Franchising industry rules should be made in public

…self-regulation for franchising is a recipe for trouble.

The Toronto Star
December 27, 1994

Franchising industry rules should be made in public
John Lorinc

We Canadians like to make the casual assumption that our private sector is over-regulated, especially when compared to our neighbor to the south. Yet when it comes to franchising – an industry as American as, well, McDonald’s – conventional wisdom falls apart.

The U.S. closely regulated this vast region of its economy, both at the federal and state level, whereas Canada (except Alberta) holds to the laissez-faire school.

This anomaly stems from the fact that U.S. law has traditionally required far greater disclosure from companies seeking to sell portions of themselves –either in the form of shares or as franchises – to the general public.

But this legal gap may soon become a shade narrower due to the recent decision by Ontario’s minister of consumer and corporate relations, Marilyn Churley, to establish an industry task force to investigate the taboo topic of franchise legislation in the province.

When the group, comprising both franchisors and franchisees, gathered for its first meeting this month, self-regulation was at the top of the agenda. The reason is simple enough: the Ontario government has neither the will, nor the cash, to monitor franchising. Self-regulation may seem, at first blush, like the perfect compromise.

Unfortunately, self-regulation for franchising is a recipe for trouble.

The idea, roughly, is to enact a law mandating an industry body to govern companies which sell franchises. Franchisors would then be required to join (after all, what good is voluntary self-regulation?) and adhere to a code of conduct, as is the case for accountants, investment dealers, lawyers and other professionals. But as the task force will learn, this scheme has two central difficulties: conflict of interest and licensing.

The self-regulatory model, first of all, is worthless unless franchisors are required to belong to the industry body, and that fact raises the question of how to determine the standard for admission. Unlike law or real estate, franchising is a way of doing business, not a vocation whose practitioners must master and identifiable set of skills.

So what, then, should be the criteria for admission? The size or the age of the system? The franchisor’s promise to adhere to a code of ethics? It’s also true that the industry body will necessarily straddle many sectors of the economy, so should car manufacturers and supermarket chains belong to the same organization that admits pizza and doughnut franchisors?

Admission is the next hurdle, for the industry body will have to have some mechanism for applying those admission standards. While guidelines will certainly be drawn up, such decisions will ultimately be made by members of the industry group, and this raises the spectre of conflict of interest: Will self-regulation lead to a scenario in which an established franchisor could have the power to determine whether a potential competitor is allowed to join the industry? What guarantee will new franchisors have that their ideas or innovations won’t be pinched in the process of becoming approved? And will franchisees have any say in these decisions?

It is also probable that the self-regulatory model will revolve around the concept of disclosure. For a franchisor to be allowed to ply its trade, it will have to draw up a prospectus, like those required by publicly traded companies. These will be made available to investors and they will contain detailed information about the franchise.

The next question is, what sort of information will these disclosure documents contain?

Take, for example, a common industry practice: Most franchisors receive kickbacks – or more politely, “rebates” – from their suppliers (and landlords). The way this works is that the franchisor uses its purchasing power to negotiate discounts on supplies. Franchisees buy these goods at a mark-up from the discounted price, and the supplier remits the difference to the franchisor.

So, on the topic of self-regulation, should prospective franchise investors have the right to know, in advance, the precise value of these rebates and to whom they are being paid?

Another potential disclosure item concerns “related companies.” Some franchisors buy supplies from firms in which they have a financial interest. Obviously, then, it is not clear whether the franchisees are getting the best deals on their supplies (a point which is often used to sell a franchise) because the franchisor may have a vested interest in purchasing goods from one particular company rather than on the open market.

Anyone who invests their money on the stock market can find out about related-company transactions and insider trades. Should prospective franchise investors then know about the existence of non-arm’s length suppliers before they lay down their money?

Even if the industry and the government do come up with a suitable disclosure document, other meddlesome problems will arise. Will prospectuses be available to the media? Who will enforce the code of conduct and the accuracy of the prospectus? What will happen to franchisors who break the rules; i.e. is the onus on the industry body to do the policing, or on the individual franchisee to prove a transgression? Finally, if the industry body does have the wherewithal and inclination to police its membership, will the system allow for appeals?

In spite of all the tough questions, it is encouraging to see that these issues are finally going to be addressed in a quasi-formal setting – for the first time in the 23 years since an Ontario royal commission recommended franchise regulation.

As the Ontario government embarks on the search for suitable regulation, it would do well to throw open the doors to the discussion. The more public the debate, the better.

John Lorinc writes about the franchise industry.

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