Beware the hidden Franchise Agreement

By Jack Newton, Law Graduate, MST Lawyers

A judgment by the New South Wales Court of Appeal on 15 April 2015, that a distributorship agreement was a franchise agreement, has cost the ‘franchisor’ over $200,000.

The case not only concerns whether or not the agreement is a franchise agreement, but also concerns circumstances where one party represents that it will not enforce a particular provision but then seeks to terminate for breaching that provision.

The facts

In September 2011, Workplace Safety Australia (“WSA“) entered into a distribution agreement with Simple OHS Solutions (“Simple“) that granted Simple the exclusive right to provide occupational health and safety training services to employers. The distribution agreement required Simple to pay WSA fees in consideration for the provision of the training services.

The distribution agreement imposed an obligation on Simple to subscribe a minimum number of customers per month which would be assessed each six months, and provided WSA with the right to terminate the distribution agreement if Simple did not reach the prescribed number in a six month period.

During the negotiations between the parties prior to the execution of the distribution agreement, the director of WSA who was responsible for negotiations made several statements to the director of Simple as follows:

• “I don’t expect you to make your targets initially”;
• “Like with any new business it will take you some time to get used to everything and meet your sales targets”; and
• “As I said I don’t expect you to make your sales target at first, but our office will help you and you will get here”.

Simple did not meet the minimum customer requirement for the first six month period, and in March 2012, WSA purported to terminate the distribution agreement on two bases:

• that Simple had not subscribed the minimum number of customers; and
• that Simple had not paid an instalment of a fee, which it said was due on 23 March 2012 and therefore overdue (this is not analysed in this article).

The New South Wales Supreme Court judgment

In December 2013, the New South Wales Supreme Court found that WSA had wrongfully terminated the distribution agreement.

The Supreme Court agreed with a submission from Simple that the distribution agreement was, in effect, a franchising agreement within the meaning of the Franchising Code of Conduct (“Code“).

The Supreme Court held that because the Code’s disclosure and termination requirements were not satisfied, WSA’s termination of the distribution agreement was wrongful and a breach of the Code. The Supreme Court further held that because WSA had represented to Simple that the minimum subscription requirement would not be enforced for the “initial period” of the contract, WSA could not then terminate for breach of that requirement within the first six month period.

The Supreme Court awarded Simple $208,178.34 plus interest.

The appeal

WSA appealed to the New South Wales Court of Appeal arguing first, whether the distribution agreement was a franchise agreement and second, whether WSA was prevented from enforcing the minimum subscription requirement because of its prior representation.

On 15 April 2015, the Court of Appeal found against WSA on all grounds, and upheld the Supreme Court’s judgment of $208,178.34 (plus interest) in favour of Simple.

The arrangement between WSA and Simple was, in many ways, very different to the standard franchising arrangement. Simple had operated under its own name and corporate identity since 2004. It maintained its name and corporate identity even during the life of the distribution agreement. This is very different to the ordinary franchising arrangement, yet did not prevent the Court from finding that the distribution agreement was a franchise agreement.

The Court of Appeal was easily satisfied that the Distribution Agreement granted Simple the right to carry on a business of offering, supplying or distributing goods or services in Australia. Most of the debate concerned whether the business was carried on under a system or marketing plan, and whether that system or marketing plan was substantially determined, controlled or suggested by WSA.

The Court of Appeal found that numerous clauses in the Distribution Agreement amounted to a system or marketing plan that was substantially determined, controlled or suggested by WSA. These included:

• the requirement that Simple submit to WSA a detailed business plan;
• the power of WSA to give directions to Simple (including about the business plan), which Simple was required to comply with;
• the power of WSA to refuse consent to marketing and promotional activities;
• the requirement that Simple process and administer all sales in accordance with the processes advised by WSA; and
• the requirement that Simple use standard forms, product information sheets and a marketing manual, all issued by WSA.

The Court of Appeal also held that the statements made by WSA’s director meant that WSA could not enforce the very provision it had represented it would not enforce. This was a further way in which the distribution agreement had been wrongfully terminated.

The lessons to be learned

The first lesson, and putting aside the actual decision, is that litigation takes a long time. The distribution agreement was executed in September 2011, and was terminated in March 2012. The action in the Supreme Court wasn’t heard until November 2013 with judgment published in December 2013. The appeal was heard in October 2014 though judgment wasn’t published until April 2015.

Litigation is often a very long and very costly exercise with no guarantee of obtaining your desired result. Serious efforts should be made to resolve disputes as soon as practicable.

Second, and perhaps more importantly, the judgment is a resounding warning that parties to any agreement must be extremely cautious about ignoring the possible application of the Code to their agreement, or worse, trying to avoid compliance with the Code.

In an employment contract case many years ago, a Federal Court Judge once said that parties “cannot create something which has every feature of a rooster, but call it a duck and insist that everyone else recognise it as a duck“. The same can be said for franchise agreements.

If it falls within the definition of “franchise agreement” in the Code, the parties will be bound by the Code and any party that breaches the Code will pay a large price. Here, that price was over $200,000 and was payable even though the suggestion that the agreement was a franchise agreement did not arise until after the distribution agreement had been terminated.

Those who are prudent would be wise to seek expert legal advice as soon as possible, to put themselves at ease over whether the Code applies to their own arrangements. Spending a small amount of money on advice now, may end up saving many tens or hundreds of thousands of dollars later.

The amendments to the Code, effective 1 January 2015, mean that with the introduction of civil penalties and pecuniary penalties, failure to comply with the Code will have more serious repercussions.

For further information or to discuss a possible review of your documentation, please contact John Sier by email at john.sier@mst.com.au or by telephone +61 8540 0200.