Canada: Cannabis Retail Strategy Will Likely Pivot To Franchising

Last Updated: October 8 2018
Article by Chad Finkelstein

It can be challenging to keep up with news in Canada's cannabis industry. 

In the province of Ontario, we are living through an era of rapid change, as the provincial government has, in short order, upended the planned public model of cannabis retail sale through government-operated outlets, replaced it with a legislative framework for private sale and released draft legislation that raises at least as many questions as it answers.

Bill 36 was released last week, and it seeks to amend various pieces of provincial legislation and enact one new statute in relation to the use and sale of cannabis in Ontario.  One of the biggest question marks leading up to the bill's release date was whether Ontario would place limits on the number of retail store licenses available and, if so, how.

The result was somewhat unexpected.

Private retail sale of cannabis is not unique to Ontario.  In different forms, the provinces of British Columbia, Alberta, Saskatchewan, Manitoba and Newfoundland have all established regulatory regimes for private enterprise to operate retail stores.  But Ontario's model was always speculated to follow the British Columbia and Alberta models more closely than the others, and those two provinces each provide for different types of restrictions on cannabis retail store licenses.  It would appear that all such restrictions are structured with a view towards ensuring that smaller players have the same opportunity to participate in retail markets as do larger ones, and that the latter does not dominate the space to the exclusion of the former.

To that end, Alberta essentially caps any company, or group of companies under common control, from obtaining more than 15% of the total number of provincial retail store licenses.  Alberta would seem to have corporate stores owned and operated by licensed cannabis producers in its sights, and has not specifically targeted franchises. 

British Columbia, on the other hand, looks to have franchising squarely in mind.  It prohibits more than 8 retail store licenses to be issued to a company, or a group of companies, including where that company or companies can influence or affect the activities of other retail stores.  While this language from B.C. does not call out franchises by name, it seems likely that the intent was to cap retail stores on a per-brand basis, though I think the precise wording is open to interpretation.

So all eyes were on Ontario to see what the retail store license limitations would look like.  And Ontario responded by directly restricting licensed producers (LPs) of cannabis.  Specifically, once enacted, Ontario laws would limit LPs from owning and operating more than one retail store, and that store must be at the LP's production facility.

This announcement likely turned the retail strategy of many LPs upside down.  If a LP had a view towards owning more than just one store in Ontario to sell cannabis, those plans have just been fundamentally altered.

Allow me to introduce the cannabis industry to the franchise business model.

Let me say at the outset that I am not an advocate for franchising as the preferred method of distributing one's goods and services to market.  There are numerous advantages and disadvantages to franchising, from both business and legal perspectives.  But it may be the most viable option for scaling a retail cannabis strategy since LPs are capped and there are no restrictions in Ontario for franchising stores to independent owner-operators. 

And there are good business reasons for franchising.  The cannabis industry is being regulated in unique ways across the country.  If a cannabis brand cannot differentiate its products by price (because the government controls price), and products can barely be differentiated by packaging (because the government has severely limited packaging designs), then the retail experience becomes the primary method of distinction for the cannabis consumer.  The hallmark of franchising is the consistent and uniform method of operations that it entails.

You can get a sandwich from anywhere.  But if you see a sandwich shop bearing a brand and product that you know, side-by-side with one that you don't – well, I can't say which one you would choose, but the fact that we have so many large sandwich chains is testament to the power of franchising, brand recognition and consumers' preferences towards the familiar.

Cannabis will be no different, except that the prices will be uniform and the packages will look the same.  Now picture those two sandwich shops – identical in price, identical in product design.  Don't you lean towards the brand you know?  The one that recreates the same customer experience and operates in accordance with a set of uniform standards?  Especially when shopping for a hyper-regulated product such as cannabis?

LPs and their lawyers are discerning the language of Bill 36, looking for possible ways in which they might be able to organize a business to maintain ownership interests in retail stores, rather than franchising.  Notably, the Ontario legislation places the one-store-per-LP cap on that company and its "affiliates". 

Here's the kicker – the legislation does not provide for a definition of "affiliate".  Looking to other legislation that governs corporations in Ontario (like the Business Corporations Act), it is clear that the operative element of an "affiliate" is control. In other words, if one corporation is controlled by another corporation, those two corporations will likely be deemed to be affiliates of one another.  As a result, while we await clarity from the government on the meaning of "affiliate", LPs are exploring whether they can maintain a minority interest in corporations which own retail stores, thereby not controlling them, and thereby not being an affiliate of them.

Maybe that method of structuring is available.  But what some LPs may not realize is that this unaffiliated entity which owns and operates the retail store may still be a franchise.  It doesn't really matter what they call it.  Ontario's franchise legislation provides for a statutory definition of a "franchise", and if a LP is taking a minority interest in another corporation which operates under a trademark license from the LP and pays some kind of fee to it, that will likely meet the statutory threshold for being a franchise.

And, subject to meeting any available exemptions, this would subject the LP to all of the same rules and regulations which govern conventional franchises, including the all-important requirement to provide pre-contractual disclosure to a prospective franchisee.  While franchising isn't quite as strictly regulated as cannabis, the laws governing franchising can be a bit of a minefield, and the penalties for non-compliance are massive.

Notably, in the wake of the release of Bill 36, the Canadian Franchise Association issued an alert to its members, stating "The CFA applauds these pro-business initiatives and welcomes these changes that are sure to ease the burden on businesses, and therefore franchising, in Ontario".

Cannabis laws can be challenging to keep up with, and the industry is evolving at breakneck speed.  By the time you read this column, Ontario may have already provided answers to some of the unknowns I have raised here.  But, for now, franchising may be the most viable retail strategy for LPs, and a structure where LPs acquire minority stakes in operating entities will likely not avoid the application of those laws.

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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