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CARTELS BILL IMPACT ON FRANCHISING
COULD BE HUGE

by Deirdre Watson,
last updated 29/06/2015

June 2015 – A new law is possibly the most significant ever to have affected franchising in New Zealand, says barrister Deirdre Watson

The Commerce (Cartels and Other Matters) Amendment Bill 2011 was introduced into Parliament on 13 October 2011. Passage of the Act now appears imminent[1]. If passed, the Act could have significant repercussions for franchising. Franchise businesses need to get to grips with this legislation now and ensure they know what to expect. There will be serious civil and criminal penalties for transgressors under this legislation, possibly the most significant law ever to have affected franchising in New Zealand.

The following article is not intended as a substitute for legal advice, rather as a summary of the key elements of the proposed law. Every franchise is different and franchised businesses should seek legal advice from an expert now as to whether they may or may not be in breach of the Act, if passed.

What are the main features of the bill at a glance?

As noted by the Commerce Commission[2], the Bill:

  • Will introduce a new cartel prohibition, replacing the current prohibition on price fixing;
  • Provides three exemptions to the cartel prohibition for:

- Vertical supply contracts;
- Joint buying arrangements;
- Collaborative activities.

  • Enables parties involved in a collaborative activity that enter an arrangement containing a cartel provision to seek clearance from the Commerce Commission for that arrangement;
  • Makes engaging in cartel conduct a criminal offence, although criminal sections will not be available until two years after the Bill has passed.

What are Cartels and Cartel Provisions?

The purpose of the Commerce Act is to promote competition in markets for the greater benefit of the consumer. The underlying economic theory is that effective competition plays a significant role in driving the performance of the NZ economy[3].

One of the ways in which the Act promotes competition is by prohibiting cartels. Cartels are considered likely to substantially lessen competition because, by definition, a cartel exists when competitors agree to reduce or remove competition that exists or would otherwise exist[4].

The Commerce Commission has explained[5] that, under the Bill, a Cartel provision is any provision in an arrangement between competitors that has the purpose, effect or likely effect of:

1. Fixing prices (for eg, an agreement not to compete on price or on any element of price)

2. Restricting output (for eg, an arrangement to prevent, restrict or limit output, production capacity, supply, acquisition, etc)

3. Allocating markets (for eg, an agreement not to sell to or buy from certain customers or suppliers, or in particular areas).

Is a franchise agreement an agreement between competitors?

It is important to note at the outset that there will not be a cartel arrangement in play where parties are not in competition with each other. In most franchise systems the franchisor will not be in competition with their own franchisees. This is not however always the case. Where, for example, a Franchisor owns (or part owns) its own outlet, it might be found to be in competition with franchisees. Similarly, where it sells online direct to the end consumer, yet at the same time has franchisees who sell to those consumers, it may also be in competition with its franchisees. There may also be instances where the franchisees are in competition with each other.

Where a franchisor is in competition with a franchisee or where franchisees are found to be in competition with each other, there will be a competitive relationship. It is at that point the franchisor needs to be alive to the fact there may be provisions in their agreement which amount to Cartel provisions.

Do franchise agreements contain cartel provisions?

Yes, in short, they can do. The following is some further detail about the three categories of cartel provisions:

1. Fixing prices

Price fixing has been with us for a while. It occurs when parties enter into or give effect to an arrangement fixing, controlling or maintaining the price of goods and services that two or more parties to the agreement supply or acquire in competition with each other, or any discount, allowance, rebate or credit for goods or services that two or more of the parties supply or acquire in competition with each other[6].

2. Restricting output

Restricting output provisions are fairly common in franchise agreements. In simple terms they are provisions where a party is seeking to restrict the “output” of another party. For example:

  • Franchise agreements that limit trading hours or other forms of working capacity
  • Restraint of trade clauses

Agreements which seek to restrict the output of a franchisee will fall foul of the Act.

3. Allocation of markets

“Market allocation” potentially has a worryingly wide application in franchising. Under the proposed definition, market allocation means:

Allocating between any 2 or more parties to a contract, arrangement or understanding, or providing for such an allocation or, either or both of the following:

a) The persons or classes of persons to or from whom the parties supply or acquire goods or services in competition with each other;

b) The geographical areas in which the parties supply or acquire goods or services in competition with each other.

Examples of marketing allocating are:

  • Franchise agreements frequently restrict the activity of a franchisee to a particular geographical area. Exclusivity will often be granted to a franchisee in that particular area.
  • A franchisor may reserve for itself the right to service nationwide customers and leave franchisees to service local customers.

What are the exemptions?

The Bill provides three exemptions to the cartel prohibition. These are for:

  • Vertical Supply contracts;
  • Joint Buying arrangements;
  • Collaborative activities.

The Vertical Supply contracts exemption will apply where:

  • The parties have entered into a supply contract;
  • The contract contains a cartel provision;
  • The cartel provision relates to the supply or likely supply of goods or services by one party to the other, including the maximum price at which the goods may be re-supplied.
  • The cartel provision must not have the dominant purpose of lessening competition between the two parties.

The Joint Buying exemption will only apply to price fixing. It is likely to have limited significance in franchising. A joint buying agreement is one where say a group of retailer buyers group together to purchase a large order of product at a discount. According to the Commerce Commission[7], the conduct will be exempt where the provision:

  • Relates to the price of goods or services some of the competing buyers collectively acquire;
  • Provides for the competing buyers to collectively negotiate the price for goods or services which they then purchase individually, or
  • Provides for an intermediary to take title to the goods and resell or resupply them to one or more of the competing buyers.

Finally, a Collaborative Activity Exemption may apply. The collaborative activities exemption replaces the narrower exemption for joint ventures. It is broadly defined as an activity carried on in co-operation between two or more people that does not have the dominant purpose of lessening competition between the parties. The cartel arrangement must be reasonably necessary for the purpose of the collaborative activity.

Although some have expressed the view that franchising will qualify for this exemption I take a different view. The Commerce Commission guidelines note[8] that to qualify as a collaborative activity, the parties need to be combining their businesses, assets or operations in some way in a commercial activity, or otherwise operating a commercial activity jointly. They need to be doing something more than simply agreement how to run their separate businesses.

Franchisors and franchisees would not normally consider themselves in a collaborative arrangement with each other, in this sense. Nor would be so in substance. They are businesses which have a symbiotic relationship but they are not in business together, in the partnership sense, and nor are they joint venture partners. The success of one is not necessarily dependent on the success of the other.

Clearance

The Bill will, if enacted, enable parties involved in a collaborative activity that enter an arrangement containing a cartel provision to seek clearance from the Commerce Commission for that arrangement.

Conclusion

Franchising contracts are directly at risk under the proposed Bill. The fact that an exemption for franchising was not embodied in the final Bill speaks volumes. Franchise agreements will potentially be squarely in the firing line.  It is important to recognise that each franchise is different. Franchisors should seek expert advice about what impact the proposed Bill may have on their unique system and whether or not they will be able to seek a clearance.


Notes:

[1] The Bill is currently at the Committee Stage in Parliament as at June 2015.

[2] Commerce Commission, Competitor Collaboration Guidelines, Revised Draft, August 2014.

[3] Competitor Collaboration Guidelines, para 1.1.

[4] Competitor Collaboration Guidelines, para 1.8.

[5] Competitor Collaboration Guidelines, para 1.10.

[6] Competitor Collaboration Guidelines, para 2.22

[7] Competitor Collaboration Guidelines, para 4.3

[8] Competitor Collaboration Guidelines, para 5.9

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