Does the Implied Covenant of Good Faith and Fair Dealing Apply to San Diego Franchises?

In brief, the answer is “yes.” The implied covenant of good faith and fair dealing is applicable to all franchise agreements in San Diego and elsewhere here in California. However, franchisees should not place too much reliance on the good faith covenant. In general, the covenant does not prevent a franchisor from exercising rights that are expressly provided for in the franchise documents. It is essential to have an experienced San Diego corporate attorney review your franchise agreements to provide advice and counsel.

The implied covenant of good faith and fair dealing is a judge-made rule that is implied in every contract that exists in California. The general idea is that parties to a contract must act in good faith towards each other. Parties cannot act intentionally to frustrate the purpose of the contract and prevent the other party from obtaining the benefit of their bargain. Since franchises are based on written contract, the good faith covenant is applicable to franchise arrangements.

When there is a dispute between a franchisee and a franchisor, there is a tendency by the franchisee to claim that the franchisor is acting in “bad faith.” This is particularly true where there is a dispute over termination, non-renewal, or enforcement of franchise requirements — such as remodeling and refurbishing of the location – as well as the use of new products, coupon-use requirements, and more. However, as noted, the good faith covenant only applies if there are no express provisions in the contract that allow the franchisor to take the actions that it is taking.

One of the more widely-reported recent cases involved the 7-Eleven franchise. See Khorchid v. 7-Eleven, Inc., Case No. 18-8525 (US Dist. New Jersey 2018). In that case, a 7-Eleven franchise was terminated and the local franchisee sued claiming that the parent franchisor acted in bad faith. The particular local owner had been a vocal critic of the management style of the franchisor and of various franchise rules and requirements. For example, he complained that he was forced to buy products from 7-Eleven vendors even though he could find merchandise at a lower cost elsewhere. This diminished his profit, he argued. Because of these types of criticisms, the franchisee claimed that his franchise was terminated because he was a “trouble-maker.” However, it was also true that the franchisee was in clear violation of the franchise agreement. As such, 7-Eleven argued that it had a clear right under the agreement to terminate the franchisee regardless of his criticisms. Moreover, any argument that a given action is a breach of the contract cannot also be a breach of the good faith covenant. Any breach of contract claim must be separate from the more general claim of violation of the good faith covenant.

In the Khorchid case, these two rules led to dismissal of the case (with leave to amend the complaint). The court agreed with 7-Eleven that it could not be charged with violation of the good faith covenant by exercising rights allowed under the franchise agreement. The plaintiff had separated his breach of contract and good faith covenant claims. The good faith covenant claim requires evidence of bad motive or malice. However, the plaintiff did not plead his claims as required and, as such, the case was dismissed. The case is still pending, and a new complaint has been filed.

These same rules apply here in California as shown in the case of Wolf v. Walt Disney Pictures and Television, 162 Cal.App.4th 1107 (Cal. App. 2008) involving the Roger Rabbit movie and its marketing. In that case, the plaintiff — Gary Wolf — sold the rights to use certain characters from some of his novels to Disney Studios in exchange for payment of 5% of “gross receipts.” However, Wolf eventually sued Disney claiming that Disney purposely arranged to obtain non-monetary compensation through various promotional agreements. Disney did not pay Wolf 5% of the value of those agreements because the non-monetary compensation was not part of the “gross receipts.” When he sued, Wolf claimed that Disney violated the good faith covenant. However, the courts rejected the claim. The licensing agreement signed by Wolf gave Disney the express right to make decisions on how to market and monetize the movie and the characters therein. The express rights in the licensing agreement could not be limited by use of the implied covenant.

Contact San Diego Corporate Law

For more information, contact corporate law attorney Michael Leonard, Esq. of San Diego Corporate Law by email or by calling (858) 483-9200. Mr. Leonard has the experience to review your franchise disclosure documents and agreements, help with the purchase (or sale) of a San Diego franchise, and/or assist with any business-related matter. Mr. Leonard has been named a “Rising Star” four years running by and “Best of the Bar” by the San Diego Business Journal. Like us on Facebook.

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