Thinking of franchising your restaurant? Not knowing the law could cost you.
Before discussing what franchise law is all about, and what it means for franchisors and franchisees doing business in Canada, it is important to first understand why we have franchise laws in the first place.
Currently, five Canadian provinces (Ontario, Alberta, Prince Edward Island, New Brunswick and Manitoba) have franchise legislation in place, with a sixth (British Columbia) expected to enact franchise law at some point in the near future. Those five provinces provide for a statutory definition of a “franchise”, which, at its most elemental, can be summarized as follows: (i) granting someone a right to conduct a business under a trademark; (ii) charging some initial and/or ongoing fee for that right to conduct that business under that trademark; and (iii) exercising substantial control over that business owner’s operations.
If you can decisively eliminate any one of those three elements from your business model, you are likely not operating as a franchise. This is the biggest difference between franchising, and other methods of product and service distribution, including pure licensing – under non-franchise models, that element of control and/or assistance does not exist. Rather, the licensor only grants the trademark right and charges a fee for it.
It is often said that the hallmarks of franchising are consistency and uniformity, so that if you walk into your favourite coffee shop anywhere in Canada, for example, you can expect a certain menu of products and services, and the same general customer experience as you would find at any of their outlets. Accordingly, it is no surprise that the legal definition of a franchise would include a control element since, in order to achieve that level of consistency and uniformity, a franchisor must exert a considerable amount of supervision in ensuring that its standards are complied with.
Franchise law exists to ensure that if a franchisor is exercising that much control over a franchisee’s business (and with good reason – it’s for the benefit of the system and the consumer experience, after all), then the franchisee should be treated as fairly as possible.
So what are the best ways to ensure that franchisees are not taken advantage of? Franchise laws provide for a number of important statutory rights for franchisees, including imposing a positive duty on both sides to act in good faith and in accordance with reasonable commercial standards, and a right for franchisees to associate with each other without fear of reprisal from the franchisor.
But the cornerstone of franchise law is the franchise disclosure document (FDD), a prospectus-like compendium of information about the franchisor and the franchise system. The FDD is intended to aid franchisees in making informed investment decisions, so it includes a description of all material facts about the franchise offering, including:
- background information on the franchisor, its affiliated companies and any other brands it offers or operates
- biographies on the franchisor’s officers and directors
- litigation and bankruptcy history of the franchisor and its principals
- estimated costs of establishing the franchise
- estimated costs of operating the franchise on an ongoing basis
- summary of training and support offered by the franchisor
- details of the franchisor’s advertising programs
- list of franchisor’s trademarks and other intellectual property being licensed to the franchisee
- summary of a franchisee’s restrictions with respect to obligations to purchase or sell certain products or services
- summary of the franchisor’s policies regarding exclusive territories
- a list of current and former franchisees
- summary of the termination, renewal and transfer provisions in the franchise agreement
- a copy of the franchisor’s most recent financial statements
- copies of each agreement that the franchisee will be required to sign as a condition to acquiring the franchise
Although not required by law to do so, some franchisors will also take the opportunity to disclose sales histories or earnings projections in an FDD, but due to the very real fear of liability for misrepresentation the decision to do so and presentation of this information ought to be considered extremely carefully.
In addition, franchise legislation requires that a prospective franchisee receive the FDD at least 14 days before that prospective franchisee signs any agreement relating to the franchise or pays any money to the franchisor. This ‘cooling off’ period is intended to give franchisees an opportunity to consider the FDD, and review it with friends, family and business and legal advisors. If a franchisor fails to provide an FDD within this timeline, never gives one at all or gives one that is so deficient that it could never actually be considered a valid disclosure document, that franchisor faces severe penalties if it doesn’t comply with the various disclosure requirements. Specifically, if a franchisor has a franchisee sign something or pay something in advance of the franchisee receiving an FDD or before the 14-day cooling off period has expired, the franchisee may have up to 60 days from the date it made the payment or signed the agreement to rescind its franchise agreement. Going further, if the franchisee never received an FDD at all, or received an FDD that was so deficiently prepared that it was equivalent to a franchisee never receiving an FDD at all, the franchisee may have up to 2 years to rescind its franchise agreement.
The result of a “rescission” remedy is that a franchisee should be put back in the place it was before the franchise agreement was signed, meaning a refund on fees paid to the franchisor, a repurchase of supplies, inventory and equipment and compensation for operating losses. It is a big penalty for non-compliance.
Franchising is a proven effective method of business expansion, and the restaurant industry comprises a significant portion of franchised businesses. It is a model that suits restaurants well, but is not necessarily the desired method of expansion for everyone. Take the time to consider the pros and cons of franchising and consult with business, legal and financial advisors to understand whether it makes sense for you…especially before you sign any agreement with, or collect any payment from, a prospective franchisee.