The amendments (the “Amendments”) were part of a suite of amendments recommended by Ontario’s Business Law Advisory Council (the predecessor to the Business Law Modernization and Burden Reduction Council), of which Sotos LLP’s Peter Viitre was chair of the Franchise Law Working Group. The Amendments were introduced in 2017 pursuant to Ontario’s Cutting Unnecessary Red Tape Act, but have been awaiting proclamation ever since. The Amendments make select common-sense changes to the Act and the Regulation to enable franchisors to more efficiently grow and operate their businesses, while also adding clarity and precision to certain language in the Act and Regulation. Each of these Amendments is explored in detail below.

Payment of Deposits

A franchisor in the Province of Ontario is not currently permitted to accept the payment of any consideration by a prospective franchisee prior to the expiry of the 14-day disclosure “cool down” period following delivery of a disclosure document. This broad prohibition prevents franchisors from collecting a monetary deposit from a prospective franchisee at any point prior to the expiry of the cool down period.

The Amendments update Section 5(1)(b) of the Act to clarify that a franchisor will be permitted to request and accept a monetary deposit from a franchisee (including by way of a deposit agreement) prior to, or during, the 14-day cool down period without contravening the Act. Franchisors should be sure to heed the requirements introduced by the Amendments, which state that a monetary deposit may only be accepted if: (i) such deposit does not exceed twenty percent of the franchise fee (up to a maximum deposit of $100,000), (ii) the deposit is fully refundable to the prospective franchisee at any point without deduction, and (iii) payment of the deposit by the franchisee does not force or otherwise bind the franchisee to enter into a franchise agreement with the franchisor.

The granting to franchisors the ability to accept monetary deposits brings the Act in line with the provisions of several other provincial franchise acts, which permit franchisors to accept deposits prior to the expiry of the appliable cool down period.

Confidentiality Agreements and Location Reservation Agreements

Currently, a franchisor may not allow a prospective franchisee to sign a franchise agreement or “any other agreement relating to the franchise” prior to the expiry of the 14-day cool down period. The broad wording of the prohibition prevents franchisors from taking steps to protect the sensitive information contained in their disclosure document, including by prohibiting franchisors from requiring the prospective franchisee to enter into a confidentiality agreement with respect to the disclosure document and its contents.

The Amendments add Section 5(1.1) to the Act, which provides that, while the broad prohibition on a prospective franchisee entering into a franchise agreement prior to the expiry of the disclosure period still remains, franchisors will now be permitted to bind a franchisee to a confidentiality agreement or a location reservation agreement prior to this point. In particular, a franchisor can require a prospective franchisee to enter into a franchise-related agreement prior to the expiry of the disclosure period so long as the agreement only: (i) requires any information or material that may be provided to a prospective franchisee to be kept confidential, (ii) prohibits the use of any information or material that may be provided to a prospective franchisee, or (iii) designates a location, site or territory for a prospective franchisee.

Franchisors should note that they will not be able to rely on this exemption if the confidentiality agreement in question requires the franchisee to keep confidential information that is not, or ceases to be, confidential information pursuant to the specifications of the Act.

Prescribed Contents of a Statement of Material Change

Neither the Act nor the Regulation currently prescribes the specific content or requirements to be included in a Statement of Material Change (“SMC”). The Amendments, through their addition of Section 5(5.1) of the Act, now clarify that an SMC must include certain prescribed content, including a certificate of disclosure certifying that the SMC: (i) contains no untrue information, representations, or statements, whether of a material change or otherwise, and (ii) includes every material change. Moreover, the Amendments require that each such certificate of disclosure be signed and dated by the franchisor (if not incorporated) or by one or more officers and/or directors (if incorporated), as applicable.

Although seasoned franchisors and their legal counsel have already been including items similar to the newly-prescribed content in SMCs as a matter of best practice, the updates to the Act and Regulation add a welcome degree of certainty to the process of providing an SMC to a prospective franchisee.

Clarification of Certain Disclosure Exemptions

The Amendments update several existing instances where a franchisor is not required to provide a disclosure document to a prospective franchisee, or otherwise meet the disclosure obligations of Section 5 of the Act. In particular, the Amendments update the following disclosure exemptions:

Franchisor Officer/Director Disclosure Exemption

Pursuant to Section 5(7)(b) of the Act, a franchisor is not currently required to provide a disclosure document to a prospective franchisee where the prospective franchisee has been an officer or director of the franchisor (or of a franchisor’s associate) for at least six months. Franchisors and their legal counsel, however, have long criticized the imprecise wording of this exemption, arguing that it is not fully evident when this exemption may actually apply. For instance, it is ambiguous whether the individual applying for the franchise in question must personally be the franchisee under the franchise agreement, or if the actual franchisee could be a corporation controlled by the former officer/director. Ambiguity such as this left many franchisors unwilling to risk relying on this exemption for fear of a future claim against them.

