The recent case of Rafferty v Time 2000 West in the Federal Court of Australia has explored the definition of a franchise agreement under the Franchising Code of Conduct (the Code).
Definition of franchise agreement
In basic terms, an agreement is deemed to be a franchise agreement if it fulfils the following elements:
- a written, oral or implied agreement is in place
- there is a right to supply goods or services under a system or marketing plan that is substantially determined, controlled or suggested by the alleged franchisor
- the operation of the business is associated with a trade mark and
- a fee is payable to the alleged franchisor
The exact meaning of the above definition has been a point of discussion and debate in the franchising sector since the introduction of the Code in 1998. However, the decision in the Rafferty case has provided some clarity as to the second limb of the above definition, relating to the requirement for a system or marketing plan.
The case arose out of a failed arrangement between to import and sell modular accommodation units (MAUs), specifically semi-permanent prefabricated buildings that are often used in mining settlements. The parties signed a heads of agreement and then progressed to executing a formal document that was referred to as a “Rights Agreement”. The Rights Agreement granted Rafferty the right to import and sell the MAUs in Australia.
When the relationship between the parties broke down, Rafferty took legal action to have the Rights Agreement set aside on the basis that it was a franchise agreement pursuant to the definition under the Code. Rafferty relied on the fact that Time 2000 West (Time) had failed to comply with several sections of the Code, including the requirement to provide a disclosure document in accordance with section 6B of the Code.
Whilst negotiating the terms of the Rights Agreement, the parties were cognisant that it might constitute a franchise agreement under the Code. The parties decided to proceed on the basis that it was not a franchise agreement because they believed there was no system or marketing plan in place. In an attempt to allay this concern, it was specifically noted in the Rights Agreement that a system or marketing plan would not be imposed by Time.
Factors that determine whether there is a system or marketing plan
For guidance on the factors to be considered in determining whether a system or marketing plan exists, the Court looked to the cases of “Capital Networks” and “Kyloe”.
The Court identified that if some or all of the following elements are present, a system or marketing plan substantially is likely to exist:
- a centralised bookkeeping and records-keeping computer operation operated by the franchisor
- the franchisor having the right to screen and approve all promotional materials
- a prohibition on the repackaging of products by the franchisee
- the franchisor suggesting the retail prices to be charged for products
- a comprehensive advertising and promotional program controlled by the franchisor
- the division of a State/Territory into marketing areas
- the imposition of a sales quota by the franchisor
- the franchisor holding approval rights of any sales personnel whom the franchisee might seek to employ
- a mandatory sales training regime imposed by the franchisor
- the franchisor providing quotation sheets to the franchisee’s employees
- the provision by the franchisor of prescribed invoices and other sales forms
- a requirement that the franchisee elicits certain information from their customers and provides that information to the franchisor and
- a restriction on the franchisee selling any products without first consulting the franchisor
The Court noted that the above factors do not need to be specifically set out in the relevant agreement, only that the power to impose such requirements arises under the agreement.
The Court decided that many of the above elements were present and as such there was a system or marketing plan substantially controlled by Time. The Court was, therefore, satisfied that the Rights Agreement was in fact a franchise agreement. The Court is yet to hand down its final orders, however it has been flagged that given that Time had not complied with the Code by failing to provide a disclosure document and ensuring that the franchisee had sought legal advice, the Rights Agreement may be set aside by the Court.
This case helps to provide further clarity and guidance as to what constitutes a franchise agreement under the Code. At this stage, the Court has not issued its final orders in relation to damages. We will further update you as to whether the Court orders Time to compensate Rafferty and/or sets aside the Rights Agreement.
It is clear that many purported licence agreements and distribution agreements may in fact fall within the definition of a franchise agreement and require compliance with the Code. Failure to comply with the Code could lead to the agreement being set aside, so it is vital that parties to such agreements obtain legal advice from an expert in franchising law before proceeding.
Contact one of our franchising lawyers to discuss any concerns you have regarding your system and documentation.
Author: Nick Rimington