The Implied Duty of Good Faith and Fair Dealing in Franchise Relationships

Posted by Alan E. Lubel on

In Georgia, as well as in virtually all other states, implied in every contract is a duty of good faith and fair dealing. This common law implied duty requires that parties to a contract exercise good faith and honest judgment in carrying out their rights and obligations under the contract and not act arbitrarily or capriciously or with an improper motive.  As recently articulated by the Georgia Court of Appeals in the case of Capital Health Management Group, Inc. v. Hartley, 301 Ga. App. 812, 817 (2009), “The requirement that a party exercise good faith and honest judgment, even where the contractual language grants the party discretion, arises from the implied duty of good faith and fair dealing imposed upon virtually every contract under Georgia law”.[1]  A similar concept is imposed by the Uniform Commercial Code on all transactions involving the sale of goods. O.C.G.A. § 11-1-203 provides that “[e]very contract or duty within this title imposes an obligation of good faith in its performance or enforcement.”

One court has explained the underlying rationale for the common law implied duty as follows: …contracts do not just allocate risk.  They also (or some of them) set in motion a cooperative enterprise, which may to some extent place one party at the other’s mercy. “The parties to a contract are embarked on a cooperative venture, and a minimum of cooperativeness in the event unforeseen problems arise at the performance stage is required even if not an explicit duty of the contract.”

AMPAT/Midwest, Inc. v. Illinois Tool Works, Inc., 896 F.2d at 1041.  The office of the doctrine of good faith is to forbid the kinds of opportunistic behavior that a mutually dependent, cooperative relationship might enable in the absence of rule.”  Market Street Associates Limited Partnership v. Frey, 941 F.2d 588 (7th Cir. 1991) (Opinion by Judge Richard A. Posner).

While in some jurisdictions this duty can serve as an independent basis for a claim for breach of contract, states such as Georgia and Florida follow a more restrictive view.  In these states, an independent claim for breach of the duty of good faith and fair dealing is not recognized; rather, any such claim must be based on a specific obligation under the terms of the agreement.  As explained in a Northern District of Georgia case, American Casual Dining, L.P. v. Moe’s Southwest Grill, L.L.C., 426 F.Supp.2d 1356 (N.D.Ga.2006), which involved a relationship under a quick service restaurant franchise:

…the common law requirement of good faith and fair dealing is not an independent source of duties for the parties to a contract.  Alan’s of Atlanta, Inc. v. Minolta Corp., 903 F.2d 1414, 1429 (11th Cir. 1990).  Rather, the covenant to perform in good faith “modifies the meaning of all explicit terms in a contract, preventing a breach of those explicit terms de facto when performance is maintained de jure.”  Stuart Enters., Int’l, Inc., 252 Ga. App. at 234, 555 S.E.2d 881 (quoting Alan’s of Atlanta, Inc., 903 F.2d at 1429).  Thus, in order to state a claim for breach of the implied duty of good faith and fair dealing, a plaintiff must set forth facts showing a breach of an actual term of an agreement.  General allegations of breach of the implied duty of good faith and fair dealing not tied to a specific contract provision are not actionable. Alan’s of Atlanta, Inc., 903 F.2d at 1429; Tart v. IMV Energy Sys. of Am., Inc., 374 F.Supp.2d 1172, 1182 (N.D.Ga. 2005).

Although a claim involving the implied duty of good faith and fair dealing can arise in almost any contractual setting, as typified by the Moe’s Southwest Grill case, a frequent application of this duty of good faith and fair dealing arises in the context of franchisor- franchisee relationships. Thus, both parties to a franchise relationship must act in good faith in interpreting and carrying out the terms of the franchise agreement and their respective rights and obligations under the franchise agreement.  Because the franchisor usually has the upper hand and is typically granted discretion with regard to most matters (such as products or services offered, facilities, and brand standards) the duty of good faith and fair dealing is most often raised by a franchisee objecting to conduct by the franchisor in enforcing the franchisor’s rights under the franchise agreement. In a case against the venerable McDonald’s franchisor, Dayan v. McDonald’s Corp., 125 Ill.App.3d 972, 990-91, 81 Ill.Dec. 156, 170, 466 N.E.2d 958, 972 (1st Dist. 1984) the court summarized the law in this area:
[T]he doctrine of good faith performance imposes a limitation on the exercise of discretion vested in one of the parties to a contract…. In describing the nature of that limitation the courts of this state have held that a party vested with contractual discretion must exercise that discretion reasonably and with proper motive, and may not do so arbitrarily, capriciously, or in a manner inconsistent with the reasonable expectations of the parties. (Bold added).

