Franchising Focus

April 2011

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Important Trends in Multi-Unit Franchising – Legal and Structural Issues

by Stephen Giles

Franchisors need to develop a multi-unit model. There are fewer available franchisees, it is costly to find them and the market is very competitive. Similarly unit franchisee quality in Australia is questionable as a consequence of essentially full employment and high middle management salaries. So systems that rely on network expansion via new single unit franchisees will struggle to expand as quickly as systems that can expand via the multi-unit model.

There are other economies in terms of the multi-unit model, such as savings on recruitment and training costs, lower initial support requirements. However the current unit franchise model cannot just be replicated, and often needs major change. Systems that rely on the franchisee working long front line hours in the business need to work on improved margins and systems. And the workable multi-unit model may need 3 units or more, not just 2. With 2 units a franchisee may still not be able to achieve the requisite operational economies, or for larger franchised businesses to employ a senior manager and change their own role to be working on the business rather than in it.

Franchisors need to ensure they are able to provide the sort of brand and systems value and support a multi-unit franchisee will require. Otherwise there will be pressure for fee reduction.

When franchisors turn their minds to these challenges they often re-think the total model. Area development arrangements may become more common in Australia, with quality unit franchisees given regions and having a development program set from the outset. The unit franchise becomes the first step, not the end in itself. Or franchisors may look to establish a mix of franchised and corporate stores with a regional franchisee or area franchisee providing local coordination and support.

There are numerous legal and structural issues that need to be considered. In a paper presented to the Multi-Unit Summit in Melbourne early March Stephen Giles listed in point form the following questions and issues most specific to multi-unit franchising:-

Franchisee structure

  • One entity, or separate entities for each outlet? Usually one entity will be best, but not always.
  • Company, trust or other structure? Sometimes a more sophisticated structure may become more appropriate.
  • Taxation, profits and losses and grouping implications? It is critical to be able to net off losses and profits between businesses.
  • Finance implications? Simple is best.
  • Guarantee relief or limitation? Sometimes the franchisee becomes of such a size and value that individual guarantees become redundant, but this needs careful consideration.

Franchise Agreement

  • Review standard definitions as they will probably need to be changed. For example: “premises”, “territory”, in term and post-term restraint terms.
  • One agreement or multiple agreements or over-arching agreement as well? We typically prefer an over-arching multi-agreement with development and aggregate performance criteria and cross-default, with separate single unit agreements to facilitate separate sale etc. However every situation is different, and merits specific consideration.
  • Performance criteria – development of the territory or region, plus criteria for aggregate group sales is often sensible.
  • It is sometimes worth creating eligibility to be a multi-unit owner so the franchisor can review that status and require divestment of one or more outlets if the franchisee cannot cope.

Common mistakes

  • Doing deals on royalties and fees - royalties should be the same as the brand and systems benefit is still substantial. There can be compromises in fee for service arrangements and rebates where the multi-unit franchisee provides efficiencies. Franchisees should be entitled to aggregate sales between outlets for rebate purposes.
  • No cross-default clause, so the franchisor is unable to take action under all franchise agreements in situations such as insolvency, serious breach etc.
  • Cross-default clauses do not comply with the Code – termination of one agreement is not automatically termination of all related agreements if they are a “franchise agreement”.
  • Variable performance of outlets not addressed by the franchise agreement performance criteria clauses.
  • Lack of alternatives to termination, such as appointment of more senior staff, management changes at outlets etc. A franchisor is less likely to want to terminate a multi-unit operator, but needs some remedies to ensure appropriate action including divestment can be taken.
  • Lack of ability to require unit divestment where multi-unit franchisee is capable at unit level but is under-performing at group level.
  • The divestment clauses do not enable the franchisor to specify which unit should be divested and allow the franchisee to divest the wrong unit.

Watch out if you don’t pay that fine on time

by Shaun Temby and Kim Lendich

With the change from Trade Practices Act to the Competition and Consumer Act comes a new national regime for consumer protection. To assist the ACCC in monitoring and enforcing these new laws, the ACCC now has the ability to issue infringement notices for suspected breaches of the Act and it appears to be making good use of these powers. Notices have been issued to businesses in a variety of industries on a variety of issues including in respect of pricing, refunds, affiliations and associations.

The ACCC can issue an infringement notice if the ACCC has reasonable grounds to believe that a person or corporation has:

  1. engaged in unconscionable conduct
  2. engaged in unfair practices (though not for misleading or deceptive conduct)
  3. engaged in pyramid selling
  4. failed to comply with certain product safety and product information requirements, or
  5. failed to respond to (or properly respond to) a substantiation notice.