To clarify the applicability of this exemption, the Amendments update the Act to specify that the disclosure exemption will apply when the prospective franchisee is either the officer/director personally, or a corporation controlled by that officer/director, so long as the individual in question either: (i) has been an officer or director of the franchisor or of the franchisor’s associate for at least six months and is currently an officer or director, or (ii) was an officer or director of the franchisor or the franchisor’s associate for at least six months and not more than four months have passed since the individual ceased being an officer or director.

With the added clarity provided by the Amendments, we expect to see franchisors increasingly willing to rely on this disclosure exemption, when applicable.

Disclosure Exemption for Franchise Investments under $15,000

The Act currently specifies that a prospective franchisee need not be given a disclosure document if that prospective franchisee is required to make a total annual investment of $5,000 or less to acquire and operate the franchise.

The Amendments update the Act and the Regulation to specify that this disclosure exemption will instead be available when the “total initial investment” (as opposed to the “total annual investment”) of the prospective franchisee does not exceed $15,000 (as opposed to the current $5,000 limit). The “total initial investment” must be calculated prior to the grant of the franchise to the prospective franchisee, and must include: (i) any deposits or franchise fees, (ii) an estimate of the costs for inventory, leasehold improvements, equipment, leases, rentals, and other property necessary to establish the franchise, and (iii) any other costs or estimates of costs associated with the establishment of the franchise.

The Amendments add considerable clarity to this exemption, and significantly increase the dollar amount threshold under which this disclosure exemption applies. We expect to see this exemption used more frequently following the Amendments taking effect, as it will permit the granting of small franchises that may not have been previously viable due to the costs of complying with the requirements of the Act and the Regulation.

Disclosure Exemption for Investments over $3,000,000

The Act and the Regulation currently provide that a franchisor is exempt from providing a disclosure document to a prospective franchisee when said franchisee is investing over $5,000,000 as part of their purchase of the subject franchise.

The Amendments amend the Act and the Regulation to specify that this disclosure exemption will instead be available when the “total initial investment” of the prospective franchisee is in excess of $3,000,000 (as opposed to the current investment floor of $5,000,000). Similar to the previous exemption above, the “total initial investment” amount must be calculated prior to the granting of the franchise and consist of the costs or estimates of the costs associated with the establishment of the franchise.

Updates to the Regulation

Contents of Financial Statements in Disclosure Document

The Amendments provide further clarity regarding the applicable accounting standards upon which franchisor financial statements (for inclusion in its franchise disclosure document) must be prepared.

Currently, franchisors are required to prepare financial statements on an audited or review engagement basis in accordance with generally accepted auditing standards or review engagement standards that are “at least equivalent to those set out in the Canadian Institute of Chartered Accountants Handbook”, as applicable. Financial statements not prepared on this basis are required to be accompanied by a report from a licenced Canadian accounting firm reconciling the non-compliant financial statements with applicable Canadian accounting standards.

The Amendments provide that a franchisor’s financial statements, when prepared on an audited basis, will be permitted to be “prepared in accordance with generally accepted auditing standards as set out: (i) in the CPA Canada Handbook – Assurance, (ii) by the Auditing Standards Board of the American Institute of Certified Public Accountants or the Public Company Accounting Oversight Board of the United States, as applicable, or (iii) by the International Auditing and Assurance Standards Board.”

Likewise, when the financial statements in question are prepared on a review engagement basis, they will be permitted to be “prepared in accordance with generally accepted accounting principles that meet the review and reporting standards applicable to review engagements as set out: (i) in the CPA Canada Handbook – Accounting, (ii) by the Financial Accounting Standards Board of the United States, or (iii) by the International Accounting Standards Board.”

This change will permit American and other foreign franchisors expanding to Ontario to include their existing non-Canadian financial statements in their disclosure document absent a report reconciling the differences in accounting practices, so long as the financial statements in question meet the requirements outlined above.

