‘New Frontlines: Regulating Bad Faith Business Conduct and Unconscionable

Conduct’

26 October 2014

Professor Bryan Horrigan BA, LLB (Qld), DPhil (Oxon)Dean, Faculty of Law, Monash University

Expert Panel Member, Australian Government’s Strengthening Statutory Unconscionable Conduct and the Franchising Code of

Conduct Inquiry

The Legal Future for Franchising?

Why you need to know

• Topical litigation (eg ACCC v Lux/Coles) and reform initiatives• Any B2B reform for unconscionability, unfair contract terms, or codes of

conduct affects franchising • Numerous unlitigated ‘test case’ issues• New statutory provisions from January 2012 – ie the new regulatory and

reform landscape is different• New principles and indicators of unconscionable conduct (eg patterns of

conduct)• Heightened regulator attention and powers (eg pecuniary penalties,

infringement notices)• ‘Root and branch’ review and CAANZ reviews cover this topic:

Capacity to inform industry discussionPossible extension of business regulation

• Triple-barrelled problem involving good faith in negotiating/drafting contracts and advice or litigation on business conduct:

Breach of good faith as an express/implied/excluded termBreach of good faith as an indicator of unconscionable conductBreach of good faith as an enforcement issue under the Franchising Code

Outcomes of Reform Initiatives

• Unconscionable business conduct regulation:- major reform now unlikely- many ‘test case’ issues under 2012 changes

• Implied ‘good faith’ obligation:- accepted contractual term in franchising contracts- mandated obligation for all franchising contracts

• Carve-outs for reform-fatigued franchising industry?:- Unconscionable conduct regulation: No- ‘unfair contract terms’ regulation: ??

Industry Positions

• ‘FAA favours option 3 … That option being: “Legislative amendment to extend the existing unfair contract terms provisions to standard form contracts involving small businesses.”’ (Franchisees Association of Australia submission)

• ‘The FCA strongly considers that Franchise Agreements should be expressly excluded from the operation of any unfair contract terms regime.’ (Franchise Council of Australia submission)

Current Reform Initiatives Affecting Franchising

Major Recent Reforms to UC Regulation

• #1: Enhanced focus upon terms and progress of contracts – not just pre-execution conduct

• #2: Harmonisation of B2B and B2C indicators of statutory unconscionability

• #3: Additional indicators of statutory unconscionability• #4: New principles of interpretation for statutory

unconscionability

Abbott Government’s ‘Root and Branch’Review Terms of Reference

• ToR 3.3.4: ‘considering whether the framework for industry codes of conduct … and protections against unfair and unconscionable conduct, provide an adequate mechanism to encourage reasonable dealings across the economy – particularly in relation to small business’

• ‘The Review Panel should only consider the Australian Consumer Law [provisions] … to the extent they relate to protections (such as from unfair and unconscionable conduct) for small business.’

Issues Paper Questions (April 2004)

• ‘Are existing unfair and unconscionable conduct provisions working effectively to support small and medium sized business participation in markets?’; and

• ‘Are there other measures that would support small and medium sized business participation in markets?’

Consumer Affairs Australia and New Zealand (CAANZ) Consultation

• ‘Extending Unfair Contract Term Protections to Small Businesses’, Consultation Paper, May 2014 (submissions due 1 August 2014)

• Option 1: Do nothing – rely on existing law (‘This is inconsistent with the Commonwealth Government’s policy commitment’)

• Option 2: ‘Light touch’ reform – self-regulating and co-regulating changes

• Option 3: Extend ‘unfair contract terms’ regime to protect small business (‘the preferred option’)

• Option 4: Legislate to require negotiation in all contracts

The Domino Effect

• Statutory unconscionability already applies to B2B and B2C transactions

• Statutory indicators of unconscionable business conduct now harmonised (since 2012) for both B2B and B2C contexts

• New presumptions of interpretation and statutory indicators focus on both terms and performance of contracts

