The report consists of recommendations, which the government will consider, and then decide what changes it will make to workplace legislation.

The report’s recommendations, if implemented, will have significant impact on the franchising industry, most significantly by changing the rules regarding unionization. The report did not recommend that franchisors and franchisees be deemed to be “joint employers” for purposes of Employment Standards Act, 2000 (“ESA”) compliance or collective bargaining and union certification.  It did recommend that the law regarding union certification be amended to permit multiple franchises of the same franchisor, in the same geographic region, to be part of the same bargaining unit. The report further suggested that strong mechanisms be put in place to ensure that employers do not unfairly interfere with employees’ rights to unionize. The intention of these measures appear to be to make it easier and more viable for employees in the franchise industry to unionize.

The report also contains numerous recommendations that, if implemented, will substantially affect employers and employees in all industries in Ontario.  These include:

• Creation of a “Workplace Rights Act”, to aid creating a culture of compliance among employers. This would combine the ESA, the Labour Relations Act, 1995,and Occupational Health and Safety Act and be more expressly focused on workplace rights.
• Increased, and more active, enforcement of employment standards rights and obligations. The report specifically singled out the issue of “misclassification” of employees as “independent contractors” for priority enforcement and suggested that the term “dependent contractor” be added to the definition of “employee”.
• Increased penalties for non-compliance with the ESA.
• Providing part-time, casual, temporary, contract and seasonal employees with the same rights as comparable full- time employees.
• Extension of personal emergency leave and bereavement leave entitlement to all employees – not only to those employed in workplaces with 50 or more employees.
• Increasing minimum vacation entitlement to 3 weeks per year after 5 years of employment.

A summary of the report can be viewed here, and the full report can be viewed here.

We are studying the report and the recommendations and will provide further updates as it becomes clear which recommendations that the government is likely to adopt.

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National franchisors considering introducing the sale of alcohol will need to grapple with the variances in liquor laws from province to province.  Although the licensing scheme is somewhat similar, there are material differences such as the minimum age requirements for staff serving alcohol.  For example, in British Columbia, employees who are at least 16-years-old may serve alcohol but may not open bottles, pour or mix liquor.  In Ontario, employees serving alcohol must be at least 18.  Quick-service restaurants regularly employ teenagers aged 16 to 19 and being required to hire older staff may increase labour costs for franchisees.  There are also various provincial regulations that can significantly affect the purchase price and product selection for restaurant and bar owners.  In 2015, Restaurants Canada conducted a survey of licensees across Canada and found that 72% of respondents reported the cost of beer, wine and spirits as having a negative impact on their business. Given that franchise consumers expect uniformity in terms of products and generally, pricing, within a country, franchisors must evaluate whether introducing alcohol is feasible logistically and that it also makes business sense for all of its franchisees.

Aside from the economics of introducing alcohol sales into a quick-service restaurant franchise system, franchisors should first consider any necessary updates to their franchise disclosure documents (FDD) and franchise agreements.  Four of the six provincial franchise statutes mandate disclosure of every licence, registration, authorization or other permission the franchisee is required to obtain to operate the franchised business.  Accordingly, the FDD should summarize the liquor sales licence requirements for each of those provinces.  Given that obtaining a new liquor sales licence can take 3 months or more and require the franchisee to complete costly leasehold improvements to ensure the location is compliant with all then-current building codes, franchise agreements should be revised to require franchisees to transfer the liquor sale licence to the franchisor (in a buy-back, termination, or expiry scenario) and in the case of transfers to new franchisees to ensure continuity of alcohol service.  It may also be useful to obtain a power of attorney to sign such liquor sale licence transfer documents on behalf of the franchisee in order to avoid issues resulting from uncooperative franchisees.

As odd as it sounds, hearing the phrase “I’ll have a medium-sized fries and a martini, please” could be a reality in the not-so-distant future.

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Franchise Fee

In addition to the actual amount of the franchise fee, you should determine if the franchise fee is refundable and if so, how much will be refunded and under what circumstances. Typically, franchisors will return at least some portion of the franchise fee if a location for the franchise is not found within a certain time period (e.g. 6 months) or if you do not successfully complete training. If the Franchisor or you are unable to secure any sites that are suitable to you, then you should be entitled to a full refund of the franchise fee. If there is no incentive for the franchisor to actually secure suitable premises, it makes little sense for the franchisor to be entitled to any of the franchisee fee as it really hasn’t done anything to earn that fee. If you don’t successfully complete training, it’s reasonable that the franchisor keep a portion of the franchise fee to cover its actual expenses.

