Luce Optical v Budget Specs [2005] FCA 1486 | Case summary

(a) Manual historical accounting records, particularly cash receipt books; (b) Historical sales ledger; (c) Historical debtors ledger; (d) Historical purchase ledger; (e) Historical bank statements and related banking records; (f) Historical sales reported to Budget Eyewear, the Franchisor; (g) Historical Hi-Cap and RX Flex records in hardcopy; (h) Patient files in hardcopy; (i) Schedules of current & historical product pricing; (j) Supplier purchase orders; (k) Any other books and records related to the Franchise. 14 Ms Wild says that although she was not at the site when Mr Maloney, Mr Frost and Mr Taylor arrived, when she did arrive she was advised of these events by Mr Livoni. Ms Wild says on information and belief that Mr Livoni asked the gentlemen what would happen if Luce Optical refused to allow the audit to take place and Mr Livoni was told that the franchisor's representative and its agents would 'pull down the door and close the site immediately if Luce Optical did not comply'. Ms Wild says she then attempted to ring Luce Optical's solicitor who was in court. Ms Wild then spoke to the franchisee's accountant, Mr Carlos Fernicola, who expressed some concern about the privacy of information in relation to customers (patients) of Luce Optical. Ms Wild says she heard Mr Frost speak to Mr Fernicola and heard Mr Frost say that they (the franchisor and its agents) were entitled to do what they were doing, that there was nothing that the franchisee could do about it and that if the franchisee resisted in any way the franchisor was entitled to immediately close down the franchisee's business. Ms Wild says that she felt she had no alternative but to allow the process taking place to occur. 15 Ms Wild says that the franchisor's agents, Ferrier Hodgson copied a range of records including information in relation to the customers of Budget Eyewear Mt Gravatt (the franchisee). Ms Wild says she was concerned that the copying of this information might involve breaches of the privacy legislation. Ms Wild says that the franchisor's agents, Ferrier Hodgson, had a photocopy machine with them and copied a range of records. Ms Wild says that Ferrier Hodgson asked both Larry Livoni and Ms Wild a lot of questions about receipt books and that both she and Mr Livoni assisted "as best as possible, however, I was still dismayed at the search and inspection of records". 16 Ms Wild says that both she and Mr Livoni asked what would happen if either of them did not answer questions asked by Ferrier Hodgson and they were told by Ferrier Hodgson that failure to cooperate would not be in their best interests. Ms Wild says that in addition to the written records Ferrier Hodgson took a copy (forensic image of data) of the computer hard drive at the site. 17 Ms Wild says that at approximately 10.15am on 25 October 2004, a facsimile was received at the site notifying the franchisee that all Budget Eyewear stores were going to be audited. The notice dated 25 October 2004 from Mr Tony McKechnie on behalf of Budget Eyewear (the franchisor) says, 'We have today commenced the process of including franchisee's in the Budget Eyewear audit program. A number of stores have been selected for audit and over time all stores in the Budget Eyewear Group will be audited.' 18 Ms Wild says that during the course of the morning she was able to speak to the franchisee's solicitor but by then the process underway had progressed substantially and most of the information on the computer hard drive had been copied and may of the documents had been physically photocopied. The process conducted by the franchisor and Ferrier Hodgson resumed on the following day, 26 October 2004. 19 Ms Wild says that no prior notice was given of the proposed audit and that the arrangements made by Mr Maloney were designed to mislead her as to the nature of the meeting which was to take place on Monday, 25 October. Ms Wild says that the appointment must have been made on the pretext of a marketing meeting so as to ensure that someone of authority would be present when Mr Maloney brought Ferrier Hodgson to the site to conduct the particular process the franchiser had in mind. Mr Maloney says in his affidavit that he made the appointment with Ms Wild and Mr Livoni for the meeting on the morning of 25 October to discuss some marketing issues. Although Mr Maloney deposes to having made an appointment for 24 October and attendance at the franchise site on 24 October, he is simply mistaken about that having regard to all the other evidence. The visitation clearly took place on the morning of Monday, 25 October. Mr Maloney says that he attended the store with Mr Frost and Mr Taylor from Ferrier Hodgson and that when he entered the store he said, 'I'm here to discuss your marketing issues and I'd like to introduce Jason Frost and his associate who are here to conduct an audit'. Mr Maloney says that, at that time, Mr Frost provided the Notice of Inspection and Audit to Ms Wild who responded that she needed to contact her lawyer and said, 'We aren't happy about this but it looks like we can't stop you'. Mr Maloney says that Mr Frost said, 'This is what I need access to [and went through a list of things]. We're going to take a copy of your computer. I've got some colleagues who are going to assist me. We'll be taking photocopies of your records. Where's the best place for us to set up so we don't cause you any disruption?' 20 Mr Maloney says that, 'once agreement was obtained from Ms Wild and Mr Livoni to proceed with the inspection', Mr Frost made arrangements for his colleague to set up a photocopier and take a copy of the hard drive of the computer. Mr Maloney says that as the inspection was proceeding, he said to Ms Wild and Mr Livoni, 'Would you like to discuss the marketing now?' and Ms Wild replied, 'You've got to be joking.' Ms Wild also says that the process taking place at the franchise site was causing suffering and severe disruption. Mr Maloney says that most of the activity being undertaken, photocopying material, copying the hard drive and the presence of the three individuals at the site occurred in the waiting area as this was the only space available. Mr Maloney says he stayed at the store throughout the day and left at 3.30pm. Mr Maloney says that at no time did Ms Wild or Mr Livoni ask either Mr Maloney or Mr Frost or M Taylor to leave. 21 Mr McKechnie is employed by the Respondent as Group Loss Prevention Manager. Mr McKechnie says that upon the completion of the process implemented at the franchise site, it was the responsibility of Ferrier Hodgson to review the information collected and prepare a report. In order to complete the report it was necessary for Ferrier Hodgson to seek certain information from health funds and undertake various analyses of data contained within an electronic claims processing and payment system used by approved service providers to health funds described as the Health Industry Claims and Payments Service system, commonly described as 'HICAPS'. 