The Franchise Law Review: Franchisees as Consumers
Today, more than 12,000 franchise systems with more than 800,000 franchisees exist worldwide.2 In some jurisdictions, expanding business operations by way of franchising is a well-established model for facilitating growth, whereas in others it is a pretty modern way for companies to tap into new markets. It is often new for franchisees too. Franchising, therefore, comes with certain risks for franchisees. They might be inexperienced, uninformed and lacking in bargaining power. More often than not franchisees face franchisors who are well informed about their own franchising system, familiar with the risks in their respective markets3 and are strong negotiators. In fact, research shows that between half and two-thirds of all franchisees enter the franchising business coming from a dependent employment.4 Franchisors typically hold the bargaining power that enables them to dictate the conditions of the future long-term relationship to the franchisees and ask them to sign their standard terms.
The correspondence between franchisees' 'weakness' and franchisors' strength causes some jurisdictions to regard franchisees as consumers. Usually this is when initially commencing the business by signing the contract, but sometimes, albeit seldom, it is throughout the entire contractual period. Thus, there are (1) some jurisdictions that never regard a franchisee as a consumer; (2) some jurisdictions that apply consumer protection laws where it is found necessary to protect the franchisee, and the franchisee actually acts as a consumer according to the statutory definition of consumer; and (3) even jurisdictions that generally deem a franchisee to be a consumer. This has an impact on various fields of law, such as consumer credit law, doorstep-selling law, law on supply contracts payable by instalments and unfair contract term law. In some jurisdictions, it follows that franchisees may even enjoy protection under laws regarding residential leases.
Whether consumer protection law is a good or a bad thing may differ depending on one's circumstances. On the one hand, obviously, it seems to be in the interests of the franchisee who seeks protection. Franchisors, on the other hand, want to regard franchisees as business partners on an equal footing5 and uphold the principle of 'freedom of contract'. According to the franchisors' mindset, the franchisee makes a well-informed business decision when entering into the franchising system. Consumer protection laws are considered 'over-regulation' by most franchisors as they could lead to an overall decrease of franchising in the relevant market; over-regulation is generally a hindrance, at least for innovation.6 Regulation – good and poor – increases the transaction costs for franchisors. Ultimately, it can cause the franchisor not to invest in the over-regulated market or make it less of a priority. However, the other side of the coin is that good regulation with a modest level of protection of franchisees can encourage more franchisees to invest in franchising, therefore increasing the possibilities for franchisors to expand and also their choice of business partners.
The following chapter shall provide a selective overview of the overlap of franchising and consumer protection and will highlight two examples.
II OBJECTS FOR CONSUMER PROTECTION LAWS
The justification for the consumer laws in each jurisdiction examined here does not necessarily differ. The United Nations Guidelines for Consumer Protection encourage nations to maintain a strong consumer protection policy and recognise that 'consumers often face imbalances in economic terms, educational levels and bargaining power . . . and should have the right of access to non-hazardous products, as well as the right to promote just, equitable and sustainable economic and social development and environmental protection'.7 Consumer laws in the various jurisdictions also share a common theme.
