Interpretation of Clauses in Franchise Agreements
Franchise agreements are inherently lengthy and detailed commercial contracts giving rise to frequent disputes as to what a clause does or does not mean. How English courts are to interpret contractual provisions was authoritatively set out by the House of Lords in Investors Compensation Scheme Limited v West Bromwich Building Society in 1998. In a more recent decision of the Supreme Court, Arnold v Britain in 2015, the Supreme Court gave a new test for interpreting contractual provisions, which is very similar to the previous test laid down by the House of Lords.
Arnold v Britain related to a dispute over the interpretation of service charge contributions in leases of a number of chalets in a caravan park in South Wales. The leases contained the following clause:-
“To pay to the lessors without any deductions in addition to the said rent as a proportionate part of the expenses and outgoings incurred by the lessors in the repair, maintenance, renewal and renewal of the facilities of the estate and the provision of services hereafter set out the yearly sum of £90 and VAT (if any) for the first year of the term hereby granted increasing thereafter by ten pounds per hundred for every subsequent year or part thereof.”
The effect of that clause is to convert a £90 annual charge in the first year to a charge of £2,500 in 2015 which would increase to over £550,000 by 2072.
Lord Neuberger gave the majority decision and set out seven factors that have to be taken into account in ascertaining the meaning of a clause which can be summarised as follows:
- Commercial common sense and surrounding circumstances should not override the language used by the parties.
- The worse the drafting, the more readily the court can depart from the words’ natural meaning, but the court should not seek out infelicities in the language because they may be irrelevant to the issue being considered.
- Commercial common sense is not to be applied retrospectively.
- The natural meaning should not be rejected simply because it gives rise to an unfair result.
- The court can only take account of facts known to both parties at the time they entered into the contract.
- If it is clear what the parties intended, the court will give effect to it.
- There is no special rule requiring the restrictive construction of service charges.
Using the above seven factors, the Supreme Court concluded that the first half of the clause requires the tenant to pay an annual charge to reimburse the landlord’s costs of providing services and the second half of the clause sets out how that charge is to be calculated and the fact that the amount of the charge may eventually substantially exceed the parties expectations at the time, was not a reason for giving the clause a different meaning.
Arnold v Britain is the latest case which emphasises the importance of the natural and ordinary meaning of a contract and that natural and ordinary meaning will “trump” commercial common sense or the need for the clause to be fair. That is significant in franchise agreements where contractual provisions are drafted by the franchisor’s legal team in contracts which either are entirely or largely non-negotiable and where concepts of fairness are, or should be, subsidiary to a franchisor’s need to protect its know-how and brand for the benefit of the franchise network as a whole.
Franchising, by social and community enterprises has been undertaken for many years. It is an area of franchising that is not often talked about, but is doing substantial good. The range and types of social franchises is extensive and varied. Many are businesses with a view to earning a profit, who, for instance, either sell products produced by persons with handicaps or employ persons with handicaps or both. Others are purely charitable or provide services to the community, such as food banks. In both these scenarios franchising, because of its requirements to create a system, that can be replicated easily, creates the perfect framework for developing the social enterprise.
There are a number of organizations actively involved in this area of franchising. The first is the School for Social Entrepreneurs (www.the-sse.org), which run courses for social entrepreneurs on franchising. As part of that course John Pratt delivers the element relating to the legal aspects of social franchising. The other organisation is Impact Hub King’s Cross (kingscross.impacthub.net).
High Court decides English jurisdiction clause applies and grants anti-suit injunction
The test for determining whether an exclusive jurisdiction clause applies to a claim is whether the applicant has shown this “to a high degree of probability”, or whether the English court “can point with confidence” to a contractual promise not to litigate elsewhere. A “good arguable case” or even a “strongly arguable case” is not sufficient.
The Court of Appeal in an earlier case had decided that a clause in a charterparty covering “all disputes arising out of this contract” covered a claim in tort for damage in the course of discharge operations.
