While, for the most part, it will be obvious on the face of an agreement whether it is establishing a franchising relationship of the kind regulated by the Franchising Code of Conduct, it is not always clear and nor is it uncommon for distribution agreements and brand licenses which are not necessarily intended to form franchise relationships to sail close to, and potentially be caught by, the definition of a "franchise agreement" under the Code.
The implications for a wholesale supplier or licensor of entering into an agreement which falls within the ambit of the Code are significant, given the restrictions imposed by the Code on the provisions which can and cannot be included in a Code-governed franchise agreement and the various disclosure and reporting obligations imposed on franchisors by the Code. This is all the more significant in light of the Government's recent amendments to the Code which, amongst other things, introduce pecuniary penalties for certain breaches of the Code.
However, it is not always straightforward analysing whether a proposed agreement does or does not meet the definition of a "franchise agreement" under the Code.
Clause 5 of the Code deems certain categories of agreement as franchise agreements for the purposes of the Code and otherwise defines a "franchise agreement" as an agreement:
- that is, in whole or part, a written, oral or implied agreement; and
- in which a person (the franchisor) grants to another person (the franchisee) the right to carry on the 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 or an associate of the franchisor; and
- 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 or specified by the franchisor or an associate; and
- under which, before starting or continuing the business, the franchisee must pay or agree to pay to the franchisor or an associate an amount such as an initial capital investment fee, a payment for goods or services, a fee based on a percentage of gross or net income or a training fee.
While parts (a), (c) and (d) have generally been well understood, the threshold at which a party to an agreement will be a "franchisee" with the right to carry on the business under a system or marketing plan substantially determined, controlled or suggested by the other party as "franchisor" is less clear.
This question was at the centre of the recent decision of the Full Court of the Federal Court in Freedom Foods Pty Ltd v Blue Diamond Growers  FCA 172, in which the court upheld the ruling of the primary judge that a licence agreement between Freedom Foods Pty Ltd and Blue Diamond Growers was not a franchise agreement for the purposes of the Code because it did not satisfy the requirement in paragraph (b) of the definition.
The case therefore provides important clarification as to the factors which are relevant in determining whether agreements that are not identified as relating to franchises can nevertheless be classified as “franchise agreements” to which the Code applies.
What you need to know
- The Code can apply to licences and agreements which meet the definition of "franchise agreement" in clause 5 of the Code, whether or not the licence or agreement is described as a franchise agreement or whether the parties intended it to be a "franchise agreement" governed by the Code.
- The Court has clarified that it will not construe the definition of 'franchise agreement' under the Code broadly and will have regard to the agreement as a whole.
- The Court considered that the most distinctive aspect of the definition is the requirement in clause 5(1)(b) of the Code, which provides that a franchise agreement is an agreement in which a franchisor grants to a franchisee the right to "carry on the business of offering, supplying or distributing" goods or services under a system or marketing plan "substantially determined, controlled or suggested" by the franchisor.
- Para (b) contains three cumulative elements which together provide that the system or plan for the business is substantially a matter for the grantor.
- The Court will pay close attention to the content of provisions concerning marketing plans and promotional plans, with the key issues being whether the grantor or grantee ultimately controls those plans and whether the grantee must conduct its business under or in accordance with those plans.
Of course, the application of the factors identified by the Court to any specific set of circumstances can be complicated and less clear-cut than the factors may at first suggest and, although the decision was unanimous, the Court acknowledged that its decision as to the extent of obligations and control imposed on the parties by the specific terms of the licence agreement in question was fact-specific and that certain provisions of that licence agreement were "equivocal" - in particular the review powers of Blue Diamond in relation to the marketing and promotional plans.
On that basis, there may well remain some uncertainty as to how to determine the threshold at which an agreement, when considered as a whole, gives the "franchisor" party sufficient control to amount to a franchise relationship and whether the review powers granted to Blue Diamond in this case could in fact be sufficient.
Nevertheless, the case provides a useful overview of the factors to be taken into account when you are contemplating a licensing agreement.
A deeper dive into the Freedom Foods Pty Ltd v Blue Diamond Growers decision
The companies entered into a licence agreement in 2011, which provided for the terms on which Freedom Foods was licensed by Blue Diamond to manufacture and sell almond milk products under the name "Almond Breeze" and associated trademarks.
The Agreement provides for a dispute resolution clause which refers certain disputes to arbitration in California. On the basis of that arbitration agreement, Blue Diamond commenced an arbitration in California. In response, Freedom Foods (and certain related parties) sought interlocutory orders in the Federal Court restraining arbitration from taking place in California on the basis that the Agreement met the definition of "franchise agreement" and so was subject to the Code, which prohibits a franchise agreement from containing a clause requiring dispute resolution in any jurisdiction outside Australia.
Decision of primary judge
The primary judge determined that the Agreement was not a franchise agreement for the purposes of the Code because it did not satisfy para (b) of the definition of franchise agreement in clause 5(1) of the Code and as such, Freedom Foods could not rely on the Code to restrain arbitration in California.
In essence, this was because the primary judge took the view that Blue Diamond did not have sufficient control of the system or marketing plan under which Freedom Foods could supply goods under the "Almond Breeze" name in Australia.
