This article, written by Ben Hanuka, was originally published by The Lawyer’s Daily on September 7, 2018. Click here to view the published article.

By Ben Hanuka

Introduction

This article outlines some of the legal principles that may apply to the enforcement of performance standards in a franchise agreement.  Discretionary rights are sometimes associated with performance standards, and these rights add complicating factors to the legal analysis.

Performance standards in franchise agreements typically refer to minimum requirements or targets that a franchisee needs to achieve as a condition to maintaining certain contractual rights, such as the right to an exclusive territory or to renew the franchise agreement.

Performance standards are often expressed in minimum revenues or number or outlets opened.  They may escalate over intervals of time throughout the term of the franchise.

They are commonly found in the service industries (as distinguished from retail or restaurant industries, for example), and more broadly in master or area development franchise rights.

In a sense, performance standards may at least technically include any requirement of a franchisee to operate the franchised business in a certain manner that the franchisor prescribes from time to time (arguably, even down to the franchisee’s day-to-day manner of operating the franchised business).

A franchise agreement containing performance standards may have one or more consequences for failure to meet them:

  1. discretionary powers by the franchisor to remove or reduce an exclusive territory, or other important rights of the franchisee;
  2. loss of entitlement of the franchisee’s right to renew the franchise term; or
  3. default provisions that give the franchisor the right to terminate the franchise agreement.

 

Discretionary Powers

It is important to distinguish between discretionary and automatic contractual rights.

Automatic or mandatory rights set out results that are not typically open for evaluation or consideration of what the contractual consequence of the failure should be; the result is pre-determined and automatic (subject to typically providing default notices and opportunities to cure defaults, as the agreement may require).

By contrast, some rights of a franchisor are discretionary.  A discretionary right is typically present when the consequence is not automatic or mandatory, but instead implies that the franchisor has a right to decide, presumably after consideration, how to enforce its discretionary right.

Some discretionary rights may set out factors that the franchisor must take into consideration before deciding whether the franchisee is in breach of the contractual requirement.

Other discretionary rights may set out the types of consequences that should flow from the contractual breach, implying that the franchisor needs to evaluate the appropriate enforcement step.

The duty of commercial reasonableness in the performance and enforcement of discretionary rights

As all rights and obligations in a franchise agreement, the performance and enforcement of discretionary rights are subject to a statutory duty of fair dealing (in Ontario, see section 3 of the Arthur Wishart Act (Franchise Disclosure), 2000; see similar provisions in other provincial franchise legislation in Canadian provinces).[1]  Fair dealing includes a duty to act in good faith and in accordance with reasonable commercial standards.

Many elements of the application of this concept in the performance and enforcement of discretionary rights remain unclear in Canadian franchise jurisprudence.

For example, is a franchisor required to evaluate the severity of the breach and the most suitable or proportionate response to it, having regard to what is commercially reasonable?  What does commercial reasonableness even mean in the context of the specific issues in dispute?

It is also unclear how the duty of fair dealing affects contractual rights and obligations that are not discretionary, but are rather automatic.  If the contractual language is clear and there is no question about the contractual breach by a franchisee, what is the scope of the duty of fair dealing to the performance or enforcement of an automatic contractual consequence, such as termination of the agreement?

Another example of a grey area in the application of the duty of fair dealing to performance standards has to do with performance standards that are practically impossible to meet.  What are the consequences if the franchisee brings evidence that a certain performance standard is impossible to achieve, i.e., if the performance standard is itself unreasonable?

Further, is it open to a franchisee to claim that a performance standard implies an earnings claim? In other words, by imposing a performance standard is a franchisor deemed to implicitly represent that those standards are realistic?  If so, does it constitute a representation of an earnings claim?  Similarly, is a franchisor required to have support for the imposition of the performance standard, in the form of financial records and other data?

These and many more questions about the interpretation of performance standards and their application and enforcement remain to be explored in franchising jurisprudence.

Ben Hanuka, J.D., LL.M., C.S., Q.Arb.  is a member of the Ontario and British Columbia Bars.  Practises in the areas of commercial and franchise litigation and arbitration.  Certified by the Law Society of Ontario as a Specialist in Civil Litigation, and principal of Law Works‎®P.C. (in Ontario) and Law Works‎®L.C. (in British Columbia).

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[1] Alberta’s Franchises Act, s. 7; British Columbia’s Franchises Act, s. 3; Manitoba’s The Franchises Act, s.3; New Brunswick’s Franchises Act, s. 3; Prince Edward Island’s Franchises Act, s. 3.

For more information about Law Works’ expertise and how we may be able to help you, please contact Ben Hanuka at ben@lawworksdev.wpengine.com or by phone in Ontario at (855) 978-5293 and in British Columbia at (604) 262-1711.

Ben Hanuka Principal of Law Works PC (Ontario)/Law Works LC (British Columbia)