Franchising – Due Diligence Issues – Supplier Rebates

One of the important issues to consider when buying a franchise is the issue of Supplier Rebates.

What is A Supplier Rebate?

A “Supplier Rebate” is a payment or financial incentive whereby a supplier of goods or services returns a portion of a purchase price to a Buyer.

What’s the Problem?

Supply chain management is one of the expected advantages or features of a franchise.  When organised properly, the Franchisor can leverage its buying power (from its whole franchise network) to ensure that inputs (be it product or service) are cheaper, more timely or of a better standard than could normally be achieved by a sole operator.

Usually, a Franchisor will arrange supply chain logistics and compel its franchisees (under the Franchise Agreement) to buy stock or services from “approved suppliers”.  If so, the Franchisee has little or no choice over its suppliers or supply arrangements.  The problem is not so much on the compulsion but when the supply arrangements are not commercial or inferior.

This problem can arise (or at least appear to arise) when the Franchisor retains a Supplier Rebate. In those circumstances, the interests of the Franchisor and Franchisee may be in conflict.

Franchisors often argue there is no conflict particularly when the rebate is applied to defray the Franchisor’s costs or otherwise applied to the benefit of the Franchise system as a whole (for example, by applying the rebate towards marketing and advertising costs). Unfortunately, in practice, many Franchisors simply retain the Supplier Rebate for their own purposes.

In some circumstances, the Franchisor retaining a Supplier Rebate may still be in the interests of a Franchisee particularly when the supply arrangement (even with the rebate) is still better than what the Franchisee could achieve on their own account.

Does the Law Ban Supplier Rebates Being Retained by Franchisors?

No.

Previously, the ACCC under the Competition and Consumer Act imposed restrictions upon a Franchisor in compelling their Franchisees to acquire products from approved Suppliers. Known as “third line forcing”, Franchisors could be prohibited from compelling Franchisees to acquire products from third parties unless authorised by the ACCC.

From November, 2017, the third line forcing provisions do not apply unless the supply arrangements result in a substantial lessening of the competition. As observed by the ACCC, it is rare for the ACCC to take action as most third line forcing arrangements do not result in a lessening of competition.

What Due Diligence Questions Should You Ask?

Under the Franchising Code of Conduct, the Franchisor must disclose in its Disclosure Document any rebate or other financial benefit from the supply of goods or services to a Franchisee including both the name of the business providing the rebate or financial benefit and whether such rebate or financial benefit will be shared directly or indirectly with Franchisees (Clause 10.1(j) and (k) of the Disclosure Document).

Unfortunately, the level of disclosure provided is often inadequate insomuch as the amount of the financial incentive is never disclosed and there is no compulsion upon a Franchisor to share or return any Supplier Rebate that they may receive.

Accordingly, Franchisees should as part of their due diligence take appropriate steps to inform themselves as to the status of any Supplier Rebates under the Franchise system. In particular, Franchisee’s  should ask the following questions:-

  1. What supply arrangements are in place?
  2. Does the Franchisor receive a rebate or financial incentive?
  3. If so, is that financial incentive shared or passed on and if so, how much?  Will the Franchisor agree to now share part of the rebate or otherwise defray some of their other costs?
  4. If no rebate or financial incentive is not in place, will the Franchisor agree to not receive a rebate unless approved by all Franchisees in the system? If so, a relevant contractual provision should be incorporated into the Franchise Agreement.

The issue of Supplier Rebates is an ongoing issue in the Franchise system and Franchisees should be aware of the inherent risk and conflict that may arise from Supplier Rebates being retained by Franchisors.

If you require any assistance or would like to discuss the issue of Supplier Rebates as part of your due diligence process, please do not hesitate to contact Heath Adams, Adams & Partners Lawyers.

Heath Adams is a Director of Adams & Partners Lawyers, and head of the commercial legal team within the firm. Heath’s primary focus is on servicing clients in the franchise sector including new and emerging franchise systems. He is an accredited specialist in Business Law. Read more about Heath here.

About Heath Adams

Heath Adams is a Director of Adams & Partners Lawyers, and head of the commercial legal team within the firm. Heath’s primary focus is on servicing clients in the franchise sector including new and emerging franchise systems. He is an accredited specialist in Business Law. Read more about Heath here.