Raine & Horne Pty Ltd v A & R Real Estate Pty Ltd
[2020] SADC 33
•13 March 2020
District Court of South Australia
(Civil)
RAINE & HORNE PTY LTD v A & R REAL ESTATE PTY LTD & ANOR
[2020] SADC 33
Judgment of His Honour Judge Slattery (ex tempore)
13 March 2020
CONTRACTS
The plaintiff is the master franchisor of the Raine & Horne franchise system. The first defendant executed a first franchise agreement and commenced as a franchisee of the plaintiff in 2012. It executed a further franchise agreement in 2017. Both were in identical terms. The second defendant was the sole shareholder and director of the first defendant and executed separate guarantees of the liabilities of the first defendant to the plaintiff under each franchise agreement.
In 2017 the first defendant commenced to fail to pay to the plaintiff the franchise and other fees payable under the 2017 agreement. The plaintiff delivered monthly accounts and reconciliations to the defendants setting out the indebtedness of the first defendant. Contrary to the terms of the Franchise Agreement, monthly franchise fees were not paid in arrears by the 10th of the next month or after receipt of an invoice calling for payment. The defendant failed to make any payment to the plaintiff after June 2018.
On 20 November 2018 the plaintiff delivered to the defendants notices of demand for payment of outstanding fees within 20 days, failing which the franchise would be terminated for breach and a liquidated damages clause would be relied by the plaintiff. The defendants failed to make the payments demanded.
The plaintiff demands payment by the defendants of all amounts due under the Franchise Agreement including the liquidated damages amount.
Whether the defendants were indebted to the plaintiff under the 2017 franchise agreement;
Whether a proper demand complying with the requirements of the Franchise Agreement was served by the plaintiff;
Whether the liquidated damages clause is unenforceable as a penalty.
Held:
1. The defendants were indebted to the plaintiff under the 2017 franchise agreement in the amount claimed;
2. The demand issued by the plaintiff on the defendants complied with the contractual stipulations in the Franchise Agreement; and
3. The liquidated damages clause is not unenforceable as a penalty.
Judgement accordingly for the plaintiff.
Corporations Act 2001 (Cth) s 127, referred to.
Andrews v Australia and New Zealand Banking Group Ltd (2012) 247 CLR 205; Legione v Hateley (1983) 152 CLR 406; Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd [1915] AC 79; O’Dea v Allstates Leasing System (WA) Pty Ltd (1983) 152 CLR 359; Paciocco v Australia and New Zealand Banking Group Ltd (2016) 258 CLR 525; Ringrow Pty Ltd v BP Australia Pty Ltd (2005) 224 CLR 656, discussed.
Walsh v Deputy Commissioner of Taxation (1984) 156 CLR 337; Cavendish Square Holdings BV v Talal El Makdessi [2016] AC 1172; Codelfa Construction Pty Ltd v State Rail Authority of New South Wales (1982) 149 CLR 337, considered.
RAINE & HORNE PTY LTD v A & R REAL ESTATE PTY LTD & ANOR
[2020] SADC 33
In this action, the plaintiff is the master franchisor of the Raine & Horne Real Estate franchise arrangement. The first defendant was a franchisee under this arrangement pursuant to a written franchise agreement dated 11 September 2017.[1]
[1] Exhibit P1, Tab 1, p.1
This was the second franchise agreement executed between the plaintiff and the first defendant. The date of the first franchise agreement is not in evidence but there is no dispute that it commenced during 2012. Each of these agreements has a five year duration and each of them are in the same terms.
The parties to the each of the five-year franchise agreements were the same; the first defendant was the franchisee and the second defendant bound himself to a guarantee in favour of the plaintiff of the whole of the franchise obligations of the first defendant.
The second franchise agreement at Exhibit P1, tab 1, carries the date of 11 September 2017 and some of the tendered documents suggest that during the 2017 year, the parties agreed upon the execution of a further franchise agreement at the expiration of the first agreement. The evidence suggests that there was not any particular negotiation prior to the execution of the second franchise agreement on 11 September 2017. It appears that the plaintiff informed the defendants of the imminent expiration of the first agreement, tendered to the defendants an agreement for execution and the parties then attended to its execution. There is no evidence of any attempt by the defendants to renegotiate any of the terms of this latter agreement or its associated guarantee. It appears that the state manager of Raine & Horne gave an explanation to the defendants in fulfillment of his obligations and the new agreement was executed. I will hereafter describe the second franchise agreement executed on 11 September 2017 as the franchise agreement.
Each of the franchise agreements were executed by the plaintiff and by the first defendant through an authorised officer pursuant to s 127 of the Corporations Act 2001 (Cth). The second defendant, Mr Swami executed each of the franchise agreements as the guarantor of the obligations of the first defendant; the terms of the guarantee are contained within para.34 of the franchise agreements.
This guarantee is in the usual terms and under it the second defendant stands in the shoes of the first defendant as a debtor of the plaintiff. The second defendant is guarantor in all things of the obligations of the first defendant and agrees to fully indemnify the plaintiff in respect of the debts of the first defendant. Relevantly, sub-para 34.2 of the franchise agreement provides as follows:
34.2 In consideration of the matters mentioned in the Recital, the Guarantors unconditionally and irrevocably guarantee to the Company the Franchisees punctual payment of all monies payable by the Franchisee under this Deed or under any IT Services Agreement signed by the Franchisee or any other obligation whatsoever of the Franchisee to the Company ("the Guaranteed Moneys") and the due and punctual performance and observance of all obligations, governance, duties or conditions contained or implied in this Deed or under any IT Services Agreement or any other obligation whatsoever of the Franchisee to the Company on the part of the Franchisee to perform or observe ("the Guaranteed Obligations").
In his evidence, the second defendant, Mr Swami agreed that each of the defendants admit their obligations both under the terms of the franchise agreement and under the guarantee. I consider that this concession was properly made and it is correct.
As well as executing the franchise agreement and its associated guarantee, the parties also executed an IT Services Agreement. That agreement is to be found at Exhibit P1, tab 2 and is also dated 11 September 2017. It is also executed by the first defendant as the franchisee and it is similarly executed by Mr Swami as the guarantor. It will be called the IT Services Agreement. The defendants do not challenge their execution of or their liabilities under the IT Services Agreement. The obligations under that agreement do not form any part of the plaintiff’s claim in this action.
The franchise agreement sets out the parties' obligations to each other under its terms. Those obligations are to be found within para.2 under which the plaintiff grants to the franchisee the franchise for the term. The term of five years is described in para.3 and the scope of the business the subject of the franchise is set out in para.4.
Under the franchise agreement, the first defendant as the franchisee acquires the right to perform under the business name all functions and services of the business except for making valuations of property. Under clause 4.3, the franchisee must carry on the franchise business at and from premises described in the schedule in accordance with the terms of clause 2.4 of the franchise agreement and it must observe the provision of the manuals provided by the plaintiff. Clause 2.4 of the franchise agreement stipulates that the franchisee may only sell, dispose of, lease and manage property situate within the state or territory specified in item 5 of the schedule. This schedule is attached to the agreement. It includes a number of terms and stipulations that are relevant to this decision. There is no dispute before the court about the definition of or the limits of this territory.
Under clause 5 of the franchise agreement, the franchisor may from time to time expand and develop new products and services to include the sale of or recommendation of associated products and services by businesses that use or operate the Raine & Horne brand. The franchisor may provide guidance and issue directions relating to how those products and services are to operate. The franchisee must then comply with all of the directions of the franchisor whether in relation to the corporate manual or about recommendations made by the franchisor.
Under clause 7 of the franchise agreement, where the franchisee refers buyers or sellers, lessors or lessees to another real estate agency, then the franchisee must, in first instance, refer them to a Raine & Horne franchise. These are terms which are usual and typical and are to be seen within most franchise agreements; they are not out of the ordinary. Their operation did not form any part of the factual or legal issues for determination in this matter.
The manuals referred to earlier are described in para.10 of the agreement. The franchisor is to provide the manuals to the franchisee, who must comply with the policies, procedures and standards set out within the manuals. The manuals may be replaced or amended from time to time and they must be treated as confidential. The content of any of these manuals does not form any part of the dispute before the court.
Under clause 11 of the franchise agreement, the franchisee must disclose to the general public that it is the principal of the franchise business, and describe itself in the way prescribed under clause 11.1.
