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You Gotta Have (Good) Faith

At the beginning of a franchise relationship, franchisees  are filled with goodwill and warm feelings toward their “partner” franchisor.   The franchisees are excited to start their business and see the franchisor as an equal partner firmly committed to their success.  Throughout the sale process, the franchisor and their brokers (aka “your consultant”) have told the franchisees that “we are in this together” and “we are committed to your success.”  Unfortunately, those promises aren’t legally binding and most franchisors are not required to act in good faith toward their franchisees.

Good faith is the fundamental legal concept that parties to a contract will treat each other fairly, honestly and not act in ways that are harmful to the other party’s interest.  Traditionally, all contracts, including franchise agreements have an implied covenant of good faith and fair dealing.  In the franchise context, good faith means that the franchisor won’t undermine the franchisee’s business by competing directly with the franchisee or imposing product or pricing requirements that eviscerate the franchisee’s business.

Dollar menu anyone?

An implied covenant of good faith only applies to a franchise agreement if it hasn’t been disclaimed by the parties.  While some franchisors are bold enough to explicitly include a disclaimer of good faith in the franchise agreement itself, other franchisors avoid an obligation to act in good faith by “reserving” rights in the franchise agreement.  In one case, a trial court found that the franchisor had no duty act in good faith toward the franchisee and could operate a competing franchise system in the franchisee’s “exclusive” territory because the franchisor had reserved that right in the franchise agreement.  Similarly, most franchisors reserve the right to unilaterally modify the “system” regardless of the impact on franchisees. Most franchisees do not understand that these reserved rights may eliminate the franchisor’s obligation to act in good faith and by signing the franchise agreement they are authorizing the franchisor to act in ways that are harmful to their interests.

These reservations and waivers are often buried in paragraphs of legalese and can easily slip past an unwary franchisee.  They are not mentioned in the Franchise Disclosure Document (FDD).  An experienced franchise attorney can spot these problem areas and explain exactly what they mean. By the time a prospective franchisee gets a copy of the FDD, they usually have had extensive contact with franchisor or its sales team and believe that they will all be on the same team.  Only if they consult with experienced franchisee counsel do they come to understand that their “team mate” may have reserved the right to treat them unfairly.

If California someday overcomes the big money the IFA throws around and succeeds in passing a good faith statute it will be a step in the right direction and more states will likely follow.  Until then franchisees must realize that most franchisors are not obligated to act in good faith and the “team spirit” they experienced in the sales process may well end when they sign the franchise agreement.

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About Howard Bundy

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I have been practicing law for over 30 years in the greater Seattle, Washington area. My office is currently in Kirkland, just a few miles from downtown Seattle. I represent franchisees in deciding whether to invest and in dealing with all of the issues that arise between them and their franchisors. I represent franchisors in preparing their contracts and disclosure documents and in getting registered to lawfully sell franchises. In addition, I handle many of my clients' real estate, business entity, contract and general business needs.

Contact me here.

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Franchise Consultant