OBJECT The object of this paper is to provide you with a quick look at how the current statutory duty of good faith impacts on the issue of encroachment.
DISCLAIMER This paper is intended as a summary only and should not be relied on as legal advice. Consult a competent franchise lawyer before acting.
SCOPE Primarily Ontario, with mention of Quebec, and a look at the US.
SUMMARY • The covenant of good faith and fair dealing is now ensconced in the franchise laws of Alberta and Ontario.
• In the context of encroachment, the covenant is used to fill gaps in the franchise agreement and as a guide in the exercise of discretion.
• The covenant will not be implied to contradict the express language in the agreement.
CANADIAN STATUTE LAW Arthur Wishart Act (Franchise Disclosure), 2000, S.O. 2000, c.3, s. 3 www.e-laws.gov.on.ca - 3.(1)3(1) Every franchise agreement imposes on each party a duty of fair dealing in its performance and enforcement.
(2) A party to a franchise agreement has a right of action for damages against another party to the franchise agreement who breaches the duty of fair dealing in the performance or enforcement of the franchise agreement.
(3) For the purpose of this section, the duty of fair dealing includes the duty to act in good faith and in accordance with reasonable commercial standards.
Franchises Act, R.S.A. 2000, c. F-23, s.7 7. Every franchise agreement imposes on each party a duty of fair dealing in its performance and enforcement.
Civil Code Of Quebec, S.Q., 1991, c. 64.
6. Every person is bound to exercise his civil rights in good faith 7. No right may be exercised with the intent of injuring another or in an excessive and unreasonable manner which is contrary to the requirements of good faith.
1375. The parties shall conduct themselves in good faith both at the time the obligation is created and at the time it is performed or extinguished.
CANADIAN CASE LAW Shelanu Inc. v. Print Three Franchising Corp., [2003] O.J. No. 1919 (C.A.).
The Court of Appeal confirmed the existence of a good-faith obligation between parties to any ‘contract of adhesion’, including a franchise agreement. No fiduciary duty exists between franchisors and franchisees, and franchisors are not required to act selflessly and with undivided loyalty in the interest of their franchisees. Having determined that a common law duty of good faith exited, the Court did not re-examine the trial judge’s findings that there was no retroactive application of the duty of good faith to agreements entered into before the coming into force of the Arthur Wishart Act.
Mincom Corona Realty Inc. v. Mincom Realty Systems Inc., [2003] O.J. No. 3491 (S.C.J.)
The plaintiff entered into a Franchise Agreement (the “Agreement”) for a business involved in the purchase and sale of real estate. The franchisor agreed to grant the franchisee the exclusive right to carry on business using the Mincom name in Hamilton. The plaintiff claimed that the defendant breached the Agreement by selling the right to use the Mincom name in Burlington to a third party and as a result, it was entitled to damages. During negotiations, it was of utmost importance to the plaintiff that the exclusive licensed area include Burlington, but the plaintiff franchisee was advised that Burlington could not be included as the defendant was negotiating with a third party. Schedule B to the Agreement defined the exclusive area that was to be granted and also set out when and under which circumstances the Burlington area would become part of the plaintiff’s exclusive territory. Six months subsequent to signing the Agreement the Burlington area had not been assigned to any third party and the plaintiff considered it to be part of its area, pursuant to Schedule B. When the Burlington territory was sold to a third party, the plaintiff drastically reduced its advertising expenditures, and when the Agreement expired the plaintiff ended the relationship declining any renewal, and claimed damages based on the alleged breach of Schedule B.
The action was granted. The court interpreted Schedule B to mean that if the defendant did not sell the Burlington territory within six months of the plaintiff signing the Agreement, then the territory would become part of the plaintiff’s exclusive territory. Therefore, the defendant breached the Agreement when it sold the Burlington territory after the territory had rightfully become the plaintiff’s. The defendant argued that the plaintiff breached the Agreement by paying fees late, and that it was therefore entitled to sell the Burlington territory. The court examined the defendant’s conduct in the face of the late payments, and found that the defendant was deemed to have waived, or was estopped from, relying on any breach of the Agreement. The defendant never sent notice of default to the plaintiff, nor did it enforce any of its remedies under the Agreement. Having found a breach of the Agreement on the defendant’s part, the court moved on to its assessment of damages. Advertising expenses, the amount paid by Corona to obtain a license, royalty fees, and loss of profits and encroachment loss were all factors the court took into consideration in awarding damages. Regarding punitive damages, the court held that by purposely choosing ambiguous wording for Schedule B, the defendant acted in bad faith which was contrary to the standards of honesty, reasonableness and fairness. The defendant’s conduct was reprehensible, oppressive and high handed and justified an award of punitive damages.
