When is your licensee really a franchisee?

Franchise versus distributorship

We are often asked what the difference is between a business operated under licence governed by a distribution agreement and one operated under a franchise agreement.   In short, the franchise relationship is predicated on control and breadth of influence, while a distribution agreement is narrower in scope and does not concern itself with marketing and merchandising.

It is a significant distinction as regardless of whether you believe yourself to be party to a distribution agreement, if the Court defines your relationship as that of franchisee and franchisor, then you may be in breach of obligations you weren’t aware of.

The Courts have helped define the distinction, most recently Rafferty v Madgwicks [2012] FCAFC 37 held that a relationship is classified as a franchise with a two stage test; the first stage is whether there is a system or marketing plan, and the second is whether the franchisor retains the requisite level of control.

The foundations of a franchise

There are certain distinct elements that a Franchise Agreement must possess as provided in section 5 of the Franchising Code of Conduct (Code) in order for a business to be considered a Franchise.  These include:

1. the franchisor granting the franchisee the right to carry on the business of providing goods or services under a system or marketing plan determined or largely controlled by the franchisor;
2. the franchisor granting the right to operate under the franchisor’s trademark, advertising or commercial symbol to the franchisees;
3. the franchisees being required to pay a fee or fees of various types to the franchisor before and during the conduct of the business which may include:

• an initial capital investment fee;
•  a payment for goods or services;
•  a fee based on a percentage of gross or net income; or
• a training fee or training school fee.

What is a system or marketing plan?

A ‘system or marketing plan’ is not defined in the Code, but Bennet J in ACCC v Kyloe Pty Ltd [2007] FCA 1522 identified the following indicators of the existence of such a System or Marketing Plan:

• “the provision by the franchisor of a detailed compensation and bonus structure for distributors selling its products;
• a centralised bookkeeping and record keeping computer operation provided by the franchisor for distributors;
• a scheme prescribed by the franchisor under which a person could become a distributor, direct distributor, district director, regional director, or zone director;
• the reservation by the alleged franchisor of the right to screen and approve all promotional materials used by distributors;”
• a prohibition on re-packaging of products by distributors;
• the provision of assistance by the alleged franchisor to its distributors in conducting “opportunity meetings”;
• suggestion by the franchisor of the retail prices to be charged for products; and
• a comprehensive advertising and promotional program by the alleged franchisor.

Her Honour also cited Master Abrasives Corporation v Williams (1984) 469 NE 2d 1196 in which further indicia were regarded as:

• “the division of a state into marketing areas;
• the establishment of sales quotas;
• the franchisor having approval rights of any sales personnel whom the franchisee might seek to employ;
• a mandatory sales training regime;
• the provision of quotation sheets to the franchisee’s employees;
• provision by the franchisor of prescribed invoices and other sales forms;
• a requirement that franchisees elicit certain information from their customers and provide that information to the franchisor; and
• a restriction on the franchisee selling any of the franchisor’s products without first consulting the franchisor”

How much control is needed?

Factors that could be used to determine whether an alleged franchisor had the degree of control over the system or marketing plan was outlined in ACCC v Kyloe Pty Ltd [2007] FCA 1522 citing Capital Networks Pty Ltd v .au Domain Administration Limited [2004] FCA 808 at 58 as:

• “the extent to which the distributor’s business involved the sale of the alleged franchisor’s products – the smaller the percentage the less likely it will be that the necessary degree of control will be found to exist;
• whether or not the alleged franchisor ostensibly assumed responsibility for product outlets by causing them to be operated with the appearance of some centralised management and with uniform standards as regards the quality and price of goods sold, services rendered and other material instances of the operation;
• whether or not the alleged franchisor placed the distributor under an obligation to advertise, to conduct promotions and to stock accessories; and
• the extent to which the alleged franchisor controls the franchisee’s business having regard to matters such as prescription of the hours and days of operation, advertising, financial support, auditing of books, inspection of premises, control over lighting, employee uniform, prices, trading stamps, hiring, sales quotas and management training.”

It was said further that even if there was not the requisite control over the system or marketing plan, a franchise agreement may be found to exist if the system of marketing plan is “substantially suggested by the alleged franchisor”.

It was contended that ‘helpful suggestions’ did not go so far as to indicate the degree of control necessary to be seen as a being a marketing plan.

The distributorship / franchisee distinction

Tracy J quoted Franchising Law and Practice by Giles, Redfern and Terry at 1.0420 as follows:

“In the case of a distributorship, the main points of difference with a franchise are that the arrangement is generally much less formal, may not have the same degree of certainty of term, may or may not be exclusive, might tend to cover a larger geographic area, and would leave the marketing, merchandising and sale decisions largely to the distributor.

No royalties are payable to the supplier by the distributor. The suppliers’ profit arises from the difference between the price at which they manufacture or which they pay for the goods and the price at which they are able to sell the goods to the distributor”.

The above cases provide guidance on the degree of control and the elements of a marketing plan which distinguish a distributorship from a franchise.

It appears that the general rule is that the more you “control” the business, the more likely it is to be defined as a franchise.

Links and further references

Legislation

Franchising Code of Conduct

Cases

Rafferty v Madgwicks [2012] FCAFC 37

Workplace Safety Australia v Simple OHS Solutions Pty Ltd [2015] NSWCA 84 (8 April 2015)

Further information

If you need assistance drafting or reviewing a Franchise Agreement, contact us for a confidential and obligation-free discussion:

Disclaimer

This article contains general commentary only.  You should not rely on the commentary as legal advice.  Specific legal advice should be obtained to ascertain how the law applies to your particular circumstances.

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