Licence Vs  Franchise

Licence vs Franchise

Licensing and/or franchising allow you to grow your business without the financial or human capital required to grow organically. The licensee or alternatively, the franchisee, provide the necessary financial and human capital.

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

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

 

What is the difference between Licence Agreements vs Franchise Agreements?

Advantages and disadvantages of Licensing vs Franchising

Which option provides more control over my business?

Licence Agreement  vs Franchise Agreement - The Franchising Code

What are the legal obligations of Franchising vs Licensing?

Licence vs Franchise - Case Studies

 

 

What is the difference between Licence Agreements vs Franchise Agreements?

Licence agreements and franchise agreements usually grant people the right to use a trade mark and intellectual property in a defined territory.

Every franchise agreement includes a licence, but not every licence agreement is a franchise. 

 

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

 

What is a Licence Agreement?

A licence agreement is an agreement between two parties where one party (the licensor) grants to another party (the licensee) the right to use its intellectual property (such as its trademark). [What is Intellectual Property?]

A common example of a licence agreement is a software licence agreement, where a licensee is licensed to use the licensor's software in its business. In this example, the licensor may provide very limited support to the licensee (in relation to the software). 

A licensee generally (although not always) operates its business using its own processes and procedures. Consequently, the licensor does not have a lot of control over the licensee's business and how it is operated.

If the licence agreement is simply a licence to use a trademark for a fee, the licensor is unlikely to provide any support to the licensee.

 

What is a Franchise Agreement?

 A franchise agreement is an agreement between two parties where one party (the franchisor) grants to another party (the franchisee) the right to use its intellectual property and its business and marketing systems. [What is a Franchise Agreement?]

The franchisee operates its business using the franchisor's trademark together with the franchisor's processes and procedures. The franchise is a template of the franchisor's business model.  Consequently, the franchisor has control over most aspects of the franchisee's business.

Given that the franchisee operates its business using the franchisor's processes, a franchisor generally provides assistance and support to its franchisees.

 

 

Advantages and Disadvantages of Licence Agreements vs Franchise Agreements

 

Licence Agreement Advantages

• Growth without capital investment (both human and financial).
• Less regulation.
• A licensor is not required to invest a lot of time and energy in providing assistance and support to licensees.

Licence Agreement Disadvantages:

• Lack of control over brand consistency.
• Lack of control over intellectual property.

Franchise Agreement Advantages:

• Growth without capital investment (both human and financial).
• Brand control 

Franchise Agreement Disadvantages:

• Regulatory compliance (Franchising Code of Conduct) [What is the Franchising Code of Conduct?].
• Time and energy invested in providing assistance and support to franchisees.

 

 

 

Licensing vs Franchising - Which Option Provides More Control?

As we have already indicated, when considering the difference between licence agreements vs franchise agreements, and the advantages and disadvantages of licensing and franchising, franchising generally provides more control over your business.

A franchise agreement generally gives you more control over your business.

One of the advantages of franchising over licensing is that franchising allows you to control the business operations and procedures of the outlet through which your good or service is sold.

However, the flip side of this is that franchising is much more regulated than licensing, so you will have to comply with the Franchising Code of Conduct (the Franchising Code).

 

 

Licence vs Franchise - The Franchising Code 

In Australia, the Franchising Code defines a "franchise agreement". 

If an agreement is a franchise agreement under the Franchising Code, the agreement will be regulated by the Franchising Code [What is a franchise agreement?]. 

The Franchising Code uses 4 criteria to establish whether an agreement is a franchise agreement:

1. there is an agreement;
2. under the agreement the franchisor grants to the franchisee the right to carry on the business under a system or marketing plan substantially determined, controlled or suggested by the franchisor;
3. under the agreement the operation of the business is substantially or materially associated with a trade mark;
4. under the agreement the franchisee must pay or agree to pay to the franchisor an amount.

It is important to note that it does not matter if you call a franchise agreement a licence agreement, if the agreement contains the four criteria, it will be a franchise agreement.

 

Let's examine the criteria a little more closely.

 

1 - There is an Agreement

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

 

2 - The existence of a marketing plan or system

In order to be a franchise agreement, the business operated under the agreement, must be 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.

Given that most licence agreements require the payment of a fee, this is generally the criteria that differentiates a licence agreement from a franchise agreement.

That is, the level of control that is exercised by the person granting the licence, is generally the criteria that causes a licence agreement to be "deemed" a franchise agreement.

 

3 - The Operation of the Business Under a Trade Mark

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

However, an agreement may grant a person the right to use a trade mark 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 trade mark. Whether or not such an agreement meets the criteria would require an assessment of the circumstances.

 

4 - The Payment of an Amount 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.

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

Other than control, the criteria that may differentiate  a licence agreement from a franchise agreement in Australia, is payment.

You need to be careful not to franchise by accident. That is, if you want to grow your business through licensing you need to ensure that the licence agreement does not contain the 4 criteria.

If an agreement contains the 4 criteria (regardless of whether it is called a licence agreement or a franchise agreement), you will need to comply with the Franchising Code.

 

 

What are the legal obligations of franchising vs licensing?

One of the advantages of licensing over franchising is the lack of regulation, and conversely, one of the disadvantages of franchising over licensing is the level of regulation [Legal Issues in Franchising].

Under the Franchising Code among 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 franchisor's 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;
• the franchisor must audit its marketing fund;
• franchisors must register a profile in the Franchise Disclosure Register.

There are substantial penalties that may be payable if you do not comply with the Franchising Code.

Compliance with the Code cannot be avoided by referring to a franchise agreement as a licence agreement [Franchising Code Compliance]. 

 

Download our Licence vs Franchise Infographic

 

 

Licence vs Franchise - Case Studies

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 (a United States case heard by the Court of Appeals in Indiana):

• 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.

 

Disclaimer

The information in this article is general in nature and is not intended to address the circumstances of any person or other entity. Although we do our best to provide timely and accurate information, we do not guarantee that the information in this article is accurate or that it will continue to be accurate in the future.