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What is a franchise?

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One of the most commonly asked questions is “what is a franchise?” Here we try to explain what is a franchise.

A franchise is an agreement between two parties, the Franchisee and the Franchisor. The first party, the franchisee, (which can be a person or a company) is given the rights to market a product or service or operate a business using the trade mark or brand name of the franchisor.

Franchising is not a business or an industry, but a method used by businesses for the marketing and distribution of their products or services and to fund their expansion. Both the franchisor and franchisee have a strong vested interest in the success of the brand and the business.

Franchising Code of Conduct
In Australia franchising is governed by the Franchising Code of Conduct which is a mandatory industry code or regulation under Australian Competition and Consumer Act (formerly the Trade Practices Act)”.

If the agreement falls within the Code’s definition then it is deemed to be a franchise agreement and it is irrelevant what the document is called or how the parties are described (e.g. licensee, agent, distributor, partner, shareholder or any other term).

If an agreement is a “franchise agreement” then there are certain legal requirements including mandatory disclosure prior to the grant of the franchise, procedures for transfer and termination and resolution of disputes.

Quite frequently business owners who have decided to enter into various arrangements for the distribution or licensing of their goods or services discover that the agreement reached is in law a “franchise agreement” and that they have unwittingly become a franchisor and are therefore subject to additional regulation and obligations under the Code.

Definition of Franchise Agreement
The Code specifies a number of elements to be present in order for an agreement to be a ‘franchise agreement’. There must be (in summary):

  1. an oral, implied or written agreement;
  2. in which a person or company (the franchisor) grants to another (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 that is substantially determined, controlled or suggested by the franchisor or its associate;
  3. which is substantially or associated with a trade mark or commercial symbol owned, used, licensed or specified by the franchisor or an associate of the franchisor; and
  4. pursuant to which there is required the payment of an amount or fee by the franchisee to the franchisor or its associate (subject to certain exclusions such payment for goods at their wholesale price).

In order to fall within the definition all of these elements must exist. For example a distribution agreement where a manufacturer sells its products at a wholesale price to a distributor to on-sell to customers or other retailers is not a franchise agreement if the distributor does not pay the manufacturer any other amount for the right to be a distributor.

If one element out of the four is not present there is no franchise agreement and the Code does not apply.

If you are not sure if your contractual arrangement is a franchise agreement or not you need to obtain expert legal advice from a lawyer with franchising experience. From 1 January 2015 there will be financial penalties for businesses who operate franchise arrangements but do not comply with the requirements of the Code even if this is accidental on their part as they were not aware they were operating a franchise. These penalties can be sought by the ACCC which enforces the Code.

What does the Code say?
The Code requires that franchisors follow certain procedures when entering into franchise agreements, the most important of which is that they must provide a potential franchisee with a ‘Disclosure Document’ which contains certain information about the business they are looking at buying.

The prospective franchisee must be given this disclosure document at least 14 days before he or she signs the franchise agreement or pays any non-refundable amount. This gives them the ability to seek professional legal, accounting and business advice. There is also a cooling off period of 7 days after they sign.The Code also has requirements about dealing with terminations of franchise agreements and disputes between franchisor and franchisee.

From 1 January 2015 there will be certain provisions which will become illegal to have in a franchise agreement and the Code requires that parties act in good faith towards each other.
Read more about what the Code says here:

Read more about what the Code says here.

In essence the provisions of the Code while mandatory, are not impossibly onerous and many businesses large and small comply with the requirements successfully.

Creating a franchise system has allowed many businesses to expand their already successful business concepts, achieve greater brand recognition and diversify risk. Franchises have many advantages for both franchisors and franchisees and with the right advice these can be established to bring great benefits to all participants.

Prepared by Corinne Attard | Partner
Holman Webb Lawyers | Sydney

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