Court Decision – Licence Agreement constitutes a Franchise

Summary

There are serious implications for licensors whose licence arrangements are captured by the definition of “franchise” under the  Franchising Code of Conduct (Code). The licensor may be required to refund all amounts paid by the licensee under the licence arrangement, and may also be subject to penalties.

The Federal Court decision in Rafferty v Madgwicks [2012] FCAFC 37 is a prime example of a “licence arrangement” being deemed to be a “franchise” in practice, and sheds light on what the Court will consider when determining whether a business is operated under a system or marketing plan determined by the “franchisor”.

Background

Rafferty entered into a business venture with Donovan which involved the sale of units. Donovan was the owner of the intellectual property in relation to the units (such as the design/layout), and licensed to Rafferty the right to use those designs in constructing the units. Donovan was paid a licence fee by Rafferty in consideration of supplying those designs.

The business venture was established by way of a number of agreements including a Rights Agreement. The business failed in May 2008. 

Claim

Rafferty made multiple claims against Donovan including that the Rights Agreement was actually a franchise, Donovan failed to comply with the Code (such as in relation to disclosure) and Rafferty was therefore entitled to a refund of all fees paid by it to Donovan as well as its costs.

A franchise agreement is defined under the Code as an agreement under which:

  1. 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;
  2. the operation of the business is associated with a trade mark of the franchisor; and
  3. the franchisee must pay fees to the franchisor.

Items 2 and 3 were not in dispute, however Donovan disputed that Rafferty was required to carry on its business of developing and selling units in accordance with a system or marketing plan controlled by Donovan.

Decision

It was found that the Rights Agreement was indeed a franchise and Donovan had breached the Code.

The Court considered that under the Rights Agreement, Rafferty was required to comply with a system or marketing plan determined by Donovan within the meaning of the Code. The Rights Agreement contained the following provisions which were indicative of a “system or marketing plan” for the purposes of the Code:

  • specific requirements for accounting and record keeping;
  • a right for Donovan to audit the financial records of Rafferty;
  • an inability for Rafferty to supply goods or services to customers without Donovan’s approval;
  • reservation by Donovan of the right to approve promotional and advertising material;
  • a requirement for Rafferty to sell the units utilising Donovan’s intellectual property, such as its trade marks;
  • requirements for merchandising and employment of sales staff;
  • stipulation by Donovan of retail pricing structures, sales structures, sales quotas;
  • creation of marketing and sales territories;
  • a restriction on Rafferty selling competing products; and
  • a requirement for Rafferty to comply with Donovan’s policies and procedures.

What does this mean for you?

This case highlights the types of factors that the Court will take into account when determining whether an arrangement is a franchise. Each arrangement will turn on its own particular facts, however be aware that even relatively minor input in the licensee’s business may result in your arrangement constituting a franchise.

Given the implications of failing to comply with the Code, it is important to get advice upfront on whether you are covered by the Code or not and how you could structure your arrangement to ensure that it does not fall within the definition of a franchise. If you have any questions about franchising and licencing, please reach out to our commercial team today.

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