|
|
[Home]
[Databases]
[WorldLII]
[Search]
[Feedback]
Federal Court of Australia |
Last Updated: 10 February 1999
Madison Pacific Property Management Pty Ltd v Australian Securities & Investments Commission [1999] FCA 62
WORDS AND PHRASES - "prescribed interest", "franchise"
Corporations Law, ss 8A, 109(H), 1064
Property Stock and Business Agents Act 1941 (NSW)
Securities Industry Act 1980 (Cth), s 43
Corporation Regulations, regs 1.02, 7.1.02
Australian Softwood Forests Pty Ltd v Attorney General (NSW) [1981] HCA 49; (1981) 148 CLR 121, discussed
Commissioner for Corporate Affairs v Casnot Pty Ltd (1981) CLC 40-704, cited
Khania Nominees v Hamilton (1986) 4 ACLC 390, cited
R v Commons (1986) 4 ACLC 551, cited
Amoco Australia Pty Ltd v Rocca Bros Motor Engineering Co Pty Ltd [1973] HCA 40; (1973) 133 CLR 288, followed
Butterworth v Lezemo Pty Ltd (1983) 8 ACLR 737, referred to
Streeter v Pacific-Seven Pty Ltd (1985) 9 ACLR 790, referred to
Alloyweld Pty Ltd v Federal Commissioner of Taxation (1984) 69 FLR 274, referred to
Oakey Abattoir v Federal Commissioner of Taxation (1984) 54 ALR 595, referred to
Australian Securities Commission v United Tree Farmers (1997) 24 ASCR 94, referred to
Waldron v M G Securities Australasia Ltd (1975) VR 508, referred to
Scott v Commissioner of Taxation (No 2) (1966) 40 ALJR 265, referred to
Snook v London & West Riding Investments Ltd [1967] 2 QB 786, referred to
Sharrment Pty Ltd v Official Trustee in Bankruptcy (1988) 18 FCR 449, referred to Re British Basic Slag Agreements [1963] 2 All ER 807 (CA), applied
FRENCH, DRUMMOND AND CARR JJ
8 FEBRUARY 1999
PERTH
|
IN THE FEDERAL COURT OF AUSTRALIA | |
| WESTERN AUSTRALIA DISTRICT REGISTRY | WAG 87 OF 1998 |
ON APPEAL FROM A JUDGE OF THE FEDERAL COURT OF AUSTRALIA
BETWEEN: (ACN 081 776 810)
First Appellant
MADISON PACIFIC AUSTRALIA PTY LTD (ACN 981 776 874) AS TRUSTEE OF THE MADISON PACIFIC AUSTRALIA TRUST
Second Appellant
MADISON PACIFIC MANAGEMENT PTY LTD (ACN 081 776 758) AS TRUSTEE OF THE MADISON PACIFIC MANAGEMENT TRUST
Third Appellant
MADISON PACIFIC MARKETING PTY LTD (ACN 081 776 794) AS TRUSTEE OF THE MADISON PACIFIC MARKETING TRUST
Fourth Appellant
MADISON PACIFIC FINANCE PTY LTD (ACN 081 776 847) AS TRUSTEE OF THE MADISON PACIFIC FINANCE TRUST
Fifth Appellant AND: Respondent JUDGE:
MADISON PACIFIC PROPERTY MANAGEMENT PTY LTD
AUSTRALIAN SECURITIES COMMISSION
FRENCH, DRUMMOND AND CARR JJ DATE OF ORDER: 8 FEBRUARY 1999 WHERE MADE: PERTH
THE COURT ORDERS THAT:
1. The appeal is allowed.
2. The orders made by Lee J on 25 June 1998 be set aside.
3. In lieu thereof the application be dismissed.
4. The respondent to pay the appellants' costs of the proceedings before Lee J and of this appeal.
Note: Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.
|
IN THE FEDERAL COURT OF AUSTRALIA | |
| WESTERN AUSTRALIA DISTRICT REGISTRY | WAG 87 OF 1998 |
ON APPEAL FROM A JUDGE OF THE FEDERAL COURT OF AUSTRALIA
BETWEEN: (ACN 081 776 810)
First Appellant
MADISON PACIFIC AUSTRALIA PTY LTD (ACN 981 776 874) AS TRUSTEE OF THE MADISON PACIFIC AUSTRALIA TRUST
Second Appellant
MADISON PACIFIC MANAGEMENT PTY LTD (ACN 081 776 758) AS TRUSTEE OF THE MADISON PACIFIC MANAGEMENT TRUST
Third Appellant
MADISON PACIFIC MARKETING PTY LTD (ACN 081 776 794) AS TRUSTEE OF THE MADISON PACIFIC MARKETING TRUST
Fourth Appellant
MADISON PACIFIC FINANCE PTY LTD (ACN 081 776 847) AS TRUSTEE OF THE MADISON PACIFIC FINANCE TRUST
Fifth Appellant AND: Respondent
MADISON PACIFIC PROPERTY MANAGEMENT PTY LTD
AUSTRALIAN SECURITIES COMMISSION
JUDGE:
FRENCH, DRUMMOND AND CARR JJ DATE: 8 FEBRUARY 1999 PLACE: PERTH
Introduction
1 This case concerns the offering to the public of franchise rights in a residential tenancy property management business, conducted by Madison Pacific Australia Pty Ltd in New South Wales. The offers involved a promise to allocate to each prospective "franchisee" three hundred randomly selected properties in the Sydney metropolitan area to constitute the "franchise territory". The properties so selected would be unlikely to be geographically contiguous. The offers were associated with invitations to each prospective franchisee to have the whole of the management of the franchised territory assumed by Madison Pacific Property Management Pty Ltd with marketing services provided by Madison Pacific Marketing Pty Ltd and loan finance by Madison Pacific Finance Pty Ltd.
2 On 25 January 1998, on the application of the Australian Securities Commission, Lee J made orders declaring that the offers of franchises constituted offers of prescribed interests within the meaning of s 9 of the Corporations Law and that the making of the offers constituted conduct on the part of the Madison Pacific companies contrary to ss 1018, 1064 and 1065 of the Corporations Law. His Honour granted an injunction restraining the companies from offering interests in the Madison Pacific franchise in conjunction with any offer or invitation to enter into management agreements in relation to that interest. The injunction did not apply to applications made to the Madison Pacific companies which had been accepted as at 25 June.
3 His Honour ordered that any person who had purchased or subscribed for any interest in the scheme was entitled to avoid the agreements made pursuant to the acceptance of that offer. He also made an order that the companies give notice to each investor setting out the terms of the order and statements of the investor's rights to avoid the scheme agreements and associated advices.
4 The Madison Pacific companies have appealed against his Honour's judgment.
Grounds of Appeal
5 The grounds of the appeal are as follows:
"1. The learned Trial Judge erred in law in finding that the investment opportunity offered by the Appellants in conjunction with the invitation to prospective franchisees to appoint Madison Pacific Management Pty Ltd as Manager of the franchisees business did not constitute a franchise as defined in Regulation 1.02 of the Corporations Regulations.Salient Features of the Scheme
2. The learned Trial Judge erred in law in finding that the offer by Madison Pacific Management Pty Ltd to act as Manager of a franchisee's business constituted the offer of a participation interest within the meaning of that expression in the Corporations Law.
3. The Learned Trial Judge should have held that the investment opportunity offered by the Appellants whether taken as a whole or individually constituted a franchise within the meaning of that term in Regulation 1.02 of the Corporations Regulations."
6 It is convenient, before turning to the issues raised on the appeal, to review some of the salient features of the scheme documentation. That documentation comprises:
1. Information Memorandum
2. Franchise Agreements consisting of:
(i) Franchise Agreement
(ii) Management Agreement
(iii) Marketing Agreement
(iv) Loan Agreement
(v) Loan Repayment Guarantee
(vi) Franchise Endorsement Page
3. Short Term Loan Agreement
7 The Information Memorandum commences with a notice advising prospective franchisees to seek their own professional advice on the proposal and related agreements. By way of disclaimer it points out that the document is not a prospectus and says that Madison Pacific has taken legal advice that the issue of the franchises is "...specifically exempt from the prospective provisions of the Corporations Law". It also asserts that Madison Pacific has legal advice that a business investor does not require a licence in accordance with the Property Stock and Business Agents Act 1941 (NSW) to operate a Madison Pacific franchise. It says by way of admonition to prospective investors:
"...a business investor should not enter into an agreement to acquire a Madison Pacific Franchise if the business investor is seeking a totally passive investment. Even in circumstances where a Franchisee opts to appoint a manager, he should do so in the knowledge that a Madison Pacific Franchise is likely to require an equivalent amount of work and attention, to that required of the owner of any other small business enterprise, run under management."8 By way of historical overview, the memorandum refers to the limits and inadequacies of the traditional property management services provided by local real estate agents. This is contrasted with the Madison Pacific philosophy of promoting and training residential property supervisors to a level equivalent to that of investment and fund managers in other financial fields. By utilising what is called the Madison Pacific system focussing on low cost, high quality services, Madison Pacific claims in the Information Memorandum to be able to attract high volume quality business and in turn high quality staff and the financial resources to provide "...an unequalled quality of property management services".
9 The Memorandum sets out what is described as an opportunity for applicants to acquire franchises utilising the Madison Pacific system and the Madison Pacific image and the option of having the business run under professional management by an approved manager. The term of the franchises is for a period of twenty years. The Memorandum states that:
"A franchise incorporates a "territory" initially consisting of more than 300 addresses within the Sydney metropolitan area, spread over many suburbs to achieve a balance of opportunity for individual franchises. Thus no one franchise territory will comprise a concentration of addresses in a particular building, suburb or area, but rather a broad spread of addresses across the Sydney metropolitan area."These addresses are computer generated to ensure similar treatment of all franchises. The territory may increase in size over time with the addition of new addresses to the database. The rights conferred by the franchise are summarised in the Information Memorandum thus:
"The franchise will entitle the Franchisee to operate a business providing services to property owners. Income is derived by Franchisees providing Madison Pacific property management services to owners of properties within the franchised territory."10 The Memorandum then described "First Year Services and Fees". These comprise a franchise establishment fee, an annual franchise fee, a training fee and a software fee. The franchise establishment fee entitles the franchisee to acquire the rights to utilise the Madison Pacific image, the Madison Pacific system and the Madison Pacific Operations Manual. There is an annual payment to enable the franchisee to continue to utilise Madison Pacific know-how. For a fee on-going sales training and property services training are offered. In addition a Property Services Software Program is offered by which franchisees would be enabled to monitor the performance of the manager, if one is appointed.
11 Under the heading "Other Services" there is reference to "Franchise Management Services (optional)" in the following terms:
"Each Madison Pacific Franchisee has the opportunity to operate their Madison Pacific business personally and will have access to an Operations Manual, together with optional sales training for themselves and/or their employees, all provided by the Franchisor.12 Also under the heading "Other Services" are the optional offers of direct response advertising programs, direct mail programs, telemarketing and other marketing services, a newsletter, prepayment of the first year's interest on loan finance from Madison Pacific Finance, and optional funding comprising a Limited Recourse Loan, an introduction to third party lending institutions "familiar with the acquisition of a Madison Pacific franchise" and a Loan Repayment Guarantee. For each of the marketing services referred to there is an optional fee payable by the franchisee. There is an Initial Fees Summary set out in the Information Memorandum which includes the Franchise Establishment Fee, the Optional Training and Software Program fees, the Optional Marketing, Advertising, Direct Mail, Telemarketing and Annual Management Fees, Newsletter subscription and Loan Repayments Guarantee. This shows a total investment of $32,500. In addition the ongoing fees payable from the "Gross Profits Only" of the franchise business are specified, being: 1. Annual Franchise Fee being 2.0% of Gross Profit
Alternatively, a Franchisee may choose to employ the services of Madison Pacific Management, an approved manager under the Franchise Agreement, who will assist the Franchisee in running their Madison Pacific business.
Further, a Franchisee may elect to nominate an alternative manager, who would need to become an approved manager, under the terms of the Franchise Agreement.
