Hi, my name’s Jeff Goldstein, of the Goldstein Law Group. Wanted to speak to you this evening about unfairness in franchise agreements. There isn’t a week that goes by that I don’t hear from several potential new clients and clients that the franchisor has treated them unfairly. However, under franchise law, there’s no requirement that the franchisor treat any franchisee reasonably or fairly.
Clients complaining about the unfairness of franchisors take many forms. In the last week or so, I’ve written down some the formulations of clients and potential clients regarding the franchisor’s alleged unfairness. Some state that franchisor’s abusive. Some state that the franchisor has overreached. Some have stated to me that the franchisor is simply unfair. Others have stated that the franchisor has acted in bad faith or unreasonably. The concept of the covenant of good faith and fair dealing is an allusive one. There are some franchisees in courts who take a very expansive view, saying that the covenant would require a franchisor to act with a duty of care and a duty to assist the franchisee. There’s another group that’s juxtaposed to that group, indicating that there’s a restrictive perception of the covenant of good faith and fair dealing, that there’s no independent cause of action, and that the covenant of good faith and fair dealing cannot override the explicit language in a franchise agreement, regardless how unfair the conduct of the franchisor might have been.
There are three main concepts that cut through that case law and through the literature regarding the covenant of good faith and fair dealing. The first is that neither party may act in a way as to deprive the other party of the fruits or the benefits of the contract which they’ve signed, in this case, the franchise agreement. The second has to do with the justifiable expectations of the party, such that neither party may act in a way that’s going to impede or undercut the other party receiving the benefits pursuant to their justifiable expectations at the time they signed the franchise agreement. And the third is set out in some detail in the restatement of contracts, just a very detailed, rendering, and printable book based on hundreds of years ago of case law. And in this case, the restatement states that you must determine a breach of the covenant of good faith and fair dealing by looking at whether one the parties has willfully rendered imperfect performance, abused their power, slacked off, or failed to cooperate. There’s one that’s not mentioned here, and that’s that I’ve had my cases, and that’s…would be articulated under the concept of where one of the parties has acted in a way as to hinder the ability of the other party to perform under that party’s obligations of the contract.
There are three components that courts deal with in determining whether there’s been a breach of the covenant of good faith and fair dealing. The first is that courts will unanimously say that they cannot interpret an agreement in a way that would contradict or conflict with an explicit provision in a franchise agreement. So for instance, in a hotel franchise agreement, where a franchisor could state we have no obligation to provide you any reservations, or in a case that I dealt with several years ago, the franchise agreement stated simply that we will provide you reservations, and the franchisee was provided two or three reservations, a very small number. And the court stated that since the franchise agreement didn’t set out a specific number of reservations, that the franchisor would be permitted, even within the confines of the covenant of good faith and fair dealing, to provide only two reservations. So even though the court or the franchisee might argue that it’s reasonable, and reasonable businessmen would provide more than two or three reservations so long as the agreement doesn’t require it and explicitly states that they only have to provide a minimum of two, that a court can’t override that provision by using a covenant good faith and fair dealing.
The second principle has to do with the franchisor being required to act reasonably. And courts would only impose that obligation where the franchisor has reserved to itself the right to undertake some activity, whether it be providing assistance or training and there’s no requirement that the franchisor act reasonably or prudently. The court would look to see whether the franchisor has acted in a reasonable manner, everything else being equal. And then there are a small number of cases that would require that in order for a franchisee to make out a covenant of good faith and fair dealing case, that it would have to show bad faith on the part of the franchisor. That’s a rare case, but still in certain circuits, in certain courts, a requirement.
The bottom line on these principles that I’ve just been discussing, is that just because a contract provision can be argued to be or is commercially unreasonable, it’s not a violation of law or of the agreement. The covenant of good faith and fair dealing can’t be used offensively by a franchisee to obtain rights that he didn’t get when he initially negotiated the contract. In essence, contract law, which governs most of franchise law, doesn’t impose any duty on the franchisor to be reasonable or act reasonably.
