UK consumer credit regulation
What should franchisors do?
Many franchise systems require 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 franchisees to focus their resources on delivering the products and 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
- lending money to franchisees when the system is established or when the franchisee experiences cash-flow difficulties.
This sounds 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 activity mentioned above might be regulated by the UK consumer credit regulatory regime and that the consequences of non-compliance can be severe.
Until April 1 2014 the UK consumer credit regime was statute-based: it was established by the Consumer Credit Act 1974 (as amended by the Consumer Credit Act 2006) and the Office of Fair Trading was responsible for its regulation. Consumer credit regulation was subsequently brought within the legal framework of the Financial Services and Markets Act 2000 and the Financial Conduct Authority (FCA) became responsible for consumer credit activities.
The Financial Services and Markets Act defines 'credit' as including "a cash loan and any other form of financial accommodation" and identifies a number of 'regulated activities', including credit agreements and regulated hire agreements.
A 'regulated credit agreement' is an agreement between a lender (ie, the franchisor) and a borrower (ie, the franchisee) that is not an exempt agreement, in which the franchisor provides the franchisee with credit of any amount.
A 'regulated hire agreement' is an agreement for the hiring of equipment between the equipment owner (ie, the franchisor) and an individual, a sole trader, a partnership of three or less or another incorporated body (ie, the franchisee). A regulated hire agreement must not be an exempt agreement or a hire-purchase agreement (ie, when the franchisee has no right to purchase the hired goods) and must be capable of subsisting for more than three months.
The exemptions 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; and
- the franchisee is a high-net-worth individual (although the income and asset thresholds are unlikely to be met by ordinary business format unit franchisees).
If no exemptions apply, a franchisor must apply to the FCA to become an authorised person and ensure that all regulated agreements:
- are in writing;
- provide specific information in the prescribed form; and
- are provided at the correct time and in the prescribed way.
Conducting unauthorised consumer credit business is a criminal offence and the penalties can be severe. Directors face a maximum prison sentence of two years, a fine or both, not to mention the potentially disastrous consequences that the activity can have on the reputation and goodwill of the brand. The credit agreement (which, in reality, might be the franchise agreement) may also be unenforceable.
While it may seem complex, with careful planning and advice, consumer credit compliance should not be an onerous task.
Franchisors should consider carefully the basis on which they transact with their franchisees and the terms of any credit that they extend to franchisees and any equipment that franchisees hire from them. The individuals within a franchisor's organisation who are empowered to negotiate terms with franchisees should be aware of these issues to avoid franchisors inadvertently carrying out regulated activity without valid authorisation.
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, without placing disproportionate burdens on companies.
For further information on this topic please contact Gordon Drakes or Vicky Reinhardt by telephone (+44 20 7861 4000) or email ([email protected] or [email protected]). The Fieldfisher website can be accessed at www.fieldfisher.com.