Under clause 13 of the franchise agreement, the first defendant as franchisee must immediately commence operation of the franchise business at the premises, and continuously operate that franchise business from those premises, as well as establishing and maintaining and increasing, to the maximum extent reasonably possible, the commission income derived from the operation of the franchise business.
Under clause 15 of the franchise agreement, the franchisee authorises and allows the franchisor to receive and access electronically on a daily basis information from any IT system provided by the franchisor and used by the franchisee to operate the franchise business, whether specified or otherwise. Within five days of the last day of each month, the franchisee must report to the company in the form and in the manner prescribed in paragraph 15.2 of the franchise agreement.
Clause 16 of the franchise agreement sets out the prescription of the fees payable by the franchisee to the franchisor. As I will be making a number of references to this clause, it is appropriate that I set it out hereunder. It provides as follows:
16. FEES
16.1The Franchisee must provide to the Company full details of its Nominated Bank Account prior to the Commencement Date, and within (7) days of the change of its Nominated Bank Account.
16.2The Franchisee must pay the Franchise Fees to the Company calculated in respect of the previous month:
(a) from the date stated in item 8 of the Schedule, by the 10th day of each month; and
(b) without set off or deduction.
16.3Franchise Fees are not payable on Agency Fees on contracts which settle before the date stated in Item 8 of the Schedule.
16.4The Franchisee must pay the Franchise Property Management Fees to the Company calculated in respect of the previous month:
(a) from the date stated in Item 9 of the Schedule by the 10th day of each month; and
(b) without set off or deduction.
16.5The Franchisee must pay the Marketing Fund Contribution to the Company calculated in respect of the previous month:
(a) from the date stated in Item 10 of the Schedule, by the 10th day of each month; and
(b) without set off or deduction.
16.6All fees payable by the Franchisee to the Company must be paid in Australian dollars by direct debit from the Nominated Bank Account to the Company’s account or in such other manner as the Company may direct from time to time. The franchisee must provide the Company with a direct debit authority on or before the date of this Deed.
16.7The Franchisee irrevocably authorises the Company to automatically deduct the Invoiced Fees from the Nominated Bank Account on the 10th day of each month.
16.8When the Company has calculated the respective amounts of the Franchise Fees, Franchise Property Management Fees and Marketing Fund Contributions for that month, to be greater than the Invoiced Fees as paid for that month, then the Company is authorised to further debit the balance of the calculated amount owing within seven days of the Company making the calculation and notifying the calculation to the Franchisee, and to the extent that the Invoiced Fees are greater than the respective amounts calculated such differential amounts will be credited to the Franchisee for the next month.
16.9If the Franchisee is in dispute over a claim for Fees, the Franchisee may abandon or compromise such claim and will only be accountable to the Company for the specified percentage of the net amount actually received by it in respect of such claim after deducting any reasonable legal fees and costs incurred in recovering same not otherwise recovered from an unsuccessful third party.
16.10The Franchisee must pay any transaction cost for the direct debit transactions referred to in this clause 16, including any merchant service fees that the Company may incur, and the Franchisee authorises the Company to direct debit the Nominated Bank Account for the amount of such costs and fees.
16.11The Franchisee will pay interest at the rate of 3% above the then current Reference Rate as published by the Australia & New Zealand Banking Group Limited in its Indicator Rates table on any money due to the Company which the Franchisee fails to pay by the due date. Interest will be calculated from the due date to the date of payment and be payable on any amount by which any Franchise Fees, Franchise Property Management Fees or Marketing Fund Contributions are unpaid. If the Australia & New Zealand Banking Group Limited ceases to publish its Indicator Rates, the Company may, in its discretion, use similar indicator rate published by another Australian Bank.
16.12The Company may review annually the Marketing Fund Contribution minimum amount payable by the Franchisee to the Company under this Deed. The Marketing Fund Contribution minimum amount may be increased by the CPI Increase amount and the Company will provide a minimum of 3 months notice of such increase.
Under this clause, the franchisee must provide to the franchisor full details of its nominated bank account and must pay fees calculated in respect of the previous month's trading, which is called the prescribed amount, as the franchise fees. The franchisee must also pay to the franchisor the franchise property management fees calculated in respect of the previous month, and must pay the marketing fund contribution calculated in respect of the activities of the previous month.
The dates for the payment of the franchise fees, the franchise property management fees and the marketing fund contributions are all in similar terms. The fees required to be paid are based upon the activities of the franchisee for the previous month and so are calculated in arrears. They are all to be paid from the date stated in item 8 of the schedule which is defined as the commencement date which in this case is 19 September 2017.[2] This is the date from which the liability arises and the payment is to be made by the 10th day of each successive month (in respect of the previous month’s trading).[3] This is a contractual liability that arises without the requirement of a formal demand being made by the franchisor upon the franchisee. In that background, it is apparent that the franchisee is called upon to pay those fees within the terms of that contractual arrangement. So much is apparent from the terms of the subsequent sub-paragraphs of clause 16 which specify the arrangements to be made for payment by direct debit. This is consistent with the absolute liability of the franchisee to make the payments called for under clause 16 as calculated as calculated under items 8, 9 and 10 of the schedule. Those items read as follows:
[2] Exhibit P1, tab 1, p 46.
[3] Exhibit P1, tab 1, p 20.
ITEM 8: Franchise Fees:
The greatest of:
6% for the first $614,400 of annual Agency Fees (adjusted annually for CPI Increase)
5% for the next $512,000 of annual Agency Fees (adjusted annually for CP Increase)
4% of the remaining annual Agency Fees (adjusted annually for CP Increase)
OR
$18,000 plus GST minimum per annum (adjusted annually for CPI Increase)
Payable from: Commencement Date
Minimum amount payable: $1,500 (plus GST) per month (but payable on a cumulative year to date basis)
ITEM 9: Franchise Property Management Fees:
1% of Residential Leasing Fees and Property Management Fees
Payable from: Commencement Date
ITEM 10: Marketing Fund Contribution:
1% of annual Agency Fees but not less than
$4,500 (plus GST) per annum, payable monthly (adjusted annually for CPI Increase)
Payable from: Commencement Date
Minimum amount payable: $375 (plus GST) per month (but payable on a cumulative year to date basis)
Under clause 16 of the franchise agreement, an irrevocable authority is to be given by the franchisee on its bank account in favour of the franchisor. The franchise fees, the property management fees and the marketing fund contributions may be deducted under this authority (viz sub-clauses 16.6 and 16.7 of the franchise agreement).
In the case at bar, the plaintiff claims the payment of interest pursuant to this sub-clause. In support of this claim, the plaintiff has tendered into evidence Exhibits P4 and P5 as proof of the reference rate as published by the Australia and New Zealand Banking Group Limited in its indicator rates table for the appropriate periods, the subject of this action. Those exhibits also disclose unchallenged evidence of the appropriate calculations of interest derived from the application of these rates. In connection with all of these obligations, under clause 17 of the franchise agreement, the franchisee is required to maintain business books of account which may be inspected or audited from time to time.
Under clause 22 of the franchise agreement there is a requirement upon the franchisee that in order to maintain uniform standards of service and to protect the good will attaching to the names "Raine & Horne Pty Limited Pty Ltd", or "Raine & Horne", the franchisee must conduct the franchise business in accordance with the company standards and the requirements of service and ethics, and in strict conformity with those requirements. Clause 22 therefore constitutes a form of a code under which the business of the franchisee is to be operated including through its employees.
Under clause 25 of the franchise agreement there is a recognition that the plaintiff has established a marketing fund and it must deposit that fund into a separate account into which is also to be paid all marketing fund contributions as received from the franchisees. The plaintiff must then use that marketing fund to pay the costs of developing and publishing advertising for the benefit of all franchisees, for conducting advertising promotions which include promotions of the Raine & Horne trademark, payment of advertising agency fees and administering and auditing the marketing fund.
