franchising relationship

Good faith in the franchising relationship

16 March 2016

Key points

  • Parties to a franchise agreement should always act honestly in exercising powers and performing obligations under the agreement and the Franchising Code of Conduct
    • Actions taken in pursuit of an ulterior purpose which do not attempt to achieve the purposes of the franchise agreement are likely to lack good faith
    • A common situation involving a lack of good faith is the issuing of default notices with a view to swift termination—a franchisor should clearly set out the nature and circumstances of the alleged breach and how it can be remedied, and the parties should attempt internal complaint-handling, Code complaint-handling, and mediation prior to termination

    Under the Franchising Code of Conduct (Code) parties to a franchise agreement, and those who propose to enter into a franchise agreement, must act towards each other ‘with good faith’. Those who breach the obligation could be liable for penalties of up to $54,000.1 But what exactly does this obligation of good faith entail? What conduct should franchisees and franchisors avoid, and what steps should they take?

    When the good faith obligation applies

    The obligation of good faith applies to any matter arising under the Code or a franchise agreement.2 Prospective franchisees and franchisors must also act in good faith in the negotiation of a proposed agreement and any dealing or dispute relating to the proposed agreement.3

    In some cases, the duty of good faith may also extend to conduct after a franchise agreement comes to an end. For example, restraint of trade clauses will often survive the end of the franchise agreement for a period of years, in which case parties will be required to perform these obligations in good faith.

    The Code does not define ‘good faith’ other than to provide that it has the meaning given to it by the unwritten law from time to time.

    Principles of good faith

    Good faith is largely situation-specific: it is not possible to define precisely what will constitute good faith or a lack of good faith in all circumstances.4 However, the Code and the common law set out minimum standards of good faith, principles which can be used to guide the conduct of those bound by the duty.

    Acting honestly and reasonably and not arbitrarily

    A party risks breaching its duty of good faith where it exercises its contractual powers and discretions, or performs its contractual obligations, unreasonably.5  Provided the party exercising the power acts reasonably in all the circumstances, the duty to act in good faith will ordinarily be satisfied.6

    Cooperating to achieve the purposes of the agreement

    A person who acts in pursuit of some ulterior purpose and not for the purposes of the agreement will probably not be acting in good faith. For example, a franchisor who wishes to terminate a franchise agreement in order to minimise its administrative costs must not artificially create the opportunity to terminate by serving the franchisor with default notices which do not have a firm basis in fact.

    The duty of good faith does not prevent a person from acting in his or her legitimate commercial interests

    Franchisees and franchisors are not required to prefer another party’s interests to their own or to subordinate their own self-interest, and each party remains entitled to act in its own best interests. This is one of the key differences between a duty of good faith and a fiduciary duty.

    The duty of good faith is not intended to impede the performance of the contract, but rather to aid and further the explicit terms of the agreement—good faith is breached only when one party seeks to prevent the contract’s performance or to withhold its benefits. As a result, it ensures that parties to a contract perform the substantive, bargained-for terms of their agreement.[7]

    A recent example: Marmax Investments Pty Ltd v RPR Maintenance Pty Ltd8

    Spanline Weatherstrong Building Systems Pty Ltd, a franchisor engaged in designing, manufacturing and selling home extensions (e.g. patios, roof awnings, covered verandas, and carports) gave permission to one of its franchisees (Marmax) to conduct business within the territory of another franchisee (RPR).

    In the Federal Court, RPR claimed that Spanline, as franchisor, had breached an implied obligation of good faith and fair dealing by allowing Marmax to operate in RPR’s territory.

    The Federal Court agreed with RPR, finding that that Spanline breached the implied terms of those agreements relating to good faith, fair dealing and providing the other party with the benefit of the agreements. The primary judge found that Spanline did so by not taking “reasonable and available steps” to protect RPR’s exclusivity and by impermissibly and clandestinely giving permission to Marmax to do work within RPR’s territory.9

    However, on appeal, the Full Federal Court disagreed with the primary judge on the scope of the implied obligation of good faith. The Full Court found that the implied duty of good faith did not require anything more of Spanline than the duty to cooperate,10 and did not require Spanline to take “reasonable and available” steps to ensure that RPR’s territory remained exclusive.11

    1 The Code s 6(1).
    2 The Code s 6(1).
    3 The Code s 6(2).
    4 Warren CJ has described the standard of conduct set by the duty of good faith as “nebulous”, and referred to the inherent “vagueness and imprecision” in defining “commercial morality”: Esso Australia Resources Pty Ltd v Southern Pacific Petroleum NL & Ors [2005] VSCA 228 at [3].
    5 ‘whether the party acted honestly and not arbitrarily’ is one of the factors to which a court may have regard when determining whether a party to a franchise agreement has breach its duty of good faith: the Code s 6(3)(a).
    6 Garry Rogers Motors (Aust) Pty Ltd v Subaru (Aust) Pty Ltd at 43,014 per Finkelstein J.
    7 Metropolitan Life Insurance v RJR Nabisco Inc 716 F Supp 1504 (1989) at 1517 cited in Marmax Investments Pty Ltd v RPR Maintenance Pty Ltd [2015] FCAFC 127 at [145].
    8 [2015] FCAFC 127. We have discussed this case previously, see [LINK].
    9 RPR Maintenance Pty Ltd v Marmax Investments Pty Ltd [2014] FCA 409 at [210] per Griffiths J.
    10 At [150].
    11 At [161].

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