Talking Politics in the Coffee Shops

As certain provinces raise the minimum wage, franchisees cancel paid breaks for their employees and turn to franchisors for some kind of contribution or adjustment
Even as franchisors were basking in the Ontario Court of Appeal’s decision in Raibex Canada v. ASWR Franchising, Ontario’s new minimum wage legislation, which came into force less than a month earlier, threatened a new wave of issues capable of striking at the core of franchise relationships.

The original ruling in Raibex raised the prospect that franchisors could not provide adequate disclosure to prospective franchisees prior to identifying and signing a lease. As such, it was consistent with a recent jurisprudential trend that lowered the threshold of what constituted a “material deficiency” in a disclosure document and so made rescission of a franchise agreement easier for franchisees to achieve. The appellate decision, however, clearly raised that threshold.

“Raibex ... restores confidence in the common industry practice of franchisors providing a disclosure document and entering into a franchise agreement prior to site selection”, says Jennifer Dolman at Osler, Hoskin & Harcourt LLP. “Provided a franchisee is given the opportunity to make a properly informed investment decision, the fact that a franchisor's disclosure isn't perfect doesn't mean there was ‘no disclosure’ giving rise to the two-year rescission remedy.”

As refreshing as it was, however, Raibex had no impact on franchisees’ reaction to the minimum wage hikes, with some making it absolutely clear that they had no intention of bearing the burden of the increased labour costs on their own.

And while Ron Joyce Jr. and Jeri-Lyn Horton-Joyce, arguably, took their frustration out on the employees at their two Cobourg locations by moving forward with the elimination of paid break times and reduction of health benefits, it was evident that neither their franchisor nor the provincial government were at all immune from their dissatisfaction.

“These changes are due to the increase of wages to $14.00 minimum wage on January 1, 2018, then $15.00 per hour on January 1, 2019, as well as the lack of assistance and financial help from our head office and from the government,” the Joyces stated in a letter to employees.

Ontario Premier Kathleen Wynne was quick to jump into the fray, calling the Joyce’s actions a “clear act of bullying.” Others blamed the Ontario government, which mandated the rise in the province’s hourly minimum wage from $11.60 to $14, or 20.7 per cent, with a further 6.7 per cent increase to $15 on January 1, 2019.  Tim Hortons’ head office responded by saying that “Team Members” shouldn’t be treated as an expense and blaming the negative publicity on a “rogue group” of franchisees.

However that may be, the fact remains that the trend to higher minimum wages is nationwide. Alberta’s minimum wage rose from $12.20 to $13.60, or 11.5 per cent, on October 1, 2017 and will rise to $15, a further 7.1 per cent increase, on October 1, 2018. PEI will raise its rate to $11.55 in April and Québec will go to $11.75 in May.

Some eight per cent of Canadian employees are paid at the minimum wage rate. In July 2017, the Canadian Federation of Independent Business concluded that 34 per cent of Ontario’s small and medium-sized businesses would consider selling, closing or moving because of the increases. “The business pressures invoked by the minimum wage hikes and other reforms are putting pressure on some franchisees and they will be looking to their franchisors for help,” says Stéphane Teasdale at Cassels Brock & Blackwell LLP.

Unfortunately, Tim Hortons isn’t the only franchisor who appears to have been slow to react to the changes in the workplace law environment. “The industry may have been caught up in some of the relief that followed on the fact that the Ontario government’s recent employment law reforms did not include provisions deeming franchisors to be joint employers — as many franchisors had feared,” Dolman says.

It is true is that the recent employment law reforms impact franchisees more directly than they do franchisors. But franchisors who don’t understand that the changes are a systemic problem are approaching the issues from a myopic perspective. “The way in which franchise systems should be addressing minimum wage and other changes to workplace law has been a major concern over the last several months,” says Allan Dick of Sotos LLP. “There’s a steep learning curve that needs to be addressed.”

With minimum wage increases hogging the spotlight, franchisors may also not have adequately turned their minds to other burdens imposed by employment law reform, such as the cascading effect on higher-earning workers. “People who are making more than the minimum wage will expect to be bumped up too,” says David Shaw at Blake, Cassels & Graydon LLP. “That could be a real problem for some employers.”

Changes to the rules governing part-time help as well as limitations on scheduling, standbys and the right to decline shifts could also impact franchisees’ profitability. “Employers who are not managing their workforce and labour costs by taking the new rules into account will find that the changes will quickly hit their bottom line,” says Helen Fotinos at McCarthy Tétrault LLP. “And quite apart from assisting franchisees by, for example, updating business systems to take into account new scheduling rules, franchisors may have to revisit their earning projections to see what franchisees need to be profitable in this new environment.”

