By Adam Ship – Partner and Lead, Franchise & Distribution, McCarthy Tétrault LLP

1. Long Awaited Amendments to Ontario’s Franchise Legislation Now In Force

On September 1, 2020, the long-awaited amendments to the Arthur Wishart Act (Franchise Disclosure), 2000, SO 2000 c 3, and its accompanying General Regulation finally came into force (O Reg 581/00). These changes somewhat modernize the legislation.

Deposits

A franchisor may now receive deposits from prospective franchisees prior to delivering a Franchise Disclosure Document. The deposit must meet the following requirements in order to be taken at this early stage:

1. The amount of the deposit must not exceed 20% of the franchise fee that is normally charged to new franchisees, up to a maximum of $100,000.
   
2. The deposit must be fully refundable, without any deductions, if the prospective franchisee does not end up signing the franchise agreement.
   
3. The deposit must be free from any obligation, that is, it must be given pursuant to an agreement that does not bind the prospective franchisee to sign the franchise agreement.

Franchisors who elect to take deposits in this fashion will be able to screen out certain candidates before going to the trouble of delivering a Franchise Disclosure Document. 

The deposit may also be taken after a Franchise Disclosure Document is delivered, but prior to the signing of the franchise agreement and prior to the delivery of any Statement of Material Change.

Confidentiality Agreements

Prior to these amendments, there was some risk in requiring prospective franchisees to sign confidentiality or non-disclosure agreements prior to delivering a Franchise Disclosure Document. This was because such agreements could have been subject to rescission under the legislation for the failure to provide a Franchise Disclosure Document. This was despite the fact that the Franchise Disclosure Document inevitably contains sensitive and in many cases confidential information. 

Now that the amendments are in force, a franchisor can safely enter into confidentiality and non-disclosure agreements as long as they meet the following requirements:

1. The agreements are confined to simply requiring the prospective franchisee to keep information or material that is disclosed confidential and/or prohibit the prospective franchisee from using that information or material for any other purpose;
   
2. The agreements do not prohibit disclosure or use of information that comes into the public domain other than as a result of the prospective franchisee breaching the agreement;
   
3. The agreements do not prohibit disclosure or use of information that may be disclosed other than as a result of the prospective franchisee breaching the agreement; 
   
4. The agreements permit disclosure or use if there is consent by the franchisor; and
   
5. The agreements do not “prohibit the disclosure of information to an organization of franchisees, other franchisees of the same franchise system or a franchisee’s professional advisors”.

This is a welcome change that protects the proprietary and confidentiality interests of the franchisor while at the same time facilitating the disclosure process that lies at the heart of the legislation. 

Site-Selection Agreements

A franchisor may now enter into an agreement with a prospective franchisee prior to delivering a Franchise Disclosure Document where such agreement “only … designate[s] a location, site or territory for [the] prospective franchisee”.

Certificate for Statements of Material Change

The amendments now require that Statements of Material Change (which are delivered after a Franchise Disclosure Document, but before the franchise agreement is signed, to disclose “material changes”) must contain a Certificate of the Franchisor. This requirement, which has been in place in a number of the other provinces with franchise legislation, substantially mirrors the requirement for a certificate in the Disclosure Document. The certificate must certify that the Statement of Material Change contains no untrue information, representations, or statements, whether of a material change or otherwise, and includes every material change. The persons who are required to sign the certificate are set out in the Regulation.

Amendments to Disclosure Exemptions

The legislation contains a number of exemptions from the requirement of the franchisor to deliver a Franchise Disclosure Document.  The amendments make some refinements and changes to four of those exemptions:

1. The exemption available to franchises granted to officers and directors of the franchisor has been refined. The exemption is now available where the franchise is granted to a corporation that is controlled by the officer and director, which broadens its scope and makes it more practical. The amended exemption also makes clear that the applicable officer and director must have held that position for at least six months and must either: (a) continue to hold the position at the time of the grant of the franchise; or (b) had previously held that position no more than four months prior to the grant of the franchise.
   
