Australia: Modernising your franchise system - Risky Business

Franchising Focus
Last Updated: 1 March 2011
Article by Shaun Temby

Franchising, as a sector, is fairly new in Australia, relative to other forms of doing business. As such, some franchise systems operate on the basis of agreements, standards and procedures that were drafted at a time when franchising was much less sophisticated than it is today. These legacy issues can have a profound impact on the ways that the business operates and on the relationship between franchisor and franchisee. While franchisors may wish to clean up these legacy issues for legitimate business reasons, they must approach with extreme caution any changes to franchise agreements, systems and procedures to modernise them by adopting current "best practice". A recent decision of the Federal Court of Australia highlights some of the dangers involved in the introduction of modern franchising standards to a long standing franchise relationship.  

Keema Automotive Group v Suzuki Automotive Co1

The franchisee, Keema Automotive Group had operated motor vehicle dealerships in Brisbane for over 50 years. At the time of the proceedings, Keema operated four motor vehicle dealerships located in three different locations in Brisbane from which it sold Honda, Hyundai, Nissan, Isuzu Ute, Kia, Suzuki and Great Wall Motor vehicles.  

The franchisor, Suzuki Auto Company (SAC), is an importer and distributor of Suzuki motor vehicles in Queensland and northern New South Wales. Keema had first established a Suzuki dealership in Queensland in 1975 on the basis of a handshake agreement between Keema's Chief Executive Officer and the owner of SAC. Further dealership agreements between Keema and SAC with respect to the other Queensland locations were entered into on the same basis in 2002 and 2003. The precise terms of the relationship between SAC and Keema was never reduced to writing. At no time over that period did SAC purport to renew or extend the oral agreements or to confirm the terms of those agreements.

In 2002, SAC commenced issuing all of its dealers with monthly non-mandatory sales targets. Prior to 2009, SAC never suggested that any serious consequences would follow from a dealership not achieving the sales targets set by SAC. No attempt appears to have been made by SAC to identify how the introduction of these sales targets fitted within the oral franchise agreements with Keema. Between 2002 and 2009, Keema failed to achieve these sales targets more often than not in each of its Queensland locations.  

In May 2009, representatives of SAC met with Keema to discuss, relevantly, Keema's sales performance. At that May meeting, SAC expressed "great concern" about Keema's sales performance. That concern was repeated in a letter from SAC to Keema in June 2009. In the June letter, SAC:

  1. Noted the "significant relationship that Keema and SAC have established", but expressed concern about further deterioration in Keema's sale of Suzuki motor vehicles.
  2. Purposed to introduce a mandatory annual sales target for Keema that would be subject to review on a quarterly basis by SAC.
  3. Stated that Keema's failure to achieve the annual sales percentage would constitute grounds for immediate withdrawal of the Suzuki franchise.
  4. Called for Keema's acceptance of those proposed arrangements.  

Later that month, Keema told SAC that Keema could not accept the sales percentage targets nominated by SAC. The parties continued to communicate regarding the June 2009 letter, but were unable to reach agreement as to the proposed mandatory sales targets. Once again, SAC did not appear to make any attempt to explain how these new requirements fitted within the existing oral franchise agreements with Keema.

In July 2009, the lawyers acting for SAC wrote to Keema confirming the imposition of the mandatory sales target and review process. In that letter, SAC's lawyers noted that if the sales target was not met then, "Suzuki will be entitled to immediately terminate its agreement with Keema" regarding the dealerships that did not achieve that target. Keema did not agree to the imposition of the mandatory sales target and complained to SAC that it was being discriminated against when compared with other Suzuki dealers.  

Between July 2009 and July 2010, Keema continued to sell Suzuki vehicles and SAC provided it with monthly reports of its sale performance compared to the mandatory sales targets set out in the June 2009 letter from SAC's lawyers.

On 21 July 2010, SAC's lawyers wrote to Keema putting it on notice that it had failed to achieve the mandatory sales target at one of its dealerships and had therefore breached its performance requirements with SAC. The letter called upon Keema to explain why that was so and propose a formal strategic plan to SAC to achieve the mandatory sales target in the future.  

In late July 2010, Keema provided SAC with a copy of that strategic plan and met with representatives of SAC to discuss it. Keema asserted that at that meeting the representatives of SAC agreed to the strategic plan.  

