new ZeaLand

ChaPter 8

wHAt to be AwAre oF in reLAtion to FrAnCHisinG in new ZeALAnd

stewart Germann | Franchising Lawyer AuCKLAND, NEw ZEALAND

About the Author

Stewart Germann is acknowledged as New Zealand’s leading franchising and licensing lawyer. Stewart is a Barrister and Solicitor of the High Court of New Zealand and also a Notary Public, and he has a BCom in accounting and an LLB from the University of Auckland. He is the principal of Stewart Germann Law Office (SGL), a boutique franchising and licensing firm in Auckland, New Zealand. The firm is New Zealand’s longest-established specialist franchising firm and the winner of multiple awards. Stewart was Chairman of the Franchise Association of New Zealand (FANZ) from 1997 to 1999 and he has been involved in franchising and licensing law for over 35 years. Stewart specialises in franchising, licensing and the sale and purchase of businesses, although SGL also undertakes a wide variety of other work. Stewart, who is included in Who’s Who Legal: Franchise 2019, is also a qualified mediator. Stewart has spoken at international franchising conferences and he has extensive franchising contacts worldwide and locally. In 2014, Stewart was made a life member of the FANZ in recognition of his significant contribution. Stewart is passionate about franchising and licensing and welcomes enquiries from overseas. Stewart graduated as a Certified Franchise Executive (CFE) in 2019 and was presented with his CFE certificate at the FCA conference at Gold Coast in October 2019 and the IFA convention at Orlando, USA, in February 2020. He is the first person in New Zealand to gain CFE certification.

New Zealand is one of the most deregulated countries in the world to conduct small to medium-sized business. There is no specific legislation controlling the operation of franchising in New Zealand and other countries like New Zealand include Singapore and the United Kingdom.

Prospective franchisees who are looking at buying into a franchise must tread carefully and do their homework. New Zealand is an exciting and fast developing market which contains over 600 franchise systems.

legal position

Although there are no specific franchising laws, there are existing laws which protect franchisees; and the three main laws which provide such protection are the Fair Trading Act 1986, the Commerce Act 1986 and the Contract and Commercial Law Act 2017. Those Acts focus in particular on misrepresentations and restrictive trade practices which include anti-competitive behaviour.

Once a franchisee has chosen a particular brand and franchise system and wishes to progress further with enquiries, the first question to ask is whether the franchisor belongs to the Franchise Association of New Zealand (FANZ). The FANZ was formed in 1996 and publishes the Code of Practice and the Code of Ethics which all members must comply with. Many franchisors belong to the FANZ but some have chosen not to join yet still comply with the Codes. Others may choose not to join and do not comply with the Codes and they should be described as renegade franchisors, in my opinion.

The Code of Practice has four main aims which are as follows:

1. To encourage best practice throughout franchising. 2. To provide reassurance to those entering franchising that any member displaying the logo of the FANZ is serious and has undertaken to practise in a fair and reasonable manner.

3. To provide the basis of self-regulation for franchising. 4. To demonstrate to everyone the positive will within franchising to regulate itself.

The Code applies to all members including franchisors, franchisees or affiliates such as accountants, lawyers and consultants and all prospective new members of the FANZ must agree to be bound by the Code before they can be considered for membership.

What does the Code cover?

1. Compliance - all members must certify that they will comply with the Code and members must renew their certificate of compliance on an annual basis. 2. disclosure - a disclosure document must be provided to all prospective franchisees at least 14 days prior to signing a franchise agreement. This disclosure document must be updated at least annually and it must provide information including a company profile, details of the officers of the company, an outline of the franchise, full disclosure of any payment or commission made by a franchisor to any adviser or consultant in connection with a sale, listing of all components making up the

franchise purchase, references and projections of turnover and possible profitability of the business.

