The Accidental Franchise

Just a few short years ago, the enactment of the Arthur Wishart Act (Franchise Disclosure), 2000 ("Wishart" or the "Act") radically altered the manner in which the business of franchising is conducted in Ontario. Pre-Wishart, franchising was merely a matter of contract. Suddenly, there was a wealth of regulatory standards to be met and obligations to deal in good faith (that extended well beyond any case law) were imposed. In addition, an unexpected problem arose – businesses that had never considered themselves to be franchisors were running the risk of being designated as such because of the inclusive language of the Act. This, in turn, imposed an entirely unexpected burden upon these "accidental" franchisors, which suddenly had to provide pre-sale disclosure or risk the severe penalties that Wishart imposes.

American franchise jurisprudence has been maturing for several decades and may indicate where our still-young but developing body of Ontario and Alberta case law (under Alberta's "new" Franchises Act) may be headed. The bulk of the American decisions embody the spirit of franchise-specific legislation, which protects potential franchisees by requiring pre-contract disclosure to ensure that they are provided with all the material information required to make an informed decision. However, in an effort to protect franchisees, some U.S. courts have gone to great lengths to find the existence of a franchise relationship between parties, for what one might consider to be questionable reasons. Whether Canadian judges will follow their American counterparts remains to be seen, but given the broad wording under Wishart, it is completely foreseeable that there are businesses in Ontario that are offering franchises unknowingly without providing required disclosure.

The franchise bar in Ontario is anxiously watching as the initial flow of cases brought under Wishart work their way to the Court of Appeal, which will help practitioners define the often-ambiguous terminology used in Wishart and the expectations thereunder. Unlike their U.S. counterparts, the Canadian judiciary has to date not been particularly active by striving to find a franchise relationship when the parties themselves may not even have realized there was one. Most Canadian cases where a party was deemed to be a franchisor are based on strong facts that were clearly indicative of a franchisor/franchisee relationship. But Wishart's expansive language, and the lack of defining case law, leaves the door wide open for a franchise to be found in surprising places – and it is the "accidental franchise" that businesses, and their advisors, should be wary of. The obligations that may be imposed under Wishart for failure to adhere to the Act, and in particular to abide by the disclosure requirements, could be extremely debilitating, or even fatal, to a business that does not recognize its existing business arrangement as being one of franchisor/franchisee, and fails to conduct itself in accordance with Wishart as a result. The astute franchise practitioner must be very clear (as far as Wishart will allow) what constitutes a franchise in this province so to avoid a client becoming an accidental franchise, and it is hoped that this paper will assist in making that determination.

FRANCHISE DEFINED In order to establish how easily a business can be captured under Wishart as being a franchise, we must first understand what the legislation defines as being a franchise.

Section 1(1) of Wishart defines a franchise as:

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, in which, 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 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 in which, 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 the franchisor, 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.

It is not overly simplistic to say that if a party to a contract meets only three requirements – the fee requirement (the payment of money), the trademark requirement (by allowing the use of the accidental franchisor’s trade-mark), and the control requirement (by providing some form of control over or assistance in the manner of operation of the business) – then a franchisor/franchisee relationship will exist.

In terms of geography, one must also be careful. Simply because a franchise exists outside of Ontario does not mean that Wishart won't apply. Ss. 2(1) of the Act states that the Act applies to a business which is "to be operated partly or wholly in Ontario". Thus, even if a franchisor is not yet active in this province – note the use of "to be operated", not in the present tense – a granting of a master franchise or an exclusive territory that includes Ontario would trigger the application of the Act.

