By: Law Works
Almost every franchise agreement has an end date. Many, but not all, contain a renewal option that the franchisee has a right to exercise on certain conditions that the franchisee must comply with. Some of the renewal conditions are subject to the franchisor’s discretion – the franchisor can refuse or approve the renewal request, or impose conditions to its approval, subject to the duty of good faith and fair dealing.
What are typical conditions of a franchise renewal options?
Where a renewal right exists in a franchise agreement, the agreement will set out the renewal terms and conditions that a franchisee must comply with. Typically, the renewal conditions include the following:
- Defaults: The franchisee must be in compliance with his obligations under the franchise agreement (i.e., no unpaid royalties or other defaults). There may be other conditions, such as requiring that the franchisee must not have been in default more than three times during term of the agreement.
- Compliance with the Operating Manual: The franchisee must be in compliance with the policies and procedures in the operating manual.
- Renovation Requirements: The franchisee may be required to upgrade or renovate their location to bring it up to the franchisor’s current standards and image required for new franchisees (e.g., signage, equipment, furnishing, fixtures, décor).
- Requirement to Sign the Current Franchise Agreement: The franchisee must enter into the franchisor’s then-current franchise agreement, which may contain significantly different terms from the original franchise agreement, including payment obligations.
- Franchisee Renewal Fee: The franchisee must pay a non-refundable franchise renewal fee. Sometimes, the franchisee may also be required to pay the franchisor’s legal fees associated with the renewal.
- Notice: The franchisee must give advance written notice of his intention to renew (e.g., not less than six months; no more than 1 year before expiration).
- Lease Renewal: Depending on the term of the head lease, it may be a condition that the lease be renewed as a condition of renewing the franchise.
- General Release: The franchisee and its guarantors may be required to sign a general release of the franchisor with respect to all claims against the franchisor (to the extent permitted by applicable law).
- Training: The franchisee may be required to complete new or refresher training.
- Credit and Criminal Record Checks: In some systems, the franchisee may be required to provide current background checks to confirm that there had been no material adverse changes to the franchisee’s background, credit, or criminal record status.
On what grounds may a franchisor refuse to agree to a franchise renewal?
Where a contractual renewal right exists and the franchisee has fully complied with all its renewal obligations, it is not open for a franchisor to refuse a renewal of the franchise.
Having said that, many of the typical renewal conditions listed earlier bring in the exercise of discretion by the franchisor in the decision of what renewal requirements to impose – such as renovation and past or current defaults.
The exercise by a franchisor of a discretionary right in the franchise agreement has to be done in good faith and fair dealing, i.e., in a commercially reasonable manner. That is a requirement imposed by section 3 of the Arthur Wishart Act (Franchise Disclosure), 2000, and the other provincial franchise statutes in Canada.
In plain terms, the duty of good faith and fair dealing means that a franchisor should not rely on a renewal right in the franchise agreement in an arbitrary manner, or based on ulterior motives, or without taking into consideration the interests of the franchisee. This is generally what the duty to act in accordance with reasonable commercial standards means.
The following are more specific areas of renewal disputes and the factors that may weigh in the good faith and fair dealing analysis.
If the franchisee is currently in default, it may be considered commercially reasonable for a franchisor to refuse a renewal.
If the franchisee is currently in compliance, but was in default in the past, it may be considered commercially reasonable for the franchisor to look at past compliance as indication of future compliance and to refuse the renewal.
A judge will weigh the severity of the defaults, the franchisor’s effort to bring the franchisee into compliance, and the length of time it took to bring them back into compliance in determining if it is commercially reasonable to deny a franchise renewal.
- Failure to Meet Performance Standards
If the franchisee is not meeting required minimum performance standards, it may be reasonable for franchisor to want to phase the franchisee out of the system by withholding consent to a renewal.
A judge evaluating whether a franchisor is commercially reasonable in refusing a renewal will examine how far off the franchisee was from meeting performance standards, whether the franchisor raised the issued and communicated the concern about the franchisee’s performance with the franchisee.
- Reduction of Territory
A franchisor may allow a renewal but reduce the size of the franchisee’s territory – if this right exists in the original franchise agreement.
For this action to be considered commercially reasonable, there probably needs to be evidence of a correlation between the size of the territory and the performance of the franchisee. In other words, the franchisor should not normally reduce the territory simply to penalize the franchisee.
A franchise renewal marks a critical juncture in the ongoing relationship between a franchisor and franchisee. Understanding franchise renewal rights and the commercial reasonableness factors is important to franchisors and franchisees and legal counsel advising them.
Franchisors hold the discretion to approve, refuse, or impose conditions on renewal requests. In exercising this discretionary right, franchisors have an obligation to act in good faith. This doctrine emphasizes commercially reasonable conduct, restricting arbitrary decisions or actions influenced by ulterior motives.
As both parties navigate this critical phase, transparency, communication, and adherence to the principles of good faith are essential for a successful and mutually beneficial renewal or other resolution to a related dispute.
This article is provided for general information purposes only and is not intended to provide legal advice. Parties in a business dispute should obtain legal advice from a knowledgeable franchise lawyer.
The Law Works website offers a vast number of resources by way of blog articles and webinars about franchise, commercial and real estate disputes. Subscribe to our newsletters to stay up to date on the latest information from us.
Law Works offers complimentary initial 15-20 min telephone consultations, which you can book online.