Legal update: Further guidance on the meaning of "franchise agreement"
by
Norton Rose
On 18 October 2007, the Federal Court of Australia handed down its judgment in ACCC v Kyloe Pty Ltd (Kyloe), which confirmed the principles enunciated in the Capital Networks case, and provided new factual examples of their application. As in Capital Networks, the case was decided in favour of the respondents to the extent that no franchise agreement was held to exist.
An understanding of when a distribution or licence agreement will be deemed to be a franchise agreement is critical, because as a prescribed code under the Trade Practices Act, there are serious consequences for failing to comply with the Code’s provisions when required.
The facts
Kyloe was the importer of “Polar Krush” ice drink dispensing machines into Australia from the United Kingdom. Kyloe appointed Impact Design Accessories Pty Ltd (Impact) as a distributor in Australia for the machines and associated products, which in turn appointed 22 sub distributors who were responsible for seeking premises for the placement of the machines, and managing their daily operation.
The Australian Competition and Consumer Commission (ACCC) brought proceedings against Kyloe and Impact for (amongst other things) failing to provide “sub distributors” with a disclosure document and 7 day cooling-off period as required by the Code. Prior to deciding this issue, the court had to decide the threshold question of whether or not Kyloe had entered into “franchise agreements” with its sub distributors.
The definition of franchise agreement
“Franchise agreement” is defined in section 4 of the Code to mean:
- an agreement (whether written, oral or implied);
- in which the “franchisor” grants to the “franchisee” the right to carry on a business under a system or marketing plan substantially determined, controlled or suggested by the franchisor;
- where the operation of the business will be substantially associated with a trademark, advertising or commercial symbol of the franchisor; and
- this occurs in exchange for the payment of a fee, either before starting or continuing the business.
The requirements for a “system or marketing plan”
As it was in Capital Networks, one of the key issues in Kyloe’s case was whether or not a right had been granted to the sub distributors to carry on a business under a system or marketing plan substantially determined, controlled or suggested by the franchisor.
The court in Kyloe considered this issue in two stages, firstly considering whether or not a “system or marketing plan” existed, and secondly whether or not any such plan had been substantially determined, controlled or suggested by the respondents.
Undefined in the Code, the court employed the following “helpful indicators” of the existence of a system or marketing plan, drawn from American and Australian case law:
- the provision by the franchisor of:
*a detailed compensation and bonus structure for franchisees;
* a centralised book and record keeping computer system for franchisees;
* a scheme whereby a person could become regional director, zone director or alike;
* assistance to franchisees in the form of "opportunity meetings";
* a comprehensive advertising and promotional program; and
* suggested retail prices for products;
-the reservation by the franchisor of the right to screen and approve all promotional materials used by franchisees; and
- a prohibition on re-packaging of products by franchisees.
Following the structure of the ACCC’s submissions, the court applied the factual situation to each indicator in turn, to assess whether on the whole, a system or marketing plan existed. The court determined that the evidence in relation to these indicators was not sufficient to satisfy it that a system or marketing plan existed. The court generally accepted the respondents’ submissions that the:
- absence of any exclusive or divided territories of operation;
- inability to inspect or audit the financial records of the sub distributors, or the premises where the machines were located;
- absence of any obligation on the sub distributors to produce a business plan; and
- sub distributors’ ability to run their businesses as they pleased (subject to minor restrictions regarding the use of advertising materials and basic machine operation training),
meant that no system or marketing plan had been established or imposed by the respondents. The court considered that 2 to 3 hours of training, advice on the proposed terms of the arrangement, and general encouragement, even when considered cumulatively, “…fell well short of a system or marketing plan”.
The court held that even if a system or marketing plan did exist, that it would not have been "substantially determined, controlled or suggested" by the respondents. In regard to the degree of control exercised, the court was guided by indicative factors distilled by Bennett J in Capital Networks from American case law, being:
- the extent to which the distributor’s business involved the sale of the franchisor’s products (the smaller the percentage the less likely the test was to be satisfied);
- the extent of the franchisor’s control over the distributor’s business (i.e. by controlling opening hours, uniform requirements and sales quotas etc) and thus an ostensible assumption of management responsibilities across the network by the franchisor; and
- whether or not the franchisor required the distributor to advertise, conduct promotions and stock accessories for the products and services.
The court did point out that even if an alleged franchisor did not substantially control the system or marketing plan, that a franchise agreement may be found to exist if the plan was substantially suggested by the franchisor. On the facts in Kyloe, the sub distributors were able to determine their own business plans, and therefore the court concluded that the respondents’ marketing advice constituted “helpful suggestions” rather than substantial recommendations.
Conclusion
Companies need to be aware of the operation of the Code as it can deem franchise agreements to arise in certain circumstances despite the intent of the parties. As the operation of the Code cannot be avoided by referring to a franchise agreement as a distribution or licence agreement, Kyloe’s case provides salient examples how and where the line is drawn between genuine distribution agreements and franchise arrangements.
In recent years, the ACCC has been vigilant in ensuring compliance with the Code. It has been very willing to take legal action to enforce the Code’s provisions. Accordingly, it is important that potential franchisors, licensors and distributors are aware of the indicative factors of a franchise agreement as discussed in Kyloe and Capital Networks in order to ensure that if their distribution networks are caught by the scope of the Code they take corresponding measures to comply with it. 05.11.2007
FCA Member
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