation ‘Not covered' means the franchisee fails to qualify because it or its occupancy arrangement does not fit under the definitions in the relevant legislation N/A applies where the franchisee owns the premises
The parties to a retail lease are free to negotiate and include a response to
franchisor insolvency in their lease contract. As was demonstrated in chapter 3.1.3,
franchisees may not have privity of contract with the owner of the premises. This
increases the franchisees’ vulnerability if the franchisor becomes insolvent in three
Franchisees will not be recognised as creditors in relation to their lost
premises interests as there will be no contractual rights to connect their
loss to the insolvency;
If they were a guarantor, the landlord will have made a legitimate call on
the guarantee when the franchisor breached the lease; thereby depleting the
franchisees’ financial resources, and
Chapter 4: Is the current regulatory response adequate to deal with the problem? 233
They have lost the right to trade from the premises as result of the
franchisor breaching the lease.
4.6 STATUTORY REMEDIES
Benchmark 2 is that there should be accessible, timely and meaningful redress
where consumer detriment has occurred. Up until the time an administrator is
appointed to their franchisor, franchisees have access to protection and redress under
Trade Practices Act parts IVA, and V division 1 and through the Code.
In practical terms however none of the remedies available in Trade Practices
Act pt IV are applicable to the franchisor administration/insolvency situation.
Damages, injunctions, deleting the offending words of a contract, enforceable
undertakings, and advertisements are all remedies based on the assumption that the
breaching party is still solvent. As mentioned in 4.2.3 administrators reject
franchisees’ requests that they attend mandatory mediation under the Code and the
Code does not apply to liquidators.
As was seen in 4.4, even if remedies were available to franchisees, the stay of
proceedings under Corporations Act s 440D means they are not able to pursue any
remedies through the courts while the franchisor entity is in administration. Nor are
franchisees able to initiate proceedings without the consent of the court569F
570 if a
liquidator is appointed. ‘While legal proceedings against the company are stayed,
existing proceedings by the company are not stayed…The liquidator has to decide
whether to continue such proceedings’.570F
571 Thus, the franchisees are vulnerable if they
decide, for example, to stop paying franchise fees following the appointment of the
administrator. The administrator may issue proceedings for anticipatory breach
without seeking leave of the court.
As has been shown in chapter 4, once the franchisor is controlled by a liquidator, the
consumer protection provisions of the Trade Practices Act and the Code cease for
practical purposes, to protect franchisees. Enforcing contractual and statutory rights
through litigation is slow and expensive. Even if litigation were affordable, the
570 Corporations Act 2001 (Cth) s 471B. 571 Murray, above n 150, 318.
234 Chapter 4: Is the current regulatory response adequate to deal with the problem?
Corporations Act imposes barriers on commencing or continuing litigation during
the insolvency process, as discussed in chapters 2.4 and 4.4.
Whilst a franchisee whose franchise agreement or premises lease has been
disclaimed has a right to lodge a proof of debt in the liquidation as an unsecured
creditor for its loss,571F
572 this is a deficient form of consumer protection.
From the time an administrator is appointed to the franchisor, franchisees have
no meaningful voice, let alone any control over their future in the insolvency process.
The current solutions available to franchisees are too fact-specific, expensive, slow
and uncertain. More elegant solutions than the law currently provides require
analysis along the lines of the OBPR’s model572F
573 for the making of sound and
572 Corporations Act 2001 (Cth) s 568D(2). 573 Introduced in ch 1 of this thesis.
Chapter 5: The deal for franchisees 235
Chapter 5: The deal for franchisees
In this chapter the current ‘fair and in good faith’ Australian benchmark for
evaluating consumer protection laws will be discussed briefly. Then, the three more
appropriate consumer protection benchmarks identified in chapter 1 will be put
forward as a basis for evaluating proposed consumer protection for franchisees
whose franchisor fails.
The Productivity Commission (‘PC’) recommends that ‘policy makers should
have regard to the evidence on how consumers and businesses actually behave.’573F
the past, lack of collated evidence on how failed franchisor suppliers and their
liquidators behave towards franchisee consumers has meant that the regulators have
not regarded the situation as one requiring attention. Since the Matthews Inquiry in
2006 the government and the ACCC have become more aware that they could play a
role ex ante in alleviating the effects of franchisor insolvency on franchisees. Ex
post, the consequences of franchisors failure for franchisees are still dealt with on an
ad hoc basis by individual insolvency practitioners.
The actual behaviour of franchisors as suppliers and franchisees as business
consumers was addressed in chapter 2 where the causes and magnitude of the
problem were identified. It was shown that franchisors fail in greater numbers and
with more serious consequences for franchisees than rhetoric suggests. It was also
shown that the failure is seldom caused by franchisees.
In chapter 3 the problem was placed in the context of an issue that is influenced
choices made by the franchisor about structuring the franchise network
the franchise agreement as a contract, for which traditional breach of
contract remedies are ill-fitted when the monopoly supplier becomes
asymmetries of information, adviser, risk, resource, contract and
574 Australian Government Productivity Commission, vol 2, above n 4, 42.
236 Chapter 5: The deal for franchisees
It was concluded that contract law will not evolve, unaided, to provide an adequate
The current statutory framework was discussed in chapter 4. It is concluded
that the law in its current form cannot deliver consumer protection to franchisees in
the event of franchisor failure. Rather, it lulls franchisees, as well as financiers and
franchisee advisers into a false sense that the franchisee’s future is secure in the
5.1 CONSUMER PROTECTION BENCHMARKS
A benchmark is ‘a standard or point of reference; a means of evaluating by
comparison with a benchmark’.574F
575 Following its evaluation of Australia’s consumer
protection laws, Australia’s PC recommended that the:
Australian Government should adopt a common overarching objective
for consumer policy, being:
To improve consumer wellbeing by fostering effective competition and
enabling the confident participation of consumers in markets in which both
consumers and suppliers trade fairly and in good faith. 575F
The PC concludes that ‘fairness’ and ‘good faith’ are the appropriate
benchmarks for measuring markets in which consumers can participate confidently.
The PC’s recommendation led to the drafting of the Trade Practices Amendment
(Australian Consumer Law) Bill 2009 (‘2009 Bill’) and the Trade Practices
Amendment (Australian Consumer Law) Bill (No. 2) 2010 (‘2010 Bill’). The 2009
Bill does not include consumer protection for franchisees whose franchisor fails
because the PC confined its inquiry to consumers that currently fall under the
definition in s 4B Trade Practices Act. The PC did not appreciate that while there
may be effective competition, confident (albeit under-informed) participation in the
market by franchisee consumers and good faith on the part of both franchisors and
franchisees, nonetheless franchisors will fail. While a franchisor’s strategic
insolvency certainly indicates lack of fairness and good faith towards franchisees, in
many franchisor failure situations there is no lack of good faith on the part of any
575 Bruce Moore (ed), The Australian Oxford Dictionary (2nd ed, 2010) 117. 576 Australian Government Productivity Commission, vol 2, above 4, 42.
Chapter 5: The deal for franchisees 237
party. Good faith is not a suitable benchmark in this context. In relation to fairness
the Commonwealth Government concludes:
The Franchising Code is designed to ensure franchisees and franchisors treat
each other at least with a certain minimum standard of fairness, and the
Government’s  proposed changes to the Franchising Code will
improve its effectiveness in promoting fairness and good practice.576F
Until the problem of franchisor failure is addressed, an acceptable level of
fairness will not have been achieved.
In chapter 2 it was demonstrated that franchisor failure is a sizeable problem
for franchisees. In chapter 3 we gained an understanding of why franchisees are
unable to self-protect through negotiating better contracts and that they could not rely
on an action for breach of contract against an insolvent franchisor delivering redress.
Chapter 3.4 demonstrated that issues of asymmetry in six spheres mitigate against
franchisees being able to self-protect via contract law.
In chapter 4 it was concluded that current remedies for breach of the Trade
Practices Act are unhelpful to franchisee consumers where their franchisor supplier
is insolvent. The franchisees’ position under the insolvency provisions of the
Corporations Act is extremely vulnerable.
On concluding that fairness and good faith are inappropriate benchmarks for
evaluating the adequacy of the response of consumer protection regulation to
franchisor failure, more meaningful benchmarks are selected. They are:
B1) Regulation should provide effective protection from serious risks and
threats that franchisees as business consumers cannot tackle as individuals.
B2) There should be accessible, timely and meaningful redress where
consumer detriment has occurred.
B3) The cost to the franchisor and legal system of meeting B1 and B2
should be less than the benefit to franchisees whose franchisor fails.
577 Commonwealth Government Response to the Report of the Parliamentary Joint Committee on
Corporations and Financial Services, above n 166, 11.
238 Chapter 5: The deal for franchisees
Australian legislation will succeed in providing adequate protection to
franchisees as business consumers when it ‘credibly demonstrates’577F
578 to all
franchisees that they can enter a franchise agreement knowing that if their franchisor
goes into administration or becomes insolvent they will:
have had the opportunity to assess and prepare for this risk before they
sign the franchise agreement,
have a legislated exit strategy.
