Quite frequently business owners who have decided to enter into various arrangements for the distribution or licensing of their goods or services discover that the agreement reached is in law a “franchise agreement” and that they have unwittingly become a franchisor subject to additional regulation and obligations. If an agreement is a “franchise agreement” then there are certain legal requirements including mandatory disclosure prior to the grant of the franchise, procedures for transfer and termination and resolution of disputes.

Franchising Code of Conduct

Section 51AD of the Australian Competition and Consumer Act (formerly the Trade Practices Act) requires corporations to comply with any prescribed industry codes.  One of these codes is the Franchising Code of Conduct which governs “franchise agreements”.  If the agreement falls within the Code’s definition then it will be deemed to be a franchise agreement and it is irrelevant what the document is called or how the parties are described (e.g. licensee, agent, distributor, partner, shareholder or any other term).  The Code requirements also apply equally to a franchise agreement or an agreement to grant a franchise agreement.

The Code specifies a number of elements to be present in order for an agreement to be characterised as a franchise agreement.  There must be (in summary):

1. an oral, implied or written agreement;

2. in which a company (the franchisor) grants (to 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 that is substantially determined, controlled or suggested by the franchisor or its associate;

3. which is substantially or associated with a trade mark or commercial symbol owned, used, licensed or specified by the franchisor or an associate of the franchisor; and

4. pursuant to which there is required the payment of an amount or fee by the franchisee to the franchisor or its associate (subject to certain exclusions).

In order to fall within the definition all four elements set out in the definition must apply.  It is usually element 2 that causes most debate and discussion as the existence of the other elements is usually easy to establish. In several cases it was found that there was no franchise because there was no system or marketing plan.

Factors that are looked at include whether or not there is a comprehensive advertising and promotional program, any ongoing training, sales reporting and standardised requirements for the provision of the goods or services . A Court is more likely to find a system in place if an operations manual is provided addressing each area of the business and/or training is provided which relates to the overall running or promotion of the business (as opposed to specific or basic training skills).

Another question may be, are the businesses operated with the appearance of centralised management and with uniform standards as regards quality and price of goods sold, services rendered and other material instances of the operation? Businesses which use a central website and telephone number for the distribution of customer leads are often indicators of a franchise system in place.

In the case of Rafferty v Madgwicks [2012] the Court looked at whether documentation which was described as a Heads of Agreement and a Rights Agreement established a franchise agreement or an agreement to enter into a franchise.  Essentially the Court said that it was not necessary for the details of a system or marketing plan to be set out in the "franchise agreement". It is enough that the agreement creates rights and obligations that would enable the franchisor to substantially determine, control or suggest that the business be conducted under a system or marketing plan.

Risks of accidentally granting a franchise

The ACCC regulates the franchising sector and enforces compliance with the Code and its disclosure requirements, cooling off and other pre-contractual obligations.

The case of  Master Education Services Pty Limited v Ketchell [2008] addressed the issue of whether a failure to comply with the technical provisions of the Franchising Code of Conduct, would automatically render an entire franchise agreement void or illegal and therefore unenforceable. The High Court ultimately decided in Ketchell that the agreement was not void by reason of the breach of the Code. However there are other risks with failing to comply with the Code.

In ACCC v Mailpost Australia Limited [2010] the Court issued injunctions, costs and compliance orders against Mailpost and its director for operating a franchise system which it had falsely claimed was not a franchise and had consequently failed to comply with the Code. Mailpost was a substantial distribution business for promotional or "junk" mail and it collapsed, going into liquidation not long after the court action was taken by the ACCC.

The legislation gives the Court a number of options when making judgments including varying the terms of the franchise agreement, terminating the agreement or awarding compensation for damages. These remedies allow the court to take in account the particular circumstances of the case and make appropriate orders. Also despite the Ketchell decision,  a party to a non-compliant franchise agreement could still make a claim that where the procedural requirements have not been met, the franchise agreement should be made void, however this would generally require proof of loss caused and that this remedy was appropriate in the circumstances.

Latest developments - penalties

In July 2013, the Australian Government issued its response to the latest independent review of the Franchising Code of Conduct and indicated that it will be introducing civil pecuniary penalties for breaches of the Codes recommended.

While the Government has “accepted in principle” the need for penalties, it has said it is still considering the appropriate maximum (could be up to $50,000) and whether there should be different penalties for different breaches. It also has foreshadowed the introduction of “infringement notices” ($6600 for a corporation ($66,000 for a listed company) for each alleged contravention) to “promote effective compliance.” These are like a parking ticket - once paid no further action is taken. They are not necessarily an admission of guilt. The problem might be if  for example an "accidental franchisor" is issued an infringement notice for each "franchisee" it has failed to send a compliant disclosure document - the amount of the fine payable could add up to something substantial.

While we now have to wait to see the legislation for the details, the former Government said it had bipartisan support for the reforms and so even with the new change in Government we may not avoid the introduction of penalties or infringement notices.

In essence, the provisions of the Code while mandatory, are not impossibly onerous and many businesses large and small comply with the requirements successfully. Creating a franchise system has allowed many businesses to expand their already successful business concepts, achieve greater brand recognition and diversify risk. Franchises have many advantages for both franchisors and franchisees and with the right advice these can be established to bring great benefits to all participants.  It is also possible with prior planning and specialist knowledge and advice, to ensure that an arrangement is structured so that it does not fall within the ambit of the Code, if this is preferred.