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Franchising’s Lack of Protection

In the wake of research released about the lack of protection for franchisees when the franchisor becomes insolvent, Adeline Teoh takes notes on each side of the debate and looks at a case where such a collapse cost a franchisee her business and personal savings.

Often thought to be less risky than most business ventures, franchising has recently boomed on the strength of well-publicised success stories. But research into the sector has revealed franchising’s fatal flaw: lack of protection of franchisees during franchisor insolvency.

Active ImageResearched by former lawyer and University of NSW lecturer, Jenny Buchan, and released by CPA Australia earlier this year, When the Franchisor Fails identifies some problems encountered by franchisees when their franchisor becomes insolvent, including lack of communication, lack of acknowledgement of their unique relationship by liquidators, and a loss of market confidence when the brand is tarnished.

“There was potential for debate about whether there needs to be more education to assist franchisees before they go into agreements, or education for administrators and liquidators about the complex relationship that franchisees have with franchisors,” says Judy Hartcher, CPA business policy adviser. “Perhaps even legislative changes [may be needed]. We thought it was worth investing in an exploratory study in this area.”

Richard Evans, CEO of the Franchising Council of Australia (FCA), agrees the issue should be discussed but suggests the report is otherwise flawed. “We don’t object to having a debate. What we object to having is inadequate research that inflames the market by saying there’s a security issue when there’s not.”

His concern is that negative media is disproportionate to the issue. “Some commentators don’t understand the work that has been done in the sector, how there’s huge growth and all these positives. So, a paper written by a lecturer is being given greater credibility than it should and reported in a very narrow way.”

But Buchan denies she is out to destroy franchising. “Franchising has just this one problem in legal terms and I’m trying to strengthen the model,” she explains. “I’m not making conclusions about the sector being a bad sector.”

For & Against Franchises

Professor Lorelle Frazer, of Griffith University, who often conducts research on behalf of the FCA, acknowledges there has been a strong reaction but notes there’s “nothing terribly unexpected” in the report. “Failure is a normal part of the business cycle,” she says. “The author is trying to point out deficiencies in the current legal framework, which doesn’t provide sufficient protection for franchisees who find themselves facing this dilemma.”

Buchan’s research was inspired by the demise of Ansett and the subsequent fallout suffered by Traveland franchisees who were affected by Ansett’s liquidation, but did not receive the same treatment as the franchisor-owned agencies. “I started to dig around and realised that [franchisees] didn’t feature in any of the liquidator’s reports beyond the most superficial mention,” she recalls. “Not only did they not have a voice, but even if Traveland were the best franchisor in the world they would still be suffering through no fault of their own.”

Evans, however, regards Traveland as an exception rather than a model example. “The real problem that franchisees have is consumer confidence within their local market,” he says. “For instance, a bread shop won’t be affected; they’re still providing bread on a daily basis. But if a consumer has to invest money before they receive the product, such as in travel, then you’ll get major local marketing issues. Traveland was affected by the collapse of Ansett and September 11.

“[Buchan] doesn’t mention the success rate of the franchisees that continued to trade and she’s only spoken to a small sample of franchisees affected,” he adds, indicating that Buchan’s poor sample group fails to represent the sector.

Although Buchan admits there was a problem in finding affected franchisees—a secondary matter she aims to address later—the issue remains. “As a piece of critical research it’s not perfect. I stated that it was statistically invalid because I didn’t get enough people, but it didn’t mean that I couldn’t make the academic analysis to highlight the problems,” she says, conceding that more case studies would have injected “more balance”.

In the report’s conclusion, Buchan recommends that franchisees try to prevent negative outcomes by writing clauses into their contract, including the ability to cease obligations with an insolvent franchisor, the right to vote on a suitable buyer, and access to suppliers’ contact details. “Ultimately,” reads the report, “solutions should aim to allow the franchisee to continue in business with or without the brand”.

However, Buchan believes that, in reality, clauses are no more than “bandaids” because liquidators are more concerned with creditors, and franchisees are rarely creditors. She suggests the best course of action is to tackle the law. “It’s a complex problem because franchising is a business structure that involves such a critical range of operators. The Corporations Act and the bankruptcy legislation control the liquidation or the completion of a company; they need a look to get some form of standard, to give those franchisees some rights. Hopefully, before the financiers cotton on. What bank is going to lend money if they know that if the franchisor fails the whole loan is at risk?” she questions. “If there’s a road that the franchisee could follow that could give the financier rights, they’re going to be much more comfortable.”

