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Chapter 8
Good faith in franchising
8.1
While the pre-contractual disclosure obligations of the Franchising Code
of Conduct (the Code) have been, for the most part, adequately addressed by
past inquiries, there remains concern at the continuing absence of an explicit
overarching standard of conduct for parties entering a franchising agreement.[1]
8.2
As described in Chapter 2, the interdependent nature of the franchise
relationship leaves the parties to the agreement vulnerable to opportunistic
conduct by either franchisors or franchisees. Franchisee opportunism may take
the form of free riding, unauthorised use of franchisors' intellectual
property rights, underperformance, or failure to accurately disclose income.
However, the franchisor's control over the provisions in the contract enables
franchisors to address opportunistic behaviour of this kind by enforcing the
terms of the franchise agreement.[2]
8.3
Franchisor opportunism has been described as 'predatory conduct and
strong arm tactics by franchisors' involving the exploitation of a pre-existing
power relationship between the franchising parties, which makes the franchisee 'vulnerable
or economically captive to the demands of the franchisor'.[3]
There is an inherent and necessary imbalance of power in franchise agreements
in favour of the franchisor, but abuse of this power can lead to opportunistic
practices including encroachment, kickbacks, churning[4],
non-renewal, transfer, termination at will, and unreasonable unilateral
variations to the agreement.[5]
8.4
Aside from the personal hardship that opportunistic conduct can cause,
such behaviour may also have negative ramifications for individual franchise
systems and the franchising sector as a whole. The imbalance of power in
franchise agreements is not something that should be changed, but what does
need to be checked is any abuse of this power.
8.5
The problem of opportunism in the franchising sector may be addressed through
constraining the behaviour of franchisors, and empowering franchisees.[6]
The introduction of a statutory obligation of good faith within the Code has
been suggested as one possible mechanism for regulating the conduct of
franchising parties and, in particular, for preventing franchisor opportunism.[7]
8.6
The concept of good faith is not new and there is existing statutory
precedent for recognising or imposing obligations of good faith, including in
the 2006 Oil Code regulations, section 51AC of the Trade Practices Act 1974
(TPA), the Victorian Fair Trading Act 1999 and Native Title legislation.[8]
8.7
Although there is no clear definition of 'good faith', it would be
generally understood to mean acting fairly, reasonably and honestly, encapsulating
the concept of 'a fair go'.[9]
The South Australian Economic and Finance Committee concluded that '[w]hile an
abstract formulation of a generalised concept of good faith may be indistinct,
the courts have demonstrated that they are able to know it when they see it, or
more properly, they know a breach of it when they see it.'[10]
8.8
However, the lack of a universally accepted specific definition of good
faith has led to differing views on the implications of inserting an express
good faith clause into the Code.
Implied or explicit good faith
8.9
Professor Andrew Terry argued that 'the experience at common law with
the implication of a good faith covenant is far from certain' and cautioned
against the inclusion of a good faith obligation in the Code as the 'holy grail
of franchise relationship reform'.[11]
He considered that a more appropriate response to specific and substantiated
problems in the sector would be a targeted response.[12]
8.10
The Australian Competition & Consumer Commission (ACCC) noted that
there was a 'degree of uncertainty' about a statutory obligation to act in good
faith, and it would be difficult to independently define or reduce to a 'rigid
rule':
... if an obligation to act in good faith were included in the
code, the meaning of good faith would have to be considered separately in each
case depending on its particular facts. This may introduce ambiguity and
confusion about the rights and responsibilities of franchisors and franchisees,
and potentially increase disputes and conflict among franchising participants.[13]
8.11
The National Retail Association (NRA) opposed the explicit inclusion of
a good faith clause in the Code:
An implied duty of good faith may already exist in the common
law and the concept continues to evolve as courts decide relevant matters. The
Auto Masters case found, for example, that the precise nature of any good faith
obligation depends on the circumstances of the case and the context of the
contract as a whole. NRA doubts whether much benefit will accrue from the
introduction of a statutory concept of "good faith" and suggests that
the more sensible course would be to allow the current legal processes to continue
to resolve argument around the concept.[14]
8.12
DLA Phillips Fox concurred:
...the current state of our common and statutory law provide
adequate protection and any attempt to introduce an explicit good faith
obligation into the Code may not only be unnecessary but an unfortunate
legislative indication that 'good faith' has a different meaning as currently
understood, applied and continually further developed by our Courts.[15]
8.13
In addition to potentially creating legal uncertainty, there were
concerns that an explicit good faith clause in the Code may add to the
expectation gap in franchise relationships:
I think it would significantly increase the expectation gap. I
am not sure whether that is a wise thing to do. The expectation gap is
significant at the moment....
