Canada: Cannabis License Act: Franchising Implications

Last Updated: November 21 2018
Article by James Judson

Before the Ontario Cannabis License Act was passed, I wrote about the relative merits of corporate store ownership and franchising as business models for cannabis retail.1 It now appears that corporate store ownership will not be an option for licensed producers who wish to establish a significant retail presence. Section 4(4) of the Cannabis License Act prohibits licensed producers and their affiliates from operating more than one retail store. The definition of "affiliate" under section 2 of the regulation to the Cannabis License Act is broad, anticipating would-be creative avenues around the intent of the rule. Franchising offers the prospect of genuine legal separation between the licensed producer and the retailer, so as to avoid contravention of section 4(4).

Per a recent Bloomberg article, licensed producer Canopy Growth Corp. is conducting due diligence into franchising as a retail platform following the passage of the Cannabis License Act.2 We can expect other licensed producers to follow suit. Licensed producers who commit to franchising should pay special attention to the retail license revocation and suspension provisions of the Cannabis License Act. The Cannabis License Act grants the regulator a right to revoke or suspend (subject to a hearing in certain circumstances) retail licenses on grounds of public interest.3 If franchisees of a specific licensed producer demonstrate a pattern of non-compliance with cannabis laws, it is possible that the regulator could take action to revoke or suspend the retail licenses of all franchise locations (please note that the concern with respect to public interest revocation is exacerbated under the corporate ownership model4). The franchise agreement must be drafted with care to include brand control mechanisms responsive to the particularities of the cannabis business,5 and those brand control mechanisms must be enforced. Licensed producers interested in multi-unit franchising (for example, through area development agreements) must perform additional risk assessment with a view to sections 12(1) and 12(2) of the Cannabis License Act, which state that in the event of revocation or suspension of a retail license, all retail store authorizations held by the license holder will be suspended or revoked, as the case may be. Licensed producers should consider "hedging their bets" to ensure that no single operator controls too great a percentage of its franchise locations.

If a licensed producer wishes to distribute its product to retailers other than its franchisees, the right to do so should be set out in the franchise agreement, to avoid potential disputes with franchisees regarding good faith conduct. The franchise agreement should also contain appropriate terms and conditions with respect to customer data protection. The data of cannabis retail customers is sensitive, and ramifications can be far reaching.6 The recent Canada Post data breach directed at Ontario Cannabis Store customers highlights the issue (albeit outside the franchise context). Data protection laws in Canada continue to evolve and become more sophisticated and onerous.

The Cannabis License Act and its regulation create a unique legislative scheme, and it will be interesting to see how business plans unfold. The application process for retail licenses opens next month. Franchisors in the cannabis space will begin "putting the wheels in motion", drafting and entering into franchise agreements conditional upon retail licenses being obtained.

Footnotes

1 http://www.mondaq.com/canada/x/741384/Franchising/Cannabis+Retail+In+Ontario+Franchising+As+A+Business+Model.

2 https://www.bloomberg.com/news/articles/2018-11-16/ontario-pot-rules-could-throw-retail-partnerships-into-disarray.

3 See section 11(1)((b) (read in light of section 3(4) para 2) and section 11(2).

4 The legal separation between franchisees and between franchisees and the franchisor forms the basis of an argument that the actions one franchisee should not have consequences for the other franchisees or for the franchisor. This argument is not available in the context of corporate store ownership.

5 I discus this issue in greater detail in http://www.mondaq.com/canada/x/741384/Franchising/Cannabis+Retail+In+Ontario+Franchising+As+A+Business+Model.

6 https://thecannabischannel.ca/author/donalee-moulton/credit-card-purchases-for-cannabis-may-not-be-private-13648/ (regarding US border protection).

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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