Area Development Agreement

An area development agreement (ADA) is a common way for franchise systems to sell multiple units to one operator. The franchisor grants a developer, usually a corporation controlled by an experienced franchisee or an investor group, the right to open a set number of units within a defined territory over a set period. In return the developer pays a development fee and commits to a development schedule. The ADA governs the pipeline; each location then opens under a separate unit franchise agreement signed with the franchisor when a site is approved.

An ADA typically covers:

• Territory. The area, and whether it is exclusive while the developer stays on schedule; see franchise territory.
• Development schedule. How many units must be open, or under signed unit agreements, by each deadline.
• Development fee. Paid on signing or at milestones; some agreements credit part of it against each unit's initial franchise fee.
• Unit agreements. Whether each unit signs the form attached to the ADA or the franchisor's then-current form.
• Default and termination. What happens to exclusivity, unbuilt units and fees if the schedule is missed.

In some systems the developer also recruits independent franchisees for the territory, who sign their own agreements directly with the franchisor. That variation is often called an area representative arrangement.

The development schedule is the heart of the deal. A typical schedule requires the first unit to open within a set number of months and further units at regular intervals. Because the developer must find sites, sign leases, finance build-outs and staff each location, delays in permits, landlord work or financing can put the schedule at risk through no fault of the developer.

Common consequences of missing a deadline include loss of territorial exclusivity, a smaller territory, termination of the right to develop the remaining units, and forfeiture of the part of the development fee attributed to units not opened. Developers commonly negotiate extensions for delays outside their control, a cure period, and a rule that missing the schedule ends only future development rights, not units already open.

Two Ontario rules shape these clauses. The disclosure regulation requires a description of any exclusive territory and, where keeping it depends on achieving a level of sales, market penetration or another condition, the franchisor's policy on when those rights may be altered. And section 98 of the Courts of Justice Act lets a court grant relief against penalties and forfeitures on terms it considers just, so a forfeiture far out of proportion to the franchisor's loss may be challenged; see liquidated damages clause.

The Arthur Wishart Act requires disclosure at least 14 days before a prospective franchisee signs the franchise agreement or any other agreement relating to the franchise, or pays the franchisor or its associate any consideration relating to it. An ADA is generally treated as such an agreement, so the franchisor must deliver a franchise disclosure document before the ADA is signed or the development fee is paid. The only payment allowed earlier is a deposit of no more than 20% of the franchise fee, to a maximum of $100,000, that is refundable without deductions and given under an agreement that does not bind the developer to proceed. The document must attach every proposed agreement the developer will sign, which means the ADA and the unit franchise agreement form.

Later units raise a separate question. The Act exempts the grant of an additional franchise to an existing franchisee if it is substantially the same as the franchise the franchisee is operating and there has been no material change since the existing agreement or its latest renewal. That exemption is unlikely to cover the first unit, because the developer is not yet operating one. It is also framed around a grant to the existing franchisee, which may not fit a unit signed by a newly formed corporation. And over a multi-year schedule, a change that may be material, such as higher fees, a rebrand or a change in control of the franchisor, is not unusual. The party claiming an exemption must prove it, so franchisors often deliver updated disclosure before each unit agreement. Other exemptions, including the one for very large initial investments, are covered under franchise disclosure exemptions.

A developer that also markets franchises should check its own exposure. Section 7 gives a franchisee a damages claim for a misrepresentation in a disclosure document, or any failure to comply with section 5, against the franchisor, its associate, its agent, its broker and every person who signed the document. The Act's definition of broker excludes a franchisee, so whether a developer is caught depends on the structure.

ADAs and unit agreements are usually linked by cross-default clauses. A cross-default makes a default under one agreement a default under the others: a missed development deadline can become grounds to terminate operating units, and a royalty default at one unit can end the development rights or every other unit. Franchisors want that leverage. Developers, who may have millions of dollars invested across locations, want the links narrowed.

Points developers often negotiate:

• Missing the schedule ends exclusivity and future development rights only, and does not affect units already open.
• A default at one unit cross-defaults to the others only for serious matters, such as insolvency, abandonment or conduct that damages the brand, and only after a cure period.
• Personal guarantees from the principals are capped, or limited to the ADA and named units rather than every agreement.
• Each unit is held in a separate corporation, which isolates operating liabilities, although cross-default clauses and guarantees can still connect them.

Because an ADA falls within the Act's broad definition of a franchise agreement, the franchisor's enforcement of the schedule and of any cross-default is subject to the statutory duty of fair dealing, which requires good faith and reasonable commercial standards.

Both structures are used for multi-unit growth, and the labels are sometimes used loosely, but the legal relationships differ. Under the Act, a master franchise is a right granted by a franchisor to a subfranchisor to grant franchises for the subfranchisor's own account. The master franchisee is a franchisee in its dealings with the franchisor and a franchisor in its dealings with its subfranchisees, so it both receives disclosure and must deliver its own.

Foreign franchisors entering Canada often weigh a master franchise against direct franchising or area development; our guide for US franchisors expanding into Ontario compares the options. If units will be opened outside Ontario, check that province's franchise statute as well; see franchise legislation in Canada.

Harjit Dhillon and Marcus Bell form a corporation to develop a poke restaurant brand across Halton Region. The franchisor offers an ADA for five units in Oakville, Burlington and Milton over four years, with a $75,000 development fee, $15,000 of which is credited against each unit's $35,000 initial franchise fee. The disclosure document, delivered 21 days before signing, attaches the ADA and the unit franchise agreement form.

Their lawyer negotiates three changes: a 90-day extension for permit or landlord delays, a carve-out so that missing the schedule ends only exclusivity and future units, and guarantees limited to the ADA and the first two units. Units one to three open on schedule.

In year three, the franchisor raises the royalty from 5% to 6% for new agreements and launches a new store design. Rather than rely on the additional-franchise exemption, it delivers updated disclosure before unit four is signed. The fifth site falls through when the landlord leases to another tenant, and the deadline passes. Under the negotiated terms, the developer loses exclusivity in Milton and the $15,000 attributed to unit five, but the four operating units are unaffected and continue under their own franchise agreements.