January 1, 2009

Proceed with caution when changing the franchise system

Businesses operating in dynamic environments must change from time to time if they are to survive and thrive. Franchise systems are no exception. The problem in franchising is that while both the franchisor and franchisee may agree on the need for change, how the change is implemented, and which side bears the brunt of the changes is something which they will rarely agree upon. Franchisors who impose what they view as the necessary changes on reluctant franchisees can find that the franchisees have a number of potent remedies at their disposal. From our vantage point, we are noticing that franchise system changes are becoming fertile ground for costly and uncertain litigation.

There are several points that must be considered before a franchisor introduces changes to its business model. The first and most important is whether the franchisor is really contemplating a new or amended form of agreement with its franchisees. The fact that the franchisor believes that the change will improve the long-term profitability of the franchisees themselves makes little difference. Any attempt to impose a different economic model from the model contained in the franchise agreement may be met with strong resistance and possibly system-wide litigation.

Take, for example, the case of a fast-food franchisor which decides to outsource a call centre which it had previously operated as part of its franchisor duties at no extra charge to the franchisee. There are a lot of good reasons why a franchisor would want to outsource this responsibility and just as many good reasons why it would impose a cost-recovery charge for this service. You may be surprised to learn that the franchisor which did this was prevented from imposing any charge on the franchisee for this service. In the words of the Quebec Court of Appeal, imposing the call-centre fee on the franchisee would result ‘in a different contract’. In the court’s view, the changes implemented by the franchisor went ‘beyond the intent of the parties’ and that ‘required the consent of the franchisees.’

The result in that case is all the more surprising considering that the franchise agreement specifically contemplated that the franchise system could be changed and that the franchisee was bound to accept such changes introduced by the franchisor from time to time. Even in the presence of a broad system-change clause such as this, the court required the franchisor to obtain the specific consent of its franchisees before implementing the change.