Beware the Accidental Franchisor

Author: j.mcrookston@goldmanhine.com

Date: MAR 21st, 2014

Topic: Industry Experts

Your Canadian business is growing. You have a great brand. You have market traction. You decide that to grow faster, you need to take your brand and license it to others. The licensees will use the brand, pay you a royalty, and you’ll keep an eye on how they conduct business to ensure that your brand isn’t being inadvertently tarnished.

You’ve heard of franchising, but you don’t want to go that route. It’s expensive. You’ve read stories about the onerous disclosure obligations, and you’re sure it will cost a fortune. But that’s okay, you think, because you’ll just call the agreement a “Licensing Agreement”, and dodge the whole issue. Licensing is the simple and easy way to go, you think to yourself.

Unfortunately, the scenario described is not uncommon. Worse, it is extremely dangerous. Prospective franchisors often think that they can avoid the application of Canadian franchise legislation (including for franchises operated wholly or partly in Ontario, the Ontario Arthur Wishart Act (Franchise Disclosure), 2000), if they call their agreement a “license agreement”. The law, however, is not so simple.

Many businesses that are not typically considered “franchises”, or that do not operate pursuant to a “franchise agreement”, may still be subject to the Wishart Act. This is because the definition of “franchise” in that Act uses relatively few, and very broad, elements to define what is or is not a franchise. As a result, it captures business relationships where the parties would not have thought they were entering into a typical “franchise”. What the parties call the agreement is irrelevant.

Even the fact that franchisors do not intend to create a franchise relationship is irrelevant to whether one has been created. In one case a court held that a franchise relationship had been formed even though the parties had not discussed franchising, had not referred to a franchise in their contract, and even though the vendor did not know what he was selling would be considered a franchise until years later.

In a case handled by our firm, and one of the first cases dealing with this issue, a martial arts dojo operated under licence was later found to be a franchise. The franchisor ended up paying the “licensee” (our client) damages for improper disclosure.

In America, which also has franchise legislation, an NBA basketball team was found to be a “franchise”, and not a licensee, because it was subject to league requirements and used league’s trade-marks. In another American case a “Master Distributor Agreement” allowing a distributor to use a manufacturer’s trade-mark, maintain a sales force, and promote the manufacturer’s products, was held to be a franchise.

This issue is dangerous to business owners because the Wishart Act (as an example) imposes onerous disclosure obligations on franchisors and imposes serious penalties if a franchisor does not comply. Furthermore, the Wishart Act imposes liability on directors and officers of franchisors, who may find themselves personally on the hook for hundreds of thousands of dollars for improper disclosure.

The law will look to the substance of a relationship, not what it was called or what the parties thought it was. So make sure you talk to a lawyer before you “license”, to make sure you aren’t inadvertently, and dangerously, franchising.