Fee Requirement Wishart has, intentionally or otherwise, moved beyond the wording commonly found in American franchise legislation regarding the requirement to make some form of payment to a potential franchisor. Whereas most American franchise laws generally require that a "franchise fee" be paid, note that Wishart requires there to be nothing more than the franchisee being required "to make a payment or continuing payments". There is no definition of “franchise fee” under Wishart, and so any kind of payment may qualify – the limits of this terminology have yet to be tested. The requirement will be met whether such payments are made directly or indirectly, to the franchisor or its associate, and either as a means to acquire the franchise or during its operation. Furthermore, and unlike Alberta and all but a very few U.S. jurisdictions1 that contain such an explicit exemption, even a payment made under a bona fide wholesale price could be captured under Wishart, which contains no such exemption to this effect.2

Alberta previously required the payment of a "franchise fee" but now requires the lower standard of any "continuing financial obligation".3 This almost certainly expands the application of the Act to encompass many product (distribution) relationships. There are many product distribution systems where the distributor is "left on his own" to come up with ways to sell the product which may not meet this test. In the event that a franchisor has prescribed some business or marketing plan, though, and the products meet the "substantial association" test with the franchisor's trademarks, it is also worth noting that under ss. 1(1)(d)(iii)(B) of the Alberta Act that there is no additional requirement for ongoing operational assistance or controls when there has been payment of a franchise fee, as defined, to find the existence of a franchise.

A payment made “otherwise” than as part of the franchise agreement will satisfy the criteria. In Ontario, and in direct contrast to the Alberta Act, any kind of single payment, which does not have to be a "franchise fee", and as opposed to “ongoing” payments, will be enough. It is also interesting to note that merely committing to make a payment or payments satisfies the requirements of the definition. A contract with no consideration other than a mere obligation to make future or deferred payments could satisfy the fee requirement even if no money changes hands.

Structuring one's affairs to intentionally avoid the fee requirement is therefore very difficult. One may rely on the exemptions in s. 5(7) of the Act, notably ss. 5(7)(g)(i), where an investment not exceeding a "prescribed amount", being $5,000 according to the regulations, allows for the exemption of the application of the Act. Suppose two parties form a partnership, which is an exempt business arrangement from the Act according to section 2(3), where one of the parties owns intellectual property and brings it to the relationship, and the other party brings capital. As a result of the partnership, no money is necessarily paid directly to the party holding the intellectual property. It has been suggested that any profits flowing to the partner with the intellectual property may constitute an indirect payment, thus satisfying the fee requirement as set out above, and thus bringing the terms of the Act to bear as a result.4 While this arrangement may rely on the “partnership” exemption in S. asdlkfasd;fj

With little judicial treatment of the fee requirement to determine its limits, and the vague wording utilized by Wishart to define what form of payment is necessary to qualify the franchisor/franchisee arrangement, the fee requirement may be easily met under a wide variety of possible scenarios.

Trademark Requirement Given the ease with which potential business relationships can qualify as franchises under the fee requirement, it is arguable that the trade-mark requirement provides even greater latitude for such a determination.

Referring to the definition of what constitutes a franchise referenced earlier, a crucial required element in both the “business format” definition found in part (a) of the definition of "franchise" under Wishart, as well as the “business opportunities” definition in part (b), is the granting by a franchisor of the right to use its intellectual property.

In much the same way as Wishart had an extremely low threshold for the fee requirement to be met, the trade-mark requirement will be satisfied if goods or services 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”. There is no requirement under Wishart that the collective intellectual property referred to above be formally assigned or licensed. Instead, there must only be some “substantial association” between the goods and services offered and the franchisor’s intellectual property. What “substantial association” actually means is still a mystery, as it has to date not been judicially considered under Wishart. It is possible that merely offering goods or services with any trademark on the labelling or packaging could satisfy this requirement. While the need to maintain business efficacy would imply that a retailer such as Wal-Mart could not be deemed to be a franchisee of each of the products that it sells, certainly the trademark requirement as well as the payment requirement (since most retailers do not sell on consignment) have been met in this retail environment and so, at least theoretically, one retailer could be a franchisee of hundreds of different franchisors. Since this would be unworkable, it may eventually require the courts to travel down the slippery slope of interpreting Wishart in such a way that makes business sense, even if it is beyond a literal interpretation of the Act itself.