5.1.1 REGULATION SHOULD PROVIDE EFFECTIVE PROTECTION FROM SERIOUS RISKS AND THREATS THAT FRANCHISEES AS CONSUMERS CANNOT TACKLE AS INDIVIDUALS (B1)
Of the national consumer policy objectives identified by Australia’s
Productivity Commission, 578F
579 following a review of those of New Zealand,579F
581 the United Kingdom,581F
582 Canada 582F
583 the fourth objective espoused by
the European Union; [t]o protect consumers effectively from the serious risks and
threats that they cannot tackle as individuals 583F
584best articulates one of the specific
issues that confronts franchisees – the risk of franchisor failure is a serious risk and
578 Commission of the European Communities, EU Consumer Policy Strategy 2007–2013, (2007) 2
<http://ec.europa.eu/consumers/overview/cons_policy/doc/EN_99.pdf> at 5 March 2010. 579 Summarised in the Review of Australia’s Consumer Policy Framework Productivity Commission
Inquiry Report, vol 2, above n 4, 52. 580 To create an environment that is conducive to good and accurate information flows between
suppliers and consumers so that consumers can transact with confidence. New Zealand Ministry of Economic Development 2003, Creating Confident Consumers — the Role of the Ministry of Consumer Affairs in a Dynamic Modern Economy, (2003) 7. Ibid, 29.
581 To prevent business practices that are anticompetitive or deceptive or unfair to consumers; to enhance informed consumer choice and public understanding of the competitive process; and to accomplish these missions without unduly burdening legitimate business activity. Federal Trade Commission (2006) ‘Strategic Plan Fiscal Years 2006-2011’, Washington, 1. Ibid, 29.
582 To place empowered consumers at the heart of an effective competition regime, bringing UK levels of competition, consumer empowerment and protection up to the level of the best by 2006. UK Competition Commission 2007, ‘The roles of the Competition Commission and Department of Trade and Industry in promoting competition’, from www.competition-commission.org.uk.
583 Building trust in the marketplace so that consumers can protect themselves and be able to confidently and knowledgeably drive demand for innovative products and services at competitive prices. (Office of Consumer Affairs, Canada 2007). www.ic.gc.ca
584 To empower EU consumers. (i) Putting consumers in the driving seat benefits citizens but also boost competition significantly. (ii) Empowered consumers need real choices, accurate information, market transparency and the confidence that comes from effective protection and solid rights. (iii) To enhance consumer welfare in terms of price, choice, quality, diversity, affordability and safety. Consumer welfare is at the heart of well-functioning markets. (iv) To protect consumers effectively from the serious risks and threats that they cannot tackle as individuals. (v) A high level of protection against these threats is essential to consumer confidence. Commission of the European Communities above n 578, 5-6.
Chapter 5: The deal for franchisees 239
threat that individual franchisees, or even group of franchisees cannot tackle by
The EU Consumer Policy strategy 2007 – 2013 states:
Confident, informed and empowered consumers are the motor of economic
change as their choices drive innovation and efficiency. The response to
these challenges lies in equipping the consumer with the skills and tools to
fulfil their role in the modern economy; in making markets deliver for them
and in ensuring effective protection from the risks and threats they cannot
tackle as individuals. 584F
This inability of franchisees to address the risks or threats of franchisor failure
as individuals is the core of their problem.
Firms incur obligations daily to suppliers, to employees and to different
classes of investors. So long as the firm is prospering the adjudication of
claims is seldom a problem. When the firm has difficulty meeting some of
its obligations, however, the issue of the priority of those claims can pose
serious problems. This is most obvious in the extreme case where the firm is
forced into bankruptcy. If bankruptcy [administration or insolvency] were
costless the reorganization would be accompanied by an adjustment of the
claims of various parties and the business could, if that proved to be in the
interests of the claimants, simply go on.585F
Where the firm is a franchisor, not only will the ‘total value of the firm fall’586F
but the franchisees to an arguably greater degree than the franchisor ‘bear [almost]
the entire wealth effect of the bankruptcy cost’.587F
What type of protection is possible within the consumer regime?
Ex ante, the protection should be in place before the franchisees sign the
agreement. This allows them to factor the possibility of the franchisor failing into
their financial models and make a more accurate evaluation of how much risk they
are taking. Thus, ex ante protection should exist in the form of both an improved
disclosure document, and implied terms in the franchise agreement. An important
585 Commission of the European Communities, EU Consumer Policy strategy 2007 - 2013, above n
578, 2. 586 Jensen and Meckling, above n 21, 340. 587 Ibid 341. 588 Ibid.
240 Chapter 5: The deal for franchisees
further component of consumer protection is for the business consumer of a failed
product, the franchise business, to have rights under the Corporations Act. This
aspect of the solution does not form part of this thesis.
IMPROVED PRE-CONTRACT DISCLOSURE
The improved disclosure should address recommendation 21 in the Matthews
The Risk Statement [to be provided to all franchisees associated with failure
of this particular franchise and its structure before they are committed to the
franchise] and the ACCC educational material should clearly describe the
risks and consequences associated with franchisor failure.588F
Improved disclosure does not mean longer disclosure. It is disclosure that is
differently structured so it is more meaningful. This will be addressed more fully in
The second response should occur at franchise agreement level. All franchise
agreements should contain implied terms including ratcheted provisions enabling
franchisees to exit the network following the appointment of an administrator or
liquidator. These are addressed in chapter 6.2.2.
What are the risks and threats?
The greatest risk to fulfilment of the promise that franchising offers franchisees
and the unmitigated threat to the viability of the franchisee’s business is that the
franchisor will fail. As has been demonstrated in chapter 2, this is a real risk and a
real threat. It is clear from 2.1.3 that franchisors may fail for a wide variety of
reasons. Few if any franchisor failures can be attributed to franchisees. None could
have been anticipated by a franchisee conducting better due diligence on the basis of
the current disclosure document, being better educated on the basis of information
currently available to intending franchisees, or receiving better legal or financial
advice before signing the franchise agreement.
It is reasonable to expect that the major legal and commercial risks that a
franchisee faces as a consequence of signing the contract could be addressed in the
standard contract. The Australian Risk Standard, AS/NZ 4360/2004 (‘Risk 589 Matthews, above 113, 44.
Chapter 5: The deal for franchisees 241
Standard’) provides a methodology for identifying and managing risk in a business
that could be used by both franchisors and franchisees to determine whether a given
franchise agreement addresses the key risk items. An aspect of the methodology is to
categorise events in tabular form as in Table 7 as ‘known knowns’, events which will
occur, such as the franchise agreement will terminate at the end of the term; ‘known
unknown’ events which are known to be possible but their effect is not fully
knowable; and ‘unknowns’. The category each event is placed in determines its
treatment in the franchise agreement.
Table 7: Risk analysis template
Day to day events Address in contract
Franchisor might fail – genuine failure.
Franchisor might decide to become insolvent.
Parent company might decide to close franchise division/ strategic insolvency.
If impact would be severe on either party, include, if not, leave to future negotiation.
Weight with respect to impact on network and on individual franchisee.
Provide contract based strategy.
Far fetched events that are never likely to impact on the network.
Address through ‘motherhood’ clauses; ie: general obligations such as to cooperate, act reasonably, act in good faith.
In the context of the Risk Standard, franchisor insolvency is a risk that should
be evaluated and planned for as a ‘known/ unknown’ i.e. – it is known that it could
occur, but unknown if or when it will occur. If it does occur, it is serious enough to
be addressed in the franchise agreement.
Why are franchisees unable to tackle these risks and threats as individuals?
The Australian Government argues that ‘the parties to the contract are best
placed to determine commercial matters’.589F
590 There are eight broad reasons why
590 Commonwealth Government Response to the Report of the Parliamentary Joint Committee on
Corporations and Financial Services, above n 166, 21.
242 Chapter 5: The deal for franchisees
franchisees are unable to accurately measure and factor in the commercial risk of
franchisor failure, even if they do identify it as a possibility. In summary:
The franchise network is a complex set of legal structures. The retail lease
models in chapter 3.2.3, and diagrams and charts in Appendix D depict the
legal environment in which the franchisor operates.
Pre contract disclosure:
o Fails to put franchisees on notice about the significant threat which is
beyond their ability to research, and beyond their control – the
franchisor’s survival. It provides only a small amount of information
about the current financial standing of the franchise network. In 2009
it was announced that:
The Government will introduce amendments to clause 1.1(d) of Annexure 1
and clause 1.1(e) of Annexure 2 of the Franchising Code to state that
franchising is a business and that like any business the franchise (or
franchisor) could fail during the franchise term.590F
This is a step towards better consumer protection but its impact is diluted by
the emphasis on the franchise. Franchisees have always accepted that their
own business might fail. It is franchisor failure that is the less manageable
o Fails to disclose specific information about the direction of money
flows within the network and the risks and threats thus accepted by
franchisees operating as commission agents.
o Does not require franchisors to provide sufficient timely information
about premises. This is particularly the case if the franchisee is a sub-
lessee or a short term licensee that does not fit within the relevant
statutory definition of tenant/lessee.
Franchisees are unable to conduct affordable and effective due diligence as
591 Ibid 22.
Chapter 5: The deal for franchisees 243
The franchise agreement is drafted by the franchisor. Because it is not
negotiable the information provided in the disclosure and acquired through
due diligence, is of limited value.
Asymmetries abound, as described in 3.4. They contribute to the
franchisees’ inability to evaluate the risk of franchisor failure, or plan for
The Code offers no rights and no protection to franchisees in this situation.
The winding up process provides liquidators with rights that are the
antithesis of franchisees’ needs. Franchisees have no right to negotiate
with the receiver or administrator. When the liquidator is appointed, they
have no franchisee-specific rights in the creditors’ pool. Strategic
insolvency cannot be anticipated.
There is no lobby group or union that represents the interests of all
franchisees whereas franchisors interests are strongly represented by the
5.1.2 THERE SHOULD BE ACCESSIBLE, TIMELY AND MEANINGFUL REDRESS WHERE CONSUMER DETRIMENT HAS OCCURRED (B2)
Currently, where the franchisor enters administration or becomes insolvent,
each of its franchisees enters a legal minefield. The legal options franchisees can
Terminate the franchise agreement for anticipatory breach, but this is
accompanied by the risk that the liquidator might initiate proceedings.
