The Franchising Code of Conduct (Code) imposes numerous obligations on franchisees and franchisors that can be difficult to navigate.
Section 18 of the Code applies the common law good faith obligation on parties to a franchise. What this obligation requires can be nebulous. This article reviews how the courts have interpreted this requirement and its practical implications for businesses.
1. Paciocco v ANZ Banking Group Ltd (2015) 321 ALR 584
Although not a franchising case Paciocco v ANZ Banking Group Ltd, the most recent High Court case which considered what the obligation of good faith entails, saw the court say that it means:
‘an obligation to act honestly and with fidelity to the bargain; an obligation not to act dishonestly and not to act to undermine the bargain entered or the substance of the contractual benefit bargained for; and an obligation to act reasonably and with fair dealing having regard to the interests of the parties (which will, inevitably, at time conflict) and to the provisions, aims and purposes of the contract, objectively ascertained’.
What each of these obligations mandate in practice, however, is situation specific.
The below three cases illustrate how the good faith obligation has been applied in the context of franchises.
2. Burger King Corporation v Hungry Jack’s Pty Ltd [2001] NSWCA 187
This case concerned a franchise between Burger King Corporation (Burger King), as franchisor, and Hungry Jack’s Pty Ltd (Hungry Jack’s) as franchisee, granting it the non-exclusive right to operate Burger King restaurants in Australia.
Under a development agreement between the parties, Hungry Jack’s was required to open four new restaurants each year in Western Australia, South Australia and Queensland. However, the granting of operational, financial and legal approval was within the ‘sole discretion’ of Burger King.
With aspirations of expanding its own direct participation in the Australian market, Burger King withheld consent for Hungry Jack’s to open further restaurants.
Critically, this meant that Hungry Jack’s was unable to meet its obligations to open four new stores annually. On this basis, Burger King terminated the agreement.
The issue before the court was whether Burger King was in breach of an implied term of good faith by preventing Hungry Jack’s from complying with its contractual obligations.
The court held that the duty of good faith requires that a party ‘not act capriciously’ or for purposes extraneous to a contract, but does not prevent a party taking action to promote its ‘legitimate interests’, provided it acts reasonably in the circumstances.
In applying these principles, the court found that Burger King had breached its duty of good faith by ‘thwart[ing]’ Hungry Jack’s’ rights in an attempt to ‘take back the market’.
This was considered an extraneous purpose that undermines each aspect of good faith as identified in Paciocco.
3. Far Horizons Pty Ltd v McDonald’s Australia Ltd [2000] VSC 310
Far Horizons Pty Ltd (Far Horizons), a McDonald’s Australia Ltd (McDonald’s) franchisee, sought damages for breach of good faith after McDonald’s opened new stores 800 metres and 4.5 kilometres from Far Horizons’ restaurants.
Consistent with the previously mentioned decisions, the court held that there was no breach of good faith merely because McDonald’s actions were adverse to the interests of Far Horizons and that something more is required to prove breach.
This is particularly the case where the franchisor can justify their actions based on bona fide system-wide considerations.
The court left open the question of whether conduct by a franchisor that ‘effectively destroys’ the business which the franchisee bargained for by entering the franchise agreement would be in breach of good faith. It indicated that the issue would ultimately fall on whether the degree of impact is so substantial to give rise to the inference that it was for an extraneous purpose.
4. Virk Pty Ltd (in liq) v YUM! Restaurants Australia Pty Ltd [2017] FCAFC 190
In 2014, Yum! Restaurants Australia Pty Ltd (Yum), Pizza Hut’s Australian franchise, implemented of a policy to decrease prices of pizzas sold by franchisees. As a part of the policy, Yum exercised contractual rights to set maximum prices of pizzas, thereby reducing the price of pizzas from $9.95 to $4.95 or from $11.95 to $8.50.
Numerous franchisees complained that they would not be able to financially survive with such pricing and argued that in implementing the policy, Yum had breached its obligation of good faith.
The Full Court of the Federal Court ultimately held that Yum had not breached its obligations of good faith.
In reaching this conclusion, the court considered that the obligation of good faith does not require a party to produce a reasonable outcome, but only mandates that the quality of their conduct is reasonable, such that they must not act in a way that is ‘capricious, dishonest, unconscionable, arbitrary or [the] product of a motive which was antithetical to the object of the contractual power’.
In reaching a conclusion in relation to good faith, a court will consider the defendant’s ‘real intention or purpose’.
Therefore, this case illustrates that there can be no breach of an obligation of good faith merely because a policy by one party has a negative impact for another. Instead, parties will be in breach of the obligation where the quality of their conduct is in bad faith, either in the way they conduct themselves or the interests that they seek to promote.
Similarly, the court confirmed that the good faith obligation does not extend to an obligation to ‘make decisions that only resulted in success and more profits for the Franchisees’.
What good faith applies to your franchise
How the good faith obligation affects a franchise will ultimately turn on the nature of the franchise, the terms of the specific franchise agreement and the conduct engaged in by the parties.
Whether a party acted for an extraneous purpose is to be determined according to what the parties agreed.
While these cases provide some guidance in relation to the judicial interpretation of good faith obligations, the requirement remains innately broad and ambiguous. Navigating the requirements therefore requires a comprehensive consideration of the facts of a matter.
Sladen Legal is happy to assist in breaking down a party’s good faith obligations. If you have any queries regarding how your business is affected by the requirements, please feel free to contact us.
If you would like to discuss this further please contact:
Alicia Hill
Principal
T: +61 3 9611 0180 | M: +61 484 313 865
E:ahill@sladen.com.au
This article was prepared with the assistance of Charlie Cooper, Law Clerk.
This article was originally published on the Sladen Legal website: Good faith in franchising: how far does it stretch?