Educating Franchisees

Despite the possible benefits of new legislation, Evans doesn’t believe much needs to change. With the recent release of the Australian Franchising Handbook, he maintains education is the key. “The biggest protection for franchisees is to do their due diligence prior to going in. The FCA is constantly trying to educate franchisees on their rights, [including] an annual right to get disclosure documents so they can review how their franchise is travelling, pre-empting a lot of liquidity issues. The ability is there for them to do that now.”

Buchan recognises there are preventative measures and options that allow franchisees to continue trading, but she compares protective legislation to a seatbelt. “A franchisor may be the best driver in the world but franchisees will feel better knowing that, in the event of an accident, they have a seatbelt. In most cases it will prevent disaster, the rest of the time it will lessen the impact of the disaster.”

All parties, including government bodies, the ACCC and ASIC, and small business Minister, Fran Bailey, agree that the issue is worth debating, which looks to be the next step. Frazer indicates a potential to take the topic further. “Jenny Buchan’s research focuses on franchisors that have gone into liquidation. What about franchisors who stop operating for other reasons? One of my PhD students is investigating other types of franchisor discontinuance,” she adds.
Whether this will result in changes to legislation is yet to be seen, but for the moment it seems that doing your homework and strengthening your local profile is the best prevention if your franchisor fails.

Information Resources

CPA Australia: (download the report) www.cpaaustralia.com.au
Franchise Coun
cil of Australia: www.franchise.org.au
Commonwealth of Australia Law: (the Franchising Code of Conduct) www.comlaw.gov.au
Australian Competition and Consumer Commission: www.accc.gov.au

Unprotected Franchisee Case Study

At the time of Ansett’s administration, Debbie Duncan’s Traveland Ballarat franchise was in the nationwide top 10 of all Traveland agencies. Although she had done her homework on Traveland and considered it an excellent business, like many, she didn’t foresee Ansett’s collapse.

“All the [franchisor] owned stores in Victoria closed and the assumption was that every Traveland office had collapsed,” Duncan explains. “We managed to get a full page in the local newspaper, [to say] ‘We are locally owned’, which cost me 10 grand.”

The biggest problem was there was no one to turn to. “Head office was closed, you couldn’t ring and talk to anyone to see what had happened. All you saw was what was in the newspaper, nothing else.”

Traveland then had a string of buyers, including Internova MCI and FOGI (Financial Options Group Incorporated), which later defaulted on their payment and came under ASIC investigation. Duncan considered it “disgusting” that the franchisees were “commodified” without any say in the buyer. “I bought my agency for $220,000 and Internova got 360 of us for $500,000. Had we had a guide, we could have bought the franchise as a co-operative.”

She was also unimpressed with FOGI. “The franchisees insisted that we meet the new owners. I said my figures have gone down 60 percent, I have eight staff, and I’ve lost 60 grand in personal savings. What are you doing with our business? This is our livelihood.” But, she goes on, it was like talking to a blank screen. “They weren’t interested in us, they were interested in getting money from the sale.”

Duncan continued to trade, trying to save her business. When Traveland went into administration she put another ad in the paper, but then decided to cut her losses. “My business was going down rapidly because people were uncertain,” she says. “On November 28 I formally resigned from the Traveland franchise—I had to give three months’ notice. Problem was, I needed to be in a franchise because of economies of scale, but I couldn’t join another group because all the franchises were taken in Ballarat.”

Eventually, Duncan bought a Jetset agency and moved it into her office, “a good strategic move, but at enormous expense.” Re-mortgaging her house, she estimates she lost $120,000 in that period. A few months later staff who had worked alongside her, saving the business, started to resign.

“It became an HR issue, not just for my agency but for the industry. It was just too volatile and they couldn’t cope. A lot of people sold their business because they were having nervous breakdowns,” she explains.

Duncan sold her agency last year but still thinks there should be changes to the sector. “Even other franchise groups around Ballarat, like Forty Winks, watched me and learnt. People said that they would hesitate buying into a franchise after what they’d observed; your fate was not in your hands, you spent your life savings to buy this agency and what help was there? There was nothing. I felt so alone in losing all this money, with not a leg to stand on.”

To save this situation from repeating itself, she recommends that an organisation be set up to advise on franchisee rights. “I’m not saying you shouldn’t do everything to save your business, but there should be someone who could look after franchisees in this situation, an emergency contact who could be our ambassador to the government to help us,” she says. “The biggest insult was that we had to collect the $10 tax to give to Ansett. I kept thinking, what about my $120,000, where’s that? I’d love to get my money back but I think I’m right at the bottom of the pecking order.”

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