Franchise agreements usually provide a mechanism to ensure that the franchisor remains in control of the premises in which the franchisee operates the franchise, in case of premature termination of their business relationship.
It will often provide that the default of the franchisee to respect the terms and conditions of the agreements will lead to their termination and the repossession, by the franchisor, of the leased premises used by the franchisee to operate the franchise.
To ensure the repossession of the leased premises, the franchisor has various tools.
As such, unless the franchisor owns the commercial building in which the franchisee operates, the franchisor may choose:
- to lease the premises and sublease to the franchisee, or
- to intervene in the lease to obtain an option to replace the tenant in case of default under the franchise agreements, or
- to oblige the franchisee, by the franchise agreement, to include a stipulation in the commercial lease in favour of the franchisor, granting it the rights to the lease at the end of their relationship.
Let’s briefly analyze each of these options.
Leasing the premises and sublease to the franchisee
In 9168-4241 Québec Inc. v. 9128-7755 Québec Inc.1, the franchisor was the tenant and the franchisee applied to the Court for a surrender of the lease concluded between the franchisor and the mall (lessor), which was denied. The franchisor remained the tenant even after the franchise agreement terminated.
In Groupe Damco Inc. v. MBEC Communication Inc.2, a clause in the lease (to which the franchisor had intervened) allowed the novation of the lease to the benefit of the franchisor.
The Court pointed out that this clause was intended to ensure that the franchisor, for all practical purposes, would remain in control of the premises. The franchisor wanted to avoid a franchisee, as signatory of a lease, terminating its franchise agreement and operating a similar business in the premises, either independently or under the banner of a competitor.
Having used the novation of the lease several times in order to assign it to a new franchisee where the prior franchisee was in default, the franchisor secured control over the premises. On the other hand, it is important to note that in novating the lease, the franchisor was held responsible for the unpaid rent.
Stipulation in favour of the franchisee, without intervention to the lease
The latter option is less advantageous for the franchisor, because it must ensure that the franchisee actually incorporates such provision in its lease. If not done by the franchisee, the franchisor could obtain the termination of the franchise agreement. If the right to repossession was not open to it, the franchisor could then “control” the premises indirectly, preventing at the very least a competing enterprise from being exploited there, though non-competition commitments are usually included in franchise agreements.
This situation presented itself in Boutique Médiévale la Table Ronde Inc. v. Distribution Obytech Nord Inc.3, where the franchisee executed a lease without the intervention of the franchisor, despite the requirement to do so in the franchise agreement.
The franchise agreement provided in particular for a repossession clause and for an undertaking, by the lessor, to transfer the lease to the franchisor at the end of the franchise agreement, upon receipt of a notice to that effect and, on the other hand, a right of first refusal on the site in favour of the franchisor if the lease was to expire. The franchise agreement provided that these benefits to the franchisor were to be included in the lease between the franchisee and the lessor.
When the franchisee signed with the lessor, it failed to incorporate the obligations of the franchisor with respect to the benefits, particularly with respect to the taking over of the premises by the franchisor. The Court ruled that by failing to include these rights, in accordance with the franchise agreement, the franchisee was in default, giving rise to the termination of the franchise agreement.
Following the non-renewal of the franchise agreement, the former franchisee used the premises to operate a business of the same nature and with almost identical inventory. The franchise agreement, however, contained a non-competition clause that the Court applied; it prohibited the former franchisee from continuing to operate its new business in the premises.
The consequences of the commercial lease, for the franchisor and the franchisee, must therefore be very carefully assessed.
By Alexandre Béchard (with the collaboration of Catherine Demers, law student, for the research)
1 2008 CanLII 1877 QCCA.
2 2017 CanLII 14808 QCCQ.
3 2002 CanLII 30540 QCCS.