Dr Jenny Buchan Australian School of Taxation & Business Law

Dr Jenny Buchan
Australian School of Taxation & Business Law
University of NSW
Kensington, NSW 2052
19 July, 2012
Assistant Secretary
Business Law Branch
Attorney-General’s Department
Robert Garran Offices
3-5 National Circuit
BARTON, ACT, 2600
Email contractlaw.ag.gov.au
Dear Assistant Secretary,
Submission to: ‘Reforming Australian contract law’ inquiry.
I lecture contract law, franchise law and international franchise law at the Australian School
of Business, UNSW. My research is on franchisor insolvency, franchise system governance
and stakeholder participation in government inquiries. My submission is confined to the
species of contract that are represented by individual unit franchise agreements. For example
the agreement between the franchisor Subway and the franchisee who will operate a Subway
outlet under a franchise agreement, a licence.
Franchise agreements are standard form, relational, agreements. Initially the franchise is
marketed in the same was as any consumer good. The relationship that is being sold/bought is
a commercial relationship. The franchise agreement is drafted by the franchisor. It contains
numerous clauses but the ones that place obligations on the franchisor are few and often
discretionary; those that place obligations on the franchisee are numerous and prescriptive.
There were approximately 980 business format franchisors in Australia in 2010. The median
number of franchisee-operated units per franchise system in 2008/9 was 22. This number can
be expanded on: the median number of units in a retail system was 40, non retail was 17. The
median turnover for the retail franchised units was $10million in 2008/09. 1 The franchise
sector is a source of jobs, a business entry point, and a source of export earnings for
Australians. The relationships between the franchisor and its franchisees, and the franchisor
and suppliers to the franchisees, are all based on contracts.
From a contract law perspective there are four principal areas where the law could service the
sector, particularly franchisees, better.
1
These franchise statistics all from Lorelle Frazer, Scott Weaven, Kelli Bodey, Franchising Australia 2010,
Griffith University.
1
[email protected]
•
•
•
•
First, standards of acceptable conduct.
Secondly, more accurate recognition of standard form commercial contracts. They are
more like consumer contracts than negotiated commercial agreements. They are not
negotiated between equals.
Thirdly’ recognition that a breach of the main contract (franchise agreement) by the
franchisor may force the franchisee to breach a number of consequential contracts (eg
sub-leases, licence agreements). It had to enter into them as a consequence of becoming a
franchisee, but the breach (even total breach by becoming insolvent) by the franchisor
does not entitle the franchisee to terminate these consequential contracts. Despite the
rhetoric, many franchisors go into administration or are wound up, insolvent. Examples in
2012 include Darrell Lea, Angus & Robertson, Oliver Brown.
Finally, the connection between contract law and insolvency law fails franchisees badly.
To elaborate on the above.
1. Unconscionable conduct in the context of relational contracts.
It is difficult for franchisees/ tenants to establish that their franchisor/landlord has behaved
unconscionably, despite evidence to the contrary. In contract law certain rebuttable
presumptions exist; for example in relation to the presumed binding nature of domestic
compared with commercial contracts. In a relational one sided contract like a franchise
agreement or a retail shopping centre lease the drafter (franchisor/landlord) holds far more
information than the other party does. This includes confidential information in relation to
how the same contract is administered in relation to every party that has signed it. I suggest
the law introduce a rebuttable presumption that unconscionable conduct has occurred where it
is alleged in a relational contract situation. It is then available to the party that holds the
information to rebut it and shift the burden of proof back onto the party alleging its existence.
For example: in Hoy Mobile Pty Ltd v Allphones Retail Pty Ltd (No 2) 2 , following the
franchisor’s refusal to mediate the franchisee had to litigate to prove it had been treated
unconscionably by franchisor Allphones, or accept defeat. The franchisee said:
I was told the proceeding were likely to cost me around [A]$300,000 … and that my matter stood a good chance of
succeeding … but more importantly there was no other way of restraining the franchisor from acting upon the termination
notice without an injunction. … At the time we thought it was commercially sensible to begin proceedings to prevent the
termination and to protect our asset. By … the end of 2006 the costs had reached $140,000. The court ordered mediation
which we attended to no avail in November 2006. The franchisor had made it clear from the beginning that they were going
to fight us all the way …We had to subpoena [telecommunications] carriers to obtain the evidence we required and even this
process was not easy and cheap. We had to provide an undertaking to the court that we would not disclose the information
we read before we were allowed to view the documents. Once I viewed the documents I was certain our issue … was an
issue that affected every [Allphones] franchisee and I was not allowed to tell my fellow franchisees or the ACCC. The
carriers each charged between [A] $1000 to over $3000 for producing the documents. 3
2
[2008] FCA 810. In Allphones Retail Pty Ltd v Hoy Mobile Pty Ltd [2009] FCAFC 85Allphones unsuccessfully
appealed the decision.
3
Evidence to Parliament of Australia Joint Committee on Corporations and Financial Services, Senate of
Australia,
Inquiry
into
Franchising
Code
of
Conduct,
undated,
4
(Nicole
Hoy)
<http://www.aph.gov.au/SENATE/COMMITTEE/corporations_ctte/franchising/submissions/sub08.pdf> at 17
January 2010.
2
[email protected]
The franchisor was held to have behaved unconscionably but the cost of proving this was
significant. Had the franchisor had to defend itself against a presumption of unconscionable
conduct the costs would have been lower as the franchisee would not have had to go to
extraordinary lengths to obtain evidence.
2. to 4.
‘When considering any problem from a legal perspective [the question must be asked]:
can the problem be addressed within the existing law? Is anything preventing franchisees
from protecting themselves against the consequences of franchisor failure by negotiating
contracts better? Intuitively, franchisors and franchisees should be able to incorporate
provisions into the contract that address the possibility of the franchisor’s business failing,
and thereby provide franchisees with appropriate consequential rights. New York franchise
lawyer Craig Tractenberg recommends:
The best protection against the risks inherent in the bankruptcy process is to terminate
the franchise agreement before bankruptcy is filed. If the franchise agreement is
terminated before bankruptcy is filed, it is not protected by the automatic stay and the
franchise is not property of the estate.4
This is an option that is available to franchisors but rarely to the franchisees. Tractenberg also
advises that ‘[c]omplete termination is required’. 5 Similarly, the best protection for
franchisees is for them to be legally entitled to terminate the franchise agreement during the
period of administration before the franchisor’s liquidator is appointed.
‘Contracts are fundamental to commerce. Contract law determines how a contract is
made, whether it is enforceable, whether it has been breached, and what remedies are
available for its breach’. 6 Franchise agreements perform the same role everywhere. In South
Africa, for example, the franchise agreement has been described in Cacun Trading No 24 CC
& Others v Seven-Eleven Corporation SA (Pty) Ltd unreported case no 18/IR/Dec 99 thus:
[a] franchise agreement is neither an employment relationship nor an independent
contracting relationship. It rather combines elements of integration and delegation,
4
Tractenberg, Craig R Tractenberg, ‘What the Franchise Lawyer Needs to Know About Bankruptcy’ (2000–
2001) (3)20 Franchise Law Journal 3. end note 8; See, for example, Moody v Amoco Oil Company 734 F 2d
1200 (7th Cir) cert denied, 469 US 982 (1984). Tractenberg is writing for an audience of lawyers whose
clients are franchisors whose franchisees are becoming bankrupt but the same applies to franchisees.