22 Mr McKechnie says that on 19 April 2005 (although the report of Ferrier Hodgson is dated 21 April 2005), almost six months after the process undertaken at the franchise site, Budget Franchising received a report from Ferrier Hodgson and on 29 April 2005 Mr McKechnie wrote to Mr Livoni enclosing 'a copy of the Audit Report prepared by Ferrier Hodgson conducted in your store on 25 and 26 October 2004. Once you read the report, you will no (doubt) realise that the Audit Report raises some very serious issues …Given the serious implications of the findings, we feel it appropriate for Budget Specs [Budget Franchising] and its lawyers to meet with you and your lawyers to discuss the report and try to agree on a course of conduct'. A meeting was proposed for 24 May 2005. On 9 May 2005, Budget Franchising was contacted by the solicitor for the Applicant and on 8 June 2005 a meeting took place at the offices of the Respondent at North Ryde in Sydney with the directors of the Applicant, the Applicant's solicitor and Counsel. 23 The report of Ferrier Hodgson was tendered by consent. The report confirms that Ferrier Hodgson was retained by Budget Franchising through its solicitors to conduct an 'independent investigation' of the franchise business of the Applicant and to provide a report on the findings arising out of that investigation. Ferrier Hodgson was asked to review source documents and other available records to determine whether all sales revenue had been recorded in financial transaction software described as 'Optomate' and, in particular, whether transactions recorded in manual cash receipt books had been recorded in Optomate. 24 Ferrier Hodgson was asked to provide an 'opinion' as to whether the franchisee was accurately reporting revenues to the franchisor and, if not, the extent of any shortfall and to 'investigate', in the case of a shortfall, the methods used by the franchisee to 'disguise the under-payment of royalties'. Ferrier Hodgson was further asked to review source documents and other available records to determine whether the transactions notified to health funds for the purpose of claiming health fund benefits differed from transactions by way of value (or as to the nomination of the relevant item sold) from transactions recorded by the franchisee and to provide an 'opinion' whether any differences between the value of transactions notified to health funds and the value recorded in the franchisee's records, constituted a shortfall in sales reported to the Respondent. 25 Ferrier Hodgson was further asked to investigate particular transactions with selected health funds, test the accuracy of reporting by the franchisee of what are described as 'integrity test transactions' and investigate whether there was any evidence of excessive claims made upon health funds. The report confirms that Ferrier Hodgson attended the Applicant's site on 25 and 26 October 2004 to conduct the investigation. 26 The report says the procedures adopted by Ferrier Hodgson and the enquiries made by the firm 'do not constitute an audit in accordance with generally accepted auditing standards. The information has not been subject to an investigation or independent verification by us and as a consequence we have no opinion on the accuracy or reliability of the books, records and financial statements of the franchisee'. (See paragraph 2.2.2 of the report). In a section of the report described as 'conduct of investigation', Ferrier Hodgson records some of the preliminary matters addressed by Ms Wild in her two affidavits. 27 The report says that the 'onsite investigation' commenced at approximately 9.30am on 25 October 2004 with Mr Jason Frost and Mr Joshua Taylor from Ferrier Hodgson undertaking the investigation. A Notice of Inspection and Audit was given to Ms Wild and Mr Livoni and the process of investigation was explained to them. The report confirms that the directors asked to speak to their lawyer. Ferrier Hodgson agreed to that request. The report says that Ms Wild said that she was not able to contact her lawyer but would call the Applicant's accountant to discuss the investigation. Ms Wild requested Mr Frost to speak to the Applicant's accountant 'as the directors did not feel that the investigation should take place'. The report says that Mr Frost spoke to the Applicant's accountant on the telephone for a short period. The report says the accountant expressed a view that he was not certain that the investigation could take place or that a copy could be made of the Optomate database operated by the Applicant. The report says that Mr Frost advised the accountant 'of the right of Budget Eyewear, or its agent, to conduct the investigation and that a notice of investigation had been provided to the directors pursuant to the franchise agreement' and that 'a copy of the computer system was required for the investigation'. 28 Paragraph 3.1.5 of the report confirms that the Applicant's accountant expressed further concern over the possibility that the computer operating the Optomate database may also contain information of a private or confidential nature and that Mr Frost briefly explained that the computer was being used to maintain 'the books and records of the franchise and accordingly it would be subject to the investigation'. 29 After these discussions, the 'investigation then commenced and a forensic image of the computer, within which the Optomate database operates, was obtained' (paragraph 3.1.6). The report confirms that on the morning of the first day of the investigation the directors of the Applicant were provided with a formal notice requiring them to deliver all books and records relating to the franchise for the period 1 July 2002 to 22 October 2004, to Ferrier Hodgson. On the afternoon of the first day of the investigation, the directors were questioned in respect of the manual cash receipt books and availability of records at the site. A part time employee of the Applicant, Ms Mary-Anne Brunjes, was interviewed by Ferrier Hodgson on the second day of the investigation concerning her role, the procedures she followed and what instructions she had been given by the directors particularly in relation to the recording of sales and the use of manual cash receipt books. Other staff of the Applicant were also interviewed. 30 Throughout the report, these events are systemically described as an 'investigation'. 31 On 21 June 2005, a letter was sent by the solicitors for the Respondent to the solicitor for the Applicant enclosing a document described as Notice of Breach and Intention to Terminate Franchise Agreement. By this document, the Respondent gave the Applicant notice of its intention to terminate the Franchise Agreement on 1 August 2005 unless the Applicant remedied nominated breaches by effecting the rectification steps A to E in the Notice by 5.00pm, 31 July 2005. The Notice was given under clauses 16.1, 16.2 and 16.3.8 of the Franchise Agreement and paragraphs 21 and 23 of the Franchising Code of Conduct ("the Franchising Code"). Seven grounds of termination are identified in the Notice. 