To What Extent Can Franchisors Use Manuals to Implement Rights and Obligations Beyond Those Present in the Franchise Agreement?

(i) Introduction

Franchise agreements typically require franchisees to conform strictly with standards and procedures that are set out, not only in the franchise agreement itself, but in operations manuals or other system-wide communiques (together, and for convenience, the “Manuals”). Such Manuals are separate documents from the franchise agreement and are not the product of any negotiation between the franchisor and franchisee; indeed, a franchisee typically is not provided with the Manuals until after it has entered into the franchise agreement. 

Nonetheless, franchise agreements usually provide that Manuals are incorporated into, and form part of, the franchise agreement. Franchise agreements also commonly include a provision that entitles the franchisor to introduce unilateral changes to the system by means of revising the Manual. By structuring their franchise agreements in this way, franchisors reserve for themselves the critical flexibility they need to adapt their systems to evolving commercial and competitive realities. 

The fact that the Manuals are separate documents from the franchise agreement (even if sometimes incorporated by reference into the franchise agreement) raises the question of what limits exist to a franchisor’s ability to use the Manuals to create rights and obligations that were not set out in its franchise agreement, or to modify terms that were originally present in the franchise agreement.

(ii) The Canadian Jurisprudence

Although the issue has not been widely considered by Canadian courts, the few decisions that have confronted it have demonstrated a clear judicial willingness to bind franchisees and franchisors alike to rights and obligations contained in the Manuals. 

Perhaps the most prominent such example is Ontario’s Fairview Donut Inc. v. The TDL Group Corp. case, which concerned the well-known Tim Hortons franchised system of quick service restaurants. Tim Hortons’ franchise agreements contained the usual provisions entitling the franchisor to revise its Manuals in order to improve methods and procedures and requiring the franchisees to comply with such changes. Tim Hortons used its Manuals to implement a sweeping system-wide change requiring of its franchisees to buy certain products directly from the franchisor instead of baking those products from scratch in their stores, as had been the convention to that point. This change by the franchisor can fairly be characterized as having dramatically revised a fundamental aspect of the franchisees’ operations as they existed at the time they had entered into their franchise agreements; nonetheless, it survived a challenge by franchisees who had argued unsuccessfully that the franchisor’s change negatively impacted their profitability.

In Ontario’s subsequent 1250264 Ontario Inc. v. Pet Valu Canada Inc. decision, the court relied in part on language contained in the Manual to find that the franchisor was contractually obligated to share with its franchisees certain volume rebates it had secured.

Church v. H & R Block Canada, Inc. was a rare franchise law decision to be issued by the Yukon court. The case concerned a provision addressing the use by franchisees of software provided by the franchisor to prepare the franchisees’ tax returns. The franchisee’s franchise agreement merely permitted the use of such software, whereas the franchisor subsequently amended its manual to mandate use of the software. The franchisee referred the matter to arbitration, claiming that the franchisor’s insistence that she use the franchisor’s software constituted a breach of contract. The arbitral panel acknowledged that the manual plainly conflicted with the franchise agreement with respect to the use of the software; however, a majority of the panel rejected the franchisee’s claim. The majority focused on the parties’ intention at the time they entered into the franchise agreement and concluded the franchisee had agreed to use the franchisor’s system, and that that system plainly included the franchisor’s software; as a consequence, the majority reasoned that the policy change concerning software introduced in the manual effectively amended the franchise agreement. The majority also observed that a “change in the use of software is not fundamental to the operation of the franchise”; the sole dissenting arbitrator disagreed, suggesting that the purported amendment altered “the fundamental relationship” between the parties. On review of the arbitral award, the Yukon court declined to interfere with the majority’s findings or conclusion. 

Taken together, these judicial statements on the issue, while sparse, reflect a clear inclination on the part of Canadian courts to treat Manuals as creating mutually binding contractual obligations; however, they provide little express guidance about the extent to which franchisors can use Manuals to change rights and obligations contained in the franchise agreement or to bargain for rights and obligations that were not originally present in the franchise agreement. 

