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Legal spotlight: must franchisors act in “good faith”?

Hamilton Pratt partners John Pratt and Gurmeet Jakhu discuss the possible legal ramifications for the franchise sector following a High Court case earlier this year:

English law does not recognise a general duty to act in “good faith” in contracts but recent comments from a High Court judge in a case with implications for the franchise sector demonstrates it is not a black and white matter.

In Yam Seng Pte Ltd v International Trade Corporation Ltd [2013] WWHC 111 (QB) (“Yang Seng”) a High Court judge said that the traditional English hostility towards a generally applicable duty of good faith is “misplaced”.

The court acknowledged that whilst it would be unlikely that a duty of good faith or any element of such a duty would be implied in every commercial contract, elements may be implied in contracts involving a longer-term relationship between parties who have made a substantial commitment. The judge stated that these “relational” contracts:

“…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 express terms of the contract but are implicit in the parties’ understanding and necessary to give business efficacy to the arrangements.”

The judge indicated that franchise agreements were “relational” contracts.

The judge’s observations were made in the context of analysing whether a party to a contract had to provide relevant information to the other party in the absence of any contractual provisions requiring such information to be provided. As a result, franchisors will in future have to provide information to their franchisees. Franchisors should not knowingly provide false information to franchisees or refuse to answer a franchisee’s questions. So that, for instance, if a franchisee asks a franchisor whether it is retaining supplier discounts, and if so asks “how much is being retained?”, a franchisor would be in breach of the limited “good faith” implied term if he refused to provide the information.

In addition to the duty referred to above, franchisors will also be subject to other implied terms deriving from a duty of good faith.

The first is that if the franchise agreement confers on the franchisor a power to make unilateral decisions which affect both the franchisor and franchisee, then the franchisor must exercise that power “honestly and in good faith” for the purposes for which it was conferred, and the power must not be exercised arbitrarily, capriciously or unreasonably.

As a result franchisors do not, on a renewal, have an entirely free hand to amend their franchise agreements in whatever way they choose and certainly franchisors cannot make changes to the franchise agreement which would result in their franchisees being unable to operate their franchises profitably.

Further where the consent of the franchisor is needed, for instance in relation to a transfer of a franchisee’s business, then the franchisor cannot withhold its consent unreasonably.

Finally any particularly unusual or onerous contract terms contained in a franchise agreement must have been fairly brought to the attention of a franchisee. This in our opinion would mean that if, for instance, a franchisor wants to limit his liability by reference to a clause in the franchise agreement this would need to be brought to the attention of the prospective franchisee.


Comment

The Yam Seng decision has created a fruitful area for franchisee lawyers to argue that a franchisor is subject to implied terms based on good faith. We believe that we are only at the beginning of this process. You have been warned!

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Hamilton Pratt

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