Acting in good faith

Under the franchising code, parties who enter, or propose to enter, into a franchise agreement must act in good faith in their business dealings with each other.

Good faith explained

Although the code does not define exactly what good faith means, it is clear that the obligation of good faith needs 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.

For new vehicle dealership agreements, the code also says that the court must consider whether the terms of the agreement are fair and reasonable. A court can also take into account other matters it considers relevant.

The obligation to act in good faith

The obligation to act in good faith applies to any matter arising in the franchising relationship.

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.

Good faith and 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 requires 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.

Considering if conduct shows lack of good faith

Whether conduct lacks in good faith depends 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 about issues or 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 directly with the other party or through mediation?
  • Are you acting for some ulterior purpose?

Examples of conduct that is and isn’t in good faith

Performance of the franchise agreement

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

As a result, the franchisor was not allowed to be involved in renting or selling video products, or a similar business, within the franchisee’s territory.

During the agreement, a business that was related to the franchisor sold DVDs through 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 the franchisor's clients.

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. This condition was 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. This information included 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 the franchisor's services
  • client to believe they were still dealing with the franchisor.

The franchisee’s dishonesty in this instance means the franchisee 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 found it difficult to accurately process invoices using the 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 then issued default notices to the franchisee, alleging that the franchisee had not complied with 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 own and operate extra stores.

Under the franchisor’s expansion policy, an existing franchisee would be eligible to operate another store when they satisfied certain criteria. This included complying with the franchisor’s standards of operation. Reviews of the franchisee’s store during the agreement showed that it was not meeting the necessary standards to be eligible to operate another store. This led to issues between the franchisee and franchisor.

Twelve months later, the franchisor decided to open a new store in an area near the franchisee's store, due to perceived commercial benefits of expanding its system. The franchisee was not offered the right to operate the new store. In this instance, the franchisor’s decision to open the store was motivated by their perceived commercial advantage.

The franchisor has acted in good faith as its actions were based on the pursuit of its legitimate business interests.

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