32 The Applicant says that the Notice of Intention to Terminate subsequently relied upon by the Respondent in a Notice of Termination dated 15 September 2005 rests upon seven grounds derived from the report prepared by Ferrier Hodgson. The Applicant says that the Respondent is not entitled to rely upon any of the grounds of termination because: (a) the power exercised by the franchisor under clause 9.1 of the Franchise Agreement giving rise to the Ferrier Hodgson report could only be exercised upon reasonable notice to the franchisee and no notice was given; (b) the Franchise Agreement is a commercial contract which is subject to an implied term that the Respondent will act in good faith and fairly in the exercise of a power conferred by the Franchise Agreement; (c) the Respondent failed to act in good faith and fairly in the manner of the exercise of the power and in the scope of conduct undertaken in purported exercise of the power. The power is said to have been exercised oppressively, capriciously, in an arbitrary way and for an improper purpose; (d) the obligation to exercise a power under clause 9.1 of the Franchise Agreement upon reasonable notice is either an expression of a proper construction to be given to the terms of the Franchise Agreement itself or alternatively, an incident of the content of the implied duty of good faith; (e) the Respondent failed to exercise the power conferred by clause 9.1 of the Franchise Agreement according to its terms with the result that the process undertaken on 25 and 26 October 2004 is unlawful and of no effect; (f) the exercise of the power constituted a breach of the Franchise Agreement and the Notice of Termination in reliance upon the grounds recited in the Notice of Intention to Terminate constituted a repudiation of the Franchise Agreement by the Respondent. The Applicant asserts that it has affirmed the contract and seeks by way of final relief in the action a declaration that the Notice of Termination dated 15 September 2005 is void and of no effect and an injunction restraining the Respondent from acting upon or implementing a termination of the Franchise Agreement, together with other relief; (g) the report prepared by Ferrier Hodgson is fundamentally flawed by reason of the manner in which the information was obtained, reliance upon erroneous assumptions made within the report, misstatements of fact contained within the report and expressions of opinion without a proper basis; (h) the conduct of the Respondent constitutes a contravention of s.51AC of the Trade Practices Act 1974; (i) the Respondent's failure to prepare and provide, as requested, a 'disclosure document' consistent with the requirements of the Franchising Code constitutes a contravention of s.51AD of the Trade Practices Act 1974 which has the effect of precluding the Respondent from exercising a power of termination under the Franchise Agreement should a basis for termination be established, on the ground that the Respondent's conduct in contravening the Code demonstrates the Respondent is not ready, willing and able to perform its obligations under the Franchise Agreement and its behaviour is repudiatory. 33 Before turning to the grounds of termination and a consideration of the Ferrier Hodgson report dated 21 April 2005, it is necessary to examine the relevant provisions of the Franchise Agreement. The Franchise Agreement contains the following provisions. 34 By clause 2, the Respondent grants the Applicant a franchise to operate one 'Budget store' within a 'location' from nominated premises. The location is described as a 'prohibited area' and the Respondent agrees that it will not open a Budget store or grant a franchise within the prohibited area without the consent of the Applicant during the term or any extension of the term. The prohibited area is a circle within a five kilometre radius from the franchise site. 35 By clause 3.1, the Respondent grants a licence to occupy the premises of the franchise site to the Applicant. Those premises are to be the subject of a lease to Budget Specs Pty Ltd and the licence is to be on the same terms and conditions of the head lease (less one day). All guarantees and securities required by the head lessor are to be provided by the franchisee and its directors at the franchisee's expense. 36 By clause 4, the Applicant assumed the following obligations (among others): (a) to actively and diligently promote the franchise and exercise its best endeavours in the conduct of the franchise 'to promote the mutual business interests' of Budget [the Respondent] and the franchisee (clause 4.1); (b) Mr Larry Livoni will personally supervise and operate the franchise business diligently in accordance with the standards and practices and obligations set forth in the Franchise Agreement and the manuals so as to maximise the revenue and profits of the franchise business (clause 4.2); (d) to be of good character and not indulge in unethical conduct during the term of the agreement (clause 4.4); (e) to observe and maintain the standards in the conduct of the franchise at least equal to those prescribed from time to time by Budget and, in particular, to comply with the methods and procedures set out in any technical manual issued by Budget (clause 4.8); (f) not to be a party to the doing of any matter or thing whereby the goodwill and commercial reputation and overall public image of Budget and/or the franchised premises may be prejudicially affected (clause 4.20); (g) to attend and to ensure that such number of the Applicant's employees as reasonably prescribed by the Respondent attend and participate in training programs as the Respondent may from time to time determine necessary (clause 4.24); (h) to 'observe and comply with at its own expense all governmental, semi-governmental, city, municipal, health, licensing, civic or any other statutory authority or utility, statutes, enactments, ordinances, rules, by-laws, regulations, proclamations, requirements, notices, orders, demands and directions affecting, relating to or in respect of the franchisee, the franchised premises, the occupancy thereof by the franchisee or the conduct thereof by the franchisee' (clause 4.26); (i) to participate in any credit card or other credit scheme or plans operated by the Respondent (clause 4.27); (j) to permit Budget 'upon reasonable notice to inspect and observe the franchise and/or to conduct a stock take of the products then held by the franchisee' (clause 4.29); (k) to 'participate in the arrangements Budget may enter into with any Health Funds or similar organizations which pay or provide optical benefits or rebates in respect of the provision of prescription lens spectacles and contact lenses and other eyewear products to eligible members of such organizations on the terms and conditions agreed to between Budget and the health fund or organization. The franchisee shall not lodge or assist in any way with the lodging of false claims for benefits'. (clause 4.33). 37 By clause 6, the Applicant agrees to pay the Respondent a marketing levy of 4% of the franchisee's annual gross sales calculated monthly and a local advertising, marketing and promotion levy of 2% of the franchisee's annual gross sales calculated monthly. 38 By clause 8, the franchisee agrees to pay the Respondent a royalty of 5% of the Applicant's gross sales. The royalty is to be calculated and payable calendar monthly with the first calculation to be made at the expiration of one month from the commencement date of 24 June 2000. The royalty is payable to the Respondent within 14 days of the last day of the month in respect of which the calculation is made. Fees derived by the Applicant for Optometric consultations are excluded from the definition of gross sales. By clause 1, Gross Sales is defined in this way. 