In our recent series, we explored what it meant to comply with the good faith obligation under the Franchising Code of Conduct (Code) at the various stages of franchise dealings.
The Code makes it clear that obligation to act in good faith does not prevent a party from acting in their legitimate commercial interests. When will conduct, which is unfavourable to one party, be considered to be in bad faith, or simply the commercial reality of good business?
This was one of the questions considered in the case of Lanhai Pty Ltd v 7-Eleven Stores Pty Ltd1. The relevant facts were that:
Lanhai was the franchisee of the 7-Eleven store in Heathmont, Victoria.
7-Eleven was the franchisor and lessee of that store under a lease with a primary term expiring in mid-2021, and a five-year option to renew.
In early 2021, 7-Eleven decided not to exercise the lease option, which then brought the franchise agreement to an end.
Lanhai claimed that 7-Eleven had breached the good faith obligation by deciding not to renew the lease, which then caused the Franchise Agreement to come to an end after a term of six years.
Whilst the franchisee separately argued (successfully) that 7-Eleven had made misleading and deceptive representations regarding the term of the lease prior to the franchise agreement, that’s a whole other story.
In this blog, we will focus on the franchisee’s claim that 7-Eleven’s decision to end the franchise agreement some 6 years later was allegedly not made in good faith.
What did the court find?
The court confirmed the key points for evaluating whether the good faith obligation had been breached, including conduct which was dishonest, inconsistent with the spirit of co-operation, arbitrary or motivated by a purpose which is contradictory to the agreement. The court also noted that good faith is not really about fairness, but more focused on ’a franchisor’s use of powers and opportunities available by reason of the franchise relationship.’
Importantly, a party is not required to rank its legitimate interests below those of the other party but should have due regard to the legitimate interests that both parties have in performing the contract.
In finding that 7-Eleven had not breached the obligation, but had merely pursued its legitimate interests, the court stated that:
1. It was an uncontested fact that the Heathmont store had not been profitable for 7-Eleven for years, and this was the franchisor’s principal consideration in deciding not to renew the lease;
2. The franchisor had followed its usual decision-making process, which included consideration of a number of key factors. Therefore, the franchisor’s decision was not merely arbitrary; and
3. Although it appeared the Heathmont store’s unprofitability was a consequence of changes to the franchise agreement including an increase to Lanhai’s ‘minimum income guarantee’, there was no suggestion that these decisions were made in bad faith or for any collateral purpose.
Importantly, the court observed that an interest in avoiding loss-making investments will usually be a legitimate reason to end a franchise agreement. Also, a franchisor did not have a standing obligation to extend the term of a franchise agreement, and the fact that the franchisee is not consulted before the decision is made does not in itself indicate bad faith.
For decisions which negatively impact franchises, franchisors should ensure their decision-making processes are methodical, consistent and take into account profitability and all other relevant factors.
Detailed records of the process should also be kept in case the decision is later challenged.
For advice about any matters relating to a franchise agreement, including termination, please contact the author, Karina McDougall.
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This publication has been prepared for general guidance on matters of interest only and does not constitute professional legal advice. You should not act upon the information contained in this publication without obtaining specific professional legal advice. No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this publication and to the extent permitted by law, Cowell Clarke does not accept or assume any liability, responsibility or duty of care for any consequences of you or anyone else acting or refraining to act in relation on the information contained in this publication or for any decision based on it.