The debate surrounding the inclusion of a duty of good faith in franchise arrangements has been clarified by the introduction of a new good faith obligation in the Franchising Code of Conduct (Code) effective from 1 January 2015. In the ACCC’s Chairman’s first speech of 2015, Rod Sims listed ensuring compliance with industry codes as one of the ACCC’s key priorities for 2015 and called out the introduction of the Code’s new good faith obligation as one area it expects to become involved in enforcement work.  This is a timely reminder to franchisors to ensure they understand, and comply with, this new statutory obligation.

Changes to the Code

The good faith obligation under the Code which applies to both franchisors and franchisees, is an obligation to act in good faith  “within the meaning of the unwritten law from time to time” with respect to any matter arising under or in relation to a franchise agreement or the Code. The obligation to act in good faith extends to pre-agreement negotiations and disputes and cannot be limited or excluded by the parties.  The wide drafting of this new good faith obligation means that the duty of good faith will be relevant to almost all aspects of the relationship between a franchisor and a franchisee or a prospective franchisee.

The Code lists the following non-exhaustive factors that a court may have regard to when determining if a party has breached its obligation to act in good faith:

  • whether the party acted honestly and not arbitrarily
  • whether the party cooperated to achieve the purposes of the agreement.

However, the Code states the obligation to act in good faith does not prevent a party to a franchise agreement, or a person who proposes to become such a party, from acting in their legitimate commercial interests. More specifically, the Code is clear that if a franchise agreement does not allow a franchisee to renew or extend the agreement, this does not mean that a franchisor has not acted in good faith in negotiating or giving effect to the agreement.

While the Code provides examples of what is not a breach of the good faith obligation, it is less certain on what the positive duty to act in good faith is comprised of. The definition of good faith in the Code by reference to common law means that the courts will be guided by case law when analysing a party’s conduct.

What is good faith?

A variety of approaches have been developed and adopted by different judges over time to define “good faith”.  Sir Anthony Mason in his article “Contract, Good Faith and Equitable Standards in Dealing[1]stated that good faith comprised three notions:

  • an obligation on the parties to cooperate in achieving the contractual objects
  • compliance with honest standards of conduct
  • compliance with standards of conduct which are reasonable, having regard to the interests of the parties.

This approach has been cited with approval in a number of cases including Burger King Corp v Hungry Jack’s Pty Ltd[2] and Hughes Aircraft Systems International v Airservices Australia[3]. In Renard Constructions (ME) Pty Ltd v Minister for Public Works[4], Priestley JA observed that the reasonableness requirement has much in common with the notion of good faith. This approach received support in a number of subsequent decisions[5] and good faith is often equated with the concept of reasonableness.

The Victorian and New South Wales courts approach to the content of a term of good faith is aligned, in that while the duty of good faith may require a party to consider the interests of another, it will not require that party to act against its own interests in doing so. In Garry Rogers Motors (Aust) Pty Ltd v Subaru (Aust) Pty Ltd[6], Finkelstein J held that an implied term of good faith would require a contracting party to act in good faith and fairly not only in relation to the performance of a contractual obligation but also in the exercise of a power conferred by the contract. He continued on to state that the implied term imposes an obligation upon the party not to act capriciously, however, it would not operate so as to restrict actions designed to promote the legitimate interests of the party.

The Code’s good faith obligation sets out the limitations previously developed under common law and outlined by Finkelstein J in Garry Rogers, in that it expressly states that the obligation to act in good faith does not prevent a party to a franchise agreement or a person who proposes to become such a party from acting in their own legitimate commercial interests. An example of this principal in practice can be found in the case of  ACI Operations Pty Ltd v Berri Limited[7], where ACI and Berri had an exclusive supply agreement. Under the terms of this agreement, Berri could obtain products from a third party where they received a bona fide arm’s length offer from a third party and ACI did not match that offer. The court held that the supply agreement recognised Berri’s legitimate commercial interest in securing a competitive price or terms for the supply of products. The court continued on to say that an implied obligation of good faith did not confine Berri to the passive receipt of third party offers and Berri could proactively seek these offers.  Provided that the party exercising the power acts reasonably in all the circumstances, the duty to act fairly and in good faith will be ordinarily satisfied. Bryne J in Far Horizons v McDonalds Australia[8] described a breach of the obligation of good faith as where a party seeks to further an ulterior purpose or a purpose extraneous to that for which a right or power is conferred.

