Mercedes-Benz wins court case against its own local dealers

Key points:

On 30 August 2023 the Federal Court delivered its judgement in in an action brought by 38 Australian Mercedes-Benz dealers against Mercedes-Benz Australia/Pacific Pty Ltd.

The Dealers alleged that Mercedes-Benz AP breached its obligation to act in good faith and engaged in unconscionable conduct as a consequence of non-renewal and end of their dealership agreements and forcing them to convert from a ‘dealership model’ to an ‘agency sales model’.

The Judge held that Mercedes-Benz AP did not engage in unconscionable conduct and did not breach the obligation to act in good faith in breach the Australian Consumer Law.

Industry insiders believe that the judgement is likely to be appealed.

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AHG WA (2015) Pty Ltd Trading as Mercedes-Benz Perth & Westpoint Star Mercedes-Benz & Ors -v- Mercedes-Benz Australia/Pacific Pty Ltd [1]

A group of 38 long standing Australian Mercedes Benz dealers (the ‘Dealers’) commenced proceedings in the Victorian Federal Court against Mercedes-Benz AP after they received notice of non-renewal of their dealer agreements.

Judgement in the case was handed down on 30 August 2023 and has important implications for the franchising sector.

Mercedes-Benz decision to change from a dealership model to agency model

Mercedes-Benz Australia/Pacific Pty Ltd (‘Mercedes-Benz AP’) operated a dealer network in Australia under which Mercedes-Benz dealers were granted the right to sell and service new Mercedes-Benz luxury motor vehicles (the ‘dealership model’).

A dealer was required to make a significant investment in establishing or acquiring a Mercedes-Benz dealership. This included acquiring stock (usually through a finance plan), investing in dealership showroom and service facilities and equipment and goodwill in their businesses involving the sale of new and pre-owned vehicles and service facilities.

Under the dealership model a dealer acquired stock at wholesale prices from Mercedes-Benz AP and could set their own retail sales price to consumers. They were able to offer other products to their customers including a range of after-market accessories or products and insurance.

Many competing brands also operated under a dealership model however other brands (such as Honda) also made the decision to pivot away from that dealership model towards an agency sales model for new-car sales.

The Mercedes-Benz agency sales model started with trials in Sweden and subsequently commenced operation in several countries including Sweden and South Africa.

Mercedes-Benz AP informed its dealer network it would be moving to an agency sales model (which they referred to as ‘retail of the future’) in Australia from January 2022.

Under the new agency model Mercedes-Benz AP would retain ownership of the vehicles, set the retail sales price and contract with the customer. A dealer became a sales agent on a fixed price commission although it could still operate its service and pre-owned car facilities.

Mercedes-Benz AP argued that the benefits of changing to the agency model allowed Mercedes-Benz AP to control the retail sales process of their vehicles (including the price) with dealers handling customer service and deliveries.

Mercedes-Benz AP asserted publicly that the change to a direct-to-consumer strategy would lead to benefits for consumers including a nationwide stock database, more transparent pricing for consumers and reduction of dealer delivery fees.

What did Mercedes-Benz AP allegedly do?

Most of the existing fixed term dealership agreements in Australia were all due to expire at the end of 2021.  There were 3 different agreements considered in the case, each of which had a different provision relating to the term and arrangements at end of term – a 2002 agreement a 2015 dealer agreement term provision and an agreement for the Wollongong dealership.

The applicants alleged that their agreements were ‘evergreen’ which meant that the non-renewal power of Mercedes-Benz AP was constrained so it could exercise the power of non-renewal only if the dealer failed to meet its sales targets, was in breach or failed to make mutually agreed improvements.

At the end of 2020, Mercedes-Benz AP served end of term non-renewal notices on their dealer network to end the dealer agreements and offer new agency agreements to move dealers from a dealership model to a fixed price agency sales model (the ‘agency model’).

The Dealers whose agreements were expiring were given until September 2021 to enter into the new agency agreement or Mercedes-Benz would cease supply of new vehicles.

Mercedes-Benz AP ended the agreements and required the Dealers to sign an agency agreement to change the nature of their businesses from a ‘dealership model’ to an ‘agency model’.  The Dealers claimed that they were economically forced to sign the agency agreement or have their businesses taken from them.

