Must franchisors act in good faith towards their franchisees?

Posted by Sheilah Mackie on
Unlike many other legal jurisdictions, English law has not generally recognised or imposed a general duty on parties to a contract to perform that contract in good faith other than in respect of particular types of contracts e.g. contracts of insurance or employment.

This does not mean that there are no circumstances where a party to a contract could be expected to act in good faith. For example there may be an express contractual requirement for one or more parties to carry out some act or discussion in good faith, or that in exercising express contractual rights a party is completely free to exercise that right as it sees fit. An example of this would be when exercising a contractual discretion a party must usually use that discretion in a way that is not arbitrary, capricious or irrational. Two recent cases in the English Courts focusing on this topic have raised important implications for those in the franchise sector.

A new general duty to act in good faith

There is no general duty for parties to a contract governed by English law to act in good faith towards one another. Similarly, a Court will not normally imply any terms into a contract unless objectively implying a term is required to reflect the parties' intentions. However, the case of Yam Seng Pte Limited v. International Trade Corporation Limited has demonstrated the willingness of the High Court to imply a duty of good faith and fair dealing into contractual relationships, particularly where the contract envisages a longer term relationship such as a joint venture, franchise or long-term distribution arrangement.

Leaving aside the facts of the case which were not franchising related, the Court stated that while it was not implying a duty to act in good faith into all commercial contracts it had no difficulty doing so in any ordinary commercial contract based on the presumed intentions of the parties and the relevant background to the contract. This obligation to act in good faith (or not act in bad faith) would cover an expectation of honesty between the parties but also an expectation that a party would not act improperly, in a commercially unacceptable way or in a unconscionable way. Depending on the circumstances, it also could also be extended to include an expectation of fidelity to the parties' bargain and a sharing of information relevant to the performance of the contract such that a deliberate omission to disclosure such information may amount to bad faith.

The Court went on to say that the types of contracts that could have these expectations implied into them were those involving a longer term relationship between the parties in which they make substantial commitments. These were referred to as "relational" contracts that required "a high degree of communication, co-operation 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". One example given of a relational contract was that of a franchise agreement.

So, what does this mean for franchisors? It means that if a franchisor is in breach of the implied duty of good faith it may justify a franchisee terminating the agreement and claiming damages from the franchisor. To help guard against this risk, it is open to a franchisor to modify the scope of the duty through the express terms of the franchise agreement and/or to attempt to exclude the duty altogether. But this latter option was stated by the Court as being "hardly conceivable", in practice, given that a party would be very unlikely to try and exclude a duty to act honestly. More practical options for a franchisor include:

  • Behaving in an honest and reliable way towards their franchisees;
  • Answering enquires from franchisees promptly and accurately; and
  • Providing relevant information to franchisees where necessary without there having to be an express obligation on the franchisor to do so.

Exercising contractual discretion

Although lawyers often remark that there is (or was) no general duty to act in good faith under English law contracts, in certain situations contractual rights given to a party have to be exercised subject to certain implied terms. One such situation is the requirement to exercise a contractual discretion in a way that is not arbitrary, capricious or irrational.

Often in franchise agreements franchisors have discretion to act in a variety of ways when faced with a particular set of circumstances; for example a franchisor may choose not to terminate an agreement where a franchisee is in breach and, instead, change an exclusive territory to a non-exclusive territory. Similarly, a franchisor faced with a request from a franchisee to sell their business will commonly have discretion about whether or not to approve the proposed purchaser or when faced with a request for a renewal term will have discretion whether or not to grant that approval ("automatic" rights of renewal are almost always hedged about with sufficient conditions that effectively give a franchisor the discretion to not grant a renewal).

Typically when exercising discretion in these circumstances, a franchisor would be subject to an implied term not to exercise that discretion arbitrarily, capriciously or irrationally. However, the Court of Appeal in the case of Mid Essex Hospital Services NHS Trust v. Compass Group UK and Ireland Ltd (trading as Medirest) rejected an argument that this implied term should apply to all instances of contractual discretion. Instead, it came to the decision that the law only implied such a fetter on the exercise of a contractual discretion where the party exercising it had to make an assessment or choose from a range of options open to it, taking into account the interests of both parties. It would not be implied where the discretion related to a simple decision of whether or not to exercise an absolute contractual right.

Looking at this from a franchising perspective, this case appears to give franchisors greater control over the exercise of discretion where there is a simple choice between taking an action or not taking it. More often than not there is a range of options to be chosen from and the franchisor will remain subject to the implied term. But it will be interesting to see whether there is a change in drafting practice within agreements following this case to make choices absolute and/or, as mentioned above, to try and execute the tricky task of excluding all implied terms.

BFA members

For franchisors who are members of the British Franchise Association, it is a requirement of their membership that they comply with the bfa's Code of Ethics. One fundamental provision of the Code requires that "parties shall exercise fairness in their dealings with each other". Now while many members do behave in such a way towards their franchisees, it is extremely rare to see it written into any franchise agreement that the franchisor will comply with the Code of Ethics. The bfa rightly try and ensure that its members do act in accordance with the Code, but the case of Yam Seng has turned the requirement to act fairly and in good faith from an ethical obligation to a legal obligation for members.

As for the case of Mid Essex Hospital, the decision would seem to give franchisors greater freedom in their dealings with franchisees. However, when coupled with the decision in Yam Seng and the Code of Ethics, bfa members would be wise to exercise all contractual discretion with an eye to their over-arching duty of good faith.

About the Author

Sheilah gives her clients practical commercial advice on a range of issues including IP/IT, franchising, data protection and FOI.

Sheilah Mackie
Email Sheilah
023 8085 7039

View Profile