Franchising
The Canadian
Franchising
System
A look at some of the common issues or disputes that may
arise in the franchisor-franchisee relationship from inception to
termination
By Pascale Cloutier & Fadi Amine; Miller Thomson LLP
M
Introduction
Much like in the United States, during the closing
decades of the last century and the opening of this one,
franchising in Canada has enjoyed increasing growth
and success. In fact, many first-time and experienced
entrepreneurs are tempted by a franchise system for
the many advantages it brings in terms of service,
recognized brands and products, trade-marks, expertise, support and a well-tested business model. For the
companies that wish to quickly expand, reach more
customers and enlarge their territorial “footprint,”
the franchise system is also an attractive business
model to implement.
With the explosive development of franchising as
a business model came the increasingly specialized
field of franchise litigation. For American businesses
and companies that may wish to expand into the
Canadian market via the franchise business model,
it is important to bear in mind that although many
aspects of the Canadian legal system and laws may be
similar to what currently exists in the US, especially
in the common-law Canadian provinces, there remain
substantial differences that, if ignored, may create
litigious situations between the franchisor and the
franchisee that otherwise may have been prevented
from the outset.
The following pages will briefly outline some of
the common issues or disputes that may arise in the
franchisor-franchisee relationship. These encompass
all stages of this relationship, from its very inception
through to its termination.
The Definition of a Franchise
From the franchisor’s and legal practitioner’s
point of view, it is imperative, before embarking on a
Canadian business expansion, to verify if such venture
falls within the definition given to a “franchise” by
the relevant provincial jurisdiction because some
provinces have laws that regulate such issues as
franchise disclosure, obligations and duties of the
parties, statutory obligations of good faith and fair
dealing, and a host of other issues that are or can be
litigious in nature, while other provinces have developed jurisprudential solutions and approaches that
may be peculiar to those provinces in particular. In
fact, it is necessary that a prospective franchisor verify
in each and every province in the country whether
there are laws that may impact the business.
The oldest franchise legislation in Canada was
adopted, in its original form, in 1971 in Alberta
through the Franchises Act R.S.A. 2000 c. F-23 (Alberta
Act), followed by the Arthur Wishart Act (Franchise
Disclosure), 2000, S.O., 2000 c. 3 (Ontario Act). The
provinces of Prince Edward Island and New Brunswick then followed suit with franchise-specific Acts
of their own (for PEI: Franchises Act R.S.P.E.I. 1988,
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Cap. F-14.1 [PEI Act]; for New Brunswick: Franchises
Act S.N.B., c. F-23.5 [NB Act] [this Act was passed in
2007, however is not yet in force, awaiting passage of
its regulations and royal proclamation]). All these
Acts define “franchise” along the following common
themes:
• A right to engage in a business;
• For the sale of goods or services substantially
associated with a trade-mark;
• In which the franchisee has certain financial
obligations towards the franchisor; and
• When the franchisor provides assistance
and services to the franchisee while retaining considerable control over the latter’s
business.
As for Québec, it does not have franchise-specific
statutes or laws and does not define what a franchise
is. However, a number of Civil Code of Québec articles
have a direct bearing and impact on the application and enforcement of franchise contracts, and
particularly because Québec jurisprudence generally
considers franchise contracts as being contracts of
adhesion (Ahsan v. The Second Cup Ltd., 2003 QCCA
10600; Provigo Distribution Inc. v. Supermarché A.R.G.
Inc. (1997), QCCA 10209), will be discussed further
on.
Franchise Disclosure
If an enterprise or undertaking falls within the
definition of a franchise within the meaning of the
above-mentioned Acts, then there are obligations that
must be met by the franchisor before the signing of a
franchise agreement with a potential franchisee. For
example, the Alberta Act provides that the franchisor
must provide a disclosure document that meets the
criteria set out in the Act to the franchisee at least 14
days before (a) the signing by the prospective franchisee of any agreement relating to the franchise, or (b)
the payment of any consideration by the prospective
franchisee relating to the franchise, whichever is
earlier. The Ontario Act and the PEI Act have similar
disclosure requirements.