If appointed, Madison Pacific Management will, on behalf of the Franchisee, manage and direct the day to day operation of the Madison Pacific business and will endeavour to promote, advance and improve the business. Regular financial and operational reports will be provided to Franchisees by Madison Pacific Management to enable them to adequately monitor their Madison Pacific business."
2. Annual Management Fee of 43.0% of Gross Profit
Loan facilities are offered by way of:
1. An advance of $15,000 from an independent financial institution (Principal Lender) with interest of approximately 12.5% p.a. over six years; and
2. Franchisees who avail themselves of the benefits of the management services and marketing services there will be access to a Limited Resource Loan from Madison Pacific Finance of $7,500 for each franchise acquired with interest at 9.75%.
13 The Limited Recourse Loan is said to be "totally self funding with repayments being made from the Franchisee's Gross Profit only". It is anticipated that loan repayments in respect of the loans would be made solely from the income generated from an individual Madison Pacific franchise. Up to 55% of a franchisee's Gross Profit (other than the first year) would be utilised to repay the loans. A summary of projected cash flows is set out, a diagrammatic representation of the corporate structure of the Madison Pacific group and a list of "risk considerations". Also incorporated in the Information Memorandum is an opinion from solicitors relating to the tax deductibility of costs associated with investment in the scheme. Detailed projected cash flows are also attached showing conservative assumptions about the average number of properties services per franchise, rising from 6.5 in year one to 13.9 in year twenty. There is an independent from Deloitte Corporate Finance on cashflow projections for individual franchise owners.
14 The Franchise Agreement itself is made between the prospective franchisee and Madison Pacific Property Management Pty Ltd and Madison Pacific Australia Pty Ltd. By cl. 2.1 Madison Pacific Australia grants to the franchisee:
"...an exclusive franchise to conduct one Madison Pacific Outlet providing the Madison Pacific Services to the Specified Properties during the Term using the Madison Pacific System and the Madison Pacific Image subject to this Agreement."15 Terms used in cl 2.1 are defined in cl 1. The Madison Pacific Services comprise:
"(a) property repairs and maintenance services, which include the co-ordination of all works and services and control of costs associated with the general upkeep, cleaning, repairs and replacement of items as required;16 The term "Madison Pacific Outlet":
(b) the compilation and maintenance of the Madison Pacific Brand and Model Identification Register;
(c) recommendations on property presentation to maximise rental potential and market value;
(d) regular property inspections;
(e) preparation of monthly statements and the provision of administrative services; and
(f) monitor, administer, supervise and authorise the disbursement of property outgoings (sic)."
"...means a business conducted under franchise from the Franchisor providing some or all of the Madison Pacific Services."17 The "Specified Properties" are defined thus:
""Specified Properties" means the addresses of properties located within the State allocated to the Franchisee by the Franchisor upon the execution of this Agreement (and being not less than three hundred (300) sites) and any other property addresses located within the State which may be allocated to the Franchisee by the Franchisor after the date of this Agreement."18 The "Madison Pacific Image" is a reference to the relevant Trade Marks, the name "Madison Pacific" and the associated marks, names, emblems, designs, logos and the like.
19 Madison Pacific retains an absolute discretion to vary the Specified Properties in circumstances which are set out in cl. 2.4. It can allocate additional property addresses from new or unallocated addresses. It can remove a rent producing property from the Specified Properties and allocate it to another franchisee where that franchisee is or becomes the owner of the property or acquires it. If the dwelling or dwellings in a specified property are replaced by a greater number of dwellings, the franchisor may remove the addresses of the additional dwellings from the specified properties and reallocate them.
20 Sub-Franchising is prohibited but the franchisee is authorised to "...appoint a manager to conduct the Franchise Business on its behalf, provided that the Franchisee has obtained the written consent of Madison Pacific in relation thereto". The franchisor's obligations in relation to the provision of training, software program and an operations manual are set out in cl 4. The duties of the franchisee are set out in cl 6 and include an obligation to:
"(a) conduct the Franchised Business efficiently and commercially and so as to preserve and enhance the Franchised Business, the Madison Pacific Image and the Madison Pacific System."21 Clause 9 provides that the franchisee shall not carry on the franchised business other than from premises approved in writing by Madison Pacific which approval shall not be unreasonably withheld. As to the management of the business cl 10 provides:
"The Franchisee shall not engage, appoint or allow any person (except the Franchisee) to manage the Franchised Business unless and until Madison Pacific has (in its absolute discretion and on such terms and conditions as it may require) approved in writing the manager and the terms of the manager's engagement or appointment."22 There is an assignment clause which permits the franchisee to "...sell the Franchised Business and assign all its rights under this Agreement". This is subject to approval of the assignee by Madison Pacific.
23 Under the Optional Management Agreement the franchisee engages Madison Pacific Management Pty Ltd "to be the sole and exclusive manager of the Franchised Business..." (cl 2.1). A first year monthly fee of $495 is specified and thereafter an annual fee of 43% of Gross Profit payable monthly in arrears.
24 The manager's duties are specified in cl 5. The primary duty is set out in cl 5.1:
"The Manager shall during the Term manage, direct and control the Franchised Business on behalf of the Franchisee."25 Clause 5.3 under the heading "Management Standards" provides that in the discharge of its duties under the agreement the manager shall (inter alia):
"(a) act with reasonable skill in managing the Franchised Business with a view to promoting, advancing and improving the Franchised Business;26 The duties of the franchisee are set out in cl 6:
.
.
.
(c) devote such time and attention to the management of the Franchised Business as may be reasonably necessary in the opinion of the Franchisor;
(d) be entitled to manage any other business for any other person;
.
.
.
(f) subject to the Franchise Agreement, act on its own initiative and exercise such powers as may be available to it as the manager of the Franchised Business;
.
.
.
(i) comply with all reasonable instructions and directions as may be given to the Manager by the Franchisee concerning the general conduct and management of the Franchised Business."
"6.1 The Franchisee hereby grants to the Manager access to and the right and power to exercise on behalf of the Franchisee in the conduct and management of the Franchised Business all the rights, powers, duties, discretions and benefits conferred on the Franchisee by the Franchise Agreement for the purpose of or in connection with the conduct of the Franchised Business by the Franchisee and without limiting the generality of this clause specifically authorises the Manager to execute on the Franchisee's behalf all documents reasonably required in the conduct and management of the Franchised Business.27 The manager is responsible under cl 8 for all payments, costs, charges and expenses incurred in the conduct and management of the business and:
6.2 The Franchisee shall not require the Manager to do anything that is not permitted, nor prohibit or restrict the Manager doing anything that is required to be done, under the Franchise Agreement."
"...shall ensure so far as possible that the Franchisee is not personally liable for such payments, costs, charges and expenses and shall indemnify the Franchisee against all such payments, costs, charges and expenses."28 There is provision for termination of the agreement for breach by the manager or, where the manager ceases to be approved by Madison Pacific to manage the Franchised Business. (cl 11) The manager is an independent contractor of the franchisee but clause 12 qualifies that statement as follows:
"12. RELATIONSHIP29 The Marketing Agreement is made between the franchisee and Madison Pacific Marketing Pty Ltd. By the Marketing Agreement the franchisee engages Madison Pacific Marketing to be its sole and exclusive marketing consultant. During the continuance of the agreement no other person is to be engaged to market the franchise business without the prior written consent of Madison Pacific (cl 2). There is provision for the payment of marketing fees and a statement of the marketing duties of Madison Pacific Marketing. The marketing services provided include an ongoing direct response media advertising program, a direct mail program, a telemarketing program, training packages for telemarketers, coordination of promotional and direct mail materials, provision and placement of media programs, detailed prospect lists and the conduct of ongoing market research and effectiveness monitoring. Under the heading "Marketing Standards" in cl 5.2 there is a requirement that Madison Pacific Marketing comply with all reasonable instructions and directions as may be given to it by the franchisee "... concerning the general conduct and marketing of the Franchised Business".
The Manager is engaged by the Franchisee as an independent contractor. Nothing in this Agreement shall be taken as constituting the Manager or any other servant, agent or contractor of the Manager an employee or servant or (except to the extent required by this Agreement) an agent of the Franchisee."
30 Clause 6 relating to the duties of the franchisee is in terms almost identical to those of the equivalent clause in the Management Agreement and other equivalents relate to termination (cl 9), the existence of an independent contractor relationship and the negativing of an agency relationship (cl 10).
31 The fourth agreement in the package is a Loan Agreement with Madison Pacific Finance whereby Madison Pacific Finance advances money to the franchisee. By cl 2.2:
"2.2 The Franchisee acknowledges to the Lender that it irrevocably elects to pay in advance the Initial Franchise Establishment Fee, the Annual Franchise Fee, the Ongoing Sales Training Fee, Special Property Services Training Workshop Fee and the Software Program Fee payable under clause 5 of the Franchise Agreement, and the first year's Management Fee and Newsletter Subscription Fee payable under clause 4 of the Management Agreement (if applicable) and the Marketing Fee payable under clause 4 of the Marketing Agreement."32 By cl 2.3 the franchisee irrevocably authorises and directs Madison Pacific Finance to pay the proceeds of the advance to Madison Pacific who will apply it in accordance with cl 7 of the Franchise Agreement.
33 In addition to the Loan Agreement there is a Loan Repayment Guarantee Agreement under which the lender, Madison Pacific finance, provides a guarantee in consideration of the franchisee executing the Franchise Agreement, the Management Agreement, the Marketing Agreement and the Loan Agreement and paying $300 to the lender. The lender guarantees the timely repayment of each Principal Lender Loan Repayment. In any period during the initial period when gross revenue is insufficient to permit the payment in full of the Principal Lenders Loan Repayment in accordance with cl 7.3 of the Management Agreement the lender shall pay to the principal lender on behalf of the franchisee a sum equal to the shortfall (cl 2(a)). In subsequent years Madison Pacific Finance offers to extend the guarantee on like terms on an annual basis (cl 2.2(b).
Statutory Framework
34 Regulation of offerings of interests other than shares and debentures dates back to amendments to the Uniform Companies Act 1961 in New South Wales in 1971. These were further amended when four of the six States adopted uniform amendments to their Companies Acts in 1975 and 1976. Subsequent development of the statute law is helpfully summarised in Ford, Principles of Corporations Law at 22.540:
"The 1975-76 amendments established the basic elements of the definition of "interests", which came to be known as "prescribed interests" when the Companies Code was adopted by the States and Territories under the co-operative companies and securities scheme, which commenced (for prescribed interests) on 1 July 1982. The basic definitional and regulatory elements of the co-operative scheme were adopted by the Corporations Law, though over time there were extensive developments and modifications in matters of detail through regulations and modifications by the Commission. The system which had evolved from 1971 was replaced by a new conceptual and regulatory system under the Managed Investments Act 1998 (Cth), which commenced on 1 July 1998."35 It was the Companies Act 1961 (NSW) and in particular ss 81 and 76 of that Act which was considered by the High Court in Australian Softwood Forests Pty Ltd v Attorney General (NSW) [1981] HCA 49; (1981) 148 CLR 121. Section 81 prohibited the authorised issue or offer of interests to the public for subscription or purchase and invitations to the public to subscribe for or to purchase any interests. The definition of "interests" in s 76 of the Act was almost identical in the relevant parts to the definition of "participation interests" in the Corporations Law.
36 In 1987 a regulation (Statutory Rule 1987 No 172) was made pursuant to the Companies Act 1981 to exempt from the definition of "prescribed interests" the offer of rights to participate as franchisees in franchises. In an Explanatory Statement issued by the Attorney-General, reference was made to cases in which franchises were held to be prescribed interests on the basis that the franchisee had an interest in profits from the franchisor's scheme or there was a common enterprise under which the franchisee could expect profits from the efforts of the franchisor. The cases referred to were Commissioner for Corporate Affairs v Casnot Pty Ltd (1981) CLC 40-704, Khania Nominees v Hamilton (1986) 4 ACLC 390 and R v Commons (1986) 4 ACLC 551.
