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The Post Office judgement has implications for franchising.

Updated: May 16, 2023


Magistrates gavel

The recent judgement in the litigation between a number of sub postmasters and the Post Office could have an impact on the franchising industry.


A question raised during the hearing was “Was the contractual relationship between the Post Office and sub postmasters a relational contract such that the Post Office was subject to duties of good faith, fair dealing, transparency, co-operation, trust and confidence…?” In answering, “Yes”, the High Court concluded that good faith and fair dealing is implied. According to the court this means parties must refrain from conduct which in the relevant context would be regarded as commercially unacceptable by reasonable and honest people. The court stressed that it is not enough just to be honest.


This follows a similar ruling in the judgement in the litigation in 2013 between Yam Seng Pte v

International Trade Corp. Here the judge found that as the parties had entered into a relational contract they must act fairly and in good faith towards each other. A similar ruling was made in the 2018 legal action between Amey and Birmingham City Council. In that case the judge decided that as the legal agreement between the parties was a relational contract; one in which the parties agree to work together over a long period, a greater level of care, transparency, good faith and integrity was required. This is the situation with franchise agreements.


There is no doubt that the Post Office acted in a dogmatic and cavalier manner when dealing with the sub postmasters and wielded its superior resources to dominate them. Sadly, this situation has been known to exist in the franchising industry where there is a similar imbalance of power between the franchisor and the franchisees. But, as we have just seen in the Post Office judgement, justice can eventually overcome wrongdoing.


Business men discussing a franchise

Franchise agreements are intentionally drafted to provide the franchisor the ability to control the business and if necessary, impose sanctions on a franchisee who does not comply with the methods set out in the operations manual.


This is fair enough because it is in the interests of both the franchisor and the other franchisees to prevent a renegade franchisee from engaging in a non-approved activity that could cause reputational damage to the brand. It is also right and proper for the franchisor to have access to the financial records of the franchisees so that under-declaration of royalties or management fees can be detected. What is not right is for the franchisor to take advantage of the imbalance of power and act solely for its own interests if it is against the interests of the franchisees. This is especially the case if the franchisor does this by using methods not set out in the franchise agreement and the operations manual.


The opportunities for this bad behaviour abound. Franchisors are in a position to negotiate rebates from the suppliers of products and services to the franchisees. Rather than passing this to the franchisees in the form of a supplier rebate, some franchisors have been known to keep this for themselves as a secret kick-back.


Another area where the franchisor can take unfair advantage of the situation is the commonly used requirement for the franchisees to contribute to a fund for promotional advertising. Where this exists, the franchise agreement usually states that the franchisor should hold this money in a separate bank account. Many agreements go further and require the franchisor to provide a bank reconciliation to show how the money has been spent. Most franchisors comply with this but some don’t. What is seldom included in the drafting of franchise agreements is confirmation that the contributions by the franchisees should only be spent on advertising from which they will directly benefit. If this grey area exists an unscrupulous franchisor could be tempted to use part of the fund to pay for advertising to recruit new franchisees. This is a major generator of revenue for the franchisor and only provides a negligible advantage for the franchisees.


The significance of the judgement in the Post Office case is clear. Relational contracts, in which the parties to work together over a long period, require good faith, fair dealing, transparency, co-operation, trust and confidence. They don’t allow the more dominant party, be it the Post Office or a franchisor, to take unfair advantage of the imbalance of power.

 

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