An Impolite Border Crossing: Franchise Law in Canada

June 10, 2015

An Impolite Border Crossing: Franchise Law in Canada
By Edward Levitt

Reprinted with permission from the “February 2015 edition of the “Corporate Counsel”© 2015ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited. For information, contact 877-257-3382 - reprints@alm.com or visit www.almreprints.com.

Canada always has been a friendly and familiar neighbor of the United States, making it the first logical country for international expansion by U.S. franchisors. The growing trend of U.S. franchise systems seeking international expansion went into overdrive for Canada in 2008, where tight money in the U.S. and relatively more accessible Canadian bank financing meant attractive deals could be done across the northern border, while almost no deals could be done in the U.S. for several years.

The Cross-Border Challenge

Crossing a border is always a challenge for any business, requiring in-depth legal and business due diligence. But crossing the U.S./Canada border may, in certain respects, be the most challenging of all international expansions. The very things that make Canada so similar to the U.S., and thus a great place to market U.S. products and services, also lull unsuspecting franchisors into making very dangerous assumptions about what their system should look like and how it should operate in Canada.

To make matters worse, since the turn of the century, there has been a proliferation of provincial franchise statutes and court cases interpreting the scope and application of these statutes. Even worse, we uber-polite Canadians have discovered our voices and developed a taste for litigation, at least when it comes to franchising. Consider 2012, when doughnut franchise powerhouses Tim Horton’s and Dunkin’ Donuts were under fire in class action lawsuits (Fairview Donut Inc. and Brule Foods Ltd. v. The TDL Group Corp. (2012) and Bertico Inc. et al v. Dunkin’ Donuts (2012)). Though Tim Horton’s emerged victorious in its case, the Dunkin’ Donuts franchisor was ordered to pay almost $16.5 million dollars in damages.

This taste for litigation may be getting too close for comfort for franchise counsel. The dramatic increase in negligence claims against lawyers in the last several years is a telling barometer of the rising technical challenges of franchising in Canada. In 2010 the Lawyers’ Professional Indemnity Company (LawPRO), the insurer of Ontario Lawyers, published the following in LawPRO, the organization’s magazine:

“LawPRO is seeing an increase in claims against lawyers by franchisees and franchisors. These claims tend to involve significant damages, which often approach or exceed the available limits under the primary LawPRO policy.”

Such claims have continued to increase since then, and LawPRO now reports that annual franchise-related claims have overtaken real estate-related claims, the traditional leader in such matters.

Dangerous Disclosure

Disclosure documents are consistently among the most painful issues for U.S. franchisors expanding into Canada. In the past, some U.S. attorneys have felt comfortable producing their own Canadian franchise disclosure documents, compiling them and delivering them to prospective Canadian franchisees. But now this has become a dangerous practice to pursue without the assistance of local counsel, in light of the rapidly increasing amount of franchise litigation and how the courts have been applying legislation.

In all of the provincial statutes, when the franchisor fails to deliver a franchise disclosure document, the franchisee has a statutory right of rescission for two years after entering into the franchise agreement. However, Canadian courts have interpreted a growing number of deficiencies in disclosure documents as amounting to no disclosure and, as such, have widened the use of this remedy.

For example, in 6792341 Canada Ltd. v. Dollar It Limited (2009), the Ontario Court of Appeal held that the failure to include the mandated signed and dated certificate alone would be enough to conclude that there was no disclosure as required by regulation. Other courts have held that failure to provide a copy of an existing head lease alone would invalidate a disclosure document. It is typically assumed that providing a consolidated financial statement of several companies, including a franchisor company (a common practice in the U.S. because of tax code provisions) would be a fatal noncompliance with the Canadian requirement to provide the financial statements of the franchisor. Also, it has become a best practice in Canada for franchisors to have several versions of their disclosure document to deal with franchisee resales, renewals and the sale of corporate units. Tedious, yes, but necessary given the country’s legal nuances.

2 Countries, 2 Counsel, 1 Goal

With shrinking budgets, it is becoming more difficult for corporate counsel to simply download franchise disclosure obligations to outside counsel, even as the financial and legal risks are growing. So what is a corporate counsel to do? A living partnership between corporate counsel and Canadian outside counsel may be the answer.

Certainly, outside counsel initially can help in shortcutting the process of producing an appropriate pro-forma disclosure document for use in Canada by the use of checklists and templates. But even further, cross-border attorneys can work together to establish a legislative compliance strategy, which will go a long way to heading off potential problems. This is especially true in larger franchise organizations, because Canadian franchise disclosure documents have to include all material facts and need to be current with most disclosure content on the date document is delivered (unlike the annual updating requirement in the U.S.). Outside counsel can provide the comfort of a second pair of eyes on any particular fact to help decide whether to disclose it.

Not to mention the ways in which franchise law is constantly evolving, so outside counsel are tremendously valuable in keeping corporate counsel up to date on legislative and case law developments.

For instance, it came as quite a shock to the franchise bar when the Midas case, 405341 Ontario Limited v. Midas Canada Inc. (2009), held that typical release language in a franchise agreement, in renewal or transfer circumstances, would not be enforceable unless there was a carve-out for rights under the franchise statute. The Midas case also held that, by providing that the law of Ontario (which has franchise legislation) governs the franchise agreement, a franchisee in British Columbia (which does not have franchise legislation) had a two-year right of rescission because the franchisor failed to provide a franchise disclosure document. These are important considerations for any franchisor to heed as it develops its cross-country strategy.

Additionally, there is a fairly steady stream of regulatory changes in Canada, which are not franchise-specific but impact franchising in such areas as privacy, waste disposal, labeling, nutritional content in menus, labor and employment, and Quebec language laws, to name a few.

Consider Canadian privacy legislation. New laws can affect how franchisees gather, store and use personal information obtained from customers, but also can affect how franchisors gather, store and use personal information obtained from franchisees. The currently hot issue in the U.S. regarding common employer status of franchisors and their franchisees is similar in Canada as to mechanics and consequences, but with uniquely Canadian twists that, if not taken into account, could result in serious consequences.

No one can deny that today’s corporate counsel is a high-functioning lawyer who is expected to handle more of a company’s legal issues in-house than has been the case in the past. While budgets, available time and resources will vary from company to company, it is safe to say that the relationship between corporate counsel and outside counsel will never go back to the old days of the “tame” in-house counsel simply managing the work of outside counsel. However, in many areas, particularly international franchise law, with all of its complexities and many moving parts, fostering an effective partnership between the two is the best way to deliver what the company needs and wants.

Edward (Ned) Levitt is a senior partner of Dickinson Wright in Toronto. He served as general counsel to the Canadian Franchise Association from 2000 to 2007 and, as a member of the Ontario Franchise Sector Working Team, was instrumental in the creation of Ontario’s franchise legislation. Among his many publications is Canadian Franchise Legislation, published by Butterworths/LexisNexis. He can be reached at nlevitt@dickinsonwright.com.

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