Legal restrictions on franchise contracts and the relationship between the parties

Franchise relationship laws

Are there specific laws regulating the ongoing relationship between franchisor and franchisee after the franchise contract comes into effect?

Other than the Canadian Franchise Acts, there are no specific statutes directly affecting the franchise relationship.

 

Operational compliance

What mechanisms are commonly incorporated in agreements to ensure operational compliance and standards?

Franchise agreements will often contain several controls and oversight mechanisms in favour of the franchisor in order to verify the accuracy of royalty payments made, supervise the use of its marks and ensure overall compliance of the franchised operations with the franchised concept and the brand. These may include an obligation for the franchisee to submit weekly, monthly or annual reports of its sales, or both, in addition to point of sale, inventory control and other software that report in real time. The franchisor may also have a right to inspect and audit franchisee's records in the event that a franchisee fails to submit such reports or such reports are suspected or determined to be inaccurate. Other controls include requiring that franchisees submit all proposed store locations, store designers and contractors, product suppliers and marketing materials to franchisor for prior approval, as well as a right to inspect the franchise location during operating hours to ensure that the franchisee is properly implementing the franchise system, including rights to assume management of the franchised location in extreme cases.

Amendment of operational terms

May the franchisor unilaterally change operational terms and standards during the franchise relationship?

In order to maintain competitiveness in the market, franchisors must continuously change and evolve their franchise systems to adapt to market realities. While franchisors may reserve the right to modify the franchise system throughout the term of the franchise agreement, the implementation of substantial operational standards may be difficult if not all franchisees are in agreement with the change or such change imposes a significant financial burden on franchisees. On the other hand, in the Province of Quebec a franchisor may be liable if it fails to implement necessary changes in order to maintain the competitiveness and relevance of the franchise system, resulting in a significant erosion of the franchise network's market share. Franchisors should, therefore, be mindful of its franchisee's interests when implementing any operational changes to avoid potential objections, whether business or legal, from a large group of franchisees in the network.

Other laws affecting franchise relations

Do other laws affect the franchise relationship?

The ongoing franchise relationship is subject to generally applicable federal and provincial statutes and the principles of contractual law that emanate from the common law or, in Quebec, the civil law.

Canadian courts have been pragmatic in their approach to on-going relational matters as they relate to franchising. The clear and express terms of a franchise agreement will be determinative of the issues arising in connection with same. If such agreements are unclear on a given point, courts will generally construct the litigious terms in a manner that provides for a ‘sensible commercial result’. This has not, however, prevented courts from rendering judgments against franchisors that excessively and unlawfully interfere with the economic interest of their franchisees.

Policy affecting franchise relations

Do other government or trade association policies affect the franchise relationship?

No other government policies or requirements directly affect the franchise relationship.

Termination by franchisor

In what circumstances may a franchisor terminate a franchise relationship? What are the specific legal restrictions on a franchisor’s ability to terminate a franchise relationship?

There are no restrictions at law on the parties’ rights to contractually establish termination rights and consequences arising upon termination. Nevertheless, courts may require that a material breach of the agreement be proven in order to permit its termination and will, from time to time, intervene to redress cases of abuse.

Termination by franchisee

In what circumstances may a franchisee terminate a franchise relationship?

There are no rights at law that would specifically allow a franchisee to terminate the franchise relationship other than those applicable to all contracts under general principles of law and those expressly granted by the Canadian Franchise Acts. Similarly, there is no restriction precluding the parties from granting specific termination rights to a franchisee, although this is not often seen in typical franchise agreements used in Canada.

Renewal

How are renewals of franchise agreements usually effected? Do formal or substantive requirements apply?

The requirements to renew a franchise agreement are not prescribed by law. As such, the franchisor and franchisee will be free to determine the conditions incumbent upon the franchisee's exercise of a right to renew the franchise agreement. These conditions generally include requirements to provide written notice of the franchisee's intention to exercise the renewal right within a specific period of time, to make certain capital expenditures to modernise its franchise location to reflect the then current image of the brand, to be in compliance with the terms of the franchise agreement and to pay a franchise renewal fee. The right to renew may also be conditioned upon the execution of an updated version of the franchise agreement. While a franchise agreement may provide for automatic renewal, it is more common for renewal to be subject to substantive requirements similar to those described herein.