Removal of Reference to “Service Marks”

Finally, Sections 6(9) and 6(14) of the Regulation currently contain references to the term “service mark”, as franchisors are required to disclose in their disclosure document certain information regarding their use of service marks as part of their operations. The Amendments strike references to “service marks” in the Regulation, as this concept arises from American trademark law and has no applicability under Canadian law.

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Not surprisingly, the coming into force of the aforementioned Amendments have the ability to substantially reduce the regulatory burden on franchisors and franchisees alike, while also providing additional clarity regarding the specific requirements of the Act and Regulation. The newfound ability of franchisors to collect deposits or bind prospective franchisees to confidentiality agreements provides franchisors with substantial flexibility and confidence to continue to efficiently and securely grow their franchise systems. Likewise, the addition of certain common-sense clarifications to existing disclosure exemptions will allow franchisors in Ontario to more easily rely on these exemptions and allow them to effectively grow their systems, while providing welcome certainty to franchisors and franchisees alike.

A copy of the Act, including the Amendments that will come into force on September 1, 2020, can be found here. A copy of the Regulation, including the Amendments that will also come into force on September 1, 2020, can be found here. Sotos LLP has over forty years of experience providing advice to franchisors across all industries, including assisting inbound and outbound franchise systems. For further information regarding the Amendments, please contact the author of this article.

Jason Brisebois, Sotos LLP

Jason Brisebois is an associate with Sotos LLP in Toronto, Canada’s largest franchise law firm. He is head of the firm’s personal services franchise practice area, and practices business law with a focus on franchising, distribution, and licensing. He is admitted to practice law in both the Province of Ontario and State of New York. Jason has been recognized as a “Legal Eagle” by the Franchise Times as a leading Canadian franchise law practitioner. Jason can be reached directly at 416.572.7323 or jbrisebois@sotosllp.com.

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The issue for dealerships is whether, because of these challenging business conditions, they would have the right to temporarily cease operations without the express written approval of the manufacturer.  However, prior to shutting its doors, a dealer must make sure that it is not running offside the terms of its dealer agreement.  Under most dealer agreements, it is a material default for the dealership to cease operations for a period of time, typically 7 to 14 days, unless performance is rendered impossible.  If a dealership ceases operations for this length of time, a manufacturer may be entitled under the dealer agreement to immediately terminate the dealer agreement (and ultimately, the dealership’s ability to sell the manufacturer’s vehicles and parts) without notice to cure.  As such, if a dealer unilaterally elects to shut its doors because of the COVID-19 pandemic, then a manufacturer could potentially terminate the dealer agreement under the strict terms of the dealer agreement.

Before taking any steps to cease operations, a dealer should consider whether its dealer agreement contains a “force majeure” clause that permits it to temporarily cease operations. While some manufacturer dealer agreements contain force majeure clauses, not all do – dealer agreements should be reviewed on a case-by-case basis to consider whether one is present and if so, is it applicable to the situation at hand.  The Supreme Court of Canada has described a force majeure clause as follows: “[a] force majeure clause … generally operates to discharge a contracting party when a supervening, sometimes supernatural, event, beyond control of either party, makes performance impossible.”

Given the fact that the Government has permitted dealerships to remain open, it is unlikely that a broadly worded force majeure provision would relieve a dealer from operating because operations, while challenging and potentially not even profitable, have not been rendered impossible.  As such, in order to constitute a force majeure, it is likely that the clause would have to expressly refer to a pandemic of the nature we are currently experiencing in order to excuse the dealer from performance under its dealership agreement. Financial difficulties in operating the dealership would typically not be considered a force majeure.  However, if the Government goes a step further and mandates the closure of dealerships, then a broadly worded force majeure provision would likely apply since operation of the dealership has been rendered impossible.

Rather than relying on its strict legal rights, if a dealer is considering temporarily ceasing operations or fundamentally changing the nature of its operations by, for example, moving to online sales only and closing the showroom, it is best to engage the manufacturer at an early stage and before any decisions are made.  The dealer should have a frank and open dialogue with the manufacturer of why operating the dealership in the traditional manner is imposing too much of a hardship on the dealer and why temporarily ceasing operations would be the right thing to do in the circumstances, both from a financial perspective, and a health and wellness perspective. This is a difficult period for both dealers and manufacturers and so there is incentive on both sides to reach a mutual satisfactory arrangement and to compromise so long as both sides are acting reasonably.  If a temporary cessation is possible, the dealer and manufacturer should try to agree on the timelines and a plan going forward of when the dealership will fully re-open for business.  Any temporary cessation of operations agreed to by the dealer and manufacturer should be confirmed by the manufacturer in writing.