The English courts may grant an injunction restraining a party from pursuing foreign proceedings – an anti-suit injunction if those proceedings have been brought in breach of a contractual obligation or where the foreign proceedings are “unconscionable”. This includes conduct that is vexatious, oppressive, or interferes with the due process of the English court.
An anti-suit injunction is a discretionary remedy, but where there is an English exclusive jurisdiction clause the discretion will ordinarily be exercised to grant an injunction unless there are “strong reasons” not to exercise it.
In the 2016 case of Hamilton-Smith and another v CMS Cameron McKenna LLP, the High Court considered the scope of an exclusive English jurisdiction clause in the defendant solicitors’ terms of business, and whether to restrain the Claimants from pursuing proceedings in Antigua. Although the case did not involve franchising the decision would apply in a franchising context.
CMS had issued a retainer letter enclosing its General Terms and Conditions of Business (the “Terms”). These included an English law clause and a jurisdiction clause covering “any dispute arising out of or in connection with the Retainer”. The letter was addressed to the Claimants as receivers of an Antiguan Bank but stated that the Terms would also apply to any subsequent work. The Claimants were subsequently appointed as liquidators.
CMS applied for an anti-suit injunction restraining the Claimants from continuing or pursuing proceedings in Antigua in respect of alleged defective advice.
The judge granted an anti-suit injunction with respect to the Antigua proceedings. However, he stated that he intended to grant a temporary stay of the English proceedings.
The judge found that the prosecution of the Claimants’ claims in Antigua was very probably a breach of contract, but had the Claimants shown strong reasons for refusing the injunction? The Claimants argued that the Antiguan court was the most appropriate forum, on the basis that the litigation as a whole was completely Antiguan, and there was a serious risk of injustice if the claims were heard in England.
The judge concluded that the mere fact that the underlying transactions took place overseas and had a foreign character did not by itself justify overriding an exclusive English jurisdiction clause.
The Claimants’ second argument was the serious risk of injustice if the claim proceeded in Antigua and the Claimants’ indemnity claim against CMS proceeded in London, rather than both claims proceeding in Antigua. In the latter event, the claims against the Claimants and the claims by the Claimants against CMS would be likely to be heard by the same judge using the evidence in the main claim. If the claims were heard in different jurisdictions, the Claimants would be seriously disadvantaged because there would be a duplication of costs and a risk that the English court might come to a judgment inconsistent with that of the Antiguan court. The judge accepted that this could give rise to real and unattractive consequences. Nevertheless, the judge concluded that in general a person who has contractually agreed not to do something cannot resist an injunction just because there are disadvantages to him in complying with the contract.
The Claimants applied for a temporary stay of the English proceedings on case management grounds pending the outcome of the claim in Antigua and the judge said he was minded to grant the Claimant a stay of the English proceedings, and would hear submissions as to the appropriate length of such a stay.
European Franchise Lawyers
The European Franchise Lawyers Association was established more than twenty years ago by Martin Mendelsohn. The idea was that an association of the leading franchise lawyers in each jurisdiction in Europe would be established. The association would meet twice a year to discuss franchise issues and developments and would work to be able to offer clients a seamless service throughout the European Union. It continues to flourish and, at its recent Athens meeting, two new members were elected – Volodymyr Yakubovskyy from Ukraine and Sergey Medvedev from Russia – reflecting the increasing economic importance of Eastern Europe. John Pratt was elected Chairman and Karsten Metzlaff of Noerr in Germany was elected Vice Chairman.
Canadian Court Enforces Franchise Termination and Release Agreement – Lessons for UK Franchisors
In the recent decision Dairy Queen Canada, Inc. v. M.Y. Sundae Inc., 2017 BCSC 358, the Supreme Court of British Columbia upheld a settlement agreement between a franchisor and a franchisee. The decision confirms that, in the absence of evidence of duress or unconscionability, a franchisor is permitted to take advantage of a superior bargaining position, and obtain an enforceable release when a franchisee is in default.
