The Franchise Code (the Code) is a mandatory code prescribed under the Trade Practices Act 1974 (Cth) (the Act). The purpose of the Code is to regulate the conduct of participants in franchising, which it does by primarily requiring franchisors to disclose specific facts to franchisees and to follow set procedures in their subsequent dealings with franchisees.
Recent case law serves as a timely reminder that describing a business arrangement as a 'distribution agreement' or similar will not prevent a Court from finding on the facts that the parties' relationship is actually caught by the statutory definition of a 'franchise agreement'.
Part IVB of the Act provides for the establishment and enforcement of industry codes of practice. Section 51AE provides for industry codes to be prescribed by regulation. The Trade Practices (Industry Codes - Franchising) Regulations 1998 (Cth) was made pursuant to this power. The Franchise Code is contained in the Schedule to the Regulations and is declared to be a mandatory industry code pursuant to Section 51ACA(1) and Regulation 3. Importantly for participants in the franchising industry, Section 51AD of the Act provides that 'a corporation must not, in trade or commerce, contravene any applicable industry code'.
Failure to comply with the Franchise Code has serious consequences for the franchisor. It may result in contraventions of Part VI of the Act.
In addition, directors of a non-compliant corporate entity may also incur ancillary personal liability under sections 75 and 81 of the Act.
What is a franchise agreement?
To be a 'franchise agreement' as defined in Section 4 of the Franchise Code requires:
- An agreement (this can be written, oral or implied).
- A grant of a right to carry on the 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 or an associate of the franchisor.
- Operation of the business substantially or materially associated with a trade mark, advertising or commercial symbol that is owned, used, licensed or specified by the franchisor or an associate of the franchisor.
- Payment of an amount by the franchisee to the franchisor or an associate of the franchisor.
By its very nature, a distribution arrangement will satisfy Requirements 1 and 4 of this definition. In most instances, it will also satisfy Requirement 3, as the distribution business is likely to be substantially associated with a trade mark, advertising or commercial symbol identifying the goods or services the subject of the distribution arrangement.
To avoid the unintentional application of the Franchise Code, it is necessary to ensure that a distribution arrangement does not satisfy Requirement 2.
To date there has been little by way of judicial consideration of what is actually required to satisfy Requirement 2. In Capital Networks Pty Limited v au Domain Administration Limited  FCA 808 (Capital Networks), Justice Bennett concluded that for Requirement 2 to be satisfied, there must firstly be a 'system or marketing plan', and secondly, the 'system or marketing plan must be substantially determined, controlled or suggested by the franchisor or an associate of the franchisor'.
In the recent decision of ACCC v Kyloe Pty Limited  FCA 1522 (Kyloe Pty Limited), Justice Tracy was required to determine whether a series of arrangements (said to be a distribution arrangement) satisfied Requirement 2, and therefore fell within the definition of a 'franchise agreement'.
Requirement 2 - system or marketing plan?
System or marketing plan is not a defined term in the Franchise Code. In the absence of Australian authority, Justice Tracy referred to American case law dealing with a similar (but not identical) provision. With reference to Master Abrasives Corporation v Williams (1984) 469 NE 2b 1196 in particular, Justice Tracy identified the following helpful indicators of the existence of a system or marketing plan:
- The provision by the franchisor of a detailed compensation and bonus structure for distributors selling its products.
- A centralised bookkeeping and recordkeeping computer operation provided by the franchisor for distributors.
- A scheme prescribed by the franchisor under which a person would become a distributor or sub-distributor.
- The reservation by the franchisor of the right to screen and approve all promotional materials used by distributors.
- Prohibition on repacking of products by distributors.
- The provision of assistance by the 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 by the franchisor.
- The division of a state into marketing areas.
- The establishment of sales quotas.
- The franchisor having approval rights of any sales personnel whom the distributor might seek to employ.
- A mandatory sales training regime.
- Provision of quotation sheets to the distributor's employees.
- Provision by the franchisor of prescribed invoices and other sales forms.
- A requirement that distributors illicit certain information from the customers and provide that information to the franchisor.
- A restriction on the distributor selling any of the franchisor's products without first consulting with the franchisor.
It is important to remember that this list of helpful indicators is not a mandatory checklist, but only indicates the type of matters which a Court may take into consideration when assessing whether a system or marketing plan exists on the facts of each case. For example, in Kyloe Pty Limited, Justice Tracy decided that it was appropriate to consider the cumulative effect of all the agreements and not the terms of each separate distribution agreement. Secondly, in finding that there was not a system or marketing plan in existence, Justice Tracy noted that:
- While Kyloe was obligated by the terms of the sub-distribution agreement to provide training to sub-distributors, and sub-distributors were precluded from negotiating with potential customers until such training was received, the training did not cover business and operational features of the sub-distributors businesses.
- During training, sub-distributors were provided with a profit profile containing recommended sales prices which, if adopted, would yield projected profit margins marked 'example only'. This was not accepted by the Court as evidence of any enforced pricing structure.
- No formal machine sales quotas were prescribed by Kyloe (although sub-distributors were required to purchase minimum quantities of materials each year).
- There was no evidence of a comprehensive advertising and promotional program (in spite of materials such as sales pitch 'scripts' provided to sub-distributors at training).
- There was no evidence in either the terms of the agreements or in practice that Kyloe or its associates reserved the right to oversee the choice of employees by sub-distributors.
- Sub-distribution agreements made it clear that there was no territorial divisions established within Australia.
- The training programs, written reports and minimum purchasing requirements were insufficient evidence to find that Kyloe exercised any control over the operation/management of the distribution businesses.
Requirement 2 - 'Substantially determined, controlled or suggested by the franchisor'?
In considering the second limb of Requirement 2, being whether a system or marketing plan can be said to be substantially determined, controlled or suggested by the franchisor or an associate of the franchisor, Justice Tracy again referred to factors identified in the Capital Networks case. These include:
- The extent to which the distributor's business involves the sale of the franchisor's products;
- Whether or not the franchisor has ostensibly assumed responsibility for uniform standards of quality, price, advertising, and promotions; and
- The extent to which the franchisor controls the distributor's day to day business.
Helpfully, the Court accepted that there are important differences between distributorship and franchise arrangements. It was noted that in the case of a distributorship, the main points of difference with a franchise are that the arrangement is generally much less formal, may not have the same degree of certainty of term, may or may not be exclusive, may tend to cover a larger geographical area and would leave the marketing, merchandising and sale decisions largely to the distributor. Importantly in determining the true nature of a distributorship, no royalties are generally payable to the supplier by a distributor.
The Federal Court decision of ACCC v Kyloe Pty Limited has gone a long way to create more legal certainty, especially by giving judicial recognition to the important differences between franchise and other business arrangements such as a distributorship.
The Court has also gone to great lengths to identify helpful indicators which can be applied to the facts of each case in determining whether a particular business arrangement amounts to a franchise.
It is also clear that any attempt to structure a business arrangement through a series of complex interrelated agreements will not be of any assistance in an attempt to evade the application of the Franchise Code.
Phillips Fox has changed its name to DLA Phillips Fox because the firm entered into an exclusive alliance with DLA Piper, one of the largest legal services organisations in the world. We will retain our offices in every major commercial centre in Australia and New Zealand, with no operational change to your relationship with the firm. DLA Phillips Fox can now take your business one step further − by connecting you to a global network of legal experience, talent and knowledge.
This publication is intended as a first point of reference and should not be relied on as a substitute for professional advice. Specialist legal advice should always be sought in relation to any particular circumstances and no liability will be accepted for any losses incurred by those relying solely on this publication.