Pursue quasi-contractual remedies.
Commence action under the Trade Practices Act if any of the directors or
another solvent party is identified that falls within s 75B Trade Practices
Any post-appointment action commenced by the franchisee requires the
consent of the court and would almost certainly be opposed by the liquidator. If the
franchisee successfully navigates the minefield it arrives at a regulatory vacuum in
relation to its rights in the administration or the insolvency. This is not satisfactory.
244 Chapter 5: The deal for franchisees
[c]ontract law makes its own promises to contracting parties: it promises to
be available to accurately interpret the agreement the contracting parties
have made, to impartially judge the performances rendered, and to reliably
implement the appropriate remedies. … Courts must be accessible at
relatively low cost in geographic and linguistic terms to contracting
Hadfield also states that:
[d]elay in the resolution of contract disputes is an important impediment to
the effectiveness of contract law – not only does the value of payment
decrease with time but so too does the probability of recovery diminish as
the potential for assets to be dissipated increases and circumstances change
to make performance more difficult and/or less valuable.592F
As was demonstrated in chapter 4, justice extracted from a solvent franchisor
through the courts was very expensive and very slow for the Hoys whose alternative
to litigation was to have their franchise terminated by their franchisor. The
franchisees ultimately won their case, and won again on appeal.593F
Hadfield’s thoughts are also valid when the redress is to come from the
diminishing assets of an insolvent estate. Accessing redress through an administrator
or liquidator is far more problematic, at any cost. Specific issues were identified in
chapters 3.3, 4.3 and 4.4.
The possibility of timely redress is particularly significant where the parties to
the dispute are in an ongoing contractual relationship. This is recognised in
franchising and addressed through the opportunity to request mediation through the
Code if the franchisor is solvent.
Timeliness is especially important for the franchisee whose right to profit from
the relationship ends on the termination date of the franchise agreement. Examples of
592 Hadfield, ‘The Many Legal Institutions that Support Contractual Commitment’, above n 22, 181. 593 Ibid 182. 594 Hoy Mobile Pty Ltd v Allphones Retail Pty Ltd (No 2)  FCA 810.
Chapter 5: The deal for franchisees 245
lack of timeliness are common where one party has an interest in not settling a
dispute. The franchisor may be reluctant to settle for fear of setting a precedent. For
example, in Hoy, following the franchisor’s refusal to mediate the franchisee had to
litigate or accept defeat. The franchisee said:
I was told the proceeding were likely to cost me around [A]$300,000 … and
that my matter stood a good chance of succeeding … but more importantly
there was no other way of restraining the franchisor from acting upon the
termination notice without an injunction. Our business was worth … about
the same amount. At the time we thought it was commercially sensible to
begin proceedings to prevent the termination and to protect our asset. By …
the end of 2006 the costs had reached $140,000. The court ordered
mediation which we attended to no avail in November 2006. The franchisor
had made it clear from the beginning that they were going to fight us all the
We had to subpoena [telecommunications] carriers to obtain the evidence we
required and even this process was not easy and cheap. We had to provide an
undertaking to the court that we would not disclose the information we read
before we were allowed to view the documents. Once I viewed the
documents I was certain our issue had merit and was an issue that affected
every [Allphones] franchisee and I was not allowed to tell my fellow
franchisees or the ACCC. The carriers each charged between [A] $1000 to
over [A] $3000 for producing the documents. 594F
In the failed Danoz Directions franchise network one franchisee signed a
franchise agreement for a five year term with a five year renewal in February 2004,
the franchisor failed in October 2004. The franchisee instituted proceedings against
the franchisor’s solvent directors alleging breaches of parts IAV and V of the Trade
Practices Act. In September 2009 two days of hearing time were allocated and in
April 2010 a further two weeks of hearing time are allocated for the litigation
595 Evidence to Parliament of Australia Joint Committee on Corporations and Financial Services,
Senate of Australia, Inquiry into Franchising Code of Conduct, undated, 4 (Nicole Hoy) <http://www.aph.gov.au/SENATE/COMMITTEE/corporations_ctte/franchising/submissions/sub08.pdf> at 17 January 2010.
246 Chapter 5: The deal for franchisees
initiated by the franchisee under the Trade Practices Act to be heard in the Federal
Court of Australia. 595F
596 This is not timely.
Timely redress is also important where the franchisees whose businesses are
required by the administrator to continue operating must keep paying staff, meeting
commitments under premises agreements (even those that involve paying money to
the failed franchisor) and meeting franchise agreement commitments while the
administrator and then the liquidator decide on the future of the franchisor.
‘Accessible and timely’ are not sufficient measures of redress where one party
is insolvent. Meaningful redress is also vitally important.
Meaningful redress leaves the franchisee able to move ahead with their life
unencumbered by debts and bad relationships accumulated through the conduct of
the franchisor. Franchisor-transmitted debt and franchisor-transmitted poor supplier
relationships should not be a consequence of being a franchisee.
Meaningful redress is also cost-effective. The trials in the Danoz and the Hoy
matter above are expensive. Few franchisees can afford to litigate. In addition to
money, the human resources in the court room on each hearing day, in Danoz, are
one Special Counsel, one junior barrister, one solicitor for each party plus the judge,
the Judge’s Associate and a court officer plus the parties and expert witnesses. All of
these people have other ways they can spend their time.
Legal options should extend beyond the theoretical and should be meaningful,
accessible and timely. This is especially where consumer loss is significant and is
brought about by failure of the monopoly supplier. The current situation fails against
5.1.3 COST BENEFIT CONSIDERATIONS (B3)
These problems [i.e. those sought to be addressed by enacting s 51AC Trade
Practices Act and the Code in 1998] have considerable economic and social
costs in that they contribute significantly to business failure. The social costs
identified included stress, marriage breakdown, poor health and suicide. The
economic costs of the business conduct issues … include an inability by
596 Hearing 2 (P) NSD1313/2008 Benjamin Morris & Anor v Danoz Directions Pty Ltd (ACN 092
832 534) (in Liquidation) & Ors.
Chapter 5: The deal for franchisees 247
small firms to gain a return on sunk costs and market inefficiencies arising
out of exploitative conduct. The overall costs of small business failure in
terms of its implications for employment and growth are also relevant.596F
The OBPR identifies as its fourth criteria the need for:
An assessment of the impact, including costs and benefits, on consumers,
business, government and community or each option, with each impacted
group identified, noting impacts on competition, small business and trade.597F
B3 is thus that the cost of the franchisor supplying and the franchisee
assimilating the information should not outweigh the benefit to the franchisee
business consumer in the newly framed regime.
‘The primary objective of cost-benefit analysis is to determine whether the
overall wellbeing (termed ‘welfare’ by economists) of society is likely to increase or
decrease as a result of implementing a specific policy’.598F
599 A comprehensive cost
benefit analysis (‘CBA’) relies on adequate base data. There is no such data available
in franchising. This partly stems from unwillingness by the government to require
franchisors to place their franchise disclosure materials on a publicly searchable
database as a pre-condition of allowing them to sell franchises. Even with a useful set
of base data, conducting a cost benefit analysis is primarily the work of an
Banks writes that ‘an effective regulation making and administrative system
should mediate the impact of the increasing demands that arise from an increasingly
risk averse society’.599F
600 As we have observed in the way franchisors shift risk to
franchisees, the franchisees are the unwitting mediators of a wide range of the
Leo Dobes reminds us that ‘[w]hen economists refer to cost-benefit analysis,
they mean social cost-benefit analysis: reflecting the fact that the analysis is not 597 The Parliament of the Commonwealth of Australia House of Representatives, Explanatory
Memorandum, Trade Practices Amendment (Fair Trading) Bill 1997 (Circulated by the authority of the Minister for Customs and Consumer Affairs, Senator the Honourable Christopher Ellison).
598 Australian Government, Best Practice Regulation Handbook (2007) 27. <http://www.finance.gov.au/obpr/docs/handbook.pdf > at 17 June 2010.
599 Leo Dobes, ‘A Practical Guide to Cost-Benefit Analysis’ in George Argyrous (ed), Evidence for Policy and Decision-Making (2009) 45, 69.
600 Banks above n 24, 15.
248 Chapter 5: The deal for franchisees
limited to the standpoint of a government budget, a firm’s profits, or an individual’s
The impact on all stakeholders must be included in a cost benefit analysis. In
the context of this thesis, they are identified in 6.3.
The cost of franchisor failure
Benefits of intervention cannot be considered in isolation from its costs… 601F
The economic cost of franchise failure is not counted in studies such as the
‘Economic Impact of Franchised Business’ conducted for the International Franchise
Association Educational Foundation, 602F
603 and is generally below the regulators’
604 As well as the cost of franchisor failure being hidden:
[t]he real costs of regulation are ‘hidden’ from view as they are the ‘off-
budget’ costs of business and society compliance with regulation.
The cumulative cost of regulation is not often considered as most
departments and agencies have responsibility only for specific regulation,
and little concern for its cumulative nature. 604F
This is the case in franchisor insolvency where, as was outlined in chapter 4,
different governments and within the governments, different departments have
responsibility for the Trade Practices Act, the Corporations Act and the states’ and
territories’ retail tenancies legislation.
Limitations of cost benefit analysis
Richard Zerbe states:
CBA attempts to solve collective action problems, which arise when
individuals or groups pursuing narrow self-interest without coordination
601 Dobes, above n 599, 69. 602 Australian Government Productivity Commission, vol 2, above n 4, , . 603 PriceWaterhouse Coopers, Franchise Business Growth Outpaces Other Buiness Sectors (2004)
International Franchise Association <http://www.franchise.org/franchiseesecondary.aspx?id=37842> at 7 March 2010.
