When is a distribution agreement a franchise agreement?

By Michael Corrigan and Ellie Palmer.

Key Points:
The case sets out the relevant factors, and brings home the importance of ensuring that agreements are drafted properly and that the disclosure required under the Franchising Code is provided.

In a recent decision, the Federal Court found that a distribution agreement was not a franchising agreement so the Franchising Code did not apply.

The Court found that the agreement, with which the Australian Competition and Consumer Commission took issue, was not a franchising agreement because there was no right to carry on a business under a "system or marketing plan".

The ACCC sought orders that Kyloe Pty Ltd had failed to comply with the mandatory Franchising Code in the documents it provided, or failed to provide to its distributors. In order to be successful in such an argument, the ACCC needed to show that the business was in fact a franchise and not just a distribution business. It failed on this point.

While the judgment does not set out new principles but confirms previous case law , it does give a clear consideration of the relevant factors previously enunciated, and brings home the importance of ensuring that agreements are drafted properly and that the disclosure required under the Franchising Code is provided.

The Court found that the distribution agreement was just that and that it was not also a franchising agreement to which the Franchising Code applies. This was because there was no "system or marketing plan" which is a relevant hallmark of a franchise.

In determining whether there is a "system or marketing plan," there are relevant factors for consideration, which are not said to be exhaustive, but which include whether the franchisor:

• provided detailed compensation and bonus structure for distributors selling its products
• provided a centralised bookkeeping and record keeping computer operation for distribution
• prescribed a scheme under which a person could become a distributor, director, district director, regional director, or zone director
• reserved the right to screen and approve all promotional materials used by distributors
• prohibited repackaging of products by distributors
• provided assistance to its distributors in conducting "opportunity meetings"
• suggested the retail prices to be charged for products
• provided a comprehensive advertising and promotional program
• divided states into marketing areas
• established sales quotas
• had approval rights of any sales personnel whom the franchisee might seek to employ
• prescribed a mandatory sales training regime
• provided quotation sheets and prescribed invoices and other sales forms to the franchisee's employees
• required franchisees to illicit certain information from their customers and provide that information to the franchisor; and
• restricted the franchisee selling the products without first consulting the franchisor.

While the factors the Court considered were not new, the judgment is important in looking at the way in which the Court determined and assessed each of the factors.

The Court found that the provision of advice as to the best locations for the machines and the provision of scripts which could be used did not amount to assistance in conducting "opportunity meetings" as understood by the American authorities upon which the Court had previously relied in determining the factors which are required for a system or marketing plan to exist. Further, the ACCC failed in establishing that there was a system or marketing plan, and thus a franchise, because the information which was to be passed on was not to be elicited from customers but was to come from records maintained by sub-distributors.

Further, guidance was not provided by Impact to the sub-distributors as to the guidance on the operation or management of the franchise. All they did was to advise what the essential terms of the agreement were and to offer encouragement.

The Court found that no mandatory sales training regime existed. and that the only training related to the operation of machines and handling of products.

In addition there was limited provision of advertising and other promotional material and no sales quotas were prescribed, nor was there any reservation of the right to oversee the choice of employees or territorial division within Australia.

On the basis of these missing factors the Court concluded that there was no substantial control of nor suggestion to adopt the system or marketing plan.

Conclusion

This case is a timely reminder that businesses which are franchises need to comply with the Franchising Code. The Court did not find Kyloe to be a franchise in this case but held that if it were then it would have breached the Franchising Code and would have been liable to penalty.