...On top of the prescriptive requirements of the Franchising Code
of Conduct and of the relatively low threshold of misleading and deceptive
conduct, that is, have you been honest or have you been dishonest, layer on top
of that this somewhat hazy, woolly concept of good faith, and all I can say to
you is that we will end up having is an increased expectation gap where people
will say, ‘But I believe that the franchisor did not act in good faith, and the
ACCC wouldn’t deal with it.’[16]
8.14
The Law Society of Western Australia stated that, as a franchise
agreement contains an implied duty of cooperation and good faith is generally
implied in contract law, 'each party will normally be expected to act in good
faith towards the other'.[17]
8.15
Ms Deanne de Leeuw, who detailed her experiences as a franchisee, argued
that 'the lack of Good Faith and Goodwill provisions within the Code enable
franchisors to act unethically, protected by the franchise contract'. She
observed that many franchisees believe that franchisors will act in good faith
towards them when they enter franchise agreements, but the 'implied' duty
'means little if a franchisor acts in an abusive or opportunistic manner
towards them'.[18]
8.16
The Motor Trades Association of Australia (MTAA) expressed concern at
the apparent ability of franchisors to effectively 'write out' an implied duty
to act in good faith through an express clause in the contract. While it has
been argued that franchisees do not have to sign up to an agreement containing
such a clause,[19]
the MTAA submitted that 'due to the bargaining power imbalance, the franchisee,
as the more vulnerable party to the agreement, will continue to voluntarily
enter into agreements despite the existence of unfavourable terms and clauses.'[20]
For this reason, the MTAA argued, 'legislation should intervene to set the
minimum standard of conduct to protect the parties to the franchise agreement.'[21]
8.17
IndCorp Franchisees' Association of Australasia argued that currently,
the concept of good faith is arbitrary and determined by whoever is in charge
at the time:
The problem that I think we have with the good faith, especially
with a company that is an American-based company, is that good faith is
determined by whoever seems to be captaining the ship at the time...so good faith
is determined at the time by whatever that person determines is good faith, not
by any set guidelines as to what good faith should entail.[22]
8.18
This view was supported by Mr Tony Piccolo MP, Member of the South
Australian Economics and Finance Committee:
The reason we say it should be ‘explicit’ is that it is implied
in law already. Given that it is implied in law, the difference between it
being an implied provision and an explicit provision is that an implied
provision can actually be written out. It is still there but it has to be
fought for in the courts. An explicit provision states up front the standard of
behaviour we require.[23]
8.19
In contrast, Professor Terry argued that an 'open-ended obligation of
good faith' would invite disputation, as there is 'no scope for good faith in
the face of express contractual provisions':
Good faith basically hangs off contractual provisions to make
sure that those contractual powers are not exercised in a capricious manner.
Good faith is not going to solve the problem.[24]
8.20
The Shopping Centre Council of Australia (SCCA) concurred with Professor Terry's
position, arguing that:
Good faith, as developed by the courts, needs to be understood
in that context, because it is only limited, it is only case specific and it is
only in that context and it is not contrary to the express words. You need a
surrounding contract and you need a common purpose to in fact imply such a
term.[25]
8.21
In not objecting to an express provision of 'good faith' being included
in the Franchising Code, without first seeing how it is defined and then implemented,
Australia Post could not see how it would materially advance the interests
of franchisees.[26]
This position was supported by the Federal Chamber of Automotive Industries who
argued that 'to introduce a statutory concept of "good faith and fair
dealing" into the Code is unnecessary and would not add any certainty or
clarity to the rights of franchisors or franchisees.'[27]
8.22
The Law Council of Australia Trade Practices Committee, Business Law
Section, drew upon the current case law to support their claim that:
Australian Courts have recognised that a franchise agreement
includes an implied term requiring parties to act in good faith and reasonably,
and not to act capriciously or for some extraneous purpose.[28]
8.23
However, they also noted that the courts had made clear that the implied
duty did not require franchising parties to act against their legitimate
business interests consistent with the terms of the agreement, but were
uncertain whether an express obligation to act in good faith would be
interpreted in the same way.[29]
8.24
The MTAA argued that the interdependent nature of the franchising
relationship, in which the 'long-term success of one party is reliant on the cooperation
and performance of the other', requires a 'greater degree of consideration with
respect to the "good faith" in dealings between parties.'
