Is a Trade Mark License a Franchise?

In Australia, franchises are regulated by the Franchising Code of Conduct (Franchise Code) made under section 51 AE of the Competition and Consumer Act 2010 (Commonwealth). A franchise consists of rights and obligations contained in a franchise agreement, which is defined in clause 5 of the Franchise Code.

Elements of a franchise agreement

Two of the required elements of a franchise agreement are that the agreement is an agreement:

in which a person (the franchisor) grants to another person (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 or an associate of the franchisor; and
under which the operation of the business will be substantially or materially associated with a trade mark, marketing or a commercial symbol:
1. owned, used or licenced by the franchisor or an associate of the franchisor; or
2. specified by the franchisor or an associate of the franchisor.

Trade mark licenses

So, because of the requirements under clause 5 (c), all franchises will inevitably include a trade mark licence. The Franchise Code provides that “trade mark” has the meaning given by the Trade Marks Act 1995 (Commonwealth), that is:

… a sign (including any letter, word, name, signature, numeral, device, brand, heading, label, ticket, aspect of packaging, shape, colour, sound or scent (or any combination of these)) used, or intended to be used, to distinguish the goods or services dealt with or provided in the course of trade by a person from goods or services so dealt with or provided by any other person.

Under the Franchise Code, a trade mark need not be registered as an Australian (or other) trade mark if it comes within the definition.

However, not all trade mark licenses will be franchises, and the licensor of a trade mark may not wish the licence to fall under the Franchise Code as a franchise agreement as the obligations on a franchisor are extensive and potentially onerous. Determining whether a trade mark licence falls over the line and is a franchise can be a difficult and uncertain exercise.

Control by a trade mark owner

The licensor of a trade mark, particularly a registered trade mark, will wish to ensure that the trade mark is used by the licensee in a manner that does not devalue or diminish the reputation of the trade mark or result in the licensor losing the trade mark.

If the owner of a trade mark, whether a registered or unregistered mark, allows the mark to be used by another, or others, this usage may mean that the mark ceases to be one which distinguishes solely the goods or services of the owner of the trade mark. For a common law, or unregistered trade mark, or registered mark, this may mean that the mark has become generic and can be used by other traders. For a registered Australian trade mark, if the owner is not using it and has not used it for a period of three years, an application may be made under the Trade Marks Act to remove the trade mark from the Register of Trade Marks.

If a registered trade mark is not used by the owner but is used under licence by another, or others, then the use by another trader, an authorised user, may be taken to be use by the trade mark owner (section 8 (3) of the Trade Marks Act) and this will mean that the mark cannot be removed from registration for non-use. Use of a trade mark by another trader will, however, only be an authorised use if and to the extent that “the user uses the trade mark under the control of the owner of the trade mark” (section 8(2)). The other trader using the mark will be taken to use the mark under the control of the owner if “the owner of (the) trade mark exercises quality control over goods or services” (section 8(3)).

The degree of quality control

The dilemma for the licensor of a trade mark who does not wish the licence to be a franchise agreement is to ensure sufficient quality or other control to protect the mark but not to exercise a degree of control that amounts to a system or marketing plan substantially determined, controlled or suggested by the franchisor (licensor) under clause 5 (b) of the Franchise Code.

The degree of quality control necessary to ensure that a registered trade mark cannot be removed for non-use must be more than just a contractual requirement in a trade mark licence. This is illustrated by a case relating to the registered trade mark Wild Geese for wine (Lodestar Anstalt v Campari America LLC [2016] FCAFC 92). The Full Federal Court considered a license agreement in which there were specific quality control requirements. The requirements were found to be somewhat illusory as they were a very low bar, but, more importantly, the Court found that the licensor did not actually enforce the requirements, and there was no actual control.

The clear message from the Wild Geese case is that a licence of a registered trademark should contain requirements for quality control that are reasonable, having regard to the nature of the product or services and the circumstances and that these requirements should actually be enforced by the licensor. This may involve requirements for reports, inspections and samples and similar provisions.

A system or marketing plan

Whether such quality control provisions then push a trade mark licence over the line so as to require compliance with a system or marketing plan substantially determined, controlled or suggested by the franchisor (licensor) so that it will be a franchise agreement caught by the Franchise Code will require consideration in each case of the terms of the license agreement and also the active measures to be taken to ensure compliance with quality control provisions.

There is no definition or guidance in the Franchise Code or legislation as to what constitutes a system or marketing plan. A number of Courts have grappled with this issue and have described various factors which will be taken into account in considering whether a system or marketing plan is substantially determined, controlled or suggested by the franchisor (licensor), but there is no definitive statement, and no authority specifically dealing with a license agreement of a trade mark that contains provisions that are only specifically intended to ensure adequate quality control.