'Gross Sales includes all sales by the Franchisee for the product sold, services dispensed or otherwise disposed of in the conduct of the business by the franchisee (whether from sales for cash or credit and irrespective of the collection thereof) after deducting cancelled customer orders, discounts and/or rebates allowed to customers. Income from the independent practice of optometry on the premises is not included'. 39 The Respondent has an interest in ensuring that gross sales are accurately determined and reported not only for the purpose of ensuring compliance with what the Respondent perceives to be the scope of the Applicant's obligations but also because the proper reporting of gross sales determines the base for the payment of the marketing levy of 4%, the additional promotion levy of 2% and royalties at the rate of 5%. Clause 8 also contains provisions dealing with the treatment of cancelled customer orders, sales to health funds and other matters going to the base on which the royalty payment is to be made. 40 Clause 9 of the Franchise Agreement contains, as Counsel for the Respondent observed, a number of ideas. Clause 9 in its entirety is set out in a schedule at the end of the judgment. The first notion is that 'the Franchisee shall keep a proper set of books of account in relation to the conduct of the Franchise and shall accurately maintain them at all times and shall retain all such books of account for a period of not less than seven (7) years from the conclusion of the financial year to which such books of account relate or otherwise contain entries'. 41 The second notion is that the 'Franchisee shall supply to Budget a yearly, and if requested by Budget, half yearly operating budgets and financial statements for the Franchise in the form required by Budget from time to time no later than sixty (60) days from the end of each year or half year'. 42 The third notion is that the 'Franchisee will at all times during the term of the Franchise permit Budget and its agents to inspect and to take copies of such books of account as well as all other records relating to the conduct of the Franchise'. 43 The fourth notion is that the 'Franchisee shall if required by Budget make such books and records available for inspection at a location stipulated by Budget'. 44 The fifth notion is that the Respondent 'may at any time during the term of the Franchise nominate an independent auditor to examine such books and records and any calculating or other equipment used by the Franchisee'. 45 The sixth notion is that 'if in the opinion of the independent auditor the Franchisee's books of account are not in order and are inaccurate to the extent that the Franchisee's Gross Sales have been understated to the extent of one per centum (1%) or more then the auditor's fees and expenses shall be paid by the Franchisee'. 46 The seventh notion is that 'should the Franchisee's records be inaccurate to the extent of disclosing an understatement of two and one half per centum (2˝%) or more of the Gross Sales then Budget shall have the right to terminate this agreement forthwith without prejudice to any other remedies it may have against the Franchise for breach of this agreement provided that Budget agrees not to exercise its rights to terminate this agreement pursuant to this clause if it is satisfied that the error disclosed was due to factors beyond the Franchisee's control [such as dishonesty by employees] and that appropriate steps have been taken by the Franchisee to guard against a similar occurrence'. 47 The eighth notion is that 'the Franchisee acknowledges that failure by it to prevent such practices by its employees may be construed by Budget as a failure of the Franchisee to properly discharge its obligations pursuant to the covenants' contained in the agreement. 48 The ninth notion is that any amount not paid or underpaid 'as disclosed by the independent auditor or by Budget's inspection of the books of account … shall be paid to Budget immediately the extent of non-payment or under-payment is established'. 49 In relation to these various notions, two aspects of the clause are presently important. The first which has two limbs is that the franchisee will at all times permit Budget and its agents to inspect and take copies of the books of account as well as all other records relating to the conduct of the franchise. A second aspect of the inspection power is the power to require the franchisee to make the relevant books and records available for inspection at a location stipulated by Budget. The second aspect of importance is that Budget may at any time nominate an independent auditor to examine the books and records and calculating or other equipment used by the franchisee. When Ferrier Hodgson and Mr Maloney entered the Applicant's premises at 9.30am on 25 October 2004, they purported to exercise the inspection power and the role of independent auditor. Mr Maloney was the employee of the Respondent in his capacity as National Operations Manager. Ferrier Hodgson were the agents of the Respondent. The Notice of Inspection and Audit dated 22 October 2004 describes Ferrier Hodgson as the agents of the franchisor for the purpose of inspection and the taking of copies of books of account and other records. If the representatives of Ferrier Hodgson were acting in the capacity as agents of the Respondent, standing in the shoes of the Respondent and owing fiduciary duties to the Respondent, there seems to me to be a serious question as to whether Ferrier Hodgson could, at the same time, act as an independent auditor under the clause; see paragraph [11] and clauses 1(a) and 1(b) of the Notice. See also clause 3 of the Notice which directs the Applicant to immediately make available 'to the Franchisor, its agents and its independent auditor all books of account etc'. The Notice of Inspection and Audit nominates Ferrier Hodgson as an independent auditor under the clause to 'carry out this audit under clause 9.1 of the Franchise Agreement'. The notice says that the person managing the audit on site will be Jason Frost from Ferrier Hodgson and the notice serves as the franchisor's introduction of Mr Frost to the Applicant, for that purpose. Mr Frost and Mr Taylor undertook the role of examining the books of account and other records so as to conduct an independent examination and, consequent upon that examination, express the 'opinion' required by the clause as to the extent of the understatement or potential understatement of gross sales by the franchisee. 50 There seems to me to be a serious question as to whether the clause when it speaks of the nomination of an independent auditor contemplates that an audit, as a technical term of art, will be conducted consistent with the standards and protocols governing the conduct of such audits. Secondly, there seems to me to be a serious question as to whether the conduct of such an audit or an examination by an independent auditor, in the circumstances of the case, can be undertaken by Ferrier Hodgson, in the independent way contemplated by the clause. 'Independent' means, 'not depending on another's authority', New Oxford Dictionary of English, 2nd Edition, 2001. 