Plaintiff v Defendants

2 The Franchise Agreement was entered into by the Franchisor ("Blockbuster") and the Franchisee ("Bytan") on 24 January 2002 for a term of ten years with an option for a further five years. The Franchisee did not exercise its option to extend the term of the Agreement which, therefore, expired on 24 January 2012. The Agreement gave the Franchisee the right to operate what was defined as the "STORE at the Site" using the Blockbuster system and the marks and business names set out in a schedule to the Agreement. The Franchise Agreement entered into between the Franchisee and the Franchisor was Blockbuster's standard form of Franchise Agreement issued to all franchisees. It was not specifically tailored to the particular circumstances of Bytan beyond the completion of various items in the schedules and the inclusion of particular matters as the standard form ordinarily contemplated. The schedule identified "Blockbuster Turramurra" as the business name and the Site as 8 Eastern Road Turramurra, New South Wales. The Franchisee was the registered proprietor of that land at the time of entering into the Franchise Agreement. Until then it had been operating a video hire store from the premises but not by reference to Blockbuster or the plaintiff's franchise.

3 The Franchisee had become the registered proprietor of the land on 25 August 1995 upon a declared consideration for duty purposes of $850,000. Bytan applied to Blockbuster for a licence to operate a Blockbuster video franchise store on 10 May 2001. In doing so it disclosed total assets of $2,286,000 of which $1,540,000 was real estate in its name. The subject land at Turramurra accounted for $990,000 of that amount and Bytan's net worth was shown as $1,478,000 after taking into account other assets and its liabilities. Bytan was described in the application as being in the business of video rental and investment, and as wishing to operate and grow the assets of the company. Its interest in Blockbuster and the major benefits of franchising as a business concept were described on Bytan's behalf as including "longer term security".

4 The Franchise Agreement conferred upon the Franchisor by clause 18.13 the option (exercisable within sixty days from the expiry of the Agreement) to purchase from the Franchisee "all the assets used in the STORE". Upon the exercise of the option the Franchisor was also entitled to require the Franchisee to close the STORE pursuant to clause 18.18. The Franchisor purported to exercise its rights under clauses 18.13 and 18.18 by letter dated 3 February 2012 but the Franchisee contends that they cannot validly be exercised unless the Franchisor purchases all of the assets of the STORE including the freehold. The letter purporting to exercise the option was preceded by correspondence between the parties in which Bytan had claimed that the Franchisor's option could only be exercised if its proposed purchase of "all the assets" included the purchase of the freehold. The option purportedly exercised by the Franchisor on 3 February 2012 was expressed as based upon the understanding that the proper construction of the Franchise Agreement did not include a requirement to purchase any interest of any kind whatsoever in the real property upon which the business was conducted, and that the Franchisor did not, in the exercise of the option, intend to purchase from the Franchisee the real property or any interest in the real property. The Franchise Agreement required the option in clause 18.13 to be exercised within sixty days of the termination of the Franchise Agreement, namely, 23 March 2012 and the Franchisor has purported to exercise the option within that time period. The parties, however, have also agreed in correspondence between their solicitors that the time in which the option may be exercised is extended to seven days following the decision in this proceeding if the option as purportedly exercised on 3 February 2012 was ineffective.

5 The words in dispute in this proceeding appear in clause 18.13 of the Franchise Agreement. That clause provided:

18.13 Upon termination of this Agreement by FRANCHISOR in accordance with its terms and conditions, upon termination of this Agreement by FRANCHISEE without cause, or upon expiration of this Agreement (without the grant of a Successor Franchise as now specifically described in Section 16), FRANCHISOR shall have the option, exercisable by giving written notice thereof within sixty (60) days from the date of such expiration or termination, to purchase from FRANCHISEE all the assets used in the STORE. Assets shall include, without limitation, leasehold improvements, equipment, furniture, fixtures, signs, inventory and lease or sublease for the Site. FRANCHISOR shall have the unrestricted right to assign this option to purchase.

In this case the Franchise Agreement has been terminated upon expiration of the term on 24 January 2012. That event conferred upon the Franchisor the option to purchase from the Franchisee "all the assets used in the STORE". The critical question is whether those assets must, as a matter of proper construction of the Franchise Agreement, include the freehold.

