Meridian Retail Pty Ltd v Australian Unity Retail Network Pty Ltd

IN THE SUPREME COURT OF VICTORIA

Not Restricted

AT MELBOURNE

COMMERCIAL AND EQUITY DIVISION

No. 2008 of 2006

MERIDIAN RETAIL PTY LTD (ACN 106 272 379)	Plaintiff
v
AUSTRALIAN UNITY RETAIL NETWORK PTY LTD (ACN 101 244 795)	Defendant

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JUDGE:	DODDS-STREETON J
WHERE HELD:	Melbourne
DATE OF HEARING:	23, 24, 25, 29 & 30 May 2006
DATE OF JUDGMENT:	21 June 2006
CASE MAY BE CITED AS:	Meridian Retail v Australian Unity Retail Network
MEDIUM NEUTRAL CITATION:	[2006] VSC 223

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TERMINATION OF FRANCHISE AGREEMENT – Whether franchisor of franchise network breached implied term of good faith by threat to remove products essential to franchisees’ viability when their initial terms expired, thus causing various franchisees to surrender their franchises prematurely – Whether franchisor then entitled to rely on contractual precondition of non-viability of franchise network to terminate the only surviving franchisee.

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APPEARANCES:	Counsel	Solicitors
For the Plaintiff	Mr M. Wise	Middletons Lawyers
For the Defendant	Mr P. Solomon	Blake Dawson Waldron

TABLE OF CONTENTS

INTRODUCTION AND SUMMARY OF DISPUTE.................................................................. 2

THE PARTIES’ PRINCIPAL CONTENTIONS........................................................................... 4

SUMMARY OF FACTS AND EVIDENCE................................................................................... 7

RELEVANT LEGAL PRINCIPLES............................................................................................... 45

APPLICATION................................................................................................................................. 56

CONCLUSION................................................................................................................................. 58

HER HONOUR:

INTRODUCTION AND SUMMARY OF DISPUTE

In this proceeding, the plaintiff, Meridian Retail Pty Ltd (“Meridian”), by second amended statement of claim dated 29 May 2006 seeks relief, including declarations and a permanent injunction restraining the defendant, Australian Unity Retail Network Pty Ltd, from acting on a notice of termination dated 16 October 2005 by which the defendant, as franchisor pursuant to a franchise agreement with the plaintiff dated 10 October 2003, gave notice effective from 30 June 2006 terminating the plaintiff’s franchise operated at the Chadstone Shopping Centre.

The initial term of the plaintiff’s franchise was from 1 October 2003 until 9 July 2007. The agreement also provided for an extension of the term until 9 October 2013 on specified conditions.

The stated basis of the defendant’s termination of the plaintiff’s franchise was that a “significant change” as defined in clause 1.1 of the agreement had occurred because, in the opinion of the franchisor, it was no longer viable to operate the franchise network in the manner contemplated by the agreement.

At the date of the defendant’s notice of termination, all other franchisees which had previously belonged to the defendant’s network of ten franchises had surrendered their franchises. The plaintiff was the only remaining franchisee. The defendant’s letter accompanying the notice of termination stated that the early termination of those franchises, together with the established trend away from use of retail outlets, indicated that the network contemplated by the agreement had ceased to exist and that it was, in any event, no longer viable, so that the agreement should be terminated.

The plaintiff complains that the notice of termination was in breach of an implied term of good faith and constitutes misleading and deceptive conduct and unconscionable conduct, because the defendant engineered the “significant change” on which it now relies for the ulterior and illegitimate purpose of forcing out the franchisees and resuming control of the retail network at minimal cost. The plaintiff contends that an implied term of good faith and fair dealing precluded the defendant from exercising its rights under the agreement so as to deprive the plaintiff of the benefit of the franchise it had negotiated.

The plaintiff argues that the defendant engineered the “significant change” on which the termination notice was founded, by causing a number of franchisees to surrender their franchises early by announcing at a franchise council meeting on 21 April 2005 (“the April meeting”) that at the expiration of the initial term of the agreements, the defendant would remove health insurance, general insurance and banking products from the range of products franchisees could provide, leaving only financial planning. The businesses would consequently be unviable in future, as health insurance accounted for 80% of the franchisees’ revenue. The defendant’s offer to buy out the franchisees was accepted by all franchisees save for the plaintiff. In October 2005, the defendant served a termination notice on the plaintiff (by then its sole remaining franchisee) on the basis that the franchise network had become non‑existent or unviable.

There is a conflict of evidence on what the defendant’s officer, Mr Travers Stow, stated at the April meeting. Broadly, the plaintiff’s witnesses testified either that Mr Stow stated, or conveyed the impression, that health and general insurance and banking products would be withdrawn at the expiration of the initial term and that those wishing to discuss the surrender of their franchises should contact him. Mr Stow, however, expressly denied that he stated that health insurance, general insurance and banking products would be removed following the rollover of the franchise agreements. He testified that he stated that the defendant would honour the existing franchise agreements and, when they rolled over in 2007 and 2008, the defendant would move to new agreements which would be much more “financial planning centric”; that more specific detail would be available over the coming months; and that franchisees who wished to discuss those matters with him should contact him.

The plaintiff also claims that Mr Stow’s alleged statement that health insurance, general insurance and banking would be removed after the expiration of the first term constituted misleading and deceptive conduct in contravention of s.52 of the Trade Practices Act 1974 (Cth) (“the Act”), and unconscionable conduct in contravention of s.51AC of the Act.

THE PARTIES’ PRINCIPAL CONTENTIONS

Mr Wise, counsel for the plaintiff, submitted that under the franchise agreements, the franchisees in the network had exclusive rights within their primary marketing areas, which constituted an impediment to the strategy of establishing 100 financial planners adopted by Mr Stow in July 2004. The defendant was also, from the outset, dissatisfied with the existing structure of the franchises’ commission for health insurance, and sought to effect changes.

Mr Wise contended that the defendant’s advisers, and Mr Stow, therefore, from November 2004 at the latest, determined to eliminate the franchises, because they were unhappy with the bargain.

The plaintiff submitted that although the franchisor had, in terms, an absolute discretion to add or eliminate products, (including “essential products” such as health insurance, general insurance and banking), the contractual power was wider than was necessary to protect the defendant’s legitimate interests. It must therefore be exercised in good faith and reasonably and not for an extraneous purpose.

The plaintiff argued that in the present case, the power was exercised for the ulterior purpose of regaining control of the retail network, thus eliminating the financial disadvantages entailed by the obligation to pay the franchises’ commission, and other costs. The plaintiff submitted that, as the cost of paying full value to buy back the franchises was prohibitive, Mr Stow, informed by both external and internal strategy reports and advice, determined to sweep the franchisees away at minimal cost to the defendant, and to their financial detriment. He gave effect to that plan by announcing at the April meeting that after the expiry of the initial terms, upon renewal or rollover, health insurance, general insurance and banking products would be withdrawn from the franchises. The plaintiff contended that Mr Stow was well aware that health insurance currently accounted for 80% of the franchisees’ revenue and that its removal would make their businesses unviable. His announcement was designed to make the franchisees take flight, leaving them with no alternative but to seek to be bought out. The plaintiff’s case is that Mr Stow disguised his plan to terminate the franchises from the board of the defendant, by deliberately misrepresenting to the board that the continued existence of the franchises, albeit in a changed form after rollover, was contemplated. As such, his advice to the board differed from prior strategy plans and advice with which he agreed because it was “window‑dressed” in order to gain board approval.

Mr Wise contended that after the April meeting, three franchisees (one of which held two franchises) negotiated to surrender their franchises at prices significantly less than the extended terms were worth. As the plaintiff did not surrender its franchise, the defendant subsequently relied on “significant change” (being the non‑viability of the network) which had been engineered by the statements made at the April meeting, in order to serve a termination notice on the plaintiff, which was, by that date, the sole remaining franchisee. The “significant change” compensation to which the plaintiff was entitled amounted to no more than a third of the full value of its franchise, if it were to continue for the extended term. In such circumstances, the exercise of the power to serve the termination notice was also in bad faith and for an extraneous purpose. As such, the plaintiff argued that the defendant had breached the implied term that its contractual powers and discretions must be exercised reasonably and in good faith. Mr Wise submitted that such a term has been recognised to apply particularly to franchise agreements. The announcement that the defendant would remove health insurance products in future was made in order to deprive the plaintiff of the benefit of its bargain. The defendant’s legitimate interests under the agreement did not extend to its removal of health insurance products from the franchises in future, whilst at the same time it intended to offer such products in the defendant’s wholly owned retail network.

The plaintiff, in its pleading, relied solely on Mr Stow’s alleged but disputed announcement that health insurance and other products would be withdrawn. At trial, Mr Wise submitted that breach of the implied term of good faith did not depend on the disputed words, because the statement that the franchise agreements would be “more financial planning centric” after rollover sufficed to “scare off” the franchisees. He contended that (as the threat which eliminated the other franchisees was in breach of the good faith obligation) the defendant could not subsequently rely on the non-viability of the network in order to terminate the plaintiff’s franchise, as satisfaction of the contractual condition entitling the defendant to do so had been achieved by its earlier breach.

Mr Solomon, counsel for the defendant, submitted that the sole question for determination was whether the defendant was precluded from relying on its notice of termination served on 18 October 2005.

He did not concede that a term requiring good faith in the exercise of powers was implied in the franchise agreement, but contended that, if it were, it had not been breached. Mr Solomon emphasised that the defendant’s power and discretion to remove products were expressly conferred in absolute terms. Alternatively, he submitted that if the defendant had breached a term requiring good faith, it was entitled to serve the termination notice, although liable to pay damages for the breach.

Mr Solomon emphasised that the plaintiff did not plead a breach of any express term of the franchise agreement. The only conduct pleaded to breach the implied term was Mr Stow’s alleged statements at the April meeting that health insurance, general insurance and banking products would not be available after roll over. The alleged statements were not an exercise of any contractual power or discretion.

