Consent Must Not Be Unreasonably Withheld To A Transfer Of A Franchise

Originally Published 7^th October 2008

In May 2008 in the case of Masterclass Enterprises Pty Ltd v Bedshed Franchisors (WA) Pty Ltd the Supreme Court of Western Australia (the Court) dealt with the issue of whether a franchisor's consent was unreasonably withheld to a transfer of a franchise.

Background

The franchisor, Bedshed, was engaged in a business with approximately 42 retail stores nationally. In 2003, Masterclass (the franchisee) agreed to purchase the Claremont Bedshed franchised business and entered into a non-exclusive franchise agreement on 12 September 2003 for over 17 years. That franchise agreement said that the business and the premises must at all times be under the direct supervision of the franchisee (or in the case of a corporate franchisee, someone having a substantial interest in the corporate franchisee) and that the franchise cannot be transferred by the franchisee without the written approval of Bedshed, which could not be unreasonably withheld. In effect, the agreement also provided that Bedshed's approval of a transfer was subject to the transferee meeting Bedshed's criteria for the selection of new franchisees and of the transferee being capable of operating the business as a franchisee.

Masterclass sought to sell Bedshed Claremont to a corporate franchisee, which proposed to have a manager operate the business on a full time basis. Initially the manager had no interest in the corporate franchisee, but was later given a minor interest (of 5%) in the corporate franchisee (and an indemnity in relation to her guarantee and liability as a director). Bedshed refused its consent to the transfer on the basis that it was not satisfied that Bedshed Claremont would be under the direct supervision of a person with a significant stake in the business. Masterclass argued that this was unreasonable and that the clause was an unlawful restraint of trade. Further issues arose as a result of the form of the franchise agreement undergoing changes.

Issues

The case dealt with three issues, namely:

1. Was the consent of Bedshed to the transfer of the franchise unreasonably withheld?
2. Was the requirement that the business be at all times under the direct supervision of the Guarantor (clause 6.2), an unlawful restraint of trade?
3. Was the form of the franchise agreement that Bedshed proposed its 'then current franchise agreement'?

Findings

1. Consent was not unreasonably withheld

The Court held that the franchisor could withhold its consent to the transfer in accordance with the provisions of the Code. Clause 20 of the Code lists circumstances in which a franchisor is entitled to withhold its consent to the transfer of a franchise, however, the Court found this list was not exhaustive. The Court also established that there is an overriding requirement that consent to the transfer of a franchise not be unreasonably withheld.

It was found that the franchise agreement between Bedshed and Masterclass involved a continuing close commercial arrangement over its term. Due to the nature of this franchise agreement, the Court found it was not unreasonable to withhold consent to the transfer on the basis that the business must be supervised by someone with a significant stake in the corporate franchisee.

2. There was no restraint of trade

Although the effect of clause 6.2 of the franchise agreement was to require the franchise business to be supervised at all times under the direct supervision of the guarantor, the Court determined that the franchise agreement did not restrain Masterclass or its directors and shareholders from any other activity. The Court found that there was no basis for concluding that the clause was calculated to have the effect of limiting competition with Bedshed's business, and there was no illegal restraint of trade.

3. 'Then current franchise agreement'

The Court did not accept Masterclass' argument that the requirement that the purchaser sign the new franchise agreement proposed by Bedshed was contrary to the Code, but commented that it was contrary to the existing franchise agreement.

The Court briefly discussed the meaning of the phrase 'then current franchise agreement'. The franchise agreement between Bedshed and Masterclass required that a purchaser would sign the 'then current franchise agreement'. The Court expressed the view that the new agreement that Bedshed proposed to the purchaser was not the 'then current franchise agreement' (as defined in the existing franchise agreement). Contrary to Bedshed's argument, the Court noted that the phrase 'then current franchise agreement' described an agreement already in force between Bedshed and a franchisee, not one which Bedshed simply proposed to enter into in the future. This was not decided in the case and was merely a comment made by the Court. The Court's comment in relation to this point is contrary to the accepted practice of the franchising industry.

What this means for franchisors

The following conclusions can be drawn from this case:

• The list of circumstances under the Code for which consent may be reasonably withheld is not exhaustive. Depending on the circumstances that arise, such as the close working relationship between the parties and the long term of the agreement, it may be reasonable for the franchisor to withhold consent to the transfer of a franchise.
• Franchisors must consider the implications of the terms 'then current franchise agreement' in franchise agreements.

Recommendations

Franchisors should review the list of circumstances set out in their franchise agreement where they can withhold consent to a transfer and ensure they are reasonable and only apply that list where it is reasonable to do so.

Franchisors should discuss with an expert legal advisor the roll out of new franchise agreements to avoid any complications.

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