A recent decision by the Supreme Court of Queensland provides a timely warning to franchisors of the risk of being overly aggressive in exercising apparent contractual rights to terminate a franchise agreement.

In the National Security Training Academy (GC) Pty Ltd v National Security Training Academy Pty Ltd case, the expensive legal proceedings ended with the Court finding in favour of the Franchisee.

The relevance of the case to franchisees is a franchisee does not need to be intimidated by a Notice of Breach that may set in motion a process that ends in the loss of a valuable business without compensation. A franchisee may have a range of arguable defences that allow it to seek an injunction stopping any attempt by the franchisor to end the franchise until the matter can be looked at and determined by the Court.

This case is also relevant to legal practitioners because the Court was prepared to resolve alternative interpretations on the meaning of a term in the Franchise Agreement by adopting the interpretation most consistent with the Franchising Code of Conduct (‘Code’).

The Issues

The Franchisor and the Franchisee entered into a franchise agreement in 2010 for a term of 5 years with an option for another 5-year term.

The Franchisor purported to terminate the franchise agreement for the breach by the franchisee.

The Franchisee applied for urgent interlocutory relief from the Court to prevent the Franchisor from taking steps, which were consequential upon its purported termination of the Franchise Agreement. This application was resolved by an undertaking by the Franchisor that had the effect of allowing the Franchisee to continue in the franchised business until the final hearing.

The Franchisee constructed its defence along three lines. Firstly, it argued that there was no breach of the Franchise Agreement. Secondly, it argued that if there was a breach, it was not served by the Franchisor with a notice to remedy the alleged breach. Thirdly, it argued that the Franchisor’s purported termination of the Franchise Agreement involved a contravention of section 51AD of the Competition and Consumer Act 2010.

The Court considered these three grounds of defence before the final hearing. The Court further considered in advance of the final hearing whether the alleged contravention of section 51AD of the Competition and Consumer Act 2010 had the consequence of invalidating the respondent’s purported termination of the contract.

It was a term of the Franchise Agreement that the Franchisee pay a franchise fee, calculated as a percentage of the Franchisor’s gross turnover according to its Business Activity Statements. This obligation was reinforced by an obligation that the Franchisee maintain appropriate accounting systems and submit to the franchisor its quarterly BAS/GST return within 7 days of the compilation of the BAS/GST return. Experienced franchised dispute lawyers will be aware that the obligation to pay franchising fees on gross income rather than net profits means that the franchisee must pay franchise fees even if it is trading at a net loss each month.

The Franchisor alleged that the Franchisee was in breach of the Franchise Agreement because it failed to forward to the Franchisor a copy of its BAS for the October-December 2012 quarter together with a cheque for payment of the franchise fee

The Facts

The termination clause in the Franchise Agreement allowed the Franchisor to terminate the Franchise Agreement if:

• There was a breach of the Franchise Agreement;

• A written notice was provided by the Franchisor to the Franchisee giving it a reasonable time to remedy the breach;

• The breach was not remedied.

Breach of the Code is a breach of section 51AD of the Competition and Consumer Act 2010. The Code requires the Franchisor to:  

• give to the franchisee reasonable notice that the franchisor proposes to terminate the franchise agreement because of the breach;

• tell the franchisee what the franchisor requires to be done to remedy the breach;

• allow the franchisee a reasonable time to remedy the breach.

On 22 March 2013 the Franchisor delivered a notice of breach to the Franchisee by way of a letter from its solicitor (‘Breach Notice’), which identified the breach as failure to submit to the Franchisor the BAS return and financial returns for the October-December 2012 quarter, and gave notice that if the breach was not remedied in 30 days of the date of the letter the Franchisor had a right to terminate the Franchise Agreement without further notice. The letter did not refer to failure to pay the franchise fees as a breach.

The Franchisee argued that the notice of breach contravened section 51AD of the Competition and Consumer Act 2010 because it did not tell the franchisee what the franchisor required to be done to remedy the breach.

