(Fortunately) no surprises in the Mercedes decision

Introduction

There were no legal surprises in the decision handed down yesterday by the Federal Court in a class action by former Mercedes dealers against Mercedes Benz¹. Mercedes had decided not to extend the term of the dealers’ franchise agreements, had provided significant notice of its intention and had offered dealers an alternative agency agreement which most dealers ultimately signed, albeit in some cases purportedly “under protest”.

Justice Beach dismissed the claims of the applicant dealers that the transition to the agency model resulted in any breach of Mercedes’ good faith obligations under the Franchising Code.

In particular, his Honour held:

1. that the power under the dealership agreements to issue non-renewal notices permitted Mercedes to issue such notices for the purpose of bringing the dealership agreements to an end. The only constraint on that power was that it be exercised in good faith². It was not a constraint on Mercedes’ power to issue the non-renewal notices that it be exercised in a manner that was not antithetical to or which destroyed the bargain struck between Mercedes and dealers;³
2. That Mercedes had not placed the dealers under economic duress in signing the agency agreements;⁴
3. The goodwill of the dealerships had not been appropriated by or transferred to Mercedes, because the continued existence of goodwill was dependent on the continued existence of the respective dealership (which had ceased to operate).⁵ Justice Beach distinguished between the accounting concept of goodwill, being the value of the assets of the dealership as a result of attracting customers and generating revenue⁶ and the legal definition of goodwill, being the legal right or privilege to conduct a business in substantially the same manner and by the same means which in the past has attracted custom to the business (such as by using Mercedes’ trade marks and selling Mercedes vehicles).⁷ Justice Beach held that it is the legal definition of goodwill which subsists under a franchised dealership agreement. Once the dealership agreement came to an end, there was no goodwill which the dealers could transfer or which Mercedes could appropriate;⁸
4. Mercedes had been influenced by the position of its parent company, but ultimately Mercedes took the action to issue the non-renewal notices. Mercedes was not a mere automaton⁹ and did not delegate its obligations under the dealership agreement to its parent company; and
5. Mercedes had not engaged in unconscionable conduct by entering into the agency agreements.¹⁰

There are a number of key takeaways from the judgment of Justice Beach:

1. The existence of a non-renewal right means that a franchise agreement is not a permanent bargain and can be brought to an end by the party with the non-renewal right;¹¹
2. Where a party has a right of non-renewal under a franchise agreement, that right is only constrained by the duty of good faith and not by any notion of the nature of the bargain;¹²
3. The content of a good faith duty as it applies to a termination without cause provision or power of non-renewal, can be distinguished from contractual provisions concerned with cooperation to produce a result beneficial to all the parties to the agreement.¹³
4. If the right of non-renewal is being exercised for the benefit of the party on whom it is conferred, it will likely to be an exercise in good faith. A power that is intended to only serve the interests of the party upon whom the power is conferred,¹⁴ such that any exercise of that power, if in pursuit of that party’s legitimate interests, will be an exercise in good faith.¹⁵ The implication is that the exercise of such a power in circumstances where the purpose is to impede the other party’s ability to obtain the benefit under the contract is more likely to infringe the duty of good faith.¹⁶
5. It was not a breach of the obligation of good faith to take a universal approach to the non-renewal of the dealership agreements and not take into account the individual circumstances of each dealer. Given that the right of non-renewal was being exercised for the benefit of Mercedes, the right was exercised in good faith.
6. Goodwill is the legal right or privilege to operate a franchised business in substantially the same manner which in the past has attracted custom to the business.¹⁷ As such, on expiry or termination of a franchise agreement, goodwill ceases to exist. It is not the case that, once a franchise agreement expires or is terminated, there is some valuable intangible asset to which the franchisee still has an entitlement. A franchisee has no right at law to be compensated for goodwill on non-renewal of a franchise agreement.¹⁸

Although the majority of the judgment has been withheld due to confidentiality, Justice Beach released a high level summary of the main themes litigated and the conclusions of the case. The summary is entirely consistent with previous court decisions and, subject to any appeal, brings to an end a highly public dispute anxiously watched by all automotive brands.

This article examines the legal principles comprising the duty of good faith in franchising.¹⁹

Good faith principles

Clause 6 of the Franchising Code of Conduct (Code) provides that each party to a franchise agreement must act towards another party with good faith, within the meaning of the unwritten law from time to time, in respect of any matter arising under or in relation to the agreement and the Franchising Code (the obligation to act in good faith). Importantly, the Code expressly provides that the obligation to act in good faith does not prevent a franchisor from acting in its legitimate commercial interests.²⁰

An obligation to act in good faith at common law is an obligation:

1. to act honestly and with fidelity to the bargain;
2. not to act dishonestly and not to act to undermine the bargain entered or the substance of the contractual benefit bargained for; and
3. to act reasonably and with fair dealing having regard to the interests of the parties (which will, inevitably, at times conflict) and to the provisions, aims and purposes of the contract, objectively ascertained.

