Repudiation in franchising

There are cases where a franchise agreement may be breached or terminated but not covered by the Trade Practices (Industry Codes - Franchising) Regulations 1998 (Cth) (“Code”).

It is clear from the wording of the Code and the Trade Practices Act 1974 (Cth) (“the Act”) that the legislative intent was that the Code is not meant to “cover the field” [1] in regard to franchising law in Australia [2]. 

Consequently, recourse may be had to common law to determine issues that arise in a franchise relationship.

The questions that will be considered are whether general contractual principles relating to termination for anticipatory breach and damages for the loss of benefit of a contract apply when a franchisee or a franchisor, by words or conduct, repudiates his obligations under the franchise agreement, implied and essential terms in a franchise agreement and the consequences of breach of those terms.

Termination under code

Clauses 21 to 23 of the Code deal with termination and are specific regarding their application. They do not cover all circumstances when a franchise agreement may be terminated. One of those circumstances is repudiation.

What is repudiation?

To quote from the High Court (references omitted) [3] 

“The term repudiation is used in different senses. First, it may refer to conduct which evinces an unwillingness or an inability to render substantial performance of the contract. This is sometimes described as conduct of a party which evinces an intention no longer to be bound by the contract or to fulfil it only in a manner substantially inconsistent with the party’s obligations. It may be termed renunciation. The test is whether the conduct of one party is such as to convey to a reasonable person, in the situation of the other party, renunciation either of the contract as a whole or of a fundamental obligation under it. Secondly, it may refer to any breach of contract which justifies termination by the other party”.

That definition incorporates: 

• showing a clear intention at the time that performance is due of being unwilling or unable to perform a contract or to only perform the obligations under the contract that suited it and in no other way; or 
• indicating before the time for performance is due that when the time arrives, the party will be unwilling or unable to perform the substance of his obligations or to perform an essential term of the contract. [4]

If the innocent party accepts the defaulting party’s repudiation, the contract may be terminated or rescinded by the innocent party although it is not rescission ab initio.

For the innocent party to be entitled to rescind an executory contract on account of the other’s repudiation, the innocent party must show not only the other’s repudiation but his own readiness and willingness up to the time of rescission to perform his essential obligations under the contract [5].  In other words, he must show that he is ready and willing to perform the contract [6].  It is up to the party who claims repudiation to prove that repudiation exists at the time of the acceptance and termination.

If the party accused of repudiation can point to an existing ground for refusal to perform the contact, they may argue that the “innocent party” had actually failed to perform a condition and was not entitled to rely on the repudiatory conduct or that the “innocent party” brought about the breaches disentitling them to rely on the conduct as being repudiatory.[7] 

Further, a party may be in constant breach but continue to maintain that they are bound by and will observe the terms of a contract.  That leads to a difficult situation where “though maintaining a claim to the benefit of a contract, a party may repudiate it or commit a fundamental breach of it by refusing to perform his obligations according to its terms” [8].

Azzi

It is difficult to know if the conduct was in fact repudiatory.  In Azzi & Ors v Volvo Car Australia Pty Ltd [9] Azzi carried on a Honda Car dealership.  In 2002 Azzi was appointed a dealer in Sydney.  There was a one year agreement to be followed by a 5 year agreement.  This was documented in a representation letter signed months after the agreement started:

“The conditions for renewal, non-renewal and termination will be clearly established within both the one (1) year and five (5) year Agreements”.

By the end of the first year and before the 5 year agreement was executed the relationship soured.

Volvo made assertions that it was not bound to give the replacement 5 year agreement. Any reasonable person would have considered their conduct to have shown they did not intend to abide by the terms of the agreement. But they totally resiled from those statements

Before repudiation was accepted Volvo’s solicitors in 2 letters made a clear unequivocal statement of Volvo’s intention to abide by the contract. Because this statement was made before repudiation was accepted, there was not then any repudiatory conduct to accept.

The franchisee claimed that a right to terminate on 120 days notice in the draft document was repudiation of the terms of the agreement, accepted the repudiation and terminated.

The court held the inclusion of the 120 days termination clause was not outside the scope of what was anticipated by the representation letter. If there were terms the franchisee considered unacceptable then the representation letter would continue until the final terms were agreed. The franchisee could object to the unacceptable clauses.

When considering repudiation “the question is what one party’s allegedly repudiatory conduct conveys to the other, not what the first party knows or intends in respect of the contract”. The subjective intentions of Volvo were irrelevant. What was relevant was the communication or non communication of those intentions to the franchisee. [10]

Since repudiation can only be accepted if a party shows a clear intention not to be bound by a contract, even if a party does engage in repudiatory conduct, if they clearly and unequivocally resile from that conduct before the other party accepts the repudiation, there is no repudiatory conduct on which to rely and terminate.  That is because they have shown clearly they do intend to be bound by the terms of the agreement.  

The Code had no application to the termination in Azzi because the repudiation fell outside the situations covered by C21 to 23 of the Code.

