Being a franchisee in an established (or up-and-coming) franchise system is a complicated legal relationship. The legal terms under the various agreements of a franchising relationship can vary greatly between systems and industries. For a prospective franchisee, this blog post is intended to provide an overview of high-level legal issues to consider when reviewing a franchise opportunity. While by no means exhaustive, these issues are intended to serve as a starting point for prospective franchisees to understand and evaluate a franchise opportunity in Ontario.
1) Know Your Rights Under the Arthur Wishart (Franchise Disclosure), 2000 Act (the “Act”)
A prospective franchisee in Ontario is entitled to receive very specific disclosure before entering a franchise relationship. If a franchisor does not provide this disclosure in the correct form, with the correct content and at the correct time, the franchisee may be entitled to relief through fairly powerful remedies.
These remedies include a right for the franchisee to rescind a franchise agreement and be repaid essentially all amounts paid to the franchisor. This recission remedy is available within 60 days of signing the franchise agreement if the disclosure is late or incomplete. If no disclosure is provided at all (or the disclosure was so deficient that it amounted to no disclosure), a franchisee can rescind the agreement up to 2 years after it was signed.
2) Understand the Financial Structure and the Realities of the Business Model
Becoming a franchisee is a complicated investment that relies not only on your hard work and money, but on the participation and support of your franchisor. A prospective franchisee is well advised to speak with a financial advisor or accountant with franchise experience to develop a detailed business plan that factors in restrictions on pricing and suppliers, and the fees and marketing expenses that may be mandatory under a franchise agreement.
3) How Can You Get Out?
Typically, a franchise agreement will not provide a clear path for a franchisee to exit the investment, except for waiting for the term to expire. Some franchise agreements may provide for a specific payment to be made for early termination; others may not address termination by the franchisee at all.
In any event, it is helpful to know your exit strategy should the franchised business not be what you were expecting, or in the event of significant drop in cash flow – because of a worldwide pandemic, as one example. Early termination becomes even more important if a franchisee’s continuing franchise payments are fixed rather than based on a percentage of gross revenue.
All is not lost for an unsatisfied franchisee; in some circumstances, there may be ways to exit without triggering unacceptable liability. Whether these solutions are practical (or even available) under a set of particular circumstances will be highly dependent on the facts of each franchisee’s situation.
- Sell the Business: One approach would be to sell the franchised business; this is predicated on finding a buyer (which may not be possible) and would be subject to any requirements under the franchise agreement that allows the franchisor to vet a potential buyer. If the franchise agreement has detailed notice and timeline provisions related to the sale of the franchise to a third-party, a franchisee must follow these as closely as possible, or risk delay or denial by the franchisor.
- Statutory Recission Remedies: If disclosure provided to the franchisee is deficient (or non-existent) a franchisee may be able to rely on the recission remedies available under the Act to terminate their franchise agreement with minimal potential liability. As discussed above, when disclosure is deficient will depend on the facts of each circumstance, and the timelines for when these remedies continue to be available are very important for all franchisees to consider.
- Other Remedies Under Contract Law: In certain circumstances where the franchisor has materially breached the franchise agreement or acted in bad faith, there may be access to certain remedies that allow the franchisee to terminate the franchise agreement while minimizing liability.
However, negotiating with a franchisor (particularly ones in less established systems) can be the most cost-effective manner to either terminate the franchise agreement or address any business issues that have caused a franchisee to want to exit the system. Often a solution can be found before resorting to more aggressive tactics. It is always helpful to remember that in many cases both the franchisor and franchisee are invested in the success of the franchised business. However, there are plenty of situations where each parties’ motives begin to diverge, and more aggressive action might be warranted.
4) Personal Exposure
If you are to enter into a franchisee agreement through a corporate entity or partnership structure, a franchisor will almost always seek personal guarantees from several of the key principals of the franchisee. Each principal should be acutely aware of this source of personal liability and should assess the risk to their personal assets in the event of liability arising out of the franchise agreement. While typically not included in most franchise agreements (particularly with established systems), some franchisees can seek to have guarantees capped at certain amounts or a least attributed “severally” among multiple guarantors in accordance with their pro-rata holdings of the franchisee entity.
Often in addition to personal guarantees, franchisors take a security interest in the assets of the franchisee. This is not necessarily a point of concern; however, if the franchisee has any outstanding debt or is seeking to obtain financing from a bank or other institution, a franchisee would be well advised to ensure that giving this security interest will not result in a technical breach under their loan documentation or required notice to be provided to their bank or other lenders.
Any franchisee is best positioned to explore a franchise opportunity when they understand not only the legal implications but the practical realities of the relationship they are entering into. While the above is a narrow snapshot of the potential issues, this blog post should provide a taste of what are some typical issues for prospective franchisees. The lawyers at Mills & Mills LLP have experience with all parties to the franchising relationship and are well-positioned to assist a new franchisee in accessing the legal suitability of a new franchise opportunity.
At Mills & Mills LLP, our lawyers regularly help clients with a wide range of legal matters including business law, family law, real estate law, estate law, employment law, health law, and tax law. For over 130 years, we have earned a reputation amongst our peers and clients for quality of service and breadth of knowledge. Contact us online or at (416) 863-0125.