UK: The Franchise Affair - Key Recent Developments Relevant To Franchising

Last Updated: 11 February 2009
Article by Jonathan Riley

Franchising has been a means of commercialising products and services since the 1850s when Isaac Singer who had made improvements to an existing model of a sewing machine wanted to increase the distribution of his machines. His efforts, though unsuccessful in the long run, resulted in some of the first franchises. Today, franchising is used in more than 70 industries and that generates more than $1 trillion in U.S. sales annually. This article reviews some recent key legal developments relevant to franchising.

The Nature Of A Franchise Agreement

The 'stand out' case in recent times is Jani-King GB v Pula Enterprises (2007). This looked at the nature of a franchise agreement in relation to the terms which might be implied into to. It also considered the extent to which the franchisor is subject to an obligation to act reasonably towards the franchisee.

Jani-King, based in the USA, is the world's largest commercial cleaning franchise company and Jani-King GB is responsible for its UK operations. Jani-King GB grants franchises to UK franchisees and provides them with training in the Jani-King cleaning system and a level of initial business from cleaning contracts procured by Jani-King.

Pula Enterprises took a Jani-King franchise. Pula then purported to terminate its franchise agreement for reasons which were not clearly articulated but revolved around a series of alleged breaches of the franchise agreement by Jani-King.

Pula argued for a very broad term to be implied in the franchise agreement "as a matter of necessary implication and/or by operation of law" that the franchisor would not act in such a way as to "destroy or seriously damage the relationship of trust and confidence" between the parties". This was without reference to any of the express terms of the agreement.

The judge rejected this, for three separate reasons:

  • There was no necessity to imply such a term: the contract worked perfectly well without it.
  • In any "complex commercial contract of this sort" there is no room for such an implied term. Where the parties have taken the trouble to spell out the terms of their contractual relationship, the courts should be very slow to imply any additional terms, particularly one couched in general terms.
  • The parties to a franchise agreement are in "a relationship which is much closer to an ordinary commercial relationship than one between employer and employee". The judge cited with approval previous cases which held that the nature of a franchise agreement is similar to the relationship between lessor and lessee (Kall Kwik Printing) and close to a vendor/purchaser agreement (Dyno-Rod).

So this case provides an important confirmation of the categorisation of franchise agreements. They are 'complex commercial contracts' with no room for broad and general implied terms. They are also 'ordinary commercial relationships' with no implied term of a relationship of trust and confidence between the parties.

The franchise agreement also contained an obligation upon Jani-King to provide "such reasonable continuing advice and assistance as the Franchisor in its sole discretion considers necessary for the efficient running of the Franchisee's Jani-King Business". Pula argued that, either by way of a contractual implied term or as a matter of law, Jani-King had an obligation to act reasonably in the exercise of its discretion. The court rejected this argument: the legal principle was already clearly established that such a discretion is to be exercised honestly and in good faith for the purposes for which it is conferred but is not qualified by an implication of reasonableness.

The franchise agreement was for a fixed term with certain express provisions for early termination. The judge quite rightly rejected out of hand Pula's suggestion of an implied term giving the right to terminate a fixed term contract on reasonable notice.

Franchisee's Reliance On The Franchisor

A basic principle of contract law is that outside evidence cannot be admitted to vary a written contract. This is a common law principle known as the 'parol evidence' rule. So if that is the case, why do we have entire agreement clauses?

Entire agreement clauses are necessary because the parol evidence rule will not apply if it can be shown that the written contract was not intended to capture the entire agreement between the parties. An entire agreement clause may be limited to simply stating that the written contract constitutes the entire agreement between the parties. If so, the clause will not prevent one party from claiming that it has been misled into entering the contract. For that reason, the contract will typically go further and state that not only does the contract contain the entire agreement between the parties, but also that each party acknowledges that it has not relied on any representations other than those set out in the written contract and excludes liability and remedies for any other misrepresentations other than as set out in the contract (a non-reliance clause).

An important point to bear in mind is that a non-reliance clause will function as an exclusion of liability clause. Under the Misrepresentation Act 1967, an exclusion of liability for pre-contract misrepresentations will only be effective if it satisfies a test of "reasonableness" (as set out in the Unfair Contract Terms Act 1977). In the case of Thomas Witter v TBP Industries (1996), the relevant provision was a blanket non-reliance statement covering fraudulent, negligent and innocent misrepresentation. The court said that an exclusion of fraudulent misrepresentation was not reasonable and, in the absence of distinctions between the different types of misrepresentation within the provision, declared the whole provision unreasonable and hence of no effect.

In the franchising sector, the scenario of a disenchanted franchisee claiming that he took the franchise in reliance upon representations made to him before he signed up which are not recorded in the contract is a familiar one. That was the nub of the recent case of Peart Stevenson Associates v Brian Holland (2008) where the franchisee claimed that both the average profit margin and the franchisee failure rate had been misrepresented to him. The franchise agreement contained a fairly comprehensive non-reliance provision, but the court held that it was unenforceable for two reasons: (i) the misrepresentations which had been made were fraudulent and it was not reasonable for liability for fraudulent misrepresentations to be excluded, and (ii) despite the inclusion of the non-reliance clause in the contract the franchisor knew that the franchisee had actually relied on the representations made to him.

On the issue of reliance, it is useful to recall the leading House of Lords case of Williams v Natural Life Health Foods (1998). NHLF ran a franchised health food stores business and the managing director was also the major shareholder. Williams took a franchise but made a big loss and closed down the business. He claimed that he had taken the franchise in reliance upon a brochure which included financial projections and other information compiled by the MD. Williams claimed against NLHF for negligence and, when NLHF also went bust, continued the action against the MD personally on the basis that he had assumed a personal responsibility. The House of Lords held that a director (or other employee) could only be personally liable for negligent misstatement if there was a reasonable reliance by the claimant on an assumption of personal responsibility by the director so as to create a special relationship between them. There was no evidence in that case that there had been any personal dealings which could have conveyed to the claimant that the MD was prepared to assume personal liability for the franchise agreement.

Health & Safety

Some potentially welcome news for franchisees is that, in an effort to save SMEs both time and money seeking to comply with health and safety laws, the Better Regulation Executive has produced a report for Government on practical measures for achieving cost-effective compliance particularly in low-risk sectors. The report highlights some of the well-known media examples of health and safety 'perils', including The Daily Telegraph's "Head Teacher made pupils wear goggles to play conkers" and The Daily Mail's "Hanging Baskets Banned". But no sign of the industry's favourite hot drink warning "Caution: this drink is hot"!

Contactless Payments

Many franchised retail outlets are now trialling or using contactless payment facilities, such as Barclaycard's OnePulse, where the customer can touch their payment card to a terminal without having to enter a PIN or sign a receipt for payments below £10. Franchisors rolling out these facilities to their franchisees should bear in mind the need to ensure that their systems meet both Data Protection Act requirements and the Payment Card Industry Data Security Standard (PCI DSS) particularly if they have not previously operated similar payment facilities.

www.lg-legal.com

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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