By Jennifer Zhang, CFE, Barrister and Solicitor, Jones Law Professional Corporation

UPDATE: On March 7, 2024, the federal government published amended guidance. Whereas the previous guidance reiterated the wording of the Section 9 test and stated that the Act applies to entities producing, selling, distributing, or importing goods, the updated guidance now specifies that reporting requirements apply to entities ‘producing’ or ‘importing’ goods. Despite the changes in the guidance, the wording in Section 9 of the Act remains unchanged. Without a clear statement of intent regarding this revision, we believe that a conservative approach for entities involved in producing or importing goods is to file the report this year.

The new Fighting Against Forced Labour and Child Labour in Supply Chains Act (“Act“), received royal assent on May 11th, 2023, and came into force on January 1st, 2024. Under the Act, reporting entities, Canadian and international businesses alike, must file their first annual report on forced and child labour in supply chains by May 31st, 2024.

To assist businesses in navigating these requirements, Public Safety Canada released its anticipated guidance (“Guidance“) on December 20, 2023, shedding light on various aspects of the Act. This article focuses on the application of the Act in a franchise context.

The Act is intentionally broad in its interpretation. Sections 9 and 10 outline the reporting obligations’ application, which involves a three-step assessment:

1. Determine if your organization is an entity under the Act.
2. Examine the business activities engaged
3. Examine the size of your business, and determine whether your organization is a reporting entity

The thresholds are further explained below.

Entities

The term “entities” encompasses more than just “legal entities” and includes corporations, trusts, partnerships, or other unincorporated organizations. Entities can be headquartered and operating in any country or jurisdiction.

In the franchise context, entities can be categorized in three buckets:

1. Canadian Franchisors, Canadian master franchisees, or a large Canadian company that operates multiple outlets
2. Foreign parent companies, i.e. non-Canadian franchisors that have subsidiaries in Canada, or non-Canadian companies/investors that own franchise businesses incorporated in Canada.
3. Non-resident Importers, i.e. typically non-Canadian franchisors/suppliers that have no subsidiaries in Canada but selling or distributing goods into Canada to its Canadian franchisees

It is worth noting that the Act extends its reach to international businesses by capturing foreign entities that have a presence in Canada or do business in Canada. So even foreign companies doing franchise can be reporting entities under the Act if they meet the test.

Business Activities

Section 9 of the Act provides that reporting obligations will apply to any private-sector entity that is:

• Producing, selling or distributing goods in Canada or elsewhere,
• Importing into Canada goods produced outside Canada, or
• Controlling an entity engaged in either of the above activities.

The Canadian approach looks at the business organization’s Canadian nexus rather than residency.

The Guidance provides that the terms selling, distributing and importing are “not intended to capture services that solely support the production, sale, distribution or importation of goods. These include, for example, marketing, administrative services, financial services and software services.” If a franchise business format is not engaged in any supply chain activities, and the franchisor only provides services and supports to its franchisees in Canada, it would not be considered as meeting the activity-related threshold.

An example would be a franchise in education category where franchisor has developed unique methods and licensed the package including the intellectual properties and know-hows to franchisees in Canada without selling any equipment or printing materials to franchisees. In this case, there is no selling, distributing, or importing goods.

A reverse example would be a beverage concept that supplies ingredients, equipment, packaging materials to franchisees in Canada. This conduct would certainly fall into the scope of “selling, distributing, or importing of goods”.

Some franchise systems engage in practices like ‘private label shipping’ or ‘drop shipping.’ These practices may fall under the umbrella of ‘selling, distributing, and importing,’ as long as the ultimate customers are located in Canada.

Importantly, there is no de minimis rule regarding the value of goods dealt with by an entity. The Guidance indicates that there is no prescribed minimum in the Act for the value of goods that an entity must produce, sell, distribute or import for the Act to apply. However, the terms as used in the Act may be understood to exclude “very minor dealings.” No further guidance is provided about this very minor dealings exception.

The analysis is very case-specific. All franchise systems have business presence in Canada or doing business in Canada should do a thorough evaluation.

Interpretation of “Control”

The Guidance emphasizes a broad interpretation of “control,” including both direct and indirect control. This is consistent with many other legislations, such as amendments to the Canada Business Corporations Act which requires corporations to file a “Individuals of Significant Control” register. Control should be considered in substance over form and may include situations in which an entity exercises joint control of an operation. Whether an entity controls another entity may be determined based on, but not limited to the accounting standards.

