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Understanding the real duration of a franchise agreement

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By Philip Colman, Principal, MST Lawyers

It is not uncommon for franchisors of retail networks to hold the lease of the franchisee’s business premises and then grant occupancy rights to the franchisee under a sub-leasing or licensing arrangement.

In those circumstances, the franchisee has no legal relationship with the landlord and any decision to renew or extend the lease or seek a new  lease, rests entirely with the franchisor.

It is also not uncommon in these circumstances for the expiry of the term of the lease to be earlier that the normal term of a franchise agreement.

Franchisors seek to overcome this by stating in their franchise agreement that the term of the franchise agreement expires on the earlier of:

  • The expiry of the term of the lease including any extensions or renewals; or
  • A date being [for example, 10 years] years from the commencement date.

In this example, if the term of the franchise agreement commenced on 1 July 2022:

  • if the term of the lease expired on 30 June 2028, but the franchisor exercised the option to renew and was granted a new term expiring on 30 June 2034, the term of the franchise agreement would expire on 30 June 2032; and
  • if the term of the lease expired on 30 June 2028, but the franchisor did not have or did not exercise the option to renew or did not negotiate a new lease, the term of the franchise agreement would expire on 30 June 2028.

The latter scenario was the subject of a decision judgment of Justice Riordan in the Supreme Court of Victoria on 22 March 2022 in Lanhai Pty Ltd and Ors v 7-Eleven Stores Pty Ltd [2022] VSC132.  In this case:

  • Ms Li and Mr Wang (who ultimately became the directors of the franchisee, Lanhai) were interested in a 7-Eleven Stores store at Mount Waverley, but ultimately 7-Eleven Stores Pty Ltd (7-Eleven Stores) did not approve them as franchisees.
  • Their focus then turned at a 7-Eleven Stores store at Heathmont.
  • In respect of Heathmont 7-Eleven Stores held a lease in respect of Heathmont that expired on 4 July 2021 that contained an option to renew for a further term.
  • 7-Eleven Stores granted a franchise to Lanhai in respect of Heathmont commencing in June 2015, after Lanhai had paid approximately $796,000 to acquire that franchised business and pay a franchise fee.
  • In April 2021, 7-Eleven Stores made a conscious decision not to exercise the option to renew the lease because the store “was a loss maker”, which meant that Lanhai would have had to stop operating the franchised business on 17 June 2021; and
  • 7-Eleven Stores offered Lanhai an ex gratia payment of $313.098.96, which was rejected.

Lanhai issued legal proceedings and was successful in obtaining an interlocutory injunction that effectively prevented 7-Eleven Stores from doing anything to prevent Lanhai from operating the franchised business pending the hearing and determination of the proceeding.

At trial, Lanhai alleged that 7-Eleven Stores engaged in misleading and deceptive conduct in allowing Lanhai and its directors to believe that the term of the franchise agreement was 10 years and that Lanhai and its directors were induced to enter into the franchise agreement by such conduct.

Lanhai also alleged that 7-Eleven Stores had breached its obligation to act in good faith and had engaged in unconscionable conduct by making the decision to close the store and not exercise its option to renew the lease.

The result

Justice Riordan held that:

  • 7-Eleven Stores had engaged in misleading and deceptive conduct in allowing Lanhai, Ms Li and Mr Wang to believe that the term of the franchise agreement was 10 years and that but for that conduct, Lanhai, Ms Li and Mr Wang would have pursued what would have been a more profitable opportunity, operating a post office;
  • Lanhai was entitled to damages of $595,246.40; and
  • 7-Eleven Stores had not breached its obligation to act in good faith, nor had it engaged in unconscionable conduct by making the decision to close the store and not exercise its option to renew the lease.

Misleading and deceptive conduct finding

Despite there being a number of documents emanating from 7-Eleven Stores to the effect that the typical 10 year term of a franchise agreement was subject to an earlier expiry of a lease and Ms Li and Mr Wang seeking and obtaining legal advice regarding the franchise agreement (and the lawyer certifying that she had fully advised Ms Li and Mr Wang regarding the franchise agreement), Justice Riordan concluded that Lanhai, Ms Li and Mr Wang had been misled and deceived into believing that 10 years tenure would be available to them.

His Honour placed reliance upon document provided to Ms Li and Mr Wang some 9 months before the franchise agreement was signed, on which the terms of franchise agreements for various store were listed (with some stating, “As per Lease” but for Heathmont stating, “10 Years”).  His Honour went on and stated:

This erroneous assumption that the franchise term for the Heathmont Store would not be affected by the Lease was reinforced by the fact that, in the Franchise Opportunity Documents, the ‘Franchise Agreement Term’ for some stores was described as ‘As per lease’ rather than ’10 years’.  The ‘As per lease’ description was used for those stores where the total of the primary lease term and all option periods was less than 10 years.  In my opinion, the differentiation between ‘As per lease’ and ’10 years’ would lead a reasonable reader to presume that, where the ‘Franchise Agreement Term’ was expressed in the Franchise Opportunities Documents to be 10 years, it was not subject to earlier termination by reason of the expiration of the primary lease term.

