Presently, over 600 pages of the 653 page judgment have been temporarily redacted pending resolution of confidentiality claims at a further case management hearing (at a date yet to be fixed). Nevertheless, what is published offers invaluable insight into the Court's interpretation of legal principles governing how existing dealer network parameters and structures may be altered moving forward – an issue of great significance for the automotive industry as the fixed-price, direct-to-consumer agency model continues to gain traction in some quarters over the traditional independent franchise sales (or reseller) model that has until now dominated the industry – as well as concepts such as goodwill of a franchised business.
Background and allegations made by dealers
In 2021, 38 of the then 49 dealers operating Mercedes-Benz dealerships in Australia commenced proceedings against Mercedes-Benz Australia/Pacific Pty Ltd (MBAuP) in relation to Mercedes' decision to move from a "dealership model" to a "fixed-price agency model". Under the new agency model, which came into effect on 1 January 2022, Mercedes retains ownership of its cars while dealers act as agents and must sell cars at a fixed price for a set commission. Previously, the dealers purchased cars directly from Mercedes and had the flexibility to choose their selling price to customers.
The dealers' claims centred on allegations that Mercedes' exercise of its contractual right of non-renewal of the dealer agreements, and replacement of those agreements with agency agreements, was not consistent with the Franchising Code obligation to act in good faith and amounted to unconscionable conduct in contravention of the ACL. In seeking $650 million in damages, the dealers alleged that:
- MBAuP's implementation of the agency model and the issuing of non-renewal notices (NRNs) (ending their relationships under the prior dealer agreements) were not the product of a genuinely conducted process, and were not conducted in good faith;
- MBAuP engaged in unconscionable conduct;
- the goodwill that dealers had built over many years of interacting with customers was appropriated by MBAuP without proper compensation;
- Mercedes knew or was recklessly indifferent to the fact that most if not all of the dealers would be worse off under the agency model, and this model was imposed on the dealers in "contumelious disregard of their interests"; and
- the issue of the NRNs was at the direction and in the sole interest of its parent company Mercedes-Benz AG (MBAG), which was an impermissible purpose under the terms of the dealer agreement.
Duty to act in good faith
Justice Beach considered how the good faith duty under the Franchising Code should be applied to a termination without cause provision or a power of non-renewal, and found that such a power has two distinguishing features. First, the very purpose of such a power is to bring the existing contractual relationship to an end, and second, such a power can serve only the interests of the party upon whom it is conferred. As such, the exercising party’s obligation pursuant to the good faith duty to act honestly and with fidelity to the bargain between the parties is informed by these distinguishing features and must recognise that the nature of the power is to bring that bargain to an end.
The Court therefore concluded that the good faith duty applied to such powers does not convert an agreement into "a contract of indefinite duration". However, it does require that the exercising party act honestly in matters connected to its performance of the contract and its exercise of the non-renewal power.
Despite Justice Beach observing that the dealers' unconscionable conduct case had more merit than the other claims they put forward and "involved a harder judgment call on [his] part" , his Honour rejected these claims.
Justice Beach observed that because "the very purpose of the non-renewal power is to bring the existing contractual bargain to an end", the mere usage of that clause to terminate the franchise agreement could not constitute unconscionable conduct. The dealers were also “well-heeled” without any socio-economic vulnerability, understood the contractual bargain they had entered into, and could not seek to change that arrangement to better suit their interests:
"But I agree with MBAuP that the applicants in essence seek to rewrite the contractual bargain struck by the dealer agreements into one which better suits their commercial interests. …. In essence, the commercial judgment made by each dealer was that MBAuP would not issue a notice of non-renewal if the dealer performed well, because it was assumed that it would be in MBAuP’s commercial interest and the dealer’s interest for that agreement to continue. No doubt that was a sensible commercial assumption to make. But it was not the contractual bargain that was struck. The NRNs could be given without cause."
Here, unconscionability or alternatively a failure to act in good faith in contravention of the Franchising Code is not established by proving that dealers would be worse off financially under the agency agreement (which was the case they put at trial).
