Canada: Franchise & Distribution Law - April 2011

The Rise of Franchise Law: Challenges and Opportunities in a Rapidly Evolving Practice Area

By Ned Levitt

This article previously appeared in the January 28, 2011 issue of The Lawyers Weekly.

The roots of franchise law in Canada go back to at least the early '70s, when the growing franchise activity in the U.S. began to creep northward and a few aspiring Canadian entrepreneurs saw opportunities in this then unusual method of distribution. Back then, as today, a lot of the activity in franchising was in the fast food industry. Little noticed at the time was the nascent real estate franchise sector, which was one of the portents of today's multi-sector, multifaceted and robust franchise marketplace. Franchising in Canada today runs the gamut from retail businesses of every type, including service businesses, to many and varied business-to-business enterprises. Today, few lawyers would say that they never encounter franchise issues in their practices.

In the '70s, for reasons mostly political, the province of Alberta chose to pass complex and restrictive franchise-specific legislation, mostly centered around pre-sale disclosure, but also requiring a franchise disclosure document to be approved by and registered with the Alberta Securities Commission. It would be two and a half decades later before Ontario would become only the second province to wade into the regulation of franchising. Less than a decade later, we now have such legislation in Prince Edward Island and New Brunswick as well, with Manitoba not far behind and, it is conjectured, more provinces to follow. While there is a significant amount of commonality among these statutes and their regulations, there are just enough differences to challenge and trap the average practitioner.

In the past, it was quite easy and relatively safe for a business owner to embark upon an expansion through a franchise distribution model. It was not uncommon for a new franchisor to employ the services of a trusted legal advisor, who had little or no knowledge about franchising. Those days are long gone. In this increasingly litigious area of law, the franchisors who do not acquire a sufficient amount of knowledge and expertise about franchising best practices are treading on very dangerous ground. And those who deign to offer such legal services without proper schooling are putting themselves at considerable risk; witness the rapidly increasing volume of negligence claims in franchise matters being handled by LawPro. Some of those claims are not just against lawyers acting for franchisors, but against those acting for franchisees as well, where a lack of knowledge about the workings of such legislation, availability of remedies and time limits formed the basis of a claim. Through the broad application of the definition of a "franchisor's associate," individuals can find themselves unprotected by the "corporate veil" and vulnerable to the claims of franchisees.

Historically, there really was no franchise common law. There was simply contract and other case law applied to franchise fact situations. The attitudes of the various judges towards franchise cases were very individual and provided little guidance to those who had to work with their decisions. While there is still arguably no common law franchise principles, the rapidly developing body of case law in franchise fact situations is amounting to the same thing, through a variety of means, including the interpretation and application of the various franchise statutes. There is now a sufficient body of such case law to conclude a number of things, including that the courts will strictly apply the disclosure requirements of the statutes, that the statutes are remedial and should be given a broad interpretation to protect franchisees and franchisors had better treat their franchisees fairly.

The tentacles of franchise law developments are spreading beyond what one would consider traditional franchise situations. Distributors of products and services who never thought of themselves as franchisors and had no idea they were required to comply with franchise legislation are surprised to find out that the very broad definitions in the statutes could catch their distribution model. These "inadvertent franchisors" are sometimes shocked to find themselves defending a claim from their "franchisees" for non-compliance with a very technical statute.

There has also been a meteoric rise in franchisee class action law suits recently. Canadian courts have spoken clearly and resoundingly that class action legislation provides an appropriate vehicle to address systemic claims by franchisees, even based on claims for breach of the implied covenant of fair dealing. This area of practice requires a high degree of expertise and experience to bring or defend such actions.

With the rapidly increasing impact of franchising on the Canadian economy comes a rapidly increasing amount of legal work required for contract drafting, statutory compliance and litigation of all sorts. Franchising has and will affect many other areas of practice including labour, workplace health and safety, environmental, immigration and competition, to name a few.

Lest anyone feel complacent that these matters do not affect them, consider the modern reality that lenders, landlords and suppliers, and those who advise them, more and more find they are dealing with a franchisor or a franchisee who is affected by these legal developments. The times they are a-changing and rapidly!

Franchisor Ordered to Offer Franchisee a Renewal

By Dennis O'Leary

In a recent decision of a retired Court of Appeal Justice sitting in a private arbitration, one of the Big Three domestic automakers was ordered to renew a franchise of one of its dealers. The manufacturer franchisor was ordered to specifically perform the franchise agreement which provided that the franchisee dealer would have an "opportunity" to renew if it satisfied all of its obligations under the franchise agreement.

More specifically, the dealer in this matter had been in business selling the manufacturer's vehicles for more than thirty years. The franchise agreement had been renewed on a number of prior occasions on a virtual automatic basis. The agreement had been revised over the years, but there was no negotiating between the franchisor and franchisee as to the terms of the franchise agreement. The same common terms applied to every dealer.