On 10 August 2010, SAC's lawyers gave Keema a notice of termination of the Suzuki dealership agreement to take effect on 31 December 2010. The termination letter referred to the previous communications between the parties and stated that as a result of Keema's failure to achieve the mandatory sales targets for one of it dealerships, Suzuki was terminating its agreement with Keema with respect to that site.  

Throughout all of these dealings neither SAC nor its lawyers appear to have attempted to explain how these new requirements sat within the pre-existing oral dealership agreements between Keema and SAC.  

On 7 December 2010, Keema commenced proceedings against SAC seeking an injunction against SAC declaring the termination of the dealership agreement unlawful on the grounds that it was unconscionable and, further, seeking by way of interlocutory relief an injunction pending the trial restraining SAC from terminating the relevant dealership.

SAC opposed the injunction on a number of grounds, including (apparently for the first time) that the oral franchise agreements were agreements that were for an indefinite terms and could therefore be terminated upon the giving of reasonable notice. SAC argued that the 4 months and 21 days notice period provided by it was reasonable and it therefore could not be said to have acted unlawfully.

Ultimately, the Court granted an interlocutory injunction restraining SAC from terminating the Keema dealership on the basis that it was open for Keema to argue that:  

  1. SAC's imposition of mandatory sales targets on the basis that a failure to reach those targets would give rise to a right to immediately terminate one or more of the oral franchise agreements constituted an unlawful attempt by SAC to unilaterally impose new contractual terms on the oral franchise agreements.  
  2. SAC's notice of termination of 4 months and 21 days was not reasonable notice having regard to the parties "significant relationship" (as admitted by SAC in its June 2009 letter).
  3. SAC had acted unconscionably in breach of the Trade Practices Act 1975 (as it was then called) in:
    1. imposing mandatory sales targets and in then attempting to rely on them to terminate the oral; franchise agreements;
    2. attempting to unilaterally vary the terms of the oral franchise agreements
    3. adopting protocols in relation to mandatory sales targets which represented a difference of treatment in SAC's conduct as compared with other franchisees in similar circumstances
    4. imposing mandatory sales targets which were not reasonably necessary for the protection of SAC's legitimate interests.
  4. SAC had breached the Franchising Code of Conduct due to SAV having issued a breach notice that did not comply with the Code.

What does this mean for franchisors?

Importantly, this is only a decision at an interlocutory stage, meaning that a full trial has not yet been conducted and (in simple terms) the applicant is given the benefit of the doubt on the strength of its arguments on the issues raised. Ultimately, it may be that SAC is able to prove that it acted reasonably, in good conscience and in compliance with the law. However, the case highlights some important lessons for franchisors trying to modernise their franchise network. For example:

  1. Franchisors must ensure that they know the operative terms of current franchise agreements. While this may seem obvious, where franchise systems have been operating for lengthy periods, the precise terms of franchise agreements may be unclear, on the basis that they are oral or a mixture of oral and written terms. The matter may be further complicated, as changes may have been agreed to those franchise agreements in the past, but which were never documented.
  2. Once the precise terms of current franchise agreements are known, then franchisors must determine whether they have the power to compel the franchisee to agree to changes to the franchise agreement, systems or procedures. Even where they do have that power, franchisees need to consider whether the imposition of those changes would be unconscionable in breach of the Competition and Consumer Act 2010.
  3. If no such power exists or the use of that power would be unconscionable, then franchisors should consider what legal and commercial options they have to encourage franchisees to accept the proposed changes. For instance, in the above case, Keema could have been offered a new franchise agreement for a defined term, including the new sales targets. That offer could have been made together with the offer of incentives to encourage Keema to accept it. If those efforts had failed, the Keema's franchise agreements could have been terminated with a longer notice period.
  4. If the changes are to be applied to a majority of the franchisees (or the larger franchisees in terms of sales), then it is imperative that franchisors have a clear strategy in place to sell the benefits of these changes to franchisees. This might involve consultation with the Franchise Advisory Committee (if there is one) or consultation with the more commercial and level headed leaders within the franchise system. All communications with franchisees must be consistent with this strategy, in an effort to win the "hearts and minds" of those franchisees. Franchise systems succeed or fail on the strength of the relationships with franchisees and large systemic changes with franchisees can destroy in an instant many years of hard won trust.

1 Stones Corner Motors trading as Keema Automotive Group v Mayfairs W'Sale Pty Ltd trading as Suzuki Automotive Group [2010] FCA 1465

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Shaun Temby
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