It is important to remember that a manufacturer has an obligation to exercise its rights under the dealer agreement in good faith and in accordance with its duty of fair dealing. Courts have generally evaluated this duty with consideration to the surrounding context facing the parties.  If a manufacturer is enforcing the dealer agreement in a heavy-handed manner in light of the business environment facing dealers at the present time, then arguably it is in breach of its duty of fair dealing.  Forcing a dealership to remain open in light of COVID-19, and threatening termination, could run afoul of the manufacturer’s duties of good faith and fair dealing to the dealers.

If a manufacturer does take steps to terminate, the National Automobile Dealer Arbitration Program (NADAP) rules may provide some protections to the dealer.  Firstly, under NADAP, a termination of the dealer agreement is an arbitrable matter.  Secondly, any termination is enjoined or paused while the merits of the termination are decided by the arbitrator.  As such, provided the dealer files a timely NADAP proceeding, it can stop the termination coming into effect until there is a decision from an arbitrator on the merits of the termination.

In closing, if a dealership is considering temporarily ceasing operations as a result of the COVID-19 pandemic, it is best to notify the manufacturer in advance and obtain written authorization from the manufacturer.  Given the current business climate, many manufacturers have already granted such requests, and we would expect most, if not all, to follow suit. If a manufacturer refuses, a dealership must know its legal rights before proceeding unilaterally.

This article was published in the May 2020 issue of the Canadian AutoWorld magazine.

Jason Brisebois, Sotos LLP

Jason Brisebois is an associate with Sotos LLP in Toronto, Canada’s largest franchise law firm. He is head of the firm’s personal services franchise practice area, and practices business law with a focus on franchising, distribution, and licensing. He has been recognized as a 2020 “Legal Eagle” by the Franchise Times as a leading Canadian franchise law practitioner. Jason can be reached directly at 416.572.7323 or jbrisebois@sotosllp.com.

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Canadian franchisors will question how an American legal development will impact their own operations north of the border. The answer is: it won’t – at least, not yet.

In the lead-up to Governor Newsom’s signing of AB-5, those involved in franchising immediately began raising the alarm on the impact it may have on the industry. Forbes, for instance, published an article earlier in September entitled “How do you Spell Trouble? California AB 5”, noting that AB-5 could be “a potential neutron bomb” for franchising.

What is AB-5?

AB-5 follows from Dynamex Operations West v. Superior Court of Los Angeles (“Dynamex”), a 2018 decision of the California Supreme Court. In Dynamex, the Court considered when a worker should be classified as an independent contractor or a full-fledged employee. As part of its analysis, the Court established a stringent, multi-pronged test (labelled the ‘ABC test’) that must be satisfied in order to successfully classify a worker as an independent contractor as opposed to a full-fledged employee. For instance, one prong of the ABC test requires the business to prove that the worker is free from its direction and control.

AB-5 codifies Dynamex, and goes even further by creating an assumption that workers in California are automatically full-fledged employees, requiring businesses claiming otherwise to successfully rebut this assumption and prove that the worker in question qualifies as an independent contractor.

The franchising industry’s primary concern with AB-5 is that the ABC test runs contrary to one of the core elements of franchising: a successful franchise system requires its franchisor to exercise a (limited) degree of control over its franchisees (and as a result, indirectly, their franchisees’ employees) to ensure a uniform standard of excellence across all franchised outlets. As a result of AB-5, franchisors’ attempts to maintain this uniform standard through their limited control of franchisees could result in the classification of franchisors, together with their franchisees, as “joint employers” of the franchisees’ employees.

In August 2019, over 160 prominent franchise brands wrote to California lawmakers warning of the impact AB-5 could have on the franchise industry. The letter notes that the brands “are gravely concerned that, if enacted as currently drafted, AB-5 could mean the death of the franchise model in California, with devastating economic consequences.” This is based on a concern that “the ‘ABC test’ for employee status which would be adopted under AB-5 fails to recognize the unique nature of the franchise model.” A copy of this letter to California lawmakers can be read here.

In response to advocacy by a variety of industry sectors, including by the International Franchise Association, the bill’s sponsor has stated that a follow-up to AB-5 will be introduced in 2020 which may introduce certain industry exemptions. Whether these changes will be responsive to concerns raised by the franchising community remains to be seen.