Whilst being a high-risk strategy for franchisees in Australia, termination for anticipatory breach is the
avenue that gives individual franchisees the quickest exit from a doomed franchise agreement; see ch 3.3
of this thesis.
5
Tractenberg, ibid, end note 9. If the franchise agreement expired prepetition or is otherwise not in
existence because of having been completely terminated prepetition it is not property of the estate. See,
for example, Days In v Gainesville P-H Properties, Inc 77 BR 285 (Bankr MD Pa 1993); But compare with
Baskin Robbins Inc v Neiberg 161 BR 606 (Bankr BD Pa 1993) (no waiver by franchisor of termination
rights) with In re Karfakis, 162 BR 719 (Bankr BD Pa 1993) (franchise agreement and real property lease
were indivisible contracts and purported termination of franchise agreement without taking possession of
real estate was incomplete termination of the integrated franchise rights of the debtor).
6
M P Ellinghaus, E W Wright and M Karras, Models of Contract Law an Empirical Evaluation of Their Utility
(2005).
3
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control and independence and is thus a multifaceted vertical structure that paves the
way for endless relational and commitment problems. 7
Any problems are ideally addressed to the satisfaction of both parties as the relationship
develops. After conducting an inquiry into franchising in 2008, the Economics and Finance
Committee of the South Australian Parliament concluded:
The basic premise on which the principles of freedom of contract and sanctity of
contract rest is that contracts are negotiated at arm’s length by equally positioned
participants in the bargaining process. That premise is not fulfilled in the typical
franchise arrangement. 8
‘Contractual relations are the essence of the firm, not only with employees but with
suppliers, customers, creditors’ 9 and franchisees. The franchise agreement is also the starting
point for the courts, administrators and liquidators determining the parties’ rights. The
franchise agreement will now be examined as the record of a bargain, and in the context of
the franchisor failing.
ADDRESSING THE FAILURE OF THE FRANCHISOR’S BUSINESS
The subject of the franchise agreement is a commercial relationship. The parties are the
franchisor as a business supplier and a franchisee as a business consumer. Once executed,
like all commercial agreements, it sits in the proverbial ‘bottom drawer’ until one party needs
to invoke legal rights. Then, it commands the parties’ undivided attention. Franchsie
agreements, as already mentioned, are very one –sided.
Because there is no public register of franchise agreements in Australia, 70 franchise
agreements … were chosen from the US website FreeFranchise docs. 10 … None of
these agreements mentioned franchisor bankruptcy … In the same agreements, 23.5
per cent were silent on the right for franchisors to terminate the agreement if the
franchisee became bankrupt. Seventy six per cent permitted the franchisor to
terminate the franchise agreement, usually with no notice and no right to cure if the
franchisee became bankrupt. 11
In Australia, the ex post experience of a Traveland travel agency franchisee is
consistent with the US findings above:
7
Tanya Woker, ‘Franchising – The Need for Legislation’ (2005) 17 South African Mercantile Law Journal 49,
51.
8
Economics and Finance Committee, Parliament of South Australia, Franchises (2008) 17.
9
Michael C Jensen and William H Meckling, ‘Theory of the Firm: Managerial Behavior, Agency Costs and
Ownership Structure’ (1976) 3(4) Journal of Financial Economics 305, 311.
10
Free Franchise Docs <http://www.freefranchisedocs.com/index.html> at 5 June 2008.
11
Jenny Buchan and Bill Butcher, ‘Premises Occupancy Models for Franchised Retail Businesses in Australia:
Factors for Consideration’ (2009) 17(2) Australian Property Law Journal 143, 170.
4
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We’d just renewed the franchise agreements on our 4 [Traveland] outlets for 5 years
when the franchisor’s administrator was appointed. We went to see a QC to see if we
could get out of the agreements and there was no way. 12
This failure to provide for an event which is demonstrably common is problematic. The
ideal world where ‘negotiations between two … parties, … are designed to advance the wants
and needs of each of those contracting parties’ 13 does not describe the experience of
franchisees. Contract theory helps explain how this imbalance arises and why it has not been
redressed by the common law. This review has an opportunity to recognise and address the
problem.
THE DESIRABILITY OF CERTAINTY IN CONTRACTS
Notwithstanding that one would assume for all stakeholders that certainty is an
outcome of the contracting process and
[t]he classical theory of contract was seen to offer predictability and certainty,
although, as Sir Anthony Mason has observed; “It later emerged, as is the case with
many legal concepts rooted in formalism, that the element of certainty was illusory” 14
Acknowledging that the franchise agreement is a relational contract is also to
acknowledge that whilst procedural certainty may be achieved, substantial certainty need not
be an outcome of the contracting process. Certainty in all dimensions is widely accepted as
being desirable in commercial relationships. Heather Ridout points out that ‘uncertainty is
death for business’ 15 in the context of the carbon trading debate. Hadfield observes:
… incomplete contracts (such as franchise agreements) often exist deeply embedded
in an ongoing relationship. The parties are not strangers; much of their interaction
takes place “off the contract” mediated not by visible terms enforceable by a court,
but by a particular balance of cooperation and coercion, communication and
strategy. 16
There is an assumption underlying a relational contract that the major foreseeable
events which could fundamentally change the relationship, are addressed in the contract.
Other events are foreseeable but seem so unlikely to one or both parties that they are not
included. The parties acknowledge, by implication, that some events are not foreseeable and
will be the subject of negotiation if and when they occur. Where certainty is not possible, a
balanced contract would be a desirable outcome.
12
Jenny Buchan and Lorelle Frazer, ‘The Domino Effect – How Ansett’s Failure Impacted on Traveland
Academy of World Business’ (Paper presented at the Marketing & Management Development
Conference, Paris, 10-13 July 2006) 1901, 1906.
13
Lindy Willmott et al, Contract Law (3 ed, 2009) 16.
14
In Bobux Marketing Limited v Raynor Marketing Limited [2001] NZCA 348, para 34 (Thomas J dissenting),
citing AF Mason, ‘Contract, Good Faith and Equitable Standards in Fair Dealing’ (2000) 116 Law Quarterly
Review 66, 70.
15
Sky News, ‘Australian Industry Group, Heather Ridout, with Kieran Gilbert’, Agenda (5 May 2009).
