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Bulletin

Commission-based affiliation: a "false franchise"?

Fasken
Reading Time 5 minute read
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Franchising Bulletin

A unique feature of franchising is that franchise structures, business models and agreements can (indeed, should) be tailored to the specific characteristics of each industry and, equally, to the operations, resources and needs of each franchise network.

There are, therefore, many variations of franchise arrangements, one of which deals with the degree of control that the franchisor has over the operation of the franchised businesses in its network.

Notwithstanding these variations (which are, moreover, entirely desirable to ensure that the franchise arrangement and structure are appropriate to each system), a franchise relationship must still have certain fundamental characteristics, one of which is that a franchisee operates a real business that it owns.

Thus, a franchisee sells the services or goods offered by the network to its customers.

In the last two years or so, we have seen the emergence in Quebec and Canada of a business model that, at first glance, looks very much like a franchise, but which, from legal, structural and financial standpoints, is completely different: the commission-based affiliation.

Commission-based affiliation is a business model that has been known for several years in some European countries (including France), especially in the fashion and accessories sectors (including leather goods, shoes and jewelry).

The main difference between a franchise and a commission-based affiliation is that, in a commission-based affiliation, the affiliate (the counterpart of a "franchisee") does not sell on his own account, but on behalf of the supplier (the counterpart of a "franchisor") the goods offered by the network.

On the other hand, as in a franchise, (i) the affiliate is a legally independent enterprise from its supplier, (ii) the legal relationship between the affiliate and its supplier is based on an agreement, (iii) the affiliate is granted the right to use its supplier's trade name and trademarks, and (iv) the affiliate benefits from ongoing know-how and assistance from its supplier. Also, like a franchisee, the affiliate undertakes, by its agreement, to respect the commercial and operational methods, the standards and the brand image of the supplier.

In a commission-based affiliation, however, the inventory of goods in the affiliate's point of sale does not belong to the affiliate, but rather to the supplier, who places it there on consignment.

When the affiliate makes a sale, this sale is legally and financially made directly between the supplier (and not the affiliate) and the customer, which implies, among other things, that the sale price must be paid into the supplier's account and that all subsequent relations with the customer (especially with regard to delivery, after-sales service and warranty) are made between the supplier and the customer.

Thus, the range of goods offered in each outlet held by an affiliate, the products on display in these outlets and the prices, terms and conditions of sale are decided solely by the supplier.

In the commission-based affiliation business model, the affiliate acts only as an agent of the supplier. As such, she/he is remunerated by a commission, or discount, which is paid to him periodically by the supplier on the basis of sales made and paid in or from his point of sale.

However, the affiliate (i) acquires or leases its outlet, (ii) develops and maintains its outlet, (iii) hires and compensates its employees, and (iv) takes on the business risk associated with the profitability of its business, the revenues of which are the commissions and other rebates paid to it by the supplier.

Compared to franchising, the commission-based affiliation business model allows the supplier to retain greater control over the prices and conditions of sale of its goods, as well as over the network's clientele. It also allows for the recruitment of individuals as affiliates who have fewer resources than would be required of a franchisee (since the affiliate does not have to invest in the purchase and financing of inventory and merchandise on display).

On the other hand, the supplier must purchase and finance the inventory and merchandise on display in its affiliates' outlets and assumes the risks associated with unsold merchandise and sales to the network's customers, such as delivery, after-sales service, returns and compliance with warranties (legal and contractual). The supplier will also often be responsible for the advertising and marketing of its network.

For its part, the affiliate will be much more dependent on its supplier than a franchisee is on its franchisor. In particular, in the event of the termination of the commission-based affiliation agreement, the affiliate ceases to have any income (since its only income consists of commissions and other rebates from its supplier) and has no clientele (since the clients are those of the supplier), while it must still meet various financial commitments, in particular with respect to its employees, its lenders and its landlord.

From a commercial point of view, the commission-based affiliation is therefore a fundamentally different business model from a franchise.

It is therefore important for a future franchisor or franchisee to distinguish a commission-based affiliation from a franchise, since it is not suitable for the same people or the same companies.

In Europe, the commission-based affiliation business model is often considered to be particularly suitable for sectors of activity in which the management of supply and inventory represents an important, complex and delicate issue, particularly with respect to fashion and seasonality.

Notwithstanding the foregoing, in provinces with franchise legislation (Prince Edward Island, New Brunswick, Ontario, Manitoba, Alberta and British Columbia), it is quite possible that, for the purposes of the application of such legislation and regulations, a commission-based affiliation may be considered a "franchise" as it often meets the criteria of the definition of a "franchise" found in such legislation.

As with all variants of the franchise and all other commercial affiliation business models, the choice of commission-based affiliation as the proper business model for the development of any network must be made with the assistance of qualified experts who will be able to guide you towards the business model that best suits you and in adapting it to your resources, your needs and your mode of operation in order to ensure the harmonious and profitable development of your network and the attainment of your objectives.

Fasken has all the experience and resources necessary to help you structure your network properly, to provide you with adequate contracts tailored to your needs, to comply with the law and to protect and enforce your rights while avoiding potential pitfalls.

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