Background

David and Elizabeth planned to go skiing at resorts north of Toronto. When they were purchasing their tickets, they signed the ski resorts’ respective waivers of liability for injuries they might suffer at the resorts. They went skiing but both had accidents. They sued the ski resorts for their damages.

The question became whether the waivers of liability that David and Elizabeth had signed were valid.

Two competing pieces of legislation applied to their circumstances. David and Elizabeth were consumers as defined under Ontario’s Consumer Protection Act (“CPA”). They were also persons entering the resort premises for which the ski resorts were responsible. Therefore, Ontario’s Occupiers’ Liability Act (“OLA”) also applied.

The Court of Appeal’s Decision

The two statutes could not be reconciled: the CPA states generally that waivers of liability or warranty are void with respect to consumers. The OLA permits waivers of liability with respect to certain premises onto which other persons enter.

The Court of Appeal decided that because the language used in the OLA was more specific than the CPA, the OLA should govern. Therefore, the waivers of liability were valid under the OLA and not void under the CPA.

In making its decision, the Court of Appeal considered the original legislative intent underlying the waivers provision in the OLA. The goal was to encourage private landowners to make their properties available to others for recreational use without allowing the fear of liability to get in the way. On the other hand, the Court found no intent in the history of the CPA to show that the legislature intended to ban a waiver of the duty of care towards visitors of premises that are captured by the OLA.

Significance of the Decision

The Court’s decision will have significance for many businesses especially those offering play, sports, and recreational services. If properly drafted and presented, waivers that are given by the consumers of such activities will provide a defence to owners or operators of such businesses. Lawyers at Sotos LLP regularly advise business operators in the restaurant and hospitality industry as well as sports and recreational enterprises on all aspects of their liability towards their customers and staff.

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When approached with preparedness, renewal negotiations can offer the opportunity to retain a great franchisee and adapt the terms of the parties’ agreement to reflect evolving priorities and changing industry conditions, or, if the arrangement is no longer fruitful, amicably conclude the business relationship.

Conversely, when a franchisor pursues a renewal in an ad hoc manner, the experience can become stormy, whereby the franchisor is unable to steer negotiations towards a beneficial conclusion, resulting in missed opportunities and, at worst, exposure to potential legal liability.

In practice, the renewal process invokes a confluence of often competing “heads” of consideration which can—and should—be contemplated during system design, when the architecture of the franchise agreement, head lease, and other ancillary documents affecting the tenor of any eventual renewal is being conceived. By drafting at this stage with an eye towards process, and in particular through fashioning terms that fit together in chronological lock-step, all while paying due attention to statutory obligations, a franchisor will be adequately prepared to effectively navigate the sometimes uncertain waters of renewal negotiations.

While it is beyond the scope of this article to thoroughly examine any particular head of consideration, or discuss at length the substantial interconnection between each head, the following will provide a high-level map of the significant issues that should be settled as a franchisor seeks to renew, or not renew, a franchise agreement.

I. TERMS OF THE FRANCHISE AGREEMENT

(a) What is the renewal right? As a preliminary step in designing any franchise system, franchisors should contemplate what mechanism for renewal will apply to the parties’ arrangement—an automatic renewal, unconditional or conditional renewal, or one of the numerous other species of renewal. To that end, think of this right like a ship’s hull: It should be the first component designed, it establishes the parameters within which all other renewal terms must fit and, on a practical level, when poorly constructed, it can threaten to sink a prospective deal. Further, at the point of negotiation, and leaving analogies aside, whichever renewal right one chooses will help determine, among other things, whether and to what extent contract terms are negotiable and which party possesses what bargaining leverage.

(b) Notice of intent versus notice of renewal? From a procedural standpoint, franchise agreements typically contain notice provisions, and in particular stipulate rules pertaining to the substance and timing of a notice of renewal required to be delivered by a franchisee. The utility of such terms lies in the commercial certainty they offer by providing confirmation of a franchisee’s agreement to continue the parties’ arrangement into a subsequent term. When drafting such provisions, franchisors should choose their language carefully. All too often, agreements speak instead of a notice of intent in place of a notice of renewal, despite the former being, for practical purposes, procedurally superfluous.

(c) When is compliance assessed? A boilerplate renewal condition found in most franchise agreements requires that the franchisee be in full compliance with the terms of the parties’ agreements. With that in mind, franchisors should investigate when such compliance is assessed—at the time notice of renewal is provided, at the time of the renewal itself, or at some other point? The answer to this question could affect the availability of a franchisee’s right to renew, if default provisions were drafted with foresight, and may provide the franchisor with a useful bargaining chip during the negotiation process.

