Incomplete Contracts: You will Pay me what I tell you to pay me, after you sign

October 10, 2008

All contracts are not the same.

Most people think of contracts as a “promise for a promise” and that’s not a bad rule-of-thumb. Sort of “I agree to pay $x for you to perform y service for me.” This is what is called a complete contract.

So far so good.

However, some contracts aren’t so simple and they tend to cause all kinds of grief. They’re are called incomplete contracts.

They in effect say: I will tell you what you will pay me, when I (maybe, unilaterally) decide to.

  • Sounds pretty dodgy, doesn’t it?
  • Who in their right mind would sign such a deal?

However, there are very good, sound reasons for entering into an incomplete contract. The strength of franchising is its ability to adapt to changing market conditions. This is the ability that you are paying for.

There is a defined reliance nature (superior:subordinate roles in both economic power and information) that creates a risk of overreaching or opportunism by the dominant party.

There is nothing personal or brand-specific about it: It’s just the nature of the beast. All franchisors are carnivores. Some have better table manners, that’s all

  • This is where the core problems in franchising arise and why there is so much trouble.

Without understanding the difference between a complete and incomplete contract, discussing potential remedies is foolhardy.

The definitive academic work in this field continues to be Problematic Relations: Franchising and the Law of Incomplete Contracts by Gillian K. Hadfield.

Download Problematic Relations

The problem is the regulators and Courts (because they are not given specific enough instruction by law-makers) only see the one-sided contract and interpret narrowly only what is within the “four corners of the contract”, to predictably one-sided results.

Hadfield:

Predictably, the franchise disputes that appear in court center on the franchisor’s exercise of its significant, relationally constrained but formally unfettered powers. And unfortunately, drawn to the model of the complete contract, courts tend to view the formal written contract as representing the entirety of the commitments structuring the franchise relationship. In practice, this approach amounts to a “business judgment” rule of enforcement: Provided that franchisor articulates some plausible business rationale for its actions, courts will not interfere.

In doing so, however, the courts fail in their traditional task of enforcing the true exchanges reached by the contracting parties.

There are solutions to this short-sightedness but they require tremendous discernment by parliamentarians.

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Collusion allegation: AUS bank and franchisor

September 18, 2008

In a Smart Company article by James Thomson called MP renews calls for investigations into mistreatment of Bakers Delight franchisee, he quotes:

NSW parliamentarian Joanna Gash has renewed calls for the Australian Federal Police to launch an investigation into accusations Bakers Delight and ANZ bank colluded to put a franchisee out of business.

Quoting emails between the franchisor and the bank, Gash alleges:

On Monday, Gash revisited the case in Parliament, producing emails from Bakers Delight chief financial officer Richard Taylor and ANZ executives that she says shows “plans had been conspired to terminate Ms de Leeuw’s franchise well ahead of time”.

The bank and franchisor deny all the allegations.

This is the first public AUS public allegation of the key franchisor:franchise banker relationship that I identified and wrote about in a 2005 paper for Industry Canada called Franchising Opportunism [free download].

The Royal Canadian Mounted Police did a 10 month investigation of a related predatory franchise lending matter. [free download: Mounties investigate ‘predatory lending’, Ottawa Citizen, March 25, 2006]

And Mr. Oudovikine is accusing the bank of transferring the loans to Country Style without his authorization before he had a chance to obtain a business plan and other financial details from Country Style.

Mr. Oudovikine says his case shows how big banks, franchisors and franchise brokers team up to take advantage of franchisees, many of whom are recent immigrants like him.

“It’s predatory lending. (CIBC) didn’t do any of the due diligence they should have done,” says Mr. Oudovikine, who sent the Citizen e-mails confirming the RCMP investigation. An RCMP official said the police force doesn’t confirm or deny investigation.

And the Canadian bank’s reaction?

Mr. Oudovikine says he has repeatedly contacted senior CIBC officials and executives about the loan dispute, to little effect. He alleges that CIBC breached the Canada Small Business Financing Act regulations that require lenders to conduct due diligence on borrowers, including their ability to repay loans.


New Zealand announces a franchise regulation review at a sales expo

August 18, 2008

The national Labour government of Helen Clark announced on August 15th that:

The Ministry of Economic Development is conducting a review of franchising regulation to explore whether there are any widespread problems in the franchising sector which may require franchise specific regulation.

The announcement, via the Ministry of Economic Development, can be seen here or the Discussion Paper can be downloaded here [Review of Franchising Regulation in New Zealand, pdf]

  • There have certainly been enough high profile franchise nightmares and spectacular fraud investigations to justify this action: Blue Chip, Green Acres, Green Power. And, usually, only the most severe ever surface into the national media [tip of the iceberg].