• ‘Unfair contract terms’ regime already applies to B2C contexts• Political, small business, and legal perception that

unconscionable business conduct regulation has not gone far enough

• Public commitment from Abbott Government to improve regulatory protection for small business

• Multiple recent/concurrent reviews (eg ‘root and branch’, CAANZ, and Franchising Code) suggest multi-pronged approach and no ‘single bullet’ outcome (ie not just about codes or unfair contract terms alone)

Unconscionable Franchising Conduct

Three Basic Forms of Statutory Unconscionability

• General prohibition - unconscionable conduct:‐ Old TPA s 51AA (in trade practices generally)‐ New CCA ACL, section 20‐ ASICA s 12CA (in financial services)‐ Corporations Act s 991A (financial services licensees)

• Unconscionable conduct in retail/personal/consumer contexts (ie B2C unconscionability):‐ Old TPA s 51AB‐ New CCA ACL, sections 21 and 22‐ ASICA sections 12CB and 12CC

• Unconscionable conduct in big/small business contexts(ie B2B unconscionability):‐ Old TPA s 51AC‐ New CCA ACL, sections 21 and 22‐ ASICA sections 12CB and 12CC‐ Some state commercial/retail leasing Acts

Competition and Consumer Act 2010 (Cth)

20 Unconscionable conduct within the meaning of the unwritten law

(1) A person must not, in trade or commerce, engage in conduct that is unconscionable, within the meaning of the unwritten law from time to time.

Strands of Unconscionable Dealing

• GARCIA-Type UC

• Wife (or other close relationship?)

• Guarantees husband’s personal/business debts

• Failure to understand

• A volunteer (no benefit)

• No or inadequate explanation

• Relevant factors known to bank

• Bank remedial actions inadequate

• AMADIO-Type UC• Weaker party under a special

disadvantage• Special disadvantage can be personal

(eg illiteracy)• Special disadvantage can also be

financial, legal, or informational (ie ‘situational’)

• Disadvantage affects weaker party’s capacity to decide best interests

• Stronger party knows and takes advantage of that disadvantage

• Exploitation of that disadvantage in the circumstances is against ‘good conscience’ in legal terms

Meanings & Levels of Unconscionability Regulation

Under ‘the Unwritten Law’ (4 categories as described by Paul Finn):‐ [1] Unconscionability as the underlying concept for Equity as a whole

‐ [2] Unconscionability as an element or finding that is essential for specificequitable actions (eg estoppel, relief against forfeiture, unconscionabledealings, unilateral mistake etc)

‐ Coercion/exploitation/advantage-taking‐ Unconscionable exercise of rights, retention of benefits etc

‐ [3] Doctrines & remedies associated with unconscionable dealings &exploitation, advantage-taking, and defective understanding:

‐ ‘spousal guarantees’ rules (eg Yerkey v Jones, Garcia)‐ ‘special disadvantage’ rule (eg Amadio/Berbatis)‐ Others (eg Bridgewater v Leahy)

‐ [4] Unconscionability as a direct ground of relief in its own right, unmediated by conventional doctrines (eg Lenah Game Meats v ABC)

• NB Only [2] or [3] are viable possibilities – still open to argument

Full Fed Ct in ACCC v Samton Holdings

• Unconscientious exploitation of a party’s special disadvantage (eg Amadio)

• Defective understanding, relationship of influence, and absence of independent explanation (eg Garcia)

• Unconscionable departure from previous representation(eg estoppel – Verwayen, Waltons Stores v Maher)

• Relief against forfeiture and penalty (eg Legione v Hateley and Stern v McArthur)

• Rescind contracts for unilateral mistake (eg Taylor v Johnson)

Competition and Consumer Act 2010 (Cth)

21 Unconscionable conduct in connection with goods or services

(1)A person must not, in trade or commerce, in connection with:

(a) the supply or possible supply of goods or services to aperson (other than a listed public company); or

(b) the acquisition or possible acquisition of goods or servicesfrom a person (other than a listed public company);

engage in conduct that is, in all the circumstances, unconscionable.

