Good Faith in Franchising
10 min read
The Franchising Code of Conduct (the Franchising Code) includes an obligation that the franchisor and the franchisee act in good faith in their dealings with the other party.
The obligation to act in good faith in franchising applies to all aspects of the relationship between a franchisor and a franchisee, including negotiations before the entry into the franchise agreement.
However, the obligation is more than just a general obligation to act in good faith.
Good Faith under the Franchising Code of Conduct
The obligation to act in good faith in franchising is set out in clause 6(1) of the Franchising Code.
Clause 6(1) of the Franchising Code provides that
Each party to a franchise agreement must act towards another party with good faith, within the meaning of the unwritten law from time to time, in respect of any matter arising under or in relation to:
(a) the agreement; and
(b) the Code.
The obligation to act in good faith contained in the Franchising Code, extends to negotiations and discussions before the entry by the parties into a franchise agreement.
Clause 6(2) of the Franchising Code provides that
The obligation to act in good faith also applies to a person who proposes to become a party to a franchise agreement in respect of:
(a) any dealing or dispute relating to the proposed agreement; and
(b) the negotiation of the proposed agreement; and
(c) the Code.
However, the obligation to act in good faith does not enable a party to make a general claim that there has been a failure to act in good faith.
For example, where a franchisee complains that a franchisor has not acted in good faith the Court has held that ‘the focus of an obligation of good faith should ordinarily be on a franchisor’s use of powers and opportunities available by reason of the franchise relationship‘.1
What is good faith?
“Good faith” is not defined in the Franchising Code.
The Franchising Code provides that “each party to a franchise agreement must act towards each other with good faith, within the meaning of the unwritten law“.
The “unwritten law” means the law developed in the Australian Courts through case law or common law.
The High Court of Australia has held that good faith involves “fairness in dealings between contracting parties“.2
Similarly, the Federal Court of Australia has held that the obligation to act in good faith means to
act honestly and with a fidelity to the bargain; an obligation not to act dishonestly and not to act to undermine the bargain entered or the substance of the contractual benefit bargained for; and an obligation to act reasonably and with fair dealing having regard to the interests of the parties (which will, inevitably, at time conflict) and to the provisions, aims and purposes of the contract, objectively ascertained.3
We have set out below some elements of the obligation to act in good faith.
Elements of Good Faith
Honesty
Fairness
Not acting arbitrarily
Co-operating to achieve the purpose of the franchise agreement
Reasonableness
Having regard to the interests of the other party
While the Franchising Code does not define “good faith”, it provides that when assessing whether a party has acted in good faith, a Court may consider if:
– a party acted honestly and not arbitrarily;
-a party co-operated to achieve the purpose of the franchise agreement.
Legitimate Business Interests
While a party must take into account the interests of the other party, the obligation to act in good faith does not prevent a party from acting in its own legitimate commercial interests.
Consequently, a party is not required to act in the interests of the other party at the expense of its own interests.
The ACCC’s view is that conduct is prohibited where it harms the franchisee but it is not necessary for the protection of the franchisor’s interests. The Federal Court of Australia has accepted that view.4
Consequently, franchisors should keep records of their business goals and objectives and reasons for decision making, so that these records can be referred to later if needed.
Conduct that may show a lack of good faith
The ACCC in it’s Franchisor Compliance Manual has indicated that the following conduct may raise concerns under the obligation of good faith:
– a franchisor treating a franchisee differently to other franchisees because the franchisee has raised concerns about the system.
– a franchisor raising numerous minor and immaterial breaches with a franchisee in an aggressive and intimidatory manner designed to extract concessions or cessation of complaints.
– franchisees using confidential information provided by the franchisor to compete with the franchisor.
– franchisees using social media to post negative comments about the franchisor or their dispute with the franchisor.
Penalties under the Code
The maximum Civil Penalty under the Code for a failure to act in good faith is 300 penalty units, or $66,600.00.
Case Study Ultra Tune
Australian Competition and Consumer Commission v Ultra Tune Australia Pty Ltd [2019] FCA 12
In early 2015, Mr Ahmed, agreed to purchase the Ultra Tune franchise business located in Parramatta, NSW. During the purchase process, Mr Ahmed had a number of meetings with Ultra Tune, during which a number of representations were made. These representations included representations about how long the franchise had been open, the rent payable and the purchase price.
In September 2015, on the basis that the deposit was refundable, as required by the Code, Mr Ahmed paid the deposit of $33,000.00.
During the training period, Mr Ahmed was provided with the disclosure document and the franchise agreement, which Mr Ahmed felt contained figures which were inconsistent with the representations.
Mr Ahmed subsequently decided not to proceed with the franchise and on 30 September 2015, requested that the deposit less the training costs be refunded.