Recent case law has applied the franchisor’s disclosure obligations strictly, and has not hesitated to
rescind franchise agreements and award damages in
case the disclosure obligations were not met strictly
and to their fullest by the franchisor.
In 1490664 Ontario Ltd. v. Dig This Garden Retailers Ltd., [2005] O.J. No 3040 (C.A.), the franchisor
(Dig This Garden) appealed a decision that granted,
amongst other things, the franchisee’s action in rescission of the franchise agreement and damages. The
facts of this case, briefly, are as follows: the franchisee
sought the rescission of the franchise contract approximately 18 months after the contract came into force,
as well as damages, claiming that the franchisor failed
in its duty to disclose material facts as set out in the
Ontario Act, and alleging loss of profit and damages
stemming from this failure.
The franchisor argued that approximately 70
percent of the required disclosure was made, and even
though this disclosure was not effectuated through a
single disclosure document, as set out in the Act, it was
nonetheless made over a period of time. Essentially,
the franchisor argued that even though it was not in
“procedural” compliance with the Act, it nonetheless
“substantively” complied with it. The court dismissed
this argument in the following manner:
[18] In my view, the facts as described by the
appellants do not fulfill the requirements of
the Act. There is no issue of “substantive” versus
“procedural” compliance. The requirement that
disclosure occur in the form of a single document is
not an empty formal requirement. The legislature
clearly envisioned that the purpose of the legislation – i.e., ensuring that a decision to enter into a
franchise agreement is an informed one – would
best be fulfilled by giving prospective franchisees
the opportunity to review a single document or
documents, so that all the information is before
them at the same time. It is simple commonsense
that people have more difficulty processing and
assessing information given at different times,
some of it orally, than they do information
provided in a single, written document.
[19] The language of the Act is unambiguous, and
it is mandatory. It prescribes in clear and precise
terms what is required. To give effect to the clear
language used in this case does not produce an
absurd result, and it fulfils the purpose of the
legislation. Therefore, I agree with the trial judge’s
conclusion that the appellants did not provide
disclosure as required by s. 5 of the Act. Accordingly, I would reject the first ground of appeal.
Considering that the franchisor did not properly
disclose material facts to the franchisee, the Court
of Appeal maintained the trial judge’s decision to
rescind the contract and award damages. An interesting aspect of the decision was that the Court of
Appeal maintained the trial judge’s decision to have
the two shareholders and officers and directors of the
franchisor jointly and severally liable to the franchisee. In fact, this is allowed for by the Act if it can be
shown that these persons meet the statutory definitions of “franchisor’s associate.”
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Franchising
In this case, the Court of Appeal concluded that
they did meet this definition, and therefore were
jointly and severally liable to the franchisor for the
payment of damages, because they were each 50
percent shareholders (therefore they jointly have 100
percent control of the company), they ran all aspects
of the company and made representations on behalf
of the franchisor to the franchisee.
In Personal Service Coffee Corp v. Beer (c.o.b. Elite Coffee
Newcastle), [2005] O.J. no 3043 (C.A.), the Ontario
Court of Appeal affirmed that the franchisee’s right
to rescind the franchise contract in the event of
non-disclosure was absolute, as well as his right to be
refunded by the franchisor “any money received from
or on behalf of the franchisee,” to have the franchisor
purchase from the franchisee any inventory remaining at the date of rescission and any supplies and
equipment at a price equal to the purchase price paid
by the franchisee, as set out in section 6 (1), (2) and
(6) of the Ontario Act.
Interestingly, before the lower court, the franchisor argued that it did not fall within the definition
of “franchise” as defined in the Ontario Act, and
therefore not subject to the disclosure obligations
contained in the Act. The lower court judge dismissed
this argument and it was not repeated before the
Court of Appeal.
