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Four essential elements of a franchise and meeting legal compliance
By Chad Finkelstein
June 22, 2011
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I frequently get approached by businesses who do not believe that they are franchises. It is common to hear that they just want to enter into a simple licensing agreement, so that they do not have to worry about all of the obligations and liabilities that come with the territory of being a franchisor. Unfortunately, the case of the accidental franchise is all too common, and some would-be “licensors” may find that their structure exposes them to a degree of liability that they are severely unprepared for.
The only provinces where franchise legislation exists are Ontario, Alberta, P.E.I. and New Brunswick, so those are the only provinces where a legal definition of a “franchise” can be found. While the wording differs slightly among them, the essential elements of a franchise are the same, and can be summarized as follows:
- the grant of the right to engage in a business;
- the contractual obligation to make a payment or continuing payments to a franchisor;
- the franchisee’s receipt of the right to sell or distribute goods or services that are substantially associated with the franchisor’s trade-marks; and
- the franchisor’s exercise of significant control over, or offer of significant assistance in, the franchisee’s method of operation, including building design and furnishings, locations, business organization, marketing techniques or training.
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Most licensing agreements will easily satisfy the first three elements of this legal test, so the question as to whether a franchise has inadvertently been created will turn on the degree of control which the licensor exercises. Too much of it, and a franchise may have accidentally been created. The consequences of being a franchisor and not having complied with the legal obligations of a franchisor are significant, so be sure to discuss with your legal counsel whether your license agreement is actually a franchise agreement.
In a franchise relationship, there is invariably an imbalance of power favouring the franchisor. This is understandable given that it is the franchisor who owns the brand, has spent considerable time and effort in developing operating standards and needs to exert a sufficient degree of control to ensure consistency in the delivery of products and services to customers of the franchise system.
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Franchise law recognizes this tilt towards the franchisor, and in those provinces where franchise law has been enacted, very specific rights are afforded to franchisees which cannot be waived.
One right, in particular, is the cornerstone of franchise law, and that is the franchise disclosure document. Not to be confused with an operations manual, the disclosure document is a compendium of various categories of information, all of which are specifically prescribed by law. In order to assist a franchisee in determining whether to enter the system, the disclosure document requires the franchisor to provide the prospective franchisee with its company history, litigation history, a description of all fees and costs necessary for the franchisee to start and continue to operate its business, a summary of restrictions and obligations contained in the franchise agreement and, perhaps most importantly, the franchisor’s financial statements. This list is far from exhaustive as there are many more headings of information required by law. However it should give you a sense of the level of detail that a disclosure document is to contain in order to aid a franchisee in deciding if the franchise is for them.
In addition, franchisees are under no obligation to buy into the franchise when they receive a disclosure document. In fact, the law requires that a minimum of 14 days pass before a franchisee can be required to pay any money to the franchisor, or sign any agreement relating to the franchise.
Franchise disclosure legislation currently exists in Ontario, Alberta and PEI and New Brunswick, with Manitoba anticipated to enact similar legislation later this year. Disclosure documents are not yet required in any other province or territory.
See also:
About the author
Chad Finkelstein is a franchise lawyer at Dale & Lessmann LLP in Toronto and can be reached at cfinkelstein@dalelessmann.com or (416) 369-7883.
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