(d) Conditions or obligations? Franchise agreements regularly contain a host of conditions for renewal that must be satisfied in order for the franchisee to enjoy the benefit of a subsequent term. Some franchisors, however, choose instead to style the same requirements as obligations of the parties’ renewal agreement. The difference between the two approaches is apparent when assessed through the lenses of certainty of performance and enforcement. That is, with respect to conditions, a franchisee has discretion whether and to what extent to fulfill the requirement, but once the parties execute a renewal agreement, the condition is tacitly deemed satisfied. With the latter approach, execution of the renewal agreement confirms the franchisee’s duty to fulfill the obligation, and provides the franchisor with tools to compel performance to a standard to the franchisor’s satisfaction.

(e) Noncompliance or leverage? As touched on above, consider the strategic value of certain procedural or substantive requirements for renewal left unsatisfied by a franchisee. Take, for example, a notice to renew submitted outside the prescribed window—while technically deficient and potentially constituting grounds to disallow renewal, a noncompliant notice can also offer leverage when negotiating an update to the parties’ agreement.

(f) What are the terms on expiry? Given that not all renewal negotiations end up with an inked deal, when drafting post-expiry terms in the initial franchise agreement, there are a myriad of considerations franchisors should pay heed to, for example, whether they anticipate wanting the right to subsequently purchase the franchisee’s assets and how those assets will be valued, as well as the enforceability of restrictive covenants, among other things.

II. TERMS OF THE HEAD LEASE

In certain systems, franchisors require franchisees to contract directly with landlords, thus absolving franchisors of leasing obligations and the headache of coordinating head lease and franchise renewal deals. For the vast majority of franchisors who, for the purposes of having more robust and direct land control, do not follow this practice, there are a number of integral considerations to keep in mind when negotiating a head lease at the outset of system design and at the point of franchise renewal.

For example:

• Will the head lease renewal be conditional upon the franchisor securing a franchisee for a subsequent term? As discussed more fully below under “When to provide disclosure?”, where a head lease renewal is not conditional, due to certain legislative rules regarding the substance and timing of disclosure documents, franchisors may find themselves forced to renew their head lease without the guarantee of a subtenant, risking the possibility of being saddled with vacant premises or an obligation to operate directly if franchise renewal negotiations falter.
• Does the head lease provide for conditions for renewal or obligations upon renewal, and are these requirements similarly styled in the franchise agreement?
• What is the timing and mechanism for setting rent applicable to the new term?

III. STATUTORY OBLIGATIONS

(a) Whether to provide disclosure? Franchisors must pay attention to their statutory obligations in preparing for renewal negotiations. By way of example, Ontario’s provincial franchise legislation requires franchisors to provide a disclosure document to franchisees prior to renewal of the parties’ franchise agreement, subject to a narrow exemption in cases where, among other things, there has been no material change since execution of the franchise agreement or the latest renewal. Where a franchisor fails to meet this exemption yet neglects to provide a disclosure document, the legislation confers on the franchisee an assortment of statutory remedies, including a right of rescission within two years of executing the franchise agreement renewal. The difficulty, of course, is in determining what constitutes a material change.

(b) When to provide disclosure? The question of when to provide disclosure is affected both by procedural and substantive statutory requirements, and is deeply imbricated with the timeline of any simultaneous head lease renewal negotiations. On the point of statutory procedure, franchise laws ubiquitously require a multi-day “seasoning period” between the time disclosure is provided and when the parties may execute an agreement or transfer any funds. From a substantive perspective, provincial franchise legislation obliges franchisors to include in their disclosure documents a copy of the applicable head lease. Together, these two obligations thus mandate that, in practice, a franchisor must have its head lease locked up before it can include it in the disclosure document, which document must in turn be delivered before the franchisee can sign the renewal agreement. A problem arises, however, in situations where the head lease renewal is not conditional upon securing a franchisee—the franchisor must enter into the new head lease without certainty that the franchisee will agree to renew the parties’ arrangement once it has had a chance to consider the disclosure document. While there are solutions to remedy this timing issue, which are beyond the scope of this article, suffice it to say that with sufficient preparation at the time of system design, this dilemma can be safely managed.

(c) What to disclose? Renewals can be, and are often used as, an excellent time to update franchisees to the current form of franchise agreement. A properly drafted franchise agreement contemplates the availability of this option for implementation at renewal. Note that any proposed updated agreement, however, will need to be the subject of disclosure for further consideration by the franchisee.