As for Québec, it does not have franchise-specific
legislation or disclosure requirements tailored specifically towards the field of franchising. However, article
1375 of the Civil Code of Québec (Civil Code) imposes a
duty to act in good faith at all stages of a contractual
relationship: “The parties shall conduct themselves in
good faith both at the time the obligation is created
and at the time it is performed or extinguished.”
The Québec courts have interpreted this provision to mean that failure to disclose important or
material information of “decisive importance” prior
to the formation of a commercial contract, during
pre-contractual negotiations, can constitute a breach
of the good faith requirement imposed by article 1375
of the Civil Code and is actionable. In fact, a Supreme
Court of Canada decision bearing on the Québec
Civil Code duty to act in good faith has confirmed
the existence of a duty to inform in a pre-contractual
relationship, and that if not respected, opens the door
to the aggrieved party to a contract to a recourse in
extra-contractual damages (Bank of Montreal v. Bail
Ltée, [1992] 2 S.C.R. 554).
Even though this above-mentioned Supreme Court
It is imperative for
litigators to not take
at face value that a
franchise contract
is a contract of
adhesion, but to
consider whether
the essential clauses
of the contract were
negotiated and
discussed between
the franchisor and
franchisee, and
then present to the
court adequate and
sufficient evidence
of such negotiations
at trial.
decision was not rendered in a franchising context,
the general principle applies to all forms of contracts
subject to Québec law.
Furthermore, other provisions of the Civil Code
militate in favor of an adequate disclosure of information to a franchisee. As already stated above, Québec
courts have generally interpreted franchise contracts
to be contracts of adhesion (Provigo Distribution Inc.,
Ahsan and Copiscope Inc. v. TRM Copy Centers (Canada)
Ltd. (1998), AZ-99011068 (C.A.)) and, as such, subject
to specific consequences directly related to this status.
Article 1379 of the Civil Code defines the contract of
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adhesion as “a contract in which the essential stipulations were imposed or drawn up by one of the parties,
on his behalf or upon his instructions, and were not
negotiable.” In fact, the Ontario Court of Appeal in
Shelanu Inc. v. Print Three Franchising Corp. (2003), O.J.
C35392, echoes this definition, and agrees with the
Québec courts that a franchise contract is generally a
contract of adhesion (at par. 66).
However, it is important to note that the status of
a franchise contract as being a contract of adhesion
is not automatic, and proof can be presented to the
court that establishes otherwise and that the essential
provisions of the contract were or could have been
freely negotiated and discussed by both parties (90697384 Québec Inc. v. Superclub Vidéotron Ltée, 2004 CanLII
32216 (QC C.S.)).
Therefore, it is imperative for litigators to not take
at face value that a franchise contract is a contract of
adhesion, but to consider whether the essential clauses
of the contract were negotiated and discussed between
the franchisor and franchisee, and then present to
the court adequate and sufficient evidence of such
negotiations at trial. If a trial judge is convinced of the
merits of this evidence, then the specific consequences
of a contract being labeled a contract of adhesion are
avoided.
In Québec, some of these consequences pertain
directly to the disclosure of information or explanations given to the franchisee prior to the signing of
the contract. Specifically, articles 1435 and 1436 of the
Civil Code state:
1435. An external clause referred to in a contract
is binding on the parties. In a consumer contract
or a contract of adhesion, however, an external
clause is null if, at the time of formation of the
contract, it was not expressly brought to the attention of the consumer or adhering party, unless the
other party proves that the consumer or adhering
party otherwise knew of it.
1436. In a consumer contract or a contract of
adhesion, a clause which is illegible or incomprehensible to a reasonable person is null if the
consumer or the adhering party suffers injury
therefrom, unless the other party proves that an
adequate explanation of the nature and scope of
the clause was given to the consumer or adhering
party.