The Franchisor entered into a standard franchising agreement with the defendant franchisees. Following several months of unpaid franchise fees, a long history of failed inspections, and other breaches of the franchisor’s standards and specifications, the franchisor decided to terminate the franchise agreement.
Instead of terminating immediately, however, the franchisor offered the franchisee the opportunity to sell its franchise business within a specified period of time. In exchange the franchisee agreed to continue complying with the franchise system standards, and released all claims past and future against the franchisor.
The franchisee failed to find a buyer and the franchisor proceeded with the termination. Notwithstanding termination, the franchisee continued to operate using the franchisor’s brand for several months before de-branding.
The franchisor commenced proceedings, seeking, among other things, damages for the tort of passing off. The franchisee counterclaimed on the basis that, among other things, the franchisor’s termination of the franchise agreement constituted a breach of the duty of good faith and fair dealing, and that the settlement agreement was signed under duress.
The Court held that the franchisee had validly released the franchisor from all prior claims against it, so could not proceed with its counterclaim. The Court held that there was no evidence that the franchisee signed the agreement under protest or sought additional time to seek legal advice. There was no evidence of duress or coercion.
Further the Court held that the agreement was not unconscionable at the time it was negotiated. The settlement agreement actually provided the franchisee with an opportunity to sell his franchise, which put the franchisee in a better position than if the franchisor had simply exercised its right under the franchise agreement. The Court also granted the franchisor’s claim for passing off but only awarded damages from the date the franchisor notified the franchisee that he should de-brand which was some three months after the franchise agreement was terminated.
Carl Zwisler of the US law firm, Gray Plant Mooty, provides a regular update on developments in franchising internationally. The latest “Global Franchise Regulation Update” is dated March 6, 2017. It is an extremely helpful summary of developments by an author with a great deal of expertise in international franchising. For those franchisors who are contemplating international expansion, it is a document well worth obtaining (http://www.gpmlaw.com ).
Brexit: Implications for Franchising
The UK’s referendum held on 23 June 2016, resulted in a narrow vote to leave the EU and on 29 March 2016 Article 50 of the Treaty on European Union was invoked by the UK government.
It is too early to tell what the likely outcome will be, following the two year negotiation process, but there are, nevertheless, issues which will clearly have to be addressed.
Whilst the majority of UK commercial law does not flow from the EU, and will not be affected by Brexit, a significant proportion of it originates from the EU, or is affected by EU law. Areas that are particularly liable to be affected include advertising and marketing, agency, competition law, consumer law, distribution and franchising, product liability, data protection and the law relating to trade secrets.
The English Prime Minister, Theresa May, has announced that EU laws will all initially become part of UK law, under a “Great Repeal Bill” to be introduced in the Queen’s Speech in April/May 2017. This Bill will:
- Repeal the European Communities Act 1972 (“ECA”) with effect from the date of Brexit. The ECA is the principal act of Parliament which makes EU law effective in the United Kingdom. The Bill will repeal the application of all EU legislation and the primacy of judgments of the European Court of Justice in the UK on questions arising out of the interpretation of EU law.
- Convert all or substantially all existing EU legislation into domestic legislation wherever practical.
At some point after Brexit, each EU originated laws remaining in force as UK law will be reviewed to establish whether they are appropriate, and a decision taken as to whether to retain, modify or withdraw such law.
On 2 February 2017, the Department for Exiting the European Union published a white paper on the UK’s exit from and the proposed future partnership with the EU but it does little more than set out what the government hopes to achieve from its negotiations with the EU and does not add materially to our understanding of what will happen post-Brexit.
Advertising and marketing
UK law on advertising and marketing is largely derived from EU legislation, in particular the Unfair Commercial Practices Directive, which regulates advertising and marketing to consumers, and the Misleading and Comparative Advertising Directive, which mainly regulates business-to-business advertising and marketing. The rules established by these Directives are both implemented by UK legislation and reflected in the UK’s Advertising Standards Authority self-regulatory codes.
It is unlikely that current UK legislation implementing these EU Directives would be substantially revised. Nevertheless, going forward, minor changes are likely to be made.