6 The task of construing the terms of a contract is to ascertain the meaning of the words used by the parties to a contract by reference to what a reasonable person would understand the words to convey.[1] In that task it is permissible to have regard to the objects which a commercial document were intended to secure.[2] Surrounding circumstances may be admissible to assist in the interpretation of a contract if the language is ambiguous or susceptible of more than one meaning.[3] In this proceeding both parties contend that their competing construction of the Franchise Agreement follows from the plain words used in the relevant clause in the context in which they are found in the Agreement itself. The Franchisee contends that the words "all assets used in the STORE" in clause 18.13 must be understood to include the Franchisee's freehold. The Franchisor contends that those words do not include the freehold.

7 I am not able to accept the Franchisee's construction as the natural reading of the words in the context in which they are used. The parties to the Franchise Agreement did not, in my view, purport to confer upon the Franchisor an option to purchase the freehold from which the Franchisee was permitted to conduct the franchise business. What the Franchisor was permitted to purchase from the Franchisee under clause 18.13 were those assets used in the "STORE" as defined. The "STORE" was defined by clause 1.48 of the Franchise Agreement as the Blockbuster Video Store which the Franchisee was granted the licence to operate at the Site pursuant to the Agreement. This definition makes a distinction between the "STORE" (as defined) and the Site from which the business was to be operated. It was not the Site which the Franchisor was permitted, at its option, to acquire by clause 18.13 but the assets used in the STORE, namely, those assets by which the Franchisee operated the business.

8 The Franchise Agreement consistently maintained a distinction between the "STORE" and the Site from which the business was conducted. The Site was defined by clause 1.46 to be the location identified in Schedule Item 2 of the Agreement and included both the interior and exterior of the "structure housing the STORE". The "STORE" was defined by clause 1.48 to be the video store which the Franchisee was granted the licence to operate at the Site. The right to occupy the premises was not something granted by the Franchisor. The Franchise Agreement, however, plainly contemplated that one of the assets "used in" the STORE, which the Franchisor might acquire under clause 18.13, would be any leasehold interest for the Site. That is clear by clause 18.13 itself. It is plain that the Franchise Agreement was drafted upon the hypothesis that a Franchisor would have the option to acquire the assets of the STORE for the purpose of enabling the Franchisor to permit another Franchisee to continue conducting the franchise business after the expiration of the Franchise Agreement. It was those assets by which the franchise business was conducted and by which the Franchisor's option and corresponding obligations would be triggered. The Franchise Agreement plainly contemplated that it would include the right to use the premises where that right was a leasehold interest. It did not expressly contemplate, and I do not consider the words capable of including, the freehold.

9 The possibility that a Franchisee might be the owner of the freehold from which the franchise business might be operated was contemplated in the Agreement. Clause 3.9 provides:

3.9 If FRANCHISEE owns the Site, whether it is a new Site or Conversion Site, at the request of FRANCHISOR, FRANCHISEE shall enter into a lease with the FRANCHISOR for a term equal to the Term of the Franchise, and will sublease the Site from FRANCHISOR, on the same terms as the head lease.

This clause may have been placed somewhat inappropriately in section 3 of the Franchise Agreement because clause 3.1 identifies the application of section 3 to circumstances which, on one reading, might never apply to those contemplated by clause 3.9. The first sentence of clause 3.1 provides:

3.1 This Section applies where the STORE is to be constructed under a Development Agreement or the STORE is to be operated on a site which is not an existing Video Store or the STORE is an existing BLOCKBUSTER Video Store.

