Is it worth the risk to continue under a licensing arrangement rather than a franchise one?

Since the new Franchising Code of Conduct came into effect on January 1 this year, businesses which have operated under a licensing arrangement are encouraged to seek advice to ensure they are not at risk of incurring major financial penalties.

Licensing is considered as a common alternative to franchising, although one is basically an extension of the other.

Licensing is where the business (i.e. the licensor) grants (under certain conditions) rights to a licensee to use a trademark and sell a product or service. This licence may also be known as a distributorship, or even agency.

Some business definitions of franchising would say that any grant based on conditions is a “franchise”. Under this definition, conditional grants including agencies, distributorships and licences are “franchises”; however, the Franchising Code of Conduct includes a legal definition of a franchise that applies under Australian law.

A large part of this definition relates to the extent to which one party substantially determines controls or suggests how the other party operates their business under the terms of the agreement. (Other factors include the requirement for an agreement to exist between the parties, for one party to grant the other conditional rights to use a trademark or marketing system, and there must be a commercial exchange between the parties before or during the operation of the grant).

I’m not a franchise because I call myself a licensing business

Any business that calls itself a license business but meets the criteria for a franchise outlined in the Code is still a franchise, no matter what the owner calls it.

Can’t the government tell us if we are a franchise or not?

Unfortunately no. The Australian Competition and Consumer Commission (ACCC) which enforces the Franchising Code of Conduct has no mandate (or the resources) to advise every business that calls itself a licensing business whether or not they are subject to the Code.

In other words, there is no registration or other approval process required before a business commences offering franchises or licences.

The applicability of the Code has always been self-assessable, with businesses determining for themselves, or taking external advice as to whether or not the Code applies.

If for some reason the ACCC did agree to a request by a licensor to determine whether or not it is a franchise, it may lead to the ACCC then prosecuting a licensor who it finds to be a franchisor.

What are the consequences of continuing to operate as a licensing business?

The risks of continuing to operate as a licensing business are significantly greater following the introduction of a new system of penalties to apply under the new Franchising Code from January 1, 2015.

Under the former Code, the ACCC would need to take a matter to the Federal Court to get a ruling on whether or not a breach of the Code had occurred. This is time-consuming and costly to the ACCC, and therefore tends to be used where there is significant detriment to the affected parties (i.e. franchisees).

The court would then determine an appropriate remedy, which might involve a number of outcomes including injunctive relief, the voiding of clauses or entire agreements, the requirement to undertake trade practices or Code compliance training, or the refund of any moneys paid under an agreement, etc.

Generally court action of this nature often starts in response to a complaint by a franchisee to the ACCC.

However, in addition to the existing remedies available through the Federal Court, the ACCC now has powers to issue fines of up to $8500 per breach of the Code, and if need be, seek pecuniary penalties of up to $51,000 per breach through the court.

If the ACCC took a closer look at a licensed business opportunity, and found that the licensor exercised substantial control over the licensees’ operations, then it may determine that the business is in fact a franchise.

This would leave the business open to one of the most serious breaches of the Franchising Code – the failure to provide a disclosure document – which is a fundamental requirement of franchisors in their dealings with potential and existing franchisees.

The maximum penalty for this particular breach is $51,000 per instance, so if there are 10 licensees who have never been issued with a disclosure document, the maximum potential financial penalty would be as high as 10 x $51,000 = $510,000 (plus the associated risk of a court ordering that those license agreements be struck down).

The substantial risk of incurring significant financial penalties alone should encourage anyone who calls their business a licence to urgently review the nature of their licensing agreements.