The New South Wales Court of Appeal was required recently to consider whether an exclusive distribution agreement constituted a “franchise agreement” under, and therefore subject to, the Franchising Code of Conduct (the Franchising Code).1
In deciding that the distribution agreement was a franchise agreement, the NSW Court of Appeal’s decision raises important points that businesses should have front of mind when documenting the terms of their commercial arrangements.
- Just because an agreement includes express terms that, for example, the agreement is not a franchise agreement and does not create a franchisor/franchisee relationship, does not mean that a franchise relationship will not arise. The intent of the parties is not relevant.
- When determining whether an arrangement is a franchise, a Court will consider the entire relationship between the contracting parties, not just the agreement.
- The definition of a “franchise agreement” under the Franchising Code is interpreted broadly. While the definition requires, for example, the business to be carried on under a system or marketing plan, it is not necessary for the agreement to include details of the system or plan, nor must the system or plan be finalised prior to the signing of the agreement.
- When preparing distribution and independent contractor agreements, it is important to ensure that the agreements do not fall within the ambit of the Franchising Code if it is not the parties’ intention.
- The Franchising Code sets out strict requirements for managing the relationship between franchisors and franchisees, including mandatory disclosure requirements, conditions and complaint handling mechanisms. The cost of compliance with the Franchising Code is expensive.
Workplace Safety Australia Ltd (WSA), the appellant, supplied online subscription packages to help businesses satisfy their obligations under occupational health and safety laws. On 19 September 2011, WSA entered into an agreement (Agreement) with Simple OHS Solutions Pty Ltd (Simple) under which Simple was appointed as the exclusive distributor of WSA’s subscription packages.
The Agreement required Simple to:
- provide a business plan setting out how Simple proposed to conduct its business;
- administer all sales using processes and standard forms prescribed by WSA;
- comply with a manual provided by WSA;
- comply with WSA’s reasonable directions;
- pay WSA a quarterly fee for a customer list; and
- sign up 15 new customers each month to WSA’s online subscription packages (the Sales Target). If the Sales Target was not met in any 6 month period, WSA had the right to immediately terminate the Agreement. A director of WSA made a representation to Simple that Simple was not expected to meet the Sales Targets initially.
In March 2012, six months after the commencement of the Agreement, WSA sought to exercise this right of termination on the basis that Simple had not met the Sales Target and had not paid the quarterly fee for the customer list.
The primary judge found that the Agreement was really a franchise agreement required to comply with the Franchising Code. WSA had not complied with the pre- contractual disclosure requirements or the pre- termination requirements of the Franchising Code. This resulted in breaches of the Competition and Consumer Act 2010 (Cth) (the Act).2
Simple was awarded damages of $208,178.34 to represent the loss suffered by Simple from the wrongful termination of the Agreement.
WSA appealed the decision.
Was the Agreement a Franchise Agreement?
The case related to one of the key factors that must be met for an agreement to be a franchise agreement. In dispute was whether the Agreement constituted a franchise agreement on the basis that Simple was required 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 WSA (as the franchisor.)3
When interpreting the Franchising Code, the Court considered that it should be mindful that a principal purpose of the Franchising Code is to protect franchisees and that relevant agreements should be considered in their entirety.
A System or Marketing Plan
The Agreement required the business plan:
- to be submitted within 30 calendar days of the date of the Agreement; and
- to set out how Simple intended to fund and operate its business.
The Court determined that, to meet the requirement under the Franchising Code relating to the existence of a system, the system does not have to be “spelt out” in the Agreement, rather it was sufficient if a clause contemplated that a business would be conducted under a system.4 (In this context, it was alleged that the marketing plan contemplated constituted a system.) In other words, the terms of the system or plan need not be finalised or prescribed in the Agreement.
Substantially Determined, Controlled or Suggested
Whether the system (or marketing plan) is determined, controlled or suggested by the franchisor, should be determined by “practical and commercial considerations”. Given the purpose of the Franchising Code is to protect franchisees, “control” should be interpreted as the “power to direct or restrain the content of the business plan on any substantial issue”.5
The Court determined that Simple was required to conduct its business under a system or marketing plan on the basis that Simple was required to:
- prepare a business plan which showed how Simple intended to conduct its business;
- use processes prescribed by WSA for sales administration purposes;
- use standard forms prescribed by WSA; and
- comply at all times with the manual (and any updates) provided by WSA. (The manual detailed how the subscription packages were to be marketed and sold although it did not form part of the Agreement.)
The Court determined that WSA controlled substantially the system because WSA required Simple to comply with its directions and had absolute discretion to refuse to consent to Simple’s marketing activities.6
Given the above, the Franchising Code applied to the Agreement and WSA was not entitled to terminate the Agreement without complying with the Franchising Code.
Franchising Code Requirements – what did WSA fail to do?
The Franchising Code required WSA, as a franchisor:
- to provide a disclosure document to assist Simple (as the prospective franchisee) to make a reasonably informed decision about the franchise before it entered into a franchise agreement.
- to not enter into a franchise agreement with Simple (as the prospective franchisee) until WSA had received a written statement from Simple to the effect that it had read and understood the disclosure document and the Franchising Code.
- to provide Simple with reasonable notice before terminating on the basis of a breach of the Agreement. (The notice of termination of a franchise agreement must state that the franchisor is intending to terminate the franchise agreement, detail what is required to remedy the breach and provide a reasonable time period to remedy the breach.)
As a result, Simple was entitled to recover the loss it suffered as a result of entering into the Agreement in circumstances where it would not have had WSA complied with the Franchising Code.7
When preparing commercial agreements, such as distribution agreements or independent contractor agreements, businesses should be aware that simply because an agreement contains a term that the agreement is not a franchise agreement does not mean that a franchise agreement does not exist.
The definition of a “franchise agreement” under the Franchising Code is interpreted broadly. While the definition requires, for example, the business to be carried on under a system or marketing plan, it is not necessary for the agreement to include details of the system or plan, nor must the system or plan be finalised prior to the signing of the agreement.
The Franchising Code sets out strict requirements for managing the relationship between franchisors and franchisees, including requirements relating to mandatory disclosure, specified conditions and specific complaint handling mechanisms. When preparing distribution, licence and independent contractor agreements, it is important to ensure that the agreements do not fall within the ambit of the Franchising Code. The consequences of non-compliance may be expensive, particularly as the sanctions may include the payment of compensation and damages, injunctions, declarations, corrective advertising, orders for refunds or contract variations and infringement notices imposing a financial penalty.
To eliminate any risk, legal advice should be sought when drafting and/or negotiating commercial agreements.