The number cannabis stores has grown quickly since the retail sale of cannabis was legalized in Canada.  For instance, in March 2021, there were 527 cannabis retail stores in Ontario.  A few months later, in August 2021, Ontario saw the opening of its 1000^th store.

Are these cannabis retail stores franchises? 

The answer may be more complicated than you think.

A brief history of cannabis retailing in Ontario

On October 17, 2018, Canada became the second country in the world to legalize and regulate the recreational use of cannabis. The federal government controls cannabis production, while the provinces have been left to regulate distribution.

Cannabis retailers in Ontario had a unique experience.

Initially, under the former provincial Liberal government, retail cannabis distribution in Ontario was going to use a wholesaler and retail framework that was similar to the one used by the Liquor Control Board of Ontario.  Under this proposed structure, the Ontario Retail Cannabis Corporation, operating as the Ontario Cannabis Store, would be the sole wholesaler and distributor of recreational cannabis products in Ontario, and all stores would be operated as provincially-run outlets.

However, these plans changed dramatically following the 2018 provincial election.  The newly elected Conservative provincial government announced that cannabis sales in Ontario would instead be conducted by retail stores operated by private businesses, which would be regulated and overseen by the Alcohol and Gaming Commission of Ontario (the “AGCO”). 

On December 13, 2018, the provincial government announced that it would use a lottery system to distribute the first 25 cannabis retail licenses.  In conducting the first lottery, there was a concern that lottery winners could immediately sell their “winning ticket” to someone else.  As a result, rules were established to ensure that lottery winners couldn’t change their corporate entity or structure, or effect a “change of control” for essentially one year after the lottery was conducted.  This meant that, in the short term, the lottery winner would be the only entity that could apply for the required retail operating licenses.

On January 11, 2019, the AGCO announced the first 25 lottery winners. Successful lottery winners were required to open their stores by April 1, 2019 or face fines of up to $25,000.

The results of the first lottery proved very interesting in that none of the established cannabis brands won the right to apply for a retail license.  Many of these brands had hoped to quickly open multiple locations under their banner, and now could not.  By contrast, the majority of the lottery winners had little to no experience with cannabis, or even operating a retail store.  Many faced multiple challenges to open by the April 1 deadline.

It is not surprising that, post-lottery, the cannabis brands moved to partner with lottery winners in what was hoped would be a mutually beneficial partnership:  the brands would get an opportunity to open stores under their banner and grow their brand in Ontario, and the lottery winners would gain access to persons with cannabis and retail knowledge that many of the lottery winners were lacking.

Many cannabis brands entered into “licensing” or “branding” agreements with individual lottery winners.  In addition to knowledge sharing, many of these deals also included start-up funds, leaseholds and equipment, and marketing assistance.  In return, store owners were often required to pay the brands a portion of their sales revenue.

On August 20, 2019, the AGCO conducted a second lottery and again, established cannabis brands moved quickly to enter into branding or licensing agreements with the 42 new lottery winners.

On December 12, 2019, the AGCO unexpectedly announced a  shift from the lottery system to an open application system that would begin starting January 6, 2020.

Too many pot shops?

While these brand partnerships seemed to make sense in the early days of cannabis retailing, in a relatively short period of time many markets became oversaturated with retail cannabis stores.  The result is that many stores are now struggling financially, and some are locked into long term contracts that no longer make sense.

Some store owners are turning to Ontario’s franchising legislation, the Arthur Wishart Act (Franchise Disclosure), 2000 (the “Wishart Act”),for a solution on the basis that the “brand agreements” are actually franchise agreements. 

Is it a franchise?

Generally speaking, parties are aware of whether or not they’re entering into a franchise relationship.  However, it’s possible that franchise relationships can arise accidentally.  In these cases, it doesn’t matter what the parties call their agreement, or whether they intended to enter into a franchise agreement or another type of agreement.  If a business meets the definition of “franchise” then the Wishart Act will apply.

Under the Wishart Act, a franchise is generally defined as a right to engage in a business in which: (1) the franchisee is required to make a payment or continuing payments to the franchisor; (2) the franchisor granted the franchisee a license to use its trademark in association with the sale of certain goods or services; and (3) the franchisor exercises significant control over, or offers significant assistance in, the franchisee’s method of operation, such as building design and furnishings, location, business organization, marketing strategies or training, or operations.

Determining whether a particular  business arrangement constitutes a franchise is a highly fact specific analysis. Not every cannabis brand who has licensed its logo and name to an individual store owner is a franchisor. What is determinative is the content of the parties’ contractual agreement, and the level of control and assistance actually provided by the cannabis brand to the store owner throughout the duration of the parties’ relationship.

