Most of the amendments to the Commerce Act 1989 passed into law under the Commerce (Cartels and Other Matters) Amendment Act 2017 are now in full force. For franchisors and franchisees, this means that the prohibition on ‘cartel provisions’ now applies to all franchise agreements. If your franchise arrangement is not yet compliant – you need to act now.
Background
The Commerce (Cartels and Other Matters) Amendment Act 2017 (Amendment Act) introduced significant amendments to section 30 of the Commerce Act. These changes replaced the existing prohibition on ‘price fixing’ with a more comprehensive array of prohibited conduct know as ‘cartel provisions’.
The Amendment Act has serious application to franchise systems, which very commonly include cartel provisions as essential components to the operation of the franchise. Breaches of the new legislation can now result in fines of up to NZ$10 million.
The Amendment Act also introduced a number of exceptions to the prohibition on cartel provisions, as well as a ‘clearance’ procedure in which parties can apply to have their use of cartel provisions sanctioned by the Commerce Commission.
What are cartel provisions?
A cartel provision is any provision, in any contract, arrangement or understanding between competitors, which has the purpose, effect or likely effect of:
- Price fixing;
- Restricting output; and/or
- Allocating markets.
A cartel provision can exist in any written or unwritten agreement, contract, arrangement or understanding of almost any kind. For franchisors and franchisees, the most easily identifiable source of cartel provisions is the franchise agreement itself, as well as underlying operational documents often referred to as an Operations Manual or Franchise Manual.
Price fixing is a prohibition which was already in existence prior to the Amendment Act, and refers to a situation where competitors arrange to set or control prices for goods and services, and includes specific aspects of price such as setting discount formulas and rebate levels. For franchises, this could mean that agreements which impose uniform pricing among franchisees (such as during promotional sales) could fall foul of this prohibition.
To restrict output often refers to a situation where competitors arrange to restrict production or supply of goods or services, often in order to create strategic market scarcity. Those in the franchise industry however may be more familiar with agreements to restrict trading hours, restrict a franchisee from operating other businesses, or to restrain a franchisee from commencing trade after the expiry of the franchise – all of which are common provisions in franchise agreement, and all of which may fall within the restricting output prohibition.
Allocating markets involves the division of a market for goods or services arranged by competitors within that market, usually on the grounds of geographic, demographic or other lines. This prohibition is particularly applicable to franchise relationships, which can frequently involve the division and allocation of geographical territories between franchisees.
Is my franchise in competition?
Where parties are not in competition with each other, the prohibition on cartel provisions will not apply. While it is easy to consider franchising as a co-operative relationship as opposed to a competitive one, for most franchises and for the purposes of the Amendment Act, this is not the case.
A franchisor will likely be in competition with its franchisees where the franchisor operates, in its own name, one or more businesses within that franchise. For example, in a franchise system of pet stores, the franchisor will be in competition with its franchisees if that franchisor owns and/or operates one of those pet stores (in addition to acting as franchisor of the system).
Even where a franchisor has no business in running its own store or outlet, a competitive relationship is still likely to exist as the franchisor directly deals and contracts with its franchisees, which are in competition with each other. The franchisor acts as the ‘hub’, connecting and binding each competing franchisee (or ‘spoke’) to the franchise system and associated franchise rules and restrictions.
Franchise provisions such as restraint of trade and territory allocation are enforced by franchisors against their franchisees, and due to the ‘hub and spoke’ relationship, can be considered cartel provisions which fix prices, restrict output, or allocate markets between the franchisees.
What are the exceptions to cartel provisions?
The Amendment Act has introduced three exceptions to the prohibition on cartel provisions:
- Contracts for vertical supply (such as where a wholesaler supplies a retailer with goods, but does not retail those goods itself);
- Joint buying arrangements (such as where a group of parties negotiate a collective agreement for the purchase of goods); and/or
- Collaborative activities.
Contracts for vertical supply and joint buying arrangements have limited application to franchises, and will likely be only seldom relied on by franchisors seeking coverage under an exception.
The collaborative activities exception however is particularly important to franchise systems. This exception provides that where cartel provisions exist between competitors party to an arrangement or activity, those provisions will not be prohibited provided that the dominant purpose of that arrangement or activity is not to lessen competition between the competitors. To claim the benefit of this exception, the competitors will also need to establish that the cartel provisions are reasonably necessary for the purpose of the arrangement or activity.
The franchise relationship is often considered one of co-operation and mutual support. On this basis, it is likely that the collaborative activity exception can apply to franchises which implement reasonable cartel provisions necessary for the operation of the franchise system. This will be heavily dependent on the precise nature or wording of the cartel provisions – as provisions which are too heavy-handed or unreasonable may fall short of the exception.
While cartel provisions do not need to be absolutely essential to the franchise system to fall within the exception, they must be more than merely desirable or preferable.
The Amendment Act also contains a specific clarification regarding how the exception applies to restraint of trade provisions which may still be in force long after the collaborative activity has ended. Ordinarily, the collaborative activity exemption can only be relied on during the course of such activity. Section 31(3) however provides that a restraint of trade provision which was reasonably necessary at the time the collaborative activity commenced can still be enforced once the collaborative activity has ended.
Seeking clearance
Franchisors or franchisees who are party to a collaborative activity which includes cartel provisions may seek a ‘clearance’ from the Commerce Commission under section 65(a) of the Commerce Act to exempt the parties from prosecution under section 30.
The Commerce Commission will, within 30 working days of a clearance application being made, decide whether:
- the competing parties are or will be involved in a collaborative activity;
- the cartel provisions relied on within that collaborative activity are reasonably necessary for its purpose; and
- the collaborative activity does or will not have the effect of substantially lessening competition in a market.
Applications which are not addressed within the 30 working day statutory timeframe are deemed to be declined, and the Commerce Commission charges a fee, currently NZ$3,680 to process an application for clearance.
Concluding comments
Franchisors and franchisees should consider whether any elements of their franchise arrangements include cartel provisions, and if so, decide how those provisions can be amended or exempted.
Lane Neave’s friendly team of experienced franchise and competition lawyers can assist you in reviewing your franchise documentation to help ensure your franchise system is compliant with the Amendment Act, as well as advise you on how, if, and why you should seek clearance from the Commerce Commission.
Business Law team
If you need any assistance with the sale or purchase of your business, do not hesitate to get in touch with the Business Law team at Lane Neave.
Gerard Dale, Claire Evans, Graeme Crombie, Evelyn Jones, Anna Ryan, Joelle Grace, Peter Orpin, Ellen Sewell, Matt Tolan, Carlo Wan, Kristina Sutherland, Jacob Nutt, Whitney Moore, Alex Stone, Ben Cooper, Lisa Catto
