If you have an arrangement where you allow another party to use your trade mark for certain goods or services, and you have certain rights to say how the business may be conducted, you may be treading into franchise territory.

Parties may enter into what they think is a “licence” agreement only to find out that it is actually a franchise arrangement. In Australia, both licensing and franchising arrangements are governed by the Competition and Consumer Act 2010 (Cth) (“CCA”). However, parties to a franchise agreement must also comply with the Competition and Consumer (Industry Codes – Franchising) Regulation 2014 (the “Franchising Code”) which imposes further obligations and requirements on the parties.

Quality Control Provisions in Trade Mark Licences

Quality control provisions play an important role in any trade mark licence arrangements. It protects the owner’s rights and interests by specifying minimum quality standards for goods and services to be provided by the licensee.

The Federal Court held in the recent case of Lodestar Anstalt v Campari America [2016] FCAFC 92 that in the context of a licence agreement, a mere theoretical possibility of “contractual control” exercisable by the trade mark owner is not sufficient to establish “control” under the Trade Marks Act 1995 (Cth). The implication of this judgment is that a trade mark owner under a licence agreement must exercise “actual control” over use of the trade mark by an “authorised user” to establish use of the mark for the purposes of defeating a non-use cancellation with respect to the mark.

The rights of trade mark owners to exercise control over licensees, whether actual or contractual, could include inspection rights of the licensee’s premises to assess the quality of goods and services provided under the trade marks, prescription of standards, specifications or manuals with respect to the quality of the licensed goods and services. In some cases, these quality control provisions may be viewed as a “system” or “marketing plan” to conduct the business and therefore the whole arrangement may be deemed a franchise arrangement.

When will a Licence be deemed Franchise Arrangement?

Whether an agreement is a licence or a franchise agreement is not dependent on the name of the document between the parties. It is a matter of substance. The ACCC and Australian courts have in the past deemed certain “licence” agreements to be franchises, and certain “franchises” to be licences, based on whether the agreements contained certain elements. If a licence agreement meets all the criteria of the definition under the Franchising Code, then the parties must comply with the Franchising Code, of which the parties cannot contract out. Failure to comply with the Franchising Code may result in the ACCC taking enforcement action and imposing penalties against the parties.

Definition of a Franchise under the Franchising Code

Under the Franchising Code, an agreement is deemed a franchise agreement if the following elements exist:

  1. a written / oral / implied agreement between the parties; and
  2. in which a person known (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, controlled or suggested by the franchisor; and
  3. the operation is substantially under a trade mark owned by the franchisor; and
  4. under which the franchisee agrees to pay to the franchisor an amount (including royalty payments, capital investment fees, up front licence fees, advertising payments, commissions and training fees).

A typical trade mark licence satisfies criteria 1, 3 and 4. Therefore, a closer consideration of point 2 - whether the right to carry on a business is granted under a system or a marketing plan that is substantially determined, controlled or suggested by the franchisor - is necessary. In particular it is important to consider whether quality control provisions in a trade mark licence to govern the quality and how the goods and services are to be provided would be deemed such a “system” or “marketing plan”.

What is a “system” or a “marketing plan”?

In Rafferty v Madgwicks [2012] FCAFC 37, the court considered and provided a useful analysis of what constitutes a “system” or a “marketing plan” and listed factors which indicates such a system is in place. Drawing from various case law, we have summarised some helpful indicators of a franchise and questions to consider in the table below.

The list in the table is obviously not exhaustive. Not all factors have to be present but rather, what is present and absent should be considered cumulatively to provide an “overall impression” of the actual nature of the agreement. The list will also vary depending on the circumstances of each case.

Indicators Considerations
Specific requirements or centralised system of accounting and record keeping provided by potential franchisor
  • Was the potential franchisee required to prepare and maintain financial records with a specific accounting firm approved by the potential franchisor?
Reservation by the potential franchisor of a right to audit the books of account and other records
  • Although a right to audit did not need to be specifically reserved, the court will also consider whether the potential franchisor has the right to access financial records.
  • These provisions are usually present in a typical trade mark licence agreement.
Provision by the potential franchisor of a detailed compensation and bonus structure for potential franchisees
  • Can the potential franchisor provide directions on how a person working for the potential franchisee could progress through the business?
Reservation of right by the potential franchisor to approve promotion and advertising materials
  • Did the potential franchisor have the right to reject advertising materials from the potential franchisee?
  • Did the potential franchisee have to follow the potential franchisor's demands regarding quality control in marketing?