Full Federal Court decision: the proper construction of clause 5(1)(b)
The primary question for the Full Court was whether the Agreement grants a right to Freedom Foods to "carry on the business of offering, supplying or distributing" the relevant products under a system or marketing plan "substantially determined, controlled or suggested" by Blue Diamond.
Definition of franchise agreement not to be construed broadly
As a starting point, the Court noted that the definition of "franchise agreement" serves to determine the scope of the Code and that the "evident purpose of the definition is to confine the Code to a certain type of business activity". The Court emphasised that the "effect and scope" of the Code should not be construed broadly (as distinct from its provisions insofar as they operate with respect to franchisees) and, to that end, should be limited to franchisees as defined.
Para (b) describes a "distinctive aspect" of franchise agreements.
Helpfully, the Court set out a list of 11 matters concerning the definition of franchise agreement which have been decided by two cases at appellate level. These matters included:
- para (b) contains three elements which express separate requirements, each of which must be met;
- the elements of para (b) concern:
- the grant of the right to carry on the specified business;
- the business to be carried on under a system or marketing plan; and
- the system or marketing plan to be substantially determined, controlled or suggested by the alleged franchisor;
- a system or marketing plan is a "co-ordinated method or procedure, or scheme whereby goods or services are sold", and "a method of operation under which a business is to be conducted";
- the system or marketing plan does not have to be spelt out in a franchise agreement;
- there are various types of contractual provisions, the presence of which may be indicative of a system or marketing plan (although much depends on the circumstances of each case); and
- regard must be given to the agreement as a whole.
In relation to the elements of para (b), the Court said that they "work together" to further narrow the category of cases that will come within para (b). The Court said the elements:
"describe a distinctive aspect of a franchise agreement, namely that instead of the ongoing conduct of the business being dependent on the business acumen and skill of the grantee as the operator of the business, the system or plan for the business is substantially a matter for the grantor. [emphasis added]
Whether the Agreement is a franchise agreement
Ultimately, the Court found the primary judge was not in error in determining that the Agreement was not a franchise agreement for the purposes of the Code. This conclusion, however, relied heavily on the Court's characterisation of the nature of obligations under the Agreement and was not entirely clear-cut.
The relevant key findings are summarised below:
- The recitals of the Agreement did not indicate that Blue Diamond conferred a right upon Freedom Foods to carry on a business in any particular manner;
- When it comes to the Agreement's operative provisions, it is important to pay close attention to the content of the provisions concerning marketing plans and promotional plans.
- Marketing plans: the Court accepted that the annual marketing plans were to be developed and implemented by Blue Diamond but found that these provisions could not, by themselves or with other rights, form a system or marketing plan by which Blue Diamond could "substantially determine, control or suggest" how Freedom Foods distributed the relevant products:
They are not directed to the manner in which Freedom Foods will itself seek to sell or distribute the product. So much is made abundantly clear from the fact that the licence agreement provides that "Blue Diamond shall implement the annual Marketing Plan" together with the absence of any mechanism by which the marketing plan may direct or suggest the way Freedom Foods will sell the Products.
- Annual trade promotion and specific promotions plans: the Court emphasised that although Blue Diamond has a right under the Agreement to be consulted about the promotional plans, the content originates entirely with Freedom Foods. To that end, the Court said that it is the business acumen and experience of Freedom Foods that informs the content of the plans, "unguided by any requirement of the [Agreement] or any overall structure or form imposed or suggested by Blue Diamond".
- The Court acknowledged various other provisions of the Agreement granting certain rights and responsibilities to Blue Diamond, but noted that such provisions were "equivocal" when it comes to determining whether the agreement is of the character described in para (b) of the definition.
- The Court rejected the proposition advanced by Freedom Foods that it is sufficient for the scheme or marketing plan to have "a relationship or connection" with the right to carry on the business that is granted by the Agreement. It found:
a construction of that kind would not give due regard to the requirement that the business be conducted "under" the system or marketing plan (not in connection with the system or marketing plan).
While the Court ultimately upheld the primary judge's decision, it noted that "in a different case" a plan that is prepared by the party alleged to be the franchisee may still have its content "directed, controlled or suggested" by the party who is a franchisor. The Court said:
"The agreement as a whole may require the marketing plan to conform to the requirements of a system that originates from the alleged franchisor. It may require the alleged franchisee to produce a plan of a kind that gives effect to an overall system or marketing plan that comes from and is overseen by the alleged franchisor. It will be a factual question in each case whether the agreement as a whole takes a form whereby a system or marketing plan comes from the franchisor (whether by way of firm determination, control or suggestion) or whether it comes from the franchisee."
Although the decision was unanimous, the Court acknowledged that its decision as to the extent of obligations and control imposed on the parties by the specific terms of the licence agreement in question was fact-specific and that certain provisions of that licence agreement were "equivocal" – in particular the review powers of Blue Diamond in relation to the marketing and promotional plans.
Nevertheless, with the Court affirming the primary judge's decision, subject to any further appeal, the arbitration of the substantive dispute will now be determined in California.