From a purely contractual perspective, there’s not much doubt about who’s legally bound to shoulder the burden. “Franchise agreements almost universally make franchisees responsible for their employees,” says Larry Weinberg at Cassels Brock. “That is almost never unclear and an important part of the historical franchising relationship that required franchisees and their employees to be independent contractors and not employees of the franchisor.”

Franchisors who don’t scrupulously avoid asserting any kind of control over employees run the not inconsiderable risk of becoming “joint employers” and greatly increasing their exposure to workplace obligations and liabilities. “The law is becoming ever more explicit that franchisors can avoid joint employer issues only if it is clear that the employees are exclusively under franchisees’ control,” Shaw says.

Tightening the franchisees’ noose even further is the standard clause in franchise contracts that requires franchisees to conform to applicable laws and regulations. “Typically, a franchise agreement has lengthy provisions making it clear that the franchisee is solely responsible for hiring and firing and complying with all labour and employment laws,” Dolman says.

It’s unlikely, then, that franchisors will be chipping in directly to mitigate franchisees’ increased labour costs. “If a franchisee comes to a franchisor for help, there’s no way that the franchisor will do anything that creates the risk of being characterized as a joint employer,” Shaw says.

The upshot is that there’s no doubt where the burden of the higher minimum wage falls.  “It’s the franchisee, not big business, that’s going to get squeezed,” Weinberg says. But would it were all that simple: after all, franchising isn’t all about franchise agreements any more than marriage is all about marriage contracts. “A franchise agreement is an asset that talks back,” says Weinberg. “Franchisors need co-operation, so they can’t rule with an iron fist.”

From a purely legal perspective, the Québec Court of Appeal’s 2015 decision in Dunkin’ Brands Canada c. Bertico suggests that franchisors have a fundamental, ongoing, continuing and successive obligation to support their brands. But the extent to which the decision impose significant obligations on franchisors to keep up with developments in the business world is unclear, as is the applicability of the case to the common law provinces. “The fact remains, however, that Dunkin’ Donuts was held liable to its franchisees because the company wasn’t working hard enough to try and help them deal with the competition from Tim Hortons and elsewhere,” says Teasdale, who represented Dunkin’ Donuts.

Legalities aside, the practical reality is that employment law reform is as much the franchisors’ problem as it is an issue for their franchisees. “The good franchisors, who are the ones with the business expertise, will be looking for solutions and options with which they can help the franchisees,” Teasdale says. “If they don’t, the pressure will build and may eventually blow up in their faces.”

Unfortunately, some franchisors are risking it. “We are aware of franchisors telling franchisees that the new employment laws are their problem,” Dick says. “So what they end up with are discontented people, and discontented people do things.”

What they frequently do first is call their lawyers, and the first thing lawyers do is start combing the franchise agreement and disclosure documents by way of “looking for loopholes,” as the comedian W.C. Fields, known for his fiery atheism, was said to have remarked when caught reading the Bible just before he passed away.

“Once lawyers start looking at these transactions, it’s amazing how many defective disclosures or defective delivery of disclosure documents crawl out of the woodwork, especially because the statutory requirements are so technical and in some aspects so strictly enforced,” says Ned Levitt at Dickinson Wright LLP.

Raibex aside, franchisors who signed up franchisees while the proposals for workplace and labour laws were in their early stages, but being bandied about publicly, may be at particular risk. “If a franchisee was aware that changes might be coming and didn’t disclose that, the failure to disclose — especially in a labour-intensive business — might rise to the level of materiality that could risk rescission of the franchise agreement,” Levitt says.

Generally speaking, rescission is available as a remedy only in a franchisee’s first two years of operation. But other remedies, like misrepresentation claims for damages, are not so limited. Dick says good franchisors won’t allow things to go in that direction. “Franchisees most frequently consult their lawyers when something has broken down and the franchisor has lost control over the problem,” he says. “Good franchisors don’t want that because they want their franchisees to thrive and think about investing in more units. So they, like the franchisees, will realize that higher minimum wages are an issue that they need to address together.”

The emphasis, as Teasdale points out, is on all sides pitching in. In other words, franchisees cannot avoid stepping up to the plate. “Because the relationship is not a vertical one, franchisees need to get to work as well,” Teasdale says. “Unfortunately, not all of them are always up to the challenge.”

Many franchisees, for example, will have to review their employment contracts to ensure they accord with the new regulatory environment. Otherwise, franchisors and franchisees will have to consider the viability of raising prices. “The public will have to be convinced that the rise in prices is a Kathleen Wynne [Ontario’s Premier] tax on consumers and not just a money grab by retailers,” Dick says. “A phase-in might be the best way to go.”

Weinberg warns parties about the Competition Act.  “It’s certainly legal for a franchisor to dictate prices, but franchisees can’t get together and combine in furtherance of a common price approach,” he says. “Requests from individual franchisees to the franchisor will pass muster, but if the requests emanate from a dialogue or meeting of franchisees, competition laws could come into play.”

