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ABA Legal Wizard Abrams Asks for Good Faith in Franchise Law Reform

Lee Abrams waves his magic wand to make a wish to change franchising for the better...

ORLANDO – Franchisee attorney Lee Abrams had no problem playing along with last year's American Bar Association Forum on Franchising's theme in its plenary session, "If I Had a Wizard's Wand," expressing his wish for franchise law reform.

The Chicago Mayer Brown lawyer said if he had a wizard's wand he would enact generally applicable legislation, either a federal statute or individual state statutes, bringing certain elements of "implied covenant of good faith and fair dealing" into a system of regulation. Abrams said he would also create a private right of action for violations of the Federal Trade Commission Act and the FTC Franchise Rule on unfair or deceptive acts or practices.

Enact good faith and fair dealing to overrule franchise agreement provisions

The past chair of the American Bar Association Forum on Franchising explained that the contemplated good faith and fair dealing legislation would override any franchise agreement provision that purports to give a party the right to act arbitrarily or unreasonably in exercising its sole discretion. And it would provide that if a franchise agreement gives either the franchisor or the franchisee discretion with respect to any particular action or inaction that is contemplated by the agreement that party must act reasonably toward the other party when exercising that discretion.

"A party using this statutory provision as the basis for challenging the other party's conduct would not be required to prove bad faith or malice; rather, such a plaintiff could prevail by proving that the defendant's conduct was not commercially reasonable, in light of all relevant circumstances," the attorney further explained

Although the law is well-settled that every contract contains an implied covenant of good faith and fair dealing, Abrams said the effectiveness of that implied covenant in franchise agreements has been diluted by judicially imposed limitations on its scope. "Most significantly, courts have held that the implied covenant cannot be used to modify or defeat express language in a contract, and that it only applies to matters that the contract does not cover expressly. As a result, many franchisors have included in their franchise agreements express contractual language that gives the franchisors complete discretion to act in certain respects, and/or provides that the franchisors are free to act arbitrarily when they exercise discretion that the franchise agreement grants to them," he asserted.  

One example Abrams gave involved a franchisor's right to open additional units (either franchised or company-owned units) in close proximity to a franchised unit. In the 1990s, several courts held that franchisees relying on the implied covenant of good faith and fair dealing could prevent franchisors from cannibalizing the business of the franchisees' existing units in that manner.

The counsel said many franchisors responded to those decisions by including in their franchise agreements provisions that authorize the franchisor to open additional units wherever it wanted. It expressly stated that the franchisee has no right to prevent the franchisor from doing so. "Where a franchise agreement contains such provisions, the courts generally have held that the implied covenant of good faith and fair dealing does not prevent the franchisor from opening a new unit that is in close proximity to the franchisee's existing unit, even though the new unit inevitably will take business from the existing unit," he stated.

Abrams feels the legislation would override contractual provisions in franchise agreements to the extent that they would permit either party to act unreasonably or arbitrarily toward the other. Legislation would require both parties to a franchise agreement – franchisor and franchisee – to act reasonably and in good faith toward each other.

"If the legislation were to have retroactive effect, however, it would override, to the extent noted above, contractual provisions in existing franchise agreements that the parties had negotiated with the expectation that their agreements would be interpreted in accordance with the plain meaning of the contractual language. Because that potentially would create constitutional issues, the legislation should be written so that it affects only franchise agreements that are entered into after the effective date of the legislation," he explained.

Franchisees should have a Private Right of Action for violations of FTC Act and Rule

The Federal Trade Commission Act, Section 5, prohibits "unfair methods of competition" and "unfair or deceptive acts or practices," Abrams pointed out. "The courts have held consistently and almost unanimously, that only the Federal Trade Commission can bring an action challenging violations of that statute, and that private parties cannot do so. Because there is no private right of action under Section 5 of the FTC Act, franchisees who are injured by violations of the FTC Franchise Rule cannot bring an action for violation of Section. But the Commission has not enforced that statute aggressively, and it has rarely challenged violations of the FTC Franchise Rule by franchisors that made inadequate disclosures," he emphatically stated.

Abrams to the ABA Forum attendees that franchisees who are injured by a franchisor's violations of the FTC Franchise Rule, or by a franchisor's other unfair or deceptive acts or practices (or unfair methods of competition) have a limited arsenal of weapons that they can use to challenge the franchisor's conduct. "They can only assert state law claims – claims under state franchise relationship statutes, claims under state "Little FTC Acts," and/or common law claims for fraud/misrepresentation, he explained.

He said because the laws on these subjects vary dramatically from state to state, franchisees' ability to sue their franchisors successfully often depends on where the franchised business is located. "Consequently, franchisor conduct that could be challenged successfully by franchisees in some states is virtually immune from challenge in other states. In the writer's opinion, that uncertainty is inherently unfair, because a prospective franchisee cannot reasonably be expected to understand those nuances before entering into a franchise agreement," he declared.

Abrams explained that uncertainty would be resolved by enactment of a statute creating a private federal right of action for violations of Section 5 of the Federal Trade Commission Act, and for violations of the FTC Franchise Rule. In closing he said, "Enactment of such a statute would give identical rights to all franchisees in the United States, regardless where their franchised units are located. Also, the development of federal case law in such actions would establish generally applicable principles governing franchisee claims against franchisors, particularly claims for inadequate pre-sale disclosures that violate the FTC Franchise Rule."

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