Katotikidis v. Mr. Submarine Ltd., [2002] O.J. No. 1959 (S.C.J.)
Given the nature of the franchise relationship, the complete abandonment of the plaintiffs (franchisees) by the defendant (franchisor) when they were experiencing serious difficulties in the operation of their Eaton Centre franchise was a serious breach of the defendant's obligation to assist the plaintiffs. When the plaintiffs themselves found a potential solution and presented it to the defendant, it was incumbent on the defendant to do what it could to assist the plaintiffs to salvage what was left of their business. Based on the practices which had been followed up to that time, and based on the promises contained in the promotional material, the defendant had a legal obligation to assist the plaintiffs. The breach of that obligation constituted an actionable wrong. The defendant went two steps further. By actually opening a new restaurant in unreasonably close competitive proximity to the plaintiffs and then awarding the restaurant to someone else, the defendant violated the implied duties of good faith and fair dealing contained in their franchise agreement and promotional materials and thereby betrayed the trust that epitomizes the relationship between a franchisor and franchisee. The existence of the practice of giving to the next closest franchisee the first right of refusal to operate a new franchise supported the conclusion that the parties to this agreement had a reasonable expectation that their relationship would be governed by the principles of good faith and fair dealing.
Gateway Realty Ltd. V. Arton Holdings Ltd. (1991), 106 N.S.R. (2d) 180 (S.C.)
The law requires that parties to a contract exercise their rights under that agreement honestly, fairly and in good faith. The standard is breached when a party acts in a bad faith manner in the performance of its rights and obligations under the contract. The defendant breached its obligation under the signed lease to act in good faith and, alternatively, breached an agreement to use its best efforts to sublet space.
P.R. St-Germain Inc. v. Provigo Distribution Inc., [2001] Q.J. No. 1551 (Q.S.C.)
The court was considering an expansion of a corporate store that the franchisee alleged would decrease its sales by fifteen to twenty percent. The court found no general rule that a franchisor can never compete with its franchisees in a market that is constantly evolving. The court was further persuaded by the existence of other competitors in closer proximity to the franchisee.
Supermarche A.R.G. Inc. v. Provigo Distribution Inc., [1998] R.J.Q. 47 (C.A.)
The court set out certain principles that applied to franchise situations, including the requirement that good faith must govern the parties in the execution of their agreement and that good faith includes an obligation to act honestly, preventing one party from abusing another party’s weaknesses. In this case, the defendant franchisor opened a chain of retail grocery stores operating under a different name which sold ‘at everyday low prices’, while preventing its own franchisees from implementing a similar pricing policy. The defendant was found guilty of acting in bad faith and abusing contractual rights. Damages were awarded to the plaintiff franchisee, although the court refused to enjoin the franchisor from continuing to compete with its franchisees.
U.S. STATUTE LAW Iowa Code, 1999, Title XIII , c.523H, s. 523H.6 Encroachment.
1. If a franchisor develops, or grants to a franchisee the right to develop, a new outlet or location which sells essentially the same goods or services under the same trademark, service mark, trade name, logotype, or other commercial symbol as an existing franchisee and the new outlet or location has an adverse effect on the gross sales of the existing franchisee's outlet or location, the existing adversely affected franchisee has a cause of action for monetary damages in an amount calculated pursuant to subsection 3, unless any of the following apply:
(a) The franchisor has first offered the new outlet or location to the existing franchisee on the same basic terms and conditions available to the other potential franchisee, or, if the new outlet or location is to be owned by the franchisor, on the terms and conditions that would ordinarily be offered to a franchisee for a similarly situated outlet or location.
