Canada: Accidental Franchises: You May Be In A Franchise Relation Without Realizing It

There are situations where commercial arrangements, not intended by the parties to be a franchisor/ franchisee relationship, have nonetheless been held by the courts to be such a relationship.

A "franchise" is defined in the Alberta Franchises Act¹, (the "Franchises Act") and is essentially a right to engage in a business where several specific factors exist. In general terms, these factors include a business where goods or services are sold or distributed under a business plan prescribed by the franchisor, that is associated with a type of trademark of the franchisor and that involves a continuing financial obligation to and significant continuing operational controls by the franchisor.

In a 2016 Ontario case, Chavdarova v. The Staffing Exchange² ("Chavdarova"), the Court ruled that if the relationship between the parties meets the conditions set out in the definition of the word "franchise" in the Arthur Wishart Act (Franchise Disclosure)³, (the "Wishart Act") then "the relationship between the parties is that of franchisor and franchisee, no matter what terminology the parties have used to describe the relationship." The Wishart Act is Ontario's franchise legislation and was modelled on and closely resembles the Franchises Act. Moreover, the definitions of "franchise" in the Wishart Act and the Franchises Act are substantially similar.

Although "franchises" are typically thought of as fast-food chains the definition of a "franchise" is sufficiently broad to draw commercial arrangements not intended as franchises under the purview of the Franchises Act.⁴ Even common business arrangements such as licensing agreements, distribution agreements and agency agreements may be considered a franchise relationship at law notwithstanding the characterization or description of such arrangements otherwise. This was the result in Chavdarova.

Examining Chavdarova

Chavdarova resulted from a failed business relationship between The Staffing Exchange Inc. ("TSE"), a business recruitment company and Lyudmila Chavdarova ("Chavdarova"), an individual who had entered into a licence agreement with TSE to access TSE's Multiple Career Listing Services.

Chavdarova claimed that the relationship was one of franchisor and franchisee in order to avail herself of the rights and remedies offered to a franchisee under the Wishart Act and TSE claimed that the relationship was that of licensor and licensee as it wanted to avoid any obligations under the Wishart Act. Ultimately, the Court found a franchise relationship to exist because the elements of a franchise relationship set out in the Wishart Act were met notwithstanding the terminology TSE and Chavdarova used to describe their relationship.

First, the requirement for a payment to the "franchisor" by the "franchisee" was met by Chavdarova in two ways: (a) pursuant to payment made by Chavdarova to TSE for her to become a TSE Career Broker which the Court characterized as a payment required by her to enter into a relationship with TSE and not simply a training fee; and (b) due to billing services provided by TSE which remitted Chavdarova's portion to her on an agreed upon schedule.

Secondly, the Court found that Chavdarova's business operated in substantial association with TSE's trademarks. The license agreement between the parties described TSE's business as a:

The entire relationship was thus found to be premised on the identification of the Chavdarova's operations with TSE's intellectual property.

Finally, the Court ruled that TSE exercised significant control over Chavdarova's methods of operation. In signing the licence agreement, Chavdarova had to acknowledge "the necessity of operating [her] business in strict conformity with [TSE's] standards and specifications." Moreover, TSE provided billing and invoicing services, collection services, office support, accounting support and other services.

Implications for an "Accidental" Franchisor and Franchisee

If a business arrangement is determined to be a franchise relationship, the parties thereto become subject to the obligations and may avail themselves of the rights under the Franchises Act.

Implications for the "franchisor"

If not exempted pursuant to the Franchises Act Exemption Regulation, a franchisor must disclose certain information to a franchisee prior to the franchisee commencing operations. Section 4 of the Franchises Act sets out the franchisor's disclosure requirements. Notably, a disclosure document must be received by a prospective franchisee at least 14 days before either the signing of any agreement relating to the franchise, or the payment of any consideration by the prospective franchisee relating to the franchise. ⁶

The disclosure document itself must comply with the Franchises Regulation⁷,(the "Regulations") and simplifying, must contain a copy of the proposed franchise agreement and financial statements of the franchisor, details of current or pending litigation involving the franchisor, disclosure of previous or pending criminal charges involving and ongoing civil claims against the franchisor, disclosure of any restrictions on the goods or services the franchisee may sell, and information about closures of franchise outlets and any exclusive territory granted to the franchisee.

If a franchisor or "deemed" franchisor does not meet the disclosure requirements, the franchisee or "deemed" franchisee may be able to rescind or cancel their agreement with the franchisor within 60 days of entering into it. ⁸ If, on the other hand, a franchisor does not provide disclosure at all, a franchisee may rescind the franchise agreement within two years of the date that the franchisee is granted a franchise. ⁹ Troublingly for franchisors, Alberta Courts appear willing to rule that "no disclosure" has occurred in the event a franchisee is supplied with a deficient disclosure document.

Contract rescission means the franchisee is returned to the financial position it was in before it entered the franchise relationship with the franchisor. This means the franchisor has to refund any money it received from the franchisee and compensate the franchisee for any losses the franchisee incurred while acquiring, establishing and operating the franchised business. Additionally, a franchisee may have a right of action for damages if it suffered a loss because of a misrepresentation contained in a disclosure document. Chavdarova was entitled to the amount of money paid by her to TSE which included money paid for supplies and equipment. She was also entitled to damages for misrepresentation.

Implications for the "franchisee"

The Franchises Act is generally weighted in favour of a franchisee. If a would-be franchisee successfully claims that he/she is in fact in a franchise relationship, the franchisee may be able to avail itself of the statutory remedy of rescission and a statutory cause of action for damages resulting for franchisor misrepresentation, both granted under the Franchises Act. Therefore, if a party to a license agreement, distributorship, or sales agency agreement decides the bargain he/she has struck with a "franchisor" is not profitable, or simply wants out of his/her agreement, he/she may claim the existence of a franchise relationship and the fact that the disclosure obligations of the "franchisor" under the Franchises Act have not been met.

Conclusion

Ultimately, if an arrangement meets the definition of a franchise set out in the Franchises Act, a court may find a franchise relationship to exist, notwithstanding a business arrangement being characterized and described otherwise by the parties themselves. A waiver or release by a franchisee of its rights or waiver of the franchisor's obligations and requirements under the Franchises Act has no impact. Accordingly, both "accidental" franchisees and franchisors should seek advice as to whether a business arrangement (proposed or existing) could be considered a franchise relationship.

Footnotes

1 RSA 2000, c F-23

2 2016 ONSC 1822

3 2000 SO 2000, c3

4 Canadian Franchise Law, supra note 1 at 39.

5 2016 ONSC 1822

6 Franchises Act, supra note 1 at s 4(2).

7 Alta Reg 240/1995

8 Canadian Franchise Law, supra note 1 at 112 – 113.

9 Franchises Act, supra note 1 at s 13(b); Canadian Franchise Law, supra note 1 at 113.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.