The concept of goodwill in a legal context is different to the concept of goodwill when it is used is an accounting context.

When there is a reference to ‘goodwill’ without a clear explanation of the context in which it is being used it can result in misunderstanding and decision making based on incorrect expectations.

An example of the impact of the difference between the use of ‘goodwill’ in a legal context as opposed to ‘goodwill’ in an accounting context occurs in AHG WA(2015) Pty Ltd v Mercedes-Benz Australia /Pacific Pty Ltd & Ors [2023]FCA 1022 (Mercedes-Benz Dealers case).

On 18 October 2021, 38 of 49 Mercedes-Benz dealers brought representative proceedings in the Federal Court against Mercedes-Benz Australia/Pacific Pty Ltd (Mercedes-Benz Australia) asserting that Mercedes-Benz conduct in terminating its franchise agreements with dealers and its introduction of an agency model:

involved the appropriation of their goodwill and customer relationships for no or inadequate compensation;
was not conducted in good faith; and
was unconscionable.

Justice Beach found that Mercedes-Benz Australia in terminating the franchise agreements had acted within its contractual rights to which good faith considerations did not apply and had not been unconscionable.

Relevant for this article are the comments His Honour made about what constitutes “goodwill” at law.

At paragraph 90 – citing the High Court in Commissioner of State Revenue (WA) v Placer Dome Inc (2018) 265 CLR 585

“[legal] goodwill is not equivalent to a going concern valuation or an accountant’s concept of goodwill” at [97]-[99] …goodwill represents a pre-existing relationship arising for a continuous course of business – to which the ‘attractive force which brings in custom’ is central…Goodwill is property in the nature of the right or privilege to conduct the business by “means which have attracted custom to the business”. The courts will protect that property – those means of attracting custom to the business – irrespective of the profitability or value of the business, so far as it is legally possible to do so”

At para 91 – “… a dealer holds goodwill constituting property only if the dealer holds the right or privilege that satisfies the definition of goodwill at law”. Citing Federal Commissioner of Taxation v Murry (1998) 193 CLR 605 at [23] by the majority.

“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 isa right or privilege that is inseparable from the conduct of the business.”

Then at [45]

“Once goodwill as property is recognised as the legal right or privilege to conduct a business in substantially the same manner and by substantially the same means which in the past have attracted custom to the business, it follows that a person acquires goodwill when he or she acquires that right or privilege.

In the Mercedes-Benz Dealers case at paragraph 94 His Honour explained, “in other words, in the context before me, the continued existence of goodwill as asserted by each of the dealers before me turned upon the continued existence of a dealer agreement, which was the source of the legal right or privilege to conduct the business in substantially the same manner and by substantially the same means that had attracted custom to the particular dealer)s)”.

At paragraph 97 – “The applicants case exhibits a misunderstanding of the meaning of goodwill at law. They routinely equate the accounting definition of goodwill with the legal definition of goodwill…..goodwill to accountants clearly means something different than goodwill to lawyers.. Goodwill for accounting purposes is essentially subjective, reflecting the excess that a purchaser is willing to pay for a business or the discount a seller is willing to accept for the same However as a matter of law, the existence of otherwise of goodwill is objectively ascertained.

At paragraph 121 – the fact that the legal definition of goodwill is tethered to 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 takes on a particular significance in a franchise context, because the franchise business cannot be conducted substantially the same manner and by substantially the same means absent the rights granted to the franchisee by the franchisor.

At paragraph 125 – Further, in the absence of any right at law for a franchisee to be compensated for goodwill on non-renewal of a franchise agreement has long been recognised.

At paragraph 127 – citing Habersberger J in Foxenden Pty Ltd v IOOF Building Society Ltd [2003] VSC 356 that a franchise merely confers a licence to participate in the franchisor’s business system for a specified time.

There has been substantial agitation for a franchisee to be paid out any accrued goodwill at the end of a franchise, in circumstance where the agreement expires and is not prematurely terminated as a result of breach by the franchisee.

As this case has emphasised there is presently no legal right to demand such a payment on cessation of the franchise agreement.

Any one purchasing a franchise needs to be aware that they are purchasing a right to operate a business, under a specific brand with all the terms and conditions attached to that operation as is set out in the franchise agreement. This right is for a fixed term and any profits from that operation are the franchisee’s less any monetary payments to the franchisor.

Unless the franchise agreement itself or circumstances as set out in section 46A of the Franchising Code of Conduct for a new motor dealership agreement arises, there is no legal right to be paid for any accrued goodwill past the end of the franchise agreement.

Should you have any queries in respect of this article please contact:

Alicia Hill
Principal
T: +61 3 9611 0180 | M: +61 484 313 865
E: ahill@sladen.com.au