Consumer Credit and Franchising – are your franchise agreements compliant? | Fieldfisher
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Consumer Credit and Franchising – are your franchise agreements compliant?

It may come as a surprise to some franchisors operating in the UK, but hiring equipment and/or extending credit terms to franchisees might be regulated by the UK's consumer credit regulatory regime, and the consequences for non-compliance can be severe.

Many franchise systems require their franchisees to use specific types of equipment, which may require significant capital expenditure. In order to keep start-up costs to a minimum and enable their franchisees to focus their resources on delivering the products and/or services required by the system, franchisors might make the equipment available to a franchisee under a hire arrangement.

Franchisors may also be tempted to lower entry barriers to their franchise system by agreeing to accept initial fees in instalments or by lending money to franchisees at the start of the franchise or during the term, where a franchisee experiences cash-flow difficulties.

This all sounds perfectly reasonable, particularly in the context of a business to business franchisor/franchisee relationship. However, it may come as a surprise to some franchisors that the types of activities mentioned above might be regulated by the UK's consumer credit regulatory regime, and the consequences for non-compliance can be severe.

How is consumer credit regulated in the UK?

Until 1 April 2014, the UK's consumer credit regime was statute based, established by the Consumer Credit Act 1974 (CCA) (as amended by the Consumer Credit Act 2006), with the Office of Fair Trading (OFT) responsible for the regulation of consumer credit. Consumer credit regulation was subsequently brought within the legal framework contained in the Financial Services and Markets Act 2000 (FSMA) and the Financial Conduct Authority (FCA) became responsible for consumer credit activities.

The FSMA defines credit as including "a cash loan and any other form of financial accommodation" and identifies a number of "regulated activities", of which regulated credit agreements and regulated hire agreements are relevant to franchising.

A regulated credit agreement is an agreement between a lender (i.e. the franchisor) and a borrower (i.e. the franchisee) in which the franchisor provides the franchisee with credit of any amount and is not an exempt agreement.

A regulated hire agreement is an agreement between (i) the owner of the equipment (i.e. the franchisor) and (ii) an individual, sole trader, a partnership of three or less or another incorporated body (i.e. the franchisee), for the hiring of equipment to the franchisee which is not an exempt agreement, is not a hire-purchase agreement (i.e. the franchisee has no right to purchase the hired goods) and is capable of subsisting for more than 3 months.

What are the exemptions?

The exemptions which are relevant for franchising include where:

  • the credit is for an amount exceeding £25,000;
  • the credit agreement is wholly or predominantly for business purposes;
  • the amount of credit is for a fixed sum and the number of repayments is 12 or less within a 12 month period;
  • credit is provided without interest and other charges;
  • the franchisee is a "high net worth individual" (although the income and asset thresholds are unlikely to be met by your average business format unit franchisee).

What happens if an agreement is not exempt?

If none of the exemptions apply, then a franchisor will need to apply to the FCA to become an authorised person and ensure that all regulated agreements are in writing, give specific information in a prescribed form and are provided at the correct time in a prescribed way.

The penalties for carrying on an unauthorised consumer credit business can be severe – it is a criminal offence which carries a maximum prison sentence of 2 years against directors, a fine or both, not to mention the potentially disastrous impact on the reputation and goodwill of the brand. The credit agreement itself (which, in reality, might be the franchise agreement) may also be unenforceable.

So what should franchisors do?

This all seems rather complex and onerous, but with careful planning and advice, consumer credit compliance should not be such an onerous task.

Franchisors should consider carefully the basis upon which they transact with their franchisees and the terms of any credit they extend to franchisees and/or any equipment they hire to franchisees. It is important that those individuals within a franchisor's organisation who are empowered to negotiate terms with franchisees are aware of these issues, so as to avoid a situation where a franchisor inadvertently carries on a regulated activity without a valid authorisation.

Watch this space

The FCA is currently undertaking a review of the regime which should be complete by early 2019. The aim is to simplify the regime where possible and ensure an appropriate degree of consumer protection while not placing disproportionate burdens on companies.