The franchise agreement also contains agreed terms about the termination of the franchise deed. They are contained within clause 31 which provides as follows:
31. TERMINATION OF DEED
31.1 The Company may terminate this Deed with immediate effect by written notice to the Franchisee if the Franchisee:
(a)no longer holds a licence that the Franchisee is required to hold to carry on the Franchised Business;
(b)becomes bankrupt, insolvent under administration or an externally administered body corporate;
(c)is a corporation and becomes deregistered by ASIC;
(d)voluntarily abandons the Franchised Business or the franchise relationship;
(e)or any of the Guarantors, is convicted of a serious offence, being an offence under any law of the Commonwealth or state or territory for which, if the act or omission had taken place in the Jervis Bay Territory, a Person would be liable on a first conviction to imprisonment for a period of not less than 5 years or a contravention of any provision of the Corporations Act 2001;
(f)operates the Franchised Business in a way that endangers public health or safety;
(g)is fraudulent in connection with the operation of the Franchised Business.
31.2If any of the events of default listed in clause 31.3 occur, the Company may terminate this Deed if the Company first gives to the Franchisee a written notice which:
(a)specifies the event of default;
(b)tells the Franchisee what the Company requires the Franchisee to do to remedy the event of default;
(c)gives the Franchisee a reasonable time to remedy the event of default which need not be more than 30 days and may be as short as 3 business days depending on the event of default; and
(d)which tells the Franchisee that the Company proposes to terminate this Deed if the event of default is not remedied within that time.
31.3The events of default will include any of the following:
(a)the Franchisee breaches any provision of this Deed;
(b)the Franchisee breaches or fails to comply with the Manual;
(c)there are fees payable under this Deed by the Franchisee to the company including the Franchise Fees, Franchise Property Management Fees and Marketing Fund Contributions which are in arrears and the Franchisee fails to pay them within fourteen (14) days of the Company calling upon the Franchisee to pay those fees;
(d)the Franchisee loses possession or the rights to occupy the approved Premises;
(e)the Franchisee, or a company, or any employee of the company, has engaged in any conduct or practice that in the opinion of the Company is detrimental or harmful to the good name, goodwill reputation or interests of the Company and the Franchisee will have failed to cease and desist from such conduct or practice or will have failed, in the case of an employee to bring such conduct or practice to an end after a period of 7 days from the date of written notice from the Company;
(f)there is any Transfer or relinquishment voluntarily or involuntarily by operation of law or otherwise of any interest in the direct or indirect ownership or any change in the operating management of the Franchised Business other than with the written consent of the Company;
(g)the Franchisee being a company, there is:
(A) a retirement or change in any of the directors without the prior written consent of the Company;
(B) an, issue or Transfer (whether registered or not) of any shares or a rearrangement of control or management of the Franchisee without the prior written consent of the Company;
(C) any dispute, disagreement or controversy among the Persons in control of the Franchisee which in the reasonable opinion of the Company detrimentally affects the interests of the Company.
(h)there is an Insolvency Event in relation to any director, partner, or Guarantor of the Franchisee;
(i)if the Franchisee consists of two or more Persons in partnership and that partnership dissolves or there is any dispute, disagreement or controversy among the Persons in the partnership which in the reasonable opinion of the Company adversely affects the proper carrying on of the Franchised Business;
(j)the Franchisee (in the case of a natural person), the Principal or a Guarantor dies or is partially or totally incapacitated which in the reasonable opinion of the Company adversely affects the proper carrying on of the Franchised Business;
(k)the Franchisee submits on 2 or more occasions at any time during the Term a report, financial statement or other information or supporting record which understates Fees or Agency Fees, unless the Franchisee substantiates that such understatement resulted from inadvertent error;
(l)the Franchisee fails or refuses to submit any report required in accordance with clause 15.2 or any other report, financial statement or other information or supporting records required herein, or submits such reports more than one week late on more than 2 occasions during any 12 month period;
(m)the Franchisee infringes the Intellectual Property in relation to this Deed or any of the services provided under an IT Service Agreement;
(n)the Franchisee violates any law, ordinance, rule or regulation of any governmental authority in connection with the operation of the Franchised Business or involving moral turpitude, and does not correct the violation promptly after notification thereof from any source, unless there is a bona fide dispute as to the violation or status of such law, rule or regulation and the Franchisee promptly resorts to courts or forums of appropriate jurisdiction to contest such violation or status; the Franchisee receives from the Company more than 2 notices of default hereunder during any 12 consecutive months (whether or not such defaults are subsequently remedied);
(o)the Franchisee does not achieve the Minimum Income specified in item 12 of the Schedule; or
(p)the Franchisee breaches any provision of the IT Services Agreement.
31.4Without limiting any other rights of the Company under this clause 31,
(a)if the Franchisee, the principal shareholder of the Franchisee or the Person who has customarily controlled and been in charge of the Franchised Business dies or becomes mentally ill or physically handicapped to the extent where, in the reasonable opinion of the Company, he or she will be unable to properly carry on and control the Franchised Business, the Company may:
(A) consent to the Personal representative or nominee or dependant of such Person carrying on the Franchised Business until such Person so nominated can take a Transfer or Novation of this Deed; or
(B) If in the reasonable opinion of the Company, there is no Person qualified to properly carry on and control the Franchised Business, provide at the expense of the Franchisee the services of an appropriate Person skilled in the management and/or carrying on of a business similar to the Franchised Business during a limited period which will not exceed 12 weeks; and
(b)the Franchisee will pay to the Company forthwith upon demand all reasonable expenses incurred by the Company under this clause.
Under clause 31.2, if any of the events of default listed in clause 31.3 occur, then the franchisor may terminate the deed if the franchisor first gives to the franchisee written notice which specifies the event of default, tells the franchisee what the company requires the franchisee to do to remedy the default, gives the franchisee reasonable time to remedy the default and tells the franchisee that the franchisor proposes to terminate the deed if the event of default is not remedied within that time.
The events of default are defined within clause 31.3 of the franchise agreement. Relevantly, clause 31.3(c) records that the events of default include circumstances where there are fees payable under the deed by the franchisee to the franchisor, whether they be franchise fees, franchise property management fees, or marketing fund contributions which are in arrears, and the franchisee fails to pay them within 14 days of the company calling upon the franchisee to pay those fees.
Clause 32 of the franchise agreement sets out the powers within the franchisor consequential upon termination. Under clause 32.3, if the franchisee repudiates this deed, or the deed is terminated by the franchisor due to breach by the franchisee, then the franchisee acknowledges that the franchisor will suffer loss and damage which will be, at a minimum, the amount payable of the franchise fees under item 8 of the schedule, and the minimum amount payable of the marketing fund contributions under item 10 of the schedule, for the unexpired period of the term.
There are a number of matters concerning the operation of clause 31 that require discussion. Clause 31.2 has operation if an event of default for clause 31.3 occurs. It is to be expected that clause 31.3 would constitute some form of code for the identification of a default which justifies a termination. I have earlier set out the content of clause 31.3. The integers of the event of default under clause 31.3(c) are:
1There are fees payable under the deed by the franchisee to the franchisor;
2The fees are in arrears; and
3The franchisee fails to pay them within 14 days of the company calling upon the franchisee to pay those fees.
The concept of fees being in arrears appears to contemplate that the fees have not been paid on time under the requirements of clause 16 of the deed. Under clause 31.3 of the franchise agreement, there is no time period of default specified and so the expression is to be understood under its ordinary meaning. A payment which is overdue for one day, for a week or a month is in arrears. Fees which are payable under the deed by the franchisee to the franchisor will be in arrears because they have not been paid on the 10th day of the following month under the operation of sub-clauses 16.2, 16.4 and 16.5. Therefore, the expression that fees are in arrears, adds little to the first concept of fees being payable under the deed by the franchisee.
The franchisee is called upon to make payment of the franchise fee by the 10th day of the following month under the operation of those sub-clauses of the franchise agreement. The call having been made by the plaintiff, an event of default for clause 31.3(a) of the franchise agreement will occur at the end of the 24th day of each month because that will be 14 days after the 10th day of the month which is the date upon which the franchisee is called to pay the franchise fees.
In the usual course, a default under a contract will require something more to be done by a franchisor to bring to the attention of the franchisee the serious consequences of the failure by the franchisee to make payment of any of the various fees. As an example only, a franchisor may be required to formally call upon a franchisee to pay the fees. Although a written form of demand is not specified within the franchise agreement, to ensure that the franchisee understands the position, usually such a "call" would be in writing, especially for the for the sake of the parties’ certainty. If the demand remains unpaid for 14 days then, there would be an event of default.
An event of default would lead automatically to a right to terminate by the taking of some similar step such as the giving of notice of termination which brings the contract to an end.
