Monday’s article in The Australian, ‘Hungry Jacks boss pushes for franchisee clause’ focuses attention once again to the ongoing debate over the regulation of the franchise sector.

In particular it raises the question of a statutory good faith requirement. Currently, there is no statutory requirement of good faith in the regulation of franchising in Australia. Though good faith is one of the criteria for determining unconscionable conduct under the Trade Practices Act Section 51AC, this section has historically provided little substantive protection for franchisees.

The Matthews Report recommended that ‘recognition in the Code of a concept of good faith and fair dealing would provide positive reinforcement to the development of improved relationships and dealings between franchisors, franchisees and prospective franchisees’, a recommendation rejected by the government.

Perhaps the recommendation was rejected due to fears that a duty of good faith would damage the sector. In the US a duty of good faith is implied in every contract governed by the Uniform Commercial Code (UCC). A general principle of good faith is also a part of all contractual relationships in many European jurisdictions. These are jurisdictions where franchising continues to thrive. Indeed the duty is thought by many to provide an important measure of security for contracting parties.

Perhaps the recommendation was rejected due to fears that a statutory duty of good faith would pose challenges for courts in interpretation? At times it may, but regardless of the applicable legislation, courts must comprehend the complexities of commercial interactions in the franchise sector. In her seminal article on the contractual relationship on franchising UCLA professor, Gillian Hadfield, observes that,

‘The doctrinal tool necessary to bring the resolution of franchise contract disputes into line with the realities of the franchise relation is the covenant of good faith and fair dealing….… Relying on the good faith doctrine as a method of introducing more accurate relational considerations requires that courts routinely look beyond the written franchise contract and examine the relationship in which that contract is embedded.… Courts should stop conceiving of the franchise relation as one solely dedicated to protecting the franchisor's trademark and goodwill. The franchise relation is a mutual exchange….The relation makes little sense unless the "contract" between franchisor and franchisee balances these mutual arrangements, establishing commitments on the part of both franchisee and franchisor.’

A statutory term of good faith is no panacea. But there are reasons why it offers a degree of protection that appears to many observers to be sorely needed and deserved by franchisees.

In order to understand this need it is important to recognize the synergistic effects of the interaction of standard form and relational contracts. Standard form contracts are prevalent across many species of contracting relationships, including consumer contracts for airline tickets, computer software, mobile phones, insurance contracts and a range of financial agreements. Relational contracts are also common. While traditionally relational contracts have been less often encountered in the consumer context than the standard form, their use is now widespread, in many of the same contexts in which the standard form is used.

Both standard form and relational qualities of contract are designed to reduce transaction costs and in this way both contract qualities increase market efficiency. This efficiency in contract formation, however, comes at a price. That price is higher levels of risk to the non-drafting party, i.e. the consumer or the franchisee. While consumers can rely on consumer protection legislation and statutory warranties in such transactions, however, franchisees do not enjoy such protections.

Two features are common to standard form contracts, unequal bargaining power and lack of negotiation. Relational contracts can also be defined by two features, incompleteness and longevity. There is often a high level of discretion, and such contracts therefore rely heavily on reciprocity and on trust that develops over time between the contracting parties.

In the franchise relationship the unequal bargaining power and lack of negotiation of the standard form combine with the relational contract’s reliance on flexibility and trust to strongly reinforce imbalance of power.

The synergistic effect of the standard form and relational qualities of the contract increases uncertainty and risk for a franchisee for three fundamental reasons:

1. the drafter/franchisor can rely on specific contractual commitments of the franchisee, while a franchisee must rely on trust, reputation and factors extrinsic to the contract;
2. a franchisor can manage risk through contract, while a franchisee cannot; and
3. the relationship cannot take shape over time with the balanced flexibility truly required of the relational contract but rather it can evolve only according to the specific dictates of the drafting party.

These problems are compounded by the fact that statutory regulation focuses on contract formation with the result that the relational qualities lose a degree of significance. TPA s52 misleading or deceptive conduct has provided an important ground for franchisee complaints with respect to contract formation. But there is no such protection upon which franchisees can rely to help ensure the performance of these contracts that typically extend for several years and longer, with high levels of discretion afforded to franchisors over that time.

The best franchisors have no reason to oppose a duty of good faith – it simply reinforces their current practices. Franchisors who take advantage of their positions of power by engaging in opportunistic behaviours may object, but such objection should only strengthen the resolve of those who are interested in the success of the sector over the longer term.

Of course, Australia does not have to follow in the steps of the US and Europe. But we should consider carefully the desired outcomes. Do we measure ‘the bottom line’ in monetary terms alone (and if so, whose money?) Do we want a franchise sector that contributes to the economy, or do we want a franchise sector that, in addition to making a substantial contribution to the economic well-being of the Commonwealth, also, and perhaps more importantly, leads the way in best practice and contributes to the well-being of Australians at all levels of commercial enterprise?