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Barren soil

Feature
|Written By Daryl-Lynn Carlson
Barren soil
Illustration: Huan Tran

Peter Dillon, a franchise practitioner in London, Ont., has been tracking what he calls a “perfect storm” for a while. The conditions have been right to deter franchise activity in Canada, he says. “There is so much confusion and uncertainty facing counsel, both in-house at franchise companies and for outside lawyers, regarding the due diligence they must perform” to ensure their companies are in compliance with both federal and provincial legislative developments, he says. Add to the mix several court decisions that have leveraged decisions against franchises and in favour of franchisees and you get the idea that franchisees are vulnerable as the “little guy.”

Dillon, a lawyer with Siskinds LLP, has tapped into the trend that Canada’s franchise environment is becoming increasingly complex both legislatively and as a result of recent court decisions. This has prompted in-house lawyers for franchises operating in Canada to be on alert and spend much more time reviewing their company’s respective documents. At the same time, U.S.-based franchises are becoming exceedingly reluctant to enter the Canadian market.

Generally, lawyers are discouraged by recent developments, which they agree have significantly served to put a damper on any franchise company’s ability to ensure prosperity and success in any given province in Canada. Therefore, there is a pervasive misconception in Canada that franchisors are big and franchisees are small and vulnerable, and that there must be some initiative within the court system to protect the “little guy,” says Dillon, author of Franchise Legislation in Canada. Yet he notes most Canadian franchises are smaller than those in the U.S., and franchise owners are diligent in their efforts to ensure the success of their business from a corporate perspective. “Most of my clients are ethical, hard-working people who have no intention of ripping people off because they want their franchise to succeed.”

Still, there isn’t any incentive for franchise companies to set up shop in Canada. In many provinces, they are required to include a document that must be signed by the president or chief executive officer of a franchise company, which can expose them personally to liability regarding any legal issues that arise over documents should they be disputed by franchisees. “U.S. franchises are reluctant to come into Canada particularly because their presidents have to sign disclosure documents,” says Dillon. “The risk is disproportionate and the cost of compliance is unreasonable.”

However, for U.S.-based counsel who work within major franchise companies, Canada is viewed as generally less litigious than the U.S.

Stephen Aronson is managing director and general counsel for Atlanta-based Roark Capital Group private equity fund, which recently purchased the North American Pet Valu franchise. He acknowledges all corporate counsel for franchises must be continually aware of developments in Canada. “We, personally, feel good about our opportunities for growth in Canada,” says Aronson. “But I think that franchisors, in general, will have to take measure in how they approach risk as, if you have a large franchise, it’s hard to make all of the people happy 100 per cent of the time.”

Because Canada is seen as less litigious — although there has been a notable increase in the number of class actions against franchise companies — Aronson says it can usually be viewed as a growth opportunity for a franchise to open in Canada.

He points to recent court decisions, based on provincial franchise legislation such as Ontario’s Arthur Wishart Act, in which the courts have sided with franchisees and heavily penalized franchise companies as the perceived “monopoly.”

However, many Canadian lawyers don’t view this country as being particularly favourable to franchises. David Kornhauser, a lawyer at Macdonald Sager Manis LLP in Toronto, spoke at a recent Ontario Bar Association conference on franchise developments. In his presentation, he referenced the new Franchises Act in New Brunswick that takes effect in February. It requires franchise companies to provide new or prospective franchise owners with full disclosure documents. Kornhauser also noted amendments proposed under Ontario’s Arthur Wishart Act will require franchise companies to provide an “educational document” that, he says, could dissuade the purchase of a franchise. It’s a “horrendous piece of legislation. It’s basically telling franchisees, ‘Don’t buy a franchise.’”

Kornhauser referenced federal legislative changes that will also affect franchise companies, including those to the Competition Act as well as proposed changes to the Consumer Protection Act and Personal Information Protection and Electronic Documents Act.

Regarding amendments to the Canadian Payments Association’s pre-authorized debit rules, he noted in his accompanying paper: “It is standard practice for franchisors to require franchisees to execute, contemporaneously, with the execution of the franchise agreement, agreements allowing the franchisor to debit a franchisee’s bank account for amounts payable by the franchisee for royalties, advertising contributions, etc.”

