Franchise Agreements: Franchise solicitor John Pratt discusses the need for the vital part of the relationship between franchisee and franchisor.
It is a fundamental part of franchising that franchisees do not do their “own thing” and adapt the franchisor’s system in whatever way suits them. Consistency and brand reputation are basic principles and if you allow a maverick franchisee to adapt the system that will inevitably have a negative impact not only on the franchisor, but also on all other franchisees. A single franchisee is able to render a brand “toxic” if publicity is given to the “bad things” that the franchisee is doing – that is precisely what happened in the early days of franchising in the UK with Ziebart Rustproofing. Ziebart franchisees were required to buy expensive sealant from the franchisor that would prevent a car from rusting but, instead, franchisees, in order to save money, sprayed cars with alternative liquids that simply encouraged rusting. When that was exposed, that was the end of Ziebart Rustproofing in the UK!
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Just as important, and this is something that is often forgotten, is that franchise agreements should protect franchisors from claims by franchisees. There has been a fundamental shift in franchising. Franchisees are now much more willing and able to exercise their rights against a franchisor. There are a number of reasons for this. First franchisees are more aware of those rights, secondly there are lawyers who specialise in assisting franchisees with their claims thirdly, after the event legal insurance and conditional or contingency fee arrangements do enable franchisees to undertake litigation which they would not be able to fund themselves and fourthly the internet makes it much easier for franchisees to talk to each other and, as a result, create an action group. Franchisors now need to ensure that their franchise agreements not only give them the ability to ensure compliance with the system by the network, but also prevent franchisees from taking action against them. This is an area which, perhaps, lawyers have been slow to address. Franchise agreements now have to try to deal with somewhat vague common law concepts such as derogation from grant, estoppel, implied terms and so on so as to limit the ability of franchisees successfully to bring claims against their franchisor.
The concepts referred to in the previous paragraph are very important in franchising because, of course, franchisors prepare the franchise agreements which franchisees are required to enter into and those agreements are non-negotiable which has resulted in franchisees and their legal teams looking at alternative “extra contractual” remedies in order to restrict a franchisor’s ability to impose franchise agreement terms on franchisees. These common law concepts are loosely based on “good faith” although English law, unlike civil law jurisdictions and, indeed, unlike the common law jurisdictions in the US, Canada and Australia does not recognise “good faith”. There was a brief flowering of the possibility that good faith obligations would be implied into “relational” contracts such as franchise agreements as a result of the High Court decision in Yam Seng in 2013, but other courts have been most reluctant to endorse the approach in Yam Seng and indeed recently the Court of Appeal closed the door on such an approach by stating that good faith would be more likely to undermine contractual terms than to uphold them.
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Nevertheless, English courts have found other ways to ensure that franchisors “play fair” which are less “obvious” than simply implying a duty of good faith. In practice, what this means is that franchisors need to ensure that their franchise agreements try to address these possible lines of attack from franchisees. Frequently franchisees allege that the franchisor made misrepresentations to them to encourage them to enter into the franchise agreement. Misrepresentations are statements of fact which are untrue and the real exposure for franchisors, in relation to misrepresentation claims, is almost always in relation to projections and cash flow forecasts that franchisors frequently prepare for prospective franchisees. Very great care needs to be taken with these because franchisors must be able to satisfy a court that the figures that were provided were based on what their franchisees were actually achieving and were not “plucked” out of thin air and, secondly, franchisors must have a reasonable belief that the figures that they are providing to prospective franchisees could be achieved by those franchisees. Franchisors will not be able to get away with arguing that the figures that they provided were simply illustrative and that they did not expect franchisees to actually take them seriously. In other words what franchisors have to do is not only ensure that the franchise agreement that is prepared for them protects them so far as possible – and it will never be possible fully to protect a franchisor – from misrepresentation claims, but franchisors should also understand that it is their responsibility to be truthful. Franchise agreements are useful, but they are not the end of the story.
A really important lesson for all franchisors is that however well drafted the franchise agreement may be, success or failure in court will often depend, at least as much, on their own behaviour and whether they have acted ethically.
John H Pratt, Hamilton Pratt