51 Ferrier Hodgson could, quite properly, be appointed or nominated as an independent auditor to examine the books and records and any calculating or other equipment used by the franchisee and express the opinion contemplated by the clause but the difficulty, in this case, at least arguably, is that Ferrier Hodgson was acting both as the agent of the franchisor and at the same time as an independent auditor. It may be that Ferrier Hodgson could act as the agent of the franchisor for the purpose of exercising the inspection power, conclude that role and then assume a role as a nominated independent auditor to exercise the examination power and then express the opinion contemplated by the clause. However, in this case, it seems that Ferrier Hodgson was both the agent of the Respondent in the exercise of the inspection power and at the same time an independent auditor in the exercise of the examination power thus leading to the expression of the third party opinion contemplated by the document. Clause 9.1 (the ninth notion) contemplates a comparison between views emerging out of either an independent auditor's examination or Budget's inspection of the books of account. This juxtaposition of two different roles or two views by different parties also suggests arguably that Ferrier Hodgson could not both be the agent of the Respondent to conduct the inspection and an independent auditor at the same time. 52 Accordingly, it seems to me that there is a serious question as to whether the conduct of the process at the franchise site on 25 and 26 October was in accordance with clause 9.1. The process described by Ferrier Hodgson seems to be not only an inspection and an examination as an independent auditor but a process described by Ferrier Hodgson as an 'independent investigation'. There may also be a serious question as to whether the clause contemplates that an independent investigation could be conducted in the sense of 'investigating the methods used by the franchisee to disguise the underpayment of royalties' as an underlying assumption of a role to be discharged by an independent auditor and whether conducting interviews of the directors and the staff of the franchisee in an investigative way is within the scope of the clause. 53 Whether the nature of the tasks to be undertaken went further than the scope of the clause, in the circumstances, is however open to legitimately different views. Had Ferrier Hodgson simply acted as a nominated independent auditor, the scope of the role would necessarily involve testing independently and at arm's length the range of matters examined in the report. It seems to me that if Ferrier Hodgson could not be both an agent of the franchisor and at the same time an independent auditor, the determination of the matters contained in the report as an independent report, arguably fail. The 'opinion' required by the clause in that event also arguably fails. 54 However, the role as agent of the franchisor to inspect and take copies of the books of account and other records relating to the conduct of the franchise and the power of the franchisor to call upon the franchisee to make the books and records available for inspection at a nominated location remains, prima facie, valid unless other considerations apply. In conducting an inspection of the books of account and other records, the franchisor would, it seems to me, be entitled to test the accuracy of the completion of the records, the extent to which the records exhibit compliance with the Franchise Agreement, the extent to which transactions relating to health funds have been properly recorded and other similar matters. 55 As to whether there are other considerations which give rise to a serious question as to whether the franchisor is entitled to rely upon the report as an expression of the investigation by the franchisor's agent of the relevant records, these matters arise. Clause 9.1 says that the franchisee will at all times permit Budget and its agents to 'inspect' and in a similar way the clause says that Budget may at any time 'nominate' an independent auditor. Clearly enough, the words cannot mean literally what they say otherwise the Respondent would be entitled to nominate 7.30pm, 11.00pm or 2.30am. The words are subject to some implied constraint at least to the extent that the time might be the orthodox business hours of operation of the franchise. The Applicant says that the power of inspection and examination can only be exercised on reasonable notice as a question of construction of the clause to reflect the intention of the parties or alternatively, there is an implied term that the power can only be exercised in good faith and fairly and the requirement to provide reasonable notice is an incident of the implied duty of good faith. 56 Had notice been given to the Applicant, steps might have been taken to seek legal advice as to the scope of the clause, the aggregated role performed by Ferrier Hodgson and the content of the obligations to be discharged by the Applicant. Although the report of Ferrier Hodgson contests (without affidavits from Mr Frost or Mr Taylor) the version of events on 25 October 2004 asserted by Ms Wild, for interlocutory purposes I am prepared to accept the version deposed to. In that version the Applicant was not able to obtain or secure access to a lawyer. No notice was given of the inspection and investigation. The Applicant was told that the process undertaken on the day was entirely consistent with clause 9.1 of the Franchise Agreement. The Applicant was told that if the directors did not cooperate, the franchisor's representative and its agents would close down the site immediately. Mr Frost in response to an expression of concern by the Applicant's accountant as to whether the process was valid, advised that the franchisor was entitled to take the steps being undertaken and that there was nothing that the franchisee could do about it. It seems to me that if an implied duty of good faith and fairness subsists and an obligation to exercise rights and powers reasonably, there is a serious question as to whether the implied obligations have been contravened. 57 If the power of inspection was exercised in breach of the implied duty, a serious question arises as to whether the Respondent is entitled to rely upon the report arising out of the exercise of the power. A further question may arise as to whether the report, if 'improperly obtained', might be admitted into evidence under s.138 of the Evidence Act 1995. 58 As to the question of whether an implied term arises that the Respondent will exercise its powers under the Franchise Agreement in good faith, fairly and reasonably, I am prepared to accept, for interlocutory purposes, that such a duty arises and that a party having a legal right shall not be entitled to exercise it in such a way that the use of the right or power amounts to unconscionable conduct. See Legione v Hateley (1982-1983) 152 CLR 406 at 444, Renard Constructions (ME) Pty Ltd v Minister for Public Works (1992) 26 NSWLR 234 at 267-269, Alcatel Australia v Scarcella & Ors (1998) 44 NSWLR 349 at 363-369, Burger King Corporation v Hungry Jacks Pty Ltd (2001) NSWCA 187 at paras. [141] to [187], Vodafone Pacific Ltd & Ors v Mobile Innovations Ltd [2004] NSWCA 15 at paras. [183] to [216], Hurley v McDonalds Australia Ltd (2000) ATPR 41-741 at paras. [21] to [31], Overlook v Foxtel [2002] NSWSC 17 at paras. [54] to [76], Far Horizons Pty Ltd v McDonalds Australia Pty Ltd (2000) VSC 310 at paras. [119] to [130], Esso Australia Resources Ltd v Plowman (1994-1995) 183 CLR 10 at page 30, Byrne v Australian Airlines Ltd (1995) 185 CLR 410 at 447-453, Breen v Williams (1995-1996) 186 CLR 71 at pages 102-103, Peters (WA) Ltd v Petersville Ltd (2001) 205 CLR 126 at paras. [35] and [36], Service Station Association Limited v Berg Bennett & Associates Pty Limited (1993) 45 FCR 84 at pages 91-99, Hughes Aircraft Systems International v Air Services Australia (1997) 76 FCR 151 at pages 191-193, Australian Competition & Consumer Commission v CG Berbatis Holdings Pty Ltd (2000) ATPR 41-755, Garry Rogers Motors (Aust) Pty Ltd v Subaru (Aust) Pty Ltd (1999) ATPR 41-703 at paras. [34] to [39], Australian Competition and Consumer Commission v Simply No-Knead (Franchising) Pty Ltd [2000] FCA 1365, Pacific Brand Sport & Leisure Pty Ltd v Underworks Pty Ltd [2005] FCA 288 at paras. [61] - [66]. 