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This is wide-ranging discussion of how franchising has developed and a look at how it may develop in future. There is good discussion of economic theory underlying franchising and a tentative attempt to predict the implication of technological developments for its future. Gehan Gunasekara Senior Lecturer The University of Auckland Business School
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Open-Source Franchising: Laws for the next generation of global business networks.
By Deemant Himmat Lodhia
(Essay contributed towards the degree of LLM at the University of Auckland, New Zealand, November 2010).
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Comments This is wide-ranging discussion of how franchising has developed and a look at how it may develop in future. There is good discussion of economic theory underlying franchising and a tentative attempt to predict the implication of technological developments for its future. Gehan Gunasekara Senior Lecturer The University of Auckland Business School Table of Contents 1.0 Introduction 2.0 Traditional Franchising 3.0 The Essence of Franchising 3.1 Global Markets, Domestic Institutions 4.0 How the Law affects Franchising
4.1 The Seven Stages of Franchise Development 4.2 System Goodwill and Intellectual Property 4.2.1 Registered Trademarks 4.2.2 Unregistered Trademarks 4.3 The Franchise Agreement
4.4 A Relational-Standard Form Contract 4.4.1 Operational Controls 4.4.2 Control of Key Elements 4.5 Indefinable Terms of the Contract 5.0 The Franchise Paradox 5.1 Economics of Franchising 5.1.1 Transaction Costs of Franchising 5.2 Regulatory Debates 5.3 Other Complications in Building a Global Franchise 6.0 Open-Source Franchising 6.1 Self-Managing Franchise Relationships 6.2 The Collaborative Franchise System
6.3 Becoming, then Remaining Well-Known 6.4 Keeping Pace with Time, Space and Technology 7.0 Conclusion 8.0 Bibliography
2
“The only permanent thing is change” Heraclitus
1.0 Introduction
The term open source describes practices that promote access to the end product’s source
materials. It may be considered a philosophy or pragmatic methodology and is being
applied in the context of franchising to illuminate the next generation of global networks.
Franchising is an ideal expansion option for any aspiring business owner ready to flap their
wings on a global scale; however commercial and legal practicalities prevent viral
distribution of ideas and values across eager consumer networks, ready and waiting for
value exchanges in free markets.1 Adam Smith’s magnum opus, The Wealth of Nations
which showed how to create national wealth through production and export of surplus, and
also expressed economic philosophers’ desire to make economics a true science, thus
modern economic thought embraced goods or objects as having utility properties and
relationships are measured in terms of prices and value-in-exchange.2
Franchising is commonly cited for its business format; management system; product or
trade name cloning capabilities in commercially successful applications and most (if not
all) of the valuable global brand names present an argumentum a fortiori. The classic
relationship between buyers and sellers is co-ordinated and regulated by the market as a
commercial transaction. As a result, it has been treated as an arm’s length relationship
carrying the common sense view that such dealings should not entail responsibility ‘for
each other’s economic and physical security to any greater extent than provided for by
their contractual agreement’3.
Legal scholars have repeatedly distinguished franchising and business format franchising
in particular as problematic relationships because of paradoxical issues involving economic
arguments of power and control, the relational yet standard form nature of the contracts
containing indefinable terms that implement unilaterally determined operational controls
while ensuring key elements of the business are retained by the franchisor and is therefore
often disadvantageous to the franchisee. In fact, the result is substantial and persistent
investor losses, misallocation of capital resources and conflicts from within the franchise 1 Adam Smith (1776). The Wealth of Nations, W Strahan and T Cadell, London. 2 Lusch RF, Vargo SL and O’Brien M, (2007), ‘Competing through service: Insights from service-dominant logic’, Journal of Retailing 83 (1) 5-18 at p.6.
3
3 Collins H (1990). ‘Independent contractors and the challenge of vertical disintegration to employment protection laws’, Oxford Journal of Legal Studies, vol.10, no.3, 353-380 at 354.
system culminating into significant volumes of civil litigation and calls for public sector
enforcement.4
Many other complications exist in building global brands. The legal barriers impeding
expanding empires, that are trying to satisfy global markets through domestic institutions,
should be of concern to the policy makers of ill-performing economies. Their regulatory
debates hint at a free market answer that gives freedom to the market, hence an open-
source franchise infrastructure containing self-managing relationships, which become then
remain well-known and are modified for evolution indefinitely through new built-in
learning capabilities. Before presenting the future, however, a brief look at the past.
2.0 Traditional Franchising
Franchising is commonly believed to be a recent phenomenon imported from the United
States since the 1950s, however, its has also been traced back to the Middle Ages, for
example, in Norman England, barons were granted territories by the King in return for the
payment of royalties, provided they met other requests by the monarch.5 Thus a franchise
granting rights to maintain order determine and collect taxes in exchange for protection. In
Japan, franchise relationships have also existed in private business and commerce, for
example the Norenkai system, whereby a former employee opens an independent branch
operation in return for a royalty, has operated since the early sixteenth century.6 The
Singer Sewing Machine company during the 1850s turned to commission agents who were
given the right (a franchise) to supply consumers within a designated territory, and it
proved its worth in terms of accelerating the market penetration of an innovative product.7
Family businesses can be representative of ‘brand’ franchise that has survived over
centuries in many countries as well.8
4 Andrew Selden (2008). Beyond the Law and the Contracts: Strategies for Effective Franchise Relationship Self-Management, Briggs and Morgan, Minneapolis, USA. 5 Alan Felstead (1993). The corporate paradox; power and control in the business franchise. Routledge, London at 39. 6 Abell M (1989). The Franchise Option: A Legal Guide, Waterlow, London. 7 Jack AB (1957). ‘The channels of distribution for an innovation: the sewing machine industry in America, 1860-1865’, Explorations in Entrepreneurial History, vol.9, no.1, February, 113-141.
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8 It is a most basic and traditional ‘brand’ unit that may be well-placed in local communities for enhanced interaction with consumers, for example, observantly Tata and Toyota have used such an approach. Rolex also remains a tightly held family business.
A simple model9 reflects the traditional franchise organisation design, allocating decision-
making authority to the franchisor with a payment for his or her services.10
Figure 1.
The traditional model of franchising is prevalent and likely to prevail because it protects
the franchisor directly and provides maximum monetary benefits almost instantly. This is
necessary because there is apparently a need to boost and protect commerce in its present
form so as not to cause further distress on global economies. The search is for an
appropriate mechanism to mitigate franchise system behaviour that leads to conflict,
litigation and eventually policy intervention.11 Legislative interventions have only
increased costs and requirements, whereas private solutions, individually negotiated are
proving quite effective in coordinating strategies, allocating costs and benefits, enable
adaptation, minimise dissatisfaction and conflict within the franchise system.12
Franchisors’ recognition of the problems that the traditional models created lead to
ameliorization and harmonious working relationships developed.13 A closer examination
of the franchise system in its present form follows.
9 Image from Andrew Selden (2008) above n 4 at 14. 10 Ibid at 13-14. 11 Ibid at 3. 12 Andrew Selden (2008) above n 4 at 3.
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13 Ibid at 14-18 citing the Midas, Pizza Hut, KFC and several other franchise models.
3.0 The Essence of Franchising
The essence of franchising is in harnessing the power of four key elements; brand; system;
infrastructure; networks.14 These value drivers are documented and packaged ready for
replication and the fulfilment of expansion strategies for enterprises of various sorts.
These elements provide the incubation environment for growth. Stronger and longer
lasting patterns weaved, documented, packaged and delivered in a sustainable manner will
survive and their values stored and carried forward by the brand. The contract is charged
with governing this process and creates the pathways to carry the brand and its associated
system through an infrastructure to the end users in various networks. The commercial
lawyer is tasked with the duty to fulfil the purpose of the business enterprise and ‘promise’
its indefinite survival.
Franchising operates on the basis of a contractual agreement between two independent business parties, the franchisor and the franchisee, in which the franchisor grants the franchisee, for the term of the contract, the right to buy and operate the franchisor’s branded and formatted business system for a fee and according to the prescribed rules and procedures developed for the system by the franchisor.15
Hence the term most commonly used to refer to this type of commercial relationship:
“business format franchising”. Most consumers do not realise that they are dealing with a
locally run business operating in line with specifications set by the brand owner. The
franchisees often own much of the physical apparatus of the business; the franchisor owns
the brand name and has the right to determine how it is used. Both do business and market
under a common brand name, yet are legally distinct businesses. “This presents a paradox.
On the one hand, a franchised business looks and acts like a branch … while on the other
hand, it retains a distinct legal persona”.16 The franchisor’s “business-format franchise”
necessarily comprises a slight variance of the above-mentioned elements17;
i. A brand name (registered or unregistered) which serves as the umbrella sign for
network, and a rallying sign for the consumer and public;
ii. a licence to the use the brand, granted to the franchisee by the franchisor;
14 Andrew Terry (2005), “Network expansion: options, opportunities and challenges”, Franchising Australia/ New Zealand Year Book and Directory. 15 Martin Mendelsohn (2004). Franchising Law, Kluwer. UK. 16 Alan Felstead, The corporate paradox above n 5 at introduction.