16
Gillian K Hadfield, ‘Problematic Relations: Franchising and the Law of Incomplete Contracts’ (1990) 42
Stanford Law Review 927, footnote 28 at 928.
rd
5
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PARTIES TO COMMERCIAL AND CONSUMER CONTRACTS ACT IN THEIR OWN INTERESTS
As The Right Hon Sir E W Thomas observes, ‘[i]t is the law of contract that has the
greatest impact on interactions where freedom of choice and action and freedom from
interference are most coveted’. 17 Parties to commercial contracts should act in their own
interests but, as K M Sharma writes:
… the liberal fiction that all the effects of a contract should be attributed to the will of
those who made it still persists though contract law today even though the
overwhelming majority of contracts are the product of the will of only one of the
contracting parties. 18
Parties to contracts act in their own interest. In franchising, though, the will of the
franchisor dominates the franchise agreement. Franchisors draft the agreement acting in their
own interest. This makes sense to the extent that franchisors can thereby ensure that the major
risks for the future integrity of their network are addressed, and can achieve administrative
efficiency through standardisation.
Each franchisor, thus, acts in its own interest. This rational approach helps explain why
franchisors make no mention of franchisor failure in franchise agreements. They believe they
are acting in their own interest. The franchise sector’s equivocal response to complying with
the voluntary sector code of practice 1993-1998 is likely to be an indication of how they
would respond to the suggestion that all franchise agreements voluntarily include provisions
addressing franchisees’ rights if the franchisor failed.
A further example of the stronger party acting in its own interest is the way issues of
risk and reward are addressed in franchise agreements. A contract negotiated between parties
of equal weight and with a mutual interest in the success of the venture would result in the
contract addressing both risk and gain in a balanced way. But, despite having assumed a
considerable amount of the franchisor’s business risk franchisees have no right to receive the
corresponding reward that a franchisor’s venture capital providers or shareholders typically
would be entitled to if the franchisor entity is sold for a profit. 19
Thus the assumption that franchisors will act in their own interests is correct. The
assumption that the weaker party to the contract, the franchisee, will act in their own
interests, is debateable. If they want to become a franchisee of a specific network they have
no ability to act in their own interests; in order to be approved as a franchisee they hand the
franchisor all of their financial information, then prior to becoming a franchisee they execute
the standard form, non-negotiated agreement drafted by the franchisor.
17
E W Thomas, The Judicial Process: Realism, Pragmatism, Practical Reasoning and Principles (2005) 382.
18
K M Sharma, ‘From Sanctity to Fairness’ (1999) 18 New York Law School Journal of International and
Comparative Law 95, 115.
19
For example S Mitchell, ‘Cartridge Refiller Tops up With $60m’, The Australian Financial Review
(Melbourne), 2 August 2007, reports on a private equity led management buyout of 80 per cent of the
franchisor’s business for an estimated $60m.
6
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A STANDARD FORM BUSINESS CONSUMER CONTRACT
In its submission to The Australian Consumer Law Consultation on Draft Provisions on
Unfair Contract Terms, the Law Society of NSW provides examples of ‘standard form
contracts’ frequently used in conveyancing transactions and states that:
the Committee believes that the use of these forms has significant consumer benefits:
[being] familiarity, comprehensiveness, compliance with legislative provisions,
frequently updates, flexibility, efficiency, risk management, balance between the
parties to the transactions.20
Whilst all of these points are valid in respect of standard form contracts drafted by an
impartial party, standard form agreement such as franchise agreements are drafted by the
overwhelmingly more powerful party in a commercial relationship. The Law Society’s
thinking about standard form contracts is inaccurate in the context of standard form,
commercial, relational contracts which include franchise agreements.
Franchising is by nature an area of commerce that operates across national and
international borders. Franchisors use standard form franchise agreements drafted, sometimes
overseas, to maximize their position. For example:
Clauses identical or substantially similar to clause 10 (drafted in the US) appear in
franchise agreements for over 14,000 Subway franchises throughout the world. The
reason Subway Systems and Doctor's Associates require disputes with franchisees to
be resolved in accordance with clause 10 is that they want to develop an
internationally consistent approach to dispute resolution with franchisees. 21
Thus, in the Subway franchise network the franchisor maximizes its position by
requiring disputes that are not able to be resolved by mediation at national level to be
resolved by arbitration or litigation in the location nominated by the franchisor, Connecticut,
USA. 22 Such a strategy is beneficial to the franchisor but is a significant disincentive to
robust dispute resolution for Subway franchisees located in Australia.
Franchisees are encouraged to read the franchise agreement and ask questions, but any
requests for changes are typically rejected by the franchisor. Standardisation of outcome is a
more important result for a franchisor than letting a new franchisee enter the relationship in
the mistaken belief that he or she has any bargaining power. The franchisee accepts the
franchisor’s unwillingness to negotiate because standardisation reinforces the franchisor’s
20
Law Society of New South Wales, Australian Consumer Law – Consultation on Draft Provisions on Unfair
Contract
Terms
(2009)
Australian
Government,
The
Treasury
<http://www.treasury.gov.au/contentitem.asp?NavId=037&ContentID=1537> at 4 June 2010.
21
Timic v Hammock [2001] FCA 74, para 6.
22
‘Doctor's Associates Inc, an American corporation, is the owner of proprietary and other rights and
interests in various service marks, trade marks, trade names and goodwill used in its business including
the trade name and trade mark ‘Subway’. Subway Systems is the Australian licensee of Doctor's
Associates. … Clauses identical or substantially similar to clause 10 appear in franchise agreements for
over 14,000 Subway franchises throughout the world. The reason Subway Systems and Doctor's
Associates require disputes with franchisees to be resolved in accordance with clause 10 is that they want
to develop an internationally consistent approach to dispute resolution with franchisees.’ In Timic v
Hammock [2001] FCA 74.
7
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mantra – we know how to do it, trust us and sign on with us and you will be successful before
you know it.
Nevertheless franchise agreements are:
long-term contracts [that] involve continuing financial commitment in the course of
which the consumer, being imperfectly informed and not fully aware about his needs
– is largely reliant on the advice, guidance and skills of his counter-party. 23
The franchise agreement places a franchisee in a position of dependence on the
franchisor in relation to services provided by both the franchisor and by third parties. Despite
all the words about support and nurturing that have resulted in the franchisee purchasing the
business, the franchisor’s position as an independent contractor is clearly stated in the
wording of the franchise agreement, as is shown for example in a typical Australian franchise
agreement.
As Rick Bigwood points out, ‘standardized [as manifested by standard form] contracts
are mostly to be endured as beneficial in complex free market economies. This is largely
because they reduce transaction costs’. 24 Bigwood acknowledges that ‘consumer protection
through market forces alone is weak’. 25 The inability of market forces to remodel franchise
agreements to accommodate franchisor failure is an aspect of extreme one sidedness that is
not to be endured. For example, franchise agreements always provide for the death or
insolvency of the franchisee. There are no statistics available for the number of franchisees
who die while being a party to a franchise agreement. In my experience acting for franchisors
of large networks, a franchisee died on two occasions. On both occasions the death affected
one outlet and the transition to a new owner was managed by the franchisor without
interruption to any other franchisees. By way of contrast, a ‘standard form contract … does
not anticipate [the franchisor equivalent of the franchisee’s death] insolvency of the
franchisor. This limits the ability of the franchisee to self protect’. 26
Another way of expressing the problems caused by the standard form is that:
[c]onflicts of interest may, and do, create counter-incentives for [creating and]
complying with contractual obligations. Especially in long term contracts and in
conditions of asymmetric information, the possibility of opportunistic behaviour
appears considerably increased not least because the value of the contract and the
investment depends on the firm’s performance after the point of purchase. 27
23
Andromachi Georgosouli, ‘Investor Protection Regulation: Economically Rational?’ (2006) Working Paper
Series, University of London, Centre for Commercial Law Studies 10 <http://ssrn.com/abstract=893451> at
4 June 2010.
24
Rick Bigwood, Exploitative Contracts (2003) 274.