37 These decisions had the result that a franchisor could be required to be a company within s 164 of the Act, to enter into an approved trust deed and to appoint an approved trustee as well as to hold a dealer's licence under s 43 of the Securities Industry Act 1980 (Cth). The Explanatory Statement said:
"None of these consequences is intended. New regulation 14A of the accompanying Regulations will therefore exempt from the definition of "prescribed interest" any right to participate or any interest, as franchisee, in a franchise."The relevant regulation is now reg 7.1.02 of the Corporations Regulations and is to be read with the definition regulation 1.20.
38 Provisions of the Corporations Law, dealing with prescribed interests, which have now been supplanted by the Managed Investments Act 1998 (Cth) are in issue in this case. It is to be noted that there are transitional provisions under the latter Act whereby interests created before 1 July 1998 will attract the old "prescribed interests" system subject to the need to comply with the new system by 30 June 2000.
39 Chapter 7 of the Corporations Law deals generally with "securities" defined in s 92 to include "prescribed interests made available by [a] body". Part 7.12 is concerned with offering securities for subscription or purchase. Division 5 deals with prescribed interests and covers ss 1063 to 1076 inclusive. The core provision regulating the sale of prescribed interests is s 1064(1):
"1064(1) A person, other than a public corporation, must not make available, offer for subscription or purchase, or issue an invitation to subscribe for or buy, any prescribed interest."40 The term "prescribed interest" is defined in s 9:
""prescribed interest" means:41 The relevant parts of the definition of "participation interest" as defined in s 9 are:
(a) a participation interest;
.
.
.
but does not include:
(c) a right or interest, or a right or interest included in a class or kind of rights or interests, declared by the regulations to be an exempt right or interest, or a class or kind of exempt rights or interests, for the purposes of Chapter 7;...."
""participation interest" means any right to participate, or any interest:42 Franchise rights or interests are exempted from the operation of Chapter 7 by reg 7.1.02:
(a) in any profits, assets or realisation of any financial or business undertaking or scheme whether in Australia or elsewhere;
(b) in any common enterprise, whether in Australia or elsewhere, in relation to which the holder of the right or interest is led to expect profits, rent or interest from the efforts of the promoter of the enterprise or a third party; or
(c) in any investment contract;
whether or not the right or interest is enforceable, whether the right or interest is actual, prospective or contingent, whether or not the right or interest is evidenced by a formal document and whether or not the right or interest relates to a physical asset, ..."
"For the purposes of the definition of "prescribed interest" in section 9 of the Corporations Law, any right to participate, or any interest, as franchisee in a franchise is an exempt right or interest for the purposes of Chapter 7 of that Law."43 The term "franchise" is defined in reg 1.02:
""franchise" means an agreement or arrangement, whether express or implied, oral or written, between 2 or more persons by which:44 Reference should also be made to s 109H of the Corporations Law which provides:
(a) a party to the agreement or arrangement (in this definition called "the franchisor") authorises or permits another party (in this definition called "the franchisee"), or a person associated with the franchisee, to exercise the right to engage in the business of offering, selling or distributing goods or services in Australia or in an external Territory, under a marketing plan or system controlled by the franchisor or a person associated with the franchisor; and
(b) the business carried on by the franchisee or the person associated with the franchisee, as the case may be, is capable of being identified by the public as being substantially associated with a mark identifying, commonly connected with or controlled by the franchisor or a person associated with the franchisor; and
(c) the franchisor exerts, or has authority to exert, a significant degree of control over the business; and
(d) it may reasonably be expected that, in carrying on the business, the franchisee or a person associated with the franchisee is, or will be, substantially dependent on goods or services supplied by the franchisor or a person associated with the franchisor;"
"In the interpretation of a provision of this Law, a construction that would promote the purpose or object underlying the Law (whether that purpose or object is expressly stated in the law or not) is to be preferred to a construction that would not promote that purpose or object."This and associated provisions of the Corporations Law reflect provisions enacted by the Companies and Securities (Interpretation and Miscellaneous) Provisions Code to enable extrinsic materials to be referred to and purposive constructions to be adopted.
The Decision under Appeal
45 The case for the Commission before the learned trial judge was that the offer documents, taken together, involved a proposal that amounted to a prescribed interest and did not attract the exemption applicable to a right to participate or interest as franchisee in a franchise for which reg 7.1.02 provides.
46 His Honour posed the question he had to answer thus:
"To determine whether the characterisation of a prescribed interest applied by the Commission to the offer documents is appropriate it is necessary to determine what form of transaction constitutes a franchise as defined in reg 1.02 to ascertain whether the exemption for a right to participate, or interest, as a franchisee in a franchise extends to the combination of transactions attacked by the Commission."47 He then turned to reg 1.02 and the four elements of the definition of "franchise" which it set out. As to the first two elements defined in pars (a) and (b) he observed that the Commission was content to accept that they were present. No argument had been submitted on the third element in par (c). His Honour's judgment focussed on the fourth element set out in par (d) of the definition. As to this the Commission said at the hearing of the appeal that it had not conceded that all the requirements of pars (a) and (b) were satisfied and in particular did not concede the condition they import that the franchise involves the carrying on of a business by the franchisee. The concession that was made in relation to (a) was that there was a marketing plan or system controlled by the Madison Pacific group. As to par (b) it was the existence of the requisite mark that was conceded and no more. There was no substantial issue on par (c) at the hearing. The Commission's case was and remained however that the definition of "franchise" requires the carrying on of a business by the franchisee either by itself or by an agent. In the event that characterisation of the case was not contested before this Court.
48 His Honour rejected the submission from Madison Pacific Management that its services under a Management Agreement would fall within par (d) as services supplied by a person associated with Madison Pacific Australia on which, under the proposed franchise scheme, a franchisee would substantially depend to carry on the business.
49 He held that, on its face, the appointment of Madison Pacific Management, which operated as an independent contractor responsible for all the costs of the managed business and indemnifying the franchisees, was "external to a franchise agreement and not an element capable of defining a franchise". His Honour went on:
"The goods or services to be supplied by a franchisor on which a franchisee may reasonably expect to be substantially dependent are those which go to the essence of the business developed by the franchisor and essential for a franchisee to obtain in carrying on the franchised business if the business is to be conducted successfully in the style of the franchisor's business. Providing for the conduct of a franchised business for the term of the franchise to be carried out by a manager associated with the franchisor tends to negate the concept of franchise embodied in the definition of that term in reg 1.02. Sole and exclusive management by a person associated with the franchisor is not a service upon which a franchisee may reasonable expect to be substantially dependent in carrying on a franchised business."50 His Honour then turned to the question whether the offer by Madison Pacific Management in conjunction with the offer of a franchise was the offer of a prescribed interest and found that it was. He considered the conduct of members of the Madison Pacific group (who were then respondents before him) as a group in publishing the offer documents and the separate conduct of Madison Pacific Management in making the offer to manage the businesses as raising the same issue. He found in effect that Madison Pacific Management's offer constituted an offer to establish the "franchised business" for absentee investors and that such business would not exist unless and until Madison Pacific Management created it. The holder of a right or interest obtained under the Agreement who appointed Madison Pacific Management was led to expect profit from its efforts and indeed for an investor, his Honour held, it represented the only way in which a profit could be obtained. The requisite common enterprise was to be found in the close connection of the operation of the franchised business with the business of Madison Pacific Management and the expectation that its efforts would provide the gain to be received by either business.
The Contentions
51 The Madison Pacific companies submitted that the Franchise Agreement, so designated in the scheme documentation, met each of the requirements of reg 1.02. In particular, it was said in relation to reg 1.02(d) that the franchisee carrying on the business expects to be substantially dependent on goods and services provided by the franchisor. In this case the goods and services provided included the Operations Manual under cl 4.4, the optional training and software under cls 4.1 and 4.2 and the allocation of territory under cl 2.
52 The reasons of the learned trial judge were challenged on the basis that his Honour in effect modified the fourth element in par (d) by holding that the offer to manage negated the characterisation of the arrangement as a franchise. The appointment of a manager was optional and the franchisee could appoint any person to act as manager with the franchisor's written approval. Moreover it was said the services of Madison Pacific Management could fall within the fourth requirement of the definition of "franchise" as services supplied by a person associated with the franchisor upon which a franchisee would substantially depend to carry on the franchise. This would not require substantial dependence on all the goods and services provided.
53 If the franchise was a franchise within the meaning of reg 1.02 the fact that there was an offer by Madison Pacific Management to manage the business could not alter that characterisation.
54 The Commission's submission did not depend upon any argument that acceptance of the management offer was the only viable way to accept the "franchise" offer generally. Although in practice that would be the probable outcome in most cases, it was enough from the Commission's point of view that the offer of the package, including management, was made.
55 There were, it was said, at least two offers of participating interests. The first was the package as a whole. The second was the offer of the Management Agreement alone. The offer of management was the offer of a right to participate in or interest in the profit of Madison Pacific Management's business undertaking. That offer taken by itself was an offer of a common enterprise.
Whether the Scheme Offers a Prescribed Interest
56 The general question to be posed pursuant to s 1064(1) is whether the conduct of the Madison Pacific group and, alternatively, the conduct of Madison Pacific Management constituted the making of offers for subscription or purchase of any prescribed interest.
57 There is no dispute that the Madison Pacific group was issuing or offering to the public the right to participate in its "franchise" scheme or extending invitations to the public to do so. The concepts of "issue", "offer" or "invitation" are wide and plainly wide enough to embrace the present case - Australian Softwood Forests Pty Ltd at 134-135.
58 The narrower question then arises whether the subject of the issue offer or invitation was a prescribed interest. This can be approached by asking first whether a relevant exemption under par (c) of the definition of "prescribed interest" applied. If the answer is in the affirmative there is no need to consider further whether the scheme would otherwise constitute a prescribed interest. If the exemption is not applicable the remaining issue is whether the scheme involves the offer of that category of "prescribed interest" designated as "participation interest". That would require the application of the various elements of the definition of "participation interest" to the facts of this case. The primary issue in this case is the application or non-application of the franchise exemption.
59 If the subject of the issue, offer or invitation is "a right or interest...included in a class or kind of rights or interests, declared by regulations to be....a class or kind of exempt rights or interests for the purposes of Chapter 7" then it is not a prescribed interest for the purposes of s 1064. Regulation 7.1.02 exempts as a class "any right to participate, or any interest as franchisee in a franchise". The question whether the offer involved "a right to participate" or "any interest" was not agitated on appeal. Those words however are to be read in combination with the definition of franchise. So the question is whether what was offered was a right to participate or an interest in "an agreement or arrangement ... by which" the various elements set out in pars (a) to (d) inclusive of reg 1.02 were satisfied.
60 Turning directly to par (d) the question is whether what was offered was a right to participate or an interest as franchisee in an agreement or arrangement by which:
"it may reasonably be expected that in carrying on the business, the franchisee or a person associated with the franchisee is, or will be, substantially dependent on goods or services supplied by the franchisor or a person associated with the franchisor."The "business" referred to in par (d) is identified in par (a) as "the business of offering, selling or distributing goods or services in Australia or in an external Territory, under a marketing plan or system controlled by the franchisor or a person associated with the franchisor".
61 His Honour observed in this case that "the franchise must relate to the establishment of a business which uses the franchisor's system of marketing goods or services...". He also said that for investors resident in Western Australia, and by extension investors resident outside New South Wales, Madison Pacific Management would establish the franchised business and it would not exist until Madison Pacific Management was able to create it. In my view that reflects the reality of the arrangements for out-of-State investors. Indeed I would go further and say it reflects the reality of the arrangements for all investors. In real terms the scheme, in its day to day operation, will be difficult to distinguish from a business conducted by the Madison Pacific group in which members of the public have been invited to invest. That observation however, does not conclude the case. There is no contention by the Commission in this case that the various agreements which make up the scheme documentation are shams. Indeed that suggestion was disclaimed. So the question whether the rights and interests offered relate to a franchise must be considered by reference to the documentation which makes up the offer rather than by speculation, however informed, about how it will be made to work in practice.
