How a Franchise Agreement and a Franchise Disclosure Document differ
There are two documents that are of vital importance...
Before discussing what franchise law is all about, and what it means for franchisors and franchisees doing business in Canada, it is important to first understand why we have franchise laws in the first place.
As I am writing this, five Canadian provinces (Ontario, Alberta, Prince Edward Island, New Brunswick and Manitoba) have franchise legislation in place, with a sixth (British Columbia) expected to enact franchise law at some point in 2014. As a result, those five provinces provide for a statutory definition of what a ‘franchise’ actually is. While the legal definition of a ‘franchise’ should not come as a surprise, it can essentially be boiled down to these three elements: (i) granting someone a right to conduct a business under a trademark; (ii) charging some initial and/or ongoing fee for that right to conduct that business under that trademark; and (iii) exercising substantial control over that business owner’s operations.
If you can decisively eliminate any one of those three elements from your business model, you are likely not operating as a franchise. This is the biggest difference between franchising, and other methods of product and service distribution, including pure licensing – under non-franchise models, that control element does not exist. Rather, the licensor only grants the trademark right and charges a fee for it.
It is often said that the hallmarks of franchising are consistency and uniformity, so that if you walk into your favourite coffee shop anywhere in Canada, for example, you can expect a certain menu of products and services, and the same general customer experience as you would find at any of their outlets. Accordingly, it is no surprise that the legal definition of a franchise would include a control element since, in order to achieve that level of consistency and uniformity, a franchisor must exert a considerable amount of supervision in ensuring that its standards are complied with.
Of course, the corollary of all of that control is that (cue movie soundtrack) with great power comes great responsibility. As a result, franchise law steps in to ensure that if a franchisor is exercising that much control over a franchisee’s business (and with good reason – it’s for the benefit of the system and the consumer experience, after all), then the franchisee should be treated as fairly as possible.
So what are the best ways to ensure that franchisees are not taken advantage of? Franchise laws provide for a number of important statutory rights for franchisees, including imposing a positive duty on both sides to act in good faith and in accordance with reasonable commercial standards, and a right for franchisees to associate with each other without fear of reprisal from the franchisor.
But the cornerstone of franchise law is the franchise disclosure document (FDD), a prospectus-like compendium of information about the franchisor and the franchise system. The FDD is intended to aid franchisees in making informed investment decisions, and franchise lawyers like me spend our days reading, writing and reviewing these voluminous documents on behalf of franchisors and franchisees alike.
The FDD should include all material facts about the franchise offering, including the business background of the franchisor and its directors and officers, litigation history, bankruptcy history, estimates of costs to establish a franchised business, estimates of costs to operate the franchised business on an ongoing basis, a list of intellectual property owned by the franchisor and licensed to the franchisee, policies on exclusive territories and volume rebates and discounts, summaries of restrictions imposed on franchisees, lists of current and former franchisees and the franchisor’s most recent financial statements, among many other items. Although not required by law to do so, some franchisors will take the opportunity to disclose sales histories or earnings projections in an FDD. Due to the very real fear of liability for misrepresentation, some franchisors are gun-shy about providing this information, so don’t be surprised if nobody is prepared to tell you how much money you’re going to make.
In addition to all of these requirements which franchise law imposes on franchisors, these statutes also require that a prospective franchisee receive the FDD at least two weeks before that prospective franchisee signs any agreement relating to the franchise or pays any money to the franchisor. This ‘cooling off’ period is intended to give franchisees an opportunity to consider the FDD, and review it with friends, family and business and legal advisors. If a franchisor fails to provide an FDD within this timeline, never gives one at all or gives one that is so deficient that it could never actually be considered a valid disclosure document, franchisees may have a very powerful remedy for up to two years to get out of the franchise agreement and be reimbursed for their investment.
No doubt that franchise law creates a considerable amount of responsibility (and potential liability) for franchisors. However, the justification for franchise law and the rights and responsibilities it affords is practical, and strikes a fair balance between the experienced franchisor who needs to exert control in order to maintain system standards, and the independent franchisee who is assuming them.