The Trade-marks Act, R.S.C. 1985, c.T.-13 requires that a trade-mark be "used" in commerce to be enforceable against potential infringers. The concept of "substantial association" as used in the Act appears to be a more broad standard, at least based on American decisions that have considered the limits of this phrase. In Wright-Moore Corp. v. Ricoh Corp.5 a photocopier distributor who was not permitted to utilize the manufacturer's trade-mark as part of its operating name, but was allowed to hold itself out as an authorized distributor, was found to operating in "substantial association" with the manufacturer's trade-mark and thus a franchise relationship was found to exist according to Indiana franchise law.

In another decision of the California appellate court, a "substantial association" was found to exist under the most tenuous of relationships. In Kim v. Servosnax, Inc.6, a cafeteria was operated in an office building under contract between the owner of the building and Servosnax. Kim was licensed by Servosnax to operate the cafeteria. The appellate court of California found that the plaintiff, Kim, was operating in substantial association with the defendant's trade-marks, despite the fact that the plaintiff was specifically prohibited from using the marks, and the marks were not used or displayed in any way at or from the premises. The court still found a substantial association because Servosnax had communicated its trade-marks to the building owner, who was found to be a "customer" of the defendant and thus a substantial association with the Servosnax’s use of the mark was found to exist.

Section 2(3)(5) specifically states that the Act does not apply to "an arrangement arising from an agreement between a licensor and a single licensee to license a specific trade-mark, service mark, trade name, logo or advertising or other commercial symbol where such license is the only one of its general nature and type to be granted by the licensor with respect to that trade-mark, service mark, trade name, logo or advertising or other commercial symbol". The scope of this exemption has yet to be determined. In the U.S., a Federal Trade Commission staff advisory opinion states that their similar exclusion for a single license implies that the license must be the one, and only one, granted and that there is no means to grant an additional license to anyone.7 Should a restrictive interpretation such as this become the standard in Canada, practitioners would be well advised to take a cautionary approach to recommending their client rely on the single-license exemption from the Act.

Significant Control / Assistance Requirement Recall that it is also a requirement that the franchisor or its associate must render "significant control over or offer significant assistance in, the franchisee's method of operation, including building design and furnishings, locations, business organization, marketing techniques or training", as stated in ss. 1(1)(a)(ii) of the Act. To date, neither the phrase "significant control" nor "significant assistance" has been judicially considered in the franchise context. How this will actually be interpreted by Ontario courts remains to be seen. Implicitly, one can surmise that there must be some form of positive direction or guidance provided by a franchisor to a franchisee, directing the franchisee in either the establishment or the day-to-day operation of the franchised business, to satisfy the "assistance" component. Of course, whether this assistance is "significant" enough to qualify under the terms of this section is a matter of fact and thus there will likely always be latitude available to the courts to decide on the appropriate application of this section of the Act. As well, note that the section requires only that assistance be offered, not actually provided.

The proper interpretation of "control", however, is a different consideration. It is reasonable to assume that the finding of control, or the lack thereof, will always be made on a case-by-case basis, taking the entire nature of the relationship between the parties into account. This has been the standard when "control" has been the measure of corporate ownership or stewardship, to determine whether or not a party has actual control or theoretical control only. Such interpretations do little to assist in the context of the Act, and in light of the de jure standard of control adhered to in cases related to the Income Tax Act, it is certainly possible that the mere ability of the potential franchisor to exert a high degree of control over a franchisee could invoke the terms of the Act.

Again, American experiences may help us when trying to anticipate how these matters may be decided by Ontario judges.

