Renewals: Smoothing Out the Process

Franchise agreements typically give the franchisee an option to renew, but renewal is often conditioned on the franchisee's execution of the franchisor's "then-current" form of franchise agreement. Where there's been little evolution in the franchisor's franchise agreement over the years, the execution of the franchisor's "then-current" form should be of little consequence. But that is atypical: as franchise systems evolve, so do their franchise agreements. Given that franchise agreements are long-term agreements, it is not surprising that, in most circumstances, the "then-current" relationship, rights, and obligations of the parties differ materially from the expiring version.

1) Can a renewal significantly alter the contract between a franchisor and franchisee? Faced with this situation, franchisees have argued that the franchisor is prohibited from requiring the franchisee to agree to significant contractual changes on renewal. Franchisors, on the other hand, argue that the inclusion of the "then-current" requirement in the expiring agreement refutes any argument that the franchisor was obligated to continue the existing franchise agreement intact and without any material changes. Unfortunately, the issue frequently ends up being litigated or arbitrated in the context of a breach of contract action.

2) Can a franchisor condition renewal on the franchisee's execution of a materially different form of a franchise agreement? Courts start their analysis with the language of the expiring franchise agreement. The objectives are to determine whether the provisions of the agreement are clear and unambiguous, and to determine the parties' intent as expressed by the contract's plain language.

Courts are naturally reluctant to interpret a contract to confer a right in perpetuity unless the language of the agreement requires that result. In other words, the view that a franchisor would be bound to the terms of an expiring contract for another term is disfavored. For instance, in G.I. McDougal v. Mail Boxes, Etc., a 2012 California appellate court rejected the franchisee's position that the franchise agreement obligated the franchisor to renew the original franchise agreement without material changes. The material changes to the franchise agreements in that case included changing the name and trademarks of the business entirely. The court first looked at the expiring agreement, which provided for renewal "on the same terms and conditions as are contained in the then-current Franchise Agreement for the sale of new MBE Centers." Based on that clear language, decided that the "then-current" provision was enforceable and that the franchisor did not breach the expiring franchise agreement by offering renewal only on the terms of the "then-current" agreement--even though the terms of the new franchise agreement were materially different. The court rejected the franchisee's argument, reasoning that the franchisee's position was at odds with the clear language of the expiring agreement.

Another argument raised by franchisees against enforcing renewals on "then-current" terms is under the implied covenant of good faith and fair dealing. Franchisees contend that inherent in all contracts is the promise that the franchisor will not frustrate the franchisee's rights to the benefits of the contract. However, it is well-established that this implied promise cannot be applied to rewrite the franchise agreement's expressed terms. The implied covenant does not impose substantive provisions that contradict the contract itself. Thus, the court in McDougal, for example, held that where the renewal provisions contain no specific obligation to renew the agreement on the same terms as the expiring franchise agreement, the franchisor will not have breached its obligation of good faith and fair dealing simply by offering renewal on its "then-current" terms.

Conclusion

The use of clear and simple words to express the intention of the parties to a contract is critical and will ultimately have a profound impact on the ability of the parties to exercise their respective rights under the agreement. A provision in a franchise agreement requiring as a condition to any renewal right that the franchisee execute the franchisor's then-current form of agreement, which may include materially different terms, is essential to the franchisor's ability to develop its system, compete effectively, and achieve consistency in its franchise relationships. Courts have found such provisions enforceable where they clearly express the parties' intent in that regard. While the issue might seem light years away, particularly for start-up franchisors, it's one that must be considered when drafting the franchise agreement and not forfeited when negotiating the agreement.

Scott C. Walton is an attorney with the Chicago law firm of Cheng Cohen LLC. He focuses in the areas of litigation and dispute resolution. Contact him at 312-243-1708 or scott.walton@chengcohen.com.