Franchisors and franchisees need to be awake to the risks of entering into illegal cartels, a recent Commerce Commission decision has highlighted.
The decision also highlights the high level of rigour needed in applying the collaborative activities exemption to the cartel prohibition.
The Commission has declined to grant a collaborative activity clearance to Anytime NZ Limited, which operates a franchise of fitness clubs. Anytime NZ sought to enter into an agreement with franchisees to impose lower and upper limits on franchisees’ pricing to members and other measures affecting price.
The application for a collaborative activity clearance by Anytime NZ was the first such application ever made both generally and for a franchise arrangement. It is very helpful generally in showing the Commission’s approach to cartels and specifically in relation to franchises, especially as the Commission has not yet issued targeted guidance for franchises.
The decision shows that provisions of franchise agreements dealing with the prices that franchisees charge customers are at risk of giving rise to illegal cartels. It also demonstrates the difficulties in justifying them as collaborative activities.
The cartel provisions
Under section 30 of the Commerce Act 1986 (the Act), cartel provisions are prohibited unless an exception applies. Cartel provisions are agreements between competitors that have the purpose, effect or likely effect of restricting output, allocating markets, or fixing prices. There is an exception in the Act for collaborative activities.
To be engaged in a collaborative activity, two or more parties must be carrying on an enterprise, venture, or other activity, in trade in cooperation and not do so for the dominant purpose of lessening competition between them (or between any two of them).
The Commerce Commission can grant a collaborative activity clearance to a proposed agreement containing a cartel provision if it is satisfied that:
- The applicant and any other party to the proposed contract, arrangement, or understanding are or will be involved in a collaborative activity. A collaborative activity is defined as any enterprise, venture or activity, in trade, that is carried out in co-operation between different parties. It must not be carried out for the dominant purpose of lessening competition between those parties.
- Each cartel provision is reasonably necessary for the purpose of the collaborative activity.
- The contract, arrangement, or understanding will not have or be likely to have the effect of substantially lessening competition in a market.
Section 30, in its current form, and the option of seeking a clearance for collaborative activities, were added to the Commerce Act in 2017. In 2021, the Commerce Act was amended to make breach of section 30 a criminal offence with imprisonment of up to seven years and fines of up to $500,000 for individuals. Companies can get fined up to $10 million, three times the value of any commercial gain or 10% of turnover.
Was the proposed agreement a cartel arrangement?
The Commission found that the proposed agreement contained provisions that were likely cartel provisions for the following reasons:
It was likely that franchisees would compete with each other because:
- Most of the clubs are independently owned. As such, they are separate legal persons for the purposes of the Act, and are potentially competitors.
- some customers view different Anytime Fitness clubs as different competitive offerings.
- some franchisees are in the same local markets.
The provisions would:
- set a price policy for all memberships sold by franchisees;
- set minimum and maximum prices for different membership types;
- allow Anytime NZ to change those minimum and maximum prices by notice to franchisees; and
- allow Anytime NZ to vary or replace the membership types for which minimum and maximum prices are set (and set new minimums and maximums for those varied or replaced membership types).
The Commission considered that the provisions were at risk of being cartel provisions as they fixed, controlled, or maintained prices.
Did the proposed agreement meet the test for a clearance?
The Commission agreed with Anytime NZ that Anytime and the franchisees were engaged in a collaborative activity by combining their businesses, assets, or operations in a commercial activity through the operation of the Anytime Fitness franchise network.
In seeking to meet the test for the collaborative activity exemption, Anytime NZ submitted that the provisions were reasonably necessary to:
provide a strong network of gym facilities in desirable locations;
ensure the focus of the franchisees is on the provision of quality facilities and services so that the chain can best compete with other gym providers; and
significantly improve the equitable allocation of membership fees as between franchisees, to address issues arising from members being able to access all clubs and to transfer between clubs.
Despite the Commission agreeing that Anytime NZ was engaged in a collaborative activity, the Commission did not agree that the proposed agreement was reasonably necessary for the above objectives. It found that the evidence showed that a strong network of clubs is possible without the proposed agreement.
The Commission also said that if there were any issues that affected the combined efforts of clubs to compete with other gyms, this was limited to a small number of franchisees in Christchurch and Auckland and not sufficient to justify the proposed agreement. The Commission even found that some of the provisions could act against the purpose of having a strong network, by including minimum price limits.
The Commission did not agree with Anytime NZ that the equitable allocation of fees was a substantial purpose of the collaborative activity, even taking into account the potential for the issue to become more widespread as the Anytime Fitness network grows.
On the question of quality, again the Commission did not agree that the reasonably necessary test was met. The reasons included that there were only a small number of clubs with quality issues, and, in any case, the Commission could not see how the proposed agreement would improve quality.
The Commerce Commission also considered that there were less restrictive options available to Anytime NZ to address the free-riding and quality issues that Anytime NZ had identified. Examples of provided by the Commission were:
- to address free-riding behaviour: be clearer with members upfront about the rules on transferring, and enforce the mechanisms that already exist, such as a 30-day cooldown period; and
- to address quality/brand issues (if they did exist): enforce the standards already contained in the franchise agreements (and potentially bolstering these standards).
The existence of these alternatives made it less likely that the proposed agreement was reasonably necessary.
What does it mean for other franchises?
The decision highlights the need for franchisors and franchisees to be careful about including provisions in franchise agreements that restrict pricing by franchisees, affect the level of goods or services supplied by franchisors or or could otherwise be a cartel provision. Where such provisions are included, there is a need for firstly check whether the cartel prohibitions apply. In doing so, keep in mind that the Anytime decision is a challenge to the often-held view that franchisees don’t compete among themselves and the franchisor.
If they do, then the second step is to carefully analyse the justification for such provisions under the collaborative activity exemption. The Commission applies the test for this exemption rigorously, and across all the parties involved in a collaborative activity.
While not considered in the Commission’s decision, which focussed on price-fixing, cartel problems can also arise in relation to provisions dealing with the amount of goods or services franchisees can produce and provisions that allocate markets between franchisees, such as by geographical area. These are quite common in franchise agreements. In comparison to pricing restrictions, market allocation measures may be easier to justify under the collaborative activity exemption, as they are often integral to franchise arrangements.
We also recommend that franchisors and franchisees review existing agreements to check whether they include cartel provisions and, if so, whether the collaborative activities exemption applies.
What does it mean for other businesses?
The decision also has wider implication for business other than franchises who are thinking about entering into collaborative arrangements that would otherwise be cartels. It shows that the test for a collaborative activity needs to be carefully applied.
This article was prepared by Duncan Cotterill Partner Nick Crang, Partner Hamish Walker and Solicitor Gina Green. For more information, please contact a member of our Competition and Antitrust team.
Disclaimer: the content of this article is general in nature and not intended as a substitute for specific professional advice on any matter and should not be relied upon for that purpose.