Enviro Systems Renewable Resources PTY LTD v Australian Securities and Investments Commission

[2001] SASC 11
(2001) 36 ACSR 762
(2001) 80 SASR 1

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(Judgment by: Martin J)

Enviro Systems Renewable Resources PTY LTD
v. Australian Securities and Investments Commission

Court:

Judge:
Martin J

Judgment date: 2 February 2001

Adelaide

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Judgment by:
Martin J

[1] The plaintiff (Enviro) seeks a declaration that a scheme in which it invites investors to participate in the growing, harvesting and sale of timber is a franchise for the purposes of Ch 5C of the Corporations Law (the Law). The defendant (ASIC) opposes the application and asserts that Enviro has been operating a managed investment scheme in breach of the provisions of the Law. I have been asked to determine the application upon the basis of restricted points of claim and defence and a statement of agreed facts with accompanying documentation.

[2] The definition of managed investment scheme in s 9 of the Law specifically excludes a franchise. If Enviro is correct, the provisions of Ch 5C of the Law do not apply. For the purposes of these proceedings, Enviro concedes that if the scheme is not a franchise, it is operating a managed investment scheme.

[3] Aussie Glass (Operations and Marketing) Pty Ltd (Aussie Glass) developed documentation for a "timber merchant franchise" scheme. Using the registered business name "Enviro Systems Renewable Resources", Aussie Glass offered interests in the scheme pursuant to that documentation from about April 1997 until about June 1998. From about June 1998, Enviro began operating the scheme and offering interests in it. It operates the scheme under licence from Aussie Glass and pays a royalty to Aussie Glass for the use of what has been called the "ES System".

[4] Maritime Funding Pty Ltd (Maritime Funding) has been retained by Enviro to market and sell interests in the scheme. Commission sales agents engaged by Maritime Funding make initial contact with potential participants. They provide potential participants with copies of an information memorandum, a disclosure document and a third document referred to as the "Blue Gum brochure". A number of documents are provided with the information memorandum, including legal advice as to the tax deductibility of fees paid in connection with the scheme, financial projections, plans of the areas concerned, a "timber merchant franchise agreement", a questions and answers document and a single page form of agreement between Enviro and a participant. As the parties sign only the single page form of agreement, the terms of the contract between Enviro and each participant are to be ascertained by reference to all of the documents I have mentioned together with 34 pages of "Regulations for Timber Merchant Franchises" (the regulations) prepared by Enviro.

[5] The documentation speaks of Enviro as a "franchisor" and a participant as a "franchisee". In essence, the documentation provides that Enviro offers participants the right to use identified half hectare woodlots to grow Tasmanian Blue Gum trees and the rights to harvest and sell the timber or timber products. The woodlots are situated on two separate parcels of land. Participants do not have a registrable interest in any of the land. One parcel is leased by Enviro. The lease provides that if the lease is terminated as a consequence of default by Enviro, the lessors are entitled to take possession of the land and trees planted on the land become the absolute property of the lessors. Enviro became the registered proprietor of the second parcel of land on 7 January 2000 and that property is subject to a mortgage to the National Australia Bank. If Enviro defaults on the terms of the mortgage, the bank is entitled to take possession of the land and trees planted on the land become the property of the bank.

[6] The combined area of the parcels of land has been referred to in the agreed Statement of Facts as the "plantation". It is divided into half hectare woodlots which are individually identifiable by reference to pegs in the ground. A grid map of the plantation shows each woodlot.

[7] According to the information memorandum and other scheme documents, participants may personally discharge their obligations or may use the services of an approved and qualified manager to manage their woodlots to the stage of producing timber ready for sale by the participant. It is stated that participants may choose to use the harvested timber as firewood for themselves or, using the "Enviro Marketing System", sell it as firewood or other timber products.

[8] The memorandum encourages potential participants by stating that growers should receive an immediate income tax deduction for 100% of the licence fees and all on-going costs. The entry cost of participation is explained as follows:

Low Entry Cost

Each one half hectare Woodlot will be issued at $3,600 annual franchise fee for the first two years and then $155 + 20% of gross thereafter (the franchise fee includes $200 first two years land rental and management fee). From the Annual Franchise Licence Fee, the Franchisor will hold as Stake holder, the Management Fees set out in the Regulations to ensure the Manager appointed by the Franchisee to manage the Franchise Woodlots is paid. Minimum entry level 2 Woodlots.

[9] The information memorandum states that there is no financial liability beyond the 2 year fee of $7200 per woodlot and the subsequent annual "franchise" fees. It is said that those fees cover rental, maintenance charges and insurance and any management fee for the woodlots up to a capped amount. It is stated that participants are in their own business and have the right to identifiable allotments of land. Reference is made to participants using the assistance of Enviro to establish and maintain a plantation on the land and to harvest and market "the produce according to the Franchisor's Marketing System". As to the sale of the timber, the information memorandum states that a participant may appoint an agent to market the firewood or timber products, but that "great benefit" is seen in marketing under the franchise name of Enviro.