Mr Solomon submitted that Mr Stow should be accepted as a witness of truth. He argued that the plaintiff’s allegation of what Mr Stow said at the meeting was, on analysis, based on the evidence of one witness, Ms Farmer, whose account had influenced that of another witness, Mr Attardi. He further argued that even if the plaintiff’s version of Mr Stow’s statements at the April meeting were accepted, the plaintiff had failed either to articulate or establish any nexus between those statements and the subsequent service of the termination notice. The facts, at their highest, established that only four franchises (owned by three franchisees) were surrendered due to Mr Stow’s statements at the April meeting. The plaintiff did not, in fact, surrender its franchise due to the statements at the April meeting; three other franchises were surrendered prior to, and for reasons unconnected with, Mr Stow’s statements at the April meeting; and there was no evidence to establish why the franchises of Messrs Barker and Archibald had been surrendered.

There was thus, he said, no causal link between the disputed statements and the defendant’s entitlement to serve a termination notice based on “significant change” constituted by the non‑viability of the franchise network.

The defendant submitted that although the service of the notice of termination was an exercise of contractual power, there was no basis for impugning it. Mr Stow’s evidence that he formed the opinion that the network was unviable only after all the other franchisees had negotiated their exit, and the plaintiff was the sole remaining franchisee, should be accepted. It was not put to Mr Stow that he intended, at the April meeting or at any stage prior to August 2006, to use “significant change” in order to “mop up” isolated surviving franchisees, and he had expressly denied any such purpose.

SUMMARY OF FACTS AND EVIDENCE

The defendant (“AU”) conducts business under the name “Australian Unity”. It is a member of the Australian Unity group of companies, which provides products and services in relation to retirement living and investments to a customer base of over 400,000 people. The defendant, as the agent of other companies in the Australian Unity group, offers services in relation to, inter alia, health insurance, general insurance, life insurance, banking and financial planning products. The Australian Unity Group’s products and services are currently offered through a variety of methods. They are available to the public through the Internet, call centres and retail outlets. In 2003, the defendant’s products and services were made available to the public through various kinds of retail outlets. Some retail outlets were owned and operated by AU itself. Some retail outlets were conducted by agents of AU. Other retail outlets were conducted by a network of ten franchises operating throughout the Melbourne metropolitan area, pursuant to a standard franchise agreement drawn in substantially the same terms for each franchisee.

The franchise agreements were not executed on the same date, but the initial terms of all the agreements were due to expire at various dates around 2007 or 2008. The plaintiff entered a franchise agreement with AU on 10 October 2003. A further agreement dated 22 October 2003 effected a variation to the plaintiff’s franchise agreement, which is immaterial to the present dispute.

The plaintiff’s franchise agreement, which is typical of the other franchise agreements, relevantly provides:

“1. Clause 2.5 provides –

‘Non-Exclusive Franchise

The Franchisee acknowledges and agrees that the Franchisee’s right to conduct the Business is not exclusive and that nothing in this agreement prevents the Franchisor or an Associate of the Franchisor from:

(a)granting other franchises;
(b)acquiring, merging or forming a strategic alliance with a competitor of the Franchisor, or of nay of the Products or Services (Acquired Business);
(c)allowing any Acquired Business and agents and franchisees of the Acquired Business to operate in the PMA as an Australian Unity authorised representative in order to satisfy (and only for such time as is required to satisfy) any obligations of the Franchisor or an Associate of the Franchisor under any agreement entered into by the Franchisor or an Associate of the Franchisor in relation to the Acquired Business;
(d)continuing to sell and market the Products and Services or other products and services directly to Major Account Customers and Direct Customers;
(e)continuing to sell and market the Products and Services (other than Financial Planning Services), or other products and services throughout independent intermediaries; and
(f)acquiring and/or selling individual Franchises from time to time.’

2.‘Essential Products’ is defined as -
‘Essential Products’ means - AU Health Insurance AU Financial Planning and such other products or services that the Franchisor determines from time to time in its absolute discretion.
‘PMA’ is defined as -
‘PMA’ means primary marketing area, being the geographical marketing area in Schedule 9.
[Schedule 9 sets out a number of suburbs in metropolitan Melbourne.]

‘Products’ is defined as –
‘Products means - the products provided by the Franchisor to the Franchisee, and which the Franchisor authorises the Franchisee to sell or provide, being those products listed in Schedule 4 as varied from time to time in accordance with clause 12.3.’

3. ‘Services’ is defined as –
‘Services means services the Franchisor authorises the Franchisee to sell or provide to customers from time to time including, but not limited to, the Financial Planning Service and the Professional Referral Service and other services listed in Schedule 4 as varied from time to time in accordance with clause 12.4.’

4. Clauses 5.1 and 5.2 provide –
‘5.1 Initial Term
This agreement commences on the Commencement Date and continues for the Initial Term unless terminated earlier in accordance with this agreement.

5.2 Further Term
The Franchisee may request that it be appointed for a Further Term by written notice given to the Franchisor not less than 6 months before the expiry of the Term (Extension Notice).’

5. Clause 5.3 provides –
‘Provided [five conditions are satisfied],
the Franchisor shall, within 28 days of receipt of the Extension Notice:
(i)offer to the Franchisee an extension of this agreement for a Further Term; or, at its option,
(ii)offer to the Franchisee the opportunity to enter into the then current Standard Franchise Terms and Conditions.’

6. ‘Standard Franchise Terms and Conditions’ is defined to mean –
‘Standard Franchise Terms and Conditions means the standard franchise terms and conditions as amended from time to time which is offered by the Franchisor to Franchisees in the Network. As at the date of this agreement the Standard Franchise Terms and Conditions are contained within this agreement.’

7. Clause 6.1 provides –
‘6.1 Promote the Network
The Franchisor must use its reasonable endeavours to promote the Network.’

8. ‘Network’ is defined to mean –
‘Network means the Franchisor’s network of independent Franchisees.’

9. Clause 6.2 provides –
‘6.2 Training
The Franchisor will:

(a)give the Franchisee advice and assistance about the operation, advertising, marketing, promotion and administration of the Business; and
(b)make available to the Franchisee for the Support Fee the Support Services as determined by the Franchisor and varied from time to time.’

10.Clause 6.3 provides –
‘6.3 Services and Products
The Franchisor will provide the Services and Products to the Franchisee in accordance with this agreement.’

11. Clause 12.3 provides –
’12.3 The Products
The Franchisor may, in its absolute discretion, by notice in writing to the Franchisee;
(a)add categories of products to, or remove them from the list of Products in Schedule 4;
(b)add to, or remove any individual products from any category of Products listed in Schedule 4.’

12.Clause 12.4 provides –
’12.4 The Services
The Franchisor may, in its absolute discretion, by notice in writing to the Franchisee add categories of services to, or remove them from the list of Services in Schedule 4.’

13. Schedule 4 provides –
‘PRODUCTS
1. Insurance Products
Range of Australian Unity Health Insurance and Australian Unity General Insurance products in accordance with the Agency Agreement in Schedule 12.

2. Investment Products
Range of Australian Unity Funds Management Limited and IMB Investment products approved from time to time, plus the Australian Unity Financial Planning ‘Approved List’ (as amended from time to time) of Australian Unity and third party approved products in accordance with the Agency agreement in Schedule 12.

SERVICES
1. Financial Planning Service
Financial Planning Service under a licence nominated from time to time by the Franchisor.

2. Professional Referral Service
Taxation, Stockbroking and Estate Planning services as arranged and approved by Australian Unity Financial Planning from time to time.’

14. Clause 26.1 provides –
’26.1 Immediate Termination by the Franchisor
The Franchisor may terminate this agreement by giving to the Franchisee notice in writing, with termination to be effective immediately upon service of the notice, if:
(a)The Franchisee ceases to hold a licence that the Franchisee must hold to conduct the Franchise;
(b)the Franchisee becomes bankrupt, insolvent under administration or an externally-administered body corporate;
(c)the Franchisee voluntarily abandons the Franchise, the Premises or this agreement;
(d)the Franchisee, Key Person or Financial Planner is convicted of a Serious Offence;
(e)the Franchisee operates the Franchise in a way that endangers public health or safety;
(f)the Franchisee is fraudulent in connection with the operation of the Franchise;
(g)the Franchisee agrees to termination of this agreement; or
(h)the Franchisor is otherwise entitled to do so.’

15.Clause 26.2 provides –
’26.2 Termination by Franchisor for Breach by the Franchisee
The Franchisor may terminate this agreement immediately if:
(a)the Franchisee breaches any provision of this agreement or the Operations Manual; and
(b)the Franchisor gives the Franchisee reasonable notice (which need not be more than 30 days):
(i)specifying the nature of the Franchisee’s breach or default;
(ii)telling the Franchisee what is required to be done to remedy the breach or default; and
(iii)advising the Franchisee that the Franchisor intends to terminate this agreement if the Franchisee fails to remedy the breach or the default within the given notice period; and

(c)the Franchisee fails to remedy the breach or default within the given notice period.’

16.Clause 26.4(a)(i) provides –
’26.4 Termination by Franchisor on Reasonable Notice
(a)The Franchisor may terminate this agreement, on reasonable notice:
(i)if a Significant Change occurs;’

17.‘Significant Change’ is defined to mean –
‘Significant Change means:
(a)where the Franchisor or its Associates cease to offer any or all of the Essential Products as part of the Franchise; or
(b)where, in the reasonable opinion of the Franchisor, it is no longer viable to operate the Network in the manner contemplated by this agreement.’

18.Clause 26.4(b) provides –
‘(b) The parties agree and acknowledged that reasonable notice, for the purposes of this agreement and the Franchising Code is:
(i)in the circumstances set out in clause 26.4(a)(i) 3 months;
(ii)in the circumstances set out in clause 26.4(a)(ii) to (vii) inclusive, 7 days.’

19.Clause 26.4(c) provides –
‘Where the agreement is terminated in accordance with clause 26.4(a)(i) and the reason for the Significant Change is within the reasonable control of the Franchisor, the Franchisor will pay to the Franchisee the Significant Change Compensation and notwithstanding clause 22 of this Agreement be entitled to continue to service customers who were customers of the Financial Planner as at the date the Financial Planner first entered into the Representative Deed.’

20. ‘Significant Change Compensation’ is defined to mean –
‘Significant Change Compensation means the amount of compensation payable by the Franchisor to the Franchisee calculated in accordance with item 5 of Schedule 2.’

21. Item 5 of Schedule 2 provides –
‘Significant Change Compensation (clause 26.4)
Amount: An amount equivalent to the ongoing and recurring annual Revenue of the Franchise plus compensation for capital expenditure expended by the Franchise during the Term in which the termination in accordance with clause 26.4 occurs (less any depreciation on that capital expenditure)’.”

