“Perpetual” Franchise Agreements: When Can They Be Terminated?

When a franchisee enters into an agreement with a franchisor, it may be contemplating a forever, “till death do us part” kind of relationship. This can be especially true in regard to the first franchisees of a new franchise system – those franchisees that enter at the start and assist in building and expanding a franchisor’s brand will likely want to enjoy the fruits of their efforts for as long as possible and in the early stages of the relationship, both parties are inevitably optimistic and likely expect that they will carry on happily ever after. The end of the relationship is understandably not one of the first things on either party’s mind. But it should be. As we all know, things do not always play out as expected.

Before entering into a franchise agreement, both franchisees and franchisors should carefully consider the terms governing the duration of their relationship as well as the circumstances which could lead to the termination of the agreement. Often, franchise agreements will automatically renew after a set period of time, so long as certain conditions are met. In those instances, if neither party breaches the agreement, and if there is no limit placed on the number of renewal terms granted by the franchise agreement, the relationship may continue indefinitely.

What Is an “Evergreen” Clause in a Franchise Agreement?

This brings us to a discussion of indefinite term contracts containing what are commonly referred to as “evergreen” clauses. An indefinite term contract is an agreement that does not have an “expiry date”. An “evergreen” clause entails the automatic renewal of the agreement year after year. What does this mean in practice? Well, in most cases, if both parties are acting in accordance with the terms of the agreement, the relationship may continue indefinitely. However, what if one party wants out in circumstances where there have been no events of default entitling the innocent party to terminate the agreement?

Can an Indefinite Franchise Agreement Be Terminated on Reasonable Notice?

In some instances, indefinite term contracts may be terminated on reasonable notice in the absence of any clause permitting such right. Courts have been willing, in some cases, to find an implied term which permits the termination of a contract without cause. The Ontario Court of Appeal has stated that when the term of a contract is not fixed and there is no provision for the termination of the contract on reasonable notice, a court may treat a contract as either perpetual in nature or as an indefinite term contract with an implied unilateral termination right on reasonable notice.[1] In the latter instance, either party to the agreement can terminate the contract if they give the other party reasonable notice. How the court determines what is ‘reasonable’ is largely dependent on the facts of each particular situation. In order to make this determination, the court must consider the following:

1. the relationship between the parties;
2. the specific terms of the contract; and
3. all surrounding circumstances.

Type of Relationship: Some types of contracts which depend upon mutual trust between the parties, like contracts of employment, partnership, or personal services, naturally give rise to an implied right to terminate upon reasonable notice.[2] Franchise agreements have also generally been found to be of a class of agreements that can be terminated upon reasonable notice without cause.[3] This is because franchise agreements are the type of contract that involve mutual trust, and each party should have the right to terminate the contract unilaterally on notice in the event there is a breakdown of that trust. In other words, trust between the parties is so important in this type of relationship that the absence of it is sufficient grounds for either party to end the contract.

Specific Terms: There may be specific terms within the franchise agreement which either point towards or away from an implied right to terminate without cause on reasonable notice. For example, if an agreement stipulates that it can only be terminated by mutual agreement or for a material breach of contract, then likely only in those two circumstances mentioned could the parties actually terminate the agreement. The courts in Ontario have also found that, given that franchise agreements are contracts of adhesion reflecting unequal bargaining power, they require the utmost good faith in their performance and the courts must carefully scrutinize their termination. In order to be appliable, a termination clause must be very clear, and its words will be read strictly.[4] When an agreement contains specific terms which set out when termination may occur, it is more difficult to establish an implied right to terminate on reasonable notice without cause. In the context of an agreement with numerous termination provisions, an additional implied right to terminate would arguably be inconsistent with the intention of the parties.

In addition to the existence and content of any termination provisions in the agreement, in order to determine whether or not a contract is perpetual in nature or an indefinite term contract capable of being terminated on reasonable notice, the existence in the contract of the express intention to be bound perpetually can provide a strong basis for a finding that the contract is actually perpetual.[5]

Where there are no specific terms governing the termination of a contract, then the courts have been much more likely to imply the right to terminate that contract on reasonable notice, especially in regard to contracts of a commercial character.[6]

Surrounding Circumstances: In addition to the nature of the relationship and specific terms in the contract, the surrounding circumstances help determine whether there is an implied right to terminate on reasonable notice. These factors include:

• the level of sophistication of the parties;
• whether the parties were strangers at the time they entered into the agreement;
• whether the parties had done prior business together;
• whether the relationship involved the need for trust, confidence, and satisfaction; and
• the amounts invested by each party pursuant to the agreement.

When Will a Court Find an Agreement to Be Perpetual?