62 In Australian Softwood Forests it was said by Mason J at 130:
"There are real difficulties in the suggestion that the court can read down the very comprehensive definition of "interest" by reference to the supposedly unintended consequences of a literal reading on everyday commercial transactions. The definition is so general and all-embracing that it is impossible to say that it necessarily excludes particular transactions which appear to be covered by the general words. The hazards of adopting such a course are not dispelled by the absence of a supporting context. It would be different if we could glean from the legislative provisions an overall purpose which being limited in scope, justified a reading down of the definition. Unfortunately in this case the search for a legislative purpose takes us back to the very words of the definition for the intended scope of the operative provisions depends so heavily on the comprehensive language of that definition."63 That proposition applying to the general language of ss 81 and 76 of the Companies Act 1961 (NSW) can be applied also to the general language of the exemptions under consideration in this case. The reference in the Explanatory Statement to the unintended consequences that franchises were caught by the prescribed interests provisions prior to the exemption does not thereby offer a basis for construction of the statutory elements of "franchise" beyond what the words of the exemption allow. There is no limiting purpose beyond the words of the Act itself to read down the scope of the exemption to cover a category narrower than the ordinary meaning of its words would suggest.
64 His Honour decided the issue of the franchise exemption by focussing on par (d). What was required was consideration of the words of par (d) and their relationship in particular to the Management Agreement offered by Madison Pacific Management. As the Commission submitted, that consideration need not proceed on the basis that resort to the Management Agreement was the only viable option for investors. It is sufficient that it is offered and the package, including that offer, examined in deciding whether it amounted to a "prescribed interest". To say that the Management Agreement is optional does not answer the proposition that the package including the Management Agreement defines what is offered. It contemplates that there will be a range of investors, even if theoretically not all, to whom what is offered and what is issued will be a right to participate in an agreement or arrangement including the management agreement.
65 His Honour characterised the Management Agreement as ".. external to a franchise agreement and not an element capable of defining a franchise". In so saying no doubt he was addressing the requirement that each of pars (a) to (d) of the definition of franchise refers to the content or operation of the relevant "agreement or arrangement". So the franchise agreement or arrangement must be something "by which" it may reasonably be expected that the franchisee will be substantially dependent on goods or services supplied by the franchisor or a person associated with the franchisor.
66 But to characterise the Management Agreement as "external to a franchise agreement and not an element capable of defining a franchise" does not conclude the question whether par (d) is satisfied. The inclusion in the offer of some component which does not fall within the definition of a franchise does not necessarily have the result that what is offered is not a franchise. His Honour went further and said that the management proposal tended to "negate the definition of franchise embodied in the definition of that term in reg 1.02". This must be linked with his further observation of his Honour that:
"Sole and exclusive management by a person associated with a franchisor is not a service upon which a franchisee may reasonably expect to be substantially dependent in carrying on a franchised business."67 One way of approaching the question is to ask whether the Madison Pacific Management proposal is inconsistent with the franchisor/franchisee relationship contemplated by par (d). If it is inconsistent and not merely superadded then it cannot stand with par (d) and a proposal incorporating the management proposal is not a franchise. If it is consistent with the requirements of par (d) then notwithstanding its practical operation, the arrangement may attract the exemption.
68 The language of par (d) contemplates a business for which the franchisee has legal responsibility albeit it will use goods and services supplied by the franchisor or its associate. It contemplates a degree of supervision and control by the franchisee reflected in the words which speak of the franchisee "carrying on the business". The reference to the franchisee being "substantially dependent" is not consistent with the franchisee operating as a mere cypher of the franchisor and effectively under the total control of the franchisor or a person associated with it.
69 The duties of the manager under the Optional Management Agreement are to "manage, direct and control the Franchised Business on behalf of the Franchisee" (cl 5.1). It is "subject to the Franchise Agreement" to "act on its own initiative and exercise such powers as may be available to it as the manager of the Franchised Business" (cl 5.3(f)). Importantly, it is to "comply with all reasonable instructions and directions as may be given to the manager by the Franchisee concerning the general conduct and management of the Franchised Business" (cl 5.3(i)). On the other hand the scope of the responsibility given by the franchisee to the manager under cl 6.1 is wide and involves a delegation of the franchisee's "rights, powers, duties, discretions and benefits conferred...by the Franchise Agreement..." By cl 6.2 the franchisee is not to require the manager to do anything that is not permitted nor to prohibit or restrict the manager doing anything that is required to be done under the Franchise Agreement. Of this it can be said, however, that the clause simply ensures that the manager cannot be prevented by the franchisee from doing anything that the franchisee is obliged to do under the Franchise Agreement. It does not displace the discretion to give general directions under cl 5.3(i). The indemnity clause of the agreement under which the manager will indemnify the franchisee against all payments, costs, charges and expenses does not of itself relieve the franchisee of personal liability for the debts of the business. It may be said however that the obligation on the manager to "ensure so far as possible that the Franchisee is not personally liable for such payments, costs, charges and expenses" suggests an obligation on the part of the manager to contract on its own behalf and not as agent for the franchisee, whether as undisclosed principal or otherwise. Indeed the agreement provides that the manager is an independent contractor engaged by the franchisee albeit it leaves open the possibility that the manager will be the franchisee's agent to the extent required by the Management Agreement and at common law in any event an agency relationship may be imputed.
70 In my opinion on an analysis of the legal rights and duties created by the Optional Management Agreement it is not inconsistent with the scheme documentation otherwise satisfying the requirements of par (d). The ultimate responsibility for carrying on the business, albeit the business may in effect be created by the manager, is that of the franchisee. The ultimate legal liability, save to the extent that it can be avoided by the manager contracting in its own right, remains with the franchisee. The franchisee has a power to give directions to the manager concerning the general conduct of the business. The manager plainly has legally enforceable obligations to the franchisee and the agreement may be terminated for breach or not renewed upon the expiry of its term.
71 Treating the Management Agreement as "external" to the Franchise Agreement, the franchise does meet the requirements of par (d) by reference to the various goods and services provided including the Madison Pacific Operations Manual, the utilisation of Madison Pacific know how, sales training and property services, the Property Services Software Program which would allow franchisees to monitor the performance of the manager, direct response advertising programs, direct mail programs, telemarketing programs and associated training packages, co-ordination of promotional and direct mail materials, provision and placement of media programs, provision of prospect lists and the conduct of ongoing market research and effectiveness monitoring. All of these services are provided for in the Marketing Agreement.
72 In any event I am satisfied that on an analysis of the legal rights and duties of the manager and those of the franchisee under the Management Agreement to which I have already referred, the services provided by the manager were within the scope of the kinds of services contemplated in par (d) supplied by the franchisor or a person associated with the franchisor.
73 I agree also with Carr J, and for the reasons that he has expressed, that the Management Agreement cannot be singled out and identified as a participation interest.
Conclusion
74 In my opinion therefore his Honour erred in holding that the proposed agreement or arrangement was not a franchise for failure to satisfy the requirement in par (d) of the definition. The appeal should therefore be allowed.
|
I certify that the preceding seventy-four numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable
Justice French. |
Associate:
Dated: 8 February 1999
IN THE FEDERAL COURT OF AUSTRALIA
WESTERN AUSTRALIA DISTRICT REGISTRY WG 87 OF 1998
|
BETWEEN: | MADISON PACIFIC PROPERTY MANAGEMENT PTY LTD
(ACN 081 776 810) First Appellant
MADISON PACIFIC AUSTRALIA PTY LTD (ACN 981 776 874) AS TRUSTEE OF THE MADISON PACIFIC AUSTRALIA TRUST Second Appellant
MADISON PACIFIC MANAGEMENT PTY LTD (ACN 081 776 758) AS TRUSTEE OF THE MADISON PACIFIC MANAGEMENT TRUST Third Appellant
MADISON PACIFIC MARKETING PTY LTD (ACN 081 776 794) AS TRUSTEE OF THE MADISON PACIFIC MARKETING TRUST Fourth Appellant
MADISON PACIFIC FINANCE PTY LTD (ACN 081 776 847) AS TRUSTEE OF THE MADISON PACIFIC FINANCE TRUST Fifth Appellant |
|
AND: | AUSTRALIAN SECURITIES COMMISSION
Respondent |
JUDGE:
FRENCH, DRUMMOND AND CARR JJ DATE: 8 FEBRUARY 1999 PLACE: PERTH
75 I have had the advantage of reading Carr J's reasons in draft. I regret that I am unable to agree with the view that his Honour takes. However, I gratefully adopt his statement of relevant facts and statutory provisions and his summary of the parties' contentions.
76 The respondent's contention is that the appellants, in soliciting purchasers for their various services, infringed s 1064(1) the Corporations Law by making an offer for purchase of a prescribed interest. This appeal is concerned with whether the appellants have a good answer to this charge in so far as they say that what they offered for purchase was the right to participate as franchisee in a "franchise" and thus the offer of something exempt from the reach of s 1064.
77 Section 1064(1) prohibits a person, subject to a qualification not presently relevant, from offering for purchase any "prescribed interest". The definition of "prescribed interest" in s 9 expressly excludes any right or interest declared by the regulations to be an exempt right or interest for the purposes of Ch 7. Regulation 7.1.02 the Corporations Regulations declares that, for "the purposes of the definition of `prescribed interest' in section 9 of the Corporations Law, any right to participate, or any interest, as franchisee in a franchise is an exempt right or interest for the purposes of Chapter 7 of that Law".
78 In order to determine whether what the appellants offered was such an exempt right or interest, it is first necessary to identify the subject matter of their offer.
79 The learned primary judge correctly, in my opinion, treated the appellants' offer as a package consisting of a number of elements. This offer was presented by the appellants to offerees in a single fifty two page document under a cover entitled "Franchise Agreements". This document is described at p 32 of the Information Memorandum, which the appellants also distributed to offerees, as "a document entitled Franchisee Agreements which embodies the various Agreements associated with the Madison Pacific Franchise and includes: Franchise Agreement, Management Agreement, Marketing Agreement, Loan Agreement, Loan Repayments Guarantee". The table of contents at p 1 of the "Franchise Agreements" document lists these five elements and a sixth document, called a "Franchise Endorsement Page". This Page, at page numbered 51, takes the form of an agreement which will arise upon the execution of the "Endorsement Page" between the person described in it as the "franchisee" and each of the following: Madison Pacific Australia, to entry into the Franchise Agreement; Madison Pacific Management, to entry into the Management Agreement; Madison Pacific Marketing, to entry into the Marketing Agreement and Madison Pacific Finance, to entry into both the Loan Agreement and the Loan Repayments Guarantee. The Endorsement Page also states that the Loan Agreement is only available if the Management and Marketing Agreements are executed, while the Loan Repayment Guarantee is only available if all three of these Agreements are executed.
80 In order to obtain a proper understanding of what was offered, it is necessary to have regard to the appellants' Information Memorandum and its "Your Key Questions Answered" document, that was also distributed by the appellants with the "Franchise Agreements" document.
81 The Franchise Agreement in terms confers on the franchisee the exclusive right to provide "the Madison Pacific Services to the Specified Properties during the Term using the Madison Pacific System and the Madison Pacific Image", ie, to supply for twenty years a range of administrative and other services in particular formats to certain owners of properties in New South Wales and to use the Madison Pacific trademark and other intellectual property in identifying those services as Madison Pacific services: see cl 2.1 and definitions of the various terms in cl 1.1 of the Franchise Agreement. While the definition of "Specified Properties" in the Franchise Agreement indicates that the franchisee is to obtain, by force of cl 2.1, the right to provide the Madison Pacific services to a minimum of 300 specific property addresses located within New South Wales, the Information Memorandum makes it clear that only property owners within the Sydney Metropolitan Area are to be included in this "territory" of 300 addresses (p 5) and that franchisees are to seek management agreements only with owners of these addresses that are residential rental properties: see p 3 and the annexures to the Memorandum incorporated in it as p 17 and pp 30 and 31. The cash flow projections in the Memorandum, at pp 10 and 27, envisage that in order to generate an average annual income of $8,150 per annum over the twenty year life of the Franchise Agreement, each franchisee will need to have the management rights to only a small number of rental properties - up to a maximum of about a dozen - recruited from the 300 properties initially allocated to the franchisee. There is, however, no restriction on the number of properties a franchisee can have under management.
82 The Information Memorandum describes the Manager's role under the Management Agreement as follows:
If appointed, [Madison Pacific Management] will, on behalf of the Franchisee, manage and direct the day to day operations of the Madison Pacific business and will endeavour to promote, advance and improve the business. Regular financial and operational reports will be provided to Franchisees by Madison Pacific Management to enable them to adequately monitor their Madison Pacific business.
