It is often said that parties must “act in good faith” when they are doing business together. What is meant by this phrase, particularly when parties are about to enter or are already in a franchise relationship?

The franchise agreement, the disclosure document and the mandatory Franchising Code of Conduct provide the perimeters of your relationship with the franchisor. Frequently, this relationship can be imbalanced in favour of the franchisor. As the owner of a particular business model, the franchisor will want you to comply with various standards so that the franchisor’s brand is uniformly presented to the market. It is, therefore, not unusual that strict obligations are imposed on you whilst limiting your ability to freely undertake your own initiatives.

Updates to the Franchising Code of Conduct

The recent updates to the Code have tried to redress this imbalance by compelling both parties to act in good faith when dealing with each other. As the new Code takes effect from 1 January 2015, it is important that you are aware of this and the other amendments to it.

Unfortunately, the new Code does not provide a definition of good faith. The Code states that good faith takes on the same meaning as given to it under the Australian unwritten law. As this unwritten law continues to develop over time, it is impossible to provide you with a firm definition. As a guideline, the new Code sets out that both parties must act honestly and not arbitrarily and to cooperate to achieve the purposes of the franchise agreement. Acting oppressive, unfairly or unreasonable may result in a breach of the good faith obligation.

What is good faith when it is applied in franchising? You should be mindful that the obligation exists during the entire franchise relationship from the negotiations to after the termination of the franchise relationship. The obligation to act in good faith does  not, however, prevent the parties from acting in their own legitimate commercial interest. For example, there is no breach if the franchisor has reasonable grounds to deny an extension of the franchise agreement or issues a default notice for a true breach of the franchise agreement.

Examples of breaches

Some examples to consider may include:

(a)        default notices were issued without any reason to do so;

(b)        not assisting the franchisee where the franchise agreement obliges the franchisor to do so ;

(c)        terminating the franchise agreement for trivial breaches of franchisee obligations;

(d)        the franchisor undertaking commercial activities in the exclusive territory of the franchisee;

(e)        the franchisor preventing the franchisee from meeting its minimum performance criteria by refusing consent to open additional stores which are required to meet these criteria;

(f)         making unilateral changes to the franchise agreement.

It is important to emphasise that the Code also obliges franchisees to act in good faith when dealing with a franchisor. For example, franchisees are not allowed to publish untrue and negative statements about the franchisor’s business in social media.

Consequences and conclusion

The obligation to act in good faith should not be taken lightly as there may be significant consequences for the wrongdoer. The new Code entitles the Australian Competition & Consumer Commission to either issue infringement notices up to $8,500 or to request the Federal Court to award civil penalties up to $51,000.

Accordingly, it is important that the parties act in good faith throughout the entire franchise relationship. Although we have seen that it is difficult to define, it may serve as a reminder that parties to a franchise agreement must act in the interest of the relationship, whilst not forgetting their own commercial interests.