3. Certification - the Code requires franchisors to give franchisees a copy of the Code and the franchisee must then certify that he or she has had legal advice before signing the franchise agreement. 4. Cooling Off period - all franchise agreements must contain a minimum 7 day period from the date of the agreement during which a franchisee may change its mind and terminate the purchase. This is very important and the cooling off period does not apply to renewals of term or re-sales by franchisees. 5. dispute Resolution - the Code sets out a dispute resolution procedure which can be used by both franchisor and franchisee to seek a more amicable and cost-effective solution. The Code requires all members to try to settle disputes by mutual negotiation in the first instance. However, this process does not affect the legal rights of both parties to resort to litigation. 6. Advisers - all advisers must provide clients with written details of their relevant qualifications and experience and they must respect confidentiality of all information received.

7. Code of Ethics - all members must subscribe to the Code of Ethics which sets out the spirit in which the Code of Practice will be interpreted.

All franchisor members of the FANZ must have a franchise agreement which contains a dispute resolution clause and a cooling-off provision. In order to resolve disputes, mediation is the favoured method and it has a high success rate in relation to franchising disputes. However, if mediation does not work then there is always litigation which is certainly at the divorce stage of the relationship.

What is a franchise?

It is helpful and essential to understand the definition of the franchise. The term “franchise” is defined in the Rules of the FANZ as follows:

“Franchise” means the method of conducting business under which the right to engage in the offering, selling or distributing of goods or services within New Zealand includes or is subject to at least the following features:

• the grant by a Franchisor to a Franchisee of the right to the use of a Mark, in such a manner that the business carried on by the Franchisee is or is capable of being identified by the public as being substantially associated with a Mark identifying, commonly connected with or controlled by the Franchisor; and • the requirement that the Franchisee conducts the business or that part of the business subject to the Franchise Agreement, in accordance with the marketing, business or technical plan or system specified by the Franchisor; and • the provision by the Franchisor of ongoing marketing, business or technical assistance during the term of the Franchise Agreement.”

Consideration should also be given to the definition of a franchise agreement which “means a contract, agreement or arrangement, whether express or implied, whether written or oral, between two or more persons by which one party to the agreement (“the franchisor”) grants, authorises or permits the other party to the agreement (“the franchisee”) the right to operate a franchise. Any contract, agreement or arrangement which purports to be a franchise agreement shall be deemed to be a franchise agreement for the purpose of this definition, notwithstanding that it may lack any or all of the requirements or attributes referred to in the definition of “franchise””.

Code of practice

Prospective franchisees will usually be given a disclosure document and franchise agreement by a franchisor. The Code of Practice states that franchisors must provide the disclosure document to prospective franchisees at least 14 days prior to the signing of the franchise agreement. The disclosure document must provide certain information including the following:

• Details of the franchisor and its directors including experience and a viability statement with key financial information of the franchisor; • Details of any bankruptcies, receiverships, liquidations or materially relevant debt recovery; • Criminal, civil or administrative proceedings within the past five years; • A summary of the main particulars and features of the franchise; • A list of components making up the franchise purchase; • Details of any financial requirements by the franchisor of the franchisee; and • Other information as listed in the Code.

Franchising in New Zealand covers goods and services in many areas including general retail, leisure and education, business and commercial, food and beverage, health and fitness, computer and technology, home and building services.

Competition law

The Commerce (Cartels and Other Matters) Amendment Act 2017 came into force on 14 August 2017. The most significant change made by the Act was the replacement of the previous prohibition on price-fixing between competitors with an expanded prohibition on cartel provisions, which extends to market allocations and output restrictions, as well as to price-fixing, by competitors. The New Zealand cartel prohibition is very wide and will have quite an impact on franchise networks. Some additional clauses must be inserted into franchise agreements and there must be explanations, in plain language, as to why certain clauses are necessary. Consideration must be given to cartel clauses in franchise agreements; for example, clauses that set or influence prices, restrict output or allocate markets will be caught. The possibility that alternative arrangements might achieve the same or a similar commercial outcome as a cartel clause should also be considered. Another consideration is whether the collaborative activity exemption or

the vertical activity exemption would apply. Expert legal advice should be obtained in relation to this Act.

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 its own franchisees but that is not always the case. For example, a franchisor that owns its own outlet might be found to be in competition with franchisees. Similarly, where a franchisor sells online direct to the end consumer, 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.