Advertising Fund

The lack of effective general advertising in return for the monetary contributions made by the franchisees to an advertising fund is a frequent source of complaints from franchisees. If the franchise agreement entitles you to obtain annual reports on the advertising activities financed by the marketing fund, you should ask the franchisor for copies of past years reports in order to determine the type of marketing that is being conducted and whether it would provide any benefit to you. You should also check the portion of the advertising fund that is spent on administration (a good rule of thumb is that administrative expenses be no more than 20% of the marketing fund).

Protected Territory/Rights Reserved

Defining a protected territory in which you will operate can be critically important, particularly if you will be operating a franchise in a highly saturated market. Beyond drawing the borders of the territory on a map, you should carefully consider whether and in what circumstances the territory can be changed by the franchisor, and what sort of exclusive rights you have to operate in it vis-à-vis other franchisees and the franchisor itself. For example, being in compliance with the franchise agreement or in “good-standing” may be a criterion for maintaining your territory. Since even the best operator may commit minor operational breaches from time to time, you should have the franchisor agree that you only need to be in “material compliance” with your obligations in order to avoid having minor technicalities result in the loss of your territory.
Despite the apparent protection of the territory given to you, the franchisor will often reserve itself certain rights such as building non-traditional locations (i.e., mobile trucks, airports, etc.) within your territory, distributing its products through alternative channels of distribution (i.e., supermarkets, grocery stores, and other outlets), or operating a business within the protected area under a different brand (even if it competes with you directly). It is important to carefully review these reserved rights since you may well have to compete for sales with your own franchisor and its other franchisees.

Required Purchases

You should be wary of franchise systems where you are required to purchase all of your products, supplies, and services directly from the franchisor or from suppliers designated by the franchisor. Although there are legitimate reasons for franchisors to impose this restriction (e.g., to maintain consistent quality throughout the system), it comes at the cost of your ability to out-source your products and supplies for more competitive prices. Moreover, the retention of rebates by franchisors, and their failure to distribute at least some of the benefits of these rebates in an equitable fashion to their franchisees (whose volume buying makes those rebates available in the first place) is often the source of great frustration on the part of franchisees. Since it is relatively standard for franchisors to reserve the right to retain all rebates it receives, you should try to get the franchisor’s assurance that it will not mark up the price of goods or services it supplies to you. At a minimum, the franchisor should agree that such rebates will not inflate prices to the franchisee above those available in the market from similar suppliers for similar products and services.

The post The Devil is in the Details: what you need to know about your Franchise Agreement appeared first on Sotos LLP.

Relocation

Often in shopping centres, the landlord will reserve the right to relocate the tenant during the term of the lease. If a relocation clause without any restrictions or conditions is exercised by the landlord, the franchisee would be obligated to move its premises within the shopping centre to a potentially worse location, at its own expense.

The franchisor should attempt to remove this clause. In large shopping centres, the landlord will most likely refuse to delete the relocation clause, but will often agree to add restrictions and/or conditions.

The franchisor should negotiate revisions that would only permit the landlord to exercise the relocation clause in the event that it plans on a reconfiguration or expansion of the shopping centre. It should not be permitted to relocate the franchisee if it wishes to provide the leased premises to another tenant.

The relocation clause should stipulate that the relocated premises will be a similar size and configuration as the current premises and be in a comparable location. For example, if the leased premises are in a food court of a shopping centre, the clause should dictate that the relocation must be within the food court. Without this clause, the franchisee could be forced to accept premises that are unfit for its business. In addition, the franchisee’s rent will likely increase if the relocated premises are larger than the original location. The franchisor may also be able to negotiate a revision to this clause that would permit it to terminate the lease should the relocated premises being offered to the franchisee be not to its satisfaction.

The franchisor should also negotiate compensation to the franchisee for relocating the premises. As a first step, the franchisor should require that the landlord pay for the franchisee’s costs to move its premises and the cost of new fixtures required to replace any fixtures that cannot be relocated. At a minimum, the landlord should be paying for the amortized value of the fixtures that cannot be relocated.

