In the vast majority of franchise systems, the contractual relationship between the franchisor and each franchisee is not based on a single agreement, but on several.
In addition to the franchise agreement, which is the core of the relationship, there are generally some preliminary agreements (such as a franchise application or offer, a territory reservation agreement and a confidentiality and non-disclosure agreement) and, also, several ancillary agreements (such as a personal guarantee, a moveable hypothec or general security agreement, a lease or sublease, a supply agreement and one or more service contracts, particularly in the area of computer and technology services).
In most cases, each of these other agreements is drafted by a lawyer with expertise in the subject matter of the agreement, i.e., a different lawyer than the one who drafted the franchise agreement.
This can lead to duplication, discrepancies and, sometimes, even contradictions between the provisions of these different agreements.
Since these agreements are drafted by or on behalf of the franchisor, and are often not subject to negotiation, any discrepancy, contradiction, or other problems of interpretation between these agreements will generally be decided by a court in favour of the franchisee.
It is therefore very important for the franchisor and its legal advisors to ensure that the provisions of the various agreements signed with the same franchisee are well harmonized and that they do not contain any duplication, discrepancies, or contradictions.
The following is a non-exhaustive list of some of the clauses in these agreements in which we may find such duplications, discrepancies, or contradictions:
1. Duration (initial term and renewals)
To the extent possible, the initial term, the terms and conditions of renewal and the length of the renewal period(s) should be similar for the franchise agreement and the ancillary agreements.
A variety of problems can arise when this is not the case.
Consider the case of a sublease for the location of the franchised business.
If the term of the sublease ends before the end of the term of the franchise agreement, how can the franchise relationship continue after the end of the term of the sublease?
Conversely, if the term of the franchise agreement terminates prior to the end of the sublease term, what will happen to the location once the term of the franchise agreement ends?
Other important issues may also arise where the term, renewal terms and the length of any renewal period of another ancillary agreement do not match the term of the franchise agreement.
In cases where, for various reasons (e.g., due to the requirements of a lessor), it is not possible to match these terms, it is important to stipulate various clauses to prevent a contract between the franchisor and its franchisee from surviving the end of the term or termination of the franchise agreement.
2. Termination and cross-default provisions
For the same reasons, it is also important that the grounds and procedure (including notices) for the franchisor to terminate an agreement be similar in the franchise agreement and in its ancillary agreements.
Particular attention should be paid to the cross-default provision (which provides that a default under an ancillary agreement automatically constitutes a default under the franchise agreement).
If the franchise agreement contains a cross-default provision, do the collateral agreements also contain such a provision?
If not, this could lead to a situation where the franchisor has the right to terminate the franchise agreement, but not to terminate an ancillary agreement.
3. Non-competition and usage provisions
Differences, and even contradictions, between a franchise agreement and an ancillary agreement are also found from time to time with respect to the non-competition and the usage provisions stipulated in these agreements.
The most frequent contradiction is between the non-competition covenants provided for in the franchise agreement, which prohibits the franchisee from operating a similar business in or around the location of its franchised business for a certain period of time after the termination of its franchise agreement, and the usage provision provided for in the franchisee's lease, which obliges the franchisee, for the entire term of its lease, to operate a business of this same type in the premises of the franchised business.
In such a case, if the franchise agreement terminates before the end of the lease term, the franchisee will necessarily be in default of one of these agreements. If the franchisee ceases to operate a business similar to the franchised business, the franchisee will be in default of its lease. On the other hand, if the franchisee continues to operate a similar business on the leased premises, it will be in default of its franchise agreement.
When the franchisor is aware of the usage provision provided for in the franchisee's lease (and, even more so, when it has negotiated or authorized such lease), such a situation may pose a significant problem when the franchisor will want to enforce the franchisee's non-competition covenants.
A second problem that we sometimes encounter with respect to non-competition covenants occurs when such covenants stipulated in both the franchise agreement and in one of the agreements ancillaries to it contain discrepancies between them.
In such a case, any such discrepancy will generally be interpreted in favour of the franchisee.
4. Jurisdiction and Dispute Resolution Provisions
Most agreements contain one or more provisions dealing with the court which will have jurisdiction to hear any dispute between the parties, and many agreements now also contain dispute resolution provisions (including mediation and arbitration).
Again, it is important that the clauses dealing with these matters be set out in similar terms in both the franchise agreement and its ancillary agreements.
For example, if the franchise agreement contains an arbitration clause and one of the ancillary agreements (such as a sublease) does not, the franchisor may have to go to court for any dispute arising out of the ancillary agreement and to an arbitrator for any dispute arising out of the franchise agreement.
What then happens to a dispute arising out of these two agreements?
5. Security interests (personal guarantees, moveable hypothecs and general security agreements)
Another subject where harmonization between a franchise agreement and its ancillary agreements is important is that of security interests granted by the franchisee to the franchisor, in particular any personal guarantees, moveable hypothecs, and general security agreements.
Here again, such security interests are often found both in the franchise agreement itself and in one or more of the ancillary agreements.
In Quebec, with respect to moveable hypothecs, it is not uncommon for the franchisor to register only one hypothec with the RDPRM ("Registre des droits personnels et réels mobiliers"). If there is only one registration when there are several moveable hypothecs in the agreements, which one has been registered and which one has not?
This can raise a serious problem when the franchisor wants to exercise such a hypothec.
A second serious problem of interpretation and application may arise when the wording of a personal guarantee, a moveable hypothec or a general security agreement provided for in the franchise agreement is different from the wording of a similar security provided for in an ancillary agreement. Which of these wordings should then take precedence?
A third important issue that concerns personal guarantees, moveable hypothecs and general security agreements deals with the nature and scope of the obligations secured by these securities.
The fact that a collateral agreement contains such a personal guarantee, moveable hypothec and/or general security agreement may raise the question of whether the personal guarantee, moveable hypothec and/or general security agreement provided for in the franchise agreement secures only the obligations of the franchisee arising out of the franchise agreement and not those arising out of other agreements between the franchisor and the franchisee. Indeed, why also stipulate another personal guarantee, moveable hypothec and/or general security agreement in an ancillary agreement if those stipulated in the franchise agreement guarantee all the obligations of the franchisee towards the franchisor?
Here again, clarity and sound harmonization of the provisions in the various agreements are necessary to prevent such ambiguities, which are likely to pose serious obstacles when the franchisor wishes to avail itself of the securities intended to guarantee the obligations of its franchisee.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