ACCC v Kyloe

In ACCC v Kyloe Pty Ltd [2007] FCA 1522, the ACCC asserted that Kyloe was operating as a franchise for the distribution of ice-drink machines and that the Distribution Agreement was really a franchise agreement. The Court found that the business was not a franchise because Kyloe, amongst other things, did not have the requisite control over the way the distributor operated the business. It is interesting to note that although Kyloe:

conducted a sales training regime; he would go to sub-distributors houses for 2-3 hours to show them how to use the machines, educate them on obligations and restrictions and provide one ‘point of sale pack’ per machine (including poster, mobile cup, flavour label);
gave advice on where to put machines;
gave exemplar scripts and exemplar retail prices; and
required sub-distributors to purchase a minimum amount of concentrate, straws and cups each year (although there were no sales quotas);

there were no:

exclusive or divided territories within which distributors might operate;
rights to inspect financial records of sub-distributors, to conduct audits or to inspect premises at which the machines had been installed; or
obligations on sub-distributors to produce a business plan.

Apart from minor restrictions imposed by sub-distributors agreements concerning the use of advertising materials and the need for sub-distributors to receive instruction about the operation of machines, the sub-distributors were free to run the business as they pleased. The Court also found that the obligations to submit written reports and order minimum quantities of products were requirements that could not be and were not enforced.

Capital Networks v auDomain Administration

On the question of whether there was any system or marketing plan that was “substantially determined, controlled or suggested” by the alleged franchisor, the Court in Kyloe looked to indicators set out in Capital Networks Pty Ltd v .auDomain Administration [2004] FCA 808. In this case, the Court examined:

the extent to which the distributors business involved the sale of the alleged franchisor’s products - the smaller the percentage, the less likely it will be that the necessary degree of control will be found to exist;
whether or not the alleged franchisor ostensibly assumed responsibility for product outlets by causing them to be operated with the appearance of some centralised management and with uniform standards as regards the quality and prices of goods sold, services rendered and other material instances of the operation;
whether or not the alleged franchisor placed the distributor under an obligation to advertise, conduct promotions and stock accessories; and
the extent to which the alleged franchisor controls the franchisee’s business having regard to matters such as prescription of the hours and days of operation, advertising, financial support, auditing of books, inspection of premises, control over lighting, employee uniform, prices, trading stamps, hiring, sales quota and management training.

These indicators were considered “helpful” for the assessment of whether a system or marketing plan exists. In Capital Networks, the following factors supported the finding that a system or marketing plan was substantially determined, controlled or suggested by the franchisor:

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; and
a comprehensive advertising and promotional program developed by the alleged franchisor.

Master Abrasives Corporation v Williams

The Court in Kyloe also considered the case of Master Abrasives Corporation v Williams (1984) 469 NE 2d 1196, which had earlier set out some further indicators that were found to be relevant with regard to considerations re “system or marketing” plan. These were:

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; and
a restriction on the franchisee selling any of the franchisor’s products without first consulting the franchisor.

The Full Court in Kyloe also stated that this was not an exhaustive list and that one fact by itself would not lead to the assumption of a franchise agreement.

Decision in Kyloe

The Court in Kyloe held that the requirements of a franchise agreement were not satisfied as the agreements did not constitute the granting of a right to carry on a business under a system or marketing plan on the basis that there was not enough control exercised by Kyloe, and there was a lack of any system or marketing plan.

Rafferty v Madgwicks

In Rafferty v Madgwicks [2012] FCAFC 37, there were several agreements whereby Rafferty was a party in the selling of Modular Accommodation Units. In order to determine whether the Rights Agreement (which was just one of the agreements entered into for the venture) was a franchise agreement as claimed by Rafferty, the Court sought to examine the level of control that Magwicks had over Rafferty’s conduct of the enterprise.

In this case, the Court looked at what was the necessary “control” and considered these features:

franchisee held an exclusive right to promote, market, sell and install the products;
franchisee had to comply with all reasonable directions as to quality control in marketing;
franchisor had absolute discretion to scrutinise proposed sales and to approve any project;
franchisee was required to meet specific sales targets;
franchisee was required to maintain financial records on a management system approved by the franchisor, who could audit those records;
restriction on franchisee selling competing products; and
requirement to comply with the franchisor’s policies and procedures as notified.

The Court held that the Rights Agreement was indeed a franchise agreement and not a license, for the purposes of the Franchising Code of Conduct, due to the following elements as indicative of a “system or marketing plan” that were present in the contractual relationship:

specific requirements for accounting and record keeping;
reservation by the franchisor of a right to audit books of account and other records;
the inability of the franchisee to supply goods or services without the approval of the franchisor;
requirement for signage, mechanising, promotional or advertising material to be approved by the franchisor;
a right of the franchisor to approve sales staff, bonus structures, reporting procedures and training for staff; and
stipulation of retail prices and sales quotas.

Criteria said to be indicative of a system being ‘substantially determined, controlled or suggested by the franchisor' include:

the extent to which the franchisee's business involved selling the franchisor's goods or services;
the degree to which the franchisor assumes responsibility for centralised management or standards of quality;
whether the franchisor dictates any mandatory obligations with respect to advertising or marketing; and
the degree to which the franchisor controls the franchisee's business having regard to advertising and financial support, auditing books and financial reporting requirements, staff and sales quota, training and the like.

