“What is a Franchise Agreement?” – A reminder after Workplace Safety Australia v Simple OHS Solutions Pty Limited

I often receive calls from new clients seeking advice as to how they can expand their business.  Of those, I am often asked whether their plans may be a franchise. Often, there is a fear or concern about establishing a franchise given the perceived difficulties and regulation surrounding franchising in Australia.

When asked, do I need to set up a franchise, my response is simply “If the arrangement meets the test of a “franchise agreement” then Yes”.  Under the Franchising Code of Conduct (called the “Code”, the key regulation for franchising in Australia) if your agreement is a franchise agreement you must comply with the Code.

The Code sets out the four steps of what meets the test of a franchise agreement. Under Clause 5 of the Code, for an arrangement to be a “franchise agreement” the following four (4) criteria must be satisfied:-

  1. First Leg:  There must be an agreement between you and the other person. That agreement can be in writing, oral or otherwise.
  2. Second Leg:  The business that will be operated by the other person must be materially associated with a trade mark or symbol devised by you.
  3. Third Leg:  Under the terms of the agreement you offer the right to carry on a business of offering services under a system or marketing plan devised by you.
  4. Fourth Leg:  The other person must pay you either an initial capital investment fee, pay for your goods and services, pay a fee based on gross or nett income earned by the operation or pay a training fee.

Oftentimes, the first, third and fourth leg of the test are clearly met. As such, the usual question is whether you are offering the other person the right to carry on a system or marketing plan devised by you.

Whilst there is no definition of “system” or “marketing plan” in the Code, cases before the Court have set out clear guidance as to this issue. Recently, in Workplace Safety Australia v Simple OHS Solutions Pty Ltd [2015] NSWCA 84 (8 April 2015), the Court reaffirmed some of those principles.

Facts

Workplace Safety Australia Ltd (WSA), provided online subscription packages designed to assist businesses to meet their obligations under occupational health and safety legislation.  Under a Distribution Agreement entered into on 19 September 2011, Simple OHS Solutions Pty Ltd (Simple), agreed to act as the exclusive distributor of WSA’s subscription packages.

Relevantly, under the agreement, Simple was required to set out a business plan indicating how it intended to operate its business; administer all sales in accordance with a process prescribed by WSA; use standard forms prescribed by WSA; comply with a manual provided by WSA; and comply with all reasonable directions of WSA.

Under the agreement, Simple was obliged to pay WSA a customer list fee in quarterly instalments and to subscribe 15 new customers per month. The agreement specified that if this minimum customer requirement was not met for any six month period, WSA had the right to immediately terminate.  It was alleged that the director of WSA had made two representations to Simple, one prior to the execution of the agreement and one shortly after, that WSA did not expect Simple to make its sales targets initially.

On 26 March 2012 (6 months after entering into the Agreement), WSA purported to terminate the agreement on the grounds of Simple’s failure to meet the minimum customer requirement and non-payment of a quarterly instalment.

The primary judge found, in favour of Simple, that the Distribution Agreement was a franchise agreement under the Code.  The judge found that WSA had not complied with either the pre-contractual disclosure requirements in Clause 6 or the pre-termination requirements in cl 21 of the Code and had thus breached s 51AD of the Competition and Consumer Act 2010 (Cth) (the “CCA”). The primary judge awarded Simple damages of $208,178.34, representing the quantum of loss suffered by Simple as a result of entering into the agreement or from its wrongful termination.

The issues on appeal were, among other things, whether the primary judge erred in holding that the Distribution Agreement was a franchise agreement.

Findings

The Court held that the word ‘system’ in Clause 4 (1)(b) of the Code refers to a method of operation under which a business is to be conducted. It is not necessary for a franchise agreement to spell out the details of a system or marketing plan. As the clause contemplates that the business will be carried out under a system or marketing plan, it is at least necessary that the agreement provides for that to occur, even if the terms of the plan are not settled or prescribed in the agreement.  The word ‘control’ in Clause 4(1)(b) of the Code should be taken to mean the power to direct or restrain the content of the business plan on any substantial issue.  This means that even if there isn’t a completely finalised plan or system, provided, the agreement allows for that system to be imposed, then the requirements under that third leg are met.

When applying this analysis to the issues before the Court, the Court focussed on the whole of the business the subject of the franchise agreement.  In this case, the Distribution Agreement conferred on Simple gave it the exclusive right to provide, grant or confer subscription packages.  Simple’s business was to be carried on under a system or marketing plan as it was required to:

  1. Set out a business plan indicating how it intended to operate its business;
  2. Administer all sales in accordance with a process prescribed by WSA;
  3. Use standard forms prescribed by WSA; and
  4. Comply with a manual provided by WSA.

The Court held that this system or marketing plan was substantially controlled by WSA as Simple was required to comply with WSA’s directions and WSA could refuse to consent to Simple’s marketing activities. Thus, the Distribution Agreement was a franchise agreement under the Code.  WSA was not entitled to terminate without complying with Clause 21 of the Code.

Conclusion

When asked the question about whether the proposal may be a franchise agreement, my approach is always to look at the proposal and ask whether you will be seeking to control (either expressly or potentially under the agreement). If so, the greater the degree of control the more likely that a franchise agreement is proposed.  This of course is not the end of the world. It just means that you need to comply with the Code. This potentially could be seen as a marketing tool for you as you can assure interested persons that you have established a proposal which takes into account the importance of ensuring that the franchisee protections under the Code will apply in your business model.

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.