[10] Some of the obligations of Enviro are described in the following paragraph of the information memorandum:

Management

Enviro Systems Renewable Resources has set up the plantation area and is caring for common areas. The Franchisee may carry out the work itself or appoint an approved forestry manager to manage the woodlots. The Franchisor has arranged information to be provided to you from a number of approved managers. The Franchisor does not receive any financial benefit from the managers and has no association with such managers.

Enviro Systems Renewable Resources will take all necessary action with regard to clearing, spraying, windrowing and the burning, ploughing, provision of roads, firebreaks and maintaining all of those to completion of the project. The Franchisee or its manager will plant and care for the trees and harvest them ready for sale. The cost of the manager up to the amount set out in the Regulations is covered by the Annual Franchise Licence Fee. Management fee (sic) vary but with some managers, the full amount of their costs will be covered by the Annual Franchise Licence Fee. If another manager is chosen, the Franchisor has allocated $5200.00 to pay management fees on behalf of the franchisee and then $25.00 per annum thereafter.

The provision of technical consultants and permanent staff is the responsibility of Enviro Systems Renewable Resources.

At your option the timber produce may be processed as firewood and bagged for sale. In the unlikely event you decide that it is not economical to clear fell the plantation for firewood, provisions are in place to continue the growth of the plantation to age 10 years or longer to realise the processing of pulp paper, woodchip or other timber products.

The franchise agreement and regulations provide for planting and overseeing of the produce for an Annual Franchise Licence Fee which includes the right to use the woodlot for growing the trees. A manager may be appointed to negotiate and market the produce using the Franchise Marketing System.

The franchise agreement provides (in order to ensure that the franchisee's interests are safeguarded) that the franchisor is obliged to make available to the Franchisee advice of an expert up to 10 years from March 1999 or date of planting. At the present time it is not anticipated that more than 10 years will be necessary in view of the proposed marketing of all trees as firewood within a maximum period of 10 years from sowing.

[11] As mentioned, the information memorandum advises potential participants of their right to use the services of an approved and qualified manager to manage their woodlot to the stage of producing timber ready for sale. The "timber merchant franchise agreement" (the agreement) provides for the use of a manager, but stipulates that the manager must possess the minimum qualifications required by Enviro. In addition, a manager can only be appointed if the prior consent of Enviro is obtained to the terms and conditions of the manager's appointment.

[12] As to the marketing of the timber or timber products, the information memorandum advises that the participant may appoint an agent for that purpose. The agreement provides that Enviro will advise a participant on the marketing and sale of trees and products and provide such assistance as the participant requires to sell the harvested trees. Paragraph 17.2 requires the participant to "follow the process and procedures as set out in the regulations and/or the operations and procedures manual (the manual) for the marketing and sale of the harvested trees" (the manual has not been completed). Paragraph 15 provides that a participant may only appoint a marketing manager to manage the sale of timber products if the manager appointed agrees to use and uses the Franchise Marketing System and only if the prior consent in writing of Enviro is obtained to the terms and conditions of the manager's appointment. This restriction is repeated in para 17.3 which requires that any marketing firm appointed by a participant to market and sell the products must enter into an agreement with the participant which includes an undertaking to comply with the process and procedures as set out in the regulations and/or the manual for the marketing and sale of the harvested trees.

[13] Blue Gum Forestry Management Pty Ltd (Blue Gum) has been approved by Enviro as a forestry manager to manage the woodlots on behalf of participants. A participant who enters into a management agreement with Blue Gum may apply for a loan of $4500 from Blue Gum, but no funds are advanced by Blue Gum to participants. The $4500 is provided by Enviro making a book entry in its accounts, recording that amount as a payment to Enviro by the participant. A further book entry in Enviro's accounts shows a notional payment of $4500 to Blue Gum by way of management fees. Blue Gum does not otherwise have sufficient funding to provide loans to participants and keeps no books in connection with the loan arrangement. The loan is a non-recourse loan in the sense that it is payable only out of harvest proceeds, if those proceeds are sufficient to meet the debt.

[14] The "franchise" fee of $3600 per woodlot per annum for the first 2 years is payable in advance. If a participant enters into a loan arrangement with Blue Gum, the amount of the loan is treated as part payment of that total fee of $7200. The fee is stated to include woodlot licence fee, land rental, forest establishment costs, management fees, cost of seedlings, insurance, maintenance charges, all sprays and chemicals and other such expenses. Other fees which are payable pursuant to the agreement between the participant and Enviro, for example, marketing and harvesting fees, are to be deducted from harvest proceeds. The cash components of the "franchise" fees are the only out of pocket payments required to be made by a participant up to and including harvest.

