When is a breach serious enough to terminate a franchise agreement?

The Queensland Supreme Court case of Little Images Pty Ltd v Fresh View Venture Pty Ltd [2011] QSC 402 is an illustration of the fact that not all breaches of a franchise agreement can be said to be a breach which would result in a right to terminate, or be sufficient to amount to repudiation (which would also result in a right to terminate).

Background

A franchise agreement is, so far as the law is concerned, a contract, and although there are additional obligations which apply (in the form of the Franchising Code of Conduct) the “general” law of contracts still applies to franchise agreements. In this case, the relevant law is that of “breach/ repudiation” and “termination”. At its most basic, the law states that a contract can be terminated by an innocent party to the contract if the other party:

• breaches an essential term (a “condition”) of the contract;
• seriously breaches a non-essential term (a “warranty”) of the contract; or
• act in a manner which indicates that it no longer intends to abide by the contract (“repudiation”).

The innocent party having terminated the contract can then claim damages that arise as a result of the termination of the contract.

Note that where the “innocent party” purports to terminate a contract as a result of a purported breach/ repudiation and that breach/ repudiation is held, in fact, to not have had the effect of giving rise to a right of termination then the “innocent party” are themselves said to have repudiated the contract. This is known as wrongful termination.

Application to Case

In this case, Fresh View Venture (the Franchisees) terminated their franchise agreement with Little Images (the Franchisors) and brought a claim for damages. According to our franchise lawyers, the Franchisees relied upon the Franchisor’s following breaches and repudiatory acts as the basis upon which they terminated the franchise agreement:

1. opening two franchises close to the Franchisees business and by extension breaching (or acting in a manner so as to repudiate) a term of the franchise agreement which stated, “until a master franchisee is engaged for this region, the franchisor will provide support for this franchisee to reasonable extent”;
2. failing to audit the marketing fund within 3 months of the end of the relevant financial year;
3. failing to contributing to the marketing fund;
4. failing to provide reasonable support to the Franchisee by the way in which the marketing fund money was spent;
5. failing to provide training to the “Nominated Representative” of the franchisee in photography and photo editing;
6. failure to provide the Franchisees with a copy of the “Operations Manual” within a reasonable time;
7. failure to provide improvements in equipment (in particular replacing a pre-existing computer and camera);
8. failure to respond to the defendants’ expressed concerns or complaints; and
9. failing to provide support generally.

In relation to these points:

1. the franchise agreement did not contain an exclusivity provision and therefore the Franchisees had to relied upon the term “until a master franchisee is engaged for this region, the franchisor will provide support for this franchisee to reasonable extent,” in order to try and establish the breach/ repudiation. McMurdo J held that the term could not be read so as to provide a form of exclusivity for the Franchisees and therefore be breached by the Franchisor opening up the two franchsies;
2. the Franchisor had not audited the marketing fund, and thereby had breached the franchise agreement, however it was noted that this breach was remedied soon afterwards.
3. the franchise agreement stated the Franchisor would contribute to the Marketing Fund on a dollar for dollar basis with the Franchise. The Franchisee argued that this included the initial $10,000 that was paid concurrently with entering into the franchise agreement. The McMurdo J disagreed and held the dollar for dollar agreement applied only to any fees paid as a marketing royalty;
4. the Franchisee argued the franchise agreement stated that their marketing contributions to the marketing fund was to be spent on marketing for their franchise only. This was held to not be the case, the marketing fund was for the promotion of the marketing fund generally;
5. McMurdo J held it was never the intention of the parties for the Franchisor to provide the Franchisee with photography and photo editing training, the training was to be limited only to operation of the business, noting that the franchise agreement contained a provision acknowledging the Franchisees intention to hire an employee to handle the performance of the photography and photo editing functions of the business;
6. the “Operations Manual” was provided 8 months after the franchise agreement was entered into and this was a breach of the franchise agreement, however again this was soon remedied;
7. there was no failure to respond to concerns or complaints; and
8. there was no failure to provide support generally.

Breaches giving rise to right to terminate

Having established that the franchise agreement had been breached by the Franchisor’s:

• failure to audit the marketing fund; and
• failure to provide an “Operations Manual” within a reasonable time,

McMurdo J then needed to consider whether the breaches (by themselves or together) could be considered breaches of a condition, a serious breach of a warranty or a repudiatory act. McMurdo J held that they could not. In reaching his decision the Judge took into consideration:

• the lack of effect the breaches had on the Franchisee’s business (it did not affect the revenue of the franchise, they were still achieving their minimum number of customers etc.); and
• the Franchisors actions of remedying the breaches.

Outcome

As a result, it was held the Franchisees had breached the franchise agreement by acting in a repudiatory manner (wrongful termination) and therefore the Franchisor had the right to terminate the franchise agreement and claim damages, which they did, and which they were awarded to the sum of $303,860.78.

Conclusion

It is vital that when terminating a franchise agreement, that it is not wrongfully terminated otherwise there could be serious financial penalties. If you are unsure whether your franchise agreement has been breached, and gives you a right to terminate, then contact our franchise lawyers who would be glad to help.