The franchise agreement thus granted a non-exclusive franchise, permitting the franchisee to conduct the business at specified premises using the AU image, marks, intellectual property and system. Although the franchise was non‑exclusive, the franchisor undertook not to establish another franchise or AU financial planner in the primary marketing area (as defined) during the term, and to direct inquiries from relevant customers to the franchisee. The franchisee was required to pay the franchisor a commitment fee and to make a number of other payments. It also had specified marketing and reporting obligations.

The franchisee was obliged to sell Products at the premises, which Products (including Essential Products) the franchisor could, in its absolute discretion, by notice in writing, remove or add.

The franchisor was entitled to terminate the franchise agreement on three months’ notice if it ceased to offer any or all of the Essential Products or where, in its reasonable opinion, it was no longer viable to operate the network in the manner contemplated by the agreement. In such circumstances, “significant change compensation” (as defined) was payable to the franchisee.

Mr McLardie, a director of companies in the Meridian Financial Group of companies to which the plaintiff belongs, and a shareholder of, and consultant to, the plaintiff, gave evidence that the plaintiff has operated the Chadstone AU outlet since October 2003. The plaintiff offered services in respect of health insurance and general insurance products, banking (building society) investment and financial planning. The business has grown during that time and is profitable.

Mr Vincent Attardi is a director of the plaintiff and the manager of its Chadstone outlet. He also works as a financial planner. He has worked for the Meridian Group since 2002, and was originally employed in its AU agency at Elsternwick.

It was not disputed that the great majority of the plaintiff’s monthly revenue was derived from commissions earned in respect of health insurance products. Mr Attardi gave evidence that 80% of the plaintiff’s revenue stream is earned from non‑financial planning products.

His evidence on the practical operation of the franchise relationship pursuant to the franchise agreement was as follows:

(a)AU conducts marketing and promotional activities in consideration for which Meridian pays a quarterly franchisee fee under the Franchise Agreement.
(b)When new members/businesses are signed up for health and general insurance products application forms and other relevant paperwork is completed in store as well as relevant details being inputted on the store computer system together with Meridian's numerical store code which is linked to AU's computer systems. At the end of each day all physical paperwork is placed into an envelope and sent to AU head office. At the end of each month AU's systems prepare commission statements which calculate what commissions are payable in respect of new business and by way of trailing commissions (paid as and when ongoing premiums are paid by members). Commission statements for health insurance are received electronically by email and commission statements for general insurance are received each month via mail.
Any claims made over the counter in respect of health or general insurance products are in virtually all cases processed and payments made in the store after keying all relevant information into the AU computer system which then calculates the amount of the claim payment.
(c)When new building society accounts are established all relevant information (including the store code) is inputted onto the store computers. That information is immediately accessible to IMB. The commission structure for building society services is calculated on a sliding scale relative to the total funds under management of those accounts attributable to the Chadstone AU Outlet. Commissions are paid by IMB quarterly and involve it sending commission payments to AU who then forward the commission payments (after deduction of its fees and charges) to Meridian. There are also commissions paid in circumstances where, for example, loan business is referred by the Chadstone AU Outlet to IMB. IMB Commission Statements are received via mail.
(d)As the financial planner for Meridian when I invest funds for clients with Fund Managers I will advise, when doing so, that I do so as part of the Australian Unity group. When funds are invested the Fund Managers will pay a commission to Australian Unity who after deducting their fees and charges then pay the balance to Meridian. Commission Statements for financial planning services are received fortnightly via email.
The day to day operation of the Chadstone AU Outlet is done essentially without any direct involvement by AU and AU already has in place systems, which are largely automated, to process the commissions paid to Meridian.
Any marketing or promotion of the Chadstone AU Outlet by AU is paid for via and as part of the payment by Meridian of the franchise fee under the Franchise Agreement. I believe, based on the matters detailed in this paragraph, that the Chadstone AU Outlet could continue to operate pursuant to the Franchise Agreement even as a stand alone outlet without too much assistance or intervention by AU other than to process commission payments via largely automated systems and standard continued marketing.

In July 2004, Mr Travers Stow commenced employment with the defendant as its General Manager, Retail Services. His role, despite a change of nomenclature, has remained, throughout, the supervision and management of AU’s direct customer services and distribution businesses, which make up its retail network. Mr Stow is a director of the defendant and of two other companies in the Australian Unity Group.

At the date of Mr Stow’s commencement of employment with the defendant, the defendant was already engaged in negotiations with its franchisees in order to alter the commission payable to franchisees for health insurance policies. Those negotiations had commenced in May 2004.

Commission was payable to the franchisees in respect of health insurance policies on two bases. First, a commission was payable in respect of new health insurance policies sold through the franchisee’s retail outlet. Secondly, there was a commission known as “trail” commission. Trail commission was a monthly commission payable to the franchisee in respect of the existing health insurance policies of customers whose residential addresses were within the franchisee’s Primary Marketing Area, as defined in the franchise agreement. The amount of the trail commission was tied to the amount of the premiums payable on the health insurance policies.

The defendant considered that the existing structure of health insurance entailed disadvantages for it and considered that a greater amount payable on “up front” commission would encourage more new sales and place less reliance on previous sales. The defendant also wished to break the link between trail commission and the health insurance policy premiums, as the premiums were rising at twice the rate of inflation. From May 2004, the defendant therefore negotiated with the franchisees to alter the relative amounts of “up front” and trail health insurance commission payable to the franchisees.

Prior to Mr Stow’s employment by the defendant, a notice of dispute was served by the franchisees in relation to the proposed restructuring of the health insurance commission. When Mr Stow commenced employment with the defendant, he took over the negotiations with the franchisees.

In December 2004, as a result of the negotiations, the franchisees agreed to accept a new health insurance commission structure. Under the new health insurance commission structure, trail commission was reduced from 2.7% to 2.25% (to inflate by 4.5% in the 2005/2006 financial year) and “up front” commission for new policies was increased from a flat rate of $100 per policy to 30% of the first year’s premiums. Further, under the new commission structure, if a franchisee earned less commission from health insurance for the 2004/05 financial year, despite making the same number of sales as in the previous financial year, the defendant was obliged to make up the shortfall.

Mr Stow acknowledged that he had been dissatisfied with the existing health insurance commission structure. He agreed that a shift from trail commissions to “up front” commissions for sales was to the defendant’s benefit. He did not concede, however, that it was necessarily to the detriment of the franchisees, as such a shift meant that their remuneration would be linked to their ability to sell. A franchisee with high sales ability could benefit from the change, although a greater sales effort was required.

The plaintiff contended that the negotiations over health insurance commissions, which resulted in the agreed restructuring in December 2004, supported its contention that the defendant was, from the outset, dissatisfied with the existence of the franchises; and that Mr Stow, in particular, had determined to eliminate the franchises if he could.

I am not persuaded that the evidence of the negotiations and agreement on restructuring of the health insurance commission supports the plaintiff’s contention. The revision of the existing structure of health insurance commissions was clearly in the defendant’s commercial interests, for the reasons frankly acknowledged by Mr Stow. The plaintiff did not contend, however, that restructuring could be, or was, unilaterally imposed on the franchisees. Rather, through a process of negotiation, the parties concluded an agreement which substantially increased “up front” commission, while reducing “trail” commission and providing a safety net for any short fall. The restructure potentially disadvantaged the franchisees in some respects, yet it also potentially increased the total commission payable to those franchisees who sold more new health insurance policies. Mr Attardi asserted that the restructure was to the franchisees’ disadvantage, as it required greater sales efforts to make the same remuneration, but acknowledged that the plaintiff’s franchise did in fact sell more policies. There was no evidence that any franchisee suffered any financial or other detriment as a result of the restructure of the health insurance commission. Further, while the franchisees initially resisted change, there was no evidence that their ultimate agreement, after a lengthy negotiation, was procured by illegitimate or improper means or was other than free consent.

The defendant’s negotiation of a revised health insurance commission structure for franchisees, which involved a considerable commitment of time and effort, was at least as consistent with its acceptance that the franchises would continue (and that satisfactory terms should therefore be negotiated for their long term operation) as with a determination to eliminate them.

On commencing employment with the defendant, Mr Stow also formed the view that the retail operators were too heavily focussed on “head office”, rather than on business growth. He considered that growth in the financial planning aspect of the defendant’s business was the “way forward”.

The Report of Port Jackson Partners dated 11 November 2004 was commissioned by the defendant. The Port Jackson Partners’ Report proposed a business goal of growth in financial planning for the defendant. It indicated that if the defendant could attract 100 experienced financial planners, it could secure $10.5 million annual profit before tax and overheads.

Mr Stow testified that he read the Port Jackson Partners 11 November 2004 Report and agreed with the suggested goal of establishing a business of 100 financial planners.

The e-mail of Travers Stow to Rohan Mead dated 18 November 2004 relevantly stated:

“Rowan, apropos our discussion of last week, if I had access to the necessary capital and the ROI [return on investment] numbers worked out, this is what I’d do with the retail network and financial planning….
· I’d buy back the franchises, creating a wholly owned network of 17 sales centres and ten agencies (add to this the potential to expand into New South Wales), ie get full control.
· I’d switch the emphasis of these outlets to financial planning as AU advice businesses, retail distribution gatekeepers to our full range of products/services.”

At trial, Mr Stow explained that by November 2004, it was clear to him that the existing franchise arrangements were not working and that it would be difficult to solve the problems while they remained in place. His view was that ideally, the defendant should gain full control by resuming ownership of the retail network. He agreed that he would have been “delighted if in some reasonable way the franchises could have been done away with”. Capital would be required to buy back the franchises. Mr Stow had not requested the funds to do so at that stage, so it was not clear whether or not funding would be available. He denied that the defendant would necessarily have had to purchase the business of each franchise as a going concern. Rather, the price would be a matter of negotiation with each individual franchisee.

Mr Stow agreed that, as the November e-mail indicated, his goal was to switch the retail outlets’ emphasis principally to financial planning, while continuing to service the other products (being health and general insurance products and banking). He stated that under the existing system, financial planning was an “add on”, but that in the future, he wished to see the outlets “become more complete financial planning businesses, while still offering the full range of products and services”

Mr Stow testified that as at November 2004, he did not view the franchises as insuperable impediments to his “grand plan”. While he was aware that over 80% of the franchisees’ revenue was currently derived from health insurance, he believed that he could work with the existing franchisees successfully to increase their financial planning businesses, as part of achieving the necessary growth in financial planners in Victoria.