Further coverage was provided by the Franchise New Zealand trade magazine in an article named: Government Wants Feedback on Franchise Regulation.

Interestingly, the Commerce Minister Lianne Dalziel made the government’s annoucement at a franchise sales show. You can see her entire speech here and please find below Minister Dalziel’s concluding remarks to her franchisor marketing and franchise banker audience:

Can I conclude by congratulating all of you for participating in this Expo and can I thank the Franchise Association for its advocacy for a sector that is a vital part of the New Zealand economy. Can I acknowledge the sponsorship of Westpac – these events don’t happen without sponsors – and can I congratulate those of you who have been chosen as the ‘show stoppers’ for going the extra mile.

It is important, at certain times, to remind those in authority that they serve citizens’ interests as well as corporate interests.

  • I would encourage franchise investors and those affected by no franchise industry oversight [such as Blue Chip] to voice their opinions to their elected officials, current government, media outlets and financial institutions.

Suing your Franchise Banker: Girding one’s Loins

July 24, 2008

Since I have set this up for a client and defined Predatory franchise lending to the Canadian government, I can tell you.

In 1995, an award-winning Canadian investigative journalist named John Lorinc published his first book, called Opportunity Knocks: The Truth About Canada’s Franchise Industry. An excellent resource; totally blackballed by the industry.

  • Canada is the first stop overseas for U.S. franchisors so our experiences are very relevant anywhere in the world.

Click here for an emphasis-added excerpt from Lorinc’s Chapter 4 called, The 90% Solution: Franchise Economics.

It deals with the a specialized corporate entity: the Franchise Banker. You should find this book and order it online if you are at all serious about learning about modern franchising.

Interesting stuff. The government guaranteed loan program is really just the icing on the cake for these most aggressive of bankers.

If it doesn’t jingle, it doesn’t count.

Rich Mimick, my business school accounting professor

Learn how franchising is financed to know who really is in charge. The brains of this outfit sure ain’t the franchisors, my little overly-trusting friend.

BTW: I should mention I had an eventful 6 week career with a Canadian bank in 2000. The training program was going well [we both thought] until they realized I was that Les Stewart.

  • Big Franchising delivers very sharp disincentives to those that raise uncomfortable questions.

The latest example was last month regarding selling insurance into the Canadian franchise industry. Who wouldn’t want me as their insurance broker, I ask you?

It seems history means nothing to some industries:

It’s probably better to have him inside the tent pissing out, than outside the tent pissing in.

Lyndon B. Johnson, 36th U.S. president

An early (around 1400) drawing of a chastity belt. [above, thanks to Wikipedia]


Franchising is much riskier than independent business

July 24, 2008

The franchise industry is well-known for its hyperbole bordering on propaganda.

For the latest example of these half-truths and silent misrepresentations see a recent modestly named article: Franchising to the Rescue.

In my opinion, this is an unnecessarily biased and dangerous article for small business investors.

It’s assumption is that franchising is a safer investment than independent business. That claim has been exploded for at least 10 years and totally ignores the recent New Zealand experience with Blue Chip and Green Acres.

  • No mention, either, of the two Australian state franchise inquiries and the upcoming national Oz industry probe. [see an excellent Oz resource, BakersDelightLies.com]

All the credible academic research comes to the opposite conclusion: Franchising is much riskier than independent business.

Research: There is an big quality difference between true academic work [published in refereed journals, funded by public money] versus private research [biased, paid for by interest groups]. It is not enough to say that there are no reliable statistics and then go ahead and spout off unsubstantiated figures.

  • Everyone knows the public remembers the numbers while forgetting the qualifications.

Publishing these self-serving guesses [with zero opposing opinions] is bordering on reckless media behaviour. Mom-and-Pop investors are risking their life savings and homes, after all.

Timothy Bates: In 1996, this university professor published an academic study that rocked the franchise industry. Bates was contracted by the Office of Advocacy of the U.S. Small Business Adminstration to look at survival patterns of franchised and non-franchised businesses.

Survival Patterns Among Franchise and Nonfranchise Firms Started in 1986 and 1987 concluded the following [see S.B.A. Research Summary, Related Bates paper]:

  • young independent small firms had a better chance of surviving than small, non-corporate franchises,
  • while franchise firms were better capitalized than non-franchise firms, about 62 percent of the franchise firms survived, versus 68 percent of the non-franchise or independent firms,
  • average profit was much higher for the independent businesses; profits were negative, on average, for the franchise firms,
  • franchises purchased from a previous owner were riskier than franchise firms started from scratch, and
  • only 49 percent of the franchises started by women in 1987 were in existence in 1991, compared with 67 percent of the independent firms started by women.