Consideration must also be given to the Commerce (Criminalisation of Cartels) Amendment Act 2019 which came into force on 8 April 2021. The Act introduced a new criminal offence for cartel conduct and the proposed new criminal sanctions reflect the covert nature of cartels and the harm they cause to consumers and the economy. The Commerce Act 1986 provides a number of statutory exceptions that would not constitute a cartel arrangement and may be pro-competitive. These exceptions relate to collaborative activities (for example, joint ventures or franchise arrangements), joint buying, vertical supply contracts and specified liner shipping arrangements as stated earlier in this paper. There are no defences for mistakes of fact relating to the elements of joint buying and promotion and vertical supply contracts. Therefore, it would be possible in the future for a director of a franchisor company to be criminally liable under the Act for a cartel offence. For an individual who commits an offence the penalty on conviction could be imprisonment for a term not exceeding 7 years or a fine not exceeding $500,000, or both. For a company which commits an offence the penalty could be up to $10 million so great care must be taken.

restrictive covenants

The New Zealand courts have recognised that it is reasonable for a person in the position of a franchisor to impose a contractual restraint upon competitive conduct by a franchisee or an ex-franchisee, but such restraints must not exceed the boundaries of the court’s notion of reasonableness. The first principle is that it is reasonable for a person to stipulate that if he or she is willing to disclose all secrets of how to establish a particular business enterprise, then the recipient of the information cannot immediately terminate the contract and set up a competitive business using the information received during the course of the relationship. If the courts did not provide protection to franchisors against conduct like this, there would be no incentive for the owners of established businesses to share their secrets with others and enhance their business skills. The second principle is that it is important for the well-being of the community that every individual should, in general, be free to advance his or her skills and earning capacity.

The Contract and Commercial Law Act 2017 in New Zealand gives the courts authority

to rewrite a restrictive covenant and to allow an excessive covenant to be enforced at a lesser level. Section 83 of the Act states as follows:

“83 Restraints of trade

(1) The court may, if a provision of a contract constitutes an unreasonable restraint of trade –

(a) delete the provision and give effect to the contract as so amended; or (b) modify the provision so that, at the time the contract was entered into, the provision as modified would have been reasonable, and give effect to the contract as so modified; or

(c) decline to enforce the contract if the deletion or modification of the provision would so alter the bargain between the parties that it would be unreasonable to allow the contract to stand.

(2) The court may modify a provision even if the modification cannot be effected by deleting words from the provision.”

The ability of the courts to modify excessive restraints is constrained by the principle that terms that could never have been considered reasonable will not be modified, as to do so would be contrary to the public interest. This is the doctrine of restraints that are in terrorem, which translates into ‘contracts that terrorise a contracting party’. If a franchisor could only ever have reasonably sought a two-year restraint within a 5-kilometre radius of the business in which the person established goodwill, then a nationwide restraint for 10 years could never be regarded as reasonable; and in that case the courts would refuse to rewrite the clause to determine that the period of 10 years should be two years and the area of the restraint should be 5 kilometres rather than the entire country. What then is a reasonable restraint? There are two factors – area and time. So the message is clear in New Zealand – for a restraint to be enforceable, it must be reasonable.

There have been a number of restraint of trade cases in the franchising sector both in Australia and in New Zealand in recent years. Two cases in 2020 were clients of mine and they are Water Babies International Ltd v Williams & Others and M and L Holdings (2018) Ltd v Whenua Productions Ltd & Kuang. Other cases include the following: Dorn Investments Ltd v Hoover (2016); Mike Pero (New Zealand) Ltd v Krishna and Mortgage Suite Ltd (2016); Mad Butcher Holdings Ltd v Standard 730 Ltd and Wightman (2019); and Mainland Digital Marketing Ltd v Willetts and Meyers (2019).