(b) The adverse impact on the existing franchisee's annual gross sales, based on a comparison to the annual gross sales from the existing outlet or location during the twelve-month period immediately preceding the opening of the new outlet or location, is determined to have been less than five percent during the first twelve months of operation of the new outlet or location.
(c) The existing franchisee, at the time the franchisor develops, or grants to a franchisee the right to develop, a new outlet or location, is not in compliance with the franchisor's then current reasonable criteria for eligibility for a new franchise. A franchisee determined to be ineligible pursuant to this paragraph shall be afforded the opportunity to seek compensation pursuant to the formal procedure established under paragraph "d", subparagraph (2). Such procedure shall be the franchisee's exclusive remedy.
(d) The franchisor has established both of the following:
(i) A formal procedure for hearing and acting upon claims by an existing franchisee with regard to a decision by the franchisor to develop, or grant to a franchisee the right to develop, a new outlet or location, prior to the opening of the new outlet or location.
(ii) A reasonable formal procedure for awarding compensation or other form of consideration to a franchisee to offset all or a portion of the franchisee's lost profits caused by the establishment of the new outlet or location. The procedure shall involve, at the option of the franchisee, one of the following:
(iii) A panel, comprised of an equal number of members selected by the franchisee and the franchisor, and one additional member to be selected unanimously by the members selected by the franchisee and the franchisor.
(iv) A neutral third-party mediator or an arbitrator with the authority to make a decision or award in accordance with the formal procedure. The procedure shall be deemed reasonable if approved by a majority of the franchisor's franchisees in the United States, either individually or by an elected representative body.
(v) Arbitration of any dispute before neutral arbitrators pursuant to the rules of the American arbitration association. The award of an arbitrator pursuant to this subparagraph subdivision is subject to judicial review pursuant to chapter 679A.
2. A franchisor shall establish and make available to its franchisees a written policy setting forth its reasonable criteria to be used by the franchisor to determine whether an existing franchisee is eligible for a franchise for an additional outlet or location.
3. a) In establishing damages under a cause of action brought pursuant to this section, the franchisee has the burden of proving the amount of lost profits attributable to the compensable sales. In any action brought under this section, the damages payable shall be limited to no more than three years of the proven lost profits. For purposes of this subsection, "compensable sales" means the annual gross sales from the existing outlet or location during the twelve-month period immediately preceding the opening of the new outlet or location less both of the following:
(i) Five percent.
(ii) The actual gross sales from the operation of the existing outlet or location for the twelve-month period immediately following the opening of the new outlet or location.
b) Compensable sales shall exclude any amount attributable to factors other than the opening and operation of the new outlet or location.
4. Any cause of action brought under this section must be filed within eighteen months of the opening of the new outlet or location or within three months after the completion of the procedure under subsection 1, paragraph "d", subparagraph (ii), whichever is later.
5. Upon petition by the franchisor or the franchisee, the district court may grant a permanent or preliminary injunction to prevent injury or threatened injury for a violation of this section or to preserve the status quo pending the outcome of the formal procedure under subsection 1, paragraph "d", subparagraph (ii).
Petroleum Marketing Practices Act, Title 15, c. 55 2802 (2) For purposes of this subsection, the following are grounds for termination of a franchise or nonrenewal of a franchise relationship:
(A) A failure by the franchisee to comply with any provision of the franchise, which provision is both reasonable and of material significance to the franchise relationship, if the franchisor first acquired actual or constructive knowledge of such failure - ……..
(B) A failure by the franchisee to exert good faith efforts to carry out the provisions of the franchise, if - (i) the franchisee was apprised by the franchisor in writing of such failure and was afforded a reasonable opportunity to exert good faith efforts to carry out such provisions; and (ii) such failure thereafter continued within the period which began not more than 180 days before the date notification of termination or nonrenewal was given pursuant to section 2804 of this title.
Hawaii Revised Statutes, Title 26, c. 482E 482E-6 Relationship between franchisor or subfranchisor and franchisee.
Without limiting the other provisions of this chapter, the following specific rights and prohibitions shall govern the relation between the franchisor or subfranchisor and its franchisees:
(1) The parties shall deal with each other in good faith.
