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Recovery of costs by franchisors: Dymocks v Chapter Three

23 Jun 2022

By Alicia Hill, Principal and Robert Kukuruzovic, Law Clerk

The New South Wales Supreme Court was asked to decide in Dymocks Franchise Systems (NSW) Pty Ltd v Chapter Three Pty Ltd [2022] NSWSC 35, what costs should be awarded, where there was no actual judgement on the merits of the case but the franchise agreement contained clauses which provided the franchisee was to pay the franchisor’s costs.

This article outlines the outcome from this case.

Facts:

The Franchisor, Dymocks, entered into a franchise agreement with the Franchisee, Chapter Three Pty Ltd, in 2015 for the Castle Hill Dymocks, with Ms Meenakshi Kapuria as guarantor.

The Agreement provided an option for Dymocks to acquire all the assets, fixtures, fittings etc. used in the conduct of the business at the end of the term.

Several weeks before the end of the franchise agreement on 31 October 2021, Dymocks gave written notice to Chapter Three that it was exercising the option.

However, Chapter Three informed Dymocks that they had already agreed to sell the assets to a third party.

This party was later identified as Prosper Global Pty Ltd (Prosper), of which Ms Kapuria’s husband was the sole director and shareholder.

Chapter Three and Prosper were initially unresponsive to requests by Dymocks for access to the assets and assurances regarding their status.

Dymocks sought and was granted injunctions against Chapter Three and Ms Kapuria which prevented them from dealing with the assets. Due to their unresponsiveness, Prosper were also later joined to the proceedings.

Shortly after this, Dymocks were granted access to the site and negotiated an agreement as to the distribution of the assets. As such, the proceedings were dismissed, save as to costs.

Issue before the Court:

The New South Wales Supreme Court was left to decide what costs should be awarded in respect of the proceedings, where:

  • there was no actual judgement on the merits of the case; and
  • the franchise agreement contained clauses which provided the franchisee was to pay the franchisor’s costs.

Contractual Obligations:

Dymocks submitted that it had a contractual entitlement to indemnity costs against Chapter Three and therefore also Ms Kapuria as guarantor.

Clause 14.6 of the agreement stated that Chapter Three:

“…indemnifies and holds harmless [Dymocks] … from and against all … cost,

expense and loss … which it incurs or suffers directly or indirectly as a result

of or arising out of:

(7) all legal costs, on a full indemnity basis … incurred by [Dymocks] in

connection with a Claim.”

Despite submissions from the Chapter 3’s counsel to the contrary, Justice Stevenson found the clauses to clearly be wide in their operation and that they did extend to claims made by Dymocks as well as those made against it.

Clause 20.13 of the Agreement further provided that:

 “(1) [Chapter Three] must pay the costs and expenses of [Dymocks] including

… legal expenses on a full indemnity basis … :

(b) in exercising or attempting to exercise its rights under this

Agreement;

(c) in taking legal proceedings against [Chapter Three] to enforce or to

attempt to enforce its rights under or in relation to this Agreement …”.

Again, Justice Stevenson held that the construction of this clause was clear in allowing Dymocks to claim indemnity costs, as it was attempting to exercise its right to obtain the assets.

His Honour noted, with agreement from Dymocks, that the Court still has ultimate discretion to award costs, even with contractual terms in place. However, the contractual terms were strongly persuasive.

Unreasonable behaviour

The Court then looked to the cases of Re Minister for Immigration & Ethnic Affairs[1] and One.Tel Ltd v Deputy Commissioner of Taxation[2] for expressions of the ‘well established’ principles of where costs may be awarded in circumstances such as these.

Those principles include where a party has acted ‘so unreasonable as to justify a costs order against it’.

The Court held that the proceedings were only made necessary due to the unreasonable behaviour of Chapter Three and Ms Kapuria in providing no confirmation as to Dymock’s entitlement to the assets.

The Court held that Prosper had also acted unreasonably in that it did not respond to Dymock’s requests until after it had been joined as a defendant. This was despite Chapter Three acknowledging that Prosper did not claim any priority over the assets.

This unreasonableness added in the court’s view credence to Dymock’s claim for damages.

Would the initiating party have succeeded

Another of those principles considered by the Court in this proceeding was where ‘the court may be able to conclude that one party would almost certainly have succeeded’, or other words, that one party was a ‘clear winner’.[3]

Counsel for Chapter Three submitted that this was not true, as Dymocks had compromised in the negotiations, had altered their initial claim and a previous demand by Dymocks to remove fixtures from the premises had implied their permission to sell the assets.

The Court instead agreed with Dymock’s submission that the real issue of the dispute was Dymock’s assertion of its rights over the assets, and Chapter Three’s refusal to acknowledge those rights.

Having gotten that acknowledgement, albeit with some compromise, Dymocks was in fact was the clear winner.

Orders

The Court ordered Chapter Three and Ms Kapuria to pay Dymock’s costs on an indemnity basis and Prosper to also pay on an ordinary basis.

Takeaways

As most will be aware the ability of a franchisor to recover costs has been constrained or now requires disclosure in the disclosure documents if there is an intention to recover those costs.

The prohibitions in the Code do not seek to constrain the Courts inherent ability to award costs to a successful party in the event that litigation is determined. So the usual principles of costs following the event, that is, the successful party being awarded there costs, still operate.

For franchisees this case serves as an example of the potential consequences of litigation, even where an actual trial does not go ahead. Chapter Three, Ms Kapuria and Prosper must now pay costs over an issue which, in light of their willingness to negotiate once proceedings had been issued, would appear to have been able to be settled between the parties.

The case also emphasises the importance of knowing the terms of the agreement and having thought about what disclosure may be required in order for recovery to be possible where events contemplated take place.

The Court’s decision on unreasonableness is a useful reminder that this is a critical factor in awarding costs. An unreasonable party faces a greater risk of costs being awarded against it.

However, the Court also expressly stated that where both parties act and continue to act reasonably until the matter was settled or the case dropped, the court will usually not order costs.

This is a clear statement from the Court that parties that are unnecessarily difficult or unwilling to resolve matters between themselves they may face financial consequences.

If you have any queries about any of the matters raised by this case, then please contact Alicia Hill on (03) 8540 0292 or alicia.hill@mst.com.au

[1] Ex parte Lai Win (1997).

[2] One.Tel Ltd v Deputy Commissioner of Taxation [2000] FCA 270.

[3] Ibid [7].