Recent Trends in Franchise Relationship Laws

8. Other Considerations

8.1 Industry-Specific Legislation

In addition to specific franchise relationship laws, several North American jurisdictions have enacted industry-specific legislation that governs franchisor relationships in product distribution franchises within specific industries.  While varying depending on the jurisdiction, these statutes generally require good faith in performing the agreement, good cause for termination or failure to renew, buy-back protection, enhanced transfer and assignment rights, disclosure, and protection from discrimination.  A detailed analysis of these industry-specific statutes is beyond the scope of this paper; the following, however, is a non-exhaustive overview of this mostly North American trend.

By way of example only, in New Jersey, the motor vehicle section of the Franchise Practices Act[45] recently underwent major amendment.  These amendments, which became law on May 4, 2011, target motor vehicle franchise abuse stemming largely from the recent insolvencies of the number 1 and 3 car factories in North America.  Broadly stated, the amendments:

• expand the list of prohibited practices;
• clarify the manufacturer’s obligation to repurchase inventory on termination or cancellation;
• create minimum warranty reimbursement rates;
• introduce automatic injunctive relief against termination; and
• modify dealer protest rights and procedures.

To expand, the newly created prohibited practices include such things as:

• prohibiting discrimination between dealers based on price, allocation, and product availability;
• limiting the ability of a manufacturer to impose conditions on the transfer of a franchise; and
• limiting the ability of a manufacturer to amend or modify the franchise agreement except in good faith and for good cause, and where such a modification would not substantially alter the rights, obligation, investment, or return on investment of the franchisee.

Further, the amendments to section 13 clarify a manufacture’s obligations to repurchase inventory from a franchisee upon termination and make it a violation for a manufacturer to terminate a franchise (without proper compensation) due to the discontinuation of a line.  The new warranty provisions now require minimum warranty parts reimbursement rates for recreation motor vehicle franchisees.   With respect to injunctive relief, the amended statute now includes a section providing for an automatic injunction against a termination when there is the timely institution of an action or alternative dispute resolution proceedings based on an allegation that the termination violates the act.  Further, the amendments broaden the ability of an existing dealer to protest a manufacturer’s appointment of an intra-brand competitor within a “relevant market area.”  The “relevant market area” has been expanded to include all dealers within 14 miles of the proposed new dealer site.  The “relevant market area” for relocations, however, remains unchanged.  Lastly, the amendments to the protest provisions limit the right of a manufacturer to reopen or reactivate a closed franchise.  Section 20 now not only incorporates restrictions based on time and mileage, but also precludes an assignee of, or successor to, a franchisor from exercising such rights at all.

 Also notable, are two new laws in both Alabama and Texas.  Specifically, Alabama has recently approved a new law that regulates the relationships between recreational vehicle manufacturers and dealers.  Bill HB341, which became law on October 1, 2011, provides buy-back protection, warranty reimbursement, and provisions for dealership transfers.  Similarly, the State of Texas has recently amended its boat dealers law.  Bill HB 1960, which became law on September 1, 2011, covers issues such as dealer territory, warranty work, and performance standards.  The amendments also eliminate the good cause for termination requirement and replace it with a prohibition on termination absent dealer default.  Various other states have enacted industry-specific statutes affecting heavy equipment, petroleum or motor fuel franchises, service stations, agricultural equipment, insurance, watercraft and outboard motors, and trailers.

While industry-specific legislation is primarily seen as a U.S. trend, in Canada several Provinces have had long standing farm implements legislation, recently updated, and offering limited protection to farmers who purchase farm implements from dealers, and limited protection to those dealers in relation to their suppliers.  Saskatchewan’s Agricultural Implements Act,[46] for example, is fairly typical of this type of legislation.  Essentially, SAIA’s dealer protection component permits either the dealer or its supplier/manufacturer to require the supplier to repurchase unused machinery, implements, and marketing materials where the agreement is terminated for any reason.  Ontario’s Farm Implements Act[47] similarly offers dealers buy-back protection, as well as renewal and transfer rights and protection from exclusivity clauses and unfair or unreasonable sales targets.  The OFIA also creates an alternative dispute resolution process to resolve, among other things, certain types of disputes between a dealer and its supplier or a manufacturer.  The Alberta Farm Implements Act[48] also offers dealers substantially the same buy-back protection as does the SAIA and the OFIA, but in addition allows either the dealer or the distributor to apply to the Farm Implements Board for compensation out of the Farm Implement Compensation Fund for any loss arising from the other’s breach of FIA.  In 2001, Alberta also enacted the Farm Implement Dealerships Act[49] which requires a distributor to have cause to terminate a dealership agreement and prohibits discrimination among dealers.

