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On Preserving The Integrity Of Contracts

Author Richard Solomon is a conflicts and crisis management lawyer with 50 years of experience in business development, antitrust and franchise law, management counseling and dispute resolution including trials and crisis management.

While in this day and age it might seem to many that there are no rules, or that whatever rules there may be are all subject to fudge doctrines, there are yet a few basic tenets of economics and the performance of markets that remain immutable. The cost associated with eliminating or diluting them is enormous. For that reason alone, fundamental rules must be respected in the absence of truly compelling reasons to modify them.

The doctrine of “good faith and fair dealing” should not be applied to franchising. Franchising is dirigiste by definition, and its underlying fundamental agreements need to reflect that effectively without second guessing by every disgruntled franchisee. The integrity of the most important economic documents in our world – enforceable agreements – should never be impaired. To do otherwise is to invite disaster.

The purpose of this article is to call attention to this issue, because we are in a mode where there is a hue and cry in certain circles for the dilution of fundamental requirements. The reasoning behind these cries are specious, but that does not diminish the ardor with which many call for their being savaged.

Historically, agreements took several forms of expression and were not always in writing in one document. In the 17th century, land conveyancing included not only a writing of conveyance, but the additional ritual of actual delivery, called livery of seizen, the parties going onto the land and the new owner breaking off a twig as a gesture of his dominion over it.

In regular commerce there were written agreements for major transactions and less formal mechanisms by which to express agreement. If you ordered a drink and drank it, you had then contracted to pay for it. That quaint custom persists to this day.

People being as they are, written agreements had to be tweaked again and again to take into account the need to eliminate grounds for dispute regarding what was promised, by whom, when, where and how much. A few centuries of tweaking resulted in rather certain terms of expression generally understood by everyone engaged in commerce.

To this was added a campaign to make written agreements reflect differentials in bargaining positions to the greatest degree possible. After World War II, with the advent of mass marketing of consumer products, and the explosive enlargement of economic activity, the need for uniformity of terms and consequences was recognized first in the Uniform Sales Act and then in the Uniform Commercial Code. These dealt with the sale of goods, but their general approach was regularly applied as well to the sale of services as a matter of common law.

While this represented regularization of business methods and terms, it also recognized that no amount of specificity in any writing could possibly account for every possible vicissitude. The unexpected had to be accounted for. This was done in three principal ways. First there was resort to custom and usage of the trade in which the agreement was active. Second was reference to other writings to fill in gaps and missing terms. Without accounting for essential terms there was no contract, only an unenforceable agreement to agree. Finally there was a doctrine called “good faith and fair dealing”.

Goof faith and fair dealing is specifically incorporated into the UCC. It is sometimes incorporated into the state law relating to services rather than products, but that varies from state to state. While most states’ law recognizes fairness doctrines and applies it where the accused conduct is truly egregious, some are more limited. In Texas, for example, the state supreme court has specifically ruled (Crim v Navistar) that there is no implied fairness covenant in franchise agreements.

Where the issue is protection of average consumers against over reaching, we have the Federal Trade Commission Act, Section 5 of which prohibits unfair and deceptive acts or practices in commerce. This approach is also reflected in various state Consumer Protection Acts and Deceptive Trade Practices Acts. These are applied mostly, but not entirely, to consumer transactions, and the approach is to treat every consumer as an idiot and decide liability on the determination of whether the accused conduct is such that it would be unfair or deceptive when used on “the average consumer”/idiot. Mass market consumer products transactions, therefore, are governed by a doctrine of “perfect tender” – either it’s perfect or exchangeable/refundable.

The world can and does live with that. It also lives with something called the Magnusson-Moss Consumer Products Warranty Act that is itself one of the more misleading pieces of legislation to come down the pike. In the guise of consumer protection, this act actually provides for machinery usable by vendors to limit liability rather than to extend warranty coverage. It permits disclaimers to the extent that the consumer was better off before the act was promulgated.

Then there is the business to business transaction category, always based upon written agreements if enforceability is of any value. Oral agreements are just a form of masochism in business to business (B to B) transactions.

Franchising is a B to B transaction, the licensing of a proprietary business model under which a business is to be operated. The earlier history of franchising, however was so fraught with fraud that a parallel was seen between franchise fraud and securities fraud. This lead to the adoption of franchise investment statutes by many states that on their face parallel the securities business fraud standards. In fact there are significant differences springing from the fact that in franchising the business invested in is to be operated by the purchaser herself, as opposed to the expectation in securities transactions that the purchaser will not be involved in the operations of the business but will depend upon the operations skills of others (management).

These franchise investment statutes are usually accompanied with regulations to guide enforcement agencies. They are interpretive and not binding upon courts, although they are often referred to as guidance resources by courts.

The disclosure requirements compelled by franchise investment statutes do not remotely suffice to inform a franchise investor of the risks assumed by the franchisee in buying a franchise. There are inadequate affirmative disclosure requirements and effective disclaimers permitted to allow the worst sort to sell the most worthless franchise investments to ignorant investors who do not know how to perform competent pre investment due diligence investigation and who usually will not be willing to pay for resources to perform competent due diligence on their behalf.

