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Does the Implied Duty of Good Faith and Fair Dealing under Pennsylvania Law Govern a Franchisor's Contractual Performance? One Federal Judge Thinks So

Commercial Litigation Alert

Author: A. Christopher Young

3/08/2010

A decision from the U.S. District Court for the Western District of Pennsylvania denied a franchisor’s motion to dismiss plaintiffs’ claim for breach of the covenant of good faith and fair dealing, bucking the conservative approach taken by most Pennsylvania courts which had confronted the breadth of the covenant’s scope. See Martrano v. Quizno's Franchise Co., L.L.C., No. 08-0932, 2009 WL 1704469 (W.D. Pa. June 15, 2009). Most courts confronting claims for breach of the covenant have found that the covenant gives rise to a separate cause of action under Pennsylvania law only when the franchisor terminates the franchise relationship. The Martrano court, however, found that the covenant supported a separate cause of action even though the plaintiffs had only alleged a breach in the performance of the contract.

More specifically, in Martrano, the plaintiff-franchisees alleged that Quiznos fraudulently sold, managed and terminated franchises nationwide. Plaintiffs asserted various state and federal claims, including breach of contract and breach of the covenant of good faith and fair dealing. The franchisees’ claim for breach of the covenant of good faith and fair dealing was premised on Quiznos’ conduct in performing the contract. Specifically, plaintiffs alleged that Quiznos failed to bargain on behalf of the franchisees when negotiating supplier agreements. 2009 WL 1704469, at *17-18. Although it is unclear whether Pennsylvania law recognizes such a claim, U.S. Magistrate Judge Lisa Pupo Lenihan refused to dismiss plaintiffs’ cause of action for breach of the covenant of good faith and fair dealing.

Pennsylvania’s courts have taken a hazy, unsettled approach to the scope of the covenant of good faith and fair dealing. Bicycle Cor. of Am. v. Meridian Bank , No. CIV. A. 95-6438, 1995 WL 695090, at *3 (E.D. Pa. Nov. 21, 1995), GNC Franchising, Inc. v. O'Brien, 443 F.Supp.2d 737, 750-751 (W.D. Pa. 2006). Generally, Pennsylvania courts have embraced the principle articulated in Section 205 of the Restatement (Second) of Contracts that “[e]very contract imposes upon each party a duty of good faith and fair dealing in its performance and its enforcement.” See Martrano, 2009 WL 1704469, at *17-18; Atlantic Richfield Co. v. Razumic, 390 A.2d 736, 740-41 (Pa. 1978).

In practice, however, Pennsylvania courts have applied the doctrine only in limited contexts, notably in the franchisee/franchisor relationship. See Razumic, 390 A.2d 736, 740-41; Creeger Brick & Bldg. Supply, Inc. v. Mid-State Bank & Trust Co., 560 A.2d 151, 153-154 (Pa. Super. Ct. 1989). Moreover, the Pennsylvania Supreme Court has only addressed the duty in the context of terminating the franchise relationship. See Witmer v. Exxon Corp., 434 A.2d 1222, 1227 (Pa. 1981) (holding that that the duty of good faith and fair dealing is “applicable only in the context of an attempt on the part of the franchisor to terminate its relationship with the franchise.”) As a result, most Pennsylvania courts have historically found that the duty gives rise to a separate cause of action only when the franchisor terminates the relationship. See Bishop v. GNC Franchising LLC, 403 F.Supp.2d 411, 418 (W.D. Pa. 2005), aff’d 248 Fed. Appx. 298 (3rd Cir. 2007); Valencia v. Aloette Cosmetics, Inc., No. 94-2076, 1995 WL 105498, at *2 (E.D. Pa. Mar. 10, 1995).

However, because the Pennsylvania Supreme Court has yet to address whether the duty of good faith extends beyond termination, a few courts have taken a different approach, either declining to reach the issue at the motion to dismiss stage, or expressly extending the doctrine beyond the termination context. See O’Brien, 443 F. Supp. 2d at 754 (declining to dismiss claim for breach of the covenant because franchisee’s breach of contract claim would proceed and stating that the court “need not, and should not, now resolve this novel question of law” in advance of necessity); AAMCO Transmissions, Inc. v. Harris, 759 F.Supp. 1141, 1148-49 (E.D. Pa. 1991) (finding that the duty may have required franchisor to disclose that it was subject to an attorney general investigation before the parties entered into the franchise agreement, and opining that it is “unlikely that the Pennsylvania appellate courts will limit the franchisor’s duty to deal in good faith to situations of franchise termination when the issue is squarely presented.”).

In refusing to dismiss plaintiffs’ claim for breach of the duty of good faith and fair dealing outside the franchise termination context, the Martrano court joined the latter camp and explicitly found that Quiznos’ franchise agreements “should be read to include an implied covenant of good faith and fair dealing in the parties’ performance of their contractual duties.” 2009 WL 1704469, at *19 (emphasis supplied). Although the Martrano court attempted to temper its holding by stating that the implied obligation to deal fairly may be viewed as an “interpretive gloss” on the franchisor’s contractual obligations, Martrano, 2009 WL 1704469, at *19, plaintiffs asserting claims for breach of the duty of good faith and fair dealing will undoubtedly ignore this qualification. Rather, defendant-franchisors should expect that plaintiffs will use the Martrano decision to bolster independent causes of action for breach of the duty of good faith and fair dealing in performing a franchise agreement, a result that the majority of Pennsylvania state and federal courts have so far pointedly resisted absent controlling authority sanctioning such claims.

While the Martrano holding does not signal a widespread shift in the application of the duty of good faith and fair dealing, franchisors should realize that once the parties have entered into a franchise agreement governed by Pennsylvania law, they may obligate themselves to act in good faith in both the performance and execution of the agreement. As a result, a franchisor should carefully consider how its performance under the agreement, including decisions governing advertising and product allocation and distribution, will impact its franchisees.

A. Christopher Young and Amber Schuknecht Martin

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