In South Africa, for instance, the purpose of the Consumer Protection Act is to promote and advance the social and economic welfare of consumers by, among other things, establishing a legal framework for the achievement and maintenance of a consumer market that is fair, accessible, efficient, sustainable and responsible for the benefit of consumers generally, promoting fair business practices, improving consumer awareness and information, and encouraging responsible and informed consumer choice and behaviour and promoting consumer confidence and empowerment.8
Similarly, in Australia, the Australian Government Productivity Commission stated that a consumer policy framework should aim to ensure that consumers are sufficiently well-informed to benefit from competition, prevent business practice that is unfair or contrary to good faith and, 'meet the needs of those who, as consumers, are most vulnerable or at greatest disadvantage'.9 Three years later, in 2010, the Australian Consumer Law (ACL) was enacted, which was designed to protect consumers, ensure fair trading in Australia and simplify existing laws.10
German consumer protection law is mostly part of the general private law, which has consumer law provisions embedded at various points. It is noteworthy that the various acts implementing the new laws into the German Civil Code are comparatively silent on the motives behind consumer protection; it is left to the courts and academics to fill the gaps and provide the theoretical basis.11
In the United Kingdom, the Law Commission and Scottish Law Commission noted that misleading and aggressive trade practices are common and lead to a high level of consumer detriment, especially for vulnerable consumers.12 Subsequently, the UK Consumer Rights Act 2015 was enacted with the primary objective of clarifying the pre-existing English laws and implementing Directive 2011/83/EU on consumer rights (the Consumer Rights Directive).13
It is uncertain whether the objectives of consumer protection laws can be considered to fit with the franchisees' situation, responsibilities and position in the contractual relationship. While fair trade might be an overall principle for consumer and commercial transactions, what might distinguish consumers from franchisees is their vulnerability, as has been pointed out in general by the Commissions in the United Kingdom and Australia, mentioned above.
III OVERVIEW OF THE APPLICABILITY OF CONSUMER PROTECTION LAW TO FRANCHISEES
With the implementation of the Consumer Rights Directive, several provisions concerning consumer rights have been renewed. Consequently, the complete harmonisation of the most important aspects should ensure legal certainty in the relation between the consumer and the entrepreneur and generate uniform consumer protection throughout the EU. However, the huge impact of consumer protection law in Germany arises from the very legal perspective on the problems concerning the 'cooling-off period';14 'very legal perspective' because many statutory provisions are applied to franchising relationships that a fair few people outside Germany would regard as provisions that typically protect consumers (principle of good faith, reasonableness of contractual terms, etc.).
ii United Kingdom
As in Germany, the United Kingdom has no specific franchising laws. Since the Consumer Rights Act 2015 was introduced, there has been an ongoing discussion on whether it could apply to franchisees. The Consumer Rights Act sets out a framework that consolidates key consumer rights covering contracts for goods, services, digital content and the law relating to unfair terms. The statute is the result of combining fragmented pieces of legislation protecting consumer rights, which often consisted of existing case law and European directives.
iii South Africa
In South Africa, the Consumer Protection Act 2008 was enacted to provide long-awaited comprehensive legislation for consumers and it is noteworthy also in relation to franchising. Legal commentators have noted that franchisors have faced a huge administrative burden since the Act's enactment. The Consumer Protection Act comes with specific provisions that have been familiar for decades, such as cooling-off periods and the necessity to include mandatory rules in the franchise agreement. However, the new law also goes further and includes rules governing the supply of goods by the franchisor to the franchisee. For instance, according to Section 21 of the Consumer Protection Act, franchisors may not furnish the franchisee with unsolicited goods or services and, according to Section 13 of the Consumer Protection Act, the franchisee has the right to choose a supplier for unbranded goods.
Because of the broad definition of 'consumer', the franchisee is eligible for the wide range of other consumer rights, too. In contrast to other jurisdictions, where franchise law has 'only' turned case law into statutory law, in South Africa, legislation has changed the business model of franchising. The franchise market in South Africa, it is said, is currently on a par with the Australian market, where legislation is very far-reaching.15
The ACL (see Section II), which is Schedule 2 of the Competition and Consumer Act 2010, is of major importance when it comes to consumer issues with respect to franchisees. The ACL forms part of the Australian national consumer policy framework. The ACL includes core consumer protection provisions prohibiting misleading or deceptive conduct, unconscionable conduct and unfair terms in standard form consumer contracts. More-informed consumers not only make better choices, but also drive competition and innovation in markets.16
IV WHAT CONSTITUTES A CONSUMER?
While the objectives of consumer protection law across the various jurisdictions might be generally the same, the scope of the law's application differs. The subjective scope is commonly defined by reference to a 'consumer'. But, surprisingly enough, the ideas as to what constitutes a consumer seem to differ even within the European Union.