2. The exemption available for fractional franchises (that is, franchises granted to franchisees with other lines of business that represent at least 80% of their sales) has been refined. The amendment now requires that the analysis as to whether the prospective franchisee’s sales from the franchise will exceed 20% of its total sales must focus only on the franchisee’s first year of anticipated sales. This means that this exemption is only available where the prospective franchisee’s total anticipated sales for the first year of the franchise must not exceed 20% of the franchisee’s total anticipated annual sales.
   
3. The exemption available for small franchise investments has been amended, to increase the maximum initial investment from $5000 to $15,000. The exemption also clarifies that the analysis of initial investment will focus on the investment categories that are required to be disclosed in the Franchise Disclosure Document, that is, franchise fees, the costs to establish the franchise, and the payments required by the franchise agreement.
   
4. The exemption available for large franchise investments has been amended to decrease the minimum initial investment to $3 million from $5 million. The exemption also clarifies that the analysis of initial investment will focus on the investment categories that are required to be disclosed in the Franchise Disclosure Document, that is, franchise fees, the costs to establish the franchise, and the payments required by the franchise agreement.

Use of Foreign Financial Statements

The amendments have broadened the types of financial statements that may be used in an Ontario Franchise Disclosure Document.  Prior to the amendments, financial statements had to meet Canadian public accounting standards for audited or review engagement financial statements. This has now been broadened to permit the use of audited or review engagement financial statements that meet the requirements of:

1. the Financial Accounting Standards Board of the United States, or
2. the International Accounting Standards Board;

Since this amendment only applies in Ontario, this will be of limited benefit to foreign franchisors attempting to expand into provinces other than Ontario.

• Alberta Franchise Dispute Emphasizes the Danger of Lax Documentation

1384334 Alberta Ltd v Buster’s Pizza Donair & Pasta Enterprises Ltd, 2020 ABQB 369 provides an important reminder of the critical importance of signed written agreements to structure a franchise relationship and the dangers of permitting a franchise location to be constructed in the absence of written agreements. 

This was a dispute primarily over one franchised location being constructed in West Edmonton. A suitable location was found and a lease was signed by the franchisor. After construction was completed by the franchisee, the franchisee operated the franchise for approximately 13 months, after which it gave notice that it was vacating.

The franchisor changed the locks and ultimately sold the location to a third party at a profit, after returning the franchisee’s owned equipment. However, the franchisor retained and ultimately sold the franchisee’s leased equipment that it had purchased under an equipment lease.

No contracts were ever signed to memorialise the parties’ agreement. The franchisor insisted that the franchisee sign (1) a sublease, (2) an agreement containing typical franchise terms, and (3) personal guarantees. However, the franchisee refused to sign anything except the sublease, which the franchisor refused to countersign in the absence of the other agreements.

Nonetheless the location was constructed by the franchisee and operated for approximately 13 months without any agreements in place. The franchisee paid rent directly to the landlord, even though the franchisor was the only party to the lease. The franchisee refused to pay any other fees to the franchisor.

The franchisee later sued the franchisor for compensation for its net losses under the rescission remedy found in Alberta’s Franchises Act, RSA 2000, c F-23. It also sued for compensation under the common law.

Under the Franchises Act, the Court found that there was no “franchise agreement” for which rescission was available. The Court found that there was no consensus as to the essential terms of the franchise. As a result, the putative franchisee had no recourse to the Franchises Act for any remedy. Instead, the Court found that the putative franchisee was merely operating on a “month-to-month tenancy” governing its occupation of the location.

The putative franchisee also sought damages under the common law for unjust enrichment. The Court dismissed this claim as well.

In the course of its reasoning, the Court found that the franchisor was enriched by the actions of the franchisee. This enrichment came in the form of the profit that the franchisor made when it sold the location to a third party after the franchisee vacated. The franchise had paid for the lease deposit, the rent, and many of the construction costs.

