A VIEW FROM TWIN PEAKS
by Paul R. Fransway, Ann Arbor Office
Quick. Define Twin Peaks. Other than the obviously now dated TV
show, up until a couple of weeks ago, the only other definition of
Twin Peaks was a restaurant chain that featured double entendre
advertising, scantily clad women servers and "man food."
Now Twin Peaks has a new definition; Twin Peaks means a mass
gunfight that left a number of people dead, a lot injured, more
than 150 people arrested with a 1,000 weapons seized, and
incidentally, a terminated franchisee who had invested more than
$1,000,000 to open their restaurant and a franchisor trying to
figure out how to do damage control. Those of us in the franchise
business immediately recognized a franchised system's nightmare
and watched from afar to see how the franchisor and franchisee
would handle the disaster. The consensus of many seems to be
"not very well." The important question, however, is what
lessons are there to be learned from the Twin Peaks debacle.
The short answer to the question that a franchisor, as the leader
of a franchise system, has to be prepared in advance of a public
relations disaster, not only from a legal standpoint but also from
a public relations standpoint. The reason is simple. It is not a
question of if a franchise system will be faced with this
type of situation but when it will happen. Only through
assuring that the franchise agreement contains terms that allow the
franchisor to take action against the franchisee if necessary and
merited, and by having a disaster response plan in place that can
limit damage to the brand, can a franchise system endure and
recover to continue to be successful.
Legal issues. What a franchisor can legally do in
situations like the Twin Peaks shootout is obviously dependent upon
what the franchise agreement provides. When the news broke that
Twin Restaurant Franchise, LLC, the franchisor, had almost
immediately terminated the franchise agreement of the Waco
franchisee, curiosity prompted the question "I wonder what
their franchise agreement says" because franchisors often do
not have clear contractual rights to terminate the franchise
agreement in situations like the Waco incident. Most franchise
agreements provide that the agreement can be terminated if the
franchisee is convicted of a felony, and a majority also provide
that the franchisor has the right to terminate if the
"franchisee commit[s] any other act which may adversely affect
or be detrimental to us, other franchisees, or any of our rights in
and to the [marks]." 1 In some cases, the franchise
agreement is drafted in such a way as to require some causal
connection between the criminality and the damage to the brand. The
problem in the Twin Peaks situation was that, based upon the
publicly known facts, the franchisee was not convicted, or even
charged with a felony, and it is subject to question whether the
franchisee's acts in Waco are what led to the damage to the
brand.2 The first lesson to be learned, therefore, is to
look at your franchise agreement and consider whether changes are
necessary. Examples of possible changes include assuring that the
criminal acts / damage to the brand are independent defaults and
that the language does not appear to require a causal connection
between the crime and the damage to the brand, the grant to the
franchisor of the right to make the determination of what conduct
or omissions by the franchisee impair the brand and the grant to
the franchisor of the right to terminate without cure if the
franchisor reasonably determines that a threat or danger to public
health or safety is likely to result from franchisee's acts or
operation.3 Clarity is the key and to the extent
possible, the agreement should be clarified with anticipated risks
in mind.4
We are a good corporate citizen. In the aftermath of what
was obviously a difficult situation, it was hard not to get the
impression that the franchisor and the franchisee were both
pointing fingers in different directions attempting to deflect
responsibility.5 From a franchise law perspective, we
can all understand that instinct since the franchisee is an
independent contractor and is ultimately responsible for what
occurs at their location. This is particularly true in an evolving
legal environment where efforts are being made to ignore the
franchisor/franchisee distinction and too much involvement by the
franchisor will be cited as evidence of control exposing the
franchisor to liability. Even so, we understand the
franchisor/franchisee distinction. The public does not. They have
even less understanding where the public safety and health are put
at risk (as was the case here) and both franchisor and
franchisee are "passing the buck." The unfortunate truth
is that the public is going to hold both the franchisor and the
franchisee responsible regardless of the legal distinctions and the
franchisor has the responsibility to limit the damage to the system
as much as possible. This requires having a team in place with
authority at the highest level to serve as the public face for the
franchise system. Retention of a good public relations firm and
designation of the internal disaster management team
before the crisis happens is essential. The immediate
response should be to have franchisor personnel with experience
interacting with the media on the ground to answer questions as
soon as possible and to tell the story from the system's side.