[15] The scheme documents, including those related to Blue Gum, do not disclose the full background to the scheme or the full extent of the involvement of Blue Gum. The agreed facts identify the following matters which are relevant to the issue to be determined:

(i)

In 1997, prior to any offers first being made by either Aussie Glass or Enviro, Mr William Turner orally agreed with Mr John Carson and Mr Stephen McNamara that he would prepare land and act as forestry manager for a proposed Blue Gum plantation at Edenhope in Victoria. Mr Turner incorporated Blue Gum for that purpose. Mr Turner knew Mr Carson through previous business dealings. Mr McNamara is a director of Aussie Glass and of Enviro.

(ii)

The arrangements with Mr Turner were:

•

Blue Gum would prepare the site for planting the trees and would plant the trees and maintain them and the plantation generally through to the proposed second harvest in 10-12 years from planting.

•

Blue Gum would be paid $700 per woodlot for costs involved in setting up and maintenance over the first 2 years and $25 per woodlot for maintenance costs thereafter. In addition, Blue Gum would be paid up to $4500 per woodlot from harvest proceeds if those proceeds were sufficient.

(iii)

Blue Gum prepared the plantation for planting prior to the first interests in the scheme being sold and has continued to prepare the land on behalf of Enviro.

(iv)

Blue Gum receives instructions from Enviro as to how many hectares to plant in each planting season.

(v)

Blue Gum applies directly to Enviro for payment of its fee. Payment is often in the form of payment of accounts for costs incurred by Blue Gum in planting and managing the plantation or reimbursement of any accounts paid directly by Blue Gum. These payments are offset against the negotiated fee to be paid to Blue Gum. No additional fee is paid to Blue Gum for preparation of the land for planting or for the establishment and maintenance of fire breaks and access roads.

(vi)

Blue Gum plants and manages the plantation as a whole and not as individual woodlots. Expenses are incurred for the plantation as a whole and not for a participant's individual woodlot.

(vii)

Blue Gum carried out the pegging of the individual woodlots and has a copy of the grid map on which the woodlots are set out. However, Blue Gum has not routinely been notified of the particular holdings of each participant, although Enviro proposes to notify Blue Gum of such identification in the future.

(viii)

Enviro ceased marketing the scheme in about January 2000. At that time, approximately 380 persons or entities had become participants with a total of 1811 woodlots (905.5 ha). However, only approximately 700 ha had then been planted.

(ix)

To date, all participants have signed a management agreement with Blue Gum:

•

Management agreements are not generally signed by Blue Gum, although agreements are often signed by Enviro's agents.

•

The management agreements do not identify the woodlots of each participant.

•

Blue Gum has not routinely been provided with copies of the management agreements, but Enviro proposes to provide copies in the future.

(x)

Blue Gum reports directly to Enviro as to the progress of the plantation. Through its reports to Enviro, Blue Gum has contributed to a periodic newsletter which is prepared by Enviro and Maritime Funding for the purposes of informing participants of matters associated with the plantation. Blue Gum has received and responded to a number of telephone inquiries from participants and has met with a number of participants at the woodlots.

(xi)

Enviro oversees the operations of Blue Gum to ensure it complies with its obligations as forestry manager. Enviro is responsible for paying Blue Gum on a participant's behalf.

(xii)

All but seven participants have taken advantage of the offer of a loan agreement with Blue Gum. After the "loan" of $4500 was deducted from the total of $7200 payable per woodlot, some participants paid the outstanding $2700 in full, while others have paid only in part with the balance payable out of their tax refund when received.

(xiii)

The practical effect of the loan of $4500 is to defer payment of part of Blue Gum's management fee.

(xiv)

Regardless of the amount paid in cash, each participant has received a receipt for $7200 per woodlot.

(xv)

The only business of Blue Gum is forestry manager for the plantation.

(xvi)

The arrangements with Blue Gum do not provide for Blue Gum to take any role in the marketing or sale of timber.

[16] Having identified in general terms the nature of the arrangement between participants and Enviro, it is also necessary to identify what rights the scheme documentation identifies as conferred by Enviro upon each participant. The preamble to the agreement contains the following paragraphs of relevance to this question:

WHEREAS:

A. Enviro Systems has developed a system for growing and marketing renewable timber resources as Timber Merchants (the business) and wishes to market and carry on the business within Australia and elsewhere (the ES System).

B. Enviro Systems has rights to use and promote certain trade and business names, trade and service marks and commercial symbols in connection with the ES System including the mark Enviro Systems and those marks and names more particularly described in the Regulations hereunder.