...the usual commercial conduct of 'acting at arms length' and the
'pursuit of individual interests' can not be expected or tolerated by the
parties to a franchise agreement. Rather, the franchise relationship should be
co-operative, enduring and guided by the principle of good faith.[30]
8.25
The Franchise Council of Australia (FCA) rejected the claim that an
express clause would merely reflect the implied duty to act in good faith that
currently exists:
There has been no rational argument advanced to justify the
introduction of a new statutory obligation to act in good faith, and no effort
made to define such a term. Rather the proposal has been misrepresented as a
codification of the existing law, or a simple change that will have minimal
effect. This is not the case.[31]
8.26
However, the FCA subsequently conceded:
... we are concerned that the definition is appropriate. If, for
example, there were simply a reiteration of the current implied position so
that it were said that in the conduct of the franchise relationship the parties
will act in good faith, or something like that, then that is just a repeat of
the current state of the law. If you are asking, ‘Would the FCA object to
repeating the current state of the law and the statutory framework?’, I think
the answer to that would be, no. Our concern is extending it.[32]
8.27
According to Associate Professor Frank Zumbo, an explicit good faith
provision would set the standard of conduct expected of franchising parties:
...the concept of good faith has not only received strong judicial
support, but now has reached the point in Australia where its nature and scope
is being defined with an increasing degree of precision. Consequently, there is
a ready body of law on which a statutory duty of good faith could quite readily
and usefully draw upon in seeking to promote ethical business conduct.[33]
A statutory duty of good faith would represent a positive
statement of what is considered ethical conduct within a franchising context
and provides an appropriate and well accepted benchmark of appropriate
standards of ethical behaviour. This is particularly relevant in a franchising
relationship given the inter-dependency of the franchisor and franchisee. The
ongoing success of the relationship requires that they act in a mutually
respectful and cooperative manner throughout the course of the relationship. A
statutory duty of good faith would set out the boundaries of acceptable conduct
in a positive manner for the benefit of both franchisors and franchisees.[34]
8.28
This view was supported by Mr Piccolo MP, who claimed that in addition
to making the current law easier to enforce, requiring the parties to a
franchise agreement to act in good faith would also promote 'business integrity
and ethics'.[35]
8.29
An express good faith obligation would also be consistent with the
policy objectives for which the Code was established.[36]
Good faith in section 51AC of the Trade Practices Act
8.30
The extent to which a party has acted in good faith is already a factor
to be taken into account by courts in determining whether conduct is considered
to be unconscionable under section 51AC of the Trade Practices Act (TPA).
