Exclusive Q&A on Franchise Law with Stewart Germann
What is the effect of competition law rules on franchising agreements?
Competition is encouraged in New Zealand and in relation to competition law the Commerce Act 1986 must be complied with. It is concerned with anti-competitive behaviour and restrictive trade practices. The Commerce (Cartels and other Matters) Amendment Bill currently before Parliament and expected to pass into law in 2017 introduces a new cartel prohibition that would replace existing price-fixing prohibitions of the Commerce Act. These prohibitions will apply to cartels comprising competitors and as a general rule franchise relationships should not be caught. However, it could be argued that franchisees within a particular franchise system would be competitors and entering into franchise agreements with a franchisor may make them parties to a cartel provision (which may divide a market and regulate prices, for example). In that event, it is likely that a "collaborative activity" exemption in the Bill will apply that would provide an exemption to a cartel provision in an arrangement where it is an enterprise "carried out by two or more people in trade and is not carried on for the dominant purpose of lessening competition between any two or more of the parties". There are also exemptions for collaborative marketing and promotions. The new Act could have significant repercussions for franchising, especially in the areas of fixing prices, restricting output and allocating markets. It is important to note that there will not be a cartel arrangement in place where parties are not in competition with each other. In most franchise systems the franchisor will not be in competition with their own franchisees but that is not always the case. For example, a franchisor which owns its own outlet might be found to be in competition with franchisees. Similarly, where a franchisor sells online direct to end consumers, yet at the same time has franchisees who sell to those consumers, it may also be in competition with its franchisees. There may also be instances where the franchisees are in competition with each other. Where a franchisor is in competition with a franchisee or where franchisees are found to be in competition with each other, there will be a competitive relationship so the franchisor needs to be cognisant that there may be provisions in its franchise agreements that amount to cartel provisions.
What steps should be taken when evaluating a franchise?
When you are considering entering into a particular franchise you must do thorough due diligence which will include obtaining accounting and legal advice. You should also check whether the franchise system is a member of the Franchise Association of New Zealand (FANZ). If it is, then it must comply with the Code of Practice and Code of Ethics published by the FANZ. If it is not (and there is no compulsion to join the FANZ) then it may or may not agree to comply with both Codes.
When evaluating a franchise you should consider the following matters:
- Full particulars of directors of the franchisor company and its track record.
- Description of the franchise.
- Initial investment required and quantum of all fees payable.
- Number of existing franchisees and number of franchisees who have been terminated.
- Training and support.
- Territorial practices and exclusivity terms.
- Realistic profit levels.
- Trade marks/logos and steps taken to protect them.
- Terms and conditions for purchase of goods or services, fixtures or property from the franchisor.
- Terms and conditions relating to termination, renewal, goodwill and assignment.
It is essential that you talk to a number of existing franchisees to ascertain whether there is good support from the franchisor, whether the training was adequate and any current problems. Your accountant will do financial projections which are essential in relation to profitability of the outlet and your lawyer will look carefully at the franchise agreement which will cover your right to sell or transfer ownership of the franchise, geographical area and types of customers, nature and extent of your obligations to the franchisor including buying supplies and services, right to renew or extend the agreement beyond the original term, terms and conditions under which the agreement could be terminated by the franchisor and a description of training and support which the franchisor must provide.
You should ascertain from the franchisor what the financial health and history of the company is, the long term viability of the products/services and whether there have been any problems and the track record of disputes. For example, if a franchisor has been involved in 3 mediations within 3 years that is a bad trend and suggests either an unhappy system or a poor choice of franchisees. You must trust the directors of the franchisor so if there is undue pressure put on a franchisee during the due diligence stage to hurry up the process then that does not augur well in my opinion. Also, if the franchisor provides no data on track record or financial strength, cannot get plans for future development, is ignorant of competition, is vague about support and training and is evasive about access to existing franchisees, then they are all negatives which would impact on your final decision.
What should be included in a well-drafted franchise agreement?
