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Can good faith be taken for granted in franchise agreements?

on Thursday, 04 February 2016. Posted in Legal

The majority of franchises are built on mutual respect. But good faith in franchise agreements is anything but black and white, explains Emily Sadler, solicitor at Paris Smith

Can good faith be taken for granted in franchise agreements?

Morally speaking, most people involved in ethical franchising would be in no doubt that a franchisor should act in good faith towards its franchisees. Indeed, franchisees themselves should act in good faith towards their franchisors. After all, is that not the very foundation of a good franchising relationship? However, it is rare to see an express contractual obligation to act in good faith towards one another contained within the franchise agreement itself. Therefore, in the absence of an express good faith clause, can those involved rely on an implied duty to act in good faith if the relationship subsequently breaks down?

The first thing to say is that this is a grey area of English law, as the courts have varied their approach when dealing with cases concerning good faith. There is no general duty to perform contractual obligations in good faith under English law, in contrast to some European legal systems, which do impose such a duty. The English courts have traditionally been concerned that having an implied duty of good faith would create legal uncertainty by imposing a vague and subjective obligation into freely negotiated contracts between commercial parties.

Is the tide turning though? In a 2013 case, the claimant, Yam Seng, was successful in arguing that its contract for the distribution of Manchester United-branded aftershave for sale at duty-free outlets in Asia contained an implied obligation for the defendant to act in good faith. The defendant, International Trade, had repeatedly misled Yam Seng about stock availability, the nature of its licence with Manchester United and lower retail prices at non-duty free outlets. Yam Seng argued that its business had suffered financial loss as a result of the defendant’s erratic and, at times, dishonest behaviour. The defendant’s breaches were sufficiently serious so as to justify Yam Seng terminating the contract.

The judge stated that the certainty of English law is not automatically undermined by recognising general duties such as the requirement to act in good faith. He noted that contracts involving long-term relationships and substantial commitment require a high degree of communication and cooperation based on mutual trust and confidence. He referred to these as ‘relational contracts’, observing that these expectations are rarely found in the express terms of an agreement but are implicit in the parties’ understanding and necessary to give business efficacy to such arrangements.

A handful of key cases followed on from the controversial decision in Yam Seng and considered the issue of relational contracts. Decisions in these cases went both ways, with some judges following Yam Seng and finding implied duties to act in good faith, with honesty and integrity, while other judges preferred the more traditional approach.

During Yam Seng, one example that was given of a relational contract was a franchise agreement. This was important for franchisors, not least because it was unclear as to what exactly was meant by the term good faith.

The test case for the franchising industry came in 2014 with Carewatch. The defendants advanced arguments in relation to Yam Seng that a clause stating that “the parties would conduct themselves as franchisor and franchisee in good faith” should be implied in the franchise agreement. In rejecting this argument, the judge noted that the agreement already contained detailed express terms that dealt with all aspects of the franchise relationship.

Any franchisor or franchisee will be well aware of the many pages in a typical franchise agreement listing all the obligations on both parties – but mainly the franchisee. As such, there was no obvious void that only an implied term of good faith could fill. The judge held, which will be of great comfort to any franchisor, that Carewatch was “free to have regard to its own commercial interests in deciding how to run its franchise business, provided that it complied with the express terms of its current franchise agreements.”

Carewatch removed some of the uncertainty for the franchising industry that was left in the wake of the Yam Seng case and confirmed that the courts are likely to take a pragmatic and commercial approach to resolving franchise disputes.

The latest key case – Portsmouth City Council v Ensign – was decided last year and involved a contract for a project that would involve the parties working together over a 25-year period – a classic relational contract. Contained within one particular clause of the contract was a requirement to act in good faith but this duty was confined to the clause in question. It was argued by the claimant that the requirement was an overriding objective that should apply to the whole contract. This was rejected but the judge did consider instead that there was an implied term that the defendant had to act honestly, on proper grounds and not in a manner that was arbitrary, irrational or capricious.

The Ensign case shows the continued reluctance of the courts to interpret express obligations to act in good faith too widely and therefore it would appear we are back where we started.

Whilst it cannot be said that an implied term of good faith could never be applied to a franchise relationship, it appears from recent case law that the idea of an implied contractual duty of good faith seems more suited to highly unusual circumstances, rather than acting as a blanket obligation that applies to the franchise industry as a whole. Whilst this will not please those who prefer black and white answers – I’m afraid law has very few of these – each franchising case before the courts, concerning the issue of good faith, will continue to turn on its specific facts. 

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