Tone ‘n’ Tan

In Tone ‘n’ Tan Pty Ltd v Bailey & Ors [11], the repudiation was clear. The Baileys were the first franchisees in May 2002.  They terminated the agreement by letter to the franchisor in December 2003.  The letter was clear that the Baileys no longer intended to be bound by the franchise agreement.  In January 2004 they opened a business at the same premises offering the same services.  They simply changed the name.

The franchise agreement stated the franchisees could terminate on 6 month’s notice. They chose not to do that and instead terminated immediately, without cause and opened the competing business.

The court understandably held that the franchisees had repudiated the franchise agreement by their letter and opening the competing business. Those actions clearly indicated an unwillingness by the franchisees to perform the franchise agreement.

There is no mention of the Code in Tone ‘n’ Tan. Voluntary abandonment of the business under clause 23(c) of the Code may have applied but was not raised. From a franchisor's point of view why would they terminate for voluntary abandonment which may not give rise to damages for the loss of the bargain under the Code, when the alternative is acceptance of the repudiation which does give rise to those damages? 

Essential terms

Azzi and Tone ‘n’ Tan dealt with the wrongdoer indicating that they would not perform the contracts at all.  Repudiation may also occur when there is a breach of an essential term or gross breaches of intermediate terms which have serious consequences. [12]

To consider terminating a franchise agreement for breach of an essential term, the essential terms must be clear.  “The focus of attention should be the contract, and the nature and seriousness of the breaches. …the intention that is relevant is the common intention of the parties, at the time of the contract, as to the importance of the relevant terms and as to the consequences of failure to comply with those terms”.[13]

Some franchise agreements define essential terms.  A list of what are to be considered essential terms like: products, intellectual property, manuals, assignment. Essential terms must relate to the system.  Vehicle appearance is essential in a mobile franchise.  But fit out requirements is essential to a static location.

• “The parties to a contract may stipulate that a term will be treated as having a fundamental character although in itself it may seem of little importance, and effect must be given to any such agreement” see Wickman Tools v. Schuler A.G.[1973] UKHL 2; (1974) AC 235, at p 251[14]

Breach by a franchisee of a stipulated essential term could give a franchisor the right to treat it as repudiation.  Drafting of the list involves extreme care.  It requires clear words as the result may be unjust, that whenever a franchisor exercises the right to terminate a franchise agreement, he could also recover damages resulting from the failure of the franchisee to carry out all the covenants of the franchise - covenants which the franchisee might have been both willing and able to perform had it not been for the termination. [15]

All terms cannot be essential.  That would mean a minor breach (such as employees must wear name badges) could have dire consequences.  Then the franchisor would clearly be in breach of their implied obligation to exercise their rights with reasonableness and good faith[16].

If a franchisor did incorrectly terminate the franchise on the basis of repudiation then the franchisor would be open to a claim for damages from a franchisee.

Defining essential terms in franchise agreements

How then should essential terms of any franchise agreement be determined?

• “It is the common intention of the parties, expressed in the language of their contract, understood in the context of the relationship established by that contract and … the commercial purpose it served, that determines whether a term is “essential” so that any breach will justify termination”. [17]

Is the term of such importance to one party that they would not have entered into the contract without an assurance of strict or substantial performance of the promise and that this ought to have been apparent to the other party?   

An essential term must be distinguished from an intermediate or non-essential term where one breach would only entitle the innocent party to damages.  But if the breaches of intermediate or non-essential terms are in a number of respects gross, and their consequences serious, then those breaches may go to the root of the contract and justify termination. [18]

An essential term may be that the franchise business be under the direct supervision of someone with a substantial interest in the business as in Masterclass Enterprises Pty Ltd v Bedshed Franchisors (WA) Pty Ltd [19] where a franchisor was held not to unreasonably withhold consent to the sale where the purchaser proposed to appoint a manager and not have the business under the direct supervision of a person with a substantial interest in the business.

Another example is ownership of intellectual property.  Normally franchisors warrant they own or are entitled to use the intellectual property.  That is essential to a franchisee.  Any breach could mean the franchisor does not have the right to grant the licence to use the intellectual property and must result in the franchisee being able to terminate for breach of an essential term.  But this is only a warranty – not listed as an essential term.  The necessary implication would be that it be regarded as a condition going to the root of the contract and any breach would entitle the franchisee to treat it as a fundamental breach giving the right to terminate and sue for damages.

Implying essential terms into Franchise Agreement

The Courts will imply essential terms into franchise agreements.  In The Cheesecake Shop v A and A Shah Enterprises [20] the court held the franchisee repudiated the implied term requiring reasonable notice to terminate.  The franchisee gave immediate notice of termination where the original term had expired.  The court said it was akin to a holding over although there was no holding over clause.[21].  The franchisee could have terminated on complying with the implied term to give reasonable notice.  The franchisee did not give reasonable notice therefore was found to have repudiated the franchise agreement.

