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What happens to your franchise agreement in the event of a change in the law?

Sometimes changes in laws and regulations can result in legislative or regulatory changes, or judicial decisions, that render illegal or void some provisions of a franchise agreement.

franchise agreementWe are living in a world that is in a constant state of change.

From time to time, some of the industries in which franchise networks operate are faced with changes in laws and regulations, with new laws and new regulations, as well as with judicial decisions that have an impact on their agreements with their franchisees.

For several years now, for example, there have been frequent major changes affecting the entire pharmacy industry. Some of those changes have a direct effect on affiliated or franchised pharmacies’, as well as on the franchisors’ and groups’, bottom line.

The same is true in numerous other industries, particularly those that involve regulated professions and businesses.

Some changes to generally applicable laws and regulations can also have a serious impact on franchise networks.

We can think, for example, of minimum wage increases, tobacco regulation, legalization of cannabis, environmental protection legislation and regulations, and personal information protection legislation and regulations.

Sometimes one of the consequences of these legislative or regulatory changes, or judicial decisions, is to render illegal or void some provisions of a franchise agreement.

In other cases, the changes mean that amendments must be made to the agreements, for example in order to:

  • comply with a new law or regulation, or to an amendment to a law or to a regulation,
  • ensure the effective functioning and sustainability of the network, or
  • maintain a healthy balance between the rights and obligations of the franchisor and of its franchisees in the changed circumstances.

These kinds of changes must sometimes be made to very important clauses of the agreement (including financial clauses).

When a change to a law or a regulation, or a judgment that creates new case law, calls for amendments to be made to a franchise agreement, what happens to the agreements that have already been signed and are then in force?

Under our legal principle, a contract can be amended only with the consent of all the parties. This means that a franchisor may not amend a provision in agreements that are then in force without the agreement of each of its franchisees.

If a change to an agreement becomes necessary by reason of a new legal environment, the franchisor becomes, in a way, dependent on its franchisees goodwill to agree to its proposed modifications. Refusal by any one of them would result in it being impossible to amend the agreement entered into with that franchisee, with the potential consequences this could have for the franchisor, the franchisee and the entire network.

Is there a way to avoid this seriously problematic situation?

Fortunately, yes.

It is possible to include in a franchise agreement one or several provisions that deal with what will become of the agreement in the event of a change in the laws or regulations, of new laws or regulations, or a judgment, that may render void, inoperative or inadequate an important provision of the agreement.

What can these clauses provide?

They come in several varieties.

In the most usual model, the provision simply states that the parties mutually undertake to negotiate diligently and in good faith the changes that have to be made to the agreement to bring it into compliance with the changes in the laws, regulations or case law, while preserving the nature and spirit of the contractual agreements between the parties, and their respective rights and obligations, to the fullest extent possible.

The clause can also then provide for a deadline for conducting and completing the negotiations and making the change.

In the context of a franchise network, however, it is possible to go a little further, by providing the possibility of amending the agreement by a franchisor’s decision approved by a strong majority vote (for example, two thirds or three quarters) of the franchisees (the vote often being calculated, in that case, on the basis of one vote per point of sale).

Some franchise agreements also include a provision allowing the franchisor (or, sometimes, any of the parties) to terminate it in the event that a change in the laws, regulations or case law affects one of its important rights (such as its right to receive royalties). A provision of that nature can be extremely useful to the franchisor in its negotiations with its franchisees regarding the changes to be made to the franchise agreement.

Some professionals who draft franchise agreements sometimes try to go even further, by including in their agreements a provision giving the franchisor the right to amend its unilaterally and without its franchisees’ agreement. Although I am not aware of any case law ruling that kind of clause to be illegal, it seems to me to run counter to the fundamental principles of contract law (which hold that a contract is created only by mutual agreement between the parties). In my opinion, therefore, there is an important risk that a court would declare a clause allowing the franchisor to unilaterally amend a franchise agreement that has already been signed and is in force to be illegal, or to annul it on the ground that it is an abusive provision.

It is also important to provide in any franchise agreement that it is a prerequisite, for any renewal of the agreement and any sale or transfer of the franchised business (or of any interest in the franchisee, where the franchisee is a company), that the franchisee shall then sign the franchisor’s standard franchise agreement that is in effect at that time. Including that condition in the franchise agreement lessens the risk of the franchisor having to live for too long with agreements containing clauses that are outdated or have become inadequate.

Because franchise agreements are often signed for long periods of time (generally two to ten years), it is very important for any franchisor, and for anyone drafting a franchise agreement, to make sure that the risk (which is very real and constant) of laws or regulations being changed or of new laws or regulations, or new case law, is covered by appropriate provisions that properly tailored to the network’s industry.

By Jean H. Gagnon, AdE, Fasken

Occasional Contributors

In addition to our regular guest bloggers, Inside Internal Controls blog published by First Reference, provides occasional guest post opportunities from various subject matter experts on the topics of risk management and best practices in finance and accounting, information technology, environmental issues, corporate governance, sales/marketing and operations, not-for-profits and business related issues in Canada. If you are a subject matter expert and would like to become an occasional blogger, please contact Yosie Saint-Cyr at editor@firstreference.com. If you liked this post and would like to subscribe to Inside Internal Controls blog click here.
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