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Be wary of default language in franchise deals

If you're a prospective franchisee and you've been given a package of contracts to review – and the franchisor's disclosure document in provinces that require it – possibly the worst thing you can do is to say to yourself: "This all seems very standard and the franchisor isn't going to change anything."

The second worst thing you can do is agree with the franchisor or its salespeople if they tell you: "This is all very standard and we aren't going to change anything anyway."

Having practiced franchise law for more than 25 years, I can honestly tell you some really goofy things find their way into franchise agreements, and they should be "discussed." And sometimes there are things in the agreements that are wrong and they pose a risk to your investment.

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You'll only know whether provisions are standard, goofy or wrong if you have a lawyer involved who knows something about franchising, and who knows what to argue and what to leave alone.

Here's one example where legal advice would help make the decision to acquire, or not acquire, a franchise business:

There's a provision in the termination section of many franchise agreements I call the "three strikes you're out" clause. There, along with all the other grounds for default that give a franchisor the ability to terminate a franchisee if the situation isn't cured, is this gem: "If the franchisee has received from the franchisor, during any consecutive 12-month period, three notices of default relating to one or more defaults under the agreement, irrespective of whether default or defaults were remedied by the franchisee."

I hate this provision. I hate it because in my experience, it can be abused by franchisors.

I've been on the receiving end of disputes where a franchisor didn't have sufficient grounds to terminate a franchisee because any defaults under the agreement were small and not material enough, thereby inviting actions for wrongful termination. A franchisor will not normally be able to terminate a franchisee for minor transgressions.

But with three minor defaults – even if notices are given separately over the course of 24 hours, and even if these minor breaches are immediately remedied by the franchisee – a franchisor may terminate on the third notice.

Its fine to say a court would overturn such draconian and, dare I say, bad faith behaviour, but more often than not franchisees in legal disputes – particularly in non-disclosure jurisdictions such as B.C. – won't have the financial resources to fight their former franchisor. Legal fees are too high. The franchisee loses.

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Because of the "three strikes you're out" clause, franchisees can lose possession of their businesses and their locations to franchisors who wouldn't have otherwise had grounds to terminate on any one default.

Franchisee lawyers should be trying to eliminate or otherwise negotiate such clauses so that franchisors don't have a heavy-handed and carte blanche means of terminating. If the franchisor isn't prepared to budge on the issue, maybe it's a deal killer.

I've seen a similar clause that allows a franchisor to terminate if the franchisee has committed three or more defaults over a 10-year term rather than a concentrated period of 12 months.

A franchise relationship is a long-term prospect, not a one-time acquisition. There will always be circumstances where a franchisee has not fully complied with the franchisor's standards or has committed a minor technical breach of the agreement. And by the same token, over a five-, 10- or 20-year life span of a franchise, there will be instances where the franchisor has breached its obligations to the franchisee.

So allowing a franchisor to terminate a franchisee based on three minor defaults over a 10-year period is a deal worth walking away from.

When I advise franchisees, I insist they talk to other franchisees within the system to get a feel for the relationship they have with the franchisor. If it means a B.C.-based franchisor should be flying to Mississauga, Ont., to talk to one or more franchisees in the system, so be it. A plane ticket to Ontario is a lot cheaper than risking your investment because the relationship you thought you were entering turned out to be very different than the one you find yourself in.

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Franchisor's lawyers are paid tens of thousands of dollars to make sure their agreements protect the franchisor and give the franchisor the flexibility to terminate a franchisee that is not up to its standards. Which is fine.

But wouldn't you rather be part of an organization where the franchisor assists its franchisees to "come up to standard," as opposed to scouring the franchise agreement for ways to terminate a franchisee for minor defaults, only to take the franchise back and sell it again?

At the end of the day, the perfect franchise relationship is one where both parties put the franchise agreement in the file and never look at it until renewal time, because the relationship matters more than the contract.

Special to The Globe and Mail

Tony Wilson practices franchising, licensing and intellectual property law at Boughton Law Corp. in Vancouver, he is an adjunct professor at Simon Fraser University, and he is the author of two books: Manage Your Online Reputation , and Buying a Franchise in Canada . His opinions do not reflect those of the Law Society of British Columbia, SFU or any other organization.

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