April 2007

Caught by the Code? Working under the Franchising Code of Conduct

In today's competitive market, businesses are continually searching for more ways to leverage revenue from their intellectual property. Some businesses look to expand their trading through trade mark licence and distribution arrangements. Many of these deals are put in place without much thought about whether the arrangement may be considered a 'franchise' under the Franchising Code of Conduct.

The problem is that most people associate 'franchising' with the common "McDonalds", "Mortgage Choice" or "ITP ? The Income Tax Professionals" type of businesses.

However, the Code has stretched the traditional boundaries of what encompasses a 'franchise'. Under the Code a wide range of commercial relationships, including some trade mark licence and distribution arrangements are now regulated and considered to be franchises.

As a result many businesses unwittingly expose themselves to the risk of non-compliance with the Code. The consequences for non-compliance with the Code can be severe, and can include damages, injunctions, and other remedial orders.

When does the Code apply?

If your business involves selling goods and services through others, there is a risk that the arrangement constitutes a franchise agreement under the Code. To be classified as a franchise agreement under the Code an arrangement must contain all of the following elements:

  • an agreement under which a person (franchisee) is required to operate a business in accordance with a system or marketing plan substantially determined, controlled or suggested by another (franchisor);

  • the operation of the franchisee's business must be associated with a specified trade mark or commercial symbol owned by the franchisor or an associate; and

  • the franchisee must pay, or agree to pay, a fee in consideration of the grant of the franchise.

While it is relatively easy to determine whether element 3 is present, it is not so easy to determine if elements 1 and 2 are present in many common forms of trade mark licenses or distribution arrangements.

The Code gives no guidance as to what constitutes a 'system or marketing plan', and there is little Australian case law on this point. Some commentators believe that arrangements as simple as where a franchisor has some control over the operations of the franchisee or where some form of assistance is given by the franchisor to the franchisee in relation to its operations could be characterised as a system or marketing plan.

While the Code provides certain exclusions, the broad definition of "franchise agreement" is apt to cover many distribution and licensing arrangements. In all circumstances, it is the substance of the arrangement (not the title of the document) that is determinative.

Trade mark licenses

Trade mark licenses often allow the trade mark owner to control the quality of the goods or services in relation to which the trade mark is permitted to be used. Otherwise, the trade mark owner may jeopardise the validity and value of its trade mark. Where there is control over the quality of the goods or services to which a trade mark is applied, it may amount to a 'system or marketing plan' and satisfy element 1. Whether or not such control will amount to a 'system or marketing plan' will depend on the degree of control given to the trade mark owner and the details of the licence.

Use of a trade mark in relation to goods or services provided by the business will usually be sufficient to satisfy element 2, particularly where the business is primarily associated with the goods or services. Trade mark licences are usually granted in exchange for some consideration, such as a licence fee or ongoing royalty payments satisfying element 3.

Distribution agreements

Just like a trade mark licence agreement, a distribution agreement will typically give the appointing party the right to control elements of how, and the standards to which, the distributor is to behave. For example, the distributor may be required to:

  • attend training courses held by the appointor;

  • provide performance reports on a regular basis; or

  • participate in general advertising or promotional campaigns.

Again, depending on the degree of control exercised by the appointing party and the particular circumstances, this control may amount to a 'system or marketing plan', satisfying element 1.

Where the distributor is required to use a trade mark in connection with their activities (which is not always the case) element 2 may be satisfied.

It is common for a distributor to have a financial obligation to the appointing party, which may like the payment of a percentage of turnover or a fixed fee. This payment may fall within element 3.

Conclusion

Businesses should carefully consider whether their proposed trade mark licensing or distribution arrangements fall within the definition of a 'franchise agreement' under the Code. Warning bells should start ringing when proposing any arrangement where one party allows the other to use its trade mark in return for a fee and prescribes how the other must behave in its business operations.

If you hear the warning bells, then your business should seek legal advice about whether or not the Code applies. Being bound by the Code is not the end of the world. It can actually be used as a positive marketing tool, by letting potential business associates know that their rights will be protected by the practices and procedures your business has put in place to adhere with the Code.

Author: Michael Cossetto