The importance of good faith clauses in franchise agreements

Good faith in commercial contracts has traditionally not been accepted, however recent decisions have seen the courts willing to accept express good faith provisions and in some instances, allowing good faith to be implied into contractual arrangements. 

The British Franchise Association (BFA) Code of Ethics includes an obligation of good faith stating that '[t]he parties shall exercise good faith and fairness in their dealings with each other' in relation to complaints, grievances and disputes. However, there is no overarching obligation of good faith in the code that would govern all the duties and obligations set out in the franchise agreement, and whilst morally binding (and there may be reputational repercussions for not complying with it) compliance with the code is not mandatory.

The decision in Yam Seng Pte Ltd v International Trade Corp Ltd [2013] established an implied duty of good faith in commercial contracts, particularly in instances of 'relational contracts' such as franchise agreements, which are often long term and involve substantial commitment.

However, the recent decision in Health & Case Management Limited v The Physiotherapy Network Limited [2018] highlights the importance of ensuring that an express good faith clause is included in a franchise agreement, in order to offer protection for breaches of good faith and other agreed terms.

Health & Case Management Limited v The Physiotherapy Network Limited [2018]

The two parties entered into a service agreement by which HCML referred clinics to TPN in return for a fee.

The agreement that the parties entered into contained several key provisions which would be later considered by the court in determining if HCML were in breach. These were:

  • clause 2.3 which provided that HCML anticipates to make circa. 700 referrals per month to TPN
  • clause 3.1 which state that HCML shall act in good faith towards TPN at all times
  • clause 14.1 providing that HCML and TPN will keep information confidential, before and after the expiry or termination of the agreement

Whilst the parties were engaged in the agreement, HCML began to construct its own database of clinics, which would act in competition to TPN's network. In February 2012, HCML requested information from TPN's databases claiming that this was required to develop a geographic pricing model, to which TPN complied. Following TPN providing the information, the number of referrals they received from HMCL reduced and later stopped completely.

TPN claimed that HCML had breached the agreement and used its database to recruit clinics into its own network.

Good faith in the agreement

The good faith provision at clause 3.1 provided that 'HCML shall act in good faith towards TPN at all times'. The court found that HCML were in breach of this clause as it had 'failed to adhere to the spirit of the contract…and be faithful to the agreed common purpose and to act consistently with the justified expectations of the parties'.

The judgment stated that, by setting up a network to rival that of TPN's and by covertly utilising TPN's data, HCML had breached its obligations under clause 3.1. In addition, the fact that it had continued to benefit from the commercial relationship whilst doing this showed it had acted in an underhand and exploitative manner, particularly as TPN would most likely have terminated the agreement had they known HCML's true intentions.

In finding that the good faith clause had been breached, the court also ruled that TPN's database right under the Database Directive (96/9/EC) had been infringed by HMCL, which was in breach of the good faith provision.

Other findings

Despite finding that the good faith provision was breached, the court found that HCML had not breached clause 2.3 because, although the agreement stated that HCML anticipated making circa. 700 referrals per month, this did not represent a binding commitment. Further to this, the court also dismissed the claim in relation to confidentiality under clause 14.1 due to the fact that the wording in the clause did not restrict the use of the confidential information by HMCL.

Practical impacts

As a franchisee, it will often be helpful to a good faith clause in the franchise agreement so that there is protection against the franchisor acting in a way which obviates their performance of the contract and does not work towards a common goal. It is vital to understand how any good faith provisions impact upon the franchisee's performance of the agreement in terms of restricting its actions. A good faith clause can also act as a safety net in instances when other contractual provisions fail, such as in TPN's case where the confidentiality agreement was insufficiently drafted.

With respect to the franchisor, it is important to consider if the franchise agreement should include a good faith clause (since omitting the clause would leave a gap which may lead to the court implying a duty of good faith). However, franchisors may want to consider a clause which reduces the scope of such a duty or excludes it altogether.

Whatever the requirements of the franchise relationship, franchisors will want to ensure that they continue to comply with the BFA Code of Ethics which requires parties to exercise fairness in their dealings with one another.

The scope of the good faith requirement is quite broad so franchisors should consider carefully the implications of it and whether or not to include an express clause in the franchise agreement to limit or exclude it. However, this may be incompatible with the BFA code.      

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