Laws and agencies regulating the offer and sale of franchises

Legal definition

What is the legal definition of a franchise?

The offer and sale of franchises in Canada is regulated by the provinces rather than by the federal government. Definitive franchise legislation is currently in force in six Canadian provinces: Alberta, Ontario, New Brunswick (NB), Prince Edward Island (PEI), Manitoba and British Columbia (BC). The Civil Code of Quebec also contains provisions applicable to all contracts governed by Quebec law, including franchise agreements.

The Arthur Wishart Act (Franchise Disclosure) in the Province of Ontario (the Ontario Act), the Prince Edward Island Franchises Act (PEI Act), the New Brunswick Franchises Act (the NB Act), the Manitoba Franchises Act (the Manitoba Act) and the British Columbia Franchise Act (the BC Act) each generally define a ‘franchise’ as a right to engage in a business where the franchisee is required to make one or several payments to the franchisor in the course of operating the business or as a condition of acquiring the franchise or commencing operations, and in which the franchisee is granted either:

  • the right to sell goods or services substantially associated with the franchisor’s trademarks in circumstances where the franchisor or any of its associates has significant control over, or offers significant assistance in, the franchisee’s method of operation; or
  • representational or distribution rights to sell goods or services supplied by the franchisor or its designated supplier, and the franchisor (or any person it designates) provides location assistance to the franchisee.

 

Under the Ontario Act, the definition of ‘franchise’   provides that the right to exercise control over the franchisee’s method of operation, as opposed to the actual exercise of that control, may be sufficient for the purposes of characterising a business as a franchise, which definition potentially increases the number of business relationships that may fall under the Ontario Act’s application.

The Ontario Act, the PEI Act, the NB Act and the BC Act apply to franchise agreements entered into on or after 1 July 2000, 1 July 2006, 1 February 2011 and February 1 2017, respectively, and to renewals or extensions of franchise agreements, regardless of whether such franchise agreements were entered into before or after such date, provided that the business operated pursuant to such franchise agreements is to be operated partly or entirely in Ontario, PEI, NB or BC, respectively. The Manitoba Act is conceptually similar and applies to franchise agreements entered into, renewed or extended on or after 1 October 2012. Furthermore, there is no residency requirement in respect of the franchisee with respect to whom the Ontario Act, the PEI Act, the NB Act, the Manitoba Act or the BC Act applies.

In Alberta’s Franchises Act (the Alberta Act), a ‘franchise’ is defined as a right to engage in a business:

  • in which goods or services are sold, offered for sale or distributed under a marketing or business plan substantially prescribed by the franchisor or any of its associates and that is substantially associated with any of its trademarks, service marks, trade names, logotypes or advertising; and
  • that involves a continuing financial obligation of the franchisee to the franchisor or any of its associates and significant continuing operational controls by the latter on the operation of the franchised business, or the payment of any franchise fee (the latter fee being defined as any direct or indirect payment to purchase or to operate a franchise), and includes a master franchise and sub-franchise.

 

The Alberta Act applies to the sale of a franchise made on or after 1 November 1995 if the franchised business is to be operated partly or entirely in Alberta and if the purchaser of the franchise is an Alberta resident or has a permanent establishment in Alberta for the purposes of the Alberta Corporate Tax Act.

Given the breadth of these definitions, Canadian franchise legislation may cover a number of business agreements and traditional distribution or licensing networks that would not typically qualify as franchise agreements, as the term ‘franchise agreement’ may be understood in other jurisdictions.

Franchise laws and agencies

Which laws and government agencies regulate the offer and sale of franchises?

Currently adopted franchise legislation is limited to the Alberta Act, the Ontario Act, the PEI Act, the NB Act, the Manitoba Act and the BC Act (collectively, the Canadian Franchise Acts). No other province or territory of Canada has regulated the offer and sale of franchises through franchise-specific legislation.

Principal franchise requirements

Describe the relevant requirements of these laws and agencies.

The Canadian Franchise Acts set forth a number of requirements governing the relationship between a franchisor and a franchisee, the principal ones being the duty of fair dealing imposed upon the parties in respect of their performance of the franchise agreement, the obligation of franchisors to disclose material and prescribed information to prospective franchisees in compliance with the relevant statutory and regulatory scheme, and the statutory right of franchisees to associate with each other and form an organisation.