This should include responses on social media where much of the
negative publicity today is spread. At the very least, they should
be there to make it clear that the company cares about the event,
that it finds the event unacceptable and will do whatever it can to
resolve the situation and to regain the public trust (including the
termination of the franchise agreement if necessary.)
This response team cannot be limited to the franchisor. A
franchisor should also provide training for franchisees about how
to deal with crisis management. In the Twin Peaks case, it appeared
that the police were blaming both the franchisor and the
franchisee, the franchisor blamed the franchisee and immediately
terminated their franchise agreement and the franchisee was making
public statements that termination was not merited and that they
did nothing wrong. While these approaches make sense from a legal
perspective, all they did was cement the thinking in the
public's mind that there was plenty of blame on both sides.
Certainly, where, as here, public officials express concern, this
concern should be taken seriously and proactively addressed even if
there is increased exposure from the franchisor and franchisee
working together. At the very least, every effort should be made to
define possible risks, to put communications personnel and others
with authority in place to respond before the need arises, to
assure communication lines between the franchisor and franchisees
are well defined and to make it clear that public officials
recommendations are always followed.6 Twin Peaks clearly
did not have these elements in place, and there are a number of
public relations consultants that point to the Twin Peaks situation
as an example of what not to do.7
What is apparently overlooked in the Twin Peaks situation is the
criminal behavior that led to the crisis. Even though the crisis
may not be of their own creation, franchisors are well advised to
proactively look at steps that can limit any damage when the crisis
occurs.
1 A review of franchise
agreements of many of the larger franchisors disclose both of these
provisions, some with variations, such as the addition of
conviction of misdemeanors involving moral turpitude, violation of
anti-terrorism laws and similar provisions.
2 Such as the criminal acts of others. The franchisee
appears to be taking this position in their public
announcements.http://www.kxxv.com/story/29092329/corporate-revokes-twin-peaks-waco-license-franchisee-disputes-police-account-of-shooting.
3 There are obvious restrictions on the right of
franchisors to terminate in states with franchise relationship laws
and under non-contractual theories, such as the duty of good faith
and fair dealing. The author submits it is better to have the
language in the franchise agreement to argue the point than not
have it. Also, in this context, often the equities will favor the
franchisor who must take action to protect the system under
egregious facts.
4 A franchisor may take the approach of "I'll
terminate first and figure it out later" but it is certainly
better not to expose yourself to a possible claim of improper
termination by the franchisee.
5 See
http://blogs.wsj.com/riskandcompliance/2015/05/26/crisis-of-the-week-biker-shootings-put-twin-peaks-in-crisis-spotlight/.
6 Some thought should be given to including a provision
in the franchise agreement that requires the franchisee to notify
the president of the franchisor of a "crisis management
event" and that defines duties when one occurs. Since the
franchisor here already knew of the public safety concerns, it
wouldn't have helped in this case, but it might be of
assistance to allow the most rapid professional response
possible.
7 See Wall Street Journal blog and http://www.ehandersonpr.com/twin-peaks-shooting/.
A NEW PARADIGM IN CANADIAN FRANCHISE LAW
The Dunkin' Donuts Case
by Ned Levitt, Toronto Office
In Dunkin' Brands Canada Ltd.,1 the Quebec
Court of Appeal upheld the trial court decision which held the
franchisor liable for failing to protect its brand, but reduced the
damages awarded to franchisees. The Quebec Court of Appeal rejected
the franchisor's argument that the trial judge had imposed a
new unintended obligation to protect and enhance the brand,
outperform the competition and maintain market share. It concluded
that the trial decision applied, rather than extend the
franchisor's duty of good faith.2 The Quebec Court
of Appeal made the following conclusions:
Express Terms of the Agreement
Explicit terms in the franchise agreements obliging the franchisor
"to protect and enhance" its brand were not merely a
"hoped-for result" but a binding contractual
obligation.3 While "the franchisor did not
guarantee that the reputation of the brand would be enhanced, it
undertook to adopt reasonable measures to that end."