25
Ibid 274-5.
26
Wayne Jenvey, ‘Rocky Roads and Rollercoasters – Turnaround Strategies for Distressed Franchise Systems’
(Paper presented at the Legal Symposium at the Franchise Australia Annual Conference, Gold Coast, 24
October 2006) 2..
27
Andromachi Georgosouli, ‘Investor Protection Regulation: Economically Rational?’ (2006) Working Paper
Series, University of London, Centre for Commercial Law Studies 10-11 fn 40 citing I D C Ramsey,
‘Rationales for Intervention in the Consumer Marketplace’ (1984) Occasional Paper for the Office of Fair
Trading 28. <http://ssrn.com/abstract=893451> at 4 June 2010..
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Contracting out would be a way in which consumers could avoid being exposed to the
risk of their counter-party’s misconduct, nevertheless the costs involved discourage
them from doing so. 28
It is easy to suggest that, having observed that other franchisees have already made the
investment in the franchise business, franchisee consumers free ride and do not conduct
extensive due diligence. Even if adequate due diligence were possible the contract is not
negotiable. As Carter et al state:
the assumption that will and intention form the substratum of every contract is heavily
attenuated by inequality of bargaining power between individual and corporation
whose power is marked by common use of standard form contracts.29
Willmott et al add that
[s]tandard form contracts are typically used by parties who are in such a strong
bargaining position … that they are able to prescribe the terms on which they are
prepared to contract on a ‘take or leave it’ basis. 30
The franchise agreement is an example of such a contract ‘negotiation’ process. The
franchisor supplier drafts the franchise agreement. The franchisee seldom has the opportunity
to vary the standard form.
RELATIONAL CONTRACT
Franchise agreements are relational contracts, and are necessarily incomplete. ‘In
contract theory, incompleteness is [also] due to the cost and sometimes unavailability of
information’. 31 During the initial contract negotiations ‘parties incur ex ante transaction costs,
including the costs of anticipating future contingencies and writing a contract that specifies
an outcome for each one’. 32 ‘Both ex ante and ex post contracting costs prevent parties from
writing complete contracts and give rise to what economists refer to as the problem of
incomplete contracts’. 33
Ex ante, the parties might not foresee all possible contingencies or they would have to
incur prohibitively high negotiation and drafting costs to partition all contingencies
sufficiently to provide for efficient obligations in each case. The contingency that the
franchisor’s business might fail is the least likely from a franchisees’ perspective, as most
believe they are buying a proven concept. ‘A challenge for parties designing contracts is to
preordain or at least constrain the course of future renegotiation so as to yield both ex ante
and ex post efficiency’. 34
28
Ibid 11.
29
J W Carter, Elisabeth Peden and G J Tolhurst, Contract Law in Australia (5 ed, 2007) 8.
30
Willmott et al, above n 13, 583.
31
Robert E Scott and George G Triantis, ‘Incomplete Contracts and the Theory of Contract Design’ (2005)
56(1) Case Western Reserve Law Review, 187, 191.
32
Ibid 190.
33
Ibid.
34
Ibid 194.
th
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As Hadfield points out, very significantly when contract law reform is being
considered, once the contract moves beyond negotiation or performance to litigation:
[t]o the extent that courts cannot distinguish between the derogation of a commitment
in an incomplete contract, and an exercise of the flexibility which is part of that
commitment, incomplete contracts cannot fully function in their role as anchor for
many complex transactions. 35
The franchise agreement is necessarily incomplete because of its long term and the
unpredictability of human relationships and commercial environments.
the legal system is likely to be a poor venue for specifying the substantive terms of
the [long term franchise] contract. It would be unrealistic to expect a relational
contract to cover all contingencies. From a franchisee’s perspective, then, perhaps the
biggest problem with franchising lies not so much in what it is, but rather what it is
not and yet sometimes appears to be. 36
‘To a lawyer, a contract may be incomplete in failing to describe the obligations of the
parties in each possible state of the world’. 37 It is thus difficult to explain why franchisors
would knowingly leave gaps around the possibility of franchisor failure when ‘the cost of
making contracts complete in this sense is trivial’. 38 A flaw in applying the theory of trading
off ‘front-end and back-end costs’ 39 to justify not providing for franchisor failure ‘up front’ is
that franchisors fail sufficiently often for the risk to be eligible for inclusion in the franchise
agreement from the outset. It would be relatively inexpensive to insert provisions about
franchisor failure into the franchise agreement, and the traditional justification that issues left
for the back end will be resolved by the courts is not justifiable where the trigger event is the
insolvency of one party.
Justice Hammond in Dymocks Franchise Systems v Bilgola Enterprises Ltd 8 TCLR
612 recognised that the
underlying recognition is that a relational contract is of an ongoing, and often
relatively open-ended, character; and that it is in society’s interest to accord to each
party to a contract of this kind, reasonable security for the protection of his or her
justified expectations. 40
A franchisee’s ‘justified expectations’ that it may continue to operate its business until
the end of the term of its licence, are often unmet if the franchisor fails.
INCOMPLETE CONTRACT
Carter et al identify that ‘The absence of genuine [pre-contractual] negotiation can
result in the weaker party signing an unfavourable contract. Partly in response to this, the law
35
Hadfield, ‘Problematic Relations: Franchising and the Law of Incomplete Contracts’, above n 202, 928.
36
Roger D Blair and Francine Lafontaine, The Economics of Franchising (2005) 221.
37
Robert E Scott and George G Triantis, ‘Incomplete Contracts and the Theory of Contract Design’ (2005)
56(1) Case Western Reserve Law Review, 187, 190.
38
Ibid.
39
Ibid 196.
40
Dymocks Franchise Systems v Bilgola Enterprises Ltd 8 TCLR 612, 630.
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of contract implies terms into certain commonly occurring contractual relationships to
complete the parties’ bargain’. 41 Under the common law some situations merit implying
terms into contracts’. 42 These may be implied to give effect to the ‘presumed intentions of the
parties’. 43 The presumed intentions of the parties could rarely be proven, to the satisfaction of
a court, to have included the franchisor’s failure. It is thus not open to the franchisee to argue
that clauses providing the franchisee with contract-based rights on the franchisor’s insolvency
were omitted because the contract did not reflect the intentions of the parties. Alternatively
terms are implied into contracts ‘regardless of intention’ 44 because the type of contract or a
specific statute mandates inclusion of that term.