As the Court held the agreement was a franchise agreement, Madgwicks was in breach of the Code for failing to provide a disclosure document, information statement and other information as required to Rafferty’s, the franchisee.

Freedom Foods v Blue Diamond Growers

In Freedom Foods Pty Ltd v Blue Diamond Growers [2021] FCA 172, Freedom Foods was the “exclusive” manufacturer of Almond Breeze under a License Agreement for a Territory including Australia. The Court ultimately found that the Licence Agreement did not satisfy paragraph (b) of clause 5(1) of the Franchise Code, and as such, the Licence Agreement is not a “franchise agreement” for the purposes of the Franchising Code because there was:

no requirement for Freedom Foods to operate “under” a marketing plan;
no sufficient relationship between the marketing plan and the right to carry on the business; and
not enough to establish that the promotional plan in place is “substantially determined, controlled or suggested”.

Workplace Safety Australia v Simple OHS Solutions

In the case of Workplace Safety Australia v Simple OHS Solutions & Anor [2015] NSWCA 84; [2015] HCATrans 264, the NSW Court of Appeal examined whether the primary judge was correct in determining that the distribution agreement was a franchise. The distribution agreement between the parties contained several indicia that WSA had the requisite control over OHS’s carrying on of the business and that the terms of the distribution agreement created obligations upon OHS to operate under a system or marketing plan, thereby fulfilling the requirements of the Franchising Code. More specifically, there was a requirement for OHS to:

to act as its exclusive distributor;
subscribe 15 new customers to subscription packages per month; and
if this minimum customer requirement was not met for each 6-month period during the term of the agreement, the appellant had the right to immediately terminate the agreement.

The appellant purported to terminate the agreement on the grounds of the respondent’s failure to meet the minimum customer requirement and non-payment of a quarterly instalment. The respondent contended that the distribution agreement was a franchise agreement within the meaning of the Franchising Code of Conduct and that the appellant hadn’t given them the disclosure requirements of the Code.

When considering whether the primary judge erred in his finding, the Court of Appeal found enough evidence to suggest WSA had provided a manual to OHS and required it to prepare a business plan. There was also a requirement to conduct the business under a marketing framework. At [92], Bathurst CJ stated that he “respectfully agree[s] that a system or marketing plan does not have to be spelt out in a franchise agreement. The contrary proposition would allow the statutory purpose of the Code to be circumvented”.

Apple Computer Australia v Mekrizis

In Apple Computer Australia Pty Ltd v George Mekrizis [2003] NSWSC 126, the Court looked at whether the Reseller Agreement (RA) identified a system or marketing plan under which the relevant business was to be operated and, if so, whether such system or marketing plan was substantially determined, controlled or suggested by Apple. However, it was not a question of whether such a system or marketing plan developed during the course of the relationship between the parties, but whether the agreement can be construed as granting a right to carry on the business under such a system or marketing plan. Apple submitted that although a right to carry on the relevant business was granted under the RA, it did not grant such a right to carry on the business “under a system or marketing plan substantially determined, controlled or suggested” by it and that, the RA was not a franchise agreement.

Although a number of terms are defined in the Code (clause 4), “system” and “marketing plan” are not defined. In these circumstances, it is appropriate to give those terms their ordinary meaning in the context of the Code and the relationship between Apple and the relevant parties. The Court found that a “system” is a set of principles or procedures according to which the relevant business is operated. Alternatively, it is an organised scheme or method pursuant to which the business is operated. A “marketing plan” is a detailed proposal for achieving the promotion or advertising of Apple’s products. The question is whether the RA identified a system or marketing plan under which the relevant business was to be operated and if so, whether such system or marketing plan was substantially determined, controlled or suggested by Apple. The Court ultimately held that although there were multiple agreements, the requirements of a franchise were not satisfied.

Navigating the minefield

These are only some of the cases that have considered the provisions of the Franchising Code and the elements of what constitutes a franchise agreement. The owner of a trade mark intending to license the mark for use by another trader must give careful consideration to the potentially conflicting requirements to ensure sufficient quality control so as not to endanger the trade mark but, on the other hand, not to fall within the net of the Franchise Code as a franchise agreement.

Although there is no definitive statement of the terms, of a license agreement that may achieve these objectives, analysis of the cases does indicate that it should be possible for a trade mark to be licensed by a straightforward licence agreement with adequate quality control provisions which do not cause the agreement to be a franchise agreement, but careful consideration should be given, and advice should be taken, in relation to the terms of the license agreement.

Penalties

The penalties for contravention by a body corporate of some provisions of the Franchising Code have been amended and, from 15 April 2022, can attract penalties being the greatest of:

$ 10 million;
three times the benefit obtained by the body corporate obtained directly or indirectly that is reasonably attributable to the contravention (if a court can ascertain this);
if the Court can not determine the value of the benefit, then 10% of the annual turnoverof the body corporate.

Given these penalties, there is a very strong incentive not to get it wrong when determining whether the Franchise Code does apply.