Exemptions

What are the exemptions and exclusions from any franchise laws and regulations?

Exemptions exist in each of the Canadian Franchise Acts, other than the Alberta Act, as follows.

 

Full exemptions

The Canadian Franchise Acts, other than the Alberta Act, do not apply to the following commercial relationships:

  • employer–employee relationships;
  • partnerships;
  • memberships in a cooperative association, as prescribed in the NB Act, the PEI Act, the BC Act or the regulations to the Ontario Act, as the case may be;
  • arrangements for the use of a trademark, trade name or advertising to distinguish a paid-for evaluation, testing or certification service for goods, commodities or services;
  • arrangements with a single licensee in respect of a specific trademark, trade name or advertising if it is the only one of its general nature and type to be granted in Canada;
  • any lease, licence or similar agreement for space in the premises of another retailer where the lessee is not required or advised to buy the goods or services it sells from the retailer or any of its affiliates (Ontario Act only);
  • oral relationships or arrangements without any writing evidencing any material term or aspect of the relationship or arrangement;
  • a service contract or franchise-like arrangement with the Crown or an agent of the Crown (except the Manitoba Act and the BC Act); and
  • an arrangement arising out of an agreement for the purchase and sale of a reasonable amount of goods at a reasonable wholesale price or for the purchase of a reasonable amount of services at a reasonable price (except the Ontario Act).

 

Partial exemptions – the obligation to disclose

All of the Canadian Franchise Acts, other than the Alberta Act, contain exemptions from disclosure requirements that include, for example, the sale of a franchise to a person to sell goods or services within a business in which that person has an interest, provided that the sales arising from those goods or services do not exceed 20 per cent of the total sales of the business during the first year of operation of the franchise.

Exemptions are also set out in the Canadian Franchise Acts, other than the BC Act, in connection with the granting of a franchise if the prospective franchisee is required to make a total annual investment to acquire and operate the franchise in an amount that does not exceed the amount prescribed under each of the Canadian Franchise Acts, currently C$5,000. Although not yet in force, it is important to note that recent legislative amendments to the Ontario Act provide that the amount required to qualify for such exemption should be based on the total initial investment, as described in the disclosure document, rather than the total annual investment.

Exemptions exist in the Alberta Act and the BC Act with respect to the obligation to provide a disclosure document as follows:

  • sale of a franchise by a franchisee provided that:
    • the franchisee is not the franchisor or an associate, director, officer or employee of the franchisor;
    • the sale is for the franchisee’s own account;
    • the sale is not effected by or through the franchisor; and
    • in the case of a master franchise, the entire franchise is sold;
  • sale of a franchise to a person who has been an officer or director of the franchisor or its associate for at least six months for that person’s own account;
  • sale of an additional franchise to an existing franchisee if the additional franchise is substantially the same as the franchise that the franchisee is operating;
  • a renewal or extension of an existing franchise agreement;
  • the grant of a franchise for one year or less and that does not involve payment of a non-refundable franchise fee (BC Act only);
  • sale of a franchise by an executor, administrator, sheriff, receiver, trustee, trustee in bankruptcy or guardian on behalf of a person other than the franchisor or the estate of the franchisor;
  • the grant of a franchise if the franchisor is considered to be operating or participating in a multi-level marketing plan pursuant to the Competition Act (Canada) (BC Act only);
  • sale of a right to a person to sell goods or services within or adjacent to a retail establishment as a department or division of the establishment, if the person is not required to purchase goods or services from the operator or the retail establishment (Alberta Act only); and
  • sale of a fractional franchise (Alberta Act only).

 

The exemptions set out in each of the Canadian Franchise Acts, while substantively similar, are not identical. Under the Ontario Act and the BC Act, the sale of a franchise to a franchisee who invests more than a prescribed amount (currently C$5 million) in the acquisition and operation of the franchise over a prescribed period is exempted from the application of the disclosure requirements. Amendments similar to the lower threshold exemption will be coming into force in Ontario, modifying the calculation to be based upon the amount of the total initial investment, as described in the disclosure document, rather than the amount invested over a prescribed period of time. One does not have to comply with the disclosure requirements under the Alberta Act when granting a licence to a person to sell goods or services within or adjacent to a retail establishment as a department or division of said establishment without requiring that the person purchase goods or services from the operator of the retail establishment. Under the Manitoba Act and the BC Act, a franchisor is not required to provide financial statements to a franchisee if the franchisor meets certain criteria, including:

  • a net worth of at least C$5 million or, alternatively, having a net worth of at least C$1 million to the extent that the franchisor is controlled by a corporation whose net worth is at least C$5 million; and
  • the existence of at least 25 of its franchisees engaged in business in Canada at all times during the five-year period preceding the date of the disclosure document.