Currently no terms are implied into franchise agreements to fit the second category following
the appointment of a receiver, administrator or liquidator. This review could resolve this gap
in the law.
Thomas adds a judicial perspective to the conclusions drawn by Carter et al writing
that:
[i]t would be quite wrong to think that a contract that omits a provision to deal with a
particular contingency is due to an oversight or the finite capacity of business people
and their legal advisers to predict future events with accuracy. … there are sound
commercial and economic reasons why the parties may deliberately choose to enter
into agreements in which no provision is made for known contingencies.45
Contracts may not be complete because they were never intended to be complete. In the
franchising arena, for example, franchisors may negotiate directly with a landlord to reach
heads of agreement in relation to the franchisees’ premises, then both franchisor and landlord
may hand the negotiations over to the landlord’s shopping centre manager or lawyer to
complete the lease details with the franchisee. The heads of agreement may constitute a
binding contract, but it is incomplete.
Thomas accurately observes that in a typical commercial negotiation:
[t]he decision as to what is the most efficient will be made having regard to … the
time available for further negotiations, the cost of more comprehensive drafting, the
risk that the core bargain will be lost, the chances of the contingency actually
occurring, and the consequences or alternatives available if the contingency does not
occur. Further, with long-term or relational contracts … the parties can anticipate that
some terms of the contract will be renegotiated and developed in the light of
experience or necessity. 46
But, by taking each of the factors identified by Thomas and placing them in the context
of the franchise sale and purchase process it can be concluded that franchise contracts are not
41
J W Carter, Elisabeth Peden and G J Tolhurst, Contract Law in Australia (5 ed, 2007) 8.
th
42
See Des Butler et al, Contract Law Casebook (2009) 73.
43
Ibid 73–4.
44
Ibid 77.
45
E W Thomas, The Judicial Process: Realism, Pragmatism, Practical Reasoning and Principles (2005) 296.
46
Ibid 296-7.
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the result of typical commercial negotiations. There is, in theory, ample time. The franchisee
has a 14-day cooling off period in which to consider the deal. By this time the franchise
agreement has already been settled through a process of franchisor centric drafting.
Cost is not the issue. The additional cost of drafting to provide a termination right for
franchisees would be negligible, especially once that provision had been incorporated as
standard into the franchisor’s usual franchise agreement. However, the franchisee is required
to sign the standard franchise agreement for the network.
There is a perceived risk that the core bargain – the sale of the franchise to the
franchisee – will be lost if the franchisee insists on additional terms. However, once a
franchisee has decided which franchise to buy, it is very difficult to dissuade them.
The damage resulting from franchisor failure is more widespread than that caused by
the failure of an individual franchisee. When a franchisor fails, all of its franchisees are
affected, most adversely. If an individual franchisee fails the franchisor will not fail, and nor
will any other franchisees.
EXPLOITATIVE CONTRACT
A franchisor has no incentive to include terms to protect the franchisee from the
consequences of the franchisors’ administration or insolvency. The franchisor has every
incentive to put itself into a contractual position where it can exploit its franchisees if the
relationship does not evolve as the franchisor expected. The concept of exploitative contracts
has been investigated in depth by Bigwood, who describes the power imbalance between the
franchisee (Plaintiff) and franchisor (Defendant) that creates the environment for
exploitation:
What is crucial is that the vulnerability that gives rise to the asymmetric power
relation between the parties is such that P ought to be excused … from having to
exercise that level of responsibility or self-reliance expected and required of the
generality of contracting parties. … the exploitable circumstances condition
presupposes a weakness or vulnerability that, in the circumstances, removes P from
the normal assumptions made about the bargaining ‘game’… the crux of the
exploitable circumstances criterion lie in the nature and extent of the power relation
existing between the parties. What matters is that P’s interests have become peculiarly
sensitive to – that is, they can be directly, strongly and adversely affected by – D’s
choices and actions and this resultant vulnerability becomes the source of D’s
bargaining power. 47
In Meridian Madam Justice Dodds-Streeton acknowledged that:
[implying] a term [of good faith], whatever the basis of its implication and whatever
its precise content, may validly operate to protect a vulnerable or disadvantaged party
“from exploitative conduct which subverts the original purpose for which the contract
was made. 48
47
Rick Bigwood, Exploitative Contracts (2003) 143.
48
Meridian Retail Pty Ltd v Australian Unity Retail Network Pty Ltd [2006] VSC 223, para 210 at [4] citing
Warren CJ in Esso Australia Resources Pty Ltd v Southern Pacific Petroleum NL (receiver and manager
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BREACH OF CONTRACT
In theory, franchisees whose franchisor failed could claim breach of the franchise
agreement by the franchisor and make out a contract law based claim, or a quasi-contract
claim. In practice, it is difficult for a franchisor to breach a franchise agreement as the
agreement imposes so few obligations on the franchisor. In the absence of a breach of a term
of the contract, a contract-based claim against a franchisor could be based on the doctrine of
frustration or on unjust enrichment or anticipatory breach.
Frustration
Events may occur after a contract has been made which makes its performance
pointless, more difficult or more costly, or even impossible. Such events may result in
the termination of the contract by operation of law, on the basis that it has been
frustrated. 49
Frustration of a contract can only arise if the following conditions are met:
a.
The supervening event must cause a fundamental or radical change to the nature of the
contractual rights and obligations;
b.
Neither party should have caused or brought about the supervening event;
c.
The supervening event must be such that it was not contemplated by the parties when
they entered the contract. It follows, therefore that there should be no provision in the
contract designed to deal with it; and
d.
It must be unjust to hold the parties to the contract to its terms as originally agreed
upon. 50
The failure of the franchisor will meet the first condition. The fundamental change from
the franchisees’ perspective is that the franchisor becomes unable to deliver on its side of the
bargain. It may have lost the right to grant licences to franchisees to use the trade marks. It
may have breached head leases that, in turn, deprive franchisees of their premises.
The franchise agreement is re-categorised as an asset or a liability and, whereas prior to
the franchisor’s liquidator being appointed the franchisee was entitled to rely on the franchise
agreement as a source of franchisor’s obligations, from the time the liquidator is appointed
the franchisee has no right of access to remedies for breach of contract and the liquidator is
entitled to disclaim the franchise agreement as an onerous contract.
Condition b. may preclude franchisees of some failed franchisors from accessing
frustration as a cause of action. If, for example, the franchisor brought about its own failure
by acting strategically, or caused it by failing to manage its finances prudently, it is possible
that franchisees may be prevented from claiming frustration.
appointed) [2004] VSC 477, who contemplated that only protection of a ‘particularly vulnerable’ party or a
party ‘at a substantial disadvantage’ may justify curial interference. In Meridian, the franchisor’s conduct
was not considered to be exploitative.
49
NC Seddon and M F Ellinghaus, Cheshire and Fifoot’s Law of Contract (8 Australian ed, 2002) 881.
th
50
D Khoury and YS Yamouni, Understanding Contract Law (7 ed, 2007) 419.
th
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Condition c. is met in almost all franchise agreements. Solutions proposed in chapter
6.2.2 would lead to franchisees being unable to access the remedy of frustration because all
franchise agreements would address franchisor failure.