On 25 March 2013 the Franchisee submitted to the Franchisor a copy of the BAS return but not a cheque for the franchise fee. The BAS return showed that a fee of $7,700.00 (inclusive of GST) was owing to the Franchisor.

The Franchisee then tried to off-set the amount owing to the Franchisor against fees it claimed it was owed for training in the sum of $7,500.00. The Franchisor did not accept this attempt to off-set and by email insisted on payment again on 28 March 2013.

On 9 May 2013, the Franchisor terminated the Franchise Agreement.

Was there a breach?

The facts showed that the Franchisee’s BAS returned was lodged with the ATO on 19 March 2013. The Franchisee then had 7 days to deliver the BAS return to the Franchisor. However, as the letter from the Franchisor’s solicitors giving the Breach Notice was served on 22 March 2013 during this 7-day period, it was served when there was no breach of an express term of the Franchise Agreement requiring the BAS return to be submitted to the Franchisor within 7 days of its lodgement with the ATO.

The Court however implied a term to the effect that the applicant should lodge its BAS quarterly returns as required by the law. As the BAS return for the relevant quarter in issue was due to be lodged with the ATO by 28 February 2013, the Franchisee was in breach of this implied term of the contract on and from 1 March 2013 as it has not lodged its return by 28 February 2013. This breach however was remedied when the BAS return was lodged with the ATO on 19 March 2013 before the Breach Notice was received from the Franchisor. Therefore, the Court found that the Franchisor was not in breach of the implied term on 22 March 2013.

The Court found that the Franchisee was again in breach of the Franchise Agreement on 26 March 2013 as by this date it had failed to provide a cheque for the franchise fee of $7,700 with the copy of the BAS. This breach was not and could not have been identified in the Breach Notice of 22 March 2013 as the breach occurred on 26 March 2013 after the date of the Breach Notice.

Did the Franchisor serve a notice to remedy the Breach?

The Court found that the solicitor’s letter dated 22 March 2013 was not a breach notice under the Franchise Agreement because there was no breach on that date.

The Court then considered whether the email sent to the Franchisee on 28 March 2013 was a notice of breach.

In considering whether or not the email of 28 March 2013 was a notice of breach under the franchise agreement the Court observed that the relevant clause in the Franchise Agreement in respect of termination was capable of alternative interpretations. The Court preferred the interpretation that was most consistent with the Code.

Specifically, and relevantly, the Court held that:

“although the Code was not incorporated as part of the contract, the concurrent legal obligations under the Code are relevant in the interpretation of this contract. If a provision of the contract is capable of more than one meaning, then the preferable meaning is that which is more consistent with the operation of the Code.”

An interpretation consistent with the Code required that the email of 28 March 2013 inform the applicant that the Franchisor would terminate the contract if the $7,700.00 fee was not paid within a reasonable time. The email did not contain this information and therefore was not a notice of breach under the relevant clause in the Franchise Agreement. For the same reason, the Court held that it was not a notice for the purpose of clause 21 of the Code.

Was there a contravention of section 51AD of the Competition and Consumer Act 2010?

As there was no breach of the Franchise Agreement as alleged, no valid breach notice under either the Franchise Agreement or clause 21 of the Code, and no valid termination of the Franchise Agreement then there was a contravention of section 51AD of the Competition and Consumer Act 2010.

Finding in favour of the Franchisee, the Court declared that the Franchise Agreement between the Franchisor and the Franchisee had not been lawfully terminated.

According to Turner Freeman Lawyers , this case shows the importance of a franchisor not to rush into issuing notices to remedy breach or terminating a Franchise Agreement. The Franchisor should obtain legal advice that there is in fact a breach and that it delivers to the franchisee a properly drafted notice to remedy breach that complies with both the franchise agreement and clause 21 of the Code.

The relevance of the case to franchisees stresses the importance of not reacting passively to receipt of a breach notice but being proactive and obtaining relevant legal advice as quickly as possible to ascertain what steps the franchisee can take to avoid termination of the franchise agreement and loss of the business.