STATE MOTOR VEHICLE LAW Kentucky In the event the manufacturer intends to establish an additional dealership or to relocate an existing one in an area represented by a dealer of the same line make, existing dealerships within 10 miles of the proposed new dealership shall be notified and given an opportunity to file a protest before the motor vehicle commission. The commission shall determine whether there is good cause to disapprove the new dealership.
Nevada A manufacturer or distributor shall not terminate, refuse to continue, or unilaterally modify any existing franchise unless the franchisor can show that it had good cause. Good-cause criteria are listed. Adding a new franchise to the same relevant market area of an existing one, whether by establishment of a new franchise or relocation of another, also is subject to the good-cause test.
California A manufacturer cannot terminate, cancel, or refuse to renew a franchised distributor, nor can a distributor do such to a franchised dealer, without good cause. Good cause is limited to failure to comply with essential and reasonable requirements of the franchise agreement, failure to act in good faith in carrying out terms of the franchise, withdrawal of the franchisor from the “marketing location” (providing the dealer is compensated) as to franchises entered into or renewed after January 1, 1979, or other legitimate business reasons. Excluded as a legitimate business reason is the purpose of assuming the franchisee's business, unless reasonable compensation for the value of the franchise —including goodwill —is paid.
Colorado It is unlawful for a motor vehicle manufacturer, distributor, factory branch, distributor branch, factory representative, or distributor representative to cancel, or cause to be cancelled, directly or indirectly, without just cause, a franchise of a motor vehicle dealer. Nonrenewal without just provocation or cause constitutes an unfair cancellation. Other unlawful acts include coercion of dealers to perform acts detrimental to themselves, coercion to accept supplies, withholding or delay of delivery of goods or services, coercion to provide installment financing with a specified lender, encroachment by addition of an additional franchise for the same line-make in a community (“community” defined as a dealer's area of responsibility as set out in the franchise) if it would be inequitable to the existing dealer (giving due consideration to sales and service needs of the public), and unreasonable refusal to approve transfers.
Montana A new motor vehicle franchisor may not cancel, terminate, or refuse to continue a franchise unless the franchisor “has cause” for termination or noncontinuance. A list of circumstances to be used by the division of motor vehicles (formerly department of business regulation) in determining whether “good cause” was established is given. The law includes a good-cause requirement for establishing new same-line-make franchises in a dealer's “community” (defined as “relevant market”).
US CASE LAW Domed Stadium Hotel Inc. v. Holiday Inns, Inc., U.S. Court of Appeals, Fifth Circuit. No. 83-3074. May 21, 1984 The hotel franchise agreement granted the right to operate a hotel at a particular site, and did not grant a territorial license. Therefore, the franchisor’s purchase and operation of a nearby hotel did not breach the franchise agreement. The franchisor’s actions did not breach the implied obligation of good faith. The franchise agreement did not grant the franchise exclusive territorial rights and the implied obligation of good faith modifies, rather than overrides, the express terms of a contract. The franchisor did not breach a fiduciary duty, as general fiduciary obligations are not imposed upon franchisors.
Patel and A.J. Patel Food Services, Inc. v. Dunkin’ Donuts of America, Inc. and Dunkin’ Donuts of Illinois, Inc., Illinois Appellate Court, Fifth Division, No. 85-2092, July 25, 1986 The franchisor’s establishment of a new franchise within one mile of an existing franchise did not breach the implied covenant of good faith and fair dealing. A provision in the franchise agreement gave the franchisor the right to establish new franchises or company stores at its own discretion. The franchisee was attempting to insert into the agreement an exclusive territorial clause that would enjoin the franchising of a competitor within one mile. However, the franchisee failed to demonstrate the necessary proprietary interest, because the franchise agreement contained no geographical or time restraints regarding the establishment of another franchise. This finding was upheld even though it was found that the new franchise would significantly encroach on the franchisee’s market area.
Fickling et al. v. Burger King Corp., U.S. Court of Appeals, Fourth Circuit, No. 87-1725, April 4, 1988.