Whether condition d. is met will depend on whose perspective is taken into account.
From the administrator’s perspective, it would be reasonable for the franchisee to be held to
the contract, whereas for the franchisee, it may be unjust.
It is suggested that an Australian franchisee could not successfully argue frustration
while the franchisor was under administration because the franchise agreement is between the
franchisor or its assigns (which includes the administrator) and the franchisee.
It is also possible that the sale of the franchise network by a liquidator to an unsuitable
buyer could frustrate the contract if Penrith District Rugby League Football Club Ltd v
Bradley Scott Fittler BC9600163 NSWSC is applied. In that case, competition under a new
league was found to be radically different from that contemplated by the contracts signed by
Bradley Fittler and Matthew Sing (‘the players’). A proposal to enter into new competitions
and to transfer club's assets to new competition licensee discharged parties from further
performance of contracts and the innocent party (in this case the players) were not
responsible for bringing about circumstances frustrating the contract. The contracts were held
to have been frustrated.
Frustration has not been raised in any Australian franchise cases. In Canada, a plaintiff
franchisee:
… sought rescission of its franchise agreement based upon fundamental breach. 51 It
also sought the return of the franchise fee, royalty fees and advertising fees paid to the
franchisor. In considering the issue of fundamental breach and the numerous alleged
breaches of the franchise agreement by the franchisor, the [British Columbia
Supreme] Court found that the franchisee had obtained substantially what it bargained
for under the franchise agreement, and accordingly found that there was no
fundamental breach of the agreement. 52
Goldman explains this particular decision stating:
Whether a fundamental breach argument has any chance of success is fact dependent.
The greater the benefit that the franchisee has already received from being part of the
franchised system, the less likely that the franchisor’s bankruptcy will be found to
have fundamentally breached the franchise agreement. 53
Unjust enrichment
Alternatively, franchisees could make out a claim in quasi-contract 54 against the
administrator or liquidator, for unjust enrichment. This action would theoretically be
51
Magnetic Marketing Ltd v Print Three Franchising Corp et al (1991) 38 CPR (3d) 540.
52
Steven H Goldman, Tackling Troublesome Insolvency Issues for Franchisees (2003) Unpublished 3-6
<http://www.goldmanrosen.com/pdf/franchiseesinsolvency1.pdf> at 29 April 2007, 11.
53
Ibid 12.
54
Bruce Moore (ed), The Australian Oxford Dictionary (2 ed, 2010) 479. ‘Quasi-contract (implied contract)
a form of the equitable remedy of restitution to restore an innocent party to his previous position.’
nd
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available to franchisees in Australia, though it has not been tested in the context of insolvency
in Australian courts. It depends firstly on the court granting consent to franchisees to embark
on litigation against the administrator or liquidator or against the directors or solvent related
entities of the failed franchisor.
The use of an unjust enrichment action could be considered by franchisees that recently
paid a franchise fee but derived very little benefit prior to the franchisor’s failure. The pool of
money available to the liquidator to pay creditors is artificially expanded by the franchise fee;
thus the liquidator is ‘unjustly enriched’. This was pleaded by a group of franchisees in
Ontario, Canada in one of the Country Style Food Services cases. 55 There, whilst the
franchisees did not act quickly or cohesively enough to succeed, the court did not rule out
unjust enrichment as a possible cause of action for future franchisor insolvency cases.
Both the action for frustration and the action for unjust enrichment may have the best
chance of success where the franchise term has only just begun, as the franchisee will have
paid all upfront costs but derived minimal benefit from the investment.
Anticipatory breach
Anticipatory breach
… occurs where a party, prior to the time for performance under the contract, evinces
an intention no longer to be bound by the contract. … [I]f the anticipatory breach
relates to a breach of an essential term or the repudiation goes to the root of the
contract, the promisee [in this case, franchisee] may terminate prior to the time for
actual performance.56
The alternative to repudiation relying on anticipatory breach is for the franchisee to
wait for the franchisor to fail to perform an obligation under the franchise agreement, and
then terminate for actual breach.
Consideration of anticipatory breach raises the issues of exactly what terms the
franchisor breached. Typically the franchisor has few contractual obligations, while the
franchisee has many. It can be difficult to identify an actual contract term on which to found
the claim of anticipatory breach following the appointment of an administrator.
Franchisees without the appropriate ipso facto termination trigger in their franchise
agreements have to decide whether to adopt the high-risk strategy of terminating their
agreements or remaining bound to the failed franchisor in a legal ‘holding pattern’. To pursue
any of the three responses to breach of contract by the franchisor outlined in chapter 3.2.8
55
Country Style Food Services Cases: Country Style Food Services Inc v 1304271 Ontario Ltd Ontario Superior
Court of Justice Chapnik J, Judgement: 11 February 2003; in the matter of the Companies Creditors
Arrangement Act, RSC 1985 C c-36, As amended AND In the matter of the Courts of Justice Act RSO 1990
c-43, As amended AND in the matter of a plan of compromise or arrangement of Country Style Food
Services Inc, Country Style Food Services Holdings Inc, Country Style Realty Limited, Melody Farms
Specialty Foods and Equipment Limited, Buns Master Bakery Systems Inc and Buns Master Bakery Realty
Inc 15 April 2002 Court of Appeal for Ontario Docket M28458 (Unreported decision).
56
Willmott et al, above n 13, 677.
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would tax an individual franchisee’s resources. Litigation would be best undertaken by a
group of franchisees.
CONTRACT AND QUASI-CONTRACT BASED REMEDIES
Franchisees’ access to remedies for breach of contract brought about by the failure of
the franchisor is hindered by a number of factors.
First, contract law remedies rely on the doctrine of privity of contract. The law
presumes that franchisees and franchisors have a contractual relationship with each other and
that this contract is the source of the breach. 57 This does not acknowledge the complex matrix
of contracts and entities that underpin the franchise relationship. The commitments that a
franchisee has under third party contracts are not contingent on the franchisors remaining
solvent. The franchisees cannot achieve this protection through negotiation as the franchisor
has often established the relationships and slotted the franchisees into them.
Second, Hadfield observes, limitations in effectiveness ‘when contract law is limited to
the awarding of damages, a remedy that may be inadequate to deter deliberate fraud and that
may be no deterrence at all against those who have no assets’. 58 Currently all remedies
accessed through the law of contract and the Competition and Consumer Act 2010 (Cth)
assume the supplier is able to deliver the prescribed solution, or that an insurer could meet a
claim. But, if the supplier is insolvent this assumption is fatally flawed.
Where the franchisor is insolvent, there is not enough money available to meet a
judgment debt to put the ‘innocent’ party back into their pre-contractual situation. The
problems are exacerbated when the number of franchisees affected by one franchisor
insolvency are counted; the ‘innocent parties’ may include as many as 600 franchisees, their
families and employees. Any litigated or mediated victory by the franchisees will be hollow.
