The fine line between IP licence agreements and franchise agreements

Freedom Foods Pty Ltd v Blue Diamond Growers offers important lessons and guidance for all drafters of IP licence agreements.

On 28 May 2021, the Full Federal Court of Appeal in Freedom Foods Pty Ltd v Blue Diamond Growers [2021] FCAFC 86 (Freedom Foods v Blue Diamond) delivered instructive reasons why an intellectual property licence agreement was not a franchise agreement. The decision contains useful guidance for practitioners, in-house counsel, and organisations who licence IP assets and seek to ensure IP licence agreements are not unintentionally made subject to the substantial obligations under the Franchising Code of Conduct. 

Background

Californian company Blue Diamond Growers (Blue Diamond) licensed Australian company Freedom Foods Pty Ltd (Freedom Foods) to manufacture and sell almond milk products under certain trade marks (Licence Agreement). A dispute arose and Blue Diamond sought to rely upon a clause in the Licence Agreement requiring arbitration of the dispute in California. Freedom Foods sought to avoid that clause on the basis that the Licence Agreement was a franchise agreement and regulated by the Franchising Code of Conduct (Code). The Code provides that a clause requiring a party to bring proceedings in any jurisdiction outside Australia “is of no effect”.

What are key implications for licensors if the Code applies?

If the Code applies, it imposes costs and administrative burdens on licensors as it is designed to protect franchisees.

For example, in addition to jurisdictional limitations, the Code sets out several obligations on licensors, including to:

• prepare an extensive disclosure document in a prescribed form containing among other things financial and business experience information, and mandatory prescribed wording (such as warnings and cooling off notices);
• provide information about arrangements that apply on termination of the agreement;
• ensure dispute resolution and termination procedures align with those set out in the Code;
• act towards the franchisee with “good faith“.

Licensors who do not comply with the Code, including inadvertently because they did not intend the licence agreement to be a franchise agreement, may be fined up to $AUD66,600.¹

Why was Blue Diamond’s Licence Agreement not a franchise agreement?

The Court determined that the most distinctive feature of the definition of franchise agreement in the Code was paragraph (b) of the definition being “the grant by the agreement of a right to carry on business under a system or marketing plan that comes from the licensor” (Element B).

In line with earlier authorities, the Court found that:²

1. Element B should be broken into three sub-elements that work together and must be met being:
   i.  the grant of the right to carry on the specified business; 
   ii. the business to be carried on under a system or marketing plan; and 
   iii. the system or marketing plan to be substantially determined, controlled or suggested by the alleged franchisor;
2. ”substantially controlled” means the power to direct or restrain the content of the business plan on any substantial issue;
3. the agreement can relate to a discrete part of the franchisee’s business (rather than the franchisee’s entire business);
4. a system or marketing plan is a ”co-ordinated method or procedure, or scheme whereby goods or services are sold” or “a method of operation under which a business is to be conducted”.

The Court held:

““the three cumulative elements of [Element B] describe a distinctive aspect of a franchise agreement, namely that instead of the ongoing conduct of the business being dependent on the business acumen and skill of the grantee as the operator of the business, the system or plan for the business is substantially a matter for the grantor. ….. the grantor has the business concept and confers on the grantee the right to carry on the grantor’s business concept under the trade mark, advertising or commercial symbol of the grantor for a fee. …  [Element B] is not concerned with agreements made by a grantor with a grantee where, after the making of the agreement, the manner of the future operation of the business of the grantee is to be determined by the grantee.”

The following features of the Licence Agreement (among others) were relevant to the Court’s finding that it was not a franchise agreement:

• the recitals indicated that Freedom Foods would continue its own business as a manufacturer and distributor of products and did not indicate Freedom Foods would be granted a right to carry on a business in a particular manner;
• marketing plans would be developed and implemented by Blue Diamond (including by spending 5% of product sales on such activities), but reviewed by Freedom Foods. The marketing plans were not “directed to the manner in which Freedom Foods” would sell or distribute products;
• Freedom Foods were responsible for the development and implementation of trade promotion and account specific promotional plans (with Freedom Foods to expend 5% of product sales on such activities). Blue Diamond was permitted to meet with Freedom Foods about these plans. The Court considered that these plans were to affect product sales. Distinct from the marketing plans, the promotional plans were about business activities that Freedom Foods were licensed to undertake. Blue Diamond had no mechanism of control over such promotional plans, even if they could meet with Freedom Foods about them;
• Blue Diamond’s right to change packaging and product formulations was to protect Blue Diamond’s IP and ongoing business interest.

This meant the Court did not restrain Blue Diamond from proceeding with arbitration in California.

Five key lessons from Blue Diamond v Freedom Foods

Blue Diamond v Freedom Foods serves as a warning to drafters of IP licence agreements (that the parties do not intend are franchise agreements) that licensors should not (and should not be given rights to):

1. direct or suggest a marketing plan or scheme for how the licensee may advertise, sell, or promote its business or the sale of products and services comprising that business;
2. control manufacturing or distribution of products in such a way that could permit control of the licensee’s business operations and methods. However, the licensor can enforce specifications about how the products are made or packaged, provided it’s necessary to protect the licensor’s business interests in connection with the activities the licensee is permitted to undertake;
3. require a licensee to develop its promotional and marketing systems within a system or marketing plan that is created by the licensor;
4. control the strategy for promotional materials. However, the licensor can have rights to approve packaging or promotional materials in respect of matters that affect the reputation of the licensor (e.g. how the licensor’s trade mark is presented); or
5. compel the licensee to do certain things that appear to give the licensor control over the licensee’s business operations. However, the licensor can have some controls over non-operational aspects to protect the licensor’s reputation or the value of the intellectual property being licensed.

The line between protecting the licensor’s reputation and intellectual property by placing obligations on the licensee to do certain things, and controlling how the licensee conducts its business, can be difficult to find.

Drafters should be mindful of this line and the other issues above, to mitigate the risk their licence agreement attracts costs, administrative burdens and potential fines under the Code.

  

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Footnotes

¹ The Australian Government has recently introduced laws to double these penalties and increase obligations on franchisors as of 1 July 2021.

²Rafferty v Madgwicks [2012] FCAFC 37; (2012) 203 FCR 1; Workplace Safety Australia Pty Ltd v Simple OHS Solutions Pty Ltd [2015] NSWCA 84; (2015) 89 NSWLR 594.