A dispute between two franchisees and the franchisor of Nando’s has recently landed in the Victorian Supreme Court. The claim was filed after an incident occurred in early January 2016 at the Narre Warren and Wareca Nando’s stores in Victoria. The franchisor allegedly had several people enter the stores after hours and take control by replacing the keys and alarm system.
The franchisees of the two stores had been under pressure by the franchisor to invest significant amounts of money in the refurbishment of their Nando’s stores in Narre Warren, Wareca Centre (Clayton), Braeside and Lysterfield. It was the ongoing disagreement regarding these refurbishments that led to the events in early January, and the subsequent court case.
Nando’s took issue with the franchisees of the Narre Warren and Wareca stores failing to upgrade any of their restaurants since purchase (between 2007 and 2011). Consequently, the branding and fit-out of the stores were no longer current.
Under the Nando’s franchise agreement, franchisees must upgrade and invest in their stores when the franchisor “reasonably requires”. In the present case, it appears the franchisor had attempted to enforce this requirement – expecting the franchisees to spend over $1 million upgrading their stores.
An inability to agree on this point led to the franchisor serving a Notice of Breach on the franchisees late last year. The franchisees alleged that no negotiations were surrounding the works, and the franchisor forced these upon the franchisees.
The franchisees are now seeking damages for, among other things, breach of the franchise agreement and breach of the franchisor’s good faith obligations. This article looks at these issues under the general law and the Franchising Code of Conduct.
What Happens When a Franchise Agreement is Breached?
A franchise agreement is a contract, and so the general law of contracts will apply where there has been an apparent breach. The law states that an “innocent party” to a contract may terminate the agreement if the other party has:
- Breached an essential term (condition) of the contract;
- Seriously breached a non-essential term (warranty) of the contract; or
- By their conduct, shown an intention to no longer be bound by the contract (repudiation).
The party bringing the claim can then claim damages that they have incurred as a result of the breach and termination of the contract. Not every breach will be sufficient to give a party a right to terminate their franchise agreement – it will have to satisfy the above criteria.
Notably, if a court finds the alleged breach or repudiation did not, in fact, give the “innocent party” a right to terminate the contract (a “wrongful termination”), then they may be held to have repudiated the contract themselves.
For example, in Little Images Pty Ltd v Fresh View Venture Pty Ltd  QSC 402, it was held the franchisor had breached the franchise agreement by failing to audit the marketing fund, and to provide an operations manual within a reasonable time. These breaches, however, were not considered by the Court to be breaches of a condition, serious breaches of a warranty or repudiatory conduct, due to the lack of effect these acts had on the franchisees and the fact that the franchisors had taken steps to remedy the breaches. As a result, the franchisee’s termination was wrongful, amounted to a repudiation, and gave the franchisor the right to terminate and claim damages.
Requirements Under the Franchising Code of Conduct
Under the Franchising Code of Conduct (the Code), once a breach has occurred, the party who is aggrieved must notify the other party of the breach (with a “Notice of Breach”) and outline how they want to resolve the issue. If the parties cannot reach a resolution within three weeks, then either party may refer the matter to mediation. If mediation is unsuccessful, then either party may take further legal action in court.
What Are the Franchisor’s “Good Faith” Obligations?
In addition to any obligations under a franchise agreement, the Code also places certain obligations on the parties to a franchise agreement. As of 1 January 2015, each party to a franchise agreement is required to act in “good faith” regarding any matter under a franchise agreement. This means the obligation applies at all stages of the franchise relationship, including pre-contract negotiations.
What Does “Good Faith” Mean?
The concept of “good faith” remains unclear in the franchising context – it is not, however, a new legal concept. Courts have discussed the notion in other types of contracts, and the interpretation in these cases shed light on how “good faith” may be applied to franchises.
Sir Anthony Mason provides an often-cited summary of what good faith requires in his article, “Contract, Good Faith and Equitable Standards in Dealing”, stating that good faith involves:
- An obligation for the parties to cooperate in achieving the objects of the contract,
- Complying with honest standards of conduct, and
- Complying with standards of conduct that are reasonable, concerning the respective interests of the parties.
Some areas where the obligation of good faith in a franchise agreement may be considered to have been breached include:
- Where a franchisor prevents a franchisee from conducting legitimate business activities under the agreement;
- Where a franchisor acts contrary to the financial interests of the franchisee;
- Where a franchisor ignores the concerns and reasonable requests of a franchisee;
- Where one party serves the other with a notice of dispute that has no real basis and/or is done for an ulterior purpose other than to resolve a genuine dispute.
Diab Pty Ltd v YUM! Restaurants Australia Pty Ltd  FCA 43
In this recent Federal Court case, Pizza Hut had developed a new cheap pizza model, which unfortunately their rival, Dominos, discovered and launched. The franchisees argued there was a breach of the franchise agreement and the good faith obligations, in respect of achieving the objects of the franchise agreement. The franchisees claimed Pizza Hut had an obligation to set prices that would enable the franchisees to make a profit, and that the cheap pizza model was not formulated in good faith.
The Court held that the good faith obligation did not encompass a strict obligation to make decisions that would only be profitable for franchisees, as this would amount to the court contracting on behalf of the parties. Pizza Hut had planned and assessed the strategy and consulted franchisees before the launch, and these actions were not considered unreasonable or done in bad faith. Rather, Pizza Hut had shown a considerable care in developing their strategy. The Court reiterated that there was no requirement for either party to subordinate their own interests to those of the other.
Although Nando’s case is still in its early stages, it will be interesting to see the Court’s discussion on the issues of good faith and reasonableness. Particularly regarding the franchisor’s ability to force franchisees to spend money on their business, and the actions they may reasonably take to achieve this.
Whether or not the Nando’s franchisor has acted in bad faith and breached the franchise agreement will depend on multiple factors, including:
- What the franchise agreement requires regarding franchisee expenditure on store upgrades;
- Whether there is an explicit good faith requirement in the franchise agreement, and if not, what an implied obligation of good faith will import;
- What amounts to reasonable standards of conduct in this situation, and whether the franchisor’s actions were reasonable under the circumstances.
If you have any questions, or need assistance resolving your dispute, get in touch with our franchise lawyers on 1300 544 755.