Q. What do I need to know before signing a General Security Agreement (“GSA”)?

The volume of documents that a franchisee must review and sign when entering into a franchise agreement can be daunting. Typically, the franchise agreement is accompanied by a considerable volume of other contracts that a franchisee will be bound to, such as a personal guarantee, confidentiality agreement, and a general security agreement (GSA). Appropriately, most of a franchisee’s attention will be on the terms of the main body of the franchise agreement, but these ancillary agreements are extremely important to understand, and while it may be tempting to view a GSA as a standard form which must be signed, it is critical to be aware of what it means, why it is there, and what future impact it could have.

What does a GSA do?

If you have ever taken out a loan or line of credit, you have probably seen and signed a GSA. Before granting the loan, the bank may have asked you to put up certain assets as collateral. By pledging those assets as collateral, you gave the bank a security interest in the assets, and if you default under the loan, the bank can exercise its enforcement rights, including the right to repossess the pledged assets.

Similarly, when signing a GSA in the context of a franchise agreement, the franchisee grants the franchisor a security interest in all of the personal property of the business, which might include equipment, inventory, furniture, rights to revenue, accounts, and proceeds. This security interest secures the payment and performance of the franchisee’s obligations under the franchise agreement. If the franchisee defaults under the franchise agreement, the franchisor will have recourse against the franchisee’s assets.

Who signs the GSA?

Franchisors will often ask for a personal guarantee from the owners of a franchisee corporation. By giving this guarantee, the individual personally guarantees the obligations of the franchisee, and in the event of the franchisee’s default, the franchisor may enforce its rights against both the franchisee and the guarantor.

However, only the franchisee corporation should sign the GSA, and the collateral provided as security should be restricted to those assets related to and/or located at the franchised business. Although the guarantor will be personally liable under the guarantee, no security interest is created in the assets owned by that individual. There is an important distinction between the personal responsibility for a franchisee corporation’s obligations and the type of collateral offered by that corporation as security for those obligations.

Why is the franchisor asking for a GSA?

The GSA is evidence of the franchisor’s security interest. In order to become a “secured party” and give notice to third parties of this interest, the franchisor must register a lien under the applicable provincial legislation. Once this lien is registered, the franchisor gains certain statutory enforcement rights and protections in the event the franchisee defaults under the franchise agreement, and priority over persons who subsequently take a security interest in the franchisee’s assets.

The franchisee should receive a fully signed copy of the franchise agreement and all ancillary agreements, including the GSA. In addition, you should request a copy of the registered financing statement for your records. As a debtor under a GSA, you are required by law to receive notice of that registration.

What effect will this have on my day-to-day operations of the franchised business?

If the franchisee seeks any type of financing, the lender will search the local personal property register to determine if there are any liens on the franchisee’s property. Typically, banks insist on having a “first priority” lien over the franchisee’s assets. If the franchisor has already registered its lien, then your bank may refuse to provide financing unless the franchisor subordinates its interest to the bank. A franchisor will usually subordinate (that is, rank second) to the bank under these circumstances, but to avoid the issue altogether, a franchisee should request that this be expressly set out in the GSA. The day-to-day operations will be otherwise unaffected by the GSA for so long as the franchise agreement is in good standing.

What happens on termination or expiration of my franchise agreement?

There are two separate elements of the franchisor’s secured interest: (1) the GSA and (2) the registered lien. Termination of the franchise agreement will often capture the GSA, and no further steps are required to terminate this agreement.

However, the termination of the GSA does not discharge (i.e. cancel) the lien registration, which remains on the personal property register of your province. On termination or expiration, the franchisee should request evidence that this registration has been discharged. Otherwise, future lenders may have trouble offering you financing when they see how many secured creditors their interest ranks behind.

Cassandra Da Re
Associate, Corporate and Commercial Law
Dale & Lessmann LLP