Six Canadian provinces, namely, Prince Edward Island, New Brunswick, Ontario, Manitoba, Alberta and British Columbia, have passed legislation regulating franchising activities.

A key component of such laws is the requirement for all franchisors to provide each prospective franchisee, at least fourteen days prior to entering into any agreement relating to a franchise, a disclosure document (called a "Franchise Disclosure Document") containing a wide range of mandatory information required under the franchise regulation in each of those provinces.

Should the franchisor fail to provide this disclosure document, these laws and regulations entitle the franchisee to rescind the franchise agreement within two years of signing it, upon simple written notice delivered to the franchisor and without having to provide any reason for doing so.

Within sixty days of receiving a notice of rescission, the franchisor must:

  1. refund the franchisee for any money received from or on behalf of the franchisee, other than money paid for inventory, supplies or equipment;
  2. purchase from the franchisee any inventory that the franchisee purchased under the franchise agreement and remaining at the effective date of rescission, at a price equal to the purchase price paid by the franchisee;
  3. purchase from the franchisee any supplies and equipment that the franchisee purchased under the franchise agreement, at a price equal to the purchase price paid by the franchisee; and
  4. compensate the franchisee for any losses the franchisee incurred in acquiring, setting up and operating the franchise, less the amounts set out in subparagraphs (a) to (c) above.

Given these rules and the serious consequences of failing to comply with them, it is very important for any person or entity that, in or for any of these provinces, enters into any agreement in form of a distribution, concession, affiliation, licensing or buying group agreement, to closely examine whether or not the proposed agreement constitutes a "franchise" agreement under these laws. If so, it is imperative to comply with the laws and regulations governing franchising.

The act of properly determining, at the time of being drafted, whether an agreement is truly a franchise agreement is even more crucial given that such laws and regulations provide a very broad definition of what constitutes a "franchise" and, as such, many agreements that we would not normally consider a franchise agreement, may very well be one under these laws.

Section 1 of the Ontario law (Arthur Wishart (Franchise Disclosure) Act, 2000, S.O. 2000, chap. 3) defines what constitutes a franchise in Ontario as follows:

'franchise' means a right to engage in a business where the franchisee is required by contract or otherwise to make a payment or continuing payments, whether direct or indirect, or a commitment to make such payment or payments, to the franchisor, or the franchisor's associate, in the course of operating the business or as a condition of acquiring the franchise or commencing operations and,

1. in which:

i. the franchisor grants the franchisee the right to sell, offer for sale or distribute goods or services that are substantially associated with a trade-mark, trade name, logo or advertising or other commercial symbol that is owned by or licensed to the franchisor or the franchisor's associate; and

ii. the franchisor or the franchisor's associate has the right to exercise or exercises significant control over, or has the right to provide or provides significant assistance in, the franchisee's method of operation, including building design and furnishings, locations, business organization, marketing techniques or training, or

2. in which:

i. the franchisor, or the franchisor's associate, grants the franchisee the representational or distribution rights, whether or not a trade-mark, trade name, logo or advertising or other commercial symbol is involved, to sell, offer for sale or distribute goods or services supplied by the franchisor or a supplier designated by the franchisor; and

ii. the franchisor, or the franchisor's associate, or a third person designated by the franchisor, provides location assistance, including securing retail outlets or accounts for the goods or services to be sold, offered for sale or distributed or securing locations or sites for vending machines, display racks or other product sales displays used by the franchisee; ("franchise"). ”

Nearly 20 years after the passing of this legislation, Ontario's courts are still regularly called upon to decide whether the scope of this definition extends to various types of agreements that meet some or all of the elements of this definition.

The decision rendered on August 27, 2018, by the Ontario Superior Court of Justice in Fyfe and Stephens v. Vardy (Dial A Bottle) is a good example of the difficulties resulting from this definition.

This decision focused on a simple one-page agreement under which the enterprise Dial A Bottle granted to a "distributor" an exclusive territory for a home delivery service of alcoholic beverages. In its exclusive territory, this "distributor" identified itself under the name of the business to which it added the name of its territory (e.g., "Dial A Bottle Richmond Hill").