What may sound high minded becomes in effect just another inadequate sop to public concerns. Contracts are permitted to be draconian. Courts enforce contracts according to their written terms and are reluctant to rewrite agreements to include terms that the parties themselves did not include.

The attempt to regulate franchise investing as a consumer transaction has not resulted in departing from the B to B contract enforcement regime, even though some consumer protection statutes treat franchising as a consumer transaction.

One should not assume that real politics is likely to provide additional remedies. Too much political muscle works against that kind of revision. At the state level, modification of a normal B to B standard has been attempted, and it occasionally produces what are called “relationship” statutes (as opposed to “disclosure” statutes) under which oppressive practices may be addressed. California. Illinois and New Jersey are examples of this.

That leaves us with the situation we now face where there is great hue and cry for “good faith and fair dealing” doctrines to be resorted to in parsing the relationship between a franchisor and its franchisees.

The demand for touchy-feely franchise regulation springs from an acute form of buyer’s remorse, the belief that what you thought you were buying into was posotovely different from what you really did buy into. The ignorant investor wants the government to make up for what he could have done for himself but failed to do – competent pre investment due diligence on deal quality. Having some “business” lawyer tell you that a franchise contract is very one sided and that he cannot say anything about whether the deal is worth signing that contract is totally worthless. To be sure, it is cheaper than real due diligence, but it isn’t even worth anything because you are just as ignorant after you bought this “advice” as you were before you did that. Is it any wonder that after you sign on you find out that business realities are vastly differently from what you convinced yourself they would be? You drank the Kool Aid.

It starts with the application to be approved. That positioning sets you up to come hat in hand asking for permission to enter a realm of exceptional people. It flatters you in the marketing materials by asking you questions about yourself that call upon you to confirm a belief that you are indeed one of those outstanding people who can and should make a major investment decision that will redirect your whole like toward some executive status you think you deserve. The psychology in franchise selling is classic bear baiting.

When you find out you have been taken advantage of – to put it mildly – you go see another lawyer where you find out that the agreement you signed leaves you no way out except bankruptcy. It is written in such a way that the franchisor can do almost anything at all without ever being in breach.

You are the only one who can be in beach in reality. You have draconian consequences if you default on anything. The franchisor has liability only for fraud in most instances.

You acknowledged that you received no financial performance information from the franchisor other than what was in the FDD, thinking you have to pretend that the financial performance information you received came from the tooth fairy, and that, in any event, you never relied on financial performance information in making your decision to invest.

Having put yourself in such a ridiculous position, with no real way out except maybe to sell to some greater fool than you were. Moreover, you cannot sell without franchisor approval which you probably won’t get if you sent them some aggressive emails about how they done you wrong.

Ultimately, you don’t have the money to wage this fight anyway. You lost it all trying to make a success out of a bozo business deal that you entered while in a state of abject ignorance.

What do these people do next? They have no real survival skills. They belong to clubs and fraternities and large organizations where individuality is not the essential means of achievement. They try to get the government to enact laws that take advantages away from franchisors and give them to you. You have no political action group and no budget to bribe legislators, so you are not going to get a get out of jail free card. Good faith and fair dealing isn’t going to happen. It could possibly happen by rule issued by the FTC, but the FTC Act does not provide for a private remedy. You can’t sue someone for violating the FTC Act. Various states have laws that provide that a violation of the FTC Franchise Rule is usable as evidence to show a violation of a deceptive trade practices act, but your lawyer will tell you correctly that very few have ever successfully made that case. Yours is an extreme long shot.

It is long established law that courts will not rewrite agreements to insert clauses that the parties did not themselves put in it. Aggressive application of one’s contractual prerogatives will not be used as a lever to re-engineer a franchise agreement in court. Maybe you could get some help in some incredibly outrageous situation, but those are few and far between. The contract was prepared in such a manner that the franchisor can do whatever he wants without fear of liability. That isn’t so 100 % of the time, but it is 99 % of the time.

Should courts be allowed to rewrite agreements to counterbalance contractual unfairness, the results of ignorant people signing tough commercial agreements? Enforceable contracts are the most important documents of commerce. Reliability of enforcement in absolutely necessary for contracts to have any value. That age old economic and legal construct is not going to be scuttled because ignorant people signed agreements they should not have signed. Moreover, what they said about themselves in their applications for approval contradicts any claim that they were susceptible to deception.

They have characterized themselves as highly educated business executives with many years business experience. You can’t under those facts sell yourself to a court or jury as a child who was taken unfair advantage of.

The decision to insert “good faith and fair dealing” into franchise relationships would undermine the asset value of every franchise company. Its portfolio of enforceable franchise agreements is its most valuable asset. With impairment of those agreements most franchise companies would become practically worthless. Courts ae not going to destroy, and should never consider destroying, the capital value of enterprises because investors refused or failed to use competent pre investment due diligence before they signed contracts and checks for big money.

This is a much bigger issue that whining losers have about their own investment mistakes. Public policy interests compel protection of contract value over investment incompetence. The world economy runs on enforceable agreements. It’s that important.

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