FCA NFC SEMINAR PAPER FRANCHISING CASE UPDATE 9 October 2016 Ben - - PDF document

Legal/47226698_1

FCA NFC SEMINAR PAPER

FRANCHISING – CASE UPDATE

9 October 2016 Ben Coogan, Partner, Thomson Geer

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CASE UPDATE 2016

CIVIC VIDEO PTY LTD –V- PATERSON [2016] WASCA 69 [27 APRIL 2016]

1 The background to this decision is really a struggling franchisee under an aging franchise product model (Civic Video) and then the involvement of a competing video store (Video Ezy) in Geraldton, Western Australia. 2 The trial judge's decision was delivered in 2014. 3 Aside from considering the factual circumstances and a claim by Civic Video regarding the tort of inducing a breach of contractual relations, the Western Australian Court of Appeal also reviewed the principles that are applicable to assessing damages for repudiation of an agreement.

THE KEY FACTS

4 Civic Video Pty Ltd (Franchisor) and the Thompsons (Franchisee) entered into agreements under which the Franchisee would operate two stores using the Civic Video System (Franchise). 5 Franchisor consent was required in order for the Franchisee to sell, assign or transfer any interest in the Franchise business or any rights under the Franchise agreements. 6 The Franchisee was required to pay a monthly franchise fee to the Franchisor under the Franchise Agreements. 7 The Franchisee fell behind in their payment of Franchise fees. 8 The Franchisee listed the stores for sale through a business broker, Mr Smith. 9 The Franchisee entered into an agreement to transfer all of their plant and equipment, excluding trade supplied equipment, to a competitor of the Franchisor (a prospective purchaser) so that the Franchisee would cease running the Franchise business. The Franchisee did not obtain the Franchisor’s consent before doing so. This sale did not proceed. 10 Later, a Mr Paterson took over the Head Lease of the complex that the Franchisee was trading at. 11 Mr Paterson made written offers to the Thompsons to purchase the assets of each of the two stores owned by the franchisee. 12 At trial, Mr Paterson gave evidence that it was his intention in acquiring both businesses to consolidate them into one Video Ezy business so that, with his existing Video Ezy store, he would then have two strong Video Ezy stores in Geraldton.

THE PRIMARY JUDGE'S DECISION

13 The primary judge found that the conduct of the Franchisee constituted a repudiation of the Franchise agreements. 14 In assessing damages, the primary judge found that at the time of the repudiation the Franchisee could not continue trading due to their financial position. 15 Accordingly, the primary judge found that the Franchisor would not have received any further Franchise fees from the Franchisee even if they had not repudiated the Franchise agreements in the manner that they

• did. Therefore, the primary judge found that there was no loss suffered by the Franchisor in this manner.

16 The primary judge assessed damages only on the basis of the loss of opportunity of the Franchisor finding another purchaser for the stores or the Franchisor itself taking over the stores. This opportunity was denied to the Franchisor by the Franchisee’s breach of the Franchise agreements.

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17 It was alleged by Civic Video that Mr Paterson had interfered in contractual relations between it and the Franchisee. 18 The primary judge identified the elements of the tort of intentional interference with contractual relations were as follows: (a) There must be a contract between the plaintiff and a third party; (b) The defendant must know that such a contract exists; (c) The defendant must know that if the party does, or fails to do, a particular act, that conduct of the third party would be a breach of the contract; (d) The defendant must intend to induce or procure the third party to breach the contract by doing or failing to do that particular act; and (e) That breach must cause loss or damage to the plaintiff. 19 In relation to that aspect, the primary judge concluded that Mr Paterson did not know, one way or another, whether the sale of the businesses to him would be a breach by the Franchisee of the Franchise

• Agreements. While the primary judge considered that Mr Paterson had grounds to suspect that by selling

the businesses the Franchisee might be in breach of the Franchise Agreements, he concluded that the suspicion did not amount to reckless indifference or wilful blindness. He therefore rejected the claim against Mr Paterson in relation to the tort of interference of contractual relations.