There was an Explanatory Note in small font on the Franchise Opportunity Documents that stated:

* Options are not guaranteed and lease extensions will be decided on a case by case basis at the sole discretion of 7-Eleven Stores. Note: Franchise Agreements continue until; the earlier of: 1) the date on which the primary (current) term of the Lease expires, or 2) the expiration of any further term of the Lease (but only if the option to extend is exercised by 7-Eleven Stores during the term of the agreement) or 3) 10 years after the effective date. * Franchisee Fees are subject to change

Justice Riordan concluded that the Explanatory Note did not erase the effect of the misleading representation as to the term of the franchise agreement, for the following reasons:

  • On its face, each of the Franchise Opportunities Documents recognises the fact that the prospective franchisee will be investing many hundreds of thousands of dollars to acquire the franchise businesses for sale. The disparity between the 10-year term and the lesser term is very significant. For example, in the case of the Heathmont Store, the term was less than seven years at the time the August Document was provided, and six years and one month at the time of entry into the Franchise Agreement.
  • The Explanatory Note is not featured prominently on the document. It is in small print and is worded in a confusing manner.  It would be difficult for a lay person to understand, even one whose first language was English, much less Ms Li and Mr Wang.
  • The asterisk referencing the Explanatory Note was placed after the words ‘Lease Term’ and not ‘Franchise Agreement Term’, which did nothing to communicate the effect the ‘Lease Term’ and options had on the ‘Franchise Agreement Term’.
  • He accepted the unchallenged evidence of Ms Li and Mr Wang that the Explanatory Note was not brought to their attention at all.

Good faith finding

The case was also run on the basis that 7-Eleven Stores had breached its good faith obligation under clause 6 of the Franchising Code of Conduct (Code) in deciding to close the store and not renew the lease.  As clause 6(6) of the Franchising Code of Conduct states that the obligation to act in good faith does not prevent a party from acting in his, her or its legitimate commercial interest, the central issue to be decided was whether, in deciding to close the store and not renew the lease, 7-Eleven Stores was acting in its legitimate commercial interest.

Justice Riordan held that 7-Eleven Stores did not contravene clause 6 of the Code because it was acting in its legitimate commercial interests.  He noted:

  • 7-Eleven Stores’ principal consideration was the fact that the store had not been profitable for a number of years;
  • An interest in avoiding loss-making investments will usually be legitimate; and
  • 7-Eleven Stores’ decision making process was not arbitrary.

Unconscionable conduct finding

The case was also run on the basis that 7-Eleven Stores had engaged in unconscionable conduct in contravention of section 21 of the Australian Consumer Law.

Justice Riordan held that 7-Eleven Stores had not engaged in unconscionable conduct for the same reasons he held that 7-Eleven Stores had not breached the good faith obligation.  He noted that 7-Eleven Stores’ conduct:

“fell well short of being so far outside social norms of acceptable commercial behaviour as to warrant condemnation as conduct that is offensive to conscience”

Lessons to be learned

In this case, it appears that 7-Eleven Stores thought it was covering itself by the various documents which stated that the  duration of the franchise agreement could not extend past the end of the term of the lease and by insisting that legal advice be obtained.

Unfortunately, there were also some documents that had the tendency to create an alternative impression and there was insufficient evidence to show that 7-Eleven Stores personnel had clearly and unequivocally explained to Ms Li and Mr Wang that in the case of the Heathmont store:

  • the lease expired on 4 July 2021;
  • 7-Eleven Stores may not exercise the option to renew; and
  • If that occurred, the franchise agreement would come to an end they would have to then close their business.

This decision, in my view, is fairly harsh.  There was plenty of material communicated to Ms Li and Mr Wang which ought to have put them on notice that they may not get a full 10 year term and it was quite amazing that their lawyer did not advise them that the term of the franchise agreement was not 10 years but rather, was until the expiration of the primary term of the lease unless 7-Eleven Stores exercised the option to renew the lease.  Unfortunately, some of it was inconsistent and confusing.

This case demonstrates how important it is that prospective franchisees clearly know when and how the franchise agreement may come to an end.  Franchisors need to be careful about using standard documentation or inconsistent or confusing documentation regarding franchising opportunities – if a franchisor is going to state the term of the franchise agreement, it must do so accurately and not seek to rely on some small font disclaimer.

The finding in relation to good faith and unconscionable conduct may provide some good guidance for franchisors in the future if they are faced with the decision as to whether or not to renew or extend a lease in circumstances where the business conducted from the premises is not profitable.  Ultimately franchisors will need to prove that decisions of this type are made in pursuit of a franchisor’s legitimate commercial interests and each case will turn on its own facts.

How we can help

At MST Lawyers, we have a very talented team of franchising lawyers who have been at the cutting edge of the Code’s evolution since 1998 and the provision of advice to franchisors and franchisees about the issues raised in the above case.  Our goal is to give clear, accurate and correct advice to our clients.  We will make calls and not sit on the fence, because we are confident that the advice we give is accurate and correct.  Our points of contact are:

Raynia Theodore: raynia.theodore@mst.com.au

Esther Gutnick: esther.gutnick@mst.com.au

Philip Colman: philip.colman@mst.com.au

Alicia Hill: alicia.hill@mst.com.au