A highly anticipated judgement and possible reforms: key developments in franchising in 2023

It has been another busy year for the franchise sector. In August 2023, Mercedes-Benz Australia/Pacific Pty Ltd was successful in a Federal Court case brought by 38 of its Australian dealers. These dealers challenged the carmaker’s decision to not renew their dealer agreements and to implement an agency model, seeking A$650 million in compensation.

The Federal Court’s decision came shortly after the Federal Government announced an independent review of the Franchising Code of Conduct (the Code). In its response to the review, the Australian Competition and Consumer Commission (ACCC) proposed significant change to the regulation of the sector, including supporting the replacement of the Code with a licencing regime.

The ACCC has also recently warned franchisors to review their standard form agreements to ensure small business franchisees receive protections under the Australian Consumer Law’s unfair contract terms regime, which is also a current compliance and enforcement priority for the regulator.

In this article we outline the ACCC’s proposals and priorities and discuss the main takeaways from the decision in AHG WA (2015) Pty Ltd v Mercedes-Benz Australia/Pacific Pty Ltd [2023] FCA 1022. We also consider the key changes to workplace laws, passed by Parliament in early December 2023, that are likely to be relevant to franchise businesses.

Mercedes moves from franchising to agency model

Between December 2021 and mid-2022, Mercedes-Benz Australia/Pacific Pty Ltd (Mercedes AU) moved from a franchising model with dealers to an agency model, implementing the global strategy of its holding company Mercedes-Benz AG.

Under the franchising model, dealers would buy stock at wholesale prices from Mercedes-Benz AU, sell vehicles to customers at their own prices, set their own profit margins and develop goodwill with customers. Once the new agency model was introduced, dealers were required to act as agents of Mercedes-Benz AU, selling stock owned by Mercedes-Benz AU at set prices and receiving a fixed commission on sales.

The dealers claimed that by not renewing their dealership agreements and shifting to the agency model, Mercedes-Benz AU appropriated their goodwill and customer relationships for no or inadequate compensation and provided them with a worse financial return. They sought Federal Court relief on the basis that Mercedes-Benz had:

• acted unconscionably by exercising its contractual power of non-renewal under the dealership agreements to implement an agency model;

• exercised its non-renewal power for an improper purpose by terminating the dealership agreements as a precursor to the agency model; and

• breached its statutory duty to act in good faith towards another party under the Code.

Mercedes-Benz AU argued that dealers did not have an unconditional contractual entitlement to continue operating as a franchisee beyond the expiration of their dealership agreements. It contended that Mercedes-Benz AU had a legitimate commercial interest in moving to a non-negotiable fixed price business model, citing a market shift across the car industry to online sales, customer dislike for price haggling and rising costs which eroded dealer profitability.

Justice Beach’s decision

The Federal Court dismissed the dealers’ claims and held that Mercedes-Benz AU was not prohibited from electing to not renew the dealership agreements and instead implement the agency model.

Justice Beach found that, even though dealers may have been financially disadvantaged under an agency model, this did not mean Mercedes-Benz AU had acted unconscionably or failed to act in good faith. The dealers’ claim for 'loss of goodwill' was also rejected as there is no legal framework to support goodwill compensation at the expiry (and non-renewal) of a franchise agreement.

When the decision was handed down only around 50 pages of the 679-page judgment were published, with the additional content subject to confidentiality claims. These claims have now been settled and, at the beginning of November 2023, the full judgment was published. The judgment provides several helpful reminders for franchisors and franchisees:

• A franchisor is unlikely to be acting unconscionably by exercising its power of non-renewal to change business models. The Court described this possibility as a risk that franchisees accept when they enter into a franchise agreement (specifically if the agreement contains a right to not renew the agreement without cause or for any reason).

• A franchisor cannot be found to appropriate a franchisee’s goodwill by terminating a dealership contract, because the franchisee’s goodwill does not survive termination of the franchise agreement.

• Although franchisees may make the sensible commercial assumption that if they perform well, their franchising relationship will continue, that assumption is irrelevant when considering whether a franchisor exercises their contractual power of non-renewal in good faith.

• The good faith duty under the Franchising Code of Conduct only requires a party to act honestly when exercising its power of non-renewal without cause and does not require a contract to continue indefinitely or prevent a party from acting in its own legitimate commercial interests.

• An Australian subsidiary does not necessarily exercise a contractual power for an improper purpose merely because it was influenced by the international holding company, including when the holding company approves all key decisions, designs the relevant strategy, and obtains benefits.

Implications for franchise relationships

The decision provides franchisors with an additional level of confidence in their ability to implement a wholesale change to their operating model and franchising relationships, provided this is done with care and for legitimate reasons. Neither the obligation to act in good faith or the prohibition on unconscionable conduct prevents a franchisor from favouring its own interests to that of its franchisees.

The judgment makes it clear that a franchisor will not lack good faith by exercising its power to not renew an agreement so that it can advance its own commercial interests. Instead, the duty of good faith requires a franchisor to act honestly in matters directly and intimately connected to performance of the contract and non-renewal. Additionally, with regard to acting unconscionably, the judgment affirms that even if it is established that a franchisee might be worse off due a change by the franchisor, that does not render the franchisor’s conduct unconscionable.

