In brief

  • Agreements such as intellectual property licence and distribution agreements may constitute franchise agreements under the Franchising Code of Conduct if they fulfil the Code’s definition of ‘franchise agreement’.
  • The requirement under the definition that a ‘system or marketing plan’ be imposed or suggested by a franchisor may be evidenced by a number of factors, a non-exhaustive list of which are outlined in this case.  

Summary

In Rafferty v Time 2000 West Pty Limited (No 4) [2010] FCA 725,1 the court found that a ‘Rights Agreement’ for the grant of intellectual property usage rights, namely patents in relation to modular accommodation units (MAUs), constituted a franchise agreement within the meaning of the Franchising Code of Conduct (Code). The court also held that the Heads of Agreement which contemplated the execution of the Rights Agreement constituted an agreement to enter into a franchise agreement.

As a result, the franchisor’s failure to comply with the disclosure requirements contained in the Code rendered it liable for contravention of section 51AD of the Trade Practices Act 1974 (Cth),2 (Trade Practices Act) which mandates compliance with applicable industry codes.

Implications from the decision

This decision has significance for all parties entering into agreements that may share features with franchise agreements, including purported licence and distribution agreements. It serves as a warning that, in determining whether these types of agreements constitute franchising agreements within the meaning of the Code, their title and nature are of far less importance than the Code’s definition of ‘franchising agreement’ as explained and expanded upon by the courts.

The parties should therefore seek legal advice from a practitioner experienced in the Code because non-compliance with the Code can have serious legal and commercial consequences. In this case, the court ordered that all three agreements between the parties be set aside and that the plaintiff be repaid certain sums.3

Background

Between May 2007 and May 2008, the parties were involved in a business venture to arrange the manufacture and sale of MAUs, or semi-permanent units that can be manufactured offsite (in this instance, in China) and easily set up onsite, for the purposes of mining and tourist accommodation. Time 2000 West Pty Ltd (T2W) was incorporated for the purpose of carrying out the venture and Mr Rafferty and Mr Donovan, one of the respondents, were its directors.

The venture was established by three agreements. On or about 5 October 2007, a Heads of Agreement (HOA) was executed, followed by a Joint Venture and Shareholders’ Agreement on approximately 23 November 2007 and a Rights Agreement (RA) on or about 19 December 2007.

Under the RA, T2W was to be granted an exclusive licence to use and exploit the Time 2000 intellectual property comprising patents and trade marks (in relation to the design, manufacture, promotion and sale of MAUs) in Australia for a fee of $1 million. This grant was to be made by Time 2000 Systems (Australia) Pty Ltd (T2SA), which had been granted such a licence by Embleton, the member of the Time 2000 group of companies that had ownership of the relevant intellectual property. It was apparent from the background and content of the agreement that the parties had considered the Code and nevertheless proceeded on the basis that the definition of a ‘franchise agreement’ under the Code was not satisfied by the RA and therefore the Code did not apply.

This definition of ‘franchise agreement’ under the Code comprises four elements:

  1. a written, oral or implied agreement
  2. that grants the 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
  3. under which the operation or business will be substantially or materially associated with the franchisor’s trade mark, advertising or commercial symbol, and
  4. under which the franchisee must pay or agree to pay the franchisor in return for this right.  

Embleton and other members of the Time 2000 group of companies, as well as their advisors, argued that the RA did not constitute a franchise agreement because they had agreed prior to execution of the RA that a system or marketing plan would not be imposed under it. Clause 12 of the RA also provided that the parties agreed to enter into a Franchise Agreement on similar terms to the RA if they at any time ‘form[ed] the view that the [Code] applies or might apply to the arrangement between the parties’.

By the time the venture came to an end in May 2008 or shortly thereafter, relations between the parties (specifically Rafferty and Donovan) had broken down, no MAU had ever been manufactured or sold, and the venture appeared to have failed. Rafferty and two of his companies involved in the venture issued proceedings against Donovan and the Time 2000 group of companies (collectively Time Group) to have the agreements set aside and be repaid approximately $1.7 million. Rafferty also brought proceedings against Madgwicks, the solicitors for the Time Group, in relation to their advice on the agreements.

