A number of recent Federal Court cases have highlighted the need for businesses to consider whether arrangements entered into, such as distributorship agreements and licenses governing intellectual property, are really franchise agreements for the purposes of the Franchising Code of Conduct.

Under the Franchising Code of Conduct (the Code), the definition of a franchise agreement is quite broad. There are essentially four elements to the definition:  

  • there is a written, oral or implied agreement  
  • that agreement grants the right to carry on the business of offering, supplying or distributing goods and services in Australia under a system or marketing plan substantially determined by the franchisor  
  • the operation and the business will be substantially or materially associated with the trade mark, advertising or a commercial symbol  
  • the franchisee must pay or agree to pay the franchisor an amount of money in return for the right to conduct the business.  

If the Code applies then it has the benefit of affording franchisees certain protections, particularly in relation to access to financial and other information pertaining to the franchisor, its directors, existing franchises and their territories, and how marketing and training fees are to be used. Importantly, the franchise agreement must provide details of circumstances in which the franchisor has unilaterally varied a franchise agreement or may unilaterally vary a franchise agreement in the future.  

Rafferty v Time 2000 West Pty Ltd (No. 4) [2010] FCA 725

In this case, the Federal Court was asked to consider whether a particular commercial arrangement was a franchise agreement for the purposes of the Code.

The parties were involved in a business venture relating to the construction and sale of Modular Accommodation Units. The business arrangement was documented by three agreements – a Heads of Agreement, a Joint Venture/Shareholders Agreement and a Rights Agreement.

In short, the business venture did not succeed and Rafferty issued proceedings to have the above mentioned agreements set aside and to be repaid sums of approximately $1.7 million.

In his claim, Rafferty alleged, inter alia, that the three agreements or any of one of them constituted franchise agreements and a franchise system within the definition under the Code.

As an aside, it was contemplated prior to the signing of the documents by Time 2000 that there was potential for the agreement with Rafferty to be a franchise agreement. Clause 12 of the Rights Agreement provided that if at any time Time 2000 formed the view “that the Franchise Code of Conduct applies or might apply … the parties will sign such documents and do such acts as may be necessary to enter into a franchise agreement …”.

It was also found in evidence that the lawyers for the respondent had advised that the Code may apply to the Rights Agreement and that if it was not complied with that agreement would become unenforceable. The lawyers for Time 2000 gave evidence that clause 12 was included because it was possible that it would want to revisit the issue of franchises with Rafferty.

In his judgment, Justice Besanko concluded that the Heads of Agreement was an agreement to enter into a franchise agreement and that the Rights Agreement was indeed a franchise agreement within the provisions of the Trade Practices Act 1974 and the Franchising Code of Conduct.

His Honour noted that:

“The question of whether a particular agreement is a franchise agreement within the franchising code is to be determined by reference to the definitions in the code and not by reference to any preconceived notions of other agreements which are not ordinarily understood to be franchise agreements.”

The arguments in this case as to whether there was a franchising agreement focussed on the second limb of the definition in the Code.

“A franchise agreement is an agreement:

in which a person, the franchisor, grants to another person, the franchisee, 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 to control or suggested by the franchisor or an associated of the franchisor.

Justice Besanko found that the actual details of the alleged system or marketing plan need not be set out in the agreement or even be in existence at the time the agreement is reached but that:

“it will be sufficient for the purposes of clause 4.1(b) that there be a power in the agreement which is said to be a franchise agreement to impose a system or marketing plan substantially determined, controlled or suggested by the franchisor or an associate of the franchisor.”

Justice Besanko considered whether the terms of the definition of a marketing system were satisfied and identified that if some or all of the following elements were present, a system or marketing plan probably exists:

  • a centralised bookkeeping and record keeping computer operation provided for distributors  
  • the reservation by the grantor of a right to screen and approve all promotional materials used by the distributors  
  • a prohibition on the repackaging of products by the distributors  
  • a suggestion by the grantor of the retail prices to be charged for products  
  • a comprehensive advertising and promotional programme by the grantor  
  • the division of a State into marketing areas  
  • the establishment of sales quotas  
  • the grantor has approval rights of any sales personnel who the distributor might seek to employ  
  • mandatory sales training regimes  
  • the provision of quotation sheets to distributor’s employees  
  • the provision by the grantor of prescribed invoices and other sales forms  
  • a requirement that the distributor elicit certain information from its customers and provide that information to the grantor  
  • a restriction on the distributor selling any of the franchisor’s products without first consulting the grantor.

