Is There A Duty Of Competence in Franchising?
Think about the last time you hired a plumber or an auto mechanic, or a lawyer for that matter. Without asking, you probably knew that the person you hired owed you a legal duty to perform the job in a competent manner consistent with the standards of his or her profession. The same is true when you bought a new car or built a new house. You rightly expected that the seller would stand behind its responsibility.
Buying a franchise is usually a very large investment for most folks. It would seem logical, then, that when you buy a franchise, particularly one from an established brand, that you have the right to expect that your franchisor owes you a duty to be competent in the same way that your dentist does. But most franchisors vigorously dispute this proposition and argue the opposite, i.e. that there is no duty of competence in franchising. They often argue that even if the franchisor makes a mess of the brand, it is simply your tough luck.
I dissent from that view. To be clear, there is no no claim in franchising under tort law for “negligent franchising” in the same way that there is a claim for negligent driving or negligent doctoring. And its true that most franchise agreements do a pretty good job of disclaiming the existence of any warranty.
Good Faith And Fair Dealing
The duty of competence in franchising comes from the implied covenant of good faith and fair dealing, which is conveniently summarized in Section 205 of the Restatement (Second) of Contracts. While contract law can change a bit from state to state, Section 205 speaks for most states in stating “every contract imposes upon each party a duty of good faith and fair dealing in its performance and its enforcement.”
Under Section 205, “good faith performance … of a contract emphasizes faithfulness to an agreed common purpose and consistency with the justified expectations of the other party” – which surely include the expectation that your franchisor knows what it is doing. “Bad faith” includes conduct that violates “community standards of decency, fairness or reasonableness…” and as a matter of law in most states, a “lack of diligence and slacking off” would breach the implied covenant.
Slacking Off Is Never Permitted
In a complaint against a Pennsylvania franchisor that franchises the manufacture of building products, but fell asleep at the switch and failed to keep its product in recognized compliance with national building code standards, causing its franchisees to suffer lost sales, we cited these Restatement provisions along with some cases that applied them in arguing that the franchisor was in breach of contract.
Similar allegations have been made against a pizza franchisor that rolled out a deep dish offering without adequate testing for taste and ease of preparation; a chain of steakhouses that insisted on a new salad and desert bar concept that was a huge flop; and a national convenience store franchise that mandated its franchisees to use a back office computer system that just doesn’t work. And those are just some of my cases in which the duty of good faith and fair dealing has been used to challenge the lack of franchisor competence.
The common denominator is that the franchisees in these cases were not entitled to a guarantee of business success. But they were entitled to argue that the franchisor failed to meet standards of reasonableness and diligence. As a practical matter these cases could turn on issues such as whether the franchisor did its homework before implementing a mandate to its franchisees and whether the franchisor was responsive when problems developed.
In other words, these cases are usually fact intensive.
The Universal Bill of Rights
The Universal Bill of Rights for franchisees recently published by the Coalition of Franchisee Associations builds on the Restatement of Contracts (and the common law of most states) by expressly providing that the franchisor’s duty of good faith includes the duty to act with due care in making decisions about the franchise.
The Proposed California Statute
Meanwhile in California, a new state law has been proposed (and at this writing has cleared an initial committee review) that would significantly enhance the rights of franchisees in almost all aspects of their franchise relationships. As drafted, the Level Playing Field for Small Business Act of 2012 – Bill AB 2305 would expressly require that franchisors meet a duty of competence when managing their systems, and it would create a statutory cause of action against franchisors that fall short.
Statutory remedies are always better than common law remedies, because judges usually feel some obligation to carry out the legislative command, and because the winning plaintiff can usually recover attorneys fees and possible enhanced damages that are intended to serve as a deterrent.
Predictably the franchisor lobby (led by the International Franchise Association) is working hard to defeat this bill, but regardless of how things turn out in the Golden State, it remains clear that the duty of competence in franchising is firmly rooted in the established law of good faith and fair dealing that applies in most states.
As a final word, everyone should remember that the duty to act diligently and reasonably, et cetera, is a two-way street. Both franchisors and franchisees have the right to expect this level of competence from each other.
DOs and DON’Ts for Prospective Franchisees
Of course, new concepts and geographically-focused concepts may have no or only a limited number of franchisees. These opportunities should not simply be avoided wholesale; however, in these cases it will be particularly important to have candid and open discussions with the franchisor’s owners and representatives.
Getting Out: Important Points for Selling a Franchise
In either case, the franchisee’s right to sell the franchise will be governed by the transfer provisions in their franchise agreement.
Franchises and Business Opportunities – Understanding the Difference
For entrepreneurs seeking to hit the ground running with a new business venture, there are two main categories of opportunities out there that allow them to benefit from the experience, assets and reputation of existing business concepts. These are: (i) the franchise, and (ii) the “business opportunity”.