When Jean Florence Ketchell commenced a franchising relationship with Master Education Services on 1 February 1999, she would have had no premonition that her name would become famous within the Australian franchising sector. KetchellÍs Case, as the decision in Ketchell v Master Education Services Pty Ltd (2007) NSWCA 161 is invariably referred to, is the most significant franchising decision in AustraliaÍs history and is the first case on the Franchising Code of Conduct to be heard by AustraliaÍs highest court, the High Court of Australia.

By the time this article is in print, the High Court will have heard the franchisorÍs appeal challenging the decision of the New South Wales Court of Appeal that the franchisorÍs entering into a franchise agreement without receiving from the prospective franchisee a written statement that the franchisee has ñreceived, read and had a reasonable opportunity to understandî the Disclosure Document and the Franchising Code of Conduct as required by clause 11.1, rendered the agreement illegal and unenforceable by the franchisor. If the Court of Appeal decision is not overturned, the franchisor will not be able to recover unpaid royalties. The High Court heard the appeal on 10 June and its decision is expected in September.

The Ketchell saga is of great significance to the franchise sector. It raises both legal and wider issues.

The legal issues

That the High Court heard the Ketchell appeal is in itself an indication of the significance of the decision. There is no automatic right of appeal from a decision of a State Court of Appeal to the High Court in a civil matter. The High Court must first grant special leave to appeal. Cases must raise a significant issue of public interest. Leave to appeal is granted only in about 15 per cent of cases in which it is sought.

KetchellÍs Case concerns the difficult area of statutory illegality _ an area of law which has been described as ñshadowyî, ñnotoriously difficultî, replete with ñmany pitfallsî, marked by ñobscurities, supposed distinctions and questionable techniques of decisionî, and ñintensely controversial and confusedî (see Justice Michael KirbyÍs judgement in Fitzgerald v FJ Leonhardt Pty Ltd [1997] HCA 17).

Contracts made in direct contravention of statutory requirements preventing their formation are illegal thus rendering the contract unenforceable. The Trade Practices Act (under which the Franchising Code of Conduct is prescribed by regulation) for example prohibits the making of price-fixing contracts between competitors. Such contracts are illegal and unenforceable. While the Code does not prohibit the making of franchise agreements per se, it does in clause 11.1 expressly provide that a franchisor ñmust notî enter into a franchise agreement unless the written statement referred to above has been received.

The illegality in KetchellÍs Case flowed from the legislative command providing that the franchisor ñmust notî enter the agreement without receipt of the statement. The related requirement of clause 11.2 _ that the franchisor must receive from the franchisee a signed statement that specialist advice has either been given or has not been sought _ is prefaced by a different formula: ñbefore a franchise agreement is entered into, the franchisor must have received [the statement]î. Because the actual making of the contract in is not prohibited in this case _ the ñmust notî formula is not used _ the consequences of illegality would be unlikely to follow and the contract would be enforced. Any remedy would depend on the proof of loss that was a consequence of failure to provide the statement.

In Ketchell it was not disputed that the franchisor was in breach of clause 11.1: the franchisor had not received the written statement from the franchisee. However, it was also not disputed that the franchisor had provided as required by the Code the disclosure document, a copy of the Code and the opportunity to read and understand the documentation. The breach was what is commonly referred to as a technical breach. The Court at first instance accepted that no loss has been shown to have been suffered by the franchisee as a result of the non-compliance. The Court of Appeal nevertheless overturned the decision of the Supreme Court in favour of the franchisor and held that what was prohibited was not just conduct _ failure to receive the written statement_ but the contract itself and the recovery of money under it.

The Court of Appeal was not sympathetic to the argument that the breach was merely ñminor, technical or proceduralî commenting that ñthis is an argument that needs to be taken up with the Parliamentî. In any event the franchisorÍs breach was not regarded as inconsequential _ ñthe disclosure requirements of Code were clearly enacted for the protection of prospective licenseesî.

The wider issues

As is common knowledge the Franchise Council of Australia took the unprecedented decision to fund the costs of both franchisor and franchisee in the High Court appeal on a capped fee basis and FCA members have voluntarily contributed to this cause. In a communication to all FCA members, executive director Steve Wright emphasised that this was not a decision to support a franchisor against a franchisee, but to bring clarity to an issue of serious significance for the sector Australia wide. There was not unrealistic concern that the Ketchell decision in the Court of Appeal ñcould be a launching pad for a trend towards opportunistic litigation, which could be time consuming, expensive and distracting, with serious negative impacts on franchisors and franchiseesî.

Disputation between franchisor and franchisee is inevitable from time to time, but a very real strength of the Australian franchise sector is that both sides of the equation are not overly aligned on factional lines in combative mode. It would be highly unfortunate if franchisees read a ñthem versus usî dimension into the High Court appeal.

In the Ketchell case itself the Court of Appeal decision prevented the franchisor from enforcing the contract but as the ACCC itself points out, ñit is possible that the case will be sought to be relied upon by a franchisor seeking to defend contractual claims brought by a franchiseeî (John Martin, ACCC Small Business Commissioner in a paper ACCC Report Card on Franchising Issues delivered to the 2007 FCA Legal Symposium). Franchisee resales may be affected if the franchisor does not have on file the signed statement. Martin indeed comments that:

Judicial analysis contained in case law does support an argument that section 51AD and clause 11 should be interpreted in such a way as to allow a franchisee agreement whether the franchisor has not complied with clause 11 of the Code, but the comments of President Mason in Ketchell do not provide any assistance in support of such an argument. The strongest reason why such an argument should be accepted is that it could not have been ParliamentÍs intention, and it would be absurd, if a franchisee was deprived of any contractual rights because a franchisor failed to comply with its obligations (inserted into the Code for the purposes of protecting the franchisee) under clause 11 of the Code.

The Ketchell conundrum is both an unintended consequence of a regulatory scheme in which the quality of the drafting does not match the quality of the overall vision and an unfortunate consequence of a perverse Court of Appeal decision. n

Andrew Terry, Australian School of Business at UNSW and Special Counsel, Deacons