On 27 August 2008, the much anticipated decision of the High Court in Master Education Services Pty Ltd v Ketchell  HCA 38 was handed down. The joint and unanimous decision of the High Court overturned the orders of the New South Wales Court of Appeal and held that a franchise agreement will not be void by reason of a franchisor's non-compliance with clause 11(1) of the Franchising Code of Conduct (Code).
While the decision will be welcomed by franchisors and franchisees alike for providing certainty around the consequences of non-compliance with clause 11(1) of the Code, the High Court has left open the question of whether other breaches will render a franchise agreement void. Furthermore, while non-compliance with clause 11(1) of the Code did not render the franchise agreement void, the Code does prescribe a variety of remedies to franchisees for such a breach as well as other breaches.
Section 51AD of the Trade Practices Act 1974 (Cth) (Act) provides that a corporation must not, in trade or commerce, contravene an applicable industry code. Section 51AE of the Act and clause 3 of the Trade Practices (Industry Codes - Franchising) Regulations 1998 (Cth) prescribe that the Code is mandatory for all participants in the franchising industry. Clause 11(1) of the Code provides that:
(1) The franchisor must not:
(a) Enter into, renew or extend a franchise agreement; or
(b) Enter into an agreement to enter into, renew or extend a franchise agreement; or
(c) Receive a non-refundable payment (whether of money or of other valuable consideration) under a franchise agreement or an agreement to enter into a franchise agreement;
unless the franchisor has received from the franchisee or prospective franchisee a written statement that the franchisee or prospective franchisee has received, read and had a reasonable opportunity to understand the disclosure document and this Code.
This case first arose in a Local Court in 2003 when the franchisor, Master Education Services Pty Ltd (MES), brought proceedings against a franchisee, Ms Jean Ketchell, to recover unpaid monthly fees under a franchise agreement. In her defence, Ms Ketchell claimed that MES had not obtained the correct certificates required by clause 11(1) of the Code and that the franchise agreement was void as a consequence. The issue of non-compliance was subsequently (there was an intervening remittal back to the Local Court) considered by the New South Wales Supreme Court which at first instance found that the agreement was not illegal by virtue of non-compliance, citing authority from an earlier New South Wales Supreme Court decision¹. This decision was the subject of appeal to the New South Wales Court of Appeal. The Court of Appeal held that non-compliance with the Code and section 51AD of the Act rendered the contract illegal at common law and consequently the franchise agreement was void and unenforceable².
This decision created significant unrest for the franchise industry across Australia as it placed in doubt those franchise agreements in relation to which the franchisor had not strictly complied with the Code.
The decision of Justice Rares of the Federal Court of Australia in Hoy Mobile v Allphones Retail³ provided some measure of consolation. In Hoy Mobile, Justice Rares considered the purpose of the Code was to protect franchisees and it did not follow that the Code would have intended that a mere oversight could lead to the vitiation of a franchise agreement, leaving the franchisee without any capacity to enforce their rights. His Honour held that the agreement in that case was not void for non-compliance with the Code, stating that the decision in Ketchell was 'plainly wrong'. In their decision in Ketchell, the High Court agreed with his Honour.
High Court's decision
The question on appeal to the High Court was whether a franchise agreement was void where it had been entered into without complying with clause 11(1) of the Code.
It was not disputed that Ketchell had in fact received and read the disclosure statement and had obtained independent advice on it. Further, it was not disputed that MES had complied with its disclosure obligations.
Their Honours considered the issue was ultimately to be determined by way of statutory interpretation, including by reference to the legislative purpose of section 51AD.
The High Court stated that the section itself did not expressly state that non-compliance would result in agreements being rendered void. Rather, the section was concerned with ensuring compliance by franchisors with industry codes under the Act.
As there was no express prohibition in the Act, the Court then considered whether any such prohibition should be implied.
The High Court considered that the purposes of the scheme of Part IVB of the Act and the Code included regulating the conduct of the industry in order to improve business practices, providing some protection to franchisees and reducing litigation. The Court did not consider that it was not necessary for the purposes of the scheme to strike down each contract entered into by a non-complying franchisor. In reaching this conclusion, the Court considered it important that the Act itself gave the Court flexibility in determining remedies for a range of non-compliant conduct.
The Court considered that, in case of a breach of clause 11(1), the position of the franchisee was adequately protected by the remedies available under the Act and did not require that the agreement be void. The High Court was mindful to state however that this would not always be the case and that in some cases 'the non-compliance may be such as to warrant the court striking a contract down on the application of a franchisee'.
Further, agreeing with Justice Rares in Hoy Mobile, the High Court considered that to render void every franchise agreement where a franchisor had not complied with the Code would result in franchisors being able to avoid their obligations while potentially placing the franchisees in breach of their obligation to its third parties. It was preferable therefore for the franchisee to seek relief appropriate to the circumstances and seriousness of the breach.
The decision of the High Court in Ketchell provides welcome certainty as to the consequences of non-compliance with clause 11(1) of the Code. However, the Court has not clarified which particular instances of non-compliance may result in a franchise agreement being declared void. It is also important to note that, even when an agreement is not void for non-compliance, a franchisee will still have a range of remedies available under the Act. These remedies include damages and court-ordered variation of terms which may be more damaging to a franchisor than an agreement being void. Accordingly, notwithstanding the comfort that Ketchell's decision will provide to the franchising industry, it does not diminish the importance of vigilant compliance with the Code by franchisors.
DLA Phillips Fox is happy to assist with an audit of a franchisor's franchise documentation and processes to ensure compliance with the Code.
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