I have earlier set out the content of clause 31.2. Within the drafting of that clause, there is a discretion reposed in the franchisor to terminate the franchise business upon the happening of certain events. The termination of the deed by the franchisor may only occur if the franchisor gives to the franchisee the written notice of termination and clause 31.2(c) anticipates that a further period of time to remedy the default is given which may be between 30 days and 3 days, depending upon the circumstances. This is because of the use of the expression "calling upon the franchisee to pay" (these fees) to be found within clause 31.3(c).
The evidence before the court discloses that from no later than July 2018, the franchisor had demanded that the franchisee pay all outstanding franchise fees in the amount of $1,650 per month but these were all unpaid.[4] This was only one of the payment obligations falling upon the franchisee at that time. There was no dispute on the evidence that there had been a call for these payments by the delivery of monthly invoices and that this call had not been met by payment. The evidence before the court is that these amounts remained unpaid for a period of a further 14 days because none were paid at all.
[4] Exhibit P1, tabs 5, 6, 7, 8, 9, 10, 11, 12, 13, 14, 15 and 16.
Then, by the letter of 20 November, the franchisor demanded that the franchisee pay the total of the amounts called for payment in the sum of $12,375. A period of 21 days was allowed for payment in compliance with the requirements of clause 31.2(c). That letter warned the franchisee that the franchise agreement would be terminated if payment was not made.[5]
[5] Exhibit P1, tab 3, p 95 et seq.
By letter of 12 December 2018, the franchisor terminated the franchise agreement.[6] In this letter, the plaintiff correctly refers to the letter of 20 November and the obligation of the plaintiff to comply with the requirements of clause 31.3(c) as a breach notice. The failure to pay the fees under clause 16 is a breach of the deed (viz clause 31.3(a)). The fees payable under each of the invoices identified in the invoice schedule accompanying the letter were unpaid as at the 10th of the month (in breach of clause 16) and for not less than fourteen days after they fell due and were therefore in arrears. The call for payment by the franchise was the monthly invoices to which that call and those obligations related. The clause does not contemplate the need for a further form of demand. If it were otherwise, the franchisee would not have had a right to terminate because the letter of 20 November 2018 could only have been referable to the requirements of clause 31.3(c) and so a further period of time after 11 December 2018 would have been required for clause 31.2(c) to operate.
[6] Exhibit P1, tab 4, p 99 et seq.
However, the drafter has deliberately not used a separate demand form of phraseology when drafting clause 31.3(c) and has only used the expression “calling (for payment)…of fees”. This reflects the operation of clause 16 and the immediate liability to pay the invoiced amounts by the 10th day of the following month. Under the operation of clauses 16 and 31.3(c) the further 14 day period after the call for payment expires on the 24th day of that following month. It was therefore possible to terminate the agreement in respect of any of the months from July onwards but only after the expiration of the 24th day and the compliance with clause 31.2(c). This is what has occurred. Therefore, I am of the opinion that the concession of indebtedness made by the defendant is correct.
There was some dispute before me about the level of indebtedness but there was no dispute that there was an indebtedness for clause 31.2 and clause 31.3. There was also no dispute that the franchise agreement operated such that the franchisee was contractually indebted to the franchisor from no later than the 10th day of the month following the relevant month of trading, that the franchisor had called upon the franchisee to make the payment both under the terms of the franchise agreement itself under its contractual obligations and under monthly invoices sent by the franchisor to the franchisee. It was also not in dispute, as was the fact, that in respect of some or all of those calls for payment, the franchisee did not make payment to the franchisor. Similarly, there is no dispute about the evidence that for clause 31.2(c), the franchisor gave to the franchisee a further 21 days to make the payments of outstanding amounts but the franchisee failed or refused to make those payments. In those circumstances, there was a right within the franchisor to terminate the deed. In this action, there was no dispute about the right of the franchisee to make a decision to terminate. The only challenge was to the amount of the indebtedness. I will deal with that issue later in this judgment.
The position of the plaintiff, under its claim, is that the first defendant fell into default; and historically, it appears that the first defendant was in default in the payment of the franchise fees, franchise property management fees, and marketing fund contributions, almost from the outset of the commencement of this franchise agreement although it is not necessary for me to make any determination of what the position was under the first franchise agreement.
I am satisfied on the evidence that the plaintiff franchisor was aware, from no later than October 2017, of this default of the first defendant, and that for a period of some 13 to 14 months attempted to assist the first defendant in bringing its payments up to date. These efforts failed. It is also apparent that the franchisee was always aware of its indebtedness to the franchisor and that it did not remedy the position in satisfaction of its contractual responsibilities. That was the deliberate choice of the defendants.
I am satisfied that, in accordance with the terms of the franchise deed, the plaintiff franchisor ensured that the franchisee understood its obligations; as a result, the second defendant as guarantor understood the obligations of the franchisee. This also follows from the fact that the franchisee is a corporation, the sole director and shareholder of which is the second defendant.
The evidence given by Mr Trimble on behalf of the plaintiff satisfies me and I accept that there were ongoing costs incurred by the plaintiff in providing services to all franchisees throughout Australia and this included the defendant. These included IT services, promotional services, provision of permanent state based staff, marketing services, any and all supports required including in relation to basic accounting and the services of a state manager. I am satisfied from the evidence that each of the franchisees received an ongoing benefit from the franchisor within the franchise system and its operation. These resources were made available to each franchisee throughout the period of the franchise agreement. They were aimed at the success of the business of the franchisee and no doubt had an aspect of mutual benefit. Importantly they are embedded costs that must first be paid by the franchisor and these may be recouped from the franchisee through the various fees paid by them. Importantly they were costs that were incurred and to be incurred at the time of and after the commencement of the franchise agreement here. Historically the cost of the operation of the franchise could be assessed by the franchisor from its experience. So also could the franchisor assess the rate at which and the period over which some or all of these costs may be recouped. The evidence discloses that some resources were state or regional specific (such as three full time staff in South Australia, including a manager) and others were directed Australia wide such as marketing and IT support.
I am further satisfied from the evidence that despite the encouragement of Mr Trimble and others, the defendants did not avail themselves of the services of the franchisor in and about the operation of the franchise. This failure has no connection with the failure of the defendants to make the payments that they were required to make under the franchise agreement. Both of these circumstances are connected to separate and distinct decisions made by the defendants without recourse to the plaintiff.
The evidence before the court discloses that the first defendant was continuously followed up by the plaintiff's staff by email, by letter and by any other means available including the telephone to ensure the compliance by the defendants with the requirement of the franchise agreement.
The staff of the plaintiff gave other assistance to the defendants in a number of forms. This was over and above the other assistance offered under the franchise agreement. For example, they sent schedules and other documents to the defendants in a series of attempts to get the first defendant to comply with its obligations under the franchise agreement. I am satisfied that the intention of the staff of the plaintiff, inter alia, was to obviate the necessity for a default and to maintain the defendant as a franchisee. This would be to the benefit of all of the parties. It is of no benefit to the plaintiff or, for that matter, the defendants that a franchise not be successful. It is of clear benefit to the plaintiff and so also the defendants that this franchise operate successfully and profitably.
I am satisfied that all of the assistance given by the franchisor was directed to the successful operation of the franchise by the first defendant for the benefit of the defendants and, of course, for the plaintiff. I am also satisfied on the evidence that Mr Trimble, as the senior authorised person of the plaintiff in South Australia, did everything in his power as the new State Manager, to bring the franchise to success.
As I have said earlier, the evidence discloses that from October 2017 the first defendant was in breach of its obligations to make payments under the franchise agreement. As a result, the first defendant was in arrears in relation to those obligations under the franchise agreement from no later than October 2017 (and perhaps earlier) and that the last substantive payments on those obligations were made in June 2018. Those payments were made in respect of earlier liabilities such that the payments received by the plaintiff as franchisor were applied to earlier indebtedness. This also means that the first defendant was at least six months late in making payments to the plaintiff in respect of the fees payable under the terms of the franchise agreement.
I am also satisfied that at the same time, Mr Trimble made visits to the franchise office of the first defendant and made suggestions to the first defendant about using and taking advantage of the various tools that might be available to it in an attempt to improve the outcomes of its business. Other suggestions were made such as participation in training courses and taking advantage of the provision of online materials. The evidence of Mr Trimble was that the first defendant did not take advantage of these suggestions and these tools.
