Risks of using standard non-negotiable agreements in your franchise network

Of course, this position does not always hold, particularly when a franchisor is starting out, where it may make sense to agree special terms with early adopters, or if it is attempting to grow with multi-unit or multi-brand franchisees, in which case the bargaining position of the parties is likely to be more equal, and negotiations around certain legal and commercial terms are much more commonplace.

However, contracting on a standard form agreement does carry some risk, particularly if those terms contain general exclusions or limitations of liability. Where parties do engage on standard terms, section 3 of the Unfair Contract Terms Act (UCTA) will be applicable – however, UCTA does not define what it means to deal on a party's standard terms and so we need to look to case law for assistance.

Members of the British Franchise Association (BFA) should note that the BFA Code of Ethics says:

"Franchisor’s limited liability – general limitations or exclusions of franchisor’s liability (other than in the case of representations) are unlikely to be accepted by the BFA as being reasonable. Clauses to such effect in franchise agreements should be avoided."

However, most franchise agreements we see do attempt to do exactly this.

Franchise case law on misrepresentation has seen the engagement of UCTA as a means of disabling non-reliance/entire agreement clauses, but two recent commercial cases have brought the issue of exclusions or limitations of liability into focus…

1.    Pinewood Technologies Asia Pacific Limited v Pinewood Technologies PLC

The Facts

Despite the parties having very similar names, they are entirely unrelated entities. In this article, we refer to the parties as PTAP and Pinewood respectively.

As a very brief summary of the nature of the dispute, PTAP is a reseller of Pinewood’s dealer management system (DMS) in a few countries across Asia. PTAP claimed that Pinewood breached its obligations to ensure the DMS was kept up to date with further releases and that the DMS complied with various legal requirements. PTAP claimed damages in respect of wasted expenditure and lost profits.

In its defence and counterclaim, Pinewood not only denied the breach but also sought to rely on a very wide exclusion clause in both of the reseller agreements which included both loss of profits and expenditure.

Application of UCTA

One of the key issues considered in the case is whether the parties were dealing on one of their written standard terms of business, in which case section 3 of UCTA would be relevant and the clause would need to satisfy the requirement of "reasonableness".

We already know from the African Export-Import Bank case, that it was rejected that negotiation of any kind would prevent UTCA from applying and if terms remain "effectively untouched" with some negotiation they are likely to be deemed to be standard terms to which UCTA would be applicable but it is also not enough to argue that UCTA is engaged simply because a party has terms of business that it prefers to adopt (Hadley Design Associates). 

In the summary judgment of Pinewood, the court dismissed PTAP’s argument under UCTA, concluding that there would be no real prospect of success at trial as the reseller agreements were not concluded on Pinewood’s standard terms of business due to substantive negotiations and amendments. The court found that substantive negotiation occurred due to several key factors:

1. Amendments to standard terms (not simply the pre-drafted terms)
2. Tailored provisions (specifically on request of PTAP)
3. Negotiation process (a protracted back-and-forth between the parties)

These factors collectively led the court to conclude that the agreements were not concluded on Pinewood’s standard terms of business, thus exempting them from UCTA scrutiny.

Comments

It is interesting that although the court decided that the changes were substantial, it was actually only four clauses that were changed – one of which was a very minor amend from "best" to "all reasonable" (which the court did acknowledge on its own would not be seen as substantial). However, this does show that substantive changes does not mean a re-write of terms or a balanced agreement – but it must be more than minimal amendments.

It was also relevant in this case that, although the exclusion clause was drafted very widely, it clearly set out the applicable exclusions and did not exclude all liability for loss of any type as it did not rule out the remedy of specific performance nor a claim for direct losses incurred in remedying the issues (i.e. in procuring specific performance).

2.  Last Bus Ltd v Dawsongroup Bus and Coach Ltd

The position in Pinewood can be contrasted to the Last Bus case, which concerned a hire purchase agreement.

The Facts

The claimant (C) purchased 30 coaches from the defendant (D) on hire purchase terms (the first defendant (D1) was the supplier; the second defendant (D2) was the financer).

C alleged that the coaches suffered from a number of defects and were not of "satisfactory quality" under the term implied by s.10(2) of the Supply of Goods (Implied Terms) Act 1973 – in that they were liable to, and in four cases actually did, catch fire due to defects.  C claimed losses of EUR 10m.

D2 argued that any such implied term was excluded by a clause in the terms and conditions of the hire purchase agreement under which "conditions and warranties whether express or implied by law are excluded" and sought summary dismissal of the claim.

Application of UCTA

As the case involved a hire purchase agreement, section 6 of UCTA was relevant and the party seeking to rely on the exclusion had to demonstrate that it satisfied the reasonableness test.

At first instance, the exclusion clause was held not to be unreasonable under s.6 of UCTA and the judge granted summary judgment in favour of D2. A decision that a defendant can meet the standard of reasonableness under UCTA at this stage is relatively rare, but the judge found that D2 met this requirement on the basis that the parties were "substantial companies of equal bargaining power". In such cases, the accepted rule follows Watford Electronics v Sanderson – i.e. "unless satisfied that one party has, in effect, taken advantage of the other – or that a term is so unreasonable that it cannot properly have been understood or considered – the court should not interfere".

However, C sought appeal of this decision and the Court of Appeal (CoA) have granted the appeal. The key point that the CoA emphasised in granting the appeal is that the judge had erred in his assessment as to the equal bargaining power of the parties – the "crucial distinction" made was that even where parties are large commercial entities with equal bargaining power in relation to price this does not mean that they are of equal bargaining power in respect of the terms.

Overall, it was determined that at the least it was arguable that the clause was not reasonable so the issue should not have been dealt with by way of a summary judgment.

Comments

What is interesting here is that although it is s.6 of UCTA that is applicable and so the test of reasonableness is automatically engaged, standard terms are still relevant – here they are relevant to the assessment itself of reasonableness, as opposed to under s.3 where standard terms impact whether the test should be applied in the first place.

So, what does this mean for your franchise agreements?

The key takeaways from these cases when drafting franchise agreements are:

• Be aware when using standard terms across the network: even for parties that might otherwise be of similar size and equal in other forms of bargaining power, if the terms under which you are contracting are not equal, care should be taken with exclusion clauses and limitations of liability.
• Draft clear exclusion clauses: the cases underscore the importance of clear and unambiguous exclusion clauses in contracts, which can effectively limit liability for specific types of losses – as Pinewood successfully did with loss of profits and expenditure.
• Negotiation Impact:  substantive negotiations and amendments can prevent a contract from being considered as concluded on standard terms, thus avoiding the application of UCTA. It may well be worth considering this when issuing non-negotiable franchise agreements. 

For more information on this topic or advice on any specific franchising queries, please contact Rachel Bowley or Gordon Drakes