Dibbs Abbott Stillman: how exclusive is too exclusive?

“We’re only going to supply you with these hair-products at this very special ‘only for you’ wholesale price so long as you stop stocking my arch enemies’ products!” …

“We’re only going to buy coffee beans from you as long as you don’t go supplying that ratbag café down the road with the same coffee beans!”

“Might I remind you that you signed a franchise agreement, a term of which required you to only purchase tiger prawns from Old Joe’s Pizza supplies!”

Exclusive dealing

According to Dibbs Abbott Stillman , comments like these comprise ‘exclusive dealing’ as defined by the Trade Practices Act 1975 (Cth)(TPA). In each instance one party restrains the other from dealing independently with third parties, which is prohibited by these sections.

Broadly speaking, exclusive dealing occurs when one person trading with another imposes some restrictions on the other’s freedom to choose with whom, in what, or where they deal. Exclusive dealing clauses are quite common in commercial arrangements, particularly sales of specified products on an ‘exclusive’ basis. It is essential that such terms are carefully checked to ensure that they do not have the purpose, the effect, or the likely effect of substantially lessening competition.

Franchise model

An integral part of the franchise business model is that the franchisor and its franchisees can obtain the benefits of economies of scale and volume buying power to their mutual advantage. Equally, it is in the interests of the franchisor to retain as much control as legally possible in its relationship with a franchisee in order to exercise quality control and protect the value of its goodwill and brand as a result of the relationship. The supply/acquisition obligations in a franchise relationship can, as a consequence of the interaction of these features, become problematic.

If a franchisor stipulates that goods and services must be acquired by the franchisee from the franchisor or a party nominated by the franchisor, and from no other party, this is a type of exclusive dealing.

In a franchising context, there are two types of exclusive dealing that could arise:

? Full line forcing - a requirement on a franchisee to acquire goods and services exclusively from the franchisor and from no other supplier without the written consent of the franchisor.

? Third line forcing - a requirement on a franchisee to acquire goods and services from a third party nominated by the franchisor and no other party without the written consent of the franchisor.

If a franchisor can argue that the purpose of the full line forcing is to maintain the quality or integrity of the franchise system, and substitutable goods or services are not available through a competitor at the same quality, or at all, the franchisor is not likely to be liable. Franchisors are legally able to set quality standards for products or services purchased by franchisees. A franchisor can legally nominate suppliers that meet those standards but cannot prevent franchisees purchasing from other suppliers who meet those standards.

Full line forcing

Full Line Forcing will not be a breach of the TPA unless engaging in that conduct has the purpose of substantially lessening competition, or has or is likely to have the effect of substantially lessening competition, in a relevant market. When conduct is subject to a substantial lessening of competition test, it is not enough to merely show that an individual business has been damaged. In this context the term ‘substantial’ is interpreted to mean an effect that is real or of substance.

A franchising client in the retail food market recently asked us to advise whether a proposed exclusive arrangement with a supplier would contravene the TPA.

The sole purpose of the exclusive arrangement was to protect our client’s ‘secret recipes’.

As part of the advice, we considered that whilst the conduct clearly comprised ‘exclusive dealing’ as defined by the TPA, the conduct did not appear to have the effect of substantially lessening competition in the relevant market.

Also, the recipes were created by our client and the purpose of entering into the exclusive arrangement was to protect our client’s IP rather than affect competition.

Third line forcing

Third line forcing is not subject to a ‘substantial lessening of competition’ test.

This means that if you engage in third line forcing and you do not notify or seek authorisation from the ACCC to engage in this conduct (see section below), you will breach the TPA. For some time, a number of commentators have recommended that this be amended so that third line forcing is subject to a ‘substantial lessening of competition’ test, however, this remains unresolved. Third line forcing can be beneficial particularly in a franchise context to maintain the quality or integrity of the franchise system.

Notification and authorisation

The TPA provides processes for immunity to be afforded to parties which propose to engage in exclusive dealing conduct which may be prohibited by the TPA, when such conduct is in the public interest. The ACCC may ‘authorise’ businesses to engage in anti-competitive arrangements or conduct (other than misuse of market power) when it is satisfied that the public benefit from the arrangements or conduct outweighs any anti-competitive detriment caused by the arrangements or conduct. Businesses can also gain immunity from legal action under the TPA by lodging an exclusive dealing notification. The notification process differs from the authorisation process in that parties do not have to await an ACCC decision. The immunity given by notification operates from the date of lodgement and remains unless revoked by the ACCC on the grounds that public benefit does not outweigh anti-competitive detriment.

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