C. the foundation and essence of the ES System is the adherence by franchisees to standards and policies of Enviro Systems providing for the uniform operation of all Enviro Systems franchises including but not limited to prescribed standards of tradesmanship and quality, service efficiency, timeliness and cleanliness. Compliance by franchisees with the foregoing standards and policies in conjunction with the use of the Trade Mark or Marks provides the basis for the valuable goodwill and wide acceptance of the ES System. Moreover the establishment and maintenance of a close personal working relationship with the Franchisee in the conduct of the Enviro Systems Franchise, his/her accountability for performance of the obligations contained in this Agreement and the regulations thereunder and his/her adherence to the tenets of the ES System constitute the essence of the franchise provided for herein.

D. the Franchisee has applied to Enviro Systems for a franchise to operate the ES System and in order for Enviro Systems to provide and market renewable timber resources Enviro Systems contracts with the Franchisee to supply labour to perform such services and the Franchisee has agreed to pay to Enviro Systems a franchise fee in order to become a Franchisee to Enviro Systems and to obtain the benefit of Enviro Systems' goodwill and facilities on the terms and conditions set out below.

E. the Franchisee may at the Franchisee's option enter into a management agreement with a forestry manager recommended by the Franchisor to for and on behalf of the Franchisee manage the Franchisee's woodlots in conjunction with the Franchisee.

F. The Franchisor is the registered lessor or the Registered Proprietor of the Land.

G. The Franchisee has applied to the Franchisor to Licence the Woodlots, being a portion of the Land.

[17] The "ES System" is further described in para 24 in the following terms:

24. PROPRIETARY MARKS RIGHTS & TRADE SECRETS

The distinguishing characteristics of the ES System include the following:

(1)

the name Enviro Systems and other trade marks and trade names (with or without registration pending);

(2)

distinctive colour schemes and designs, service marks, insignia, logos, logograms, brochures, advertising, samples and other related materials;

(3)

a developed marketing concept utilising the benefits of group identification from common signs standards and products and uniform procedures for the operation of ES System businesses, including instructional literature, display material and other equipment;

(4)

administrative services, training and educational programmes, advertising data and promotional techniques, product supply and general business assistance to independently owned and operated franchisees; and

(5)

such other items as may from time to time be set out in the Regulations.

The Franchisee shall not, without the prior written consent of Enviro Systems, register or otherwise attempt to obtain and hereby disclaims any right title or interest in all or any part of the ES System, the name Enviro Systems, including the aspects of the ES Systems set out herein.

[18] In addition, the following paragraphs set out in general terms the rights being obtained by each participant:

2. GRANT OF FRANCHISE

In consideration of the Franchisee paying to Enviro Systems the Annual Franchise Licence Fee and as adjusted from time to time in accordance with the provisions herein and further subject to the provisions of this Agreement, Enviro Systems hereby grants to the Franchisee a non-exclusive franchise of the type set out in the Schedule to the Franchisee to operate an Enviro Systems Business and a licence to use the ES System and the Marks in the operation of the said Franchise and to occupy the woodlots as set out herein for the Term in the Location, and State as described in the Schedule.

3. GRANT OF LICENCE

Enviro Systems hereby grants a licence to the Franchisee to use the Franchise Woodlots and grants to the Franchisee a right of way over the Common Areas subject to the provisions hereof for the Term set out herein commencing on the Commencement Date.

4. USE OF LAND

Enviro Systems hereby acknowledges that the Franchisee shall have the right to use the Woodlots for the establishment of a plantation of Trees which are acknowledged to be the property of the Franchisee and may clear and cultivate the Woodlots and plant, tend, grow, care for, and harvest the Trees on the Woodlots and sell the wood ...

[19] Chapter 5C of the Law provides a regime for the regulation of managed investment schemes. Section 9 defines the schemes as follows:

" managed investment scheme " means

(a) a scheme that has the following features:

(i)

people contribute money or money's worth as consideration to acquire rights (interests) to benefits produced by the scheme (whether they rights are actual, prospective or contingent and whether they are enforceable or not)

(ii)

any of the contributions are to be pooled, or used in a common enterprise, to produce financial benefits, or benefits consisting of rights or interests in property, for the people (the members) who hold interests in the scheme (whether as contributors to the scheme or as people who have acquired interests from holders)

(iii)

the members do not have day-to-day control over the operation of the scheme (whether or not they have the right to be consulted or to give directions) or

(b) a time-sharing scheme;

but does not include the following:

(c)

...

(d)

...

(e)

...

(f)

a franchise ...

[20] The question I am asked to determine is whether the scheme is a franchise. If it is, the inclusion in the scheme of elements which might otherwise bring it within the definition of "managed investment scheme" is irrelevant. If the scheme is a franchise, it is not a managed investment scheme for the purposes of Ch 5C of the Law.

[21] Section 9 also contains a definition of a franchise:

"franchise" means an arrangement under which a person earns profits or income by exploiting a right, conferred by the owner of the right, to use a trade mark or design or other intellectual property or the goodwill attached to it in connection with the supply of goods or services. An arrangement is not a franchise if the person engages the owner of the right, or an associate of the owner, to exploit the right on the person's behalf.