(d) How does “fair dealing” apply? Another notable statutory obligation that applies to renewal negotiations—the duty of fair dealing (and the related common law concept of good faith, including where no statute applies)—is particularly relevant in instances where the franchise agreement confers upon the franchisor certain discretionary powers exercisable as a condition or obligation associated with renewal (e.g., the power to oblige a franchisee to renovate its premises). Where these powers are vaguely worded, such that the onerousness of the requirement depends upon the franchisor’s discretion (e.g., the extent of the mandated renovation), this statutory duty is engaged. When the exercise of discretion is done in bad faith, or is made in an unfair or unduly burdensome manner, such conduct may offend the statutory duty.

Generally speaking, the statutory duty of fair dealing, which incorporates the common law duty of good faith, requires franchisors to:

• exercise their powers under the franchise agreement in good faith and with due regard to the interests of the franchisee;
• observe standards of honesty, fairness and reasonableness;
• ensure that they do not substantially nullify the bargained objective or benefit contracted for by the franchisee, or causes significant harm to the franchisee, contrary to the original purpose and expectation of the parties; and
• exercise discretion reasonably and with proper motive, and not in an arbitrary or capricious manner.

Knowing whether a franchisor’s conduct has offended the duty of fair dealing, while difficult to assess, is essential to circumscribing commercial risk, as failure to act in accordance with this duty may result in potential legal liability.

IV. CONCLUSION

Renewals are an inevitable part of every franchisor’s business. It is therefore vital to prepare for the seamless continuation or amicable expiry of a franchise agreement by contemplating the abovementioned heads of consideration at the outset of system design. In doing so, and in seeking further advice about the application of these heads to the facts of their particular circumstance, franchisors will be better prepared to identify and leverage tactical opportunities during negotiations, further equipped to close renewals on favourable terms, and more likely to enjoy smooth sailing over the sometimes uncertain waters of renewal negotiations.

The post Navigating the Uncertain Waters of Franchise Renewal Agreements: An Introductory Map appeared first on Sotos LLP.

The development of a robust and effective compliance program is fundamental to the protection and enforcement of a franchisor’s legal rights and to the maintenance of its business model for the benefit of its entire system.

Franchisors have traditionally monitored franchisee compliance through a combination of basic tools:

1.  secret shoppers – individuals not known to the franchisees who are retained to be a guest of the franchisee’s business and to report on a checklist of operational observations. Inadequate scoring can lead to a requirement for remedial training and potentially a default notice or even termination of a franchise agreement;
2.  compliance personnel – individuals, usually employees of the franchisor, who perform store visits, with or without notice, who similarly monitor compliance and report to franchisor executive using scorecards and/or checklists. Inadequate performance can lead to the same consequences noted above.  Compliance personnel can often also provide on-the-spot training or advice on possible remedial action to be taken.  Too often, however, franchisees see head office compliance personnel as “police”, looking for infractions to report to franchisor executive.

Compliance personnel often must prepare lengthy reports.  If there are inadequacies, default notices may need to be prepared, often by in-house or outside legal counsel.  Disputes over compliance are commonplace.  Sometimes photographs taken by compliance personnel tell a thousand words.  Sometimes they can be more ambiguous than determinative.

Concerns have also surfaced on whether compliance personnel are adequately trained, are present when they say they are and whether they treat franchisees alike.

Compliance visits often lead to follow up visits, including to conduct follow up inspections, which may be the only means to ensure that problems are “cured”.

Fortunately, developments in technology are providing excellent solutions to these problems and have ushered in a new era in compliance.  As a result, costs of compliance are significantly reduced, and the ability to document concerns and ensure timely and effective curing of defaults is greatly enhanced.

A technology-based compliance system should have the following features:

1. allow the parties to upload and share common documents to eliminate disputes over the operative disclosure documents, franchise agreements, amendments, manuals, training aids, leases, subleases, supplier agreements, options and the like;
2. contain standard form interactive checklists;
3. permit the uploading and sharing of photographs and videos;
4. be tablet-based;
5. contain standard form audit reports and dates for cure;
6. contain standard form notices of default and dates for cure;
7. provide a tickler system to both parties on critical dates;
8. act as a GPS to monitor compliance personnel activity;
9. prepare comprehensive score cards;
10. prepare reports on comparative franchisee performance;
11. be easily modified by the franchisor;
12. contain manual/agreement references; and
13. contain training videos and other material.

Of the systems that purport to provide at least some of these advantages, my personal favourite in the restaurant space is the system offered by MeaZureUp.  The support team at MeaZureUp creates a fully interactive customized program which is easy to use by both franchisors and franchisees.  Store visits are efficient, interactive and leave little room for disagreement.  Immediate reports are generated.  Return visits are minimized by the ability of the franchisee to upload proof of compliance.

The integrated program can reduce reliance on secret shoppers and can allow “compliance” personnel to focus on training.  The system also allows franchisees to see compliance as less a matter of “police” work and more a matter of store training.  The fact the system generates comparative reports contributes to franchisees feeling that they are not being singled out and are subject to the same review standards as all other franchisees.