Under the Consumer Rights Act in the United Kingdom, a consumer is defined as an individual acting for purposes that are wholly or mainly outside that individual's trade, business, craft or profession.17 Most legal commentators strongly disagree that a franchisee falls into this definition and – as far as can be seen – courts have not yet granted franchisees rights under this statute. The United Kingdom thus marks the one side where it is neither ordered nor seems to be intended to treat franchisees as consumers; however, tracing the legislator's will is often a fruitless task in common law jurisdictions.
Germany takes a somewhat different position, concept-wise. Protection under German consumer law currently depends first on the role people assume in their particular legal interactions with others, regardless of their individual weaknesses and capacities; and second, on the specific situations in which weaker parties might find themselves, such as doorstep transactions. Actually, it is not about whether a person is a consumer according to the statutory definition but, in fact, about whether a person has entered into a consumer business or a non-consumer business. A franchisee is not regarded as a consumer. When the franchisee signs the franchise agreement, this action is already viewed as business conduct and, thus, conducted by an entrepreneur. However, it is a matter of ongoing discussion as to whether the franchisee is entitled to similar protection (a cooling-off period) when it comes to the conclusion of a franchise agreement as a business start-up. Furthermore, consumer protection rights could be invoked if the franchisee is required to make consistent purchases from the franchisor and if the franchisor sells the same products in his or her own franchise outlet.
South Africa is a somewhat different animal. South Africa's Consumer Protection Act seems to recognise the difficulty one has by forcing the franchisee into the common consumer definition. Thus, while defining what a consumer is generally in terms of the application of the Consumer Protection Act 2008, it merely adds basically that a consumer is also 'a franchisee in terms of a franchise agreement'.18 Thus, a franchisee is deemed a consumer. Furthermore, Section 5(7) seems to suggest that even legal entities qualify as consumers under the act. One is tempted to ask when does the franchisee not act as a consumer? It seems that while, for instance, Germany seeks to regard only the potential franchisee as a consumer before entering into the franchise agreement, South Africa extends the consumer protection even to an ongoing contractual relationship. This concept allows for a broad application of consumer protection law.
Australia marks another extreme from the United Kingdom. The concept under the ACL is that one can (already) be a consumer if one acquires goods or services as a consumer to the extent that the price or cost does not exceed A$40,000,19 regardless of purpose or use, or if the goods or services are ordinarily acquired for personal, domestic or household use or consumption. It might be possible – and subject to an ongoing discussion – for franchisees to be treated, and have the same protection, as consumers when it comes to supply of goods or services by the franchisor up to that threshold, or in the case of acquisitions where the person acquired the goods for the purpose of resupply or for the purpose of using them up or transforming them in trade or commerce.
V COOLING-OFF PERIOD
A common element of consumer protection law is the cooling-off period, which can also often be found in franchise-specific laws. For certain transactions, consumers are able to withdraw from a contract within a certain period after signing. The cooling-off period is an exception to the principle of pacta sunt servanda, or even a marked easing of the application of this principle, commonly justified by the potential for the distortion of the decision-making process arising from the inferiority of one party.20 The same weighting is found with respect to dedicated franchising cooling-off periods. However, it is doubtful whether there are a sufficient number of instances (if any) of 'fly-by-night' signing of franchise agreements to justify the legal uncertainty of a cooling-off period.
i Germany and the EU
In Germany and other EU Member States, the Consumer Rights Directive has been transposed into national law. The right to withdraw may be available to franchisees, subject to restrictive requirements; for example, if the person enters into certain financial commitments, such as being granted a loan, postponement of payment or delivery by instalments; or is starting a business for the first time or is a consumer. Although this Directive, and its application to franchisees, may differ from Member State to Member State, the impact of the legislation, where applied, does not differ: the consumer is entitled to withdraw from the contract generally within a period of 14 days after conclusion of the contract.21 Although, to the detriment of the franchisor, this period can be easily extended to slightly more than one year in the event of lack of, or insufficient, information about cooling-off rights, prior to the new law, the period was unlimited. Providing the correct information about the right to withdrawal is not necessarily an easy task for the franchisor, however, as the legislation does not provide a pattern but rather (varying) hints for drafting. At least there is a directive now that contains a sample revocation instruction by the German Franchising Association, but obviously it is not mandatory for German courts.
