When is a licence arrangement not a licence arrangement?

When is a licence arrangement not a licence arrangement?

When it turns into a franchise. Ba boom. It sounds like a joke but it’s actually a serious question that even the savviest of business owners grapple with when establishing or growing their business.

If you’re looking to expand your business, you’ll need to carefully consider it too.

If you have a loyal customer base, consistently high demand for your products or services and the capital needed to pursue a successful expansion strategy, it’s time to choose the expansion model you’ll use to govern the relationships you have with your business partners. To licence or to franchise?

When looking for ways to expand your business, it’s easy to get confused about licence and franchise models. The terms are sometimes used interchangeably but there are important differences. What are the differences between the two strategies? What are the advantages and disadvantages of franchises? What regulations must you comply with as a franchisor or licensor? And if you have already entered into a relationship with a business partner, how do you know if it is a licence or franchise agreement?

There are advantages to both licence and franchise models, and which strategy you choose will depend on how your business operates and the level of control you want over your business partners. The Australian Competition and Consumer Commission (ACCC) has a broad and rigid definition of what constitutes a franchise agreement, which means that, regardless of how you and your partners define the relationship, your business may be classified as a franchise and you may be subject to regulations under the Franchising Code of Conduct.

What is a licence agreement?

A licence agreement is a contract in which the licensor gives the licensee permission to use something without transferring ownership of it to them. Licence agreements are most often used for intellectual property, such as the licensing of a brand, logo or trademark.

Licence agreements are often considered a cheaper alternative to a franchise agreement because there are fewer upfront costs and less ongoing fees during the business relationship for the licensor. Licensees generally determine their own marketing strategies and systems for operating their businesses.

What is a franchise agreement?

A franchise agreement is also a type of contract, but it differs from a licence agreement by giving the franchisor more control over how the franchisee uses the franchisor’s property. Franchise agreements generally contain specific guidelines on how a franchisee must run its business.

Establishing a franchise system can be more expensive than entering into licence agreements, but franchise agreements give you greater control over how the franchisee operates. This allows you to roll out a common marketing plan across all franchises, monitor franchisee performance and dictate the exact methods the franchisee must adopt, including the goods and services provided, uniforms, location and shop fit out.

Think of the last time you had a Big Mac. Each McDonalds restaurant is independently owned and operated by a franchisee but walk into any restaurant around the world and you know exactly what you’ll get – the same fit out, products, packaging and service. McDonalds keeps its brand uniform by recruiting and training its franchisees and establishing explicit regulations for menu items, methods of operation, use of trademarks, and concepts for restaurant design.

How to determine if you’re in a licence or a franchise agreement

The ACCC has set key criteria for determining if your business arrangement falls within the definition of a franchise agreement. Your business may be classified as a franchise, even if you don’t consider yourself to be a franchisor.

To determine if you’ve entered into a franchise agreement, ask yourself the following questions:

  1. Is there a verbal, written or applied agreement between you and the licensee/franchisee?
  2. Has there been any payment (upfront or ongoing) for the provision of goods and services?
  3. Have you granted the licensee/franchisee permission to carry on a business?
  4. Is there a substantial system or marketing plan in place that you determined, suggested or control?
  5. Is your business substantially associated with a specific trademark or symbol?

All of these criteria must be met for an agreement to be classified as a franchise agreement in Australia. If you’ve answered yes to all of these questions, you’re most likely operating a franchise system and the Franchising Code of Conduct will apply

What is a substantial system or marketing plan?

Even with this checklist, it is not always clear if your business arrangement is considered a franchise agreement. A common question is what does it mean to have a “substantial” system or marketing plan in place?

Australian courts have determined that the following behaviours push ‘licensors’ into franchise territory:

Marketing programs:

  • Providing comprehensive advertising and promotional programs
  • Retaining the right to screen and approve promotional materials
  • Prohibitions on repackaging of products
  • Requiring mandatory sales training programs

Operations manuals:

  • Providing suggestions for retail prices charged for products
  • Assuming responsibility of a centralised management and uniform standards regarding quality
  • Having the right to inspect and audit financial records
  • Having the right to inspection the business premises
  • Hiring staff
  • Establishing sales quotas and KPIs
  • Requiring management training
  • Prescribing standard forms to be used by each franchisee

Business plans:

  • Requiring franchisees to submit a business plan
  • Guiding or requiring details relating to funding and operation of the business to be included in this plan

What is the Franchising Code of Conduct?

The Franchising Code of Conduct (Code) is a mandatory code that governs the way that franchisors and franchisees conduct business with one another. The Code includes regulations for acting in good faith, proper disclosure of information, mechanisms for dispute resolution and procedures for ending a franchise agreement. Whilst the Code excludes a few specific business arrangements from being a franchise, the overarching definition of a ‘franchise agreement’ can extend to many licence and distribution contracts. Therefore, it’s important to interrogate the actual elements of your business arrangement, and not rely on the title of your contract.

Even if the Code is inconsistent with the contract you have set up with your partners, as a franchisor, you are still legally obliged to comply. If you breach the Code, the franchisee may seek damages, or you may be hit with financial penalties from the ACCC.

What happens if your licence arrangement is really a franchise arrangement?

It’s certainly not the end of the world should you find that your licence arrangement ticks all the boxes of a franchise under the Code. In fact, franchising can be a positive marketing tool to potential business partners. Not only are you providing prospective partners with all the tools to operate a business, you are also ensuring that their rights and interests are protected under to the Code.

To comply with the Code, you’ll need to provide certain documents to your business partners/franchisees. The primary document you’ll need to prepare is called a Disclosure Document. This gets updated each financial year and is designed to give prospective and current franchisees information about your business’s systems, financial status and network.

You’ll also be required to comply with other rules under the Code relating to marketing funds and significant capital expenditure.

Finding the right strategy for your business

The decision to enter into a licence or a franchise agreement will be based on a number of factors, but the key factor is generally the level of control you want to maintain over your business partners.

If you want to expand your brand but you are not concerned with determining exactly how a business operating under your brand is run, a licence agreement may be the best strategy to pursue.

As a franchisor, you have more control over the branding and operations of your franchisee, but you are also subject to obligations under the Franchising Code of Conduct.

If you’re unsure of how to classify your business relationship or need advice on what your obligations are under the Franchising Code of Conduct, get in touch with the BlueRock Law team. We’re here to help you grow your business in the most effective way while maintaining compliance.

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