The system is structured to allow franchisors to be charged on a per unit basis.  Assuming proper drafting, this charge can be disclosed and passed on to the franchisee as a matter of ongoing training.

The system is also ideal for the preparation of a package of documents that can be handed (electronically) to counsel in the event enforcement becomes necessary.  The package would contain all franchise documents, notices and evidence which counsel may need.

At Sotos LLP, we represent leading international and national franchisors.  We can assist franchisors in the customization of their compliance programs to ensure their systems are designed optimally to deliver the results which their executive, training, compliance and legal teams want and which benefit their entire franchise networks.

The post A New Era in Franchisee Compliance Strategy appeared first on Sotos LLP.

A. A Case Study[*]

The Facts

Two parties intended to start a franchised restaurant business together. We’ll call them Joe and Hank. Each owned 50% of the shares of the company that was to operate the restaurant. They signed a unanimous shareholders’ agreement regarding the operating company. In negotiating this agreement, they turned their minds to whether a ROFR would be a good option for the disposal of shares.

Initially, their lawyer drafted a ROFR that made no provision for a partial take-up of shares by the non-selling shareholder. In other words, under that proposed clause, when and if either of Joe or Hank decided to sell his interest and leave the business, the other one would have the option of buying all or none of the offered shares.

The parties ultimately decided to have a ROFO instead. The ROFO provided that the selling shareholder must offer to the non-selling shareholder all of its shares. However, it also provided that the non-selling shareholder “may accept the Offer for its Proportionate Percentage of the Sale Shares or any other number of Sale Shares”. In other words, the ROFO, as drafted, gave the non-selling shareholder the discretion to purchase none of the offered shares, only a portion of them, or all of them.

Not long after commencement of business operations, tensions arose and Joe decided to sell his share and leave the business. He found a third-party purchaser to buy his entire interest in the business. Joe gave notice to Hank of his intention to sell. Under the ROFO in their agreement, Hank had the option of buying some or all of Joe’s shares before Joe could sell to a third party. Hank decided to purchase only 10% of the offered shares. This situation placed Joe at a very disadvantaged position. First, he would lose the third party offer, which would have given him a clean break. Second, it converted Joe’s remaining share of the business into a less appealing minority position. As for Hank, the partial pick-up eliminated the prospect of deadlocking in the future with a business partner that he did not know.

Litigation ensued.

The Arbitration & Appeal

Under the shareholder agreement in the case under consideration, the parties had agreed to arbitrate any disputes. The party that we called Joe commenced the arbitration process arguing that the ROFO led to a commercially absurd or unreasonable result in providing for a right of partial pick-up. The arbitrator disagreed and dismissed the claim.

Joe then appealed to the Ontario Superior Court of Justice, which also dismissed the appeal. The right of partial pick-up was not a commercially unreasonable term. One of the biggest disincentives of a ROFO for a non-selling shareholder is the loss of control over the identity of the purchaser. In fact, under the appropriate circumstances, a ROFO that permits a non-selling shareholder to purchase the offered shares partially can promote a sensible commercial result. Nor did the fact that this ROFO led to unequal partnership interests render the ROFO unreasonable or commercially absurd.

B. How Joe Lost the Case: ROFO vs. ROFR

Both the ROFO and the ROFR relate to exit plans in various commercial contexts such as shareholder agreements, leases and joint land ownership. The goal in drafting such exit plans is often not so much to protect the selling party, such as Joe, but to give the remaining parties some assurance that the sale of that party’s interest will not impose on them inappropriate business partners in the future. However, as was seen in this case study, the rights of the leaving party can also be impacted in unexpected ways by the choice of clause.

In shareholder agreements, a ROFR requires a shareholder who has already received an acceptable purchase offer from a third party to give the other signatories the chance to match that offer before concluding any sale with the third party. The third-party offer has to be in good faith and non-collusive. On the other hand, a ROFO typically requires a party who wishes to sell his or her shares to offer to sell the shares to the other party or parties to the agreement before looking for potential buyers beyond the existing parties. Therefore, a ROFO enables the exit provision to be triggered without the selling party first having to secure a third party buyer.

Nonetheless, as the saying goes and the above case shows, the devil is in the details.

C. Conclusion

The selection of a ROFR or ROFO provision in an agreement should be driven by the business objectives of the parties. The parties need to understand the implications of their choice because when applied to future events and considerations the outcomes can be quite different from those expected.

Counsel can play a critical role in assisting a party to an agreement in understanding these choices and in ensuring that relevant clauses are drafted properly to protect the party’s interests. At Sotos LLP, we represent parties getting into franchised and other businesses and apply our leading experience to this exercise.

