Business Practices

• Author: Frank Zaid
• Profession: Senior Partner Osler, Hoskin & Harcourt LLP
• Pages: 170-220

170

CHAPT ER 5

BUSINESS PR ACTICES

A. R E A L ES TATE CONSIDER ATIONS

1) Introduction

Next to selecting appropriate f ranchisees, the selection of well-located

sites for franchised units is perhaps t he most important factor in con-

tributing to a succes sful franchi se program. Considerations as to re-

sponsibility for the development and location of the franchised units

must begin in the e arly formation of a franchi se program. These con-

siderations will depend not only on legal factors, but on business and

f‌inancial factors a s well.

2) Real Estate Control Arrangements

The options available to the franchisor and franchisee w ith regards to

the franchise d property will depend on whether the franch ised premises

are owned by the fra nchisor, the franchisee, or a third-party l andlord.

a) Third-Party Landlord as Ow ner of the Franchised Premises

i) The Franchisor as Tenant

Most franchisors lea se premises di rectly from the landlord and t hen

sublet or assign the franchised premises to their franchisees in order

to secure prime locations. In many case s, a landlord will not negotiate

directly with t he franchisee, nor allow a franchisee to be the d irect ten-

ant. Also, by virt ue of the franchisor’s size and reputation, as well as

Business Pract ices 171

the franchis or’s f‌inancial po sition, the franchisor will usu ally be able to

negotiate more favourable terms for the lease.

a. Advantages and Disadvantages to the Franchisor

Control of franchised premi ses is a signif‌icant advantage to a fra nchisor

in the event of a defaulting franchisee. The franchisor is able to resort

to legislative landlord-tenant remed ies in addition to remedies under

the franchise ag reement.1 Moreover, control of the franchised prem-

ises will ensure g reater enforcement opportunities of post-termination

covenants in the fra nchise agreement.

As both a franchisor and landlord, the franchisor has control over

the franchise d premises and ha s complete discretion over whether to

renew the sublease, unless t here is a contrary intention expressed in

the lease agreement. Factors such as the franchisor and the franchisee

being in a long-term prof‌itable relationship do not impose an obligation

on the franchisor to renew the agreement.2 Moreover, franchisors may

control premises occupied by fra nchisees by hav ing the term of the

franchise agreement coincide with the term of the sublease.

On the other hand, a lease, because of its res ultant contingent lia-

bility, will have a negative effect on a tenant’s balance sheet and f‌inan-

cial statements. A fra nchisor faces a ri sk, in taking franchised premi ses

directly from the landlord and subletting to a franchisee, that the fran-

chisor, as the head tenant, will be responsible for all rent, payments,

and covenants under the head lea se to the landlord. In the event th at

the franchisee vacates or defaults, and is insolvent or otherwise can not

make payments due, the fr anchisor wil l be responsible for all arre ars

and ongoing payments.3 If the franchi sed premises are not well-located

or unsatisfactory for other reasons, or cannot be further sublet, the

franchisor will have an ongoing liability as a tenant.4

The franchisor must weigh the potential l iability of being the head

tenant against the r isk associated with not having proper control of the

franchised premises. In most instances, the former will be less signif‌i-

cant than the latter.

1 See Section A(3), “Remedies Available to a Fra nchisor upon Default by a Fran-

chisee,” in this chapter.

2TDL Group Ltd. v. 1060284 Ontario Ltd. (2000), 6 B.L.R. (3d) 54 (Ont. S.C.J.).

3Deer Valley Shopping Cent re Ltd. v. Sniderman Radio Sales an d Service Ltd. (1989),

67 Alta. L.R. (2d) 203, 96 A.R. 321 (Q.B.).

4Country Style Food Ser vices Inc. v. 1304271 Ontario Ltd . (2003), 7 R.P.R. (4th) 184

(Ont. Sup. Ct.).

fra nchise law172

b. Advantages and Disadvantages to the Franchisee

Because franchisors are subject to additional exposure as head tenant

of a lease, their willingness to become head tenant is an indication that

they are conf‌ident that the business at that franchised premises is vi-

able. It has often been said that, if a franchisor is not prepare d to take

the head lease itself, then the site cannot be suff‌iciently attractive for

operation by the franchisee.

However, if the franchisee defaults under the lease, the franchis-

or, as sublessor, will have additional landlord-tenant remedies against

the franchisee.5 However, the franchisee may apply for summary relief

under the Commercial Tenancies Act (Ont ari o).6 Finally, franchisors will

often require that the leas e contain a cross-default clause in which any

default under the sublease acts a s a default under the franchi se agree-

ment, and vice versa.7

c. Subleasevs.AssignmentofLease

If the franchisor takes the franchised premise s as head tenant, then

the franchisor’s control over the franchised premi ses will b e effected

through a sublease or an as signment. As illustrated by Rossi v. McDon-

ald’s Restaurants of Canada Ltd., fr an ch iso rs , a s he ad te na nt s, t ha t i nte nd

to sublet the franchised premi ses or assign t he lease to the franch isee,

must ensure that the a ssignment or subletting provisions of the head

lease are clear and un ambiguous as to their r ight to sublet and assign

to franchisee s, preferably without consent of the landlord.8 At the same

time, a franchi sor, as landlord, will wa nt the clause in the sublease with

the franchisee, with respect to as signment and subletting, to require

the consent of the franchis or.9

There are several considerations th at must be taken into account

by a franchisor in deter mining whether the franchised premi ses should

be subleased or assigned to the franchisee. The primary determining

factor will depend upon any rest rictions contained in the head lease

on subletting or assignment. As suming, however, that the franchi sor

is able to obtain the consent of the head l andlord to an assign ment or

sublease to the franch isee, then the fra nchisor must consider the legal

implications of proceeding by either mea ns.

5 See Section A(3), “Remedies Available to a Fra nchisor upon Default by a Fran-

chisee,” in this chapter.

6 R.S.O. 1990, c. L7 [CT Act].

7 See Section A(3)(a), “Cross-Default Pr ovision,” in this chapter.

8Rossi v. McDonald’s Resta urants of Canada Ltd. (1991), 1 B.L.R. (2d) 175

(B.C. S.C.).

9Re Kakamous ias and Pizza Pizza Ltd. (1984), 46 O.R. (2d) 508 (Co. Ct.).