A franchise business can be an extremely successful business model and is a common way to structure a business.
However, where the individuals involved are not suited to the franchise model, expectations are not met, or the franchise business is not profitable, complicated disputes can arise.
All franchises are built on the concept that uniform and consistent delivery of goods and services will create goodwill in the brand and returning customers across the franchise system. As a result, if a franchise buyer, known as a “franchisee”, is not able to take direction, then friction will likely arise with the owner of the system. Equally important, the owner of the franchise system, known as the “franchisor”, must have the right skill set and tools at their disposal. Running a franchise system involves a different skill set than running a successful independent business. If the franchisor can’t teach and encourage others to work within a franchise business model, provide processes that lead to the necessary consistency, account for the difference in business settings, or the business concept cannot be easily replicated, disputes are bound to arise.
Franchise disputes can arise from the initial representations and disclosure made when entering the franchise agreement. Many provinces have legislation requiring specific disclosure of information to prospective franchisees prior to entering into the franchise agreement. The legislation is intended to reduce the amount of disputes and protect the franchisee by ensuring there has been an adequate exchange of information about the franchise requirements and opportunities.
Disputes that are Specific to Franchised Businesses
In British Columbia, the province has enacted the Franchises Act, S.B.C. 2015, c.35, which came into force on February 1, 2017 to deal with disputes that are specific to franchised businesses. In addition to the disclosure obligations, the Franchises Act (B.C.) provides franchisees with:
- a right of association;
- the ability to rescind a franchise agreement where disclosure is inadequate;
- a right of action for damages in the event of misrepresentation; and,
- a codification of the duty of good faith and fair dealing between the franchisor and franchisee.
The concept of good faith and fair dealing, which is now encoded in the B.C. franchise legislation, is an important part of the franchise relationship. In a franchise relationship, the parties must cooperate in order to achieve the objectives of the franchise agreement, this is why the courts and some legislatures have imposed a duty of fair dealing. While the “fair dealing” standard permits a party to act in its own self-interest, it requires that each party have regard to the legitimate interests of the other party in the course of its actions or decisions. That being said, as long as the party owing the duty of fair dealing acts reasonably and honestly, the other party’s interests do not require undue consideration.
The Supreme Court of Canada in Bhasin v. Hrynew, 2014 SCC 71, found that in regards to the performance of all contracts, the contracting parties owe a duty of honest performance flowing from a common principle of good faith. This means that parties to a contract must not lie or otherwise knowingly mislead each other about matters directly linked to the performance of the contract.
Over the course of time, where the franchise relationship is strained either due to lack of profitability, lack of perceived value in the services provided by the franchisor or a failure to follow the systems operating procedures by the franchisee, among other reasons, disputes can arise. Most franchise agreements have specific requirements in terms of how to deal with disputes and defaults. It is important to follow the procedures set out in the agreement. Where the response to a perceived breach of the franchise agreement is to also breach the franchise agreement – for example, by the franchisor withdrawing services or the franchisee withholding royalty payments – the end result of this tactic could be disastrous. Canadian business and franchise law does not allow a party to breach an agreement simply because the other party is in breach. Consequently, the courts may allow for the termination of an agreement or other remedies, where both parties are in breach.
If the franchise agreement is terminated, it will no doubt have post-termination provisions. The most common post-termination provisions are a return of trademarked items and confidential information, non-solicitation of customers and non-competition in a specified area for a specified period of time. Whether these post-termination provisions are enforceable will depend on whether the termination was justified, whether the franchisor has breached the franchise agreement and to what extent, and the reasonableness of the clauses. Non-competition clauses are only enforced if they are reasonably necessary to protect the legitimate interests of the franchisor and are not overly broad in terms of the area covered, the scope of the clause including the activities that are restricted and the duration. If there is a conflict over whether these post-termination clauses are reasonably necessary, an experienced franchise litigator can be instrumental in deciding on the next steps.
Injunctions are often sought in the franchise context, either by the franchisee seeking to prevent a termination or by a franchisor seeking to enforce the post-termination provisions. For further information on injunctions, you should read the Injunctions section of this website.