Is your Business an Unintended Franchise?

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What is a franchise? When asked what constitutes a franchise, most people will give examples of traditional franchise businesses such as McDonald's, Canadian Tire and RE/MAX. Many people, however, are not aware that other types of commercial business arrangements such as distribution agreements or license agreements may also be considered to be franchises under Ontario law.

What law governs franchises in Ontario? In addition to laws of general application such as corporations and tax laws, franchises in Ontario are governed by the Arthur Wishart Act (Franchise Disclosure), 2000 (the "Act").

When does the Act apply? The Act sets out a very broad definition of what constitutes a ‘franchise' for the purposes of the Act. In addition to capturing traditional franchise relationships, the definition also potentially captures other types of relationships not considered by the parties to be franchises. Very generally, any business arrangement which involves the sale or distribution of goods or services in association with a ‘brand' is potentially a franchise. The Act also sets out several types of relationships which are expressly excluded from the scope of the Act, including employer-employee relationships, partnerships and exclusive trade-mark licenses.

Can you contract out of the Act? Parties cannot contract out of the Act. No matter what you call your agreement, if the agreement meets the definition of a franchise, the Act will apply. It does not matter that the parties did not realize that the business arrangement was in substance a franchise, or that the parties may have intentionally attempted to circumvent the Act's application (due to the effort and expense required to comply with the Act) by trying to make the business arrangement appear not to be a franchise. Although the case law in Ontario has yet to be fully developed, it has been held that a payment which the parties called a "license fee" was in fact and in substance a franchise fee which invoked the application of the Act. In another case, an agreement which the parties named a "dealer network agreement" was found to be a franchise agreement.

What does the Act require? The Act is essentially consumer protection legislation, with its primary purpose being to provide adequate information to potential franchisees to permit them to make an informed decision about whether to invest in a particular franchise opportunity. Accordingly, the Act places special obligations on franchisors which are not otherwise placed on parties to commercial contracts, the most onerous of which is the obligation to disclose to prospective franchisees all material facts concerning the franchise business. The Act sets out a comprehensive list of what are deemed to be material facts, including financial statements, the background of the franchisor and its principals, an estimate of annual operating costs, contact information of all other franchisees and reasons for closure of recently terminated franchises. These and other facts must be provided to the prospective franchisee in a written disclosure document at least 14 days before the earlier of: (i) the signing of the franchise agreement, and (ii) payment of any amount by the prospective franchisee. The Act also imposes a duty of fair dealing on each party to a franchise agreement and prohibits franchisors from interfering with their franchisees' right to associate with other franchisees or form or join an organization of franchisees.

What are the consequences of not complying with the Act? The Act does not require franchisors to make filings with any regulatory body. As a result, so long as both parties are content with their business relationship, there probably won't be any consequences of failing to comply with the Act. However, in the event that a franchisee becomes disgruntled, franchisors and franchisees alike should be aware of the powerful remedies available to franchisees under the Act.

If a franchisor fails to make timely disclosure to a prospective franchisee, the franchisee will then have 60 days from the date the disclosure document is ultimately provided within which to rescind (cancel) the agreement without penalty or obligation. If the disclosure document is never provided, the franchisee can rescind the agreement up to two years after the agreement was entered into. Upon rescission of the agreement, the franchisor is obligated to refund to the franchisee any money paid for inventory, supplies or equipment, repurchase any remaining inventory, supplies and equipment from the franchisee and compensate the franchisee for any losses incurred by the franchisee in respect of the business. Principals of the franchisor also face personal liability for any losses suffered by the franchisee as a result of non-compliance with the Act. As a franchisor, it is also important to recognize that ignorance of the requirements of the Act, or of the fact that the Act applies to a particular business relationship, will not be a valid defence to a claim by a franchisee.

What should I do? If your business relationship has any of the indicia of a franchise as set out in the Act, you should seek legal advice to determine whether the Act deems you to be a franchisor or franchisee. If you are a franchisor, you should determine whether you have complied with the disclosure obligations in the Act and, if you have not, give consideration to what remedies may be available to your franchisee. If you are a franchisee and are unhappy with your business relationship, seek advice on what remedies may be available to you and for how long.
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