The franchise agreement is a robust and complex legal agreement. If the franchise has been trading for some time the agreement will not be changed. It is essential for both parties to receive expert franchising advice from franchising lawyers experienced in the area. The clauses which are in franchise agreements vary considerably but the agreement must include the grant of franchise, whether the territory is exclusive or non‑exclusive, all of the fees payable to the franchisor including the up-front franchise fee, royalties, national marketing, local marketing, renewal fee and transfer fee, it will list all of the obligations of the franchisee which include promoting the business, not prejudicing the intellectual property of the franchisor, undergoing the training and passing the course, complying with minimum performance criteria, appointing a designated manager, maintaining insurance, operating the business in accordance with the manuals, maintaining secrecy and confidentiality, customer database, customer complaints, paying trade creditors, complying with all health and safety laws, complying with the IT system, not conducting any other businesses which will sidetrack the franchisee, entering into a lease or sublease of the premises, attending meetings and conferences, having sufficient working capital and complying with the obligation of good faith (if applicable).
The franchise agreement will contain obligations of the franchisor which should include providing a robust system and updating it, protecting the intellectual property including the trade marks and brand, providing initial and ongoing training, providing marketing advice, loaning the manuals to franchisees and updating the manuals from time to time, assisting with the premises and fit-out, referral of new business, promoting good relations between all franchisees and other obligations. The agreement will also contain provisions to allow a franchisee to sell or transfer the business in the future subject to strict criteria, it will stipulate the events of termination, what happens after termination, restraint on competition, compliance with legislation, whether there are rights of renewal and how they have to be exercised, whether a franchise advisory council is to be set up, operating a website and monitoring social media. It is important that the agreement contains a governing law provision and provides for dispute resolution where the usual mechanism in New Zealand is mediation. In relation to the lease of the premises, the agreement will often include clauses which a franchisee must ensure are included in the lease of premises from the landlord if the franchisee is going to take a lease direct from the landlord, and such clauses must allow the franchisor to step in and control the premises should the franchise agreement be terminated. I also require the solicitor for a franchisee to complete a solicitor's certificate which would confirm that the franchisee has read the agreement and understands it before executing it.
What are the main considerations following the termination of a franchise agreement?
A franchise agreement will be terminated either for default by a franchisee or upon the expiration of time. The franchise agreement must prescribe what is to happen upon termination of it. Immediately the franchisee must cease to operate the business and must cease to use the franchisor's name, trade marks and intellectual property. The franchisee must return any manuals, electronic stored data, software, customer templates, customer files and any other documents together with all signage, colour schemes and other features associated with the business. If there are branded products on hand they cannot be used and must be returned to the franchisor who will usually pay a fair price for them. The franchisee must execute any documents as may be necessary including transferring the telephone numbers and directory listings and assigning and transferring all e-mail addresses, domain names, Facebook pages, Twitter accounts, internet listings and internet accounts relating to the business. Any public record or entry indicating association with the franchisor must be changed and the franchisee cannot use the trade marks and name in the future. In relation to assets of the business, the franchisee may be entitled to sell all or part of them to the franchisor at a price to be agreed between the parties or, failing agreement, at a price to be settled by an independent chartered accountant. Confidentiality, intellectual property and restraint on competition covenants by the franchisee will survive a termination and must be enforceable following termination.
How are franchising disputes typically resolved? What are the best alternatives to litigation?
Franchising disputes are typically resolved by either mediation or arbitration. The Franchise Association of New Zealand sets out a dispute resolution procedure in its Code of Practice and the relevant provision is as follows:
"Subject to subclause (9), unless a party has complied with the following subclauses (1) to (8) that party may not commence court proceedings or arbitration relating to any dispute with any other party to this Agreement.
(1) Where a dispute arises between the Franchisor and the Franchisee (“the parties”), the complainant will set out in writing the nature of the dispute.
(2) Both parties will make every effort to resolve the dispute by mutual negotiation.
(3) In the event that the parties are unable to reach a resolution of the dispute within twenty one (21) days of the dispute first being raised by one party with the other, either party may by notice in writing (“the Mediation Notice”) notify the other party that it seeks to have the dispute resolved by mediation.
(4) If the parties have not agreed within ten (10) days of the issue of the Mediation Notice on the choice of a mediator then either of them may at any time apply to either the Chairperson or other proper officer of the Franchise Association of New Zealand Inc or to the Chairperson for the time being or other proper officer of the New Zealand Law Society to nominate a Mediator for the purpose of the dispute. Such Mediator may be (but is not required to be) chosen from any panel of mediators from time to time nominated for the purpose by the Franchise Association of New Zealand Inc.
(5) The proceedings of the Mediator will be as informal as is consistent with the proper conduct of the matter and shall allow the Mediator to communicate privately with the respective parties and their lawyers and the parties shall be entitled but not obliged to be legally represented. The Mediator may co-opt other expert assistance.
