Many equate franchising with the well-known and recognized quick-service restaurants and coffee bars prevalent around the world. But you would be surprised to learn that many of the goods and services providers that one uses on a regular basis are franchised. In fact, the use of franchising as a means of distributing goods and services crosses all industries, in both the ‘business to consumer’ and the ‘business to business’ markets.
What may be more surprising is that a simple licence or distribution arrangement may be a franchise under provincial franchise law resulting in the licensor or distributor being subject to strict pre-sale disclosure obligations and harsh remedies for non-compliance.
The provinces of Ontario, Alberta, Manitoba, New Brunswick, PEI and British Columbia have each enacted franchise-specific legislation which requires, among other things, the provision by a franchisor of pre-sale disclosure to prospective franchisees. The purpose of the legislation is to ensure that a prospective franchisee has the information necessary to make an informed investment decision and to protect both prospective franchisees and those already party to a franchise relationship.
The legislation and, in particular, the disclosure obligation imposed on franchisors, has been broadly interpreted by the Courts in order to “level the playing field” and the perceived imbalance of power in the franchisor-franchisee relationship. The legislation prescribes the information which must be included in a disclosure document and requires that a disclosure document be provided to a prospective franchisee at least 14 days prior to: (i) the signing by the prospective franchisee of the franchise agreement or any other agreement relating to the franchise; and (ii) the payment of any consideration by or on behalf of the prospective franchisee to the franchisor or franchisor’s associate relating to the franchise.
What is a “franchise”?
A “franchise” is broadly defined and can inadvertently capture license and distribution arrangements not intended by the parties to be a franchise and is irrespective of what the parties initially intend and call their business arrangement. The franchise legislation defines it as follows:
“Franchise” means a right to engage in a business where the franchisee is required by contract or otherwise to make a payment or continuing payments, whether direct or indirect, or a commitment to make such payment or payments, to the franchisor, or the franchisor’s associate, in the course of operating the business or as a condition of acquiring the franchise or commencing operations and,
(a) in which,
- the franchisor grants the franchisee the right to sell, offer for sale or distribute goods or services that are substantially associated with the franchisor’s, or the franchisor’s associate’s, trade-mark, service mark, trade name, logo or advertising or other commercial symbol, and
- the franchisor or the franchisor’s associate exercises significant control over, or offers significant assistance in, the franchisee’s method of operation, including building design and furnishings, locations, business organization, marketing techniques or training, or
(b) in which,
- the franchisor, or the franchisor’s associate, grants the franchisee the representational or distribution rights, whether or not a trade-mark, service mark, trade name, logo or advertising or other commercial symbol is involved, to sell, offer for sale or distribute goods or services supplied by the franchisor or a supplier designated by the franchisor, and
- the franchisor, or the franchisor’s associate, or a third person designated by the franchisor, provides location assistance, including securing retail outlets or accounts for the goods or services to be sold, offered for sale or distributed or securing locations or sites for vending machines, display racks or other product sales displays used by the franchisee.
The definition in (a) above reflects the more well-known and common form of franchised businesses, referred to as a ‘business format franchise’ while the definition of a ‘franchise’ under part (b) will apply to those arrangements common to vending machine distribution arrangements.
There are 3 key elements to the business format franchise which, when present together in a business arrangement, constitute that arrangement a franchise under the franchise legislation:
- a payment element, whether direct or indirect, initial or on-going*;
- association with another’s trade-mark or other commercial symbol; and
- the exercise of significant control over, or assistance with, the franchisee’s method of operation of its business.
*Note that all of the provincial franchise legislation, other than that in Ontario, exempts from the payment element ‘payment by the franchisee of a reasonable amount of goods or services at a reasonable wholesale price’. A similar exemption under Ontario’s franchise legislation is awaiting proclamation into force.
Accordingly, so long as there is payment of some consideration and an element of control or assistance, any business arrangement that involves the sale or distribution of goods or services associated with another’s trade-mark or brand may be a “franchise.” There is no guidance in the legislation as to what would be considered to be “significant” control or assistance. However, it would include any obligations imposed on a licensee or distributor in the operation of the licensed business or distribution arrangement which are beyond those pertaining to use and protection of trademarks or required training in the operation of the equipment or other goods that are being distributed.
If the license or distribution arrangement is determined to be a franchise, the arrangement is subject to the franchise legislation and the licensor/franchisor is required to provide pre-sale disclosure in compliance with the legislation.
There are extraordinary remedies available to a franchisee if the disclosure requirements are not complied with. If disclosure is not provided or the disclosure provided is substantially deficient in its compliance with the legislative requirements, a franchisee to rescind (terminate) the franchise agreement for 2 years following the entering into of the franchise agreement, obligating the franchisor to refund all fees paid by the franchisee, purchase from the franchisee all supplies, equipment and inventory at the price paid by the franchisee and compensate the franchisee compensate the franchisee for any losses that the franchisee incurred in acquiring, setting up and operating the franchised business. The legislation also provides franchisees with the right to bring a claim against the franchisor and against others involved in the franchise grant in their personal capacity, for misrepresentation or for failure to comply with the disclosure requirements.
The Courts have interpreted the disclosure requirement strictly, in favour of franchisees, in order to meet the purpose of the legislation. Furthermore, all prospective franchisees are entitled to the same disclosure, irrespective of their sophistication or actual knowledge and there is no ‘contracting out’ of the legislation..
Licensors and distributors in Canada should consult with their professional advisors to determine whether their proposed arrangements fall within the franchise definition or learn how to structure the arrangement so that it doesn’t.