ISSUE BEFORE THE COURT OF APPEAL

20 The Franchisor appealed the primary judge’s decision. The Franchisor argued that the damages should have been assessed on the basis of the Franchisor’s loss of bargain rather than its loss of opportunity. 21 The Franchisor alleged that the primary judge erred in finding that Mr Paterson did not induce the Franchisee to breach their Franchise Agreements with the Franchisor.

THE COURT OF APPEAL DECISION

22 The Court of Appeal found in favour of the Franchisor in relation to the issue of damages, but against the Franchisor in relation to its allegation that Mr Paterson induced the Franchisee to breach their Franchise Agreements. Did Mr Paterson induce the Franchisee to breach their Franchise Agreements? 23 Civic Video attacked two findings of fact of the primary judge; namely that Mr Paterson did not know the sale of the businesses by the Franchisee would breach their Franchise Agreements, and that Mr Paterson did not intend to induce or procure the Franchisee to breach the Franchise Agreements for the following reasons: (a) while Mr Paterson did not receive a copy of the Franchise Agreements, he was experienced in the

• peration of video stores pursuant to Franchise Agreements (due to his operation of Video Ezy

franchised businesses) and was aware that the Franchise Agreements generally had the provision requiring the Franchisor's consent for early termination; (b) there was evidence from Mr Paterson's enquiry of the business broker as to Civic's attitude to the sales that Mr Paterson was alive to the fact that the Franchisee might be breaching the Franchise Agreements; (c) the inclusion of an indemnity in the Sale Agreement to protect Mr Paterson is an acknowledgment that the sale of the businesses by the Franchisee would be in breach of contract;

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(d) the fact that Mr Paterson was prepared to pay $500,000 for the two stores, one of which he was going to close, in circumstances where he was aware the Franchisee were impecunious and could not continue in business, demonstrated that the acquisition was for competitive reasons, to ensure that Civic Videos stores ceased to operate in the Geraldton area. 24 The Court of Appeal focussed on the fact that an appellant who seeks to overturn findings and facts which depend to any substantial degree upon credibility assumes a formidable burden. 25 The Court accepted that the primary judge's finding that Mr Paterson agreed to acquire the Head Lease of the Durlacher Street complex at a time when a previous purchaser's agreement to acquire the Franchisee's business was still on foot, and that Mr Paterson was only approached about acquiring the Franchisee' business after the previous purchaser's agreement was terminated and when he had agreed in principle to acquire the Head Lease of the Durlacher Street complex. 26 The Court of Appeal found that the legal advice came from the business broker Mr Smith, not the Franchisee with whom Mr Paterson had no contact. The Court of Appeal also found that it was not inherently likely that Mr Smith did not know what the legal advice was and had not concerned himself with the nature of the legal advice, but only whether or not it meant the sales would be proceeding. 27 In relation to the indemnity clause being inserted into the Sales Agreements, the evidence of both Mr Paterson and Mr Smith (the business broker) was that Mr Paterson had not requested it to be inserted and that it had been inserted by Mr Smith. The Court of Appeal found that the fact that it operated in Mr Paterson's interest, rather than the interests of the Franchisee, did not preclude the possibility that Mr Smith thought that it was an appropriate provision to include in the Agreements. 28 In relation to the sale price, the Court of Appeal did not overturn the primary judge's findings and noted that an argument to the contrary ignores the offer made some three weeks earlier previous by the prospective purchaser for $405,000 plus stock valuation.

