Exclusive dealing and obligations

Bianca Sevastos, Senior Associate, Baybridge Lawyers

This article appears in the September/October 2013 issue of Business Franchise Australia & New Zealand


If you are a franchisee and you are obligated to purchase products and services from the franchisor, or a particular supplier nominated by the franchisor, you should be aware of the legal concept of ‘exclusive dealing’ and how it impacts you and the operation of your business.

What is exclusive dealing conduct?

Broadly speaking, exclusive dealing in franchising is where the franchisor restricts its franchisee’s freedom to choose from whom it buys goods or services, what goods and services it buys, and where it sells such goods and services. Most types of exclusive dealing are against the law only where such conduct is deemed to substantially lessen competition, although other types are strictly prohibited.

Third line forcing

Third line forcing in franchising occurs when a franchisor forces its franchisees to purchase goods or services from a particular third party nominated by the franchisor and no other party without the franchisor’s written consent. For example, Hot Dog Pty Limited will offer franchise agreements on condition that the franchisees buy their hot dog buns from Buns Supply Pty Ltd only.

Strictly speaking, third line forcing is prohibited by the Competition and Consumer Act 2010 (the Act) notwithstanding businesses may be granted exemptions from the Australian Competition and Consumer Commission (ACCC) which will allow
exclusive dealing arrangements when it is satisfied that the public benefit from the conduct will outweigh any anti-competitive detriment.

The ACCC has accepted the following public benefits in assessing third line forcing notifications:

• Fostering business efficiency;
• Improving product quality;
• Promoting competition in relevant markets.

In particular, in circumstances where franchisees can save by buying the product and services from a nominated supplier instead of buying in a competitive market this will be considered to have positive benefits in terms of competition and consumer welfare.

Full line forcing

Full line forcing in franchising occurs when there is a requirement on a franchisee to acquire goods and services exclusively from the franchisor and no other supplier without the written consent of the franchisor. For example, Ink Cartridge Pty Ltd will offer franchise agreements on the condition that franchisees buy their ink cartridges from Ink Cartridge Pty Ltd (or a related entity) only.

Full line forcing will not be a breach of the Act unless engaging in that conduct has the purpose of substantially lessening completion, or is likely to have the effect of substantially lessening competition, in a relevant market.

Recent Case

In the recent case of Pampered Paws Connection Pty Ltd v Pets Paradise Franchising (Qld) Pty Ltd (2012), the franchisee (Pampered Paws) brought an action against the franchisor (Pets Paradise) for engaging in exclusive dealing in relation to the franchise. The franchisor granted a franchise agreement to the franchisee to sell pets and pet accessories. The franchisee was required to purchase such pets and pet accessories from a particular supplier nominated by the franchisor, which was a related entity of the franchisor. Initially, it was found that the franchisor had breached the exclusive dealing provisions of the Trade Practices Act 1998 (TPA) by forcing its franchisees to purchase ‘allocated stock’ from its related entity.

Notwithstanding, the court then acknowledged that the applicable provisions of the TPA were subsequently amended in 2006 to allow related entity exclusive dealing and the franchisor was therefore not in breach of the relevant provisions.

Your obligation to purchase products and services from nominated suppliers

Most franchisors will require its franchisees to purchase the approved products and services from a supplier or suppliers nominated by them. While such requirement may seem restrictive from the outset, in good franchise systems this arrangement is mutually beneficial to both the franchisor and franchisee.

As an independent business owner your capacity to purchase products and services at discounted rates is limited by the volume of the goods and services required for the operation of your business. In a franchise network, where there are tens or perhaps hundreds of franchisees and franchisor corporate owned stores, the size of the orders for the products and services required for the network is exponentially greater. The volume of the orders will mean that the franchisor will have the power  to negotiate significant volume discounts from the suppliers which may be passed on to franchisees. The end result is a competitive advantage that results in higher operating margins for each franchisee.

Another reason why a franchisor may wish to nominate the supplier of products and services is for quality control and consistency throughout its network. The franchisor will have spent considerable time and effort establishing its brand and creating  a reputation in the market place by developing a recognisable standard throughout its network. The franchisor will want to protect the integrity of its brand by ensuring its franchisees maintain that standard and one way to do this is ensuring that all products and services offered by its franchisees are from approved suppliers.

Most franchise agreements contain provisions which will enable the franchisees to purchase products and services from an alternate supplier. It is likely that these provisions will stipulate that any products and services from an alternate supplier will
need to meet the standard and quality of the franchisor and that the alternate supplier can supply the quantity of the stock required for the franchise network among other requirements.

Role of the ACCC

The ACCC plays a key role in the franchising sector. It is responsible for promoting compliance with the Act, including Australian Consumer Law, and the Franchising Code of Conduct (the Code) through education, liaison and, where necessary, enforcement action. The ACCC has the power to audit franchisors for compliance and can require a franchisor to provide any documents it is required to keep, generate or publish under the Code. The ACCC is able to conduct random audits and
does not need to suspect that the franchisor may have breached the Code before conducting its audit. Notwithstanding, in the ACCC’s submission to the 2013 Franchising Code review it stated that the ACCC had served audit notices on 33 franchisors.
The vast majority of these franchisors had been found to be compliant with the Code following these audits.

Baybridge Lawyers is a specialist corporate and commercial law firm and a leading authority on all franchise related matters. They are seen as trusted advisors to many brands nationally and internationally.

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