4
Implied Obligations Incidental to the Nature of the
Franchise Agreements
The franchisor's "obligations were based not just in the
text of the franchise agreements but also on duties that it had
implicitly assumed in respect of the whole network of
franchisees."5 The franchise agreements
"established a relationship of cooperation and collaboration
between the franchisor and its franchisees, reflecting both common
and divergent interests, over a long period of
time."6 In other words, "the character of the
specific franchise arrangement was an on-going one in respect of a
system that the parties agreed to sustain as critical to the
success of the brand."7 Given the role the
franchisor assigned to itself in "overseeing the on-going
operation of the network" and the uniform system of standards,
the Quebec Court of Appeal held that it was fair to hold that the
franchisor had implicitly agreed to undertake reasonable measures
to help the franchisees, over the life of the arrangement, to
support the brand.8 This included "a duty to assist
them in staving off competition in order to promote the on-going
prosperity of the network as an inherent feature of the relational
franchise agreement." 9
Implied Obligation of Good Faith
The Quebec Court of Appeal confirmed that a franchisor's
obligation of good faith "is not confined to the circumstances
of franchisors that compete unfairly with their
franchisees."10 Rather, a franchisor owes an
obligation of good faith and loyalty to its franchisees requiring a
franchisor, by reason of "superior know-how and
expertise" upon which the franchisees rely, to support
individual franchisees and the whole of the network through its
on-going assistance and cooperation.11 This duty is
"not on the basis of the duty to perform contracts in good
faith but rather on the distinct theory of implied
obligations" from the nature of the franchise agreement and
equity.12 The nature of the agreement and equity
"provide two distinct normative justifications for this
implied obligation of good faith." 13
Implied Obligations owed by the Franchisor to the Network
of Franchisees
The franchisor also had a duty to assist and co-operate that
includes an obligation to take reasonable measures to protect them
from the new market challenges presented by the entry of an
aggressive competitor into the market. Beyond the duty not to take
actions that would wrongfully cause them harm, the franchisor
assumed, on the basis of this implied duty of good faith, a duty to
assist and cooperate with the franchisees by taking certain active
measures in support of the brand.
The agreements created, through express language and by necessary
implication, a duty owed to the franchisees collectively to take
reasonable measures to support and enhance the brand. This included
the duty to respond with reasonable measures to help the
franchisees as a group to meet the market challenges of the moment
and to assist the network of franchisees by enforcing the uniform
standards of quality and cleanliness it holds out as critical to
the success of the franchise. It is up to the franchisor to enforce
the authority it has given itself under the franchise agreement.
The undertaking to take reasonable measures to protect and enhance
the network, can best be thought of as an implicit duty in each
contract upon which an individual franchisee can take action in the
event of breach.
Conclusion
Continuing to adopt a business as usual approach in the face of a
competitive threat is not sufficient to satisfy the
franchisor's contractual obligations. The franchisor did not
take reasonable measures, in particular, to protect and enhance the
brand in the face of the competition. Had the franchisor taken
proper measures to protect and enhance the brand and,
notwithstanding those efforts, a competitor had encroached on some
of the franchisees' market share, the latter would have had no
basis for complaint. It remains to be seen if this case, decided
under the Civil Code in Quebec, will influence the evolution of the
common law in the other provinces. Given the numerous cases which
have firmly established the concept of good faith and fair dealing
in the Common Law, as it applies to franchising, it would seem a
safe bet that the Dunkin' Donuts case will, in some form or
other, work its way into the Common Law.
1 2015 CarswellQue 3066,
2015 QCCA 624, J.E. 2015-692, EYB 2015-250660.
2 Ibid at para 76.
3 Ibid at para 44.
4 Ibid at para 86.
5 Ibid at para 59.
6 Ibid at para 62.
7 Ibid at para 63.
8 Ibid at para 64.
9 Ibid.
10 Ibid at para 69.
11 Ibid at para 71.
12 Ibid at para 70.
13 Ibid at para 71.
Watch the extra step... when crossing the resale exemption
path
by Andrae J. Marrocco, Toronto Office
Section 5(7)(a)(iv) of the Arthur Wishart Act (Franchise
Disclosure), 2000 ("AWA"), states that disclosure
obligations do not apply to a franchisor in circumstances where
there is a grant of a franchise by an existing franchisee to
another person if the grant of the franchise is not effected by or
through the franchisor (the "Resale Exemption"). For
greater certainty, Section 5(8) of the AWA provides that a grant is
not effected by or through a franchisor merely because, (a) the
franchisor has a right, exercisable on reasonable grounds, to
approve or disapprove the grant; or (b) a transfer fee must be paid
to the franchisor in an amount set out in the franchise agreement
or in an amount that does not exceed the reasonable actual costs
incurred by the franchisor to process the grant. In other words,
the resale exemption is intended to operate in circumstances where
an existing franchisee sells its franchise business to a
prospective franchisee with minimal involvement from the
franchisor.
