By: Law Works
Most franchise systems depend on operating standards, procedures and policies. These requirements are typically contained in a franchisor’s operating manual.
Franchisors need to regularly update and revise the operating manual (e.g., updating hours operation, adding new menu items, or implementing a new cleaning procedure). That is the main reason why operating conditions are contained in an operating manual and not in the franchise agreement – because various operating requirements need to change and update regularly.
An operating manual is separate and different from the franchise agreement. It must be consistent with the broader terms and conditions in the franchise agreement and must not circumvent the terms of the agreement. Any meaningful changes to operating requirements in the operating manual – if they result in significant new expense or other hurdles for franchisees – must be commercially reasonable in the circumstances.
This article examines the legal nature of the operating manual, what is considered an enforceable change, and the factors to consider when updating or making changes to it.
How is the operating manual different from the franchise agreement?
The franchise agreement is the legal document that imposes the requirement on franchisees to comply with the operating and procedural requirements in the operating manual.
The operating manual sets out operating standards and obligations for all franchisees in the system. This often includes minute details that are far too specific for inclusion in the franchise agreement. By their nature, operating standards, procedures and policies are subject to ongoing modifications and amendments as the franchise system evolves during the terms of franchise agreement. These provisions are purely operational, rather than legal, and do not generally relate to the contractual intent of the parties. Some examples of what may be found in an operating manual include the following requirements:
- hours of operation;
- list of approved suppliers;
- building or store design requirement (e.g., colour scheme, equipment, layout, size, etc.);
- in a food business – the menu;
- preparation and packaging of products;
- forms required for the day-to-day operation, and
- facility cleaning requirements and procedures.
By contrast, the franchise agreement is the legal contract in which the franchisor grants to the franchisee the license to operate a business using the franchisor’s trademarks in exchange for consideration (i.e., franchise fees and royalties) and control over the franchisee’s operations. It is a high-level legal document that sets out the parties’ fundamental legal rights and obligations to one another. The legal terms are designed to be broad enough to stay current during the entire term of the agreement. Any changes to the franchise agreement must be done by way of a formal amendment with the agreement of all parties.
Other than requiring the franchisee to comply with the requirements of the operating manual, a typical franchise agreement also requires that the franchisee comply with all laws and government regulations that apply to the operation of the business.
What types of changes can a franchisor legally make to the operating manual?
A typical franchise agreement gives the franchisor the right to modify the franchise system throughout the franchise term. Modifications to the franchise systems are usually done by making changes or additions to the operating manual.
Disputes may arise between a franchisor and one or more franchisees if certain proposed or intended changes to the operating manual can have significant implications to the operation of the franchise. Often this type of change is technically allowed based on a clause in the franchise agreement that gives the franchisor the right to require renovations or equipment upgrades during the term of the franchise agreement. However, enforcing this right must be done in a commercially reasonable manner, based on the duty of good faith and fair dealing that is imposed on both sides to the franchise agreement.
For significant operating changes to the operating manual to be legally valid, two conditions should be satisfied.
- First, the change must be authorized by the franchise agreement (typically using broad language about changes to operating procedures or the system) and it must not directly or indirectly circumvent or contradict the requirements in the franchise agreement.
- Second, the changes (if resulting in significant cost or burden to franchisees) must be commercially reasonable.
Commercial reasonableness: changes that require significant investment or expenditure
It is not surprising that changes resulting in costly expenditures can lead to franchisee push-back. For example, for a franchisor to require a relatively new franchisee who opened just two years ago to invest $50,000 in store upgrades runs a serious risk of being considered commercially unreasonable and in bad faith. Similarly, requiring franchisees to buy a new piece of equipment would be considered commercially unreasonable if they had just been required to purchase a different one last year.
A case example involving a significant dispute was a class action lawsuit involving the Tim Hortons franchise system back in 2012. The franchisees objected to the pricing of newly introduced sandwiches that were added to the product mix. Presumably the franchisor made this menu change through the operating manual. The court ruled that the requirement was commercially reasonable for the franchise system to remain competitive. The franchise agreement stated that the franchisees must sell all product offerings required by the franchise system.
Another example of permissible operating changes relates to the pandemic, such as being required to install plexiglass barriers, purchase PPE for employees, or implement new cleaning or safety procedures. For the most part, these were permissible changes given that franchise agreement requires franchisees to comply with laws and government regulations.
Commercial reasonableness: changes driven by ulterior motives
Significant operating changes must not be required for ulterior motives. For example, a franchisor should not seek to impose significant changes to the business model through the operating manual. For example, in a case involving a gym franchise, the franchisor allegedly took advantage of the pandemic closures to launch online home exercise classes marketed directly to customers, while not allowing the franchisees to offer their own online classes or otherwise benefit from the business model change. This was a fundamental business model change and there was evidence that the franchisor had been contemplating this change before the pandemic.
How to implement a change to the operating manual
As noted earlier, for a significant change it is important to first ascertain whether the change is authorized by the franchise agreement and does not have the result of circumventing a requirement of that agreement.
Second, it may be important to have documentation about the commercial reasonableness of the change – why the change is required. This should also include adequate communication and dissemination to all franchisees in the system.
In addition, for significant changes that may require time to implement, franchisees should be given a reasonable timeframe to do so. For example, requiring all franchisees to implement a mid-day cleaning procedure is something that can be implemented effective immediately. Requiring franchisors to work with a contractor to make design change to the premises may take a few months. It is a case-by-case analysis.
Maintaining and updating the operating manual is a critical aspect of ensuring the smooth operation and evolution of any franchise system to stay current with the market and competition. The operating manual serves as a detailed guide for franchisees, outlining the specific standards, procedures, and policies they need to adhere to in their day-to-day operations. However, making significant operating changes to this manual requires careful consideration and adherence to legal and contractual obligations. Ultimately, when it comes to significant changes, the process of updating and enforcing the operating manual is a delicate balancing act, requiring franchisors to protect the integrity of their brand while respecting the contractual rights of franchisees. Striking this balance is essential for the long-term success and growth of the franchise system and for compliance with the franchisor’s legal rights and obligations.
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 commercial lawyer.
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