Termination provisions are among the most important in any franchise agreement.
They determine when and how the franchisor may terminate the franchise agreement before the end of its term when the franchisee defaults on its obligations.
Firstly, it is important to consider that article 1604 of the Civil Code of Québec provides that "notwithstanding any stipulation to the contrary," a party to an agreement does not have the right to terminate it "if the default of the debtor is of minor importance, unless, in the case of an obligation of successive performance, the default occurs repeatedly."
In plain language, that means, despite what the provisions of a contract say, if the other party has defaulted and the default "is of minor importance," the contract cannot be terminated unless the default "occurs repeatedly."
That test was rightly underscored in the judgment rendered by the Superior Court of Quebec in Hardy Ringuette Automobiles inc. v. Freightliner Ltd. (Sterling Trucks Division), which was successfully argued by my colleague Frédéric Gilbert. In that case, the Superior Court of Quebec dismissed an injunction application brought by a franchisee who was seeking to maintain in force a franchise agreement that the franchisor had terminated by notice of termination following some defaults committed by the franchisee.
In his reasons for judgment, the Honourable Justice Jean Bouchard (now of the Court of Appeal of Quebec) stated: "The Court therefore concludes that the breaches set out in the Default Notice were actual and serious and occurred repeatedly, that Hardy Ringuette did not perform its obligations within the time allowed, and that, consequently, Freightliner had the right to terminate the franchise agreement on January 30, 2005."
Secondly, we must also consider articles 1590, 1594, 1595, 1597 and 1598 of the Civil Code of Québec which provide, as a general rule, that a demand must be served on the defaulting party before the other party may exercise its rights, including the right to terminate a contract.
The purpose of the demand is to allow the defaulting party "sufficient time for performance, having regard to the nature of the obligation and the circumstances; otherwise the debtor may perform the obligation within a reasonable time after the demand."
If a demand is not served before the filing of a judicial application, article 1596 of the Civil Code of Québec provides: "Where a creditor files a judicial application against the debtor without his otherwise being in default, the debtor is entitled to perform the obligation within a reasonable time after the demand. If the obligation is performed within a reasonable time, the costs of the demand are borne by the creditor."
However, article 1594 of the Civil Code of Québec allows a contract to stipulate that the mere lapse of time will put the debtor (for example, the franchisee) in default by the terms of the contract itself. This a provision that may be extremely useful in a franchise agreement.
Thirdly, close attention must be paid to any provisions of a franchise agreement that provide for the termination to be automatic as a result of certain defaults or events.
By providing for automatic termination in certain situations, the franchisor could:
- End up with a franchise agreement that has been terminated (when the default or event that triggers automatic termination has occurred) without even knowing, or intending, it, and
- Provide an easy exit door for a recalcitrant franchisee, who may then, by intentionally doing or failing to do something, cause the automatic termination of its franchise agreement even when the franchisor does not want that.
In general, the only case situation which, under the provisions of a franchise agreement, should trigger its automatic and immediate termination is the franchisee's bankruptcy.
All other cases should, instead, grant the franchisor the right to terminate the franchise agreement immediately upon written termination notice, with or without a previous period to remedy the default depending on the nature or seriousness of the default.
Provisions of that nature allow the franchisor to retain control over how the situation with the defaulting franchisee is managed and over the choice of the remedies and recourses that appear the most appropriate to the franchisor in the specific circumstances of each case.
Three practical tips
- Your franchise agreement should provide for other remedies and recourses than only termination in case of a default. The purpose of these provisions is to deter your franchisee from breaching, or attempting to breach its obligations under the franchise agreement and to provide you with more than one tool in the event of a breach, so that you are not then limited to terminating, or not terminating, the franchise agreement. Such remedies may include penalties, suspension of certain rights or privileges, loss of renewal options, loss of territory protection, etc. Obviously, these provisions have to be adapted to the characteristics of your industry and of your franchise network;
- The cases where termination may occur and the termination procedure must be clear, easy to understand and specific. Article 1432 of the Civil Code of Québec provides that any ambiguity in termination provisions will be interpreted against the franchisor. Therefore, these provisions should be as clear and specific as possible. You must also make sure that the termination process is realistic, so that it can actually be followed if it is needed;
- It is also desirable for the franchise agreement to provide clearly what must be done at the time of termination and afterward. This offers the dual advantage of:
•Clearly informing the franchisee of what it must then do or not do, and
•Making it easier to obtain an injunction in the event that the franchisee fails to comply with its obligations after its franchise agreement has been terminated.