What does this mean for franchising?
In its 18 August 2021 decision in Pakistan International Airline Corporation v Times Travel (UK) Ltd, the Supreme Court unanimously held that economic (or lawful act) duress is a valid concept under English law. The Court also confirmed the key elements of the doctrine and provided clear guidance on how it should be applied by the courts.
This is the first time that the Supreme Court has considered the issue of whether, and in what circumstances, a party can set aside a contract on the ground that it was entered into as a result of the other party threatening to carry out a lawful act.
While it confirmed that its boundaries are not fixed, the Supreme Court emphasised the narrow extent of the doctrine and it advocated a cautious approach to any extension. The Court identified only two situations where it had been applied, and the Court declined to endorse any principles for its development, even where a threat was used to enforce a demand that had been made in bad faith.
Although this decision applies to a travel agency relationship, it is relevant to several commercial relationships, such as franchising and distribution relationships where the franchisor or principal is a monopoly supplier and there is an unequal bargaining power. These types of relational, network agreements are characterised by long terms and high levels of investment. They may be exclusive in nature and will often contain a right to renew, subject to certain conditions. Typical renewal conditions include an obligation to:
- pay renewal fees;
- refurbish premises;
- waive any existing claims; and
- enter into the standard franchise or distribution agreement at the time.
There are compelling reasons to include these types of conditions but, on a bad set of facts, it is conceivable that a franchisor or principal seeking to exploit the asymmetry in the relationship could find itself vulnerable to a claim for lawful act duress.
The case arose due to a dispute between a small travel agent, Times Travel (UK) Ltd, and Pakistan International Airline Corporate (PIAC), Pakistan's flag carrier airline.
In 2009, Times Travel was appointed as an agent for PIAC and authorised to sell its tickets. The contract could be terminated by PIAC at any time with one month's notice. In September 2012, as a result of a dispute relating to the rate and payment of commission to Times Travel, PIAC gave notice to Times Travel, terminating the contract and reducing its fortnightly ticket allocation from 300 to 60. At approximately the same time, PIAC offered Times Travel a new contract (with the original ticket allocation) on the condition that it agreed to waive any claim that it had to the disputed commission. At that time, Times Travel's business almost entirely comprised selling tickets for flights to Pakistan on planes owned by PIAC and so the loss of the contract would have put it out of business. Faced with this prospect, Times Travel reluctantly agreed to accept the new contract, but later it brought a claim for the unpaid commission, arguing that it was entitled to rescind the new contract on the grounds that it had entered into it under economic duress.
The first-instance court agreed with Times Travel but the decision was overruled by the Court of Appeal on the grounds that PIAC had genuinely believed that the commission was not payable. The Court of Appeal held that a claim for economic duress could be established only if PIAC's demand that Times Travel gave up its claims for the commission had been made in bad faith, in the sense that it did not genuinely believe that it had a defence to those claims. The Court of Appeal found that it did not matter that PIAC's belief was unreasonable (for further details please see "Economic duress and franchising: when does a threat not to enter into a contract amount to economic duress?") .
Times Travel appealed to the Supreme Court.
The Supreme Court dismissed Times Travel's appeal, finding that PIAC's behaviour did not amount to economic duress.
Essential elements of economic duress
The entire panel agreed that economic duress does and should exist as a matter of English law, and they recognised it as a ground for the rescission of a contract. The panel also agreed that economic duress requires the following essential elements:
- there is an illegitimate threat (or pressure exerted) by the defendant;
- the illegitimate threat (or pressure) caused the claimant to enter into the contract; and
- the claimant had no reasonable alternative to acquiescing to the threat (or pressure).
What constitutes an illegitimate threat or pressure?
The panel did not agree on the issue of what the law has previously recognised as an illegitimate threat or pressure.
Lord Hodge (in the majority judgment) took a narrow view of the scope of the doctrine. He identified just two circumstances where economic duress has been recognised and a remedy provided:
- the exploitation of knowledge of criminal activity by the claimant (or those associated with it); and
- the use of illegitimate means to manoeuvre the claimant into a position of weakness to force it to waive its claim.
Hodge also asserted that, although the boundaries of the doctrine were not fixed, courts should approach any extension with caution, particularly in the context of contractual negotiations between commercial entities.
Rejection of bad faith demand requirement
Hodge asserted that, in the absence of a general principle of good faith in contracting or a doctrine of imbalance of bargaining power, the fact that one party had been induced to agree to another party's demand simply because the stark inequality of bargaining power between them gave it no effective choice but to agree to it, was insufficient on its own to establish a claim for economic duress.
Hodge asserted that, although PIAC's actions entailed "hard-nosed" commercial negotiation that exploited its position as a monopoly supplier, its behaviour was not sufficiently reprehensible as to fall within the existing boundaries of economic duress.
What does this mean for franchising?
There are situations when a franchisor's behaviour upon renewal could be too assertive and so risk being deemed as lawful act duress. For example:
- where the renewal fee is high and bears little relation to actual costs incurred. While not legally binding, the British Franchise Association's Guide to the Code of Ethics (the BFA's Guide) discourages "the charging of renewal fees if used as a method unfairly of imposing a financial burden at a time when the franchisee may be in a vulnerable position";
- where the franchisee has a legitimate claim or grievance against the franchisor, the franchisor knows it is liable but delays the claim and then achieves absolution at renewal via the waiver;
- where the refurbishment costs are disproportionately high when set against the renewal term and franchisee's ability to see a return on its investment. The BFA's Guide states that:
the overriding objective [of renewal] is to ensure that the franchisee has the opportunity to recover their franchise specific initial and subsequent investments and to exploit the franchised business for as long as the contract persists.; and
- where the proposed renewal agreement is substantially different from the franchisee's existing agreement. The bigger the differences, the harder the justification. The BFA's Guide states that the renewal should not impose "unreasonable conditions to create barriers which may renewal less attractive than it fairly should be".
This judgment undoubtedly represents a narrow interpretation of the doctrine's scope and it confirms a high threshold for proving economic duress.
While the Court did confirm that the boundaries of economic duress are not fixed, its emphasis on the narrow extent of the doctrine and its assertion that it should be applied both rarely and restrictively in the context of commercial negotiations means that it is likely to be harder for economic duress claims to succeed in the future.
The Court's clear guidance on the extent to which bargaining power can be leveraged in contract negotiations will be well received by powerful commercial entities, such as franchisors and monopoly suppliers or purchasers, that regularly impose conditions on the grant or renewal of an agreement.
For further information on this topic please contact Gordon Drakes at Fieldfisher LLP by telephone (+44 20 7861 4000) or email ([email protected]). The Fieldfisher LLP website can be accessed at www.fieldfisher.com.