Issues

The parties conceded that:

  • parts (a), (c) and (d) of the Code’s definition of ‘franchise agreement’ were fulfilled when it came to the RA, and
  • no aspect of the requirements for franchise agreements under the Code, particularly those in relation to disclosure, had been complied with.

The main issue in this instance was therefore whether the RA fulfilled part (b) of the definition, that is, whether there was a ‘system or marketing plan substantially determined, controlled or suggested’ by the Time Group. Consequently, there was an issue as to whether the HOA constituted an agreement to enter into a franchise agreement. If both of these were answered in the affirmative, contravention of section 51AD could be fairly easily established.

Other issues, including the alleged negligence of Magdwicks and the possible exception for overseas companies such as Embleton, also arose.

Decision

Was part (b) of the definition fulfilled under the RA?

Besanko J emphasised that the determination as to whether an agreement constitutes a ‘franchise agreement’ must be made by reference to the definitions in the Code, and not the title, nature or distinctive features of the agreement in question.

As to the existence of a ‘system or marketing plan’ within the meaning of the Code specifically, the court held that a mere contractual power to impose (or simply ‘suggest’) such a plan—rather than its actual enforcement under or incorporation into the agreement—will be sufficient, given the constantly shifting nature of such plans and the ease with which the definition could be circumvented otherwise. The meanings of ‘substantially’, as not necessarily covering the entirety of the business, and ‘offering, supplying or distributing goods’, as being those acts of marketing and sale rather than design and manufacture, were also laid down.

The court then set out a number of (non-exhaustive) factors for determining whether a ‘system or marketing plan’ exists, based on earlier cases of Capital Networks and Kyloe:4

  • a centralised bookkeeping and recordkeeping computer operation provided by the franchisor
  • the franchisor having a right to screen and approve all promotional materials
  • a prohibition on the repackaging of products by the franchisee
  • the franchisor suggesting retail prices to be charged for products
  • the franchisor having a comprehensive advertising and promotional program
  • the division of a state into marketing areas
  • the establishment of sales quotas
  • the franchisor having a right to approve any sales personnel
  • a mandatory sales training regime
  • the provision of quotation sheets to the franchisee’s employees
  • the provision of prescribed invoices and other sales forms
  • a requirement that franchisees elicit certain information from their customers and provide it to the franchisor, and
  • a restriction on selling any of the franchisor’s products without prior consultation.

Besanko J noted that not all factors need to be present and will likely be weighted differently on a case-by-case basis. In this instance, the factors were largely satisfied under both the HOA and the RA based on clauses in these agreements specifically providing for such rights as well as more general clauses, found in both agreements, that mandated T2W’s compliance with policies and procedures defined by Embleton, with the approval or refusal right for projects given to T2SA and with reasonable quality control directions made by T2SA.

The court also noted the fact that T2W was to carry out and conduct an entirely new business as a distinctive feature in this case. In cases where an existing business is being acquired, the question of whether a ‘system or marketing plan’ exists within the meaning of the Code is likely to be far clearer.

Was the HOA an agreement to enter into a franchise agreement?

With the factors above having been satisfied, the issue was that the HOA could best be described as an ‘option arrangement’ when it came to the relevant franchise agreement (the RA). Whereas Embleton was bound to enter into the RA, T2W was given a mere option to do so.

Besanko J held that the words ‘agreement to enter into a franchise agreement’ should be broadly construed, and would therefore include an option arrangement where ‘it is practically certain that the option will be exercised’. Here, the prospective franchisee (T2W) was controlled by Donovan and therefore this practical certainty could be established.

Other issues

The court also held that Madgwicks did not engage in misleading and deceptive conduct by not advising Rafferty that the agreements would constitute franchising agreements under the Code and that, for the purposes of a cross-claim brought by the Time Group, Madgwicks provided proper and complete advice as to the Code and were not knowingly concerned in the Time Group’s contravention of section 51AD of the Trade Practices Act.

As to the exception that previously existed in the Code whereby franchisors incorporated outside Australia who only grant one franchise were exempted from the obligations under the Code,5 the court found, based on its construction of the exception, that it did not apply to Embleton in this case (having been incorporated in Hong Kong) because the agreements and the surrounding circumstances clearly indicated that more than one franchise was contemplated at the time of execution.