In addition to the common terms and conditions, each dealer was asked to sign a one-page execution form which contained important language from the dealer's perspective, namely, that:

"This Agreement will expire without any action by either Dealer or [Manufacturer] on [date] or in accordance with the terms of the Agreement. Dealer is assured the opportunity to enter into a new Dealer Agreement with [Manufacturer] at the expiration date if [Manufacturer] determines Dealer has fulfilled its obligations under this Agreement."

The manufacturer decided as a result of the economic downturn that it wished to reduce the number of dealers and gave notice to several hundred that it would not be renewing their franchise agreement. The dealer in this instance was in compliance with all aspects of its obligations under the dealer agreement and, indeed, had regularly received above average and superior performance review ratings. The manufacturer attempted to rely on language in the common terms of the agreement to the effect that it had control over the size and location of the franchisees. The question before the arbitrator was, in its simplest terms, whether the franchisor's right to control the number and location of its dealers took priority over the dealer's right of renewal in a situation where the dealer was in compliance with all of its obligations under the franchise agreement. The dealer here asked for an order requiring the manufacturer to specifically perform the franchise agreement and afford the dealer an opportunity to renew.

Specific performance is an equitable remedy that is available only where it is demonstrated that an award of monetary damages would not adequately compensate the aggrieved party. It is said to be a remedy which is commonly sought but rarely received (except in purchase and sale of land cases), but there appears to be an increasing willingness on the part of the courts and arbitrators to award the remedy in appropriate circumstances. This is an important development from the perspective of franchisees desirous of continuing in business.

One of the common obstacles that must be overcome in franchisor/franchisee relations in respect of any claim for specific performance is the relationship between the parties. Where there is a complete breakdown and the relationship appears dysfunctional, it will be difficult to convince a court that the parties should be forced to continue to cooperate in the future. While this may be a concern in respect of smaller start-up franchises where there are dealings between the franchisor and franchisee on a regular basis, it should be less of a concern for existing established corporate franchises. Many of these are operated on a managed basis with specific employees assigned to deal with specific territories or franchisees. There is often no relationship difficulty between the franchisee and the franchisor's representatives. In such circumstances, there may be no reason to assume that the relationship cannot continue if a franchise agreement is ordered to be renewed.

It is therefore extremely important for the franchisee to not antagonize the franchisor leading up to any trial. To the extent that the franchisee creates relationship difficulties, thereby allowing the franchisor to demonstrate that there is "bad blood" and/or animosity between the parties, then it is all the more likely that a court will be reluctant to require the parties to continue to work together under a renewed franchise agreement.

The other lesson from cases of this nature is the importance of the wording of the franchise agreement. Renewal terms are obviously of critical importance to the parties. The clearer the language of the renewal provisions of a franchise agreement, the more likely it is that a court will conclude that the franchisor is obligated to offer a franchisee a renewal contract. The court will also look at the past history of the parties. To the extent that renewals were virtually automatic, this will reinforce the position taken by the franchisee that a renewal contract should be offered absent contractual grounds existing to decline to renew.

The bottom line of such cases is that a franchisee need not view the prospect of obtaining an order compelling the franchisor to offer to renew a franchise agreement as a remote event. Where there is no failure on the part of the franchisee to live up to its obligations, and with appropriate language in an existing agreement in effect promising renewal, an order for specific performance is obtainable.

Conversely, franchisors seeking to retain control over decisions about the number, location and distribution of franchisees should give careful consideration to the language of the franchise agreement. To the extent that the language of relevant clauses is equivocal or confusing, the greater the risk that an interpretation unintended by the author of the clause will be given to the agreement. This case demonstrates that absent clear language, the franchisor may be compelled to continue the relationship.

Choice of Law Clauses: What They Do and Don't Do

By Angela Swan

It is customary for agreements that are drafted by lawyers to have what is called a "choice of law clause." (Some agreements also have what is called a "forum selection clause" which seeks to control where litigation between the parties may take place. The need for and enforceability of such a clause is a topic for another day.) There is a great deal of misunderstanding over both the need for a choice of law clause and its effect.

When a court is asked to interpret a contract, it will look at the contract from the place, the province or country, where it is. In the case of a simple transaction, made and completed in one province, this solipsistic view will cause no problems and will not defeat the expectations of the parties. A choice of law clause is an attempt by the parties to direct the court to look at the law of the specified jurisdiction for the interpretation of the agreement. It is very important to notice that a choice of law clause—at least in the usual case and with the usual wording of such clauses—is concerned with and deals only with questions of interpretation. The drafter of a contract will have used words and phrases that he or she understands in the context of the place where he or she practises.