Should Canadian Franchisors be Concerned?

Franchisors in Canada are all too aware of the ever-present risk that they may be deemed a “joint employer” (along with their franchisees) of their franchisees’ employees. Such designation may expose a franchisor to a variety of employment-related obligations, including the requirement to provide the workers additional minimum compensation, vacation pay, overtime pay, and additional payment on termination. It may also leave the franchisor vicariously liable for the acts of these workers, despite the franchisor having limited or no involvement in their hiring, training, or management.

Canadian franchisors active in California should consider the potential implications that AB-5 may have on their operations there, and consult their California legal advisors for further advice. Otherwise, Canadian franchisors can temporarily exhale, knowing that AB-5 applies only to California franchise operations.

Nonetheless, the passing of AB-5 should concern Canadian franchisors. Proposals which partially or substantially mirror AB-5 are gaining traction in a variety of jurisdictions, both inside and outside of the United States. Moreover, Canadian systems should keep in mind that many tenets of our own federal and provincial laws (including Ontario’s Arthur Wishart Act (Franchise Disclosure), 2000) were inspired by American legal developments. AB-5’s entrenchment may inspire other jurisdictions – including in Canada – to follow suit.

Although not nearly as consequential as AB-5, Bill 148 (The Fair Workplaces, Better Jobs Act), introduced by the Wynne government prior to its defeat in the 2018 Ontario election, dictated that, among other things, in the event that a worker disputed their designation as an independent contractor, the onus would rest on the employer to prove that this employee was properly classified as an independent contractor. The Ford government’s Bill 47 (The Making Ontario Open For Business Act) later repealed portions of Bill 148, and reaffirmed the onus of a worker disputing their designation as an independent contractor to prove misclassification, but it is clear that considerations similar to the ones that drove AB-5 are gaining traction in Canada.

Although only time will tell if Canadian jurisdictions will adopt AB-5 style reforms, Canadian franchisors should continue to monitor this trend vigilantly, and continue employing best practices to shield themselves from being accidentally designated as a “joint employer” of their franchisees’ employees. In particular, franchisors should ensure that they are exercising no more control than is necessary to maintain uniform standards across their franchise systems, and review their systems and procedures to ensure they are not directly involved in the hiring, firing, training, scheduling, or overall management of their franchisees’ employees. Overreach by the franchisor can also result in franchisees losing their small business taxation treatment.

Sotos LLP has over forty years of experience providing advice to franchisors across all industries, including assisting inbound and outbound franchise systems. Jason Brisebois is an associate in Sotos LLP’s corporate law group, and is admitted to practice in both the Province of Ontario and New York State. For further information on this article, contact him at (416) 572-7323.

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On October 11, 2019, the Council provided several recommendations to the Ontario Ministry of Government and Consumer Services (the “Recommendations”) relevant to franchisors and other businesses alike, including removing the requirement under the Business Corporations Act (Ontario) (the “OBCA”) that at least 25% of a corporation’s directors be Canadian residents. The Recommendations also propose amending the OBCA to lower the approval threshold necessary for a written shareholders’ resolution in lieu of a shareholders’ meeting for privately-held corporations.

Most relevant to franchisors, however, are the Council’s Recommendations relating to the Arthur Wishart Act (Franchise Disclosure), 2000 (the “AWA”). The Recommendations propose amending the AWA to prescribe the following:

• the manner of determining “Total Initial Investment” for the purposes of the minimum and large investment thresholds;
• any changes to the current minimum and large investment threshold amounts for exemptions from disclosure;
• the amount of the deposit payment under which fully refundable deposit agreements that does not bind a prospective franchisee to enter into a franchise agreement would be exempt from disclosure;
• what information must be contained in a statement of material change; and
• the accounting standards for financial statements that must be included in a disclosure document.

The Council’s Recommendations closely resemble submissions originally made (including by Sotos LLP) to the Wynne government in 2017, which were disregarded due to uncertainty prior to its defeat in the 2018 general election. Although the Recommendations do not drastically alter the AWA, implementation of these changes could alter franchisor practices when vetting and disclosing new franchisees. Moreover, such changes, if implemented, could necessitate the updating of existing disclosure documents and related items.

No timeline has been provided for when a bill containing the Recommendations may be tabled, but it is expected to happen in 2020. Public comment on the Recommendations closed on November 26, 2019. You may review the Recommendations here.

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