Issues in franchise resales: disputes over price and conditions

1. Disagreement over the Resale Price

A franchisor may not always approve the proposed resale price, even if the existing franchisee (seller) has come to an agreement with the proposed buyer about that price. A franchisor may have legitimate concerns about the proposed transaction.

For example, the purchase price may be unduly high. Another example may involve a proposed purchase that is overly leveraged – such as if the buyer is looking to finance a significant portion of the purchase price but the sales revenues do not support the cost of servicing the loan.

On the other hand, it is also possible that the proposed resale price is too low, i.e., the existing seller looks to sell the franchise at a price that would leave amounts owing to the franchisor or other creditors, such as for unpaid royalties, sales tax (HST, GST or PST, depending on the province), bank loan, rent arrears, etc. Here, the issue is whether the selling franchisee can pay off the balance of the amounts owing to the franchisor and other creditors, to the extent that the resale price does not cover these amounts.

Another dispute over the resale price may come up if the franchisor takes over the location from the franchisee and looks to sell it on behalf of the franchisee or for the franchisee’s account. The franchisor’s primary objective may be to recoup amounts owing to it and other creditors, while the existing franchisee’s goal is to try to recoup more – hence potentially giving rise to conflicting interests.

At issue in these circumstances is whether the resale price is commercially reasonable in all the circumstances.

2. Disputes Over Who Resells the Business – Franchisor or Existing Franchisee

Similar to the previous scenario, in cases involving a defaulting franchisee, the franchisor and franchisee may disagree over who has a right to resell the business and to receive the proceeds of the resale.

If the franchised business is in default of its contractual obligations, the franchisor may have a right to terminate the franchise agreement or take other self-help remedies in the franchise agreement, such as taking over management of the location and reselling it.

There are three options for a resale of a financially distressed or defaulting franchised business (these are discussed in greater detail in our article Franchisor’s Options in Reselling a Distressed Franchised Business):

• The franchisor requires the existing franchisee to resell the business to a third party, subject to consent of the franchisor and on terms that the franchisor specifies, such as proceeds of payment, paying off creditors, discharging liens, etc.
• While the franchisor may require the franchisee to resell the business to a third party, the franchisor may take over the interim operation of the business and require that it be paid for its interim operation from the proceeds of the resale.
• The franchisor terminates the franchise agreement, takes over the operations of the franchised business, and resells the assets of the business to a new franchisee.

In terms of disclosure obligations, if the franchisor is involved in the resale process in any way (other than basic passive approvals that are set out in franchise legislation), the franchisor’s involvement may constitute “effecting the transfer” of the business and it may be required to provide the new purchaser with an adequate disclosure document: this is discussed in our article, Effecting the Transfer for a Franchise: What Does it Mean.

3. The Franchisor Refuses to Approve the Buyer

Under most franchise agreements, a franchisor has a right to approve the proposed buyer of the franchise, based on various criteria, such as operational and financial qualifications.

At issue here is whether the criteria imposed by the franchisor are commercially reasonable, and if so, whether the franchisor applied these criteria in a fair manner, i.e., if the buyer genuinely fails to meet them.

4. Franchisor’s Conditions to the Resale – such as Renovations

Most franchise agreements give the franchisor the right to impose various requirements, such as renovations, as a condition of consenting to the resale of the franchise.

At issue here is whether the scope and cost of the proposed renovation is commercially reasonable. An old location may naturally require renovations. Similarly, a location that is out of date with the rest of the system will likely require an upgrade to current system standards. It may also be that the current franchisee has neglected the maintenance and upkeep of the location, requiring renovations to bring it to acceptable standards.

Other than potential disputes about these requirements, the selling franchisee and proposed buyer may have to come to an agreement on the allocation of this cost between them.

5. Head Lease Reaches End of Term

In franchised businesses operating out of a physical location, the term of most franchise agreements ends at the expiration of the term as set out in the franchise agreement or the lease term – whichever comes first.

Without a reasonable term left on the lease, a franchisor may not agree to a resale. Without a valid lease term, there is, in effect, no viable business for the existing franchisee to sell. It may be necessary to first renew the lease term with the landlord.

If the existing franchisee is a tenant under the lease, they will need to first negotiate a lease renewal and obtain the consent of the landlord to the potential resale of the location to a new franchisee.

It may also be possible that the franchisor will require that the head lease be assigned to it or its affiliate, as part of the resale of the location. The franchisor or its affiliate will then enter into a sublease with the proposed buyer.

The lease renewal process itself can be prolonged if the parties cannot come to an agreement on the lease renewal rate. A lease renewal dispute with the landlord can throw a wrench in the seller’s plans to resell the franchised location.

Most leases state that the lease renewal rate will be at the fair market rate of comparable premises at the time of renewal. What constitutes a comparable premise and what is the fair market rate can be in dispute and may require a legal process to reach a resolution. This needs to be resolved first as a condition of obtaining the franchisor’s approval.

6. Franchisee’s Internal Shareholders Dispute

If there are two or more shareholders in the franchised business, a dispute between them can complicate a resale. A dispute might involve allegations by one shareholder against another such as mismanagement or misappropriation.

There may also be disagreements about the resale itself – one shareholder may want to sell the business while the other may prefer to renew the franchise agreement. The shareholder who wants to stay in business may not be able to buy the other one out, putting the future of the franchised business in limbo. Our article, How to Handle Shareholder Disputes: Common Causes and Solutions, discusses disputes of this nature.

In this situation, the shareholders need to comply with the resale terms of the franchise agreement before the sale can occur. If one or all refuse to comply with these terms, the franchisor may need to take over the business and manage the resale of the business and operate it in the interim, among other options available to the franchisor.

7. The Franchisee is Reluctant to Commit to a Renewal

Another scenario where a resale of a franchise may be contentious involves a franchisee who does not want to continue operating the business because of personal reasons, such as retirement, serious illness, caregiving responsibility, or other life changes. A resale of the franchise may be the natural solution.

It may be that the existing franchisee has a spouse or other family member who wants to take on this role. A transfer of franchise rights to a family member is likely subject to approval of the franchisor. If the family member is not qualified to operate the business, the franchisor may not approve the transfer and force a sale. The issue here is whether the existing franchisee has contractual rights to transfer the franchise to a family member under more relaxed contractual terms that a sale to an arm’s length party.

Conclusion

The resale process can be intricate and multifaceted, often influenced by various factors ranging from compliance with system standards, financial disagreements, lease complications and shareholder disputes. The seven common areas examined shed light on the complexities inherent in such transactions. Usually, these types of disputes involve two or more issues.

Ultimately, successful resales of franchised locations require collaborative efforts, clear communication, adherence to contractual obligations and commercially reasonable conduct. By addressing these common areas of contention, franchisors can mitigate risks and foster smoother transitions, ensuring the continued success and stability of franchised businesses.

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The information contained in this article is provided for informational purposes only and does not constitute legal advice. Readers should not act on this information without seeking professional legal advice from a lawyer experienced in this area. The content in this article may not reflect the most current legal developments, and the application of law can vary in different provinces and territories. As such, the information in this article is not guaranteed to be complete, correct, or up to date. The author and the publisher of this article disclaim all liability for any actions taken or not taken based on any or all of the contents of this site.

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