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17 Martin Mendelsohn above n 15.
iii. a business system – a business concept formatted into a duplicable value “package”
founded on the franchisor’s tested Know How and his or her continued assistance
during the term of the agreement;
iv. payment by the franchisee of a financial consideration, either in a direct form, such as
an entrance fee and/or continuing fee (“royalty”), and/or an indirect form such as a
mark-up on supplied goods;
v. Investment in, and ownership of, the franchised business assets.
These are the elements requiring legal influence to enable operations on global markets as
domestic institutions.
3.1 Global Markets, Domestic Institutions
Franchise relationships are highly contractual, often encapsulated in lengthy and detailed
documents, but their use is more difficult to gauge. Nonetheless, franchisees are bound by
a contract, the terms of which have been subject to little or no negotiation, but designed
instead to safeguard and privilege the interests of franchisors ahead of theirs.18 Matters get
further complicated when we consider ‘where’ this relationship is to be established as
expanding enterprises routinely face transaction counter-parties who operate within quite
different legal and political systems, and who rank social priorities quite differently.19
“Globalisation” and “global markets” are misleading terms, because they mask the local
quality of much of the activity within those rubrics,20 hence ‘Global Markets, Domestic
Institutions’ represents franchising’s eventual form if it is to continue being considered as
the premier vehicle for international expansion.21 Understanding global and domestic
legal implications provides the wheels and roads for the brand’s vehicle in very diffe
terrains.
rent
18 Alan Felstead, The corporate paradox above n 5 at 128. 19 Milhaupt CJ (2003, ed.). Global Markets, Domestic Institutions: Corporate Law and Governance in a New Era of Cross-Border Deals, Columbia University Press, New York. 20 Ibid at 1-3.
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21 Andrew Terry (2009). ‘The Regulation of Franchising in Asia: A Comparative Study’, 6th Asian Law Institute Conference, Hong Kong 29/30 May, at 2.
4.0 How the Law affects Franchising
The essence of franchising is spread in global markets as domestic institutions through the
law. The two strands of law in the context of franchising22 are;
i. Laws affecting business generally and the industry in which [it] operates; and
ii. Laws relevant only because the marketing method chosen is franchising.
It is clear that all businesses have to identify and comply with all legal requirements
affecting business.23 The law affects franchising at every stage and in foreseeable and
sometimes unforeseeable ways. The brand provides a singular currency for the purposes of
exchange and this can be made up of innumerable elements. The present day spread of
cultural icons is evidence of successful franchising applications over various legal regimes
over decades.
The starting point for development of the business for franchising is through a pilot
operation to enable the franchisor to identify these laws.24 “[T]he franchisee will certainly
expect the franchisor’s system to reflect and respect all relevant laws”.25 Relevant laws
may include26 town and country planning restrictions, by-laws and building regulations,
health, hygiene and safety acts, business, employment and tax laws, discrimination,
disabilities and other laws applicable to the specific type of business.27 Once the general
business and industry laws are understood, the laws relevant for franchising in particular
can be considered in the seven stages of the franchise transaction.
4.1 The Seven Stages of Franchise28
i. The development of the concept by means of a pilot operation to explore the validity
of the concept in practical operations, allow fine-tuning and to establish business,
operational and accounting systems in order to prove evidence of marketability to the
consumer. At this stage careful environmental analysis and a most suitable and
optimum decision needs to be made in light of the given resources in order to develop 22 Martin Mendelsohn (2004). Franchising Law above n 15 at 37. 23 Ibid 24 Ibid. 25 Ibid. 26 This list is by no means exhaustive. 27 Martin Mendelsohn (2004). Franchising Law above n 15 at 38.
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28 Ibid at 37-44.
an operational manual, essentially a detailed constitutional document for the business
franchise. The franchisor creates many intellectual property rights including trade
mark, name, goodwill, trade secrets, confidential information, copyright material,
designs, patents, manufacture process, formulae or recipes.29 First and foremost,
these rights must be protected. “Delay can be fatal and names [or other intellectual
property] do get stolen”.30 The common law of passing off may be considered but
prevention is always better than the cure.
ii. Structuring the franchise package involves the franchisor deciding on marketability
based on the results of the pilot project. Important structural decisions which affect
the commercial and legal shape of the transactions are made at this juncture.
Considerations include involvement in the property chain, tying products, territorial
considerations (exclusivity, size, viability, targets), length of agreement, renewal,
initial and continuing fees, methods and procedures for enforcement, the seven P’s of
marketing (price, people, promotion, place, process, physical evidence and product)
or for a globalising enterprise, a slight variant seven P’s31 (people, planet, profit,
passion, personal (relations), principles, priority). There are many practical decisions
including nature and range of services, training, design and layout, fit-out,
operational and interaction methods, protection of customer base, franchisee and
third party characteristics etcetera.32 The legal considerations to fulfil may stem
from property, competition, tax, employment, privacy, commercial and contractual
laws.
iii. Marketing the franchise package to would-be franchisees involves the preparati
marketing materials, determining recruitment method, interview and sel
procedures and financial arrangements. Disclosure, misrepresentation,
discrimination, contract and the protection of secret and confidential information are
the primary legal considerations at this stage.
on of
ection
e franchise contract may be signed
and binding obligations start to flow both ways. 34
33 Th
29 Ibid at 38-39. 30 Ibid at 39. 31 As found in many annual statements of multinationals. 32 Ibid at 40-41. 33 Ibid at 41.
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34 Ibid at 42.
iv. Opening for business requires transforming the new recruit into a fully trained
operator ready to trade. Site decisions, fit out, equipment, stocks and utilities are
dealt with in accordance with local practices.
v. The continuing long-term relationship has started and the franchisor wants to ensure
that the franchisee performs and that its system is protected in operation and from
unfair competition.35 The contract and its attached operating manual govern this
bond. Enforceable commitments are specified according to varying priorities and
legal constraints. Sanctity of contract is maintained in many jurisdictions.
vi. The termination of the contract requires a strategy to ensure continued survival under
expiring events and by providing for time and opportunity for curing defaults.36
vii. The consequences of termination calls for protection of the franchisor and the
franchise network against unfair post-termination competition especially through use
of know-how and other confidential information. This may require de-identifying
and providing for return or transfer of any specified items used in the franchise.
Another view that franchise lawyers consider is the centrality of intellectual property issues
since the protection of the brand is a key factor in storing accumulated value for any
venture, therefore first and foremost, protect the brand and its accumulated goodwill.
4.2 System Goodwill and Intellectual Property (IP) Issues
The most important asset being licensed is the IP and the fundamental principle of IP law
is that first in time means first in right, however, the manner in which the law governs the
IP and its various commercial recipes in each country is different. The collective system
goodwill is another aspect in need of protection to enable the franchisor to indefinitely reap
benefits of his or her original idea. IP rights are created through Trade Marks, copyrights,
designs and patents granting valuable monopoly rights to owners.37 Franchising is
essentially an IP licence (usually a trade mark) supplemented by a mandated system and
business format. A key factor for the franchise system’s success is the strength of the trade
35 Ibid.at 42-43. 36 Ibid at 43.
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37 Andrew Terry, ‘Legal Aspects of Brand Management’ School of Business Law and Tax, Australia School of Business, University of NSW.
mark. The value of brands can be many times more than all the physical assets owned by
it and the value of leading global brands relies on legal recognition and trade mark
protection.38
4.2.1 Registered Trademarks
Trade Mark protection is the law’s recognition of the psychological function of symbols
and is the primary legal expression of the marketing concept of brand, the oldest form of
IP.39 “The brand is an integrated perceptual structure or unity conceived as functionally
more than the sum of its parts”.40 The overall identity of the brand relates to consumers
and includes its many image associations that provide meaningful value for the purpose of
exchange.41 The law recognises and protects the brand either as a registered trademark,
identified by the symbol ® or as an unregistered trademark (‘TM’) thus maybe protected
by the common law tort of passing off or by actions for misleading or deceptive conduct by
pirates.
The territorial nature of trademark law and the lack of a single universal registration
system present many challenges to franchisors considering expanding to new markets.42
The extent to which exclusivity over franchise territories is granted has important
consequences for both parties, often defined in a way as to privilege franchisor interests
over franchisees. For franchisees, it determines insulation from competition within the
chain i.e. dilution of any monopoly power they might have. For franchisors, it determines
the leeway with which they can expand without being reliant on the franchisee’s plans.43
Nearly all countries have a system for registration and protection of distinctive trademarks,
mostly as a result of a non-negotiable obligation that arose out of the Agreement on Trade-
related aspects of Intellectual Property Rights44 (TRIPS) mandating minimum trademark
38 Andrew Terry and Heather Forrest (2008). ‘Where’s the Beef? Why Burger King is Hungry Jacks in Australia and other complications in building a global franchise brand’, 28 Northwestern Journal of International Law and Business 171, at part III. 39 Andrew Terry ‘Legal Aspects of Brand Management’ above n 37 at 2. 40 Red Bull Australia Pty Ltd v Sydneywide Distributors Pty Ltd [2001] FCA 1228 (Federal Court), upheld on appeal Sydneywide Distributors Pty Ltd v Red Bull Australia Pty Ltd [2002] FCAFC 157 (Full Court). 41 Ibid. 42 Terry A and Forrest H (2008). ‘Where’s the Beef?’ above n 38. 43 Alan Felstead, The corporate paradox above n 5 at 105.