8.31
The FCA stated that 'at a conceptual level the Code supports the basic
principles of freedom of contract, but provides additional specific protection
beyond the already powerful remedies of misleading or deceptive conduct and
unconscionable conduct contained in the Trade Practices Act'.[37]
DLA Phillips Fox also submitted that the interrelation between the Code and
the relevant parts of the TPA as they apply to franchising are 'robust and
broad enough in scope and application to provide adequate protection to
franchisees'.[38]
8.32
Competitive Foods Australia Pty Ltd (CFAL) maintained that the Code and
section 51AC of the TPA were inadequate in preventing unethical or 'rogue'
franchisors, who did not act consistently with accepted industry norms and
practices, from 'abusing their stronger bargaining and contractual powers to
the disadvantage of franchisees'.[39]
The MTAA also rejected the argument that the existence of good faith in section
51AC of the Trade Practices Act provided sufficient protection to franchising
parties:
...the reference to good faith is not sufficient for the
requirements under the Code, as the unconscionability provision of the TPA is a
difficult benchmark to meet. Often the conduct of franchisors, whilst
significantly detrimental to a franchisee, may fall short of the scope of 51AC.[40]
8.33
Mr Robert Gardini concurred with this view, noting legal advice he had
received that a motor dealer agreement that allowed termination at will with 12 months
notice fell outside the scope of section 51AC because 'the conduct of the
distributor was within the confines of its original contractual rights under
the agreement and not in breach of the Code.'[41]
He submitted:
...section 51AC has an extremely high benchmark and distributors
operating within their contractual rights will prima facie fall short of
breaching the unconscionability provisions.[42]
8.34
The Motor Traders Association of NSW also submitted that the current
regulatory framework was inadequate, noting that the TPA's unconscionability
provisions have 'eluded objective interpretation'. Concepts of 'good faith'
and 'fair dealing' other than 'peripheral mention in section 51AC of the TPA,
had also 'eluded general application to franchise legislation in Australia'
despite being introduced in international jurisdictions.[43]
8.35
The Franchisees Association of Australia (FAA) was critical of the
limitations of considering good faith when interpreting section 51AC:
The current 51AC has characteristics which are listed as (a)
through (k) to help identify contributing elements to unconscionable conduct,
but the courts seem to take the view of guidance from the phrase “in all the circumstances”
as meaning all elements, not just some, or the majority, must be present.
Clearly there is a gross failure of the intent of
‘unconscionable conduct’ under current Trade Practice Laws. The FAA requests
that Section 51AC should be redrafted and then re-tested by the ACCC so that a
fairer balance is obtained.[44]
8.36
The Australian Competition & Consumer Commission (ACCC) advised that
there is a difference between unfair and unconscionable conduct and that, while
not designed to prohibit merely unfair conduct, section 51AC:
...recognises there may be an inequality of bargaining position in
arrangements between small business and larger, more powerful organisations
(such as large franchisors), and aims to afford small businesses protection
from exploitation from a stronger party. This exploitation, however, must go
beyond normal hard commercial dealings to be unconscionable conduct.[45]
8.37
Yum! Restaurants Australia (YRA) also commented on whether
unconscionable conduct provisions should be extended to 'unfair' conduct. It
noted that franchisors make decisions not only in their own interest but also
in the interest of the franchise system as a whole. YRA observed:
In a business setting, things can and do happen which may seem
"unfair" from one person's perspective but which clearly are not
fraudulent, abhorrent or beyond all good conscience. Any attempt to prevent
businesses from exercising their business judgment within these bounds would be
inappropriate and could seriously impact the development of the industry in
question.[46]
8.38
While noting the intention of the unconscionable provisions in the TPA
was to provide a level playing field for commercial parties of different sizes
and bargaining strengths, Ms de Leeuw observed that 'the lack of clarity
surrounding its definition has meant that it is rarely used and is therefore
ineffective.'[47]
8.39
Post Office Agents Association Ltd (POAAL) suggested that the inclusion
of an explicit good faith clause in the Code would give the franchisee
'something to point to' and, while not necessarily stronger than the current
requirements, 'would be more immediate and certainly be cheaper'.[48]
8.40
Ms Jenny Buchan noted that although the absence or presence of good
faith is a factor courts may consider when determining whether conduct has been
unconscionable, this was 'not the same as imposing a mandatory requirement that
business relationships that fall under 51AC must be entered into,
conducted or prematurely terminated with good faith by all parties.'[49]
Defined versus general good faith
8.41
While there was general support among franchisees for the inclusion in
the Code of a broad requirement to act in good faith, some considered that good
faith should be defined.
8.42
Professor Warren Pengilley supported a general obligation on franchising
parties to 'disclose material facts and act in good faith'.[50]
This could be accomplished by either a short statement to the effect that
'parties shall deal in utmost good faith' or a more expansive statement such as
the one found in a Texas Bill, namely:
The franchisor and franchisee shall prior and subsequent to the
execution of a binding franchise or other agreement have the mutual obligation
to deal fairly, openly, honestly and in good faith and to exercise reasonable
care and diligence in complying with all provisions of the franchise and other
agreements between them.[51]
8.43
Professor Pengilley argued that:
...a requirement that parties act in good faith...would cover any
omissions in legal remedies which may exist. It would fulfil much the same role
as s.52 of the Trade Practices Act (i.e. as an overarching provision to cater
for conduct not within other black letter law prohibitions).[52]
8.44
The FCA expressed concerns about the potential scope of an undefined
good faith clause. Early in their appearance before the committee they said
that without a 'precise description' a good faith clause would have the effect
of inviting legal argument about its meaning and application, especially with
respect to the end of the term of a franchising agreement.[53]
The committee notes, however, that the FCA later indicated that they would not
object to a good faith clause that simply reiterated any existing implied
common law requirement to act in good faith (see paragraph 8.26).
