Focus: Court decision brings cold comfort to franchisor
8 July 2010
In brief: A recent Federal Court decision that a franchisor engaged in unconscionable conduct towards its franchisees provides useful guidance to franchisors. The court found that the franchisor abused its position of strength to impose significant increases in fees payable by its franchisees. The case also examined the legality of a franchisor withholding its consent to assignment of a franchisee's interest unless the new franchisee executed a franchise agreement which gave the franchisor additional benefits. Partner Tim Golder (view CV), Senior Associate Robyn Chatwood and Law Graduate Ben Mee discuss the implications of the court's decision.
- Summary of facts of the case
- Was there a term in the agreement which would allow the franchisor to increase its fees and, if so, on what basis could the franchisor do so?
- Can a franchisor take advantage of a franchisee-initiated assignment to recast the commercial terms?
How does it affect you?
- The case1 gives guidance to how courts will assess the legitimacy of a franchisor's rights to increase franchise fees charged to franchisees during the term of an agreement.
- You should be aware that the inclusion of an 'entire agreement' clause in a written agreement will not provide complete protection, as a court will, in certain circumstances, incorporate other oral and implied terms into the agreement based on the discussions and understanding of the parties.
- Franchisors should carefully evaluate their criteria for withholding consent to a franchisee transferring its agreement to another. It may be considered unconscionable to use the transfer opportunity to extract a better bargain.
Seal-A-Fridge is an Australian franchisor who uses a Telstra '13' telephone number that distributes incoming calls geographically between various franchisees.
Clause 3C(a) of the franchise agreement provided 'the franchisee shall be responsible for paying its own costs associated with the use of the national telephone number'.
The written franchise agreement also contained an entire agreement clause. However, the parties had exchanged other documents and had discussions about the Telstra fees, which were not contained in the final written franchise agreement.
The payment of a $50 per week fee to cover the costs payable by the franchisor to Telstra for use of the 13 number had effectively been agreed orally with each of the relevant franchisees before entry into the agreement and was paid by the franchisees in addition to their own usage costs. Three years later, in 2001, the franchisor sought to increase this fee to $75 per week, then again to $100 per week in 2004. The franchisor also secured from some franchisees variations to the franchise agreement to expressly include the obligation to pay the fees.
In response to complaints, the Australian Competition and Consumer Commission brought an action against Seal-A-Fridge alleging, among other things, that Seal-A-Fridge had engaged in various acts of unconscionable conduct under section 51AC of the Trade Practices Act 1974 (Cth) (the TPA).
Final orders were handed down on 30 June 2010, declaring that Seal-A-Fridge had engaged in unconscionable conduct in relation to its fee increases, restraining Seal-A-Fridge from increasing the fees without a proper contractual basis and requiring Seal-A-Fridge to implement a compliance program.
Was there a term in the agreement which would allow the franchisor to increase its fees and, if so, on what basis could the franchisor do so?
Justice Logan construed Clause 3C(a) to connote only a liability on the franchisee to pay its own telephone usage costs, rather than any contribution towards establishment and ongoing costs of maintaining the 13 number. However, it was held to be common ground before entry into the agreements that a $50 per week fee was payable to Seal-A-Fridge in respect of the 13 number and that the figure was an estimate that may need to be adjusted over time to meet cost fluctuations. On this basis, and notwithstanding the entire agreement clause in the franchise agreement, the court held that the written agreement omitted an oral term of the contract to the above effect, and the franchisees could not rely on the written agreement to ground an argument that, before signing the deeds of variation, there was no liability to pay any weekly service fee. That oral term was supplemented by an implied term allowing for adjustment of the weekly service fee payable in line with movements in the CPI index. The court considered in the alternative that the omission of an express term referring to the $50 weekly payment liability was a mutual mistake capable of rectification.
