Trade Mark Licensors Beware!

This article first appeared in The Watermark Journal Vol 23 No 3 (September 2006) 

The Australian Government recently announced that it would be conducting a review of the disclosure requirements of the Franchising Code of Conduct. According to Government figures, franchising in Australia is an $80 billion industry that employs more than 600,000 people. The Federal Minister for Small Business and Tourism, Fran Bailey, states that franchising in Australia “is growing rapidly and an undoubted small business success story”.

The Franchising Code of Conduct (“the Code”) regulates franchising in Australia. The Code is a prescribed industry code under the Trade Practices Act 1974 (Cth), and compliance with the Code is mandatory. The Code applies to all franchise agreements entered into on or after 1 October 1998.

The Code is intended to protect franchisees, who are typically small business operators with limited financial resources and who may lack significant business experience. The Code governs the type of provisions that can be included in a franchise agreement, and requires franchisors to make extensive disclosure to existing and prospective franchisees of matters relevant to the franchise. The Australian Competition and Consumer Commission (“ACCC”) has brought a number of successful cases against franchisors who have failed to comply with the provisions of the Code.

According to Minister Bailey, concerns have been raised regarding the adequacy of the disclosure obligations on franchisors. The Minister stated: “Most people in the franchising sector do the right thing, but given the level of concern, I have decided to review the disclosure section of the Code”.

The Minister’s comments suggest that the outcome of the Government review is likely to be an increase in the disclosure obligations of franchisors. This is likely to be of significant concern to companies whose intellectual property licensing activities fall within the ambit of the Code, who are already concerned about the regulatory burden imposed by the Code and the cost of compliance.

Definition of “franchise agreement”
The Code contains a very broad definition of “franchise agreement”. In essence, a “franchise agreement” under the Code is an agreement, whether oral, express or implied, under which a person (the franchisor) grants to another person (the franchisee) the right to carry on a business:

• under a “system or marketing plan” which is substantially determined, controlled or suggested by the franchisor; and
• where operation of the business is substantially or materially associated with a trade mark specified by the franchisor; and
• which requires the franchisee to pay a fee before starting or continuing the business.

Significant points arising from the definition are:

a single agreement or licensee can be a franchise – there is no requirement for multiple licensees;

• there is no requirement that the relevant “system or marketing plan” be confidential or in any way proprietary to the franchisor;
• compliance with the relevant “system or marketing plan” by the franchisee need not be compulsory – any system or marketing plan “suggested” by the franchisor will suffice;
• it does not matter how the parties describe their relationship – any licence agreement may be a franchise if the elements of the Code definition are satisfied (a point confirmed by a decision of the Federal Court of Australia earlier this year).

The term “system or marketing plan” is not defined in the Code, but cases in relation to the meaning of the term suggest that it will be interpreted broadly. A decision of the Supreme Court of New South Wales in 2003 held that a “system” is, according to its ordinary dictionary meaning, “a set of principles or procedures according to which the relevant business is operated”, or “an organized scheme or method pursuant to which the business is operated”, and that a “marketing plan” is “a detailed proposal for achieving the promotion or advertising” of the products of the business.

Quality control provisions in a trade mark licence, which are essential to valid trade mark licensing in Australia, may take the form of a “system or marketing plan”, with the result that trade mark licences will often fall within the definition of “franchise agreement”. This is particularly likely in the case of service mark licences, where quality control is typically implemented through the specification of business procedures and standards to which the licensee must comply.
It seems likely that the relevant “system or marketing plan” must exist at the outset of the parties’ relationship, and must not arise or be created during the subsequent course of their relationship, although this point has not been fully tested in the courts.

There are a number of exceptions to the definition. For example the Code does not apply where:

• the franchisor resides, is domiciled or incorporated outside Australia, and grants a single master franchise into Australia (the Code would apply to the sub-franchises granted by the master franchisee); or
• the franchise is for goods or services that are substantially the same as those previously supplied by the franchisee for at least 2 years prior to the franchise agreement, and sales under the franchise are less than 20% of the franchisee’s gross turnover for those goods or services in the first year of the franchise; or
• the only fee payable by the franchisee is for goods at or below their usual wholesale price (i.e. a supply/distribution arrangement). 

Impact of the Code
One of the most onerous requirements on a franchisor under the Code is the requirement to supply an annual “disclosure document” to franchisees, and to prospective franchisees. The content of a disclosure document is set out in detail in the Code, and includes matters such as:

• a summary of the relevant business experience of the franchisor, and each director, secretary or partner of the franchisor with managerial responsibility;
• details of any legal proceedings relevant to the franchise in which the franchisor has been involved;
• information about the franchise, including number of franchisees and their contact details;
• certain information in relation to licensed intellectual property, and the franchisee’s rights and obligations in relation to that intellectual property;
• a summary of key provisions of the franchise agreement; and
• certain information in relation to marketing or co-operative funds to which the franchisee may be required to contribute.

The Code also governs the making of franchise agreements and the type of provisions which can be included in a franchise agreement. For example:

• before entering into a franchise agreement, the franchisor must have received from the franchisee signed statements from an independent legal or business advisor or accountant, to the effect that the prospective franchisee has received independent advice in relation to the proposed franchise;
• franchisees enjoy a “cooling off period” - a franchisee may terminate a franchise agreement, without reasons within 7 days of entering into the agreement, and may receive a refund of moneys paid;
• a franchise agreement must not prohibit a franchisee from entering into an association of franchisees, and must not contain a general release from liability in favour of the franchisor;
• a franchisor must not unreasonably withhold consent to the transfer of a franchise;
• a franchisor must give a franchisee reasonable notice of proposed termination of the franchise agreement, and must give reasons for the proposed termination;
• a franchise agreement must contain a dispute resolution procedure involving mediation. 

The consequences of non-compliance can be severe, and can include the imposition of financial penalties.

Trade mark owners should be aware of the potential for the Code to apply to trade mark licences, and seek professional advice in respect of whether the Code applies in the circumstances of their particular licence agreements.