U.S. franchisors face strict Canadian disclosure laws

Provincial rules provide a wrinkle for franchises looking to expand to Canada

Canada has been an attractive option for U.S. investors and businesses for years. Not only is it America’s largest trading partner, but the thousands of miles of mutual border, common cultures and shared languages make Canada a logical choice for international business relations (see “The Canada Report” in the November 2011 issue).

Canada also is a logical first step for U.S. franchisors looking to expand into the international marketplace. While the financial crisis put a damper on U.S. franchisors pushing into Canada in recent years, the relatively strong Canadian
economy has reinforced the neighbor to the north as an ideal target when looking to court prospective franchisees.

But despite the recently increased activity in U.S. franchisors moving into the Canadian market, there are some still-developing legislative issues about which they should be aware before plunging head-first across the border.

Legislative Landscape

Unlike in the U.S., where the Federal Trade Commission oversees franchising and the furnishing of Franchise Disclosure Documents from franchisors to franchisees prior to reaching an agreement (with a number of states adding other regional requirements), Canada has no federal regulator. The province of Alberta adopted the first franchise legislation in Canada in the early 1970s, which it amended to disclosure-style legislation in 1996. Since then, Ontario passed similar franchise legislation in 2000, and was followed by Prince Edward Island (2005), New Brunswick (2007) and Manitoba (2010). Manitoba’s law, however, is yet to be proclaimed in force, but is expected to happen later this year.

The disclosure laws in Canada require a franchisor to present a prospectus-style disclosure document to a franchisee a minimum of 14 days prior to entering into an agreement or any money changing hands. Therefore, the franchisee has all of the necessary information to make an informed investment decision prior to entering into the agreement.

There also is a relationship component to the legislation. The Canadian statutes require both parties to adhere to a duty of fair dealing in the franchise agreement, meaning that both franchisor and franchisee must act in good faith and in accordance with reasonable commercial standards.

“The duty to act fairly is directed at that economic imbalance between franchisor and franchisee,” Fasken Martineau Partner Darrell Jarvis explains. “In most cases, the franchisor has a great deal more power in the relationship.”

While there’s an overall consistency to different provinces’ legislation, there are some minor differences between the provincial laws. Bennett Jones Partner Murray Coleman says that the three provinces to most recently enact disclosure legislation have made some improvements upon Alberta and Ontario’s laws.

“For example,” he says, “in Ontario, there’s no opportunity for electronic delivery of a disclosure document. Today, people would expect that to be possible. In Prince Edward Island, New Brunswick and Manitoba, electronic delivery appears in their statutes.”

Despite this recent trend in adoption of franchise legislation, there’s currently no talk of the other provinces following suit anytime soon.

Prickly Perception

There have been a handful of lawsuits in recent years that perpetuated the perception that Canada’s franchise laws are overly strict. Although Canadian counsel assert that this is not the case, they do acknowledge a recent judicial trend of trying to rebalance the relationship between franchisor and franchisee, with the pendulum swinging in favor of the latter party.

One key difference between Canadian and U.S. franchise disclosure laws is the franchisor’s obligation to disclose all other material facts to a franchisee. The laws mandate that the franchisor divulge about 40 specific items in its disclosure document, based on the province, plus all other material facts during the full duration of the disclosure period. A material fact can be any information that would have a significant impact on the franchisee’s decision to enter into the franchise agreement, or on the price of that franchise. This information varies per situation, and can be specific to a particular potential franchisee or site that’s being offered to that franchisee.

“You need to step back and ask yourself what other material facts may exist that the franchisee would need to have in front of them to make an informed investment decision,” says Osler, Hoskin & Harcourt Partner Andraya Frith. “And now, in many cases, you have to have a customized disclosure document for each candidate. The days of just providing your standard form franchise disclosure document are over.”

This issue of material fact disclosure is a potential thorn in the side of franchisors. Ontario’s Court of Appeal ruled in two recent decisions that if there’s a material omission in a disclosure statement, the franchisee has two years after signing the franchise agreement to seek a rescission remedy. If the franchisee is awarded a rescission action, it can recoup all of its money plus any additional building costs, royalties, fees and even losses incurred during that two-year period.

As a result of these decisions, Adam Ship, an attorney at McCarthy Tétrault, says franchisees now have an incentive to carefully examine their disclosure documents to find material omissions.

“If in two years the franchise was a poor performer, or the market is just not performing well, franchisees are beginning to go back and carefully review their disclosure documents,” he says. “If the franchisor wasn’t very diligent when working on that document and missed something, the franchisee then has a right to get their money back.”

Counsel Considerations

While the Canadian franchise regime is similar to that of the U.S., it’s still important for U.S. franchisors to do their homework before heading for the border. In-house counsel should remember that Canada is a foreign country and that it would be wise to retain Canadian counsel to assist with both the preparation of disclosure documents and the overall development of the franchise in Canada.

“The differences are sufficient to require retaining Canadian counsel,” Jarvis says. “It would be a mistake not to.”

Both Jarvis and Coleman suggest franchisors prepare a national disclosure document that meets the disclosure obligations of each of the provinces so that it can be used in any of the provinces requiring disclosure.

There also are many aspects to the project that go beyond just core franchising. Prior to entering the Canadian marketplace, counsel should ensure the franchise’s trademarks are available and, if so, protect them by filing applications as soon as the decision is made to expand. Counsel should take into account all tax considerations, and review all of the company’s agreements to ensure compliance with Canadian laws, especially with regard to antitrust, gift card and privacy laws.

Frith adds that Canada’s approach to leasing can be quite different from what U.S. franchisors are accustomed to at home. The same goes for labor and real estate costs, which tend to be higher in Canada than in the U.S., and will need to be factored into disclosure documents. Then there is making sure that the franchisor understands the cultural differences, consumer preferences and the local competition as well. Expanding into Québec also can be a challenge. Québec not only has a different culture and language, but also is a civil law regime while the rest of Canada adheres to common law.

“Many of our more successful U.S. clients who come to Canada first run a corporate pilot store so they can get a better understanding of the Canadian marketplace and what the costs of establishment will be for franchisees,” Frith says. “Then they later use that corporate store as a training center for future franchisees, convert it to a franchise or continue to run it corporately.” 

Contributing Author

Join the Conversation

Advertisement. Closing in 15 seconds.