While the plaintiff contended that Mr Stow had determined, as at November 2004, to terminate the franchises in order to put his “grand plan” into effect, I am satisfied that his account of his contemporaneous views was frank and truthful, and that although he recognised that health insurance was then the principal source of the franchisees’ revenue, he had not concluded that the continued existence of the franchises was necessarily incompatible with the goal of establishing 100 financial planners, decided to destroy the franchises if they impeded his strategies or determined to withdraw health insurance products after the expiration of the initial term.

Strategic Review Workshop materials dated 23‑24 November 2004 were prepared by Port Jackson Partners for Mr Stow and other officers of the defendant. Port Jackson Partners discussed the document with Mr Stow while preparing it. It contained charts which indicated a projected growth in the retail network if the defendant regained control.

Mr Stow agreed that, as identified by Port Jackson Partners, by 24 November 2004, he considered that regaining control of the retail network was an important goal for AU. Recognition of that goal was also reflected in Mr Stow’s e-mail to Rohan Mead dated 18 November 2004.

Mr Stow’s notes dated December 2004 reflected his thoughts at the time. The notes relevantly stated that one of the operational issues was “exiting the existing retail network structure” and below that, dot points noted an “orderly transition over 3 years” and “believe existing franchise network will unravel”.

Mr Stow denied that “transition” meant the elimination of the franchises. Rather, he contemplated transition to other models contemplated at the time. He agreed that he believed that the existing franchise network would unravel or fall apart, as there was “much unhappiness”. He also thought that the network was unviable at an economic level and was not functioning well at an operational level. He thought that some franchisees would exit, but was not sure how many, or what factors would motivate an individual franchisee.

He denied that, prior to August 2005, he was certain that the network would unravel, although he believed it probable. At an earlier stage, he believed that it might be possible to salvage the network. He was aware that the defendant must use reasonable endeavours to promote the network and testified that he made efforts to salvage it. He acknowledged, however, that once the franchisees started to exit, he did not try to find alternative franchisees.

Mr Stow stated that was aware of the “significant change” clause in the franchise agreements, but was conscious that the terms of the contract, the requirement not to act unconscionably and the need to negotiate with the franchisees limited the defendant’s ability to change the franchise agreements “going forward”.

In cross‑examination, Mr Stow agreed that the retail network had high fixed costs and was a loss-making part of the defendant’s business. Although the cost could be reduced by relocation from high cost real estate at the end of the franchise leases, he was aware that the franchise agreements, with their fixed commission structure and the restrictions on unconscionable conduct, limited the defendant’s capacity to turn the situation around.

Mr Stow conceded that he would have been happy if he were able to “sweep away” the franchise agreements.

Mr Attardi gave evidence that at a franchise council meeting in late 2004, Mr Stow stated that the “way forward” and the “big ticket” item for AU would be financial planning. He indicated that his target was to introduce 100 financial planning licensed representatives of AU within three years.

In about December 2004, Mr Stow requested Mr Attardi to service the financial planning clients of the Southland retail outlet which was owned by AU. Mr Attardi complied with the request and asked if the Southland retail outlet could be converted to a franchise operated by the plaintiff. Mr Stow said that this could be discussed at a later date.

Workshop materials produced by Port Jackson Partners for a workshop on the retail network review dated 13 January 2005 indicated that the current franchise and agency arrangements constrained short term change.

Mr Stow agreed that that was the case, that regaining the franchise outlets would provide AU with commercial flexibility and cost saving and that he would therefore have been delighted “if these franchise agreements were to disappear”.

On 14 February 2005, Mr Stow replied by e-mail to a number of questions put to him by franchisees, prior to the franchise council meeting scheduled for 17 February 2005.

In his e-mail, Mr Stow responded to a question about the percentage of commissions currently retained by AU on all lines of product. In his response, he stated that the matter was governed by the disclosure document and the franchise agreement. He referred, inter alia, to the recent change to the health insurance commission and stated, “I have no plans at this time to make any further changes to the business model and fee structures”.

Mr Stow agreed that another question, “What’s the intention for the retail network?”, indicated the franchisee’s concern about a customer survey on the use of retail outlets. His e-mail reply stated that, “I am reviewing the whole AURN/AUFP strategy”.

Mr Stow denied that the statement that he had no plans at that time to make any further changes to the business model and fee structures was disingenuous, because he had, in fact, already determined to terminate all the franchises. He testified that his response was tailored to a specific question which, in essence, asked whether the defendant would, in future, cap certain fees which it was entitled to retain.

In my opinion, fairly construed in context, Mr Stow’s response cannot be viewed as an absolute statement of general intent. In accordance with Mr Stow’s testimony, its meaning is limited by the particular context of the specific question to which it responds and the nature of the e‑mail “dialogue” in which it appears.

The franchise council meeting on 17 February 2005 was attended by Mr Stow, Simone Kantzides, Michelle Guy, Ronald Rose, Susan Di Pietro, John Barker, Margaret Webster, Robyn Farmer, Vito Ventura and Vincent Attardi. At the meeting, Ms Di Pietro questioned Mr Stow about a statement (made at a previous meeting) that a review of the AU retail network would take place. Mr Stow replied that “there was going to be a retail network review as part of a general review of the retail network and that the results of the survey and review would be advised when the results came to hand”.

A first draft of a Strategic Plan dated 21 January 2005 was prepared for the defendant by David Bradley. Mr Stow, who was absent at the time, had no input into the first draft of the Strategic Plan.

The second draft of the Strategic Plan, dated 4 February 2005, was apparently not the sole work of Mr Stow, but he had input into it. The second draft reflected Mr Stow’s thinking at the time.

The second draft relevantly stated:

· Provide an exit strategy for the existing franchisees giving them the choice of working through to the termination of their agreements or exiting earlier at commercially acceptable price.
· As franchisees exit, roll the model out across Victoria.

Mr Stow denied that the above signified a decision to force out unwilling franchisees. He conceded that his thinking made no allowance for any franchises beyond three years, but testified that “I was going to provide the ones that wanted to leave with a way out and it concerned converting them into the new model wholly owned by AU as and when they were ready”.

Mr Stow denied that an overall strategy to provide an exit strategy for existing franchisees as at 4 February 2005 was inconsistent with the statement that he had no plans at the time to make further changes to the fee structure.

The Port Jackson Partners Final Report dated 24 February 2005 was prepared by Port Jackson Partners in order to submit the strategic plan to the AU board for final approval.

Mr Stow read the Final Report of Port Jackson Partners very carefully. He regarded the information it contained as invaluable. He testified, however, that he did not simply adopt the Final Report, but formed his own opinion based on its contents.

The final Port Jackson Partners Report (“Final Report”) stated that:

“The franchise agreements should be terminated as they are unsustainable models for meeting AU’s retail network needs. The transaction and sales volumes are insufficient to justify the high costs of maintaining the franchise outlets under the current commission agreement model, especially as servicing volumes continue to fall. These outlets have not, on the whole, been successful at leveraging sales into other products and services, and the arrangements limit AU’s flexibility to manage and alter its retail network design as customer needs change.”

Mr Stow agreed that the Final Report advocated that the franchises and agencies should be terminated, as that would save costs, outweighing the reduction in sales and customers, and that a better result could be achieved by retaining a retail network and conducting it in a different, low cost way.

The Final Report proposed replacing some franchises and agencies with alternative low cost outlets. It stated, “Controlling our own outlet network buys back flexibility to exploit future market conditions or to close in future”. Mr Stow acknowledged that he had agreed that AU would obtain benefits from regaining control.

He agreed that the Final Report generally concerned the expected benefits and economics of terminating the franchise agreements early. The Final Report showed a graph giving an estimated cumulative value of closing outlets and opening low cost alternatives in a given year, which, over three years, was estimated to produce a potential benefit of $6 million if the strategy of replacing metropolitan franchises with low cost outlets were adopted.

The Final Report stated:

“There is a clear road map of strategic initiatives to be undertaken.
2. Franchise and agency outlets.
·     Finalise physical outlet model, if any, in each location
·     Design appropriate transition plan to manage the network closure or restructuring
·     Announce intention not to renew current arrangements to franchise and agency outlets
·     negotiate with individual franchisees to close their outlets earlier.”

The Final Report was presented to Mr Stow, Mr Mead and Mr Peter Cavestes on 24 February 2005. It was well received. Mr Stow was charged with the responsibility of implementing the strategy.

An Implementation Plan dated 28 February 2005 was prepared by David Bradley. It stated, inter alia:

“Franchises and Agencies:
·     Get external legal opinion re franchise agreements
·     Prepare contingency PR strategy, design incentives to minimise scope for franchisees to sour customer relations
·     Announce intention not to renew agreements
·     Negotiate with individual franchises to close outlets earlier and
·     Rollout closures and replacement outlets.”

Mr Stow stated that the above represented David Bradley’s theory, and attempted to capture every possible thing that might need to be done if the Port Jackson Partners strategy were to be implemented.

On 7 March 2005, Mr Rose, the owner of the Moonee Ponds and Geelong franchises, initiated discussions with the defendant to terminate his franchises.

By an agreement made on 10 March 2005, Mr Ventura, the owner of the Greensborough franchise, agreed to surrender the franchise to the defendant.