8.45
The Motor Traders Association of NSW concluded that, while the requirement
to act fairly and in good faith would be hoped to cure current deficiencies, in
reality 'terms such as these will import a subjective element to conduct
assessment which will be a breeding ground for disputes'. It suggested that it
was necessary, therefore, to underpin these concepts with an 'objective
proscription of categories of conduct which are regarded as inappropriate.'[54]
8.46
Professor Andrew Terry also supported the need to provide a clear
definition of good faith:
If there is to be an obligation of good faith enshrined in the
Franchising Code of Conduct, I strongly impress on the committee the importance
of trying to spell out what good faith means rather than just throwing the
general motherhood, feel good sort of statement up there and probably giving
false hope to a lot of franchisees that now they are protected by an obligation
of good faith and can pay less attention to education, due diligence or talking
to other franchisees.[55]
8.47
7-Eleven Stores argued that as there is no 'concluded definition of
"good faith" in the Trade Practices Act or the law, a requirement for
franchisors and franchisees to act generally in good faith would not assist the
franchise relationship'. They suggested instead that if a duty of good faith
is included in the Code it should be on the following basis:
(a) it is imposed in a way that does not derogate from otherwise
lawful terms of franchise agreements but only to assist the parties exercise
them;
(b) the duty applies equally to Franchisees and Franchisors;
(c) the duty is defined in some way. For example, “good faith
means the Franchisee and Franchisor cooperating to achieve the objects of the
franchise agreement honestly and in compliance with reasonable standards of
conduct” (adopted from Sir Anthony Mason “Contract, good faith and equitable
standards in fair dealing” (2000) 116 LQR66 (2000)); and
(d) the duty applies to discreet aspects of the
Franchisee/Franchisor relationship and not generally. For example, “the
prospective Franchisee and the Franchisor will negotiate in good faith in
relation to the renewal of the franchise agreement”.[56]
8.48
CFAL sought to define the concept of good faith as a proposed new
section of the Code.[57]
The draft provisions, modelled on the standards of conduct outlined in clause
12 of the 1993 voluntary code of conduct, would provide in part that:
23A Obligation to act in good faith
-
A franchisor and a franchisee shall act towards each
other in good faith in the exercise of any rights or powers arising under, or
in relation to, a franchise or the renewal of a franchise.
-
For the
purposes of sub-clause (1), good faith in relation to conduct by a franchisor
or a franchisee means that the party has acted:
-
honestly
and reasonably; and
-
with
regard to the interests of the other parties to the franchise,
in all the circumstances, including without limitation:
-
the
commercial and business objects of the franchise;
-
the
legitimate business interests of each of the parties, and what is reasonably
necessary for the protection of those interests;
-
the
respective financial and non-financial contributions made by each of the
parties to the establishment and conduct of the franchised business;
-
the
risks taken by each of the parties in the establishment and conduct of the
franchised business;
-
the
alternative courses of action available to the parties in respect of the matter
under consideration; and
-
the
usual practices in the industry to which the franchise relates.[58]
8.49
Yum! Restaurants Australia Group (YRA) did not, in principle, oppose a
statutory definition of good faith. However, in recognising that good faith
generally means 'acting honestly and reasonably during the course of the
relationship', YRA made the following observation:
The principal criteria YRA would place upon a legislative
concept of good faith is that it must be sufficiently certain and it must not
unduly interfere with the contractual rights of the parties. These are not
inconsiderable hurdles to overcome...it is not an easy concept to define without
risky imposition upon the ordinary operation of business in a market-based
economy.[59]
8.50
YRA addressed the relative merits of a general versus a defined
obligation to act in good faith, noting that a general statutory duty to act in
good faith would confirm that good faith is imported into franchise agreements
but it would not remove uncertainty surrounding its meaning. It would, however,
enable the concept to 'develop organically and incrementally, based on actual,
rather than hypothetical scenarios'. [60]
Alternatively, achieving greater certainty via a specified set of factors would
depend on the factors chosen and on whether they were proscriptive or allowed
for discretionary decision making.[61]
Implications for current agreements and other sectors
8.51
Several submissions raised concerns about the possible effect that the
inclusion in the Franchising Code of Conduct of an express obligation to act in
good faith would have on existing agreements and other commercial arrangements.
