By Alistair van Schalkwyk, Franchise Specialist Lawyer, ASCO Legal

The current media scrutiny of income and work guarantees in New Zealand franchise systems, as highlighted in recent articles by The Press and Stuff, has brought this issue to the fore. As a franchise specialist lawyer, I would like to offer a legal perspective on the benefits and risks associated with income guarantees in franchise agreements, particularly for home and commercial services franchises.

What Are Income Guarantees?

Income or work guarantees in franchise agreements are contractual assurances given by franchisors to franchisees that they will receive a minimum level of income or volume of work, particularly during the initial phase of the franchise relationship. These guarantees are often marketed as a way to reduce the perceived risk for new franchisees entering the system.

The Appeal of Income Guarantees

In times of economic uncertainty, such as those New Zealand is currently experiencing, the allure of guaranteed income is strong. For prospective franchisees, these guarantees can:

Provide Security: They offer peace of mind that a minimum income is assured, helping franchisees manage cashflow and meet financial commitments.
Aid in Financing: Lenders may look more favourably on applications supported by guaranteed income, potentially making it easier for franchisees to obtain funding.
Facilitate Decision-Making: The promise of an income floor can help prospective franchisees overcome hesitancy about entering business ownership.

How Income Guarantees Are Structured

The structure of income guarantees varies widely between franchise systems. Common approaches include:

Minimum Weekly or Monthly Earnings: The franchisor promises a set amount per week or month.
Work Allocation Guarantees: The franchisor guarantees a minimum number of jobs or leads.
Top-Up Arrangements: If the franchisee’s actual earnings fall short of the guaranteed amount, the franchisor pays the difference.

It is crucial to examine the fine print. Guarantees are rarely unconditional and often subject to compliance with system requirements, minimum performance standards, and other obligations.

Legal Considerations and Risks

While income guarantees can provide comfort, they also carry significant legal and commercial risks for franchisees.

Reliance on the Guarantee: Franchisees may be tempted to rely too heavily on the guarantee, neglecting the need to develop their own customer base.
Stringent Conditions: Guarantees often require strict compliance with operational procedures, marketing efforts, and reporting. Failure to meet any requirement can void the guarantee.
Misrepresentation Risk: If guarantees are oversold or not clearly explained, there is potential for claims under the Fair Trading Act 1986 for misleading or deceptive conduct. These claims can be difficult to prove for a franchisee.
Credit Risk: If a franchisor is unable to meet its income guarantee obligations and is placed in liquidation, it leaves the franchisee’s claim to payment under the guarantee as an unsecured creditor and unlikely to be paid.
Dispute Risk: As seen in the recent media coverage, disputes can arise when franchisees’ expectations do not align with the reality of the guarantee’s terms or the franchisor’s ability to deliver.

Lessons from Recent Disputes

The recent articles referenced above detail cases where franchisees felt let down by income or work guarantees. Common themes include:

Unrealistic Promises: Some franchisees allege that sales material overstated likely earnings or failed to disclose restrictive guarantee conditions.
Lack of Transparency: Franchisees were sometimes unaware of the full extent of their obligations to qualify for the guarantee.
Enforcement Challenges: When disputes arose, franchisees often faced difficulty enforcing their perceived rights under the guarantee.

These disputes underline the importance of robust due diligence by a franchisee on a franchise system before committing.

Best Practice Recommendations

For Franchisors

Draft Clear Guarantee Terms: Ensure all guarantee provisions are transparent, unambiguous, and comprehensively documented in the franchise agreement.
Disclose All Conditions: Provide full written disclosure of all requirements for accessing the guarantee, including performance benchmarks and reporting obligations.
Avoid Overpromising: Marketing material should be factual and avoid making representations that cannot be substantiated.

For Franchisees

Conduct Thorough Due Diligence: Investigate the franchisor’s track record and speak to existing franchisees about their experience with guarantees.
Understand the Fine Print: Carefully review all conditions attached to any guarantee and seek independent legal advice before signing.
Plan for Self-Sufficiency: Treat any guarantee as a safety net rather than a substitute for building a sustainable business.

Conclusion

Income guarantees can play a valuable role in supporting new franchisees and enhancing the attractiveness of franchise systems in New Zealand. However, franchisees must approach them with caution as this is essentially a promise given by a franchisor and a promise is only as good as the party that provides it. Franchees should therefore due their due diligence and ensure that they are dealing with a reputable franchising system and ask for additional information about the system including a disclosure document with up to date information about the franchise system and financial position of the franchisor.

In addition, well drafted agreements and realistic expectations are essential to minimise disputes and ensure a fair outcome for all parties.

Alistair van Schalkwyk is a franchise specialist lawyer at ASCO Legal, advising on all aspects of New Zealand franchise law.

Income Guarantees in New Zealand Franchise Systems: Benefits and Risks