Covenant of Good Faith Fair Dealing

Understanding the Covenant of Good Faith and Fair Dealing in Franchising

Short Definition:
In franchising, The Covenant of Good Faith and Fair Dealing refers to the obligation for both franchisors and franchisees to act honestly and fairly towards each other so as not to destroy the right of the other party to receive the benefits of the franchise agreement.

Long Definition:
The Covenant of Good Faith and Fair Dealing is an implied contractual obligation that requires parties in a franchise agreement to interact with each other in ways that do not harm the other party’s rights to the benefits of the contract. This covenant does not require any party to act altruistically or to sacrifice their interests but mandates that neither party will do anything that will injure the right of the other party to receive the benefits of their agreement. This includes making decisions and taking actions that are honest, fair, and in accordance with the expectations set by the franchise agreement.

Additional Definition: At the heart of a franchise is an agreement that sets out the essential contractual obligations governing the relationship between franchisor and the franchisee. The franchise agreement, however, cannot spell out all the obligations that a franchisor may owe the franchisee, and it has been argued that the franchisor also has an implied duty of “fair dealing” not contained explicitly in the franchise agreement. Courts usually find that the implied covenant of good faith and fair dealing cannot be used to contradict clear provisions in an agreement.

History and Usage:
The concept of the Covenant of Good Faith and Fair Dealing has its roots in common law and has been a part of U.S. contract law for many years, varying slightly by state. In franchising, this covenant is particularly significant due to the ongoing relationship between franchisors and franchisees, which requires sustained cooperation and mutual reliance. The covenant helps maintain balance in the relationship, ensuring that both parties adhere to the spirit of the agreement, not merely the letter of the law.

Five Questions often asked and answers to each question:

1. Is the Covenant of Good Faith and Fair Dealing explicitly stated in franchise agreements?
   • While not always explicitly stated, the covenant is a legal doctrine that courts recognize as an implicit part of all franchise agreements in the United States.
2. How does the Covenant of Good Faith and Fair Dealing affect day-to-day franchise operations?
   • The covenant ensures that both franchisors and franchisees execute their roles in a manner that is not only compliant with the franchise agreement but also aligns with mutual respect, fairness, and honesty in daily operations.
3. Can a franchisor change the terms of the franchise agreement under this covenant?
   • A franchisor can propose changes to the terms of the agreement, but such changes must be made in good faith, with fair dealing, and typically with reasonable notice to the franchisee, keeping in mind the interests of both parties.
4. What are some examples of breaches of this covenant in franchising?
   • Examples include a franchisor arbitrarily withdrawing support or resources, misrepresenting earnings potential, or unfairly terminating the franchise agreement.
5. How can a franchisee protect themselves if they believe the covenant has been breached?
   • Franchisees should document all interactions that suggest a breach and seek legal advice. Dispute resolution mechanisms such as mediation or arbitration may also be outlined in the franchise agreement as steps prior to litigation.

Example of three, legally correct, sentences using the term – ‘Covenant Of Good Faith Fair Dealing’ related to franchising:

1. During negotiations, both parties ensured that the Covenant of Good Faith and Fair Dealing was considered when establishing the terms of their franchise agreement.
2. The franchisor’s decision to provide additional support to struggling franchisees was a good example of adhering to the Covenant of Good Faith and Fair Dealing.
3. When a dispute arose over territory rights, the franchisee appealed to the Covenant of Good Faith and Fair Dealing in their franchise agreement to seek a resolution that would be fair to both parties.

Summary:
The Covenant of Good Faith and Fair Dealing is essential for fostering a positive and productive relationship between franchisors and franchisees, ensuring that both parties enjoy the benefits of their agreement while operating their business. This covenant underpins the franchise agreement with a layer of protection against opportunistic behaviors, thus supporting the long-term success of the franchise network. Understanding and respecting the Covenant of Good Faith and Fair Dealing is crucial for maintaining a cooperative and thriving franchise relationship.

Learn more about franchising in The Educated Franchise – 3rd Edition