Considerations for Franchisors and Franchisees During the COVID-19 Pandemic
As the COVID-19 pandemic persists, franchisors and franchisees may be uncertain as to their rights and obligations under their existing franchise agreements and in providing and receiving disclosure documentation upon renewal, resale and entering into new franchise agreements.
Franchisees who have or may temporarily close their businesses as a result of the COVID-19 pandemic should review their franchise agreements for clauses regarding failure to operate their businesses for a number of consecutive days and determine whether their agreements set out exceptions to the franchisees’ obligation for continuous operation. Franchisors, in turn, will need to consider whether they are able to enforce these contractual obligations on franchisees whose businesses have closed in accordance with government mandates.
Payment of Franchise Fees
Due to the negative impact of COVID-19 on revenue, many franchisees are struggling to pay franchise fees. If your franchise fees are set at a fixed amount to be paid periodically, review your franchise agreement to determine whether late payment or failure to pay franchise fees constitutes a default of your legal obligations. A struggling franchisee may have less cause for concern if the parties have agreed that franchise fees are directly correlated to revenue.
In determining whether to enforce default provisions, franchisors will be wise to consider the costs associated with terminating a franchise agreement and the potential lack of demand and interest (considering the current state of the market) when attempting to replace franchisees.
Franchisees and franchisors should also review their franchise agreements for force majeur clauses. A force majeur clause may release a franchisee from some or all of its obligations under certain circumstances, such as a pandemic. For more information on force majeur clauses, see our blog entitled COVID-19 and Commercial Agreements – Force Majeure and Frustration.
Addressing COVID-19 in Disclosure Documentation
Prospective franchisees who have received a franchise disclosure document but have not yet signed a franchise agreement, may request (and, if applicable, the franchisor will be required to provide) a statement of material change detailing the impact of COVID-19 on the franchise system. Franchisors should also revise existing disclosure documents to address any changes in training, costs of establishing the franchise, financing programs and timelines and disclose any other information about the franchisor or franchise system that would “reasonably be expected to have a significant effect” on the value of the franchise or on the franchisee’s decision to purchase the franchise.
As market conditions and Canada’s business environment are ever-evolving, it is important for franchisors and franchisees to regularly review their agreements, update one another and work together to resolve issues arising out of changing circumstances and revise disclosure documentation accordingly. If you have questions regarding your franchise agreement or require assistance with disclosure documentation, we recommend that you seek advice from a lawyer with franchise experience.