You Gotta Have Faith?

There have only been a few reported cases involving franchise businesses in 2019.

You Gotta Have Faith?

There have only been a few reported cases involving franchise businesses in 2019. Most are uninteresting, so for this article we will focus on an issue still facing all franchisors; namely the uncertainty over whether franchise agreements are subject to good faith.

The BFA Guide to the Code of Ethics requires parties to a franchise agreement to exercise fairness with each other to resolve complaints and disputes with good faith. 

However, neither the BFA Guide nor the Code itself has contractual force.  It is a condition of membership but the Courts have so far been very reluctant to compel franchisors to slavishly follow the provisions of the Code in their dealings with franchisees, such that franchisees could force compliance as though it were a contractual term.

English law has traditionally been hostile to the notion of parties to commercial contracts owing each other a duty of good faith and the Courts have previously dismissed arguments that a franchise agreement contains an implied term that both parties act in good faith towards each other (Carewatch
Services Ltd v Focus Caring Services Ltd [2014]

Carewatch involved a franchise agreement for home care services and the enforceability of post termination covenants. The Defendant was a franchisee who operated two franchise agreements and had concerns that Carewatch was deliberately trying to run down the franchise side of its business in favour of its own branches, which were free to compete with franchisees in the same areas.

The Court rejected the Defendant franchisee’s claim that good faith was implied into the franchise agreement and decided that the Court will only imply terms into contractual relationship, where it is necessary. There was no general obligation of “good faith” owed between parties to a commercial contract.

The Court may have raised eyebrows at the franchisee’s assertion that the franchisor was subject to good faith, when at the same time it had surreptitiously tried to trade in competition with the franchisor.

The Carewatch decision was consistent with a number of other cases which, at the time, were trying to row back from a decision in the case of Yam
Seng Pte Ltd v International Trade Corp Ltd [2013]
.  The Judge in Yam Seng extended the scope of good faith to what he described as “relational contracts”.  The Judge described such contracts as those which “may require a high degree of communication, cooperation and
predictable performance based on mutual trust and confidence and involve
expectations of loyalty which are not legislated for in the express terms of
the contract but are implicit in the parties’ understanding and necessary to
give business efficacy to the arrangements

The decision that Mr Justice Leggatt gave in Yam Seng was widely disliked by many senior Judges who felt that it was a significant departure from many decades of established case law where the Courts have permitted parties to commercial contracts to make bad bargains.  The general ethos is that commercial parties should be free to contract with each other how they wish and they should be held to the plain wording of that contract (subject to any statutory exceptions such as the Unfair Contract Terms Act).

Accordingly, when, after Yam Seng, Claimants sought to imply an additional term of good faith into a commercial arrangement, which would otherwise limit the power of one party to act in accordance with the express contractual terms or the rights reserved to them, then in a number of cases, including Carewatch, the Courts have taken an opposite view. 

It’s in the post

This has come into sharp focus again with the long running group High Court action commenced by 550 former sub-postmasters against the Post Office (Alan Bates and Others v Post Office Limited [2019]). The background to this claim concerned the Post Office’s accounting system “Horizon” which the sub-postmasters claimed contained accounting discrepancies that ultimately caused them substantial losses for which the Post Office held them personally accountable. 

One of the key issues determined by the Court in this case was whether the contracts in place between the Post Office and the sub-postmasters were “relational contracts” which gave rise to a duty of good faith. 

This was a bitterly contested case where the Court’s sympathy was plainly with the sub-postmasters who had lost their businesses and, in some cases, faced imprisonment for fraud because of the accounting discrepancies.  The Post Office fought every point they could, including on one occasion when they felt that the Judge was too obviously favouring the sub-postmasters, trying to get the Judge removed from the case, for which they were slapped down by the Court of Appeal.

The action has now settled with a payment of over £50million to the sub-postmasters, but not before Mr Justice Fraser dealt with the Claimants’ case that as their individual contracts with the Post Office were relational in nature that there ought to be a term of good faith implied into that contract.

Mr Justice Fraser set out 9 specific characteristics that are expected to be present in order to
determine whether a contract between commercial parties ought to be considered
a relational contract
, these are:-

  1. There must be no specific express terms in the contract that prevents a duty of good faith being implied into the contract.
  2. The contract will be a long-term one, with the mutual intention of the parties being that there will be a long-term relationship.
  3. The parties must intend that their respective roles be performed with integrity, and with fidelity to their bargain.
  4. The parties will be committed to collaborating with one another in the performance of the contract.
  5. The spirits and objectives of their venture may not be capable of being expressed exhaustively in a written contract.
  6. They will each repose trust and confidence in one another, but of a different kind to that involved in fiduciary relationships.
  7. The contract in question will involve a high degree of communication, co-operation and predictable performance based on mutual trust and confidence, and expectations of loyalty.
  8. There may be a degree of significant investment by one party (or both) in the venture. This significant investment may be, in some cases, more accurately described as substantial financial commitment.
  9. Exclusivity of the relationship may also be present.

It is not difficult to see these factors in most franchise relationships.

The Court found that good faith includes an obligation to
“refrain from conduct which in the relevant context, would be regarded as
commercially unacceptable by reasonable and honest people” and an
obligation of “transparency, co-operation, and trust and confidence”.

Defining good faith in your
franchise agreement

So, what do these recent cases mean in reality for franchisors?

Franchisors should exercise caution and assume that their English law franchise agreements may be now seen as “relational” in nature and carry the risk of including an implied term of good faith.

A franchisor could simply expressly exclude any duty implied on it to act in good faith to the franchisee in the franchise agreement. But this may raise problems at the commencement of any franchise relationship and is arguably contrary to the Code of Ethics. It is probably better for a franchisor to define a limited duty of good faith to reduce the risk of the court’s interference in implying a wider duty. This approach was endorsed by the Court in Russell v Cartwright [2020].

That case concerned a property development business in which four individuals entered into joint venture agreement.

The joint venture agreement contained obligations on the individuals to act in good faith in limited and specific matters, which, the Court held, meant that implying a more general duty would be inconsistent with the express terms. 

All parties to commercial contracts want certainty as to the terms that they have agreed.  Ambiguous terms create uncertainty and a risk of litigation to get a proper interpretation.  Where there is scope for a Court to imply terms, which the parties have not themselves written down, then there is further scope for litigation to resolve disputes over what the contracts actually mean.  With Mr Justice Leggatt now in the Court of Appeal, there is likely to be a Judgment that is appealed and taken to the Court of Appeal, where it will have an opportunity to either uphold the thinking in Yam Seng and Bates or to restate the position as it has been for so many years that good faith is not to be implied into commercial contracts.

Until that time, franchisors should try to resolve their uncertainty for themselves, and they have the ability to do so by expressly addressing good faith into the franchise agreements.  In doing so however, franchisors need to be careful not to constrain themselves unduly. 

Russell Ford is a director and Alicia West is a senior solicitor in Owen White’s specialist franchising team, handling a variety of disputes for both new and established franchisors and franchisees.

Alicia West
Alicia West