In addition, each of the Canadian Franchise Acts other than the Alberta Act and the BC Act affirms that a franchisor may apply for a ministerial exemption allowing it not to include its financial statements in a disclosure document.

Franchisor eligibility

Does any law or regulation create a requirement that must be met before a franchisor may offer franchises?

Except for compliance with applicable Canadian Franchise Acts and other legislation, there is no requirement – for example, that a franchisor be in business for a minimum period, that a franchisor has operated a minimum number of franchisor-owned operations, or that a franchisor has operated in Canada with franchisor-owned operations for a minimum period – that must be met before a franchisor may offer franchises.

Franchisee and supplier selection

Are there any laws, regulations or government policies that restrict the manner in which a franchisor recruits franchisees or selects its or its franchisees’ suppliers?

There are no generally applicable restrictions governing the recruitment and selection of franchisees or franchisee’s suppliers, the locations of franchised outlets or the distance between outlets. However, it is important to note that such restrictions do exist in certain industries whose products or services are specifically regulated, such as the tobacco industry, the alcohol industry and the cannabis industry.

Pre-contractual disclosure

What is the compliance procedure for making pre-contractual disclosure in your country? How often must the disclosures be updated?

A franchisor governed by any of the Canadian Franchise Acts must furnish a prospective franchisee with a disclosure document not less than 14 days before the earlier of the signing by the prospective franchisee of the franchise agreement or any other agreement relating to the franchise, or the payment of any consideration by or on behalf of the prospective franchisee to the franchisor or any of its associates relating thereto.

All of the Canadian Franchise Acts, other than the Ontario Act, exclude confidentiality and site selection agreements from the definition of franchise agreements for the application of the disclosure requirements. In addition, the Alberta Act and the BC Act also exempt agreements that only contain terms and conditions relating to a fully refundable deposit (that is, a deposit that does not exceed 20 per cent of the initial franchise fee and is refundable without any deductions or any binding undertaking of the prospective franchisee to enter into any franchise agreement). The recent legislative amendments to the Ontario Act will soon harmonise it with the other Canadian Franchise Acts in respect of this exemption by allowing franchisors to enter into confidentiality agreements and location or territory reservation agreements, as well as to accept fully refundable deposits of not more than C$20,000, without triggering the prior disclosure obligation.

A franchisor must also furnish a prospective franchisee under each of the Canadian Franchise Acts with a description of any ‘material change’ as soon as practicable after the change has occurred and prior to the earlier of the signing of any agreement or the payment of any consideration by the prospective franchisee in relation to the franchise. A ‘material change’ is defined as a change (even if not yet implemented in certain cases) in the business, operations, capital or control of the franchisor or any of its associates, or in the franchise system, which change would reasonably be expected to have a significant adverse effect on the value or price of, or on the decision to acquire, the franchise.

Pre-sale disclosure to sub-franchisees

In the case of a sub-franchising structure, who must make pre-sale disclosures to sub-franchisees? If the sub-franchisor must provide disclosure, what must be disclosed concerning the franchisor and the contractual or other relationship between the franchisor and the sub-franchisor?

Each of the Canadian Franchise Acts imposes the obligation to disclose upon ‘franchisors’, the definition of which includes a sub-franchisor with regard to its relationship with a sub-franchisee. Accordingly, pre-sale disclosures must be made to a sub-franchisee by the sub-franchisor in accordance with the same procedural and substantive requirements, and exemptions pertaining thereto, that apply to franchisors with regard to their relationships with their franchisees. Moreover, information regarding a sub-franchisor’s relationship with the franchisor must be disclosed to a prospective sub-franchisee, but only to the extent that such information constitutes a material fact or is necessary for the sub-franchisor to properly acquit itself of its duty to furnish the information expressly prescribed by the relevant statutory and regulatory provisions governing disclosure.