59 In Pacific Brands Sport & Leisure Pty Ltd v Underworks Pty Ltd at para. 64, Justice Finkelstein has gathered together a range of cases and articles reflecting American jurisprudence supporting the proposition that a duty of good faith is an incident of every commercial contract unless the duty is excluded expressly or by necessary implication and that the duty operates as a fetter upon the exercise of discretions and powers conferred by the contract including the power of termination in circumstances where the elements of a breach of the content of the duty is made out. For present purposes, I rely upon the Australian Authorities referred to in paragraph [58] of these Reasons. 60 The grounds of termination relied upon in the Notice of Termination which in turn relies upon the Notice of Breach and Intention to Terminate are these: (a) 'The Franchisee has engaged in fraudulent conduct in the operation of the franchise. The Franchisee has deliberately failed to record all sales and has understated income in reports to the Franchisor. The Franchisee has underpaid royalties. The Franchisee has falsified records to health funds and has engaged in conduct that has resulted in health funds paying rebates in excess of the rebates that customers are entitled to. Details of the fraudulent conduct is set out in detail in the audit report dated 21 April 2005 prepared by Ferrier Hodgson (audit report).' (b) 'The Franchisee has breached clause 4.4. The Franchisee has failed to record all sales; has under stated gross sales in reports to the Franchisor and has underpaid royalties as set out in sections 4 and 5 of the audit report. The Franchisee has given indirect details in certain health fund transactions listed in section 6 of the audit report to relevant health fund and has claimed incorrect rebates in those health funds transactions. Full details of the breaches are set out in section 6 of the audit report. The Franchisee has knowingly done this.' (c) 'The Franchisee has breached clause 4.20. The Franchisee has been a party to the doing of actions whereby the goodwill and commercial reputation and overall public image of Budget Eyewear may be prejudicially affected. The Franchisee in submitting false claims to health funds and claiming rebates from health funds in excess of the rebates customers are entitled to is conduct which may prejudicially affect the commercial reputation and overall public image of Budget Eyewear. Details of this conduct is set out in section 6 of the audit report.' (d) 'Failure to keep copies of invoices and receipts and other primary documents whether in original form or electronically is a breach of the Income Tax Assessment Act and regulations. The Franchisee has breached clause 4.26 of the franchise agreement.' (e) 'The Franchisee has breached clause 4.33. The Franchisee has given incorrect details in certain health fund transactions listed in section 6 of the audit report to relevant health fund and has claimed incorrect rebates in those health funds transactions. Full details of the breaches are set out in section 6 of the audit report. The Franchisee has knowingly done this.' (f) 'The Franchisee has breached clause 8.1 because the franchisee has failed to pay the correct amount of Royalty to the Franchisor. Based on limited financial information you gave the auditor, the Franchisee owes the Franchisor at least $1,471.70 to the Franchisee for unpaid Royalty for the period 1 July 2003 to 30 June 2004.' (g) 'The Franchisee has breached clause 9.1 by failing to keep accurate books of account relating to the franchised operation. The books of account do not record all sales. The books of account do not record accurate health fund transactions. Details of incorrect reporting is set out in the audit report.' 61 I have taken the view that a serious question arises as to whether Ferrier Hodgson could exercise the examination power as an independent auditor in the circumstances and a serious question arises as to whether the inspection power has been exercised in the manner consistent with the implied duty. I have also expressed the view that a serious question arises as to whether there is an implied obligation to provide reasonable notice prior to the exercise of the power conferred by the Franchise Agreement upon the Respondent and in consequence of these matters, a serious question arises as to whether the Respondent is entitled to rely upon the report. If the report is the emanation of the inspection power and it is open to the Respondent to rely upon the report for the purposes of a further exercise of power, namely the termination power, the grounds of termination need to be addressed. 62 The first two grounds rely upon fraudulent conduct. Ground 1 relies upon a deliberate failure to record all sales and a deliberate understating of income in reports to the Franchisor. Ground 2 asserts the same conduct and also raises the deliberate falsification of transaction details concerning health funds. Ground 2 asserts a breach of clause 4.4. Ground 3 asserts a breach of clause 4.20 on the basis of conduct damaging to the goodwill and commercial reputation of the Franchisor which in turn relies upon the conduct reflected in Grounds 1 and 2. Ground 3 also relies upon the submission of false claims to health funds. As to these three grounds, conscious and deliberate fraud is alleged and it seems to me, for interlocutory purposes, fraud in that sense means the common law notion of fraud formulated by Lord Herschell in Derry v Peek (1889) LR 14 App. Cas. 337 at page 374 (Lord Herschell) and at pages 343 and 344 (Lord Halsbury LC). 63 In the affidavits in response to the allegations contained in the grounds of termination and the content of the Ferrier Hodgson report, Ms Wild and Mr Livoni say that they were not motivated by any deliberate or conscious intention in the way alleged. The first three grounds do not seem to suggest a reckless disregard for the position but allege conscious and deliberate conduct. That conduct is denied. 