UPDATE ON FEBRUARY 1, 2017
This blog will serve to demystify franchising law in B.C. First, I'll describe what franchising is. Then I'll give an overview of the applicable law in B.C. If you're reading this and considering purchasing a franchise, hopefully by the end of the blog you'll better understand the franchising business model and have some tools to help you navigate your business opportunity.
What is Franchising?
Franchising is a business model where an individual (franchisee) is granted the right to use a business model/concept and brand for a prescribed period of time. In return, the franchisee pays prescribed upfront costs and ongoing dues to the franchisor.
Franchising is widely popular because the franchisor avoids the liability and cost of building chain stores and expanding to new locations themselves, and the franchisee has support and training from the franchisor as well as licensed use of the franchisor's brand and other proprietary intellectual property. Franchising as a business model is unique in many ways and the success of the franchisor is greatly dependent on the success of its franchisees (and vice-versa). The following are other hallmark characteristics of franchising:
- The franchisor controls many aspects of the franchisee's business operations.
- The franchisor has superior economic resources and bargaining power.
- Because the franchisee relies on the franchisor for information about whether to purchase the business, disclosure is key.
Are there special laws in place to govern franchising?
In some provinces, yes. Franchising is regulated in five provinces: Ontario, Alberta, Manitoba, New Brunswick and Prince Edward Island. In these provinces the laws are largely based on a uniform set of laws.
As of Feb 1, 2017, the new BC Franchises Act (based on Bill 38 http://www.leg.bc.ca/40th4th/1st_read/gov38-1.htm) will come into force.
I'm a potential franchisee. What do I need to know?
The franchise agreement negotiated between franchisor and franchisee governs. Further, if the franchisor is a member of the Canadian Franchise Association (CFA), the franchisor must adhere to the CFA's Code of Ethics, namely, the requirements of the Code's disclosure policy. Failure to do so and the CFA may sanction the franchisor. (But that's little comfort to the franchisee as there are no other statutory remedies).
If you're thinking about getting "in" on a franchise, be sure to:
- Read any and all disclosure documents the franchisor provides before you sign anything. And if nothing is provided, ask!
- Understand the financial statements and pro-forma financial projections given by the franchisor - do the numbers make sense? Consider going over the figures with an accountant.
- Understand who is the franchisor, and their reputation (are they a member of a franchise association?) Try to find out where other franchisees are located.
With respect to the franchise agreement itself, pay careful attention the terms, especially the following:
- Review and Cooling off period. Does the franchisee have time to review disclosure documents before signing a franchise agreement? And after signing, is there a period of time which the deposit (if paid) can still be refunded if the franchisee wants to walk away?
- Deposit structure. How much is required up-front and how much time is required to make the payments? What (if any portion) of it is refundable?
- Royalty payment obligations. Because payments and fees are usually calculated based on gross sales, crunch the numbers to understand how much sales is necessary to break-even or make a profit.
- Supply-purchase obligations. Must the franchisee purchase supplies from the franchisor's preferred supplier? Are the supply terms unfavourable to the franchisee? Find out if the prices are inflated and if it is more cost-effective to purchase from another supplier instead.
- Territory restrictions. What is the territory/location that the franchisee is permitted to operate in? Can the franchisor restrict or limit operations of the franchisee in that territory at any time, or operate competing businesses in that territory?
In practice, if you're thinking about purchasing a franchise location, many of the franchisors you've heard of, or come across, operate nationally. For example, the CFA is a massive association and many franchisors are members of it. If the franchisor is reputable and has their ducks in a row, they likely have a streamlined approach to providing disclosure documents (harmoniously across the provinces), and already adhere to the laws required in the five provinces with specialized franchising laws.
B.C.'s NEW Franchises Act
After Feb 1, 2017, the new Act and its regulations will introduce numerous changes (for the better!) on the franchising law landscape in B.C., including:
- Disclosure. While most franchisors already provide disclosure documents to the franchisee, they were actually not required to before the Act was passed. Now the Act includes the duty of disclosure, and franchisors will be legally required to disclose prescribed information including financial statements, information about the franchise system, the business records of the franchisor and the franchise location. Also, timing is key. Disclosure must happen at least 14 days before the franchise agreement is signed. Disclosure may also be done by e-mail.
- Rescission. If disclosure is deficient, or no disclosure is made at all, the franchise agreement may be rescinded at franchisee’s option up to 60 days after entering the franchise agreement. If no disclosure document was ever provided, the franchisee has up to two years to rescind. In both cases, without penalty or obligation to franchisee.
- Duty of Fair Dealing. Both franchisor and franchisee have a duty of fair dealing in performance of the agreement. Additionally, parties have a duty to act in good faith.
- Right of association. The franchisee has the right to associate with other franchisees without interference by the franchisor (including forming or joining an organization of franchisees).
- Statutory right of action for misrepresentation. The right to sue for misrepresentation exists now, but if legislation is passed, this just gives franchisees another avenue to sue if misrepresentation happens. What is unique about this provision is that the right to sue will also extend to include misrepresentations in financial projections and pro-forma revenue/operating forecasts. Franchisors should be cautious and state that financial statements are based on assumptions about the future and that actual results may vary. If disclosure statements are accompanied by such cautionary language, such a right to sue may not be available.
- Direct distribution rights disclosure. If the franchisor wishes to reserve the right to sell goods and services directly and in competition with its franchisees, this intention should be declared in the disclosure document.
- Fully refundable deposit. Some provinces have allowed franchisors to obtain a fully refundable deposit up to a certain dollar amount before disclosure is made. In these cases, the deposit must be refundable in the event that the franchisee does not sign a franchise agreement. It is recommended that since the franchisor gives up commercially sensitive information and may be placing a territory “on hold” for a prospective franchisee during negotiations, the deposit is an indication of the franchisee’s good faith prior to receiving disclosure. The maximum level of the deposit is not to exceed 20% of initial franchise fee.
If you're considering purchasing a franchise, make sure to read your disclosure documents and franchise agreement thoroughly, and talk to legal and financial professionals about your obligations before signing. It may be helpful to keep notes of your communications with franchisors and talk to other franchisees to hear their experiences. Lastly, make sure to understand start-up costs and on-going financial liabilities of purchasing the franchise.