Competition and Consumer Act 2010 (Cth)21 Unconscionable conduct in connection with goods or services

(4)It is the intention of the Parliament that:

(a) this section is not limited by the unwritten law relating to unconscionable conduct; and

(b) this section is capable of applying to a system of conduct or pattern of behaviour, whether or not a particular individual is identified as having been disadvantaged by the conduct or behaviour; and

(c) in considering whether conduct to which a contract relates is unconscionable, a court’s consideration of the contract may include consideration of:

(i) the terms of the contract; and

(ii)the manner in which and the extent to which thecontract is carried out;

and is not limited to consideration of the circumstances relating to formation of thecontract.

Competition and Consumer Act 2010 (Cth) (Annotations in ‘[ ]’)

22 Matters the court may have regard to for the purposes of section 21[Non-Exhaustive List of 12 Statutory Indicators of B2C and B2B UC]:

(a) [relative bargaining positions] the relative strengths of the bargainingpositions of the supplier and the customer; and

(b) [beyond legitimate commercial interests] whether, as a result of conduct engaged in by the supplier, the customer was required to comply with conditions that were not reasonably necessary for the protection of the legitimate interests of the supplier; and

(c) [understanding of documents] whether the customer was able to understand any documents relating to the supply or possible supply

of the goods or services; and

Competition and Consumer Act 2010 1974 No. 51 (Cth)(d) [undue influence, unfair tactics, and duress] whether any undue influence

or pressure was exerted on, or any unfair tactics were used against, the

customer or a person acting on behalf of the customer by the supplier or a

person acting on behalf of the supplier in relation to the supply or possible

supply of the goods or services; and

(e) [equivalent pricing and circumstances] the amount for which, and thecircumstances under which, the customer could have acquired

identical orequivalent goods or services from a person other than the supplier;

and

(f) [equivalent treatment] the extent to which the supplier’s conduct towardsthe customer was consistent with the supplier’s conduct in similartransactions between the supplier and other like customers; and

(g) [code compliance I] the requirements of any applicable industry code; and

Competition and Consumer Act 2010 1974 No. 51 (Cth)

(h) [code compliance II] the requirements of any other industry code, if thecustomer acted on the reasonable belief that the supplier would

complywith that code; and

(i) [non-disclosure] the extent to which the supplier unreasonably failed todisclose to the customer:

(i) any intended conduct of the supplier that might affect the interests ofthe customer; and

(ii) any risks to the customer arising from the supplier’s intended conduct(being risks that the supplier should have foreseen would not beapparent to the customer); and

Competition and Consumer Act 2010 1974 No. 51 (Cth)

(j) [contractual terms, progress, and conduct] if there is a contract between the supplier and the customer for the supply of the goods or services:

(i) the extent to which the supplier was willing to negotiate the terms andconditions of the contract with the customer; and

(ii) the terms and conditions of the contract; and

(iii) the conduct of the supplier and the customer in complying with theterms and conditions of the contract; and

(iv) any conduct that the supplier or the customer engaged in, in connection with their commercial relationship, after they entered into the contract; and

(k) [unilateral variation] without limiting paragraph (j), whether the supplier has a contractual right to vary unilaterally a term or condition of a contract between the supplier and the customer for the supply of the goods or services; and

(l) [good faith] the extent to which the supplier and the customer acted in good faith.

Spigelman CJ in A-G (NSW) v World Best Holdings [2005] NSWCA 261

‘Over recent decades legislatures have authorised courts to rearrange the legal rights of persons on the basis of vague general standards which are clearly capable of misuse unless their application is carefully confined. Unconscionability is such a standard … Unconscionability is a concept which requires a high level of moral obloquy. If it were to be applied as if it were equivalent to what is “fair” or “just”, it could transform commercial relationships.’

