Canadian Franchise

How Can You Tell the Good Franchisors from the Bad?

from Ned Levitt, senior partner, Dickinson Wright LLP.

The success of a franchise system and the contentment of the franchisees in the system are very much a product of the character, strengths and weaknesses of the franchisor.

A franchisor, to be successful, has to become an expert in the business of franchising, as well as the business being franchised. Fortunately, we are living in a time when information is only a few keystrokes away. Prospective franchisees today habitually do background checks on prospective franchise systems and the franchisor on the Internet.

Without a doubt, the legislative requirement in many provinces (Alberta, Manitoba, Ontario, Prince Edward Island and New Brunswick) to provide a pre-sale disclosure document to prospective franchisees adds greatly to their ability to investigate a possible franchise purchase. Other sources of information include those who deal with the franchisor, such as suppliers and landlords. The current franchisees in the system are some of the best sources of information. However, a less obvious, but equally valuable source of information about the franchisor is the franchise agreement itself. In fact, in many ways, it may be one of the most important sources of information, provided one knows what to look for.

A franchise agreement, which can run to 50 pages and more, is a “Franchisor’s document”, which is to say that its principle intent is to protect the interests of the franchisor and the system. While there are important elements for franchisees in the franchise agreement, like the term, renewal rights, the territory, exclusivity, etc., the bulk of the franchise agreement deals with what franchisees must do, cannot do or how they will suffer if they breach the agreement. It also actually creates the franchise relationship and defines almost all of the rights and obligations of each party.

Unquestionably, a franchise agreement is a lopsided document, which is to be expected, as the franchisor needs to protect the important elements of the system for all concerned, including other franchisees in the system. Having said that, there are industry norms and standards to measure such “lopsidedness”. To the extent and how a franchise agreement deviates from these norms and standards, can speak volumes about a franchisor, its intentions and what it will be like being a franchisee of such a franchisor.

A poorly worded and disorganized franchise agreement means the franchisor has not made the commitment of time and money to learn the basics of franchising and hire a legal advisor who has expertise in franchising. As promising as the business being franchised may be and as knowledgeable as the franchisor may be in that business, for franchisees to be successful and for the system to flourish, the franchisor must become expert in franchising as well and surround themselves with the right professionals. It may also indicate that the franchisor is distracted by other business matters, such as the operation of its own corporate stores in the same system.

While defaults by the franchisee and their consequences will and should be dealt with in the franchise agreement, lack of adequate notice to cure the defaults and consequences that are too severe, speak to a franchisor who is too tough minded and/or insecure. The best franchisors are ones that handle such matters firmly but fairly.

Too many provisions that call for excessive payments from franchisees for such things as support services, renewal fees, transfer fees, training fees, approval fees, etc. point to a franchisor who may be more interested in its bottom-line than the franchisees. Similarly, provisions that transfer all of the benefits of volume purchases of inventory and supplies by franchisees to the franchisor are indicative of a franchisor who may be simply greedy. A savvy franchisor knows full well that the franchisees have to succeed for the franchisor to succeed.

In healthy franchise systems, the resale of franchises by franchisees, to capitalize on success or because of life changes, is seen as a normal part of the growth and functioning of the system. Provisions in a franchise agreement which make such resales difficult, such as the approval of the franchisor not only being required but also being in the sole discretion of the franchisor, may indicate that the franchisor is overly controlling.

Consistency in a franchise system is important and necessary. So, one would expect that franchisees would not be permitted to easily deviate from the system standards. On the other hand, extensive provisions in a franchise agreement, particularly a new system, requiring the franchisee to implement substantial changes to how the business is operated at the whim of the franchisor may be indicative of a franchisor who lacks confidence in what they have created. One of the most dangerous types of franchisors, is the one that is learning about the business along with its franchisees.

Where franchisors have multiple corporations owning or controlling various aspects of the system, there is a concern that the franchisor is too insecure and is putting too much emphasis on protecting its assets from the possible failure of the system. This occurs when the system trademarks, premises leases, patents, etc. are owned by separate but related corporations. If the franchisor does not have faith in the system, what does that say about its commitment to the success and welfare of its franchisees?

There are many, many other areas of franchise agreements which help paint a picture of the thinking and attitudes of the franchisors who created them. To bring that picture into focus, prospective franchisees need to have the franchise agreement reviewed by lawyers who really know franchising. The effort and expense will be well worth it and will allow the prospective franchisee to gain insight into the franchisor that is hard to come by otherwise.

Ned LevittEdward (Ned) Levitt is a senior partner of Dickinson Wright LLP, Toronto, Canada, and Chair of its Franchise Law Group.  He served as General Counsel to Canadian Franchise Association from 2000 to 2007 and, as a member of the Ontario Franchise Sector Working Team, was instrumental in the creation of Ontario’s franchise legislation.  Among his many publications is Canadian Franchise Legislation published by Butterworths/Lexis Nexus.

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