The e-mail of David Bradley to Leigh Dewer dated 16 March 2005 relevantly stated:

“Leigh
As mentioned, I have reviewed the PJP report presented to Rohan on 24 Feb, as to whether it is still current and consistent with our thinking in recent weeks. I have also been mindful that the pack would be read stand-alone by Board members, rather than accompanying a presentation by a PJP person, so needs to be self‑explanatory.
The key point is that, as Rohan pointed out, the Board members need to be led gently from their previous understanding of the strategy to the new direction, which needs to be presented as a well‑explained evolution, rather than a revolution. The current PJP pack doesn’t do that, so Travers’ strategy plan may need to do so.
A few other points stand out. Some result from comments made by Rohan when the pack was presented to him. Some others are minor, but perhaps it’s worth pointing them out to PJP, to see if they are happy to change them.
p2:     “eliminate” current franchise and agency agreements. Might be better if it were to say something like “do not continue with” or “do not renew”. Also applies on pages 6, 13, 17.
You (and the Board) should be aware that the 14 FTEs is PJP’s estimate of what’s possible. We are yet to do the detailed work to determine what’s possible in practice. A similar comment applies to page 47.
p14:   “terminated” might be better expressed as “not renewed”.
p18:   “outlet closure program” might be better described as “network restructuring”. Ditto pages 21 and 32 (in 2 places).
p19:   Rohan asked that a total be included for each colour bar.
p22:   Rohan asked that the comments re fraud risk be removed.
p27:   there appear to be 2 errors near the bottom of the table. “Retail network” should be “retail network management”, and there should be no amount under current cost of the call centre instead of the $1600k shown.
p28:   Rohan asked that there be a shaded bar to reflect the base case.
p30-31: this diverges from Travers’ intended strategy. Suggest this divergence will need to be explained to Board members. See comments re p 73 below.
p33:   would Travers and Rohan be happy with call abandonment rates of 15% being advised to the Board? If included, should be dealt with in Travers’ strategy plan.
p.34: Rohan requested that his be done later rather than now. I understand this is still being discussed between Rohan, Travers, Peter and Tony. If it were included in the pre-reading pack, suggest it be dealt with specifically in Travers’ strategy plan.
p73:   is bound to be a hot topic at the Board retreat”

The next Strategic Plan was dated 17 March 2005. It was, in effect, Mr Stow’s own document. It relevantly stated:

“1. Business Strategy & Basis of Competition
1.1 Introduction
Over the last 2-3 years, AU’s member servicing & sales distribution channels have undergone considerable re-structuring to arrive at the present multi‑channel network based around an in-house call centre, sales to corporate groups and a retail network of franchised or company owned sales outlets. This has been accompanied by a rationalisation of the pre‑existing agency network, with amalgamation and retention of some larger agencies in regional Victoria. During this time, a financial planning business was established in the retail network with the strategic intent of building a more diversified and holistic retail service offering and diversifying revenue streams. A retail network review was recently carried out by Port Jackson Partners in conjunction with key AU staff, the contents of which is presented in the packs distributed to the AU Board and Executive prior to the April Retreat. This plan references much of the material contained in that pack.
The current model has a number of serious flaws, which are adversely affecting our ability to deliver the kind of revenue AU needs to effectively grow its product manufacturing and member servicing businesses and to manage costs. These are:
1.The mix of different retail business models (agency, franchise and company owned) is producing inter-channel conflicts as clients chose to move from one type of retail outlet to another and between channels, depending on their buying/servicing preference and needs.
2.The revenue model for the franchise channel links HI trail revenues to a (largely) static member population residing in a primary marketing area (PMA) and linked (now) to inflation (was linked to medical inflation). Member activity in the franchise channel generated out of each PMA is falling as channel substitution takes place. In effect we have created a high fixed cost infrastructure with a remuneration model that is inversely related to activity. This remuneration model is not economically sustainable.
3.The location and physical layout of the current retail outlets is not ideally configured for financial planning activities, and it is debateable whether it is possible to simultaneously manage a business of this type and be an effective financial planner. These factors are distracting the fledgling financial planning businesses from establishing a viable alternative revenue stream.
4.Several of the current franchisees are not performing to standards required by their agreements with AU, in terms of achieving agreed growth in financial planning revenues and health insurance sales, quality of service to members and compliance.

In summary, our current distribution model does not effectively meet the needs of its two biggest customers – Health Insurance and Financial Planning. That being said, significant progress has been made in establishing the core elements of a financial planning business, with some encouraging early indications that the AU brand could be part of an effective lead generation program supporting a network of AU financial planners.
The key elements of the strategy direction proposed in this plan are:
·     View AURN and AUFP as two parts of a whole and thus a complementary strategy across both businesses.
·     Place greater emphasis on monitoring franchisee performance and compliance, and performance manage those who do not meet the requirements of their franchise agreements.
·     Develop a new commission structure, to apply once current franchise agreements expire in 2008-2009. This structure would be an extension of the changes introduced in January 2005, and would be designed to better meet AU’s commercial needs and place more emphasis on financial planning revenue and less on commissions from health insurance. As part of a new arrangement there may also be scope to reduce franchisee costs, so achieving similar net incomes.
·     Communicate the new arrangements to franchisees. We expect that some may choose to exit at a commercially acceptable price prior to their current agreements expiring, others may prefer to continue until the end of their current term, whilst others may seek a renewal after 2008-2009, under the new arrangements.
·     As franchisees exit, either through choice, performance management or natural attrition, progressive transition to a wholly owned and branded “service counter” model situated inside selected pharmacy and AUFP locations.
·     In the short term, retain sales centres in key locations, make their operations more cost-effective, and review in approx FY09.
·     Future AUFP locations to be established or acquired in physical premises and locations based primarily on their suitability for financial planning activities.
·     Place more emphasis on AU mass marketing programs on driving product sales and service demand through the Call Centre and electronic channels (HICAPS, internet), whilst still promoting sales through retail outlets.
·     Corporate Groups remain a growth strategy with the additional new opportunities provided by the GU merger.

1.2     Value proposition
AU’s value proposition to our target market (middle Australia) is the trustworthy, caring and efficient delivery of key services relating to their health and financial well being. Our competitive advantage is best defined by:
·     our heritage of mutuality
·     the type and scale of our current operations
·     our physical presence on the ground in our main markets.”

As Mr Stow acknowledged in cross‑examination, the 17 March 2005 Strategic Plan (which was, in contrast to all preceding documents, unequivocally his own), differed from the Final Report of Port Jackson Partners because it clearly contemplated that some franchises would roll over for an extended term with new conditions and a changed emphasis. While it envisaged the ultimate elimination of the franchises over time, it did not require an enforced immediate termination of all franchises or a refusal to roll them over. Rather, it contemplated a gradual transition. The Strategic Plan stated:

“Place greater emphasis on monitoring franchise performance and compliance and performance manage those who do not meet the requirements of their franchise agreements”.

It also proposed the development of a new commission structure for franchise agreements, to apply once the current terms of the franchise agreements expired, as an extension of the changes introduced in January 2005.

Mr Stow acknowledged that his Strategic Plan advocated less emphasis on health insurance commission and more emphasis on financial planning. It contemplated extending the change already made, which had reduced trail commission and increased up front commission. Mr Stow did not consider resistance to such further change inevitable, as he had ultimately secured the franchisees’ consent to the previous changes.

He acknowledged that it was quite clear that some franchisees might choose to leave on communication of the new arrangement, but he had believed that some franchisees might seek a renewal.

The Strategic Plan also stated that the aim of the exercise over time was to move to a wholly‑owned and branded retail model.

Mr Stow conceded that there was inconsistency between the proposition that franchises might subsist after 2008 or 2009 under a new commission structure and ultimately introducing a wholly owned AU network service counter model. He explained that the service counter model was an idea under serious consideration at the time, but was soon after abandoned.

I am not persuaded, in any event, that transition to a wholly owned network over time is necessarily inconsistent with the extension and continuation of some franchises, as all depends on the timing.

While it was clear that Mr Stow envisaged, and hoped, that all franchises would ultimately be eliminated, that is not incompatible with the extension of some franchises on changed terms. He stated that his views on the retail network were, at the time, forming as follows:

“What was happening during that period was I was taking the information that was – had been given to me by the consultants and I was starting to work out what I needed to present to the Board which was my, essentially going to be my operations plan for the business. So in essence I had to turn the theory of the consultants’ work into the practical – into a practical real world strategic plan. … In writing this document I not only took into account all of … the consulting reports that I had received but I would have also synthesized all the information that was coming to me from … the day to day operations, my dealings with the franchisees. I guess the practicality, the day to day operational practicalities and … this strategic plan reflected what I thought I could achieve and that’s what I presented to the Board.”

Further, Mr Stow testified that he determined to advise the franchisees as soon as possible that there would be new arrangements in future, in order to give them as much warning as possible, by flagging that he would seek to change arrangements in two to three years’ time.

In cross‑examination, Mr Stow strongly denied that he had included the reference to continuing franchises in the Strategic Plan simply as “window dressing“ in order to “soften up” the board of the defendant and secure its approval, thus concealing his real plan to eliminate the franchises.

He acknowledged that the e-mail of David Bradley had suggested that he should tone down the language of the Port Jackson Partners Final Report, and take a more “softly softly” approach in order to gain board approval. Further, he acknowledged that on the advice of Leigh Dewer, he removed the word “terminate” from the slides and board presentation material. He denied, however, that he “window-dressed” the language and the entire strategy in response to those suggestions.

He stated that he removed the word “terminate” because the language of Port Jackson Partners was harsh and he was “the executive that had to deliver the strategic plan and … the words had to be my words … and I could only deliver what I knew to be possible.”

Mr Stow strongly denied that he had in fact adopted Mr Bradley’s proposed option of “pulling health insurance from the franchisees, and paying them compensation on the assumption that this would make their businesses unviable”, and that, in making a transition from the “harsher” Port Jackson Partners’ Final Report strategy of 24 February 2005 (which made no allowance for franchises) to making allowance for them, he was simply “window-dressing”.

Mr Stow also denied that he was aware that it would be impossible to devise a new type of commission structure acceptable to the franchisees and therefore determined to eliminate them. Further, he denied that he deliberately deceived or misled the board, by adopting the pretence that the franchisees would be permitted to continue.

Rather, he testified that, despite his knowledge of the franchisees’ current heavy reliance on health insurance revenues, he thought that it would be possible to design a business model which would meet the needs of both franchisor and franchisees.

Mr Attardi gave evidence that in March 2005, he and Mr Stow discussed the introduction of financial planning targets for franchisees. Mr Attardi stated that he put it to Mr Stowe that this was because the franchisees were an impediment to achieving 100 financial planners in Victoria and Mr Stow said “that’s correct”.

On 3 – 4 April 2005 the board of the defendant held a retreat at which Mr Stow’s strategic plan was presented and approved.

Mr Ronald Rose, who operated franchises at Moonee Ponds and Geelong, initiated the termination of his franchises prior to the April meeting, which he did not attend. He had raised the possibility of terminating the franchises, because he did not think that AU had a sound structure in place for financial planning, which he saw as the main future activity of his business. He was aware that the Greensborough franchise had already terminated its agreement with AU and thought that the same opportunity might be available to him.