I am also satisfied on the evidence given by Mr Trimble that the use of those tools is consistent with the successful operation of franchises. These included customer relationship management databases, targeted advertising campaigns and the other similar services which have been successfully employed in other franchise arrangements of the plaintiff.
Mr Trimble became aware of the lack of application by the defendants and their staff to their tasks as real estate agents as a result of at least two matters. The first, his observations of the operations of the first defendant when he attended the premises of the first defendant; second, as a result of the complaints that he received about the operation of the first defendant as a Raine & Horne franchisee.
Mr Trimble reacted to the external complaints he received by attending at the premises and encouraging the defendants to take advantage of the services offered by the plaintiff franchisor for its own advantage; he also gave guidance to the defendants about the successful use of these resources by other successful franchisees. The evidence satisfies me that those efforts came to nothing principally because the defendants failed or refused to take advantage of the availability of those resources under the franchise agreement.
The defendants informed me that the franchise had already been operated for five years before they entered the second agreement. They were well aware of the whole of their responsibilities under the current franchise agreement due to their familiarity with the operations of the earlier agreement. Similarly, they were aware of the assistance they could obtain from the franchisor under the same arrangements.
There was no dispute on the evidence and it was not put in issue that the plaintiff gave a formal explanation to the defendants about the obligations under the franchise agreement, the operation of the franchise agreement and the resources available to the defendants under it at the time that the franchise agreement was executed in 2017. The same position pertained in relation to the 2012 agreement.
Having operated the franchise arrangements for at least five years prior to entering into the 2017 agreement, the defendants had a clear understanding of the terms of that agreement, the business in which the franchise operated, including its market and the risks and rewards involved in operating as a franchise. Mr Swami agreed that he executed the franchise agreement in both capacities, understanding the obligations upon the first defendant as franchisee as well as his own personal obligations of guarantor and that, ultimately, responsibility would fall upon his shoulders if there was a failure to make payments under the franchise agreement by the first defendant.
Mr Swami also accepted in his evidence that he was ultimately responsible for providing information to the office of the franchisor when required, and this included in relation to settlements generated within the office of the franchisee or any property management fees that might have been received. He accepted that this information was not so provided and that he was aware of the failure of the first defendant to fully pay the fees required under clause 16 of the agreement.
In his evidence, Mr Swami said that he did not think that it was serious when he received the requests from the franchisor over a period of months seeking the provision of information in relation to the calculation of the franchise fees payable by the first defendant. I am satisfied on the evidence that over a period of a number of months, he ignored the requests being made of him by the franchisor to bring matters into order. He agreed that he failed to pay upon the monthly invoices received from the defendant calling for the payment of franchise fees by the 10th of the month of issue.[7]
[7] Exhibit P1, tabs 5, 6, 7, 8, 9, 10, 11, 12, 13, 14, 15, 16, 17; pp 105-116.
He also said at the same time, there were staff within his office, including at least up until early September 2018, his wife, who had all of the information being requested by the plaintiff “at their fingertips”. No explanation was given about why those staff were not directed to make any response to the plaintiff and to provide that information or to make the necessary payments.
He said in evidence that for the months between April and June 2018, there was nothing to report because, as he said, there were no settlements. Rather than make a statement to the franchisor to that effect, he ignored the requests that were being made. This was in circumstances where he understood the ongoing obligations upon the first defendant franchisee to continue to make the payments as they were prescribed under the franchise agreement. He seems to have not taken any steps to ameliorate his position.
However, the evidence discloses that the first defendant did not pay the fees under the franchise agreement, it was possible for that company to obtain credit in the amount of $17,300 to be paid into a general account on 21 November 2018 for payment of other outstanding accounts. The evidence also discloses that shortly afterwards, he went on holidays to Thailand for which he paid airfares and for which he had available to him spending money of some $4,000.
I find that the events of default for clause 31.3 of the franchise agreement was the failure of the defendants to pay the amounts due under clause 16 of that agreement by the 10th of the month as demanded and then within 14 days of that date having been called upon to make payment.
I take as an example the plaintiff’s tax invoice dated 6 August 2018,[8] no. FF15458. It seeks payment of franchise fees for July 2018 in the amount of $1,650 including GST. The due date is 10 August 2018. I am satisfied that it remained unpaid thereafter. This was the method by which the defendants were called upon to pay the fees.
[8] Exhibit P1, tab 6, p 106.
I am also satisfied and I find that there were arrears in the payment of the fees, due under clause 16 of the franchise agreement that were continually carried forward by the plaintiff and payments were made by the defendants from time to time. The payments made to the plaintiff were applied to the earliest outstanding invoiced amount. On 20 November 2018, a reconciliation of outstanding amounts due by the defendant was prepared and delivered by the plaintiff. This disclosed that the outstanding amounts due dated back to the invoice of 7 June 2018, document number FF15078 (for franchise fees). This document shows the compounding nature of the growing indebtedness. It emphasises that when read with other invoice documents that there were continuing breaches of obligation by the defendants over this time period.
By letter of 20 November 2018[9] sent to each of the defendants, the plaintiff informed the defendants that on the records held by the plaintiff, the first defendant was indebted to the plaintiff as franchisor in an amount of $12,375, accrued due to the failure by the first defendant to pay franchise fees, marketing fund contributions and other forms of franchise fees to the franchisor in accordance with the obligations imposed under clause 16 of the franchise agreement.
[9] Exhibit P1, tab 3, p 95 et seq.
The letter states that this failure to pay these outstanding debts is despite repeated correspondence and contact from the franchisor concerning the debt over a prolonged period of time. The evidence before me discloses that the franchisor made every effort to contact Mr Swami and to ensure that the relevant information was provided. For reasons which are unclear, Mr Swami did not provide that information.
The letter goes on to assert that the first defendant is in breach of the franchise deed for failure to pay franchise fees, franchise rental fees and marketing fund contributions. The letter sets out clause 16 of the agreement, which is the provision which stipulates the requirement to pay the relevant fees. None of that was in any sense an apparition for Mr Swami because he was well familiar with the operation of clause 16 and the defendants’ obligations.
Mr Swami and the first defendant are informed that in order to rectify the breach, then by 5 p.m. on Tuesday, 11 December 2018, they were required to pay all moneys outstanding, as per the statement attached or enclosed, and to provide a written guarantee that the franchise will ensure that all future debts are honoured.[10]
[10] Exhibit P1, tab 3, p 97.
The letter then stipulates:
A failure to rectify the breach in the manner set out above will result in the franchise deed being terminated pursuant to clause 31 of the franchise agreement.
The letter is the notice pursuant to clause 31.2(c) of the franchise agreement. It provides 21 days for the breach to be rectified. It gives notice that a failure to rectify will result in the deed being terminated. The deed may only be terminated under clause 31.2.
Under clause 31.2(d), if any of the defaults listed in clause 31.3 occur, the company may terminate the deed if the company first gives the franchisee a written notice which:
(d) Tells the franchisee the company proposes to terminate the deed if the event of default is not remedied within that time.
This is to occur after the franchisee is given a reasonable time to remedy the default, which can be as short as three business days and as long as 30 business days, and the notice tells the franchisee what the company requires the franchisee to do to remedy the event of default.
I am satisfied on the evidence that the defendants did not respond to this letter. The plaintiff then communicated with the defendants by letter of 12 December 2020.[11] The letter announced that the demand in the breach letter of 20 November 2018 for payment of the outstanding $12,375, had not been met. There was considerable debate before me about the calculation of the amount of $12,375. I have received into evidence Exhibits P2 and P3 and the viva voce evidence of Mr Trimble. This evidence satisfies me of the amounts properly chargeable by the plaintiff to the defendants under the franchise agreement. Those invoices are set out in Exhibit P2. I am satisfied that Exhibits P2 and P3 record all of the payments made by the defendants on the accounts properly chargeable to the first defendant. Those payments are reflected in the plaintiff's records up to the payments made on 21 November 2018 for the franchise fees and the monthly marketing fees. There was a small credit of some $312.50 applied to the invoice for June 2018. There is also evidence of payments for a technology fee, none of which forms part of this claim; they are to be found in Exhibit P3.
[11] Exhibit P1, tab 4, p 99 et seq.