The standard of fair dealing or reasonableness that is to be expected in any given case must recognise the nature of the contract or relationship, the different interests of the parties and the lack of necessity for parties to subordinate their own interests to those of the counterparty. A party is not required to subordinate the party’s own interests, so long as pursuit of those interests does not entail unreasonable interference with the enjoyment of a benefit conferred by the express contractual terms so that the enjoyment becomes worthless or perhaps seriously undermined.

A duty of good faith requires honest and genuine assessment of rights and obligations and it requires that a party negotiate by reference to such.

The Federal Court in Geowash²¹ summarised the current state of the law as to the meaning of good faith for the purposes of cl 6(1) of the Code:

1. the term 'good faith' imports a normative standard to be observed by the parties in dealings as to matters to which the standard is applied;
2. the normative standard embraces an obligation to act honestly and with fidelity to the bargain concluded between the parties;
3. the normative standard also embraces an obligation to act co-operatively in matters related to performance;
4. the standard does not require a party to subordinate its legitimate interests to those of the counterparty, but it does require due regard to the legitimate interests that both parties have in the performance of the contract they have made;
5. conduct which is dishonest, capricious, arbitrary or motivated by a purpose which is antithetical to the evident object of any provision of the franchise agreement or the Code that governs the conduct being scrutinised, or conduct which is otherwise motivated by bad faith, will not meet the standard;
6. where the scrutinised conduct, viewed in the particular context, is objectively unreasonable then the unreasonableness may form part of the basis for a conclusion that there has been a lack of good faith, but objective unreasonableness is insufficient of itself to amount to a lack of good faith; and
7. the quality of the scrutinised conduct is to be evaluated having regard to the circumstances of the particular parties, particularly their sophistication, commercial power and the relative significance for each party of the subject matter of the conduct.

Conclusion

As the Mercedes Case reinforces, the express terms of the contract, and the provisions of the Code, are very important when considering any good faith claim. The franchise agreement gives the franchisor express contractual rights, and the Code provides a comprehensive regulatory framework that specifically addresses “end of term” requirements. Although the obligation of good faith does apply to “end of term” dealings between the parties, it is only in atypical circumstances in which it will alter the contractual rights of the parties. Those circumstances include where the Franchisor is acting dishonestly in a relevant respect, failing to have regard to the legitimate interests of the franchisee, or is acting pursuant to an unreasonable ulterior motive. Typically, such circumstances will be absent when all that a franchisor is seeking to do is to bring to an orderly end a fixed term contractual relationship without a right of renewal.

The existence of the comprehensive “end of term” framework in the Code is also relevant in the context of acting reasonably. A party that is exercising a clear contractual right, and complying with the comprehensive regulatory framework specifically designed to address the expectations of contracting parties at end of term, typically must be acting “reasonably” according to law.

The following comments in the Ultra Tune case²², and followed in the Mercedes Case, are particularly pertinent to end of term arrangements:

“… It must be accepted that the party subject to the obligation is not required to subordinate the party’s own interests, so long as pursuit of those interests does not entail unreasonable interference with the enjoyment of a benefit conferred by the express contractual terms.

Where the benefits enjoyed under a franchise agreement by a franchisee are for a defined duration, a franchisor’s insistence on the commercial relationship coming to an end in accordance with the defined duration of the franchise agreement is very likely to be permissible as the franchisee will have already enjoyed its full contractual entitlement to the benefits.

Nonetheless, where a franchise network is seeking to change the nature of its model following the expiry of existing franchise agreements, advance consideration ought to be given to the following matters in order to maximise the prospects of successful implementation of the change:

1. Rationale for change: How compelling/persuasive is the business case and how best to articulate that to the network.
2. Analysis prior to implementation: Considering undertaking advance pilot studies, modelling and forecasts.
3. Consultation and engagement: There needs to be alignment between the commercial strategy and the psychological strategy to encourage franchisees to support the change (or at least not to be actively resistant to it). In this regard, it is important to explain the rationale for the change and how it is fair and reasonable (and for it to be objectively fair and reasonable). Franchisees need to feel that their views are being considered, that they are being provided with relevant information and the ability to engage with the decision making in respect of the change.

It will be interesting to see how dealers react to the Mercedes decision, given the recently announced review of the Franchising Code of Conduct is strongly directed towards the automotive provisions. Several of the questions in the consultation paper are expressly directed to the automotive provisions, including a specific question relating to “adequate minimum standards relating to structural and/or operational change management.”²³ The following question asks about the “impact” of “the 2021 amendments to the obligation to act in good faith in relation to new car dealerships”²⁴. Justice Beach also referred to the absence of any right to compensation for goodwill on non-renewal of franchise agreements and whether legislative change is required.

The parties are still to make submissions on costs and the release of the remainder of the decision. As noted above, Justice Beach’s findings on the individual claims of the chosen “exemplar” applicants are confidential and have not yet been released. Although the skirmish in the Mercedes Case has ended decisively (subject to any appeal), and without any real legal surprises, the battle may well continue on the political front.