The COVID-19 pandemic has created an unprecedented level of disruption to franchise systems, which is now forecast to last for several more weeks, if not months.
Franchisors are understandably continuing to focus on the immediate and frontline needs of their franchisees, employees and customers, as certain franchise stores are now operating on reduced hours, different business models (e.g., restaurant franchisees operating on a takeout or delivery basis only) or are prevented from operating at all during declared states of emergency.
In response to this crisis, we are aware of several franchisors that are providing some form of financial and other relief to franchisees, such as deferring the payment of monthly royalty fees, deferring advertising fees or extending construction and renovation deadlines for new and renewing franchisees. In such cases, franchisors should review the contractual provisions in their franchise agreements and provide clear communication to franchisees about the scope and duration of these relief measures. Some franchisors that are in a financial position to do so are offering eligible franchisees direct loans, in some cases as a form of bridge financing, while the franchisees await the benefits of various government relief programs. For more information about the various government relief programs available to support businesses affected by the COVID-19 crisis, please see our blog post, “Canadian federal and provincial governments offer relief to businesses in response to COVID-19.”
How should franchisors plan to provide relief to franchisees?
When considering how to respond to the COVID-19 crisis, franchisors should have a careful and well-thought-out plan for providing relief from contractual obligations or for providing other forms of financial and non-financial relief. Franchisors should avoid quick ad-hoc decisions based on one-off requests from individual franchisees and instead come up with a detailed plan for how to respond to the crisis. This plan should assume that this is not a short-term problem and that the impact of this crisis will likely last several months. When considering the nature of the relief, franchisors should consider how the relief would be treated in the event of a franchisee bankruptcy and take steps to try and protect their interests in such an event.
What contractual elements will affect the way relief is provided?
- Force Majeure provisions: While the form of these clauses vary from contract to contract, a force majeure clause sets out terms under which a party that is unable to perform contractual duties as a result of an event beyond the control of that party may be excused and avoid contractual obligations and termination. Franchisors should consider, if they have a force majeure clause, whether this would affect their ability to enforce contractual obligations under the franchise agreement. For more information about force majeure clauses and COVID-19, please see our blog post, “Contractual rights and obligations in the context of COVID-19.”
- No waiver provisions: Franchisors should consider whether their franchise agreements protect them in circumstances where they are not insisting on strict adherence to the terms of the franchise agreement. A no-waiver provision states that relief from insistence on strict adherence to the terms of the franchise agreement will not be considered a waiver of the franchisor’s rights or deprive the franchisor of the right to insist upon strict adherence at a later date. If the franchise agreement does not have a no-waiver provision, consider adding this language to any communications to franchisees about the terms of the relief provided.
- Duty of good faith and fair dealing: While determining whether to provide relief, or what form the relief should take, franchisors should also consider the duty of good faith and fair dealing. This duty is a mutual one, owed by each of the franchisor and the franchisee to the other. The case law is settled that this duty does not create new obligations between the parties or alter the express terms of the franchise agreement, nor does it require a franchisor to put the franchisee’s interests ahead of its own. However, the duty requires that parties act in a commercially reasonable manner and take the legitimate interests of the other party into consideration when exercising their rights and performing their obligations under the franchise agreement. Generally speaking, Canadian courts will respect the business judgment of a franchisor when assessing whether it exercised its discretion based on a proper motive and as part of a defensible business plan.
How should franchisors document the relief provided?
Any relief provided by a franchisor should be documented properly and should include at least the basic terms of the relief, such as
- the duration of the relief (e.g., is it for a set period, tied to the end of provincial emergency measures, determined by the franchisor or subject to some other mechanism?);
- whether it is a waiver or a deferral of a payment (and if it is a postponement, what are the repayment terms);
- whether the franchisee must otherwise remain in good standing to benefit from the relief;
- any circumstances in which the relief is forfeited;
- whether the relief is assignable if the franchisee sells its franchise; and
- what agreements (such as a loan agreement, general security agreement or personal guarantee) must be entered into in order for the relief to be provided.
As discussed above, franchisors should be careful to communicate to franchisees that any relief provided does not waive the franchisor’s rights under the franchise agreement or deprive the franchisor of the right to insist upon strict adherence to the terms of the franchise agreement at a later date.
The pace at which the pandemic is continuing to evolve and the strained resources required of franchisors and franchisees to manage their operations during the economic and health crisis can make it challenging, if not impractical, to require each franchisee to enter into a formal agreement documenting the terms and conditions of any relief being provided. To avoid any misunderstandings or disputes, franchisors should, at a minimum, clearly communicate in writing the nature and scope of the relief being provided to eligible franchisees.
Any financial relief should also be included in the franchisor’s franchise disclosure document or statement of material change, including the disclosure and attachment of any agreement a franchisee will have to sign in order to receive the relief.