Quebec is one of the only Canadian legal jurisdictions without a specific franchise legislation. The core legal body lies with the Civil Code of Quebec and Court precedents. In this context, a potential franchisee may wonder what is the extent of their legal duties, in particular, at the precontractual stage (meaning before formally entering into the franchise business venture): What are the franchisor’s legal disclosure obligations? To what extent do the franchisee’s “due diligence” duties go? What use can they make of the trade and brand names? What are the main pitfalls? We intend to cover these topics in the following article, while also providing practical tips.
Franchisor’s Disclosure Obligations and Potential Franchisee’s Duty to Seek Their Own Information
Under Quebec law, and contrary to other Canadian jurisdictions, the franchisor is not subject to specific and regulated “franchise disclosure obligations.” Rather, the franchisor is bound to disclose to the potential franchisee everything that is necessary for the future franchisee to provide an “informed consent”[1]. This implies the communication of all key information such as, for example, the draft franchise agreement, the franchise history, key information on the network, some general financial information, pending Court litigation (if they are likely to have an effect on the franchise network) and other corporate information. However, the notion of “informed consent” is even broader. If the potential franchisee requires, they may also imply a duty of the franchisor to communicate internal memos pertaining to the potential franchisee’s personal situation, projected business location, and even psychological tests[2].
The potential franchisee, however, is also subject to their own duty of due diligence. They should not only consider information provided by the franchisor, but should also carry out their own research through a due diligence process. The franchisee should, inter alia, request pro forma information (accounting projections and simulations) from the franchisor, and proceed to obtain their own information concerning the franchisor’s reputation, and even solvency. Where possible, the potential franchisee should seek to obtain information and learn about other established franchisees of the network they intend to join. If the potential franchisee is purchasing an existing and operating franchise, their due diligence duties are even more extensive: they should ask for financial statements, expenses (rent, real estate taxes, food costs, insurance, labour costs, inventory, etc.), profit margins, and more.
Brand and Trade Names
Every new franchisee needs to understand that, under the terms of the franchise agreement, the brand and trade names which are so reputed (and which, in many cases, are the first and paramount reasons why the potential franchisee joins the network) are “rented” and not “sold.” In other words, the franchisee has no ownership rights over the franchise brand and trade names and can only use them within a very restrictive set of rules. For instance, franchisees cannot use at will the franchise symbols, brand, and trade names in association, such as to their activities on social media without prior approval from the franchisor. Failing to comply can lead to serious damages and substantial Court awards.
Practical Tips
To ensure compliance with the legal obligations, a potential franchisee should be accompanied by a franchise specialist (whether a legal professional or an accounting professional). Very often, at the outset of a business venture, a franchisee seeks to spare and save as much money as possible. Not retaining the services of a franchise specialist (mainly for economic concerns) is, by far, the most typical and costly pitfall awaiting any potential franchisee. For instance, many unsuccessful franchisees realize, after a few months into the franchise operation, that they were not “sold” the concept they were expecting. For example, the franchisor may not truly have a sophisticated network, the technical and operational support may be defective, etc. Most franchisees do not know that after a certain time limit, if they have not made their claims known or decided to ask for annulment of the franchise agreement, the Courts will not allow such annulment because they will consider that, by their actions, the franchisee has “confirmed” the agreement. Being advised by an expert at the very early stages of their business endeavour will allow the future franchisee to access relevant information, truly understand the extent of their legal and business obligations, and sometimes realize that the projected franchise business contemplated is not necessarily suited to their needs.
Frédéric Gilbert
Partner
Fasken Martineau DuMoulin LLP
fgilbert@fasken.com
[1] 9150-0595 Québec inc. v. Franchises Cora inc., 2013 QCCA 531.
[2] Ibid.