[22] ASIC submitted that, viewed properly, the scheme does not involve a franchise because participants are passive investors who take an interest in a collective investment scheme, namely, an interest in a timber plantation. It argued that, at best, Enviro has an unregistered trademark and there is no design or other intellectual property or goodwill attached to it in relation to the scheme. No profit or income is earned by a participant exploiting the right to use the trademark or other intellectual property or goodwill. Whatever income may be derived in due course, it is derived from the growing of trees rather than from the exploitation of any relevant right.

[23] Counsel for Enviro conceded that Enviro has not conferred a relevant right in connection with the growing and harvesting of the trees. He submitted that the scheme involves participants earning income by exploiting rights conferred by Enviro in connection with the supply of timber and timber products. Those rights are the right to use a trademark, namely, the Enviro name and Enviro logo, and the right to use other intellectual property, namely, the ES System.

[24] Throughout the recent development of the regulatory regimes governing managed investment schemes and franchises, a distinction has been drawn between passive investments and those arrangements in which the prospects of the business succeeding are, to a significant extent, dependent upon the activities of investors. In the 1980s, it was held in a number of decisions that offers of franchises were offers of interests falling within the regulatory provisions that were the predecessors to the managed investment scheme provisions. The National Companies and Securities Commission (the NCSC) responded by using its discretionary powers to exempt franchise arrangements from the regulatory provisions on a case by case basis. On 22 January 1986, the NCSC introduced policy statement 118 which provided a guide as to the circumstances in which the NCSC would exercise its discretion to grant an exemption. The view of the NCSC as to the underlying basis of a franchise arrangement can be discerned from that statement:

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 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 of the franchise to the franchisor.

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. [my emphasis]

[25] A review of the legislation was undertaken in 1986. A consultative paper published in 1986 repeated the theme that a franchisee is not a passive investor in another's venture, "but is an active contributor to what he or she properly regards as his or her own business venture".

[26] In September 1987, reg 14A of the Companies Regulations and reg 5A of the Securities Industry Regulations came into force. Those regulations excluded franchises from the definition of prescribed interest. NCSC policy statement 118 was withdrawn. A definition of "franchise" was inserted into reg 2 of the Companies Regulations on 27 October 1988. On 1 July 1998 the Managed Investments Act commenced operation and the exclusion for franchises was retained. That Act followed recommendations made by the Australian Law Reform Commission and the Companies and Securities Advisory Committee in report No 65. In recommending that franchise arrangements should not be regulated under the Managed Investment Scheme provisions, that report stated:

Franchise arrangements usually involve the purchaser obtaining the rights to use a particular name and the franchise owner providing back up support and ensuring standardisation of marketing. Franchises involve a degree of investor involvement in the day to day management of the investment. This makes the application of the collective investment provisions of the Corporations Law inappropriate. [my emphasis]

[27] As Drummond J observed in his dissenting judgment in Madison Pacific Property Management Pty Ltd v ASC (1999) 89 FCR 263 ; 30 ACSR 218, the history to which I have referred reflects a view that typical franchisees do not require the extent of protection appropriate for passive investors. Speaking of a 1987 regulation which excluded franchises from the prescribed interest regulatory regime, his Honour said (FCR 286; ACSR 239-40):

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 their own business 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.

[28] By way of contrast, passive investors are at a greater risk. Drummond J highlighted the difference in the following terms (FCR 286; ACSR 240):

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 it 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 of 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.

[29] The definition of "franchise" in the Law came into operation on 1 July 1998. At about the same time, by regulation pursuant to the Trade Practices Act 1974 (Cth), in recognition of the very strong growth of the franchising form of business, and also in recognition of the power imbalance between franchisors and franchisees, a mandatory Franchising Code of Conduct (the Code) was introduced. Limited parts of the Code applied from 1 July 1998. The remainder, including the definition of "franchise agreement", came into operation on 1 October 1998. For present purposes, the relevant parts of the definition referred to a franchise agreement as an agreement:

(a) ...

(b) in which a person (the franchisor) grants to another person (the franchisee) the right to carry on the business of offering, supplying or distributing goods or services in Australia under a system or marketing plan substantially determined, controlled or suggested by the franchisor or an associate of the franchisor; and

(c) under which the operation of the business will be substantially or materially associated with a trade mark, advertising or a commercial symbol:

(i)

owned, used or licensed by the franchisor or an associate of the franchisor; or

(ii)

specified by the franchisor or an associate of the franchisor; and

(d) under which, before starting business or continuing the business, the franchisee must pay or agree to pay to the franchisor or an associate of the franchisor an amount ...