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44 Agreement on Trade-Related Aspects of Intellectual Property Rights, Apr 15, 1994, Marrakesh Agreement Establishing the World Trade Organisation, Annex 1C, 1869 UNTS 299 (1994), available at; http://www.wto.org/english/tratop_e/trips_e/t_agm0_e.htm (accessed November 2010).
and IP protection for the members of the World Trade Organisation45. TRIPS incorporates
and binds members to uphold the Paris Convention for the Protection of Intellectual
Property46 which integrates basic principles of national treatment47 and most favoured
nation status.48 Significant inroads in harmonising trade mark registerability criteria and
the administration of the registration process was made by the Madrid Agreement49 and the
Madrid Protocol50.
The international procedural mechanism, the Madrid system51 offers a trademark owner
the possibility to have his trademark protected in several countries by simply filing o
application directly with his own national or regional trademark office. However, the IP
right is granted by a specific territory and is exercisable only within that territory’s
borders.
ne
52 En Bloc registration under the Madrid Protocol permits the filing, registration
and maintenance of trade mark rights in more than one jurisdiction, provided that the target
jurisdiction is a party to the system.
An international mark so registered is equivalent to an application or a registration of the
same mark effected directly in each of the countries designated by the applicant. If the
trademark office of a designated country does not refuse protection within a specified
period, the protection of the mark is the same as if it had been registered by that Office.
The Madrid system also simplifies greatly the subsequent management of the mark, since it
is possible to record subsequent changes or to renew the registration through a single
procedural step. Further countries may be designated subsequently.
An example of a registerable mark53 is;
any letter, word, name, signature, numeral, device, brand, heading, label, ticket, aspect of packaging, shape, colour, sound or scent used or intended to be used which can be graphically represented and is capable of distinguishing the applicant’s goods and/ or services relating to the trade mark sought for registration from the product of another,
45 With 150 members and 29 observer governments seeking accession. 46 Paris Convention for the Protection of Industrial Property, March 20, 1883, 21 UST 1583, 828 UNTS 305 as revised and amended in 1967 and 1979, available at; http://www.wipo.int/treaties/en/ip/paris/trtdocs_wo020.html (accessed November 2010). 47 That is, rights from the national system must be available to all member states. 48 Terry A and Forrest H (2008). ‘Where’s the Beef?’ above n 38 at part III. 49 Madrid Agreement Concerning the International Registration of Marks, Apr 14, 1891, 828 UNTS 389, as revised in 1967 and 1979, available at; http://www.wipo.int/madrid/en/legal_texts/trtdocs_wo015.html 50 Protocol Relating to the Madrid Agreement Concerning the International Registration of Marks, June 27, 1989, 28 Indus.Prop.L & Treaties 3-007, 001 (July-Aug. 1989). 51 The Madrid system is administered by the International Bureau of the World Intellectual Property Organisation (WIPO) in Geneva, Switzerland. Current membership of 84 countries. For more information see http://www.wipo.int/madrid/en/ 52 Terry A and Forrest H (2008). ‘Where’s the Beef?’ above n 38 at introduction.
12
53 Australian Trade Mark Act 1995.
and which is not substantially identical with or deceptively similar to another person’s TM registration or application. 54
The central concept of registrability is distinctiveness, that is, each mark must be capable
of distinguishing goods and or services from that of other traders. Registration is only for
that particular class. The Nice Classification is a system of classifying goods and services
for the purpose of registering trademarks specified by the World Intellectual Property
Organization. It groups products into 45 classes, 34 for goods and 11 classes embrace
services. Since the system is recognised in numerous countries, this makes applying for
trademarks internationally a more streamlined process.
Foreign trade marks adopted locally, sometimes coincidental but often intentionally and
simply a piratical manoeuvre by a shrewd individual or group poses the most serious threat
to global expansion of well-known brands.55 Strong reasons exist to use the same brand
for global consistency because goodwill crosses national boundaries and distribution,
patterns, packaging, communications etcetera are facilitated and made more efficient.56
The expanding franchisor may have to buy the right to use the trade mark from a pirate or
relinquish efficiencies by launching under a new brand. The Burger King and Hungry
Jacks cases57 highlight the need for caution and foresight58.
4.2.2 Unregistered Trademark
Under the ancient Assize of Bread and Ale enacted in the mid-thirteenth century, being the
first law in British history to regulate the production and sale of food, traders were required
to distinguish goods by marks to enable identification of manufacturers.59 One unintended
consequence was the promotion of branding. Unethical traders applied a competitor’s
brand to their less attractive product, which in turn demanded the common law to protect a
trader’s goodwill in his or her mark through an action now known as ‘passing off’.60
54 Ibid. 55 Terry A and Forrest H (2008). ‘Where’s the Beef?’ above n 38 at introduction. 56 Ibid. 57 Hungry Jack’s v Burger King [1999] NSWSC 1029; Burger King Corp v Hungry Jack’s Pty Ltd [2001] NSWCA 187. 58 Terry A and Forrest H (2008). ‘Where’s the Beef?’ above n 38 discusses the case in-depth. 59 Andrew Terry, ‘Legal Aspects of Brand Management’ above n 37 at 3.
13
60 Ibid.
The law of passing off can be summarised in one short general proposition – “no man [or
woman] may pass off his [or her] goods as those of another”.61 In practice, the plaintiff
must:62
i. Establish a goodwill or reputation attached to the goods or services;
ii. Demonstrate a misrepresentation by the defendant to the public (whether or not
intentional) leading or likely to lead the public to believe that the goods and services
offered by him [or her] are the goods or services of the plaintiff; and
iii. Demonstrate that the misrepresentation has caused or threatened damage to the
plaintiff’s reputation or goodwill.
In the branding space the common law passing off action and domestic statutorial action
may overlap providing additional protection.63 A severe limitation of the passing off
action is that “[a] plaintiff with a reputation in a brand in a particular geographic area may
succeed in restraining a competitor from carrying on business using that name in that area,
but will not succeed in restraining the defendant from using that name in areas where the
plaintiff has no prior reputation.”64 A substantial and long-established American
franchised system under the name “Taco Bell” could not restrain a Sydney restaurant from
carrying on business under the name because the Sydney restaurant had commenced
business four years before the US company commenced operation in Sydney.65 The more
liberal approaches now allow traders a right to protect promotional as well as trading
goodwill in a range of circumstances.
[Passing off] is wide enough to encompass other descriptive material, such as slogans or visual images, which radio, television or newspaper advertising campaigns can lead the market to associate with a plaintiff’s product, provided always that such descriptive material has become part of the goodwill of the product.66
61 Ibid at 4 quoting from Reckitt & Colman Ltd v Borden Inc (1990) 17 IPR 1, 7 per Lord Oliver. 62 Erwen Warnick BV v Townend & Sons (Hull) Ltd [1979] AC 731 (House of Lords); ConAgra Inc v McCain Foods (Aust) Pty Ltd (1992) 33 FLR 302 (Full Federal Court). 63 Andrew Terry, ‘Legal Aspects of Brand Management’ above n 37 at 4. 64 Ibid at 5. See for example, Targetts Pty Ltd v Target Australia Pty [1993] FCA 191, where the litigant had 82 discount stores throughout Australia, but was restrained from using its name in connection with any business of retail sale of clothing, footwear or Manchester products within 30 kilometres of a certain intersection in Launceston Tasmania. In that are, the reputation in the substantially identical name “Targetts” resided with a local department store. 65 Taco Co of Australia Inc v Taco Bell Pty Ltd (1982) 42 ALR 177. Example cited in Andrew Terry, ‘Legal Aspects of Brand Management’ above n 37 at 5. The law has since been replaced by a more liberal approach laid down by the Full Federal Court in ConAgra Inc v McCain Foods (Aust) Pty Ltd (1992) 33 FCR 302 holding that it was not necessary for a trader to have a place of business or even trade in Australia to be successful in maintaining a passing off action.
14
66 Per Lord Scarman in Cadbury Schweppes Pty Ltd v Pub Squash Co Pty Ltd (1981) 55 ALJR 333 at 336.
Whatever the method of protecting the intellectual property is chosen by the ultimate idea
owner, the spread through licensing of this property depends on the relationship formed by
the agreement which spells out the laws governing the bonds of franchise that deliver the
values to the end-users.
