In this article, John Pratt and James Barrett of Hamilton Pratt discuss the approach to, and the importance of, franchise regulation around the world.
The issue of whether and how to regulate franchising continues to intrigue all those involved in franchising. Those in favour of regulation can cite a number of reasons for it, including the following.
First, the importance to a franchisee of entering into a franchise agreement. Other than the purchase of somewhere to live, nothing that an individual might do is likely to have such major financial implications.
Second, franchisees almost always have to pay a substantial initial fee. If that initial fee significantly exceeds the cost to the franchisor of granting a franchise, then there is a significant danger that a franchisor’s business becomes the sale of franchises rather than ensuring that its franchisees are successful.
Third, franchisors need to grow their franchise network because an essential element of franchising is that the brand franchisees use should be generally recognised and valued. While in entrepreneurial cultures (such as the USA and Australia) there appears to be a large number of would-be entrepreneurs willing to take the substantial risks of entering into a franchise for the undoubted significant rewards, in less entrepreneurial cultures (such as those in Europe) finding suitable franchisees is often challenging, with franchisors competing against each other for a small pool of would-be franchisees. Even in entrepreneurial countries, franchising has recently attracted negative publicity that may make it more difficult to recruit franchisees. This puts pressure on franchisors to attract franchisees, and there is therefore a danger that franchisors seek to paint too rosy a picture of their franchise in order to distinguish their franchise offer from those of other franchisors.
There are also those who argue against legal intervention in franchising, who point to the following:
- Why is franchising singled out for “specialist treatment” when other similar business arrangements are not?
- The reality is that you cannot protect the ignorant from making stupid business decisions.
What is important is to ensure that franchisors treat prospective and actual franchisees “properly”, because it is in their commercial interests to do so. Having laws diverts franchisors from this objective so that they simply focus on complying with what the law requires. Once legally compliant they need not concern themselves with supporting their franchisees to ensure they operate successful businesses.
There is undoubtedly something in both sides of the argument but it is just too simplistic to believe that one size fits all. Different countries have adopted different responses to franchise regulation because the issues and challenges are dependent on the franchising market in their country.
The USA has, of course, led the way with franchise regulation. The Federal Trade Commission’s Franchise Rule became effective on 21 October 1979, nearly 40 years ago, but the agency’s interest in franchising preceded that – indeed, it had proposed to adopt a franchising trade regulation rule as early as November 1971. At state level the California Franchise Investment Law – the first US franchise disclosure law – became effective on 1 January 1971. New Jersey was the first US state to adopt a franchise relationship law, which took effect from 21 December 1971.
Since then, in the Americas, franchise laws have been introduced in Argentina, Brazil, and the majority of provinces in Canada and Mexico. France was the first EU member state to introduce a franchise disclosure law: the Doubin Law, in 1989. This was followed by regulation (whether in the form of disclosure laws, relationship laws, or a combination of the two) in eight other EU member states and six non-European countries. Franchise laws have even been introduced in Africa (in three countries) and Asia – in countries such as Azerbaijan, Mongolia, Kazakhstan and Kyrgyzstan who, on the face of it, have very little franchising activity.
It certainly appears that those who argue against franchise regulation are losing the argument, with an increasing number of countries introducing franchise regulation. However in many countries, such as China, the introduction of franchise laws was, at least in part, prompted by a desire to restrict foreign (particularly American) franchisors from dominating their home franchise market. This is, of course, in part motivated by a desire to protect Chinese citizens from the perceived worst excesses of capitalist franchising. Indeed, a trade minister from the Far East recently explained that his country had been a British colony, and he indicated that there was a strong national feeling that they were taken advantage of by the British, and so they did not want others doing the same with their unfair commercial practices!
Other countries that have introduced franchise regulation on the US model have done so for a number of reasons. In some cases, these include the argument that, if Americans benefit from US protections, then why shouldn’t citizens of other countries receive the same protections from the same US franchisor? There is also the sense, in some cases, that if the country that is by far the largest exporter of franchise systems regulates franchising in their home market in a particular way, then clearly it works and they should do something similar.
