Good Faith in Franchising

From 2006-2013 there have been multiple government enquiries at a State and Federal level into franchising. Again in 2013 a Federal enquiry is currently taking place into, among other things, good faith in franchising.

At its simplest form, Franchising allows a Franchisee to operate a business under a name (with all incumbent goodwill) in accordance with a prescribed system. Franchising is an extremely successful form of business arrangement. In Australia there are in excess of a thousand franchise systems with tens of thousands of Australians owning and operating a franchised business.

The relationship between a Franchisor and Franchisee is defined in the franchise contract, the mandatory Franchising Code of Conduct (the “Code”) and other relevant laws such as the Consumer and Competition Act (previously known as the Trade Practices Act).

The relationship between the Franchisor and the Franchisee can be imbalanced. The Franchisor as the creator of the business concept will want to ensure that their concept is uniformly presented to the market place. It is therefore not unusual for a Franchisor to dictate operational and behavioral standards whilst limiting Franchisee initiative. For example, the Franchisor may restrict independent supply arrangements sourced by a franchisee.

On the flip side, there is little scope under a franchise contract for a franchisee to hold a errant franchisor to account. Unless specifically negotiated, there are few, if any, mandatory obligations imposed upon a Franchisor under a franchise contract.

The Code is meant to redress some of the power imbalance in the franchise context. The Code imposes minimum standards required of Franchisors in areas such as disclosure, termination and dispute resolution.

Having said that, the Code does not restrict many of the things that a Franchisor can elect to do (or not do) under a franchise contract. In some circumstances, the exercise of that discretionary power by a Franchisor may result in seemingly unfair or unreasonable decisions against a franchisee. It is in these circumstances, that the Courts have been prepared to imply into the franchise relationship an obligation of good faith.

The obligation to act in good faith is the obligation of a party not to exercise a contractual right with a sole or dominant motive which is contrary to the reasonable expectations of the parties to the contract. In effect, the legal principles associated with good faith include the following:-

  1. A Franchisor is required to act reasonably and honestly (to an objective standard);
  2. A Franchisor must not act for an ulterior motive;
  3. A Franchisor must recognize and have regard to the legitimate interest of both the Franchisor and the Franchisee under the contact; and
  4. The Franchisor must have regard to avoiding the rendering of a Franchisee’s interest in an Agreement worthless.

Whether a term of “good faith” is implied depends upon the facts each case. However, the Courts have been prepared to imply such a term in the following situations:

  1. Where default notices is issued without any basis for doing so;
  2. Where the Franchisor prevents a Franchisee from conducting legitimate business activities under the Franchise;
  3. Where the Franchisor engages in activities aimed at discrediting or otherwise placing unnecessary financial pressure upon a Franchisee.
  4. Where a Franchisor terminates a contract after the Franchisee has requested a compulsory mediation;
  5. Where a Franchisor terminates a franchise for minor, trivial and/or stale breaches of the contract;
  6. Unless specifically reserved, where a Franchisor authorizes and/or undertaking activities within a territory of the Franchisee (even if that territory is nominated as a “non-exclusive” territory);
  7. Diverting enquiry from a Franchisee;
  8. Allowing new franchisees to operate in or near a territory which may cause significant impact upon the business of an existing Franchisee.

The current review of the Code and the issue of good faith will be interesting for all participants in the industry. What the review will recommend is unknown, however, given the FCA sees no need to impose “good faith” provisions under the Code it may be unlikely that any substantial change will occur.

Heath Adams is a Director of Adams & Partners Lawyers, and head of the commercial legal team within the firm. Heath’s primary focus is on servicing clients in the franchise sector including new and emerging franchise systems. He is an accredited specialist in Business Law. Read more about Heath here.

About Heath Adams

Heath Adams is a Director of Adams & Partners Lawyers, and head of the commercial legal team within the firm. Heath’s primary focus is on servicing clients in the franchise sector including new and emerging franchise systems. He is an accredited specialist in Business Law. Read more about Heath here.