Should You Start a License or Franchise Agreement

Franchising Code of Conduct

Franchising Business owners often consider whether the best model to grow their business is to make a license agreement or franchise agreement for their concept. Generally, licensing and franchising both involve selling the use of certain intellectual property rights to third parties, such as trademarks, software, or business processes. The key difference between a franchise and a licence is that a franchise entails a greater deal of control by the franchisor and is more regulated as it is governed by the Franchising Code of Conduct. Pursuant to the Franchising Code of Conduct, if an agreement constitutes a franchise agreement, the franchisor must provide the franchisee with a disclosure document and franchising agreement. If the franchisor fails to do so the terms of the franchise/franchising agreement may not be enforceable because the franchisor is in contravention of the Franchising Code of Conduct.

It is important to note in this regard that a franchise agreement cannot be converted to a licence simply by changing the name of the document. In classifying the franchise agreement, the Courts will look at the content and substance of the franchise/franchising agreement and not the intention of the parties nor the name given to the document.

The recent decision by the Full Court of the Federal Court in Rafferty v Madgwicks [2012] FCAFC 37 (the Rafferty Decision) highlights this fact and has serious implications for franchisors and licensors, particularly licensors of intellectual property and distribution rights.

Whether your business relationship will amount to a franchise or a licence is to be determined in light of the definition of a ‘franchise/franchising agreement’ in the Franchising Code of Conduct. Clause 4(1)(b) of the Franchising Code of Conduct provides that one of the critical limbs to determining whether a franchise agreement exists is whether the agreement grants 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…’ (emphasis added).

The Court determined in the Rafferty decision that this is a two stage test. The first test is whether there is a system or marketing plan by franchise/franchising and the second test is whether the franchisor retains the requisite level of control.

Implications form the decision for franchise/franchising

The Rafferty Decision extends the application of the Franchising Code of Conduct well beyond the conventional business relationship between parties to a franchise agreement.

This decision has significance for parties entering into licensing, distribution, supply and joint venture agreements in circumstances where the grantor of rights has, or may have, some level of control over the system, or marketing, of the grantee’s product or service. It is the content and substance of the franchise/franchising agreement and not the intention of the parties nor the name given to the agreement that is important in determining whether the agreement is a franchise/franchising agreement.

Further, preliminary agreements such as Heads of Agreement may constitute a franchise/franchising agreement, or an agreement to enter into a franchise agreement, for the purposes of the Franchising Code of Conduct thereby requiring disclosure.

We highly recommend that your commercial arrangements, which are not intended to constitute franchise/franchising agreements, be reviewed with the Rafferty Decision in mind to ensure that they are not held to be franchise agreements thereby requiring compliance with the Franchising Code of Conduct.