Steve Wright | Advisor | FTI Consulting

The Balance of Power

The Royal Commission into the banking sector is about to get underway – and its twists and turns may provide some pointers for small businesses, particularly those in franchised and licensed businesses.

It may at first seem a conceptual stretch to make this link, but there are some interesting analogies in key themes likely to be explored in the Royal Commission this year and those which may unfold in franchising/licensing, especially those in the retail sector.

An article in the Australian Financial Review in December highlighted one of the key themes: the reversal of the onus of proof; and the cost of remedying what may well be someone else’s mistakes - or deliberate misdeeds.

The article, by respected former Commonwealth Bank CEO David Murray, described the potentially very negative consequences of the bank Royal Commission, giving rise to proposals which prompted a move away from ‘caveat emptor’ to ‘caveat vendor’.

Those who have watched the progress of the Fair Work Act amendments relating to employee payment obligations will no doubt be aware that this ‘drift from caveat emptor to caveat vendor’ is exactly what has happened in the franchising/licensing sector.

Among other hair-raising aspects of the FWA amendments, entitled ‘Protecting Vulnerable Workers’, the onus of proof has been reversed to mean that brand owners may be held responsible for misdeeds by their franchisees/licensees.

In other words, if a franchisor knows that a franchisee has failed to pay an employee properly and fails to address the situation, then the franchisor may be held liable as well as the franchisee.

In the banking context, the analogy is that if a bank knowingly sells a product or advice which turns out to work against the interest of the customer, who for instance goes broke, then the bank may be held accountable under law.

It is not hard to see how this could frighten bank managers and shareholders. It is a big move to shift the onus of proof fall on to the bank to prove that it did all it could to sell the right product/service and that the ultimate financial failure was indeed the fault of the customer.

However, there is not a lot of love for banks in the community – including small business.

As business commentator Jennifer Hewett said: “Given the perceived imbalance of power between a borrower and a bank, there’s certainly a community expectation that individuals will be treated fairly and their own interests treated as paramount.” This is a very good point – and has been a key theme underpinning franchise-specific regulation, since it emerged through the Franchising Code of Conduct 20 years ago.

The Code’s provisions covering initial and ongoing information disclosure and ‘good faith’ negotiation are aimed at ensuring parties enter agreements with their eyes wide open and that there is no attempt to exploit the “perceived imbalance of power”. Unfortunately, as with bank contract disclaimers, franchise agreement disclosure documents can be long and impenetrable for a potential franchisee.

A constructive way the Code has been amended over the years has been a requirement for a franchisor to include a ‘plain English’ summary of the main risks associated with entering a franchise agreement.

A good franchise will have an easy-to-read informative document of this type, which actually gives sound advice on what to do before signing an agreement.

Navigate the Maze

Another very positive aspect of the way the Code works in practice is found in its unique and highly effective provisions mandating complaint handling including timely dispute resolution able to be completed at a fraction of the cost of a legal argument.

These are all positive measures which are simply not available for business agreements in the non-franchised world. They have been introduced to provide protection to potential franchisees, just as the FWO amendments aim to provide protection of vulnerable workers.

The question is at what cost, and who is to pay? This was the precise theme of my article in this magazine a little over a year ago: ‘Raising the bar for franchisor responsibility – but at what cost?”

In the banking Royal Commission context, the question is posed as to what affect would the onus of proof reversal have on bank advice and lending practices. Would it cause them to withdraw from risk, resulting in a sharp cutback in lending? Perhaps there may be a jump in the price of lending, through higher fees and/or interest rates?

Many entrepreneurs and potential small business owners already complain that it is often very difficult to convince a bank to take the risk and back a new business borrowing proposal. Many complain that interest rates are already marked up too much for small business risk compared to that applied to other segments of the economy.

Again, franchising has an edge over the broader small business market. A potential franchisee has a much better prospect of getting lending approval if he or she is applying to join a successful franchise network.

Some of the bigger, more established franchises have an ‘accreditation’ status with a lender or panel of lenders. This can help new franchisees get access to funds, usually with comfort they are doing so at competitive rates. But in the instance of a market wide credit crunch, everyone is affected.

So, in the banking context, is the reversal of onus of truth something which would hurt banks and business? If Mr Murray is right, and it would have “profound” implications, then it is safe to assume that small business would be the first to feel the repercussions. In the franchising context, the ‘at what cost’ question is all too easily – and painfully -- answered for 7-Eleven, the first network to be targeted by the Fair Work Ombudsman for franchisee employee underpayment.

To its significant credit, 7-Eleven has paid out more than $150 million in franchisee underpayments; and trusts that the integrity of its position, diligent franchisee communication, bearing all responsibility and paying out all claims will carry it through. To its chagrin though, what 7-Eleven has learned is that not even the money it has spent and the improvements it has made can guarantee that opportunists within a franchising network will not try to rort the system.

The brand has also spent millions to ensure it has the systems to properly execute a centrally-controlled franchisee employee payment system.

Most franchise networks can’t afford this kind of remedy, but for the bigger brands, a new standard of franchisee service delivery has been established – one which protects the brand owner.

This is a very serious issue not just for franchisors, but for franchisees as well. Not every franchise network is able to absorb the shock and the cost of a situation like this, there is an impact on all elements of the network.

Could the franchise community have dealt with things differently? There is a possible answer to that question.

Dominos, Pizza Hut and Caltex are three of the other biggest names to be targeted by FWO Natalie James. Each has dealt with issues in different ways, but there is no missing the decisiveness of the Caltex headquarters.

Perhaps seeing the pain of 7-Eleven, and wishing to avoid as much of it as possible, Caltex acted swiftly to purge the system. According to the most recent media report, it has axed as many as 49 franchisees (who owned more than 100 sites) following an audit of franchisee payment records.

The reason it has been able to do this so decisively is that the specific regulatory code set up for petrol retailing – the Oil Code – gives brand owners much greater opportunity to terminate franchisees who break the rules.

That is why 7-Eleven has conducted a campaign to have the Franchising Code changed. Imposing an accountability on franchisors and reversing the onus of proof is a serious double whammy. To then compound it by lack of availability of serious sanction is very hard to swallow for franchisors with long experience in the franchise sector. To avoid expulsion from the network, an offending franchisee need only redress the fault, according to the requirements of the Franchising Code of Conduct. This process can be repeated over and again, without penalty.

A year ago, I flagged these issues - the willingness of some to feed the crocodile in the hope that it would leave eating them till last has meant that the political opportunity to have the issues debated publicly is probably past for the near future – certainly the term of this Parliament.

And given that Labor moved the Fair Work Act amendments which resulted in the onus of proof reversal, if there is a change of Government at the next election, there is very little prospect of change in the next Parliamentary term.

What will be the cost? It is hard to estimate, but it’s a good bet that it is going to continue to rise.

Steve Wright is known for his depth of experience in corporate and investor relations, industry representation and financial market activity. A former CEO and company director, he has represented small and large international companies including five years as Executive Director of the Franchise Council of Australia.

Steve Wright was Acting Chief Executive of the Retail Council, the voice of Australia’s top retailers until early 2017 and is now a Senior Director and Advisor at international firm FTI Consulting.

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