Third, the powers given to administrators and liquidators under the Corporations Act
render franchisees’ consumer protection and contract law rights impotent. In Australia, any
litigation embarked on by any party other than an administrator needs to overcome the hurdle
posed by Corporations Act 2001 (Cth), section 440D which imposes a limited stay of
proceedings
(1) During the administration of a company, a proceeding in a court against the
company or in relation to any of its property cannot be begun or proceeded with,
except:
(a) with the administrator’s written consent; or
(b) with the leave of the Court and in accordance with such terms (if any) as the
Court imposes.
Nor are franchisees able to initiate proceedings without the consent of the court if a
liquidator is appointed. The second important power is that liquidators have a statutory right
57
The Franchising Code of Conduct requires the franchisor to make disclosure, but only requires limited
information about the other franchisor’s controlled entities that the franchisee must do business with.
Appendix D of this thesis graphically demonstrates the numerous possible relationships.
58
Gillian K Hadfield, ‘The Many Legal Institutions that Support Contractual Commitment’ in Claude Menard and
Mary Shirley (eds), Handbook of New Institutional Economics (2004) 175, 194.
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to disclaim onerous property. 59 There are several aspects of the franchisor/franchisee
situation that may give the liquidator cause to exercise this right. Franchise agreements
themselves are contracts that may be disclaimed by the franchisor’s liquidator as
unprofitable. 60 Head leases between franchisor and landlord might also be disclaimed,
possibly leaving the franchisee with no premises tenure.
CONTRACT-RELATED COMPLICATIONS
Consequential contracts
The execution of the franchise agreement also means that the franchisee is entering a
number of consequential contractual commitments. The franchisor:
serves as a nexus for contracting relationships and … is also characterized by the
existence of divisible residual claims on the assets and cash flows of the [franchisor]
which can generally be sold without permission of the other contracting individuals.
… emphasizing the essential contractual nature of [franchise networks] … [This]
focuses attention on a crucial set of questions – [including] and how [the contractual
relationships] are affected by changes exogenous to the organization.61
Consequential contracts in this context occupy three categories:
First: Contracts entered into with the franchisor; including such agreements as licences
to use intellectual property, software and premises, and various finance arrangements. 62
Second: Contracts entered into with third parties, related to the franchisor such as
supplier agreements concerning stock, licence to use intellectual property, lease of premises
and finance arrangements.
59
See Corporations Act Part 5.6, Division 7A - "Disclaimer of Onerous Property" and Michael Murray, Keay’s
Insolvency: Personal and Corporate Law and Practice (5th ed, 2005) 340. ‘In some cases liquidators do not wish
to retain property because it is too onerous, worth little or is unsalable. In such circumstances, liquidators wish
to get rid of the property in order to avoid responsibilities and costs in relation to it. In disclaiming, the
liquidator gives notice to others that he or she wishes to be rid of any interest in the property. If a person
suffers loss as a consequence, those persons to whom notice has been given are required to try to mitigate
their loss. They may lodge a proof of debt in the liquidation in respect of the amount of that loss. The
liquidator may disclaim property referred to in section 568(1) Corporations Act 2001 (Cth) (including) land
burdened with onerous covenants (for example a lease of retail space in the franchisor’s name that is licensed
to a franchisee as occupier with no status on the title and no privity of contact with the landlord) and contracts
).’
(including franchise agreements This procedure is also explained in Enviro Systems Renewable Resources v
Australian Securities & Investments Commission (2001) 80 SASR 1; 36 ACSR 762; 2001 WL 115336; [2001] SASC
11 by Martin J. ‘In essence, the documentation provides that Enviro (franchisor) offers participants
(franchisees) the right to use identified (property). Participants do not have a registrable interest in any of the
land. One parcel is leased by Enviro. The lease provides that if the lease is terminated as a consequence of
default by Enviro, the lessors are entitled to take possession of the land and trees planted on the land become
the absolute property of the lessors’. The same applies to a lease of a shop.
60
Corporations Act 2001 (Cth) Part 5.6 Div 7A. For example, Sue Mitchell, ‘Signature Out of Pulp But Not Out of
Juice’, The Australian Financial Review (Sydney), 1-2 April 2006, 10. ‘After disclaiming 17 leases on the lossmaking bars [ie. the leases of premises occupied by Pulp franchisees], the only assets the liquidators had
available to sell were ‘fridges, blenders and mixers’.
61
Jensen and Meckling, above n 9, 311.
62
Frazer and Weaven, Franchising Australia 2004, above n 63, found that 29 per cent of franchisors provide
finance to franchisees, with the most popular being direct finance supplied by the franchisor (59 per cent).
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Third: Contracts entered into with third parties unrelated to the franchisor such as
supplier contracts, vehicle leases, lease or licence of premises, equipment leases, loan
agreements – secured over real property or shares owned by the franchisee before it becomes
a franchisee and employment contracts with the franchisee’s employees.
All of the contracts in the three categories above are executory.
Pending assumption or rejection [by the liquidator] the debtor [here, franchisor] is
technically not required to perform the obligations under the executory contract,
whereas the non-debtor party [here, the franchisee] is still required to perform. 63
Typically, all consequential contracts assume the franchisor will remain solvent. The
franchisee’s situation under any of the above consequential contracts will also be impacted by
the franchisor’s failure.
International dimensions of franchise agreements
Franchise relationships and agreements often contain international dimensions.
International law may have an impact on the jurisdiction and forum in which a franchise
agreement is judged. Importantly, cross border insolvency issues may become relevant to
domestic franchisees by virtue of the franchisor, the parent company, the owner of trade
marks or the franchisor’s financier being outside Australia.
When the franchisor/ franchisee relationship is placed in jeopardy through the
appointment of an administrator or liquidator to the franchisor, the franchise agreement is the
first place an administrator or liquidator looks to determine what responsibilities the
franchisor has and what rights its franchisees have. At that point it is too late for the
franchisor and franchisee to negotiate a change in the terms of the franchise agreement. It is
thus important to understand whether franchise agreements, as a genre, can realistically be
expected to contain provisions relating to franchisor failure.
Private law does matter to those who can use it effectively, for example businesses that
incorporate judicial rulings in standard terms or that seek judicial [or regulator] 64 rulings as a
framework for structuring their business methods. Consumers have rarely been able to
harness private law to have such systemic effects. 65
Private contract law is, however, unable to provide solutions to the problem. ‘The
franchise situation is a classic example of an unresolved treatment of contracts. Executory
contracts, of which franchise agreements are an example, are not specifically considered in
the UNCITRAL Legislative Guide on Insolvency Law’. 66 Rohrbacher explains that ‘the
63
Tractenberg, above n 4, end note 22–5.
64
For example Bakers Delight’s successful application under Trade Practices Act 1974 (Cth) s 47.
65
Iain Ramsay, ‘Consumer Law, Regulatory Capitalism and the ‘New Learning’ in Regulation’ (2006) 28(1)
Sydney Law Review, 9, 33.