At the heart of the claim is the economic affect that this conduct by Mercedes-Benz AP has had on the ‘goodwill’ of each of the Dealers’ businesses. The Dealers claim that by forcing them to move to the agency model it would significantly reduce their profits and strip them of existing business goodwill and significant customer databases they had built up over many years as a Mercedes-Benz Dealer.

In response, the group of Dealers commenced proceedings seeking $650 million in compensation.

Nature of the proceedings against Mercedes-Benz AP

Essentially the Dealers case appears to have been based on the premise that:

1. The Dealers were entitled to continue to operate under the dealership model permanently if they reached their targets, did not breach the agreement and made mutually agreed improvements.
2. Because of the evergreen arrangements, the non-renewal power which could be exercised without cause by Mercedes-Benz AP did not extend to permitting Mercedes-Benz AP to use that power to continue the relationship under the agency model.
3. The non-renewal notices were invalidly issued.
4. The purpose of issuing the non-renewal notices was motivated by a purpose which was the anthesis of their dealer relationship and dealership model; namely to allow Mercedes-Benz AP to take the current customer relationships and profits to be earned in the balance of the unexpired lifetime of their customers without compensation.

The Dealers argued that the proper purpose of the non-renewal power was to allow Mercedes-Benz AP to bring an end to the relationship where they did not meet the targets or did not carry out the agreed improvements and not to continue the relationship on different terms proposed by Mercedes-Benz AP.

Interestingly the Dealers did not allege or claim that Mercedes-Benz AP had made a representation to them that a Dealer could renew their dealership agreement unless Dealer failed to meet its sales targets, was in breach or failed to make mutually agreed improvements.

Similarly, the Dealers did not allege or claim that Mercedes-Benz AP made a representation that they would not in the future exercise the non-renewal power provided the Dealer met its sales targets, was not in breach or had made mutually agreed improvements.

The Dealers alleged that Mercedes-Benz AP engaged in that conduct for an impugned purpose and that each of the non-renewal notices:

1. were issued in breach of the good faith obligation; and
2. were issued in contravention of certain alleged implied duties owed to the Dealers under their dealership agreements namely:
   • the duty to cooperate to achieve the objects of each dealer agreement; and
   • the duty to act reasonably and in good faith; and
3. The non-renewal notices were issued for a purpose foreign to the power of non-renewal in each of the 3 different forms of dealer agreement.

The Dealers claimed that:

1. the agency model as implemented by Mercedes Benz AP involved an appropriation of their goodwill and customer relationships for no or inadequate compensation. They alleged that the agency model has provided a worse financial return to the Dealers than existed under the prior dealership model.
2. The implementation of the change to the agency model and issuing of non-renewal notices ending the dealership agreements were not the product of a genuinely conducted process and were not conducted in good faith.
3. That Mercedes-Benz AP had appropriated the Dealer’s goodwill without compensation.
4. That Mercedes-Benz AP knew or were recklessly indifferent to the fact that most if not all of the Dealers would be worse off under the agency model.

The Dealers alleged Mercedes-Benz AP breached the ACL and CCA:

1. Firstly, by issuing non-renewal notices to end the agreements that were beyond the contractual power of Mercedes-Benz AP under the dealer agreement – This claim was a contractual claim and the Dealers claimed that given the whole context of the agreement, was the issue of non-renewal notices to end the dealer agreements done for a proper purpose namely to bring the dealer agreement to an end for the purposes of entering into the agency agreement.
2. Secondly, by breaching its obligation to the Dealers to act in good faith – there is an express obligation imposed under clause 6 of the Franchising Code.
3. Thirdly, by cancelling the dealer agreements and forcing the dealers to sign an agency agreement with heavily reduced levels of commission amounted to unconscionable conduct.
4. Finally, the conduct amounted to economic duress to force the Dealers into signing an agency agreement with the threat of restricting supply of available vehicles until the new agency agreement was signed and justified the Court granting of orders to set aside or rescind the agency agreements.