[*] This case study is taken with some modification from recent litigation reported as 2293611 Ontario Inc v JSegal Holdings Ltd, 2016 ONSC 7577.

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In a case decided June 8, 2017, Mendoza v. Active Tire & Auto, 2017 ONCA 471, the Court of Appeal re-affirmed these principles. If the disclosure document fails to comply with mandatory rules about what must be included, the document will be deficient and give rise to franchisee rights to rescind the franchise agreement. A right to rescind will arise even if the franchisee did not read the disclosure document, the Court of Appeal concluded.

The crucial deficiencies in Mendoza were that the disclosure certificate was signed by only one officer or director, not two, and the audited financial statements were outdated. Deficiencies with a certificate and in financial statement disclosure have been repeatedly confirmed in other cases to give rise to franchisee rights to rescind the franchise agreement within two years of entering into it and to claim repayment of all monies paid to the franchisor, investments made to acquire the franchise and operational losses.

Franchisors must ensure that disclosure documents are in full compliance with the Act because technical defences that focus on the franchisee’s lack of reliance on recognized deficiencies will not succeed.

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CASL protects Canadians from spam and electronic messaging that lead to problems such as identity theft, harassment, and fraud. CASL requires that persons who are sending a commercial electronic message to an electronic address must obtain the recipient’s consent, identify themselves, and offer an unsubscribe option. It also requires that advertising messages not be false or misleading.

The suspended provisions would have allowed private lawsuits against individuals and organizations for violations of the legislation. The provisions were originally scheduled to come into force on July 1, 2017.

The question that arises is: what does this suspension mean for businesses in Canada?

Importantly, this suspension does not mean that you no longer need to comply with CASL. All businesses must have a CASL compliance policy in place and take positive action to be ready for July 1, 2017. Apart from the private right of action, the balance of CASL and the obligations that apply under the legislation remain in place. As of July 1, 2017, the legislation will no longer presume the implied consent of the recipients of commercial electronic messages in business relationships that already existed as of July 1, 2014. For that reason, organizations that do not comply with CASL requirements face risks of significant regulatory enforcement and high penalties. For example, the Canadian Radio-television and Telecommunications Commission can investigate violations of CASL and impose various penalties. Therefore, the suspension does not affect such risks, and all businesses that are governed by CASL must take immediate steps to ensure compliance by Canada Day 2017.

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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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The facts

Prinova Technologies is a consulting business.  From 2004 to 2007, DMCT LLP acted as Prinova’s accountants.

Between 2006-2007 DMCT performed work on a number of matters for Prinova, for which it charged Prinova approximately $66K.  DMCT’s work in these years included structuring a “butterfly transaction” for Prinova.  In performing this work, DMCT had assured Prinova that the way the transaction was structured would result in no tax consequences to Prinova.

Prinova was not satisfied with DMCT’s work, including its work on the butterfly transaction.  It refused to pay DMCT’s bill.  Prinova claimed that DMCT’s work was unnecessary and deficient.  It also claimed that DMCT performed the work so poorly that Prinova had sustained damages as a result.

DMCT sued Prinova for non-payment of fees.  The parties settled at an early stage of the litigation.  As part of the settlement, Prinova paid DMCT approximately half of the amount DMCT had charged for its services.  The parties also executed a broadly-worded, mutual release. The release purported to release all claims “arising from any and all services provided by DMCT to Prinova through to and including December 31, 2007”.

Discovery of the unanticipated claim

Years later, Prinova discovered that the butterfly transaction was not “tax-free”.  To the contrary, DMCT had structured the butterfly transaction to make Prinova subject to an income tax liability of approximately $1.24 million.

Prinova sued DMCT for its alleged negligence in structuring the butterfly transaction.  It sought to set aside the release and recover damages from DMCT, including for legal and accounting fees spent by Prinova to obtain a court order rescinding the butterfly transaction.

DMCT took the position that Prinova had released DMCT from all liability for the butterfly transaction when it executed the release, and therefore its claim was barred.

The Court of Appeal’s Decision

Two courts agreed with Prinova.  They found that the release did not prevent Prinova from suing DMCT for this newly discovered claim related to the butterfly transaction.

However, the Ontario Court of Appeal overturned these lower courts.  It found that the release barred Prinova from suing DMCT in respect of the butterfly transaction.

Releasing unknown/unanticipated claims

In this case, the Ontario Court of Appeal provides some important guidance on releasing unknown claims.

The Court found the “released claims” were defined specifically and clearly in the language of the release; the parties had released “all claims” arising from the services provided by DMCT to Prinova up to a certain date.