If the ACCC forms this belief then it can issue a notice that you pay up to $1,320 (individuals) and $6,600 (corporations). You then have 28 days in which to pay the infringement.

If you pay the infringement, then the ACCC will not take the matter further. However, if you fail to pay the notice then the ACCC may commence proceedings.

A recent example of where this has taken place is where the ACCC issued 8 infringement notices to 8 different restaurants for failing to advertise a single price for their products. The restaurants had used disclaimers at the bottom of their menus stating that a surcharge applied on Sundays or public holidays, a practice which in unlawful. Four of these restaurants paid the notices and no further action was taken. Their financial exposure was limited to the amount of the infringement notice, which could not have been more than $6,600.

The other four restaurants did not pay the infringement notice and the ACCC commenced proceedings against the restaurants. Each of those 4 restaurants was found guilty and the court ordered that they each pay a penalty of $13,200 (double the maximum amount permissible under an infringement notice). Further, and perhaps more significantly, each was ordered to pay the ACCC’s costs. Costs of legal proceedings can be very significant and will often far exceed the cost of an infringement notice.

That said, paying the infringement notice may not always be the right decision for your business. It is important to bear in mind the public nature of the process and the potential damage to your business’s reputation, particularly given the ACCC only needs to suspect a breach to issue a notice. Either way you should not sit on a notice if received and should act quickly to get advice and assistance in responding.

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The Top 10 on-line retailers

by Stephen Giles and Kim Lendich

The growth of e-commerce is a major issue facing business in Australia and around the world. A recently published list of the top 10 Australian on-line retailers according to traffic and revenue figures (excluding aggregators and auction sites) highlights the importance of price and convenience to on-line shoppers and provides an interesting insight into the types of sites gaining traction.

According to Smartcompany, Australia’s top10 on-line retailers are:

  • Catch of the Day – it has a “one-deal-a-day” format.
  • DealsDirect – is Australia’s biggest online department store.
  • Big W – – allows on line shoppers to buy almost anything they could get in a Big W store.
  • Dick Smith – allows shoppers to buy what they could get in store.
  • JB Hi-Fi – allows shoppers to buy what they could get in store, with the added “perk” of free shipping on certain days.
  • BrandsExclusive - members enjoy offers to participate in on line sales for products at discounted rates.
  • OzSale – an Australian private shopping club.
  • Oo.com.au – an Australian and New Zealand on-line department store.
  • EB Games Australia - one of Australia’s biggest entertainment chains.
  • Crazy Sales – on-line retailer offering products at very low prices.

Each of these sites is worth a look. However it is also worth looking at some of the sites with a specific industry focus, as they are impacting specialty retail in those industries. The furniture, homewares, clothing, appliance and entertainment sectors all have significant e-commerce sites.

From a legal perspective the competitive threat to retail networks is real, and franchisors and retailers need to be able to respond. Franchise agreements, supply contracts and trading arrangements should be reviewed to ensure a network is not hamstrung by existing contracts from making an appropriate competitive response.

Similarly any e-commerce strategy needs to be designed with legal and business flexibility in mind. In our experience a retailer’s first e-commerce response is often wrong, so documents need to allow for dramatic revision of the arrangements to respond to the customer’s requirements. Beware of compensation arrangements to bricks and mortar retailers for e-commerce sales, as in our experience they are often too generous. Similarly the product distribution needs to fit the customer’s requirements, not just pacify existing retailers. And do not be afraid to have multiple e commerce responses if that suits the customer.

For legal assistance with your e-commerce activities contact any member of our team.

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Occupational Health and Safety Obligations for Franchisors

by Jessica Kanevsky

A recent case handed down by the Industrial Court of New South Wales on 2 March 2011 highlights the requirement for a franchisor to ensure the occupational health and safety of its franchisees. The franchisor in Inspector Estreich v Parker Hannifin (Australia) Pty Ltd [2011] NSWIRComm 11 was fined $110,000 after an “erroneous view” of its safety obligations towards its franchisees led to an explosion that injured a worker.

The franchisor, Parker Hannifin (Australia) Pty Ltd (Parker Hannifin) was in the business of supplying motion control products including fluid connector products, hydraulic components, filtration and automation products. The franchisor purchased the ENZED Group in June 1989 and developed the ENZED franchise network. Hose Doctor franchisees were granted the right to operate a mobile hose and fitting service business. Parker Hannifin has 61 franchised ENZED Service Centres, 129 franchised Hose Doctor mobile businesses and 67 of its employees working directly for the ENZED Service Centres throughout Australia.