I am therefore satisfied that the formulation of the plaintiff's claim in this respect is correct. There is no evidence of any substance from the defendants that leads me in any way to doubt the method of calculation of the plaintiff's claim of $12,062.50. I am therefore unable to accept the defendant's evidence on that point.
The letter of 12 December 2018 first identified the breach letter of 20 November 2018 and then identified that to rectify the breach it was necessary to make payment of the outstanding amount and that amount was not received. It then announced that the franchise deed is terminated with immediate effect and sets out the contents of clauses 32 and 33 and then the consequences of the termination. The final page of the letter identifies that the current amount owing in respect of outstanding franchise fees, rental franchise fees and marketing fund contributions is $12,062.50 and that under the franchise agreement and upon termination, the first defendant became liable for the franchise fees and marketing fund contributions for the unexpired term of the agreement. That sum was $94,875. The total payable was $106,937.50 and a demand was made for payment of that amount by 7 January 2019 in for the plaintiff to release the first defendant and therefore also the second defendant from the obligations under the agreement. That sum was not paid and it is the plaintiff’s money claim here.
There are two considerations here: the first is the entitlement to terminate the agreement and the second is the guarantee and the liability of the second defendant. I am satisfied that under the franchise agreement there has been an event of default for clause 31.3 due to the failure to pay the outstanding fees within the time stipulated. Contractually no other inquiry is required; the defendants have failed to make the payments required within the time period specified. The plaintiff was then entitled to give notice of the termination of the franchise agreement; it did so by its letter of 12 December 2018.[12]
[12] Exhibit P1, tab 4, p 99 et seq.
Although it is not strictly necessary to make any finding on the point, I am satisfied on the evidence that the failure or refusal of the defendants to pay the required amount under the demand pursuant to the franchise agreement, was contumelious. I am satisfied that the first defendant had available to it funds sufficient to make payment of the outstanding sums; it deliberately chose not to make those payments. I am further satisfied that the termination by the plaintiff of the franchise agreement was in accordance with its terms and its requirements. I find that the defendants cannot impeach the actions of the plaintiff in terminating the franchise agreement under its terms by its letter of 12 December 2018. The termination complied with contractual requirements of the franchise agreement and the common law principles in relation to rights of termination have no application. I am satisfied that the plaintiff complied with its contractual obligations and had a contractual entitlement to terminate, which it properly exercised.
I am satisfied that the amount claimed on the notice was correct at the date of issue.[13] It was not contractually necessary for the plaintiff to continuously reissue notices of demand to the defendant. The final debt of $12,062.50 was due and owing, and its constituent amounts remained unpaid in full for the period prior to and after the notice stipulated its demand. In any event if I am wrong about the question of the calculation of the amount of the demand, the result is no different. Clause 31.3 of the franchise agreement[14] requires that any fees outstanding must be paid within 14 days of the plaintiff's request. The clause requires payment of outstanding amounts. These are calculable and in this case the defendants contend that the first defendant was indebted in the amount of $6,363 but do not suggest that this amount has ever been paid by the first defendant. Therefore, on the defendants’ best case, the first defendant was indebted to the plaintiff in the amount of $6,363 but refused to make payment. I am satisfied that on a proper reading of the clause it was necessary for the defendant to make payment of all outstanding moneys under the terms of the request and the demand. The amount outstanding of $6,363 on the defendant's case should have been paid and a failure to make its payment was a breach of the requirements of clause 16 and was a default for clause 31.3(a) and (c). I am also satisfied that under common law principles concerning rights to terminate, the knowledge of the first defendant of its breach was a matter that could have been taken into account by the plaintiff and would have justified the termination in any event. It is for that reason why I have formed the conclusion that the result would not have been any different.
[13] Walsh v Deputy Commissioner of Taxation (1984) 156 CLR 337 at 340.
[14] Exhibit P1, tab 1, p 32.
I turn to the second matter. As the defendants did not have legal representation, I required the plaintiff to address the question of the contractual doctrine of penalties under the operation of clause 32.3. The defendants earlier had some form of legal advice, but very early in this matter I formed the view that they had not had fully competent advice in light of the state of the defendant's pleadings. I therefore imposed the requirement upon the plaintiff to address the question of penalties, even though the defendants did not plead that the operation of clause 31 of the franchise agreement may have operated as an unenforceable penalty. In the usual course, for the question of penalties to be in issue, it was necessary for the defendant to have raised this defence in their pleadings. They failed to do so, however for the sake of completeness, and to ensure complete fairness to the defendants, I required the matter to be canvassed both in evidence and in the addresses of the plaintiff's counsel.
In considering the legal issues that arise for consideration here, I need to record a number of findings of fact that are largely not in dispute.
The Raine & Horne group is a nationally operating franchise group. It is a private company. The evidence of Mr Trimble satisfies me that nationally it employs about 40 full-time staff however this varies from time to time, depending upon demand. I am satisfied that there are three full-time staff employed in South Australia, one of them is Mr Trimble. Their role, inter alia, is to give all the assistance possible to all franchisees to ensure the profitable operation of these franchises. I am satisfied that such help was given to the first defendant.
As a state manager, Mr Trimble is required to visit franchise offices and provide advice about best business practice, and he must then review this advice from time to time. I am satisfied that this is what Mr Trimble did in this circumstance. There are a number of products or features which can be used by a franchisee, one of them was called a DigiKit, which is a software product and it provides appraisal information to vendors in real time. It can be used by Raine & Horne agents to give advice to potential vendors. I am satisfied that it also provides the function of allowing tracking of open inspections. Another product is called Amplify; this is made available to franchisees and it is in the form of a social marketing tool, the costs of which are subsidised out of the marketing fund. I am also satisfied that personal services in the form of training is given to franchisees on a regular basis.
There are other types of support, such as IT support, which is given in accordance with the franchise arrangements. Albeit that the question of the payments for IT services does not form part of this claim, it is still relevant that IT support services were provided by the plaintiff to franchisees and this included in relation to websites, emails, and in development of hardware. A graphic artist service is also available to franchisees. The evidence before me satisfies me that the revenue generated from property management, that is, for example rentals and the like is minimal, and the franchise fees and marketing fund fees are critical to the operation of the business of the plaintiff. In that circumstance, all franchisees are liable to pay monthly franchisee fees and marketing fund contributions. These are required to be paid for the whole of the term of the franchise agreements and these funds are all pooled centrally and investments are then made, for example, in infrastructure for the common benefit of all franchisees. Obviously enough, the staff employed by the franchisor would be paid from those funds as would the cost of the premises in which those staff are housed. Therefore, the franchisor provides a central source of information and support but also on the ground support and information through state managers.
Logically, when Raine & Horne sign up a new franchisee, it is required to provide support under the terms of the franchise agreement. It adjusts its business accordingly, so that it has the capacity to provide the support to the franchisee. In return, the franchisee is required to make the payments under the franchise agreement. This is a hand in glove arrangement. These services could not be provided without these payments and the infrastructure required to surround the service provider could not be created without ongoing payments under the franchise agreement. It would follow that in the event that a franchise or series of franchises is lost, then there is already a committed overhead expense for Raine & Horne as plaintiff, which could not be extinguished immediately, and which would need to be dealt with according to the Raine & Horne business plan. That is an ongoing expense. As one example, it would not be expected that the housing of the services in a central location would be upon a weekly or monthly rental basis. This would usually be done upon an ongoing basis over a longer period of time, such as a two, three, four or five-year lease arrangement. This then becomes an embedded cost of Raine & Horne, which must be met by Raine & Horne in and about the support of the franchise arrangement. The same considerations apply to state based employees who are retained in the expectation of the need to provide ongoing services to franchisees. Although contracts of employment may be the more easily terminated than a formal lease, they still carry ongoing associated costs such as leave entitlements, long service leave and termination entitlements. The same considerations apply to the costs of ongoing development of computer hardware and software.