Non-compete and other restrictive covenants need to be included in the relevant franchise agreement to be enforced during the term of the agreement. The type of clause that I often include is as follows:

“The franchisee shall not during the term or any renewal period or at any time following the termination of this agreement or its expiration through the effluxion of time except with the prior written approval of the franchisor carry on or be directly or indirectly engaged or concerned or interested whether as principal, agent, partner, shareholder,

investor, financier, lender, director, employee, consultant, independent contractor or otherwise howsoever in any business conducted in competition with the business, the franchisor and its other franchisees, or any similar business.”

In other words, a franchisor and a franchisee have a relationship for the term of the franchise agreement. During that period the franchisee must not compete with the particular franchise system and must not divulge confidential information to any third party outside the system without the consent of the franchisor. A breach of these covenants will usually give rise to an event of termination allowing a franchisor to terminate the franchise agreement with the particular franchisee plus it will allow the franchisor to enforce the personal covenants given by the directors and shareholders of the franchisee in relation to the restraint.

CoVID-19 and force majeure

Many contracts contain express provision stating that performance will be excused if rendered impossible by unavoidable causes such as acts of God, the Queen’s enemies, vis major, or force majeure, as discussed earlier. Clauses of this type are effective if they are drafted precisely and unambiguously.

Whether the outbreak of COVID-19 constituted a force majeure event will depend on the wording of the force majeure clause in question. In the absence of reference to a disease or pandemic in the clause, general terms such as “act of God” or “government restrictions” may apply. Determining this will require careful consideration of the contract and surrounding circumstances.

The term “act of God” is a common legal term meaning an extraordinary occurrence or circumstance which could not have been foreseen or guarded against. It is not necessary that the event has never happened before, only that it is extraordinary and could not reasonably be anticipated. To be an “act of God,” and not merely an accidental circumstance, the effect must be wide-reaching and overwhelming. Some examples of what have been construed as acts of God include the following:

• Violent storms;

• Extraordinarily high tide; • Unprecedented rainfall; • Fire caused by lightning; • Earthquake; and • Extraordinary snowfall.

The common being that the event is sudden or more severe than previous instances of the same event. A regular snowfall or fire is unlikely to be treated as an act of God.

In addition, determining whether the pandemic crisis has “prevented, hindered or delayed performance” of the contract will also depend on the specific facts and terms of contract. Often force majeure clauses will require that performances rendered legally or physically impossible, although some clauses have a lesser standard.

Franchise agreements

All franchise agreements in New Zealand should contain a robust force majeure clause. The author would go so far to say that if any franchise agreement does not contain a force majeure clause then the drafter of the document may be negligent. The type of force majeure clause that the author invariably includes in his franchise agreements states:

Neither party shall be liable to the other and neither party shall be deemed to be in default for any failure or delay to observe or perform any of the terms and conditions applicable to the party under this Agreement (other than the payment of money) caused or arising out of any act beyond the control of that party including (but not limited to) fire, flood, lightning, storm and tempest, earthquake, strikes, lock-outs or other industrial disputes, acts of war, acts of terrorism, riots, civil commotion, explosion, malicious damage, government restriction, unavailability of equipment or product, disease and/or virus of epidemic or pandemic proportions or other causes whether the kind enumerated above or otherwise which are beyond the control of that party and where such failure or delay is caused by one of the events above then all times provided for in this Agreement shall be extended for a period commensurate with the period of the delay.

The purpose of the above clause is to ensure that neither party will be liable to the other for any events outside their control. Common events are listed in the clause like fire, flood, lightning, storm and tempest and, of particular relevance to current events, the phrase “disease and/or virus of epidemic or pandemic proportions.”

No one can predict the future and all parties, especially a franchisor and a franchisee, should be afforded the protection of a well-drafted force majeure clause. COVID-19 is merely a symptom of the greater problem of unexpected or unanticipated events, be they in the form of the next pandemic or some other future disaster. Uncertainty will always pose a risk to interference with contractual relations, and a well-drafted force majeure clause is a necessary component of mitigating contractual risk.