Refusal to renew

May a franchisor refuse to renew the franchise agreement with a franchisee? If yes, in what circumstances may a franchisor refuse to renew?

In Canada, a franchisor may refuse to renew a franchise agreement with its franchisee unless such renewal is contractually required. The franchisor may contractually subject such renewal to the signature by the franchisee of a new franchise agreement and other conditions, including performance goals that the franchisee is required to achieve.

Transfer restrictions

May a franchisor restrict a franchisee’s ability to transfer its franchise or restrict transfers of ownership interests in a franchisee entity?

A franchisor may contractually restrict a franchisee’s ability to transfer its rights and interests under the franchise agreement, most notably by subjecting such transfer to the prior consent of the franchisor.

Fees

Are there laws or regulations affecting the nature, amount or payment of fees?

No general restrictions apply to payment of initial fees. Where franchises are involved in the sale of specifically regulated products or services, including liquor, medical or pharmaceutical products and services, however, a franchisor’s ability to collect royalties on such sales may be restricted.

Usury

Are there restrictions on the amount of interest that can be charged on overdue payments?

Franchise agreements frequently set out the rates of interest charged on overdue fees and royalty payments. Section 347 of the Criminal Code (Canada) provides that anyone who enters into an agreement to receive interest, or who receives a payment or partial payment of interest, at an effective annual rate of interest (broadly defined) in excess of 60 per cent on the credit advanced, commits an offence thereunder.

In addition, section 4 of the Interest Act (Canada) specifies that unless the contract expresses the applicable rate of interest on an annualised basis, interest will only be recoverable at a rate of 5 per cent per annum despite the terms of the contract.

Foreign exchange controls

Are there laws or regulations restricting a franchisee’s ability to make payments to a foreign franchisor in the franchisor’s domestic currency?

A franchisee may be required to make payments in a foreign franchisor’s domestic currency. Nevertheless, the Currency Act (Canada) precludes a Canadian court from rendering a judgment in any currency other than Canadian currency.

Confidentiality covenant enforceability

Are confidentiality covenants in franchise agreements enforceable?

Confidentiality covenants in franchise agreements are not only enforceable but highly advisable in light of the fact that recourse is only otherwise available under common law tort, as opposed to under any specific Canadian statute governing trade secrets or other confidential information. Confidentiality clauses can be for a longer duration than non-compete clauses.

Good-faith obligation

Is there a general legal obligation on parties to deal with each other in good faith during the term of the franchise agreement? If so, how does it affect franchise relationships?

The Canadian Franchise Acts impose a general obligation of fair dealing upon the parties to a franchise relationship.

It is established law in Canada that the relationship between a franchisor and a franchisee is generally not a fiduciary one.

The Supreme Court of Canada has found that there is an inherent duty for parties to honestly perform their contractual obligations. Canadian courts (even in provinces without franchise legislation) have also generally begun to read into franchise agreements an implied duty of simple good faith (as opposed to ‘utmost good faith’). A perhaps more fulsome obligation exists under the Civil Code of Quebec, which imposes a legal requirement for all parties in matters governed by Quebec civil law to conduct themselves in good faith during contractual and pre-contractual dealings. Accordingly, the courts have stated that where the franchisor retains sole discretion to authorise, prevent or proceed with a particular course of action, the franchisor will have to exercise its discretion reasonably. In addition, the duty to act in good faith requires a prompt response to another party’s request and the making of a decision within a reasonable period of time thereafter. Moreover, parties under a duty of good faith must also pay any amounts that are clearly owed to another party in a timely manner.

The duty to act in good faith does not necessarily preclude a franchisor from competing with its franchisee (assuming, of course, the absence of contractual exclusivity in favour of the franchisee). A franchisor that opts to compete with its franchisee must ensure that it continues to perform its legal obligations towards the latter and that it acts in such a way that the franchisee may continue to enjoy the benefits of its franchise. The common law principle of non-interference with the freedom of the parties to contract will often limit judicial interference in franchise agreements whose terms are found to accurately reflect the intent of the parties and are not patently inequitable. A determination as to whether a duty of good faith has been breached will be contingent upon all of the surrounding circumstances.