8.52
The FCA cautioned that the lack of an authoritative High Court decision,
combined with a duty to act in good faith that did not 'clearly and precisely'
address its content, would be 'highly undesirable' and would have wider
implications beyond the franchise sector:
... the imposition of a statutory good faith obligation would
discriminate unfairly against franchising when compared to distribution,
licensing, agency, joint venture and other commercial arrangements. The current
law strikes a sensible balance, and provides greater certainty.[62]
8.53
For similar reasons, Ms Buchan suggested consideration should be given
to inserting a good faith requirement into Part V Division 2 of the TPA to make
it a requirement for all consumer contracts:
If a requirement of good faith is inserted into the Code the
risk is that, by deduction, good faith is not required in other consumer
contracts as it is franchise contracts that have been singled out for imposing
the obligation.[63]
She noted that:
For me there are risks in inserting good faith in the code and I
suppose the risk is that, in that twisted way that we lawyers operate, it might
be interpreted that it is not so important in non-franchise agreements.[64]
8.54
The MTAA considered that the inclusion of the explicit provision would
'have very serious moral and educative benefits for any agreements on foot'.[65]
The MTAA did not consider that the inclusion of a good faith provision into the
Code would have a retrospective impact in terms of existing contracts, except
where the implied term had been excluded from the contract:
If you said that it was a simple description of good faith, the
impact on existing agreements would be to say that the courts already imply a
term of good faith into those agreements. So it would be just providing
statutory backing to the implied term that already exists....However, it might
apply to some agreements where that implied term had been excluded from the
agreement.[66]
8.55
In relation to the implications for existing contracts, CFAL sought
advice on whether the inclusion into the Code of provisions relating to good
faith and fair dealing would involve any retrospective alteration to existing
franchise agreements.[67]
Mr Robertson SC advised:
In my opinion such an amendment would be unlikely to be regarded
by the courts as involving a retrospective alteration of existing franchise
agreements....
There is a distinction to be drawn between conduct, on the one hand,
and contract on the other. To regulate future conduct does not involve the
retrospective alteration of the contract pursuant to which that conduct will be
or might otherwise would be engaged in.
In my opinion therefore any such amendment would do no more than
regulate future conduct of existing franchisees and franchisors.[68]
Committee view
8.56
The committee is of the opinion that the optimal way to provide a deterrent
against opportunistic conduct in the franchising sector is to explicitly
incorporate, in its simplest form, the existing and widely accepted implied
duty of parties to a franchise agreement to act in good faith.
8.57
The committee notes that a number of submissions recommended specific
changes to the Code to address a range of opportunistic conduct. While some of
these recommendations may warrant further investigation, the diverse nature of
the franchising sector presents the potential problem that a specific change,
while beneficial for one system, may have unintended consequences for another.
8.58
The committee envisages that the role the insertion of 'good faith' in
the Code will have on termination and renewal is to ensure that what has
already been stated in the courts will be uppermost in franchisors' minds when
contemplating non-renewal or termination without breach—that is, that any
decision to do so should not be made capriciously and without consideration for
the reasonable rights of the other party to the agreement.
8.59
The express obligation to act in good faith is not designed to alter the
current rights of franchisors to maintain control over the integrity of their
brand. It will, instead, provide a clear, overarching statement of expectation
as to the standard of conduct that should be adopted by franchisors, franchisees
and prospective franchisees.
Recommendation 8
8.60
The committee recommends that the following new clause be inserted into
the Franchising Code of Conduct:
6 Standard of Conduct
Franchisors, franchisees and
prospective franchisees shall act in good faith in relation to all aspects of a
franchise agreement.
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