However, the Court found that this enrichment was within the reasonable expectation of the parties. The Court noted that the franchisee refused to sign the franchise agreements. The parties never reasonably expected that the franchisor would pay the franchisee for its expenses in establishing and operating the franchise without those agreements having been signed.

However, the Court did find that the franchisor had unlawfully seized the equipment that the franchisee had leased from a third party.

The franchisor attempted to justify the seizure on the basis that it had purchased that equipment directly from the equipment lessor after the franchisee allegedly breached the equipment lease.

The Court rejected this argument, finding that the franchisee had not breached the equipment lease and was therefore entitled to the fair market value of that leased equipment. The Court awarded the franchisee damages equal to the value of the leased equipment, minus any amounts owing under the equipment lease.

This hotly contested litigation could well have been avoided had proper agreements been signed before construction commenced. 

• BC Labour Relations Case Makes “Common Employer” Finding in the Franchise Context

Sobeys Capital Incorporated v United Food And Commercial Workers International Union, Local 1518, 2020 BCLRB 97 is a matter for which the CFA has recently brought an application for reconsideration and a request for intervenor status. As a result of the continuing nature of the matter, the following is simply a brief and descriptive summary of the case for informational purposes.

In this matter, a union representing workers in various industries in BC asked the BC Labour Relations Board to declare a franchisor to be a “common employer” with a number of its franchisees.

The matter involved five locations which the franchisor previously operated corporately, but which it sold to franchisees in 2019 to operate the stores under a different brand. The franchisor paid all the costs associated with the conversion of the stores to the new brand. The franchisor had previously been the employer of the former employees who worked at those stores and had entered into a prior collective agreement with the union. Following the conversion, the franchisor advised the union that all labour relations issues were to be directed to the franchisees who took over the locations.

The franchisor owned one preferred share in each of the franchisee corporations, which required the franchisor to consent to certain actions taken by the franchisees relating to the governance of the franchisee corporations.  The franchisor’s position before the Board was that this shareholding structure was merely for tax purposes to facilitate payment of fees to the franchisor through corporate dividends.

The franchisor and franchisee also entered into operating agreements (in addition to the franchise agreement) under which the remuneration of employees of the franchisees was to accord with the franchisor’s policies.

The Board’s decision turned on the BC Labour Relations Code, which permits the Board to treat more than one entity as one employer where the business is carried on by or through more than one entity or a combination of them under common control or direction. 

In finding that the franchisor and the franchisees were a common employer for purposes of the union’s application, the Board emphasized the “substantial control” exercised by the franchisor. While the Board acknowledged that the franchisees had ultimate control over labour relations for their own employees, it nonetheless emphasized the following factors in finding substantial control sufficient to justify its common employer decision:

1. The franchisor’s ownership of one preferred share in the franchisee corporations;
   
2. The franchisor’s control over the levers of profit and loss for the franchisees, particularly in relation to:  the shareholders agreement, which gave the franchisor the right approve decisions concerning the franchisees’ finances; the operating agreement, which gave the franchisor certain control over the wages paid to franchisees’ employees; the franchisor’s control over food supply and pricing; and the requirement that franchisees use the franchisor’s payroll services and other software;
   
3. The franchisor’s “common management” of the franchisees, through its mandatory policies that covered many aspects of the franchisee’s operations, including what the Board found to be “extensive” policies addressing food safety and handing, store layout and merchandising, and COVID-19 related procedures; and
   
4. The interdependence of the stores’ operations, with the franchisees benefiting from competitive pricing for products, the assumption by the franchisor of all the costs and management of the stores’ construction and brand conversion, and the franchisor’s control through the shareholders agreement.

The Board was also required to consider whether the union properly demonstrated a “labour relations purpose” for making a common employer declaration.  In finding that the union had met this requirement, the Board emphasized the following: 

1. The finding would “prevent the erosion of bargaining rights”, since the franchisor had “fragmented the bargaining unit into stand-alone stores” through its franchising of the five locations; and
   
2. The franchisor retained “substantial control” over the franchisees and “actual ownership … through the preferred share.”