Australia has approximately 6,500 retail service stations, with the majority branded as one of the major oil companies, such as BP, Caltex, Mobil or Shell. However, a relatively small number of sites are actually owned or operated by these major companies. As such, branding agreements – that is, the agreement between the smaller retail petrol site operator and the oil company – are essential in the downstream petroleum industry. The terms of a branding agreement have significant influence over how a service station operates. Accordingly, these agreements need to be carefully considered and reviewed to ensure they take into account the commercial realities of the industry whilst allowing each party reasonable legal safeguards.
In the second of Moulis Legal’s Petroleum Contract Series, lawyer Alexandra Geelan and senior lawyers Lauren Gray and Ann Jovanovic examine service station branding agreements and discuss some of the key clauses parties should give careful consideration to before signing on the dotted line. Moulis Legal offers a specialised legal consultation service to members of the downstream petroleum industry.
Many service stations in Australia are also branded to oil companies under franchise arrangements. Moulis Legal will consider the issues in petroleum franchise agreements in the next newsletter in this series.
Parties need to consider what happens under a branding agreement if there is a significant change in economic or local conditions, which may affect the viability of a service station. This has been highlighted by the recent dramatic drop in the oil price, but may be a result of unexpected developments around the service station. Market conditions play an essential role in the legal arrangements for the downstream petroleum industry, and any branding or other legal agreement needs to adequately recognise and respond to those conditions.
While most branding agreements are pro-forma agreements provided by the branding oil company, an operator needs to appreciate that they have more bargaining power than they realise. Many contractual clauses are actually negotiable and operators need to take advantage of that rather than readily signing.
Why operate a branded service station?
One of the key determinates of a business’ success is its brand and reputation. While price remains the number one factor in a consumer’s decision1 to purchase petrol from a specific station, brand and reputation remain key factors in a customer’s decision making process. This is where branding agreements can be used by service station operators (“operators”), to increase business and profitability by “piggybacking” off an already established and well-reputed brand or name in the industry.
Branding agreements allow an operator to have instant brand recognition and virtually guaranteed fuel supply at prices linked to terminal gate price. These advantages make them an attractive option for many operators. In addition, an operator can benefit from the oil company’s knowledge and experience across all areas of their business, including pricing, competition and administration. However, the inevitable consequences of entering into a branding agreement are that operators will lose some freedom in the way they manage their business.
Most branding agreements contain restrictions on how operators can use the ‘brand’ in their day-to-day operations, including restrictions on the types of petroleum products sold, and obligations to carry out certain marketing activities. While these measures are understandable as the oil company seeks to safeguard their reputation, operators should seek to build some flexibility into these clauses, such as being able to refuse unreasonable or commercially unviable activities.
Large, international oil companies have continued to reduce their direct involvement in the petroleum retail industry, preferring instead to enter into arrangements with small and medium independent businesses to operate branded service stations which exclusively sell their petroleum products. According to the ACCC, in 2013-14, only 8.9% of petrol retail sites were directly owned and operated by the refiner-wholesaler whose branding is on the site. The majority of service stations are owned and/or operated by distributors, franchisees, independent retailers or commission agents.2
For an oil company, a branding agreement offers the advantage of ensuring its brand remains at the forefront of consumers’ minds, and guarantees demand of its products at predictable volumes. This in turn maintains the market value, reputability, and consumer perception of its business, without many of the risks and costs associated with running multiple service stations.
Branding agreements usually form part of a suite of petroleum contracts for operating a branded service station and include essential terms about the operation, appearance and marketing of a service station.
As with many other agreements commonly used in the downstream petroleum industry, branding agreements are typically standard form contracts developed and provided by the oil company. New legislation will come into force across Australia on 12 November 2016 which will place many of these standard form contracts at risk of containing void provisions (Moulis Legal examined the new laws in the first edition of its Petroleum Contract Series, click here for further information).
Getting out of branding agreements
The ability to exit a branding agreement is critical, particularly where operating under it becomes commercially unviable. Given most branding agreements are standard form contracts prepared and supplied by the oil company, the right to terminate, assign, novate, or vary the agreement can be imbalanced. This imbalance can have the effect of “locking” the operator into the terms of the agreement with very little opportunity to exit and/or seek to vary its terms.
Many branding agreements last approximately 10 years (this can vary from contract to contract). During that timeframe much could happen, such as an adverse change in economic or local conditions, which could make it difficult for some operators to continue operating under the same price and volume requirements. For example, a new bypass is built which results in a significant reduction in the number of motorists passing a service station. This may leave an operator struggling to meet the minimum volume requirements under the agreement. To avoid being locked into these unfavourable conditions, it is imperative that branding agreements contain a clear pathway for the operator to exit or vary this arrangement during its term.
All branding agreements require the operator to exclusively offer the brand’s petroleum products for sale (with some possible exceptions in cases where the products cannot be delivered or supplied). This is a reasonable expectation given the oil company wants to ensure that the products sold under its branding are of a certain quality and standard. Most oil companies will also seek to control pricing of their products under the agreement.