An analysis of the fees charged by the Manager in the first year, relative to the second and later years, highlights the additional works and services that will be performed by the Manager in the first year. The servicing, introduction and development of rapport with new tenants and landlords, together with the establishment of new records and close physical analysis of the franchise territory itself is significantly greater in the first year.
83 There is emphasis in the Information Memorandum upon the advantages to an offeree of entering not only into the Franchise Agreement, but also into the Management Agreement. The Memorandum at p 5 refers to the opportunity for offerees to acquire one or more franchises and also "the option of having the business run under professional management by an approved Manager". The advantages of this are discussed at some length at p 6 and elsewhere: at, eg, p 4, there is reference to the high standard of training given to Madison Pacific's residential property supervisors. This can only be read as a reference to the people who will provide services to franchisees who enter into the Management Agreement. At pp 13 and 14 of the Memorandum, there is further reference to Madison Pacific Management's capacity to "provide superior state-of-the-art asset management and more economical services for property owners". Moreover, the Madison Pacific Manager is responsible, to the exclusion of the franchisee (who is indemnified accordingly), for all payments, costs, charges and expenses incurred in the conduct and management of the franchised business (cl 8), a provision which would also add to the attractions of the Management Agreement.
84 The property management system to which franchisees must adhere under the Franchise Agreement includes the provision to the property owners of rent collection services, as well as maintenance and related services. Rental collection can only lawfully be carried out in New South Wales by a person licensed under the Property, Stock and Business Agents Act 1941 (NSW). A Madison Pacific associate, Madison Pacific Property Management, is so licensed and, if franchisees enter into Management Agreements with Madison Pacific Management, Madison Pacific Australia contends that there are good grounds for thinking that franchisees can rely on the Madison Pacific Property Management's licence in respect of rent collection services provided under their franchises. If the franchisee does not enter into the Management Agreement, he will, in order to collect the rentals from his properties, either have to take out an NSW real estate agent's licence himself (an unattractive proposition for a franchisee, especially one with only a handful of properties in his franchise, even if an ex-NSW resident can obtain such a licence) or engage as his own manager or, at least, manager of his rent collection services, a person appropriately licensed in NSW. The operations manual to which a franchisee is entitled by cl 4.4 of the Franchise Agreement states:
A franchisee who does not elect to appoint Madison Pacific to manage all aspects of their real estate business must have either the appropriate licence to operate a Real Estate Agency in New South Wales, or engage a licensed person as an employee....
If an unlicensed franchisee appoints a licensed person to manage the office, that person must be in attendance at all reasonable times and remains responsible for trust accounting. An absentee licensee breaches the requirements of the Act and is therefore illegal.
It is essential that you obtain a copy of and regularly refer to the Property, Stock and Business Agents Act 1941 as it sets out your obligations as a Real Estate Agent. Your obligations are onerous and are designed to ensure that agents act ethically and responsibly and in the best interests of their clients.
85 It would very likely be impracticable for a franchisee to engage a licensed agent as his employee to collect the rents from a small number of rental properties under management that were scattered around Sydney. Counsel for the appellants accepted that what is said in this regard in their operations manual is an erroneous overstatement; but it could only serve to make the Management Agreement that much more attractive, as do the statements about the onerous obligations imposed on franchisees who do not choose to engage the Madison Pacific Manager.
86 The Information Memorandum goes on to explain that franchisees who enter into each of the Management and Marketing Agreements will, for the purpose of assisting the franchisee to acquire the franchise, have the further options of entering into the Loan Agreement under which an advance of $7,500 is payable, on advantageous terms as to repayment, by Madison Pacific Finance to the offeree and the option of an introduction to a third party lender procured by the appellants who will be prepared to make a further advance of up to $15,000 to the offeree, the repayment of which will be guaranteed under the Loan Repayments Guarantee by Madison Pacific Finance. The Information Memorandum indicates (p 3) that if the whole package, which includes the loans available under the Loan Agreement, is taken, the franchisee will only need to find $10,000 of his own moneys to acquire the entire $32,000 package. But if a franchisee takes the whole package, there would appear to be little point in paying the $9,340 necessary to acquire the optional sales training program, the optional workshop training or the optional software program included in that package. The Information Memorandum also contains a legal opinion to the effect that all of the payments of $32,000 required if the whole package is taken, save for the $1,000 franchise establishment fee payable under the Franchise Agreement, will be tax deductible. Adding further to the attractiveness of the Loan Repayments Guarantee only available with the Loan Agreement, and thus all the other Agreements, is the statement in the "Your Key Questions Answered" document that it is supported by "up to $10 Million held on deposit in a Solicitor's Trust Account". The only financial advantages of becoming a Madison Pacific franchisee discussed in the appellants' "Your Key Questions Answered" document are those flowing from a decision by a franchisee to choose "the full package of options available". Moreover, the accountants who gave the opinion as to the soundness of the cash flows projected for franchisees by the appellants and included in the Information Memorandum based their advice on the assumption that it would be "Madison Pacific" rather than the individual franchisees who would have the task of persuading property owners to sign up with franchisees for the property management services to be provided:
The project depends upon the successful sale of franchise and associated services and implementation of the Madison Pacific Franchise system in the manner contemplated. The return to owners will be sensitive to a range of uncertain factors including the following:
...;
* the ability of Madison Pacific to acquire and attract a sufficient number of property managements;
...;
* the ability of Madison Pacific to negotiate property management service fees on the terms assumed; and
...
87 An offeree is under no compulsion to take up all elements of the offer. He can accept the offer of the Franchise Agreement and nothing more. But the appellants' offer can be seen to have been structured to make it attractive to offerees to accept the whole package. Moreover, the nature of the franchised business the subject of the offer appears, from the limited evidence on which the parties asked the trial judge to base his decision, to be such as to make it, in practical terms, difficult for offerees to manage it themselves.
88 In order to achieve what is referred to as "fairness to all franchisees" in the allocation of the 300 addresses initially made to them by Madison Pacific, each franchisee's initial allocation of 300 addresses will be scattered in different locations around Sydney (Information Memorandum p 5). The basic aim is to persuade a small number of owners of the properties that are residential rental properties in each group of 300 to agree to management of their properties within a particular franchise. The learned primary judge observed that just how a business conducted under the Franchise Agreement as a Madison Pacific outlet was to be established in respect of the 300 sites allocated to the franchisee on execution of the Franchise Agreement is not the subject of detailed explanation in the offer documents. It appears that this is to be achieved either by the franchisee himself (with or without the benefit of the training services he can purchase under the Franchise Agreement) or by Madison Pacific Management and Madison Pacific Marketing, if the franchisee takes up the options of the Management and Marketing Agreements. Under cll 4.1 and 4.2 of the Franchise Agreement, the offeree has the option of undertaking an ongoing sales training program and a special property services training workshop organised by Madison Pacific Australia as franchisor and the option of obtaining a property services software program from the franchisor. These particular services are designed to fit a franchisee to market the Madison Pacific System the subject of his franchise to owners of the properties allocated to him under his franchise. It will be a time consuming task to identify the owners of residential rental properties within this allocation of 300 addresses and to persuade a sufficient number to enter into a property management agreement with a particular franchisee. A franchisee can, however, leave all this to Madison Pacific Marketing by taking up the option of the Marketing Agreement. The offers are made, inter alia, to people in Perth. Assuming a dozen or so owners from each lot of 300 can be persuaded to sign up with each franchise, it would be impracticable for the ordinary Perth offeree in person or by the worker or workers engaged by only the one franchisee to conduct the franchised business of managing as well as collecting rents from this small number of rental properties scattered around Sydney. Even a Sydney resident franchisee would find it burdensome to do that. Again, a franchisee can leave all this to Madison Pacific Management if he or she takes up the option of the Management Agreement.
89 The case must be disposed of on the basis that the various agreements and arrangements comprising the appellants' offer were not shams: the respondent did not suggest that they were and only a limited range of factual material was put before the learned primary judge. It can be accepted that a person could enter into the Franchise Agreement without necessarily having to enter into the Management Agreement or any of the other Agreements. But that is not to say that, when considering whether an offer proscribed by s 1064 was made by the appellants and whether the appellants' offer was an offer of an interest as franchisee in a franchise within the definition of that term in reg 1.02 as applied to reg 7.1.02, it is appropriate to have regard only to the legal forms or structures which the appellants have chosen to adopt. In determining that question, it is not only permissible but necessary to have regard also to the practical effect of the arrangements offered by the appellants. See Amoco Australia Pty Ltd v Rocca Bros Motor Engineering Co Pty Ltd [1973] HCA 40; (1973) 133 CLR 288 at 303 - 304 and 313 - 314. That the parties chose to fight the case before the learned primary judge on limited evidence does not preclude this Court from forming a view on this matter.
90 The appellants chose to make a package offer, formulated in a way that made it attractive to offerees to accept the entire package, even though it always remained open to offerees to accept only a part of what was offered. The documentation provided to potential franchisees emphasised the advantages to a franchisee of the management, marketing and loan agreements. Notwithstanding the exhortations in the offer documentation, eg, in the "Important Notice" introducing the Information Memorandum and in the form of client report apparently used by the appellants in marketing the package that a franchisee, even one who accepted the entire package, should not regard himself or herself as a mere passive investor, the offer was presented by the appellants to offerees as a bundle of arrangements which, if accepted, would very likely free the offeree of the need to take any active part in the conduct of his or her franchised business.
91 When the issue is whether an agreement or arrangement constitutes a franchise as defined in reg 1.02 so that it will be an exempt interest within reg 7.1.02, the question is not whether the prospective franchisee will be engaged in or carrying on a business in the abstract or whether it can be said for some purposes that he or she can be regarded as carrying on a business. The only question of present relevance is whether the franchisee will be engaged in or carrying on a business within the meaning of those expressions as they are used in the particular statutory context now of concern, ie, in reg 1.02 paras (a), (b) and (d), as applied to reg 7.1.02. The answer to that question involves a purposive, not a literal, interpretation of these regulations, as well as of s 1064: see ss 8A and 109H of the Law.
92 The evolution of the current regulatory regime in respect of franchising is summarised at pp 2 and 3 of the learned primary judge's reasons and in more detail at |P2.0030 to |P2.0080 of Franchising Law and Practice, by Giles, Redfern and Terry. In the first half of the 1980s there were a number of decisions in which it was held that the offer of a franchise under which the franchisee was required to actively carry on the franchised business was nevertheless the offer of an interest within the precursors of the prescribed interest prohibition in s 1064 the Corporations Law: see Commissioner for Corporate Affairs v Casnot Pty Ltd (1981) CLC 40-704; Khania Nominees Pty Ltd v Hamilton (1986) 4 ACLC 390 and R v Commons (1986) 4 ACLC 551. There were, however, decisions the other way in which emphasis was placed on the fact that the profits envisaged to arise from the franchised business would be derived, at least in substantial part, from the efforts of the franchisee to justify the conclusion that the offer of such a franchise was not the offer of a prescribed interest or its equivalent: see Butterworth v Lezemo Pty Ltd (1983) 8 ACLR 737 and Streeter v Pacific-Seven Pty Ltd (1985) 9 ACLR 790. Following the line of decisions commencing with Casnot, however, the National Companies and Securities Commission ("the NCSC") assumed the obligation of enforcing the "prescribed interest" provisions of the companies legislation then in force against franchisors. Initially, this involved the NCSC in deciding, on a case by case basis, whether to exercise its statutory power to exempt particular franchisors from these provisions. By Policy Statement 118 of 24 February 1984, the Commission set out certain disclosure conditions which, if fulfilled by a franchisor, would generally result in the Commission exercising its statutory discretion to exempt the franchisor from the "prescribed interest" provisions of the corporations legislation then in force. The Commission explained its decision to adopt this policy and the justification of the policy as follows:
1. In this statement, the National Companies and Securities Commission ("the Commission") sets out its policy on franchising schemes - in particular, the extent to which it will be prepared to exercise its power, under section 215C to exempt franchisor companies from compliance with all or any of the provisions governing prescribed interests in Division 6 of Part IV of the Companies Act and Codes ("the legislation").