What relief the Dealers wanted

They sought declarations that Mercedes-Benz AP contravened S51ACB of the CCA by breaching the obligation of good faith and that Mercedes-Benz AP engaged in unconscionable conduct in contravention of S 21 of the ACL.

The Dealers sought orders from the Court:

1. To declare the non-renewal notices to be void and to set them aside.
2. To award damages and or orders for compensation for losses the Dealers suffered as a result of implementation of the agency model.
3. To declare the agency agreements, service agreements and parts agreements entered into with Mercedes-Benz AP were all void ab initio.
4. To make Mercedes-Benz AP specifically perform and carry into effect the dealer agreements and to restore the dealers to the full enjoyment of their rights under their dealer agreement as if they continued in full force and effect after 31 December 2021.

What Mercedes-Benz AP argued

In response Mercedes-Benz AP, claimed that their action in ending the dealer agreements and moving to an agency model was justified for competition reasons because of the appearance of disruptors in the auto retailing market.

The Mercedes-Benz AP defence included that:

1. The Dealers did not have an unconditional contractual entitlement to continue as a dealer beyond 31 December 2021.
2. Mercedes-Benz AP had a legitimate commercial interest in moving to a non-negotiable fixed price business model because there was a market shift to online sales; a customer dislike for haggling on price, increased competition amongst luxury car rivals and because rising costs had eroded dealer profitability.

Decision of the Federal Court

The Federal Court found that:

1. The purpose of the non-renewal power conferred on Mercedes-Benz AP was to bring the contractual bargain to an end.
2. The commercial bargain struck by the dealer agreements was not a permanent bargain.
3. It agreed with submissions by Mercedes-Benz AP that:
   • The Dealers sought to rewrite the contractual bargain struck under the dealership agreements into one the better suited their commercial interests.
   • The Dealers sought to convert a commercial judgement they made at the time they entered into the agreements into a guarantee of permanent tenure (subject to qualifications).
   • It was a fetter on the exercise of Mercedes-Benz legitimate business judgement as to how best adapt to a changing marketplace for their brand in Australia.
   • The commercial judgement of each Dealer was that Mercedes-Benz AP would not issue a notice of non-renewal if they performed well as it was assumed to be in the interests of Mercedes-Benz AP and the Dealer for the dealership agreement model to continue.
   • Mercedes-Benz AP could give non-renewal notices without cause.

4. It agreed that Mercedes-Benz AP exercised the non-renewal power for the purpose for which it was created – to end the bargain.

5. It did not agree that the Dealers were subjected to economic duress and not able to give their consent freely to enter into the agency agreements because of threat to end the relationship and cease supply if they didn’t sign the agency agreement.

6. It rejected the claim that Mercedes-Benz AP engaged in unconscionable conduct.

7. It followed previous Court decisions in relation to the treatment of goodwill at end of term including those contained in The Federal Commissioner of Taxation -v- Murray (1998) 193 CLR 605 namely that:

“….goodwill is an asset of the business because it is the valuable right or privilege to use the other assets of the business to produce income. It is the right or privilege to make use of all that constitutes “the attractive force which brings in custom”. Goodwill is correctly identified as property, therefore because it is the legal right or privilege to conduct a business in substantially the same manner and by substantially the same means that have attracted custom to it. It is a right or privilege that is inseparable from the conduct of the business.”

Mercedes-Benz AP argued that the franchised business cannot be conducted in substantially the same manner and by substantially the same means absent the rights granted to the franchisee by the franchisor.

Goodwill at end of term

The Federal Court stated that in a franchise context the legal definition of goodwill is aligned with the legal right or privilege to conduct a business in substantially the same manner and by substantially the same means that have attracted custom to it.

The central pillar of the Dealers case involved the allegation that the purpose of the non-renewal notices was to appropriate the Dealers goodwill and it was unconscionable of Mercedes-Benz AP to appropriate that goodwill in the dealership business without compensation.

The Court found that the arguments raised by the Dealers exhibited a misunderstanding of the meaning of goodwill at law. The Court found that the Dealers equated the accounting definition of goodwill with the legal definition when they were in fact different.

