Navigating high-stakes franchise renewal disputes: A guide for franchise parties and their lawyers

Introduction 

Franchise agreement renewals can pose complex legal challenges, whether you are a franchisor navigating operational changes or a lawyer advising the franchisor or franchisee. Renewals involve critical issues such as the franchisee’s right to renew, mandatory upgrades, and compliance with franchise disclosure laws. This article provides insights into these renewal issues and highlights key legal considerations to help franchisors as well as lawyers who represent either franchisors or franchisees stay compliant and minimize disputes. 

A franchisee’s right to require renewal (if the renewal right is in the franchise agreement) 

A franchisee’s right to a renewal depends on whether there is a right of renewal in the franchise agreement and what conditions it imposes to the renewal. 

Depending on the renewal conditions, a franchisor may potentially deny a right of renewal if the franchisee is in breach of its obligations. However, a franchisor must not act unreasonably. Canadian provincial franchise statutes impose a mutual obligation on franchisors and franchisees to act in good faith and uphold reasonable commercial standards. In this context, a franchisor must act in good faith and fair dealing, without ulterior motives, and must take the franchisee’s interests into consideration, in exercising any discretion as to whether to reject a right of renewal which most likely would be heavily scrutinized. 

For example, in 2659953 Ontario Inc. v. Druxy’s Franchising Inc., a franchisee’s renewal was denied due to multiple breaches and failing the franchisor’s audits of the premise. The franchise agreement and lease expired while the renewal was being discussed, and the franchisee operated on a month-to-month basis with the intention of selling the business. The court rejected the franchisee’s interlocutory injunction motion and held in favour of the franchisor. This case is discussed in detail in our article, “Ontario court dismisses franchisee’s injunction after franchise expired and location shut down”. 

Our article “Can franchisors refuse to renew franchise agreements?” covers common renewal disputes, including defaults, performance standards, and territory reductions. 

Conditions for renewal: Changes to the franchise agreement  

Disputes sometimes arise about the extent and scope of changes that the franchisor has a right to impose on a new franchise agreement based on its then-current form and whether it may contain materially different terms from those in the original franchise agreement.   

The franchisor’s right to impose a new franchise agreement for the renewal term depends on the terms of the original franchise agreement. The extent of the changes that a franchisor may make will depend on the wording of the renewal conditions in the original franchise agreement. Some allow the franchisor to impose materially different terms, while others are not as explicit. 

Our article, “Franchise renewals: Introducing material changes to the renewal franchise agreement, examines case examples such as the following: 

• Timothy’s Coffees of the World v. Switt, where a 3% higher renewal royalty was disputed. 

• Pointts Advisory Ltd. v. 754974 Ontario Inc., where renewal and advertising fee changes were in dispute. 

• France v. Kumon, where a franchisee resisted signing a new agreement as a renewal condition. 

Conditions for renewal: Renovations or equipment upgrades 

In franchise systems with physical stores or locations, franchise agreements often allow franchisors to require renovations or upgrades as a condition for renewal. These upgrades can be critical to maintaining brand identity, keeping locations competitive, and incorporating new offerings.  

Sometimes these are system-wide upgrades. Other times, these requirements are specific to the franchised location that is up for renewal. Perhaps the location is old and needs to be brought up to currents standards. It may also be that the franchisee neglected maintenance and upkeep of the location.  

The scope and cost of renovations required by the franchisor must be commercially reasonable, if the franchise agreement otherwise uses broad language. Some upgrades to the premise or equipment can run into the hundreds of thousands of dollars. Some franchisees may allege that the financial burden of these upgrades makes continuing to operate the franchise financially unsustainable.  

It should be noted that even if the franchisee seeks to resell the franchise location, rather than renew it, it (or alternatively, a prospective buyer of the location) may still be responsible for renovation requirements (See our article “Issues in franchise resales: disputes over price and conditions” for more). 

 As with other discretionary rights that a franchisor has under the franchise agreement, the imposition of significant renovation or upgrade requirements must be exercised in good faith and in a commercially reasonable manner. This issue is explored in detail in our article “Franchise renovations and system changes during COVID-19”. Although this article is not specific to a renewal, the scope of systems can come into play in the renewal conditions. 

Disclosure requirements at renewal 

A franchisor is required to deliver a franchise disclosure document (FDD) on a renewal or extension of a franchise agreement where (i) there has been no interruption in the operation of the business operated by the franchisee, and (ii) there has been no material change since the franchise agreement or latest renewal or extension of the franchise agreement was entered into. 

The key here is whether there has been a material change (which is defined in franchise legislation) since the franchise agreement or latest renewal or extension of the franchise agreement was entered into. 

In most situations, an FDD is required – a franchisor is legally required to deliver an updated FDD which must meet all statutory requirements, including all material facts. Even though the renewing franchisee likely has intimate knowledge of the location’s sales and operating environment as a result of running the business, the requirement to deliver a fulsome and compliant FDD is not affected by that. There may also be other facts that the franchisee is not aware of, such as those relating to the system, regulatory changes, evolving market conditions, upcoming changes to a shopping centre, etc. 

Our article, “A franchisor’s comprehensive guide to updating an FDD”, explains these obligations in greater detail, including what the courts may consider a material change or material fact.  

Consequences of non-renewal 

If the franchise agreement is not renewed, the expiration or termination provisions in the franchise agreement come into effect. The typical consequences include non-compete obligations, de-branding requirements, potential right to buy out assets at book value, etc. Common post-termination obligations also include the following: 

• Non-competition clauses: These restrict franchisees from operating competing businesses within certain areas and for specific durations. 

• Ownership of client lists: Some agreements prevent franchisees from soliciting customers post-termination. 

• Franchisor’s right to purchase assets: Many agreements allow the franchisor to buy the franchisee’s assets at net book value, reselling the business to a new franchisee. 

• Intellectual property: Franchisees must de-brand and remove all identifying features of the franchise system (if allowed to operate from the same location). 

 The consequences of a termination are explored in greater detail in  “Consequences of franchise terminations and settlement options“.

This article addresses essential aspects of franchise renewals, including the franchisee’s right to renew, required upgrades, and disclosure obligations. It explores real-world cases and legal obligations, offering practical guidance to franchisors and lawyers representing franchisors or franchisees. Both parties will benefit from understanding good faith obligations, material changes in agreements, and the potential consequences of non-renewal. 

—  

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.  

The Law Works website offers a vast number of resources by way of blog articles, courses and webinars about franchise, commercial and real estate disputes. Subscribe to our newsletters to stay up to date on the latest information from us.  

Law Works offers complimentary initial 15-20 min telephone consultations, which you can book online.