In relation to the actual fee increases, the court examined the increases in Seal-A-Fridge's profit margin on the fees obtained through the two fee increases (from $18,870 to $41,534 and then to $91,816) and stated that, while Seal-A-Fridge was not contractually prohibited from making a profit from the weekly fee, it had no contractual authority to unilaterally and arbitrarily increase the fee to the extent that it did. The court also relied on 'misstatements, non-disclosure of information, threats and intimidation and abuse of Seal-A-Fridge's position of strength in relation to being able to cut off the phone number' and concluded that, in the circumstances, the abuse of that position of strength grounded a finding of unconscionability.
Can a franchisor take advantage of a franchisee-initiated assignment to recast the commercial terms?
The case also dealt with the issue of whether a refusal to consent to assignment of a franchisee's interest unless a superior bargain could be obtained was permitted by the agreement and, if not, whether such a refusal would be unconscionable.
The agreement provided that Seal-A-Fridge must consent to a sale or assignment of a franchisee's interest subject to particular conditions being fulfilled, including that the transferee execute the franchisor's then current franchise agreement. When a request was made by a particular franchisee, Seal-A-Fridge incorporated an additional 10 per cent 'turnover fee' into the replacement franchise agreement to be executed by the transferee.
The court held that the relevant provision did not permit the franchisor to withhold consent on the basis that the proposed transferee would not consent to a 'radically different formula' by which the fee for access to the 13 number was to be calculated. To permit such an interpretation would allow a franchisor to diminish the worth of the interest that it had initially sold, and it is the assignment of that interest, not some interest of diminished worth, to which the franchisor was required to give consent. The outcome may have been partly influenced by the fact that the additional 'turnover fee' was clearly not referable to the franchisor's costs of maintaining the 13 number (to which the fee was said to relate). However, the case demonstrates the importance of carefully drafting clauses regarding consent to assignment to ensure franchisors retain flexibility in relation to the franchise terms governing both 'new' franchisees and those to whom an existing franchise is assigned.
Notwithstanding the above findings, the court held that, of itself, this erroneous construction of the agreement by the franchisor did not amount to unconscionable conduct.
In conclusion, three important lessons can be drawn from the judgment.
- The case makes clear that an entire agreement clause may not be a sufficient safeguard against the parties' pre-contractual negotiations and statements having some bearing on the construction of the contract. Although these clauses are useful, it is best practice to deal with issues arising in these discussions through express terms in the written agreement, as implied terms and oral terms inconsistent with the written agreement are unlikely to be incorporated. Care must also be taken to ensure such clauses do not infringe the Franchising Code's prohibitions on waivers of representations.
- The case is a reminder that a franchisor is not prohibited from making a profit on fees that are based on particular services provided by third parties. What is important is that the basis of the fees, and the circumstances in which they may be increased, are dealt with clearly and comprehensively in the agreement between the parties.
- Finally, the case serves as a warning to franchisors who seek to take advantage of a franchisee's request for consent to an assignment of the franchise agreement. A court may find unconscionable conduct if consent is used as a lever to extract a better bargain than was originally made by the parties to the agreement, although it appears that evidence of bad faith may be required, as an erroneous construction of a contractual right will not in itself be unconscionable. However, careful drafting of the franchisor's contractual rights with a consideration of both this decision and Clause 20 of the Franchising Code may provide franchisors with greater flexibility in relation to the terms by which 'new' franchisees introduced under a transfer are bound.
The decision is timely in light of the recent reforms of unconscionable conduct provisions in the Australian Consumer Law (see our Focus: Changes to unconscionable conduct laws and Franchising Code of Conduct, 5 March 2010.
- ACCC v Seal-A-Fridge  FCA 525; ACCC v Seal-A-Fridge (No 2)  FCA 681.
- Tim GolderPartner,
Ph: +61 3 9613 8925
- Andrew WisemanPartner,
Ph: +61 2 9230 4701
- Susie WellsSpecial Counsel,
Ph: +61 3 9613 8627