ACCC v Lux Distributors P/L [2013] FCAFC 90 (15 August 2013)

• Latest decided ACCC test case• Judicial rethink on how ‘moral obloquy’ works in this field

of regulation• B2C context, not B2B• Facts predate the latest statutory unconscionability

reforms• Old (not harmonised) list of unconscionability indicators

(eg no applicable ‘good faith’ indicator) • No need to discuss latest statutory additions

(eg new principles of interpretation) in the judgment• Important test case – but not the last word on statutory

unconscionability ‘test case’ issues

Corrs’ Public Assessment of Lux Case’s implications

• Rethink on previously accepted door-to-door sales tactics• 1st case linking UC provisions and provisions on ‘unsolicited

consumer agreements’• Emphasis upon the nature of the powerful actor’s conduct, not the

nature of the vulnerable actor’s response• ‘Cooling off’ periods don’t mitigate otherwise unconscionable

conduct• ‘Matrix of circumstances’ approach applies• Legislation protecting consumers may provide benchmarks of

applicable norms of conduct• Deception up front in consumers’ homes poisons everything that

follows(see: Corrs in Brief: ‘Sucked In – Full Court Clarifies Unconscionable

Conduct Provisions in the Australian Consumer law in ACCC v Lux’)

Unconscionability and Good Faith

• Co-extension of content and limits of ‘good faith’ under contract and statutory unconscionability?

• Two-stage analysis of ‘good faith’ issues for transactional purposes

• Problems in trying to avoid statutory unconscionability by drafting devices

• Implications for judicial revision of expansive ‘reasonableness’ glosses on good faith

• Implications for Abbott Government’s ‘root and branch’ review of Competition and Consumer Act

Good Faith Deficiency as Indicator of Unconsionable Conduct

ACL Sections 21(1) and 21(4): - ‘A person must not, in trade or commerce, in connection with [supply/acquisition of

goods/services] engage in conduct that is, in all the circumstances, unconscionable.’- ‘It is the intention of the Parliament that:… (c) in considering whether conduct to which a contract relates is unconscionable, a

court’s consideration of the contract may include consideration of:(i) the terms of the contract; and(ii) the manner in which and the extent to which the contract is carried out;

and is not limited to consideration of the circumstances relating to formation of the contract.’

ACL Section 22: ‘Without limiting the matters to which the court may have regard for the purpose of determining whether a person [the supplier/acquirer/customer] has contravened section 21 … the court may have regard to:

… (g) the requirements of any applicable industry code; and(h) the requirements of any other industry code [under particular conditions]; and…(l) the extent to which [the parties] acted in good faith.’

Review of the Franchising Code of Conduct

Inquiry Recommendations

• Amend Franchising Code to include express obligation of good faith in franchise agreements

• Coverage extends to negotiation/performance under franchise agreement and Code

• Content left to be determined by courts• Applies to both franchisor and franchisee• Cannot be excluded by private agreement between the parties• Obligation cannot prevent party acting in legitimate commercial

interests• Absence of renewal right does not prove bad faith by franchisor• Non-disclosure of franchisee details to prospective franchisees must

be at the request of the franchisee (not the franchisor’s instigation)

Exposure Draft – Franchising Code Regulations

• Substantive obligation: ‘obligation to act in good faith’ enshrined as obligation under the Code

• Definition: inclusive GF definition = (a) honesty + (b) non-arbitrariness + (c) mutual cooperation to achieve franchise agreement’s purposes

• Non-exclusion: can’t draft away the GF obligation• Legitimate commercial self-interest: GF obligation can’t

trump this• Renewal: mere failure to include renewal option does not

amount to breach of GF obligation• Contract law: obligations of good faith under the judge-

made law still apply

Contractual Good Faith and Franchising

Two Chief Justices on the Problem for Practitioners and Parties

• ‘(F)or a number of reasons, some to do with the work of legislators, some to do with judicial law-making, and some to do with the temper and spirit of the times, we can no longer say that, in all but exceptional cases, the rights and liabilities of parties to a written contract can be discovered by reading the contract.’ (Gleeson CJ, 1995)