604 An exception is the exploratory Australian study funded and published by CPA Australia. The resulting report When the Franchisor Fails (2006) <http://www.cpaaustralia.com.au> at 17 June 2010.
605 Carroll, above n 25, 4.
Chapter 5: The deal for franchisees 249
arrive at outcomes that are collectively inferior to those that could be
achieved with coordination.605F
‘There are two issues raised here. One is the value of the use of benefit-cost
analysis (CBA) and the other is to what extent to which its use can be protected from
destructive effects of the political process’.606F
607 Zerbe’s paper addresses the value of
CBA but equally important in franchising policy, where some sectors have a strong
vested interest in the status quo, is the second question. The world of business format
franchising includes numerous individuals and groups with different agendas, a
sizeable amount of self-interest stemming from ego, a wish to retain power, an
unwillingness to see the big picture and factors as mundane as the constraints of the
6-minute time sheet. To objectivise the problem of franchisor failure as it impacts on
franchisees, to repackage it in a CBA is a useful step towards a solution in that the
focus can thereby shift from the individual problem to a collective solution.
Steps in cost benefit analysis
A CBA may include the following steps, following identification of the
Forecast impact on franchise purchases
Estimate cost to franchisors
Estimate benefits to franchisees
Estimate impact on government
Estimate other [consequential] effects
Aggregate costs and benefits into an estimated total net benefit
Assess policy risks and uncertainties
Consider incidence of the policy on different social groups.607F
606 Richard O Zerbe, Jr, ‘An Ethical Benefit-Cost Analysis’ (Paper presented at The Searle Centre
Cost-benefit Analysis of Regulations: Lessons Learned, Future Challenges Conference at Northwestern University School of Law, September 2007) citing at fn 31 Theodore M Porter, Trust in Numbers: The Pursuit of Objectivity in Science and Public Life (1995) 187.
607 Ibid, 4. 608 Adapted from <http://www.treasury.gov.au/documents/790/PDF/Cost_Benefit_Analysis.pdf> at
7 March 2010.
250 Chapter 5: The deal for franchisees
The currently favoured consumer protection benchmarks of fairness and good
faith, and accessible and timely are insufficient when evaluating the sufficiency of
consumer protection response for franchisees of failed franchisors.
The benchmarks proposed; B1, B2 and B3 do get to the heart of the problem.
Until the problem is understood any solutions will be patchy and unsatisfactory.
They will not protect franchisee consumers at their most vulnerable time.
All current possible contract and quasi contract based actions fail to address the
problem and fail to measure up to benchmarks B1 and B2. The statutory avenues
currently available to franchisees are equally unusable in practice.
In chapter 6 a number of possible non-regulatory and then regulatory responses
are proposed. The regulatory responses are evaluated against B1 and B2
Chapter 6: Consumer protection to address the benchmarks 251
Chapter 6: Consumer protection to address the benchmarks
If franchisor failure is a hidden risk, what is the best way of protecting the
franchisee’s business from the effects of franchisor failure? How can the situation be
addressed more satisfactorily, predictably, efficiently and economically? In 6.1 non-
regulatory solutions are canvassed. In 6.2.1 and 6.2.3 consumer protection strategies
that do not involve amending insolvency laws are identified.
6.1 POTENTIAL NON-REGULATORY SOLUTIONS
6.1.1 STATUS QUO
In the ‘do nothing’ solution requires all franchisors to continue preparing,
updating and delivering extensive Code compliant disclosure that fails to place the
franchise offering in an accurate context from the perspective of franchisees being
able to evaluate commercial or legal risk. Franchisees will continue to pay for legal
and financial advice on the inadequate information and to be unable to objectively
verify much of that information. Most franchisees will not negotiate ipso facto
clauses into their agreements and will not be able to protect their own assets as well
as franchisors can. Franchisees will continue to be unnecessarily vulnerable to the
It has been acknowledged that more education is needed for prospective and
incumbent franchisees, and also for franchisors. Australian Government sponsored
reports on franchising have identified education as an essential part of the solution to
short comings of the franchise model.608F
609 The Reid Report identified ‘the inadequacy
of advice and education for small businesses’609F
610 as a matter for concern. The
609 Task Force above n Recommendation 41; Committee on Industry, Science and Technology (the
Reid Committee) Finding a balance; Towards fair trading in Australia (1997) Recommendation 7.3 and 7.4; Matthews, above n 113, Recommendation 21 ; Economic and Finance Committee, Parliament of South Australia, Franchises (2008) 38 and 87; Chris Bothams, Inquiry into the Operation of Franchise Businesses in Western Australia (2008) 14.
610 Committee on Industry, Science and Technology (Reid Committee), above n 609, 1. <http://www.aph.gov.au/house/committee/isr/fairtrad/report/CHAP1.PDF > at 22 June 2010.
252 Chapter 6: Consumer protection to address the benchmarks
Matthews Review’s Report610F
611 contained 15 references to education. The South
Australian Parliament Report in 2008 contained 42 references to education. It did not
directly identify education as a solution to franchisor failure.611F
The West Australian report, also in 2008, referred to education 38 times,
including the following observation about franchisee failure:
The risk of business failure [impliedly a franchisee’s business, not a
franchisor’s] will always exist. This risk can be reduced by undertaking
thorough business feasibility assessment and planning prior to entering into
any commercial arrangement. …The importance of pre-entry education for
franchisees has emerged as a key issue. … It has been reported anecdotally
that in many cases, prospective franchisees do not educate themselves prior
to entering into a franchise arrangement. 612F
It was demonstrated in chapter 3 that the operating in the perfect world of thorough
business feasibility assessment and prior planning is impossible in some cases and
ultimately of no benefit if a franchisor fails.
Pre-contractual education was placed in context in Opportunity not
opportunism where it was noted that ‘[a]lthough education, advice, disclosure and
due diligence generate important information about the potential for success, the true
nature of franchising cannot be appreciated until the relationship is under way’.613F
The commonwealth Government responded by writing:
the Government has explored avenues to better balance the rights and
liabilities of franchisees and franchisors in the event of franchisor failure
(Recommendation 4). The Government supports the development, by the
ACCC, of additional educational information on the potential consequences
and liabilities franchisees could be exposed to in the event of franchisor
The importance of education cannot be discounted. Education will make
611 Matthews, above n 113. 612 Economic and Finance Committee, South Australian Parliament, Franchises (2008). 613 Government of Western Australia, Inquiry into the Operation of Franchise Businesses in Western
Australia, Report to the Western Australian Minister for Small Business (2008) 14. 614 Commonwealth Government Response to the Report of the Parliamentary Joint Committee on
Corporations and Financial Services, above n 166, 7. 615 Ibid 21.
Chapter 6: Consumer protection to address the benchmarks 253
franchisees and their advisers more aware of the possibility of franchisors failing.
Education cannot protect franchisees if their franchisor does fail.
It should also be noted that it is difficult for the ACCC to provide meaningful
educational material that would alert a franchisee within a network that their
situation is worse than that of others in the network because the franchisor has
chosen to shift more risk onto them specifically. For example if the franchisor
usually uses leasing model 4 or 5 but on this occasion has selected model 10 because
there is a demolition clause in the lease. Only the franchisor will know this is an
aberration from its usual practice.
6.1.3 FRANCHISEE UNION
Franchisees face significant impediments to self-representation as lobbyists or
as litigants. Franchisees do not join trade unions in Australia. As individuals they do
not have resources to involve themselves personally in politics at a national level in
addition to running their own business and in some cases participating in their own
franchise network’s advisory council. They risk alienating their franchisor if they
express views that the franchisor or the FCA find threatening or inconvenient.
Franchisees may fear that if, hypothetically, they were seen to be devoting time to
union affairs, their franchisor would build a case to terminate for breach of a term of
the franchise agreement that requires the franchisee to devote all time and energy to
The problem of whether a franchisee union could be established and how it
would be funded has been overcome in Japan. There, individual owners of franchised
convenience stores were permitted to become members of an existing union in
In Europe, recognising the difficulties of finding time and money for
consumers to self-represent effectively:
[t]he EU has subsidised consumer group representation through the
European Consumers’ Organisation (BEUC) and the European Consumer
Law Group (ECLG) as well as specialised groups such as European
616 Anderson Mori and Tomotsune, Formation of Labour Union by Convenience Store Franchisees
(2009) <https://www.internationallawoffice.com%2fNewsletters%2fDetail.aspx%3fg%3d4ca4add7-f8bd-4530-a6eb-82b0fa183729> at 5 January 2010.
254 Chapter 6: Consumer protection to address the benchmarks
Association for the coordination of Consumer Representation in
While franchisors and franchisees do have matters of common interest where
the FCA can provide adequate representation, the areas where their interests are in
conflict should not rely on academics or individual franchisees with sufficient
motivation and courage to make a submission to a government inquiry, to be aired.
The argument for union membership has appeal. It is easy to dismiss one
franchisee’s voice as non-representative, but would be difficult to dismiss a union
representing the 71,000 franchisees in Australia.