One interpretation of what constitutes "significant control" or "significant assistance" is that such control or assistance may exist where a party must be more reliant on guidance or control from another party than it is on its own abilities. Though the decision appears questionable, such was the principle of an FTC decision adjudicating between Meridien Hotels, Inc. and the Parker-Meridien Hotel in New York, NY.8 In that matter, Meridien Hotels, Inc. provided the "franchisee" with access and training in the use of its proprietary reservation system, and included the Parker-Meridien as part of its overall advertising strategy. The written agreement between the parties further provided for other elements of control available to the franchisor, some, but not all, of which were exercised. The FTC nonetheless found that there was not a significant degree of control as the hotel's management did not utilize any expertise of Meridien in the day-to-day operations of the hotel itself. FTC advisory opinions have elaborated that one must assess the entire operation of a franchisee's business when determining whether significant control has been exerted – not just whether significant control or assistance has been provided for only a portion of the franchisee's overall business.9 The drafters of the Alberta Franchises Act went in a different direction than Ontario, one that is more reminiscent of wording found in most American state franchise legislation. The notion of "significant control / assistance" does not form part of the definition in the Alberta Act. Instead, a franchise is found, in part, where goods or services are sold, offered or distributed "under a marketing or business plan prescribed in substantial part by the franchisor or its associate".10 At first glance, this definition may seem more restrictive, but when the definition of "marketing plan" is considered, it may actually be more expansive.

The requirement that the plan be "prescribed" by the franchisor requires a certain element of control by the franchisor. Ongoing control is not stipulated as being necessary. Since the marketing or business plan must be "prescribed" in "substantial part" by the franchisor. This means that the franchisor must have effective control over this aspect of the franchisee's business and, therefore, a factual examination of the elements of control is warranted. Consider the effect of a franchisor that does not perform his duties, or offer the assistance required, pursuant to a franchise agreement – such a franchisor may be able to argue that he is not a franchisor. Another potentiality is that of a relationship that evolves into a franchise by reason of the increased control or assistance offered by the reluctant franchisor: is disclosure suddenly required upon crossing some notional threshold?11 Potential Locations of Accidental Franchises Since a "laundry list" of places where unexpected franchises might exist is impossible to accurately prepare, this section is intended to combine the elements discussed earlier with real-life examples to indicate how the Act can be used to find a franchise relationship in unexpected places as food for thought for the practitioner that may never have considered the application of the Act to his or her clients' businesses.

One of the indicia for the finding of a franchise arrangement is when a franchisor offers "location assistance". Since it has never been judicially considered, we are required to hypothesize what exactly this term means. In a general sense, it could be interpreted to mean any kind of help provided to the franchisee in the opening of its actual retail location. This may come about by aiding a franchisee with selecting an operational location for its storefront, assisting with lease negotiations, or aiding in the build-out of the retail environment, to name a few examples. Consider the result of what can happen as the Internet increasingly becomes a legitimized and mature means of delivering goods and services. If a franchisee is selling any kind of product or service on-line, which would be done in conjunction with a URL that belongs to or is associated with the franchisor's "commercial symbols", it is arguable that the establishment of a website under these circumstances could be seen as offering "location assistance", where the location is cyberspace and a 'bricks and mortar' location is impossible.

The most likely source of franchises to be found when none was intended is in the world of product distributorships. Certainly, the primary requirements to find the existence of a franchise system, at least under the Act, are present. First, payment of any kind of fee, and not necessarily an ongoing payment, nor a "franchise fee" (as needed in most other jurisdictions), would satisfy the first requirement under ss (b)(i) of the definition in the Act. Since the Act lacks an exemption for a purchases made for a bona fide wholesale cost, it should be extremely simple to find a payment or commitment to pay some form of money in almost any product distribution system, as the goods are supplied exclusively by the distributor to the vendor/ franchisee. The final requirement, then, is for the franchisor to supply “location assistance”. As discussed, the true breadth of this term has not been adequately determined as of the date of this paper. But it is easy to identify some of the obvious franchises-to-be that seem to satisfy the definition. Automobile dealers, for example, certainly appear to qualify. The brand identifier is included in the dealership’s name in almost every instance. The vehicles are paid for by the dealer, either before or after the cars are sold (and note that there is no requirement that the payment be made at any particular time). And finally, the manufacturer of the vehicles historically retains the right to assist with the selection of or approve the location of a given vendor’s dealership. And yet, these vendors do not yet appear to be treated as franchisees in the traditional sense of the world.