Commercial Agents Regulations
The Commercial Agents (Council Directive) Regulations 1993 implement the Commercial Agents Directive (86/653/EC). These Regulations give commercial agents (as quite narrowly defined) certain rights that go beyond those implied under the English common law. These include rights to minimum periods of notice and a right to compensation or an indemnity on termination of the agency. A considerable amount of EU and UK case law has developed since the Directive and Regulations were introduced but unlike in some EU countries, notably Germany and Austria, the English courts have not applied these Regulations “by analogy” to franchising. Perhaps going forward, in view of the UK commitment to free markets, the Regulations will be repealed.
After Brexit, the EU’s competition rules will continue to apply to agreements or practices of UK businesses that have an effect within the EU, for example, the appointment by a UK franchisor of a franchise within the EU (and also within the EEA, where a similar competition regime applies).
The UK’s Competition Act 1998 is based on EU law, and includes an anti-competitive prohibition similar to Article 101 of the Treaty on the Functioning of the European Union (“TFEU”). As a result, Brexit will have little effect on franchise agreements that are granted to franchisees within the United Kingdom because the UK authorities will continue to enforce within the UK competition rules similar to those applicable in the EU.
The EU’s Vertical Agreements Block Exemption Regulation and guidelines protect franchise, distribution and other types of vertical agreement from much of the EU competition regime. The exemption applies under the Competition Act 1998 to vertical agreements effective within the UK but which do not have an effect on trade between EU countries. When the Regulation expires on 31 May 2022 the UK government will need to decide whether to “adopt” the regulation that replaces it.
The law relating to trade secrets has been developed through the common law in the UK. However, it will potentially be affected by the new Trade Secrets Directive. The EU formally adopted the Trade Secrets Directive in May 2016 and member states will have to transpose the Directive into their national law by 9 June 2018. It is not yet clear whether the UK government will implement the Directive.
The great majority of the Directive is currently reflected in UK law and so if the Directive was implemented by the UK government, it is unlikely to result in significant changes in practice.
The vast majority of UK consumers’ rights and remedies derive at least in part from EU law and are relatively long standing and accepted as establishing a fair balance between the interests of consumers and traders. Given that the government has only recently undertaken the consolidation exercise involved in passing the Consumer Rights Act 2015, it seems unlikely that amending consumer protection law will be an immediate priority following Brexit.
An EU proposal for a franchise-focused European Legal Act was announced in October 2016. It is yet to be seen whether this proposal will be progressed but, if it does, it is possible, but unlikely, that the UK will adopt something similar.
Further, the UK would not be involved with any future EU attempts to create an EU-wide contract or similar law, such as the proposed but currently abandoned Common European Sales Law, or the draft Directive governing online sales of goods to consumers which is currently progressing through the EU’s institutions.
Many franchisors have their trademarks registered under a single EU-wide trademark registration. It is inevitable that, on Brexit, legislative steps will need to be taken to ensure that these registrations remain effective purely as a matter of UK law, and perhaps that a system of reciprocal recognition is introduced.
In the UK, a claim for a defective product may be based on breach of contract, negligence or the Product Liability Directive.
Product liability claims based on breach of a contract or on negligence will, because they are based on UK principles, will be unaffected by Brexit. The position has been partially harmonised for contracts with consumers by the Consumer Guarantees Directive on the sale of consumer goods and associated guarantees.
The Product Liability Directive (85/374/EEC) has been enacted into UK law by the Consumer Protection Act 1987 (CPA), which provides that the producer shall be liable for damage caused by a defect in its product. Liability under the Directive, and hence also under the CPA, is strict; a consumer will have a claim irrespective of whether the producer is at fault. Post-Brexit, the CPA will still apply and hence there will be little, if no immediate impact on the UK’s strict liability regime.
The UK’s Data Protection Act 1998 was implemented in March 2000 as required by the EU’s Data Protection Directive of 1995. It has worked well and there does not appear to be any desire to move the UK away from its eight Data Protection Principles. If that is right, it is likely that data, post Brexit, will be able to pass freely between the EU and the UK.