Apart from the franchise contract binding the
franchisor and the franchisee to one another and
setting out each party’s contractual obligations, the
other fundamental document that sets out the param-
eters of any successful franchising relationship is the
franchise operations manual, which, in essence, sets
out the day-to-day operations of the franchisee and is
enforceable by the franchisor as a breach of contract
if not respected.
This franchise operations manual is precisely
such an “external clause” to the contract referred to
at article 1435 of the Civil Code, and if not expressly
brought to the attention of the franchisee, in this case
the adhering party, before the contract is signed, the
courts may decide that the operations manual or any
other such document is null and therefore not enforceable (Gagnon, H. Jean, La franchise au Québec, Wilson
& Lafleur Martel ltée, Montréal, 2003, pp. 228.12 to
228.14). It is therefore useful to have a clause in the
contract that refers directly to the franchise operations manual and that a copy be given to the potential
franchisee before the signature of the contract.
Understandably, one need not dwell for long on the
consequences of such nullity on a franchise relationship overall to understand that it is certainly not in
the best interest of the franchisor or the rest of the
franchise network to have certain of their members
not follow the same operating procedures as everyone else. Therefore, in Québec, the franchisor must
divulge before the signing of a franchise contract any
document that is external to the contract itself and that
sets out duties and obligations upon the franchisee.
The franchisor also has an obligation to adequately
explain to the franchisee, before the signing of
the contract, the nature and scope of the contractual clauses contained therein. As is often the case,
franchise contracts use rather specialized language
that may be difficult to understand to an inexperienced individual. It is therefore in the best interest
of the franchisor to explain to the future franchisee
the meaning of the contractual clauses, or encourage him to seek professional legal advice to have the
meaning explained to him (9069-7384 Québec Inc.), if
the franchisor wishes to avoid the consequences of
article 1436 of the Civil Code (La franchise au Québec,
pp. 228.11 to 228.12).
That being said, Québec jurisprudence also requires
from the franchisee an obligation to inform him- or
herself. This obligation can be satisfied in several ways,
either by the franchisee asking questions, carefully
reading the documents and the franchise contract
provided by the franchisor, carefully inspecting the
equipment sold along with the franchise, asking to
meet existing franchisees, etc. In other words, the
franchisee must have an active role in the informa-
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Franchising
tion-gathering process.
For this reason, the court dismissed the appeal.
In Les Investissements Stanislas et Patricia Bricka Inc.
c. Groupe CDREM Inc., 2001 CanLII (QC C.A.), the
Québec Court of Appeal dismissed an appeal formed
by the franchisee after the trial judge came to the
conclusion that the franchisee did not prove along
the balance of probabilities misrepresentation by the
franchisor relative to the profitability of the business.
The franchisee had purchased a corporately owned
franchise directly from the franchisor, and after a
year and half of operations, asked for the annulment
of the sale and the franchise contract. In support of
his action, the franchisee alleged that the franchisor
guaranteed a certain threshold of profitability, which
was not reached in actuality. The franchisee points to
the fact that during the pre-contractual negotiations
the franchisor had provided financial statements that
supported the projected profitability of the franchise.
This action is dismissed by the trial judge and at
appeal, the Québec Court of Appeal affirmed the
decision of first instance.
Lastly, in order to obtain annulment of the
franchise contract or other remedies, the franchisee can’t merely allege and prove misrepresentation.
The franchisee must prove that his error (in signing
the contract) “was induced by fraud committed by
the other party or with his knowledge” and that his
consent was vitiated because, “but for that error, [the
franchisee] would not have contracted, or would have
contracted on different terms.” Fraud may result
also from silence or concealment, on the part of the
franchisor, of revealing decisive information (Article
1401 of the Civil Code).
In this affair the contract of sale of the business to
the franchisee contained the following clause, under
the heading “Representations and Warranties of
Seller”:
That the internal statement of operations attached
hereto as Schedule C fairly presents the financial
operations of the Purchased Business for the fiscal
periods ended February 28, 1993, and February 28,
1994, the whole in accordance with generally accepted
accounting principles.