Covid-19 had a dramatic effect on commercial leases in New Zealand. Some commercial leases were on a modern form of Deed of Lease which contained the important “No Access clause”; but older leases did not contain that clause. The “no access clause” is contained in the Deed of Lease published by the Auckland District Law Society. The meaning of “no access” is best explained by quoting clause 27.5 below:

If there is an emergency and the Tenant is unable to gain access to the premises to fully conduct the Tenant’s business from the premises because of reasons of safety of the public or property or the need to prevent reduce or overcome any hazard, harm or loss that may be associated with the emergency including: (a) a prohibited or restricted access cordon applying to the premises; or (b) prohibition on the use of the premises pending the completion of structural engineering or other reports and appropriate certifications required by any competent authority that the premises are fit for use; or (c) restriction on occupation of the premises by any competent authority, then a

fair proportion of the rent and outgoings shall cease to be payable for the period commencing on the date when the Tenant became unable to gain access to the premises to fully conduct the Tenant’s business from the premises until the inability ceases.

For renters that could not rely on a “no access” clause, some landlords showed no empathy, were greedy and charged full rental during the lockdown period, notwithstanding that the tenant could not access the premises and had zero turnover. In the author’s experience, other landlords decided to charge fifty percent or twentyfive percent. The best and most popular landlords were those who charged zero during the lockdown period, and those landlords often offered an extra month rent free for tenants. Those acts of kindness will not be forgotten, and franchisors that those that lease franchised premises to franchisees are more likely to retain good franchisees at the time of renewal.

While the effects of a global pandemic do not specifically feature in previous case law, it may still be possible to draw inferences from the existing body of cases about how the doctrine of frustration may apply to the effects of COVID-19.

Survey of franchising

In 2017 a survey of New Zealand franchising was conducted by Massey University (Auckland) and Griffith University (Queensland, Australia) and some highlights from that survey are as follows:

• The number of business format franchise systems operating in New Zealand has increased with 631 business format franchise systems operating in New Zealand, compared with 446 in 2012.

• The number of units operating with business format franchise systems has also increased with an estimated 37,000 units compared with 23,600 in 2012. • It is estimated that franchised business contributes around $27.6 billion to the New

Zealand economy.

• 72 per cent of franchises are NZ-founded. • There are an estimated 124,200 employees of New Zealand business format franchise systems, up from 80,400 in 2012, with approximately 60% of employees estimated to be in permanent full time employment.

• Franchising covers a wide range of industry categories and sub-sectors. Predominant sectors included “retail trade” (23%), “other services” (20%), “accommodation and food retail” (18%) and “administration and support services” (8%). • The median total start-up cost for a franchise was $308,500 for retail and $87,550 for non-retail.

• The median initial franchise fee was $35,000.

• The overall level of disputation per franchise unit was low (1.9%). Only 22% of franchisors experienced a substantial dispute with a franchisee within the last 12

months. The most common action was mediation (49%), followed by correspondence via a solicitor (41%). There was little incidence of litigation (10%) where substantial disputes occurred. • Most business format franchisors operate in retail trade, followed closely by service industries.

A new survey of franchising will be undertaken in 2021 and the result should be available before the end of this year.

Independent legal advice

It is essential for prospective franchisees to obtain independent legal advice from a lawyer experienced in franchising as well as independent accounting and taxation advice. A franchisee should have a number of meetings with the franchisor and its representatives and all questions and answers should be written down and carefully kept for future use if required. Prospective franchisees should be able to rely upon everything they are told but be wary of financial projections provided by the franchisor. That is a dangerous area and in my opinion franchisors should not provide financial projections at all but should provide actual financial results with the direction that the franchisee must go to its own independent accountant.

Attractive market

New Zealand is very attractive for franchising and many overseas systems have entered the market including from Australia, USA, Canada and the United Kingdom. International franchising was thriving worldwide until the global pandemic of 2020. The FANZ has been very successful in promoting self-regulation and high standards in franchising, and its Code of Practice is widely understood and accepted by many franchisors in New Zealand. At the end of the day, it is for a franchisee or master franchisee to make the decision whether or not to proceed with the purchase of a franchise or master franchise. Careful due diligence should always be undertaken so that franchisees are fully informed before signing any documentation.

SteWArt GermAnn Franchising lawyer - Auckland, new Zealand

stewart@germann.co.nz www.germann.co.nz