Ultra Tune refused to refund the deposit on the basis that the money had been used to pay for signage and equipment and was now non-refundable.
In 2017, the ACCC commenced proceedings against Ultra Tune for a number of matters including the failure to comply with the good faith obligations contained in the Code.
The Federal Court found that
-Ultra Tune failed to explain why the orders for the equipment and signage could not have been stopped or why the equipment and signage could not be used by another franchisee or resold by Ultra Tune to another franchisee.
-Ultra Tune had sought a large deposit without giving Mr Ahmed a reasonable time to consider the purchase of the franchise business, particularly given the representations made to him.
The Federal Court also found that Ultra Tune breached its obligation to act in good faith by:
-failing to honestly disclose information about the franchise;
-making misrepresentations to Mr Ahmed about how long the franchise had been open, the rent payable and the purchase price;
-putting pressure on Mr Ahmed to pay $33,000.00 before providing documentation relevant to the purchase of the franchise;
-requiring the payment of $33,000.00 and subsequently treating it as a non-refundable deposit without making it apparent to Mr Ahmed that the money would be treated as non-refundable;
-making a decision to expend the $33,000.00 on signage and equipment without the need for urgency;
-failing to repay Mr Ahmed the deposit.
The Federal Court ordered that Ultra Tune pay a penalty of $54,000.00 (the maximum at the time) for the breach of the obligation to act in good faith.
Case Study – Pizza Hut
Diab Pty Ltd v YUM! Restaurants Australia Pty Ltd [2016] FCA 43
Clause C1 of the Franchise Agreement entered into between YUM! Restaurants Australia Pty Ltd and its franchisees contained a standard pricing clause which provided that:
Franchisee will not permit any Approved Product to be sold at the Outlet at any price exceeding the maximum retail prices advised by the Franchisor to the Franchisee from time to time.
In June 2014, Pizza Hut introduced a new pricing model. In particular, Pizza Hut advised its franchisees that certain pizzas were to be offered for $4.95, which was a decrease in previous pricing.
Under Clause C1 of the franchise agreement, the Pizza Hut franchisees were not able to sell the $4.95 pizzas for a higher price.
A number of Pizza Hut franchisees alleged that the pricing was unprofitable and that Yum had breached its obligation to act in good faith in implementing the pricing.
The Federal Court did not agree.
The Federal Court considered “the purpose” of the franchise agreement.
In doing so, in addition to Clause C1 of the franchise agreement, the Court considered clause 6.2 of the franchise agreement which provided that:
Franchisee will participate in such national and regional advertising, promotions, research and tests as Franchisor from time to time requires and Franchisee will not have any claim or action against Franchisor in connection with the level of success of any such advertising, promotion, research or test.
With respect to the purpose of the franchise agreement, the Federal Court found:
An obligation to ensure profits for each Franchisee with respect to a given promotion, including the setting of a maximum price which is particularly low, is not only inconsistent with clause 6.2, it is also commercially unrealistic in the context of different factors ensuring profit.
In addition the Federal Court considered whether YUM acted “honestly and fairly” and found with respect to YUM’s CEO:
He may have demonstrated poor business judgment, particularly with the benefit of hindsight. However, that does not equate to a lack of fidelity to the bargain or to unconscionable behaviour.
The Federal Court also considered whether YUM acted “reasonably”:
He made what he considered to be the best decision from the point of the view of Yum and the future profitability of the Franchisees. He and the Yum executives, rightly or wrongly but reasonably, believed in a first mover advantage.
COVID-19 and Good Faith in Franchising
In it’s COVID-19 information release, the ACCC highlighted the need for franchisors to be aware of their obligation to act in good faith during the COVID-19 pandemic.
When considering whether a franchisor is acting in good faith, the ACCC suggest that potential questions to ask include:
Is the franchisor making timely decisions?
Is the franchisor consulting with franchisees regarding issues or proposed changes?
Is the franchisor imposing conditions on franchisees that are not necessary to protect its interests?
Is the franchisor genuinely attempting to resolve the dispute?
Is the franchisor acting for some ulterior purpose?
The government has also indicated that franchisors should be working with franchisees to waive, reduce or defer franchise fees while their businesses are affected by the Coronavirus restrictions.
Further Information
Should you require 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.
- Australian Competition and Consumer Commission v Ultra Tune Australia Pty Ltd [2019] FCA 12
- Commonwealth Bank of Australia v Barker [2014] HCA 32
- Paciocco V Australia and New Zealand Banking Group Limited [2015] FCAFC 50
- Australian Competition and Consumer Commission v Ultra Tune Australia Pty Ltd [2019] FCA 12
- Posted by Ana Haarsma
- On July 21, 2020
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