If there is a significant change in oil prices or unfavourable economic conditions arise, an operator should ensure their agreement has the flexibility to address these external issues by, for example, sourcing petroleum products from a cheaper supplier or placing restrictions on the discretion which oil companies have with their pricing to take into account market conditions. Proper consideration and legal drafting in branding agreements will help respond to these outside risks, and reduce the possibility of long-term commercial detriment to operators (such as if the operator cannot reasonably compete with other service stations).
Termination of branding agreements
The first draft of a branding agreement will frequently contain unilateral termination rights in favour of the oil company. As a starting point, operators should seek to negotiate more balanced and reasonable termination and variation rights. Ideally, operators should seek to incorporate voluntary termination rights that can be exercised at any time during the term of the agreement by providing prior notice. Exit arrangements need to be clear and as balanced as possible so that operators can end this relationship without carrying unreasonable residual risks. Obviously, this must be balanced against the relative bargaining power of both parties in negotiating contractual changes. However, operators are regularly surprised by the willingness of oil companies to negotiate such terms.
For operators who manage several branded service stations, there needs to be careful consideration to ensure termination clauses operate independently for each service station so that if any termination event arises for one service station, it does not affect the others (unless the parties otherwise agree). Although it may be more prudent to have separate branding agreements for each service station, if operators choose to use one branding agreement to cover multiple sites, then clear terms need to be included to differentiate which clauses apply to each site and what happens if a particular site ceases to operate or is sold.
Branding agreements may also seek to impose financial penalties on a party who terminates or breaches an agreement. While a party to an agreement may be liable to pay certain costs as a consequence of terminating or breaching the agreement, these costs must be a ‘genuine pre-estimate of the damage’ that is likely to be incurred as result of the termination or breach. A clause which seeks to impose liability for amounts that are not a genuine estimate of the likely loss may be deemed a penalty and, by law, would be unenforceable. With that in mind, penalty clauses are not always clear terms in the agreement as they may be couched in other clauses with different descriptions. If an operator can identify a clause that operates, in effect, as a penalty, then they may be able to use such clauses to strategically negotiate for other contractual concessions.
With proper contract development and management, termination and variation rights between parties can be more balanced, reasonable and fair in branding agreements.
Assigning or transferring rights under branding agreements
Similarly, there may be circumstances where an operator may wish to assign, novate or transfer its rights and obligations under the agreement to another party (such as when the operator wants to sell the business and site).
Many branding agreements contain strict assignment clauses where the operator can only assign, novate or transfer its rights under the agreement with the consent of the oil company, in its absolute discretion. This means that there is no requirement for the larger company to be ‘reasonable’ in its decision to refuse to consent to an assignment or transfer. Alternatively, many agreements require that the prospective transferee or purchaser meet specific requirements of the oil company, such as having substantial experience in the industry, before the oil company will consent to the assignment, novation or transfer.
In many assignment clauses, the oil company has a right to terminate the contract and seek damages (or even terminate) if the operator attempts to assign, novate or transfer a clause without obtaining consent from the oil company. In such cases, the operator risks incurring significant financial damages for breach of contract as well as the likelihood that the subsequent transaction (such as the sale of a site) will also fall through. As such, careful consideration of these commercially restrictive clauses is critical.
Operators under branding agreements should ensure that the other party cannot unreasonably withhold its consent to an assignment or transfer or that, if there are minimum requirements imposed on prospective transferees, the requirements are reasonable and not onerous. This helps to secure the operator’s ability to exit the agreement in the long-term, if circumstances substantially change. For example, we have included in some assignment clauses the right to seek independent expert assessment as to whether the assignee is suitable – this takes some of the discretion away from the oil company.
When negotiating assignment and transfer clauses, operators should also consider whether they have any ongoing liability after the assignment, transfer or novation is complete, especially in relation to anything done before the transfer takes place. Where possible, an operator should seek to transfer all risk and liability so they can leave the business without residual liabilities.
Usually in branding agreements, the oil company will include a clause which allows them to assign, transfer or vary their rights under the agreement and at their discretion. Operators should consider reserving their right to receive notice before the oil company exercises such rights. This would be important to cover situations where the oil company may decide to sell or transfer their branding arrangement to a fuel competitor whom the operator may not wish to do business with. Prior notice may give the operator an opportunity to reassess the agreement to deal with these circumstances before they actually occur (subject to the other terms in the agreement).
Branding agreements present a potentially commercially profitable alternative to operating an independently branded service station by providing operators with instant brand recognition and day-to-day operational knowledge and support. However, given the terms of a branding agreement can be strict and onerous, it is important that each party has the flexibility to leave or suspend its obligations under the agreement if the circumstances call for it. Ultimately, to reap the commercial benefits from a branding arrangement, an operator should seek to negotiate key terms that they consider are the commercial imperatives to operate their businesses successfully. Due consideration and proper advice (at a technical, business and legal level) is critical to ensure the groundwork for a branding arrangement works for both parties. A branding agreement which seeks to balance both party’s rights and obligations can set the foundation for a profitable and long-lasting commercial relationship.