The Franchise Law Minefield

Franchisors face a complex and challenging legal environment across Canada

Canada has the second-largest franchise industry in the world, behind the US. There are an estimated 1,300 franchise brands with more than 78,000 franchise units across the country. They employ more than one million Canadians, representing upwards of 7 per cent of the working force. US franchises dominate the landscape. Franchising is particularly significant in Ontario, which boasts 56 per cent of the country’s franchise headquarters and 65 per cent of its outlets.

For all this activity, only six provinces have franchise legislation. Alberta was first in 1971 and enacted a major update in 1995. Six years later, Ontario borrowed heavily from Alberta in passing the Arthur Wishart Act (AWA). Manitoba, New Brunswick and Prince Edward Island followed with legislation that was substantially similar to that in Ontario.

British Columbia’s new Franchises Act received Royal Assent late last year and the government is busily drafting regulations. At press time, it wasn’t clear when the Act would be proclaimed. “My best guess is that the legislation will be in force in the latter part of 2016,” says Blair Rebane of Borden Ladner Gervais LLP in Vancouver.

But the legislation hasn’t really evolved. Alberta’s law has not changed since the 1995 update and Ontario hasn’t revised the AWA – which doesn’t even allow for electronic delivery of disclosure documents – since its inception 15 years ago. Most of the provinces don’t have any statutory provisions to cover distant sales, such as those made online.

But even the BC legislation is substantially similar to the outdated franchise laws in the other jurisdictions. For example, the provisions regarding two of the most significant elements of franchise legislation, namely the disclosure provisions and the duty of good faith and fair dealing, closely mirror their counterparts elsewhere in the country.

As it turns out, disclosure is the major bugbear. Ontario, for example, is one of the only jurisdictions in the world that has an open-ended and subjective standard of disclosure that includes “all other material facts.” To make matters worse, there’s no guidance in the legislation as to what “other material facts” should include, leaving room for considerable interpretation on key disclosure items.

To their credit, BC legislators followed Alberta’s lead by putting a “substantial compliance” provision in their law. It provides that minor defects not affecting a document’s substance will not give rise to rescission, the primary remedy for inadequate disclosure.

That is not to say that the British Columbia legislation won’t suffer from a fair dose of the interpretive uncertainty that plagues the rest of Canada.

“The BC government did not adopt recommendations made by the CFA [Canadian Franchise Association] and OBA [Ontario Bar Association] proposing to limit disclosure requirements to a finite list of ‘material facts’ or to further restrict the definition of a ‘franchise agreement’ to the agreement granting the franchise,” says Larry Weinberg of Cassels Brock & Blackwell LLP in Toronto. “As such, the same indefinite scope of what may need to be disclosed in any one case, present in the other provinces, will likely be a feature of British Columbia’s legislation.”

Among other things, all this uncertainty creates undue costs for individual franchisees and constitutes a significant entry barrier for foreign companies looking to enter the Canadian retail marketplace.

Fortunately, there is a move to change, as evidenced by the mere enactment of BC’s new laws. In Ontario, when the Business Law Agenda Stakeholder Panel, created to make the province a more competitive business jurisdiction, filed its report in July 2015, one of the 12 pieces of legislation targeted for a major revamp was the AWA, which governs franchising law.

The Stakeholder Panel recommended that revisions to the AWA be focused on creating more disclosure certainty for users, “taking account of legislative and case law developments in Canada, the United States, and elsewhere, and identifying opportunities for harmonization with the other provinces.”

In early March, the government set up a new Business Law Advisory Council with a mandate to advance the Panel’s recommendations. Still, just what kind of priority the AWA will get in the massive task involving the overhaul of many statutes remains to be seen.

 

Meanwhile, the lingering uncertainties have engendered considerable high-profile litigation.

“There were more franchising decisions in 2015 than any year in recent memory, and a couple were incredibly significant,” says David Shaw of Blake, Cassels & Graydon LLP in Toronto.

The key decisions, mostly in Ontario and Québec, featured the likes of GM, Pet Valu and Dunkin’ Donuts. But, arguably, what the collective impact of the complex, sometimes difficult to comprehend jurisprudence did most was to highlight the need for legislative change.

The Québec Court of Appeal, for example, found Dunkin’ Donuts liable to the tune of about $11 million for breaching its duty of good faith towards a group of 21 franchisees. The court ruled that the franchisor had failed to protect and enhance its brand in the face of a competitive onslaught from Tim Hortons that saw Dunkin’ Donuts’ market share reduced from 12.5 per cent in 1995 to 4.6 per cent in 2003.

“We’re all waiting to see if Dunkin’ Donuts will impose significant obligations on franchisors to keep up with developments in the business world,” says Joëlle Boisvert of Gowling WLG LLP in Montréal.

But the “wait” period could be somewhat lacking in focus. “The Court of Appeal was not clear on what ‘enhancement’ meant, so franchisors are still calling me all the time about that,” says Stéphane Teasdale of Dentons Canada LLP in Montréal.

As well, because Québec has no franchise legislation, controversy still rages about whether and how Dunkin’ Donuts affects the duties of franchisors in provinces that do have franchise laws.