It should be possible for franchisees to insure against the consequences of their
618 In a submission to the 2009-10 Senate Economics Committee
Inquiry into Liquidators and Administrators, Greg Crook, a director of a supplier
adversely affected by the insolvency of a mining company wrote:
[s]uppliers to industry have few options … Take out their own insurance
[debtor insurance] at rates that are up there with the insolvency practitioners
themselves. …The cost of this insurance is … becoming even more out of
reach as the risk to the insurers book escalates as insolvencies are becoming
more and more common. There is no way that suppliers can be secured …
they have no choice but to be unsecured creditors. 618F
Crook proposes that:
ASIC’s charter should be to ensure protection for all stakeholders and this
could be achieved by writing into AS 4000 that there should be reciprocal
insurance rights for all stakeholders. If premiums were gathered by the
insurance industry on every contract then the overall premium would be
The insurance solution is appealing but in the franchising sector the absence of
reliable comprehensive data about franchisor failure would make it difficult for
617 Ramsay, above n 329, 18. 618 The author is not aware of any such insurance but theoretically the risk and potential loss are
measurable so the possibility of insurance should not be ruled out. 619 Submission to Economics Committee, Australian Commonwealth Senate, Inquiry into
Liquidators and Administrators, 3 December 2009, Submission Number 1 (Greg Crook). 620 Ibid.
Chapter 6: Consumer protection to address the benchmarks 255
actuaries to assess the likelihood of failure or the magnitude of loss, and therefore to
set premiums accurately. Further, the absence of a mandatory requirement that
franchisors register would make it extremely difficult to achieve widespread
compliance with any requirement to pay into an insurance fund.
6.1.5 RECONFIGURE SOME OBLIGATIONS
Requiring franchisors to provide their own security deposits for retail premises
could help mitigate the effects of their failure on their franchisees. This would mean
that if the franchisor failed, a franchisee in a model 3, 4, 6, 7 or 10 leasing situation
would not be called on to meet the franchisor’s liability for unpaid rent or outgoings.
This is a partial solution, limited to franchisees conducting their franchise under the
Requiring franchisors that operate through the commission agency model to
supply personal guarantees from the franchisor’s directors to franchisees is also
possible, though ad hoc and seldom agreed to by franchisors. Personal guarantees
would remain actionable if the principal debtor, the franchisor, became insolvent.
6.1.6 DEEM FRANCHISORS TO BE TRUSTEES
An option would be for some of the funds received by franchisors to be
deemed to be held on trust for the franchisee. For example, currently, the sums like
the $60,000 option fees in Table 3 charged for future sites are currently treated as
general revenue and are not traceable in the franchisor’s insolvency. Ideally, these
sums should be held by franchisors on trust for the franchisees until the paid-for
options are exercised. The moneys franchisees pay to a central advertising fund
would also be easy to hold in a separate account with the franchisees as beneficial
owners until the moneys are spent for legitimate advertising purposes.
Which moneys franchisors should be holding on trust would be a topic for
6.1.7 LEGISLATE SOLUTIONS
[T]here are three fundamental questions surrounding the debate about
Why do consumers need protection?
When ought the state intervene to protect them?
256 Chapter 6: Consumer protection to address the benchmarks
How ought the government to intervene? 620F
Andromachi Georgosouli adds that:
consumer protection policies have as an overarching objective to improve
economic efficiency by remedying market failures and preserving the
fairness of the process and outcomes of the transactions. 621F
Consumer protection does not exist in a regulatory vacuum. Thus, a fourth
fundamental question should be added:
What is the context in which consumer protection functions?
This leads to the question; why do consumer protection inquiries,622F
models created by franchise academics623F
624 and regulatory responses assume that the
supplier, in this case the franchisor, will be solvent at the time the product or service,
the franchise business support, is supplied?
‘[C]onsumer protection has an ancient genesis, dating back at least to Roman
times with the adoption in Roman law of various implied warranties against latent
defects in the sale of goods’.624F
625 Trebilcock identifies two sources of pressure on
traditional consumer protection regulation, being:
the rapidity of technological change, globalisation and deregulation of
formerly regulated monopolies have dramatically expanded the range of
consumer products and services available in any given jurisdiction, making
product and service-specific regulation increasingly problematic and
intensifying the informational challenges faced by consumers.625F
a veritable revolution in industrial organisation theory … particularly as it
relates to market structure, bargaining power and information, has rendered
simplistic structure-conduct-performance paradigms that keyed on a small
621 Iain D C Ramsey, ‘Rationales for Intervention in the Consumer Marketplace’ (1984) Occasional
Paper for the Office of Fair Trading 1, in fn 24 of Georgosouli, above n 338. 622 Georgosouli, above n 338, 7. 623 For example Australia’s Productivity Commission Review of Australia’s Consumer Policy
Framework, vol 2, above n 4. 624 For example Francine Lafontaine; K Shaw; and Gillian K Hadfield. 625 Trebilcock, above n 29, 68. 626 Ibid.
Chapter 6: Consumer protection to address the benchmarks 257
number of variables and that underpin many aspects of contemporary
consumer protection policy also increasingly problematic.626F
Trebilcock’s conclusion that the true focus of consumer protection is in the
quality and cost of information falls short. He concludes, by implication, that with
sufficient of the right information provided at the right time and the right price, the
consumer can be adequately protected. This may be true where goods and services
are not designed to last for decades, or where ongoing servicing is provided by
replacement suppliers. It does not apply when the business of the franchisor supplier
Further, Trebilcock et al’s analysis starts with the assumption that the
consumer market is competitive and, by implication, that it remains competitive even
once a product has been acquired by a consumer. They suggest that ‘where a market
is very imperfectly competitive or non-competitive, problems of consumer protection
may have to be addressed through competition policy or economic regulation’627F
rather than through consumer protection.
The sale of franchises is a hybrid. Before the franchise agreement is executed
the market is competitive. Once the agreement has been executed the franchisee is
committed to dealing with a monopoly. This is demonstrated through the network of
contractual relationships that is shown in relation to retail premises and trade marks
in chapter 3.2. Franchisees have purchased a bundle of products, services and use
rights from the franchisor.
If the franchisor’s business fails, there is no alternative franchisor to step into
the insolvent franchisor’s shoes. A competitor may potentially take over the
company owned and franchisee owned sites but may not wish to enter contracts with
the existing franchisees. A purchaser purchasing even an expensive item such as a
car is not obliged to return to the manufacturer for driving lessons, servicing, all
routine future suppliers of parts, petrol and oil, and ultimately to sell the vehicle only
through the manufacturer. The purchaser of the vehicle may get it serviced
anywhere, buy petrol anywhere and can sell it on the open market long after the
manufacturer has ceased to exist. The insolvency of the manufacturer is not going to
627 Ibid. 628 Ibid 69.
258 Chapter 6: Consumer protection to address the benchmarks
prevent the consumer from gaining full use and enjoyment out of the car. Franchisees
are different because the bundle of products, services and use rights only stays intact
while the franchisor is solvent. The insolvency of the franchisor almost without
exception deprives the franchisee of what it has purchased.
In answer to Ramsey, Georgosouli and Trebilcock, here is a situation when the
state ought to intervene to protect consumers. The forces of the competitive
marketplace have failed franchisees. Consumer protection policy is an appropriate
vehicle to correct this market failure. In conclusion, the problems will not go away,
and they will not be resolved without parliamentary intervention. A range of
regulatory interventions is now proposed.
6.2 REGULATORY SOLUTIONS
An essential step when amending legislation is being considered in Australia is
to conduct a Best Practice Regulation Preliminary Assessment using the procedure628F
provided by the Australian Government Department of Finance and Deregulation. In
line with this process, the problems were identified in chapters 2, 3 and 4. Solutions
are proposed in 6.2.
These solutions are designed to:
provide franchisees and their advisers with more meaningful pre-contract
level the playing field for franchisees before they sign a franchise
agreement, during the franchisor’s administration and after the franchisor’s
business is wound up
keep the franchise network intact long enough to determine whether it may
be sold as a viable network rather than being dismantled.
A cost benefit analysis that would be needed to satisfy B3 will demonstrate the
solutions will reduce disclosure and documentation costs for franchisors
In Australia, pre-contractual disclosure under the Code is fundamentally
modelled on the North American disclosure requirements. This focus has not served
629 Australian Government, Department of Finance and Deregulation, Regulatory Impact Analysis
Guidance Material <http://www.finance.gov.au/obpr/proposal/ria-guidance.html> at 7 March 2010.
Chapter 6: Consumer protection to address the benchmarks 259
franchisees as well as a more global or Europe centric focus would have done. As
Iain Ramsey observes:
[t]here is now a significant difference between the substantive rules and
institutional approach to standard form consumer contracts in Europe and
North America. Standard form consumer contracts that are used in North
America would not be permitted in Europe and the proactive approach
adopted by the Office of Fair Trading is currently unknown in North
Australia tends to have taken its lead from North America. Franchise
agreements are standard form consumer contracts, as was demonstrated in chapter
3.3.4. The supply of a franchise business to the franchisee business consumer is
similar, theoretically, to any other product that is supplied with a standard form
contract, and with a projected life span of the number of years denoted in the
franchise agreement. Stephen Corones and Philip Clarke state that:
Part V divs 2 and 2A [Trade Practices Act]… focuses on transactions rather
than on the structure of markets. Its aim is to regulate market failure arising
from information asymmetry … The consumer protection provisions are
designed to ensure that there is sufficient information available to potential
consumers so that consumers will get “value for money.”630F
A fundamental assumption is that the franchise system will work, to the
standard described, through to the end of the term.
Part V addresses information asymmetry in relation to transactions in three
different ways … in relation to supply of goods and services, liability for
false representations is imposed on the supplier who is in the best position to
know the characteristics of those goods and services. 631F
The supply of a franchise business to the franchisee business consumer is
similar, theoretically, to any other product that is supplied with a standard form
contract, and with a projected fixed life span denoted in the sale agreement.