2. The effect of the judicial determination in the Casnot case, (1981) CLC 40-704, was to confirm that many offers of interests in franchising schemes are "prescribed interests". The Commission's policy is predicated on the assumption that the above decision will continue to be accepted by the Courts throughout Australia. ...
...
5. In the Commission's view, the relationship between franchisor and franchisee in a typical franchising arrangement differs in a number of important respects from the conventional relationship between offerors of "prescribed interests" and investors. While the investor in a typical "prescribed interest" merely assumes the obligation to transfer a sum of money to the promoter for use in a scheme, enterprise or arrangement expected to produce profits, a franchisee usually undertakes the continuing operation of a small business which he regards as, substantially, his own. The scope of franchising schemes is demonstrated by the wide variety of franchised businesses. They include, as examples, fast-food outlets, printing shops, computer bureaux, dry-cleaning shops and electronic/video stores. The typical franchisee's investment of both effort and capital in the franchised business usually extends on a continuing basis considerably beyond the amount he pays in consideration for the franchise to the franchisor.
6. The nature of the business enterprise involved has led the Commission to accept that the typical franchisee is more readily prepared and equipped to assume some risk and requires less continuing protection than the typical investor in "prescribed interests". ...
93 It is apparent from this that the NCSC accepted arguments that the "typical" franchisee was seeking a business opportunity for himself rather than the opportunity to make a passive investment; so the typical franchisee did not require the protection appropriate for passive investors provided by the "prescribed interest" provisions of the corporations legislation (at least if franchisors made appropriate disclosures before franchise agreements were made). See also Franchising Law and Practice at |P2.0050. The Commission withdrew Policy Statement 118 when the precursor to reg 7.1.02 the Corporations Regulations came into effect on 1 September 1987. The Explanatory Statement that accompanied the issue of the precursors to regs 1.02 and 7.1.02 stated it was never intended that the prescribed interest provisions of the companies legislation should apply to franchises of the kind the subject of the decisions in Casnot, Khania and Commons.
94 In my opinion, reg 7.1.02, like its 1987 precursor, gives effect to the same policy considerations that led the NCSC to issue its Policy Statement 118. The justification for the regulation excluding franchises from the "prescribed interest" provisions of the Corporations Law is that typical franchisees are not passive investors, but are persons who carry on their own businesses of selling products or services, even though they do that under a system devised by and with varying forms of assistance and supervision provided by the franchisor. See Vol 2 Australian Corporation Law, Principles and Practice, p 74,365. The object of the provisions now found in Ch 7 the Corporations Law is to regulate the offering of investment opportunities otherwise than by the issue of shares and debentures in certain corporations. Ford's Principles of Corporations Law, by Ford, Austin & Ramsay, at p 22,178, observes:
Broadly, the special feature in an offering of a prescribed interest is that an investor is invited to hand over value to another person on terms that the investor will have the chance of receiving an increment but will be relying on other persons to contribute to all or some of the managerial effort needed to obtain the increment.
95 Chapter 7 is aimed at restricting offers to participate in projects where the risk of the project succeeding or failing is wholly or very substantially dependent on the activities of the promoter about which risk the promoter is well placed to provide information to offerees that is not likely to be available to them from any other source. The reason why it appears to have been considered that offers of franchised businesses should not be subject to the conditional proscription in s 1064 the Corporations Law is that the risk that such a business will succeed or fail is, to a significant extent, dependent on the activities of the franchisee: it is for this reason that such a franchisee does not need the protection given by the "prescribed interest" provisions to persons who have to rely wholly or very substantially on the promoter to generate returns for them.
96 If regs 1.02 and 7.1.02 are read against this background and interpreted purposively, an agreement or arrangement will only possess each of the characteristics set out in the definition of "franchise" in reg 1.02 and thus be exempt by force of reg 7.1.02 from the operation of the "prescribed interest" provisions of Ch 7 if the franchisee under the agreement or arrangement has the effective conduct of the franchised business. In other words, the expression "to exercise the right to engage in the business of ..." in sub-par (a), the expression "the business carried on by the franchisee" in sub-par (b), the expression "the business" in sub-par (c) and the expression "in carrying on the business, the franchisee ..." in sub-par (d) should all be read as describing a situation in which, whatever be the ongoing commercial role of the promotor-franchisor, there is a substantial area of business activity which the franchisee himself conducts, either personally or by his own agent, in which area of activity the promotor-franchisor is not involved.
97 The offer here in question is not just the offer of a franchised business. An integral part of the offer is a proposal to relieve the offeree of the risks and burdens of conducting the business himself and to leave all that instead, to various of the franchisor's associates. The offer is such that if accepted in full, whether a franchised business succeeds or fails, will depend substantially, if not wholly, on the efforts of the franchisor's associates. The offeree will have a largely passive role and no involvement in the day-to-day management of the business. This is so, notwithstanding the limited powers of control over the Madison Pacific Manager the franchisee is given by the Management Agreement (see cl 5.3(i) and cf cll 5.3(a), (f), (j), 6.1, 7). The offer is made, moreover, in circumstances in which acceptance of the package proposal is made attractive to the offeree. In determining whether the making of the offer is exempt from the reach of s 1064(1), it is not to the point that it is capable of acceptance in a manner which would result in a simple arrangement coming into existence which would possess all the characteristics of a "franchise" as defined in reg 1.02. It is still an offer also capable of acceptance in a manner which would, for the reasons given, bring into existence a more complex arrangement that would lack the essential feature of a "franchise" so defined. This consideration is fatal to the appellants' reliance on reg 7.1.02 to take their activities outside the reach of s 1064(1).
98 By their defence, the appellants admit that the Madison Pacific Scheme comprising the Franchise, Management, Marketing and Loan Agreements and the Loan Repayments Guarantee together constitute a "participation interest" within par (a) of the definition of that expression in s 9 of the Law. Once it is seen that the appellants' offer includes the opportunity to offerees to enter into a package of arrangements with all the various appellants, whatever be the answer to the question whether that part of that package offer that comprises the offer of the Management Agreement with the third appellant is by itself the offer of a "prescribed interest" cannot affect the proper characterisation of the appellants' package offer. It is therefore unnecessary to deal with ground 2 of the notice of appeal.
99 I therefore agree with the conclusion reached by the learned primary judge, although for slightly different reasons.
|
I certify that the preceding twenty five (25) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable
Justice Drummond. |
Associate:
Dated: 8 February 1999
| IN THE FEDERAL COURT OF AUSTRALIA | |
| WESTERN AUSTRALIA DISTRICT REGISTRY | WAG 87 OF 1998 |
ON APPEAL FROM A JUDGE OF THE FEDERAL COURT OF AUSTRALIA
BETWEEN: First Appellant
MADISON PACIFIC AUSTRALIA PTY LTD
(ACN 981 776 874) AS TRUSTEE OF THE MADISON AUSTRALIA TRUST
Second Appellant
MADISON PACIFIC MANAGEMENT PTY LTD
(ACN 081 776 758) AS TRUSTEE OF THE MADISON PACIFIC MANAGEMENT TRUST
Third Appellant
MADISON PACIFIC MARKETING PTY LTD
(ACN 081 776 794) AS TRUSTEE OF THE MADISON PACIFIC MARKETING TRUST
Fourth Appellant
MADISON PACIFIC FINANCE PTY LTD
(ACN 081 776 794) AS TRUSTEE OF THE MADISON PACIFIC FINANCE TRUST
Fifth Appellant AND: Respondent
MADISON PACIFIC PROPERTY MANAGEMENT PTY LTD (ACN 081 776 810)
AUSTRALIAN SECURITIES AND INVESTMENTS COMMISSION
JUDGE:
FRENCH, DRUMMOND & CARR JJ DATE: 8 FEBRUARY 1999 PLACE: PERTH
Introduction
100 This is an appeal against declaratory and injunctive orders made by a judge of this Court, on 25 June 1998. The orders included a declaration that by reason of the appellants' offer to the public to apply for a franchise from the second appellant, which included an offer to enter into a management agreement with the third appellant,
* the offer to apply for the franchise constituted an offer of a prescribed interest within the meaning of s 9 of the Corporations Law; and
* the appellants' offer was conduct contrary to ss 1018, 1064 and 1065 of the Corporations Law.
101 An order was made restraining the appellants from offering any interest in what was described as "the Madison Pacific Franchise" in conjunction with any offer to enter into any management agreement in relation to that interest. There were other, consequential, orders including orders designed to protect the interests of some one hundred investors who had entered into franchise agreements and management agreements with the respective appellants.
102 The short question, so far as the appeal is concerned, is whether the interest offered was a right to participate in or an interest, as franchisee in a "franchise". The decision at first instance was made before the Managed Investments Act 1998 (Cth) came into effect on 1 July 1998. That Act provides a definition of "franchise" which is very different from the definition contained in Regulation 1.02 of the Corporations Regulations (set out and discussed below). It also recasts obligations in relation to what were "prescribed interests". However, despite the changes to the relevant law, I accept that there are serious consequences, so far as the appellants are concerned, resulting from the decision at first instance which warrant the hearing and decision of the appeal. The matter has not, in my view, been rendered moot by the new legislation.
Factual Background
103 The following is a summary of the facts either found by his Honour or assumed to be the facts for the purposes of his judgment. Each of the appellants is a related corporation of the other appellants in that all the issued shares in each appellant are held by the same company. The first appellant, Madison Pacific Property Management Pty Ltd ("Madison Pacific") has acquired the business of Bligh Realty Pty Ltd, a company which is licensed to carry on business in New South Wales as a real estate agent. Madison Pacific has developed an image, techniques and materials for the marketing of certain services. The services comprise various aspects of the management of residential rental properties. They are embodied in what is described as the "Madison Pacific System". Madison Pacific has licensed the second appellant, Madison Pacific Australia Pty Ltd ("Madison Pacific Australia") to use the Madison Pacific System and associated trade marks, trade names, logos and the like which are together referred to as the "Madison Pacific Image". It has also licensed Madison Pacific Australia to grant to franchisees the right to use the Madison Pacific System and the Madison Pacific Image within New South Wales on certain terms and conditions. Madison Pacific Australia offered investors who entered into an agreement referred to as a franchise agreement ("the Franchise Agreement") the right to conduct a business of providing services to property owners at 300 "sites" in Sydney using the name Madison Pacific, the Madison Pacific System and the Madison Pacific Image. The sites, described in the Franchise Agreement as "Specified Properties", were identified by computerised random selection of telephone numbers throughout the metropolitan area of Sydney. One of the underlying assumptions of the overall arrangements was that 25% of residential properties in New South Wales were rental properties. Another was that lessors of residential properties in Sydney could be persuaded to engage the services of the franchisee by the proposed lower than usual rates of commission and by the specialised nature of such services, being services provided otherwise than in conjunction with general real estate agency services. It was common ground that the 300 properties would include business and industrial premises. The arrangements foreshadowed that a franchisee would endeavour to identify which of his or her Specified Properties were residential rental properties with a view to persuading the owners of those properties to retain the franchisee to manage them. The franchisee's income was to be derived by providing Madison Pacific property management services to owners of those properties. In addition to the offer of a franchise, the appellants also offered to such franchisees the management services of the third appellant, Madison Pacific Management Pty Ltd ("Madison Pacific Management") upon the terms and conditions of a management agreement ("the Management Agreement"). If the franchisee took up that offer (but not otherwise) then the fourth appellant, Madison Pacific Marketing Pty Ltd ("Madison Pacific Marketing") offered the provision of marketing services for one year, the fifth appellant, Madison Pacific Finance Pty Ltd ("Madison Pacific Finance") offered a loan to finance the purchase of the franchised business (and certain other outgoings related to the franchised business) and a guarantee of the investor's indebtedness under the borrowing arrangements. Under the Management Agreement, Madison Pacific Management was appointed sole and exclusive manager of the franchised business for the term of the franchise (20 years). Madison Pacific Management agreed to meet the expenses of the business and to indemnify the franchisee against all such costs, charges and expenses. Madison Pacific Management was to receive a fee of $5530 for the first year and 43% of the "gross profit" of the business each year thereafter. The whole of the balance of the gross profit was to be applied by Madison Pacific Management to loan repayments and franchise fees payable by the franchisee. Once the loans were repaid, the franchisee would be entitled to 43% of the gross profit less only the franchise fees.