Let’s take a look at several instances in which the claim of a breach of a covenant of good faith and fair dealing, usually arises in my practice, as relayed to me by potential clients and existing clients. The first deals with terminations and renewals. The argument by franchisee is that the franchisor didn’t act in good faith or acted unreasonably in terminating the franchisee or refusing to renew the contract. A second major category in which this arises, the covenant of good faith, deals with encroachment or exclusive territories types of cases, where the franchisee argues that the franchisor has not acted reasonably in either putting another competing franchisee close to the complaining franchisee or itself, in some cases, the franchisor as undertaking conduct that would compete with the existing franchisee. A third category that I deal with concerns transfers, where a franchisee must get the consent that the franchisor either transfer, or assign, or sell his or her franchise. In that case, the franchisee would be arguing that a franchisor’s refusal to approve the transfer or the sale itself, would be a violation of the franchise agreement because it was unreasonable for the franchisor to deny the consent in that case. And the fourth category is sort of interesting in that it’s rarely found explicitly in cases, but it permeates almost all the allegations in franchise litigation. And that is what I call minimum standards of performance of the franchisor. And franchisee would be arguing there that the franchisor acted unreasonably and therefore violated the covenant of good faith and fair dealing by not meeting the franchisor’s minimum standards or minimum requirements of proficiency or ability to perform its obligations.
We’ll take a look at each one very briefly. And then I wanted to end this evening by taking a look at a couple cases that…a very, very recent one, then one from earlier this year on the covenant good faith and fair dealing. First reason I gave above, the first context in which the covenant of good faith and fair dealing would arise, deals with terminations. And in this context, the franchisee is arguing that he was terminated in bad faith, which would be a violation of the covenant of good faith and fair dealing. We [inaudible 00:09:10] you in those cases that the franchisee is the one who’s placed at risk, and therefore, all of the return for incurring that risk would be stripped from the franchisee if the franchisor were permitted to unreasonably terminate a franchisee. And in that case, we wanna avoid a forfeiture of the business, which would occur as a result of an unfair termination. The franchisor, on the other side, would argue that there shouldn’t be any imposition of the requirement of good cause to terminate the franchisee. And the franchisor usually, and in almost all cases now, doesn’t include in his franchise agreement a requirement that he act with good cause in terminating a franchisee. And without that kind of clause in a franchise agreement, courts will never read in a concept that the franchisor has to act reasonably in terminating a franchisee. And that goes pretty much hand in hand with the principle that I discussed earlier, that a court will not do anything to undercut completely the explicit language of a franchise agreement. So in this case, if the franchise agreement stated that a franchisor could terminate a franchisee for missing a royalty payment by a week, under that condition, the franchisee who might be terminated because he missed it, payed it a week and a day later, wouldn’t be permitted or recognized by a court to have asserted a good claim of a covenant good faith and fair dealing breach. In other words, the court isn’t gonna override a provision…an explicit provision in a franchise agreement that gives one of the parties the right to do it, even though that it might be commercially unreasonable or unfair.
The second context in which a covenant faith and fair dealing violation occurs is in an encroachment case, where a franchisor, in some way, undertakes competition with the franchisee, thereby placing another franchisee close to the franchisee who’s complaining, or the franchisor itself competes with another franchisee. Usually, these cases started out before technology began to move rapidly with respect to physical locations. Somebody would have a store, a franchisee, in point A, and then a couple miles away, the franchisor would put another franchisee, B, and the question there was whether the franchisor acted in bad faith or violated the covenant of good faith and fair dealing in putting another franchisee so close physically to the store of franchisee A. And those cases now have been resolved in two ways. One, unless the agreement explicitly says that the franchisee has a right to all the territory in between two points, that franchisee is not gonna gain any protection under the agreement or under the covenant. Franchisors have hammered the nail home repeatedly over time till it’s almost never seen, or a franchise agreement doesn’t explicitly state that the franchisee has the rights to only the very specific location from which that franchisee is operating. So there’s never a problem where a franchisor would choose to put franchisee number two down this…the block from franchisee number one. And again, although that’s unfair and it might be commercially unreasonable, the covenant of good faith can’t be used to override an explicit provision of the franchise agreement.