• ‘Nothing truer can be said of the duty of “good faith” in contract law.’ (Warren CJ, 2010)

Topical Regulation of Good Faith Beyond Contract

Relevant Area of Law

• #1A International commercial law (eg sale of goods, commercial arbitration, etc)

• #2A Transnational commercial law (eg contractual construction and ‘governing law’ clauses)

• #3A Contract law (express, implied, and excluded obligations)

• #4A Franchising agreements

• #5A Australian Consumer Law (indicator of unconscionable conduct - both B2B and B2C dealings since 2012)

• #6A ASIC Act (indicator of unconscionable conduct in financial services)

• #7A State commercial leasing laws (indicator of unconscionable conduct)

• #8A Unfair contract terms regime for B2C contracts under Australian Consumer Law

Practice/Reform Area

• #1B Cross-border business agreements in multiple industry sectors

• #2B Transnational judicial development of common law (eg UK, Australian, HK, and Singapore courts on contractual good faith)

• #3B Australian Government’s Review of Contract Law

• #4B Wein franchising inquiry and draft legislation

• #5B Abbott Government’s ‘root and branch’ review of competition law and policy – potential knock-on effect for consumer regulation too

• #6B Knock-on effect for financial services regulation

• #7B Knock-on effect for commercial leasing regulation

• #8B Live issue for B2B contracts under ‘root and branch’ review

Current Australian Legal Position

• Mixed results over time on whether good faith is implied in commercial agreements• No general term implied by operation of law that:

– parties must act in good faith when negotiating a contract– parties must exercise good faith in performing a contract

• Good faith terms can be implied in specific contracts (eg employment contracts, franchising contracts, or if contract otherwise void for uncertainty)

• Current academic/judicial debate over:– What good faith means (eg honest disclosure, non-arbitrariness, reasonableness – and what kind of

reasonableness?)– Correlation/overlap with cognate obligations (eg cooperation, reasonable endeavours, mutual fidelity to the

bargain)– Whether some notion of good faith underlies all or much contract law doctrine– Whether good faith is an extra term or a rule of construction (ie the method of incorporation)– Whether existing judicial approach of implying good faith terms is correct– What method for implying terms applies in particular circumstances– Limits of good faith obligations in contract (eg legitimate commercial expectations)– Limits to excluding contractual good faith by drafting devices– Relationship between good faith in contract and lack/breach of good faith as an aspect of unconscionable

business conduct

Content/Components of Good Faith (see Mason, Carter, Peden, Seddon etc)

• #1 Honesty:- Broader than just avoiding fraud- Full informational disclosure, at all stages? (commercial-in-confidence v precipitously

‘showing your hand’ v being at risk of bad faith through inadequate or untimely disclosure, especially when the business relationship is breaking down)

- Reputational and legal risks of attempts to exclude• #2 Motivational proportionality:

- Non-arbitrary- Non-capricious- No improper purposes or ulterior motives (eg convenient excuses)- Need for sound commercial basis for action

• #3 Fidelity to the mutual bargain:- Cooperation in achieving mutual benefits- Non-frustration of other parties’ capacity to gain contractual benefits- Problem: extent to which this requires consideration of other parties’ interests- Mitigator: good faith cannot override a party’s legitimate commercial interests

• #4 Reasonableness:- Construed at large or by reference to the contract?- Over-reach by some courts produces both unclear law and undue caution by big

business and legal drafters/advisers, and hence fuels impetus for reform

Drafting Perspectives on Good Faith

• ‘(M)y present feeling is that an attempt contractually to exclude the duty to act honestly would fail [and] what foolhardy entity would be prepared to contract on that basis anyway [but] the possibility of contractually excluding an obligation to act reasonably in [the] objective sense is much more arguably open.’ (Australian state supreme court CJ (de Jersey CJ))

