ACCC v Kyloe: Is a distribution arrangement a "franchise agreement"?
Readers may recall from the August franchising update our summary of the decision in Ketchell v Master of Education Services Pty Ltd [1], where the New South Wales Court of Appeal held that a breach of disclosure obligations by a franchisor rendered a franchise agreement an illegal contract. In that case, the franchisor’s action to recover unpaid franchise fees from a franchisee failed because the franchisor had failed to comply with clause 11 of the Franchising Code of Conduct. The Court said that clause 11 of the Code, when read with section 51AD of the Trade Practices Act, directly prohibited the recovery of those moneys and further, rendered the receipt of non-refundable payments illegal. It was also noted that the Code does not empower a court to relieve a franchisor against non-compliance with clause 11.
ACCC seeks declarations as to breach of the Franchising Code
As a recent case illustrates, a failure to comply with the Code may also attract the interest of the Australian Competition and Consumer Commission.
In ACCC v Kyloe [2], the ACCC commenced proceedings in the Federal Court against an alleged franchisor – Kyloe – on the basis that it had breached section 11 of the Code by failing to provide disclosure documents to its Sub-Distributors of ‘Polar Krush’ products. Kyloe defended the proceedings on the basis that its business arrangements with its Sub-Distributors did not constitute franchise agreements and were therefore not governed by the Code.
The Elements of a Franchise Agreement
The relevant question for the court was whether a franchise agreement existed within the meaning of clause 4 of the Code. Previous authority has established that the definition in clause 4 contains a series of cumulative elements, all of which must be present before an agreement can be said to be a franchise agreement, and the court in Kyloe proceeded on this basis.
The first requirement is that there is a written, oral or implied agreement. In Kyloe, this element was easily satisfied, as it will be in most cases.
Secondly, a person must grant to another the right to carry on the business of offering, supplying or distributing goods or services. Further, this right must be granted under a system or marketing plan which is determined, controlled, or has been suggested, by the franchisor or associate of the franchisor.
In Kyloe, the respondents argued that it had never granted a right to carry on a business, because the agreements entered into with the Sub-Distributors did not seek to limit the capacity of the Sub-Distributors to develop their businesses as they wished. This argument was rejected by the court.
However, the court did accept the respondent’s argument that there was no system or marketing plan in place. The ACCC alleged that the agreements created a plan which required each Sub-Distributor to do or refrain from doing certain things in relation to the marketing of the products. The evidence did not support this allegation. The court noted that there was little regulation by Kyloe of the Sub-Distributors. Kyloe had not provided any kind of intensive training, nor had it undertaken to promote sales techniques. There was no comprehensive advertising or promotional program, and Kyloe had not even recommended particular retail prices.
As the elements of clause 4 of the Code are cumulative, the failure of the ACCC to convince the court that a system or marketing plan existed had the consequence that the court found that no franchise agreement existed. The remaining elements present in clause 4 of the Code were therefore not considered in detail.
Conclusion
Although in this particular instance there was no franchise agreement, the Court emphasised the point that had the agreement constituted a franchise agreement, Kyloe would have breached the disclosure obligations of the Code. The lesson for distributors is to check carefully whether your agreement is a franchise agreement and if so, to comply with the disclosure obligations set out in the Code, or risk being unable to recover unpaid fees from franchisees and/or risk having to defend litigation against the ACCC.
Scott Guthrie | Partner | Brisbane
[1] [2007] NSWCA 161
[2] [2007] FCA 1522
Gearing Up For New Disclosure Requirements
This table sets out the key action items to get you ready for the commencement of the updated Franchising Code of Conduct (1 March 2008). Some of these dates will vary if you have a financial year end different to 30 June 2007, but 1 March 2008 applies to everyone.
|
Date |
Action |
|
30th September 2007 |
By now you should have:
1. produced an updated disclosure document in the form required under the current Code (clause 6(1) of the Code requires an update within 3 months of the end of the 2006/2007 financial year);
2. prepared financial statements for the marketing fund's receipts and expenses in the 2006/2007 financial year;
3. had the marketing fund financials audited (unless 75% or more franchisees had waived the audit requirement); and
4. attached a copy of the Code and the new amending regulation to your Disclosure Document |
|
1st October 2007 to 1st February 2008 |
Compile information in order to update your disclosure document to comply with changes to the Code. In particular:
§ Obtain details of former franchisees where sale/non-renewal/termination occurred in the previous 3 years. Ensure contact details of former franchisees are correct;
§ Discuss with former franchisees if their name, location and contact details will be disclosed in the Disclosure Document from 1 March 2008 or review old settlement deeds/ confidentiality clauses; and
§ Review agreements with suppliers to ensure no confidentiality clause is breached if the franchisor discloses the name of a supplier who provides rebates or other financial benefits to the franchisor.
With respect to marketing funds, consider inserting a power of attorney clause in the franchise agreement. This will allow the franchisor to cast a vote in favour of non audit of the marketing fund on a franchisee’s behalf if no vote has been received from that franchisee. |
|
1st March 2008 |
Issue a revised disclosure document in accordance with the following changes to the Code.
1. included amended warning statement on the front cover regarding deduction of reasonable expenses from refund ir franchisee terminates during cooling off periods;
2. provide a separate document with franchised business details and history of the site or territory. If previously subject to a franchise, give this document with the disclosure document;
3. the disclosure document can be signed by a director or other officer or authorised agent of the franchisor;
4. each officer of the franchisor must disclose their name, position held and qualifications and relevent business experience;
5. any proceedings against any director of the franchisor to be disclosed;
6. provide the names of the persons or the entities who provide rebates or other financial benefits tot the franchisor in connection with the supply of goods or services to franchisees;
7. discloes the name, location and contact details of past franchisees that have been terminated, transferred or otherwidse exited the system during the past 3 financial years. A franchisess may request that their details are not provided;
8. refer to the relevent conditions of the franchise agreement in relation to the franchisee and franchisor obligations instead of summarising these conditions; and
9. include group financial statements as well as franchisor’s financial statements, where franchisor is part of a corporate group (unless franchisor provides auditor’s report on solvency statement instead).
The following must now be provided with the disclosure document:
1. Franchise Agreement with all known details completed, or up to date template Franchise Agreement;
2. Related agreements – leases, subleases, licences, guarantees, confidentiality agreements etc; and
3. Copy of the consolidated new version of the Code(available from the Government Printer). |
|
Between 1st July 2008 and 31st October 2008 |
For marketing funds, ask franchisees to vote on not having financial statements audited, for the financial year just ended and the next 2 financial years.
Prepare the financial statements detailing the marketing fund's receipts and expenses and complete any audit (if required). |
|
Within 30 days of preparation but not later than 31st October 2008 |
Provide all franchisees with a copy of the financial statements of the marketing fund and (if required) the auditor's report on those statements. Audits are required unless:
a. within 4 months of the end of the financial year, 75% of franchisees who contributed to the fund, voted that an audit was not necessary; or
b. the future relevant financial year falls within 2 consecutive years from the end of the financial year in which a vote was taken. |
|
31stOctober 2008 |
Finalise annual update of disclosure document (per clause 6(1) of the Code within 4 months of the end of the 2007/2008 financial year). |
Lis Boyce, Partner & Piny Ly, Lawyer, Sydney
