March 28, 2016

Give your franchise agreement a facelift – Part 1

Changes in technology, customer needs, and the laws governing franchising require franchise agreements to evolve reactively, to accommodate such shifts as they happen, and proactively, in anticipation of what the future might bring. Regular review of your franchise agreement can help you stay on top of the waves of change, address current and potential business issues, and help protect your legal interests in the event of a dispute or termination of the agreement.

To help get you started, we have created a three part article outlining common provisions in franchise agreements that you might want to consider revamping.

General Releases

Franchise agreements often stipulate that franchisees must release all claims against the franchisor as a condition for granting a transfer or renewal of the franchise.  For example:

“The Franchisor shall not unreasonably withhold its approval of a transfer, provided that the following conditions are met:

… The Franchisee must have executed a general release, in form satisfactory to the Franchisor, of any and all claims against the Franchisor…”

Recently the Ontario Court of Appeal confirmed that a franchise agreement provision requiring a franchisee to release its claims against the franchisor under the Arthur Wishart Act (Franchise Disclosure), 2000[1] (the “Act”), violates Section 11 of the Act and is therefore unenforceable, and that any release obtained pursuant to such a provision will be void.[2]  Although the provision set out above does not specifically reference the Act, it states that any and all claims are to be released, which would, on a plain reading of the provision, include claims under the Act.  One way to revise such a general release provision in light of Cora could be to add a carve-out for claims under the Act (e.g., “all claims are released except to the extent limited or prohibited by the Arthur Wishart Act (Franchise Disclosure), 2000”).

Interest Rates

U.S.-based franchisors ought to be wary of carrying over their form of franchise agreement when expanding into Canada as certain legal concepts may not translate to the Canadian context.  One example is the American practice of stating interest rates as “the lesser of [X]% and the highest lawful rate of interest permitted by applicable law”.  In the US, many state laws provide for certain statutory maximum interest rates that may be charged (called the “usury limit”).  The usury limits differ from state to state and range from approximately 5% to 24%.  State law also provides state-specific exemptions from usury limits.  Given these differences, the interest provision set out above ensures that the franchisor is on-side of such usury laws without the need to adapt its form of franchise agreement for each state.

Unlike the U.S., however, Canada does not have usury limits under provincial laws which franchisors would be at risk of contravening in the normal course.  Instead, franchisors must take note of other legislation governing interest rates when drafting such provisions.  First, it is an offense under the Criminal Code to charge and collect interest over 60% per annum.[3]  In that regard, a common pitfall for franchisors is the failure to realize that lump sum penalties levied against franchisees for late payments may also be considered interest, especially since these penalties are often assessed monthly for every month the arrears remain outstanding.  Accordingly, when such lump sum penalties are levied against franchisees in addition to the interest charged for late payments, the aggregate amount can result in the effective rate of interest under the agreement being greater than the criminal rate.  Franchisors should also be wary, more generally, of applying late payment penalties of any sort, particularly when the penalties are very large in comparison to the actual amounts of the late payments to which they are applied.  Second, the Interest Act requires that for interest rates exceeding 5%, the interest rate must be expressly stated on a yearly basis regardless of whether the interest is payable at a rate for a period that is less than a year (e.g., monthly interest rate).[4]  Failure to state the effective annual interest rate will result in interest rate being limited to 5% and any sum paid for interest over that amount would need to be returned.

[1] S.O. 2000, c. 3.

[2] 2176693 Ontario Ltd. v. The Cora Franchise Group Inc 2015 ONCA 152 [Cora].

[3] Section 347, R.S.C. 1985, c. C-46.

[4] Section 4, R.S.C. 1985, c. I-15.

Check back tomorrow for part 2 of this 3-part blog post Give your franchise agreement a facelift.