Top Five Franchise Termination Considerations

If you are an existing franchisee within any franchise system operating in Canada, at one point or another you are bound to want to find out what it takes to get out of your franchise agreement.

You will want to know what would result from your franchise agreement being terminated.

By the same token, you will be interested in what rights your franchisor may have against you – if your franchisor were to try to terminate your franchise agreement.

After many years of practice, having litigated many precedent-setting cases, as well as what we call “run of the mill” cases, and having fielded innumerable inquiries from franchisees about our services, here are what I consider the top five overall issues that every franchisee must initially examine when considering the effects of terminating the franchise agreement:

1. How much do you owe to your franchisor?

What are all outstanding royalties and other franchise payments that you likely owe to your franchisor under the franchise agreement and any related agreements?

Having a good idea about this amount is an important first step.  Without knowing the total debt for which you may be on the hook, you will not be able to weigh all the risks and benefits involved in getting out of the franchise agreement.

2. Is your franchisor entitled to post-termination rights?

Does the franchise agreement contain post-termination/expiration restrictions against you, such as non-competition covenants? These may potentially restrict you from continuing to operate the business after termination or expiration.

Similarly, does the franchise agreement give to the franchisor rights to take over the assets of your business upon termination, or to otherwise buy them from you at nominal value?

These are issues of potentially significant concern.  Their analysis is legally and factually complicated.  You may start the process by at least identifying all those rights and obligations.

3. Are you personally on the hook for the head lease?

Often, franchisees are required to personally guarantee the head lease of their location, even if the head lease is between the landlord and a franchisor’s affiliate, and you are only a subtenant under a sublease.

If you are appear as a guarantor or indemnifier under your head lease, you potentially have significant liability at least to your head landlord.  This liability needs to be considered when devising your best strategy.

4. Is bank financing secured against your business assets?

Franchised businesses in the food or retail industry are typically financed by a Small Business Loan from a bank.  The SBL is secured against the assets of the franchised business.

If you are in this situation, your bank, as a creditor, likely has rights against your business assets that rank in priority to the rights of the landlord and franchisor.

Your exit strategy for terminating or getting out of your franchise agreement needs to take into account these secured rights that the bank has, and the negotiations that are possibly required with the bank, franchisor and landlord (in addition to any other creditors, particularly secured creditors).  You will also need to consider the rights of the secured creditors as among themselves.

5. What was the franchisor obligated to do for you, but failed?

Has the franchisor failed to fulfill any of its obligations to you? Prepare a list of all those obligations together with some reference to the key evidence that you have in support.

This will help guide your franchise lawyer when analyzing and assessing your most promising and best grounded lines of attack.

Even more importantly, are you sitting on potential rescission rights?  This is potentially one of the most important question in this entire analysis.

If you are entitled to rescission, your chances of pursuing meaningful remedies against your franchisor will be significant.  You will need to retain an experienced franchise lawyer to properly conduct this analysis.  The key elements that need to be determined on this issue are the following:

1. Did the franchisor deliver to you at the outset a compliant franchise disclosure document that contains all information, documents and material facts as required under the Arthur Wishart Act (Franchise Disclosure), 2000, or comparable franchise disclosure legislation in other provinces?
2. If the answer to (i) is no, you may move on to the following question: are you presently within two years from the date that you signed the franchise agreement?
3. If the answer to (ii) is yes, you will need to consider delivering to the franchisor a formal notice of rescission.  There is a two-year limitation period under the Act for doing so.

You may want to read other articles in the Law Works Franchise Law Blog about the following issues covered in this article:

• Franchise Rescissions in Ontario: A Disclosure Document Primer
• Not All Complaints By Franchisees Are Legitimate
• Terminating a Franchise: Practical Issues for Franchisors (Part I)
• Terminating a Franchise Agreement: A Primer
• Franchisees closing down: problems with getting help