If you are looking for ways to expand your successful business, you may be tossing up between using a franchise or licence model. Each model has its advantages and can offer an effective strategy for expansion. There are, however, important differences between a licence and franchise agreement that you should understand.
Your system and written contract will determine whether you are a licensor or franchisor. Even if you are entering into licence agreements with licensees and do not consider yourself to be a franchisor, the Australian Competition and Consumer Commission (ACCC) may actually classify you as a franchisor.
In running a franchise disguised as a licence, you run the risk of inadvertently breaching the Franchising Code of Conduct, and therefore open yourself up to potential enforcement actions.
What is a Licence Agreement?
A licence agreement is a written contract in which you (the licensor) give another person or company (the licensee) the right to use something. An intellectual property licence is an agreement that gives a licensee rights to use the brand, logo, trade mark, copyright, know-how or any other type of intellectual property the licensor owns. Licences can be very specific or broad in terms of what intellectual property the licensee can use and how they can use it.
For example, you may own a fashion brand and decide to add a range of sunglasses. After investigating the cost to make the sunglasses yourself, you realise it’s easier or cost-effective to outsource and enter into an agreement with a manufacturer. The manufacturer then designs and produces the sunglasses with your brand. In this example, a licence agreement would allow the manufacturer to use your brand.
What is a Franchise Agreement?
Like a licence agreement, a franchise agreement is also a type of contract. The most distinctive feature of a franchise agreement is that a franchisor exercises significantly more control over franchisees than a licensor. Unlike a licence agreement, franchise agreements will contain specific directions on how the franchise must operate the business and give detailed specifications on the level and type of marketing that each franchisee must carry out when selling to customers.
The Code defines ‘franchise agreements’ and sets out specific elements that must all exist for a particular arrangement to be considered a franchise.
|Have I Entered into a Franchise Agreement?|
If you have answered yes to all of the above, then you are likely operating under a franchise agreement. Regardless of whether you have entered into an agreement with a different name (such as a licence agreement), you will still be considered operating as a franchise.
Key Characteristics of a Franchise and a Licence
|Common marketing plan for all franchisees||Licensees determine their own marketing|
|The franchisor dictates the exact methods and systems (such as uniforms, fit-out and location) the franchisee will adopt||Licensees are free to develop their own system for operating their business, such as by choosing the fit-out for their storefront|
|The franchisor monitors franchisee performance (e.g. specifying minimum performance criteria/quotas)||No requirement to comply with performance criteria|
|Franchisees pay certain fees, which could include payments to a marketing fund||Licensees pay certain fees. The licensor will not operate a marketing fund|
|Franchisees use the franchisor’s intellectual property (e.g. trade marks)||Licensees use the trade marks and intellectual property of the licensor|
Am I a Franchisor?
Even though the elements set out in the Code and described in the checklist above offer useful guidance, it is not always obvious what each of these legal principles means.
For instance, how do you assess whether you ‘substantially’ control the system or marketing plan for the business? And considering that licence agreements also require payments (usually in the form of an upfront fee) – what types of payments indicate a franchise agreement as opposed to a licence agreement? These are not easy questions to answer.
|Checklist: Is it a Franchise Arrangement?|
|It is possible that the system or marketing plan you have in place is, in fact, a franchise arrangement if you:
The level of control that you exercise relates to your ability to direct or limit the franchisee’s business plan in a significant way. Even if you don’t control most aspects of the franchisee’s business, if you suggest most of the above, then you are likely franchising (rather than licensing) your business.
Risks of Becoming an “Accidental Franchisor”
If a licence agreement is actually a franchise agreement, then the Franchising Code of Conduct will apply. There are various obligations that you must comply with – even if these obligations are not set out in the written contract.
Good Faith Obligations
You must act in good faith when interacting with the franchisee and disclose certain information through a disclosure document (which franchisors must update annually). It may be that, had you disclosed the information required by law, the ‘licensee’ would not have entered into the contract with you. They may then seek damages because of losses they have incurred as a result of your inadequate disclosure.
Application of the Code
The Code also restricts the types of clauses that you can include in a franchise agreement. For instance, the Code states that you cannot force a franchisee to settle disputes by way of mediation or litigation in a place outside the State or Territory in which the franchisee is conducting its business. If there is an inconsistency between the clauses in the franchise agreement and the Code, the Code will apply.
Breaches of the Code
The ACCC can impose financial penalties for breaches of various aspects of the Code, including failure to act in good faith and failure to provide notice of a breach.
Whether you choose to franchise or licence largely depends on the amount of control and level of ongoing responsibilities you are willing to commit to your business.
Remember that even though a franchise system provides you with more control (therefore allowing you to ensure uniformity across your network), it also comes with greater ongoing obligations as a franchisor. These include annual financial reporting and support and training of franchisees.
If you choose to licence your business, keep your licence agreement simple. Avoid including clauses relating to the branding and appearance of the licensee’s business, otherwise, you may be held to the standard of a franchisor.
If you have any questions or need assistance drafting a franchise or licence agreement, get in touch with our specialist franchise lawyers on 1300 544 755.
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