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Allens Arthur Robinson

Focus: Franchising – August 2008

Franchising agreements and illegality

In brief: Some certainty and common sense has re-entered the Australian franchising industry with today's highly anticipated judgment of the High Court of Australia in Master of Education Services Pty Ltd v Ketchell. Partner Andrew Wiseman (view CV) and Lawyer Tim Holden report.

How does it affect you?

  • In a simple and compelling judgment, the High Court has unanimously upheld the appeal to it from the New South Wales Court of Appeal's decision in Ketchell v Master of Education Services Pty Ltd [2007] NSWCA 161.
  • Contraventions of clause 11 (1) of the Franchising Code of Conduct by the franchisor will not lead to franchising agreements being held to be unenforceable and illegal.
  • Ketchell should close the door on the possibility that contraventions of other clauses of the Code will lead to franchising agreements being held to be unenforceable and illegal.

Background

Part IVB of the Trade Practices Act 1974 (Cth) (the TPA) is titled Industry Codes. Section 51AE provides that regulations may prescribe an industry code and declare it to be mandatory. Section 51AD states that a corporation 'must not, in trade or commerce, contravene an applicable industry code.' Clause 3 of the Trade Practices (Industry Codes – Franchising) Regulations 1998 (Cth) prescribes the Franchising Code of Conduct (the Code) and declares it to be a mandatory industry code.

Central to this case is clause 11(1) of the Code, which prohibits franchisors from entering into, or renewing or extending, a franchise agreement or receiving any non-refundable money in connection with a franchise agreement unless the franchisor has received a written statement from the franchisee or the prospective franchisee that it has received, read and had a reasonable opportunity to understand the franchisor's disclosure document and the Code.

Facts

Master of Education Services Pty Ltd (the franchisor) sued Ms Jean Ketchell (the franchisee) in the local court for money due under a franchise agreement executed between the parties on 11 February 2000. The franchisee claimed in her defence that the franchisor had failed to comply with clause 11 of the Code. The issue arose whether this contravention rendered the contract unenforceable for statutory illegality. In the proceedings below the Court of Appeal, it was found that, while the franchisor did not comply with clause 11(1), it did not render the receipt of the non-refundable payment illegal. This was consistent with the preferred school of thought at that time.

Court of Appeal

In the NSW Court of Appeal, President Mason, with whom Justices Basten and Handley agreed, controversially concluded that s51AD, read together with clause 11, directly prohibited the franchise agreement in question and therefore the recovery of the moneys claimed. The court placed particular emphasis on the words 'must not' in clause 11 (1) of the Code. In doing so, the court concluded that a franchising agreement will be unenforceable and illegal if, in contravention of clause 11(1) of the Code, a franchisor fails to obtain from a proposed franchisee the required written statement that the franchisee has received, read and had a reasonable opportunity to understand the Code.

This sent serious ripples through the Australian franchise community. The reality was that many, if not most, franchisors were likely to have slipped up on the odd occasion under clause 11(1) of the Code.

For a more detailed analysis of the Court of Appeal's decision, see Allens Focus: Franchising – August 2007.

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High Court

Today, some certainty and common sense has been restored with the decision in Master of Education Services Pty Ltd v Ketchell [2008] HCA 38. The High Court, constituted by Justices Gummow, Kirby, Hayne, Crennan and Kiefel, unanimously held that, while the failure to comply with clause 11(1) is a contravention of the TPA, it does not result in the illegality and unenforceability of a franchise agreement made between a franchisor and franchisee. In contrast to the approach taken by the NSW Court of Appeal, the High Court had specific regard to the purpose of the TPA, including the language of clause 11(1), and the object of the Code itself.

The High Court noted that the purposes of Part IVB and the Code are to regulate the franchising industry, with the goal of improving business practices and decreasing franchise-related disputes, while providing protection to franchisees proposing to enter into franchise agreements. In addition, the High Court confirmed that the prohibition in s51AD of the TPA is directed at securing compliance with the requirements of the Code by franchisors but it is not then converted into a prohibition on making an agreement where there is non-compliance with the Code. The High Court stated [at 25] that:

It is no part of the scheme, and unnecessary to the purposes mentioned, to strike down a contract made by a non-complying franchisor. It is sufficient for the purpose of the scheme that a franchisor is aware of the obligations imposed by the Code and that action may be taken by a franchisee under the Act with respect to a contravention of s 51AD.

  

In relation to clause 11(1) of the Code, the High Court determined that, while it contains imperative language, after having regard to the ordinary principles of construction, it can not be inferred or implied from the language in clause 11(1) that non-compliance will render a contract void and unenforceable.

The High Court determined that the consequence of contravention of clause 11(1) of the Code is the grant of remedies provided for in Part VI and possibly an action under s51AC of the TPA. In the High Court's view, the TPA provides a flexible range of remedies (eg damages, court-ordered variation of terms or even court-ordered termination) that deliver a better and more fitting approach to a contravention of s51AD than the harsh and unintended consequences provided by the common law and the position reached by the NSW Court of Appeal.

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Conclusion

The High Court's decision confirms that a franchising agreement is not illegal because a franchisor or franchisee has contravened clause 11 (1) of the Code. In light of the High Court's reasoning, it is highly unlikely that contraventions of other provisions of the Code, for example, the disclosure obligations contained in clauses 6(1) and 10, will lead to franchising agreements being struck down.

In coming to this conclusion, the High Court has settled the uncertainty in relation to the application of the common law concept of illegality to the Code that has plagued the franchise industry since the NSW Court of Appeal's decision in August 2007.

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