Within the report itself, Bates said:

…the franchisee route to self-employment is associated with higher business closure rates and lower profits for the young, largely noncorporate firms, relative to independent business ownership. p. 8.

U.S. Government: On June 24, 1999 Dr. Bates appeared before the U.S. House of Representatives’s Subcommittee on Commercial and Administrative Law. The Oversight Hearings on the Franchising Relationship were called to review the state-of-the-union in American franchising. Click here for a .pdf copy of his testimony.

Bates:

Findings of my research indicate that new and small franchisees are more likely to discontinue operations than independent startups, and this holds true when firm and owner traits are controlled for statistically. One clear-cut finding was that franchisees starting by purchasing the firm from a previous owner were riskier than franchisees starting from scratch. A person entering self-employment by purchasing an ongoing franchise risks acquiring a firm that is more likely than a de novo startup to go out of business within the next few years. [my emphasis]

These Kiwi industry gentlemen know all about


Who does Franchise law serve?

June 7, 2008

Laws should be like clothes. They should be made to fit the people they serve.

Clarence Seward Darrow (1857 – 1938).

I believe Darrow is correct: Existing franchise laws do protect who they are meant to protect. But it is not who most investors think it is.

If not Me, Who then?

  1. Many franchise investors think the laws are there to serve them.
  2. Franchisors (product and business format), franchisor associations, the franchise bar, bankers, sales agents, and bankers believe the laws are there to serve them.

Who do you think is likely to be more accurate?

Considerations:

  1. Laws are a result of a competition between brokered interests within a democratic political arena. Those without a voice, have no influence.
  2. The law can be used to present an illusion of safe (or safer) investing when, in fact, the opposite might be true.
  3. The business of providing legal services can further distort any attempts of remedy through the law.
  4. Any franchisee legal “win” lasts as long as it takes to sell the legal “software patch” by the franchise bar to their customers (franchisors).
  5. Franchise attorneys act as litigation gatekeepers. Perfectly valid claims are routinely sabotaged because the lawyers depend so much on profile and referrals from their national association.
  6. Legal services are a credence good AND an effective monopoly (once you choose one lawyer). The risk of experiencing a legal expert who cheats is quite high.

Credence Good Monopolists

With a credence good, consumers are never sure about the extent of the good that they actually need. Experts such as doctors and lawyers, as well as auto mechanics and appliance service-persons (the sellers) not only provide the services, but also act as the expert in determining the customer’s requirements. This information asymmetry between buyers and the seller creates strong incentives for the seller to cheat… Credence Goods Monopolists, Winand Emons, 1997


Franchise law is an ass?

June 6, 2008

Ontario is where one in three Canadians live. It is the home province of the petroleum, grocery and automobile head offices. There are 500 franchise systems, 40,000 franchised stores and $40-50 billion in annual sales.

The province of Alberta had the first franchise law and Ontario lagged behind with the Arthur Wishart Act (Franchise Disclosure) Act in 2000. Investors think it is not much to write home about. Two other provinces have passed laws since Wishart and they are even weaker.

In March 2000, five expert witnesses were invited to speak to the members of provincial parliament. I was one of them.

My prediction in 2000. Excerpt:

Mr Stewart: What I’m afraid of is that there we’re going to create a law that gives the illusion of a solution so that the salesman at the trade show can say: “Ah, see this law? We can’t do that any more. We can’t be unfair. You have the right.” I’m not sure if the salesman is going to also say, “But you’ll have to have $50,000 to take it to court to prove it yourself.” The onus in Bill 33, in large measure, is on the franchisee to prove damage. The franchisee is in no economic position, in most cases, to do that.

By 2008? The Wishart Act is being ignored by most everyone, the government refuses to look at strengthening and any effective franchisee advocacy has been sold down the river.

As happens sometimes, the law serves those that have the ability to influence it. It doesn’t matter what the objective truth is, the subjective truth (reality based in power) won in Ontario in 2000 and continues to win around the world.

Looking to the law for help is just as rare as finding love in a Whorehouse. Possible but mostly a fairy tale told to create false hope and billable hours.

This illusion allows franchise lawyers to attract “practice clients” (ie. franchisees: broke, one time) while waiting to land their “real” future clients (ie. franchisors: cash, repeat).

If you would like to review my entire testimony, click here for a .pdf (8 pages) or here under the Legislative Assembly of Ontario.


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