Franchise Agreement

A franchise agreement is the long-form contract at the centre of a franchise relationship. The franchisor licenses its trademarks, operating system and know-how; the franchisee invests its own capital to open and run a location, follows the system's standards, and pays initial and ongoing fees. Most systems use one standard form for every franchisee, so the document tends to favour the franchisor and negotiation focuses on a short list of points.

The Arthur Wishart Act defines the term broadly: a franchise agreement is any agreement that relates to a franchise between a franchisor, or a franchisor's associate, and a franchisee. A sublease, equipment lease or general security agreement signed with the franchisor can sit inside that definition alongside the main contract. Whether the relationship is a franchise in the first place turns on the statutory test explained under franchise.

Unless an exemption applies, the franchisor must deliver a franchise disclosure document at least 14 days before a prospect signs any of these agreements or pays anything beyond a small, fully refundable deposit, with copies of every proposed agreement attached. The disclosure document must also state that independent legal and financial advice should be sought before signing, and the 14 days are the time to get it.

Every franchise agreement covers the same commercial core, though the numbers vary widely by system:

• Grant and territory. What the franchisee may operate, at which site, and whether any territory is exclusive or only protected; see franchise territory.
• Term and renewal. A fixed initial term, often matched to the premises lease, and any renewal rights with the conditions attached to them.
• Fees. An initial franchise fee, a continuing royalty, an advertising or brand fund contribution, and charges for technology, training, renewal and transfer.
• Supply. Obligations to buy from the franchisor, its associate or approved suppliers, and limits on what the franchisee may sell and to whom.
• Standards and control. The operations manual, inspections, reporting, audit rights and the franchisor's right to change the system.
• Premises. Site approval, build-out and often a sublease or lease rider; see franchise head lease and sublease.

Ontario's disclosure regulation, O. Reg. 581/00, requires the disclosure document to describe purchase restrictions, the franchisor's rebate policy and, for an advertising fund, the share spent on advertising and the share retained by the franchisor in the two prior fiscal years. It must also warn that goods and services bought under the agreement may not be the lowest-cost option available, so read the agreement and the disclosure together.

The Arthur Wishart Act applies to a franchise agreement, and the business run under it, whenever that business is operated partly or wholly in Ontario. It does not set royalty rates, term lengths or renewal rights. Instead, it writes protections into every agreement that the contract cannot remove:

• Duty of fair dealing (section 3). Each party owes the other a duty of fair dealing in the performance and enforcement of the agreement, which includes acting in good faith and in accordance with reasonable commercial standards. A party that breaches it can be sued for damages. The duty binds both sides and governs how discretion over approvals, renewals, transfers and terminations is exercised; see duty of fair dealing.
• Right to associate (section 4). A franchisee may associate with other franchisees and form or join a franchisee organization. The franchisor and its associate cannot prohibit, restrict or penalize that, and any contract term that tries is void.
• Ontario law and forum (section 10). A clause restricting the application of Ontario law, or sending disputes to a forum outside Ontario, is void with respect to a claim otherwise enforceable under the Act in Ontario.
• No waivers (section 11). Any purported waiver or release by a franchisee of a right under the Act, or of an obligation the Act imposes on the franchisor, is void.

Renewal, transfer and termination rights come from the contract. The Act grants no automatic right to renew, and a renewal or extension is exempt from fresh disclosure where the business has operated without interruption and there has been no material change since the agreement or its last renewal. Our guide to franchise renewal, transfer and exit in Ontario covers notice periods, consent standards and termination procedure in detail.

On a sale, most agreements require the franchisor's written consent, a transfer fee, training and approval of the buyer, and a general release. Many also give the franchisor a right of first refusal to buy the business on the buyer's terms. Under the Act, the grant of a franchise includes a sale of shares in the corporation that owns it, and most transfer clauses likewise treat a change of control of the franchisee as a transfer.

A franchisee reselling its own business generally need not give the buyer a disclosure document if the sale is for its own account and is not effected by or through the franchisor. Approving the buyer on reasonable grounds, or charging a transfer fee set in the agreement or limited to reasonable costs, does not by itself mean the sale is effected through the franchisor, but where the franchisor does more, such as recruiting the buyer, the exemption may not be available. The conditions are explained under franchise disclosure exemptions.

When the agreement ends, the franchisee usually must stop using the marks, de-identify the premises, return the manual and customer data, and honour a non-competition and non-solicitation covenant for a set period and radius. Ontario's ban on non-competes in the Employment Standards Act, 2000 applies to employees, not franchisees, so a franchise covenant is tested at common law for reasonableness in duration, geography and activity; see non-compete agreement. Many agreements also give the franchisor an option to buy the assets or take over the lease.

Most franchisors require the individuals behind a franchisee corporation to sign a personal guarantee of the agreement, and many take security over the franchisee's assets.

Franchisors rarely change the economics for one franchisee, but these points are often negotiated: a cap or burn-off on the guarantee, a cure period before termination, renewal on substantially similar terms, a narrower non-compete, release of the outgoing franchisee and guarantors on an approved transfer, and limits on new mandatory fees. Lamba Law's franchise law practice reviews franchise agreements for franchisees and drafts them for franchisors.

Daniela Ruiz is buying a burrito restaurant franchise for a site in Burlington. The franchisor delivers its disclosure document on March 2, with the franchise agreement, a sublease and a personal guarantee attached, and she signs on March 20. The agreement sets a $40,000 initial fee, a 6% royalty and a 2% brand fund contribution on gross sales, a 10-year term with one 5-year renewal on the then-current form, a 30-day right of first refusal on any sale, a $10,000 transfer fee, and a two-year non-compete within 10 kilometres of any location in the system across Canada.

Before signing, her lawyer flags three points. A clause bars her from joining any collective organization of franchisees; under section 4 that clause is void. The disclosure shows the franchisor retained part of the brand fund in each of the last two years. And the non-compete reaches every location in the country, which may be wider than a court would enforce.

The franchisor will not move on the royalty, but agrees to limit the non-compete to 10 kilometres from her own location, to release Daniela and her guarantee on an approved transfer, and to a 30-day cure period for payment defaults. Six years later Daniela sells to Owen Park. The franchisor declines its right of first refusal, approves Owen, and the negotiated release ends her personal exposure on closing.