66
United Nations Commission on International Trade Law, UNCITRAL Legislative Guide on Insolvency Law
(2004) <http://www.uncitral.org/uncitral/en/uncitral_texts/insolvency/2004Guide.html> at 5 June 2010.
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troublesome issue in executory contracts is not that property and contracts are treated so
differently but that debtors and creditors are treated so differently’. 67
The [franchisor] is a legal fiction which serves as a focus for a complex process in
which the conflicting objectives of individuals (some of whom may ‘represent’ other
organizations) are brought into equilibrium within a framework of contractual
relations. In this sense the ‘behaviour’ of the firm [the franchisor] is like the
behaviour of a market, that is, the outcome of a complex equilibrium process. 68
The insolvency of the nexus triggers a move to a new equilibrium in which the
administrator, and then the liquidator, controls the destiny of the franchisees through the twin
mechanisms of the franchise agreement and the Corporations Act.
The justifications for a contract not to be comprehensive in its terms - that it is
relational, too expensive to include all possible future contingencies, that the franchise
agreement needs to be standardised for ease of administration - do not support the omission
of terms about franchisor failure; an event whose possibility is real, and whose consequences
can be devastating for the franchisee consumer. It can be concluded that relational contracts
are not well equipped to deal with franchisor failure as the event that triggers a need to
renegotiate, franchisor failure, also signals the end of the relationship between the franchisor
and its franchisees.
Woker observes that ‘the law of contract is wholly inadequate for the purpose of
regulating modern franchise relationships and practices’. 69 The report ‘Opportunity not
opportunism’ acknowledged that the current contractual arrangements between franchisor
and franchisee are not satisfactory and recommended ‘that the government explore avenues to
better balance the rights and liabilities of franchisees and franchisors in the event of
franchisor failure’. 70 I submit that providing rights for franchisees whose franchisor fails is
one area that would benefit greatly from statutory interference.
The franchise agreement, in its current form, is unable to address franchisor failure
satisfactorily. As Thomas J wrote in relation to a distributorship agreement, ‘The sheer
commercial absurdity of this lopsided bargain prompts the question as to how it could have
come about. There is an explanation’. 71 In relation to franchisor failure, the explanation lies
partly in the franchise agreement and partly in economic and legal considerations’. 72
67
B Rohrbacher, ‘More Equal than Others: Defending Property-Contract Parity in Bankruptcy’ (2005) 114(5)
The Yale Law Journal 1099, 1128.
68
Jensen and Meckling, above n 9, 311.
69
Tanya Woker, ‘Franchising – The Need for Legislation’ (2005) 17 South African Mercantile Law Journal 49.
70
Joint Committee on Corporations and Financial Services, Australian Senate, Opportunity Not Opportunism:
Improving Conduct in Australian Franchising, above n 166, Recommendation 4 [6.40] xv.
71
Bobux Marketing Limited v Raynor Marketing Limited [2001] NZCA 348, para 18 (Thomas J, dissenting).
72
PP 3 to 22 are quoted from my PhD dissertation Jennifer M Buchan Franchisor Failure: An Assessment of
the
Adequacy
of
Regulatory
Response
(August
1,
2010).
Available
at
SSRN:
http://ssrn.com/abstract=1746306 or http://dx.doi.org/10.2139/ssrn.1746306I where I also explore
asymmetry and other economic and legal considerations.
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As franchisors and landlords want, and need, flexibility and the freedom to evolve the ir
businesses, they should be prepared to accept some limitations on their ability to over reach
in relation to their most vulnerable and most committed (in terms of sunk costs invested by
franchisees and tenants) contracting arrangements.
1. What are the main problems experienced by users of Australian contract law?
Which drivers of reform are the most important for contract law?
Are there any other drivers of reform that should be considered?
Harmonisation of contract law with insolvency law in the field of executory/ relational
contracts. Neither consumer protection, nor contract law nor insolvency are isolated concepts.
UNCITRAL recognises the need to look beyond the boundaries of each legislative silo when
addressing problems that cross boundaries. It:
raises [the challenge of] the relationship between insolvency and other law. [It]
recommends that ‘‘the relationship between insolvency law and other laws should be
clear and, where possible, references to the other laws should be included in the
insolvency law. 73
UNCITRAL has raised an important issue.
2. What costs, difficulties, inefficiencies or lost opportunities do businesses
experience as a result of the domestic operation of Australian contract law?
The GFC slowed the net growth in the franchise sector with a decline of 7 % of
franchise systems and 2 % of franchise units reported from 2008 to 2010. In the two year
period to 2010, 56 franchise systems ceased operating and 88 ceased franchising. 74 This
affected between 2,200 and 5,700 small businesses operating as franchisees and put at risk
up to =$1,584,000,000 worth of franchisee investments. 75 Part of this cost can be attributed
to the fact that executory contracts (which franchise agreements are) do not give the solvent
party any particular rights in the insolvency process. This loss is an economic externality that
deserves to be addressed so that public and investor confidence in the franchise model
remains strong.
3. How can Australian contract law better meet the emerging needs of the digital
economy? In what circumstances should online terms and conditions be given
effect?
73
UNICITRAL, Legislative Guide on Insolvency Law (2005) 19
.
<http://www.uncitral.org/pdf/english/texts/insolven/05-80722_Ebook.pdf> at 15 December 2009
74
75
Frazer L., Weaven S. & Bodey, K. Franchising Australia 2010 (2010), Asia-Pacific Centre for Franchising Excellence, Griffith
University.
Calculated using known totals and averages 56+88x40x$275,000=$1,584,000,000.
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4. To what extent do businesses experience costs, difficulties, inefficiencies or lost
opportunities as a result of differences between Australian and foreign contract
law?
See my answer to 2 above (p20) as many franchisors trade internationally and many
have their trademarks registered offshore. 76
5. What are the costs and benefits of internationalising Australian contract law?
It is important to provide local dispute resolution mechanisms so that parties to contracts, eg
Subway franchisees, never have to go to Connecticut to resolve contract disputes.
6. Which reform options (restatement, simplification or substantial reform of
contract law) would be preferable? What benefits and costs would result from
each?
7. How should any reform of contract law be implemented?
National, no exceptions, possibly include New Zealand. We should make it easier for
businesses to do business Australia-wide and to understand the law of contract.
8. What next steps should be conducted? Who should be involved?
As representatives on Law Society committees (those who are typically asked to comment on
proposed law) tend to be drawn from the larger firms – who represent parties with a strong
interest in the status quo, in the current certainty, I suggest involvement of people with
experience of the weaker parties to commercial contracts, maybe suburban solicitors, and
mediators of contract disputes, in any ongoing review process.
Yours faithfully
Jenny Buchan,
PhD, LLM, LLB
76
See Buchan, Jenny M., Franchisors' Registered Trade Marks under Australia's Trade Marks Act 1995 (Cth)
(June 1, 2008). 22nd Annual International Society of Franchising Conference, St. Malo, France; UNSW
Australian School of Business Research Paper No. 2009 BLAT 04. Available at SSRN:
http://ssrn.com/abstract=1334466 or http://dx.doi.org/10.2139/ssrn.1334466
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