We are experiencing unprecedented disruption to business and the economy.

Many businesses including many franchises are currently unable to operate due to government restrictions and we don’t know how long these government restrictions will remain in force.

In these circumstances, franchisors and franchisees are eager to know where they stand in relation to their franchise agreements and related agreements. We have been asked whether force majeure clauses (clauses dealing with events out of control of the parties) will apply in the current circumstances and if so, what the consequences are for both franchisors and franchisees. The application of the doctrine of frustration has also been raised, which if it applies could lead to the termination of the relevant contract or franchise agreement.

We consider both force majeure clauses and the doctrine of frustration in general terms below. However, we note that each person’s circumstances will be different and that legal advice should be obtained in relation to your particular circumstances.

Force Majeure Clauses

Force majeure clauses deal with events that occur which are out of the control of the parties and set out what happens when you are unable to perform your obligations due to these events. Essentially, the parties to the contract (franchise agreement) have agreed on the allocation of risk between them, if any of these force majeure events occur.

Usually, a force majeure clause will enable the non-performing party to escape liability for failing to perform as a result of a force majeure event which is not reasonably within the control of that party.

Typically, a force majeure clause will set out a list of force majeure events which are reasonably beyond the control of the parties. While a pandemic such as coronavirus is generally not included as a force majeure event, government restrictions (which have arisen as a result of the coronavirus) may well be included.

Generally, payment obligations will continue during a force majeure event, even though a party may be prevented from performing its obligations under the franchise agreement or from operating its business. These payment obligations will obviously fall away if they are based on turnover and the business is not operating.

You should read any franchise agreement or related agreement to check whether the agreement includes a force majeure clause and if so, you should consider its terms.

In particular, you should make yourself aware of any notice provision which requires that the affected party provide notice within a certain time frame.

A force majeure clause operates in the same way as other clauses in a franchise agreement. That is, the clause must be interpreted using contractual principles, taking into account the factual circumstances.

Frustration of Contract

In certain circumstances there may be a mutual discharge of a  franchise agreement, where an event happens after the franchise agreement is entered into, that makes it impossible for a party to perform the obligations under the contract. This is known as the doctrine of frustration.

Essentially, if frustration is established, the franchise agreement is automatically terminated at the point where the performance of obligations under the contract becomes impossible.

After the termination of the franchise agreement, the parties to the contract will be “discharged” from any future obligations.

However, any obligation which arose under the franchise agreement, before the franchise agreement became impossible to perform (such as the payment of royalties falling due), will continue to be an enforceable obligation after termination.

At common law, losses lie where they fall if a franchise agreement is terminated for frustration. For example, if an obligation cannot be performed but payment has been made, the payment is not refunded.

In addition, any contractual obligations which are expressed to survive the termination of the contract, may still be enforceable. For example, intellectual property obligations under a franchise agreement.

The states of South Australia, New South Wales and Victoria each have legislation which deals with frustration and applies to make the outcome fairer to the parties.

The doctrine of frustration is applied in very limited situations. While the circumstances of each case will need to be assessed, to establish frustration of contract the event generally must:

• not be an event which either party took on the risk of occurring, when entering into the contract;
• not be as a result of a default of any one or more of the parties to the contract;
• make the contractual obligation impossible to be performed (not merely delayed);
• not be an event that should have been foreseen by the parties.

Further, the existence of a force majeure clause in a contract which defines the event as a force majeure event, is likely to have the consequence that the contract will not be frustrated (as the parties have allocated or assumed risk).

What you should do

As we have set out above you should:

• review your contracts and consider whether the contract contains a force majeure clause;
• consider the application of any force majeure clause and in particular consider whether there are notice provisions;
• obtain legal advice in relation to your particular circumstances, the application of any force majeure clause and consideration of the doctrine of frustration.

Further COVID-19 Information

Should you need further information on these or any other franchising issues, contact us.

Disclaimer

The information in this article is general in nature and is not intended to address the circumstances of any person or other entity. Although we do our best to provide timely and accurate information, we do not guarantee that the information in this article is accurate or that it will continue to be accurate in the future.