Franchisees as consumers

Does any law treat franchisees as consumers for the purposes of consumer protection or other legislation?

Consumer protection legislation in Canada has been enacted at the provincial level. The applicability of such legislation is generally restricted to transactions entered into for personal, family or household purposes and the legislation generally excludes from its ambit transactions entered into for business purposes. In a 2004 case before the Superior Court of Quebec, a franchisee sought to avail itself of protection under the Consumer Protection Act (Quebec) but was unsuccessful, the Court concluding that the tenor of the correspondence between the franchisee and the franchisor, as well as the nature of the franchise agreement, both clearly implied a commercial relationship falling outside of the scope of the legislation.

Language of the agreement

Must disclosure documents and franchise agreements be in the language of your country?

The Charter of the French Language (Quebec) compels businesses to prepare franchise agreements and disclosure documents in French for use in the Province of Quebec unless the parties have expressly agreed that another language may be used, which is not uncommon in circumstances where both parties are comfortable in such other language.

Restrictions on franchisees

Describe the types of restrictions placed on the franchisees in franchise contracts.

Franchise agreements often provide for exclusive territories and exclusive dealings with designated suppliers. These are not illegal per se , but are subject to competition law concerns relating to substantial lessening of competition and market barriers, including the exclusive dealings and abuse of dominance provisions of the Competition Act (Canada). Restrictions on the customers that the franchisee is entitled to serve may not be acceptable as they may be viewed as violating the market division prohibitions of the Competition Act or providing strong evidence of collusion pursuant to the same. These business practices are only subject to review if they have a negative impact on competition in the concerned market, which would typically only arise if a franchisor or its network has a considerable market share.

Price maintenance is a reviewable trade practice under the Competition Act. The threshold for enforcement authorities to apply sanctions on the basis of price maintenance requires that the franchisor’s conduct be likely to have an adverse effect on competition. Providing a minimum resale price or advertised price may be considered evidence of undue influence by the franchisor and invite review by the Competition Bureau; however, franchisors may impose maximum prices as long as the latter are clearly referred to and defined in the franchise agreement and are not construed by courts as demonstrating an intent to establish a minimum resale price. Accordingly, it is always prudent for franchisors to include disclaimers, whether in advertising or on packaging, to the effect that franchisees are at liberty to establish their own resale prices. Furthermore, it is preferable to contractually provide that prices are only suggested and that the failure of the franchisee to adhere to the suggested prices will not result in termination of the franchise agreement or detrimentally affect the relations between the parties.

Franchisors who are deemed to control a market are also subject to review by the Competition Bureau under the abuse of dominance provisions in the Competition Act. As of 2009, the criminal pricing provisions addressing price discrimination, predatory pricing, geographical price discrimination and promotional allowances have been repealed with a view to promoting innovative pricing programmes and increasing certainty for Canadian businesses. Nonetheless, such pricing policies may be reviewed under civil provisions of the Competition Act where there is evidence of a likely substantial anticompetitive effect.

Non-competition and non-solicitation covenants are closely monitored by the courts. All restrictive covenants raise restraint of trade concerns and, accordingly, only reasonable restrictions as to scope of action (described with sufficient particulars), duration and geographical reach will be upheld by the courts. Canadian courts will generally not write down or reduce restrictive covenants determined to be unreasonable, but will uphold or strike down the covenant in its entirety.

Last, all Canadian provinces permit the selection of a foreign governing law as long as doing so is not considered to be in fraud of the domestic law. That said, Canada is party to numerous international treaties such as the Vienna Convention on the International Sale of Goods – where the selected or applicable law is that of Canada, the foregoing Convention finds automatic application unless expressly set aside by the parties in their contract.

Competition law

Describe the aspects of competition law in your country that are relevant to the typical franchisor. How are they enforced?

The Competition Act sets forth penal and civil recourses with respect to various practices, including those identified as conspiracies and collusion, abuse of dominance, price maintenance, promotional allowances and price discrimination, false or misleading advertising, deceptive marketing and pyramid selling, refusal to deal, exclusive dealing, tied selling, as well as certain other vertical market restrictions.

