Canada: What Is The True Contract Between A Franchisor And Its Franchisees?

Last Updated: October 26 2018
Article by Jean H. Gagnon

All franchisees sign a written agreement with their franchisor, which sets out at great lengths the parties' rights (mostly the franchisor's rights) and obligations (mostly the franchisee's obligations).

However, by the very nature of the very close legal and business relationship between a franchisor and a franchisee, the contract between them comprises a component that has, or should have, a much wider influence on their conduct and their decisions, as well as on their respective rights and obligations, than does the actual wording of the written agreement. It is that component that both behavioural specialists and, according to the judgment rendered by the Court of Appeal of Quebec on April 15, 2015 in Dunkin' Donuts, the courts refer to as the "relational contract".

This "relational contract" is composed of the rules that are needed for maintaining the close collaboration that the parties are seeking over the long term of their legal and business relationship.

Paradoxically, the strength of this relational contract derives not from the fact that it has been written down (since it almost never is), or even that it has been discussed (since it only very rarely is); rather, it derives from the very nature of the franchisor-franchisee relationship, which involves close and daily interaction and collaboration between individuals and businesses that have both common and diverging interests.

The success of a long-term relationship of this nature, that must also constantly evolve and change, cannot derive solely from the static text of the agreement initially signed. It must also involve a mutual collaboration commitment, in which each party must play its role in such a way that the considerations behind the franchisor-franchisee agreement are not voided or defeated for either party. That commitment also calls for maintaining a very high degree of good faith and mutual loyalty throughout the relationship.

Of course, the goal of the franchisor and of each franchisee is the success and profitability of each one's own business (which sometimes calls for negotiations, that are not always easy, concerning how the revenue generated by the network is to be divided between them), but, especially in the long term, one cannot succeed or maximize its profitability if the other does not also succeed or is not profitable.

There is therefore a mutual obligation to maintain a delicate balance between the entirely understandable objective of each party to increase its own profits, and the commitment of each party to contributing to the ongoing collaborative relationship in which each of them must benefit.

The true contract between a franchisor and its franchisees

Several studies that have been conducted of numerous franchise networks (including those done by Greg Nathan, a world-renowned psychologist and franchising consultant with the Franchise Relationship Institute in Australia) have concluded that the quality of the collaboration between a franchisor and its franchisees rests far more on adherence to the relational contract than to the written agreement.

Those studies show that, in practice, it is possible to predict, with a high degree of accuracy, the probability that franchisees will willingly agree to comply with their franchisor's rules, policies and directives and to participate in its initiatives and programs, based on their answers to the following two questions:

  • Do the decisions made and actions taken by my franchisor's executives show that they genuinely make the success of the entire network (which is composed of both the franchisees and the franchisor), as a whole, their priority over the individual interests of the franchisor alone?
  • Do my franchisor's executives really know what they are doing, where they are going and how to manage the network (in other words, "Are they competent")?

The relationship of trust, the franchisor's interest in franchisees' success, and the competence of the franchisor's executives, in its franchisees' perception, are the determining factors of a healthy franchisor-franchisee relationship.

Conversely, when franchisees believe that their franchisor is concealing important information from them, is making bad decisions, is not demonstrating leadership and competence in its management of the network, or is putting its own interests ahead of those of the network as a whole, they will interpret those actions as breaches of the relational contract between franchisor and franchisees.

There is then a strong risk that the franchisees will decide to react to this "unfairness" (in their perception of the situation).

Legal or business issues thus play only a very secondary role as compared to the feeling of unfairness resulting from those perceived breaches of the relational contract.

Four practical tips

Based on the conclusions from studies of the franchisor-franchisee relational contract, the following are four ways in which a franchisor can enhance and improve the quality of its relationship with its franchisees:

  1. Discuss with each new franchisee (and, on an ongoing basis, with all franchisees), from the outset (even before the franchise agreement has been signed), as candidly, openly and clearly as possible, the franchisor's and franchisee's respective roles and commitments, what each of them can expect of the other, and how the franchise network operates;
  2. Demonstrate transparency in the manner in which the franchisor makes decisions and in the reasons for the decisions made by the franchisor, and, to the fullest extent possible, share with franchisees the results of the strategies put forward by the franchisor, and involve franchisees in the decisions, strategies, projects and initiatives that have a direct impact on their franchised businesses;
  3. Regularly show franchisees that the franchisor and its executives make the success of the entire franchise network (which includes the franchisees as well as the franchisor) their top priority and that they are concerned about the profitability of both franchisor and franchisees, and explain how the decisions and initiatives proposed by the franchisor may have a positive impact on their profitability in the short, medium and long terms;
  4. Adequately test new projects, programs and initiatives before launching them across the network and consult franchisees regarding the ones that may have a significant impact on their businesses or themselves.

To summarize, a franchisor should never underestimate the power of the negative energy that can be generated by the feeling that a franchisee's franchisor (in which the franchisee has placed their trust) has breached the relational contract between them.

In closing, we note that these observations are very consistent with the concepts discussed in the book Getting to We: Negotiating Agreements for Highly Collaborative Relationships (Jeanette Nyden, Kate Vitasek and David Frydlinger, Plagrave MacMillan, August 2013), which I strongly urge you to read, and with the principles I lay out in my recently released book, Le partenariat stratégique: L'ingrédient clé du succès en franchisage (Éditions Yvon Blais, October 2018).

Fasken has all the expertise and resources that are needed to assist you and to provide you with support and guidance so that you are able to better manage your relationships with your franchisees and are able to prevent and to achieve prompt and effective resolutions of any issues, problems, challenges or disputes within your network.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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