4.3 The Franchise Agreement
For a good agreement, an understanding of basic contract principles, franchise regulations,
local and international trade practices, competition legislation, trademark laws and the
application of franchise related common law is prerequisite, followed by periodic review
and updates.67 The agreement is part of a set of documents including an initial Franchise
Application that is required before releasing the standard franchise agreement, with a
conditional deposit or other fees. Upon satisfactory application, the franchise agreement is
released that may include assignments, guarantees, user agreements for trade marks,
security agreement to protect disbursements owned to the franchisor and leasing
arrangements for any real property or arrangements for other assets required for the
venture.68
Each contract needs careful drafting with the franchisor’s intentions in mind, relating to the
specific type of franchise business, proven success, allocation of risks and responsibilities
amongst the parties.69 Specific clauses cover every intricate detail of operations and the
very fine print is in the operations manual. But, no matter how much drafting is done,
ultimately the contract is incomplete.70 The relational-standard form nature of the contract
‘completes’ the transaction through operational controls and by retention of ownership of
the key elements required for the franchise’s indefinite operations.
67 Frank Zeid (editor), Legal Analysis of Typical Franchise Agreement, from Canadian Franchise Guide, Carswell. 68 Ibid. 69 Ibid.
15
70 Gillian Hadfield (1990). “Problematic Relations: Franchising and the Law of Incomplete Contracts”, 42 Stanford Law Review 927 at 947. See paragraph below on indefinable terms for an ‘incomplete contract argument’.
4.4 Indefinable Terms of Franchise Contract
Franchise contracts are by necessity incomplete “because mutual desires for flexible, but
bounded, responses to uncertain future conditions limit the scope and precision of
verifiable terms”.71 Contractual incompleteness and relational complexity amongst parties,
who are not strangers, allow them to interact and balance various elements while ensuring
accumulated reputation capital of franchisor’s brand is forever maintained.72 The
incomplete nature of the franchise contract73 provides the opportunity for successful, yet
flexible coercion of resources to fulfil consumer demands. Disputes tend to centre on
formal and actual exercise of unfettered powers, yet despite relational constraints and some
business rationale for the franchise parties’ actions, courts will not interfere to address the
true nature of the exchange.74 Hadfield concludes that commitments stem not just from the
written document but also from the common understanding of the relationship, therefore its
content must be understood in order to enable proper enforcement of the true franchise
exchange.75
Andrew Terry examines76 the underlying relational considerations that influenced the
judgement in Dymocks Franchise Systems (NSW) Pty Ltd v Todd 77 which supports a wider
look at franchising relationships than just the contract provisions. The relational vibe is the
dominant quality likely to be more influential in franchising litigation.78
4.5 Relational-Standard Form Contract
The contract governing the relationship is commercially grounded. The franchise
agreement is the primary franchise document placing legally binding obligations and duties
on both parties. The document is often a standard form contract and any departures from
the printed form are rare with little or no room for variation, that is, the contract is non-
negotiable and offered on a take-it-or-leave-it basis.79 Dr Elizabeth Spencer outlines the
essential attributes of both standard form and relational contracts, and discusses how
71 Ibid at 927-928. 72 Ibid at 928. 73 Ibid at 947. 74 Ibid at 992. 75 Ibid at 992. 76 Andrew Terry (2005). ‘Franchising, Relational Contracts and the Vibe’, 33 ABLR 287. 77 Dymocks Franchise Systems (NSW) Pty Ltd v Todd [2002] 2 All ER (Comm) 849. 78 Andrew Terry (2005) above n 76.
16
79 Alan Felstead, The corporate paradox above n 5 at 95.
unequal bargaining power, lack of negotiation of standard form, reliance on relational
flexibility, implicit trust to reinforce imbalance of power in relationship and the higher
risks and uncertainty to the franchisee create problems that only compound when statutory
regulation focuses on contract formation while neglecting relational qualities.80 Her article
concludes with a call for revision to account for the combined effects of standard form and
relational nature at all levels in the relationship.81
Franchisees have little bargaining power because they are seeking to use the accumulated
experience; know-how and trade mark of the franchisor, and are economically inferior to
the franchisor whilst suffering from unequal access to relevant information. The clauses in
the agreement impose far more requirements on the franchisees than the franchisor and
differences exist in detail, level of specification and the degree of flexibility applied in
practice.82 Franchisors retain control over key strategic decisions and take some of what is
produced as a result. Hadfield examined this interplay underlying the relational structure
including factors such as superiority, experience (or lack of it), intimacy and
interdependence that gives rise to potential for conflict.83 The relational structure, norms
and practice is important to identify the incomplete content of the relationship.84
This is also revealed in the contract in three ways85; the controls placed on the operation of
the business; the payments made by the franchisee to the franchisor86; and the retention of
key elements of the business apparatus by the franchisor.
80 Dr Elizabeth Spencer (2008). ‘Unintended (or are they?) Consequences: the interaction of standard form and relational contracting in franchising’, Franchise Law Symposium, Bond University, November. 81 Ibid. 82 Alan Felstead, The corporate paradox above n 5 at 96. 83 Gillian Hadfield (1990). “Problematic Relations” above n 70 at 955-969. 84 Ibid at 991-992. 85 Alan Felstead, The corporate paradox above n 5 at 97.
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86 Note that reciprocity is identified as a key motivational factor.
4.5.1 Operational Controls
As Lucchesi puts it to Michael Corleone "[We gladly put you at the helm of our little
fleet,] but our ships must all sail in the same direction. Otherwise, who can say how long
your stay with us will last. It's not personal, it's only business. You should know."87
Despite the absence of a boss, the franchisees are required to operate within procedures
laid down and subject to unilateral change by the franchisor and maybe committed to
adhere to franchisor-set performance targets and give primacy to franchisors’ turnover
maximisation goals. Franchisees appropriate profits and losses only after they have made
turnover related payments to the franchisor. Although the franchisees buy or lease much
of the physical business apparatus, some parts remain with franchisor and restrictions may
exist on their use during and after the currency of the agreement.88 The business idea,
name and format is simply ‘borrowed’.
“Since the provisions of the operating manual can be changed at the prerogative of the
franchisor, the franchisees find themselves in the tenuous position of being bound to a
contract that can be modified unilaterally by the franchisor.”89 However, changes can only
be made if they do not contradict other clauses in the contract.
Operational controls are designed to regulate day-to-day business so as to convey a
common, uniform image to the consumers and to shape the longer-term development of the
franchisee’s business.90 The franchisee is buying the right to operate on a pre-determined
basis and the detailed minimum standards are laid down in the operations manual. These
standards may relate to a number of issues such as, size, layout, décor of premises,
organisation and staffing, technical training, service facilities and equipment, to receiving
and handling customers, accounting and stocking systems, and to advertising and sales
promotion. The franchisor is usually allowed to unilaterally ‘make amendments,
alterations and improvements to the operations manual from time to time’. “In effect, this
commits the franchisee to an open-ended agreement.91
87 Mario Puzo and Francis Ford Coppola (1990). The Godfather; Part III. Paramount Pictures. 88 Alan Felstead, The corporate paradox above n 5 at 191. 89 Hunt SD (1972). ‘The socioeconomic consequences of the franchise system of distribution’, Journal of Marketing, vol.36, July, 32-38 at 36-37. 90 Alan Felstead, The corporate paradox above n 5 at 98.
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91 Ibid at 100.
The importance placed on uniformity has a determining influence on the degree of outlet
monitoring required, and this may be stipulated in the contract to be with or without
warning.92 In sectors where uniformity is less important, monitoring is less stringent
especially where the scope for customers to compare products or services across the chain
is limited.93 Minimum quality standards and keeping track of complaints may suffice but
the most important standardisation device is the initial training instead of ongoing
monitoring.94 The potency of these factors is determined by the franchisor through the
contract and the nature of the product market that franchisees face.
Operational control of the franchisee’s business is through certain inter-related factors
contained in the operations manual which is incorporated with the franchise contract.
More complete and in-depth detail in the manual increases the potential for uniformity and
details may be updated regularly through bulletins announcing new regulations.95 “The
provisions applying to the franchisee tend to say that ‘the franchisee will do such and such
at a given place, in a specific amount of time, and in a particular manner’. On the other
hand, franchisor provisions are inclined to be more vague and are hedged in limiting
phrases, such as ‘the franchisor at its sole discretion’, ‘at a time and place chosen by the
franchisor’ and ‘the franchisor reserves the right to vary its policy with regard to X, Y and
Z from time to time in the light of experience’.”96
Another factor that gives franchisors operational control over franchisees, concerns the
specificity of the product or service supplied at the outlet, but this varies significantly for
different industries, for example, fast food products are highly specified whereas car
servicing is determined by the franchisees expertise, so the manual may only provide a
guide to bespoke production.97 A third factor is the need for uniformity which seeks to
address an externality problem, that is, if any one franchisee allows quality to deteriorate
and benefits from savings of the reduced quality while customers perceive the quality to be
the same as other outlets bearing the same trade mark thus benefiting at the expense of
other franchisees.98 “The credibility, viability and enforceability of the [franchise] system
92 Ibid at 119. 93 Ibid at 121. 94 Ibid at 121. 95 Luxenberg S (1985). Roadside Empires: How the chains franchised America, Viking Penguin: New York, at 78-79. 96 Alan Felstead, The corporate paradox above n 5 at 96. 97 Felstead A (1988). ‘Technological change, industrial relations and the small firm: a study of small printing firms’, unpublished PhD, University of London.
