The Lifecycle of Franchise and Distribution Agreements in Europe – Part 2

In the first article of the series, the inconsistent disclosure requirements and varying ability to withdraw from negotiations were identified as some of the core issues to consider during the pre-contractual stage. As negotiations progress and agreements approach final form, the parties must remain attentive to differences between jurisdictions, ensuring that documents are drafted in compliance with mandatory local laws.

This second article will explore the underlying legal principles which underpin many of the divergences between jurisdictions and will examine how good faith manifests itself in the drafting and interpretation of franchise and distribution agreements.

I. The Contrasting Attitudes Towards Good Faith

A. English Courts' Reluctance to Interfere with Contractual Terms

English law is often perceived as more predictable and pro-business than many European civil law systems. One of the reasons for this, is that generally English courts are unwilling to interfere with the wording of a contract which has been negotiated and will only imply terms where there is an obvious contractual gap or manifest error. In contrast, many civil law jurisdictions generally imply the concept of "good faith" which can impact the conduct of parties before, during and after the conclusion of a contract. However, while it is fair to say that English courts generally continue to be unwilling to interfere with the freedom to contract, recent case law suggests that they are much more willing to do so in respect of "relational contracts".

The classification of some contracts as "relational" was first advanced by the High Court in Yam Seng Pte Ltd [2013].[1] Although there is no definitive test for identifying relational contracts, subsequent case law has identified some factors which indicate that a contract is relational, including that: the contract tends to be a longer term contract; it involves the parties working closely; the parties each repose trust and confidence in one another; it involves a high degree of mutual collaboration and communication; one or both parties have made significant investments; and the relationship between the parties is exclusive. Whilst the relational nature of a contract will depend on the facts, joint venture agreements and, importantly for current purposes, franchising and distribution agreements, are often likely to meet these requirements and be deemed relational contracts.

A key case in this area is Bates & Others v Post Office Ltd [2019][2].  The court found that because the contracts between the Post Office and its subpostmasters were relational in nature a wide-ranging duty of good faith could be implied. The matter arose following the realisation that the Post Office had erroneously pursued thousands of their subpostmasters for financial shortfalls which were in fact caused by the accounting software in use at the time, Horizon. In the lengthy judgment, the court implied a set of specific obligations including obligations not to conceal error and shortcomings with the Horizon software. It is highly unusual for the court to imply specific obligations, and it did so in this case due to the obligation of good faith the Post Office owed its subpostmasters.

B. Good Faith as a General Principle in Civil Law

In European civil law jurisdictions, the duty of good faith is much more deep-rooted and pervasive.  France, for example, enshrines the obligation to act in good faith in its civil code. In fact, the French civil code specifies that contracts must be negotiated, formed and executed in good faith and that this principle is one of public order (meaning its application cannot be excluded). The legislator's desire to clarify that good faith is enforceable during negotiations means that the French legal system accepts that good faith will place some limits to contractual freedom. Good faith also creates an active obligation to share certain information with the counterparty – as demonstrated in the mandatory disclosure regime in France. For further detail on this, see the previous article in this series.  

II. The Practical Impact of Good Faith

A. Limited Impact in the UK

Where good faith can be implied in English law agreements, it requires the parties not to behave in a way that “would be regarded as commercially unacceptable by reasonable and honest people.” What this means will depend on the facts, but although the concept of implied good faith, even in the limited context of relational contracts, may seem atypical in English law, in practice it does not usually mean much more than expecting parties not to act dishonestly. Additionally, as is the case for any other implied term, good faith must be implied to give business efficacy to the contract (the "Business Efficacy Test") or must be so obvious that it goes without saying (the "Officious Bystander Test"). Separately, in the absence of language to the contrary, in English law agreements there is a more limited implied obligation to exercise contractual discretion in a manner which is not, arbitrary or capricious, or for an improper purpose, referred to as the Braganza duty. This duty arises even where the franchisor's or principal's contractual right to approve is expressed as being "at its sole discretion" and arguably extends to "absolute discretion" too. A discretionary right (e.g. a right to approve a proposed location for a store) shop should not be confused with a binary contractual choice (to terminate or not to terminate). The latter is not subject to this duty.

B. The Active Role of Good Faith in Europe

Good faith can impose additional, non-contractual, obligations on brand owners in the context of franchise and distribution agreements. In Italy, good faith is a general principle that is called into play only where there are not more specific breaches and violations, as a fail-safe. In the context of franchising, Italian case law recognises and gives the franchisee the right to a minimum territorial exclusivity, even if not expressly set forth in the contract, as an expression of good faith. German law also recognises a general principle of good faith which is connected to concepts of loyalty and fidelity and these create various practical obligations. For example, the principle of good faith establishes a duty on the franchisor to treat its franchisees equally and restricts the franchisor's (contractual) rights to make changes to the franchise system – the franchisor may only make such changes after giving sufficient notice and the changes must not unreasonably disadvantage the franchisee.

In the Netherlands, acting in good faith in a franchise context involves elements such as: an obligation on the franchisor to continue to innovate and develop the franchise business to ensure it remains commercially relevant; ensuring that all franchisees are carefully selected to avoid a situation where one bad partner negatively impacts the wider franchisee network; and a requirement to communicate with franchisees in relation to business operations.

Concluding Thoughts and Practical Advice

• Good faith exists as a concept in English law, but it usually has a more significant role in civil law jurisdictions.
• Recent English case law has developed and, to a certain extent, widened the concept of good faith, particularly when it comes to relational contracts, but as it stands, even when good faith can be implied, it broadly means that parties have a duty not to act badly. The Braganza duty is likely to have more significance, given that franchisors and principals have wider discretionary powers under franchise and distribution agreements.
• The practical impact of good faith in civil law jurisdictions has to be considered on a jurisdiction-by-jurisdiction basis, but it is worth remembering that it can apply from negotiation, through to the formation and execution of the contact.
• If reviewing a civil law franchise agreement, it can only be fully understood by reference to the underlying principles of the applicable civil code.
• Choice of English law may circumvent the impact of good faith principles under local law, but it is still helpful to understand and attune to these principles as this will foster greater understanding with the counterparty.

If you would like more information on this topic, please contact Gordon Drakes or Rachel Bowley.

This article was co-authored by trainee Melissa Couvet.