A franchise operates within an existing business structure that gives the franchisor discretion to implement strategies, introduce new products and set prices for the ‘branded’ goods or services. These commercial decisions however must be exercised in ‘good faith and reasonableness’.
The obligation of good faith is reflected in the Franchising Code of Conduct which sets out mandatory processes for buying and selling a franchise, and regulates the conduct of franchisors and franchisees.
The obligation of good faith was considered at length in Virk Pty Ltd (in liquidation) v Yum! Restaurants Australia Pty Ltd  FCAFC 190.
The case concerned an appeal from an earlier decision where Pizza Hut franchisees claimed that, by introducing its ‘Value Strategy’, franchisor Yum! breached terms of its franchise contract, engaged in unconscionable conduct and was accordingly liable in negligence. The strategy required franchisees to slash pizza prices and reduced the pizza range from four to two categories, resulting in financial loss for many franchisees.
The original case and appeal were unsuccessful, with both considering the scope of the duty of good faith and whether that duty requires a franchisor to act reasonably.
Parties to a franchise arrangement must act in good faith within the meaning of the unwritten law as determined in various cases. Essentially, good faith requires parties to act reasonably, honestly and not arbitrarily, with a common goal of achieving the purposes of the agreement.
Franchisees however must be aware that franchisors will usually have discretion to change branding, introduce or delete products, or change policies and processes. Whilst this discretion is not unfettered, it may, as in the above case, impact upon the financial viability of the franchisee’s business. In this respect, franchise agreements often contain terms protecting the franchisor from claims if the business or proposed location of the business is unsuitable, or the franchise unprofitable.
Franchisees should give careful consideration to the constraints of a franchise system and the potential need to adapt to changes imposed by the franchisor, before committing to an agreement.
Tim Hayter, Principal, Mid West Lawyers
This information is general in nature and should not be relied upon as legal advice. Formal legal advice should be sought for your particular circumstances.