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98 Alan Felstead, The corporate paradox above n 5 at 119.
is at stake, if [the franchisee] can thumb his nose at the system and its standards then so too
can operators everywhere.”99
[F]ranchisors are armed with a whole battery of control mechanisms designed to induce franchisees into their service. The contract gives franchisors powers to curb individual flair for the sake of uniformity and to ensure that their economic interests are given primacy in the running of the outlet, despite a substantial sum of investment by the franchisee.100
Different circumstances may lead either to rigid imposition of the terms of contract or the
franchisors may choose to turn a blind eye. Contracts may be ‘used’ in two ways; regulate
the ongoing relationship with certain clauses enforced or through contractual remedies in
the event of something going wrong.101 The use of such powers varies from franchise to
franchise.
4.5.2 Retention of Ownership of Key Elements
Franchisors retain ownership of the intangible business assets and may also exercise a
‘hold’ over many tangible assets as well, for example, franchisee’s right to assign only to
approved buyer or a ‘stake’ in site or equipment. Production requires upfront capital to
buy the tangible assets, use of tangible and intangible assets combined with labour efforts
into a working format. The franchisor secures an on-going source of revenue on basis of
supplying the franchisees with a format that ‘works’ but to sustain revenues, access to the
business format must be limited, otherwise it would be available to all at no cost.102 For
example, early franchisors failed to appreciate this point; McDonald’s generously shared
information about their production procedures, equipment and suppliers, so no one needed
a franchise to learn the ‘secret’ and many imitators set up competition. “By restricting the
transfer of relevant ‘know-how’ and accumulated business experience to its franchisees
alone, a franchisor is able to engender a dependent relationship from which a return can
then be drawn”.103
Control of intangible assets is retained by the franchisor through non-competition and non-
solicitation clauses prevalent in franchise agreements. Both types of clauses prevent
99 Dayan v McDonald’s Corporation [1982], unpublished, at 83 per Judge Curry’s opinion. 100 Alan Felstead, The corporate paradox above n 5 at 107. 101 Beale H and Dugdale T (1975). ‘Contracts between businessmen: planning and the use of contractual remedies’, British Journal of Law and Society, vol.2, no.1, Summer 45-60. 102 Alan Felstead, The corporate paradox above n 5 at 110.
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103 Alan Felstead, The corporate paradox above n 5 at 111.
former franchisees from competing with the franchisor’s business through use of contacts,
acquaintances and other knowledge acquired through the franchise but must be of limited
duration and geographical scope to be enforceable.104 “[A] good deal of legal ‘know-how’
is required for the successful drafting of a restrictive covenant.”105 Much turns on the
court’s interpretation of the wording used.
Another common way to gain enhanced control over franchisees is through stake in the
property on which the branch is built. The franchisor owns the head-lease and sublets to
the franchisee. The best known examples are McDonald’s and Dunkin’ Donuts.
“[F]ranchisees have virtually no ownership rights in the intangible business assets and only
restricted rights in the more tangible ones”.106
5.0 The Franchise Paradox
Franchisees operate businesses that are neither independent nor subsidiaries of another
company. They can be more aptly considered to be ‘betwixt and between’ these two
extremes.107 This is reflected in the ambiguous nature of the franchisee’s status;
sometimes acting and responding like employees, while at other times resembling
independent businesses. Prima facie, franchisees are legally independent from franchisor
and others in chain, yet they trade in much the same way and under a common brand name
as those from whom they are supposed to be autonomous.108 This paradox is examined in
light of the forces of autonomy versus control, and determining who has the upper hand.
The mechanisms of control remain in the hands of franchisors, which allow them to shape
and reshape how franchisees do business in spite of the fact that franchisees remain legally
independent of the franchisor, invest their own money and take on greater risks implying
that one party has the ability to wield power over another despite appearances to the
contrary.109
104 Aikin O (1991). ‘Creating workable restraint clauses’, Personnel Management, vol.20, no.10, 89-90. 105 Person LJ in Commercial Plastics Ltd v Vincent [1964] 3 All ER 546 at 555. 106 Alan Felstead, The corporate paradox above n 5 at 114. 107 Office Overload Ltd v Gunn [1977] FSR 39 CA. 108 Alan Felstead, The corporate paradox above n 5 at 37.
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109 Ibid at 202.
5.1 Economics of Franchising
The difficulties in franchising arise from its basic structure, that is, the franchisor needs to
control the franchisees delivery of the output from the franchisor’s system, and this creates
the franchisee’s problem of opportunistic use of that control power that leads to potential
conflicts of interest.110 The franchisor’s quality control problem is a result of the system’s
differentiated output that consumers expect and are willing to pay for, and to fulfil this
expectation, the system needs to be implemented correctly at the retail level.111
The trademark is a storage medium of value, and a better store of values means enhanced
financial gains.112 Values are vulnerable to franchisee free-riding, a principle-agent
problem in economic literature that pervades almost all organisational forms.113 The
greater control problem, however, is the divergence between franchisee and franchisor.114
A franchisee wants to maximise her profits from the operation of the outlet; she does not wish to undertake any efforts or expenditures that will not compensate the undertaking. On the other hand, once a franchisor establishes a particular franchise, it aspires to sell more franchises and increase royalty revenues.115
Unrestricted control by the franchisor will favour franchisor’s interest and create risks of
opportunism.116 The franchisee’s investments are usually a sunk cost, which cannot be
easily recovered in case of business failure thus creating an important incentive for an
established relationship.117 The conundrum is that the franchisee cannot abandon the
investment and the franchisor can create situation where loses induced, for example, raise
costs at franchisee’s expense.118 Deciding whether the exercise of control was legitimate
or opportunistic is difficult and this is why franchise contracts are incomplete because the
task is too enormous to write in every detail of a long-term relationship.119 The
consequence of these unsolved problems is constant re-interpretation and enforcement in
light of given resources and abilities.
110 Gillian Hadfield (1990). “Problematic Relations” above n 70 at 949. 111 Ibid at 950. 112 Ibid. 113 Ibid. 114 Ibid. 115 Ibid. 116 Ibid at 951. 117 Ibid at 951. 118 Ibid at 951-952.
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119 Ibid at 953.
Commitments to take or refrain from taking certain actions are indispensable elements in
interaction and exchange transactions.120 As the transaction spreads out over time and
becomes more complex, more solid grounding is required, and is therefore provided by the
contract.121 “The philosophy underlying the nineteenth century ideal of ‘sanctity of
contract’ is that both parties to the contract are approximately equal and enter into it
without coercion. However, the franchisee does not bargain with the franchisor as an
equal.”122 Franchisees are economically inferior to franchisors, and without access to the
franchisor’s accumulated knowledge, experience and trade mark as well as contractual ties,
the franchisees business aspirations will remain difficult if not impossible. “The most
obvious consequence of this situation is to make the franchisee dependent on their
franchisor”, thus a key source of power in the organisation.123 “Power is having something
that somebody else wants”.124
The franchisor relies on the franchisees’ money capital to expand their network and
substantially reduce risks to the franchisor should an outlet fail. The franchisee bears the
greater financial risk should the business make a loss, yet shares the profits with the
franchisor when trading profitably.125 “[T]he legal ‘independence’ of franchisees belies
the economic fact that, despite bearing most of the risk of setting up a branch, they are not
able to reap the full rewards of their own efforts.”126
5.1.1 Transaction Costs of Franchising
The existence of transaction costs rests on the combination of certain human attributes and
presence of certain environmental factors. The behavioural factors are bounded rationality
and opportunism; and the environmental factors are uncertainty, complexity and small
business exchange.127 Bounded rationality specifies a state in which players have limited
analytical and data processing capabilities therefore limits to formulating and solving
complex problems. If not for bounded rationality, all economic exchange could be
organised through contracts written for each and every contingency.128 Costs could be
120 Ibid at 927. 121 Ibid at 927. 122 Alan Felstead, The corporate paradox above n 5 at 77-78. 123 Pfeffer J (1981). Power in Organizations, Pitman: Boston, Massachusetts. 124 Farney quoted in Pfeffer (1981) ibid at 100. 125 Alan Felstead, The corporate paradox above n 5 at 107. 126 Ibid at 109. 127 Ibid at 62-63.
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128 Debreu G (1959). Theory of Value. Yale University Press, New Haven, Conn., London.
reduced in a more certain and uncomplicated world. But for the simultaneous existence of
both bounded rationality and opportunism; contracting problems are trivial, that is, the
presence of bounded rationality precludes complete ex ante contracting, thereby rendering
all contracts incomplete.
