The Danger of the Accidental Franchise

  • January 10, 2018
  • Chuck Merovitz and Kelli-Anne Day

The overarching purpose of the Arthur Wishart Act (Franchise Disclosure), 2000, S.O. 2000, c. 3 (“AWA”) is to protect franchisees. Substantively, this purpose is borne out in three central ways: (1) through the statutory obligation of fair dealing; (2) through a positive right of franchisees to associate with other franchisees; and (3) through a rigorous disclosure obligation imposed upon franchisors.

In order to gain access to the remedies as set out in the AWA, a business relationship must fit the legislative definition of a “franchise.” This definition is expansive and leaves significant room for interpretation. As a result, many business owners may find themselves conducting their day-to-day affairs in a manner that can be characterized as a franchise without even knowing it. This article will explore this idea of the “accidental franchise.”

The AWA defines “franchise” as follows:

A right to engage in a business where the franchisee is required by contract or otherwise to make a payment or continuing payments, whether direct or indirect, or a commitment to make such payment or payments, to the franchisor, or the franchisor's associate, in the course of operating the business or as a condition of acquiring the franchise or commencing operations and,

  1. in which,

    1. the franchisor grants the franchisee the right to sell, offer for sale or distribute goods or services that are substantially associated with the franchisor's, or the franchisor's associate's, trade-mark, service mark, trade name, logo or advertising or other commercial symbol, and

    2. the franchisor or the franchisor's associate exercises significant control over, or offers significant assistance in, the franchisee's method of operation, including building design and furnishings, locations, business organization, marketing techniques or training, or

  2. in which

    1. the franchisor, or the franchisor's associate, grants the franchisee the representational or distribution rights, whether or not a trade-mark, service mark, trade name, logo or advertising or other commercial symbol is involved, to sell, offer for sale or distribute goods or services supplied by the franchisor or a supplier designated by the franchisor, and

    2. the franchiser, or the franchisor's associate, or a third person designated by the franchisor, provides location assistance, including securing retail outlets or accounts for the goods or services to be sold, offered for sale or distributed or securing locations or sites for vending machines, display racks or other product sales displays used by the franchisee

The above definition is rife with disjunctive options and general thresholds. One need only consider the number of times the word “or” appears in the above definition to appreciate that it was intended to cover a wide array of business relationships. While such a flexible definition gives the legislation the ability to effect its inherently protective purpose, it also causes uncertainty.

For example, what degree of association needs to be reached before it becomes “substantial”? How much control is “significant” control? How much assistance is “significant” assistance? Does the “vendor” provide training to its “purchasers”? Is this training mandatory? How is the “vendor’s” business or product marketed to prospective “purchasers”? Is the relationship between the parties ongoing? These are some of the questions that require careful attention when reviewing an agreement that may give rise to a potential franchise relationship because they may result in unintended consequences for unsophisticated parties. One of the potential consequences is that of the “accidental franchise”. This occurs when a business arrangement is found to be a franchise, although this was not necessarily the intention of one or both parties.

If the statutory thresholds are met and a franchisor-franchisee relationship is found to exist, the accidental franchisor will find itself exposed to rescission claims from each accidental franchisee with whom it entered into business in the preceding two years.

Subsection 6(6) of the AWA states that the franchisor, or franchisor’s associate, as the case may be, shall, within 60 days of the effective date of the rescission,

(a) refund to the franchisee any money received from or on behalf of the franchisee, other than money for inventory, supplies or equipment;

(b) purchase from the franchisee any inventory that the franchisee had purchased pursuant to the franchise agreement and remaining at the effective date of rescission, at a price equal to the purchase price paid by the franchisee;

(c) purchase from the franchisee any supplies and equipment that the franchisee had purchased pursuant to the franchise agreement, at a price equal to the purchase price paid by the franchisee; and

(d) compensate the franchisee for any losses that the franchisee incurred in acquiring, setting up and operating the franchise, less the amounts set out in clauses (a) to (c). 

Depending on the number of contracts entered into by the accidental franchisor over the preceding two years, the rescission remedy can give rise to ruinous liability.

The purpose of the AWA as a whole is to “protect franchisees” and this remedial purpose guides the courts in their application of the legislation. The risks associated with engaging in the conduct referred to in the definition of “franchise” are many, the disclosure obligations are onerous, and the consequences for non-compliance are severe. As such, lawyers advising clients in situations where there is a potential for a finding of an accidental franchise ought to treat seemingly innocuous agreements with a healthy dose of caution.


About the author

Chuck Merovitz and Kelli-Anne Day, Merovitz Potechin LLP

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