Licence or Franchise

If you are considering licensing or franchising your business or part of your business, you should consider which growth strategy is the right one for you.

In this article we look at the difference between licence agreements and franchise agreements.

What is the difference?

Licence agreements and franchise agreements generally grant people the right to use a trademark and intellectual property in a defined territory.

So, what is the difference between a licence agreement and a franchise agreement?

In Australia, franchise agreements are governed by the Franchising Code of Conduct (the Code). The Code uses 4 criteria to decide whether an agreement is a franchise agreement. In order to fall within the category of a franchise agreement, the agreement must meet all 4 criteria.

It is important to note that it does not matter if you call an agreement a licence agreement. The agreement will be assessed against the 4 criteria set out below. 

There is an agreement

The existence of an agreement is one of the criteria which needs to be met for an agreement to be a franchise agreement.

Importantly, the agreement does not have to be in writing – it may be a verbal or partly verbal agreement or it may be implied.

Clearly a licence agreement will meet the criteria of “the existence of an agreement”. Consequently, this criteria is not relevant to determining whether a licence agreement is a franchise agreement.

The operation of the business under a trademark

The operation of a business substantially or materially associated with a trademark, advertising symbol or commercial symbol, is another criteria which needs to be met for an agreement to be a franchise agreement.

As previously set out both licence agreements and franchise agreements generally grant people the right to use a trademark.

However, an agreement may grant a person the right to use a trademark within and as part of an existing business (which operates under its own brand). If so, the agreement may not meet the criteria of a business “substantially” or “materially” associated with a trademark. Whether or not such an agreement meets the criteria would require an assessment of the circumstances.

The payment of a fee by the franchisee to the franchisor

The agreement must provide that before starting or continuing the business, the person receiving the right to operate the business must pay or agree to pay an amount to the person granting the right.

Fees include:

  • royalty payments,
  • up front licence fees,
  • advertising payments,
  • commissions,
  • training fees, and
  • payment for goods (excluding goods and services supplied on a genuine wholesale basis or payment for goods taken on consignment and supplied on a genuine wholesale basis).

Some distribution agreements do not come within the definition of a franchise agreement because the only fees paid are for goods (to be distributed) on a wholesale basis.

The existence of a marketing plan or system

The final criteria which needs to be met for an agreement to be a franchise agreement is that the business to be operated under the agreement is operated under a system or marketing plan substantially determined, controlled or suggested by the franchisor or an associate of the franchisor.

It is likely that there is a system or marketing plan if some or all of the following apply:

    • there are suggestions for retail prices to be charged for products or services,
    • there are products that must be produced,
    • there are recipes that must be followed,
    • there are specific methods for providing services,
    • there are detailed advertising programs,
    • there are restrictions on the sale of products.

Compliance with the Code

Under the Code amongst other things:

  • franchisors must disclose certain information to a franchisee before a franchisee enters into a franchise agreement;
  • there are restrictions on terms which can be included in a franchise agreement;
  • there are restrictions on the franchisors ability to terminate the franchise agreement;
  • there is an obligation on both parties to act in good faith;
  • certain dispute resolution terms are required to be included in the franchise agreement.

Compliance with the Code cannot be avoided by referring to a franchise agreement as a distribution or licence agreement. 

The following case studies are examples of where the ACCC alleged that an agreement (while referred to as a distribution or licence agreement) was a franchise agreement.

Case Study – ACCC v Kyloe Pty Ltd [2007] FCA 1522

Kyloe was involved in the distribution of ice-drink machines as well as the re-sale of various items used in conjunction with the machines including cups, straws and frozen drink concentrate. These were all branded goods originating from the one company.

The ACCC claimed that the agreement between Kyloe and their sub distributors was

  • a franchise agreement, and
  • Kyloe had contravened the Franchising Code of Conduct by failing to provide disclosure documents to the sub-distributors prior to the signing of the franchise agreement.

In this case the Federal Court said that a ‘franchise agreement’ may be defined by four elements.

  • an agreement that is written, oral or implied in whole or in part,
  • a grant by the franchisor to the franchisee of a right to carry on a 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,
  • the franchisee’s business operation is substantially or materially associated with a trade mark, advertising or commercial symbol that is either owned, used, specified or licensed by the franchisor,
  • the franchisee makes particular payments to the franchisor.

How the business chooses to describe their model is immaterial. The court held that if all four criteria are satisfied and there are no exceptions to the criteria, then the arrangement, contract or agreement is considered by the courts to be a franchise agreement and the Code applies.

During the trial the court looked at the earlier case Capital Networks Pty Ltd v .auDomain Administration [2004] FCA 808 for what the court called “helpful indicators” as to the presence of a franchise agreement. These indicators included:

  • the provision by the franchisor of a detailed compensation and bonus structure for distributors selling its products,
  • a centralised bookkeeping and record keeping computer operation provided by the franchisor for distributors,
  • a scheme prescribed by the franchisor under which a person could become a distributor, direct distributor, district director, regional director, or zone director,
  • the reservation by the alleged franchisor of the right to screen and approve all promotional materials used by distributors,
  • the prohibition on re-packaging of products by distributors,
  • the provision of assistance by the alleged franchisor to its distributors in conducting ‘opportunity meetings’,
  • suggestion by the franchisor of the retail prices to be charged for products,
  • a comprehensive advertising and promotional program developed by the alleged franchisor.

There were also several other issues considered that came from the earlier case of  Master Abrasives Corporation v Williams (1984) 469 NE 2d 1196:

  • the division of a state into marketing areas,
  • the establishment of sales quotas,
  • the franchisor having approval rights of any sales personnel whom the franchisee might seek to employ,
  • a mandatory sales training regime,
  • the provision of quotation sheets to the franchisee’s employees,
  • provision by the franchisor of prescribed invoices and other sales forms,
  • a requirement that franchisees elicit certain information from their customers and provide that information to the franchisor,
  • a restriction on the franchisee selling any of the franchisor’s products without first consulting the franchisor.

The court stressed that this list is not complete and none of the factors by themselves would lead the court to assume the presence of a franchise agreement.

The court did not find that Kyloe was a franchise, as

  • there didn’t appear to be enough control exercised by the distributor, and
  • there was a lack of any system or marketing plan.

However the case illustrates the complexities which may arise when determining whether an agreement is a franchise agreement or a licence agreement.

Contact us to review any licence or distribution agreement.

Let us use our experience and expertise to assist you franchise your business

 

 

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