Franchise Legislation


Volume 47, Number 11

Written By: Laura Pratt

Franchising in Canada “can be a bad scene,” says Gerry Docherty, president and COO of Good Earth Coffeehouse, a Calgary-based restaurant with 46 locations, all but two of which are franchised. Although franchising legislation has been in place in the chain’s home province for some time, Docherty calls its apparently imminent arrival in B.C., where his company also operates, a welcome development. “You can make any claims you want right now. Once there’s disclosure legislation, you can’t do that. There are strict rules around what you can and cannot say,” he says.

Such is the preoccupation of the players on the westernmost edge of this country’s franchise machine, as the governing bodies of British Columbia consider the merits of adopting legislation that will require franchisors to provide a disclosure document, financial statements and more upon entering a deal with a franchisee. It’s anticipated the province will draft legislation, seek public comment on it, and introduce it by 2016, joining five provinces already equipped with the codification. (for more details, see “The B.C. Plan,” p. 34)

Toronto’s Canadian Franchise Association (CFA) has encouraged governments to be as uniform as possible when drafting standards. Ideally, franchises want to use one franchising document for the entire country, says Peter Snell, a partner who practises in the franchise law arm of Gowling Lafleur Henderson in Vancouver.
The most widely accepted rationale behind the advent of franchise legislation is investor protection. Stories abound of abuse by franchisors who have discouraged franchisees from such due diligence as financial statement review, acquaintance with officers and directors and becoming familiar with a chain’s track record.

“The heart of the franchisor is found in those documents. Do they have a thousand lawsuits against them for doing evil things? Are they planning to take your money and leave you dry? It would be in those documents,” says Wayne Taylor, an ex-franchisee of a Blenz Coffee outlet in Vancouver.

Taylor left the operation in October 2013 after five years “in financial hardship.” He claims that when he signed an agreement to buy a Blenz franchise in 2008, the franchisor said it would renew his five-year lease when it expired. But, he claims Blenz didn’t do that and denies ever suggesting it would. Taylor tried to sell but says he couldn’t, because Blenz wouldn’t approve any of the buyers he identified. In response to the lawsuit, Blenz stated that it wasn’t aware of potential buyers and wasn’t obligated to approve a sale, according to Taylor. Ultimately, court documents show Taylor sold his franchise for $50,000 — approximately $130,000 less than what he originally paid, and he is now involved in a multi-party lawsuit against directors of Blenz, one of whom replied to the aforementioned claims in an emailed statement to F&H. “We firmly deny all of Mr. Taylor’s allegations, which are frivolous and an embarrassment. This matter is currently before the courts,” said Brian Noble, director and co-founder of Blenz.

Regardless of the outcome of the suit, Taylor now understands the value of disclosure. “With legislation, there is at least a chance that the franchisee can stand up and fight, at least you can know what the franchisor is really like before you buy,” he says.

Franchise legislation borrows from the precedent set in the securities industry, providing a prospectus to potential buyers before they can sell shares on a stock exchange. It details any litigation in which the company is involved, profiles its officers and provides information about anything that might impact the stock being considered. Similarly, franchise legislation calls for full disclosure of “all material facts” about the franchise in question — critical to folks who might otherwise act on emotion alone. “Initially, people get really excited about a brand, but loving a product isn’t enough to decide whether it’s a good business for you. You need to understand the total costs of investment and who the people are behind the system. These things are really important for potential investors. It’s a way of codifying this due-diligence process,” Snell says.

This legal development comes at a price for regional franchisors in provinces without franchising legislation. For national franchisors the cost of compliance with each new province is marginal. Either way, there is intended to be a benefit in the itemized expectation from both sides. It guarantees franchisees two years to walk away from a deal and compels the franchisor to pay back the franchisees’ fees and losses, but could it be ushering the industry into a new era of litigiousness? As other provinces have developed and implemented franchise legislation, the number of claims against franchisors has seemingly increased. “It promotes lawsuits. [Franchisees] who aren’t happy with the business they bought into go talk to a lawyer who, quite often, will say it’s worth taking a shot at claiming a right of rescission,” says Snell.

Indeed, the legislation is proving to be punitive for those “franchisors that do everything on the cheap and fail to prepare proper disclosure,” says John Sotos, a preeminent franchise lawyer and founding partner of Toronto’s Sotos LLP. “When the franchisee fails, because the franchisor has failed to comply with the law, he has an extraordinary remedy to recover losses from the franchisor and also from the franchisor’s principals, personally. So a start-up franchise system is growing nicely, but then it gets hit by litigation for substantial amounts of money because of deficient or non-existent disclosure, [putting] a damper on growth. It’s a new trend.”