64 Ground 4 relies upon a failure to keep records required by the Income Tax Assessment Act. The directors of the Applicant say that they have kept all appropriate records to meet the requirements for the lodging of returns for the Australian Tax Office as required by the Income Tax Assessment Act and that the information relevant to those matters is assembled and provided to the Applicant's accountants from time to time to enable appropriate documentation to be produced. Ground 5 relies upon a conscious and deliberate statement of incorrect details concerning health fund transactions. The conscious and deliberate conduct alleged in the ground of termination is denied. Ground 6 relies upon a failure to pay correct royalties in an amount of at least $1,471.70. This amount is determined by the expression of the opinion by Ferrier Hodgson in the report. I have already found that a serious question arises as to whether Ferrier Hodgson could, in the circumstances, act as an independent auditor and form the relevant opinion. As to Ground 7, the Respondent contends that the Applicant breached clause 9.1 by failing to keep accurate books of account relating to the franchised operation. The term 'books of account' is not defined. The Applicant contends that it keeps books of account which reflect profit and loss statements which in turn reconcile with bank deposits and are consistent with the financial statements prepared by the Applicant's accountants for each financial year since commencement of the franchise namely the financial years ending 2001, 2002, 2003 and 2004. 65 The affidavits of Ms Wild seek to contradict various aspects of the report by Ferrier Hodgson. The report suggests based on various analyses that the Applicant has understated sales revenue by $29,434.18 which represents 5.9% of sales reported to the Respondent or 5.6% of what would have been the expected sales taking account of certain adjustments to reflect timing differences between the date of receipt of cash and the date of sales. One fundamental matter which is the subject of real controversy is whether the Applicant has understated gross sales or whether the understatement is confined to a failure to properly record cash sales and other transactions in the financial management software system known as Optomate. It seems to me, although I make no findings about the matter since this is an interlocutory application, that the Franchise Agreement required the Applicant to record all transactions in the Optomate system and that, in practice, the provision of weekly spreadsheets to the Respondent reciting weekly gross sales derived from Optomate was a statement of gross sales in fact for the franchised business. The Applicant strongly contests this notion and says that all sales were and are recorded correctly in the bank deposit statements and that the Applicant has no incentive to understate gross sales through Optomate because all gross sales are reflected in the bank statements. Nevertheless, the Respondent seems to rely upon Optomate reports as a statement of transactional performance of the franchise each week in each financial year. 66 The Ferrier Hodgson report deals with anomalies in relation to the use of manual cash books recording particular transactions, the inability to identify eight 'test' transactions in the Optomate system whereby eight transactional random sales occurred at the instigation of forensic investigators (keeping the relevant records). The aim of these 'integrity tests' was to determine whether the sales could be identified in reported transactions to the franchisor. The report also deals with an analysis of credit card transactions and health fund transactions. As to credit card transactions, a particular statistical result is derived by testing 243 credit card transactions, reflecting a probability of omission of certain transactions from the Optomate system. Paragraph 5.5.8 suggests that 31 of the 243 transactions reflecting $2,687.35 or 7.2% of the value of transactions tested (and 12.8% of the number of transactions) could not be located in the Optomate system. Similarly, 302 health funds transactions with MBF were tested in the financial year ending 30 June 2004. Of these, 48 transactions were said to reveal health fund benefits paid in excess of the maximum entitlement of a member. 36 of the 48 transactions were forwarded to MBF and of those 36 MBF identified records for 29 and of the 29, 24 transactions reflected irregularities. Paragraph 6.4.4 analyses six transactions by reference to a printout from the HICAPS system (see paragraph [21]) and the Optomate system particularly the field notes. The report concludes that in respect of these examples there has been either an understatement of sales revenue recorded in Optomate or, alternatively, the benefit claimed from the health fund is in excess of the amount of the member's entitlement. 67 These are all serious matters which may, properly considered, give rise to a conclusion, ultimately, on all the evidence that the Applicant has engaged in conduct in breach of the Franchise Agreement and has engaged in conduct of the character alleged. For present purposes, however, it seems to me that there is a serious question in relation to the preparation of the report both in relation to the aggregated role discharged by Ferrier Hodgson and in the context of whether the Respondent has discharged the implied duty previously discussed. The affidavits of Ms Wild seek to demonstrate that fundamentally, the Applicant has utilised the Optomate system but for particular transactions such as those in relation to the deposit book, that Optomate was not always functional and that in relation to the arrangements with Veteran's Affairs, there is alleged an arrangement with the Respondent that those transactions would not be processed through Optomate. All of these matters are contested and denied. Each matter needs to be tested. 68 It seems to me that there is a sufficient factual controversy to give rise to a serious question in relation to the grounds of termination. Counsel for the Respondent says that the nature of the relationship between the franchisor and the franchisee is one of trust and that because trust has broken down the relationship cannot be sustained in any workable form. The submission is that in the exercise of the discretion, no order should be made restraining the exercise of the power of termination because the continuing relationship would be dysfunctional and has irreparably broken down. Counsel submits that the Applicant has a remedy in damages should it sustain, at trial, a cause of action for breach. 69 It seems to me that the practical effect of failing to make an order is that the Applicant will suffer an immediate loss of the franchise and may be irreparably damaged in a way which would make a remedy in damages difficult to pursue. The final relief sought in the action involves declarations and injunctions. A claim for damages may be introduced into the proceedings upon the formulation of the Statement of Claim. The aim of the order in restraining the Respondent from giving effect to the termination of the franchise is simply to prevent, pending trial until all questions are finally dealt with, termination of the franchise agreement and the licence to occupy the franchised premises in the circumstances of the case. The question of whether damages would provide the Applicant with an adequate remedy is a matter best suited for determination once all relevant facts are in the possession of the trial judge. In relation to the question of the failure of the relationship between the Applicant and the Respondent and the true nature of that relationship, it may be desirable to preserve the status quo until all the facts can be determined; Bingham & Anor v 7-Eleven Stores Pty Ltd [2003] QCA 402 at paras. [110] to [116]. It seems to me that the balance of convenience favours the making of an order. Accordingly, I will make an order, upon the Applicant and Tracey Maureen Wild and Larry Livoni giving the usual undertaking as to damages, restraining the Respondent by itself, its servants or agents from acting upon or implementing a Notice of Termination dated 15 September 2005 of a franchise agreement between the Applicant and the Respondent dated 23 June 2000. 