March 31, 2016

How to Spot a Franchise Agreement

If it looks like a duck, walks like a duck and quacks like a duck, then it probably is a duck.

In the recent appeal from a decision by a single Judge, the Supreme Court of New South Wales in Workplace Safety Australia v Simple OHS Solutions Pty Ltd [2015] NSWCA 84 was tasked with deciding whether a ‘Distribution Agreement’ between the parties was in fact a Franchise Agreement.

Workplace Safety Australia (“WSA”) provided online subscription packages to assist businesses with meeting their obligations under occupational health and safety laws. WSA and Simple OHS Solutions Pty Ltd (“Simple”) entered into an agreement where Simple was appointed as a distributor. Before entering into the agreement and afterwards, the director of WSA made representations to Simple that WSA did not expect Simple to make its sales targets ‘initially’. There was no further clarification on what time frame this ‘initial’ period covered. Six months into the agreement WSA terminated the agreement on the basis that Simple had failed to meet its sales targets.

The main issue for the Court was whether the original trial judge correctly held that the agreement constituted a Franchise Agreement, and WSA had failed to comply with the Franchising Code of Conduct (“the Code”).

Under the Code there are four elements which must be met for an agreement to constitute a Franchise Agreement:

1. there is an agreement which is written, oral or implied; and

2. one person grants to another person the right to carry on a business of offering, supplying or distributing goods or services in Australia under a system or marketing plan substantially determined, controlled or suggested by the franchisor; and

3. under which the operation of the business will be substantially or materially associated with a trade mark, advertising or a commercial symbol owned, used or licensed by the franchisor or specified by the franchisor; and

4. under which, before starting or continuing the business, the franchisee must pay or agree to pay the franchisor a fee. As an example, this fee can include an initial capital investment, payment for goods or services, or a royalty fee, but excludes payments for goods or services supplied on a genuine wholesale basis or repayment of a loan.

There was no contention that the agreement satisfied elements 1, 3 and 4. The debate surrounded element 2, namely whether Simple was required to adhere to a system or marketing plan determined, controlled or suggested by WSA.

The agreement required Simple to:

1. set out a business plan on how Simple was to operate its business;

2. administer all sales in accordance with a process prescribed by WSA;

3. comply with a manual provided by WSA which detailed how subscription packages would be marketed and sold; and

4. comply with all reasonable directions of WSA.

The Court noted that it is not necessary for the details of the system or marketing plan to be spelt out in a Franchise Agreement, but rather, that the agreement provides that the business will be carried out under a system or marketing plan controlled by the franchisor. The Court found that the cumulative effect of the requirements throughout the agreement was that the parties intended for the business to be carried out under a plan.

WSA contended that because Simple was the party who prepared the plan, WSA therefore did not have control over the business plan. Without this requisite control, the requirements of the Code would therefore not be satisfied. The Court disagreed, noting that whilst Simple was required to produce the business plan, WSA had the power under the agreement to control its content and provide directions which Simple was required to comply with. WSA substantially controlled the plan because it had absolute discretion to refuse consent to Simple’s marketing activities. The result of this was that the agreement satisfied all of the elements in the Code outlined above and therefore constituted a Franchise Agreement.

Because a Franchise Agreement existed between the parties, WSA had not acted in accordance with the Code. WSA had failed to:

1. provide Simple with a Disclosure Document before entry into the agreement;

2. receive legal, accounting and business advice statements from Simple before entry into the agreement; and

3. terminate the agreement in the manner set out in the Code, which includes providing reasonable notice of, and an opportunity to remedy, a breach of a Franchise Agreement before proceeding with termination.

Simple was entitled to damages in the sum of $208,178.34 because Simple would not have entered into the Franchise Agreement if WSA had complied with the Code. Simple maintained that if, before entering into the Agreement, it was aware that WSA intended to enforce the sales targets under the Agreement, then Simple would not have entered into the Agreement. Further, WSA had failed to terminate the agreement in accordance with the Code.

Despite the intentions of the parties, a Franchise Agreement existed because Simple was:

1. required to prepare a marketing plan;

2. not permitted to do marketing without the prior consent of WSA; and

3. was required to follow the directions of WSA.

This decision acts as a lesson that just because an agreement is not called or intended to be a Franchise Agreement, it may nevertheless be caught within the ambit of the Code. The Code is intended to provide protection to franchisees involved in transactions where there exists an inequality of bargaining power between the parties, therefore it is important to look at the substance of an agreement to determine whether it will be governed by the Code.

It is essential to always obtain legal advice before entering into commercial agreements to ensure full compliance with the relevant laws.