Are you considering licensing or franchising your business? Are you uncertain whether your current contractual arrangement is a license or a franchise? The difference between the two business models is important and has a significant impact on an individual’s compliance obligations at law.
Generally, license agreements and franchise agreements both grant the right to use intellectual property and a trademark in a defined territory. Every franchise agreement contains a license, however, not every license agreement is a franchise.
What is the difference between the two contractual arrangements?
A franchise agreement grants the right to a person to carry on a business under a system and/or marketing plan substantially determined or controlled by the Franchisor. Under the agreement, the Franchisee is permitted to use a trademark or symbol owned by the Franchisor.
In Australia, franchising is regulated by the Franchising Code of Conduct (the Code) which commenced on 1 January 2015. The Code was created under section 51AE of the Competition and Consumer Act 2010 (Cth) (the Act). Prior to the commencement of the Code, a previous mandatory franchising code had been in operation in Australia since 1 October 1998.
The code includes:
- disclosure requirements;
- a good faith obligation;
- a dispute resolution mechanism;
- a cooling-off period;
- procedures for ending a franchise agreement.
Under the Code, the definition of ‘franchise agreement’ is very broad. If an agreement meets the criteria contained in the definition, the agreement will be a franchise agreement irrespective of the title used to describe the agreement. That is to say, the language used to describe the agreement is not determinative of the type of agreement – the type of agreement will be determined by the substance of the agreement over its form.
A franchise agreement is defined in section 5 of the Code as an agreement:
- in which a person (the Franchisor) grants to another person (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 or an associate of the Franchisor; and
- under which the operation of the business will be substantially or materially associated with a trademark, advertising or a commercial symbol owned, used, or licensed by the Franchisor or an associate of the Franchisor; and
- under which, before starting or continuing the business, the Franchisee must pay or agree to pay to the Franchisor or an associate of the Franchisor an amount including, for example an initial start-up fee, marketing fee, or royalty fee.
It is not uncommon to see ‘Licensors’ deliberately attempt to characterise agreements as license agreements to avoid the operation of the Code and the obligations that arise under it.
In August 2018, the Australian Competition and Consumer Commission (ACCC) accepted a court enforceable undertaking from Husqvarna Australia Pty Ltd in relation to claims that its dealership agreements were likely to contravene the Code, the Act, and specifically Schedule 2 of the Act; the Australian Consumer Law (ACL).
The relevant conduct identified by the ACCC was that Husqvarna represented to its dealers that the dealership agreements they entered into were not franchise agreements. The ACCC was concerned that the dealer Trading Terms and Conditions were likely to constitute a franchise agreement between Husqvarna and each dealer, and that Husqvarna had not complied with the Code.
Failure to comply with the Code can give rise to financial penalties for breaches of up to $66,000 per breach. Section 51ACB of the Act prohibits a corporation from contravening the Code. Further, representations to the effect that ‘the agreement is not a franchise agreement’ may be at risk of being false or misleading representations in contravention of sections 18 and 29(1)(m) of the ACL.
As of 1 September 2018, the maximum civil penalty for corporations under the ACL increased significantly from $1.1 million per contravention to the greater of:
- $10 million; or
- three times the value of the benefit (if the court can determine the value of the benefit obtained from the offence by the corporation); or
- 10% of the annual turnover of the corporation (if the court cannot determine the value of the benefit).
The maximum penalty for individuals also increased from $220,000 to $500,000.
A license agreement is a written contract which allows an individual (a ‘Licensor’) to grant another individual (a ‘Licensee’) the right to use something (including a brand, copyright, logo, trademark, know how, or some other type of intellectual property). Licensing allows an owner of intellectual property or a trademark to grant the right to someone to use that intellectual property whilst retaining ownership of it.
A license agreement will not fall under the Code if any of the criteria listed above are not met.
A key difference under a license agreement is that an individual is able to carry on its business and determine its own marketing plan without being substantially determined or controlled by another entity.
Major differences between a licence agreement and a franchise agreement are:
- fees are usually payable under both agreements however under a franchise agreement, usually a payment to a marketing fund is specified whereas a licence will not have a payment to a marketing fund;
- licensees have control over their own marketing whilst franchisees have to use common marketing;
- franchises provide systems whilst licences develop their own systems;
- franchises have monitored performance criteria whilst licences have none provided for compliance;
- franchises use another’s intellectual property/trademarks whilst a licence uses their own.
You may believe that you are operating under a licence agreement when in fact, you are operating under a franchise agreement and therefore the Code will apply. A breach of the Code can mean that you are subject to significant financial penalties from the ACCC.
You should take great care if you choose to licence your business. You should keep the licence agreement simple (including not having clauses about the branding, appearance and style of your business) so as to avoid it being deemed a franchise.
It is always prudent to seek legal advice about drafting the terms of a licence agreement before you enter into one. If you need assistance or advice on what constitutes a licence, or a franchise agreement then please contact John Gdanski or Patrick Fabris.
Article written by Patrick Fabris.