In United Group Rail Services Limited v Rail Corporations New South Wales[9], the NSW Court of Appeal provided some examples of what is required under an obligation to negotiate in good faith with respect to a dispute arising under a contract:

  • a party may not be entitled to threaten a future breach of contract in order to bargain for a lower settlement sum than it genuinely recognises is due
  • a party would not be entitled to pretend to negotiate, having decided not to settle what is recognised to be a good claim, in order to drive the other party into an expensive arbitration that it believes the other party cannot afford
  • if a party recognises, without qualification, that a claim or some material part of it is due, the obligation may require payment to be made.

The 2010 case of AMC Commercial Cleaning (NSW) Pty Ltd v Coade[10] considered the duty of good faith in the context of a franchise agreement.  In this case, the NSW Supreme Court held that a franchisor had breached its duty of good faith on numerous occasions, including (among other things) by serving a ‘default notice’ that was baseless, endeavouring to find ways to impose financial burdens on the master franchisee, failing to supply leads in accordance with the terms of the master franchise agreement, failing to render invoices within a reasonable time and failure to use reasonable endeavours to collect debts.

A good faith obligation should not be confused with a fiduciary obligation.  A fiduciary relationship is where a person has an obligation to exercise rights and powers in good faith and for the benefit of the other person.  For example, a trustee has a fiduciary obligation to a beneficiary, as in certain circumstances do people in partnership with each other. In equity, a person in a fiduciary relationship cannot make a personal profit at the expense of the person to whom they owe a fiduciary duty or put themself in a position where their duty conflicts with their own personal interests.

What should franchisors do?

As noted above, the breadth of the Code’s good faith obligation means that it will apply to almost all aspects of a relationship between a franchisor and a franchisee or a prospective franchisee.  In particular, franchisors should be conscious of this obligation when:

  • negotiating the terms of a franchise agreement with a prospective franchisee
  • deciding whether or not to enter into a franchise agreement with a prospective franchisee
  • considering whether to consent to the transfer of a franchise
  • considering whether a franchisee has satisfied its conditions of renewal
  • determining arrangements in relation to the supply of goods or services to franchisees
  • dealing with disputes with franchisees or prospective franchisees
  • considering whether to terminate a franchise agreement.

There are some basic guidelines that franchisors should adhere to in order to minimise the risk of being found to be in breach of the duty of good faith. For example, franchisors and commercial parties generally should ensure that decisions made and actions taken have legitimate business objectives that can be demonstrated.  In order to assist parties in this respect, franchisors and commercial parties should maintain detailed records that set out the business objective which can be later referred to if questioned.  In drafting notices of breach and termination, franchisors should ensure that they identify the nature and basis of the allegations and what action must be taken to remedy it.  It is also strongly recommended that a franchisor instigate and participate in mediation prior to ultimately terminating the franchise agreement.

A franchisor should resist issuing notices of breach and threatening termination of a franchise agreement where it has no genuine intention to terminate but is seeking to manipulate an outcome or coerce the franchisee into conduct which is not directly related to the breach notice.  Equally, withholding consent to a renewal or transfer of a franchise for an ulterior purpose should be resisted.

Additional changes to the Code effective from 1 January 2015 mean that the ACCC can seek penalties of up to $51,000 for breaches of penalty provisions of the Code.  The ACCC also has additional powers to collect information and conduct compliance audits, so franchisors should be diligent in maintaining records that evidence the business rationale for decisions made and actions taken with respect to franchisees and prospective franchisees.