However, the franchise contract contained clauses
to the effect that the franchisee obtained independent
legal and financial advice and that he had the opportunity to carefully read the franchise agreement and
understand its meaning. Also, the contract contained
clauses to the effect that the franchisee is aware that
the business is a commercial enterprise and therefore
subject to risks, that its success was dependent on his
abilities as an independent business man, and that
the franchisor made no representations or warranties whatsoever as to the profitability or success of the
business.
The Court of Appeal of Québec found that despite
the fact that the franchisor had provided financial
statements that seemed to support the projected
profitability of the business, the franchisee failed to
ask questions that would have permitted him to understand them, and merely satisfied himself with the
information already at hand without seeking more.
Duty to Act in Good Faith
As in Québec, all the above-mentioned Acts impose
a duty of fair dealing and to act in good faith to both
parties in a franchise relationship (section 7 of the
Alberta Act; section 3 of the Ontario Act; section 3 of
the PEI Act; and section 3 of the NB Act ). However, the
courts have recognized the existence of a common-law
duty of good faith extant between franchising parties,
and have not hesitated to enforce such a duty and to
hold the party in breach of this duty liable for damages
or injunctive relief. This duty to act in good faith and
fair dealing does not mean, however, that the franchisor has a fiduciary duty towards his franchisee.
The leading Ontario court case on this matter is
the Court of Appeal decision in Shelanu Inc. v. Print
Three Franchising Corporation (2003), O.J. C35392,
where the court concludes on the existence of a
common-law duty to act in good faith that must exist
between some contracting parties and particularly in
a franchise context. The court is of the opinion that
“in some instances a duty of good faith may arise
ordinarily out of the nature of the relationship, or the
circumstances created by the other party” (para. 65).
Interestingly enough, in order to justify this duty to
act in good faith at common law, the court echoes the
Québec courts that a franchise contract is a contract
of adhesion (para. 66).
In Shelanu, the franchisee alleged that the franchisor breached its statutory and common-law duties of
good faith when the franchisor permitted the establishment of three similar businesses to the franchisee
but operating under a different banner (Le Print
Express) in relative close proximity to the franchisee’s
establishment (Print Three), thereby diverting clientele to the three new establishments. The franchisor
argued that the Le Print Express shops were geared
towards an entirely different target market (individuals and small businesses), while the plaintiff’s franchise
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serviced larger volume and commercial clients.
overturned the trial judge’s decision on this issue.
On the basis of the particular facts of the case (para.
107), the court held that the franchisor did not breach
its duty to act in good faith towards its franchisee in
establishing the three Le Print Express shops and
A leading Québec case on the issue of the implied
duty of good faith between a franchisor and franchisee is Supermarché A.R.G. Inc. et Supermarché Frontenac
Inc. c. Provigo Distribution Inc., [1998] R.J.Q. 47 (C.A.).
In this case, the franchisor (Provigo Distribution Inc.)
was being sued by the franchisees (Provigo) for having
opened and operated in proximity to their supermarkets a differently branded (Héritage) supermarket
that supposedly targeted a different clientele, with a
different price structure and services, however with
the consequence that the Héritage store entered into
direct competition with the franchisee and causing
pecuniary damages. The franchisee argued that the
franchisor, in acting in this manner and by forcing
them to maintain a higher price structure than the
Héritage brand of supermarkets, breached its general
duty to act in good faith towards them.
The Court of
Appeal of Québec
found that despite
the fact that the
franchisor had
provided financial
statements that
seemed to support
the projected
profitability of
the business, the
franchisee failed
to ask questions
that would have
permitted him to
understand them,
and merely satisfied
himself with the
information already
at hand without
seeking more.