An alleged oral exclusive territorial agreement of indefinite duration between a fast food franchisor and franchisee was barred by the Florida statute of frauds. Since the related franchise agreements were of 20 years' duration, the oral agreement was neither susceptible of performance nor intended to be performed in less than one year, in violation of the statute of frauds. Moreover, the existence of such oral agreement was contradicted by franchise agreement provisions that expressly disavowed any grant of an exclusive territory. Thus, a claim that a grant of franchises on two nearby military bases breached the oral agreement was barred. The claim that the franchisor's grant of franchises violated the implied covenant of good faith and fair dealing failed to raise a genuine issue regarding the franchisor's breach of the enforceable, unambiguous, express terms of the franchise agreement. Florida law does not imply the obligation of good faith in derogation of the express terms of a contract.
Carlock et al. v. The Pillsbury Co. et al., U.S. District Court, District of Minnesota, Fourth Division. August 8, 1989 Mass distribution of pre-packaged ice cream through supermarkets and convenience stores, which allegedly saturated the market, did not breach ice cream shop franchise agreements or the implied covenant of good faith. The mass distribution was not a breach of contract because the franchisor's right to distribute through non-franchised outlets was reserved in the franchise agreement and its system of dual distribution was already in place when the agreements were executed. Although evidence suggested that the franchisor might have focused on increasing sales of pre-packaged pints at the expense of franchise sales and failed to counter the effects on franchisees, such conduct does not breach the implied covenant of good faith. Under New York law, the implied covenant does not create independent substantive rights or rights inconsistent with those explicitly set out by contract. The contractual language giving the franchisee the right to distribute ice cream through any method authorized the franchisor to aggressively distribute pre-packaged pints even if it adversely affected franchise sales.
Sparks Tune-Up Centres, Inc. v. Gary White, U.S. District Court, Eastern District of Pennsylvania.
No. 89-664. May 1, 1989.
Failure to pay royalties, to submit weekly written reports, and to make advertising contributions were contract breaches that justified termination of an automobile tune-up franchise. While admitting that it failed to perform these contractual obligations, the franchisee claimed that the failures were caused by the franchisor's establishment of two franchises within five miles of its location. The franchisee alleged that such encroachment breached an implied covenant of good faith and fair dealing. Although Pennsylvania law recognizes the covenant of good faith and fair dealing, it does not imply the covenant in an area of a contractual relationship in which the contract has an express term. In this case, the franchisor was expressly authorized to open the new franchises.
Scheck v. Burger King Corp., U.S. District Court, Southern District of Florida. No. 89-1281. July 6, 1992 A fast food franchisor's opening of a franchise close to an existing franchise might have breached the implied covenant of good faith and fair dealing notwithstanding the franchise agreement's express denial of a grant or implication of any area, market, or territorial rights. The denial of territorial rights did not necessarily imply that the franchisor could open franchises at will, regardless of their effect on the franchisee's operations. In fact, the agreement did not even mention the franchisor's rights in placing franchises. Consequently, no explicit terms of the contract were overridden by the implied covenant of good faith and fair dealing. Case law, cited by the franchisor, holding that the covenant of good faith and fair dealing could not be implied in contradiction of an express contractual provision was inapplicable, since the contractual language in those cases contained both a denial of an exclusive franchise to the franchisee and a grant to the franchisor of the right to establish competing franchises. The franchisor's potential encroachment problem could be readily remedied by rewriting its franchise agreement to unequivocally reserve the specific rights that the franchisor alleged to exist under the current agreements. Consequently, the franchisee's right to bring a valid cause of action outweighed any undefined threat to the franchisor's administration of its franchise system.
Simmons v. Mobil Oil Corp., U.S. Court of Appeals, Ninth Circuit. No. 92-16092. July 15, 1994.
A gasoline station franchisee could not prevail on its claims against a franchisor for breach of the implied covenant of good faith and fair dealing, since it failed to present evidence that the franchisor's establishment of additional company-owned outlets in the franchisee's area was done in bad faith, or that the franchisor had actually attempted predatory pricing at the additional outlets or failed to provide the required support services.
Rado-Mat Holdings, U.S. Inc. v. Holiday Inns Franchising, Inc. et al. New York Supreme Court, County of Niagara. No. 76747. December 17, 1991.