The “significant change” compensation paid to Mr Rose was less than the net profit he would have made over the next seven years (the remainder of the term and option). Mr Rose gave evidence that he received about 45% of that profit through the termination of his franchise agreement.

On 21 April 2005, an AU franchisee meeting occurred at the defendant’s head office in South Melbourne. The meeting was attended by Travers Stow, Simone Kantzides, Michelle Guy, Susan Di Pietro, John Barker, Margaret Webster, Robyn Farmer and Vincent Attardi. Mr Stow addressed the meeting.

There is a conflict of evidence on what was said at the April meeting. Mr Stow gave evidence that at the meeting, he stated:

“(a)we (meaning AURN) have existing franchise agreements which we will honour; but
(b)when these agreements roll over in 2007 or 2008 we will be looking to move to new agreements that will be much more financial planning centric;
(c)over the coming months, I will come back to you with more specific detail on how these agreements will look; and
(d)in the meantime, if any of you (meaning the representatives of the franchises) wish to discuss this with me, please come and speak to me.”

Mr Stow denied that, at the April meeting, he communicated any intention to withdraw the health insurance, general insurance and banking from the franchises. By “financial planning centric”, he meant placing financial planning in the centre, with everything else at the periphery. While he was aware that the franchises currently gained 80% of revenue from health insurance, he did not intend his communication to signal that the franchises would be made unviable after rollover. He considered the statement that a new agreement would be “much more financial planning centric” was fairly general and did not expect that it would cause franchisees to exit. He stated that he had given careful consideration to exactly what he should say at the April meeting.

Mr Stow did not deny that he expected that some franchisees would choose to leave the network upon negotiation of a commercially acceptable price, or would negotiate to become a financial planner in the network.

Ms Guy, who was employed by Australian Unity Group Services Pty Limited as a Manager – Shared Services, attended the April meeting. She stated:

“I recall that, at one of the meetings (ie either on 17 February 2005 or on 21 April 2005), the following occurred:
(a)Travers Stow made a presentation to the franchisees in relation to a report prepared by Port Jackson Partners, one hard copy of which was passed around among the franchisees in attendance;
(b)There was discussion by Travers Stow in the context of the Port Jackson Partners report to the effect that Australian Unity would change moving forward and would focus on financial planning, that health insurance was declining in terms of traffic through to retail outlets, that claims were declining and that if the franchisees were to be strong in their business in the long term there would need to be a focus on other areas than health insurance, and that financial planning was one of those areas;
(c)Travers Stow also said words to the effect that:
(i)financial planning was going to become more important to Australian Unity;
(ii)there was a declining member base for Australian Unity outlets based on statistics that had been prepared and that in the future franchisees would have to develop different areas of their business;
(iii)an emphasis would have to be placed on financial planning;
(iv)the current agreements would be served out until 2008 unchanged but there would be changes to the agreements; and
(v)if, going forward, the franchisees were not in a position to fulfil the business requirements of the changed agreements then they should talk to him.”

Ms Guy testified that prior to the April meeting, she was not aware that AU had adopted a retail strategy to move away from independently‑owned franchises towards a wholly‑owned, lower‑cost services counter model. She was generally aware that there was diminishing traffic in retail outlets, but had no detailed knowledge. She received an agenda prior to the April meeting.

Her recollection was that Mr Stow said that upon roll over, there would be new agreements, with the emphasis on financial planning and less emphasis on health insurance, general insurance and banking.

She was aware that franchisees earned their revenue predominantly through health insurance, and recognised that the proposed change would affect them. It would also have an impact on her job, as she managed a relief pool and staff at retail outlets.

At trial, Ms Guy firmly denied that Mr Stow had said that health insurance products would be removed. The withdrawal of health insurance products had “huge ramifications throughout the business, because that’s the bulk of our business”. Ms Guy distinguished withdrawal of the product from withdrawal of, or reduction in, trail commissions.

She testified that she had a clear recollection of the April meeting and was confident that she would have remembered something as significant as a withdrawal of health insurance products.

Mr Attardi gave evidence that at the April meeting, Mr Stow said the following:

(a)AU intended to honour the current franchise agreements with franchisees but that at the expiration of the initial term of those agreements franchisees would be offered new franchise agreements which would be focussed on financial planning. He said that AU intended to remove health insurance, general insurance and building society services from the business services which could be offered by franchisees. Mr Stow said that this determination had been made by AU because the utilisation of retail outlets by AU members/customers was down;
(b)based on what he had said in respect of the future direction of AU he said that if anyone present wanted to discuss those matters further with him, then his door was open.

Further, Mr Attardi gave evidence that at the April meeting, Mr Stow also stated that a customer survey which AU had conducted on the use of retail outlets demonstrated that “the utilisation of retail outlet services had decreased”.

Mr Attardi conceded that Mr Stow made the statements to which Mr Stow testified, save that he had no recollection of Mr Stow stating that, over the coming months, “I will come back to you with more specific detail on how these agreements will look”. He agreed, however, that Mr Stow invited the franchisees to discuss the matter with him.

In particular, Mr Attardi agreed that, although he could not be sure of the exact words, Mr Stow said something to the effect that “when the franchise agreements roll over in 2007 or 2008 we will be looking to move to new arrangements that will be much more financial planning centric”.

He testified that he had a very clear recollection that Mr Stow stated that AU intended to remove health insurance, general insurance and building society services from the franchisees after roll over.

Mr Attardi gave evidence that in a subsequent conversation, he put to Mr Stow that the defendant had assessed the closure of the Greensborough franchise and had determined that the loss of sales did not warrant the cost of the retail outlet continuing, to which Mr Stow replied, “Yep, that’s right”.

Ms Di Pietro operated the Camberwell franchise outlet. She gave evidence that at the April meeting, the following occurred:

“The meeting proceeded normally and towards the end of the meeting Travers Stow who was conducting the meeting on behalf of the defendant, said that at the end of the initial term of all franchise agreements the defendant would offer new franchise agreements which would be financial planning centric. He also said that:

(a)if anyone present wanted to exit or get out because of what he had just said that they should contact his secretary about making a time to come to speak with him;
(b)the defendant would buy back that part of the franchise business relating to health insurance, general insurance and building society services and that discussions would be along the lines of the significant change clause contained in the franchise agreements; and
(c)this offer would not be open forever and that franchisees should not expect to trade out the remainder of their initial terms and still have the offer on the table.”

Ms Di Pietro gave further evidence that:

“In order to clarify Mr Stow's comments to the meeting I asked him that if franchisees approached him about exiting their franchises, then discussions would be along the lines of the significant change calculation contained in the franchise agreements, to which he responded "yes".”

In cross‑examination, Ms Di Pietro conceded that she was not certain that Mr Stow used the words “buy back” and that “the take” she took from the meeting was that the defendant was offering to buy back the portions of the business relating to health insurance, building society and general insurance. She recalled that Mr Stow said that existing agreements would be honoured. Although she did not recall the exact phrase “we will be looking to move to new agreements that will be more financial planning centric”, she had a clear recollection of the words “financial planning centric”.

Ms Webster operated the Ballarat franchise. She gave evidence that she did not specifically recall a meeting on 21 April 2005, but testified that:

“In early 2005 I recall being told at a franchisee meeting by the defendant (I can’t recall exactly who spoke nor exactly what date the meeting was on) that health insurance, general insurance and building society services would be removed from franchise agreements at the end of the initial terms of franchise agreements and that only financial planning services would be available to be offered by franchisees after that time. I also recall being told that unless our franchises were already operating a viable financial planning practice, then at the expiry of the initial term of the franchise agreements we would not be offered a renewal of the franchise which would be for financial planning only.

Mrs Webster had not spoken to Mr Attardi about her recollection of the April meeting. She made clear that she did not have a specific recollection of what was said. She was unable to identify the person who made the statements she referred to. She stated that there were informal discussions after the franchise council meetings and that she carried away the “understanding” that health insurance, general insurance and building society services would be removed.

She agreed that Mr Stow stated that existing agreements would be honoured and that, when the agreements rolled over in 2007 or 2008, “we will be looking to move to new agreements that will be much more financial planning centric”.

Ms Farmer, the operator of the Glen Waverley franchise, gave evidence that at the meeting:

“Mr Stow addressed the Meeting. In that address:
(a)he delivered the findings of an AU customer survey which I recall had been conducted earlier in 2005 (February/March). The survey had involved, from my experience, a person attending the Glen Waverly franchise for approximately 2 days interviewing customers on the premises or through later telephone calls. I believe from discussions with other franchisees that a similar approach was taken in respect of some other AU franchises. Mr Stow said that the survey had been completed and he handed out copies of a report on the results;
(b)he said that whilst AU would honour all of its current franchise agreements, at the end of the initial term of those franchise agreements, AU would offer new franchise agreements which would be focussed on financial planning and that health insurance, general insurance and building society services would not form part of the services to be provided by franchisees.
(c)he said that if this new franchise model was not one which the franchisees were happy with or not the direction that any franchisees wanted to go, he’d be happy to discuss an exit strategy with them.

In cross‑examination, she agreed that, although she could not recall his exact words, Mr Stow had made a statement to the effect that “there was going to be a different franchise agreement when the roll over came, that they would be altering the franchise agreements to something centred on financial planning”. She could not deny Mr Stow’s assertions of what he had said.

At trial, Mr Attardi was evasive and unconvincing in relation to possible conversations he had had with Ms Di Pietro concerning the April meeting. Although he could not be certain that he had spoken with her at all, he acknowledged that he could have had five or ten conversations with her, which could have concerned the April meeting. He had no recollection of discussions with Ms Di Pietro about the April meeting between the receipt of the termination notice on 18 October 2005 and 7 March 2006, when the proceeding was issued.

Ms Di Pietro acknowledged that she had spoken with Mr Attardi since the litigation commenced, but was vague about the details. She recollected that the conversations were general in nature, and related to how she was going with her new business. In response to whether they had spoken about this litigation, Ms Di Pietro stated that Mr Attardi may have mentioned that there was “something in the wind”, but she did not recall what he had said.

Mr Attardi acknowledged that he had telephoned Ms Farmer on three or four occasions, in order to ascertain her opinion of what Mr Stow had said at the April meeting.