Goodwill from an accounting perspective is essentially subjective, reflecting the excess a purchaser is willing to pay for a business or the discount a seller is willing to accept for the same. At law the existence of goodwill is objectively ascertained.

The Court held that in respect to the nature of goodwill at law under a franchise agreement:

1. Goodwill is property because it is the legal right or privilege to conduct a business in the same manner and by the same means that attracted custom to it.
2. It is an asset of the business because it is a valuable right or privilege to use the other assets of the business to produce income.
3. It is only when a person holds that right or privilege that they hold goodwill constituting property.

The Court referred to other cases including the decision in Ranoa Pty Ltd -v- BP Oil Distribution Ltd (1989) 91 ALR 251 where the court held on termination or expiration of a franchise agreement (and lease of a petrol station) that the franchisee had no right to continue to operating the business and no right (in the absence of any specific provision in the agreement to the contrary) to any goodwill that may have accrued to the business whilst it was operated by the franchisee.

In that case their Honours held that:

“the benefit of goodwill built up by reason of the tenant carrying on a business from the leased premises enures to the benefit of the landlord at the expiration of the term.”

What does this decision mean to the automotive and franchising sectors?

The judgement comprises more than 3752 paragraphs (most of which have been temporarily redacted due to confidentiality concerns) and it will take time to digest.  Unfortunately, most of the judgement may not be released until those concerns have been resolved.

It is possible that the decision may be appealed. The impact of this decision is not limited to the Automotive sector and extends to franchise agreements as well.

The Federal Court has now considered and determined, following an established line of cases the extent to which ‘goodwill’ built-up by a dealer in its business can end at end of term when the agreement expires and is not renewed, or it is terminated before expiry and the right or privilege to conduct the dealership ends.

Importantly, the absence of any right to compensation for goodwill on non-renewal of a franchise agreement is an issue that has for many years attracted the attention of those wanting to change franchising laws in Australia.

End of term issues

Despite changes in franchising laws in relation to the enforceability of restraints of trade where a franchise agreement is not extended, it is clear that no right to compensation and no general right under the Franchising Code is given to a franchisee that allows them to renew or extend their existing agreement or to enter into a new agreement.

Part 5 of the Franchising Code also imposes an obligation on a distributor of ‘new motor vehicles’ to include certain types of compulsory compensation clauses in a new vehicle dealership agreement; that includes in an agency agreement.

Those clauses allow the dealer to claim compensation for the premature end of their agreement caused by certain action of the distributor in ending the agreements before they expire. Those provisions did not apply in this case.

Importantly franchisors are often asked by franchisees about what will happen to their right to continue the business at end of term including whether their agreement will be renewed or extended or whether they can enter into a new agreement at end of term.

A franchisor needs to be careful not to make a representation as to a future matter concerning whether the franchisee can renew or extend their existing agreement or to enter into a new agreement at end of term.

This would include a franchisor either making a representation that the franchisee could renew or extend their existing agreement or to enter into a new agreement if certain things occurred or alternatively that the franchisor would not exercise a right or discretion not to renew or extend their existing agreement or to enter into a new agreement at end of term.

A representation as to a future matter will be taken under the ACL to be misleading unless the person making the representation had reasonable grounds to make the representation at that time.

The Dealers in this case did not allege such a representation was made. The outcome may have been different if in fact such a representation was alleged and established to have been made by Mercedes-Benz AP.

Importantly the Franchising Code provides that:

• The obligation to act in good faith does not prevent a party from acting in its legitimate commercial interests[2]; and
• If a franchise agreement does not give a franchisee an option to renew or allow the franchisee to extend a franchise agreement that does not mean that the franchisor has not acted in good faith in negotiating or giving effect to the agreement at end of term. [3]

This article was written by Derek Sutherland, Consulting Principal, Keypoint Law.

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[1] AHG WA (2015) Pty Ltd Trading as Mercedes-Benz Perth & Westpoint Star Mercedes-Benz & Ors -v- Mercedes-Benz Australia/Pacific Pty Ltd [2023} FCA 1022

[2] Clause 6(6) of the Franchising Code

[3] Clause 6(7) of the Franchising Code