Mr Michael Pascoe was the working director of MCP Maintenance & Contracting Pty Ltd (MCP), a Hose Doctor franchisee of Parker Hannifin. MCP purchased the Hose Doctor franchise in March 2007.

The franchised business provided mobile servicing of high pressure hoses and hydraulic hose fittings and accessories. Hose Doctor franchisees drive vans that are specially fitted with a rear workshop and report to an ENZED Service Centre which allocates clients and performs administrative tasks. MCP utilised an ENZED Service Centre located at Wetherill Park. That centre was operated by Ricomore Pty Limited (Ricomore).

Hose Doctor franchisees were required to comply with Parker Hannifin’s mandatory specifications, standards, operating procedures and training requirements. Parker Hannifin had documented occupational health and safety procedures that MCP was required to follow. MCP was required to lease or purchase a van for the operation of its franchise and the van was to be painted and customised at the cost of MCP and stocked by Ricomore. There were also obligations on MCP to maintain the van in good repair. There was no obligation in the franchise agreement requiring MCP to have the van approved by Parker Hannifin.

Prior to the explosion incident in June 2008, Parker Hannifin had not considered it had any responsibility to ensure that the vans used by the Hose Doctor franchisees complied with the relevant State occupational health and safety laws or Australian Standards regarding such matters as the carriage of dangerous gases.

Parker Hannifin understood that because the Hose Doctor franchisees had purchased, owned and operated their vans, each Hose Doctor franchisee was responsible under their franchise agreement for ensuring that their vans complied with the relevant occupational health and safety laws.

In June 2008, Mr Pascoe was driving his Isuzu van from a client’s premises to a supplier’s premises when there was an explosion in the workshop compartment of his van. The force of the explosion sent metal into its cabin and blew out the front windscreen.
Pascoe escaped with minor injuries, but as a result of this incident Parker Hannifin was charged with and pleaded guilty to breaching s10(1) (duties of controllers) of the New South Wales Occupational Health and Safety Act 2000 for the failure to require that any motor vehicle used by a Hose Doctor franchisee contained a ventilation system that would eliminate the possibility of oxygen and acetylene building up.

Although Parker Hannifin exercised control over Hose Doctor franchisees, its mandatory specification standards and operating procedures did not ensure that Hose Doctor franchisees complied with Australian Standards in respect of the storage and transport of flammable substances. The Australian Standards require proper ventilation in the carrying of dangerous gases. The judgement of Marks J in Inspector Townsend v Carrier Air Conditioning Pty Ltd [2008] NSWIRComm 74 which was handed down two months prior to the incident was said to demonstrate the forseeability or obviousness of the risks, the serious consequences of dangerous gases exploding and the simple remedial steps of ventilation available that underlined the objective seriousness of Parker Hannifin’s offence.

Parker Hannifin contended that MCP could have put into place additional safety systems and noted that Mr Pascoe’s injuries were only minor. It was also noted in the report commissioned by WorkCover that the “root cause” of the explosion was poor trade practice on the part of the person who had left the valves in the workshop compartment of the van open.

In the course of the proceedings, Parker Hannifin admitted that it had made misguided assumptions about the extent of its safety obligations towards its Hose Doctor franchisees and confirmed that after the incident new safety processes including procedures for storing flammable gases had been introduced.

The Court held that Parker Hannifin was wrong in assuming that it was only responsible for the health and safety aspects of the products it supplied to the ENZED Service Centres who then supplied them to the Hose Doctor franchisees. This assumption had been made by Parker Hannifin because of the fact that Hose Doctor franchisees were independent businesses that were subcontracted to perform service functions using Parker Hannifin’s products.

Justice Haylen found that Parker Hannifin’s failure to give safety directions regarding the safe storage of dangerous gas constituted a serious and potentially fatal breach. Although it was accepted that Parker Hannifin’s failure was caused by an “erroneous view of its obligations, these wrong assumptions could not reduce the seriousness of the offence resulting in the $110,000 fine.

This case is a timely reminder that a franchisor may be responsible for ensuring that the premises (including a vehicle) that it has control (or limited control) over by virtue of the franchisee/franchisor relationship complies with relevant occupational heath and safety laws, notwithstanding that a franchisee is an independent business proprietor.

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