Further, there is what I would describe as an accelerated effect if there is non-payment and a determination of a franchise as a result. It would lead to a reduction of a financial capacity across the board to support services and training, but especially investment in such things as infrastructure. It also limits the capacity of the franchisor to make whatever expenditures are necessary to maintain market position and market share by adopting and adjusting to changed local, national and international circumstances. It might be said that the loss of one franchisee would have a particularly profound effect but that expressed view cannot withstand commercial scrutiny. As has been observed, commerce depends upon the circulation of money and commercial arrangements are usually based upon the assessment of a number of criteria most of which are connected to cashflow. Planned expenditure usually embraces a number of scenarios. One scenario that cannot be predicted is where, as here, a long-standing franchisee unilaterally acts in a way that leaves no option other than to terminate the franchisee agreement. The franchisor planned its expenditures to benefit the franchise arrangement based upon the continuing existence of a franchisee that had been in place for six years.
The parties have agreed upon a liquidated damages clause which avoids the need for the court to commence an enquiry about damages and to reach a decision on that topic. At common law, this type of clause is only enforceable if it is a genuine pre-estimate of loss. If the clause does not meet that requirement, it will usually be unenforceable as a penalty. The question then is whether this clause is a penalty clause.
This question has been considered several times recently by the High Court of Australia and a number of guiding principles may be derived from these decisions.
1In Andrews v Australia and New Zealand Banking Group Ltd,[15] French, CJ, Gummow, Crennan, Kiefel and Bell JJ said:
[15] (2012) 247 CLR 205.
Mason and Deane JJ observed in Legione v Hateley [16] that, as the term suggests, a penalty is in the nature of a punishment for non-observance of a contractual stipulation and consists, upon breach, of the imposition of an additional or different liability.
[16] (1983) 152 CLR 406 at 445.
In general terms, a stipulation prima facie imposes a penalty on a party (“the first party”) if, as a matter of substance, it is collateral (or accessory) to a primary stipulation in favour of a second party and this collateral stipulation, upon the failure of the primary stipulation, imposes upon the first party an additional detriment, the penalty, to the benefit of the second party. In that sense, the collateral or accessory stipulation is described as being in the nature of a security for and in terrorem of the satisfaction of the primary stipulate.[17]
[17] Andrews at [9]-[10].
2Different from the position in England[18] and the earlier position in Australia,[19] a penalty can comprise a collateral stipulation that depends upon an event other than a breach of contract. This does away with the distinction made by Gibbs CJ in O’Dea (at 367) of there being a difference between a penalty and the circumstance where a party is required to make a payment upon the happening of an event where the party is not in breach of a contract. That payment may now be classed as a penalty.
[18] Cavendish Square Holdings BV v Talal El Makdessi [2016] AC 1172 at [11].
[19] O’Dea v Allstates Leasing System (WA) Pty Ltd (1983) 152 CLR 359.
3In Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd,[20] Lord Dunedin said at pp 86-87 as follows:
[20] [1915] AC 79.
I do not think it advisable to attempt any detailed review of the various cases, but I shall content myself with stating succinctly the various propositions which I think are deducible from the decisions which rank as authoritative:
1. Though the parties to a contract who used the words “penalty” or “liquidated damages” may prima facie be supposed to mean what they say, yet the expression used is not conclusive. The court must find out whether the payment stipulated is in truth a penalty or liquidated damages. This doctrine may be said to be found passim in nearly every case.
2. The essence of a penalty is a payment of money stipulated as in terrorem of the offending party; the essence of liquidated damages is a genuine covenanted pre-estimate of damage.
3. The question whether a sum stipulated is penalty or liquidated damages is a question of construction to be decided upon the terms and inherent circumstances of each particular contract, judged of as at the time of the making of the contract, not as at the time of the breach.
4. To assist this task of construction various tests have been suggested, which if applicable to the case under consideration may prove helpful, or even conclusive. Such are:
a. It will be held to be a penalty if the sum stipulated for is extravagant and unconscionable in amount in comparison with the greatest loss it could conceivably be proved to have followed from the breach.
b. It will be held to be a penalty if the breach consists only in not paying a sum of money and the sum stipulated is a sum greater than the sum which ought to have been paid. This is though one of the most ancient instances is truly a corollary to the last test. Whether it had its historical origin in the doctrine of the common law that when A promised to pay B a sum of money on a certain day and did not do so, B could only recover the sum with, in certain cases, interest, but could never recover further damages for non-timeous payment, or whether it was a survival of the time when equity reformed unconscionable bargains merely because they were unconscionable – a subject which much exercised Jessel MR in Wallis v Smith – is probably more interesting than material.
c. There is a presumption (but no more) that it is a penalty when “a single lump sum is made payable by way of compensation, on the occurrence of one or more or all of several events, some of which may occasion serious and others but trifling damage”.
On the other hand:
d. It is no obstacle to the sum stipulated being a genuine pre-estimate of damage, that the consequences of the breach are such as to make precise pre-estimation almost an impossibility. On the contrary, that is such the situation that it is probably that pre-estimated damage was the true bargain between the party.” (citations omitted)
Following the more recent decisions in Australia, especially the Paciocco[21] case, these tests are to be seen as guidance only and are couched in the language of their time; the issue is the policy of the rule and that is to avoid punishment. Any application of these principles must be viewed in a way that serves those policies.[22]
[21] Paciocco v Australia and New Zealand Banking Group Ltd (2016) 258 CLR 525.
[22] Ibid per Kiefel J at [32].
4In the application of the principle of avoidance of punishment (for breach) it becomes necessary to make a comparison between the operation and effect of the clause and the intent of the beneficiary of the clause who seeks to enforce it. This process is directed at deciding whether the quantum of liquidated damages is out of all proportion to the interest sought to be protected, namely the (plaintiff’s) interest in the performance of the contract. In Paciocco, Gageler J said at [164]:
[164] And as the facts in Clydebank and Dunlop again both sufficiently illustrate, the fact that the amount of a payment stipulated to be made on breach of contract is set at a level which provides a negative incentive – even a very strong negative incentive – to perform the contract is not enough to justify the conclusion that the stipulation served only to punish. The prospect of paying compensatory damages to be assessed by a court in the event of breach itself provides a negative incentive to perform a contract. The relevant indicator of punishment lies in the negative incentive to perform being so far out of proportion with the positive interest in performance that the negative incentive amounts to deterrence by threat of punishment.
Similarly, in Paciocco, Keane J said at [256]:
[256] To similar effect, this Court in Ringrow[23] rejected the suggestion that the impugned provision must be proportional to the legitimate commercial interests of the party relying upon it in order to avoid being characterised as a penalty. It is only where the impugned provision requires a payment upon breach which is out of all proportion to the legitimate commercial interests of the party relying upon it that the punitive character of the provision stands revealed.
[23](2005) 224 CLR 656 at 667‑669 [27]‑[32].
5The enquiry includes whether the clause operates to punish the party in default operating as a threat. This will include ascertaining the parties’ commercial position and identifying whether the clause serves a legitimate purpose.[24]
[24] Cavendish at [32] and [52].
Under this enquiry, it is necessary to look at the true construction of the contract. In order to do that, it is necessary to canvas the whole of the circumstances of the contract. This will require an objective assessment of the purpose of the clause as at the date of the contract. In Paciocco at [157]-[158] Gageler J said as follows:
[157] In O'Dea v Allstates Leasing System (WA) Pty Ltd,[25] Wilson J asked of the stipulation in issue in that case whether it "can be considered to be a 'genuine pre-estimate of the creditor's ... probable or possible interest in the due performance of the principal obligation'" (citing Hills) or "whether it is a penalty inserted 'merely to secure the enjoyment of a collateral object'" (citing Sloman v Walter). That succinct framing of the inquiry is consistent with Andrews and Dunlop. It is also very useful.
[25] (1983) 152 CLR 359 at 383; [1983] HCA 3.
[158] The ultimate question of whether a stipulation imposing a detriment on a contracting party in the event of non-observance of another stipulation is a penalty is reflected in the formulation Wilson J drew from Sloman v Walter. To ask whether a stipulation serves merely to secure the enjoyment of a collateral object is to ask whether the conclusion objectively to be drawn from the totality of the circumstances is that the only purpose of the stipulation was to punish: to impose a detriment on a contracting party in the event that a principal contractual stipulation is not observed, in order to deter non-observance of that principal stipulation. To ask that question in the context of a stipulation for the payment of money on breach of contract accords with the statement of Lord Dunedin in Dunlop that "[t]he essence of a penalty is a payment of money stipulated as in terrorem of the offending party".
The whole of the circumstances will include the parties’ position as at the date of the contract.
