guest column: April-May 2014

Sooner or later, virtually all franchise relationships will come to an end.

Sooner or later, virtually all franchise relationships will come to an end. Some will expire naturally at the end of their terms. Others will be terminated, whether by one side in a contentious situation or mutually by consent. 

A franchisor wishing to terminate the franchise agreement early (meaning before the end of the term in the franchise agreement) will typically rely on the default and termination provisions of a franchise agreement. The default and termination provisions set out what acts or omissions of the franchisee are curable or non-curable, and the mechanism that a franchisor is required to follow to give notice to the franchisee. Curable defaults refer to defaults of the franchisee that he or she can diffuse, repair, or “cure”. The franchisee can get out of trouble by complying with curing requirements set out in the franchise agreement and, by doing that, avoid being terminated.

Non-curable defaults are defaults of the franchisee that he or she cannot cure.  Having committed non-curable defaults, the franchisee cannot cure those defaults.  The ball shifts to the franchisor to decide whether to terminate the franchise agreement. The franchise agreement typically provides a mechanism for doing so. A franchisor is wise to strictly follow the notice and any other formal requirements set out in the franchise agreement to effect termination. Termination of a franchise agreement by a franchisor in this way is called a “self-help remedy” because the franchisor undertakes this process without court approval, essentially on a self-help basis.

What happens to the retail location of the franchised business after the agreement is terminated depends on who controls the lease (whether the head lease of the location is in the name of the franchisor or franchisee), the terms and conditions in the franchise agreement about continued operation of the location, and non-compete and other “restrictive covenants” in the franchise agreement.

A franchisee who disputes the franchisor’s termination of the franchise agreement or the franchisor’s right to take over the operation of the location must commence legal proceedings, whether in court or arbitration (depending on the language of the franchise agreement), to dispute the termination and seek either damages or injunctive relief, or both. In all disputes, negotiations should be pursued exhaustively before commencing legal proceedings.

By the same token, a franchisor who wishes to terminate the franchise agreement or take over the franchised business but does not wish to do so on a self-help remedy basis, or is unable to reach an amicable settlement with the franchisee, will need to launch a legal proceeding for damages or injunctive relief, or both, to terminate the franchise agreement and, where desired and justified, take over the operation of the franchised business.

Franchisees wishing to get out of a franchise often have to look at whether they are entitled to a rescission (meaning cancellation) remedy in those Canadian provinces where mandatory franchise disclosure is required, which are: Ontario, Alberta, Manitoba, New Brunswick and Prince Edward Island (with British Columbia in the works). A statutory rescission cancels all franchise contracts if the franchisor failed to deliver a franchise disclosure document as required under the provincial franchise disclosure legislation.

A successful rescission entitles a franchisee to cancel all franchise agreements and seek compensation for all his or her investment in the franchised business, including the purchase price of the franchise, the cost of setting up the business, the cost of inventory and supplies, royalties and franchise payments paid to the franchisor, and losses the franchisee incurred in the operation of the franchise. This right is subject to a limitation period of two years from the date that the franchise agreement was signed. 

Often, a franchisee will need to launch a legal proceeding to prove that he or she is legally entitled to rescission and to
legally prove the damages that he or she is seeking. The legal proceeding is typically pursued in court as a lawsuit. However, often the dispute is required under the language of the franchise agreement to be resolved by private arbitration outside of the court system.

In court or in arbitration, proving the last category of damages, being the losses that the franchisee incurred in the operation of the franchise, is not easily done and requires a fair bit of accounting evidence and analysis.

Ben Hanuka is a franchise lawyer and principal of Law Works P.C. (www.lawworks.ca), a Toronto corporate law boutique with expertise in franchise disputes and many industries, including the restaurant and hospitality industries. He may be reached at
ben@lawworks.ca.