Statutory Framework
104 Section 1064 of the Corporations Law provided that no person, other than a public corporation, shall make available, offer for subscription or purchase, or issue an invitation to subscribe for or buy, any prescribed interest.
"Prescribed Interest" was defined in s 9 as meaning
"(a) a participation interest; or
(b) . . .
but does not include:
(c) a right or interest, or a right or interest included in a class or kind of rights or interests, declared by the regulations to be an exempt right or interest, or a class or kind of exempt rights or interest, for the purposes of Chapter 7..."
"Participation Interest" was defined in s 9 in these terms:
"Participation Interest means any right to participate, or any interest:
(a) in any profits, assets or realisation of any financial or business undertaking or scheme whether in Australia or elsewhere;
(b) in any common enterprise, whether in Australia or elsewhere, in relation to which the holder of the right or interest is led to expect profits, rent or interest from the efforts of the promoter of the enterprise or a third party; or
(c) in any investment contract;
whether or not the right or interest is enforceable, whether the right or interest is actual, prospective or contingent, whether or not the right or interest is evidenced by a formal document and whether or not the right or interest relates to a physical asset..."
Regulation 7.1.02 of the Corporations Regulations provides:
"For the purposes of the definition of `prescribed interest' in section 9 of the Corporations Law, any right to participate, or any interest, as franchisee in a franchise is an exempt right or interest for the purposes of Chapter 7 of that Law."
The term "franchise" is defined in Regulation 1.02 as follows:
"...an agreement or arrangement, whether express or implied, oral or written, between 2 or more persons by which:
(a) a party to the agreement or arrangement (in this definition called `the franchisor') authorises or permits another party (in this definition called `the franchisee'), or a person associated with the franchisee, to exercise the right to engage in the business of offering, selling or distributing goods or services in Australia or in an external Territory, under a marketing plan or system controlled by the franchisor or a person associated with the franchisor; and
(b) the business carried on by the franchisee or the person associated with the franchisee, as the case may be, is capable of being identified by the public as being substantially associated with a mark identifying, commonly connected with or controlled by the franchisor or a person associated with the franchisor; and
(c) the franchisor exerts, or has authority to exert, a significant degree of control over the business; and
(d) it may reasonably be expected that, in carrying on the business, the franchisee or a person associated with the franchisee is, or will be, substantially dependent on goods or services supplied by the franchisor or a person associated with the franchisor;"
The Decision at First Instance
105 In the proceedings before the learned primary judge the respondent contended that the appellants, each a proprietary company, engaged in conduct that contravened s 1064 of the Corporations Law. It sought an order restraining the appellants, or any of them, from continuing that conduct. The appellants argued they were offering a right to participate, or an interest, as franchisee in a franchise and such right or interest was not a "prescribed interest" for the purpose of s 1064. The question which the primary judge had to decide was whether the appellants' offer was to be so characterised i.e. was the subject matter of the offer a right to participate, or an interest, as franchisee in a franchise?
106 The definition of "franchise" in Regulation 1.02 requires there to be an agreement or arrangement "by which" four sets of circumstances are brought about. The first is that the franchisor authorises or permits a franchisee to exercise the right to engage in the business of, inter alia, selling services under a marketing plan or system controlled by the franchisor. The respondent (both at first instance and on appeal) contended that there was no relevant business engaged in by the franchisee, but accepted that, if there were such a business, there was an agreement or arrangement by which Madison Pacific Australia authorised or permitted the franchisee to sell services under a marketing plan or system controlled by it.
107 Secondly, the business carried on by the franchisee (pursuant to the authority or permission) is to be capable of being identified by the public as being substantially associated with a mark identifying the franchisor, or a person associated with a franchisor. For the purposes of the proceedings before the primary judge and before us the respondent took a similar position in relation to this requirement as in relation to the first requirement - i.e. no business being carried on by the franchisee, but if there were such a business it was capable of being so identified.
108 Thirdly, the franchisor must have authority to exert a significant degree of control over the business of the franchisee. His Honour found that under the relevant agreement this requirement was satisfied. At first instance, the respondent had made no submission to the contrary. However, at the hearing of the appeal the respondent, while conceding the significant degree of control, sought to maintain its general position that there was no relevant business of the franchisee.
109 The fourth requirement is that there be a reasonable expectation that in carrying on the business, a franchisee will substantially depend on goods or services to be supplied by the franchisor, or a person associated with the franchisor. The appellants submitted that there were goods and services such as the provision of an operations manual, optional training, the use of computer software and the allocation of a "territory" which would satisfy this requirement. The same was said to apply to the services of Madison Pacific Management under the management agreement. These were all goods and services which, under the proposed franchise scheme, a franchisee would substantially depend on to carry on the franchised business. His Honour disagreed, finding (at 17) that:
"The appointment of Madison Pacific Management as sole and exclusive Manager of a franchised business for the whole of the term of the franchise would not be an arrangement that would be within the contemplation of the fourth limb of the definition of a franchise as a service on which the franchisee would reasonably expect to be substantially dependent in carrying on that business. Madison Pacific Management carries on business as a manager of businesses franchised by Madison Pacific Australia and according to the terms of the management agreement is an independent contractor responsible for all costs of the managed business, indemnifying the franchisee against such costs. On its face such an arrangement is external to a franchise agreement and not an element capable of defining a franchise. The goods or services to be supplied by a franchisor on which a franchisee may reasonably expect to be substantially dependent are those which go to the essence of the business developed by the franchisor and essential for a franchisee to obtain in carrying on the franchised business if the business is to be conducted successfully in the style of the franchisor's business. Providing for the conduct of a franchised business for the term of the franchise to be carried out by a manager associated with the franchisor tends to negate the concept of franchise embodied in the definition of that term in reg 1.02. Sole and exclusive management by a person associated with the franchisor is not a service upon which a franchisee may reasonably expect to be substantially dependent in carrying on a franchised business."
Grounds of Appeal
110 The grounds of appeal were that the primary judge:
1. Erred in law in finding that the investment opportunity offered by the appellants in conjunction with the invitation to prospective franchisees to appoint the third appellant as manager of the franchisee's business did not constitute a franchise as defined in Regulation 1.02;
2. Erred in law in finding that the offer by Madison Pacific Management to act as manager of a franchisee's business constituted the offer of a "participation interest" within the meaning of that expression in the Corporations Law; and
3. Should have held that the investment opportunity offered by the appellants, whether taken as a whole or individually, constituted a franchise within the meaning of that term in Regulation 1.02
Was there a Franchise? (Grounds 1 and 3)
111 It is convenient to consider grounds 1 and 3 simultaneously.
(b) by the offer of the Management Agreement taken individually.
The respondent stressed that it was not contending that the characterisation of what the appellants offered depended upon the proposition that the only viable way in which the offer could be accepted was by accepting the package in its entirety. The fact that the offer was made as a package, was enough for the purposes of its submissions. The appellants had admitted in their defence that the offer of all of the components together constituted a participation interest.
The Franchise Exemption 115 However, despite the above disclaimer, the respondent contended that, in practical terms, the offer could only be taken up as a package by a person either not residing in New South Wales or not being licensed under the Property Stock and Business Agents Act 1941 (NSW). To assess the true nature of the transaction it was appropriate so it was submitted, to look to the substance and effect of the component parts in their totality. Substance was to be preferred over form: Amoco Australia Pty Ltd v Rocca Bros. Motor Engineering Co Pty Ltd [1973] HCA 40; (1973) 133 CLR 288 at 292-293, 304, 314; Alloyweld Pty Ltd v Federal Commissioner of Taxation (1984) 69 FLR 274 at 280; Oakey Abattoir v Federal Commissioner of Taxation (1984) 54 ALR 595 at 604; Australian Securities Commission v United Tree Farmers (1997) 24 ASCR 94 at 100. The respondent contended that as a package the scheme involved: * the investment of money by the investor;
* the allocation of 300 residential addresses ("the territory") within New South Wales to the investor;
* the management by Madison Pacific Management, for the term of the Franchise Agreement, of any properties within the territory the owners of which became Madison Pacific clients;
* the marketing and promotion of the businesses including the investor's territory, by a Madison Pacific company;
* the provision of a loan by a Madison Pacific company to assist with the payments due under the scheme on condition that fees and costs were prepaid where possible;
* the repayment of all loans from the proceeds of the earnings from the territory;
* the payment of all expenses in the running of the business by a Madison Pacific company;
* sharing of profits generated from properties within the territory between the investor and the Madison Pacific companies;
* no liability on the investor for the various loan repayments other than from the funds generated from properties within the territory;
* the reservation by Madison Pacific Management and Madison Pacific Marketing to themselves of the right to perform like services for other licensees; and
* a grant to the Madison Pacific companies by the investor of all rights, powers, duties, discretions and benefits conferred on the investor by the licence.
116 Taken as a whole, this was not a franchise within the definition contained in Regulation 1.02. The essence of that definition was that the franchisee (or a person associated with the franchisee) exercised the right to engage in the particular business under the marketing plan or system controlled by the franchisor or its associate. The franchise exemption was designed to overcome the application of the prescribed interest provisions to the types of arrangements which were dealt with in Commissioner of Corporate Affairs v Casnot Pty Ltd (1981) CLC 40-704; Khania Nominees Pty Ltd v Hamilton (1986) 4 ACLC 390 and R v Commons (1986) 4 ACLC 551 as could be seen from the explanatory statement in relation to the relevant statutory rules [Statutory Rules 1987 No. 172]. The mere acceptance of the offer of a Management Agreement did not result in Madison Pacific Management becoming a person "associated with the franchisee". Even though, as a matter of form, the franchise agreement conferred the right to conduct a business, simultaneously by the execution of the same document, those rights were transferred back to the management company. At no instant of time, nor in any real way, was the franchisee given any right to conduct the business, which was an essential element of a franchise within the definition. There was no carrying on of the business by the franchisee, in any real sense, whether through an agent or otherwise. The offer of a Management Agreement taken individually 117 The respondent contended that the only question was whether the offer of a Management Agreement fell within the definition of a franchise. As senior counsel for the respondent put it, the fact that there was "on the menu" something which might satisfy the franchise definition (for example the franchise agreement on its own) did not mean that the selection of something else from the menu carried with it the immunity enjoyed by that one element of the overall package. If an investor chose the whole package then it simply wrote out a cheque for, say, $10,000, signed the one form which accepted all of the documentary offers and sat back to wait until the income stream started to appear "some years down the track". If all went well, then money would start to flow in and the debt would be paid off. That was all that the investor had to do. We were taken to what might be the situation if all investors made that choice. In those circumstances, the respondent contended that the promoters, having started with a scheme which involved their possession of rights to promote and market the Madison Pacific System and the Madison Pacific Image, by offering portions of those rights would end up with $30 million from the investors (3000 investors @ $10,000 each). There would be a further $45 million from the external lender and another $20 million advanced from within the appellant group effectively to be repaid out of generated income from the business if all went well. The appellants retained the right to promote, market and use the Madison Pacific System in New South Wales and "to effectively run that business and make a profit", some of which was then distributed, after all the loans were paid off, back to the investors, calculated by reference to the particular properties which they happened to have within their territory. The respondent submitted that the scheme was quite clearly a capital-raising scheme by the promoters, structured in a way which allocated different responsibilities to different companies within the group. Looked at in those terms, the end product was no different from simply going to the market with a proposal in exchange for some share of the future profit of the business that was to be run by the promoter. This was, so it was contended, clearly the type of scheme to which the provisions of Chapter 7 of the Corporations Law were directed. The term "profit" in the definition of participation interest did not mean the difference between the receipts of a company and its expenditure. The term was to be construed as including any benefit or advantage accruing from the management use or sale of property or from the conduct of business, or any gain or pecuniary advantage: Waldron v M G Securities Australasia Ltd (1975) VR 508 at 529-530. The offer of the Management Agreement by itself was an offer to participate in a common enterprise [within paragraph (b) of the definition] between the investor and Madison Pacific Management. By contributing its "territory" to the operations of Madison Pacific Management, the investor joined in that enterprise and was led to expect profits from the efforts of the manager. Butterworths v Lezemo was distinguishable in that regard. The present case was entirely different. Here the business of operating "Madison Pacific Systems" was carried on entirely by the management company, that is by the offeror. There was nothing at all to be done by the investor to generate profit from the business. The term "franchise" necessarily implied the carrying on of the business by the franchisee, not by the franchisor or a person associated with the franchisor.