6In so doing, there is a risk of offending the rules of interpretation of a contract by reference to extrinsic material. That in turn raises a more distinct problem of deciding the “only” purpose of a clause. It is quite difficult intrinsically to show that a clause has only one purpose and so it appears likely that identification of a number of purposes may obviate the clause operating as a penalty.
7On the question of construction, some meaning must be given to the expression “inherent circumstances” in the third of Lord Dunedin’s tests. The law of Australia (Codelfa Construction Pty Ltd v State Rail Authority of New South Wales (1982) 149 CLR 337) is that regard may only be had to extrinsic circumstances in the case of an ambiguity within the contractual terms. In Paciocco, the High Court appears to have accepted that the issue of construction is to be determined by a full examination of the position of the party seeking to enforce the clause. In Paciocco, Kiefel J held at [31] as follows:
[31] The question whether a sum to be paid on default is a penalty, as distinct from liquidated damages, was said by Lord Dunedin[26] to be a question of construction, but his Lordship is not to be taken to suggest that it will be answered by the language of the contract alone. This is evident from the reference to the "inherent circumstances" of the contract, which includes the position of the party whose interests are to be protected by the stipulation for the payment of the sum on default.
Similar sentiments were expressed in Cavendish[27] and this is the approach that I will take to the question of construction and the identification of the “inherent circumstances”.
8In the application of the fourth test of Lord Dunedin, in aid of construction, the application of the test in Ringrow Pty Ltd v BP Australia Pty Ltd[28] is whether the sum is out of all proportion to damage likely to be suffered as a result of the breach so that it was extravagant and unconscionable in amount in comparison with the greatest loss; it was not enough that it should be lacking in proportion, it had to be out of proportion.[29]
9The third test (found in paragraph 4(c) in Dunlop above) requires a consideration of events in respect of which compensation is payable on the occurrence of one or more events, some serious and some trifling. That consideration has no application here as the event of default was major and termination occurred under the contractual stipulations.
[26] Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd [1915] AC 79 at 86-87.
[27] Cavendish Square Holdings BV v Talal El Makdessi [2016] AC 1172 at [28].
[28] (2005) 224 CLR 656 at [11]-[12].
[29] Ringrow at [32]; see Paciocco at [29], [34], [54] and [221]; see also Cavendish at [226].
I turn then to the question of penalty per se. The first thing to be said is that there has been no challenge within the evidence of the genuineness of the pre-estimate of loss claimed by the plaintiff.
In the application of those authorities I am satisfied that the amount claimed is a genuine and agreed pre-estimate of loss for the reasons earlier expressed. In reaching that conclusion I have had regard to the inherent circumstances of the case. It is not merely another term of the agreement. These circumstances include the embedded costs incurred by the plaintiff in establishing this and other franchises, in maintaining and supporting this franchisee and then the service that it provides to the franchisees. The amount not only does not lack proposition, it is not out of proposition with these costs and so the damage likely to be suffered as a result of the breach. It was not excessive when compared with the interest sought to be protected.
Secondly, I am satisfied that the amount is calculated by reference to the expense which the plaintiff franchisor has incurred and will incur in arranging to make available to the first defendant as franchisee and other franchisees the provision of the services, part of the cost of which was already incurred and embedded and which would continue to be incurred by the franchisor because of the nature of the arrangements made by the franchisor in and about the creation of the franchise and the support that it gives to franchisees.
Third I am satisfied that there is no aspect of the mitigation of the plaintiff's loss which arises. Once there is termination nothing is left of the franchise and there would otherwise be no return on the expenditure made by the plaintiff franchisor in the expectation that the defendant would honour the five- year term of the agreement.
Fourth, the clause takes into account the discharge of Raine & Horne as promisee because it has an overhead expense that is embedded and incurred in anticipation of the completion of the contractual obligations. There is no evidence that these may be terminated at the whim of that firm and, for example, without penalty.
Fifth, I am satisfied that the amount payable was not out of all proportion to either the loss to be suffered by Raine & Horne, or of its interest in receiving performance of the primary obligation of the defendant. This is because I am satisfied that it was in the nature of a quid pro quo, namely, a payment in connection with the services to be rendered.
Sixth, I am satisfied that the term is not a stipulation that is collateral to the primary obligation. This is because I am satisfied it is equivalent to the reduced minimum of the primary obligation.
Seventh, I am satisfied that it is not a collateral stipulation which imposes an additional detriment upon the defendant to the benefit of the plaintiff franchisor. It is the amount that would always have been paid, at a minimum, over the five-year term. Both the amounts at a minimum are the same, there is nothing over and above the other.
In his decision in Paciocco, Keane J said at [221]:
[221] Only in cases where gross disproportion is such as to point to a predominant punitive purpose have agreed payments payable on breach of contract been struck down as penalties. It may be that other laws concerned with unfair or unreasonable use of superior bargaining power will affect the validity of the provision. But subject to such laws the penalty rule is not engaged by a provision which achieves a profit for the promisee at the expense of the promisor. That is because if the provision is not distinctly punitive in its character the penalty rule does not operate to despise the parties' freedom to settle for themselves the contractual allocation of benefits and burdens and the rights and liabilities following a breach of contract.
Here, the term of the arrangement was for a period of five years and the prior term for the earlier agreement was the same. Here the defendants were well aware of the terms, both for the first defendant, as franchisee and for the second defendant as guarantor. They were familiar with them from the earlier agreement from 2012, and they were familiar with them again as a result of the explanations given to them in 2017.
They were therefore familiar with the fact that the fees claimable, and in respect of which this claim is made, are all fixed at the time of the making of the contract. At the same time the liquidated damages clause 32.3, was also fixed (at the time of the making of the contract).
I am also satisfied that the plaintiff gave the defendants every opportunity and assistance to recover their position. I accept that the plaintiff was not in any position other than it was required to pursue the defendants.
In those circumstances, I find that clause 32.3 of the franchise agreement is not a penalty.
I turn to the question of costs thrown away. In this matter, some two days before the action was to commence, an interlocutory application was taken by the defendants for the adjournment of the trial. At the time, the defendants were assisted by a solicitor, Mr Mahadeva. There was some suggestion in the evidence that a decision had been made by the defendants to change lawyers, but there was no evidence upon the point and nothing turns upon it.
Very shortly before this trial was due to commence I was informed that the defendants had decided not to proceed with the application. There was no explanation given as to why that decision had been made. As a result, the plaintiff was put to costs and expense in preparing to meet that application; I received and read a number of authorities upon which the plaintiff wished to rely in opposition to the defendants’ application.
I am satisfied that the application had no basis in fact or law and it had no prospects of success on the settled authorities that bind me. The application was brought in contumelious disregard of the authorities that are relevant and applicable to such applications and it caused unnecessary wasted costs to be incurred by the plaintiff. It was in the nature of an abuse of process, but it is only sufficient to find that it was doomed from the outset. So much is obvious from its abandonment.
As a result, the plaintiff is entitled to its costs thrown away on an indemnity basis for this application. Those costs, on the evidence, are in the amount of $1,756.15.
I turn to the question of interest. Exhibits P4 and P5 satisfy me that the interest payable by the defendants under clause 16.11 of the franchise agreement accrued to 10 March 2020 is in the amount of $15,563.50. That interest is calculated on the principal sum of $106,937.50 made up of a claim of $12,062.50 and $94,875 to which I have earlier referred. The content of Exhibits P4 and P5 satisfy me of the ANZ base rate, the method of calculation and the quantum of the interest. I am also satisfied that under the operation of clause 16.11 the obligation to pay interest on the outstanding sum at that rate is ongoing.
I make the following orders:
1Declaration that the franchise agreement between the plaintiff and the first defendant dated 11 September 2017 being found in Exhibit P1, tab 1, p.1 and following, was validly terminated by the letter of 12 December 2018 (P1, tab 4, p.99).
2Judgment in favour of the plaintiff in the sum of $122,056.60 as at 10 March 2020, being the addition of the sum of $12,062.50, $94,875 and interest in the amount of $15,563.56.
3A declaration that the plaintiff is entitled to claim interest pursuant to clause 16.11 of the terminated franchise agreement on any unpaid debt but on a simple interest basis only.
4The plaintiff have the costs of the defendants’ abandoned adjournment application fixed in the sum of $1,765.15.
5The plaintiff have the costs of the action to be assessed if not agreed.
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