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Mind the disclosure gap

Industry Spotlight
|Written By Richard Foot
Mind the disclosure gap

Tony Wilson gets a lot of calls from desperate franchise owners. Not the sophisticated or the wealthy, but small-time operators who re-mortgaged homes or borrowed money from family members, and then lost their shirts in the process, or were bullied by the company they invested with.

Because Wilson practises law in Vancouver, there’s little he can do to help his local mom-and-pop clients, outside the lengthy and cumbersome avenues of the common law. British Columbia is one of five remaining provinces without specific legislation protecting franchisees from fraudulent, inept, or underfinanced franchisors.

“Because immigration is so prevalent here, I see a lot of franchisees — often new Canadians — where the deal hasn’t worked out,” says Wilson, a franchise specialist with Boughton Law Corp. “I don’t want to say that all franchising is bad, that’s not the case. But there are circumstances where people have come from other countries and have been taken advantage of by unscrupulous franchisors, and they really don’t have much of a remedy. Why isn’t B.C. seeking to help these investors?”

In October, Manitoba will become the fifth province, after Alberta, Ontario, New Brunswick, and Prince Edward Island, to enact legislation requiring franchisors to fully disclose financial data, litigation history, and other information to prospective franchisees.

Disclosure laws offer franchisees a range of protections, including codified standards of good faith and commercial reasonableness, and the ability to enforce an agreement once it has been entered. Most importantly, disclosure documents give franchisees the right to rescind contracts — and fully recoup investments and lost earnings — where a franchisor has failed to disclose the required information.

For both sides, such statutes also have the benefit of levelling the industry playing field, by discouraging what franchise lawyers call “fly-by-nighters” — franchisors lacking either sound business models or ethical sales practices.

A decade ago, when Alberta and Ontario were the only provinces with franchise legislation, provincial finance ministers asked the Uniform Law Conference of Canada, the independent public-sector legal reform body, to help streamline the franchise system by recommending a model disclosure law all provinces could adopt.

John Sotos, of Toronto-based Sotos LLP, co-chaired that effort, producing a model law subsequently adopted, with local variations, by New Brunswick, Prince Edward Island, and now Manitoba. For reasons neither Sotos nor Wilson can fathom, four other provinces — B.C., Saskatchewan, Nova Scotia, and Newfoundland and Labrador — have yet to adopt any kind of franchise law, meaning franchisees in those jurisdictions have no protections other than the common law. Quebec has no formal franchise statute either, although Sotos says Quebec’s civil code does offer a “modicum of regulation” in the franchise area.

“There have been noises emanating from Quebec in the last few years about franchise-specific legislation,” says Sotos. But no similar interest appears to be coming from other unregulated provinces, particularly B.C., one of Canada’s largest economies.

“B.C. was one of the jurisdictions that provided a senior government lawyer who played a very active role in our [Uniform Law Conference] project,” says Sotos. “But we’ve since seen nothing from B.C. and I don’t know why.”

He says one reason may be that franchisees, who tend to be small-business owners, are fiercely independent and unrepresented by industry associations, and therefore have little influence with governments or politicians.

When Canadian Lawyer InHouse contacted the B.C. government in June, the issue wasn’t on its radar. Officials at the province’s Small Business Branch weren’t even sure who was responsible for franchising matters for the government, and were unable to respond to queries about the possibility of a future disclosure law in B.C.

“What we have here is a two-tiered nation on franchise law,” says Wilson. “We have certain provinces where the law protects franchisees, and certain provinces where all franchisees can count on is the common law. It costs a lot of money to go to court for franchisees. And those in disputes with their franchisors tend not to have a lot of money.”

This statutory dichotomy also creates a two-tiered administrative system for national franchisors. Tim Hortons isn’t required to treat all its franchisees equally under the law. In the city of Lloydminster, Sask., for example, which straddles the Alberta-Saskatchewan border, a Tim Hortons franchisee on the Alberta side must receive a formalized, legal disclosure document from the company, while a different owner on the other side has no right to such a document.

Exactly how national franchisors treat franchisees in unregulated provinces appears to be a sensitive matter. In-house counsel for several major franchisors, including Tim Hortons, M&M Meat Shops Ltd., and The Second Cup Ltd., either declined or did not respond to requests for interviews for this article.