He recalled that, in the course of an early conversation, he first asked Ms Farmer for her recollection of what Mr Stow had said at the April meeting, and then stated his own recollection.

The Court of Appeal stressed that the duty of good faith did not amount to a fiduciary duty and did not preclude a party from having regard to its legitimate interests.

In Garry Rogers Motors (Aust) Pty Ltd v Subaru (Aust) Pty Ltd[12] Finkelstein J refused to grant an injunction restraining the termination of the applicant’s Subaru motor vehicle dealership. The terms of its appointment provided for termination in writing, effective upon a specified period after the notice.
[12](1999) ATPR 41-703.

Finkelstein J recognised that:

“Recent cases make it clear that in appropriate contracts, perhaps in all commercial contracts, such a term will ordinarily be implied; (not as an ad hoc term based on the presumed intention of the parties) but as a legal incident of the relationship …
If such a term is implied it will require a contracting party to act in good faith and fairly, not only in relation to the performance of a contractual obligation, but also in the exercise of a power conferred by the contract. There is no reason to think, prima facie at least, that the obligation of good faith and fair dealing would not act as a restriction on a power to terminate a contract, especially if that power is in general terms.
…
In my view, a term of the contract that requires a party to act in good faith and fairly, imposes an obligation upon that party not to act capriciously. It would not operate so as to restrict actions designed to promote the legitimate interests of that party. That is to say, provided the party exercising the power acts reasonably in all the circumstances, the duty to act fairly and in good faith will ordinarily be satisfied.”[13]

[13]At [10-11].

His Honour concluded that there had been no improper exercise of a contractual power, because there was good reason to terminate the dealer, which had refused to adopt an appropriate improvement programme. Further, ample notice had been given, permitting the dealer to organise its affairs.[14]
[14]At [ 11].

It has been recognised that such an implied term would have to be consistent with the express terms of the agreement. In Burger King Corp v Hungry Jack’s Pty Ltd[15] the Court of Appeal accepted that “an implied covenant will only aid and further the explicit terms of the agreement and will never impose an obligation which would be inconsistent with other terms of the contractual relationship.”[16]
[15][2001] NSWCA 187.
[16]At [173].

In Central Exchange Ltd v Anaconda Nickel Ltd[17], the Western Australian Court of Appeal accepted that the principles of good faith could not block the use of terms that actually appear in the contract.
[17](2002) 26 WAR 33.

Both in Central Exchange Ltd v Anaconda NickelLtd and Burger King, the statement of Easterbrook J in Kham & Nate's Shoes[18] was approved. Easterbrook J there stated:

“Firms that have negotiated contracts are entitled to enforce them to the letter, even to the great discomfort of their trading parties without being mulcted for lack of ‘good faith’. Although courts often refer to the obligation of good faith that exists in every contractual relation … this is not an invitation to the court to decide whether one party ought to have exercised privileges expressly reserved in the document … knowledge that literal enforcement means some mismatch between the parties’ expectation and the outcome does not imply a general duty of ‘kindness’ in performance, or judicial oversight into whether a party had ‘good cause’ to act as it did. Parties to a contract are not each other’s fiduciaries, they are not bound to treat customers with the same consideration reserved for their families.”[19]

[18]Kham & Nate's Shoes No 2 Inc v First Bank of Whiting (1990) 908 F 2d 1351.

[19]At 1357.

In Far Horizons Pty Ltd v McDonalds Australia,[20] Byrne J rejected the plaintiffs’ claims that the decision of the defendant franchisor, (McDonalds), to open two new stores in the vicinity of those operated by the plaintiffs’ franchises, (and not to offer the licences for either new store to the plaintiffs), was actuated not by legitimate commercial considerations, but by a desire to punish the plaintiff franchisee and pressure it to leave, or to make an example of it to warn potentially dissident licensees. His Honour observed:

“I do not see myself at liberty to depart from the considerable body of authority in the country which has followed the decision of the New South Wales Court of Appeal in Renard Construction (ME) Pty Ltd v Minister for Public Works. I proceed, therefore, on the basis that there is to be implied in a franchise agreement a term of good faith and fair dealing which obliges each party to exercise the powers conferred upon it by the agreement in good faith or reasonably, and not capriciously or for some extraneous purpose. Such a term is a legal incident of a contract.”[21]

[20][2000] VSC 310

[21]At 30.

He concluded that McDonald’s exercise of its express contractual right to open a competing store which would have an impact on an existing franchisee was not subject to alleged implied restrictions, in circumstances where the franchisee had no exclusive territorial rights and was, from the outset, aware of the possibility of such an action. His Honour stated:

“I leave for another day the case where the impact caused by the new store is such that it effectively destroys the business which the impacted operator had bargained for or where the degree of impact is such as to give rise to the inference that its opening was for a purpose which might give rise to the operation of the implied obligation of good faith and fair dealing.”[22]

[22]At [51].

In Commonwealth Bank of Australia v Spira[23], Gzell J, following Barrett J in Overlook v Foxtel[24], did not consider that the duty of good faith should be limited to particular types of commercial contracts[25]. His Honour also adopted Barrett J’s view that pursuant to the duty “A party is precluded from cynical resort to the black letter but is not fixed with a duty to subordinate self‑interest entirely. The duty is not one to prefer the interests of the other contracting party. Rather it is a duty to recognise and to have due regard to the legitimate interests of both parties in the enjoyment of the fruits of the contract delineated in its terms”.[26]
[23][2002] NSWSC 905.
[24][2002] NSWSC 17.
[25][2002] NSWSC 905 at [143] and see Biscayne Partners Pty Ltd v Valance Corp. Pty Ltd [2003] NSWSC, 874; BC200305873.
[26][2002] NSWSC 905, at [155].

In Commonwealth Bank of Australia v Spira, Gzell J considered that the duty of good faith applied to a facility agreement between a bank and a commercial borrower, but found that the term of good faith had not been breached, in circumstances which included variations to the agreement and the provision of further funding in which the lender “was entitled to consider its legitimate commercial interests even if they were inimical to those of [the borrower]”.[27]
[27]At [161].

In Bamco Villa Pty Ltd v Montedeen Pty Ltd; Delta Car Rentals Aust Pty Ltd v Bamco Villa Pty Ltd,[28] the defendant franchisor owned a system and associated trademarks used in the business of renting cars and trucks. It licensed a number of franchisees to use the system and trademarks. It also carried on business on its own behalf at certain locations and had a number of agencies.
[28][2001] VSC 192

The plaintiff, Bamco Villa, was a corporate franchisee which conducted a franchise business in branches situated at Richmond and Camberwell.

The franchisor sought to rely on a termination notice based on a series of alleged breaches by the franchisee. One alleged breach was the franchisee’s closure of its Camberwell branch without the franchisor’s consent.

Mandie J found that the franchisee’s closure of its Camberwell branch constituted a breach of the franchise agreement, which required the franchisee to maintain the physical facilities in approved locations within the franchisee’s territory. The franchisee’s breach, absent a defence, would justify the termination of the franchise agreement upon service of a termination notice. His Honour accepted, however, that the franchisor’s purported termination was, inter alia, in breach of an implied term that it would exercise its powers under the franchise agreement reasonably, in good faith and not capriciously.

Mandie J agreed with the authorities recognising the implication of a term requiring each party to exercise the powers conferred on it in good faith and reasonably, and not capriciously, or for some extraneous purpose, as a legal incident of such agreements.

He accepted that the conduct of the franchisor or its associated parties was the continuation of a concerted campaign by their controller to force the plaintiff franchisee out of business. In particular, the franchisor parties had permitted the establishment of branches in competition with the plaintiff franchise, and had used economic and financial influence to procure the co-operation of a third party to compete with the plaintiff.

His Honour was satisfied that “it is more probable than not that the franchisor’s conduct materially contributed to [the franchisee’s] financial difficulties which led to the closure of the Camberwell premises. The conduct of the franchisor was in breach of contract. It was intentional. The magnitude of [the franchisee’s] loss upon termination – a franchise which still has, on the evidence, a substantial value – would be great … “.[29]
[29]At [165]

He concluded:

“In all the circumstances to which I have referred, the termination was in my view made in breach of the franchisor’s obligation to exercise the power in good faith and reasonably. The opportunity to terminate arose in significant part from the franchisor’s conduct in breach of contract which was intended both to harm [the franchisee] and to benefit [the franchisor parties]. I note that the franchisor has caused or permitted [the associated parties] to obtain a number of valuable benefits …
In the circumstances, the failure of [the franchisee] to maintain the Camberwell premises was not a breach which the franchisor, acting in good faith and reasonably, ought to have relied upon as a ground for exercising the power to terminate the franchise agreement.”[30]

[30]At [166-167]

Mandie J considered that the controller of the franchisor and associated parties “having materially contributed to the financial state of [the franchisee] which caused the closure of the Camberwell premises, would then have sought to derive benefit from that situation for himself or for the [other] parties. I conclude that [the franchisor’s] termination of the franchise agreement was exercised in breach of the said implied term and was therefore of no effect.”[31]
[31]At [169]

In Esso Australia Resources Pty Ltd v Southern Pacific Petroleum NL(receiver and manager appointed)[32] the plaintiff, Esso, contended that the first defendant (“SPP”) (a party to a joint venture to exploit mineral tenements with Esso and another party,) was not entitled to sell its interest in the joint venture to a third party without Esso’s consent. Under the joint venture agreement, Esso’s consent was not required in the case of a sale by SPP to a related corporation, provided that the related company assumed the assignor’s obligations and the assignor guaranteed the assignee’s performance. SPP was in administration. A draft deed of company arrangement had been approved by the creditors of SPP. The administrators proposed to sell its interest in the joint venture to a public company yet to be incorporated. The price paid would form a fund for the benefit of SPP’s creditors. The defendants contended that Esso’s consent was not required, as the new company would be related to SPP within the meaning of the joint venture agreement, and the draft deed provided for the assignee to assume the assignor’s obligations and for the assignor to give a guarantee.
[32][2004] VSC 477, 23 November 2004.

Esso argued that the proposal would breach an implied term of good faith in the joint venture agreement, because, in essence, the structure of the deal was designed to comply technically with the joint venture agreement, whilst preventing the operation of the consent and preferential right of purchase provisions.