Now, these types of encroachment cases have taken a turn with the expansion of technology, such that franchisors have began to compete with franchisees through different methods of distribution. So for instance, you’ve got a Häagen-Dazs case or a Corbell case, where the franchisor traditionally supplied the franchisee with the ability to serve ice cream to ultimate consumers. Well, at some point, the franchisor decided, “Hey, we can make more money by still keeping the franchisees, but distributing ourselves this product through supermarkets and other retail establishments ourselves.” But obviously, what happened was the supermarkets that knew methods of distribution for the franchisor competed with the traditional franchisee framework and with specific franchisees in particular, take away the profits, run ’em out of business, and then franchisees would sue. Franchisors, again, were given the nod by the courts that stated that the franchisor was, again, under no obligation to act reasonably and in good faith in setting out a new distribution method. But…and again, franchisors made sure that by modifying all their agreements, to state, explicitly, that the franchisors permitted to carry out any methods of distribution, whether or not they do or don’t compete with the franchisee.
The third context in which the covenant of good faith and fair dealing arises in my practice has to do with transfers and relocations of franchisees. In this context, almost every franchise agreement, and actually everyone that I’ve seen, requires that a franchisee obtain the consent of the franchisor before that franchisee can transfer, sell, assign the franchise to a third party, whether it be a family member or not. And there are some provisions in franchise agreements that would exempt the family member, but the general concept is that franchisor consent is almost always required before a franchisee can transfer or sell his business. And obviously, this sort of program gets to my desk when a franchisee has signed a sales agreement by sell with a third party to get rid of the franchise. And the franchisor at the last minute, or even at the earliest minute, tells the franchisee, “We’re not gonna approve this third party.” And the franchisee, at that point says, “You’re killing my whole business. I need to get out. This is my value in the business that I built up, and I have a right to sell it.” A franchisor states, “We don’t have to act reasonably, but even if we did, we’re using certain objective criteria to preserve our interest, to protect our interest. We have a right…legitimate right to protect the system against poor operators who might come in, to whom you might transfer the business.” Courts have found, in this case, that almost all franchise agreements give that right to the franchisor with “sole discretion” to the franchisor to decide whether it will provide or not provide consent. So it’s very difficult for a franchisee to challenge a franchisor’s refusal to let it sell, by arguing that the franchisor didn’t act in good faith or reasonably.
Fourth context in which covenant of good faith and fair dealing disputes arises in my practice, has to do with allegations that the franchisor failed to perform competently. And in this context, it’s easier to see how the franchisee, in essence, is held hostage to the franchisor’s competence or incompetence. Franchisees are gonna argue, in this case, that being a franchisor under the franchise agreement requires a minimum level of competence. Franchisors are gonna argue that they shouldn’t be held to being a guarantor of the franchisee’s ability to succeed under the franchise agreement. And the covenant of good faith and fair dealing comes in when a franchisee says that, “Franchisor, you acted improperly. You didn’t obtain a minimum level of performance in assisting us, in training us, in providing a framework in which we could work as a system.” And the franchisors can argue, depending on this franchise agreement, that, “We have no obligation implied or explicitly required under law.” And the franchisee is arguing that even if it’s a not in the franchise agreement, the covenant of good faith and fair dealing from the common law would apply. The franchisors have almost always prevailed in these types cases, although there are those where a good franchisee lawyer would be able to make some headway.
I wanted to point out some of the factual…very quickly, some of the factual areas in which the franchisor’s competency or his ability to carry out its mission, has been addressed by a court, and very quickly how it’s been resolved. First, courts have held that a franchisor is in no position to be required to provide anything more then a manual and some limited instruction or a two or three weeks class, in many cases. And this is because in the franchise agreement, it does not state that the franchisee is entitled to anything more than that. There are also cases that franchisees have brought that said that a franchisor, for instance, has not provided reasonable marketing support. And the franchisor will argue many times successfully to a court that there’s nothing in the franchise agreement that indicates that the franchisor must provide a specific amount of marketing support, either dollar wise, or qualitatively, or in any given time period. And courts have said, so long as there’s nothing in the agreement, entitling a franchisee to a specific minimum standard requirement, that the franchisee’s case would fail under the covenant of good faith and fair dealing analysis.
