Give your franchise agreement a facelift – Part 3

Changes in technology, customer needs, and the laws governing franchising require franchise agreements to evolve reactively, to accommodate such shifts as they happen, and proactively, in anticipation of what the future might bring. Regular review of your franchise agreement can help you stay on top of the waves of change, address current and potential business issues, and help protect your legal interests in the event of a dispute or termination of the agreement.

This is the final part of a three part article outlining common provisions in franchise agreements that you might want to consider revamping. Don't miss part 1 and part 2.

Dispute Resolution Clauses and Waiver of Class Actions

Increasingly, franchise agreements include clauses whereby the franchisee waives its right to pursue a class action. Based on current case law, such clauses are not invalid. However, they will not necessarily be enforced by a court.

In 1146845 Ontario Inc. v. Pillar to Post Inc.[1], a franchisor sought to stay a class action brought by some of its franchisees. The franchise agreement contained a class action waiver clause and mandatory arbitration provisions. The franchisees argued that Section 4 of the Act (which provides franchisees the right to associate with other franchisees and prohibits franchisors from interfering with that right) included the right to bring a class action. The court rejected that argument. However, in granting the franchisor’s motion to stay the class action, the court relied on the mandatory arbitration clause in the franchise agreement, not the class action waiver. Thus, while the class action waiver clause was not specifically invalidated by the court, the clause was not specifically upheld, either.

In addition, in 2038724 Ontario Ltd. v. Quizno’s Canada Restaurant Corporation[2], the court found that the mere fact that a class action waiver clause was in a franchise agreement was insufficient justification for staying a class action proceeding. However, the court noted that a class action waiver clause would be a strong factor in determining whether a class proceeding is the preferable procedure.

In light of the Pillar to Post and Quizno’s decisions, therefore, we can conclude that inclusion of a mandatory arbitration provision in a franchise agreement might be more effective for those franchisors wishing to avoid class action proceedings than inclusion of a class action waiver clause, alone.

On a related note, if arbitration is provided for in the franchise agreement, franchisors should consider specifying the related processes and procedures. For example, the franchise agreement should set out how an arbitration proceeding is initiated, how an arbitrator is chosen, timelines, etc.. With respect to choosing the arbitrator, the franchise agreement may allow the franchisor to choose the arbitrator[3] provided that such discretion is exercised in good faith as required by Section 3 of the Act (e.g., appointment of a non-arms length party would likely not be upheld by a court).

Non-Competes

Developing a successful franchise system requires significant time, effort and resources. Naturally, a franchisor’s proprietary information, including its operating methods, standards and specifications, is incredibly valuable. Post-term restrictive covenants, such as non-competition provisions, can help ensure that franchisees do not use that know-how to run a competing business and damage the goodwill of the franchise system once the relationship ends. Under Canadian law, non-compete provisions are generally considered to be contrary to public policy, in that they constitute restraints on trade. They will, however, be enforced if the restrictions they contain are reasonable, having regard to both the interest the covenantee is seeking to protect and the extent to which they prevent the covenantor from being able to make a living. The key parameters to consider in such an analysis are the duration of the covenant (i.e., for how long the covenantor is prohibited from competing) and its geographic scope (i.e., the area in which the covenantor is prohibited from competing). For this reason, franchisors are advised to consider very carefully how much protection they actually need and to draft the temporal and geographic scope of their non-compete provisions to reflect that minimum amount of protection.

Two additional practices also deserve consideration. First, franchisors will sometimes insert into their franchise agreements a non-compete clause that contains a cascade of restricted times and/or areas in which the prohibition will apply, with the intention that the court will strike out (i.e., “blue pencil”) the overly-broad parameters, thus leaving the parties with a clause that is properly enforceable. An example of such a clause is as follows:

“Following the expiration of this Agreement the Franchisee shall not, for a period of two (2) years, operate, carry on or be engaged in or be concerned with or interested in a Competing Business:

(a) within the Territory; or

(b) within a radius of 3km of any office and each and every other office from which the Franchisor or franchisee thereof operates; or

(d) within Canada; or

(e) within Canada and the United States; or

(f) within Canada, the United States and Europe.

The Franchisee agrees that the restrictions in Section 15.3 are reasonable, that sub sections (a),(b) (c), (d), (e),and (f) thereof are separate and distinct agreements, that the greatest restriction of them should apply, failing which the next greatest restriction, and that if one of them is determined to be void or unenforceable it shall not affect the validity of the other.”

Unfortunately, while this practice is quite common and effective in other jurisdictions, such as the United States, Canadian courts have historically been quite reluctant to give effect to it, primarily on the argument that the court is not there to “re-make” the contract between the parties (i.e., to amend an otherwise unenforceable contract to render it enforceable).

Notably, in Shafron v. KRG Insurance Brokers (Western) Inc.[4], the Supreme Court of Canada confirmed that “blue-pencil” severance, may only be applied if the parties would have agreed to the remaining obligation without varying other terms of the contract (in other words, the part that is severed is not the main purpose of the clause). Accordingly, non-compete provisions that include multiple geographic scopes, such the above example, would likely not be enforceable under Canadian law. Again, the better practice would be to draft such provisions to stipulate only the minimum distance and time period necessary to protect the franchisor’s legitimate business interests.

The second practice franchisors typically employ to get around this issue is to insert non-solicitation clauses into their franchise agreements, either in addition to or in place of the non-compete. Canadian courts are generally much more willing to enforce clauses that restrict the covenantor from soliciting the employees or customers of the covenantee, primarily because the nexus between the restriction and the interest that the covenantee is seeking to protect is much clearer, and the damage the covenantor would cause by violating the restriction much more readily foreseeable.

Conclusion

When reviewing and revising your franchise agreement, the importance of clear and comprehensive drafting cannot be overemphasized. Since franchise agreements have been found to be “contracts of adhesion” (i.e., they are typically in a standard form and presented on a “take it or leave it basis”), courts will interpret the provisions of franchise agreements with a view to protect the more vulnerable contracting party (i.e., the franchisee).[5] This means that any ambiguities in drafting will be resolved in favour of the franchisee, and even where the drafting is clear, the court will construe the provisions to give the franchisee the most preferable position possible as opposed to construing the provisions in accordance with commercial reasonableness.

As a final tip, franchisors must ensure that the franchise disclosure document and ancillary agreements are updated to accord with any changes made to their form of franchise agreement and consider whether and how such amendments might be implemented for franchise agreements currently in force.

[1] 2014 ONSC 7400.

[2] [2008] O.J. No. 833.

[3] 2162683 Ontario Inc. v. Flexsmart Inc., 2010 ONSC 6493.

[4] 2009 SCC 6.

[5] Cora, para 38.