Issues in Competition Law and Franchise Agreements in Australia

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This article looks at Australian competition law issues, as applied to franchise agreements, including plans to extend unfair contract terms legislation.

A franchise agreement is an agreement under which one party (the ‘franchisor’) grants another party (the ‘franchisee’) the right to carry on a business supplying goods or services under a specific system or marketing plan substantially determined, controlled or suggested by the franchisor. The concept ‘franchise’ has developed along side the economic ideals of a free market, which has at
its foundation three ideals, namely, caveat emptor, the freedom to contract and the sanctity of the contract, which are based on the notion that not only is an individual in the best position to judge its own interests, but an efficient market transaction requires commercial players to have the liberty to contract with whoever is willing, and that once promises are made they must be kept.

The Competition and Consumer Act 2010 (CCA) (the ‘Act’) and the Franchising Code of Conduct (the ‘Code’) provides for Australian franchises, and outlines the rights and obligations which franchisors and franchisees have under the legislation. Although there are many issues in relation to the balance between competition law and franchise agreements, the underlying philosophy for the legislation and the Code seems to be while anti-competitive agreements and practices are prohibited by the Act, authorisation may be granted in cases where the public benefits of the conduct outweigh the effect on competition.

Unfair contract terms

The Commonwealth government has recently released an exposure draft of proposed legislation that would extend consumer protection against unfair contract terms to small businesses contracts that are standard form and with a value less than the prescribed threshold. Therefore, notwithstanding the current protection afforded to franchises in the Code, such as good faith obligations and provisions for compensation and goodwill, there are now further mechanisms to provide for the general review of unfair contract terms.

Section 24 of the Australian Consumer Law states an unfair term is one that causes significant imbalance in the parties’ rights and obligations; that would cause detriment (financial or otherwise) to the party if it were to be relied on; and is not reasonably necessary to protect the legitimate interests of the party who would be advantaged by term. Section 25 and the explanatory materials further lists the type of terms that would amount to an unfair contract term, including terms permitting the franchisor, but not the franchisee, to terminate the contract, compulsory acquisition of the franchise by the franchisor at less than the market rate, and giving the franchisor the ability to unilaterally change rights and obligations under the contract.

The effect of the proposed changes will include enforcement actions taken in respect of any unfair terms in standard form in small business contracts, which can be identified by using the factors listed in section 27 of the Australian Consumer Law, therefore giving the court the ability to make a range of orders including declaring a term, or if the contract cannot operate without the term, the entire contract void.

Exclusive dealings

Section 45 and 47 of the Act prohibits various forms of exclusive dealing, which occurs where the franchisor imposes restrictions on the franchisee and its freedom to choose with whom, what, and where they deal, and captures two types of anti-competition vertical transactions including the conditional supply of goods or services, or refusing to supply for specified reasons.

In particular, third line forcing is absolutely prohibited, and occurs when the franchisor will only supply goods or services, or gives a particular price or discount on the condition that the franchisee buys the goods or services from a particular third party. However, a franchisor that wishes to engage in third line forcing conduct may lodge a notification with the Australian Competition and Consumer Commission (ACCC) who can provide the franchisor with protection from legal action under the Act.

Other types of exclusive dealings are only prohibited if the conduct has an effect of substantially lessening the competition in the relevant market. These include full line forcing, which are dealings that involve the franchisor refusing to supply the goods or services unless the franchisee agrees not to either buy goods of a particular kind or description from a competitor, or resupply goods of a particular kind or description from a competitor. Therefore, arrangements where franchisors set objective quality standards and allow franchisees to source goods and services from any supplier provided they meet the standards, or require the franchisee to purchase goods from the franchisor or a related company, are allowed if they do not have the effect of substantially lessening competition.

An assessment on whether an exclusive dealing will result in a substantial lessening of the competition involves consideration of matters such as whether there has been a real effect on the competition in the overall market for the particular product and its substitutes; whether the refusal to supply would substantially restrict availability of that type of product to consumers; and whether consumers are severely restricted in their ability to buy the product or its substitutes. Therefore, the more exclusive the product, the more powerful the supplier, and the more likely the competition will be affected.

The ACCC will consider the impact of any conduct on an entire community, and not merely the franchisee. Therefore, it considers public benefits such as consistency across the franchise system; more efficient operation and management to the benefit of customers; and more efficient and effective bargaining between the franchisor and the franchisee.

Remedies against exclusive dealings include approaching the supplier to discuss the purpose of the exclusive dealing, seeking assistance from any trade associations or industry bodies who may be able to help by suggesting improvements to marketing strategies or acting as an arbitrator to settle disputes, contacting the local Small Business Commissioner, taking mediation or private legal action, or notifying the ACCC with documentary evidence. Section 24 of the Act further provides penalty provisions under which the ACCC can take court action to seek a financial penalty, or issuing an infringement notice for breach.

Restraint clauses

General restraint clauses prohibiting franchisees from competing during the term of the franchise agreement and for a period after the expiration of agreement is generally considered anti-competitive but is recognised as enforceable in limited circumstances, such as the sale of a business. However, such restraint clauses will not be enforceable if it goes beyond what is reasonably necessary to protect the legitimate commercial interests of the franchisor.

Resale price maintenance

Under section 40 of the Act, it is prohibited to engage in the practice of resale price maintenance. Various forms of resale price maintenance is captured in relation to goods and services including the withholding of supply as a result of failure to agree to or to adhere to a resale price maintenance regime. However, a franchisor is able to stipulate maximum prices or to recommend a price list under section 97 provided the franchisor makes it clear the prices are recommended only.

Territorial exclusivity

A clause constituting territorial exclusivity will not be prohibited unless it has the purpose of is likely to have the effect of substantially lessening competition. It will be allowed if the restriction of competition is for the public benefit and is limited to a reasonable time period generally not exceeding five years.

Good faith obligations

The Code outlines good faith obligations owed by both parties and stipulate the obligation is to reflect the common law. It requires the parties to an agreement to exercise powers reasonably and not arbitrarily or for some irrelevant purpose, and states certain conduct may lack good faith if one party acts dishonestly, or fails to have regard to the legitimate interests of the other party, for example, acting for some ulterior motive or in a way that undermines or denies the other party he benefit of the contract.

These good faith obligations extend to all aspects of the franchising relationship including pre-contractual negotiations, performance of the contract, dispute resolution, and termination of an agreement. However, while good faith requires a party to have due respect to the rights and interests of the other party, it does not require a party to act in the interests of the other party and does not prevent a party from acting in their own legitimate interests.

There are many pieces of legislation and authoritative bodies regulating over the area of franchising in order to ensure maximum fairness in the economy and minimum anti-competitive activity. Therefore, although there are issues in balancing the competition law and legitimacy of franchise agreements, they are sufficiently controlled by the established principles and laws in Australia.

ABOUT THE AUTHOR: Matthew Murphy
Matthew Murphy is a Partner in the MMLC Group.

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Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer. For specific technical or legal advice on the information provided and related topics, please contact the author.

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