Licence or franchise?
Two recent Australian Competition and Consumer Commission (ACCC) actions have highlighted the need to carefully consider whether the Franchising Code of Conduct (Code) governs commercial agreements such as intellectual property licences and distributorship agreements.
The directors of Synergy in Business Pty Ltd (Synergy) and Lawsons Trading Co Pty Ltd (Lawsons) found out the hard way that the requirements of the Code cannot be avoided simply by describing a franchise relationship as a licence.
Criticism has been levelled at the breadth of the definition of a franchise agreement in the Code and its capacity for catching arrangements (such as certain product distribution arrangements) that would not generally be understood to be a franchise. The two cases do not provide new guidance on this issue as they were not disputed. They do, however, serve as a reminder to licensors of intellectual property to consider whether they are genuinely licensing or are in fact providing a business system governed by the Code.
Section 4 of the Code provides that a franchise agreement arises when:
- a franchisor grants to another person a right to carry on a business of supplying goods or services under 'a system or marketing plan'
- the system or marketing plan is substantially determined, controlled or suggested by the franchisor or an associate of the franchisor
- the business is associated with a trade mark provided or owned by the franchisor, and
- the franchisee must pay to the franchisor an amount in return for the right to conduct the business including such payments as training fees, a capital investment fee or a royalty.
The Code excludes certain relationships from the operation of the Code such as where the relationship consists only of payment for goods or services at or below their usual wholesale price or where only one master franchise is granted.
Difficulties frequently arise in determining whether a licensor is granting the right to a person to carry on the business 'under a system or marketing plan' provided by the franchisor or is simply licensing one or more trade marks or other intellectual property (with certain conditions, such as quality control conditions, attached).
If an agreement is governed by the Code, a number of reasonably onerous obligations are imposed on the franchisor including:
- a requirement for the franchisor to provide an disclosure statement regarding the franchise to a prospective franchisee. This disclosure statement must contain detailed information about the franchisor, its directors, existing franchises and their territories, finances and how marketing and training fees are to be used
- obtaining a statement from prospective franchisees that they have received a copy of the Code, that they have read and understood the franchise agreement and that they have taken independent legal advice in relation to the agreement
- providing a cooling off period whereby the franchisee may withdraw from the arrangement within seven days of the earlier of signing the franchise agreement or making a franchise payment.
A breach of the Code is a breach of section 51AD of the Trade Practices Act 1974. A breach gives a person who suffers loss a right to seek damages against the franchisor or to injunct them from continuing the breach. The court is also given a wide range of other powers in relation to a breach such as the power to make orders including varying or refusing to enforce the agreement or to make the franchisor disclose certain information or conduct corrective advertising.
Persons who aided or abetted a breach or who are otherwise knowingly involved in a breach may also be liable under the Act.
Australian Competition & Consumer Commission v Ewing
(FCA, 28 January 2004)In Ewing, Synergy, acting through its directors, 'licensed' a business training and development program known as the 'Best Practice Program'. For around $20,000, participants received a five day training program (on how to approach and train prospective customers and conduct the business) and a workshop kit consisting of stationery, marketing materials, testimonials and similar items.
Synergy claimed that participants receiving the training would become accredited business development specialists and earn $100 per hour in their first year. Synergy also implied that participants had the potential to earn a six figure income even if they had no previous consulting or other relevant background.
The terms of the licence agreement required the licensee to acknowledge that it was not entering into a franchise relationship and to provide a general release of liability to Synergy.
The court was satisfied that the 31 'licence agreements' entered into by Synergy were franchising agreements within the definition in the Code. The court held, on the basis of a statement of facts consented to by the parties, that Synergy had breached the Code (and therefore section 51AD of the Trade Practices Act 1974 which provides a legislative basis for the Code) and that the directors were also liable under subsection 75B(1) of the Act for being knowingly involved in that contravention.
The court made a number of orders by consent of the parties including:
- a restraint on all of the respondents from repeating the above breaches
- a restraint from requiring a general release of liability in franchise agreements for a period of three years
- a requirement to provide a 14 day 'cooling off' period to all those who had signed agreements and to refund in full any payments made by parties wishing to terminate
- a requirement that the directors disclose the existence of the proceedings and the orders made in any franchise sale that they are involved
- a requirement to implement an appropriate compliance program if the directors are involved in such business, and
- a requirement that the directors pay the ACCC's costs of $35,000.
Lawsons Trading Co Pty Ltd
In a media release on 4 February 2004, the ACCC announced a further action against Lawsons. Lawsons sold, though a licence and supply agreement, a business of spraying vehicles with protective coatings known as 'Armour Linings'.
They too had attempted to characterise the relationship as a licence rather than a franchise. Ultimately, Lawsons admitted to breaches similar to those outlined in the case of Ewing. Lawsons provided court enforceable undertakings to stop engaging in similar conduct in the future, to provide appropriate franchising documents, to refund the franchise purchase price where applicable, to implement a trade practices compliance program and to send its director to a compliance program.
While the above cases involve relatively clear cut breaches of the Code, a large number of examples arise where it is much more difficult to determine whether the Code applies. The lesson is that it is dangerous to assume that an arrangement is simply a licence or merchandise supply agreement without carefully examining the impact of the Code.
This article provides a summary only of the subject matter covered, without the assumption of a duty of care by Freehills or Freehills Carter Smith Beadle. The summary is not intended to be nor should it be relied upon as a substitute for legal or other professional advice.