The discussion above focuses mostly on circumstances in which a court may find an agreement to be terminable on reasonable notice, but this is only one possible outcome. A court may instead conclude that the agreement is perpetual. The Ontario Court of Appeal has confirmed that in fact, there is no presumption in favour of treating an indefinite term contract as terminable instead of perpetual. Rather, each situation is context-specific and depends on how the contract was constructed.^[7] In Conseil Scolaire Catholique Franco-Nord v Nipissing Ouest (Municipalité), the Ontario Court of Appeal considered whether an indefinite service agreement was perpetual or could be terminated on reasonable notice. The Court applied the three factors discussed above – the type of relationship, the specific terms of the contract, and the surrounding circumstances – and concluded that the agreement was perpetual. In reaching that conclusion, the Court noted that the agreement was not a strictly commercial arrangement and that the relationship did not depend on the type of mutual trust that might otherwise give rise to an implied right to terminate on reasonable notice.^[8]

What does all this mean in practice? Although courts may imply a right to terminate an agreement on reasonable notice in certain circumstances, they will also enforce perpetual obligations where the parties have clearly agreed to them, or where the nature of the relationship, the specific terms, and the surrounding circumstances indicate that the parties intended a perpetual agreement. While commercial agreements, including franchise agreements, may be more likely to be found terminable on reasonable notice, parties should still carefully consider these issues when drafting their agreements and clearly express their intentions regarding the duration and termination of the relationship.

What Have Canadian Courts Said About Perpetual Franchise Agreements?

The courts have considered the question of whether a termination clause could be implied into a franchise agreement with a purportedly “perpetual” term a few times, with varying results.

France v. Kumon

In France v. Kumon, 2014 ONSC 5890, the Ontario Superior Court of Justice considered whether an oral franchise agreement could be terminated upon reasonable notice. In this case, a franchisor purported to terminate a verbal franchise agreement when, after protracted negotiations and an 11-year hiatus, a franchisee refused to sign the franchisor’s new form of written franchise agreement. The franchisee argued that the franchisor had no right to terminate the franchise agreement because it was a perpetual contract. The Court held that where a franchise agreement does not contain a termination clause, a court has two options: (1) to imply a right of termination; or (2) to treat the agreement as perpetual. In this case, the Court found that there was no evidence that a perpetual contract was the parties’ intention, for a few reasons: (i) the franchisor, in all versions of its written franchise agreement, did not wish to have perpetual contracts with its franchisees; and (ii) the franchisee’s objections to the new written franchise agreement did not have anything to do with the length of its term or renewal provisions and so the court concluded that the franchisee was not concerned with the perpetuity of the agreement. Given that the verbal franchise agreement was not a perpetual contract, the Court held that it could be terminated on reasonable notice.

Petro-Lon Canada Ltd. v. Petrolon Distribution Inc.

Alternatively, in Petro-Lon Canada Ltd. v. Petrolon Distribution Inc., 1995 CanLII 7407, an arbitrator refused to imply a right to terminate on reasonable notice into a franchise agreement. The franchise agreement in this case was a written agreement which contained a defined initial term, and an unlimited number of automatic renewals thereafter (unless the franchisee provided notice that it did not want to renew). There were also termination provisions written into the franchise agreement which indicated that: (i) either party could terminate the agreement on notice if there was a material breach; (ii) the franchisee could terminate the franchise agreement without cause to the exclusion of the franchisor; and (iii) the franchisor could terminate the franchise agreement with cause. The franchisor tried to terminate the franchise agreement without cause by providing the franchisee with 11.5 months notice of its termination. The arbitrator held that given that: (i) the franchisee had made a substantial investment into the business in terms of money and time; (ii) the contract could be terminated for cause; (iii) the contract could be terminated by the franchisee on notice without cause; and (iv) the contract contained performance requirements only for the first year, no clause permitting termination on reasonable notice should be implied in favour of the franchisor. The arbitrator’s decision was upheld by the court on appeal.

What Should Franchisors and Franchisees Consider Before Signing?

What appears to be a long-term, endless relationship may not be forever. Both franchisors and franchisees should keep in mind that, although it is possible for a franchise agreement to be perpetual, the courts will only uphold such an agreement in certain circumstances.

Before moving forward with a franchise agreement, think about the kind of relationship you want to have with your franchisee or your franchisor. Are you prepared to offer your franchisees automatic renewals year after year? Are you prepared to enter into an agreement that allows your franchisor to terminate you without any cause on 60 days’ notice? What will happen to the franchisee’s investment if the agreement is terminated? No one expects a relationship to end on unhappy terms, but it happens, and it is better to contemplate termination scenarios at the beginning of the relationship, rather than at the end. In order to avoid any uncertainty and a potential battle in court, both franchisees and franchisors should be sure that their intention as to the length of the term and any renewal terms is very clearly expressed in the franchise agreement, that the franchise agreement contains express provisions as to how and when it may be terminated and that it may only be terminated in accordance with those express provisions, and that they both understand the circumstances under which each of them can terminate the relationship.

About the author

John Yiokaris

John Yiokaris is a partner at Sotos LLP, a full-service law firm based in Toronto.  He has been recognized by Chambers Canada, LEXPERT, Who’s Who Legal, Lexology, and Best Lawyers Canada as a leading Canadian franchise law practitioner.

John practices business law with a specific focus on franchising and disputes and he is trusted counsel to both franchisors and franchisees.  If you are negotiating, renewing or considering the termination of a franchise agreement, contact John to discuss the agreement and your options. He can be reached directly at 416.977.3998 or jyiokaris@sotos.ca.