Forcing a Franchisee’s Hand

By: Marianne Marchesi, Lawyer, Franchising, Mason Sier Turnbull

Franchising generally involves the supply of goods or services by a franchisor or a supplier approved by the franchisor to its franchisees. But this kind of conduct may constitute third line forcing, and franchisors need to be careful in restricting a franchisee’s freedom to deal with particular suppliers.

Third line forcing involves the supply of goods or services on the condition that the purchaser (the franchisee) acquires goods or services from a third party nominated by the supplier (the franchisor). Third line forcing is prohibited outright by section 47 of the Competition and Consumer Act 2010 (Cth).This means that it will be illegal regardless of whether the conduct has the purpose or effect of substantially lessening competition and regardless of the market power of the franchisor. There must, however, be some element of compulsion, in that the franchisee would not be granted franchise rights by the franchisor if the franchisee did not agree to acquire goods or services from a particular supplier specified by the franchisor.

Commonly in franchise systems, franchisors nominate suppliers who they believe meet specific quality standards. Franchisors should take care to ensure that they are not forcing franchisees to use certain suppliers. A franchise agreement should allow for an approval process, so that if a franchisee wishes to acquire goods or services from a different supplier, it is not restricted from doing so.

In Pampered Paws Connection Pty Ltd v Pets Paradise Franchising (Qld) Pty Ltd (No 10) [2012] FCA 25, the franchisee, Pampered Paws, alleged that Pets Paradise supplied the goods and services constituted by the franchise on the condition that Pampered Paws would acquire stock from a particular supplier. At the time of signing the franchise agreement, Pampered Paws was also required to sign a supply agreement with that particular supplier. The judge considered that Pets Paradise would not have allowed the franchise to be formally granted and operated by Pampered Paws unless the stock was acquired from that supplier, and therefore held that Pets Paradise had engaged in third line forcing.

There is an exception to third line forcing for related companies. It is not uncommon for franchisors to have associated companies who supply goods or services to franchisees. However, the definition of related company needs to be carefully considered. Requiring franchisees to acquire goods or services from an associated company may still constitute third line forcing, even though the franchisor and associated company are in some way ‘related’.

Franchisors should consider whether their supply arrangements need to be restructured to ensure they are complying with the Competition and Consumer Act. If this is not possible, franchisors who wish to require franchisees to purchase goods or services from particular suppliers may need to consider the ACCC’s notification process. Notification is a process under which parties that propose to engage in third line forcing may obtain immunity from prosecution. The immunity afforded by a third line forcing notification will only extend to the conduct which constitutes third line forcing as described in the notification.  The immunity arises 14 days after the notification is lodged, unless the ACCC objects. 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 purchaser under the arrangement, such as lower costs or better quality product;
• whether the conduct promotes business efficiency; or
• whether the conduct promotes competition.

For further information on third line forcing, or if you would like assistance in lodging a notification, please contact MST’s Franchising Team on 8540 0200.