Some ambiguity of meaning of this clause may be introduced by the use of the word "or" in two places and by the potential doubt about whether its opening words are intended to limit the operation of the section as a whole. It is, however, clear that the plain words of clause 3.9 have operation beyond a restricted meaning of clause 3.1. Clause 3.9 applied to the circumstances of the Franchise Agreement between Blockbuster and Bytan. The Site was a Conversion Site within the meaning of clause 3.9 and the Franchisor could, had it elected to do so, have required the Franchisee to give Blockbuster a lease which Blockbuster would then have subleased back to Bytan for the term of the Franchise Agreement on the same terms as the head lease. Had that occurred there could be little doubt that the unexpired term of any such lease would have been one of the assets that Blockbuster would have had to purchase under clause 18.13 upon the exercise of the option. For present purposes, however, the point is that those drafting the Franchise Agreement were conscious of a difference between freehold and leasehold interest as the basis upon which the Franchisee might operate the business. What the Franchisor was to purchase under clause 18.13 were the assets used in the STORE but was not required to purchase the premises from which the STORE was conducted. The assets to be acquired were to include a lease where one existed but those drafting the Agreement did not extend the meaning of the assets used in the STORE to the freehold title which the Franchisee might have had. The presence of clause 3.9 tells against a construction of clause 18.13 as conferring upon the Franchisor an option to acquire the freehold.

10 There are other features of the drafting of the Franchise Agreement that support the construction maintained by the Franchisor. One is the presence of detailed provisions dealing with the position of a Franchisee with a leasehold interest as compared to the absence of corresponding provisions where the Franchisee is the owner of the freehold. Thus, for example, there are detailed provisions dealing with aspects of the amount to be paid for the length of the remaining term of any lease or sublease for the Site of the STORE. Clause 18.15 identifies the purchase price for the assets as being "the fair market value, determined as of the date of termination or expiration" of the Agreement. Specific matters are identified in that clause for the purpose of determining the fair market value, including the length of the remaining term of the lease or sublease. What is noticeably absent is any indication of any matters to be taken into account for the purpose of determining the fair market value of the freehold. The same is true about clause 18.17 which provides for what is to occur upon settlement of the purchase of the assets contemplated by clause 18.13. Clause 18.17 identifies the instruments to be provided by the Franchisee at the settlement of such a purchase. One of the instruments identified is "the lease or sublease for the Site". There is no mention of a Certificate of Title or a discharge of any mortgage in respect of the freehold. Clause 18.17 does provide that the Franchisee was to provide an instrument at settlement of "good and merchantable title to the assets purchased" but that reference, especially in light of the specific mention of the lease or sublease, cannot reasonably be construed as including a reference to a Certificate of Title or a discharge of mortgage. It is plainly a reference to the assets used in the video hire business such as chattels and fixtures.

11 Another example of the close attention in the drafting of the Franchise Agreement to the details needed to be provided for in the case of a Franchisee with a lease and the contrasting absence of details in the case of a Franchisee owning the freehold may be seen in the context of the provisions dealing with the Franchisor wishing to transfer the franchise. Clause 15.8 provides that the Franchisor would not unreasonably withhold its approval of the transfer of a franchise provided that the conditions of clause 15.8 are met. It is a detailed and lengthy provision and applies to all circumstances coming within the defined term "Franchisee Transfer". Clause 1.24 defines that term with some precision but makes no mention of the freehold.

12 Clause 3.7 also reveals the drafter's appreciation of a difference between the position of a Franchisee embarking upon the franchised business under a lease and the position where the Franchisee has ownership of the freehold estate at which the business is conducted. Clause 3.7 requires the Franchisee to obtain "Lawful Possession" for the conduct of the franchised business in terms directed primarily to a Franchisee whose possession depends upon a lease. Clause 1.33, however, defines "Lawful Possession" to include the acquisition of an estate or interest in the Site and, in that event, required the Franchisee to settle the acquisition and to receive the relevant deed or registered Certificate of Title conferring upon the Franchisee the immediate possessory rights with respect to the Site. The possibility of the Franchisee owning the premises was, therefore, contemplated by the parties and the consequences for the parties in that circumstance were expressly dealt with when relevant. The parties, however, did not provide for any of the matters that would be expected to be dealt with if the Franchisor was also obtaining an option to purchase land. There are none of the safeguards for a potential purchaser to secure title or any attempt to ensure compliance with any conveyancy requirement which one would expect to find if the Agreement was intended to operate as an option to purchase real estate.

