Many franchisors require their franchisees to source products and services for use and sale in the franchised business from certain suppliers approved by the franchisor.

This requirement may be specified in the terms of the franchise agreement or it may be found in the franchisor’s operations manual (or similar).

If as a franchisee you fail to use preferred suppliers, you risk being in breach of the franchise agreement, which could ultimately result in termination of the franchise agreement and/or legal action by the franchisor to recover any loss or damage incurred because of your actions.

Pros and cons of preferred suppliers

Franchisees are often happy to avail themselves of the franchisor’s preferred suppliers because doing so:

• ensures the products and services purchased are consistent with other members of the franchise network;
• ensures the products and services purchased are acceptable to the franchisor and comply with any prescribed standards or quality requirements;
• may provide benefits of any group discounts or competitive supply terms negotiated by the franchisor which the franchisee would not otherwise be able to secure; and
• frees them from the hassles of investigating and sourcing their own network of suppliers and allows them to instead focus on conducting the franchised business.

However, using the preferred supplier arrangements can sometimes be detrimental to the franchisee, for example if:

• they are more expensive, less competitive or less reliable than those the franchisee is able to source individually;
• the products are of lesser quality than those the franchisee is able to source; or
• the franchisee is able to obtain benefits (such as rebates, marketing opportunities, reduced storage requirements or increased customers) from acquiring its own locally-sourced products.

On face value, franchisees are obliged to comply with the terms of the franchise agreement and use the franchisor’s preferred suppliers. 

You should, however, check whether such arrangements constitute third line forcing and are therefore illegal.

Is the arrangement legal?

Third Line Forcing is a type of exclusive dealing conduct which is prohibited by section 47 of the Competition and Consumer Act 2010 (CCA). It occurs when a business will not supply goods or services, or give a particular price or discount, unless the purchaser buys goods or services from a particular third party.

In contrast to other types of exclusive dealing, third line forcing is prohibited by the CCA irrespective of its effect on competition.

In a franchising context, the CCA would make it illegal for a franchisor to make it a condition of the franchise agreement that the franchisee must purchase products from a specified third party. 

There are some exemptions, including where the supplier and the franchisor are related parties, and there are also provisions in the CCA that enable a person seeking to engage in third line forcing to effectively obtain permission from the ACCC to do so. 

This permission can be gained through what is known as notification or authorisation but public benefit must be demonstrated before such permission will be granted.

Preferred supplier arrangements are also unlikely to be illegal where:

• the franchisor has approved several suppliers, from which the franchisee is free to choose whom to engage for supply;
• the approved suppliers have been nominated because they satisfy the franchisor’s standards and quality controls;
• the franchisor provides a process whereby new or alternate suppliers can be suggested, assessed and approved, provided they meet the franchisor’s quality standards.

In summary, franchisors may nominate preferred suppliers which meet their quality standards. Franchisees must comply with the franchisor’s mandatory supply arrangements, if the franchise agreement contractually obliges them to do so, unless the arrangements constitute third line forcing (or another type of anti-competitive conduct prohibited by the CCA) and the franchisor has not obtained notification or authorisation from the ACCC for engaging in such conduct.

So what should you do?

Before entering into a franchise, you should carefully review the franchise agreement, disclosure document and any operations manual to ensure you are aware of any mandatory supply arrangements and should seek out detailed information regarding the supplier arrangements, including all relevant terms and conditions of supply.

You should also confirm whether the franchisor has any third line forcing notifications in place, which would oblige you to comply with mandatory supply arrangements even if they constitute third line forcing.