One who agreed to discuss the issue is Liisa Kaarid, vice president and legal counsel for Loblaw Companies Ltd. Kaarid says the company treats its franchisees — which operate stores under various banners such as No Frills and Valu-mart — no differently no matter where they operate in Canada.

“In terms of franchise agreements, there is no difference in content from what we provide jurisdiction to jurisdiction. The terms of the contracts remain the same,” she says.

In regulated provinces, Loblaws gives franchisees the information mandated by the relevant disclosure law. Franchisees in unregulated provinces get the same material, she says, except that it is delivered in what Kaarid describes as a plain-language document, rather than the legalese required by formal disclosure documents (franchisees in regulated provinces also get the plain-language version, she says).

“We provide fulsome information to all our franchisees, not because we’re required to by law in every province, but because we know that it makes good business sense,” she says. “There’s generally a real desire to act in a decent manner — that’s not to make the world a better place and have everyone singing Kumbaya, it’s just a good way to do business.”

Jennifer Dolman, a partner with Osler Hoskin & Harcourt LLP in Toronto, who advises a variety of franchisors, says many other national companies voluntarily disclose to franchisees in non-disclosure provinces.

“Most of the clients we deal with will provide a disclosure document in provinces where there’s no legislation,” she says. “Even though they’re not subject in those areas to legislation, they still want to share information so everyone is properly informed.

Dolman cautions, however, that just because an unregulated franchisee receives disclosure information, that document confers no special legal rights on the franchisee.

“If a dispute came up, and a company had given a franchisee a disclosure document that was purely informational, they’re not going to be able to rescind the contract or sue the franchisor for not complying with disclosure legislation,” she says.

“[But] if there was some kind of misrepresentation, they can still sue you, like they always could for things like that, at common law.”

A further wrinkle in the franchise system is the recent jurisprudence in Ontario, where a majority of the country’s franchisors are based, and where the courts appear to be strengthening the Arthur Wishart Act, Ontario’s 12-year-old disclosure statute, in favour of franchisees.

In 2010 the Ontario Court of Appeal upheld a controversial ruling of the lower court in 405341 Ontario Limited v. Midas Canada Inc., which dealt with side issues related to a class action by franchisees against Midas Canada Inc. Among other things, the courts said the Wishart Act, and all the rights it confers on franchisees — including the right of rescission — applies outside the province when franchisors use the act as the governing law of contracts in those jurisdictions.

That may seem like an obvious outcome, but Dolman says it has caused alarm among Ontario-based franchisors, many of which have for years used the Wishart Act as the template for agreements in unregulated provinces. “Franchisors who use Ontario as the governing law for franchises operated outside of that province do so at the risk of having the Arthur Wishart Act apply,” she says.

That doesn’t mean prospective franchisees in B.C., for example, have a right to disclosure prior to signing a contract with a franchisor from Ontario. But they do obtain that right, and all its related protections, once a contract is signed or once an existing contract comes up for renewal.

The practical result, says Dolman, is that franchisors are now reconsidering whether to use the Wishart Act in contracts outside Ontario.

“Any franchisor who is getting proper legal advice is not going to have the Ontario law apply in their agreements [outside the province]. But the real problem is not with new contracts,” she says. “It’s where you’ve got agreements that haven’t expired yet that may have Ontario governing law clauses left over, and what that might mean.”

Dolman says the obvious solution for franchisors grappling with these complexities is simply to “keep your franchisees happy, so there won’t be any litigation.”

Most franchisors do follow that strategy, says Sotos, but not all — which is why disclosure laws exist. “Disclosure legislation is designed to eliminate the opportunists who figure they’ll run a program, sell as many franchises they can over a few years before everybody wakes up and discovers there’s no real business there. And by then they’ve taken the money and left the country.”

And it’s not just small-time franchisors or newcomers who sometimes operate improperly, says Sotos. “It’s fair to say that the majority of franchisors operate ethically. It is not correct to say that even some prominent names don’t engage in deceptive practices. Being prominent does not preclude somebody from being high handed in their operations.”

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