Do online sales breach a franchisee’s exclusive territory clause?

One of the most eagerly awaited decisions for our franchise lawyers in 2014, this case foreshadowed some of the major changes made to the Franchising Code of Conduct in 1 January 2015. This case study will examine the limitations placed on franchisors in making online sales into a particular area without breaching a franchisee’s exclusive territory clause.

Case

Case Study: Video Ezy International Pty Ltd v Sedema Pty Ltd [2014] NSWSC 143

Background

Sedema became a Video Ezy franchisee in 2003 for the suburb of Hazelbrook in NSW. The franchise agreement between Sedema and Video Ezy stated Sedema would be granted an “exclusive” territory for the suburb of Hazelbrook for 10 years. This meant that Sedema would be the only Video Ezy franchise in Hazelbrook and it also prevented Video Ezy, and any of its associated businesses, from opening a similar business in Hazelbrook (i.e. it prevented Video Ezy from competing).

During the term of the franchise agreement, Blockbuster, a related company to Video Ezy, began offering “TiVo”, a product that gave its users access to on-demand videos. Similarly, another related company EzyDVD, through its website ezydvd.com.au, operated as an online retailer for DVDs. Blockbuster and EzyDVD were related companies and all held under the one group and were therefore, in effect, the same.

Sedema’s claim

As a counterclaim to Video Ezy, Sedema argued Video Ezy had breached the “exclusive territory” clause of the franchise agreement by offering customers access to the on-demand videos and by operating as an online retailer. This was because the nature of the method of delivery of the products and services meant that Video Ezy could and was serving customers located in Hazelbrook.

Video Ezy’s argument

Video Ezy based their argument on 2 main lines of reasoning:

1. that the exclusivity provision prevented the rental/ selling of videos “within” the territory but not “into” the territory; and
2. that there was a fundamental difference between “brick and mortar” businesses and online business and therefore the prevention on it competing, did not apply.

The Decision

The NSW Supreme Court rejected Video Ezy’s arguments and agreed with Sedema. It supported the original decision made by the Magistrate at the first instance who determined,

“The distinction suggested between the operation of a “bricks and mortar” business and on-line trading is illusory”

Our franchise lawyers find the following statement especially enlightening,

“It would have been no different had VEI, VEA, Blockbuster or EzyDVD commenced operating a business of the sale or hire of video products by mail order, at a market stall or out of the back of a truck in the territories. It would be an affront to the reasonable person on the ‘Bondi bus’ to suggest that it was the common understanding of the parties that VEI and VEA could sell or hire video products by mail order, at a market stall or out the back of a truck in the territories. So too would it be to suggest that the TiVo movie service and ezydvd.com.au on-line businesses were any different.”

Good Faith

The NSW Supreme Court also found that that a duty of good faith is to be implied into Franchise Agreements.

Franchising Code of Conduct

Following this decision, the Franchising Code of Conduct was updated on 1 January 2015, and two of the major changes to the Franchising Code of Conduct involve the matter of online sales and good faith.

Franchisors are required to disclose in the Disclosure Document at item 12, information on whether they or a related company will make products or services available online.

The Franchising Code of Conduct now expressly incorporates the obligation of Good Faith into all Franchise Agreements (Part 1 – Division 3).

Conclusion

This case set a clear precedent on determining what would be considered “exclusive” territory. If you are a Franchisor or a Franchisee and have a question on your territory, feel free to contact us and one of our franchise lawyers will be able to assist.