119 When one turns to the modern equivalent of that regulation (Regulation 7.1.02) I think it is important to appreciate the width of the language by which franchise interests are exempted. The relevant reference is to:
"... any right to participate, or any interest, as franchisee in a franchise ...".Regulation 1.02 relevantly defines "franchise" as meaning an agreement or arrangement, whether express or implied, oral or written, between two or more persons "by which" (and then follow the four criteria discussed above). I would emphasise the use of the word "arrangement", a very wide expression, in conjunction with the words "by which". It seems to me that if there can be seen to be an arrangement by which the factual circumstances referred to in each of the four paragraphs come about, then there will be a franchise. If so, any right to participate or any interest as franchisee in that arrangement is an exempt right or interest for the purposes of Chapter 7 of the Corporations Law. An arrangement may precede and include entering into agreements: Re British Basic Slag Agreements [1963] 2 All ER 807 (CA). 120 Next, I think it is important to note that the respondent did not contend that the arrangement or the various agreements which formed part of the arrangement were shams. The essence of a sham is that something is not what it appears to be, that underlying the appearance of the transaction is a different reality: Scott v Commissioner of Taxation (No 2) (1966) 40 ALJR 265 at 279, Snook v London & West Riding Investments Ltd [1967] 2 QB 786 at 802; Sharrment Pty Ltd v Official Trustee in Bankruptcy (1988) 18 FCR 449 at 454-458. The respondent went quite close to such a contention when, for example, it submitted that there was in substance no conferral effectively of any authority or permission on the franchisee to exercise rights to engage in a business. This was said to involve no more than an analysis of the substance and effect of the transactions when undertaken as a package. As I have mentioned, in support of that submission the respondent relied upon cases such as Amoco, Alloyweld, Oakey Abattoir and United Tree Farmers.
121 The primary issue, as it developed in the appeal, was whether there was any relevant business. In paragraph (a) of the four criteria the business is relevantly defined as being "... the business of offering, selling or distributing ... services ...". In paragraph (b) the business is described as "... the business carried on by the franchisee or the person associated with the franchisee ...". The references in paragraphs (c) and (d) are simply to "the business" and "carrying on the business" respectively.
122 I do not think that there is any doubt that offering to provide and providing the services of property management to lessors of residential properties in return for fees would constitute a business. It may be accepted that the arrangement in this matter is different from the traditional franchise arrangements which surfaced in the three cases which gave rise to the promulgation of the franchise exemption. However, over a decade has passed since those decisions. Business methods, and particularly franchising methods have evolved considerably over that period of time. In my view, there was a relevant business which the franchisee was given the option of conducting either in person or by an agent. The fact that the circumstances may have made it highly unlikely that any agent other than Madison Pacific Management would be appointed by a franchisee, does not, in my opinion, alter the characterisation of the rights conferred upon the franchisee. One starts with the overall arrangement, which extends beyond the actual agreement and then examines the legal rights conferred. The evidence is that these documents were drawn professionally and some of them were settled by senior counsel. There is no suggestion of sham. There was no evidence that the parties conducted themselves otherwise than in accordance with the terms of the agreements. In those circumstances, the rights conferred upon the franchisee (at the stage of determining whether there was a relevant business) are to be found in the contracts. The Franchise Agreement defines the "Franchise Business" as meaning the business, the operation of which is permitted by virtue of the rights and benefits granted by the franchisor to the franchisee pursuant to that agreement. When one reads the franchise clause (clause 2.1) with the definition of "Madison Pacific Outlet" it can be seen that the franchisor grants to the franchisee an exclusive franchise to conduct a business under franchise from the franchisor providing some or all of the "Madison Pacific Services" to the "Specified Properties" during a term of 20 years using the Madison Pacific System and the Madison Pacific Image. The Specified Properties are in reality 300 properties identified through a random selection of telephone numbers. Under the "arrangement" the franchisee is offered the services of a manager, a marketing company and a finance company. The function of the marketing company is to publicise the services to be provided under the Madison Pacific System. A reference to clause 5.1 of the Marketing Agreement shows that some of those marketing services may be specific to the franchisee's own business. Most of them would appear to be services which will be provided in a manner which will market the Madison Pacific System as a whole, thereby endeavouring to benefit all of the franchisees. However, this latter aspect can be seen in the marketing of many franchises of a conventional type throughout Australia. Clause 5.1 of the Management Agreement provides that the Manager shall during the term of the franchise manage, direct and control the Franchise Business on behalf of the franchisee. Madison Pacific Finance offers to provide a loan from the proceeds of which the franchisee can pay for the franchise and the various services to which I have referred. To the extent that those several services result in lessors of particular specified premises entering into property management agreements, then there is created what I regard as a relevant business. It is the business of providing property management services to those particular lessors for commission payable to the particular franchisee in whose list of specified properties the lessors' property may appear.
123 Even though the Manager might be seen to be managing the business of numerous franchisees in a co-ordinated manner it does so as agent for each of those persons. At any given time, the services rendered on behalf of a particular franchisee to a particular lessor can be identified. The same applies to the commission payable to each particular franchisee for the rendering of those services to the particular lessor. The Manager binds itself severally to each of the franchisees to act with reasonable skill in managing the Franchise Business with a view to promoting, advancing and improving it [clause 5.3(a) of the Management Agreement], to take steps to comply with the Franchise Agreement and all laws applying to the conduct of the Franchised Business [clause 5.3(b)] and to devote such time and attention to the management of the Franchise Business as may be reasonably necessary in the opinion of the franchisor.
124 The Manager covenants to comply with all reasonable instructions and directions as may be given to it by the franchisee concerning the general conduct and management of the Franchised Business [clause 5.3(i)]. During the hearing of the appeal there was a discussion about the scope of that sub-clause given the provisions of clause 6.1 of the Management Agreement which reads:
"6.1 The Franchisee hereby grants to the Manager access to and the right and power to exercise on behalf of the Franchisee in the conduct and management of the Franchised Business all the rights, powers, duties, discretions and benefits conferred on the Franchisee by the Franchise Agreement for the purpose of or in connection with the conduct of the Franchised Business by the Franchisee and without limiting the generality of this clause specifically authorises the manager to execute on the Franchisee's behalf all documents reasonably required in the conduct and management of the Franchised Business."125 Senior counsel for the respondent contended that this clause operated "instantaneously" to grant "in their entirety" to Madison Pacific Management the rights which the franchisee was purchasing. I disagree. To start with, the rights conferred by clause 6.1 are not conferred to the exclusion of the franchisee. If the franchisee so chose, it could augment the efforts of the Manager to persuade lessors of residential properties in its list of Specified Properties to engage the services to be provided by its agent. There is nothing in the Franchise Agreement which would prohibit this. Clause 10 of that agreement is quite consistent with such an auxiliary role, although its primary purpose would seem to be to preserve the right of a franchisee to manage all of the Franchised Business. Furthermore, I accept the appellants' submissions that if that franchisee thought that the Manager was not doing enough to promote the Franchised Business or was conducting its (the franchisee's) business in an unsatisfactory manner, it could issue appropriate instructions to the Manager to rectify the situation. Four or more breaches of any of the Manager's obligations under clause 5 of the Management Agreement (subject to due notice and failure to rectify within 28 days of such notice) provide grounds for the franchisee to terminate the Management Agreement. It is quite consistent with the overall "arrangement" for a franchisee to interest itself in the conduct and progress of that part of the activities of Madison Pacific Management as constitutes the conduct of the franchisee's business. A prudent franchisee would monitor the activities and results obtained by the Manager. The "Information Memorandum" (AB 87) refers to the likelihood that a Madison Pacific Franchise will require an equivalent amount of work and attention to that required of the owner of any other small business enterprise run under management. In the absence of any suggestion of a sham, I can see no reason why a bundle of legal rights and obligations conferred upon and assumed by the respective parties precludes the characterisation of the Manager's activities as agent for the franchisee (see clause 12 of the Management Agreement) from being characterised as a business. The evidence suggests that each particular business will be a small one. That can be seen from the detailed projected cash flow (AB 116). That document contemplates as little as 6.5 properties under management per franchise in year 1, rising to only 13.9 such properties in year 20. If those projections prove to be correct, it can be seen that by the end of the seventh year of the franchise the loans would have been repaid and a significant net cash flow generated. It is natural to approach the scheme, focussed as it is to a substantial extent on the availability of tax deductions, with a degree of scepticism, and to be tempted to regard it as being perhaps somewhat bizarre. But that, in my opinion, is not to the point. The point is, in my view, that at any particular time there can be identified a business activity carried on on behalf of a particular franchisee which can be characterised as its business.
126 I now turn to the question of whether the fourth criterion in Regulation 1.02(1) was satisfied. With great respect to the primary judge, I think that it was satisfied. Taking the "arrangement" offered, I think that it is quite clear that it was an arrangement "by which" it might reasonably be expected that, in carrying on the business, the franchisee would [the actual wording is "is, or will be"] be substantially dependent on services supplied by the franchisor or a person associated with the franchisor. Given the economies of scale sought to be achieved by the Manager conducting simultaneously the various businesses of the franchisees, it would, in my opinion, reasonably be expected that the franchisee would engage the Manager for that purpose. The whole arrangement was one in which that might reasonably be expected to occur, i.e. that the Manager as agent of the franchisee would carry on its (the franchisee's) business. [Although clause 12 of the Management Agreement disclaims the constitution of the Manager as an agent of the franchisee, that disclaimer is qualified by the words "(except to the extent required by this Agreement)". In my view, the obligation accepted by the Manager, by clause 5.1 of that agreement, to "... manage, direct and control the Franchised Business on behalf of the Franchisee" had the result that the Manager became the franchisee's agent for those purposes at least.] In those circumstances, it is not necessary to consider the further issues of whether the additional goods or services supplied by the franchisor would fall within sub-paragraph (d), or whether the Manager became a person associated with the franchisee.
127 I would reject the respondent's contention that the Management Agreement can be singled out and identified as a "participation interest". I do so because of the width of the exemption worked by Regulation 7.1.02. I repeat the words "... any right to participate, or any interest, as franchisee in a franchise ...". Each franchisee, as such, has the option of engaging the Manager under the Management Agreement. The offer of the managerial services can be seen as a very important part of the franchise. Indeed, I have held, that, by itself, it satisfies the fourth criterion of the definition as an "arrangement" by which it may reasonably be expected to constitute services upon which the franchisee will be substantially dependent. In my view, it would fly in the face of the obvious Parliamentary intent, to which I have referred above, to remove such an important part of what is offered to the franchisees from the exemption conferred by Regulation 7.1.02. The arrangement should be viewed as a whole. If it is an arrangement by which the various criteria are satisfied, then it is a franchise, as the whole "arrangement" falls outside the definition of "prescribed interest". In those circumstances, it is not necessary for me to consider the appellants' other arguments for excluding the offer of a Management Agreement from the definition of "prescribed interest". Conclusion 128 For the foregoing reasons, I would allow the appeal and set aside the orders made at first instance.
|
I certify that the preceding twenty-nine (29) numbered paragraphs are a true copy of the Reasons for Judgment of Justice Carr |
Associate:
Dated: 8 February 1999
|
Counsel for the Appellant: | Mr M L Bennett |
| Solicitor for the Appellant: | Bennett & Co |
| Counsel for the Respondent: | Mr J A Chaney |
| Solicitor for the Respondent: | Michael Gething |
| Date of Hearing: | 16 November 1998 |
| Date of Judgment: | 8 February 1999 |
AustLII:
Copyright Policy
|
Disclaimers
|
Privacy Policy
|
Feedback
URL: http://www.austlii.edu.au/au/cases/cth/FCA/1999/62.html