NB These provisions are usually present in a typical trade mark licence agreement.

Prohibition of re-packaging of products
  • Did the agreement prohibit the potential franchisee from re-packaging the products?

NB These provisions are usually present in a typical trade mark licence agreement.

Assistance in conducting opportunity meetings
  • In case law so far, a general advice regarding best locations, scripts for approaching potential customers and provision of a small amount of promotional and marketing material did not amount to “opportunity meeting”.
Stipulation by potential franchisor of retail pricing structures
  • Were there actual requirements to be followed by the potential franchisee for pricing structures in agreement? Or just projected profit margins based on a “recommended selling price”?
  • Did the potential franchisor have a website with recommended retail pricing on it?
Potential franchisor provides detailed advertising programs and promotional schemes
  • Did the potential franchisor seek to establish a marketing plan under which the goods or services are to be marketed?
  • The provision of limited quantity of advertising and other promotional material may not be adequate.
  • Were there requirements to give prominence to the trade mark or brand in all displays, catalogues and other promotional material?

NB These provisions may be present in a trade mark licence agreement and distribution arrangement.

Creation of marketing or sale territories
  • Was the right granted limited to a geographic territory only?
  • The existence of a territorial restriction may support the argument for a franchise arrangement.

NB These provisions are usually present in a typical trade mark licence agreement.

Establishment of sales quotas or targets
  • Did the potential franchisee have to meet specific sales targets or quotas?
  • Would failure to do so result in a termination of the agreement?
  • Did the arrangement require the potential franchisee to order and purchase a minimum quality of products or services from the potential franchisor?

NB These provisions may be present in a trade mark licence agreement and distribution arrangement.

Potential franchisor has approval rights of sales personnel to be employed by franchisee
  • Did the potential franchisee have to hire personnel as required by the potential franchisor?
  • Was there evidence that the potential franchisor had the right to oversee the choice of the franchisee employees?
  • The court has held that a provision with a requirement that the potential franchisee had to “employ sales persons as reasonably required” by the potential franchisor fulfils this criteria.
Mandatory sales training regime
  • Did the potential franchisor have an obligation to provide training to the potential franchisee?
  • Was a training fee payable by the potential franchisee?
  • Provision of materials to assist in dealing with potential customers, recommended scripts and/or advice on locations of business may not be enough for finding a mandatory sales training regime.
  • Generally the more extensive the training, the more it confirms that there is a franchise agreement in place.

NB These provisions may be present in a trade mark licence and distribution arrangement.

Provision of quotation sheets or prescribed invoices and other sales forms or other branding
  • Was there mandatory use of trading name, uniforms or stationery determined by the potential franchisor?
  • Were standard forms prescribed by the potential franchisor used by the potential franchisee in the running of the business?
Requirement for potential franchisee to pass on customer information to the potential franchisors
  • Customer information under this requirement must come from the customers to the potential franchisor.
  • The court made a distinction between information from customers and regular written reports regarding general details of sales, service stock and outstanding customer orders.
  • The latter may not be considered “customer information”.
Control over what can be sold by the potential franchisee
  • Were powers provided to the potential franchisor to approve or refuse any proposed sales by the potential franchisee?
  • Was there a restriction on what the potential franchisee could sell especially in relation to related products?
  • Was there a non-compete clause?

Usually, in many franchise operations the only business operated by the potential franchisee is the franchise business itself. The smaller the proportion of the potential franchisee’s business selling goods and services under the agreement, the lower the risk it has of being a franchise.

When considering the above factors, the court will rely on contractual provisions and on some evidence of the interaction between the parties.

The court also stated that it is actually not necessary for the details of the system or marketing plan to be set out in the agreement. It is enough that the agreement creates rights and obligations that would enable the potential franchisor to substantially determine, control or suggest that the business be conducted under a system or marketing plan.

What does it mean for you?

If you are planning to enter into a trade mark agreement or a distribution agreement involving a trade mark, it is essential for the parties to consider whether the terms regarding influence and quality controls in an agreement could go as far as making the licence agreement a franchise arrangement.

A franchise agreement will require compliance with the Franchising Code. With the franchising sector in Australia currently undergoing significant legislative changes, including a recent prohibition on franchise agreements containing “unfair terms”, and the Fair Work Amendment (Protecting Vulnerable Workers) Bill 2017, making franchisors responsible for breaches of workplace laws by its franchisee, just passed through the Senate earlier this month, it is even more imperative for parties to consider early in the negotiation process the intended nature of the agreement and to enlist experienced legal professionals to advise on such issues.