The interplay of relational and standard form nature of the franchise contract may help
reduce transaction costs.129
Tying the franchisor’s income to the fortunes of the franchise network (either by levying a royalty on franchisee turnover, marking-up supplies or simply providing a distribution outlet for finished goods) ensures that franchisors bear some of the costs of the opportunistic behaviour of their franchisees. Franchisors therefore stand to lose out, both in terms of the falling value of the franchise chain and more immediately in falling revenue from the network, should franchisees ‘skimp’ on quality. The immediacy of falling revenue heightens franchisor incentives to maintain quality levels; franchisors therefore have a particular interest in closely monitoring the quality of the goods produced or services supplied.130
If a minimalist approach is taken we can lower transactions costs and create economic
growth prospects by removing legal shackles hindering the spread of what could otherwise
be very successful franchises. A pre-determined set of high values;
Franchisees’ customers value the trade mark as providing information about the price and reassurance of a minimum level of quality of goods and services sold by establishments bearing a given trade mark. Those who buy from the franchisees have this information precisely because the franchisor polices the system and maintains quality according to a pre-determined set of standards.131
Franchisors possess a brand, idea or format (i.e. ‘know-how’), and the business is shaped
according to the franchisor’s accumulated experience. Many franchise businesses would
not exist without the franchisor’s scarce knowledge, thus they properly seek rewards from
a competitive market place.132 In franchising, the economic power is exercised by
controlling the use of intangible assets such as the trade mark, idea and format.
Conflict of interest is also evident in determination of pricing as long as the franchisor
receives royalty from revenues.133 The franchisor aims to maximise outlet turnover
whereas the franchisee seeks profit maximisation. Revenue or other performance targets
129 Dr Elizabeth Spencer (2008) above n 80. 130 Alan Felstead, The corporate paradox above n 5 at 67-68. 131 Ibid. 132 Marglin SA (1984). ‘Knowledge and power’, in Stephen FH (ed.) Firms, Organization and Labour: Approaches to the Economics of Work Organization, Macmillan: London.
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133 Alan Felstead, The corporate paradox above n 5 at 102.
are set unilaterally by the franchisor and should the franchisee fail to meet targets, the
franchisor may invoke remedies such as the right to appoint a manager or the ultimate
sanction of revoking the agreement.134 On the other hand, if targets are being met easily
then it may be necessary to invoke expansion triggers in the contract (if any) so as not to
let sales go begging.
An economic perspective highlights how a franchise exchange may achieve balance as
risks to the franchisee are reduced through the experienced and sophisticated business
practices of the franchisor.135 The franchisee relies on the superior knowledge and follows
directives.136 In practice, a significant balancing act is played by the relational norms that
deliver on the commitments.137 Opportunism necessitates various institutional devices to
deter malpractice resulting from this economic conundrum during the life of the contract
and is the subject of much regulatory debate.138
5.2 Regulatory Debates
Many forces and actors contribute to the regulatory process (meta-regulation) as they try to
move away from command and control structures to delegated regulation to networks of
stakeholders, policy makers, consumers and international organisations.139
A recent contribution of normative economics to the search for a rational division of
powers and the unification of law explains the advantages in any unified substantive
economic (framework) policy (in contrast to process oriented policy); unification
contributes to securing the freedom of the individual, it increases the certainty and the
knowledge of laws, and it improves the efficiency of economic organisation.140 However,
being too perfectionist at harmonisation entails too many controversies beyond the scope
of this essay. The real dilemma well known in business and antitrust law is that;
134 Ibid at 104-105. 135 Gillian Hadfield (1990). “Problematic Relations” above n 70 at 991-992. 136 Ibid. 137 Ibid at 930. See for example, Stewart Macaulay’s demonstration of how disputes in automobile franchises are often resolved on the basis of relational norms instead of contractual terms. Stewart Macaulay (1966). Law and the Balance of Power. 138 Alan Felstead, The corporate paradox above n 5 at 63. 139 Dr Elizabeth Spencer (2008) above n 80.
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140 Bernholz & Faber (1986), “Uberlegungen zu einer normativen okonomuschen Theorie der Rechtsvereinheitlichung,” 50 RabelsZ 35-60 at 41.
too much law impairs the development and innovativeness of markets, too little law leads to abuses and ultimately to the perversion of the free markets themselves. The answer may lie in the elaboration of market law (framework policy) and key rule harmonization (which is not the same as minimum harmonisation).141
An antipodean analysis may give support to this proposition, for example, in June 2009
New Zealand’s Minister of Commerce announced, following a full assessment of the
industry, that no franchise specific regulation was required.142 The decision was
influenced by a change of power to a Conservative Government with election pledges of
limited interference with business and regulatory requirements, an observation that
extensive disclosure requirements in overseas markets fail to remedy the imbalance of
knowledge and negotiating power because they are so long and detailed that the very
people who are intended to benefit from them would be unlikely to read them and a well
structured voluntary scheme may prove suffice.143 It is no surprise that New Zealand ranks
third in overall ease of doing business indicators.144 Nonetheless, a large number of trade,
consumer, competition (anti-trust) and other commercial legal and practice protections or
requirements provide a more reliable business environment without the unnecessary
baggage. Isolated examples of misrepresentation at the criminal end of the scale and
concerns about the potential for an overeager franchisor to misrepresent business
opportunities is not evidence of endemic fraud or misleading conduct. Clear cases of fraud
can be addressed through criminal prosecution, whilst allegations of misrepresentations
may be resolved through dispute resolution processes or through the Courts.145
Australia, despite its vast reservoir of untapped resources, territorial superiority and many
other advantages, ranks tenth in ease of doing business perhaps indicating anomalies in
policy regulating business activity, of which franchising is a significant portion. The
Franchising Code of Conduct is Australia’s mandatory franchising code and was the
Government’s response to the 1997 Fair Trading Report that cited issues of high economic
costs, such as no returns on sunk costs, market inefficiencies out of exploitative conduct
141 Buxbaum RM and Hopt KJ (1988). Legal harmonization and the Business Enterprise: Corporate and capital market law harmonization policy in Europe and the USA. Integration through Law; Europe and the American Federal Experience Vol.4, Walter de Gruyter, Berlin, at 263. 142 Ministry of Economic Development, Review of Franchising Regulation in New Zealand, Discussion Document August 2008. 143 Cotterill D (2009). ‘Franchising in New Zealand’, available at http://www.taglaw.com/index.php?option=com_content&view=article&id=1404:franchising-in-new-zealand&catid=150&Itemid=100082 (accessed 8th November 2010). 144 http://www.doingbusiness.org/rankings
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145 David v TFAC Limited CA26/2008 involving a home services master franchisee which sued the New Zealand master franchisor for return of their purchase price based on misrepresentation is a classic example of ‘buyers remorse’ and the Court of Appeal leaned on the black letter contract law and did not consider franchisees to be in need of consumer-like protection.
and implications for employment and growth; and social costs of business failure, such as
stress, marriage breakdowns and poor health.146 Accompanying the Code was a
prohibition on misleading, deceptive and unconscionable conduct.147 Although Australia
has comprehensive regulation, inquiries in 2008 suggest concern at a lack of an
overarching standard of conduct for the conduct of parties in a franchise contract.148
Most countries continue to rely on underlying commercial laws to regulate franchising
supplemented by voluntary self-regulatory codes of practice, however; there has been a
clear move towards dedicated regulation over the past decade,149 for example China
introduced a regulation on the Administration of Commercial franchises in 2007, Vietnam
has a modern and well-drafted law since 2005, Korea introduced the Fair Franchise
Transaction Act 2002 (amended 2007). However, the top three countries for doing
business are Singapore, Hong Kong and New Zealand, and all three have comprehensive
voluntary self-regulation administered by a national franchise association.150
Business are shaped by regulation and administration by government, the challenge is for
unregulated sectors to either adapt to ‘proper conduct’ voluntarily and build sufficient
protections under general commercial law or provide official recognition with specific
regulation. “The most successful systems are innovative, dynamic and responsive”.151 The
regulatory environment must be designed to be supportive of innovative, dynamic and
responsive structures to allow commerce to freely occur in the marketplace hence
contribute to developing economies.
Another threat is that despite efforts, harmonization may remain merely a formality
without true behavioural change.152 It has been suggested that significant legal integration,
at least on the legislative scene will take place ‘from below’ or at least not only ‘from
above’.153
146 Andrew Terry, “Franchise Regulation in Asia: A Comparative Study”, 6th Asian Law Institute Conference, Hong Kong 29/30 May 2009. 147 Trade Practices Act 1974(Cth) ss 51AC and 52. 148 Andrew Terry, “Franchise Regulation in Asia” above n 146. 149 Ibid. 150 Ibid. 151 Andrew Terry (2005) above n 37 at 25. 152 Buxbaum & Hopt above n 141 at 266.
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153 Ibid at 271. For Legal Harmonization in general, see the study by Kotz, “Rechtsvereinheitlichung – Nutzen, Kosten, Methoden, Ziele,” 50 RabelsZ 1-18, esp. at 12 (1986) (with English Summary).