More recently a Data Protection Directive and Regulation has been issued by the EU which will both come into force in May 2018. It is likely that both these instruments will be acceptable to the UK government and will be retained.
CRC Regulations Increase Allowance Price up to Scheme Closure in 2019
The CRC Energy Efficiency Scheme (Allocation of Allowances for Payment) (Amendment) Regulations 2017 (SI 2017/211) were made on 27 February 2017 and come into force on 31 March 2017. The Regulations:
- Increase the price of allowances purchased in forecast and compliance application periods in 2017, 2018 and 2019 and for special allocations.
- Provide for a final compliance sale in 2019.
This information is relevant to those franchisors who are responsible for energy used by their UK franchisees, where the UK entities in the franchise chain fall within the scope of the CRC Scheme.
The government is in the process of abolishing the CRC scheme and replacing it with a business tax.
McDonald’s European Problems
McDonald’s has been accused of forcing franchisees in France, Germany and Italy to charge more in their franchised outlets than McDonald’s had been charging in its own outlets.
Anti-trust complaints have been filed, alleging that McDonald’s abused its market power to harm franchisees and customers. It is alleged that the excessive pricing practices by McDonald’s French franchisees has cost consumers an extra 232 million euros in 2015 alone.
McDonald’s has responded by saying it invests heavily in programmes to help franchisees succeed and “McDonald’s and our franchisees operate in a highly competitive marketplace, and our franchisees set their own menu prices.”
McDonald’s is also under investigation by French authorities over an alleged strategy of shifting revenue to Luxembourg and Switzerland to avoid taxes. McDonald’s could also face a substantial tax recovery bill as European Union regulators finalise their decision in a parallel case.
These developments highlight the tough line taken by the tax authorities – reflecting public opinion – on multi-nationals seeking to minimise their tax liability in countries where they undertake substantial trading activities. Further, franchisees and organisations representing franchisees, are becoming more aware of their rights and have prepared to take action to defend those rights.
2016 Franchise Cases Review (Part 2)
Armchair Answercall Limited v People in Mind Limited
Kendlebell operated a franchise offering telephone answering services. It had ten franchisees. Kendlebell approached Armchair Answercall (“AA”) with a view to being taken over but instead AA proposed a services agreement under which AA would manage the Kendlebell business under a new method developed by AA under which franchisees would effectively become sales branches for services offered by AA. The franchisees were notified and immediately raised objections to the loss of control of invoicing and payment and to the removal from them of the call handling function which they previously exercised. The franchisees asserted that their franchise agreements were void or, if not, that they had come to an end by the franchisees accepting what they asserted were AA’s repudiatory breach of the franchise agreements. The franchisees communicated their rejection of the new terms. The franchisees, in addition, had set up an alternative answering service. AA submitted that these events amounted to a frustration of the contract.
The Court of Appeal concluded that AA’s failure to persuade the franchisees to accept the new method was not a supervening outside event, which the parties could not reasonable have foreseen as a real possibility and, therefore, could not constitute frustration of the contract.
Rush Hair Limited v Hayley Gibson-Forbes, S.J Forbes Limited
In this case the High Court had to consider whether post termination non solicitation and non compete covenants contained in an agreement transferring a franchisee’s business back to the franchisor were enforceable. The first covenant applied for two years and prevented the selling franchisee from canvassing, soliciting, enticing or employing certain key employees from the franchise business. The second was a non compete covenant also lasting two years preventing the franchisee from being involved in a competing business within the franchisee’s territory.
Notwithstanding these covenants, the franchisee opened a hairdressing salon within her previous franchise territory and hired one of the key employees. The Court found that she was in breach of both covenants.
The decision created no new law but reinforces that on a sale of a franchise business more extensive post termination non compete and non solicitation covenants can be enforced than in a franchise agreement. Generally, such covenants in franchise agreements last for only one year.