Good Faith in Franchising: What Franchisees and Franchisors need to know

‘Good faith’ is a key obligation in Australian Franchising law; applying to both franchisors and franchisees. While the concept of ‘good faith’ is well established, its practical scope remains one of the most challenging aspects of franchise regulation.

Section 18 of the Franchising Code of Conduct (Code) imposes a good faith obligation on parties to a franchise. However, what is meant by ‘good faith’ is largely unclear. Courts have therefore been called upon to determine the meaning of good faith and the circumstances in which a party’s conduct may amount to a breach of that obligation.

While not a decision involving a franchise, the High Court in Paciocco v ANZ Banking Group Ltd (2015) 321 ALR 584, considered what is required to meet the standard of acting in ‘good faith’, describing it as:

‘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 times conflict) and to the provisions, aims and purposes of the contract, objectively ascertained.’

Importantly the obligation to act in ‘good faith’ does not require a party to subordinate its own legitimate commercial interest to those of the other party. Rather requiring that contractual powers be exercised reasonably, honestly and for a proper purpose.

Below are further examples of how Courts have interpreted the requirement of ‘good faith’ and its implications for businesses.

1. Far Horizons Pty Ltd v McDonald’s Australia Ltd [2000] VSC 310

Far Horizons Pty Ltd (Far Horizons) was a McDonald’s Australia Ltd (McDonald’s) franchisee, operating two stores – one at Fountain Gate Shopping Centre, and one in Endeavour Hills in Melbourne.

McDonald’s granted licenses for two new stores, one being 800 metres from Far Horizons Fountain Gate store, and one 4.5 kilometres from Far Horizons Endeavour Hills store.

Far Horizons sought damages for a breach of an implied duty to act honestly, fairly and in good faith on the basis that in granting licenses to franchisee’s who would be in direct competition with Far Horizons, McDonald’s had breached that duty.

Despite the impact these licences were likely to have on Far Horizons’ profitability, the Court held that a franchisor acting contrary to the interests of a franchisee will not necessarily constitute a breach of good faith, particularly where the franchisor has considered the decision at a system-wide level.

Importantly, this case left open the possibility that if a franchisor ‘effectively destroys’ the business of the franchisee, a breach of the good faith obligation may be found. However, such a finding would turn on whether the failure of the business could be linked to any separate cause, and whether the degree of impact is so substantial its gives rise to any inference that it was for an extraneous purpose.

2. Virk Pty Ltd (in liq) v YUM! Restaurants Australia Pty Ltd [2017] FCAFC 190

Yum! Restaurants Australia Pty Ltd (Yum), Pizza Hut’s Australian franchise, granted a franchising license to Virk Pty Ltd (Virk). Yum exercised its contractual rights to set the price of pizzas – reducing the price of pizzas from $9.95 to $4.95, and from $11.95 to $8.50.

Subsequently, numerous franchisees argued that these reductions would render their businesses unviable, and that Yum had thus breached its obligation to act in good faith.

In reaching its decision, the Court considered the defendants ‘real intention or purpose’. Maintaining that good faith does not require the outcome to be reasonable, but rather, that the quality of the conduct must be reasonable so as to 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’.

Ultimately, the Full Court and Federal Court held that Yum had not breached its obligations of good faith, the case supporting the view in Far Horizons Pty Ltd v McDonald’s Australia Ltd that there is no breach of the good faith obligation where the policy of the franchisor has a negative impact for the franchisee. Rather, the obligation to act in good faith will only be breached where the quality of the conduct is in bad faith. Such a finding may be made on the basis of either the interests they are promoting, or the way in which they have conducted themselves. As such, franchisors are not obliged to ‘make decisions that only [result] in success and more profits for [their] franchisees’.

3. Burger King Corporation v Hungry Jack’s Pty Ltd [2001] NSWCA 187

Burger King Corporation (Burger King) granted Hungry Jack’s Pty Ltd (Hungry Jack’s) a non-exclusive licence to operate Burger King restaurants in Australia.

Pursuant to this agreement, Burger King had ‘sole discretion’ in relation to operational, financial and legal decisions in relation to Hungry Jack’s development. A development agreement (DA) between Burger King and Hungry Jacks stipulated that Hungry Jack’s was required to open four new restaurants each year in South Australia, Western Australia and Queensland.

As Burger King looked to participate directly in the Australian market however, they withheld their consent for Hungry Jack’s development of future restaurants with the result that Hungry Jack’s was unable to fulfil its obligation to open four new stores annually.

As this was in breach of the DA, Burger King terminated the agreement.

In contrast to the above decisions, Burger King’s conduct had directly prevented Hungry Jack’s from complying with its obligations under the DA, and thus, the Court was required to consider whether this genre of conduct was compliant with the good faith obligation.

While it was held that a party taking action to promote its own ‘legitimate interests’ will not necessarily be considered as in ‘bad faith’ provided they have acted reasonably in the circumstances, it was also noted that a party must not ‘act capriciously’ or for purposes extraneous to a contract.

Based on these principles, the Court found that Burger King had breached its obligation to act in good faith by looking to ‘thwart Hungry Jack’s’ rights in an attempt to take back the market’.

This is an important decision as it illustrates the operation of how considerations of what interests the franchisor is promoting, and what the quality of their conduct is in making those decisions, impact whether they have acted in breach of their obligations.

How good faith applies to you

How the concept of ‘good faith’ applies is dependent upon the contractual agreement, the nature of the conduct of the parties, and the intentions underpinning decisions – which are unique in each arrangement.

The above decisions illustrate some of the core principles and provide commentary on how Courts have interpreted the requirement to act in ‘good faith’.

If you require guidance on how your business is affected by these requirements, please contact:

Alasdair Woodford
Principal
T: 03 5225 5217 | M: 0436 456 144
E: awoodford@ha.legal

Joseph Flanagan
Senior Associate
T: 03 5226 8504 | M: 0491 307 550
E: jflanagan@ha.legal

Tayla Berger
Senior Associate
T: 03 5226 8559 | M: 0407 825 365
E: tberger@ha.legal

This article was prepared with the assistance of Phoebe Tol, Law Clerk.