Furthermore, franchisees have the right to expect that the franchisor will not act to destroy the right of the franchisee to enjoy the fruits and benefits of their franchise agreements. See Scheck v. Burger King Corp., 756 F.Supp. 543 (S.D.Fla. 1991) (complaint by franchisee for territorial encroachment by allowing new Burger King franchise within two miles of plaintiff’s location); But see Burger King Corp. v. Weaver, 169 F.3d 1310 (11th Cir. 1999) (no duty independent of the terms of contract). The duty to act in good faith is especially relevant when a franchisor’s discretion to act is limited by a contractually-mandated “reasonableness” requirement.  As stated by a court examining a fast-food franchise relationship, the duty of good faith applies “to effectuate the intentions of the parties or to honor their reasonable expectations” and “when the manner of performance under a specific contract term allows for discretion on the part of either party.”  Bonnano v. Quizno’s Franchise Company, LLC, 2008 U.S. Dist. LEXIS 21678 (D. Colo. March 5, 2008) (claim that franchisor abused its discretion and frustrated the reasonable expectations of the franchisees).  This standard has been applied in determining whether a franchisor exceeded the “reasonableness” requirement of a franchise agreement in changing policies and procedures, as follows:
…when AAMCO decided to change its policies its implied duty of good faith compelled it to do so “reasonably and with proper motive.”  All the contractual discretion in this case rested with AAMCO–precisely the type of situation that the duty of fair dealing was designed to control. So even if the express terms of the Agreement permitted AAMCO to alter its policies, it could not change them arbitrarily. Bonfield v. AAMCO Transmissions, Inc., 708 F.Supp. 867,884 (N.D.Ill. 1989)(Bold added).

A  context in which the power of a franchisor may be tested occurs, for instance, in attempts to introduce new menu items or to require new or upgraded facilities in a quick service restaurant.  See Payne v. McDonald’s Corp., 957 F.Supp. 749 (D.Md. 1997)(not unreasonable or a breach of the implied covenant of good faith and fair dealing for McDonald’s to require that franchisees modernize their restaurant before the franchise was renewed).  Recently, the issue of good faith and fair dealing has arisen in a number of high-profile cases challenging changes by franchisee organizations–Quixotic challenges, some would say.  In a case pending in Delaware, Kentucky Fried Chicken franchisees have revolted against the use of their marketing dollars to promote grilled chicken, rather than the Colonel’s traditional fried chicken.  The Dairy Queen franchisees association similarly brought suit, unsuccessfully so far, to challenge the required conversion to the new upscale “Grill and Chill” restaurant concept. And, a group of Burger King franchisees have filed a legal action objecting to the below cost promotion of $1 cheeseburgers on the dollar menu.  Although the duty of good faith and fair dealing does not change the terms of the contract in these or any similar disputes, it “acts as a limitation on the reserved discretion of a party to a franchise agreement.”[2]

If a dispute proceeds to litigation, the determination of the reasonableness of the conduct of parties to a franchise relationship may, in the proper case, be a question of fact for a jury to determine.  Either the franchisor or the franchisee may be called up to demonstrate that they have acted reasonably and in good faith and fair dealing in performing and enforcing their obligations and rights under the terms of the franchise agreement.

[1] A general statement of this duty is found in the Restatement (Second) of Contracts Sec. 205 (“Every contract imposes upon each party a duty of good faith and fair dealing in its performance and its enforcement.”)
[2]  Fundamentals of Franchising, 3rd Ed., Barkoff and Selden, American Bar Association 2008, p. 223; see generally, T.M. McLaughlin and C. Jacobs, Termination of Franchises: Application of the Implied Covenant of Good Faith and Fair Dealing, 7 Franchise L. J. 1 (Summer 1987).