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The Obligation Of Good Faith In Franchise Agreements: A Lesson In Constructing The Terms Of Sale

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By Nicholas Mason, Law Clerk and Alicia Hill, Principal, MST Lawyers

In the recent decision of Trampoline Enterprises Pty Ltd & Ors v Fresh Retailing Pty Ltd & Anor [2019] VSCA 74, the Victorian Supreme Court of Appeal has considered the obligation of a purchaser to act in good faith in the context of a franchise sale agreement. The Court also illustrated the circumstances in which the determinations of an independent expert may be challenged.

Background

In the original proceedings before the County Court, Trampoline Enterprises (Trampoline) made several claims against Fresh Retailing (Fresh). The claims followed Trampoline agreeing to purchase the assets and franchise business of the Trampoline retail ice-cream and gelato business from Fresh in September 2013.

At the time the purchase agreement was made, Fresh was in the process of establishing a further franchise store in Craigieburn. This store was excluded from the sale agreement and instead dealt with under a separate “Earn Out Deed” that formed an annexure to the main agreement.

The Earn Out Deed

A clause of the Earn Out Deed obliged Trampoline to pay Fresh $140,000 if the Craigieburn store became operational within 180 days of sale agreement completion date. If it did not, a lesser sum was payable. A further clause obliged Trampoline to act in good faith and not unreasonably or intentionally delay the signing of documentation or performance of any act necessary to recruit a franchisee to the Craigieburn site.

The new store eventually opened two days after the 180-day timeframe. Fresh claimed that Trampoline acted in breach of its good faith obligation in the lead up to the store opening and was subsequently entitled to the $140,000 sum, not the lesser sum.

 “Excluded Employee” Clause

The agreement itself provided that Trampoline would make an employment offer to all existing employees of the business except those regarded as “excluded employees”. Mr Moore and Ms Malempre were originally classed as excluded employees.

A subsequent agreement between the parties saw that Trampoline would indeed employ Mr Moore and Ms Malempre. Consequently, Trampoline recorded in its accounts a liability for annual leave entitlements accrued by the two employees as a total sum of $18,626.53. However, in light of advice that Fresh could be entitled to a tax benefit if it paid the expense, Fresh paid the entitlements of both employees before their employment was transferred to Trampoline.

The Appeal

The appeal was confined to firstly whether Fresh was entitled to the $140,000 payable under the Earn Out Deed; and secondly whether Trampoline was entitled to an adjustment in respect to the sale price given Fresh’s decision to pay out the $18,626.23 in accrued leave entitlements.

Considering “Good Faith” In The Context Of The Sale Agreement

The principal issue for consideration was the construction of the good faith clause in the Earn Out Deed. Trampoline argued that its obligation to “act in good faith and not unreasonably or intentionally delay” required not only a delay but that the delay itself must have constituted an act that was not in good faith. The Court favoured this construction.

The Court of Appeal upheld the primary judge’s finding that Trampoline did not act in good faith. Evidence that a shopfitter was instructed by Phillip Tucker, Trampoline’s head of business development, to delay obtaining the occupancy certificate required to have the Craigieburn store commence trading was critical to this finding. The direction not to proceed with the occupancy certificate for a period exceeding one month was deferring a basic step necessary to enable the Craigieburn store to open within the 180-day period that was not exercised in good faith. Further, Trampoline did not offset the delay by any positive actions to advance the opening time frame.

Adjustment In Respect Of The Two Excluded Employees

Trampoline Enterprises conceded that the parties varied the Sale Agreement and that Fresh then further sought to alter the agreement by paying out the two employees. Trampoline did not agree to this further alteration. Fresh maintained that its decision to pay out the leave entitlements was a valid right exercisable under the Fair Work Act and that Trampoline was not entitled to have the accruals adjusted under the Sale Agreement.

The dispute enlivened a clause in the agreement that disagreement would prompt the involvement of an Independent Accountant. The Court reviewed the authority and articulated that an expert determination would be conclusive and binding except in the event of manifest error.

The Court of Appeal found that a manifest error in the determination by the Independent Accountant had occurred, in that there was a failure to take into account the effect of the emails exchanged between the parties. These emails were critical in varying the Sale Agreement between the parties such that it was to include adjustments to be made for Mr Moore and Ms Malempre. The purchase price was revised down to take into account the payments made.

Lessons To Learn

Parties to franchise Sale Agreements seeking to rely on good faith clauses should either insist they be included as separate terms so as not to be read conjunctively with other obligations or carefully consider how a combined clause limits the interpretation. A failure to do so may negate the intention behind the term and impose a higher standard of conduct to satisfy a good faith obligation.

Additionally, while courts are generally reluctant to question the findings of independent experts, manifest errors such as a failure to consider correspondence that fundamentally alter the terms of agreement will provide suitable grounds for court intervention to set aside a determination.

If you require assistance preparing or reviewing a franchise contract, please contact our Franchise Law team by email or phone +61 3 8540 0200.