630 Ramsay, above n 329, 34. 631 Stephen Corones and Philip H Clarke, Consumer Protection and Product Liability Law (2nd ed,
2002) 5. 632 Ibid.
260 Chapter 6: Consumer protection to address the benchmarks
Franchisors need franchisees to make significant investments of both time
and [equity and borrowed] money in their businesses. But, of course, such
investments are only worth making if the franchisee can expect to earn some
reasonable return on these investments over a sufficiently long period of
time. If it takes five years, for example, to fully recoup ones investment in a
franchise, then no franchisee should invest unless the relationship is
expected to last for at least five years.632F
When a consumer purchases a product or service in Australia, and the product
or service does not meet standards, the person has rights to claim against the supplier
or manufacturer. These options are currently not available to franchisees that
purchase into a franchise network that turns out to be faulty and to fail.
6.2.1 MAKE FRANCHISE AGREEMENTS ACCESSIBLE
Every franchisor should be required to post all versions of their standard pro
forma franchise agreements on a publicly accessible, free, website. This would mean
that franchisees and their advisors could:
Compare the document they have been asked to sign with the franchisor’s
pro forma agreement. This would enable them to identify differences that
may then require explanation. It would also enable them to identify how
the agreement has changed over time. This will be particularly helpful to a
franchisee purchasing in a re-sale. They will be able to identify whether
the agreement differs from the one the current franchisee operates under in
any material way. It will also assist advisers who are not familiar with the
nuances of franchising as opposed to transactions concerning non-
Compare the document with others operating in the same sector of the
Making the database publicly available would be a step further than the
recommendation of the Matthews Review that recommended ‘[t]he Government
implement a mandatory process of franchisor registration and annual lodgement of
the most current disclosure document and other prescribed information’.633F
633 Blair and Lafontaine, above n 46, 264. 634 Matthews, above n 113, Recommendation 23, 13.
Chapter 6: Consumer protection to address the benchmarks 261
6.2.2 AMEND S 51AC TRADE PRACTICES ACT
Three options for reforming s 51AC were examined by Bryan Horrigan, David
Lierberman and Ray Steinwall in ‘Strengthening Statutory Unconscionable Conduct
and the Franchising Code of Conduct’.634F
635 These were, to provide a list of examples,
or a statement of principles, and to pursue non-legislative options.
The list of examples proposal was rejected. It was considered ‘legislatively and
administratively burdensome’ 635F
636 and potentially ‘requiring numerous
637 It was also considered to be something which the regulators can
achieve outside the rigid framework of legislation by developing effective guidance
The statement of principles received more favourable consideration than the
list of examples. It was accepted that principles which ‘lower the standard to one of
fairness and justness would dilute the concept … in addition to overtaking the
proposed unfair terms provisions of the Australian Consumer Law’.638F
One option may be to redraft the events listed in Trade Practices Act s 51AC
(a) – (k) and to add a statement of principles as a new section. Thus, s 51AC and the
new section would operate together as do ss 51A and 52. Section 52 sets out a broad
statement of principle in relation to misleading and deceptive conduct, s 51A shifts
the burden of proving the conduct was not misleading under s 52 to the party that
made the representation if the representation was with respect to any future matter. If
one party to a franchise agreement, say, the franchisee, establishes that any of events
occur, the other party, say the franchisor, has to satisfy court the events are not
unconscionable. This places the burden of proof on the party that has set up the
unconscionable situation, being the party that has the evidence to rebut if the conduct
is not unconscionable.
635 Bryan Horrigan, David Lieberman and Ray Steinwall, ‘Strengthening Statutory Unconscionable
Conduct and the Franchising Code of Conduct’, Australian Government, The Treasury, Department of Innovation, Industry, Science and Research (2010) 18.
636 Ibid 26. 637 Ibid. 638 Ibid 28. 639 The Nature and Application of Unconscionable Conduct Regulation, Issues Paper 2009
(Submission Professors Christensen and Duncan) 6 cited in Horrigan, Lieberman and Steinwall, above n 642, fn 118, 31.
262 Chapter 6: Consumer protection to address the benchmarks
6.2.3 IMPLY TERMS INTO ALL FRANCHISE AGREEMENTS VIA FRANCHISE CONTRACTS ACT
The Australian Government concluded, after receiving Opportunity not
If potential franchisees can identify and access the information needed
informed business decision, they should have a better basis with which to
negotiate a contract that meets their requirements. Parties engaged in trade
and commerce should have a high degree of freedom to contract. 639F
Two aspects of this statement are fundamentally flawed. Firstly, the paragraph
starts with the powerful little word ‘if’. It was demonstrated in this dissertation that
franchisees cannot identify the information needed to make an informed business
decision. When they can identify it access becomes an insurmountable hurdle in
some situations. Structure of the franchise network, deficient disclosure
requirements, deficient publicly accessible information and prohibitive costs lead to
the response – if they could, they would, but very often they cannot!
Secondly, the notion of franchisees being able ‘to negotiate a contract’ is
flawed. For the reasons discussed in chapter 3, the contents of most franchise
agreements are not negotiable. At best the franchisee can understand it as a legal
document. Even this understanding will leave them without context. It is like getting
married without meeting, far less getting to know, ones intended spouse’s family
A solution is to protect franchisees from the worst results of franchisor failure
through new legislation. The idea of specific franchising legislation is not new. It
was proposed in 1997 in the Reid report whose recommendations were adopted by
making adhesion to the Code compulsory.
Under the more far reaching franchise law now proposed, terms would be
implied into all franchise agreements by incorporating the Code and implied terms
into legislation modelled on the Insurance Contracts Act 1984 (Cth) whose purpose
640 Commonwealth Government Response to the Report of the Parliamentary Joint Committee on
Corporations and Financial Services, above n 166, 21.
Chapter 6: Consumer protection to address the benchmarks 263
to reform and modernise the law relating to certain contracts of insurance so
that a fair balance is struck between the interests of insurers, insureds and
other members of the public and so that the provisions included in such
contracts, and the practices of insurers in relation to such contracts, operate
fairly, and for related purposes.640F
The Insurance Contracts Act did not protect insureds from the sometimes
devastating results of the failure of HIH insurance group so it is not a perfect
template. It does provide an example of a statute having been enacted to regulate an
area that is traditionally mainly regulated by common law – the law of contract. It
also accepts the notion of fairness, which echoes the sentiment express in 1997 641F
before the Code was made mandatory.
The purpose of a Franchise Contracts Act would be to reform the law relating
to business format franchise agreements so that a fair balance is struck between the
interests of franchisors, franchisees and other stakeholders so that the provisions
included in such contracts, and the practices of franchisors in relation to such
contracts, operate fairly, and for related purposes.
To achieve the objectives a wide range of implied terms are proposed below.
An overwhelming benefit of legislation over all obligations being contained in
individual franchise agreements as is the case now is that franchise agreements
would be shorter. This would help reduce the time and expense devoted to generating
agreements. This would save both franchisors and franchisees money.
In proposing that terms be implied into all franchise agreements it must be
acknowledged that franchise agreements can be disclaimed as onerous contracts by
liquidators. They would, however, apply to the franchisor and the administrator.
Product or service warranty
When a consumer purchases a product or service in Australia, and the product
or service does not meet standards, the person has statute based642F
<http://www.comlaw.gov.au/comlaw/Legislation/ActCompilation1.nsf/0/8993B3C6A1DDA189CA25749000200A9B?OpenDocument> at 7 March 2010.
642 Reith, above n 113; Reid Committee, above n 616. 643 Under the Trade Practices Act at national level, or the state and territory Sale of Goods Acts. Note
these rights will be replaced with new statutory consumer protection rights under Trade Practices Amendment (Australian Consumer Law) Bill (No 2) (Cth) 2010 available at Parliament of
264 Chapter 6: Consumer protection to address the benchmarks
against the supplier or manufacturer. These avenues are currently not available to
franchisees that purchase a franchise that turns out to be faulty and to fail – not fit for
its purpose. The Trade Practices Act does not provide redress if a manufacturer
becomes insolvent, but the Corporations Act classifies consumers of defective
products as unsecured creditors. The franchisor failing before the end of the franchise
term is arguably analogous to a product or service failing.
The Trade Practices Act implies terms into consumer agreements but
franchisees do not fit the definition of ‘consumer’ in the Trade Practices Act s 4B.643F
Nor will franchisees fit within the new Australian Consumer Law (‘ACL’). They do
not fit the ACL’s definition of ‘consumer’.
Under the Trade Practices Act protection is provided for ‘consumers’ from
manufacturing defects, acknowledging that one defectively manufactured product
can cause damage to hundreds of consumers.
Terms are implied into contracts for the supply of goods and services by
statutes. Currently this occurs through the Trade Practices Act, Part V div 2. In
relation to sale of goods where state or territory legislation applies, terms are implied
into contracts for sale of goods and for supply of services necessarily ancillary to the
supply of the goods through state legislation.
A potential response would be for the wording in the Trade Practices Act to be
incorporated into a Franchise Contracts Act so a franchisee could claim the failed
franchisor had breached new equivalents of the terms currently implied by the Trade
An equivalent to s 69 would imply undertakings as to title, encumbrances
and quiet possession. It would become relevant where the franchisor has
not secured premises leasing rights but requires the franchisee to
commence trading, such as in Shakespeares case.
An equivalent to s 70 that concerns supply of goods by description would
apply, for example, to protect the franchisee purchasing a greenfields
Australia <http://parlinfo.aph.gov.au/parlInfo/search/display/display.w3p;query=Id%3A%22legislation%2Fbillhome%2Fr4335%22> at 6 June 2010.
