How to stay legal with preferred suppliers

By Sarah Stowe | 16 Aug 2016 View comments

Is compelling franchisees to use a supplier legal? Image: incompetition.com.auFranchisors, do you force your franchisees to acquire goods or services from a specified third party supplier?

If so, this is likely to constitute third line forcing, which is prohibited by section 47 of the Competition and Consumer Act 2010 (CCA).

Third line forcing involves the supply of goods or services (that is, the grant of the franchise) on the condition that the purchaser (the franchisee) acquires goods or services from a third party nominated by you. Commonly in franchise systems, franchisors nominate suppliers who they believe meet specific quality standards. This might include:

  • Group insurance policies
  • Products and stock to be sold to customers
  • Merchandise and packaging
  • Technology or software to be used in the franchised business

Whilst this makes commercial sense and ensures consistency across the brand, you should ensure that appropriate measures are taken to comply with the law.

It may be possible to structure your supply arrangements so that, whilst you have a list of preferred suppliers, franchisees are not actually restricted from using alternative suppliers. These alternative suppliers could still be approved by you to ensure they meet your standards, meaning quality is not compromised. If approved, these alternative suppliers could then form part of your list of preferred suppliers.

Alternatively, a ‘notification’ may be submitted to the Australian Competition and Consumer Commission (ACCC). This may be the better option where it is not possible to re-structure your supply arrangements, such as if your suppliers have customised goods or services for your franchise system.

A notification describes the conduct and sets out the public benefits and detriments likely to arise from the conduct. If accepted, a notification grants you immunity from prosecution. The ACCC may object to the notification if it does not regard that the public benefit from the conduct will outweigh any anti-competitive detriment. In assessing the public benefit, it may consider:

  • the benefit to the franchisee under the arrangement, such as lower costs or better quality product;
  • whether the conduct promotes business efficiency; or
  • whether the conduct promotes competition.

The ACCC has stated that in regards to franchise arrangements, it considers that the following public benefits may arise:

  • consistency across the franchise system, which may benefit customers and increase the value of the franchise system as a whole;
  • more efficient operation and management of the franchise system where all franchisees operate compatible equipment and purchase the same goods; and
  • more efficient and effective bargaining between the franchise group and its suppliers.

Notifications are published on the ACCC’s public register. Although uncommon, the ACCC can revoke a notification if the public benefit no longer outweighs the public benefit. For example, a Seal-a-Fridge notification was revoked as the ACCC determined that the conduct did not actually deliverany cost savings or benefits to franchisees.

The notification process is relatively straightforward and cost-effective. At the time of writing, the lodgement fee for submitting a notification is $100 – well worth it considering that the consequences of infringing the CCA can be significant. The ACCC may order penalties of up to $10 million for companies and $500,000 for individuals.

In addition to this, there may be other consequences such as compensation payable to a franchisee or having a franchise agreement considered void.

In the case of Pampered Paws Connection Pty Ltd v Pets Paradise Franchising (Qld) Pty Ltd, the franchisor (Pets Paradise) required its franchisees, including Pampered Paws, to purchase pet products from a specific supplier and enter into a related supply agreement. Pampered Paws argued that this constituted third line forcing, as the franchise would not have been granted unless Pampered Paws entered into the supply agreement.

The court agreed that Pets Paradise had engaged in third line forcing. However, in this case, damages were not awarded as Pampered Paws had not relied on or suffered loss as a result of the conduct. Nevertheless, it is clear that costly legal action could have been avoided had the franchisor considered its supply arrangements more carefully from the outset.

So, what do you need to do?

  • If you are unsure whether your supply arrangements constitute third line forcing, speak to a lawyer with franchising expertise.
  • Even if you have submitted a notification, it is important to communicate with your franchisees to ensure they understand the process used to select suppliers and the reasons for doing so.
  • Monitor your suppliers to ensure benefits are still being delivered to your franchisees and customers.
  • Ensure your disclosure document accurately discloses your supply arrangements (including any ownership interests in suppliers or rebates received).