If you are a distributor of goods or you licence a trade mark your distribution agreements or trade mark licence agreements could in fact be characterised as a franchise agreement under the Franchising Code of Conduct (Code) and be regulated by the Code. The Code prescribes a list of four criteria for a franchise agreement. If all four criteria are satisfied, the arrangement will be deemed to be a franchise agreement and fall within the coverage of the Code, regardless of how the parties label their arrangements. The Code imposes a number of obligations on franchisors, particularly in relation to the disclosure of information. These obligations can be expensive and time consuming. If it is not your intention to have a franchise business you should ensure that your arrangements are structured carefully and appropriately.
ACCC v Kyloe Pty Ltd [2007] FCA, 1522
The importance of this principle was highlighted last year in the Federal Court. The ACCC instituted proceedings against Kyloe Proprietary Limited (Kyloe) and Impact Design Accessories Pty Ltd (Impact) alleging that their distribution arrangements were in fact franchise agreements and that Kyloe and Impact had breached the Code by, among other things, not providing proper disclosure documents, cooling off rights or appropriate dispute resolution procedures. Kyloe and Impact promoted the distribution of Polar Krush ice drink machines and the resale of various Polar Krush products and entered into sub-distribution agreements with 22 sub-distributors. Kyloe and Impact licensed the use of their trade marks as part of their distribution arrangements. The sub-distributors were required to promote the products, observe all of Kyloe’s directions and instructions in relation to product promotion and obtain advertising approval from Kyloe (in relation to method, form, style and content) before advertising the products.
Was it a franchise agreement?
The Federal Court held that the Kyloe and Impact distribution arrangement was not a franchise agreement because at least one of the four criteria for a franchise agreement was missing. The four criteria are:
- The agreement must be written, oral or implied in whole or in part.
- The franchisee’s business operation must be substantially or materially associated with a trade mark, advertising or commercial symbol that is either owned, used, specified or licensed by the franchisor.
- The franchisee must pay the franchisor a fee.
- The franchisor must grant the franchisee a right to carry on a business of offering, supplying or distributing goods or services in Australia, under a system or marketing plan substantially determined controlled or suggested by the franchisor.
The Federal Court held that the fourth criterion had not been satisfied as there was no system or marketing plan.
What is meant by a system or marketing plan?
The court explored what was meant by a ‘system or marketing plan’ and set out the following non-exhaustive list of factors. These were:
- detailed compensation and bonus structures for selling products,
- a centralised book-keeping and record-keeping computer operation,
- schemes prescribed for the appointment of distributors, direct distributors, district directors, regional directors or zone directors, d) rights to screen and approve promotional materials,
- prohibitions on re-packaging of products,
- assistance in conducting 'opportunity' meetings,
- suggestions for retail prices to be charged for products,
- comprehensive advertising and promotional programs,
- division of a state into marketing areas,
- establishment of sales quotas,
- rights to approve sales personnel employed by the ‘franchisee’,
- mandatory sales training regimes,
- provision of quotation sheets to the ‘franchisee’s’ employees,
- provision of prescribed invoices and other sales forms to the ‘franchisee’,
- requirement that the ‘franchisee’ gather information from customers for the ‘franchisor’, and
- restrictions on ‘franchisee’ selling the ‘franchisor’s’ products without consulting the ‘franchisor’.
The court held that, while there was some sales material and general guidance given by Kyloe and Impact, this fell "well short of a system or marketing plan". Restrictions on the use of advertising material was described as minor. The sub-distributors had no exclusive or divided territory within which to operate, they were not required to produce business plans and neither Kyloe nor Impact had any right to inspect the financial records of the sub-distributors or to audit or inspect the premises at which machines had been installed. The court concluded that the sub-distribution arrangements bore "all the hallmarks of a distributorship", stating: "[t]here was no ongoing support; no sub-distributor was confined to a particular territory; marketing merchandising and sale decisions were, to a great extent up to the sub-distributors; and no royalties were payable to Kyloe".
What does this mean for me?
If you want to ensure that your arrangements reflect a true distribution agreement or trade mark licence and it is not your intention to enter into a franchise agreement, you will need to review your documents carefully before entering into the arrangement. If you have several options open to you on how to conduct your marketing activities you should consider whether any of those alternatives bring you within the ‘system or marketing plan’ operation of the franchise agreement definition and, if appropriate, adjust your arrangements accordingly. You should be aware that if you already have an agreement in place which contains provisions that bring you within the operation of the Code, you cannot avoid the application of the Code by simply not enforcing those rights. Your agreements would need to be amended to avoid the application of the Code. You should seek legal advice to ensure that this is done properly.