5.3 Other Complications in Building a Global Brand
There is no formal strategic guide for even the most successful cultural brands.154
Building a global iconic brand requires a build up of customer experiences and marketing
to create meaningful associations for repeat patronage.155 Brands become powerful
because the collective nature of individual perceptions continually reinforces stories that
are treated as truth in everyday interactions.156 Customers value brands for their identity
values, that is, stories that consumers find valuable in constructing their identities. The
myth eventually resides in the markers.
Developments over the last century influenced by mass marketing of consumer goods and
more recently services combined with increase in legal protection has enabled brand
owners to build set of values, both tangible and intangible, which are appropriate and
attractive to consumers and conducive to development of customer loyalty.157 There is no
reason to alter this commercially beneficial idea-spreading virus; in fact, there is more
reason to ensure removal of barriers and harmonisation of key rule principles that may
boost viral branding.158 The next chapter, on open source franchising looks at a franchise
law beyond contractual boundaries and provides hints at establishing self-managing, well-
known and individually-tailored global brands that benefits all the parties linked in the
chain that eventually provides the experience satisfying the desire that gave rise to an idea.
“We must become the change we wish to see”. Mahatma Gandhi.
6.0 Open-Source Franchising
Modern organisational responses call for a move towards systems that coordinate cross-
unit networks and elicit cooperation of branches rather than ordering it as in a hub-and-
spoke mode.159 The idea of a ‘flexible firm’ that reins in its frontiers and includes only a
narrow ‘core’ of workers that can still exercise various degrees of control over those
154 Douglas B Holt (2004). How brands become icons: the principles of cultural branding. Harvard Business School Publishing, Boston, Massachusetts at xi. 155 Douglas B Holt (2004). How brands become icons at 3. 156 Ibid at 3. 157 Andrew Terry ‘Legal aspects of Brand Management’, above n 37. 158 Douglas B Holt (2004). How brands become icons.
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159 Bartlett CA and Ghoshal S, Managing across borders: new organizational responses’, in Gupta AK and Westney DE (2003, eds.). Smart Globalization: Designing global strategies, creating global networks. MIT Sloan Management Review Series, Jossey-Bass, San Francisco.
operating on the ‘periphery’160; the underlying relationship is commercial rather than
employment.161 Apparently there is a movement towards more market-based business
relationships.162 Andrew Selden examined the evolution of the American franchise system
organisation and design of their internal governance structures in reconciling the divergent
interests of the franchisor and franchisee communities.163 He concludes with suggestions
for a baseline public sector support necessary for an environment in which parties can
establish effective private sector solutions to the franchise relationship management
challenges.164
6.1 Self-Managing Franchise Relationships
The problems plaguing franchise relationships are not irreconcilable.165 In fact a large,
diverse and growing body of non-legal academic research on networked businesses,
including franchise systems, already explores in great depth the underlying structure and
operations of such systems.166 Franchising provides a strategic alliance between
autonomous partners bound by contract and when practiced successfully, it leverages
parties’ very different resources and skills to generate mutual benefits in the form of a
shared business enterprise.167
The law has struggled to grasp this unique character and efforts by franchisees to import
countervailing principles from other two-party and semi-adversarial legal relationships, for
example fiduciary duties as in partnerships, have mostly been rejected by the courts of
law.168 The fundamental business of the franchisor is very different to the franchisee in
goals, perspectives and necessary resources.169 The franchisor is a licensor of intellectual
property and is primarily concerned with maximum commercial exploitation of it through
whatever means available, whereas the franchisee is engaged in a retail operation, selling
the goods and or services represented by the system’s brand identity in order to maximise
160 Alan Felstead, The corporate paradox above n 5 at 11 161 A good retail example is H & M; see www.hm.com 162 Child J (1987), ‘Information technology, organisation and the response to strategic challenges’, paper presented at the 8th EGOS Colloquium, Antwerp. 163 Andrew Selden (2008). Beyond the Law and the Contracts above n 4. 164 Ibid. 165 Ibid at 3-4. 166 Ibid. 167 Ibid. 168 Ibid.
29
169 Ibid at 3-7.
the bottom-line.170 With differing goals and expectations, the potential for conflict is only
exasperated by information imbalance that breeds unequal bargaining power in
coordinating strategies and allocating gains.171
Command and control hierarchies, inherited from the traditional forms of franchising, have
proven counter-productive as problems increase with the system’s growth, age and
experience.172 The key correlates for a franchise system’s commercial success should now
include factors such as role integrity, loyalty, trust, commitment, solidarity, equity,
mutuality, flexibility and restraint in the use of power within the relationship.173 These
form the key drivers behind the Franchisee Perceived Relationship Value (FPRV), the
result of a study that analysed exchanges in franchise relationships as functions of
combinations of self-interest, cooperation, reciprocity and increasing mutual benefit.174
Reciprocity being the key driver for satisfaction is therefore of critical importance to
developing open-source business systems as motivational satisfaction is built-in with the
new structure. Traditional structures must be replaced by formalised active collaborative
ones that formally coordinate inter-organisational strategies under prevailing conditions.175
6.2 The Collaborative Franchise System
A structure for system of governance through joint, collaborative interaction of the
franchisor and a franchisee association allows for differences of opinion and heated debate
but it produces an outcome that both parties feel they can ‘live with’ precisely because the
process represents and respects the goals and interests of both sides.176 Figure 2 represents
an idealized depiction of a collaborative franchise system governance structure, illustrating
how all organs of the business can participate and relate to a collaborative decision-making
apparatus.177
170 Ibid. 171 Ibid. 172 Ibid. 173 Ibid at 4-5. 174 Tracey R Harmon & Merlyn A Griffiths (2008), ‘Franchisee Perceived Relationship Value’, 23 J. Bus & Indus. Marketing 256. 175 Andrew Selden (2008). Beyond the Law and the Contracts above n 4 at 4-5. 176 Ibid at 18.
30
177 Ibid.
Figure 2.
Because of the central role of the original ‘creator’; the franchisor or owner, in organising
the various entities to become self-managing; their fortunes must be assured; as the entire
group grows, the most fair and equitable reward as per their wish should be provided;
investors will withdraw the most financial rewards whilst others in the chain will also get
their ‘fair share’. These are normative ideals and the age old questions of what is ‘fair and
just’ can potentially be answered by market dynamics for the specific outlet(s), perhaps
eliminating business privacy in the transition because the brand vehicle is being driven by
the informed consumer, some may say it is already happening, for example with Google
have spread the myth of ‘don’t be evil’ backed up by a most powerful system onto the
world wide web infrastructure, they removed the greed and let the pure idea flow freely; it
became well-known and then benefits reverted back to its owners in insurmountable ways.
Google found novel ways of generating revenue178 whilst continuously re-inventing its
image and using its information base for global benefits. A lot of win-win-win results but
now they also have to deal with privacy issues.
Other concepts that may lend support to such structures, may be imported from other legal
disciplines, for example, resource sharing concepts developed by environmental lawyers,
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178 For example through AdWords that charge businesses for delivering their image across to anyone with internet access modified to their locality and nature of the website.
such as equitable benefit-sharing schemes, sustainability etcetera may provide additional
sustenance.
6.3 Becoming, then Remaining Well-Known
Sir Edward Bernay’s believed that “[t]he engineering of consent is the very essence of the
democratic process, the freedom to persuade and suggest”.179 “The conscious and
intelligent manipulation of the organised habits and opinions of the masses is an important
element in democratic society. We are governed, our minds are molded, our tastes formed,
our ideas suggested, largely by [people] we have never heard of. This is a logical result of
the way in which our democratic [societies are] organised.”180
Iconic brands have extraordinary value because they address collective anxieties and
desires of nation(s).181 Similarities result because identity is constructed in response to the
same or similar historical changes that influenced the nation built through mass media
perhaps by use of identity myths such as imaginary stories or other aspirations of
identity.182 The myth eventually resides in the markers and consumers experience the
myth when using or interacting with the end-good or service therefore forming a tight
emotional connection to the brand.183 Becoming well-known and famous (in order to
benefit in some way) is the purpose of a business’s expansion plans, it is not being
suggested that every brand will achieve this purpose, however unfettered expansion is
possible for many, as yet, unknown brands.
Having formed an idea that engenders the consent of the masses, all it takes for an idea
owner to begin franchising… “is the desire to [enter] and the ability to convince at least
one other person (a potential franchisee) that he or she should buy the right to operate a
business under the franchisor’s trade mark and to abide by certain contractual
conditions.”184 The key advantage with franchising is that it has few natural barriers to
entry for potential franchisors. To enter franchising, huge capital outlays for
manufacturing facilities are not required; a ready-made national dealer network does not
have to be in place; massive national advertising campaigns are not necessary; the 179 Edward L Bernays (1947) “The Engineering of Consent”. See also his magnum opus, Propaganda (1928). 180 Ibid. 181 Douglas B Holt (2004). How brands become icons at 6. 182 Ibid. 183 Ibid.