A third place I’ve seen courts discuss a covenant of the good faith and fair dealing breach has to do with franchisees arguing that a franchisor did not provide credit or additional product to the franchisee to expand. And again, the franchisee would argue, “Hey, it’s not commercially reasonable not to provide that to me. It’s unfair not provide it to me.” And courts have said, so long as its not in the franchise agreement, that the franchisor was required to provide the franchisee with A, B, and C, X amount of credit over a certain period of time, that the court would not then undertake an analysis of all the considerations made by the franchisor in deciding not to provide that credit.
Fourth factual circumstance that I’ve seen dealing with the covenant of good faith and fair dealing is that franchisees would argue, “You haven’t trained properly.” They say, “Mr. franchisor, you owed me a certain obligation to provide a minimum level of training so I can succeed.” And courts have said, so long as the franchise agreement doesn’t say the franchisor has a requirement to provide 10 weeks of training in X, Y, and Z ways, that so long as the franchisor provided any training whatsoever, even incompetent training, that it would meet its obligation under the franchise agreement, such that it would not imply company a covenant of good faith and fair dealing into the agreement on the training issue. If you look back over these cases, the courts I think are saying, “We’re very reluctant to second-guess franchisor decisions.” There’s other ways of looking at it, the bottom line is that’s the way almost all these cases turn out. Again, where you’ve got state franchise law that’s very specific to a particular circumstance or case, those do provide an escape route from this very oppressive legal regime under covenants of good faith and fair dealing.
What I’d like to do now is take a look at a recent case on the covenant of good faith and fair dealing that I saw earlier today, and just give you a small idea of how these cases are played out in the claims, counterclaims, and things of that nature. The recent case that I’m referring to came out with the United States District Court for the Eastern District of New York. And this case involved the plaintiff, a franchisee, that sold car security systems to car dealers, and the defendant was the manufacturer or the distributor of these items and basically acted in a dual distribution way. And there’s nothing wrong with that, but that was just a fact that of the case, where the franchisor, the manufacturer, both sold to its franchisees or distributors, and also sold directly to car dealerships, who were then the same customers as the franchisees or the distributors sold to. There was a pricing dispute where, in essence, the franchisor was selling to the car dealerships at a price that was lower than the price that it was using to sell to its franchisees. So that when the franchisees went to the car dealerships to sell them this product, the prices that they were able to offer, that the franchisees were able to offer, had to exceed the price that the franchisor was selling its product to these dealers directly for.
This is an interesting case because although it wasn’t a final decision, or a jury case, or a verdict, due to some procedural wrangling, the court indicated that, theoretically or conceptually, certain of the franchisee’s claims in this regard, that it was being treated unfairly by this pricing…this dual distribution pricing mechanism where they were undercut, could be a violation of the covenant of good faith and fair dealing. And the court states, let me just read the small part, that, “Here the plaintiff claims,” and the plaintiff was the franchisee, “that the defendant did not sell the franchisee product at its ‘best price’, was dishonest in telling the franchisee that it was, and sold the product at cheaper prices to other dealers. The plaintiff further alleged that upon hearing that its tactics may be hurting the plaintiff,” so the franchisee’s business, “the franchisor’s Director of Sales from New York and New Jersey, commented, ‘F them’.” And the court held that these types of allegations, given these facts, could, in certain circumstances, support a covenant of good faith and fair dealing breach. There were many other allegations, as you can imagine, and I trust Robinson Patman [SP], breach a contract fraud and things of that nature. But this little piece of it, this liver, was interesting because it, as you can tell from the rest my discussion, these kinds of claims almost never see the light of day.
In concluding today, I wanted to give you my view that although there’s not a high likelihood that covenant of good faith and fair dealing cases would live to see the light of day after a motion of dismiss, there are some cases that do. And there’s still enough wiggle room in the state franchise statues, as well as the common law, as you can see by that last case regarding car dealerships, that would allow a good franchisee lawyer to properly help its franchisee client in asserting a covenant of good faith and fair dealing case. So unfair conduct could, at the end of the day, be a violation of law and statute. In order for you to determine that, you should contact a good franchisee lawyer and explain your situation. And as in all cases, there are statute of limitations that would be running on a covenant of good faith and fair dealing claim that would make it to your benefit to contact a lawyer as soon as possible to determine whether you might lose the ability to assert that claim at a later point by not moving quickly to file a complaint. Thanks for your being with me today, and if anybody has any questions, feel free to give me a ring. Thanks again.