The regulation of franchising is, of course, not limited to specific franchise laws and takes many forms. In the USA there has been a very considerable focus on characterising franchisors and franchisees as joint employers. As with so much in franchising, because of the relatively limited numbers at the franchise bar (with regular communication between lawyers throughout the world and attendance at conferences, most of which are organised in the USA) other jurisdictions often follow trends originating in another jurisdiction. For instance, US joint-employment issues have since been experienced in Canada, Australia and France.
While the joint-employment issue in the USA and elsewhere has focused on the peculiarities of the franchise relationship, non-specific franchise developments, which have a direct and very real effect on franchising, can arise as part of the general trend to treat small businesses (including franchisees) as consumers and protecting them from unfair contract terms. Both Australia and France adopted laws on this in 2016 and judicial decisions in Austria have, in limited circumstances, treated franchisees as consumers during the early stages of their negotiations with the franchisor.
In many civil law jurisdictions – Germany being the prime example – the relevant provisions of the Civil Commercial Code impose good faith obligations in the negotiation phase of a franchise agreement. Those requirements are in many ways more challenging for franchisors than specific disclosure requirements, because they leave the difficult question of whether proper and adequate disclosure has been made for the courts to decide –and judges inevitably have varying views on that.
Even more subtly, in some countries, existing legal concepts are used extensively to protect franchisees. In England and Wales, for instance, misrepresentation claims are often successfully brought by franchisees who argue that franchisors, when providing information to a prospective franchisee, are in a unique position to know the truth. If their information is incorrect, it is likely to be a fraudulent misrepresentation, liability for which cannot be excluded in the franchise agreement. This makes the individual who made the misrepresentation personally liable – a substantial disincentive to providing misleading information!
As demonstrated above, it is wrong to proceed on the basis that all franchisors need do is focus on franchise legislation. The challenge for franchisors wishing to be legally compliant is becoming increasingly complex. Further, the implications for a franchisor in serious breach of legal requirements can be catastrophic, because it could affect their whole network.
The first and most obvious solution is that franchising needs to be more ethical, with franchisors universally taking a much more direct and real interest in the success of their franchisees – with zero willingness to accept franchisee failures. In the UK, for instance, any franchisor with a franchisee failure rate of anything approaching 10 per cent would be considered a failing franchisor. In a relatively small country such as the UK, news of high failure rates spreads quickly, especially because of the importance in the UK of franchisee funding – which is almost always supplied by a small number of specialist franchise units of the leading banks. The banks simply stop funding prospective franchisees if they are not confident in the ability of the franchisor to have successful franchisees who are able to repay their loans.
Equally, national franchise associations need to take a long hard look at their requirements for their members. In those jurisdictions where the law regulates franchising, it has been suggested that it may be difficult for a national franchise association to impose additional requirements on its members in relation to ethical behaviour. That may or may not be true. Within Europe where, as shown above, a number of countries have adopted their own legislation, all national franchise associations who are members of the European Franchise Federation are committed to ensuring that their members comply with their Code of Ethics. These associations are powerful and most franchisors in European countries can see the commercial benefits of being members. This puts the national franchise associations in a powerful position to regulate ethical behaviour.
In the UK, for instance, the British Franchise Association (BFA) has a mechanism for receiving complaints from franchisees and the power to investigate and ultimately expel members for a failure to comply with its Code of Ethics and/or for having an unacceptably high failure rate. Historically there has been some doubt as to the extent to which the BFA has actually enforced these provisions, but there are signs that it is becoming increasingly willing to do so.
The advantage of powerful national franchise associations enforcing ethical behaviour is that it encourages this behaviour in franchisors – and for those who are not advocates of franchise regulation, it makes such regulation less likely.
As indicated at the beginning of this article, it is wrong to assume that a particular model will be appropriate everywhere. There are, indeed, many good reasons why the UK model, which has no franchise regulation and/or other provisions that could specifically apply to franchising, may not be appropriate elsewhere. However the assumption that extensive US-style franchise regulation is a good thing throughout the world clearly needs to be challenged. Each country should have its own approach relating to specific issues in that country; and, of course, it should be borne in mind that there is no evidence that extensive franchise legislation actually works to promote either franchising or ethical behaviour.