When franchisees go rogue

Claims to state and federal inquiries into franchising in 2008 and 2010 that rogue behaviour by franchisors was widespread have not been supported by the small number of prosecutions achieved by the franchise regulator (the ACCC) over the years.

This doesn’t necessarily mean that all franchisors are angels, but it does rebut an extremist argument at the time that franchisors were crooks determined to send their franchisees broke, and that franchising itself was fundamentally broken.

Since those inquiries, there have been changes to the Franchising Code of Conduct in 2010 and again at the commencement of this year, which have further regulated the behaviour of franchisors toward their franchisees.

Of particular note is the obligation to act in good faith, which unlike all bar one other obligation under the code actually applies to franchisees as well as franchisors.

In an environment where the behaviour of franchisors toward franchisees is highly regulated, to what extent does the obligation to act in good faith require franchisees to improve their behaviour toward franchisors?

In the wake of the 7-Eleven wage fraud scandal whereby individual franchisees deliberately underpaid and intimidated their employees, it could be argued that the franchisees failed to act in good faith to their franchisor given the consequences of their actions.

7-Eleven is paying the cost for the sins of its franchisees, and without any legal liability to do so, has agreed to repay wages and interest to any worker shortchanged by their franchisee which could cost the chain millions.

This is a prime example where the failure of franchisees to meet their own statutory obligations to pay proper wages and entitlements has caused harm to the brand and to the franchisor.

It could even be described as the behaviour of rogue franchisees and it is not the only kind of rogue behaviour demonstrated by franchisees.

Failing to maintain other kinds of statutory obligations is also an example of rogue behaviour, which endangers the business of the franchisee, and the brand integrity and reputation of the franchisor.

Other statutory obligations, such as the requirement to pay tax, hold or renew licences necessary for the business to trade, etc, could easily cause problems for a franchisor and a brand if franchisees deliberately (or otherwise) fail to fulfil their obligations.

So while franchisors invest considerable time and energy to check that their franchisees comply with the franchise system itself, the media coverage of 7-Eleven has shown how important it is for franchisors to also check that franchisees are maintaining their statutory obligations.

This is generally a condition of the franchise agreement in any event, but one that is often managed by exception when non-compliance is detected, rather than as part of a proactive audit by the franchisor.

Another type of rogue behaviour by franchisees is the diversion of capital and labour away from their franchise businesses.

Whereas failing to comply with statutory requirements and the minimum standards outlined in the franchise agreement and/or operations manual may be fairly black and white, the diversion of labour and capital away from the franchise business may not be seen by the franchisee as rogue behaviour.

Yet in reality, when a franchisee ceases to give their business their full time attention and allocation of capital resources, the business usually suffers.

So why do franchisees divert their capital and resources elsewhere? Often it is due to a feeling that they have “conquered” their franchise, and they are now looking for another challenge (while still keeping the franchise as the cash cow that pays for their next venture).

In any event, when franchisees start getting involved in businesses other than their franchise, or start committing large amounts of their working time to activities other than their franchise, the franchise can be expected to suffer, which has a knock-on effect to the franchisor and the brand.

For example, if a franchisee becomes involved in, say real estate development, the business will provide the cash flow to support the development, but if the costs exceed expectation, then there will be insufficient capital left in the business for necessary reinvestment, such as a refurbishment at the end of a lease.

The future of the business is now compromised, and any further difficulties with the franchisee’s external activities will put the business under further pressure, and possibly send it bust.

So if a franchisor wants to protect themselves and their brand from rogue franchisee behaviour, they should vigorously monitor system compliance, monitor the franchisees’ compliance with their statutory obligations, and also monitor any diversion of the franchisee’s labour and capital to activities outside the business.

Jason Gehrke is the director of the Franchise Advisory Centreand has been involved in franchising for more than 20 years at franchisee, franchisor and advisor level.

He advises both potential and existing franchisors and franchisees, and conducts franchise education programs throughout Australia, and publishes Franchise News & Events, a fortnightly email news bulletin on franchising issues and trends.