Three recent decisions dealing with the Resale Exemption have
reaffirmed the court's narrow interpretation and application of
the Resale Exemption. In each case, the court held that the
franchisor's role in the resale extended beyond that of a
"passive participant" (as stipulated by the
jurisprudence), disqualifying the franchisor from being able to
rely on the Resale Exemption.
In Brister v 2145128 Ontario Inc., the Applicant
franchisee (the newly admitted franchisee) called into question the
Respondent franchisor's reliance on the resale exemption. The
Court reiterated jurisprudence that in order for a franchisor to
rely on Section 5(7)(a)(iv) of the AWA, a franchisor must not be an
active participant in the grant of the franchise and should
essentially confine its role to merely exercising its right to
consent to the transfer.
The Ontario Superior Court of Justice determined that the
Respondent franchisor had in fact been an active participant in the
grant of the franchise because it had required the Applicant
franchisee (prospective franchisee at the time) to:
- successfully pass an interview conducted by the Respondent franchisor prior to obtaining approval;
- agree to undergo training from both the then-existing franchisee and the Respondent franchisor;
- assume the rights and obligations of the then-existing franchisee under the premises lease as sole tenant in place of the Respondent franchisor; and
- enter into a general security agreement in favour of the Respondent franchisor.
Importantly, the then-existing franchisee had not been required
to execute a general security agreement. This requirement included
something that went beyond the then-current arrangement with the
then-existing franchisee.
A similar outcome arose in 2147191 Ontario Inc. v Springdale
Pizza Depot Ltd. The Ontario Court of Appeal upheld the
summary judgement preventing the franchisor from relying on the
Resale Exemption. The Court of Appeal found that the
franchisor's course of conduct could not be construed as merely
passive participation, but rather went beyond the bounds of the
existing relationship:
- The franchisor met with the prospective franchisee on a number of occasions;
- The franchisor and prospective franchisee discussed the possibility of a fresh grant of a franchise right (although it was determined that the transfer was the preferable avenue in the end); and
- The franchisor required the prospective franchisee to sign and provide an acknowledgement providing additional comfort and protection to the franchisor that was not found in the original franchise agreement.
In 2256306 Ontario Inc. v Dakin News Systems Inc., the
Ontario Superior Court of Justice rejected the Defendant
franchisor's arguments that the resale exemption applied. In
this case, the existing franchisee was operating on a month to
month basis after the original franchise agreement had expired.
Nonetheless, the existing franchisee transferred the franchise
business to a prospective franchisee. Subsequent to such transfer,
the Defendant franchisor discovered that the original franchise
agreement had expired and sought to have the Plaintiff prospective
franchisee sign a franchise agreement for the continued operation
of the franchise. This requirement went beyond a passive role on
part of the Defendant franchisor and was enough to render the
Resale Exemption inapplicable.
The approach of the courts has been consistent. The Resale
Exemption will only apply in circumstances where franchisors remain
"passive participants" in any grant or transfer
transaction whereby an existing franchisee conveys the franchise
business to a new franchisee. The plain example is where a
franchisor does nothing more than provide its approval for the
transaction. Particularly where a franchisor imposes additional
requirements of the prospective franchisee, the franchisor is
clearly no longer passive. Franchisors should tread very carefully
when considering a reliance on the Resale Exemption.
Alberta Changes its Laws on Guarantees
With the coming into force of Alberta's Notaries and
Commissioners Act (Alberta), effective April 30th, 2015, the
Guarantees Acknowledgement Act (Alberta) is amended in
several ways important to franchisees and franchisors. The
amendments provide, inter alia, that any guarantee from an
individual not obtained in compliance with the following rules is
unenforceable:
- each individual that provides a guarantee must appear before an active practicing lawyer and sign a certificate in a prescribed form in the presence of such lawyer acknowledging that such person has signed the guarantee. Signing in front of a student-at-law or notary public is no longer sufficient; and
- the lawyer must be satisfied and certify that the individual guarantor is aware of, and understands, the contents of the guarantee.
The Notaries and Commissioners Act (Alberta) also removes the limitation on the fees to be provided for such services, which was previously capped at $5.00.
These amendments are relevant to franchisors and franchisees as franchise agreements often require the principal of a corporation, where the franchisee is a corporation, to personally guarantee the corporate franchisee's obligations under the franchise agreement. Franchisors should update any existing acknowledgement certificate they use in respect of guarantees from individuals and make any corresponding amendments to their franchise disclosure document.
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