A hotel franchisor's establishment of a new franchise within two blocks of an existing franchise did not breach the implied covenant of good faith and fair dealing, since the franchise agreement expressly disclaimed any grant of exclusive territory and the implied covenant could not contradict or alter an explicit term of the agreement. The franchisor's establishment of a new franchise did not breach a fiduciary duty, since there was no fiduciary relationship between the franchisor and the franchisee. The franchise agreement stated that no fiduciary relationship was intended or created by its terms. The transactions were between separate business entities dealing at arms' length.
Romacorp, Inc. v. TR Acquisition Crop and Slabakis, U.S. District Court, Southern District of New York. No. 93 Civ. 5394. December 1, 1993.
A restaurant franchisee's failure to assert rights to territory granted under the franchise agreements constituted a waiver of the right to claim encroachment as a defense to termination of its franchises for nonpayment of fees. The agreement specified procedures to be followed in the case of a territorial dispute and the franchisee had not invoked those procedures, even though the franchisee objected to the opening of the competitor. The president of the franchisee had copies of all of the relevant agreements and knew or should have known of the procedure. The franchisor and the new franchisee had justifiably relied on the existing franchisee's failure to demand compliance with the agreement. Establishment of a new restaurant franchise within five miles of an existing franchise did not constitute an unreasonable intrusion on the territory of the existing franchisee, as it would not cause a loss of more than 10% of the existing franchisee's sales. Sales comparisons with the franchisee's other restaurants did not show any decline in sales attributable to the competition. The new franchise’s lower prices did not demonstrate encroachment because the existing franchise had been charging prices higher than recommended by the franchisor. Furthermore, when the franchisee bought the franchise from a previous owner, the franchisee negotiated for and accepted a covenant with a territorial limitation of only one mile. The franchisor's investigation of the effect on the existing franchise of the competitor was reasonable, and the determination was a good faith business judgment.
Burger King Corp. v. C.R. Weaver and M-W-M, Inc., U.S. Court of Appeals, Eleventh Circuit. No. 96-5438. March 9, 1999.
A fast food franchisor did not breach the implied covenant of good faith and fair dealing by opening a new franchise that allegedly encroached on two franchises owned by a franchisee. The franchise agreements did not grant the franchisee an exclusive territory. Therefore, the franchisor had no contractual duty to refrain from licensing new franchises near the franchisee's restaurants. Under Florida law there could be no breach of the implied covenant absent the breach or derogation of an express term of the underlying contract. A federal district court did not abuse its discretion in denying a fast food franchisee the opportunity to conduct discovery on a franchisor's encroachment policies. Discovery was denied not because the sought-after documents contained settlement discussions, but because the franchisee had failed to demonstrate their relevancy. The franchise agreements did not grant the franchisee an exclusive territory. Absent a derogation or breach of the express terms of the agreements, there could be no violation of the implied covenant.
Camp Creek Hospitality Inns, Inc. v. Sheraton Franchise Corp. et al., U.S. Court of Appeals, Eleventh Circuit. No. 95-8960. April 30, 1998.
The hotel franchisor could have breached the implied covenant of good faith and fair dealing by establishing its own hotel in the same vicinity as one owned by a franchisee. The franchise agreement expressly permitted the franchisor to authorize a competing franchise in the same vicinity as the franchisee's hotel, but was silent with respect to whether the franchisor was permitted to establish a franchisor-owned hotel in the same area. Given all the facts and circumstances surrounding the establishment of the franchisor-owned hotel, reasonable people could differ over whether the franchisor's conduct violated the implied covenant. Even though the hotel franchisee had been more profitable every year since its franchisor opened a company-owned hotel in the same vicinity of the franchisee's hotel, the franchisee could have suffered damages as a result of the franchisor's alleged encroachment in violation of the implied covenant of good faith and fair dealing. The franchisee's experts presented credible theories and measures of damages attributable to the additional intra-brand competition associated with the franchisor-owned hotel's entry into the market.
In re Vylene Enterprises Inc., Debtor: Vylene Enterprises Inc. v. Naugles Inc., U.S. Court of Appeals, Ninth Circuit. No. 94-56470. July 29, 1996.