Some franchisors, Shaw believes, may reduce royalty rates by way of helping franchisees cope with their new labour costs. For his part, Dick suggests that franchise systems consider rationalizing menus and offerings to cut back on lower-margin items, tightening cost controls, training employees in a broader range of tasks to avoid call-ins, and changing store hours to have more closures at unprofitable times.

Automation also works. “I would expect franchisors will turn to technology to help reduce their franchisees’ dependence on employees altogether,” Shaw says. “McDonalds, for example, has already installed kiosk ordering screens at their locations.”

But the need for investment in technology can breed friction. “There can be a tension between franchisors that need to make systemic changes to keep their market share and stay competitive and franchisees who may be resisting that,” Dolman says. “For example, when franchisors look to get their brands out by means of online apps or other types of online presence, they may be taking away franchisees’ bread and butter.”

The upshot is that “encroachment” has become topical in the industry, with historical issues of territorial encroachment giving way to encroachment that occurs when franchisors resort to alternative distribution. “The more consumers buy online, the less they’re going to buy at the store,” Dolman says. “And that means encroachment may become the next legal battlefield.”

It’s a battlefield that is shaping up quickly: according to the National Retail Federation, US sales on Cyber Monday eclipsed those on Black Friday for the first time. To stay competitive with the retail environment, franchisors are trending to “omnipresence” with physical stores, online stores and platforms for mobile devices. “It’s all about improving the brand experience for customers who want the option of shopping on multiple platforms, perhaps even at the same time,” Dolman says. “In this new ‘omni-channel’ retail world, physical stores, websites and apps function better when they’re all integrated.”

This new world has an impact on the franchise relationship, then, because franchisees are no longer the only ones dealing with their customers. “When it comes to sales, franchisees may be competing with the franchisor’s website and their customers’ mobile devices,” Dolman says. “Who gets credit for these e-commerce sales? The franchisee or the franchisor?”

Encroachment issues can also arise in regards to alternative distribution channels. “To stay competitive in an environment of retail convergence, franchisors can’t just rely on franchisees selling product from their stores,” Dolman says. “We’re increasingly seeing products that traditionally were only sold by franchisees now available in non-franchised stores, in department stores, grocery stores, pharmacies, convenience stores and kiosks.

Finally, encroachment can also occur when competing franchisors merge or brands purchase their competitors. But it’s not as if all this is a sudden revelation to franchise lawyers or their clients. “Technology, the internet and e-commerce have played an increasing part of the evolution of selling products and service for the last 10 or 20 years, and they will continue to do so,” Teasdale says. “From a legal perspective, we’ve been taking these developments into account since they’ve emerged.”

Indeed,  franchisors have tried to limit potential liability arising from encroachment claims by reserving applicable rights to themselves from the time the internet imposed its unique species of territorial issues on the industry. But no matter how broadly franchisors reserve the right to do what it takes to survive, including expanding beyond bricks and mortar, the ultimate question is always the extent to which such encroachment undermines the franchise agreement. “Courts are going to ask themselves whether franchisees really understood how far franchisors could go, and whether franchisees can still expect reasonable returns on their investments,” Dolman says. “They’re also going to ask how the duty of good faith and fair dealing comes into play.”

Quite apart from the fact that increased online sales can destroy a franchisee’s business if not accounted for in the franchise relationship, franchisors may well require franchisees’ co-operation to maximize the online experience. Franchisors may want to permit customers to take returns to a store instead of sending them back, or may wish to encourage customers to pick up their purchases at the store instead of having them delivered.

“This is particularly important when a franchisor is dealing in complicated products that require some training for customers, or where customers are likely to need accessories or add-ons and it makes more sense to buy them at a local store,” says Blakes’ Shaw.
In such cases, co-operation is paramount by way of ensuring a good customer experience. “Franchisees who aren’t getting anything out of the online sales or are ticked off at the franchisor’s online practices are not likely to co-operate — so sometimes franchisors have no choice but to buy that co-operation,” Weinberg says.

Franchisees are doing that in various ways, either in the franchise agreement or by striking deals otherwise: for example, sometimes they pay a reverse royalty to the franchisee if the online purchaser’s address lies within the franchisee’s territory and sometimes they pay a flat royalty calculated in a variety of ways.

Ironically, the seismic changes enveloping the retail market could help the mom and pop operations that populate franchisees’ demographics. “Retail everywhere will have to undergo seismic change to survive, and in that environment individual mom and pop operations have just about no chance,” Shaw says. “But give these operations an established brand that has a well-developed franchise system and enough purchasing power, and they may very well have opportunities not only to survive but to succeed and expand.”