Prinova advanced several arguments in support of why it could still sue DMCT for damages relating to the butterfly transaction.  It argued that it didn’t know about the tax liability at the time of the release and the release didn’t expressly state it was releasing “unknown” claims.  On that basis, Prinova argued that such unknown claims were “carved out” of the release and could still be pursued by Prinova.

The Court of Appeal rejected Prinova’s argument.  It found that Prinova had given up its rights to sue DMCT for, among other things, its work on the butterfly transaction in 2007.

Importantly, the Court found that a release need not specifically refer to “unknown claims” to release them.  The Court reasoned that “unknown claims” were included in the clear definition of “released claims”, which included all claims arising out of the services that DMCT provided to Prinova before the end of December, 2007.    The Court found that Prinova, in suing DMCT for unanticipated consequences of the butterfly transaction, was trying to sue DMCT for exactly the sort of claim that the parties had agreed to release.

The Court rejected the idea that to release unknown claims, the parties must specifically state they are releasing unknown or unanticipated claims.  In so doing, the Court rejected the lower court’s finding that “unless a release has exceptionally comprehensive language, it applies only to claims that were known to the parties at the time that it was executed. A dispute that had not emerged, or a question which had not arisen, cannot be absorbed by the words of a general release”.

How this applies to your disputes

Broadly worded release provisions may include the release of claims currently unknown to the parties.  When entering into a settlement and releasing claims, parties should carefully consider exactly what claims they are releasing and whether they want to preserve their ability to pursue any claims later.

Although this decision applies generally to the resolution of civil litigation, there will likely continue to be exceptions where specific language will be required to release some claims.  For example, in the context of franchise disputes, it is likely that, despite this new decision, express language will still be needed to release certain claims under Canadian provincial franchise legislation.

Sotos LLP’s litigators guide parties through dispute resolution.  We can help you to ensure that, at the end of a dispute, the right claims are released, and where applicable, claims that are to be preserved, are preserved.

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Franchisors often operate corporate stores which they own and which replicate to various degrees the original business. The profitability model for these stores is usually equivalent to the financial modeling applicable to the original business.

For the franchisees of one of these businesses, its profitability model is similar. However, its ability to control aspects of its revenues and expenses is impacted by the system within which it operates. Those impacts are in the form of the financial costs controlled by the franchisor. Often, these costs are directly linked to the franchisor’s means for making money from its franchise system. There are various potential silos of charges which a franchisor can apply to a franchisee’s business. Each franchisor will pick and choose which silos best suit its system and its financial goals. These choices will fundamentally affect the attractiveness of its system to potential franchisees. Often, these costs are directly linked to the primary silos as discussed below.

1. Franchise Fee (Initial)
Most franchisors charge an initial fee. This is often equated to the initial fee for the grant of the license to operate the system using the franchisor’s system and trademark(s). Franchise fees range in size. Against this fee, the franchisor must consider that it will incur expenses in granting a franchise which can include such things as brokerage fees and the cost of compliance with the applicable statutory disclosure regime.

2. Initial and Ongoing Training
Franchisors utilize employees and others to train new franchisee operators/managers. Franchisees typically bear the cost in the form of a training fee. Franchisors may add a profit component to the training fee.

3. Ongoing Royalties/Fees
Franchisors typically charge a royalty as a percentage of the franchisor’s gross sales or as fixed fees charged periodically (usually monthly). The royalty or fee is reflective of the underlying licensing arrangement. Franchisees usually pay these amounts without regard to their own profitability. They become a cost of operating like any other unavoidable fixed or variable expense.

4. Advertising Fund
Franchisors typically maintain a fund to which franchisees contribute to permit the establishment and operation of advertising campaigns locally, regionally and nationally for the benefit of the system as a whole. Franchisees may be required to contribute a percentage of their gross sales, again without regard to their own profitability. These contributions are applied to the hard costs of advertising but are also often applied to cover the wages of franchisors’ employees administering the fund and other head office costs. Franchisors can charge for these services on something other than a pure cost recovery basis if they choose to.

5. Sublet Rent Upcharges
Some franchisors lease premises to be used by their franchisees in the operation of their businesses as a means of “land control”. They then sublet the premises to the franchisees. Franchisors with excellent covenants might be able to negotiate lower rents than could their independent franchisees. Some franchisors, if permitted by their leases, upcharge the rent paid by the subletting franchisees.

6. Supplies and Equipment
Franchisees typically use a variety of supplies and equipment mandated by the franchisor. Franchisors mandate this use for purposes of quality control and consistency of customer experience. They also do so in order to take advantage of collective buyer power. The benefit of this buyer power may or may not be shared with franchisees. Franchisors might upsell the products to their franchisees directly or indirectly. They can also seek rebates from the system suppliers which, again, they may choose to keep for themselves or share with their franchisees. They may negotiate for marketing dollars to be paid by product and service suppliers including for application to the costs of system conventions. They might create private label programs where they supply their goods for use to the system at prices they determine. Most franchisors oblige their franchisees to only procure supplies from approved suppliers enabling these arrangements. The franchisor’s expenses for its role in the supply chain can be covered as well through these arrangements.