ii South Africa
South Africa is also familiar with the cooling-off period, as it is included in the franchising sections of the Consumer Protection Act. The franchisee has a right to cancel the franchise agreement without cost or penalty within 10 business days of having signed the agreement by giving written notice to the franchisor.22 However, unlike in Germany, the law provides guidance for the franchisor on how to inform the franchisee about this right. The exact wording of the applicable section providing this right to the franchisee must be printed at the top of the first page of the franchise agreement, together with a reference to the section and the Act.23
Australia is familiar with the right to withdrawal too, but the franchisee's right is not so extensive. On the other hand, provisions are applied widely to all franchisees, not only those to be regarded as consumers, which is similar to the German concept. The Australian Franchising Code of Conduct24 provides that a prospective franchisee is entitled to a cooling-off period of seven days after entering into a new franchise agreement.
VI JUDICIAL CONTROL OF CONTRACT TERMS
If no dedicated franchising legislation exists, the review of the contractual terms of franchise agreements by the courts often depends on the application of the laws concerning unfair contract terms or standard terms respectively. More often than not, the application of the law (or at least the extent of the application) depends on whether it is a consumer contracting with an entrepreneur. In some jurisdictions, the application of the law depends on whether a standard form contract is used. In these cases, a franchisor's desire to use a consistent agreement pattern for his or her outlets comes at a price: the franchisor's terms will be reviewed by a judge for their fairness or reasonableness. The franchisee, on the other hand, can sit back and trust that terms to their (considerable) detriment will be softened or even removed by the courts.
For standard form contracts,25 the German Civil Code contains provisions governing, for example, the content of the contractual terms.26 Even though the basis of the law is laid down in an EU directive that states that EU Member States have certain rules in common, German law on standard terms goes further than legislation in the rest of the world. German law is particularly strict on businesses. Contractual clauses are subject to an in-depth review by the courts and incomprehensible clauses are reversed to the franchisor's detriment. Clauses that are deemed to be contrary to statutory provisions are deemed invalid. Although core provisions regarding business-to-consumer transactions are similar in all EU Member States, one particular difference in Germany is that the courts tend to apply dedicated consumer provisions to business-to-business (B2B) transactions as well if the situation is 'comparable', and this position is often assumed by the courts. Furthermore, provisions identified as invalid by the courts are not reduced to a level at which they are legally valid, they are simply invalid as a whole. No reduction of invalid provisions to preserve validity is conducted.27 Thus, even though a franchisee is not a consumer in terms of German law, his or her protection here comes close.
