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By Ben Hanuka, J.D., LL.M., C.S.
How much leeway does a franchisor have to introduce material changes into a renewal franchise agreement? This depends on the wording of the renewal clause in the original franchise agreement.
On the one end of the spectrum, the original renewal clause may provide the franchisor with an unequivocal right to introduce any type of material change into the renewal franchise agreement, from higher royalty and advertising contribution rates to any other materially different tern that the franchisor uses in its ‘then-current’ form of franchise agreement at the time of renewal.
On the other end, the original renewal right does not expressly give to the franchisor any right to change the terms of the original franchise agreement at the time of renewal.
Difficulties come up where the renewal clauses fall somewhere in the spectrum. For example, a renewal clause may state that the franchisee is required to sign the franchisor’s then-current franchise agreement – without addressing whether it may contain material changes. Another may go further and state that the new form may contain different royalty rates, without otherwise stating that it may contain any other materially different terms.
In Timothy’s Coffees of the World v. Switt, an Ontario decision from 1996 (predating the Arthur Wishart Act (Franchise Disclosure), 2000), the renewal clause simply stated that, among other things, the franchisee was required to “execute the form of franchise agreement then in use” by Timothys.
Timothys’ new franchise agreement increased the royalty from six to nine percent. It implemented its new franchise agreement three years before the renewal of the franchisees in this case. The franchisees were aware of this new franchise agreement for about two years before the renewal. The franchisees made a first payment based on the new royalty rate, but later changed their minds.
The trial judge found that the franchisees did not raise any issues of concern when they first received the new franchise agreement. Basically, the franchisees were looking to force Timothys to negotiate a better royalty rate than its then-current rate. The trial judge found that the franchisees, husband and wife, were not helpful and held in favour of Timothys.
It is possible that the Timothys decision was impacted by the ulterior motives of the franchisees throughout their dealings with Timothys and their evidence in court, and the extensive good-faith efforts of Timothys.
In 2006, in Pointts Advisory Ltd. v. 754974 Ontario Inc., an Ontario court addressed, among other things, the scope of a contractual franchise renewal. The franchise renewal condition was on the fulsome end of the spectrum: it stated that the new agreement may contain different terms, as to royalties and otherwise.
Among other things, the franchisor requested a franchise fee of $75,000, and an advertising contribution of 5%, up from the original amount of 4%.
Yet, there was no evidence that the franchisor’s requested franchise renewal fee of $75,000 was its then-current franchisee fee. The evidence established that its current fee was $50,000. And while the requested increase in the advertising contribution to 5% was what the franchisor charged on paper, evidence showed that several franchisees paid only 3%.
Based on this evidence, the court held that the renewal fee should have been $50,000, and the franchisee had a right to continue paying the original percentage of 4%
In 2014, in France v. Kumon, an Ontario court dealt with a refusal by a franchisee to sign a new franchise agreement as a condition of renewing her franchise. As in the Timothys case, the franchisee was unreasonable.
She had an original oral agreement. By the time of the renewal, Kumon requested that she sign its standard form of written franchise agreement which it had in place across the system by that time. At some point, Kumon notified all franchisees, including the franchisee in this case, of its intention to require that all franchisees sign a formal written franchise agreement. The written agreement required the franchisee to move her location from a church classroom to commercial space at a significantly higher cost to her. Kumon assured her that it would grandfather her church location for at least five years.
Evidence showed that all franchisees in the system, except for the franchisee in this case, signed the written franchise agreement. The franchisee claimed that she had a perpetual oral agreement. The court held that in the circumstances of the oral agreement, either party could terminate the agreement on reasonable notice, and upheld Kumon’s termination of the oral franchise agreement (subject to a reasonable notice period).
The court made some interesting comments about balancing the franchisor’s right to change a business model with the duty to ensure that a franchisor does not use its stronger bargaining power to force unfair changes, or to act unconscionably towards the weaker party. The court left open whether a franchisor may impose unfair changes – indeed, it suggested that doing so would be prohibited.
About material changes affecting the business model, it remains to be seen how future cases with more involved and nuanced facts help develop the courts’ legal analysis.
Ben Hanuka is a member of the Ontario and British Columbia Bars. He is Certified by the Law Society of Upper Canada as a Specialist in Civil Litigation, and principal of Law WorksTM P.C. (in Ontario) and Law WorksTM L.C. (in British Columbia).
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