A choice of law clause can be used in two ways. In the case of an agreement, particularly a standard-form agreement, drafted by one party (e.g., a franchisor) and offered to many others (e.g., franchisees) who may be in several provinces, it makes sense to pick the law of one province as the law, against which the agreement will be interpreted (and in the context of which the agreement was drafted).

The other way involves what can be regarded by the courts as abusive. An agreement between, say, an employer and employee in Ontario which "chooses" the law of some jurisdiction other than Ontario may be seen by the courts as an attempt by the employer to escape what the employer may regard as undesirable features of Ontario law. In such a case, the clause is likely to be ineffective.

It is important to keep in mind that the choice by a franchisor of, for example, the law of Manitoba in a choice of law clause will not avoid the application of the Arthur Wishart Act (the "Act") to franchisees in Ontario. The law of Ontario, represented by the Act, will be regarded as a law of "mandatory application" and it will be applied, certainly by an Ontario court, whatever the agreement may say.

It is unusual, but perfectly possible, for the parties to do more and incorporate in their agreement, just as they can incorporate a schedule or some other document, the provisions of a statute. The fact that they can do this is the reason why it is important to be careful in drafting a choice of law clause. The decision that will be examined in the next paragraph is an example of the franchisor doing (or being held to have done) precisely that.

In 405341 Ontario Ltd. v. Midas Canada Inc., 2010 ONCA 478, 322 D.L.R. (4th) 177 (C.A.), the plaintiff, a franchisee, sought certification of a class action against the defendant, a franchisor. The franchise agreement had this choice of law clause:

Controlling Law: This Agreement, including all matters relating to the validity, construction, performance, and enforcement thereof, shall be governed by the laws of the Province of Ontario.

The trial judge and the Court of Appeal held that this clause was effective to impose on the franchisor the terms of the Arthur Wishart Act (Franchise Disclosure), 2000, S.O. 2000, c. 3, sections 4 and 11, with respect to all its franchisees, notwithstanding that some of them were not in Ontario. The application of the Act in these circumstances was held not to involve the extra-territorial (and unconstitutional) application of Ontario law; it was as if the franchisor had said to all its franchisees, "We're happy to extend to you all the rights you would have, were you Ontario franchisees." In other words, it had (or, again, was taken to have) incorporated the Arthur Wishart Act into its franchise agreement.

The Court did not draw the distinction between a choice of law clause (as I have explained it) and a clause incorporating the provisions of a law, foreign or domestic, into an agreement, just as one might incorporate the terms or definitions of another agreement. (The difference lies in the fact that the changes in the governing law apply to the agreement, while the provisions of the law incorporated into the agreement are fixed at the date of the agreement.)

The important observation on the case is to say, "Be very careful what you ask for!"

The choice of law clause in Midas Canada is very unusual; I do not remember ever seeing one like this before.

In my opinion, a choice of law clause should say no more than this:

This agreement is governed by the laws of [Ontario] and the laws of Canada applicable therein.

A clause in this form is very common. (The reference to the "laws of Canada" is technically unnecessary, "Ontario law" includes the laws of Canada.) Given the risks to franchisors created by the Arthur Wishart Act and Midas Canada, it might, however, be safer to say:

This agreement is to be construed and interpreted in accordance with the laws of [Ontario] and the laws of Canada applicable therein.

While I have often suggested this form of the clause to clients, it's not common, though it has the advantage of stating precisely what the chosen law is to do and recognizes that it can do no more.

Whatever you do, stay away from the language used by Midas; it's far too dangerous.

The clauses I have offered, particularly the first one, may not avoid the problems faced by Midas in Midas Canada, but they do not invite, as the Midas clause obviously did, the court to do more. In a situation where, for example, you know that there is idiosyncratic (and perhaps unwanted) legislation in, say, Ontario, you might want to make the governing law, the chosen law, the law of the province where the franchisee is. Such a clause could easily be included in a standard-form agreement. Remember that you cannot avoid the application of, say, the Arthur Wishart Act or similar legislation in any other province by choosing the law of another province where there is no such legislation. By choosing the law of the place where the franchisee is, you largely eliminate the possibility that a court would be moved to apply a law like the Arthur Wishart Act to a franchisee who is not in the province with legislation like that.

The Midas Canada case does not mean that the choice of Ontario law in a choice of law clause, regardless of how the clause is drafted, will make the Arthur Wishart Act applicable to all franchisees wherever they are. A clause choosing, say, Ontario law must, however, be carefully drafted to make it very clear that the choice identifies only what can be called the background law against which the agreement was drafted and is not to be taken as a decision to give all franchisees the rights they would have had under the Arthur Wishart Act, had they been Ontario franchisees.

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.

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