Interestingly, despite noting that "there were various themes that from time to time MBAuP put to dealers that were either exaggerated or turned out to be incorrect," there were no specific allegations pleaded that MBAuP made false, misleading or deceptive representations to dealers prior to implementing the changes to the network structure (for example, that the prior agreements would never be altered or that an agency model would not be introduced or some other such representations on which the dealers may have claimed to have relied to their detriment). There is, therefore, no analysis in the current form of the judgment about matters of this kind. Of course, reasoning may potentially be further elucidated on these kinds of matters, to the extent they were relevant to the unconscionable conduct and lack of good faith allegations (albeit not pleaded as separate allegations of themselves), after confidentiality matters are resolved.
Justice Beach held that the dealers' goodwill was tethered to the dealer agreements and lost when the dealer agreements ended. In coming to this conclusion, Justice Beach noted that "in a franchise context, the fact that the legal definition of goodwill is aligned with the legal right or privilege to conduct business in substantially the same manner and by substantially the same means that have attracted custom to it, is significant" (consistent with the definition of "franchise agreement" in the Franchising Code). This is because the franchised business cannot be conducted in this way absent the rights granted to the franchisee by the franchisor.
In coming to this conclusion, Justice Beach distinguished "accounting goodwill" from "legal goodwill" and applied High Court authority that legal goodwill established by a franchise ends (so that there is nothing to be taken or transferred by a dealer) when the contract giving the right to conduct the franchised business ends: see Commissioner of State Revenue (WA) v Placer Dome Inc (2018) 265 CLR 585 and Federal Commissioner of Taxation v Murry (1998) 193 CLR 605.
The Court held that:
"Now more generally the applicants say that the notion that goodwill as a matter of legal analysis ends when the underlying franchise agreement terminates is inconsistent with the analysis in Murry. But I disagree. Goodwill in terms of the legal concept did not transcend the non-renewal of the dealer agreements. Moreover, there was no acquisition or appropriation by MBAuP of the dealers’ goodwill at the time of the service of the NRNs or at any time thereafter."
As such any goodwill lost by the dealers was lost by a contractually valid, good faith, and conscionable exercise of a non-renewal notice clause and thus no compensation was payable to dealers.
Parent company's interests
As noted above, the dealers contended that issuing the NRNs was at the direction and in the sole interest of its parent company MBAG. They argued that this was an impermissible purpose for which to issue an NRN under the terms of the dealer agreement.
The Court held that MBAuP was acting in accordance with the directions and interests of MBAG but that the company was not acting as "an automaton" for its parent. Noting MBAuP's evidence suggesting that the decision-makers in Australia were in favour of the agency model shift ahead of the MBAG direction, Justice Beach held that a subsidiary acting in the interests of its parent company and itself are not "improper, foreign or collateral" purposes to the power to issue an NRN.
Ultimately, Justice Beach held that even in pursuit of a nation-wide strategy or with lack of consideration for individual dealers MBAuP was using the NRN power for its sole benefit in individual agreements and thus was not acting outside of the framework of that agreement.
Key takeaways and industry insights
The judgment places primacy on the contractual bargain between franchisor and franchisee. It is therefore critically important that franchisees understand the commercial implications and risks of any arrangements they enter into with a franchisor, especially where the franchisee as in this case is seen as a sophisticated party that freely and willingly entered into the franchise agreement.
Justice Beach emphasised that, while the case was forensically complex, it was "legally straightforward" and while delivering the judgment was reported as stating: "Given the facts of this case, leading to an adverse result for the applicants, it may be that further consideration needs to be given to the terms of the Franchising Code and possible modification. And that is a matter for another day. And obviously, in another forum”.
Such comments will no doubt be of particular interest to automotive industry participants, and franchise industry participants more broadly, within the context of the Treasury's current Independent Review of the Franchising Code of Conduct and the consultation paper released on 22 August 2023 which outlines a number of proposed changes and reforms to the Franchising Code of Conduct and seeks feedback on those proposed changes and reforms from interested parties by 29 September 2023.
Feel free to contact us with questions on how this case impacts your franchising arrangements.