13 The construction I adopt is consistent with the commercial purpose sought to be achieved by the parties through the Franchise Agreement. The parties sought to deal with the conduct of a business. Neither was dealing with the sale of land. Blockbuster is a Franchisor of a business and not an investor in real estate. Bytan sought to acquire the right to conduct a franchise business from a Site and not to sell, or to give an option to sell, its real estate. Neither the Franchise Agreement nor any document forming part of, or connected with, the bargain between the parties, or which existed at any time until the dispute between the parties, suggested in any way that the deal between the parties was to be, or was to include, the sale of freehold. In my view Bytan (and any other Franchisee) would have been surprised to have been told that entering into the Franchise Agreement had conferred upon the Franchisor an option to purchase the land at a non specified price upon termination of the franchise, and, furthermore, without a fee. The grant of an option over the freehold would be a significant commercial transaction of a kind that is unlikely to be intended to have been included in a clause directed primarily to the acquisition of items of trading stock used in a video hire store. It is one thing for clause 18.13 to include leases in the meaning of the words "all the assets used" in the STORE but quite another to say that they did not need to specify that the freehold was also to be included because it was included in any event. Indeed it is the improbability of the words "all the assets" being understood to include real property that may explain the parties' caution of expressly including leasehold interests within the meaning of the term. Another consideration against the Franchisee's construction can be seen from the improbability of the parties wishing to put themselves in the position that the option could only be exercised if the Franchisor purchased the freehold. The requirement that the Franchisor purchase "all" of the assets upon exercise of the option is in part a protection for the outgoing Franchisee by ensuring that all of the franchise assets are acquired, but it is improbable that the Franchisee would, by mere implication, put itself in the position of being compelled to sell the freehold at the election of the Franchisor. It is also improbable that the Franchisor would put itself in the position of not having the right to choose whether or not to purchase the freehold if it had otherwise wanted the ability to acquire the freehold as well as the other assets upon termination of the franchise. The Franchise Agreement would be expected to deal specifically and in detail with the sale of so significant an asset and to include detailed provisions concerning other parties with potential claims upon the real estate.

14 I do not think that regard to surrounding circumstances is permissible in this case because I can see no ambiguity in the meaning of the words used in clause 18.13. However, if regard is had to the surrounding circumstances, they do not support the construction urged upon me by Bytan. Bytan contends that the location of the premises was an important factor in the successful operation of the business. That may be accepted, but the importance of the location tells against rather than in favour of Bytan's argument. The significance of the location suggests that the parties would have been concerned to ensure an express dealing with the freehold if they had intended to include it amongst the assets the Franchisor could acquire upon termination at its option. One might, for example, have expected to see separate consideration, or at least acknowledgment of consideration as part of that moving from the Franchisor, for the grant of so valuable a right as an option to acquire a commercially significant freehold. Furthermore, both parties were aware that Bytan was, amongst other things, an investor in real estate and that the land from which the franchise was to be conducted was a significant asset. Those circumstances make it unlikely that those entering into the Franchise Agreement intended that Bytan would grant, without specific mention, an option for its investment premises to be acquired by the Franchisor.

15 The Franchisor exercised the option under clause 18.13 by letter dated 3 February 2012. In that letter it also required Bytan to close the STORE pursuant to clause 18.18. Bytan contends that the right purportedly given to Blockbuster by clause 18.18 cannot be exercised. The contention was made upon the basis that the option under clause 18.13 had not validly been exercised (which I have rejected) and upon the separate and independent basis that "the right to exercise the option to purchase the STORE is only available where Blockbuster either itself or through a new incoming franchisee intends to continue operating the STORE - it is not available to simply [sic] punish the outgoing franchisee by shutting it down". Later in Bytan's written submissions it contended that "the overwhelming inference [from the evidence] [was] that the object which Blockbuster is seeking to achieve by requiring the STORE to be closed is a defacto restraint".[4]