(6) In any mediation the following shall apply:
(a) everything that occurs before the Mediator will be in confidence and in closed session;
(b) all discussions will be on a “without prejudice” basis;
(c) no documents brought into existence specifically for the purpose of the mediation process shall be called into evidence in any subsequent litigation by either party;
(d) each party to the mediation shall be given proper opportunity to present its case;
(e) the Mediator shall be required to act fairly, in good faith and without bias for the purpose of seeking a resolution of the dispute and to treat all matters in confidence and to have regard to the fairness and reasonableness of all matters relating to the dispute including the need for the Franchisor to maintain the integrity of its name, image and the System and the reasonable interests of other franchisees and members of the System;
(f) the parties to the mediation and the Mediator shall co-operate with a view to the mediation being determined as speedily as possible and within fourteen (14) days after referral to the Mediator;
(g) the costs of the mediation will be borne by the parties equally unless otherwise agreed or determined by the Mediator and the parties shall grant immunity from liability to the Mediator;
(h) the parties to the mediation shall each report back to the Mediator within fourteen (14) days of the end of the mediation hearings on actions taken, based on the outcome of the mediation; and
(i) subject to the other provisions of this clause, the Mediator shall have the right to determine procedures relating to the conduct of the mediation.
(7) If the dispute is not resolved within forty five (45) days of referral to mediation any party which has complied with the provisions of this clause may by written notice terminate the dispute resolution process and may then commence Court proceedings and/or take any other action it sees fit relating to the dispute.
(8) The parties may by agreement in writing between them agree to extend any of the time periods referred to in the previous provisions of this clause and, if they do, the extended time periods shall apply and be binding on the parties in substitution for the relevant time period contained in this clause.
(9) Nothing contained in these provisions shall prevent a party from seeking injunctive relief from an appropriate Court, where failure to obtain such relief would cause irreparable damage to the party concerned or the franchise system. Further, these dispute resolution procedures will not apply to events giving rise to rights to the immediate termination of the franchise agreement where such events are clearly specified in the franchise agreement."
Most franchise agreements prescribe mediation but some require arbitration. Mediation is a voluntary process whereby the skills of the mediator are used to resolve a dispute. Mediation proceedings are conducted in private and are subject to confidentiality. Arbitration, which is also private, requires the arbitrator to make a decision which is binding upon the parties. Arbitration is meant to be less complex and less costly than litigation but I know of some arbitrations where the pre‑hearing procedures are complex and the costs have been considerable. If there is no arbitration clause in the franchise agreement then, if a mediation is unsuccessful, either party can institute litigation proceedings. Notwithstanding all of the above, a party is not prevented from seeking injunctive relief where failure to obtain such relief would cause irreparable damage to the party concerned or the franchise system.
What provisions are usually made in relation to intellectual property rights?
A key provision in a franchise agreement concerns intellectual property rights. It is essential to preserve the intellectual property rights of the franchisor which has invested time and money into securing those rights. While the franchise agreement is effective, the franchisee is licensed to use those intellectual property rights in operating the franchised business. The definition of intellectual property is important and can change considerably but a definition which I like is as follows:
"IntellectualPropertyincludes copyright, trade marks, trade, business and company names, domain names, design, trade secrets, know‑how, confidential and other proprietary rights, trade dress, get‑up, logos, symbols, insignia, emblems, telephone numbers, email addresses, websites, and anything published, circulated, transmitted or disseminated in any way on any social media by the franchisor and all other forms of intellectual property rights (and together with all rights to registration of such rights) whether created before or after the date of the agreement whether registered or unregistered, and whether existing in New Zealand or elsewhere which are or become owned by or available to the franchisor or which are adopted or designated now or at any time in the future by the franchisor for use in connection with or comprising any part of the system."
All intellectual property including trade marks is usually owned by an entity which is different from the franchisor. That other entity would enter into a licence agreement with the franchisor to use the trade marks and intellectual property; and then the franchisor enters into franchise agreements which include those intellectual property rights.
Stewart Germann Law Office (SGL) is New Zealand’s longest established specialist franchising law firm and Stewart is one of only two New Zealand lawyers included in the International Who's Who of Franchise Lawyers 2016.
SGL clients include many of New Zealand’s best known national and international franchise brands and Stewart has extensive franchising contacts worldwide and locally. He is actively involved in international franchising and has written many articles which have been published overseas including in the International Journal of Franchising Law.
Stewart can be contacted on +64 9 308 9925 or by email at stewart@germann.co.nz
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