7. Transfer and Renewal Fees
Franchisors often charge franchisees fees if they wish to transfer their agreements or renew them. Some of these costs will be applied to the costs the franchisor will incur in the transfer/renewal processes. Sometimes their administrative and legal costs are added to the fees introducing a profit element to the franchisor.

8. Build out / Purchase Costs
Franchisors often control the process by which franchised stores are built out or renovated. They may have affiliated businesses responsible for build outs or renovations. They may contract out the work and charge an upcharge to the franchisee responsible for paying for the work. These charges can cover hard costs such as the salaries of those franchisor employees managing this construction. The charges may well exceed the franchisor’s costs for being involved in the construction. As such, the build out or renovation of a store can yield profits for a franchisor directly and indirectly.

9. Events – Opening Date / Conventions
Franchisors usually mandate a franchisee’s participation in opening store promotions and system conventions. Franchisors can choose to charge for these events on something other than a costs recovery basis and thereby be another source of profit for them.

10. Interest Charges
Amounts which may be past due can attract a contractual interest obligation on the part of the franchisee in an amount that can exceed the franchisor’s own costs of borrowing. This creates another potential profit silo.

11. Compliance Systems
Franchisors are regularly engaged in the monitoring of franchisee performance. These processes, including staff visits, secret shopper programs, audits and compliance software programs, are an expense to the franchisor. Franchisors can seek to pass on the expense or other charges relating to the activity. Again, these charges may or may not include a profit component.

12. Fines / Rewards
As an aid to compliance and franchise improvement, franchisors may have a fine/reward system where franchisees are rewarded for system compliance and fined for non-compliance including mandatory payments for defaults which may do more than offset the costs of managing defaults.

Conclusion:
Each of these potential charges can add to a franchisee’s costs of operating that it would not have if it was not part of a franchise system. The items paid for may or may not bring off-setting improvements to revenues that a franchisee could expect to earn if it operated outside of the system. Importantly, franchisees generally have little say on when or whether to incur these costs. They should make their decision to buy into a franchise having fully analyzed the potential impact of these charges weighed against the anticipated benefits of being in the system. These costs can impact the viability of franchises and their attractiveness in the marketplace. They can impact an existing franchisee’s willingness to invest in its own growth. Franchisors must balance these competing and interdependent considerations when devising and developing their systems and establishing these charges for maximum system efficiency. Their agreements with their franchisees must also permit them to have maximum flexibility to alter the charges they impose as market changes affecting the business occur.

At Sotos LLP, we help emerging and established franchisors understand these options, design systems to apply them and draft agreements and disclosure documents to reflect their expectations and best practices.

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Following publishing of this blog, Raibex Canada Ltd. v. ASWR Franchising Corp. (“Raibex”) decision has been overturned by the Ontario Court of Appeal with reasons that provide further clarity to those buying and selling franchises and their advisors as to the availability of remedies for improper disclosure under Ontario’s Arthur Wishart Act (Franchise Disclosure), 2000 (the “Act”). Please see our latest blog on the case here.

Lawyers are often asked to prepare franchise disclosure documents (“FDDs”) for franchisors prior to a location being secured.  Practically speaking, some franchisors do not want to undertake the cost and effort and possible risk of finding and securing a site unless they have a committed franchisee.  Franchisors consider franchisees to be committed only once they have signed a franchise agreement or at least paid some initial franchise fee or deposit.  While this is a common business scenario, the legal framework is fraught with risk as exemplified by the recent Ontario case, Raibex Canada Ltd. v. ASWR Franchising Corp., 2016 ONSC 5575 (“Raibex”).

Question 1: Is it OK to disclose a prospective franchisee before a site has been chosen?