And, it’s worrisome, according to Lorraine McLachlan, CFA president and CEO. British Columbia’s pending legislation is “unnecessary,” she says. “Broadly speaking, we support this, but we don’t think franchise legislation is necessary in any province.” That, she says, is because it sets the scene for questionable legal decisions. “A judge can make a determination that a disclosure documentation is sufficiently deficient as to be considered not having met the need to provide disclosure. That means that, up to two years into a relationship, a franchisor may have to return a franchisee to the state they were in prior to the franchise,” explains the CFA executive.

While that sounds like admirable protection for the little guy, McLachlan bristles against its inherent presumption about franchisees. “There’s a mythology that franchisees are unsuspecting, unsophisticated investors. It’s dangerous, because it leaves the franchisor liable to misrepresentative acts by the franchisee, where he may decide that this wasn’t the right thing for him and wants a no-cost way out.” Franchising flourishes through a symbiotic relationship, she notes, a reality that means the franchisor succeeds only when the franchisee succeeds. “So, it’s not in the franchisor’s best interest to be disingenuous with their franchisee.”

In fact, there’s an expectation of franchisors to grow the business on behalf of their franchisees. Those who are reckless with this obligation suffer for it. “The franchisors that are growing aggressively are those that keep a very tight lid on the cost of construction and goods,” says Sotos. But there are others who are turning a unit that used to cost $400,000 to build into a million-dollar project by requiring costly upgrades, without a corresponding increase in sales; it’s a dangerous trend in franchising, he explains.

He believes franchisors must avoid burdening the franchise business with unnecessary costs. “Franchisors that are prudent in terms of the cost of developing a site and of keeping the cost of goods as competitive as possible are seeing growth. Conversely, those that don’t do those things suffer.” More than that, franchisors must comply with the franchising legislation in place in their home province and, unlike the United States, Canadian provinces follow the Uniform Model Franchise Law (for more details, see “The B.C. Plan,” p. 34), resulting in substantially uniform regulation across the country. So, compliance costs for each additional province adopting franchise legislation are marginal — a positive development he’s pleased to see spreading across the country. “Have competent people advise you,” adds Sotos. “Just like building a house, you’ll have a lot more success if you hire an architect who knows what he’s doing, as opposed to your brother-in-law working out of his basement.”

And, in the swirl of controversy and confusion that surrounds the advent of franchise legislation, it’s critical that potential franchisees consider the entire picture. “The disgruntled franchisees are usually the ones who feel that the franchisor didn’t tell them everything they need to know, and the wool was pulled over their eyes,” says Gowling’s Snell. It’s important this individual understands that a franchise isn’t a guaranteed success story. “It’s providing the tools, but the owner himself has to make a business independently. That’s often lost on franchisees. They feel like they’ve paid the money and should sit back and count their chickens,” adds Snell.

The CFA’s McLachlan agrees. She often speaks to groups of would-be franchisees who assume the industry is a source of ready riches. “They think the money will roll in. But there’s a lot of sweat equity that goes into a franchise for a franchisee. You have to work hard, and that’s sometimes misunderstood.” To redress the scene, the CFA is embarking on an outreach mission to help lawmakers better understand the essence of the franchise relationship. The initiative is still in its early days, so details are scarce, but “it’s a major priority for us this year,” McLachlan says.

Such efforts are necessary, says Snell, who’s also director and chair of the CFA’s legal and legislative affairs committee. “Education is [important] to help governments understand how franchising is a unique model and an extremely important driver of the economy. We want to encourage investment, not discourage it. The majority of franchise systems in this country are foreign brands, which have chosen Canada as an accessible and welcome place for franchising. But if franchising in Canada becomes difficult to do, franchise systems won’t expand to here,” he says.

Indeed, agrees Good Earth’s Docherty who welcomes the potential B.C. legislation. With it, he contends, the ethical franchisors will be distinguished from their unethical counterparts, and the natural model will be allowed to thrive. “Franchisors and franchisees need to be on the same page. After all, if franchisors aren’t successful, the brand’s not going to grow. It is through the success of the franchisees that franchisors succeed. That is [this legislation’s] focus.”

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