Good Faith in franchising… bad for Goodwill
One of Australia’s largest and oldest franchise systems has been rocked to its core with revelations of underpayment of wages by its franchisees and allegations of dubious reporting. 7/11 is bruised and battered amidst franchisee discordance and scrutiny by Australian regulators.
The 7/11 wage price scandal reinforces that every franchisor has obligations of good faith under the Franchise Code of Conduct (the Code) to ensure a positive culture of compliance for its franchisees. This signals that financial reporting and governance systems should be prevalent throughout the franchise system to minimise risk of breaching the Code. The investigation of 7/11 and subsequent public outcry, heralds the increased risk to the franchise sector of being sniffed out by the corporate watchdog and sounded off by whistle-blowers for non-compliance with the Code.
The dramatic developments with 7/11 remind Australian franchisors and franchisees of their putative obligations of good faith now required by the Code. The amended January 2015 Code includes “civil penalty provisions” which empower the Australian Competitor and Consumer Commission (ACCC) to fine franchisors up to $54,000 per breach of each civil penalty provision. A timely warning for those playing in Australia’s $144 billion franchise sector.
Good faith requires parties to exercise their powers reasonably and not arbitrarily. Certain conduct may lack good faith if one party acts dishonestly, or fails to consider the legitimate interests of the other party. The 7/11 controversy has lifted the lid off the compliance toolbox of other franchise systems to unveil possible breaches of these good faith provisions. In fact, former ACCC head, Allan Fells suggests that wage and financial reporting goes further than just the 7/11 franchise. In my view, the biggest issue (at least in the short-term) is the fact that ‘good faith’ is not defined by the Code and is widely drafted. This inevitably leads to exposure, expectation, and uncertainty and when these conditions exist, there is risk. Arguably franchisors and franchisees understand the exposure of entering a business relationship, and have expectations about certain outcomes. However, it seems to me that uncertainty creates the most risk for both parties.
In context of the good faith provisions, uncertainty is created by the lack of a guiding definition of the term and the potential reach of the ‘good faith” net. This is of particular concern because the provision applies to pre-contract conduct as well as conduct during the relationship and possibly after (with regards to non-compete provisions, non-disclosure obligations etc.). While it is too early to measure and evaluate changes in conduct of either franchisor and franchisee, it is becoming increasingly apparent (at least anecdotally) that franchisors are making changes to their contractual, relational and operational approach when dealing with franchisees, based on advice from their legal advisors. As for franchisees, I don’t believe much has changed. They either don’t see the change as an issue or don’t have the preparedness or the financial resources to seek legal advice.
How can Franchisors comply with the Code and ward off the Devil from damaging their goodwill?
In light of the public exposure of 7/11 and the likelihood of further investigations by the regulators, franchisors must implement effective measures to ensure a positive culture of compliance and to quarantine the goodwill in their system. Successful implementation of the following 5-Point Strategy would mitigate the risks of breaching the good faith provisions thereby creating fertile soil to grow the goodwill of the system for both franchisor and franchisee.
- The Devil is the Detail– Ensure your franchise agreement is well drafted and balances each party’s economic and legal risks with the least amount of contractual discretion. A franchise agreement must clearly outline the obligations of both franchisor and franchisee including the renewed obligations of good faith enunciated as part of the changes to the Code.
- The Devil is in the Language– Manage your departure from plain language agreements towards a return to complex and lengthy franchise agreements as franchisors move to be more detailed and specific about their intentions in doing whatever is necessary to protect their legitimate commercial interests. Whilst this might reduce the information asymmetry between franchisee and franchisor, there will be an added complication and therefore cost to the franchisee during the due diligence process, to the extent that legal and financial advice sought will have to be based on a more complex and lengthy set of documentation.
- The Devil is in the Financial Model– Greater thought and care need to be exercised by franchisors when structuring the franchise arrangement. The ad hoc, market based, common practice based approach of setting upfront fees, ongoing fees and exit fees need to be more robust and defensible. The issue of goodwill- what it is, who owns it, how to value it and when it exists becomes a key consideration for new, emerging and existing franchisors. Conceivably, while the conception and implementation of the necessary response to this problem might be within the reach of resource rich franchisors, sadly those marginal franchisors (and there are many) may find this problematic and therefore are exposed to a greater level of risk.
- The Devil is in the Communication– The abject obsession of airing grievances and conflicts in the social and digital media is increasingly become a battleground for unhappy franchisees. A scan of some of the blog platforms and social media networks provides a good snapshot of this risk. Franchisees are yet to understand that the good faith provisions apply to them also and that they have an obligation not to unjustly trash and denigrate the franchisor’s brand. A practical compliance system coupled with appropriate education for your staff, franchisees and their staff and their respective obligations under the Code will reduce risk.
- The Devil is in the Support– Reassess the role and function of your field support staff (monitoring and advising). Everything that is said in conversation, advice that is given (verbally or written) and actions taken are now being scrutinized through the lens of good faith. This extends to advice in relation to operational matters such as marketing, stock procurement, disputes, and staffing. Again, well-resourced franchisors are progressively adapting their processes and training their staff, but the not so resourceful franchisor is literally swimming against the tide.
Even though the outcome of 7/11 wage price scandal appears to focus fault on the franchisees, in the future franchisors could be accused of breaching their good faith obligations under the Code if they single out a particular franchisee.
The recent amendments to the Code makes it clear that investigation around good faith can be reviewed in every circumstance. Every franchisor should take time to ensure that its obligations of good faith have been met under the new rules, as the wash up of the 7/11 wage price controversy may broaden compliance with Australia’s 79,000 Franchise units in operation in Australia.
Rather than improving the symbiotic relationship between franchisor and franchisee, the initial impact of the good faith provisions appears to be unintentionally driving a bigger wedge between the parties fuelled by the need to ‘manage risk’. This means more systems, more procedures, more bits of disclaimers and acknowledgments to sign, more risk management and less risk sharing.
If in doubt about your compliance obligations under the franchising Code of Conduct, always seek the advice of a specialist to ensure a healthy culture of compliance in your organization.
Dr Maurice Roussety is a Consulting Strategist for DST Advisory and Lecturer in Small Business, Franchising and Entrepreneurship at Griffith University in Queensland, Australia. He has worked with leading organisations such as Queensland Transport, IAG, Westpac, Australia Post, Coles Myer, Red Rooster, Commonwealth Bank, ACCC, and Optus. Maurice holds a PhD in Intellectual Property and Franchise Goodwill Valuation. He also holds a Master’s degree in Leadership and in Business Administration. He is available for consulting and public speaking engagements and can be contacted further at maurice@dstadvisory.com or you can visit him at www.mauriceroussety.com.au