The Québec Court of Appeal refused to lay down a
general rule to the effect that a franchisor may never
own or operate other businesses or establishments
that may enter into direct competition with its franchisees. To do so, the court explained, would inhibit the
franchisor from adapting to changing market conditions and consumer tastes and ultimately condemn
the franchisor “to death.” A franchisor is not in breach
of its duties towards the franchisee merely by the fact
of a restructuring of its operations and strategies in
face of competition, on the condition that (1) it be
done in good faith, (2) that it not target specifically
the franchisees, and (3) that it does not empty the
franchise contract of all its value and advantages.
Having said that, the court then continued to
explain that the franchisor has an implied duty of
technical and commercial assistance to its franchisees, and that in a situation where the franchisor must
alter its structure or strategy in the face of stiff competition and that such alterations may directly impact
the franchisee, then the franchisor has an obligation
to assist, through its acquired expertise, advice and
know-how, the franchisees to also adapt or otherwise
maintain the original relevance of being bound by a
franchise relationship. In effect, the franchisees and
franchisor are bound in a partnership, or a collaborative undertaking, and the implied duty of good faith
and assistance stems from this relationship.
The above-mentioned examples highlight the
franchisor’s duty of good faith in the context of
encroachment by the franchisor upon the business
and livelihood of the franchisee. However, this duty
extends to all aspects of the franchise relationship
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Franchising
and even towards the termination of the relationship.
However, this does not mean that a franchisee can
insist that a franchise agreement be renewed upon
expiry of the term of the agreement (530888 Ontario
Ltd. v. Sobeys Inc. (2001), 12 B.L.R. (3d) 267 (Ont.
S.C.J.); Automobiles Jalbert Inc. v. BMW Canada Inc.,
[2006] J.Q. No. 8803 (Q.C.A.)). In Simard v. Provi-Soir
Inc., J.E. 93-284 (Q.C.A.), the Québec Court of Appeal
explains that there may exist cases where the refusal
to renew a fixed-term franchise contract can be
considered abusive given the collaborative economic
relationship between the parties (para. 6).
Conclusion
American franchisors that wish to expand into the
Canadian market need to understand the various
provincial subtleties that govern franchise law and
litigation in Canada, even though the general structure may resemble existing American legislation. This
is especially true in the case of Québec, where the
franchisor must deal with and navigate through a civil
law tradition.
Nonetheless, franchising in Canada is thriving and
we do not see in the foreseeable future a reduction in
the interest of businesses or entrepreneurs to explore
this commercial possibility.
From the litigator’s point of view, it will be interesting to watch for further jurisprudential developments
on the common-law and the statutory (for those
provinces that have enacted such legislation) obligations of fair dealing and to act in good faith, and in
Québec, on the implied obligation of acting in good
faith and the Civil Code obligation of the same name.
Also, other provinces may follow in the path traced
by Alberta, Ontario, Prince Edward Island and New
Brunswick in drafting franchise-specific legislation
and it is likely that these will be partly or substantially
inspired by existing legislation and practices.
Pascale Cloutier, Miller Thomson LLP
Tel: (514) 871-5486 • Fax: (514) 875-4308 • E-mail: pcloutier@millerthomsonpouliot.com
artner in Miller Thomson’s Montréal office and chair of the firm’s National Franchise
Group. Her practice focuses on commercial litigation matters relating to franchising and
distribution, competition, contract law, products liability and real estate. Over the years, she
has acquired solid experience in pleading before courts of all instance, as well as expertise
in mediation and commercial arbitration, specifically urgent proceedings such as injunctions and safeguard orders. She has spoken on several occasions at national and international
conferences.
P
Fadi Amine, Miller Thomson LLP
Tel: (514) 871-5402 • Fax: (514) 875-4308 • E-mail: famine@millerthomsonpouliot.com
itigation associate in Miller Thomson’s Montréal office. He has been involved in a broad
range of civil and commercial litigation matters, including class actions, insolvency and
restructuring, consumer protection, competition law as well as matters relating to franchising
and distribution. He also acts for major national and international lending institutions in
asset recovery and debt collection. He has been successful in pleading before Québec courts
of all instances and has particular expertise in urgent proceedings.
L
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