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What are the Franchisor’s obligations if a Franchisee’s exclusivity of territory is threatened?

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By Marian Ngo, Lawyer, MST Lawyers

Many franchise agreements grant an exclusive territory in which the franchisee may conduct the franchised business, without competition from other franchisees and the franchisor. Logically, these exclusivity clauses usually prohibit the franchisee from operating in other franchisee’s territories.

The clear delineation of franchise territories and written rules governing such conduct is important in preserving each franchisee’s rights in their territory, but what are the franchisor’s obligations if a franchisee encroaches on another franchisee’s territory?

The Full Federal Court has considered this issue in the recent case of Marmax Investments Pty Ltd v RPR Maintenance Pty Ltd [2015] FCAFC 127. In this case, the Franchisor, Spanline Weatherstrong Building Systems Pty Ltd (“Spanline”) and the Franchisee, RPR Maintenance Pty Ltd (“RPR”) were parties to a franchise agreement which granted RPR an exclusive territory. Marmax Investments Pty Ltd (“Marmax”) was also a franchisee of Spanline, operating in the territory adjacent to RPR’s territory.

Background

From June 2009, RPR began complaining to Spanline that Marmax had been operating in RPR’s territory. In July 2009, Spanline conducted a search of a database which revealed that Marmax had completed 13 jobs in RPR’s territory however concluded that nothing looked suspicious and did not take the matter any further. Unbeknownst to RPR, in July 2009, Spanline had given Marmax conditional permission to service customers who lived in RPR’s territory. Throughout 2010 and 2011, RPR continued to provide Spanline with evidence of Marmax encroaching on RPR’s territory.

By an email dated 14 December 2011, Spanline wrote to Marmax setting out the arrangements they were to follow for conducting work outside of their territory. Subsequent to this email, without RPR’s knowledge or consent, Marmax obtained Spanline’s consent to Marmax not informing RPR of any referrals or leads it received relating to RPR’s territory, and Spanline’s consent to Marmax retaining leads it received by telephone relating to RPR’s territory.

RPR commenced legal proceedings against Spanline and Marmax in June 2012, claiming that Marmax had encroached on its territory by servicing customers residing within RPR’s territory, and that Spanline had breached the franchise agreement by not taking appropriate action to prevent the encroachment.

The Initial Federal Court Decision

RPR was initially successful at trial against both Spanline and Marmax. The trial judge held that Spanline breached RPR’s franchise agreement by not ensuring that RPR’s franchise was exclusive and by failing to take reasonable and available steps to ensure that Marmax did not service customers in RPR’s territory.

Spanline and Marmax appealed the decision and were both successful in part. This discussion will focus on the issues arising between Spanline, the Franchisor and RPR, the Franchisee, rather than the issues arising between the respective Franchisee parties.

Spanline’s obligation not to encroach on the Franchisee’s exclusive territory

The Full Court found that in granting an exclusive franchise, Spanline was under a “correlative obligation” to refrain from establishing or operating its own Spanline business in RPR’s territory and from granting another franchisee rights to establish or operate a Spanline business in RPR’s territory.

This “correlative obligation” was breached when Spanline gave Marmax permission to perform work in RPR’s territory and amounted to a breach of contract by Spanline, such breach causing RPR loss of opportunity to secure the work performed by Marmax.

Spanline’s obligation to prevent other Franchisees from encroaching on the Franchisee’s exclusive territory

In the initial decision, the trial judge had accepted RPR’s contention that Spanline’s obligations to RPR pursuant to the franchise agreement extended beyond refraining from positive conduct. The trial judge based his reasons on implied contractual terms that the parties would:

  • act in good faith and deal fairly with each other; and
  • do all things necessary on their part to enable the other party to have the benefit of the contract (“duty to cooperate”).

An implied term must be necessary to give business efficacy to the contract in which it is implied. Necessity will only support an implied term if, in the event that the implied term were absent, the rights enjoyed by the contract would be worthless or seriously undermined. In other words, an implied term is not necessary if the contract is effective without it.

Spanline’s duty of good faith and fair dealing

In considering Spanline’s implied duty of good faith and fair dealing, the Full Court referred to the case of Burger King Corporation v Hungry Jack’s Pty Ltd [2001] NSWCA 187. In this case, it was discussed that the implied obligation of good faith does not place contracting parties in a fiduciary relationship and therefore, does not require a contracting party to prefer the interests of the other contracting party, or to subordinate its own self-interest. The Full Court held that in this matter, the implied duty of good faith did not require anything more of Spanline than a duty to cooperate.

Spanline’s duty to cooperate

In considering Spanline’s implied duty to cooperate, the Full Court determined that in order to “do all things necessary to give the other party the benefit of the contract”, Spanline was required to refrain from taking steps which would infringe upon, or cause a third party to infringe upon, the exclusive franchise granted to RPR.

However, Spanline was not required to take positive steps to prevent infringements by Marmax or to investigate such conduct, as these actions would exceed the requirement of necessity. In reaching this decision, the Full Court commented that Spanline’s failure to investigate Marmax’s infringing conduct would not render the RPR Franchise Agreement worthless or seriously undermined.

Conclusion

This case highlights that in granting a franchise for an exclusive territory, the franchisor is prohibited from operating the franchised business or granting further franchised businesses within that territory. However, in the absence of direct requirements in the franchise agreement, the franchisor may not be obliged to take any positive action preventing other franchisees from encroaching a franchisee’s exclusive territory.

Prospective franchisees should review the territory provisions in the franchise agreement to determine whether the franchisor has an express obligation to take action against those who infringe upon the franchisee’s exclusive territory. Though the obligation may not exist contractually, it may be in the commercial interests of franchisors to actively enforce a franchisee’s exclusivity of territory, in order to prevent disputation and/or dissatisfaction within the franchise network.

For more information, please contact our Franchise Law team by email franchise@mst.com.au or by telephone +613 8540 0200.