644 See Appendix A of this thesis for wording of s 4B.
Chapter 6: Consumer protection to address the benchmarks 265
business based on its description and the franchisor’s evaluation of its
Importantly for franchisees whose franchisor fails, an equivalent to s 71
would imply undertakings as to quality and fitness. The specific franchise
business being sold, and the franchisor supporting it, would have to
measure up to the undertakings as to quality and fitness for purpose for the
duration of the licence being granted.
The franchisee relies on the existing businesses it sees, and on the
appearance the franchisor maintains that it will remain solvent and will
continue to deliver the aspects of the business it holds itself out to be
providing. Thus a clause similar to s 72 of the Trade Practices Act that
concerns supply of goods by sample should be implied;
A term similar to s74 which addresses supply of services should be
implied. This would, as the current legislation does for consumer
purchases, extend to both those services that have not been supplied with
the requisite due care and skill (Trade Practices Act s 74(1)) and services
that are not fit for their purpose (Trade Practices Act s 74(2)).
Franchisees are clear about their purpose – they are buying a business that
is currently viable or that will become viable once they have established it.
Franchisors should not, therefore, have difficulty implying a term like s
74B Trade Practices Act which addresses goods not fit for a purpose made
clear at the time of purchase;
A term that achieves the same result as the current s 74C Trade Practices
Act would provide consumer protection in respect of false descriptions and
could be applied to franchises that are sold as licences and thereby avoid
complying with the Code.
74D Trade Practices Act addresses goods of unmerchantable quality
which turns out to be the case with franchise businesses sold by
franchisors that were already insolvent when the franchisee paid its
franchise fee; or finally
74E Trade Practices Act (non- correspondence with sample).
266 Chapter 6: Consumer protection to address the benchmarks
The remedies currently provided in the Trade Practices Act are inappropriate
as they depend on the breaching entity being able to make good the breach in one of
a range of ways; the franchisor is insolvent and cannot do this.
The Trade Practices Act Part VA concerns damages for defective goods. Under
current law, franchisees would be ineligible to claim under Trade Practices Act pt V
div 2 or 2A as, again, they are not a ‘consumer’ under Trade Practices Act s 4B or
they are not purchasing ‘goods’.
Franchisees are, however arguably purchasing ‘services’ for the purposes of
the Trade Practices Act s 4(1). For pts V 2 and 2A to apply to franchisees of failed
franchisors a definition of ‘business consumers’ would need to be added to the Trade
Practices Act and several consequential amendments would be required including
expressly extending pt V div 2 and 2A to include business consumers.
Implied terms re franchisor duties
The franchisor currently has a duty under item 18(2) of the Code disclosure to
tell franchisees about a breach of the Corporations Act within 14 days of becoming
aware of it. There is no evidence as to whether they do so, or not. However, even if
they do, the moment the franchisee has executed the franchise agreement and the 14
day cooling off period has expired, it is too late for the franchisee to protect itself
from a franchisor’s breach of the Corporations Act. The franchisor’s breach of the
Corporations Act is not a breach of the franchise agreement and does not give the
franchisees the right to terminate the franchise agreement and all ancillary
Where the franchisor is a corporation the franchisor directors’ duties644F
be expanded so the directors owe to franchisees the same duties as directors currently
have to a company. The rationale behind this is that franchisees provide a significant
amount of the operational infrastructure that, absent franchisees, the franchisor
would have to supply, and franchisees assume a significant amount of the franchisors
business risk. The issue of franchisors duties to franchisees could usefully be pursued
in the future.
645 Directors have statuory duties under Corporations Act 2001 (Cth) ss 180 (care and diligence),
181 (good faith), 182 (use of position), 183 (use of information), 184 (good faith, use of position and use of information – criminal offences), 190 (responsibility for actions of a delegate), 191 (disclosure of material personal interests) and 588G (insolvent trading).
Chapter 6: Consumer protection to address the benchmarks 267
Imply term requiring franchisor to obey all relevant law
The franchisor should have an implied contractual obligation consistent with
the franchisees’ current obligation to carry on business activities in compliance with
all laws, regulations and Codes of conduct. A statutory obligation should exist to
require the franchisor to meet all contractual and statutory obligations between;
itself and the franchisee
itself and third parties (for example franchisor obligations in the head
lease, and other supplier agreements on which the franchisee and its
commercial reputation rely)
itself and ASIC, the ATO and other levels and arms of government
relevant to the franchise network
where a breach would cause harm to the franchisee. A breach of this implied term,
depending on its seriousness, could give rise to a right for the franchisee to terminate
the franchise agreement and sue for damages for breach of contract.
The term would need to be drafted widely enough to acknowledge that it might
not be the franchisor that fails – it might be the parent company or another critical
entity in franchisor’s network that fails, taking the franchisor with it.
Implied term that franchisor will comply with all contractual or statutory obligations towards third-parties
The franchisor should be required to comply with all collateral contract
obligations and all obligations that arise under statute. A breach of any of the third-
party or collateral contractual obligations that impacted detrimentally on franchisees
would enable the affected franchisees to terminate their agreements and seek
damages from the franchisor.
This term would be used by franchisees whose franchisor did not pay the rent,
outgoings or other third-party payments that it had received from the franchisee in a
timely way. In failing to do so, the franchisor has put the franchisees’ businesses and
reputation at risk.
Requiring franchisee consent to changes that would have a material effect on franchisees
The Matthews Review recommended that ‘[c]onsideration be given to
prohibiting unilateral changes by franchisors to arrangements with franchisees which
268 Chapter 6: Consumer protection to address the benchmarks
have materially adverse effects on the franchisee without franchisee consent’.645F
government responded by stating that:
this will be addressed through reform to section 51AC of the Trade
Practices Act in relation to unconscionable conduct where unilateral
variation clauses will be a factor that may indicate a corporation has engaged
in unconscionable conduct.646F
The theme of unilateral contract variation is being addressed. In 2010 the Small
Business Minister Dr Emerson announced, in announcing amendments to the Code:
Franchisors would have to make it clear to prospective franchisees that there
may be unilateral contract variations, unforseen capital expenditure … 647F
When the causes of franchisor administration and insolvency are taken into
consideration, it is clear that an even more problematic area of material change is the
franchisor adopting strategies that put the entire network at risk. Franchisees have no
right to know about the franchisors plans that are implemented by the franchisors’
related entities. The feasibility of requiring that franchisors disclose, and possibly
secure franchisees’ consent to, major strategic changes that could put the network at
risk, should be explored.
No contracting out
Legislated consumer protection for franchisees must not be able to be avoided
by contracting out.
Implied term to take effect on appointment of administrator
A term would be implied into all franchise agreements that if an administrator
is appointed to the franchisor or to any of the entities in the franchisor’s network that
threaten the viability of the franchisee’s business, a 2 step process will be triggered:
Step 1: when an administrator is appointed to their franchisor any franchisee
may give notice to the administrator that if a satisfactory resolution
(restructuring that takes into account the franchisee’s interests as well as
646 Matthews, above n 113, 42. 647 Australian Government Response to the Review of the Discolsure Provisions of the Franchising
Code of Conduct (2007) 6. 648 The Hon Dr Craig Emerson MP, ‘Better Protection for Franchisees’ (Media Release, 3 March
2010) <http://minister.innovation.gov.au/Emerson/Pages/default.aspx> at 23 May 2010.
Chapter 6: Consumer protection to address the benchmarks 269
those of the franchisor’s creditors, or sale to appropriate buyer) is not found
within x days, it will terminate the agreement,
Step 2: if the administrator does not meet the requirements in x days, the
franchisee have the right to terminate the franchise agreement, without this
being a deemed breach by the franchisee and without it compromising any
other rights the franchisee may pursue. The franchisees may express their
losses as unsecured creditors for an amount of their initial investment,
adjusted by depreciation and other appropriate considerations, plus any
amounts currently owed in the franchisor’s administration/ subsequent
This approach could be adopted in relation to both franchisor and franchisee
failure. This would mean the current asymmetrical provisions in the Code and all
franchise agreements favouring franchisors in the event of franchisee failure could be
removed from franchise agreements, thus making them shorter. It would also
eliminate the risk of franchisees being sued by the administrator or liquidator for
There is currently debate in insolvency law about the merit of ipso facto
clauses. Step 1 above is a refined ipso facto clause:
The IPA argue[s] that the ability of the non-insolvent party to terminate
these contracts destroyed enterprise value and, if businesses could be
provided with some limited protection from these automatic terminations the
potential for restructuring businesses would be significantly improved.648F
Currently franchisor give themselves, but not the franchisees ipso facto clauses
in the franchise agreement. Arguably the IPA’s wish is not as valid in the franchising
context as it may be in, for example, a supplier contract.
For franchisee consumers to be given statutory protection in the form of a
modified ipso facto clause would be consistent with the approach in jurisdictions
such as Canada that recognise parties to executory contracts as meriting special
consideration in insolvency of one of the parties.
649 Morgan Kelly, ‘Failing Businesses Can be Saved’, The Australian Financial Review’ (Sydney),
30 November 2009, 55.
270 Chapter 6: Consumer protection to address the benchmarks
Consequential amendments as additional implied terms
The franchisees’ option to terminate their franchise agreement would have a
secondary right attached to it – on the appointment of the administrator, all payments
(eg, royalties, advertising, rent) falling due from the franchisee to the franchisor or
any franchisor-related entity that was also under administration would cease to be
payable. Payment obligations – without arrears – would resume if the franchise
network was successfully revived. This would mean the vulnerable business
consumers, the franchisees, were not funding the administration.