Demolition

The landlord will often have a clause that would permit it to terminate the lease in the event that it wishes to demolish the building. In this event, the franchisee would be forced to relinquish its leased premises.

The franchisor should attempt to remove this clause from the lease agreement. However, depending on its bargaining power, the landlord may insist that this clause remain in the lease. At a minimum, the franchisor should obtain a condition that would require the landlord to provide a year’s notice prior to terminating the lease and provide evidence that it has taken steps towards demolishing the building.

The franchisor may also attempt to negotiate compensation to the franchisee for the amortized value of the fixtures that cannot be removed from the premises.

Sale

The Landlord may have a sale clause in its standard form lease agreement, which would either entitle it to terminate the lease agreement upon entering into a sale agreement for the property, or would entitle the purchaser to terminate the lease agreement. Same as in the demolition clause, the franchisee would be forced to relinquish its leased premises.

The franchisor should demand that this clause be deleted from the lease agreement. It is more likely that a landlord would sell the property rather than demolish the property, and it creates too much uncertainty for the franchisee’s prospects in the location.

Renewal

It is in franchisor’s interest to obtain options to renew, whenever possible. It provides more certainty to the franchisor that it can have control over the leased premises for a period that is longer than the original franchise / lease term. Although the franchisee, when entering into a franchise agreement, is not likely to receive options to renew its franchise, it may still view options to renew the lease as a favourable term. In their mind, it increases the likelihood that its franchise agreement would get renewed at the end of the original term.

The thing to be careful with renewal clauses is that the landlord will likely stipulate that the tenant cannot be in default of the lease or previously in default of the lease. Considering the fact that the franchisor is not involved in the day to day operations at the premises and is relying on the franchisee to perform the tenant’s obligations, the franchisor should attempt to soften the condition. The tenant should have the option to renew if it has previously been in default, provided that the said defaults have been rectified. It may be reasonable for the landlord to require that the tenant cannot have been in default more than a couple of times during the term.

The franchisor should either negotiate the amount of rent that will be payable during the option(s) to renew or stipulate that the rental rate will be at the fair market rental rate and that the franchisor is permitted to take the landlord to arbitration in the event that the sides cannot agree on the fair market rental rate during the renewal term. Without an agreed upon rental rate or a method of determining the rental rate, the options to renew would be subject to the landlord agreeing to offer a fair rate.

Lastly, the franchisor should be mindful of when it must provide notice to the landlord of its intent to exercise an option to renew. If the franchisor intends to renew its franchise agreement with the franchisee, it should be in contact with the franchisee prior to the expiry of the lease’s notice period.

Disclosure

In addition to negotiating these clauses in the lease, the franchisor should highlight them in the disclosure document that it sends to the franchisee. In many cases, these clauses could result in either the franchise agreement being terminated before the end of the term or an increase in costs borne by the franchisee. As a result, they should be properly disclosed and considered by the franchisee before deciding on whether to make a significant investment in acquiring and establishing the business.

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Around the World

We have recently witnessed some major changes to franchise legislation in both California and Australia.  Developments in these jurisdictions are of importance to the global franchise world; in particular, shifts in California’s regulatory landscape are significant given its role as a global pioneer of franchise legislation. In fact, California was the first state to enact franchise legislation in 1970.  Australia, on the other hand, toyed with all manner of indirect and voluntary regulation before adopting a fairly stringent regulatory regime in 1998.

Franchising is a global industry – what happens in one jurisdiction often travels to others, albeit sometimes years (or even decades) later. Fundamentally, what drives franchise regulation are edgy business practices, widespread harm, and a receptive political climate. Changes in Australia and California are noteworthy because they represent the latest thinking as to where things are going when the franchising relationship breaks down or becomes unduly frayed.

California

Changes to franchise legislation that came into effect in January 2016 have been referred to as “unprecedented”, “monumental” and a “game-changer”.  The California Franchise Relations Act (the “CFRA”) was amended to provide franchisees with greater protection by imposing additional obligations on franchisors when terminating franchisees, in addition to other amendments.