Due diligence

What due diligence should the parties undertake before entering a franchise relationship?

While the scope of proper due diligence efforts is too broad to be addressed in a short response, we would include at the core of such efforts: (1) from a franchisee’s perspective, conducting proper due diligence on the business opportunity being offered including evaluating its financial return, meeting with already established franchisees in the franchise system and building a business plan; and (2) from a franchisor's perspective, it will be important to evaluate the financial wherewithal of the prospective franchisee and whether its representatives have sufficient experience in the industry to successfully operate a franchise location and a fulsome grasp of the vision and philosophy of the franchised concept so as to be an effective operator and representative of the brand. In addition, with respect to franchisees establishing the first Canadian franchise location of an existing foreign franchise system in Canada, it will be important for franchisees to evaluate whether the franchisor has adapted its franchise system to the Canadian market to comply with certain local requirements, for example, whether the franchisor has translated its materials and website to French for franchisees located in the province of Quebec.

What must be disclosed

What information must the disclosure document contain?

The regulations under each of the Canadian Franchise Acts require that general information concerning the franchisor be included in the relevant disclosure document. Such information includes the history of the franchisor, the business background of its directors, the general partners and the officers of the franchisor, and whether any of those persons has been subject to bankruptcy or insolvency proceedings or has been previously convicted of fraud or unfair or deceptive business practices. While substantively similar, the list of information that must be disclosed under each of the Canadian Franchise Acts is not identical.

Financial statements must be included in the disclosure document governed by the Canadian Franchise Acts, although the requirements set out in the regulations adopted under the Alberta Act (Alberta Regulations) differ substantially from those adopted under the other Canadian Franchise Acts. For instance, the latter regulations compel the inclusion in each disclosure document of statements regarding initial ‘risk factors’, whereas those are not required under the Alberta Regulations. The regulations adopted under the BC Act (BC Regulations) also differ from those adopted under the other Canadian Franchise Acts as they require franchisors having operated for less than one fiscal year to disclose an opening balance sheet, prepared in the same manner as financial statements.

The disclosure document must also include all ‘material facts’. This encompasses any information about the business, operations, capital or control of the franchisor, its associates or the franchise system that would reasonably be expected to have a significant effect on the decision to acquire or the value of the franchise. Unlike all of the other Canadian Franchise Acts, the BC Act does not require franchisors to disclose how they select franchise locations, unless this information is considered a ‘material fact’ that would otherwise be subject to disclosure. The BC Act also provides that franchisors must provide potential franchisees with a list of all current franchises in Canada and not only those located in BC.

Continuing disclosure

Is there any obligation for continuing disclosure?

None of the Canadian Franchise Acts requires continuing disclosure beyond the signing of the franchise agreement or the payment of any consideration by the prospective franchisee to the franchisor with respect to the franchise, whichever occurs first. Before this point, any material change, defined as any change or prescribed change that could reasonably be expected to have a significant adverse effect on the value or the price of the franchise to be granted or on the decision to acquire the franchise, must be brought to the prospective franchisee’s attention as soon as practicable.

Despite the lack of explicit continuing disclosure requirements, each of the Canadian Franchise Acts contains a broadly stated obligation of good faith and fair dealing. The possibility cannot yet be ruled out that Canadian courts might interpret good faith and fair dealing as requiring disclosure of certain material information under certain circumstances.

Disclosure requirements – enforcement

How do the relevant government agencies enforce the disclosure requirements?

Disclosure requirements are typically enforced by the affected parties rather than by government agencies as the interests are generally considered to be private rather than public.

Disclosure violations – relief for franchisees

What actions can franchisees take to obtain relief for violations of disclosure requirements? What are the legal remedies for such violations? How are damages calculated? If the franchisee can cancel or rescind the franchise contract, is the franchisee also entitled to reimbursement or damages?

Under each of the Canadian Franchise Acts, an action for damages or rescission may be instituted by the franchisee for non-compliance. The NB Act provides that a party to a franchise agreement may, in the event of a dispute with another party to such agreement, trigger a mandatory alternative dispute resolution mechanism (mediation). The foregoing does not, however, preclude any party to such franchise agreement from availing itself of other recourses available under contract or at law.

