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Kickbacks in Franchising

4th August 2017

From time to time the British Franchise Association (BFA) issues its members, of which Mundays are one, with ‘technical bulletins’ and guidelines. The technical bulletin issued by the BFA this month describes supplier incentives within the franchise network, otherwise known as ‘kickbacks’.

The BFA highlight that most franchisors consider direct kickbacks to be unethical. However, there can be a number of scenarios which arise within the industry that could, perhaps surprisingly to some, be viewed as a kickback and as such should be disclosed to franchisees.

The BFA gives two examples of where kickbacks arise in franchising:

  1. a paper manufacturer which pays commission to the franchisor of a printing franchise which is calculated as a percent of the value of paper purchased by its franchisees.
  2. where a franchisor asks a bank or other financier to pay an introduction fee for every new franchisee the franchisor sends to the bank for franchise funding.

Whilst these are not direct kickbacks, any sources of income including hidden commission will be regarded as payments by the franchisee.

Within the franchise industry exclusive purchase arrangements are commonplace and necessary for franchisors in ensuring consistency and quality across the franchise network. Such arrangements may include discounted purchases or rebates or a franchisor may supply the product with its own profit margin, these are all kickbacks.

The technical bulletin refers back to the BFA’s Ethics of Franchising, which requires that franchisees should understand what they are required to pay under the franchise agreement and what they get in return. The guidance states as a general rule:

“no franchisor should have secret sources of income from the operation of the system by franchisee, e.g. hidden commission or kickbacks. These are in essence payments by franchisees, since they do not result in the passing on to franchisees of the cost benefits of membership of the bulk purchasing power of the network and can indeed increase the costs to the franchisees.”

The problem with incentives of this nature is not that they exist per se, and in some cases, it is common and can make good commercial sense to negotiate such arrangements, the BFA highlight that in order to for a franchisee to make informed decisions, the existence of such arrangements should be disclosed. It is the non-disclosure of any such kickbacks that the BFA considers a breach of the rules of ethics.

This latest bulletin falls into the category of best practice advice and whilst not mandatory, franchisors may wish to look at arrangements with commercial suppliers as a result. The BFA expects its members to disclose the existence and level of any kickbacks to ensure fair dealing. For franchisors which are not BFA members, they should bear in mind that the BFA Code of Ethics was recognised in the case of Drivertime Recruitment Ltd. re DST Ltd., when assessing the behaviour of franchisors generally.

For further information contact Fiona Moss part of the Franchise Team at Mundays which covers property, employment, dispute and commercial. 

The contents of this update are intended as guidance for readers. It can be no substitute for specific advice. Consequently we cannot accept responsibility for this information, errors or matters affected by subsequent changes in the law, or the content of any website referred to in this update. © Mundays LLP 2017.

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