Key changes under the CFRA include the following:

• Franchisors may only terminate when there is “substantial noncompliance” – all other terminations are no longer on the table;

• Franchisors must provide a written explanation for termination and are required to repurchase a franchisees’ assets at the value of the price paid, minus depreciation, upon termination or non-renewal (with specific exceptions carved out);

• Franchisees have more time to address deficiencies under franchise agreements and are also entitled to a longer notice period in the case of termination (with certain exceptions carved out); and

• In a wrongful termination, franchisees have additional remedies available – they may be awarded the fair market value of the franchised business and assets.

Australia

Living up to its antipodean geography, Australia recently introduced new legislation which regulates franchising through amendments to the Australian Securities and Investments Commission Act (the “ASICA”) by extending protection to small business contracts under an existing provision on unfair contract terms. Basically, if a franchise agreement falls within the definition of a small business contract, an unfair term in the agreement will be void. An unfair term is defined under ASICA as one that:

• would cause a significant imbalance to the parties’ rights and obligations under the contract;

• is not reasonably necessary in order to protect the legitimate interests of the party advantaged by the term; and

• would cause detriment to a party if it were to be applied or relied on.

A list of examples of unfair terms is provided under ASICA and includes terms (as in California) such as one that permits only one party to vary the terms of the contract and one that limits a party’s right to sue another party.

This sad state of affairs was entirely predictable as it was preventable.  Caution to Canadian colleagues to heed the rule of reason: All successful business relationships are structured so as to balance risks and rewards such that everyone has an opportunity to reap a reasonable return on their investment. Franchise lawyers are uniquely positioned to influence the development of economically sustainable relationships through legal drafting.  Encouraging business arrangements that do not reflect this principle not only do a disservice to clients but also to an industry that has revolutionized the small business world.

Is Canada Next?

What do changes in California and Australia mean for Canadian franchising – will these significant regulatory changes find their way into Canadian legislation? While the relational balance of power is a topic of ongoing discussion, especially in British Columbia with the recent development of franchise legislation, such amendments are not in Canada’s foreseeable future.  Unless unanticipated events transpire in the next few years that forcefully steer discussion towards the need for change, the status quo across provinces will, in all likelihood, prevail.

That being said, the changes discussed above will have an impact on Canadian franchisors who operate internationally or plan to expand into California or Australia – the changes in California affect all franchise agreements entered into or renewed on or after January 1, 2016, while the Australian legislation applies to applicable contracts entered into or renewed on or after November 12, 2016.

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The Franchisor/plaintiff, Home Instead, Inc., operates a senior care services chain that “provides very personal services to vulnerable people.”  The Franchisor had purported to terminate the two defendant Franchisees for numerous breaches of their franchise agreements.  The alleged breaches included misleading the Franchisor by failing to disclose they were in business together and operating an unrelated third business out of one of the franchisee’s offices.  The franchise agreements at issue had specific prohibitions against owning interests in multiple franchises without the Franchisor’s consent and operating other businesses out of the franchise premises.  The Franchisor had come to court seeking an injunction against the Franchisees to ensure that they fulfilled their contractual obligations post-termination.

The Franchisees/defendants brought a cross-motion, seeking an injunction to prohibit the Franchisor from terminating their franchise agreements.

The Court granted the Franchisor’s request for an injunction.  In doing so, the court’s reasons suggest what facts were important to the motion judge in reaching his decision.  These reasons provide some insight into how future, similar cases may be decided.

• Credibility matters.  The motion judge found that the Franchisees’ written evidence raised serious issues regarding their credibility.  For instance, although the Franchisees denied they were in a business relationship, their own emails to each other seemingly showed otherwise. This factor appears to have negatively affected the Franchisees’ case.
• The nature of the system can make a difference. The Court found that a business built on trustworthiness, such as one that provides personal care services to seniors, is “in a different position” than other, less personal types of businesses. The Court found that the continued operation of “rogue” franchisees could threaten the Franchisor’s goodwill and reputation, particularly given that the parties operate in “this age of social media and viral phenomena.”  The Court suggested that negative publicity, even on seemingly small matters, can cripple a brand built on trust.
• “On purpose” may outweigh “by accident”.  In its reasons the Court stated that where there is a strong prima facie case suggesting deliberate misconduct, the Court should be less sympathetic to any pleas made by the apparent wrongdoers.  Here, the Court seemed to give significant weight to the fact that the Franchisees “deliberately deceived” the Franchisor and were operating “rogue” businesses.  Given the nature of the business and the importance of ensuring the system’s reputation for trustworthiness, the Court found that the harm of the Franchisees continuing to operate would be “irreparable” because, among other factors, “the risk of a rogue franchisee very much threatens the franchisor’s goodwill, reputation, and implicates its responsibility to maintain the integrity of the chain.”  The Court also noted that if franchisees who “actively colluded to deceive the franchisor” were permitted to continue operations a franchisor may be unable to protect itself from further misconduct.