 

Rescission

Pursuant to all Canadian Franchise Acts, other than the Alberta Act, a franchisee may rescind the franchise agreement without penalty or obligation: ‘for late disclosure’, no later than 60 days after receiving the disclosure document if the franchisor failed to provide said document or a statement of material change within the prescribed time or if the contents of the disclosure document do not satisfy statutory requirements; or ‘for absence of disclosure’, no later than two years after entering into the franchise agreement. In either case, within 60 days of the effective date of rescission the franchisor must:

  • purchase from the franchisee any remaining inventory, supplies and equipment purchased pursuant to the franchise agreement, at a price equal to the purchase price paid by the franchisee, and refund any other money paid by the franchisee; and
  • compensate the franchisee for the difference between any losses incurred in acquiring, setting up and operating the franchise, and any amounts paid or refunded pursuant to the preceding paragraph.

 

Should a franchisor fail to provide the disclosure document as required under the Alberta Act, the prospective franchisee is entitled to rescind the franchise agreement by giving a cancellation notice to the franchisor or its associate, as the case may be, no later than the earlier of 60 days after receiving the disclosure document or two years after the grant of the franchise.

The franchisor does not have an obligation to purchase any of the franchisee’s assets under the Alberta Act but must instead, within 30 days after receiving a cancellation notice, compensate the franchisee for any net losses incurred by the latter in acquiring, setting up and operating the franchised business.

 

Damages

Pursuant to all Canadian Franchise Acts, other than the Alberta Act, if a franchisee suffers a loss because of a misrepresentation contained in the disclosure document or in a statement of material change or as a result of the franchisor’s failure to comply with any disclosure requirements, the franchisee has a right of action for damages against the franchisor, the franchisor’s broker (if any), the franchisor’s associates, every person who signed the disclosure document or statement of material change and, under the Ontario Act, the franchisor’s agent, all of whom are jointly and severally liable.

Under the Alberta Act, a franchisee who suffers a loss resulting from a misrepresentation contained in a disclosure document has a right of action for damages against the franchisor and every person who signed the disclosure document, on a joint and several basis.

Disclosure violations – apportionment of liability

In the case of sub-franchising, how is liability for disclosure violations shared between franchisor and sub-franchisor? Are individual officers, directors and employees of the franchisor or the sub-franchisor exposed to liability? If so, what liability?

Liability is imposed on franchisors and sub-franchisors for misrepresentations contained in a disclosure document, although the extent and scope of such liability is contingent upon the applicable franchise legislation. Where a franchisor and a sub-franchisor are found liable for misrepresentations contained in a disclosure document, their liability will be of a joint and several nature.

Generally, the officers, directors and employees of a company cannot be sued in their personal capacity for the debts and obligations of the company. Accordingly, a key advantage presented by the subsidiary structure is the creation of a generally effective shield for the foreign franchisor seeking to avoid exposure to liabilities arising in Canada. Nevertheless, liability will not be entirely absorbed by the corporate subsidiary in those cases where a separate entity furnished a guarantee under the franchise agreement or breached its legal or statutory obligations in regards to the same.

The Canadian Franchise Acts extend liability for misrepresentations contained in a disclosure document to a much broader class of persons than those who would otherwise be liable under Canadian common law. Under the Alberta Act, a franchisee has a right of action not only against the franchisor, but also against every person who signed the misrepresentative disclosure document. Similarly, each of the other Canadian Franchise Acts provide that a franchisee may not only claim damages for misrepresentation from the franchisor, but also from the broker and associate of the franchisor as well as every person who signed the relevant disclosure document or statement of material change. In light of the very broad statutory construction given to the term ‘franchisor’s associate’, the principal owner or controlling shareholders of a franchisor who are personally involved in the granting or marketing of the franchise may qualify as franchisor’s associates. Similarly, parent companies of Canadian subsidiaries incorporated for the purpose of conducting franchise operations in Canada may also qualify as franchisor’s associates where such parent companies participate in the review or approval of the granting of a franchise.

General rules on offer and sale

In addition to any laws or government agencies that specifically regulate offering and selling franchises, what are the general principles of law that affect the offer and sale of franchises? What other regulations or government agencies or industry codes of conduct may affect the offer and sale of franchises?

General principles of law that may affect the offer and sale of franchises vary depending on the province in which a franchisor wishes to grant franchises.

