Acting in good faith

Under the Franchising Code of Conduct, parties who enter, or propose to enter, into a franchise agreement must act in good faith towards one another. This means that both current and prospective franchisees and franchisors must act in good faith in their business dealings with each other.

Good faith

Although the Code does not define exactly what good faith means, it does state that the obligation of good faith is to reflect historical judge-made law (known as the ‘common law’).

Under common law, good faith requires parties to an agreement to exercise their powers reasonably and not arbitrarily or for some irrelevant purpose. Certain conduct may lack good faith if one party acts dishonestly, or fails to have regard to the legitimate interests of the other party.

Australian courts have found business dealings to be not in good faith when they involve one party acting for some ulterior motive, or in a way that undermines or denies the other party the benefits of a contract.

The Code outlines certain matters that a court may consider when determining whether a party has acted in good faith. These matters are whether the party:

  • acted honestly and not arbitrarily
  • cooperated to achieve the purposes of the agreement.

A court can also take into account other matters it considers relevant.

Obligations

The obligation to act in good faith applies to any matter arising in relation to the code or a franchise agreement. The obligation extends to all aspects of the franchising relationship, including:

  • pre-contractual negotiations
  • performance of the contract
  • dispute resolution
  • the end (including termination) of an agreement.

The obligation to act in good faith may also extend to conduct after a franchise agreement comes to an end. For example, if a franchise agreement imposes obligations that will continue after the agreement has ended, the franchisor or franchisee may be required to carry out these obligations in good faith.

The obligation to act in good faith cannot be excluded or limited by a clause in another document, including a franchise agreement.

Legitimate business conduct

While good faith requires a party to have due regard to the rights and interests of the other party, it does not require a party to act in the interests of the other party. Neither does it prevent a party from acting in their own legitimate commercial interests.

For example, while good faith will require parties to act honestly and cooperatively during the negotiation of a franchise agreement, it is unlikely to compel a franchisor to make requested additions or changes to an agreement. Similarly, the decision by a franchisor not to offer a franchisee an option to renew or extend their franchise agreement does not mean that the franchisor has not acted in good faith in negotiating the agreement.

Conduct that shows lack of good faith

Whether certain conduct will lack good faith will depend on the circumstances surrounding the conduct.

When considering whether your conduct is in good faith, potential questions to ask include:

  • Have you been honest with the other party?
  • Have you considered the other party’s interests?
  • Have you made timely decisions?
  • Have you consulted with the other party regarding issues/proposed changes?
  • Do you have a contractual right to act in that way?
  • Are you imposing any conditions on the other party? Are those conditions necessary to protect your interests?
  • Where a dispute has arisen, have you attempted to resolve the dispute (either directly with the other party, or through mediation)?
  • Are you acting for some ulterior purpose?

Examples

Performance of the franchise agreement

The franchisor of a video rental franchise system granted a franchisee and exclusive licence over a particular territory.

This means the franchisor was not allowed to be involved in the rental and/or sale of video products, or a business of a similar nature, within the franchisee’s territory.

During the agreement, a business that was related to the franchisor sold DVDs via its website to consumers who lived in the franchisee’s territory. The franchisor did not take any action to prevent these online sales.

By allowing its related business to sell DVDs within the franchisee’s territory, the franchisor has not acted in good faith as it failed to remain loyal to the promise of the franchise agreement.

Dishonest business dealings

The franchisor of an electrical testing franchise system granted a franchisee the right to perform electrical testing work for clients of the franchisor.

Under the agreement, the franchisee was not allowed to be involved in a business substantially the same as the franchise, or in competition with the franchisor, for defined periods and within defined areas, during the term of the agreement.

For the purpose of the franchised business, the franchisor disclosed confidential information to the franchisee, including the names and details of its clients, together with the pricing and other arrangements negotiated by the franchisor. During the franchise term, the franchisee ‘took over’ a number of the franchisor’s clients.

The franchisee led the franchisor to believe that the client no longer required its services, and led the client to believe they were still dealing with the franchisor. The franchisee’s dishonesty in this instance means he has not acted in good faith.

Acting for an ulterior purpose

The franchisor of a motor vehicle service franchise system entered into a franchise agreement that required the franchisee to follow specific procedures for invoicing and reporting.

During the agreement, the franchisee experienced difficulty in accurately processing invoices using software and hardware supplied by the franchisor. Meetings with the franchisor failed to resolve these issues, leading to a breakdown in the franchising relationship.

The franchisor subsequently issued a number of default notices to the franchisee, alleging that the franchisee had not complied with its invoicing and reporting requirements. However, the franchisor did not have a solid basis for alleged breaches as it was unclear whether the franchisee had failed to follow these requirements. The franchisor's default notices were motivated by its desire to eventually terminate the franchise agreement.

The franchisor later terminated the agreement on the basis that the franchisee had failed to remedy the alleged breaches. In this instance, the franchisor has not acted in good faith because it was acting for an ulterior purpose.

Acting for legitimate commercial reasons

The franchisor of a takeaway food franchise system entered into a franchise agreement that gave the franchisee the right to operate a franchised business at a specific location.

The franchisee did not have an exclusive territory and there was no limit on the franchisor's ability to open new stores. The franchisee did not have a right to be considered to own and operate additional stores.

However, under the franchisor’s expansion policy, an existing franchisee would be eligible to operate another store if they satisfied certain criteria, including compliance with the franchisor’s standards of operation. During the agreement, reviews of the franchisee’s store indicated that it was not meeting the necessary standards required for the franchisee to be eligible to operate another store. This led to issues between the franchisee and franchisor.

12 months later, the franchisor decided to open a new store in the vicinity of the franchisee's store due to perceived commercial benefits of expanding its system.

The franchisee was not offered the right to operate the new stores. In this instance, the franchisor’s decision to open the stores was motivated by the perceived commercial advantage to the franchisor in opening new stores. The franchisor has acted in good faith as its actions were based on the pursuit of its legitimate business interests.

More information

Franchising

Tags

Audience