Kornhauser added, “Significant amendments to the Canadian Payments Association rules that came into force on Feb. 28, 2010, will require franchisors to update their pre-authorized debit agreements to comply with the rules. The rule applies to all PADs which are entered into after Feb. 28, 2010, failing which they may be unable to collect these amounts.”

Under the Competition Act, the implications for franchisees are potentially even more onerous. “Effective March 12, 2010, agreements between competitors (including potential competitors) to fix prices, allocate sales customers or markets, or to fix or control production or supply of a product will be illegal,” he wrote. “Penalties include fines of up to $25 million and imprisonment for up to 14 years.”

However, as a result of the issuance of the new “competitor collaboration guidelines,” franchise agreements will not be subject to criminal prosecution as long as the agreement is truly limited to the franchisor/franchisee in question and does not mask a broader conspiracy among the parties.

In addition, there have been a significant number of class action lawsuits initiated against franchise companies in Canada by franchisees, although most are in the very preliminary stages and have not had any judicial determination that could serve as guidance for further similar cases, says Kornhauser.

Daniel Vukovich, in-house counsel for M&M Meat Shops Ltd. and a former Pizza Pizza Ltd. legal department lawyer, says it is important for in-house counsel to educate staff at each respective franchise headquarters about the nuances regarding any dealings with franchisees to avoid litigation or a prospective breach of provincial laws, which he acknowledges have become, relatively speaking, more onerous over recent years.

Vukovich, who spoke at the same OBA event, emphasized the importance of bringing in a lawyer from a private law firm to assist in-house lawyers with implementing an annual review process to look at the franchise’s business, policies, financial records, and any communications that could have an adverse effect on franchise owners with respect to provincial laws and possible litigation.

He also affirmed the importance of retaining all documentation so the franchise can have easy and ready access to any records it needs pertaining to its franchise owners. “Given that all of our departments have communications with the franchisees, you need to be able to get your hands on any relevant documents,” he says.

He said many in-house lawyers can typically be relied on to provide any and all legal advice for the company, although in many circumstances it can be very helpful to seek advice from outside lawyers when possible.

Vukovich says many lawyers who work for franchise companies were particularly intrigued with the decision in 405341 Ontario Ltd. v. Midas Canada Inc., wherein the Ontario Court of Appeal upheld a class action decision that alleged the parent company breached its duty of good faith and fair dealing with its franchisees by eliminating a preferential purchasing system. The franchisees had launched a class action against the company, alleging it had violated its franchise agreement by outsourcing to a third-party product supplier. The franchisees won their case in the Ontario Divisional Court but the parent company appealed — and lost.

The case served as insight for many in-house counsel, particularly in terms of class actions. “I know there were many lawyers who followed this case as we were all trying to see where the bar is being set,” says Vukovich. While the facts of the case were specific to Midas franchise owners, other lawyers followed the case because it was one of the first class actions that received a court ruling. “It’s an important case and one that everyone was interested in seeing the outcome,” Vukovich says.

Ultimately, keeping an eye on the courts and knowing how to keep on top of the related legal issues is an ongoing learning experience for all in-house counsel, he says. Jonathan C. Lisus, a partner at Lax O’Sullivan Scott Lisus LLP, says besides Midas, 1518628 Ontario Inc. v. Tutor Time Learning Centres LLC is also important because the Ontario Superior Court noted the Arthur Wishart Act’s main intent is to protect franchisees.

Lisus also says in the Ontario Superior Court matter 1318214 Ontario Ltd. v. Sobeys, franchisees successfully prohibited Sobeys Capital Inc. from terminating franchise agreements with a group of franchise owners within the same company based on their right to associate under the act as franchisees.

Lisus warns lawyers who serve franchises as either in-house or otherwise. “Litigation places the relationship between the parties under a microscope. The imposition of a judicial microscope on any relationship can yield unexpected and sometimes artificial results,” he wrote in an accompanying paper to his OBA presentation.

“However, when the microscope is fitted with a lens ground to a prescription premised on vulnerability and an inequality of bargaining power the potential for adverse consequences for the franchisor is substantially enhanced. In these circumstances, counsel would do well to pay close regard to the lessons recent developments teach and to keep a close eye on the opportunities and threats presented by the Court’s concern for proportionality and access to justice.”

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