While the penal provisions of the Competition Act impose a higher burden of proof, their violation grants injured parties the right to sue for damages caused by such practices; those damages are restricted to actual loss and costs. Fines are also applicable for certain types of offences. On the other hand, reviewable practices are civil in nature and are subject to the exclusive jurisdiction of the Competition Tribunal, upon the request of the commissioner of competition or at the request of a private party with leave from the Competition Tribunal to that effect. In the latter case, private litigants may only seek redress of conduct that constitutes a breach of an order under the Competition Act, as monetary awards are not provided for. The Competition Tribunal may make orders for a reviewable trade practice to cease, or compel a business to accept a given customer or order on reasonable trade terms.

The Commissioner of Competition heads the Competition Bureau and has broad powers of investigation and inquiry, such as search and seizure, examinations under oath, and ordering the production of physical evidence or records and wire tapping (in certain circumstances). Its enquiries are conducted under strict rules of confidentiality and its powers remain subject to the supervision of the courts. On the international level, the Competition Bureau has concluded numerous agreements of notification and mutual assistance with its international counterparts and is an active member of the International Competition Network.

Courts and dispute resolution

Describe the court system. What types of dispute resolution procedures are available relevant to franchising?

The Constitution Act 1867 sets out the areas of law with respect to which the federal government has the power to legislate (for example, intellectual property, bankruptcy, trade and commerce) and the areas of law with respect to which each provincial government has the power to legislate within provincial borders (eg, property and civil rights). Canada also has a dual court system. The Federal Court of Canada has jurisdiction over matters in respect of which jurisdiction as to subject matter is specifically conferred to it by statute, whereas the provincial courts have residual jurisdiction over remaining matters.

Choice of forum clauses are generally enforced by the Canadian courts, thus making it possible for the parties to choose that a non-Canadian court resolve any dispute or claim arising from any agreement. In addition, mediation and arbitration are viable and recognised mechanisms of dispute resolution across Canada. Furthermore, Canada is a signatory party to the United Nations Convention on the Recognition and Enforcement of Foreign Arbitral Awards. Both the federal and the provincial governments have also adopted substantially similar legislation to the UNCITRAL Arbitration Model Law. To date, four provinces (Ontario, British Columbia, Alberta and Saskatchewan) have incorporated mandatory alternative dispute resolution processes into their respective procedural statutes, and most provinces have enacted arbitration legislation. In addition, the revised Quebec Code of Civil Procedure, which came into force on 1 January 2016, requires parties to consider private dispute prevention and resolution methods before referring their dispute to the courts.

Arbitration – advantages for franchisors

Describe the principal advantages and disadvantages of arbitration for foreign franchisors considering doing business in your jurisdiction.

The principal advantages and disadvantages of arbitration for foreign franchisors in Canada are essentially the same as for local franchisors.

Arbitration has the main advantage of being confidential. Disputes between franchisors and franchisees do not become a matter of public record as would be the case with litigation in the judicial system. In addition, arbitration gives the parties a level of control that they may not otherwise have over some aspects of the dispute, such as choice of venue and forum and the selection of an arbitrator with expertise in franchise issues or the relevant technical or specialised fields. Arbitration agreements are final, reliable and not open to appeal; Canadian courts have generally refrained from intervening in such decisions. Finally, arbitration tends to be faster and cheaper than litigation, at least in theory.

As for its disadvantages, arbitration, like litigation, can become bogged down procedurally, diminishing the cost and time savings that often motivate its use. The lack of ability to appeal heightens risk for the parties that have no recourse against a bad decision. Some also argue that arbitration clauses that preclude access to the judicial system will prevent the use of proceedings such as injunctive or other equitable relief that can be obtained quickly to effectively end a breach of contract.

National treatment

In what respects, if at all, are foreign franchisors treated differently from domestic franchisors?

There is no legal discrimination or heightened level of legal requirements for foreign franchisors. Nevertheless, depending on the vehicle they choose through which to export their franchises to Canada, foreign franchisors may find themselves subject to a different taxation regime from domestic franchisors, and subject to certain notice requirements under the Investment Canada Act. As a practical matter, franchisees may be more hesitant to enter into a franchise agreement, particularly one where the obligations of the franchisor (for example, training, advertising) are numerous, in circumstances where the franchisor has no domestic presence of note.

Law stated date

Correct on

Give the date on which the above content is accurate.

20 June 2019.