Further to my comments of September 2023 below as to a review of the franchising code of conduct, that review has been completed and on 8 February 2024 a report was released. Review of the Franchising Code of Conduct Final Report | Treasury.gov.au, Dr Michael Schaper (“Report”).
As I indicated earlier, a review of franchising and insolvency would have been premature given the recommendation of the 2023 PJC Report on Corporate Insolvency to deal with that issue in any comprehensive review of insolvency law. The Report agrees.
The Report acknowledges that the impact of franchisor insolvency on franchisees can be significant, though it will depend on the nature of the insolvency – a franchisor business may be sold as a going concern and continue to support the franchisee network; but in other cases, the franchisor may end up in liquidation.
As the Report says
“insolvency is a risk that permeates across the economy and all business‑to‑business transactions.
The Code does not remove commercial risks in the ordinary course of business. It does, however, attempt to ensure that prospective franchisees are well aware of these risks before signing up to any
agreement. Guidance and education material promulgated by government and industry associations should continue to highlight these risks and encourage franchisees to satisfy themselves as to the
financial viability of the franchisor and the franchised business”.
But apart from changes to insolvency laws being beyond the scope of the review, the Report noted that the 2023 PJC Report’s recommendation of a comprehensive review of Australia’s insolvency laws, if such a review were to be conducted, might provide a further opportunity to consider the position of franchisees when a franchisor becomes insolvent.
The federal government has announced a Review of the Franchising Code of Conduct and has issued a consultation paper of August 2023. Review of the Franchising Code of Conduct (treasury.gov.au)
The reviewer, Dr Michael Schaper, writes that since the introduction of the mandatory Franchising Code of Conduct in 1998, the franchising sector has seen substantial growth. The sector encompasses a diverse range of industries from fast-food chains and retail outlets to services-oriented enterprises. It contributes approximately $170 billion each year to the Australian economy, and employs over half a million people.
Around 90 per cent of franchisors, and almost all franchisees, are small businesses. The regulatory framework governing franchising in Australia is primarily guided by the Franchise Code of Conduct which aims to ensure fairness and transparency in the franchisor-franchisee relationship, outlining key rights and obligations for both parties. It addresses crucial aspects such as disclosure, dispute resolution, termination, and the provision of essential information to potential franchisees.
The Code supplies the regulatory support to guard against misconduct and seeks to foster a business culture that drives competitiveness, sustainability, and productivity.
Throughout its evolution, the franchising sector in Australia has encountered “challenges” that necessitate periodic reviews and adaptions of the regulatory landscape, aimed at refining and enhancing the Code’s effectiveness.
This 2023 review of the Franchising Code of Conduct will assess the impact of recent changes to the Code, such as those relating to New Car Dealerships (Part 5) and the Franchise Disclosure Register [see the Competition and Consumer (Industry Codes—Franchising) Amendment (Franchise Disclosure Register) Regulations 2022, which inserted Part 5A into the Franchising Code, which establishes the Register.] Importantly, the scope of the review also encompasses the general fitness for purpose of the Franchising Code and the role of both the ACCC and the Australian Small Business and Family Enterprise Ombudsman in supporting the sector.
This consultation paper is said to identify key themes and issues for the Review on which submissions are invited.
It refers to the impact of franchisor insolvency on a franchisee which varies depending on the nature of the business and the franchise agreement.
“A franchisee may be unable to receive stock, may lose the right to use the franchisor’s brand, or occupy their premises if the franchisor holds the head lease. They may still be required to make payments to suppliers, landlords, banks and employees while unable to operate their franchise”.
It notes that the ACCC has emphasised the importance of the franchisee considering insolvency issues before entering into a franchise agreement, including by way of searching the Disclosure Register. For example, the Information statement for prospective franchisees says that “if the franchisor becomes insolvent, you may not be compensated for the loss of your business. You may not get back the money you contributed to a marketing fund”.
Parliamentary Joint Committee on Corporations and Financial Services Report
The 2023 PJC Report on Corporate Insolvency received a submission about franchising and insolvency and it recommended that this be considered in any major review of insolvency law.
It noted that franchisees can be dependent on the franchisor’s good faith and competent business operation and may therefore face significant issues if a franchisor becomes insolvent. Franchisees invest significant sunk costs in their business, which cannot currently be recovered from an insolvent franchisor. It was said that
“franchisees do not see the insolvency coming in the same way as unpaid employees or late-paid trade creditors may do. They can rarely take proactive action to protect their rights and assets”.
Specific issues that arise for franchisees when the franchisor becomes insolvent are said to include that:
- franchisees do not get the same voice as franchisor employees and creditors during a liquidation;
- they are unable to use intellectual property licences that are essential to the operation of the individual franchises;
- the franchisor has control or involvement in leases for premises;
- lenders take security of the franchisor’s and franchisee’s assets that are needed to operate franchises;
- when liquidators are winding up a franchisor, a franchisee may face many uncertainties relating to leases, franchise agreements, supplier contracts, marketing funds and IP licences; and that
- liquidators can disclaim onerous contracts.
The following suggestions for reform to address some of these issues were made:
- requiring franchise marketing funds to be held in trust;
- entrenching ipso facto right for franchisees, so that they can leave the franchise brand and trade independently;
- expanding directors’ duties in a franchise network to include duties towards franchisees;
- “recognise and eliminate unjust enrichment of franchisors’ creditors”;
- where franchisors sell franchises while insolvent, making defrauded franchisees priority creditors;
- allowing franchisee representation at creditors’ meetings;
- “require liquidators to select competent buyers of the franchise chain, not simply anyone who can satisfy some of the franchisor’s creditors demands”; and
- expanding the FEG to include the employees of franchisees of insolvent franchisors.
The Committee received no other detailed submissions on franchises and insolvency and wisely deferred consideration of the issues to the proposed comprehensive inquiry. Insolvency policy could at least address most or all of these issues.
This inquiry by Dr Schaper may not be the one to determine the balancing exercise required. There are often calls for increased priority in insolvency for particular types of claims, that seek to water down the fundamental pari passu principle. Perhaps there is enough to do in reforming the 19th century structure for employee priorities upon which FEG relies, rather than adding more.