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184 Alan Felstead, The corporate paradox above n 5 at 80.
ownership of, or access to, unique sources of supply is not essential; and the ownership of
unique patent rights is not required.185 Ample capital, national advertising, a well-known
trade mark and patented processes are all desirable, but not necessary, for a potential
franchisor to enter the industry.
6.4 Keeping Pace with Time, Space and Technology
Just as Jimi Hendrix’s Experience can be played through the technical storage system
delivered over established global networks via a free market based institutional
infrastructure design, in order to trigger the iconic image almost seamlessly amongst
listeners, so to must the new self-sustaining experience(s) be recreate-able at any given
time, space and available technology.186
Human evolution through better educational foundations has placed the present generation
at a crux in this point in time where a leap into the future is within grasp because of
continuously improved technical superiority and a better understanding of the complexities
of life, time and space. Weaved patterns created by entrepreneurs using such threads
provide clues as to what consequences we can expect.
Current think-tanks are pondering topics including for example, robotics187, artificial
intelligence188, terra-forming189 on Mars (for the time being) to create a sustainable
185 Ibid. 186 A franchise networks past performance may not necessarily be repeated in the future by following the same methods of doing business. The commercial environment may have changed significantly challenging fundamentals of the business set-up. The franchisor may therefore seek to reshape the franchise to meet the changing environment. For example, Kentucky Fried Chicken renamed its entire franchise network brand to KFC because of changing consumer perception towards fried foods, more specifically the label ‘fried’ deterred customers from patronising their outlets as health issues became more prominent in recent years. Another example, discussed at length in Alan Felstead’s The corporate paradox above n 5 at 157-186 is Coca-Cola’s franchise restructure throughout the 1980s as a result of changes in the business environment. The old structure had outlived its usefulness as small territories prevented low-cost production and distribution systems being established and the demands of large retailers for better terms and conditions of supply became more difficult to accommodate as a direct result of the franchise structure which gave franchisees monopoly rights within a small geographically defined area. The franchisor flexed its hierarchical muscles by demanding changes during contract renewals thus creating a new generation of franchisees with fewer members but with larger territories able to support up-to-date, high capacity plants and distribution networks. 187 With the advent of robotics we no longer need employees and managers or Training Manuals as they are replaced by programmers and software engineers who can understand and apply quantum mechanics in order to drive the machines (i.e. robots) to perform mundane physical tasks. MacDonalds – the world’s first and still largest franchise has been working on such fully-automated systems for a long time.
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188 Not only will robots replace physical tasks; mental-bots will take over decision-making once the artificial intelligence barrier is overcome. Ray Kurzweil has used Moore's law (which describes the relentless exponential improvement in digital technology) to calculate that desktop computers will have the same processing power as human brains by the year 2029. He also predicts that by 2045 artificial intelligence will
environment for human settlements, new energy sources190, implications of graphene191,
quantum and nano-mechanics, stem cells, enhancement of the human deoxyribonucleic
acid or modifications of the natural instructions of other biological and chemical matter,
mining for resources beyond Earth’s environment and perhaps most importantly the
dealing with associated resultant implications in daily human life. These are but a few of
the nearly seven billion ideas floating in various market places across the globe today.
Many of these recipes and especially those that require interaction with end-users can be
rapidly replicated and deployed using franchising.
The paramount need for uniformity or standardisation192 may perhaps be altered to accept
the need for sensible flexibility in order to allow adaptation of best local practices into the
global networks know-how matrix. It can be further enhanced by seeking to vary per
individual consumer clientele by design, for example, Prada’s latest retail outlet on Corso
Venezia, Milan introduced ‘the personal touch’ Made to Order service which takes
personalisation of clothing and fashion apparels to a whole new level.193 The flexibility to
cater to individual consumers’ tastes and preferences can be built into the system so that
customisation always occurs at point of interaction. By ensuring a cyclic flow of
information, best practices built in one location can be transferred and applied in another
part of the world thus retaining some degree of globalisation while remaining a domestic
institution. Human technological advancements means systems, networks and
infrastructure are in a continuing state of flux, and will provide ever-changing methods of
brand or idea distribution in the exchange process for (hopefully) some equitable
remuneration.
reach a point where it is able to improve itself at a rate that far exceeds anything conceivable in the past, a scenario that science fiction writer Vernor Vinge named the "technological singularity". Edward Fredkin argues that "artificial intelligence is the next stage in evolution, an idea first proposed by Samuel Butler's "Darwin among the Machines" (1863), and expanded upon by George Dyson in his book of the same name in 1998. 189 … is the process of deliberately modifying a planet’s atmosphere, temperature, surface topography or ecology to be similar to those of Earth to make it habitable by terran organisms. NASA has held several debates on the planetary engineering of Mars using large greenhouse gas emitting industries to create a self-regulating Martian biosphere. See for example, planetologist Christopher McKay, (1982). "Terraforming Mars". Journal of the British Interplanetary Society. 190 Hydrogen, wind and solar are just the beginning of the end for fossil fuels. 191 On October 5, 2010, the Nobel Prize in Physics for the year was awarded to Andre Geim and Konstantin Novoselov from the University of Manchester for their work on graphene often described as a "wonder material" with many possible technological applications from ultra-fast transistors to DNA sequencing. 192 Chapter 26 LBO 5th Edition pp.692-698.
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193 Tsang C http://theglassmagazine.com/forum/feature.asp?tid=614#title (accessed 8th November 2010). Also referred to as ‘Metailing’ in business circles.
7.0 Conclusion
If some of the concepts hinted at in the preceding arguments are embedded into the fabric
of the franchise agreement, then we can witness superfast brand deployments.
Development of franchising is still in its infancy as far as law and commerce is concerned.
The key issue for the lawyer is how to harmonise the law and the business enterprise so as
to unleash economic booms. The entrepreneurial spirit will consistently reinvent customer
experiences thus franchising contracts that suits the given purposes and prevailing
circumstances will evolve. Effects of technological revolutions such as the internet and
mobile phones are re-shaping the way business is done and many more technologies will
change how things are being done tomorrow. It is acknowledged globally that humans are
engaging in unsustainable ways of doing business and the global commune requires
restructuring human behaviour towards sustainable mannerisms.
The essence of franchising captures and steadily maintains the end manifestation of all that
is the brand, for benefits to all those involved in the value chain. The key balancing act
being played by the market is in evaluating the need to standardise diverse tastes and
preferences, while at the same time trying to diversify standardised goods and services to
suit local conditions. For the budding entrepreneur, it is essential to bring together the
various elements and begin to weave stronger and longer lasting super-legal bonds. As the
myth of the Adidas brand suggests, “Impossible is nothing”. In order to give franchising
law a dynamic boundary, it may be essential to include the consumer, or whoever the end-
user is intended to be, for more meaningful definition of the business model. Business-
format franchising encapsulates the essential elements for the successful spread of a brand
and its associated values.
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Observing global and mega-trends, innovation and global connectivity, barriers that have
existed in the past are being further reduced. The next generation of franchises will
incorporate the consumer and community; the franchisee will on behalf of franchisor form
a symbiotic relationship and get attached to the brand. Local knowledge is particularly
crucial in emerging markets where such knowledge can help the expanding business not
only in penetrating these markets but also in capitalising on opportunities for innovation
and reverse learning.194 It is not so problematic with newer technologies to link the brand
to the consumer directly. Open-Source franchising is a free market idea that will give
‘proof of our collective potential to change the world’. Reiterating Jimmy Wales
suggestion;195
We can keep it open – you can use the information in [an open source franchise in] any way you want. We can keep it growing – spreading knowledge everywhere and inviting participation from everyone.
Benefit-sharing is another integral part of the scheme; the more equitable the scheme the
greater the uptake of franchise as local conditions of ‘what is fair’ are prioritised over a
foreigner’s imposition of ‘what I think is fair’, thus encouraging deeper growth for the
brand. The beneficiaries of the scheme are the franchisor – the one with the packaged
franchise, the franchisee – the suitable candidate(s) to engage with the consumer and
deliver the good or service produced by the franchise, and the consumer (or community)
derives multiple benefits from end-use. Free markets determine and accent to the
franchise. An equitable and sustainable benefit in return from the various markets is then
justified and can be rightfully demanded and maintained at law and supported by whatever
governing body in control of their respective territories. The final echo that rings is ‘easier
said then done’ but in giving freedom to the markets, entrepreneurs will get it done then
say it, or as Mae West so eloquently articulates; “an ounce of performance is worth pounds
of promises.”
194 Arnold DJ and Quelch JA, ‘New strategies in emerging markets’, in Gupta AK and Westney DE (2003, eds.). Smart Globalization: Designing global strategies, creating global networks. MIT Sloan Management Review Series, Jossey-Bass, San Francisco.
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195 Founder of Wikipedia.
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Red Bull Australia Pty Ltd v Sydneywide Distributors Pty Ltd [2001] FCA 1228 (Federal
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Erwen Warnick BV v Townend & Sons (Hull) Ltd [1979] AC 731 (House of Lords);
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Dayan v McDonald’s Corporation [1982], unpublished.
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