70 In relation to Visionmax, the Applicant operates a franchise at Shop 21, Brassall Shopping Mall, Hunter Street, Ipswich. Visionmax entered into a franchise agreement on 22 December 1997 and affidavit material has been filed by Mr Max Sarracino, a director of Visionmax. Mr Sarracino deposes to events that also took place on Monday, 25 October 2004 at 9.30am when he was met by five men at the Ipswich store. The circumstances of the implementation of the process at the Ipswich store are described in Mr Sarracino's affidavit of 21 September 2005 and a further affidavit dated 28 September 2005. Mr Sarracino says the events of the morning of 25 October 2004 were 'like something out of a gangster movie'. I do not propose to recount in detail the factual allegations but Mr Sarracino says that the representatives of the Respondent, Tony McKechnie and Mr Simon Tame, and the agents of the Respondent, Ferrier Hodgson, conducted the process in a way which was forceful, dominating, unnecessarily assertive, without notice and unreasonable. 71 The franchise agreement in the case of Visionmax is in substantially similar terms to that of Luce Optical. Clause 9.1 of the Luce Optical document is clause 8.1 in the Visionmax document. In all other relevant respects, the document is the same. For the reasons I have expressed as to the basis for a serious question to be tried concerning Luce Optical, I similarly find a serious question to be tried in relation to the purported termination of the franchise agreement with Visionmax. The Notice of Inspection and Audit similarly appoints Ferrier Hodgson as the Respondent's agents and as a nominated independent auditor. The Notice of Breach and Intention to Terminate dated 22 June 2005 addressed to Visionmax is in substantially similar terms to the Notice addressed to Luce Optical. 72 I propose to make a similar order in respect of Visionmax. 73 It seems to me important to make time available to hear and determine, finally, the factual and legal controversy between these parties and for that purpose I propose to allocate trial dates for the matter, namely, 13, 14, 15, 16 and 17 March 2006. I propose to list the matter for directions for the completion of all interlocutory steps, on Tuesday 25 October at 9.30am. AFFIDAVIT MATERIAL FILED AND READ ON THE APPLICATION BY LUCE OPTICAL · Affidavit of Kimball Charles Gladstone sworn 21 September 2005. · Affidavit of Tracey Maureen Wild sworn 21 September 2005. · Affidavit of Tracey Maureen Wild sworn 28 September 2005. · Affidavit of Larry Livoni sworn 28 September 2005. · Affidavit of John Temple-Cole sworn 3 October 2005. · Affidavit of Lisa Holder sworn 3 October 2005. · Affidavit of Simon Tame sworn 3 October 2005. · Affidavit of Terence Michael Potter sworn 30 September 2005. · Affidavit of Tony McKechnie sworn 30 September 2005. · Affidavit of Barry Morse sworn 30 September 2005. · Affidavit of John Francis Lukin sworn 4 October 2005. · Affidavit of Amanda Harley sworn 1 October 2005. · Affidavit of Sally Green sworn 1 October 2005. · Affidavit of Gary Maloney sworn 30 September 2005. · Affidavit of John Temple-Cole sworn 3 October 2005. AFFIDAVIT MATERIAL FILED AND READ ON THE APPLICATION BY VISIONMAX · Affidavit of Kimball Charles Gladstone sworn 21 September 2005. · Affidavit of Max Sarracino sworn 21 September 2005. · Affidavit of Max Sarracino sworn 28 September 2005. · Affidavit of Moira Gabbedy sworn 30 September 2005. · Affidavit of Barry Morse sworn 30 September 2005. · Affidavit of Terence Michael Potter sworn 30 September 2005. · Affidavit of Moira Gabbedy sworn 30 September 2005. · Affidavit of Simon Tame sworn 3 October 2005. · Affidavit of Tony McKechnie sworn 30 September 2005. · Affidavit of Terry Gabbedy sworn 3 October 2005. · Affidavit of John Temple-Cole sworn 3 October 2005. CLAUSE 9.1 OF THE FRANCHISE AGREEMENT BETWEEN LUCE OPTICAL PTY LTD AND BUDGET SPECS (FRANCHISING) PTY LIMITED "9.1 In addition to the requirements contained in Clause 9.2 hereof, the Franchisee shall keep a proper set of books of account in relation to the conduct of the Franchise and shall accurately maintain them at all times and shall retain all such books of account for a period of not less than seven (7) years from the conclusion of the financial year to which such books of account relate or otherwise contain entries. The Franchisee shall supply to Budget a yearly, and if requested by Budget, half-yearly operating budget and financial statements for the Franchise in the form required by Budget from time to time no later than sixty (60) days from the end of each year or half year. The Franchisee will at all times during the term of the Franchise and with three (3) months of the expiration thereof permit Budget and its agents to inspect and to take copies of such books of account as well as all other records relating to the conduct of the Franchise and shall if required by Budget make such books and records available for inspection at a location stipulated by Budget. Budget may at any time during the term of the Franchise and within three months of the expiration thereof nominate an independent auditor to examine such books and records and any calculating or other equipment used by the Franchisee. If in the opinion of the independent auditor the Franchisee's books of account are not in order and are inaccurate to the extent that the Franchisee's Gross Sales have been understated to the extent of one per centum (1%) or more then the auditor's fees and expenses shall be paid by the Franchisee. Should the Franchisee's records be inaccurate to the extent of disclosing an understatement of two or one-half per centum (2˝) or more of the Goss Sales then Budget shall have the right to terminate his Agreement forthwith without prejudice to any other remedies it may have against the Franchisee for breach of this Agreement PROVIDED THAT Budget AGREES not to exercise its rights to terminate this Agreement pursuant to this Clause if it is satisfied that the error disclosed was due to factors beyond the Franchisee's control such as dishonesty by employees and that appropriate steps have been taken by the Franchisee to guard against a similar occurrence. The Franchisee acknowledges that failure by it to prevent such practices by its employees may be construed by Budget as a failure by the Franchisee to properly discharge its obligations pursuant to the covenants herein contained. Any amount not paid or underpaid as disclosed by the independent auditor or by Budget's inspection of the books of account together with interest on the deficiency at the rate specified in Clause 30 of the Agreement from the date when the amount not paid or underpaid as aforesaid first became payable by the Franchisee to Budget shall be paid to Budget immediately the extent of non-payment or underpayment is established." I certify that the preceding seventy-three (73) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Greenwood.

Luce Optical v Budget Specs

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Judgment (15 paragraphs)

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Cases Cited (12)

Cited By (2)