Hollingworth J, observed that:

“Good faith can also be regarded, conceptually, as an obligation to refrain from acting in ‘bad faith’. This ‘excluder’ approach was first articulated by Professor Summers, who identifies ‘bad faith’ conduct as encompassing: evasion of the spirit of the deal, wilful rendering of only substantial performance, abuse of a power to determine compliance, interference, and failure to co-operate in the other party’s performance. The excluder approach has received some Australian judicial support in Renard Constructions and Overlook and was recently acknowledged in England by Lord Scott in Manifest Shipping Co Ltd v Uni-Polaris Shipping Co Ltd.”
‘Unless the assured has acted in bad faith he cannot, in my opinion, be in breach of a duty of good faith, utmost or otherwise.’

By enabling judges to compare the conduct in question with a check list of “bad faith” behaviour, excluder analysis is said to help them form views about whether a breach of good faith has occurred. However, whether it does anything to extend the definition of good faith beyond questions of reasonableness, legitimate interests and extraneous purposes is highly debatable.”[33]

[33]At [133].

Her Honour assumed that a general duty of good faith could be implied into the joint venture agreement, but found that there was no lack of good faith or fair dealing in the first defendant’s acting to promote its own interests consistently with the basis on which it could be taken to have entered the agreement.[34]
[34]At [19].

On appeal, Esso advanced a new argument that SPP was in breach of an implied obligation of good faith because the proposed deed of company arrangement provided that it would be wound up after the payment of class creditors, thus depriving Esso of the benefit of the guarantee and the continued presence of an original participant.

The Court of Appeal rejected that contention. It evinced a reserved approach to the implication of a term of good faith.

Buchanan JA (with whom Warren CJ and Osborn AJA agreed) rejected an argument that the obligation of good faith qualified the SPP’s right of assignment, as:

“It is difficult to discern a want of good faith in the exercise of a power which can serve only the interests of the party on whom the power is conferred. The ostensible purpose of the exercise of such a power will almost invariably be its true purpose … “. In Metropolitan Life Insurance Co v RPR Nabisco Inc, Judge Walker said:
“In other words, the implied covenant will only aid and further the explicit terms of the agreement and will never impose an obligation which would be inconsistent with other terms of the contractual relationship … Viewed another way, the implied covenant of good faith is breached only when one party seeks to prevent the contract’s performance or to withhold its benefits. … As a result, it thus ensures that parties to a contract perform the substantive, bargained for terms of their agreement.”

If a contractual right or power, which is intended to advance only the interests of the party on whom it is conferred, is fettered by an implied obligation of good faith, resort to the duty may become an obstacle to the promotion of that party’s legitimate interests.
I am reluctant to conclude that commercial contracts are a class of contracts carrying an implied term of good faith as a legal incident, so that an obligation of good faith applies indiscriminately to all the rights and powers conferred by a commercial contract. It may, however, be appropriate in a particular case to import such an obligation to protect a vulnerable party from exploitative conduct which subverts the original purpose for which the contract was made … “

Buchanan JA considered that it was unnecessary to determine whether a contractual duty of good faith was implied, as the provision in the proposed deed of arrangement was not “unreasonable, capricious or in pursuit of an ulterior purpose and did not prevent the performance of the contract or deny Esso its benefits”. His Honour observed that the proposed deed advanced SPP’s legitimate interests and it was not required to subordinate its creditors’ interests to the interests of Esso. “The duty of good faith, unlike the duty imposed upon a fiduciary, is not a duty to prefer the interests of the other contracting party, but rather to have due regard to the interests of both parties and the benefits afforded by the contract.”

Warren CJ noted that, despite the clear judicial recognition of the doctrine of good faith:

“The Courts had more often than not decided these matters on other bases and thereby avoided the conceptual difficulty that can attend the concept of a duty of good faith”.

Her Honour also recognised that the “current reticence attending the application and recognition of a duty of good faith probably lies as much with the vagueness and imprecision inherent in defining commercial morality. The modern law of contract has developed on the premise of achieving certainty in commerce. If good faith is not readily capable of definition then that certainty is undermined. It might be that a duty of good faith is no more than a duty to act reasonably in performance and enforcement, a long established duty. Of course, some commentators have regarded the duty to act reasonably as properly subsumed within the duty of good faith.

Ultimately the interests of certainty in contractual activity should be interfered with only when the relationship between the parties is unbalanced and one party is at a substantial disadvantage, or is particularly vulnerable in the prevailing context. Where commercial leviathans are contractually engaged, it is difficult to see that a duty of good faith will arise, leaving aside duties that might arise in a fiduciary relationship”.

APPLICATION

The Court of Appeal in Esso Australia Resources Pty Ltd v Southern Pacific Petroleum NL (receiver and manager appointed) expressed reluctance to endorse the implication of a term of good faith as a legal incident of commercial contracts. It expressed a preference for[35] “ad hoc implication meeting the tests laid down in BP Refinery (Westernport) Pty Ltd v Shire of Hastings[36] rather than “implication as a matter of law creating a legal incident of contracts of a certain type”.[37] Warren CJ doubted whether the good faith obligation was other than a manifestation of the established contractual duty to “act reasonably in performance and enforcement”.[38] The markedly cautious approach to the implication of a term of good faith was based principally on its potential to undermine the certainty and sanctity of a bargain made by equals. The decision, however, recognised that such a term, whatever the basis of its implication and whatever its precise content, may validly operate to protect a vulnerable or disadvantaged party “from exploitative conduct which subverts the original purpose for which the contract was made.”[39]
[35][2004] VSC 477, 23 November 2004 at [25]
[36](1977) 180 CLR 266.
[37]Esso Australia Resources Pty Ltd v Southern Pacific Petroleum NL (receiver and manager appointed) [2004] VSC 477, 23 November 2004, at 5-6.
[38]At 2.
[39]At [4] Warren CJ contemplated that only protection of a ‘particularly vulnerable’ party or a party ‘at a substantial disadvantage’ may justify curial interference.

It was not established that the franchisees, in the present case, were vulnerable or substantially disadvantaged in relation to the franchisor. Relevant authorities indicate, however, that the implication of an obligation of good faith may be particularly appropriate in the context of a franchise relationship, doubtless because it frequently embodies a significant disparity of bargaining power.

On the assumption that the franchisees were, by virtue of the franchise relationship, relevantly vulnerable or disadvantaged, in my opinion an implied obligation of good faith would preclude the franchisor from exercising, or threatening to exercise, its literally unqualified power under the franchise agreement to remove a vital product (such as health insurance) from the franchises in order to secure their premature determination, negate their extended term and expropriate the franchisees’ interests at an undervalue. Such conduct, if established, would be for a purpose extraneous to that for which the power was conferred, and would subvert the original purpose for which the franchisee agreement was made.

Further, if a breach of the obligation of good faith created the opportunity to terminate the plaintiff’s surviving franchise by materially contributing to the satisfaction of the contractual precondition of terminating the plaintiff’s surviving franchise, in my opinion, equity would either preclude reliance on that contractual pre‑condition or would otherwise sanction it as tainted by the breach.

It is, however, unnecessary for me to determine whether a term requiring good faith was implied in the present case and if so, how it would apply, as, on the facts I have found, there was no breach of such an obligation of good faith, on any of its various articulations.

CONCLUSION

I have found that the evidence does not establish that Mr Stow planned to eliminate the franchisees by threatening the future removal of health insurance products, in order to compel them to surrender their franchises at an undervalue, thereby enabling the defendant to provide health insurance products at its wholly owned retail networks instead. I am not persuaded that he entertained or acted upon such a purpose or that he stated that health insurance products would be removed after roll over, or at all. I accept Mr Stow’s account of his evolving commercial aims and plans of action. I am satisfied that he did not tailor his advice to the board in order to disguise an intention to destroy the franchises and thus secure board approval by deception. Further, the evidence does not establish that Mr Stow’s statements at the April meeting caused the surrender of six franchises. Three franchises were surrendered prior to, and unconnected with, the events at the April meeting. There is no evidence to establish why Mr Barker and Mr Archibald altered their arrangement with the defendant. The plaintiff did not surrender its franchise as a result of statements made at the April meeting.

Although three franchisees surrendered their franchises as a result of the April meeting, I do not consider that their action was caused by improper, unfair or unreasonable conduct or a threat of such conduct. Further, I am satisfied that following the April meeting, the defendant did not bully or pressure the three franchisees to surrender their franchises or to accept unfair terms or an unfair price. There is no evidence that the defendant conducted the negotiations with the other surrendering franchisees unreasonably or unfairly. I am satisfied that the defendant kept the franchisees informed, gave them timely notice of its intention to effect change in the future and allowed ample time for the franchisees to negotiate and arrange their affairs.

I am satisfied that, all the other franchisees having surrendered by August 2005, Mr Stow formed the view, on reasonable grounds, that the franchise network was non‑existent or unviable, thus entitling the defendant to serve the termination notice.

I am not persuaded that, although Mr Stow consistently desired the termination of the franchises as a commercial ideal, he engaged in any improper, exploitative or unfair conduct in order to achieve that end. I accept his testimony that his strategy was to facilitate an orderly transition, consistent with the rights of the franchisees and the possible continuation of some franchises after their initial term, on changed conditions.

Under the franchise agreement, on specified conditions, the franchisor could offer the franchisee an extension for a further term or (at the franchisor’s option), an opportunity to enter into the then current Standard Franchise Terms and Conditions, as amended from time to time and offered by the franchisor.

The franchisee was thus not contractually entitled to an extension on the same terms and conditions as applied to the initial term of the franchise. Further, even during the initial term, the franchisor had an absolute discretion to add or remove products, including essential products.

The defendant’s intention to change conditions and direction following roll over of the franchise agreements was, in my opinion, an intended exercise of its contractual powers and entitlements for the legitimate purpose of promoting its commercial interests. I am not persuaded that its conduct was unreasonable, harsh, unfair, dishonest, exploitative or actuated by any ulterior purpose.

Although Mr Wise ably advanced all possible arguments, in my opinion, the plaintiff has not established that the defendant breached any applicable obligation of good faith. The claims of misleading and deceptive conduct and unconscionable conduct pursuant to the Trade Practices Act are likewise not established on the facts.

The defendant was therefore entitled to serve, and may rely upon, its notice of termination dated 18 October 2005. It follows that the plaintiff’s claims should be dismissed.

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[2006] VSC 223

21 June 2006