ii United Kingdom
In the United Kingdom, franchisees entering into a standard terms franchise agreement can invoke the Unfair Contract Terms Act 1977. However, as this Act seeks only to reduce the possibility of limiting one's own liability, the franchisee can only claim further protection if he or she actually falls within the definition of 'consumer', so the Consumer Rights Act applies. However, as this is highly unlikely, and because in the United Kingdom the principle of good faith is applied less to B2B contracts than it is in civil law jurisdictions, franchisees might have a hard time before UK courts, which (still) uphold the principle of 'freedom of contract' to a large extent. However, it is observed that the understanding of good faith with respect to commercial contracts is currently shifting in common law jurisdictions. Whereas before it was often said to apply only to non-business transactions, in common law jurisdictions there now appears to be a tendency28 of easing the principle of freedom of contract and imposing a duty of good faith, or at least honesty and integrity, in commercial contracts as well.29
iii South Africa
South Africa's Consumer Protection Act also offers the franchisee strong protection against unfair contract terms. Part G of the statute (the right to fair, just and reasonable terms and conditions) applies to franchisees too. According to Section 48 of the Consumer Protection Act, it is required, among other things, that pricing, terms of the contract, and marketing of the goods and services are fair, reasonable and just. Furthermore, the franchisor must draw the attention of the franchisee to important terms of the contract;30 other terms are prohibited.31
Interestingly enough, the law also seeks to regulate prices. According to Section 48(1)(a)(i) of the Consumer Protection Act, the supply of goods or services may not be offered for a price that is unfair, unreasonable or unjust. Hence, South Africa even intervenes in price-fixing. In contrast, as a rule, German law on general terms and conditions, despite being extremely comprehensive, never regulates the two core essentaliia negotii of an agreement: pricing and performance description. The same can be found in UK law.32
The Australian Consumer Law, now for the first time in Australian history, regulates unfair terms in standard form contracts, yet it is limited to consumer contracts. There are some requirements that include franchisee as consumers, which means they can be protected against unfair contract terms. Nevertheless, franchise agreements have not been considered to be consumer contracts so far. Also, as in Germany, the contract must not be negotiated. If a term is declared unfair, it will be deemed void, but the rest of the contract will continue, which is also similar to the practice in Germany.
The new Law, which entered into force on 12 November 2016, takes the approach of including franchisees under the Unfair Contract Terms provisions. The Law will protect small businesses from unfair terms in standard form contracts, granting the franchisee further protection as consumers. The small businesses are definitely protected if at the time of entering the contract at least one party to the franchise agreement is a business that employs fewer than 20 people; and either the price payable up front under the contract does not exceed A$100,000 or the contract has a term of more than one year and the price payable up front does not exceed A$250,000. Most franchise agreements are for a five- or 10-year term and the price payable up front to the franchisor is often less than A$250,000, depending on the nature of the franchise system. It can be expected that many franchise agreements will fall within the definition of a small business contract.
Another issue that has a bearing on franchising arises in relation to the Australian Competition and Consumer Commission, as the Commission is empowered to issue infringement notices if it determines a violation of the Competition and Consumer Act 2010 (e.g., by an unfair practices provision in the franchise agreement). The Commission can issue a fine and, probably with greater impact, will publish details of paid infringement notices in a publicly accessible33 register. Thus, knowledge of bad business behaviour will potentially be publicly disseminated.
The question of whether to apply consumer protection laws to franchisees hinges on the issues of who should bear the risks and whether franchisees should be protected from their own decisions and conduct.
However, even if this question is to be answered in favour of the franchisee, what is the actual benefit to the franchisee? Inherent and hidden risks will become apparent to the franchisee no earlier than the point at which the franchisee deals with the franchise documentation that he or she seeks to sign; any real risk that the franchise system is faulty in some way will only emerge later. Nonetheless, the franchisee is protected by his or her right to rescind and by ordinary statutory law or franchising legislation requiring, for instance, a model franchise outlet to have been run by the franchisor (although this is rare). Thus, this already mitigates the need for that period of uncertainty, the cooling-off period. Furthermore, it is doubtful whether the availability of a short window in which to exercise the right to withdraw can protect a franchisee from being imperfectly informed (e.g., with respect to the possibility of withdrawing from the contract if a franchisee should sign a 'fly-by-night' contract). Any defects in the contractual object are likely to become apparent only much later.
However, where the franchisee relies on the advice, guidance and skills of the franchisor34 – as is often the case – this structural weakness in the relation might bring the franchisee close to the position of a consumer and therefore justify the application of consumer protection legislation.
1 Jiri Jaeger is a partner and Frederik Born was formerly an associate at Bird & Bird LLP.
2 Source: GTAI; the figures come from a report from 2019, in which the IFA projected the number of franchise establishments to increase by 2.1 percent in 2020.
3 In some jurisdictions, the franchisor is even required to operate a trial franchising outlet before contracting with a franchisee.
4 See the summarised results from Australia, France and the United Kingdom by Buchan, Franchisees as Consumers, p. 42 et seq. (2013).