The accepted view regarding conditions to be satisfied to imply terms into contracts is:

• “(1) it must be reasonable and equitable; (2) it must be necessary to give business efficacy to the contract, so that no term will be implied if the contract is effective without it; (3) it must be so obvious that 'it goes without saying'; (4) it must be capable of clear expression; (5) it must not contradict any express term of the contract." [22]

Courts would be reluctant to imply terms into a franchise agreement that did not comply with those conditions.

It is apparent from the decided cases that the category of situations where the courts will imply essential terms into franchise agreements is only limited by the facts that come before the courts.

Conclusion

The Code’s application is different in the two specific types of repudiation discussed.

The termination provisions of the Code are not applicable where there is repudiation of a franchise agreement for anticipatory repudiation: that is where one party evinces a clear intention not to be bound by the terms of the agreement or the clear intention to fulfil the agreement only in a manner substantially inconsistent with its obligations and not in any other way.

That conclusion is reached because the actions by the “repudiating party” are not strictly in breach of the terms of the franchise agreement. If there is no breach of the terms of the franchise agreement, then there is no obligation under the Code to give a notice to the franchisee requiring the breach to be remedied.

In cases where there is a breach of an essential term set out in the franchise agreement, the provisions of C21 of the Code will apply. A notice should be given that complies with the Code.

But what if the breach is a breach of an implied term in the franchise agreement? Is notice then required to be given under C21? Or is it a case where because the term is not set out in the franchise agreement, it is not necessary to comply with C21?

Because the term is implied into the franchise agreement, surely it is a breach of the franchise agreement thereby requiring that the notice under C21 be given.

From a franchisee’s point of view, the same principles apply. If the breach complained of is breach of an implied term, then the franchisee should also give notice.

If the conduct of the franchisor amounts to anticipatory or actual repudiation then the franchisee would have the right to accept the repudiation and terminate the franchise agreement. That action may lead to significant loss to the franchisee by loss of the rights granted under the agreement and invoking of the termination obligations.

There is always the argument that because the franchisor had repudiated the agreement, he is not entitled to rely on any further performance by the franchisee of its obligations under the agreement. From a lawyer’s point of view that would be an interesting case to run.

By Janice Bywaters, Bywaters Timms Lawyers . Bywaters Timms Lawyers offer franchise legal advice dispute resolution services.

[1] Master Education Services Pty Limited v Ketchell [2008] HCA 38
[2] See S51AEA of the Act and clause 2 of the Code.
[3] Koompahtoo Local Aboriginal Land Council v Sanpine Pty Limited [2007] HCA 61
[4] Mr Justice McGarvie, “The Discharge of Contracts”, Current problems in Law (Leo Cussen Institute forContinuing Education), Vol 2 (1980) p1 at p 9
[5] Rawson v Hobbs (1961) 107 CLR at 480-481
[6] Savoy Investments (Qld) P/L as trustee v. Global Nominees P/L as trustee [2008] QCA 282
[7] Bamco Villa Pty Ltd v Montedeen Pty Ltd; Delta Car Rentals Aust Pty Ltd v Bamco Villa Pty Ltd [2001] VSC 192
[8] Progressive Mailing House Pty Ltd v Tabali Pty Ltd [1985] HCA 14; (1985) 157 CLR 17
[9] [2007] NSWSC 319 
[10] See for example remarks by Deane and Dawson JJ in Laurinda Pty Ltd v Capalaba Park Shopping Centre Pty Ltd (1989) 166 CLR 623
[11] [2007] WADC 97
[12] Koompahtoo Local Aboriginal Land Council v Sanpine Pty Limited [2007] HCA 61
[13] Koompahtoo Local Aboriginal Land Council v Sanpine Pty Limited [2007] HCA 61
[14]Shevill v Builders Licensing Board [1982] HCA 47; (1982) 149 CLR 620
[15]Shevill v Builders Licensing Board [1982] HCA 47; (1982) 149 CLR 620 – adapted from Gibbs CJ discussion regarding leases.
[16] For the purposes of this paper it is assumed there is an implied term of good faith
[17] Koompahtoo Local Aboriginal Land Council v Sanpine Pty Limited [2007] HCA 61
[18] Koompahtoo Local Aboriginal Land Council v Sanpine Pty Limited [2007] HCA 61
[19] [2008] WASC 67
[20] [2004] NSWSC 625
[21] Many franchise agreements now contain holding over clauses.
[22] Codelfa Construction Pty Ltd v State Rail Authority of NSW [1982] HCA 24; (1982) 149 CLR 337

Endnotes Reference material:
CCH Contract Law Commentary – Termination for Repudiation
G Gunasekara, ‘Good faith, repudiation and franchise agreements’ [2002] NZLJ 453
C Turner, Australian Commercial Law, Lawbook Co, 2006 – The Franchise Agreement
P Hamilton, Business and Franchise Practice Manual – Termination