Client orders could be received by the "distributor" itself or by a call centre, which dispatched orders to each "distributor" based on its territory.

Dial A Bottle collected from its "distributors" $3 for each referral made through its call centre and $3 per delivery. Each "distributor" was also required to pay an initial amount of $40,000 to Dial A Bottle when the agreement was signed.

Both the documentation used by Dial A Bottle to recruit "distributors" and the agreement signed by each of them clearly indicated that the agreement was not a "franchise".

Fifteen months after signing the agreement, one of the Dial A Bottle's "distributors" sent a notice of its decision to rescind the agreement in accordance with the law governing franchising in Ontario because Dial A Bottle had never provided a disclosure agreement as required under such law.

Given Dial A Bottle's refusal to acknowledge this notice of rescission, the "distributor" commenced an action seeking reimbursement of the amounts paid to Dial A Bottle as well as various expenses related to what the "distributor", now considered a "franchisee", despite the terms in the agreement clearly stating otherwise.

In its decision, the Ontario Superior Court of Justice first reiterated that determining the legal nature of an agreement cannot be made solely by its title, nor on the characterization provided therein. As such, in this decision, the fact that the agreement expressly stipulated that it was not a "franchise" arrangement did not prevent the court from concluding that it was a franchise.

Although the Dial A Bottle agreement was very concise, the Ontario Superior Court of Justice quickly found that the first two of three essential elements for an agreement to constitute a "franchise" under the law were present, namely:

  1. the initial payment and continuing payments in the course of operating the business,
  2. granting the franchisee the "right to sell, offer for sale or distribute goods or services that are substantially associated with a trade-mark, trade name, logo or advertising or other commercial symbol that is owned by the franchisor."

Regarding the third element of the test for determining whether a business arrangement is a franchise, namely, that the franchisor "has the right to exercise or exercises significant control over, or has the right to provide or provides significant assistance in, the franchisee's method of operation, including building design and furnishings, locations, business organization, marketing techniques or training," which is the most difficult to clearly define and is the basis of most of the litigation in the area of franchising, the Ontario Superior Court of Justice considered the following various aspects of the agreement that was signed and concluded:

[31] I find that the defendant did have significant control over the important aspects of the plaintiffs' business. The Exclusivity Agreement states that the defendant will manage the territory owner/operator's business. It controlled taking orders, referring those orders to the plaintiffs, the logo, marketing material and web design. Further, it controlled phone line billing, telemarketing and telephone book advertising. It charged a $3 management fee on each delivered order.

[32] Based on this evidence, I find that defendant exercised significant control over the important aspects of the plaintiffs' business. I find that the test has been met in this regard.

Having found that all three elements of a "franchise", as defined in the Ontario legislation governing franchises, were present in the Dial A Bottle agreement, the Ontario Superior Court of Justice concluded that, despite its express provisions to the contrary, the agreement was indeed a franchise arrangement and ordered Dial A Bottle to pay its former "franchisee" distributor the amounts payable when an agreement is rescinded in accordance with the law.

This decision underscores the importance of properly defining the nature of any agreement of this kind, and not on the basis of the terms stipulated therein, but rather based on the elements of the definition under the law.

On May 10, 2018, in Diduk v. Simpson, the Manitoba Court of Queen's Bench rendered an interesting decision on the same question regarding another distribution agreement, this time involving a chemical product, whereby it reached a contrary conclusion (namely, that the business arrangement did not constitute a "franchise").

The criteria on which the Manitoba Court of Queen's Bench relied to reach its decision were, however, the same as those used by the Ontario Superior Court of Justice in Fyfe and Stephens v. Vardy (Dial A Bottle).

Both decisions illustrate the importance of clearly defining the true nature of the contract before entering into an agreement in any of the provinces with legislation regulating franchises as well as the inherent risks of not properly defining the nature of such business arrangement.