• ‘Commercial parties are now faced with the question of whether they dare to suggest in negotiations that they are not prepared to perform in ‘good faith’ as that may require reasonableness on their part. Alternatively, should they expressly state that they will not behave reasonably, or will that be a “deal-breaker”?’ (Prof Peden)

• ‘Whether you characterise the question as one of ‘good faith’ or of the court believing that it has more wisdom than the parties to determine what is reasonable, the practitioner has a problem … A clear clause will embarrass the judiciary into submission.’ (Canadian practitioner, 1985)

• ‘I find arresting the suggestion that an “entire agreement” clause is of itself sufficient to constitute an express exclusion of an implied duty of good faith and fair dealing.’ (Prominent Australian academic/judge (Paul Finn), 2003)

Client-Focused Analysis of GF Options

• #1: Relevant industry standard/expectation? (eg mining JVs, franchising)• #2: Relevant client preference/need? (eg public v private sector contexts)• #3: Effective combination of clauses for exclusion, eg:

- ‘entire agreement’ clause- ‘sole discretion’ clause- ‘negation of implied terms’/exclusion clause (ie not just GF?)- ‘no other/additional obligations’ clause (ie to cover things beyond implied

terms)- ‘no other dilution of our client’s position by operation of law, to the extent it

can be excluded’ clause (ie to maximise exclusionary effect)- flow-on effect of mixed express/silent treatment of GF throughout agreement

• #4: Other means/doctrines that condition exercise of contractual rights and surrounding conduct – unfair, arbitrary, unreasonable, and unconscientious exercises of powers and discretions

• #5: Supervening regulation by law regardless of parties’ private agreement:- limiting doctrines (eg limits on exclusion clauses)- legislative intrusion (eg ‘unfair contract terms’ and ‘unconscionable conduct’

laws)- other regulation (eg codes of conduct)

Multi-Level Drafting Options on GF

• Use ‘choice of governing law’ clause as default GF position:- cross-border transactions (eg law of NY)- Australian jurisdiction (eg NSW v Victoria)

• Remain silent – leave it to the courts to imply down the track• Impose express, general, and undefined GF obligation on some/all

parties• Impose express, general, and defined GF obligation on parties• Define/confine GF throughout the contract:

- Only some parties in some contexts- Only for some stages of the contract

• Exclude GF to the extent lawfully possible

Practical Implications I

• Commercial clients:- Contract says unconditionally ‘I can do X’ but risks being read as ‘I can do X if I’m not

acting dishonestly, arbitrarily, uncooperatively, unreasonably etc’ – legitimate fear - Capacity to lock down everything by private agreement – illusory hope- Clarity around contractual rights and obligations – genuine commercial concern- Reservation of right to act unreasonably or in bad faith – commercially untenable- Preclusion of honesty as a basic contractual obligation – commercially untenable- Exclusion of good faith to the limits of the law – commercially realistic, if at genuine

arm’s length- Capacity to limit ‘reasonableness’ to ‘reasonable under the contract’ – possible- Evidence-based demonstration of legitimate commercial interests being served –

desirable • Transactional advice:

- Three-pronged approach to advice:Good faith as an express, implied, or excluded contractual obligationAbsence/breach of good faith as an indicator of unconscionable conductFactor in choice of governing law (eg NSW v Victoria, NY etc)

- Limits to drafting around norms of conduct

References

• Rt Hon Lady Justice Arden, ‘Coming to Terms with Good Faith’, Singapore Academy of Law, 2013

• B. Horrigan, ‘New Frontlines in Regulating Unconscionable, Unfair, and Bad Faith Business Conduct’, The Monash Law e-Briefing, June 2014

• B. Horrigan, ‘New Directions in How Legislators, Courts, and Legal Practitioners Approach Unconscionable Conduct and Good Faith’, Queensland Legal Yearbook 2012, Queensland Supreme Court Library, 2013