Are you on the same page as your franchisees?

In brief, a recent Federal Court decision has held that a franchisor’s supply arrangements constituted third line forcing, and that a failure to disclose completely a franchisee’s obligations to accept and pay stock under those supply arrangements breached the Franchising Code of Conduct.

Franchisors are required to comply with the Franchise Code of Conduct in their dealings with franchisees. However, an additional and fundamental requirement for franchisee success is a franchisee having faith in its franchise system and the franchisor. If that is not present, franchisor compliance with the Franchising Code of Conduct, or franchise agreement restrictions, is not likely to make the franchisor–franchisee relationship work, because the franchisee will always rankle at the control that the franchisor has over the franchise system. 

Franchisor control over supply

A recent instance of this may be the recent Pampered Paws¹ case. As is the case in many franchise arrangements for franchisors to obtain better prices for products for franchisees and to maintain the franchise system’s reputation, franchisees in the Pets Paradise system were required to stock only approved products and there was an approval process for other products. In practice, franchisees stocked mainly products supplied by Global Pet Products Pty Ltd (part of the Pets Paradise group).

Pampered Paws did not want to be required to stock Global pet products, nor did it seek many approvals for the other products that it did stock. Pampered Paws brought an action including many allegations of misrepresentations, but was only successful at court on two counts:

1. the Global supply arrangements were a form of third line forcing, prior to the changes to the Trade Practices Act (as it then was) to exclude related party transactions 
2. the franchise disclosure document did not specify that the franchisee would be required to enter into a Global supply agreement and accept and pay for stock from Global. This was worsened by the Global supply agreement being absent from the initial franchise document pack, although it had been provided to other franchisees.

The court is still to hear argument on damages, although Mansfield J did comment that it was unclear whether Pampered Paws had suffered damage because of the franchisor’s conduct and failure to disclose. For Pets Paradise going forward, the disclosure issue can be addressed for new franchisees by amendments to the disclosure document, and the related party supply arrangements are no longer prohibited as third line forcing.

Both parties must work to build the franchise relationship

Reading the case, the fundamental problem that gave rise to the action may have been that the franchisee did not want to be tied to the franchise system, or to be restricted in how the franchisee operated her franchise, and that this was exacerbated by the issues on which the franchisee succeeded at court in relation to the supply of Global products.

In Australia, there have been recent changes to the Federal Franchising Code of Conduct, and in several states, contempating additional state based franchising legislation to seek to ensure franchisors behave appropriately towards franchisees. Legislation goes some way towards addressing the information power imbalance, by requiring franchisors:

1. disclose particular types of information that may impact on a franchise business  
2. to allow franchisees an opportunity to take expert business, legal and accounting professional advice.

However, another key element to franchise success should not be addressed by legislation and is to some extent the franchisee’s responsibility. That is, prospective franchisees need to be open about their expectations for independence going into the relationship, so that franchisors can provide relevant information about what control the franchisor has, and why.

This article was written by Amalia Stone, Senior Associate, Sydney.

Endnotes

1. Pampered Paws Connection Pty Ltd (on its own behalf and in a representative capacity) vs Pets Paradise Franchising (Qld) Pty Ltd (No 10)[2012] FCA 25

More information

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