18.18 If FRANCHISEE cannot deliver clear title to all of the purchased assets as aforesaid, or in the event there shall be other unresolved issues, the closing of the sale shall be accomplished through an escrow. Further, FRANCHISEE and FRANCHISOR shall, prior to closing, comply with all legal requirements applicable to such purchase. FRANCHISOR shall have the right to set off against and reduce the purchase price by any and all amounts owed by FRANCHISEE to FRANCHISOR, and the amount of any encumbrances or liens against the assets or any obligations assumed by FRANCHISOR. If FRANCHISOR or its assignee exercises this option to purchase, pending the closing of such purchase as hereinabove provided, FRANCHISOR shall have the right to appoint a manager to maintain the operation of the STORE. Alternatively, FRANCHISOR may require FRANCHISEE to close the STORE during such time period without removing any assets from the Site. FRANCHISEE shall maintain in force all insurance policies required pursuant to this Agreement, until the date of closing. If the Site is leased, FRANCHISOR agrees to use reasonable efforts to effect a termination of the existing lease for the Site and enter into a new lease on reasonable terms with the landlord. In the event FRANCHISOR is unable to enter into a new lease FRANCHISOR will indemnify and hold harmless FRANCHISEE from any ongoing liability under the lease from the date FRANCHISOR assumes possession of the Site.

This clause is directed to facilitating the acquisition of the enterprise franchised by the Franchisor from the Franchisee. Amongst the rights given to the Franchisor in that context is the right "to close the STORE". It does not give the Franchisor a right to require that the Site not be used for any other purpose. It does not confer upon Blockbuster the right to prevent Bytan leasing the premises to another person or to conduct another business. It does, however, give Blockbuster the right to require that the STORE (as distinct from the use of the Site) be closed. That may not prevent Bytan from operating a different video business from the same Site using its own assets or assets from other sources. What it does mean, however, is that Blockbuster is entitled to secure its business interests, by amongst other things, requiring the STORE to close pending the settlement of the purchase of the assets. That it has no intention of conducting (or may not be able to conduct) the business from the Site is not relevant to an exercise of the contractual right. The Franchisor is entitled to protect its business interests by requiring the STORE to close until the purchase of the assets used in the STORE. In any event, there is no evidence that Blockbuster is seeking to exercise the right in clause 18.18 "to punish" or as "a defacto restraint" as was asserted. Indeed, in a letter dated 19 March 2012 from Bytan's solicitors to Blockbuster's solicitors the former conveyed to the latter Bytan's instructions that it was "not prepared to lease the STORE" to Blockbuster. There is no basis upon which the Franchisor should not be entitled to exercise its right under clause 18.8 to require the closure of the STORE pending an expeditious purchase of the assets.

17 Accordingly, the orders in this proceeding will be to dismiss the summons by the first defendant dated 26 March 2012 and orders and declarations in favour of the plaintiff as follows:

1. A declaration that on the proper construction of the Franchise Agreement entered into between the plaintiff and the defendants on or about 24 January 2002, the expression "all the assets used in the STORE" in clause 18.13 does not include the real property known as 8 Eastern Road, Turramurra in the State of New South Wales and contained in Folio Identifier 4/12905 and 5/12905.
2. A declaration that by written notice dated 3 February 2012 (being the notice referred to in paragraph 14 of the affidavit of Victoria Nomikos sworn 13 February 2012) the plaintiff has validly exercised the option set out in clause 18.13 of the Franchise Agreement.

1. An order that the first defendant close the STORE (as defined in the Franchise Agreement) for the entirety of the time period commencing 11 May 2012 and concluding at the time when the purchase of the assets used in the STORE is completed pursuant to the plaintiff's exercise of the option in clause 18.13 of the Franchise Agreement.

1. The defendants pay the plaintiff's costs of enforcing the Franchise Agreement pursuant to clauses 20.13 and 20.14.

I will hear the parties on any additional questions concerning the costs of this proceeding.

BB AUSTRALIA PTY LTD (formerly known as Blockbuster Australia Pty Ltd) (ACN 058 986 673)

[1] Maggbury Pty Ltd v Hafele Australia Pty Ltd [2001] HCA 70; (2001) 210 CLR 181, 188 (Gleeson CJ, Gummow and Hayne JJ).

[2] McCann v Switzerland Insurance Ltd [2000] HCA 65; (2000) 203 CLR 579, 589 (Gaudron J).

[3] Western Export Services Inc & Ors v Jireh International Pty Ltd [2011] HCA 45; (2011) 86 ALJR 1; Codelfa Construction Pty Ltd v State Rail Authority (NSW) [1982] HCA 24; (1982) 149 CLR 337, 352 (Mason J).

[4] Cf BB Australia Pty Ltd v Karioi Pty Ltd [2010] NSWCA 347; (2010) 278 ALR 105.