The Guidance also points out that:

“In the case of franchises, whether a franchisor needs to report depends on whether it controls, within the corporate sense, any entities engaged in the activities described in subsections 9(a) or 9(b). Whether a franchisee needs to report depends on what activities the franchisee is engaged in (i.e., the activities covered by section 9).

This is the only one place throughout the Guidance where franchise scenario is specifically mentioned. Franchisors and franchisees are both likely to be captured.

Based on the interpretation, in addition to the franchisors and franchisees scenario, a private equity that has controlling interests in a franchise system engaged in section 9 activities could possibly be a reporting entity.

It’s very common for franchisors to create a separate affiliate company to function as the system-wide supplier. Regardless of the corporate structure within a franchise system, the supplier company would almost certainly meet the test if it supplies goods into Canada.

All the above discussion pertains to the concept of ‘control’ from a corporate governance standpoint. However, what about a franchisor’s control over franchisees through contractual agreements, specifically when the franchisor requires that franchisees must import goods exclusively from an ‘approved supplier’ or a ‘designated supplier’? Does such contractual influence categorize the franchisor as controlling entities engaged in import activities? Unfortunately, the Guidance does not provide a clear answer to this scenario, and additional clarifications may be sought from Public Safety Canada.

Interpretation of Size-related Threshold

Additionally, the entity must meet the size-related threshold. The entity either

• Is listed on a stock exchange in Canada, or
• Has a place of business in Canada, does business in Canada or has assets in Canada and, based on its consolidated financial statements, has met at least two of the following three conditions in at least one of its last two financial years:
  • Had at least C$20-million in assets
  • Generated at least C$40-million in revenue
  • Employed an average of at least 250 employees, or
• Is prescribed by regulations (although no such regulations have yet been promulgated)

The first bullet point is quite straightforward. On the second bullet point, the guidance further interpreted:

“The size-related thresholds (assets, revenue and employees) should be calculated based on consolidated financial statements, with asset and revenue values converted into Canadian dollars if those statements use a different currency. …

This means that assets are not restricted to assets located in Canada, revenue is not restricted to revenue from business activities in Canada and the number of employees includes those residing or employed in Canada or in any other jurisdiction.”

This interpretation significantly broadens the scope of application.

Regarding revenue, international franchisors intuitively tend to look at their revenue from Canada, and comes to the conclusion that the $40 million revenue threshold is not met. In fact, for many international franchisors who have been well-established in other countries (such as the USA) and later expanded to Canada, the Canadian Dollar $40 million (equivalent to about USD 30.6 million) total revenue in its consolidated financial statements is not a high bar.

On the note of assets, depending on the industry, franchise business are typically not heavy-assets companies. However, franchisors should take note that, not only money, land, vehicles, equipment, inventory are assets, intangible assets, including intellectual property and good will attached to which are considered as assets as well. Typically, franchisors have trademarks registered in Canada. Also, assets are to be calculated on a gross basis, not a net basis.

The number of employees is also counted globally, not restricted to Canadian employees.

Once two out of three conditions (revenue, assets, employees) are satisfied in at least one of its last two financial years, the entity must file a report.

In summary, businesses can conduct an initial self-assessment using the following checklist to determine their potential reporting obligation:

• Do you have any presence in Canada or do business there, even if you’re not a Canadian company?
• Do you produce, sell, distribute, or import goods in Canada or elsewhere? Exclude: Services like marketing, administrative, financial, or software services.
• Do you control another entity engaged in covered activities (distributing, selling, importing, etc.)? □ If yes, both entities likely need to report.

If yes, continue:

• Is your business listed on a Canadian stock exchange?
• OR: Does your business meet two of three thresholds: at least C$20 million in assets (tangible and intangible), C$40 million in gross revenue (based on consolidated financial statements), or 250 employees (global) in at least one of the last two years?

This checklist serves as a starting point for businesses to evaluate their obligations under the Act and ensure compliance with the new Supply Chain Law. Our lawyers, Paul Jones and Jennifer Zhang are on the CBA International Trade and Sanctions Section. If you have further questions, feel free to contact us.