Advice & Tips Ask an Expert Franchisee January/February 2021

Q. What do franchisees need to know about selling a franchised business?

A: Many franchisees acquire a franchise in the hope that they will ultimately be able to realize a profit on the sale of the franchised business. In fact, franchise agreements contemplate this reality since they allow the franchisee, on the prior written consent of the franchisor, to transfer the franchised business, including the benefits of the franchise agreement, to a third party. Like everything else in a franchise agreement, the provisions dealing with a transfer are quite detailed – for simplicity I will refer to these provisions as Transfer Provisions

The definition of a transfer in most franchise agreements is quite expansive and includes the sale, transfer, assignment, encumbrance, pledge or other conveyance (the latter language is an attempt to cover not only include the grant of security to a bank or other lender but also the realization by that bank or lender against the assets of the franchised business) of any interest in the franchise agreement, or the assets, or shares of the franchisee corporation. As such, franchisees should be careful that they do not inadvertently trigger the Transfer Provisions when, for instance, they issue more shares of the franchisee corporation or bring in a new shareholder or partner. Usually, Transfer Provisions are somewhat less restrictive in respect of a transfer to a family member upon the death of disability of the franchisee principal.

Transfer Provisions contain a variety of requirements. The franchisor will rightfully wish to assert its authority to determine whether it approves the person(s) who is to operate the franchised business – for simplicity I will refer to this person as the Purchaser. This means the Purchaser must prove, to the franchisor’s satisfaction, that they meet the franchisor’s standards for new prospective franchisees which include business, ethical, reputational, and financial standards.

Franchisees should be aware of the process involved in the transfer of their franchise agreement. Ideally, most lawyers acting for the Purchaser will draft the agreement of purchase and sale so that it is conditional upon the consent of the franchisor, and if the lease is held by the franchisee, the consent of the landlord. Once the purchase agreement has been finalized, it is sent to the franchisor for its consideration and approval. 

Most transfers of franchises require somewhere between 45 to 90 days to complete. The amount of time will depend on a variety factors including:

a) whether the franchisor wishes to exercise its right of first refusal i.e. to itself buy the franchised business;

b) whether the franchisor wishes to have the Purchaser execute its current form of franchise agreement or just consent to an assignment of the franchise agreement;

c) whether the franchisor is compelled to, or if not prefers to, issue a disclosure document; and

d) if the franchisor is compelled, or prefers, to issue a disclosure document, the amount of time it will take the franchisor to assemble the required information. 

Other requirements include that: there be no existing default; the franchisee settles all accounts both with the franchisor and third parties; the Purchaser enters into a written agreement with the franchisor agreeing to assume all of the franchisee’s obligations or alternatively, the execution of the franchisor’s then current form of franchise agreement, which may contain, among other things, different royalty rates and advertising contributions; the Purchaser and its key employees successfully complete the franchisor’s training program; the franchisee pays certain fees to the franchisor, which can be a flat fee or a percentage of the amount paid to the franchisee by the Purchaser; the franchisee pays all of the franchisor’s out-of-pocket costs of administering the assignment; and that the franchisee delivers a complete release in favour of the franchisor. 

In respect of the fees payable, franchisees should carefully review their franchise agreement to ensure that the fees the franchisor proposes to charge them for the transfer are actually set forth in the existing franchise agreement. Sometimes franchisors try to charge fees beyond the amount that they have contractually agreed to collect. 

Further, in respect of the release in favour of the franchisor, following the decision of the Ontario Court of Appeal in 405341 Ontario Limited v. Midas Canada Inc.[1] (Midas), it is no longer appropriate for a franchisor to insist on the execution of a release as a condition to the transfer of a franchise agreement. In Midas, the Court of Appeal states that the requirement that a franchise execute a release as a pre-condition to a renewal of a franchise is prima facie unenforceable and contrary to franchise legislation (in Midas this was pursuant to the Arthur Wishart Act (Franchise Disclosure) 2000). As such, franchisees should push back against this requirement if it is being imposed by the franchisor. 

Like everything else in the world of franchising, a franchisee’s best protection for a smooth transition of their franchised business is an experienced franchise lawyer. 

David Kornhauser (MBA, LLB)
Corporate Counsel
Macdonald Sager Manis LLP