What is a franchise agreement?

A franchise agreement is a contract between a franchisor and a franchisee that grants the franchisee the right to operate a business under the franchisor’s system, standards, and intellectual property, in exchange for fees and compliance with the franchisor’s standards. A franchise agreement is the principal legal document that governs an ongoing franchise relationship and sits at the centre of every franchise system. A franchise agreement defines the territory, term,  fees, and royalties, the operating system the franchisee must follow, the trademarks and other intellectual property licensed to the franchisee, the training and support the franchisor will provide, and the ongoing obligations of both parties.

Why you should consider a franchise agreement

Establishing the franchise relationship. A franchise agreement is the document that papers the legal relationship between franchisor and franchisee. Without a franchise agreement, the parties have an unclear and ambiguous basis for the franchise arrangement.

Granting and licensing the franchise system. A franchise agreement licences the franchisor’s trademarks, operating manuals, proprietary methods, training, and other elements of the franchise system to the franchisee. The scope of the licence — including which trademarks, procedures, and confidential information and data is shared — is a core part of any franchise agreement, and supports the consistency of the franchise system across locations.

Defining the territory and exclusivity. A franchise agreement defines the geographic territory in which the franchisee may operate and whether the franchisee has any exclusive or protected territory. Issues commonly arise around encroachment by the franchisor or other franchisees, online sales that cross territorial lines, and the franchisor’s reserved rights to operate alternative channels. A clearly drafted territory and exclusivity provision in a franchise agreement prevents disputes that often arise as the franchise system grows.

Setting fees, royalties, and ongoing payments. A franchise agreement defines the initial franchise fee, ongoing royalties, marketing or advertising fund contributions, technology fees, and other payments the franchisee is required to make. The structure of these fees, how they are calculated, and when they are payable may be heavily negotiated and have a significant effect on the franchisee’s economics.

Allocating responsibility for the operating system. A franchise agreement requires the franchisee to operate the business in accordance with the franchisor’s system, including operating manuals, training requirements, marketing standards, supply requirements, technology systems, and quality control. A franchise agreement also defines what the franchisor will provide in terms of training, ongoing support, and updates to the system.

Planning for renewal, transfer, and exit. A franchise agreement addresses what happens at the end of the term — including renewal rights, transfer rights, and the franchisee’s obligations on termination or expiry. These provisions are often the most consequential parts of a franchise agreement because they determine whether the franchisee can continue operating, sell the business, or pass it on to a successor.

Relevant laws and regulations

Franchises Act, RSA 2000, c F-23. Alberta’s franchise legislation, which regulates the offer and sale of franchises in Alberta, requires franchisors to provide a franchise disclosure document before signing a franchise agreement, imposes a statutory duty of fair dealing on both parties, and creates rights of rescission and damages for non-compliance.

Trademarks Act, RSC 1985, c T-13. Canada’s federal trademarks legislation, relevant to any trademarks and goodwill as part of the franchise system.

Copyright Act, RSC 1985, c C-42. Canada’s federal copyright legislation, relevant to operating manuals, marketing materials, software, and other copyright-protected elements of the franchise system licensed under a franchise agreement.

Competition Act, RSC 1985, c C-34. Canada’s federal competition legislation, which can apply to exclusivity provisions, resale price maintenance, and territorial restrictions.

Consumer Protection Act, RSA 2000, c C-26.3. Alberta’s consumer protection legislation, which can apply to the downstream consumer-facing operations of a franchise system and which intersects with a franchise agreement where the franchisee’s operations involve consumer transactions.

Common legal issues

Compliance with the Franchises Act disclosure obligations. A franchise agreement is governed by the disclosure framework under the Franchises Act, which generally requires the franchisor to provide a franchise disclosure document at least fourteen days before the franchise agreement is signed or any consideration is paid. Non-compliance with the disclosure obligations can give the franchisee a statutory right to rescind the franchise agreement and recover damages, and these claims are a significant source of franchise litigation in Alberta.

Statutory duty of fair dealing. The Franchises Act imposes a duty of fair dealing on the parties to a franchise agreement, including a duty of good faith and commercial reasonableness in the performance and enforcement of the franchise agreement.

Territory, encroachment, and reserved channels. Disputes commonly arise where the franchisor opens a new location, signs another franchisee, or enters online or alternative channels in a way that the franchisee considers encroaches on its territory. A franchise agreement that does not clearly define the territory, the exclusivity, and the franchisor’s reserved rights is a frequent source of these disputes.

Renewal, transfer, and the franchisor’s approval rights. A franchise agreement defines whether the franchisee has a right to renew at the end of the term and on what terms, and whether the franchisee can transfer the franchise to a buyer or successor. The franchisor’s approval rights over a transfer, the right of first refusal, and any required payment of transfer fees may be heavily negotiated.

Termination and post-termination obligations. A franchise agreement defines the grounds on which the franchisor can terminate — including non-payment, breach of standards, abandonment, and insolvency — and the cure rights available to the franchisee.

Restrictive covenants and post-term non-competition. A franchise agreement typically includes non-competition, non-solicitation, and confidentiality covenants that bind the franchisee during and after the term. These covenants need to be reasonable in scope, geography, and duration to be enforceable, and overly broad post-term non-competition covenants in a franchise agreement can be unenforceable.

Source of supply and tied selling. A franchise agreement often requires the franchisee to purchase specific products or services from the franchisor or designated suppliers. Tied selling and exclusive dealing arrangements should be drafted with competition law considerations in mind.

Frequently asked questions

Are franchise fees and royalties negotiable? Franchise fees and royalties under a franchise agreement are commercial terms, but in practice many franchisors offer their franchise agreement on standard terms that are not significantly negotiable, particularly for smaller franchisees. Larger or more sophisticated franchisees may have leverage to negotiate specific terms.

Can a franchise agreement be terminated early? A franchise agreement can generally be terminated where the contract permits, including for material breach, failure to comply with the franchisor’s standards, non-payment, and insolvency. The grounds for termination, the notice required, and any cure rights are commercial terms of the franchise agreement, subject to the statutory duty of fair dealing under the Franchises Act.

Can the franchisor change the franchise system during the term? Most franchise agreements give the franchisor the right to update the franchise system during the term — including changes to operating standards, technology, products, marketing, and supplier requirements. The franchisee is generally required to comply with system updates.