'Good Faith' in franchise agreements: the latest court decisions

10 September 2014

Whilst 'good faith' principles continue to take root in English commercial law, one franchisee has discovered that tough but commercially acceptable decisions by its franchisor will not lead to a successful claim for breach of good faith.

A year ago, the High Court in London issued a milestone judgment in Yam Seng v ITC and concluded that 'good faith' in the sense of honesty should be implied into commercial agreements which are relationship-based and which require ongoing communication and cooperation between the parties, singling out 'some joint ventures, franchise and distribution agreements' – or more generally what the judge called 'relational agreements' - as examples of agreements where implied good faith was appropriate.  The judge held that:

  • good faith is recognised in most civil law systems and many US states, it is 'gaining ground' in Canada and Australia, and English law would be 'swimming against the tide' if it resisted it; and
  • good faith simply gives effect to the 'presumed intention' of the parties: implying a term of honesty reflects the shared values and norms of the parties.

Understandably, some commentators called into question how much impact the decision would have. But the answer is now becoming clear. In the June 2014 High Court case of Emirates Trading (which concerned a dispute over the failure to deliver product under a long term supply contract), the judge described the Yam Seng judgment as "masterly", and approved the reasoning on the circumstances in which a term of 'good faith' could be implied. In a similar vein, in the July 2014 decision of Bristol Groundschool v IDC, the High Court ruled that a duty of good faith should be implied into a 'relational' contract for the production and distribution of training materials for pilots. The judge said it is clear from the Yam Seng decision that "good faith extends beyond, but at the very least includes, the requirement of honesty" and "[t]he relevant test is that of conduct which would be regarded as "commercially unacceptable" by reasonable and honest people in the particular context involved". 

These cases can, however, be contrasted with the July 2014 High Court decision in Carewatch Services Ltd v Focus Caring Services Ltd & Others in which the defendant franchisee tried unsuccessfully to argue that (amongst other alleged implied terms) the franchise agreement contained an implied term that the parties would conduct themselves in "good faith and/or deal with each other fairly and in particular not in a manner that would damage each other's business interests".  The judge's conclusion may have been influenced by the nine other terms the defendant argued were also implied into the agreement which the judge described as "wide and imprecise" and unnecessary in what was a detailed commercial agreement.  The judge in Carewatch agreed with the reasoning of the judge in the case of Hamsard v Boots (which concerned the termination of a supply agreement between the parties for the supply of children's clothes to Boots stores) who said that he did not regard the Yam Seng case as authority for the proposition that there is a general obligation of good faith implied into all commercial agreements or that there is some sort of positive obligation implied that a party to a contract should subordinate its own commercial interests to those of the other contracting party.

A standard of good faith is taking shape under English commercial contract law.  The Emirates and Bristol Groundschool decisions are just the latest sign of this genuine paradigm shift.    By contrast, the Hamsard and Carewatch decisions illustrate that the concept of good faith has its limitations and courts will not allow contracting parties (such as franchisees) who are treated toughly, but commercially fairly, to use the concept to benefit from rights and protections which the agreement did not give them.

When making a decision which will affect the franchise network as a whole, particularly if it may impact on the value or profitability of the franchisees' businesses, a franchisor needs to ensure that the decision would be viewed as 'commercially acceptable' to an outsider.  However, it need not subordinate its own interests to that of its franchisees; as the judge in the Carewatch case said "[a franchisor] is free to have regard to its own commercial interests in deciding how to run its franchise business, provided always that it complies with the express terms of its current franchise agreement".

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