8.2 Self-Regulation

Numerous country specific and one regional franchise association have adopted franchise codes of conduct designed to govern their franchise members during the franchise relationship as a condition of association membership.[50]  For example, franchise groups such as the World Franchise Council (“WFC”) and the International Franchise Association (“IFA”) have included codes of ethics as part of their self-regulation programs.  The WFC’s Principles of Ethics, for instance, are based on the common principles and experiences of its member countries[51] and describe “good professional conduct” amongst the actors in franchising.[52]  Similarly, the IFA Code of Ethics establishes a framework for the implementation of best practice in the franchise relationship.  It represents the “ideals to which all IFA members agree to subscribe in their franchise relationship.”[53]  The IFA’s self-regulation program goes even further and includes an Ombudsman to help identify, facilitate, and encourage the early resolution of disputes that arise.

In practical terms, these codes are useful tools for both franchisor and franchisee but are not intended to address every issue.   Like most self-regulation models these codes are not a substitute for regulation and have no force of law, but rather provide recommendations and guidelines for how best to resolve disputes.  The voluntary nature of these codes also renders them largely ineffective as their application is limited to members and the worst consequence for violation is likely expulsion and, possibly, breach of contract claims.  That said, when a dispute arises, it will be important to review these codes as they may ultimately influence a court’s decision-making process as evidence of custom and usage and courts may even impute code obligations into the contract under review.

8.3 The Commissioner Model

In a very recent development, both South Australia (“SA”) and Western Australia (“WA”) have State Bills at advanced stages of the legislative approval process.  The SA bill is anticipated to become law in late 2011 and the WA bill is at the Committee stage of the approval process.  Both the WA and SA franchising bills are intended to strengthen the existing regulatory framework and provide enhanced protection for franchisees.  The bills empower the Small Business Commissioner to investigate, prosecute, and impose fines for any breach of a number of codes including the Franchising Code of Conduct.  If passed, the bills will also impose a general duty to deal fairly and in good faith.  The debate on the issue is no different: opponents of the bills fear the new law will bring down the franchising sector and result in the end of freedom of contract.  Proponents, on the other hand, believe the laws will create a level playing field and allow franchisees to protect their rights and interests.  If passed, the bills will herald more support for the shift to relationship laws in franchise regulation.

9. Conclusions and Lessons Learned

While the franchise model continues to be a successful vehicle for business investment, it brings with it many relationship challenges.  As already discussed, franchise agreements are contracts of adhesion and as such statutory intervention is necessary to mitigate and alleviate the power imbalance that exists between franchisors and franchisees.  Many jurisdictions have already come to realize this need and have taken ownership of ensuring some level of protection for franchisees who are often small business people without the resources or sophistication to effectively challenge franchisor opportunism.   One of the first attempts to level the playing field was through the use of mandatory disclosure requirements.  While important, as time progressed and some franchisors continued to behave opportunistically, it became obvious that disclosure laws alone were inadequate in protecting franchisees throughout the ongoing business relationship.  As a result, many jurisdictions introduced relationship laws aimed at regulating the core of the franchise model, that is, the contract.  These laws, unlike disclosure laws, override certain contractual provisions by mandating standards of conduct and circumscribing certain franchisor rights.

Given the growth and penetration of the franchise business model, in mature as well as emerging markets, there is little doubt that opportunistic behaviour will be restrained by increasing amounts of both pre and post sale regulation.  One could hope that with increased regulation it would follow in principle, if not in form, some uniformity across borders.  In furtherance of that objective, it might be worth it for UNCITRAL or perhaps a committee of this group to draft a principled and balanced model regulatory guide for jurisdictions seeking, as they will do, to regulate this dynamic industry. [54]

So what can we conclude going forward?  First, franchise laws with relationship requirements already exist in a number of countries, many of which are “top priority markets” for international franchisors.  These laws will likely expand into other countries.  Franchisors should take note.  Second, while specific “franchise relationship only” laws are confined to a few jurisdictions, there are other bodies of law that will affect the franchise relationship, and franchisors will be well advised to take those into account in preparing their franchise agreements.  Lastly, it should be emphasized that franchise relationship laws by-and-large do not impose requirements that are so burdensome they would deter a franchisor from entering into franchise agreements.  Thus, while certain structuring techniques, such as, off-shore structuring, bifurcating agreements, etc. may be useful in overcoming certain regulatory hurdles, the authors do not believe that franchisors in most cases need to, or should, use these techniques to try to circumvent the franchise relationship laws.  Complying with these laws in most instances is not difficult, and alternative structures may impair a franchisor’s ability to enforce its rights in the future.