Answer: Leaving the decision in Raibex aside, many would argue that Ontario’s Arthur Wishart Act (Franchise Disclosure) 2000 (the “AWA”) and its regulation clearly states that a franchisor’s disclosure obligation ends when the franchisee signs the franchise agreement or pays any money assuming an FDD has been provided to the franchisee at least 14 days prior to one of those events.  On the other hand, the AWA also requires franchisors to disclose all “material facts” together with the amount of any deposit and estimates of the costs for leases and leasehold improvements.  The overriding purpose of the FDD is to provide full and accurate disclosure so the franchisee can make a properly informed decision about whether they should make the investment and how much to invest is worth: 1490664 Ontario Ltd. v. Dig This Garden Retailers Ltd. (2005), 2005 CanLII 25181 (ONCA) at para. 16.  Without knowing the terms of the lease, a prospective franchisee would arguably not have all “material facts” sufficient to make a properly informed investment decision.  The AWA also requires that an FDD include “all copies of all proposed franchise agreements and other agreements relating to the franchise to be signed by the prospective franchisee”.  Where the franchisor signs the head lease for a franchisee’s site and then subleases to the franchisee, the form of sublease will typically incorporate all terms of the head lease.  In such case, failing to attach the head lease to the FDD is arguably tantamount to failing to attach all agreements relating to the franchise that the franchisee must sign.

Question 2: How did the Raibex decision change the above analysis?

Answer: In Raibex, the court found that a franchisor must disclose information about leasing arrangements to all franchisees.   If it is impossible to do so because the information is not yet available, then “the franchisor is not yet ready to deliver the statutorily required disclosure document.  The franchisor must wait – it does not get excused from its statutory obligations,” the court concluded. In other words, Raibex suggests that franchisors may not provide interested franchise candidates with their FDD before the terms for a site to be leased are known.

Question 3: How far does the Raibex decision go? Since “material facts” could arise at any time, when can a franchisor feel comfortable that it would not be prematurely disclosing a prospective franchisee?

Answer: Whether all information that is required to be included in the FDD is available will likely depend on the specific franchise being granted.  Franchisors should be guided by the purpose of the AWA and ask themselves whether the franchisee is being given all of the information it needs to make a fully-informed investment decision.  A distinction should also be made between those “material facts” that are necessary as a matter of course (such as the terms of a lease for franchises with physical storefronts) from “material facts” that may or may not happen (such as litigation against the franchisor).  In the former case, franchisors ought to wait for such “material facts” to materialize before disclosing a prospective franchisee. In the latter example, a franchisor’s statutory obligation should be limited to disclosing those material facts it has at the time disclosure is made since it would be unreasonable, and in many cases impossible, for franchisors to wait for such “contingent” material facts to materialize before disclosing a prospective franchisee.

Question 4: Are there any exceptions to the rule that franchisors must wait until a site has been found before disclosing a prospective franchisee?

Answer: The Raibex decision does not provide much guidance as to when a franchisor may safely disclose a prospective franchisee prior to a location being secured although, the court stated that it did not rule out such possibility and that “presumably, a materially complete form of sublease including the provisions said to be incorporated from the head lease could have been included and, provided it was materially accurate, that problem would be addressed” (at para. 77).  Accordingly, very large franchisors that are able to dictate the specific parameters of the lease it will commit to or franchisors that exclusively lease space with specific landlords, or franchisors that can disclose the most adverse lease terms that will affect the franchisee’s business would be able to disclose all material terms of leasing arrangements prior to securing a specific location for a franchisee.  Franchisors might also use a statement of material change if they secure sites between the time they gave out an initial FDD and before they entered into a franchise agreement or took a deposit.  This does not solve the possibility of having a committed franchisee in hand before securing the site.  In that situation, the franchisor should include a term in its lease allowing it the option to get out of the lease if the franchisee does not materialize.

Question 5: Should franchisees refuse to sign a franchise agreement or pay any fees if no site has been secured yet?

Answer:  Following the decision in Raibex, if a franchisee proceeded without having the site secured, it would likely be in a position to rescind its franchise agreement within two years of signing it. If, on the other hand, the franchisee requested that all of the missing information be provided prior to signing any agreements or paying any money, the franchisee would become a better informed purchaser but likely lose any rights to rescind the agreement.  While it may be tempting to a franchisee to effectively have a two-year business insurance policy from the franchisor, it may not be the “get-out-jail-free card” that is appears to be.  For example, an appeal court may reverse the decision in Raibex, a future court could choose not follow Raibex where the facts slightly differ, and the franchisor and those personally liable for deficient disclosure may not be solvent at the time a judgment or an action based on rescission can be enforced.

Question 6: What should parties do if an FDD has been provided and a franchise agreement signed before a location is selected?

Answer: The safest way to proceed is for the franchisor to return all money paid by the franchisee and the parties should cancel all signed agreements.  The franchisor should then re-disclose the franchisee based on the new FDD being for a new grant.  This time, the FDD should contain all material facts related to the head lease and the premises. The FDD should also include a copy of the head lease for the premises.  Following this process, a franchisor provides to the franchisee all relevant information about the franchise that it needs to make an informed decision about proceeding with the franchise at the specific location thus fulfilling the purpose of pre-sale disclosure under the AWA.

For questions regarding Raibex and other recent legal developments in franchising, please contact any of the Sotos team.

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