In finding that many of the above elements were present and as such there was a system or marketing plan substantially controlled by Time 2000, His Honour was satisfied that the Heads of Agreement was an agreement to enter into a franchise agreement and the Rights Agreement was a franchise agreement for the purposes of the Code. As such, Time 2000 was found to be liable to Rafferty for a contravention of section 51 AD of the Trade Practices Act (1974) (Cth).

In a separate judgment (Rafferty v Time 2000 West Pty Ltd (No. 5) 2010 FCA873), His Honour ordered that Rafferty be repaid the $1.7 million, together with the sum of $416,111.29 on the account of interest.

Note – At the time of print, the respondent Time 2000 Systems Australia had lodged an appeal against the judgment, the hearing of which was listed on 24 and 25 February 2011. We will provide you with further updates as the matter progresses.

Alpha Centauri Enterprises Pty Ltd v Mortgage House of Australia Pty Ltd [2010] NSWCA 188

Mortgage House of Australia Pty Ltd (Mortgage House), the respondent, operated a mortgage broking business providing financial services to members of the public through a range of “business partners”. Alpha Centauri Enterprises (Alpha Centauri), the appellant, was one of those business partners. In or about April 2005 the agreement between Mortgage House and Alpha Centauri was terminated.

In initial proceedings in the Equity Division of NSW of the Supreme Court, Alpha Centauri alleged that Mortgage House had repudiated the agreement. At first instance the Alpha Centauri’s claim together with Mortgage Houses’s cross claim (seeking relief for loss of damage suffered by it as a result of the alleged repudiation of Alpha Centauri, who effectively abandoned its business) were dismissed. Alpha Centauri appealed.

The main issues for determination were whether the “Business Partner” agreement was a franchise agreement for the purposes of the Trade Practices Act and the Franchising Code of Conduct (the Code) and, if the agreement was governed by the Code, the consequence of failure by Mortgage House to serve a disclosure document and a notice of default.

In dismissing the appeal, the Full Court of the NSW Court of Appeal found that the agreement between the parties did constitute a franchise agreement. It was not disputed that paragraph 4(a), (b) and (c) of the definition of franchise agreement under the Code of Conduct were established. The “limb” in issue was the fourth limb, that is, whether the franchisee must pay or agree to pay to the franchisor an amount of money.

The court found that the fourth limb of the definition was satisfied because:

  • the cost of stationery paid by Alpha Centauri to Mortgage House was at full retail  
  • there was a requirement that Alpha Centauri repay to Mortgage House 1/3 of the sale price of part or all of the franchise business  
  • there was a requirement that Alpha Centauri pay to Mortgage House part of each loan application fee.  

As to the consequences of the failure by the respondent to serve a disclosure document and a notice of default pursuant to the Code, the Court found that the failure to do so did not give rise to loss or damage to Alpha Centauri. Importantly, the Court found that Alpha Centauri had failed to identify in what way the provision of a disclosure document would have improved its position. Furthermore while the franchise service fee should have been disclosed as a payment required to be made by the franchisee to the franchisor, Alpha Centauri was fully aware that such a deduction was required by Mortgage House. Again the Court found that the failure to disclose that requirement was not demonstrated to have caused any loss or damage to the appellant. As such the appeal was dismissed.  

Lessons learnt

The lesson prospective or existing franchisors should take from this is that it can be risky and possibly very costly to assume that an agreement is simply a licence or distributor agreement without carefully examining the impact of the Code of Conduct.

What all parties to a franchise agreement must remember is that the name given to the written document will not be the clincher in a court’s determination as to whether it will be characterised as a franchise agreement. Simply put, a document called a “Licence Agreement” or “Distributorship Agreement” will be a franchise agreement and therefore governed by the Code if it satisfies the 4 tier definition in clause 4 of the Code. The risk for a franchisor can be far reaching – if it does not comply, a court or the ACCC may impose penalties and require the franchisor to comply with the Code.

Importantly, company directors should take note: if a company promotes a licence agreement or a distributor agreement or other commercial agreement which attempts to exclude the requirements of the Code, its directors, servants, agents or associates may be held liable.

A franchisor may also be liable to pay compensation to the franchisees or even offer the franchisee an opportunity to exit their agreements. So beware, the consequences can be far reaching!any of the issues raised in this alert, in particular