Federal Court decision signals the end of the road for Mercedes-Benz franchise agreements

Mercedes-Benz Australia/Pacific Pty Ltd (MBAuP) has been found not to have engaged in unconscionable conduct against its Australian dealers when it moved the dealers from long-running franchise "dealer" agreements onto "agency" agreements.

This article examines what this decision means for businesses operating franchise models.

Facts

Mercedes-Benz dealers in Australia operate as independent businesses. Under a dealer agreement with Mercedes-Benz, dealers were able to purchase Mercedes-Benz vehicles at wholesale prices, and resell the vehicles at a price negotiated with their customers. This arrangement effectively gave each dealer the ability to set their own profit margins, and meant that customers could shop around and compare prices between different Mercedes-Benz dealers.

From 2018, Mercedes-Benz issued ‘non-renewal notices’ to its Australian dealers, and shifted to an agency model in January 2022. This shift to an agency model was part of a global strategy being rolled out at the behest of MBAuP’s parent entity, Mercedes-Benz AG (MBAG). Under this agency model, MBAuP retains ownership of the vehicles, has significant control over the sales process, and pays the dealer a fixed commission for each sale.

The claim by the dealers

38 of the 49 Mercedes-Benz dealers across Australia claimed that MBAuP:

1. exerted pressure on them to enter into the agency agreements, placing them under duress to sign the agency agreements with no opportunity for meaningful negotiations;
2. engaged in unconscionable conduct by appropriating the dealers’ goodwill in their businesses without compensation; and
3. contravened its obligation under the Franchising Code to deal with the dealers in good faith by engaging in the unconscionable conduct.

Either party could issue a non-renewal notice to the other party, without cause, at the end of the dealer agreement term. The dealers claimed that their dealer agreements were, in practice, ‘evergreen’, meaning that there was an expectation that they would be renewed, unless the dealer failed to meet a target or make mutually agreed-upon improvements. The dealers also contended that the non-renewal right contained in the dealer agreement did not extend to permitting MBAuP to convert its existing relationship with the dealers into an agency agreement.

The dealers sought to have the agency agreements set aside and receive $650 million in compensation for loss of goodwill and the cost of investments made in their dealerships.

The Court’s decision

Not unconscionable to terminate the dealer agreements

Justice Beach rejected the claim that the dealer agreements were evergreen, noting that the non-renewal power was appropriately exercised by MBAuP for the very purpose for which it existed in the dealer agreement (ie to bring the dealer agreement to an end). His Honour found that the dealers had made a commercial judgement when they entered into the dealer agreements with MBAuP, and the dealers were – in effect – seeking to rewrite that bargain they had reached with MBAuP into one which guaranteed that the dealer agreement would be permanent.

Though it was reasonable for the dealers to have assumed that it would not be in MBAuP’s commercial interests to terminate its agreements with dealers that were performing well, this did not reflect the actual contractual bargain reached between the parties.

Good faith dealings under franchise code

Justice Beach held that the duty of good faith which applied to MBAuP’s exercise of the power not to renew the dealer agreements (without cause) “does not convert an agreement into a contract of indefinite duration.” His Honour observed that:

“If a contractual right or power, which is intended to advance only the interests of the party on whom it is conferred, is fettered by the obligation of good faith, resort to the duty may become an obstacle to the promotion of that party’s legitimate interests. Such a power may be contrasted with one that is concerned with co-operation to produce a result beneficial to all the parties to the agreement.”

In light of these principles, the Court concluded that MBAuP possessed and exercised the power of non-renewal for its own benefit, and that its exercise of the non-renewal power did not constitute a breach of MBAuP’s obligation to deal with its franchisees in good faith.

Not unconscionable to enter into agency agreements

Justice Beach acknowledged that the dealers were left with little meaningful choice regarding the shift to the agency model, and were given limited time to consider the agency agreements, which were provided on a ‘take it or leave it basis’. His Honour also noted:

• There was ‘no doubt that MBAuP played hard-ball in its negotiations with dealers’;
• There was also ‘no doubt that the introduction of the agency model had significantly diminished the upside that dealers had under the dealership model in terms of potentially earning profits’ above what they would earn under an agency model; and
• MBAuP had encouraged the dealers to make long-term investments in their businesses and facilities.

However, the shift to an agency model was clearly connected to the validly issued non-renewal notices contemplated in the dealer agreements. Importantly, his Honour found that MBAuP had not acted unconscionably or failed to act in good faith simply because a dealer would be worse off under the new agency model. The dealers had placed themselves in this ‘situational disadvantage’ in part by entering into these dealership agreements, and accepting the inherent risk that MBAuP could issue a non-renewal notice without cause at the end of the agreement’s term.

What this decision means

Franchisors seeking to bring a contractual relationship to an end can rely on the terms of the bargain struck with their franchisees, as non-renewal by a party for legitimate commercial purposes is likely to be in good faith. However, a franchisor exercising a non-renewal right should be careful to ensure that in observing their duty of good faith, it acts honestly in matters connected to the performance of the contract and its exercise of the non-renewal power. Franchisors should ensure that adequate notice is given to franchisees about any major changes to their commercial relationship, and refrain from ‘hard-ball’ tactics to minimise pushback from potentially aggrieved franchisees.

For franchisees, this judgment should serve as a timely reminder to focus primarily on the terms of the franchise agreement as agreed, rather than relying on implied understandings. Courts are unlikely to assess whether any implied commercial motives or endorsements by a franchisor should act as a handbrake on a party’s contractual rights, including a right of termination. It is only likely to be in instances where a franchisor is acting dishonestly or in pursuit of an ulterior motive that they may be found not to be acting in good faith.

The potential impact on consumers was not considered in this judgment,^[1] though it can be noted that an indirect consequence of this decision is a loss of intra-brand competition, which may result in higher prices due to a loss of competitive tension between Mercedes-Benz dealers in Australia.

Important Disclaimer: The material contained in this article is comment of a general nature only and is not and nor is it intended to be advice on any specific professional matter. In that the effectiveness or accuracy of any professional advice depends upon the particular circumstances of each case, neither the firm nor any individual author accepts any responsibility whatsoever for any acts or omissions resulting from reliance upon the content of any articles. Before acting on the basis of any material contained in this publication, we recommend that you consult your professional adviser. Liability limited by a scheme approved under Professional Standards Legislation (Australia-wide except in Tasmania).