[30] The definitions in the Law and the Code, and the history of regulation of passive investment schemes and franchise arrangements, support the view that the Legislature intended to exempt from the regulatory regime applicable to managed investment schemes those types of arrangements in which the risk that the business will succeed or fail is, to a significant extent, dependent on the activities of the franchisee. On the other hand, the Legislature intended that passive investment schemes in which the risk of the business succeeding or failing is wholly or very substantially dependent on the activities of the promoter, and in which business it is not intended that the investor will actively participate, should be regulated by the regime applicable to managed investment schemes.

[31] Having ascertained the overall object of the relevant regulatory regimes, s 109H of the Law requires this court to prefer a construction of the provisions of the Law which promotes the purpose or object underlying the Law in preference to a construction that would not promote that purpose or object.

[32] Against that background, in addition to ascertaining the legal form of the arrangement, in my opinion it is appropriate to consider the substance of the scheme promoted by Enviro and the way in which it has and will work in practice. In opposing such an approach, counsel for Enviro submitted that this court should take a narrower approach restricted to determining the rights and interests created by the scheme documentation. In support of his proposition he relied upon the approach of the majority in Madison. In particular, he drew attention to the observations of French J that "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": p 276. However, as counsel for ASIC pointed out, the court in Madison was asked to examine the arrangement said to be a franchise on the basis that there was a marketing plan or system controlled by the promoter and it was conceded that a requisite mark existed. There was no contention that the various agreements which made up the scheme documentation were shams. Having made the observation that the suggestion of a sham was disclaimed, it was then that French J said "[s]o the question whether the rights and interests offered relate to a franchise must be considered by reference to the documentation ..." (my emphasis). In the matter under consideration, although ASIC did not suggest that the arrangements amounted to a fraud, it argued that the arrangement was a sham in the limited sense that, in reality, although presented as a franchise it is intended to work in practice as a passive investment scheme.

[33] The scheme documentation provides that a participant is entitled to retain the harvested timber or sell it personally or through the appointment of a manager. The participant, either personally or through a manager, is both entitled and required to use what Enviro claims is a system that it has developed for the marketing and sale of the timber. Enviro submitted that, in this way, each participant would be operating a business and earning income through the exploitation of a right conferred by Enviro to use Enviro's trademark and system. In addition, the exploitation of that right would occur in connection with the supply of goods, namely, timber.

[34] On a literal reading of the scheme documentation that submission is correct. However, on the basis of the agreed facts and documentation, and drawing inferences reasonably open from that material, the scheme must be considered in its entirety in order to determine whether it amounts to a franchise for the purposes of the Law.

[35] An examination of the total scheme reveals a number of significant features:

(i)

Enviro does not offer participants merely an opportunity to become involved in the business of selling timber and timber products through the exploitation of a relevant right. The scheme involves the growing of the trees that will provide the timber for sale in 5 and 10 years time. A substantial part of the package offered to participants, therefore, does not involve the supply of goods.

(ii)

Notwithstanding the claim by Enviro that the relevant business is that of selling timber, the primary focus of the documentation is upon the growing of the trees.

(iii)

Although the documentation provides for participants to manage the growing of the trees themselves or through approved managers other than Blue Gum, the scheme is designed to ensure in practice that the plantation as a whole is managed by Blue Gum under the supervision of Enviro and that investors do not personally or through a manager other than Blue Gum manage the growing stage:

•

Enviro has retained Blue Gum to plant and manage the plantation as a whole and not as individual woodlots.

•

Expenses are incurred for the plantation as a whole and not for a participant's individual woodlots.

•

Generally speaking, Blue Gum does not sign management agreements with individual participants. Such agreements are often signed by Enviro's agents.

•

The management agreements with Blue Gum do not identify the woodlots of each participant.

•

Blue Gum has not routinely been provided with copies of management agreements with participants.

•

Blue Gum has not been routinely notified of the particular woodlots held by each participant.

•

Blue Gum reports to Enviro.

•

Enviro oversees the operations of Blue Gum.

•

Legal advice given to Enviro concerning the tax deductibility of fees paid by participants in a letter dated 9 May 1997, was given on the basis that each participant "will" enter into a management agreement with Blue Gum.

•

Participants are offered a strong incentive not to manage their woodlots personally. The scheme documentation requires Enviro to pay the manager appointed by the participant from the licence fee paid by a participant. However, there is no provision for a reduction in the licence fee if a participant personally manages the woodlots and declines to appoint a manager. The regulations provide that if a participant does not use a manager, Enviro "may" retain the management fees of up to $5200 per woodlot "as and against the additional work required to be undertaken by the Franchisor to ensure the proper management, maintenance of and adherence to the Franchise System by the Franchisee".

•

Participants are also offered a strong incentive to appoint Blue Gum as the Manager by reason of the availability of the non-recourse loan from Blue Gum.