A methodology by which to assess the enforceability of terms contained in the Manuals, and that would be consistent with those few reported decisions, would be to ask whether those terms (i) can be said to contain the essential elements of a contract; and (ii) are consistent with the franchisor’s duty of good faith.

(iii) Terms in the Manuals Should Contain the Essential Elements of a Contract

Fairview Donuts is authority for the proposition that even very significant system changes can be implemented via revisions to the franchisor’s Manuals; but in that case, the court found that the change had been undertaken following prior consultation with the franchisees and resulted
in overall gains to the franchisees.

Although not expressly stated by the court, the franchisees’ gains in Fairview Donuts can be understood as a form of consideration for the system change, which, along with the fact that the change was the product of consultation, would be consistent with the rationale that the systemic
change had all of the necessary features of an enforceable bargain. [1]

Would the same result have arisen had the franchisor forced the change on its franchisees without consultation? Or if the result was shown to have resulted in significant losses to a majority of the franchisees? Or if the change had actually derogated from rights bargained for by the franchisee in the franchise agreement?

It would not be a large leap to restate those questions as asking whether the essential elements of a bargain underly any given provision
in a Manual: is it the product of an accepted offer? Is it supported by consideration? Is that consideration mutual?

When examined through this contractual framework, a right or obligation created in a Manual may be more likely to survive a franchisee’s challenge if the term could give rise to affirmative answers to those questions and thereby be characterized as more closely resembling an enforceable bargain.

It would be difficult to imagine a court permitting a franchisor to implement terms in a Manual that solely benefited the franchisor when
the franchisor had not bargained for those rights to begin with in the franchise agreement. To use an extreme example, the court could be expected to view with disfavour an effort by the franchisor to rely on the Manuals as authority for doubling the royalty rate that was set out in the franchise agreement. A franchisor’s attempt to solicit post-termination covenants or conditions of transfer that were not originally bargained for in the franchise agreement could similarly be expected to attract judicial scrutiny.

On the other hand, “win-win” terms in the Manuals that stand to improve the franchisees’ position or enhance the strength of the system
overall (even at the cost of a net loss to some franchisee) may find favour with the court because such terms contain the essential elements of a contract.

Also more likely to be viewed favourably by the court are changes terms in the Manuals that can be fairly characterized as being mere iterations of an earlier, more general meeting of the minds reflected in the franchise agreement, as was the case in Church.

(iv) Terms in the Manual Should Be Consistent with the Duty of Good Faith

An additional limit on the franchisor’s freedom to create binding rights and obligations via its Manuals is the duty of good faith it owes to its franchisees. The court in Fairview Donuts noted that “where the franchisor is given a discretion under the franchise agreement, the discretion must be exercised reasonably and with proper motive, and … not … arbitrarily, capriciously, or in a manner inconsistent with the reasonable expectations of the parties.” The court found ample evidence in Fairview Donuts that the franchisor’s systemic change was a rational business decision that had regard not only to the franchisor’s own interest, but the interests of its franchisees. 

Those comments by the court support the proposition that terms and conditions in the Manuals that are additional to, or that modify, the terms in the franchise agreement, will be open to challenge by a franchisee if (i) they depart from what the franchisee could be said  reasonably to have expected when it had entered into the franchise agreement, (ii) are motivated only by the advancement of the franchisor’s interests, (iii) are not supported by a clearly articulated rationale, or (iv) are commercially unreasonable. Evidence of dishonesty on the part of the franchisor with respect to such terms can also be expected to undermine its effort to bind the franchisee to terms in the Manuals.

(v) Key Takeaways

Franchisors in Canada would appear to enjoy considerable latitude in implementing binding rights and obligations through the use of Manuals; however, that freedom is almost certainly not limitless. Terms in the Manual that never existed in the prior franchise agreement, or that purport to revise the franchise agreement stand to be open to challenge by a franchisee if such terms (i) lack the essential elements of a mutually accepted bargain, or (ii) are inconsistent with the franchisor’s duty of good faith. 

[1] A notable and somewhat unusual feature of the provision contained in many of the franchise agreements at issue in Fairview Donuts dealing with changes to the manual provided that “such changes shall not unreasonably alter the [franchisee’s] rights or obligations under” the franchise agreement. 

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