5 However, research from Australia shows that nearly one third of all Australian franchisors do not have experience in starting a business before setting up their franchising network; Frazer, Weaven, Bodey, 'Franchising Australia 2010', p. 118, cited by Buchan, Franchisees as Consumers, p. 16 et seq. (2013).
6 Financial Services Authority, 'Financial Services Authority: A New Regulator for the New Millennium', (January 2000), p. 6 et seq.; Abell, The Law and Regulation of Franchising in the EU, 190 (2013).
7 United Nations, Department of Economic and Social Affairs, United Nations Guidelines for Consumer Protection (as revised and adopted in 2015), at I.1 (available at: https://unctad.org/en/Pages/DITC/CompetitionLaw/UN-Guidelines-on-Consumer-Protection.aspx, last visited 24 November 2020).
8 Consumer Protection Bill, Chapter 1, Part B.
9 Australia Government Productivity Commission, Review of Australia's Consumer Policy Framework, Inquiry Report, Vol. 1, No. 45, p. 13 (2008).
10 Explanatory Memorandum, Trade Practices Amendment (Australian Consumer Law) Bill (No. 2) 2010, Consumer guarantees, p. 12.
11 Micklitz, Münchener Kommentar BGB, Section 13 at paragraph 67, 5 (8th ed., 2018).
12 Law Commission and Scottish Law Commission, 'Consumer Redress for Misleading and Aggressive Practices' (Law Com No. 332; Scot Law Com No. 226), p. viii. (2012).
13 Explanatory Notes, Consumer Rights Act 2015, paragraph 5 et seq.
14 See Flohr, in Handbuch des Vertriebsrechts, Section 29 at paragraph 86 (Martinek, Semler, Flohr, eds., 4th ed. 2016).
15 Zeidman, 'Is a franchisee a consumer or not?', Franchise Times March 2016 (available at: http://www.franchisetimes.com/March-2016/Is-a-franchisee-a-consumer-or-not, last visited 24 November 2020).
16 Explanatory Memorandum, Trade Practices Amendment (Australian Consumer Law) Bill (No. 2) 2010, 'Consumer guarantees', p. 12.
17 Consumer Rights Act 2015, Section 2(3).
18 Consumer Protection Act, Chapter 1, Part A, Section 1.
19 From 1 July 2021, the monetary threshold of A$40,000 will increase to A$100,000.
20 For Germany see, for example, Mörsdorf, in beckonline.GROSSKOMMENTAR Section 355 at paragraph 3 (Gsell, Krüger, Lorenz, Reymann, eds., September 2020).
21 German Civil Code, Section 355 paragraph 2.
22 Consumer Protection Act, Section 7(2).
23 Consumer Protection Act, Section 2(2)(a) Regulation 2.
24 Part 3, Division 5, Section 26.
25 Exceptions apply.
26 Sections 305 et seq.
27 Settled case law since Federal Court of Justice NJW 1982, 2309.
28 See, for example, Zhong Xing Tan, 'Keeping Faith with Good Faith? The Evolving Trajectory Post-Ym Seng and Bhasin', JBL (2016), 420.
29 However, with regard to the United Kingdom, a general principle of good faith still does not exist; see Chitty on Contracts, at paragraph 1-1 (33rd edn, 2019).
30 Consumer Protection Act, Section 49.
31 Consumer Protection Act, Section 51.
32 Explanatory notes, Consumer Rights Act 2015, paragraph 18.
33 http://registers.accc.gov.au/content/index.phtml/itemId/939950, last visited 24 November 2020.
34 Georgosouli, 'Investor Protection Regulation: Economically Rational?', University of London – Centre for Commercial Law Studies (2006), p. 10 (available at: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=893451, , last visited 24 November 2020), cited by Buchan, 'Consumer Protection for Franchisees of Failed Franchisors: Is There a Need for Statutory Invention?', QUTLJJ 9/2 (2009), 232, 235.