The tenancy contract between the landlord and the franchisor would be
A novation occurs when two parties to a contract enter into an agreement
with a third party under which, in consideration of the first party [the
landlord] releasing the second party [the franchisor] from the contract, the
third party [franchisee] undertakes to assume responsibility for performance
in place of the second party. A transaction … is not effective as a novation
unless an intention is clearly shown that the second party’s obligations are to
be extinguished. 649F
The franchisee would step into the shoes of the failed franchisor but would not
take on the liabilities accrued by the under-performing franchisor. Premises rent
formerly collected by the franchisor for on-payment to landlords would thus become
payable direct to the landlord. This would not disadvantage the administrator or the
franchisee’s landlord, but would enable the franchisee to demonstrate to the landlord
whether the franchisee has a viable business as an independent operator.
These provisions would provide an incentive for the administrator to
acknowledge franchisees as parties with rights, not merely to categorise franchise
agreements and premises leases as assets or liabilities of the franchisor. They would
enable the administrator to keep the franchise network together if a viable buyer was
found quickly, but not leave franchisees in limbo for extended periods while the
The drafting would have to be done with careful attention to incentives. It is
important not to incentivise the administrator from acting too hastily in proposing the
650 NC Seddon and MP Ellinghaus, above n 368, 360.
Chapter 6: Consumer protection to address the benchmarks 271
administration proceed quickly to liquidation to prevent the franchisees from
exercising their option to terminate.
6.2.4 AMEND FRANCHISING CODE OF CONDUCT
Prospective franchisees do not currently have access to all information they
need to make an accurate assessment of the risk of the franchise network failing and
the impact that failure could have on their future business.
In economic terms the duty to disclose is formulated on the following basis:
[I]n general a person has a property right to information when it is costly to
gain such information, but the person does not have a property right and
therefore cannot take advantage of this information when the information is
obtained at a very low cost.650F
An application of this principle means franchisors would provide franchisees
with less disclosure that is of greater value; information the franchisee could not gain
access to otherwise, or only at great cost. This is also recognised in Opportunity not
Better disclosure does not necessarily mean more disclosure; disclosure
documentation should be in line with Code requirements and should focus
on the provision of information which is difficult and/or expensive for the
franchisee to obtain through other means.651F
Four aspects of the Code could usefully be amended. They are the Code’s
application to administrators, the scope of entities that the franchisor has to disclose,
the form and content of the disclosure document and the public accessibility of the
Application of Code to administrators
If the Code does apply to administrators, franchisees are ‘business consumers’
and entitled to remedies available under the Trade Practices Act for breaches of the
Code. If it does not apply, the administrator is regulated only by the IPA’s Code of
Professional Conduct and by its obligations under the Corporations Act. As was
explained in 4.3.2, the current, untested view held by some administrators that the
651 D Wittman, Economic Foundations of Law and Organization (2006) 194, 104. 652 Commonwealth Government Response to the Report of the Parliamentary Joint Committee on
Corporations and Financial Services, above n 166, xiii.
272 Chapter 6: Consumer protection to address the benchmarks
Code does not apply to administrators is abused by some administrators. This results
in administrators denying franchisees the right to request mediation during the
administration. Mediation might not be the disastrous waste of time and resources
that administrators claim – it may be a way of opening a meaningful dialogue
between administrators and franchisees and provide the administrators with a loyal
franchisee base whose contracts can be sold.
Power and funds imbalances, the tight time lines surrounding all aspects of the
winding up procedure, the embargo on commencing litigation against the party in
administration, mean it is unlikely that franchisees would ever be able to mount an
effective challenge, so the incorrect view prevails. To resolve this, a statement should
be inserted in the Code to clarify that it does apply to administrators.
Entities making disclosure
The franchisee needs to base its purchasing decision on full, specific and
accurate information. The franchisee should be given information that is specific to
its actual business. Even franchisors that have invariable rules about specific aspects
of business do make exceptions for particular sites, so generic information is not
It was shown in 3.2.1, Table 1 and Appendix D that ‘the franchisor’ is typically
only one of a group of numerous corporate and trustee entities.652F
653 The franchisor is
not necessarily the entity whose failure will trigger the failure of the group. In
chapters 3.2.2 and 3.2.3 two of the key ‘assets’ of the franchisor, registered trade
marks and head leases, provided numerous examples of the range of business
structuring models franchisors use. The fragmentation of ownership of vital assets
means that the current form of disclosure by and of the franchisor exposes only a
very small part of the franchise network to scrutiny by the franchisees’ advisers.
The Matthews Review recommended653F
654 and the Australian Government
653 For example there were approximately 40 entities in the Ansett group of which Traveland was a
franchisor casualty; 51 entities in the two corporate groups and their related entities that made up the Kleenmaid empire. Fifteen franchisor and related entities in BHG.
654 Matthews, above n 113, 44-5.
Chapter 6: Consumer protection to address the benchmarks 273
[t]he requirement under item 20 of Annexure 1 [of the disclosure under the
code] to disclosure financial details [should] be extended, where applicable,
to include the consolidated entity to which the franchisor belongs. 654F
To achieve fuller, more telling information a credit rating agency report on the
franchisor entity should be required to be provided by the franchisor. This would be
more meaningful to the franchisee than a very full and potentially confusing mass of
numbers supplied under the amended item 20. The item 20 information is attached to
entities whose function in the network the franchisee would not be aware of.
A credit rating agency provides context for the franchisor entity’s operations.
Such a report shows related entities and individual directors which are not presently a
feature of disclosure. It reports on their credit history which, if one believes that
history repeats itself, is significant information to an incoming franchisee interested
in assessing risk. The information provided would enable an accountant to analyse
the franchisor’s attitude to risk, debt, and creditors and would provide a far more
comprehensive picture of the franchise network than is provided through the current
It should be noted that credit rating agencies do obtain some of their
information from the subject entity. To avoid this being misleading, the information
that was supplied by franchisor or related entity should be identified so the franchisee
will not be misled into believing the report is entirely objective.
Form and Content of the Disclosure
Recommendation 1 of Opportunity not opportunism655F
656 proposes the current
absence of warnings about franchisor failure should be addressed thus:
The … Code [should] be amended to require that disclosure documents
include a clear statement by franchisors of the liabilities and consequences
applying to franchisees in the event of franchisor failure.656F
655 Australian Government Response to the Review of the Discolsure Provisions of the Franchising
Code of Conduct, above n 415, 8. 656 Parliament of Australia, Joint Committee, Inquiry Into the Franchising Code of Conduct (2008)
submissions and final report para 4.80 <http://www.aph.gov.au/SENATE/COMMITTEE/corporations_ctte/franchising/index.htm> at 6 June 2010.
657 Commonwealth Government Response to the Report of the Parliamentary Joint Committee on Corporations and Financial Services, above n 166, xiii. This was also recommended in Matthews,
274 Chapter 6: Consumer protection to address the benchmarks
This would not be a total solution, but it would put franchisees on notice that
the franchisor may fail. The government responded that:
individual franchisees, rather than franchisors, would be better placed to
assess the liabilities and consequences applying to them in the event of their
franchisor failing. In addition, such a statement may induce a belief among
franchisees that, in the event of franchisor failure, they will not be exposed
to any risks other than those noted in the disclosure document. 657F
The government’s preference for generic information to be supplied by the
ACCC is problematic. Information without context can be very misleading. Because
of considerable variation of risk shifting within each franchise network, any risk
statement would be most valuable if it were tailored to each specific franchisee’s
situation. Only the franchisor could do this, and only in relation to assets/ contracts to
which the franchisor or a related entity was a party. Franchisors should set out in
plain English specific possible contractual and statutory consequences of their own
failure for their franchisees. They would include information such as:
The franchisor’s liquidator may disclaim (i.e. terminate) the premises
lease. This could result in you losing your right to trade from the premises.
If you provided a guarantee for the franchisor’s head lease, you would lose
the amount of the guarantee as it would be paid to your landlord. You
could not claim it back from the franchisor’s liquidator.
If the landlord would not grant you a new lease you would lose the entire
fit-out and could not trade from your premises any longer.
The franchisor’s liquidator may disclaim your franchise agreement. This
would mean you could no longer trade as a franchisee of [franchisor].
If your lease was not disclaimed but the franchise agreement was
disclaimed you would have to continue paying rent and outgoings on your
premises, but would have to change the name of your shop and may not be
able to buy the same stock as you did while you were a franchisee.
above n 113, 13 and agreed to in principle in the Australian Government Response (2007) 7-8 which placed the responsibility, inappropriately, with the ACCC.
658 Commonwealth Government Response to the Report of the Parliamentary Joint Committee on Corporations and Financial Services, above n 166, 21.
Chapter 6: Consumer protection to address the benchmarks 275
If the franchisor does not own the trade marks, patents or designs that you
need access to for your business, you are most likely to lose the right to
use these if the franchisor becomes insolvent. You may also lose access to
these if an administrator finds a buyer for the franchisor. That buyer may
not accept you as a franchisee.
This franchise is a commission agency. If the franchisor fails, you will not
receive any commission from the administrator or liquidator. Please
consider the impact of receiving no commission on your cash-flow and
make provision for it.
If you reach a mediated settlement where the franchisor has agreed to pay
you money, you would become an unsecured creditor for as much of that
sum as remains unpaid if the franchisor fails. This should put franchisees
on notice to require security from the franchisor or its directors for any
Over time ex ante warnings may lead to franchisors being more open to amend
their standard franchise contracts to level the failure part of the playing field. It may
also lead to banks that fund both a franchisor and its franchisees being more diligent
about managing the franchisor side of the ledger, preventing the franchisor from
excessive borrowing that might jeopardise the viability of the network.
A reconfigured disclosure would be valuable. It would enable franchisees to