A victory for common sense in High Court decision

The Australian franchise sector is celebrating the clarity and certainty provided by the High Court of Australia in its decision in Master of Education Services Pty Limited v Ketchell [2008] HCA 38 handed down on 27 August 2008.

HCA 38 handed down on 27 August 2008. Allowing the appeal from the NSW Court of Appeal, the High Court in a unanimous decision held that the failure to comply with clause 11(1) of The Franchising Code of Conduct did not automatically result in the illegality and unenforceability of the Franchise Agreement made between the franchisor and the franchisee. In the words of the High Court:

"The detailed provision by the Act for the consequences Of non-compliance with an industry code, such as the Franchising Code of Conduct, does not support a conclusion that it was intended that the harsh consequences provided by the common law were to follow upon contravention of s 51AD. The Act provides a more flexible approach. It allows a court to prevent entry into a franchise agreement, to vary the terms of an agreement entered into in breach of the Code, or to terminate such an agreement or provide compensation for loss and damage, if it is shown to have been caused by the contravention." [1]

The decision vindicates the stance taken by the Franchise Council of Australia to pursue the appeal. As mentioned in Issue 17 of the Franchise Review, the High Court granted special leave to appeal to the franchisor on the basis of an affidavit provided by FCA director and Deacons partner Stephen Giles as to the significance of the decision to the franchise sector. In granting special leave the High Court took the unusual step of requiring an undertaking (which ultimately was in essence underwritten by the FCA) that the franchisors would pay the costs of both parties to the appeal. The FCA approached the ACCC and the Federal Government for assistance, but they declined. The FCA board resolved to proceed alone, and contributed approximately $250,000 in funding from its reserves and member contributions.

This was the first time the FCA had ever intervened or provided funding for legal proceedings. As the representative body of franchisors and franchisees the FCA board does not normally intervene in legal disputes, but in this instance it was felt that the matter was important for both franchisors and franchisees. Not only does the decision improve the risk position for franchisors, who were at risk of having otherwise valid franchise agreements declared illegal for what might be considered to be a technical breach of the Code, but it provides clarity for franchisees, as noted by the court:

One of the purposes of the Code is the protection of the position of the franchisee. It is not expressed to prohibit the franchisee from entering into an agreement where a franchisor had not complied with cl 11. As Rares J pointed out in Hoy Mobile Pty Ltd v Allphones Retail Pty Ltd (No 2), it would be an unusual result if, in that circumstance, a franchisee's bargain was struck down in every case, regardless of the position in which it places the franchisee. It is not to be assumed in every case that a franchisee wishes to be relieved of their bargain. To render void every franchise agreement entered into where a franchisor had not complied with the Code would be to give the franchisor, the wrong-doer, an opportunity to avoid its obligations, and at the same time to place the franchisee in breach of obligations to third parties. A preferable result, and one for which the Act provides, is to permit a franchisee to seek such relief as is appropriate to the circumstances of the case. Some cases of non-compliance with cl 11 might involve substantial non-disclosure; others may only involve a failure to obtain the written statement, confirming that the franchisee has read and understood the disclosure document and the Code. This is such a case. [2]

The facts in Ketchell's case are set out in Issue 17 of the Franchise Review. The critical issue before the High Court was the extent to which the common law concept of illegality applied. The respondent argued that it was not necessary to look beyond the wording of the legislation, which contained a statutory prohibition on the franchisor entering into a franchise agreement without first complying with clause 11(1) of the Code. The High Court disagreed.

The High Court considered the history of the enactment of section 51AD and the Code to determine whether there was a clear statutory intention that a contract entered into in breach of the Code would not be illegal and void. It felt that the purpose of s5 I AD is directed to securing compliance by franchisors with the requirements of industry codes, and the consequence of contravention is the grant of remedies provided for in Pt VI of the Act. [3]

The High Court then considered the Second Reading Speech of the Trade Practices Amendment (Fair Trading) Bill 1997, and the Explanatory Statement with respect to the regulations which prescribe the Code. It was said that the operation of the franchising sector had been of concern to the Government for many years. The sector was characterised by high levels of dispute, generally arising out of the imbalance of power between franchisors and franchisees. Major problems in the sector included inadequate disclosures by franchisors prior to franchise agreements being entered into.