Other legal developments

Franchisors and franchisees should be aware that earlier in December, a suite of changes to workplace laws were passed by Parliament as ‘Part 1’ of the Government’s 'Closing Loopholes' workplace reforms (with ‘Part 2’ the subject of further scrutiny in early 2024). The most significant of these changes are:

• the introduction of a Federal 'Wage Theft' offence with criminal consequences for the 'intentional' underpayment of employment-related entitlements;

• significantly increased maximum civil penalties for underpayments, along with a lowering of the ‘serious contravention threshold’;

• the introduction of an 'objective' test of casual employment, which will mean there is likely to be less certainty as to the engagement status of casual employees. This change is accompanied by an additional casual conversion regime which will sit alongside the existing casual conversion framework in the Fair Work Act 2009 (Cth);

• the introduction of legislative rights for workplace delegates; and

• the introduction of the a 'Regulated Labour Hire Order' regime (the renamed 'Same Job, Same Pay' provisions).

Although the above reforms apply broadly to all employers, and are not targeted at franchise arrangements, there are some proposed technical amendments which do focus on franchise businesses. Specifically, a number of amendments to the multi-employer bargaining regime clarify that multiple employers carrying on similar business activities under the same franchise may forcibly (i.e. without consent) be drawn into a multi-employer bargaining process, subject to certain requirements being met.

A franchisor and their franchisees can already be compelled to bargain together under existing industrial laws. However, the changes would confirm that they can now be exposed to the revamped multi-enterprise bargaining streams introduced by the Government in the 2022 Secure Jobs, Better Pay reforms and the coercive measures available to unions under the new regime. These include the power of unions to ‘block’ employers from putting a proposed agreement to an employee vote, as well as the ability of unions to apply to ‘rope in’ other employers into an existing agreement.

ACCC report on Unfair contract terms in franchise agreements

On 15 December 2023, the ACCC published a report on Unfair contract terms in franchise agreements, following targeted franchising compliance checks in July 2023. See our previous Insight on the changes to the unfair contract terms regime which took effect on 9 November 2023.

The ACCC has warned franchisors to urgently review and amend their standard form franchise agreements or be prepared for potential enforcement action after a review of franchising contracts found wide-ranging concerns under the unfair contract term regime. Clauses in franchise agreements which are of particular concern to the ACCC include:

• unilateral variation clauses, where they give the franchisor an unconstrained ability to vary key aspects of the agreements or where there is insufficient prior notice to the franchisee of the change, and no ability for the franchisee to leave the agreement without incurring financial detriment;
  
  
• clauses that permit withholding or setting off payments, which may cause cash-flow issues to small businesses and are especially concerning where the franchisor could withhold or set-off payments in any circumstance, such as where the payment by the franchisee is not due or disputed;
  
  
• clauses that permit franchisors to terminate an agreement at any time without cause on reasonable notice, given the significant detriment to the franchisee where such termination is unlikely to be reasonably necessary to protect the franchisor’s legitimate interest;
  
  
• restraint of trade clauses which go beyond what is reasonable, which is often the case with cascading restraints; and
  
  
• clauses which give the franchisor the right to conduct an audit in circumstances where the franchisee is required to cover all fees and expenses related to the audit without limitation and without a reasonableness constraint on the franchisor.

Enforcement action and an independent review of the Code

The proper administration and reporting on the use of marketing funds remains an enforcement focus for the ACCC. This was again illustrated by the recent action by the ACCC publicised in December 2023 against health food and beverage franchisor Delicia Franchising. Franchisors must ensure that marketing fund statements are carefully prepared with the required detail and shared with franchisees in accordance with the Code.

Additionally, an independent review (Review) of the Code is currently underway. The Code is made under the Competition and Consumer (Industry Codes-Franchising) Regulation 2014, and is due to expire in April 2025. In August 2023, public comment was invited on:

• the scope of the Code;
  
  
• the processes required before entering into a franchise agreement;
  
  
• ongoing obligations in franchise relationships;
  
  
• the processes required to end a franchise relationship; and
  
  
• enforcement and dispute resolution.

In its submission to the Review, published in October 2023, the ACCC expressed a number of concerns with “persistent issues” regarding the Code’s suitability for a complex industry. It cited the power imbalance between franchisees and franchisors, which it believes continues to lead to significant disputes and financial harm to franchisees. The ACCC’s submission suggests major changes to the regulation of the sector, and includes that:

• The ACCC has limited ability to proactively or quickly prevent harm to franchisees and must prioritise when deciding which franchise matters it investigates. This often means it is unable to investigate all reports and cannot quickly take action in every circumstance where a potential breach of the Code is identified.
  
  
• The Code should be replaced by a ‘licencing regime’, which could provide a more robust compliance framework and reduce the harms that persist in franchising arrangements. Such a licencing regime could include:

• appointing a new regulator to oversee the licencing regime;
  
  
• allowing the regulator to impose conditions on the franchisor’s licence or impose a suspension or cancellation of the licence to address concerns with franchisor conduct; and
  
  
• imposing obligations on the franchisor to ensure franchisees have the skills, knowledge and experience to successfully operate a franchise.

• If a decision is made to retain the Code, the ACCC recommends a number of changes, including that:
  

• penalties should be added for breaches of more clauses in the Code;
  
  
• infringement notice penalties for alleged breaches of the Code should be increased;
  
  
• express warnings to franchisees and prospective franchisees should be required to draw prospective franchisees’ attention to certain issues or risks prior to purchase; and
  
  
• the franchising disclosure regime should be strengthened, which could realise some of the potential benefits of a licensing regime.

The findings and recommendations of the Review are scheduled to be provided to the Minister for Small Business by the end of December 2023.