The Federal Court (the Court), in the decision of ACCC v Kyloe, has clarified the criteria set out in the Franchising Code of Conduct (the Code), which determines when an agreement is considered to be a 'franchise agreement'. In particular the Court investigated and expanded on an element of the 'franchise agreement' definition and the meaning of 'a system or marketing plan'.
Kyloe was involved in the business of distributing Polar Krush ice-drink machines and the re-sale of various Polar Krush products including cups, straws and frozen drink concentrate – which were branded goods originating from the Northumbrian Ice Cream Company Ltd (NICC).
The ACCC claimed that Kyloe contravened the Code by failing to provide disclosure documents to sub-distributors of Polar Krush products.
Kyloe argued that their business arrangements with sub-distributors did not constitute a franchise agreement, but rather a distribution or dealership agreement, and therefore the Code did not apply.
The Code is a mandatory industry code under the Trade Practices Act (TPA), and outlaws certain provisions in franchise agreements and requires other minimum conditions. It requires franchisors to disclose information about themselves and their associates, both before and after the parties agree to their arrangements. A breach of the Code is a breach of the TPA.
'Franchise agreement' is defined by four criteria irrespective of how parties describe their arrangement. If all four criteria are satisfied and no exception to the criteria is present, then the arrangement is considered a franchise agreement and the Code applies.
The four criteria are:
- an agreement that is written, oral or implied in whole or in part
- a grant by the franchisor to the franchisee of a right to carry on a business of offering, supplying or distributing goods or services in Australia, under a system or marketing plan substantially determined, controlled or suggested by the franchisor
- the franchisee's business operation is substantially or materially associated with a trade mark, advertising or commercial symbol that is either owned, used, specified or licensed by the franchisor
- the franchisee makes particular payments to the franchisor.
Firstly, Kyloe argued that there was no right granted to carry on a business as they did not attempt to restrict the development of the sub-distribution. This argument was rejected by the Court.
Secondly, Kyloe argued that there was no system or marketing plan in place. The phrase a 'system or marketing plan' is not defined in the Code. Australian Courts have generally looked to American cases for guidance to define a 'system or marketing plan'. Factors that they have considered include centralised bookkeeping, a scheme where an employee could become regional director etc, reservation by the franchisor of the right to approve all promotional material, comprehensive advertising and suggestions in regards to pricing.
The Court found that while Kyloe had entered into an agreement and granted a right to carry on a business, the ACCC failed to establish the presence of a 'system or marketing plan'. The Court found that there was no such system or marketing plan because there was minimal regulation of the sub-distributor by Kyloe, and in particular they did not provide any training or information in relation to sales, advertising, promotion or prices. As a result the Court held that there was no franchise agreement, and therefore, the Code did not apply to this arrangement. Despite a finding that the arrangement between the parties was not a franchise agreement, the decision provides useful discussion regarding the definition of a 'system or marketing plan'.
Factors determining the existence of a 'system or marketing plan'
The Court referred to the following factors as 'helpful indicators' of the presence of a franchise agreement as identified by Bennett J in Capital Networks Pty Ltd v .au Domain Administration Ltd:
- the provision by the franchisor of a detailed compensation and bonus structure for distributors selling its products
- a centralised bookkeeping and record keeping computer operation provided by the franchisor for distributors
- a scheme prescribed by the franchisor under which a person could become a distributor, direct distributor, district director, regional director, or zone director
- the reservation by the alleged franchisor of the right to screen and approve all promotional materials used by distributors
- a prohibition on re-packaging of products by distributors
- the provision of assistance by the alleged franchisor to its distributors in conducting 'opportunity meetings'
- suggestion by the franchisor of the retail prices to be charged for products
- a comprehensive advertising and promotional program developed by the alleged franchisor.
The Court referred to some further indicators which were considered by the Court of Appeals of Indiana in Master Abrasives Corporation v Williams:
- the division of a state into marketing areas
- the establishment of sales quotas
- the franchisor having approval rights of any sales personnel whom the franchisee might seek to employ
- a mandatory sales training regime
- the provision of quotation sheets to the franchisee's employees
- provision by the franchisor of prescribed invoices and other sales forms
- a requirement that franchisees elicit certain information from their customers and provide that information to the franchisor
- a restriction on the franchisee selling any of the franchisor's products without first consulting the franchisor.
While the Court in Kyloe stressed that the above list is not intended to be an exhaustive list of relevant considerations it does serve to focus attention on the type of matters which will be used to determine whether the necessary 'system or marketing plan' exists in a particular case.
Implications for Franchisors
Due to the serious consequences for failing to comply with the Code's provisions, understanding when a distribution or licence agreement will be treated as a franchise agreement is crucial. The Court in Kyloe stated that if the ACCC's claim that the distribution agreement was in fact a franchise agreement had succeeded then Kyloe would have been required to comply with the Code and would have been in breach of the Code.
Distributors or trade mark licensors who do not want agreements with their sub-distributors or licensees to be treated as franchise arrangements and therefore regulated by the Code, must ensure that their arrangements do not satisfy the criteria for a franchise under the Code. The criteria which relates to whether a 'system or marketing plan' exists can be particularly difficult to judge and must be carefully considered.
As compliance with the Code cannot be avoided by referring to a franchise agreement as a distribution or licence agreement, distribution or trade mark licences must be structured appropriately before they are finalised.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.