From an analysis of this material the court concluded that the purposes of the scheme of Pt IVB and the Code in question are to regulate the conduct of persons in the franchising industry in order to improve business practices, to provide some protection to franchisees proposing to enter into franchise agreements and to decrease litigation. Those purposes are sought to be achieved, in large part, by ensuring that a prospective franchisee is in a position to make an informed decision about the operation of the franchise and is encouraged to take independent advice before entering into a franchise agreement. The scheme is largely directed to the franchisor, who is obliged to provide that information and advice. Section 51AD may be seen to promote compliance with the Code, by providing, in effect, that non-compliance will amount to a contravention, for which there are remedies available under Pt VI. It is no part of the scheme, and unnecessary to the purposes mentioned, to strike down a contract made by a non­complying 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.

The conclusion reached by the High Court was unavoidable once the court determined it was able to have regard to legislative intent in determining whether the contract should be considered illegal. It is hard to imagine more compelling evidence. The court summarised the position as follows:

"The detailed provision by the Act for the consequences Of non-compliance with an industry code, such as the Franchising Code of Conduct, does not support a conclusion that it was intended that the harsh consequences provided by the common law were to follow upon contravention of s 51AD. The Act provides a more flexible approach. It allows a court to prevent entry into a franchise agreement, to vary the terms of an agreement entered into in breach of the Code, or to terminate such an agreement or provide compensation for loss and damage, if it is shown to have been caused by the contravention. In that regard the extended meaning which may be given to loss and damage by s 82, which is suffered by reason of entry into contractual obligations, may assume significance. [4]

... To render void every franchise agreement entered into where a franchisor had not complied with the Code would be to give the franchisor, the wrong-doer, an opportunity to avoid its obligations [5], and at the same time to place the franchisee in breach of obligations to third parties. A preferable result, and one for which the Act provides, is to permit a franchisee to seek such relief as is appropriate to the circumstances of the case. Some cases of non-compliance with cl 11 might involve substantial non-disclosure; others may only involve a failure to obtain the written statement, confirming that the franchisee has read and understood the disclosure document and the Code. This is such a case.

That is not to say that franchisors should not take Code compliance seriously. The High Court appeared to indicate that only "inconsequential" breaches would avoid serious consequences. It endorsed the comments of the NSW Court of Appeal that the disclosure requirements of the Code were clearly enacted for the protection of prospective franchisees, but felt the range of remedies afforded by the Trade Practices Act (which include declaring an agreement void in whole or in part as initio or at the point in time) were broader, more flexible and to be preferred.' The High Court also appeared to take the view that the insertion of the prohibition on unconscionable conduct was intended to remedy the problems of imbalance of power and inappropriate conduct in the franchise sector. So it may be that the High Court would take a broader view of unconscionable conduct in the context of a franchise relationship than might currently be seen to be the case.

Stephen Giles - Partner, Deacons Lawyers and FCA Director

This article appears courtesy of The Franchise Review

[1] Master of Education Services Pty Ltd v Ketchell [2008] HCA 38 at paragraph 38.

[2] Master of Education Services Pty Ltd v Ketchell [2008] HCA 38 at paragraph 39.

[3] There is also the possibility of an action under s 5 1 AC.

[4] Demagogue Pty Ltd v Ramensky (1992) 39 FCR 31 at 33 per Black CJ, 42-43 per Gummow J, 46-48 per Cooper J.

[5] See also Yango Pastoral Company v First Chicago (1978) 139 CLR 410 at 426 per Mason J.

[6] Master of Education Services Pty Ltd v Ketchell [2008] HCA 38 at paragraph 41.