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The fundamental aspects of the franchise agreement

Written by : Joseph Adler
Franchise agreements are deceptively simple commercial documents. While most do not contain unduly complicated provisions per se, there are several traps for the unwary. No doubt a franchise agreement is very much like other commercial documents, though there are certain aspects of a franchise agreement which are peculiar to it or which otherwise deserve special attention. This paper is our attempt to highlight some of those key contractual terms and to pose various ways to address the issues raised when drafting some of these provisions.

Before we do so, however, it is important to set the context for our analysis of theses provisions. To draft a franchise agreement requires more than simple drafting expertise and a good understanding of the franchisor’s existing business operations and objectives. Lawyers and their clients when drafting franchise agreements are confronted by an almost impossible task. They must anticipate specific business and legal issues that might one day in the future arise, which issues have not yet been contemplated at the time that the agreements are drafted.

The problem of anticipating change in contractual matters is not unique to franchise law as it is clearly pervasive in every other area of the law. Yet, it is exacerbated by the fact that the length of many franchise agreements is much longer than in most other commercial agreements. Some franchise agreements are 10, 15 or 25 years or more in duration, so anticipating every possible change and scenario when originally drafting such agreements is virtually impossible. Yet, the success of the system to some extent depends upon a franchisor’s ability to address such possible changes in the franchise documentation.

At the same time, the Arthur Wishart Act (Franchise Disclosure), 2000 (Ontario) (the “Act”) requires that the information disclosed by a disclosure document provided by franchisors to prospective franchisees be accurately, clearly and concisely set out [Emphasis added]. A major component of the disclosure document, of course, is the franchise agreement and all other related documentation to be signed by the prospective franchisee. Arguably, such agreements and other documentation therefore should be similarly drafted in an accurate, clear and concise manner. The challenge is to draft the agreement as broadly as possible and to anticipate changes over the life of the agreement, while at the same time adhering to the “accurate, clear and concise” obligation under the Act.

Furthermore, franchise counsel are increasingly being asked by their clients to draft their franchise documentation in as plain language as possible and to reduce the amount of legalese present in the documentation. Franchisors not only want to be legally protected from their franchisees, suppliers and other third parties, but they also desire user-friendly franchise agreements that may be used as marketing tools themselves and that do not unnecessarily confuse or intimidate their prospective franchisees. Traditionally lengthy franchise agreements may not therefore satisfy the requirements of the Act nor will it meet the requirements of more demanding franchisors.

To provide franchisors with a measure of flexibility, therefore, franchisors have relied upon the operations manual and policy statements for the issuance of standards and policies affecting the franchise system. This is legally accomplished by the incorporation of the operations manual by reference into the franchise agreement and by general distribution of such policies. Please see below for a further discussion of this practice. TOR_A2G:1192809.1

The Act and the disclosure requirements arising out of the Act have considerably altered the franchising landscape in this Province. Since the advent of the Act, franchisors must be mindful when drafting their franchise agreements of the statutory duty of fair dealing (which does not seem to differ much from the common law duty of good faith and fair dealing), the right of franchisees to form or join franchisee organizations and the new disclosure obligations imposed by the Act and the Regulations to the Act. For example, franchisors may no longer interfere, prohibit or restrict, by contract or otherwise, a franchisee from forming or joining a franchisee organization or otherwise prevent them from associating from other franchisees. Any such prohibition or restriction in the franchise agreement will be rendered void and ineffective by virtue of Section 10 of the Act.

Finally, the popularity of the Internet and e-commerce, has presented a whole host of issues that franchisors must address in their documentation, from protecting trade secrets and other intellectual property on the Internet, to domain name and website control and protection, to website terms of use and online privacy issues. Once again, the franchise agreement should be amended to specifically address these very important issues. In addition to considering the Act, there are several sometimes competing and overlapping objectives that also require attention when drafting franchise agreements. The most important objective in drafting a sound franchise agreement is to “bullet-proof” your franchisor client. One does so by clearly setting out the applicable legal rights, obligations and remedies of the franchisor, franchisee and guarantors, if any. For example, franchise agreements will inevitably deal with the sale, transfer and termination of franchises, and establish the payment obligations of the franchisees and the manner by which the franchisee is to conduct its business operations. Protecting the value of the brand, trade-marks, trade secrets and confidential and proprietary TOR_A2G:1192809.1

Information is another objective which deserves serious attention by franchisors and their counsel. Franchise counsel must now also take steps to ensure consistency between the terms and conditions of the franchise agreement (and other agreements) and the disclosure document when preparing the franchise documentation. Internal inconsistencies between the franchise agreement, for example, and the disclosure document not only reflect poorly upon the franchisor, but also expose the franchisor to a possible claim of misrepresentation under the Act or under the common law.

Finally, it is important to consider the following objectives when drafting the franchise agreement:

  • The process of drafting the franchise agreement should help to solidify the franchisor’s understanding of its own system and confirm that understanding with both prospective and existing franchisees. In other words, counsel should ensure that the franchise agreement accurately reflects the way the system is operated in reality.

  • Ensuring that the agreement does not contain provisions that are unduly abusive, unconscionable or otherwise unfair. Such provisions dissuade prospective franchisees from purchasing the franchise or cause franchisees and their counsel to request amendments to the agreement, thereby increasing the cost of selling the franchise. Furthermore, such onerous provisions could possibly generate dissension amongst existing franchisees and the franchisor and are more likely to be rendered unenforceable by an arbitrator or a court, for example.

  • Adopting a more collaborative approach to relations as between franchisor and franchisee and otherwise minimizing disputes with franchisees. For example, franchisors might consider including language that would institutionalize the creation of a franchisee association or advisory council to better co-ordinate their TOR_A2G:1192809.1

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