(iv)

The "franchise" fees payable by a participant are identified in the information memorandum as related to the growing of the trees and not as a fee payable for the opportunity to exploit a relevant right in connection with the sale of the timber.

(v)

Notwithstanding the statement in the information memorandum that there is no financial liability to a participant beyond the total of $7200 per woodlot for the first 2 years and the subsequent annual franchise fees, the disclosure document and Franchise Regulations prepared by Enviro envisage additional fees:

•

The disclosure document identifies a "marketing" fee payable by the participant to Enviro of not more than 2.5% of the gross revenue for each woodlot held by the participant. Payment is identified as due after each harvest, not after the sale of the timber. The regulations express the fee as 2.5% of "gross margin of the Franchisee's timber sales per annum".

•

The marketing fee is identified by the disclosure document as a contribution by the participant to a marketing or co-operative fund controlled and administered by Enviro. It identifies the purposes for which Enviro is entitled to use the funds as "to conduct corporate advertising campaigns and other promotional activities".

•

The regulations also provide for a "harvest" fee that a participant is liable to pay Enviro on an annual basis. The amount of the fee is specified as the "actual cost of harvest".

(vi)

The documentation provides for the franchise agreement to terminate on completion of the second harvest which is required to take place between 10 and 11 years after planting. No allowance is made for the franchise agreement to continue for a period after harvest in order for the participant to operate the business of selling the timber.

(vii)

Apart from the requirement that a harvest fee be paid to Enviro, the documentation is silent as to harvesting and conversion of the timber into a saleable product.

(viii)

As to the sale of the timber, the documentation does not identify a system or blue print for the operation of the business of selling the timber. The information provided as to a system is as follows:

•

The information memorandum contains the following:

Marketing

The Franchisor's Marketing System requires the cut timber to be marketed in 20 kg bags distributed throughout various outlets in South Australia and Victoria.

These outlets will include woodyards, service stations, markets, shopping outlets etc ...

•

Paragraph 17 of the agreement refers to a participant following the process and procedures set out in the regulations or the manual for the marketing and sale of harvested trees. Regulation 5.11 is concerned with undertakings by Enviro with respect to marketing, but it merely speaks of conducting research, advertising campaigns and other promotional activities for the products and services "offered to the public" by Enviro and franchisees. A schedule of advertising and promotion is attached which lists only well recognised outlets and means of advertising. Paragraph 4 of the yet to be completed manual refers to sales and marketing, but no system is identified. Counsel for ASIC not unkindly described the content as comprised of "motherhood" statements.

(ix)

The documentation does not identify a specific fee as paid by the participant in return for the opportunity to exploit a relevant right owned by Enviro in connection with the sale of the timber.

(x)

On 26 August 1989 Enviro signed an agreement with Don Grant Agency Pty Ltd trading as PA's Family Firewood (Grant) to supply to Grant "bulk Blue Gum" in a form described as:

... all clean and dry seasoned rounds approx. 100 mm in diameter cut to lengths of approximately 300 mm.

The term of the agreement is expressed as "five years after first harvest expected in 2003". Grant has undertaken to purchase from Enviro "as sole supplier" provided Enviro maintains supplies ordered, but no minimum tonnage is required. Enviro has undertaken to use all reasonable endeavours to fulfil orders.

(xi)

The scheme documentation lists a number of undertakings by participants. Those undertakings include the arranging and maintaining of insurance against various risks identified in a schedule to the regulations. Allowance is made for Enviro to arrange "a group insurance scheme" in which it is said that participants "shall be entitled to participate".

During submissions, insurance documents were tendered. The current certificate of insurance identifies insurance coverage for two plantations of 400 and 100 ha. The age of the plantations is said to be 2 and 3 years. In response to a question on the certificate asking whether Enviro maintains the plantation personally, the "No" box has been ticked and the name of the contractor is given as "Blue Gum Forestry Management". A booklet comprising the terms of the insurance includes a clause which states that if the insured requires the interest of another party to be covered, a request to that effect must be made. Included with the documents is an email message of 12 January 2001 from Enviro to the insurer requesting that a list of franchisees be attached to the policy. The documentation includes a 14 page list identifying 500 franchisees.

[36] In my opinion, when the scheme documentation is analysed in its entirety, the intent of the scheme is that Enviro will control the day-to-day operations of the scheme from beginning to end. Enviro offers a total package which is presented in such a way that potential participants are encouraged to take up the entire package. Notwithstanding the assertions that participants will be running their own businesses, Enviro does not intend that participants should take an active role in the day-to-day operations of any aspect of the scheme. The success or otherwise of the scheme is entirely dependent upon Enviro. In reality, although it is possible that some participants may choose to take an active role, the scheme is designed to attract passive investors.