DAMAGES

29 The Court of Appeal found that the Franchisor was entitled to 'loss of bargain' damages; that is, damages to put the Franchisor in the position it would have been in if the Franchisee had performed the Franchise Agreements – what, it has been suggested, might be better described as 'hypothetical performance' damages. 30 The Court of Appeal found that as the Franchisor's case was advanced at trial, the assessment of those damages did not involve any question of loss of chance and nor was it relevant that, due to their poor trading results, the Franchisee may, or would, have been unable to perform the Franchise Agreements for the balance of the term. The damages remained, in the Court of Appeal's opinion, to be assessed on the basis of the amount that the Franchisor would have received had the Franchisee performed the Franchise Agreements for the balance of their respective terms. 31 In support of a Notice of Contention, as submitted by the Franchisee, that by virtue of clause 10.2 of the Franchise Agreements the Franchisee were not required to conduct the businesses throughout the term but only to use their best endeavours to do so. Therefore, if the Franchisee had not repudiated the Franchise Agreements they would have been unable, even using their best endeavours, to continue to trade and would have closed their businesses at that point. It was argued that this would have constituted voluntary abandonment of the businesses, for which the Franchisor's only remedy would have been to terminate the Franchise Agreements and given no right to damages for breach. 32 The Court of Appeal did not accept that argument. 33 The Court of Appeal found that on no fair reading of those provisions, in the context of the Franchise Agreement as a whole, clause 10.2 be understood to mean that the Franchisee were required to conduct the business only for so long as they were able to do so using their best endeavours.

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34 Further, the Court of Appeal found that the Franchisor's right to terminate if the franchise voluntarily abandoned the business should not be read as giving a franchisee carte blanche to walk out of the business at any time during the term without any liability for doing so. 35 The Court of Appeal remitted to the primary judge the assessment of the damages to be undertaken according to law. However, the Court of Appeal commented on one aspect where the primary judge took the view that Civic was not entitled to damages in respect of the advertising fees which it would have received from the Franchisee had they performed the Franchise Agreements. 36 The relevant provisions can be described as follows: (a) Clause 5.2(b) of the Franchise Agreements provided that the Franchisee was to pay to the Franchisor a monthly advertising fee calculated in accordance with that provision. (b) Clause 15.1 provided that the Franchisor must credit all such fees paid by Franchisees to the 'advertising fund' and separately account for them in its books and records of account. (c) Under clause 15.2, the Franchisor was required to develop and implement an advertising, development and marketing program for the 'Civic Video System' and to use the advertising fund to pay all expenses it thereby incurred. It further provided that if at any time the advertising fund did not have sufficient credit to meet the Franchisor's expenses, the Franchisor was not obliged to provide any advertising, development and marketing program. 37 The Court of Appeal noted that it was significant that the advertising, development and marketing program in which the fees were to be expended were for the 'Civic Video System' generally and not specifically in relation to the Franchisee stores. 38 The primary judge found that if the Franchisor was awarded damages in respect of the advertising fees it would be entitled to use those funds as its own and thereby be in a better position than it would have been in if the Franchisee had performed the Franchise Agreements. The primary judge concluded that Civic's claim in respect of the unpaid advertising fees must therefore fail. 39 Significantly, the Court of Appeal found that the primary judge was in error in so finding. It said that the Franchisor was entitle to enforce the Franchisee's contractual obligation to pay to it all the advertising fees for the purposes of the advertising fund and following the termination of the Franchise Agreement, to seek damages for the diminution of the funds available to the Franchisor to develop and implement the advertising, development and marketing program for the Civic Video System by reasons of the Franchisee' failure to perform the Franchise Agreement. 40 The Court found: (a) the Franchisor was entitled to loss of bargain damages, to put the Franchisor in the position it would have been in if the Franchisee had performed the Franchise Agreements for their respective terms; (b) those damages did not involve any question of loss of chance or opportunity on the part of the Franchisor; and (c) the poor trading performance of the Franchisee’s stores and the Franchisee’s financial position prior to the repudiation were irrelevant to the assessment of loss of bargain damages.

KEY POINTS FROM THIS CASE

41 This case emphasises that the consequences of repudiation can be severe. The Franchisee may have had a much better outcome if they had obtained consent to assign first (if necessary from the Court). Of course, there was no guarantee that the Franchisor would have provided the consent, but the Franchisor would have been required to consider the issue carefully before reaching its decision.

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42 This case also confirms that it is very difficult to prove up a case based on the tort of interference of contractual relations. 43 The assessment of damages in respect of advertising fees, in my view, seems to be a harsh one for the franchisee but one open to the Court to make.

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