Australia's Franchise Regulation Needs Good Faith Protection

Dear Friends,

First, a disclaimer: I hope you will please accept that I am still learning a great deal about this and other areas of franchise law. That said, I would contribute as follows and hope it makes sense. If not, I look forward to being educated.

As I understand it, Australian courts do not accept a duty of good faith is to be implied in every contract, but such a duty has been implied into franchising contracts. (see e.g. Hungry Jack’s case, Far Horizons Pty Ltd v. McDonalds Australia Ltd, Bamco Villa Pty Ltd v Montedeen Pty Ltd and the discussion of the issue in Dymocks Franchise Systems (NSW) Pty Ltd v. Todd ) I am advised that good faith only applies during the contract term, not to renewals, which is Matthews recommended expressly introducing it into the Australian Code. (See also the SA report) For a court to imply a term, must be

1. Reasonable and equitable
2. Necessary to give business efficacy to the contract (So no term will be implied if the contract is effective without it.)
3. So obvious it goes without saying
4. Capable of clear expression
5. Not in contradiction of any express term.

BP Refinery (Westernport) v. Hastings Shire Council

• Requirements for Implication in Law & Fact: Must be necessary
• Terms Implied in Fact
• Onus On the pty alleging the implication
• Reasonableness: More precise req’ts to meet all elements of the test
• Intention(s) of the Parties Actual intention of the pties is what matters
• Terms Implied in Law
• Onus On the pty denying the implication (assuming such a term has been implied in similar kks)
• Reasonableness is more central, may be suffic even if biz efficacy & obviousness are not satisfied
• Intention(s) of the Parties Presumed intention

Academic Elizabeth Peden has observed that where good faith is in the contract courts “need to understand the purpose of the contractual provision”. But we don’t understand the contractual provisions or the contract as a whole. And we shouldn’t restrict ourselves to the time of formation. If good faith is an implied term rather than construed in the contract, franchisors can contract out of it. Commercial construction gives effect to parties’ intentions. I have surveyed a number of contracts and, not surprisingly I have found very few mentions of good faith in these contracts. While a common law implied term of good faith can be avoided by drafting, 51AC(3) good faith can’t be avoided by contract. But note that statutory good faith has to be interpreted according to common law principles because there is no definition of good faith in the TPA. And 51AC(3) has not proved terrifically useful to franchisees.

As for the AAFD standards as a sort of alternative, I think they are a terrific step. (Am I correct that the main incentive for franchisors to comply with the AAFD standards is recognition in the marketplace?) I am afraid that we have no appropriate vehicle for such standards in Australia, as the FCA would be unlikely to adopt such standards as the IFA presumably would have been.

Finally, I might add that a colleague advises further as follows:

‘The renewal issue involves a complex dynamic – the franchisee has no right of renewal (although the evidence is over 90% are renewed); but the franchisor has no right to take over the business at the end of the term, so the franchisee must close the business if there is no renewal. This permits opportunism by the franchisor who can leverage the franchisees investment (sunk costs) and the restraint of trade provisions in the contract to appropriate the goodwill built up in the business by the franchisee (which the franchisor does not own – call it locational goodwill if you like), hence the opportunism. Standard form contracts make it worse. So on the one hand the franchisor can act opportunistically, but the franchisee has no formal legal protection, such as a duty to negotiate in good faith or a presumption in favour of renewal unless the franchisor has a good cause not to renew.’

Would very much like to welcome Prof Hadfield on her next visit to Oz.

Best,
Liz

Liz,

I agree fully that good faith is necessary as a standard but there is a real risk of only providing the illusion of investor protection.

Since the Arthur Wishart Act (Franchise Disclosure) was passed in 2000 (good faith & commercial reasonableness), I see very little actual improvement for franchise investors. I would argue that things have gotten worse because Wishart gives only a pretense of protection and very little litigation has defined good faith.

For goodness sake, the Ontario Ministry of Government and Consumer Services won't even provide any direction as to what is and what is not a franchise as defined by their own provincial statute.

Professor Hadfield testified as an expert witness in 2000 at the Wishart hearings:

...it [good faith or other standards] needs to be understood to mean is that franchisors are explicitly obligated to exercise their discretion as if it were their own assets at risk. (link to full testimony on AU site or ON Bill 33)

Further,

Opportunism is formally the extracting of the value of the sunk investment that somebody has made in a relationship, taking advantage of the fact that someone is locked in to a certain extent…

Hadfield goes to great lengths to define the sunk cost investments as the distinctive nature of the frachise relationship in Problematic Relations: Franchising and The Law of Incomplete Contracts, 1990.

It is the separation of ownership of assets and the control of those assets that allows franchisor opportunism to happen within the discretionary actions.

Opportunism Detection: A franchisor action that affects franchisees can be viewed as either legitimate or illegitimate (opportunistic).

Hadfield suggests courts be instructed by politicians to define good or bad faith using this one practical test:

Would the decision have likely been made if the franchisor owned the assets themselves (ie. if it were their store)?

If YES, then the decision was likely legitimate and therefore in good faith.

If NO, then the decision was likely opportunistic (eg. the franchisor took advantage of the franchisee's sunk cost investments.) Therefore, the action was likely in bad faith.

Australian policy makers would be wise to:

1. enshrine this opportunism test along with good faith provisions, or
2. drop the embarrassing soft-shoe shuffling (ACCC, et al).

Better yet, Why not invite the good USC Prof to speak in Oz, for herself?

Les Stewart MBA
Understanding Franchising

Some Background: Hungry Jack's restaurants are what Burger King had to be called in Australia because the Burger King trademark had already been registered there by another company. U.S.-based Burger King overcame the problem after years of effort. There are some 300 locations in Australia.

What is somewhat ironic about Jack Cowin seeking better franchise protection is that Jack, who lends his name to Hungry Jack's, is a master franchise for not only Burger King but also Yum Brands. His company, Competitive Foods Australia, is responsible for licensing new Yum Brands and Burger King franchisees, opening its own stores and managing operation standards to franchised locations. It is the second largest franchise of Burger King in the world.

So he as a sub-franchisor for Australia, is acting reasonably in his own self-interest by seeking stronger regulation of franchising to protect himself against U.S.-based Yum Brands.

Cowin won a major case against Burger King, in which the Australian courts concluded that Burger King had tried to orchestrate a default of Hungry Jack's developmental duties to free them of the master franchise. The latest battle of Cowin's company is against Yum Brands.

Hungry Jack's history can be found on Wikipedia.