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Obtaining Injunctions After Termination Of A Contract: The Role of Good Faith

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Written by Alicia Hill, Principal and Benjamin Caddaye, Law Clerk, MST Lawyers

Recently the Supreme Court of Victoria had to determine in Delahunt v Swim Loops Pty Ltd [2018] VSC 269 whether the Franchisees should be granted an injunction to allow them to regain possession and operation of the business while proceedings were before the Court. The Franchisee argued that the Franchisor had terminated their Franchise Agreement in addition to being evicted from the franchise premises.

The Court granted the injunction allowing Mr and Mrs Delahunt back into the business to continue to operate it subject to a resolution of other issues.

The Swim Loops Franchise

In early 2016, Mr and Mrs Delahunt entered into a Franchise Agreement and Licence Agreement to operate a Swim Loops franchise and began providing swimming lesson to children in September 2016.

However, two months later they began to notice issues with the plant and equipment installed in the swim centre. The defects concerned a faulty water heater, incomplete fit-out works, planning permit issues and incorrect calculation of the royalty and advertising fees payable.

The Franchisees had received advice from their accountant that they were entitled to set-off the costs arising from these issues ($49,531.17) against its royalty and advertising fee liability ($30,735.63). Therefore, in November 2017 the Franchisees did not pay their fee liability, replying to the requests for payment by the Franchisor with a statement that they intended to set-off the amounts due to the above issues. The Franchisor responded to this stating that the Franchise Agreement contained no right of set-off and that payment was required immediately.

In March 2018 the Franchisees still had not made the payment, and the Franchisor served a Notice to Remedy Breach demanding the sum of $30,735.63. Franchisees then retained a solicitor to act on their behalf. However, the solicitor became ill and required hospitalisation, and it was not until 11 April, the day when the Notice expired, that the solicitor was in a position to respond. He requested an extension in time for compliance, explaining his hospitalisation. The Franchisor rejected the request on 13 April.

On 16 April in an attempt to comply, the Franchisees offered to pay $32,739.13 immediately by electronic transfer. The Franchisor did not respond to this request.

Then, on 17 April, the Franchisor served a Notice of Termination on the Franchisees and seven minutes later attended the Swim Loops franchise. The Franchisees were directed to leave the premises, and the locks were promptly changed to ensure that they could not return.

The Application To The Court

A day later on 18 April, the Franchisees issued an urgent summons in the Victorian Supreme Court requesting a mandatory interlocutory injunction.

This injunction would require the Franchisor to return possession of the premises and operation of the business to the Franchisees while the dispute regarding the termination of the Franchise Agreement was before the Court.

Order 38 of the Supreme Court (General Civil Procedure) Rules 2015 empowers the Court to issue an injunction at any stage of proceedings, including urgently before the commencement of proceedings.

However, to obtain such an injunction, the Franchisee was required to demonstrate:

  1. the existence of a serious issue or serious issues in dispute;
  2. a sufficient likelihood of success at trial in respect of one or more or those issues;
  3. the applicant will suffer injury for which damages would not be an adequate remedy; and
  4. the balance of convenience favours the granting of an injunction.

Serious Question To Be Tried

The key submission by the Franchisees in relation to the existence of a serious issue in dispute was an allegation that the Franchisor had breached their obligation to act in good faith as required by the Franchise Code. The submissions made by the Franchisee proceeded on the basis that the Notice to Remedy Breach was ineffective due to a series of defects, including an inconsistency between whether there were 21 or 28 days for compliance.

At this stage, the Court was not required to make a final determination on the issues, but agreed that there were serious questions to be tried, namely that:

  • the Franchisor had not precisely stated the basis for the sum required to be paid by the Franchisee in the Notice to Remedy Breach;
  • the Franchisor had failed to follow the requirements of the Notice to Remedy Breach by not allowing a ‘reasonable time’ for compliance with the Notice;
  • the Franchisor’s Notice of Termination would arguably fail due to a failure to allow reasonable time for compliance, and a failure to follow the dispute resolution procedure in the Franchise Agreement;
  • the Franchisor had arguably breached the obligation to act in good faith, in light of the offer made by the Franchisees to pay an amount more than the sum stated in the Notice to Remedy Breach.

While the Court accepted the Franchisees had a sufficient prospect of success with the above arguments, it rejected submissions that there was an arguable case that the Franchisor had acted ‘unconscionably’ under the Australian Consumer Law.

Balance Of Convenience

Having established the first requirement for an interlocutory injunction, the Court had to weigh up the arguments to determine whether the balance of convenience was for or against the granting of an injunction.

The Franchisees put forward five arguments for the balance being in their favour.

Firstly, the business goodwill developed by the Franchisees while they operated the business was at risk by their immediate, unexplained and unpublicised absence from the business.

Secondly, the Franchisees had financed the franchise fee with a mortgage over their home and had offered to pay the amount sought from them. If the injunction were not granted, they would suffer personal financial prejudice in not being able to generate income.

Thirdly, as the Franchisees had been active members of their local community, with their own children attending daycare with children who also attended the swim school, they argued that without the injunction, there would be significant reputational damage.

Fourthly, the Franchisees had acquired knowledge of their customers, some of whom were children with special needs and the Franchisor was unlikely to be able to run the business to the benefit of the children who received lessons in the same way the Franchisees could.

Finally, the six employees that were employed by the Franchisees had not all agreed to enter new contracts with the Franchisor, resulting in ad hoc arrangements and the demotion of one staff member. The Franchisees argued that they would better manage the employment conditions of the staff.

In opposition, the Franchisor put forward their own arguments as to why the balance favoured them.

They submitted that damages would be an adequate remedy, and no irreparable harm would ensue if the injunction was not granted. They argued that they had the experience, expertise and resources to operate the franchise properly. Finally, they claimed that the Franchisees had acted with unreasonable delay and that the injunction sought would compel it to continue a business relationship that was subject to an irreparable breakdown in trust and confidence.

Justice Digby’s Orders

His Honour accepted the argument that the re-entry by the Franchisor into the premises was causing, and if not stopped, would continue to cause, disruption and negative consequences for the swim centre and the children who were taught there. By promptly restoring the status quo, the Franchisees would be able to obviate the severe financial consequences they would have otherwise suffered. Conversely, there were no financial consequences for the Franchisor in allowing the Franchisees to operate the business. Therefore, the balance of convenience was decisively in favour of the Franchisees.

His Honour granted an injunction, giving the Franchisor 24 hours to render up possession to the Franchisees and return operation of the business to them, on the condition that the Franchisees pay the $30,735.63 demanded in the Notice to Remedy Breach. Furthermore,  the Franchisor was deemed unable to proceed on the basis that the Franchise Agreement had been terminated.

Consequences

This case demonstrates the difficulty with exercising termination rights. On a black letter analysis, the Franchisees in this scenario did not pay before the time for compliance expired, which might lend to the view that termination by Swim Loops was justified.

However, taking into account the obligation found in most contracts to act in good faith, it is clear that the circumstances around the hospitalisation of the Franchisees’ solicitor, his requests for an extension of time and the offer of payment in full weighed against such a hard-line view.

The Court was willing in such circumstances to reverse the decision of the Franchisor to retake possession and terminate the Agreement. This case illustrates a need to be particularly cognisant of the obligation of good faith when terminating, as acting unreasonably may result in the kind judicial intervention seen in Delahunt v Swim Loops.

If you have any questions about this article or the issues raised by it, please feel free to contact Dispute Resolution and Litigation team by email, or phone +61 3 8540 0200.