Is your business a franchise?

Is your business a franchise?

Do you ever wonder whether your business complies with all of the regulation that’s out there? Is there something in shadows, just waiting to catch you out? Ok, that introduction sounds ominous but bare with me, I’m not trying to scare you. However, I do want to draw your attention to the way franchising regulations may affect you, even if you don’t see yourself as a franchise.

As a business lawyer, my clients tend to see me when they are preparing to scale and grow. Often, they’ve already workshopped their growth model, and re-jigged their business plan to factor in new locations, interstate expansions or new partners. It’s at this point that I often have to break the news to the excited client: “do you know that your new business model is a franchise?

That question is often laughed off, as the client shakes their head. “Of course I’m not a franchise, it’ll just be a licence to use our name and brand.” Sounds simple, right? Wrong.

You see, when it comes to classifying a relationship between two people, the law doesn’t care so much about what you call the relationship, it will look to the substance of your conduct (i.e. if it looks like a duck, and quacks like a duck, the law will call it a duck). In our case, if your business meets certain criteria (discussed below), the law will deem it to be a franchise regardless of what you actually intend.

Before I delve into the intricacies of what is a franchise, I need to make something very clear: franchising is not a dirty word. Sadly, franchising has developed a bad name in this country owing in large part to a few high profile scandals. Even before recent events put franchising in the spotlight, clients and their advisors have often (unnecessarily) bent over backwards trying to avoid the franchise tag, fearing that it brings added cost and complexity to their business. Rather than fear that added regulation, why not embrace it as part of your pitch: prospective investors and partners should be attracted to your business because you operate a compliant business within a highly regulated sector. Ok, with that out of the way, read on to find out what will (and won’t) classify as a franchise under current regulations.

The Code

Franchising in Australia is governed by the Franchising Code of Conduct (ok, it is formally schedule 1 to the Competition and Consumer (Industry Codes – Franchising) Regulation 2014, but that is a real mouthful, so I’m just going to refer to it as the Code). As far as the Code is concerned, an agreement between two parties will be considered to be a franchise agreement if:

  • one person (the franchisor) grants another person (the franchisee) a right to carry on business of selling goods or services:
    • by reference to a common brand or trade mark which is owned by or controlled by the franchisor (or related party of the franchisor); and
    • under a system or marketing plan which is substantially determined or controlled by the franchisor (or related party of the franchisor); and
  • the franchisee is required to pay an amount to the franchisor in order to start to continue operating the business (e.g. an initial training fee, or an ongoing royalty).

A business relationship will only be deemed to be a franchise if all of the above criteria are met. I’ve elaborated on each element of the test below:

An Agreement

In order for the Code to ap`ply, there must be ‘an agreement’ which relates and governs the operation of a business. Given that the Code captures written, verbal or implied agreements, this criteria will be met any time there is a business relationship between two people.

Common Brand

Having established that there is an agreement,  the next step in determining whether a relationship is a franchise is to check whether the agreement requires use of a common brand. If you will be letting another person  operate their business under and by reference to a brand that you own or control, then this requirement is satisfied. This will usually be relatively easy to work out, and is as simple as asking what the sign on the door will read.

System or marketing plan

Things get a bit more complicated when determining whether an arrangement confers a right to supply goods or services using a “system or marketing plan controlled by the franchisor.” As is often the case, lawmakers have used a phrase in the Code without taking the extra step of defining what that might mean. Thankfully, case law has stepped in to fill in the blanks. The following factors may help parties determine whether there is a common system or marketing plan for franchising purposes:

  • Does the purported franchisor divide restrict sale rights to territories or marketing zones? If so, will the purported franchisee be restricted to only selling within that territory?
  • Are there sales quotas that must be achieved?
  • Is there training that must be carried out in relation to a particular sales technique or in the use of a system?
  • What level of assistance does the purported franchisor provide in finding, pursuing and securing leads?
  • Will parties be required to use standardised forms for quotes, orders, and invoices?
  • Will the purported franchisor have approval rights over marketing and sales content, social media posts and sales personnel?
  • What level or reporting must be provided to the purported franchisor, and will they be entitled to inspect and audit the franchisee’s business?

The above factors will give an indication as to whether there is a common system or marketing plan, without necessarily being an exhaustive list. As a general guide, the more control a person has over another’s business, the more likely it is that the business is operated pursuant to a prescribed system.

Payment

The final element of a franchise relationship is that it must involve a payment from the franchisee to the franchisor in return for the right to operate the business. The wording used in this part of the Code is quite broad, and captures payments:

  • an initial capital investment fee (i.e. A franchise fee);
  • for goods or services;
  • a royalty, or other fee based on a percentage of revenue; or
  • a training fee.

The  Code also sets out a few exceptions. These are:

  • Payments for sales on a genuine wholesale basis;
  • Repayment of Loans;
  • The supply of goods on consignment; and
  • Payment of rent.

Consequences

To recap, you will be running a franchise if:

  1. You grant others the right to carry on a business and supply goods and services;
  2. They will run their business by reference to your name and brand;
  3. You have a system in place in relation to the way the business is operated and marketed; and
  4. You will be paid a fee in return for granting the above rights.

If the above criteria apply to you, then you will be subject to the Code, and must comply with its terms (I’ll discuss some of these in a later post). A failure to comply may lead to trouble with the ACCC (which regulates franchises), as well as difficulties if you end up in a dispute with the franchisee.

Other options

It is possible to structure your business in a way which does not attract the operation of the Code. For example, you can:

  • Allow people to sell your goods and services under a prescribed system, but using their own name and brand. This option may increase sales, but unfortunately does not necessarily grow your band;
  • Alternatively, you can forego control by only having minimal systems in place for the sale of goods or services under your brand name. This is problematic, as it allows others to trash your brand with bad or inconsistent service; or
  • You can forego payments, which isn’t as crazy as it might sound. This is because you can build a system that may not pay you a royalty but is required to purchase goods and services from you and your nominated suppliers on a genuine wholesale basis. This allows you to make a return from those sales, including from rebates given by your nominated supplier. Also note that the Code only applies where the franchisee pays the franchisor and the Code will not apply whether the money flows the other way (e.g. Telstra and Optus shops pay a commission to the retailer instead of collecting a royalty).

Key takeaway

If you are considering licensing your name and brand to others, then it pays to consider how and when the Code applies. If you have any questions, then get in touch to discuss.