[37] In my opinion, the purpose or object of the legislation and the regulatory regimes created pursuant to the legislation would be easily defeated if the court felt obliged to rely solely upon a strict view of the legal rights and duties created by the documentation and was required to ignore the realities of the scheme as it is designed to operate in practice. The essential features of the scheme offered by Enviro are directed towards creating an arrangement which is inconsistent with the type of arrangement intended by the Law to be a franchise and, therefore, to be exempt from the regulatory regime governing managed investment schemes. In my opinion the scheme offered by Enviro is not a franchise for the purposes of the Law.

[38] The conclusion I have reached is sufficient to dispose of the application. However, as other issues have been argued it is appropriate that I express my views about some of those issues.

[39] As mentioned, the scheme documentation does not identify a system for marketing or selling timber or timber products. Enviro does not have any experience in this area. It has never sold any timber or timber products and nothing has been supplied to the market pursuant to the scheme under consideration. The information contained in the scheme documentation is very general and, in my opinion, it fails to disclose anything remotely approaching a system in respect of which Enviro could legitimately claim to own the intellectual property.

[40] A very similar timber scheme came under consideration in Australian Securities and Investments Commission v Austral Timber Pty Ltd (1999) 32 ACSR 641. In its essential features, the scheme was identical to the scheme under consideration. Byrne J addressed the question as to whether the profits which a participant was to earn would be derived from the exploiting of "a right to use a trademark or design or other intellectual property or the goodwill attached to it in connection with the supply of goods and services". His Honour observed that at "first blush" it appeared that income would be earned from the business of the participant as a participating timber merchant. This was the information conveyed to participants in the information memorandum. In that matter the "franchisor" had, at a late stage, applied to register a particular trademark. Of critical importance was his Honour's conclusion that it did not appear from the material before him that the use of the trademark was "likely to or [was] intended to contribute to the earnings by participants of profits or income": p 652. On that basis his Honour concluded that the scheme was not a franchise, but was a managed investment scheme for the purposes of Ch 5C.

[41] The basis upon which his Honour reached the conclusion that it did not appear that the use of the trademark was likely to or was intended to contribute to the earnings is not clear. The plaintiff submitted that his Honour's conclusion was influenced by his finding that the scheme was fraudulent and that this was a basis for distinguishing that authority. However, the conclusion as to fraud was based upon the financial arrangements between Austral Timber and participants which his Honour found were in part a sham and were entered into for the purpose of defrauding the Australian Taxation Office. Such a finding did not reflect upon the question which his Honour posed as to whether the profits would be derived from exploiting a relevant right.

[42] ASIC contended that it is a reasonable inference from the documentation that no genuine system of marketing and selling the timber has been developed by Enviro. Counsel for Enviro submitted, however, that such an inference could not be drawn from the documentation and that I should proceed on the basis that a system exists even if it is not identified in the documentation. He suggested that the reference to selling timber through nominated outlets in particular size bags disclosed the existence of a system or parts of a system and that I should not, therefore, be prepared to infer that Enviro had not developed a system which could be exploited by participants.

[43] The total circumstances disclosed in the documentation and agreed facts leave me with the strong impression that Enviro has not developed any system which can reasonably be regarded as the intellectual property of Enviro. In other words, Enviro does not own a right to use a particular system, which right is capable of being conferred upon a participant and of being exploited by a participant in connection with the supply of timber. The scheme envisages the earning of income, but not through the exploitation by a participant of a right to use a particular system owned by Enviro. Similarly, although Enviro has applied for the registration of a "logo", the scheme is not designed to enable a participant to earn income by exploiting the right to use the logo or any other form of trademark.

[44] In these circumstances, in my opinion the arrangement offered by Enviro does not amount to a franchise. Enviro does not intend that a participant will earn income by exploiting a right conferred by Enviro to use a trademark or other intellectual property or goodwill attached to it in connection with the selling of the timber.

[45] Counsel for ASIC also submitted that, whatever right is conferred upon a participant in the arrangement, the right must possess some inherent value. She argued that in the absence of some inherent value, it could not be said that a participant would earn income by "exploiting" the right. The word "exploit" imports the notion of exploiting a value within the right. Enviro submitted, however, that the expression "exploiting a right" means merely "using a right".

[46] In view of the decision I have reached on other grounds, it is unnecessary for me to explore this interesting issue. It is sufficient to observe that, regardless of any particular meaning to be attributed to the expression "exploiting a right", the definition of "franchise" at least requires that the parties anticipate that the exploitation of a relevant right will result in the earning of income. The definition refers to an arrangement under which a person "earns profits or income" by exploiting a relevant right. It is not a difficult step to conclude that if a relevant right does not possess some inherent value or will not, in a meaningful way, create the potential for a participant to earn income, the arrangement cannot be classified as a franchise.

[47] The application for a declaration that the scheme offered by Enviro is a franchise for the purposes of the Corporations Law is refused.