This case is an example of the Court making an order, in this case an interlocutory injunction, to hold franchisors and franchisees to the strict terms of their agreements.  Here, the Court expressly declined to delve into an analysis of the nature or reasonableness of the franchise agreements.  Instead, it simply enforced the bargain the parties made:  “The franchisor operates on strict contractual rules on which its business lives or dies. I make no comment or finding on the wisdom of its rules. The franchisees have chosen to invest in and bind themselves to the franchisor’s system and franchise agreement.”

In a subsequent decision dealing with costs of the motion,[2] the motion judge was similarly guided by the franchise agreements in fixing costs.  The judge saw “no basis to exercise discretion to relieve the defendants from their commercial bargains.”  Accordingly, he fixed the costs of the plaintiff on a substantial indemnity basis, as specified by the franchise agreements, in the amount of $200,000.  However, in a somewhat surprising twist, the motion judge did not make those costs payable to the franchisor immediately.  Rather, the motion judge deferred to the trial judge to determine whether those costs should actually be paid, depending on the outcome of the trial.  This is unusual given the harsh findings on the motion, including that the Franchisees had significant credibility issues.

[1] 2015 ONSC 7630 (CanLII).

[2] 2016 ONSC 255 (CanLII).

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Ontario’s franchise protection statute, the Arthur Wishart Act (Franchise Disclosure), 2000, and its associated Regulation put limits on how information about the profitability of the business can be disclosed to the potential buyer of a franchise.

The Wishart Act radically changed the way franchises are sold. Before the Act came into effect, many franchisors would provide a franchisee with a pro forma statement showing profitability at various sales levels. In some cases, few franchisees in the system had ever actually achieved those sales levels. This had the potential to mislead purchasers. Other times, a franchisor would provide back-of-the-napkin profitability information to the purchaser that could not be verified. The franchisor usually insulated itself with disclaimers that told the franchisee not to rely on the information even though the sole purpose of providing the information was to induce the franchisee to buy the business.

The Wishart Act was supposed to change all of that. It requires a franchisor to deliver to the potential buyer of a franchise a pre-sale disclosure document that discloses all material information about the business and the franchise system. If a franchisor wishes to give information about the potential profitability of the franchise, it must do so in the form of an earnings projection in the disclosure document itself. To ensure that the information in the earnings projection is verifiable, the disclosure document must state the reasonable basis for the earnings projection, the assumptions underlying it and a location where information is available for inspection that substantiates the projection. The disclosure document must also contain a certificate attesting to its completeness and accuracy. Failure to comply with these strict requirements exposes the franchisor and the individuals who signed the certificate to significant liability.

Although the Wishart Act has been around for over ten years now, old practices die hard. This is especially true when it comes to statements about the profitability of the franchise. Some franchisors try to circumvent the Act by giving pro formas or profitability statements outside of the disclosure document. Sometimes this is done for the ostensible purpose of assisting the franchisee in preparing a business plan to obtain bank financing. Another method is to send the franchisee an “information package” containing what are said to be “typical” earnings experiences of other franchisees, along with a disclaimer. Many sales brokers employed by franchisors fall into the trap of giving this sort of information to potential purchasers outside of the disclosure document.

All of these practices are now prohibited in Ontario. The only place where earnings information can be disclosed to a potential purchaser of a franchise is in the disclosure document. If the disclosure document says that the franchisor ‘does not provide earnings projections, then no such information can be provided. If the franchisor does provide earnings information, it must provide it in the disclosure document itself and not in any other format.

The Wishart Act was intended to stamp out all forms of representations about earnings other than those contained in a disclosure document. Circumventing the restrictions in the Act can land the franchisor and any franchise sales people in hot water.

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