A fast food franchisor that established a new franchise within a mile and a half of an existing franchisee's restaurant breached the implied covenant of good faith and fair dealing, even though the franchise agreement did not grant the franchisee an exclusive territory. Although not entitled to an exclusive territory, the franchisee was still entitled to expect that the franchisor would not act to destroy the franchisee's rights to enjoy the fruits of the franchise agreement. The bad faith character of the franchisor's actions was shown by the fact that the establishment of the competing restaurant had the potential to reduce the franchisor's royalties from the franchisee's operations.
Lee v. General Nutrition Companies, Inc., Bus. Franchise Guide (CCH) para 12,411 (C.D. Cal. Nov. 27, 2001).
Plaintiff franchisees complained of competition from the franchisor’s company-owned stores and sales over the internet. The franchise agreement only promised that the franchisor would not place another store in the protected area, and clearly reserved all other rights to the franchisor. The plaintiffs did not dispute that the conduct was permitted under the contract terms, but claimed that it was the way in which the franchisor used various means of competition to undermine their business that breached the covenant. The court found that argument entirely un-persuasive, and dismissed the claim holding that the plaintiffs were trying to apply the implied covenant of good faith to prevent the franchisor from doing what it was contractually permitted to do.
Matterhorn Group, Inc. v. SMH Inc. and Swatch U.S.A., Inc., 2002 WL 31528396 (Bankr. S.D.N.Y. Nov. 15, 2002).
The court set up the parameters of the implied covenant of good faith and fair dealing as follows:
1. every contract contains one; 2. the implied covenant encompasses promises that a reasonable promisee would be justified in believing were included in the contract; 3. the covenant is a pledge not to do anything that would destroy or injure the other party’s rights to receive the fruits of the contract; 4. the pledge includes a promise not to act arbitrarily or irrationally in exercising any discretion reserved; and 5. the covenant cannot override other terms of the contract or create independent obligations.
Cohn v. Taco Bell Corp. 1994 U.S. Dist. LEXIS 338 The plaintiff franchisees claimed the franchisor had breached its covenant of good faith and fair dealing by placing another restaurant too close to their establishment and destroying their profitability forcing them to sell their franchise back to the defendant. The court found that the defendant’s commitment to use its best efforts to assist franchisees in day to day operations and management techniques did not imply a commitment to shelter the plaintiffs from competition encouraged by company owned restaurants. Motion to dismiss the plaintiff’s action was granted.
Lee v. Flintkote Co., 193 U.S. App. D.C. 121; 593 F.2d 1275; 1979 U.S. App. LEXIS 17697 This appeal resulted from a summary judgment rejecting a claim for intentional interference by a third party with contractual relations subsisting between franchisees of retail panelling stores and their franchisor. At issue was whether the franchise agreements conferred upon the franchisees the exclusive right to sell the franchisor’s product within the franchised territories. The court upheld the summary judgment and stated that a party may not reach outside unambiguous contracts for an argument seeking to impart uncertainty, and then utilize the extrinsic material to resolve the alleged doubt.
CODES OF CONDUCT CFA Code of Ethics 6. Fairness should characterize all dealings between a franchisor and its franchisees. Where reasonably appropriate under the circumstances, a franchisor should give notice to its franchisees of any contractual default and grant the franchisee reasonable opportunity to remedy the default.
Uniform Commercial Code 1 – 203 Obligation of good faith Every contract or duty within this Act imposes an obligation of good faith in its performance or enforcement.
Official Comment 1-203 – Purposes:
This section sets forth a basic principle running throughout this Act. The principle involved is that in commercial transactions good faith is required in the performance and enforcement of all agreements or duties. Particular applications of this general principle appear in specific provisions of the Act such as the option to accelerate at will (Section 1-208), the right to cure a defective delivery of goods (Section 2-508), the duty of a merchant buyer who has rejected goods to effect salvage operations (Section 2-603), substituted performance (Section 2-614), and failure of presupposed conditions (Section 2-615). The concept, however, is broader than any of these illustrations and applies generally, as stated in this section, to the performance or enforcement of every contract or duty within this Act. It is further implemented by Section 1-205 on course of dealing and usage of trade. This section does not support an independent cause of action for failure to perform or enforce in good faith. Rather, this section means that a failure to perform or enforce, in good faith, a specific duty or obligation under the contract, constitutes a breach of that contract or makes unavailable, under the particular circumstances, a remedial right or power. This distinction makes it clear that the doctrine of good faith merely directs a court towards interpreting contracts within the commercial context in which they are created, performed, and enforced, and does not create a separate duty of fairness and reasonableness which can be independently breached. See PEB Commentary No. 10, dated February 10, 1994.
