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Notwithstanding what franchise parties might have intended when they first got together, not every franchise relationship is destined to last. There are many reasons why franchise relationships fall apart. Some franchisees rush into buying a franchise without fully appreciating what is involved or required. Others expect a quicker or more substantial return on their investment, and still others discover they would prefer to run their own operation and make their own decisions.
Franchisees typically don’t have the right to unilaterally terminate their franchise agreements. Simply walking away when they’ve had enough will usually constitute a default of their franchise agreement, entitling the franchisor to sue the franchisee for monies owing under the agreement. However, a disgruntled or unhappy franchisee may avoid a dispute by negotiating an exit strategy with the franchisor. It is rarely in the interest of the franchisor to maintain a relationship with a franchisee who has lost interest in being a part of the system.
Franchisors on the other hand, usually have wide latitude under a franchise agreement to terminate a franchisee. Most franchise agreements contain lengthy termination provisions all favouring franchisors. These are summarized in disclosure documents in those provinces with franchise legislation. Depending on the nature of the default, a franchisor may or may not have to give a franchisee notice of default with an opportunity to fix it. For more serious defaults such as fraud, abandonment or bankruptcy, a franchisor may be permitted to terminate the franchise agreement without any notice.
If a franchisor gives notice of default or termination, the notice should be clearly written and refer to the relevant provision(s) of the franchise agreement. If the default is one that can be fixed, the franchisee must be advised of exactly what it needs to do and by when. As for a notice of termination, the effective termination date must be spelled out, as well as the franchisee’s obligations. Most franchisees must de-identify and for a reasonable period of time not compete with the franchisor. Franchisees may also be exposed to unpaid royalties for the remainder of the franchise agreement.
To avoid being terminated, franchisees must comply with all of the terms of their franchise agreements. If franchisees anticipate they will have difficulty making royalty or other payments, they should communicate in advance with the franchisor to work out alternative arrangements. Franchisees are better off asking for support upfront than ignoring their obligations and facing termination.
Franchisors should be able to enforce terminations provided they act in accordance with the terms and conditions of the agreement. However, if they haven’t exercised their termination rights fairly they may have difficulty doing so. Unlike some U.S. state laws that deal expressly with terminations, Canadian franchise statutes only require parties to franchise agreements to perform and enforce their obligations in good faith and in accordance with reasonable commercial standards. Examples of when a franchisor may be enjoined from terminating a franchise agreement on account of the duty of good faith and fair dealing are if the franchisor specifically promised the franchisee it wouldn’t treat its non-payment as a default, or if, without a legitimate business reason, the franchisor sought to enforce a contractual provision it had not enforced against any other franchisee.
If at an injunction hearing, a franchisee can show that its only source of income is the franchise operation, and that it will go bankrupt unless it can continue operating the franchise pending trial, a court likely will restrain a franchisor from terminating the agreement. A franchisee will be expected to comply with the franchise agreement and depending on its payment history, a court may impose COD terms on the franchisee for the franchisor’s supply of product.
The reality is, the last thing any franchisor wants is for one of its stores to go dark. To avoid terminations, franchisors should pay close attention to early warning signs of problems and address any issues both practically and on a timely basis. If the relationship can’t be rectified and is headed for divorce, then given the uncertainty, cost and time associated with going to court to enforce any termination, franchisors may wish to consider alternative exit strategies like buying-out the franchisee, helping the franchisee find a third-party buyer, or putting a management arrangement in place.