Recent economic challenges may have franchisors considering changes to their current franchise systems. A franchisor may be seeing steady decreases in royalty fees and advertising contributions, staff reductions, delays in payments to suppliers or landlords, or reduced inventory purchases from franchisees. The response may be to temporarily defer or waive fees, begin location specific promotional campaigns, attempt to negotiate concessions with suppliers and/or landlords or increase the frequency of audits and inspections of franchisees’ books and records. A franchisor may also wish to adjust the products and/or services the franchise system offers.

If you are considering making such a change to your franchise system it is important that you consider the concept of "good faith" and "fair dealing" and the consequences of these concepts to your system in times of change.

The Arthur Wishart Act (Ontario)i, (the "Act"), regulates a franchisor’s obligations to its franchisees. The Act imposes on each party to a franchiseagreement the duty of fair dealing in the performance and enforcement of the agreement and provides franchisee damages against a franchisor who breaches the duty. The Act specifically states this duty includes the duty to act in good faith and in accordance with reasonable commercial standards. The duty of good faith has recently been summarized ii as follows:

• A party may act in its own interest, however, in doing so that party must also have regard to the legitimate interests of the other party;
• If A owes a duty of good faith to B, so long as A deals honestly and reasonably with B, B’s interests are not necessarily paramount;
• Good faith is a minimal standard, in the sense that the duty to act in good faith is only breached when a party acts in bad faith. Bad faith is conduct that is contrary to community standards of honesty, reasonableness or fairness; and
• Good faith is a two way street. Whether a party under a duty of good faith has breached that duty will depend, in part, on whether the other party conducted itself fairly.

The question will be whether the change you are considering is "fair" and in line with the concept of good faith. Success or failure of a strategy for change in a system will depend on how accurately the threat of the current economic climate to the system has been assessed. How well has the threat and possible responses been communicated with franchisees? Is the proposed change reasonable given the circumstances? It is vital that a franchisor review the following considerations when contemplating a change.

• Has there been proper communication with the franchisees? A franchisor should communicate as early and as much as possible. Communicate the challenges being faced, why the change is considered necessary, how the change will address the challenges, and the business case for the change. If at all possible request feedback.
• What are the business reasons for the proposed system change and how well is the proposed change going to address the challenges affecting the system?
• How is the proposed change expected to make the system as well as individual franchisee more competitive?
• Will all franchisees be permitted or required to make the proposed changes on the same terms or conditions and timing? If not what is the rationale behind the differences? It will always be best if you can implement uniform changes throughout the system, requiring all to adopt or allowing all to adopt.
• What is the estimated cost of the change and who will incur the costs? Are costs to be incurred by franchisees reasonable relative to the average initial costs and annual revenues, the anticipated return for the franchisees, the degree of risk involved, and the remaining term of the individual agreements?
• Consider whether consent of the franchisees should be obtained or what notice is owed. Can a franchisor unilaterally implement the change? There are several cases in which the court has required the franchisor to obtain the consent of the franchisees before implementation of the change can occur. Significant changes to the services and/or products offered or used have often become problematic. Lack of consent may create a breach of the agreement between the franchisor and the franchisees and damages may be owed to the franchisees. Thus, always consider whether a change will require some form of approval or whether you can simply rely on the system change clause in the agreements.
• What, if anything, is the franchisor prepared to do in response if the change leads to expected or unexpected negative consequences for any or all of the franchisees? Good faith may be demonstrated by the willingness to take actions that are not required, for example the provision of loans when implementing the changes or royalty relief if need be.

Generally changes can be made, especially when a system is facing economic challenges. However it is vital to keep the above considerations in mind. Never act contrary to what you communicate to your franchisees. Honesty is a key criterion for good faith. The use of your contractual right to change, for reasons other than what your say or what is reasonably expected based on the overall relationship, is questionable. Although you don’t have to put your franchisees’ interests first, you must always give their interests reasonable consideration. Keep in mind, Courts have been given a great deal of room to maneuver if they don’t agree with your actions so keep the above considerations in mind at all times.

Amy M. Delisle, B.A.(Hons.), L.L.B
Business Law Group
Tel: 905.276.0422
E-mail: adelisle@kmblaw.com

The comments in this newsletter are of a general nature and are not designed to replace professional advice in specific situations. If you would like extra copies of this newsletter, or you know of anyone who would be interested in joining our mailing list, please contact Cheryl Woolcott at (905) 276-9111.

i
Arthur Wishart Act (Franchise Disclosure),
2000, S.O. 2000, c. 3

ii
1117304 Ontario Inc. (c.o.b. Harvey’s Restaurant) v. Cara Operations Ltd., [2008] O.J. No. 4370