It is to be noted that under the Sales Article definition of good faith (Section 2-103), contracts made by a merchant have incorporated in them the explicit standard not only of honesty in fact (Section 1-201), but also of observance by the merchant of reasonable commercial standards of fair dealing in the trade.
IFA Code of Ethics Every franchise relationship is founded on the mutual commitment of both parties to fulfill their obligations under the franchise agreement. Each party will fulfill its obligations, will act consistent with the interests of the brand and will not act so as to harm the brand and system. This willing interdependence between franchisors and franchisees, and the trust and honesty upon which it is founded, has made franchising a worldwide success as a strategy for business growth.
IFA Code of Conduct Sound franchising practice requires a franchisor to consider those factors relevant to its business that will determine the impact of an additional outlet on the business of an existing franchisee and to balance the projected impact with the needs of the franchisor’s network to expand, gain market share and meet competition.
The relevant factors are as follows:
1. territorial rights of existing franchisees contained in their franchise agreements; 2. similarity of the new outlet and the existing outlet in terms of products and services to be offered and the trademarks to be used; 3. whether the new outlet and the existing outlet will sell products or services to the same customers for the same occasion; 4. the competitive activities of the market; 5. the ability of the existing outlet to adequately supply anticipated demand; 6. the positive or negative effect of the new outlet on the existing outlet; 7. the quality of operations and physical condition of the existing outlet; 8. compliance by the franchisee of the existing outlet with the franchise agreement; 9. the experience of the franchisor in similar circumstances.
National Automobile Dealer Arbitration Program Rule 6:
“Dealer who meets the following conditions and who also sells the identical vehicle vans as that of a proposed new dealer – point or proposed new relocation of a dealership of another dealer may submit for arbitration under NADAP regarding whether the new dealer point or relocated dealership should be created or permitted.”
“Good faith means the observance of reasonable commercial standards by balancing the interests of the dealer, the manufacturer, the collective interests of the manufacturer and all of its dealers, and the interests of the customers of all of its dealers, and by recognizing the competitive nature of the automotive industry.”
Rule 7:
“If a Dealer Agreement contains any unilateral or discretionary right, the party exercising the right must do so in good faith. Quite clearly, the manufacturers’ discretion to establish a new dealer point in close proximity is subject to arbitration under NADAP.”
More information. For more information on franchising in Canada, the United States and internationally, please contact Peter Macrae Dillon, head of Siskinds Franchise Law Group. Peter is the author of the annotated Ontario Franchise Disclosure Act and the annotated Alberta Franchises Act and over 30 other publications on the subjects of franchising, licensing and distribution. He is licensed in Ontario and New York. Peter can be contacted at 800-816-9596 ext. 389 or by email at peter.dillon@siskinds.com. Please visit our website at www.franchiselaw.ca The information contained in this note is for general reference only, and should not be relied upon as constituting legal advice.
peter macrae dillon Siskinds franchise franchisor franchising lawyer attorney Toronto Ontario Canada www.franchiselaw.ca
Encroachment and Good Faith in Franchising - To learn more about this author, visit Peter Macrae Dillon's Website.
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Peter Macrae Dillon
(Visit Peter's Website)
Peter Macrae Dillon is one of North
America’s leading and most-respected
franchise attorneys. He is licensed to
practice law in Ontario and New York. He
specializes in advising start-up
franchisors in the conversion and early
stages of franchising. His group
represents mature Canadian and American
franchise systems operating in Canada, the
United States, and internationally. Email
Peter at pe
ter.dillon@siskinds.com or visit his
website at: www.franchisel
aw.ca
peter macrae dillon franchise franchisor
lawyer attorney Toronto Ontario Canada www.franchisel
aw.ca
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