1st December, 2014 · Policy Viewpoint

The meaning of ‘Good Faith’

5 minutes to read

After months of consultation the Government released the final version of the Franchising Code of Conduct (new Code) on 3 November 2014, replacing the old Code from 1 January 2015.

It is the most significant review of the Franchising Code since it was introduced in 1998. A major feature of the Code is the codification of good faith. Good faith is a topic often discussed and referred to, but often not well-understood in terms of its legal meaning.
What does good faith mean and is it new?
The common law duty of good faith is said to apply in most commercial contracts including Dealer Agreements. The common law duty of good faith requires each party to ‘exercise the powers conferred upon it by the agreement in good faith and reasonably, and not capriciously or for some extraneous purpose’ (Far Horizons Pty Ltd v McDonald’s Australia Ltd [2000] VSC 310).

To the surprise of many, the Exposure Draft of the Franchising Code released for consultation in April 2014 contained a definition of good faith. The proposed definition would have meant a different and lower threshold legal test compared to the legal test under the common law. This is similar to the test of unconscionable conduct where there is a common law meaning and a separate statutory meaning.

However, in the final round of consultation, the Government has been persuaded not to proceed with the statutory definition and to instead allow the common law to develop the concept of good faith. To counterbalance the removal of the proposed definition, the new Code has set out the matters it thinks a court should have regard to when considering whether a party to a Dealer Agreement has contravened the good faith provisions.

This guidance is new and could encourage courts to adopt a different philosophy in relation to claims for lack of good faith. It should also be noted that the Government appears set to introduce a statutory definition in the Grocery Code of Conduct which applies a different test and that too may have some bearing in the future development of the common law.

The obligation to act in good faith set out in the new Code is as follows:

6. Obligation to act in good faith

(1) 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:

(a) The agreement; and
(b) This code.

This is the obligation to act in good faith.

(2)The obligation to act in good faith also applies to a person who proposes to become a party to a franchise agreement in respect of (Emphasis added):

(a) Any dealing or dispute relating to the proposed agreement; and
(b) The negotiation of the proposed agreement; and
(c) This code.

Matters to which a court may have regard

(3) Without limiting the matters to which a court may have regard for the purpose of determining whether a party to a franchise agreement has contravened subclause (1), the court may have regard to:

(a) Whether the party acted honestly and not arbitrarily; and
(b) Whether the party cooperated to achieve the purposes of the franchise agreement (Emphasis added)

Subsection 6(2) of the new Code makes clear that the concept of good faith applies to all aspects of the franchise agreement. This is ‘new’ and will extend the application of good faith to the negotiation of a franchise agreement, performance of the franchise agreement and the termination of that franchise agreement. This is a significant difference to the common law duty of good faith where there is no consensus on whether the concept applies to all aspects of a contract.

Impact on the Dealer Agreement

As set out above, one of the matters to which a court may have regard to is the purposes of the franchise agreement.

The purposes of a Dealer Agreement are sometimes set out in the ‘Recitals’ or ‘Background’ section of the Dealer Agreement. The recitals section does not set out contractual rights and obligations and usually consists of generic statements about the purpose of the agreement. Recitals are sometimes omitted from a Dealer Agreement altogether.

The recitals may now have more significance in Dealer Agreements in relation to good faith claims. The purposes of a Dealer Agreement in the context of the automotive industry can often depend on where a particular motor vehicle brand is placed in the product and distribution cycle. If it is a new start-up brand, a distributor may be heavily reliant on the skills and resources of the Dealer to build the brand from scratch. It is generally accepted that it may take many years for a Dealer to profit from a start-up brand and a Dealer will only absorb start-up costs on the understanding that they will represent the brand in more profitable years once the brand matures. The challenge for distributors is to reward Dealers for building the brand from a low starting point.

On the other hand, a mature brand may justifiably seek much greater levels of investment in facility, infrastructure, people, equipment, marketing and training from Dealers to assist it to move to the next level in its growth phase. This might be after many years of good profits, low capital investment requirements and a current product range that can firstly, justify more investment and secondly, generate a return for Dealers. The challenge for Dealers in this situation is to match the ambitions of the distributor.

Given the purpose of the Dealer Agreement is relevant to the obligation to act in good faith, the contents of the recitals or a separate statement of purposes will need to be given further consideration. Conduct or behaviour that defeats these stated purposes may give rise to a breach of the obligation to act in good faith.

The codification of good faith may also require a broad review of Dealer Agreements to ensure there are no provisions that if exercised could lead to claims of a lack of good faith.

The fact that the obligation to act in good faith applies to all aspects of the Dealer Agreement, including the negotiation of a Dealer Agreement may mean that a distributor is more cautious and conservative about the information it is willing to share with a prospective Dealer for a new PMA. Alternatively, a distributor may attempt to limit its risk through wide ranging disclaimers in any data or information provided to a Dealer prior to entering into a Dealer Agreement.
Enforcement policy and other industry codes

The Deputy Chair of the ACCC, Dr Schaper, made clear the ACCC’s likely enforcement policy in relation to the new Code. He indicated the ACCC will focus on particularly serious conduct, including breaches of the ‘key pillars’ of the revised Code. Specifically, he said, ‘This is likely to include failure to act in good faith, failure to provide a disclosure document, refusal to attend mediation and unlawful termination of a franchise agreement … Fundamentally, good faith will require both parties to a franchise agreement to remain loyal to the contract they have entered into … Acting for an ulterior purpose, or in a way that undermines or denies the other party the benefits of the contract are examples of conduct that may qualify as bad faith.’ (Emphasis added).

As referred to above, the Treasury department recently released and consulted on a proposed new Grocery Code of Conduct (Grocery Code). The proposed Grocery Code also includes an obligation to act in good faith, however, it has a statutory definition for good faith. The definition includes a broad obligation not to put suppliers under duress in their trading relationships and the need for certainty in trading, particularly in relation to production, delivery and payment.

Penalties

Breaching the obligation of good faith in the Franchising Code may result in a court imposed civil penalty of $51,000 (300 penalty units). The ACCC can also issue infringement notices for breaches of the Franchising Code, which amounts to a penalty of $8,500 (50 penalty units). Although the amounts are relatively low the brand damage associated with a fine or infringement notice may have a significant impact on a brand. The ACCC requires reasonable grounds to believe that a person has contravened a civil penalty provision of an industry code before it may issue an infringement notice.
Conclusion

The codification of good faith is an important change that will underpin the Franchising Code as a whole, with the aim of improving standards of conduct within the franchise sector. It will be very interesting to note how the automotive industry participants approach changing the Dealer Agreement to deal with the codification of good faith, how the ACCC enforce the new requirement to act in good faith and how the courts interpret the new good faith obligation in the new Code.

 

Vinesh George
Franchise Lawyer