If, on the facts, the relationship between parties meets the definition set out above, then the relationship between the parties is that of franchisor and franchisee, no matter what the contracts are called or what the parties actually intended.

Ontario franchise legislation and rescission

If a business arrangement is determined to be a franchise relationship under the Wishart Act, the parties have certain rights and obligations. Among the rights granted to the franchisee is the right of rescission for lack of disclosure.

Under the Wishart Act, a franchisor (or brand owner) is required to provide a “disclosure document” to a prospective franchisee (or store owner) before any legal agreements are signed or before any payments are made by the prospective franchisee. The disclosure document is like a prospectus; it must contain all important information a franchisee needs to know about the franchise opportunity.  If disclosure is not provided or if the disclosure is defective, a franchisee may have a right to “rescind” the franchise agreement. In plain language, rescission puts an end to all franchise agreements. 

In addition, the franchisor, and possibly others, are required to refund to the franchisee all of the franchisee’s costs and expenses in connection with his or her purchase, setup and operation of the franchise business.  These repayment obligations can be very significant, particularly if the costs of establishing the store were high and the business has sustained significant operating losses.

Under the Wishart Act a rescission claim must be made within two years of the date the store owner entered into any agreement with the brand.   

The AGCO and franchising

Until recently, it was arguably unclear as to whether the AGCO permitted retail store owners to enter into “franchise agreements” with brands.  However and as noted above, this lack of clarity didn’t stop license holders from entering into “license agreements” or other arrangements with brands following the first and second lottery.  As some of those store owners now look to exit these contracts via rescission, questions have been raised as to whether these relationships can even be considered “franchises” if, as some argue, franchises were not permitted by the AGCO.

First, it’s important to remember that it’s the Wishart Act, and not the AGCO, that determines whether something is a franchise in law.  Whether the AGCO permitted franchising of retail cannabis stores is arguably irrelevant to whether the parties are, in fact, caught by the Wishart Act.

What was the AGCO’s early position with respect to franchising?  As mentioned above, in the early days of cannabis retail in Ontario, the AGCO implemented certain restrictions prohibiting licensed cannabis producers and their affiliates from owning or having influence over a  retail cannabis store that would result in “control in fact” of that store.  Did this mean that franchising was prohibited?  While no court has yet ruled on these issues, the answer is arguably no.  There was not, and never has been, a prohibition against the franchising of retail cannabis stores.

Regulating “control in fact” is not the same as regulating franchising.  That is because the “control in fact” element is not present in the franchise relationship.

“Control in fact” is a well-established legal concept that relates to a party’s ability to control the corporate governance and ownership interests of another party.  In other words, the ability to control a company.

That type of control does not exist in the franchise relationship. A franchisor does not exercise control over the corporate governance and ownership interests of their independently owned and operated franchisee. Rather, franchising focuses on a franchisee’s method of operation and adherence to franchise system standards intended to protect the franchisor’s brand.

Put simply: franchisees maintain control of the company that owns and operate the business, and franchisors provide the playbook that franchisees must follow with respect to day-to-day operations.

Notably, following industry-wide consultations, on February 8, 2022, the AGCO updated the Registrar’s Standards for Cannabis Retail Stores to expressly permit retail cannabis store owners to enter into a franchise agreement with a licensed producer or its affiliate.  The new rules will take effect on June 30, 2022.

Conclusion

The rapid proliferation of  retail cannabis stores in Ontario has likely led to numerous “accidental franchises” being created, where cannabis brands entered into de facto franchise relationships with retailers, rendering these brands “franchisors” and the store operators their “franchisees”.  As certain markets become over-saturated with retail cannabis stores, these issues will come to the fore for both brands and store owners as some retailers look to the Wishart Act to exit their contractual arrangements. 

Both brands and store owners are well-advised to contact an experienced franchise lawyer to determine whether their existing relationship may be subject to the Wishart Act, and what possible exposure or remedy they may have under Ontario’s franchise legislation. 

ABOUT THE AUTHORS
Adrienne Boudreau is a partner with Sotos LLP in Toronto, home to Canada’s largest group of franchise lawyers.  She provides counsel to many franchised businesses, for both franchisors and franchisees, and has extensive experience litigating franchise rescission cases.  Adrienne can be reached directly at 416.572.7321 or aboudreau@sotos.ca.

Michelle Logasov is an associate at Sotos LLP. Her practice focuses on general commercial litigation, including franchise litigation, and class actions. Michelle can be reached directly at 416.572.7306 or mlogasov@sotos.ca.