“Some commentators have argued [that the Supreme Court of Canada’s decision in] Bhasin, [which for the first time held that a duty of good faith existed with respect to all contractual dealings], combined with Dunkin’ Donuts, increases the duties of franchisors across Canada,” says Jennifer Dolman of Osler, Hoskin & Harcourt LLP in Toronto. “But Dunkin’ Donuts is based on concepts contained in the Civil Code of Québec that are not mirrored in the law of other Canadian provinces and, in any event, the decision is not binding on courts outside of Québec.”

Nadia Effendi of Borden Ladner’s Toronto and Ottawa offices thinks courts have been careful not to import Bhasin into franchise law. “What judges are saying is that the focus should be on the duties spelled out in the legislation,” she says.

Less than three months after the Dunkin’ Donuts ruling, the Ontario Superior Court of Justice deferred to GM’s business judgment in dismissing a class action brought by dealers after the company’s Canadian arm, in a reorganization aimed at avoiding a Companies’ Creditors Arrangement Act filing, refused to renew some 240 dealer agreements. Interestingly, the reasons for judgment made no reference to Dunkin’ Donuts.

At press time, the GM case was on appeal to the Ontario Court of Appeal, while the Supreme Court of Canada had denied leave to appeal in Dunkin’ Donuts — therefore the status of even the clearer principles enunciated in these cases remains uncertain.

But no more uncertain than other important issues, especially those touching on the balance between franchisor control and franchisee rights. Towards the end of 2014, the Ontario Superior Court decided, in Pillar to Post, that a franchisor could enforce an arbitration clause precluding a franchisee from participating in a class action. By contrast, the Cora decision from the Ontario Court of Appeal, delivered just a few months after Pillar to Post, established that franchisors could not rely on contractual provisions requiring franchisees to release claims otherwise enforceable under Ontario law. Most recently, the issue arose in the GM case, where the Ontario Superior Court ruled that waiver by a franchisee of a right under the Wishart Act will generally be void and unenforceable unless the release is given by a franchisee with the advice of counsel in settlement of a dispute for existing and fully known breaches of the legislation. Finally, there are no cases on the emerging issues arising from master franchise disputes, which tend to arise in the context of foreign franchisors.

“Generally speaking, the jurisprudence has created a moving target,” says Helen Fotinos, who practices in the Toronto office of McCarthy Tétrault LLP.

But there hasn’t been a total absence of progress on the certainty spectrum. “In a general sense, we are finally getting a significant body of case law that provides franchisors and franchisees with some guidance,” says Ned Levitt of Dickinson Wright LLP in Toronto.

But just in case the uncertainty arising from domestic legislation and case law isn’t enough of a headache for the franchise business, developments in the US have raised the specter of a serious new blow to the industry.

In 2015, the National Labor Relations Board suggested in Browning-Ferris Industries of California that joint-employer status could arise when a party had the contractual right to control terms and conditions of employment. The previous test required the actual exercise of such control. Under the new test, franchisors could be liable as joint employers of their franchisees’ staff if the franchise agreement was drafted to include or imply control over employment, regardless of whether the franchisor in fact exercised such control. Franchisors found to be joint employers could be held responsible for each of their franchisees’ union obligations and hiring and firing relationships.

Considering it is not binding, Browning-Ferris has caused quite a stir in Canadian franchising circles. “The idea behind franchising is to grow with partners who are independent contractors and invest their own capital,” Teasdale says. “Making the franchisor a joint employer annuls that concept because it means the franchisor becomes invested in the business of the individual franchisee.”

The prospect of joint employment in the industry is most acute in Ontario, where the government is considering changes to the Employment Standards Act and Labour Relations Act. “If joint employment arrives anywhere in this country, it will be a game-changer,” Shaw says.

What’s problematic is that there’s no bright line in the law as to the degree of control required to invoke a finding of joint employment. “Franchisors have to be careful not to cross over the line, but the line is not definable,” says Susan Friedman of DLA Piper (Canada) LLP in Toronto.

So while there have been no legislative or jurisprudential developments on this in Canada yet, franchise lawyers are taking a preventative approach. “We’ve been advising some of our clients to scale back on some of the areas in their operations manuals and practices that touch on employment issues,” Fotinos says.

Control is also at the core of concerns regarding the impact on franchisors of Ontario’s Healthy Menu Choices Act, which comes into force on January 1, 2017. The new legislation requires regulated food-service premises with 20 or more locations in Ontario that sell prepared, ready-to-eat food to post itemized caloric and other nutritional content on menus.

Although the CFA successfully advocated for lawmakers to change the application of the Act so that franchisors won’t, as originally contemplated, be liable for breaches of the law by their franchisees, franchisors will still have to be careful that they do not fit within the category of someone “who has responsibility for and control over the activities.” The Act is specific in providing that such a person “may” include a franchisor.

 

Despite all this, franchising remains a business model that has proven to be quite stable in Canada. Fotinos, a former general counsel at Kia Canada Inc. and St. Louis Bar & Grill, believes that a continuing inflow of US franchise systems will fuel the Canadian market. Friedman maintains that franchises will continue to be attractive propositions for an aging population not quite ready for retirement but with retirement packages in hand.

However that may be, there will of course be a host of business considerations that will determine the future of franchising. But as history has shown, what the legislators and the judges do could have a profound impact on the balance between franchisors and franchisees that is so critical to the future of the sector. That’s where lawyers with the proper expertise come in.

“It’s no place for amateurs,” says Levitt.