In brief

  • The Franchising Code of Conduct may apply to a licensing or distribution agreement in circumstances where the principal retains some control over the marketing of the product.
  • Disclosure requirements will apply to a preliminary agreement when the subsequent agreement is deemed to be a franchise agreement.

Summary

In Rafferty v Madgwicks [2012] FCAFC 371 the full Federal Court held that the Franchising Code of Conduct (Code) applied to a licence of intellectual property rights. The court held that a critical element in discerning whether an agreement is a franchise agreement was whether there was a system or marketing plan, substantially determined, controlled or suggested by the franchisor.

The franchisor contravened section 51AD of the Trade Practices Act 1974 (Cth) (Trade Practices Act) as it did not comply with the disclosure requirements contained in the Code.2

Implications from the decision

This decision has significance for parties entering into licensing or distribution agreements in circumstances where the principal wishes to retain some control over the marketing or distribution of the product.

Parties should be aware that the Code will apply to agreements to enter into franchise agreements. As such, if a party is concerned that a commercial arrangement may fall within the ambit of the Code, they should seek advice early to ensure that they meet the requirements of the Code.

Background

The facts giving rise to this appeal arose out of a business venture between Mr Rafferty and his controlled companies Santora Holdings Pty Limited and Karaville Holdings Pty Limited (collectively Rafferty Parties) and Mr Donovan and his controlled companies Time 2000 Systems (Australia) Pty Limited (T2SA), Time 2000 Operations (Australia) Pty Limited (T2OA) and Embleton Limited (Embleton) (collectively Donovan Parties). The purpose of the business venture was to market and sell mobile accommodation units (MAUs).

The venture was documented in three agreements, a Heads of Agreement (HOA) between Mr Rafferty, Mr Donovan, Embleton and T2SA,  a Joint Venture and Shareholders’ Agreement (JVSA) between Mr Rafferty, Santora, Time 2000 West Pty Limited (T2W) and T2OA and a Rights Agreement (RA) between T2SA, T2W, Embleton, Mr Rafferty, Santora and Karaville. Under the RA T2W was to pay $1 million to T2SA to license the patents and trademarks of Time 2000 from Embleton. Importantly the RA placed obligations on T2W regarding the promotion, marketing, selling and installation of MAUs.3

Issues

The main issue on appeal was whether the trial judge erred in finding that the Code applied to the RA and the HOA.

Decision Was the RA a ‘franchise agreement’?

A franchise agreement will exist if the agreement grants 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, controlled or suggested by the franchisor…’. This is a two stage test. The first enquiry is whether there is a system or marketing plan, the second is whether the franchisor retains the requisite level of control.

The court listed the factors which indicate the existence of a system or marketing plan. These include:

  1. specific requirements for accounting and record keeping,
  2. reservation by the franchisor of a right to audit the books of account and other records,
  3. inability of the franchisee to supply goods or services to customers without the franchisor’s approval,
  4. reservation by the franchisor of the right to approve promotional and advertising material,
  5. provision by the franchisor of bonus structures or equivalent for those selling its goods or services, 
  6. provision by the franchisor of training for staff selling its goods or services,
  7. stipulation of retail pricing structures, sales structures, sales quotas,
  8. creation of marketing and sales territories, 
  9. reservation by the franchisor of the right to approve sales staff, 
  10. reporting systems in relation to profit or turnover, 
  11. restriction on the franchisee selling competing products, 
  12. controls on the use of brand and trading names, 
  13. requirements for signage and merchandising, 
  14. management structure, and 
  15. badging requirements regarding uniforms, stationary, trading name etc.

The court held that factors (a) through (d), (g), (h), (k), (l), (m) and (o) existed on the facts and that these factors, taken together, indicated that the RA created rights that would enable the franchisor to substantially determine, control or suggest that the business be conducted under a particular system or marketing plan.

The court paid particular attention to the finding of the trial judge that the RA obliged the franchisee to comply with the policies and procedures of the franchisor. The Donovan Parties and Madgwicks argued that this was merely a generic clause and could not support the existence of a system or marketing plan. This proposition was rejected. The court stated that, when considering the agreement as a whole, it was clear that the policies and procedures clause would enable a system or marketing plan to be imposed by the franchisor.

Factors relevant to determining whether there was the requisite level of control included:

  1. the extent to which the franchisee’s business involved the sale of the franchisor’s goods and services, 
  2. the degree to which the franchisor assumes responsibility for some centralised management and for uniform standards regarding quality, 
  3. whether or not the franchisor places the franchisee under an obligation with respect to advertising and promotional campaigns, and 
  4. the extent to which the franchisor controls the franchisee’s business, having regard to advertising and financial support, auditing of books, inspection of premises, hiring of staff, sales quotas, management training.

The court found that the franchisor retained the requisite level of control over the system or marketing plan. The business of the franchisee was solely concerned with the sale of the franchisor’s goods; the franchisor had a critical degree of control over the franchisee’s business; and the franchisee was required to meet specific sales targets and give prominence to the trade marks and trade and brand names of the franchisor.

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

The court found that an agreement to enter a franchise agreement does not require all of the terms of the franchise agreement to be agreed. Furthermore, despite there being no requirement in the HOA for T2W to enter into the RA, the court found that is was practically certain that T2W would do so. It is not a requirement of the Code that an agreement to enter a franchise agreement contain a legally binging obligation to do so. As such, the HOA was found to be an agreement to enter into a franchise agreement.

Conclusion regarding the Code

The court upheld the trial judge’s findings that the RA was a franchise agreement and that the HOA was an agreement to enter into a franchise agreement. Embleton and T2SA did not comply with the Franchising Code, in contravention of section 51AD, as the Rafferty Parties were not provided with a copy of the Code or the disclosure documents in accordance with clause 10 of the Code. Furthermore, they did not receive the written statements in accordance with clause 11.

Other issues

The court also held that two of the franchisors engaged in misleading and deceptive conduct in contravention of section 52 of the Trade Practices Act. This was in relation to representations made by Mr Donovan regarding the progress the franchisor had made in developing prototype MAUs.

The court rejected two claims made by the Rafferty Parties against the solicitors advising the Donovan Parties. The first claim was that the solicitors had engaged in misleading or deceptive conduct. The second claim was that the solicitors were involved in the contravention of section 51AD, within the meaning of sections 75 (1)(a) and (c) of the Trade Practices Act.

The court also rejected the cross-claim by the Donovan Parties that the solicitors had breached their retainer by failing to warn the Donovan Parties that the Code may apply to the RA or HOA.