A key consideration as a Franchise Agreement nears its expiry is whether any contractual options for a further term should be exercised or permitted to be exercised.

Franchise agreements often contain a suite of clauses including: options to renew the franchise, to require the end of the franchise’s operation by the franchisee, to purchase assets or assign leases. To avoid misunderstanding all parties to the franchise agreement should ensure that they are fully aware of and understand the terms of any options in their agreement.

A recent case of BB Australia Pty Ltd v Bytan Pty Ltd & Ors [2012] VSC 171, in the Victorian Supreme Court, highlighted the importance of the parties’ interpretation and understanding of the option clauses in the franchise agreeement.

Background

The case concerned a Blockbuster Video franchise which was operated by Bytan Pty Ltd. Bytan owned the land on which the Blockbuster store was operated. In the franchise agreement with BB Australia (formerly known as Blockbuster Australia Pty Ltd), there contained two important option clauses exercisable upon the expiry of the franchise agreement:

  1. an option, exercisable by the franchisor, to purchase from the franchisee “all the assets used in the store”; and 
  2. an option, exercisable by the franchisor upon the exercise of the asset purchase clause above, to require the franchisor to close the store.

Upon the expiry of the franchise agreement BB Australia sought to exercise these two options.

The franchisee argued that:

  1. the first option was not exercised correctly as BB Australia had not sought to purchase the land on which the store was located as a part of “all the assets used in the store”; 
  2. that because of this ineffective exercise, they could not require the exercise of the second option; and (c) that the second option was seeking to achieve “de facto constraint” through its exercise.

The Issues

The Court was asked to consider whether:

  1.  “all the assets in the store” included the freehold land on which the franchise operated; and 
  2. whether the second option was sought to be exercised in order to punish or be a de facto restraint on Bytan.

The Court’s Decision

The Court found that the option to purchase “all the assets in the store” could not be construed to include the right to purchase the freehold land. In determining the meaning of the option clause the court looked to:

  1. The plain meaning of the words used in the franchise agreement; and 
  2. The objects which the clause was intended to secure.

Amongst the reasons for court’s construction of the clause were the facts that:

  • the words of the agreement made a distinction between the “store” and the “site”; 
  • it was not the “site” which was permitted by the option to be acquired;
  • other features of the agreement’s drafting supported this construction; and 
  • the purpose of the clause was to enable the franchisor to permit another franchisee to continue conducting the franchise business, which did not encompass the purchase of a commercial real estate asset.

The Court found further that the second option clause was consistent with this construction in that it gave the Franchisor the right to have the store closed, as distinct from the right to have the site excluded from use for any other purpose.

Bytan was not prevented from operating a different movie rental business from the same premises.

There was no evidence that this clause was exercised to punish or restrain Bytan, rather it was to enable BB Australia to secure its business interests in having the store closed while the purchase of the assets was finalised.

Practical Assistance Provided by the Decision

The case presents a clear emphasis on the importance of parties to a franchise agreement to understand what is meant by particular words in their franchise agreements and to seek to have clear definitions of key words.

The need for court interpretation can often be avoided with clear drafting as it reduces the need for external determination involving examination of clauses phrasing and context.

When conducting reviews of franchise agreements it is useful to consider:

  • whether or not their franchise agreement contains option clauses; 
  • what rights are to be conferred on each of the parties upon the exercise of the option clause/s; 
  • the precise nature of those rights: what is affected and how; 
  • the relationship between clauses – whether some are dependent on the exercise of others; 
  • what will be required of each party upon the exercise of the clause/s; and 
  • the ramifications to each of the parties on the exercise of the option clause/s.

To ensure a comprehensive understanding of the terms of any option in a Franchise Agreement, parties should:

  • terms are clearly drafted and defined if so required in the franchise agreement;
  • the entire contract is read, including the definitions to consider if meaning is clear;
  • The effect aimed for is in fact plainly stated in the option clauses.

Ending or extending a franchise term can be a sensitive time for all parties which is assisted by the clarity of understanding of each of the parties of what action is required, how effect is given to clauses and the outcome of implementation of option clauses.