In all provinces of Canada other than Quebec, general common-law principles regarding contract formation govern the offer and sale of franchises. In Quebec, franchise agreements are governed by the general principles of contract formation found in the Civil Code of Quebec and are generally regarded as contracts of adhesion. The Civil Code of Quebec, in an effort to correct a presumed economic imbalance between the parties, provides more favourable interpretation principles and a significantly broader margin of redress for the adhering party to a contract of adhesion than that which would be available absent a contract of adhesion. Furthermore, an abusive clause in a contract of adhesion will be considered null, or the obligation arising from it may be reduced by a court.

In addition, courts in Quebec have established that franchisors have an obligation to inform potential franchisees of any information in their possession that may have a decisive influence on the franchisee’s will to contract. While franchising practitioners in Quebec have generally viewed this disclosure obligation as essentially similar to the obligation of franchisors under the Canadian Franchise Acts to disclose all ‘material facts’ to the franchisee , Quebec courts may give it a broader interpretation – courts have found a franchisor liable for failing to disclose to the potential franchisee internal reports and documents commissioned and produced upon the franchisor’s request and at its expense, such as feasibility studies in respect of potential locations and aptitude tests with respect to the potential franchisee.

General rules on pre-sale disclosure

Other than franchise-specific rules on what disclosures a franchisor should make to a potential franchisee or a franchisee should make to a sub-franchisee regarding predecessors, litigation, trademarks, fees, etc, are there any general rules on pre-sale disclosure that might apply to such transactions?

There is no such general obligation to disclose under the common law system in Canadian provinces. Nevertheless, the civil law applicable in the province of Quebec does contain general principles applicable to all contracts. Article 1375 of the Civil Code of Quebec establishes that the duty of the parties to conduct themselves in good faith also extends to pre-contractual negotiations and has generally been interpreted as imposing a positive obligation to inform the opposing party of any information which could affect its decision to enter into the contract. This diverges from the fair dealing provisions of the Canadian Franchise Acts that apply only in the ‘performance and enforcement’ of a franchise agreement.

The obligation to inform can be sanctioned in several ways depending on the situation. If the withheld information is sufficiently important that it would have caused the franchisee not to contract or to contract on different terms, the franchisee’s consent is considered to have been vitiated, either due to error under article 1400 of the Civil Code of Quebec (if withheld inadvertently) or fraud under article 1401 (if withheld intentionally). In such cases, the franchisee can apply for annulment of the agreement and damages. However, in cases where a franchisee fails to reasonably enquire about such information, the franchisee’s negligence may constitute a valid defence to its claim for error, thereby preventing the franchisee from obtaining relief.

If the withheld information is not important enough to affect the validity of the contract, or if it is but the franchisee nevertheless prefers to maintain the agreement, the franchisee can simply claim damages or a reduction of its obligations set out in the franchise agreement equivalent to the damages to which it would otherwise be entitled.

Fraudulent sale

What actions may franchisees take if a franchisor engages in fraudulent or deceptive practices in connection with the offer and sale of franchises? How does this protection differ from the protection provided under franchise sales disclosure laws?

The rights conferred by each of the Canadian Franchise Acts are in addition to, and do not derogate from, any other right, remedy or recourse that a franchisee may have in law.

Judicial decisions emanating from the common law provinces reflect a general and growing affirmation of the common law duty of good faith in franchising, the substantive requirements of which will be conditioned by the specific set of circumstances surrounding the formation of the franchise agreement and the conduct of both parties. Where the courts find that there has been a breach of such duty of good faith, the franchisor may be found liable to the franchisee for its damages. Not every breach of such duty will constitute a fundamental breach of the franchise agreement, which fundamental breach would excuse the franchisee from future performance under the agreement.

In addition, pursuant to article 1401 of the Civil Code of Quebec, an error by a party induced by a fraud committed by the other party, or with its knowledge, will nullify consent whenever, but for the error, the misled party would not have contracted or would have contracted on different terms. It is important to note that in Quebec silence may amount to a misrepresentation. Such a fraud could be sanctioned with damages and annulment of the contract or, should the franchisee prefer to maintain the contract, a reduction of its obligations set out in the franchise agreement equivalent to the damages to which it would otherwise be entitled.

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20 June 2019.