It is a fundamental part of franchising that all franchisees within a system will provide the same products and/or services to their customers.

Many business owners have developed their own unique products and have selected franchising as their method of choice for business expansion. Indeed a unique product or service is often the keystone of a successful franchise.

What happens then when a franchisor does not manufacture its own product, but instead has a supply arrangement with a third party?

This article examines the circumstances in which a franchisor may fall foul of the exclusive dealing prohibitions within the Competition and Consumer Act 2010 (Cth) in the course of setting up and operating a franchise network, specifically by engaging in ‘third line forcing’ conduct.

What is Exclusive Dealing?

Section 47 of the Competition and Consumer Act 2010 (the Act) prohibits the practice of ‘exclusive dealing’.

Exclusive Dealing occurs where one trader imposes restrictions upon another trader’s freedom to choose with whom, or where it does business.

Types of Exclusive Dealing

There are a number of types of Exclusive Dealing, including:

  • Supplying goods or services (or supplying a discount) on the condition that the purchaser of those goods must also acquire goods or services from a third party (third line forcing);
  • Supplying goods or services (or providing a discount) on the condition that the purchaser does not acquire goods from a competitor of the supplier, or agrees not to re-supply goods or services acquired from a competitor of the supplier;
  • Supplying goods or services (or providing a discount) in exchange for the purchaser not re-supplying the goods or services to particular persons (or classes of persons) in particular places;
  • Or, refusing to supply goods or services because a purchaser will not agree to any of the above conditions.

When is Exclusive Dealing allowed?

It is quite clear that Exclusive Dealing is all around us in the marketplace.

The Act allows businesses to engage in exclusive dealing conduct that is not third line forcing, provided that it does not operate to substantially lessen competition.

An example given by the ACCC of exclusive dealing:

“Beauty Product Limited produces skincare products. The company will only supply its skincare products to beauty salons on the condition that the beauty salons will not acquire skincare products from other suppliers.”

This conduct will only be prevented under the Act if it has the purpose, effect or likely effect of substantially lessening competition.  

Why is ‘third line forcing’ different?

Third line forcing occurs where a supplier, Company A, sells goods/provides services to a Purchaser, on the condition that the Purchaser also buys goods/services from Company B.

Third line forcing also encompasses conduct whereby Company A refuses to supply goods/provide services to the Purchaser because it does not agree to buy from Company B.

Third line forcing is different from other types of exclusive dealing because it is prohibited outright by section 47 of the Act, regardless of its effect on competition.

Even if a commercial third line forcing arrangement has no affect whatsoever on competition, it will still be a breach of the Act.  

How does this affect Franchising?

Third line forcing can arise in franchising in a myriad of different ways. A common hypothetical is considered below:

You are a business owner who has decided to franchise. You have found your first franchisee, signed them up to a franchise agreement in full compliance with the Franchising Code of Conduct, and your franchisee has now commenced trading.

You have a long standing supply arrangement with a manufacturing company who has developed customised products to your specifications. These products are unique and sold only by your business.

It is vital that your franchisee also sells these products to its customers. Your franchisee must not be able to sell products which you have not approved, lest it weaken your businesses reputation.

As a result, your franchise agreement compels your franchisee to purchase its products from your nominated supplier and from no other supplier.

The supply arrangement has been fully disclosed to the franchisee upon signing the franchise agreement and the franchisee has consented to purchasing its products from your nominated supplier.

As a condition of you providing the franchise services (the supply), the franchisee must agree to purchase products from a third party (your supplier).

You have engaged in third line forcing conduct and may be pursued by the ACCC for your breach of the Act.

How can franchisors protect themselves?

Include a supplier approval process

A franchisor may avoid engaging in third line forcing conduct altogether if the franchise agreement does not prohibit supply from other parties.

This does not mean a franchisor cannot stipulate requirements that any other supplier must meet in order to supply the goods. Common requirements include: duality, durability and materials used.

This is commonly found in an ‘approval process.’ That is, a process which allows franchisee’s to have an alternative supplier approved if it meets the franchisor’s standards.

By incorporating an approval process into their franchise agreement, franchisors can ensure that they are not ‘forcing’ their franchisees to use their supplier, whilst still maintaining the standards they want for the franchise. The franchisee may find an alternative supplier of the same quality should they choose to.

However, this will not be a solution for all franchisors.  

Notification to the ACCC of Exclusive Dealing Conduct

If a franchise system requires conduct which constitutes third line forcing, the franchisor can obtain immunity from prosecution under the Act by lodging a Notification of Exclusive Dealing with the ACCC.

Section 93 of the Act allows persons who intend to engage in third line forcing (and other exclusive dealing practices) to notify the ACCC of their intention to engage in this conduct.

While the notification is in place, the franchisor will be immune from prosecution by the ACCC for engaging in the type of conduct described in that notification.

To be valid, the notification must be in the prescribed form, contain all relevant information, and be accompanied by the prescribed fee.

For third line forcing notifications, the immunity from prosecution will automatically commence 14 days after the notification is lodged with the ACCC, unless the ACCC has objected to the notification.

The ACCC may object to or revoke a notification if it considers that the likely public benefit will not outweigh the likely public detriment of the conduct.

When assessing the public benefit, the ACCC may consider whether the conduct:

  • Fosters business efficacy;
  • Improves product quality; and
  • Promotes competition in relevant markets.

Related Bodies Corporate

It is common for a franchisor to set up a separate entity to manufacture and/or supply the goods to its franchise system. This separate entity will then be a third party with whom the franchisees must contract.

There is an exception to third line forcing conduct if the third party supplier is a ‘related body corporate’ to the first supplier.

It is important to note in this context, that the definition of ‘related company’ must be carefully considered.

A company that is in some way associated with the franchisor, such that it may fall within the definition of a ‘related entity’ under the Corporations Act 2001 (Cth), will not necessarily be a ‘related company’ for the purposes of the third line forcing exemption.

Requiring franchisees to acquire goods from a related company to the franchisor may still, in some circumstances, constitute third line forcing.