Another example is that of an operator of a gas station. Most of the major fuel retailers operate a series of dealerships to sell their product, under what is traditionally called something like a “retail licensee agreement”. No mention is made of a franchise relationship in any of the documentation, and yet, each agreement clearly details: (1) the payment of money from the “licensee” to the “licensor”, (2) the right granted to the “licensee” to use the “licensor’s” trade-marks, and (3) the specification of a retail location from which the business is to be operated. It is suggested that there are accidental franchises waiting to be identified right under our very noses, affecting some of the biggest industry sectors in the country, if the Act is not quickly narrowed in scope either by the courts or by revisions to the legislation itself.

Merely providing training or any other form of assistance (note that the definition is not exclusive) may well capture other industries that sell “branded” goods and services, where the buyer (franchisee) makes a required payment to the ultimate brand holder. These industries may very well include such institutional operations as insurance brokers/vendors and private mortgage companies that offer mortgage products from recognized and accepted business sources. The agents/brokers will, in most cases, be required to follow certain rules, standards and requirements of the insurance or mortgage companies, which may pertain to product promotion, restrictions on customers or territories, or accounting methods and reporting, among others. The issue of whether an insurance agent is, or can be, a franchisee, has been raised in several U.S. jurisdictions. In several cases, the American courts have determined that the relationship between the agent and the insurance company did not create a franchise. The key to each decision lies in the analysis of the agent's rights or ability – or lack thereof – to "sell" the insurance products of the insurance company. Fundamentally, without the right to bind the insurance company, most courts felt that there could not properly have been an "offering" of the insurance products by the company to the agent. However, the closer agents come to abiding by the Wishart usage of "selling" or "offering" (and there is now a class of agent called "managing general agents" who have the authority to underwrite policies, and/or enter into contracts, on behalf of an insurance company), the more likely an Ontario court would find in favour of the existence of a franchise. The FTC, in its interpretive guides, has expressly stated that "agency relationships in which the independent agents, compensated by commission, sell goods or services (e.g. insurance salespersons) are excluded" [from the coverage of the FTC Rule], since there is no "required payment". Wishart may not lead to the same result, given that virtually any form of required payment will satisfy the terms of the definition.

Television stations that are affiliated with a national or even regional network for programming may also be captured by the Act. They pay a fee for the programming they air, and are told what shows to broadcast, and when, at least for their prime-time slots. They hold themselves out as affiliates of the master broadcaster through the use of the broadcaster's logos and shared advertising. Many of the indicia of a franchise are there. The outcome may well depend on the meaning of “required payment” under the Act.

In several American cases, computer software re-seller agreements have been held to be franchises12. In 1998, the FTC ruled that a technology integration service business, which configured computer technology to fit specific customers' needs, was a franchise since the promoter licensed others to use its advertising, marketing expertise and logos in the their own marketing activities.

In the “business opportunities” portion of the definition (in ss. (b) of the definition of “franchise”), “the provision of assistance regarding 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” will satisfy the definition, assuming the required payment of money is present and there is some form of trade-mark or other commercial symbol in use. Thus, companies that place vending machines in cafeterias, schools, and other public places are likely acting as franchisors, provided that they purchased the right to do so and received some assistance for the location of the accounts. Magazine resellers to retail locations such as variety stores may also qualify. Private-label automated teller machines, as another example, are usually in locations where one party holds an exclusive contract for the provision of bank machines to such location, and who then sub-contracts the right to operate the machine to an investor who purchases and maintains the machine. A commission is paid to the holder of the machine's location lease by the machine owner. All the elements of a "franchise" are present, and yet, this form of business operation is rarely, if ever, one that adheres to the requirements under the Act.

Finally, consider a working arrangement of medical professionals operating under a common banner of "XYZ Healthcare", which acts, for all intents and purposes, as the "brand" of the practice as a whole. While the franchise analysis may falter on the control/assistance factor or possibly on the partnership exemption to the Act referred to earlier, it may not, such as in a scenario where some form of business or operational advice is provided to the practitioners in the group by one another. And while there will likely be some form of agreement between the parties disclaiming any control over each other's professional practice, in order to maintain uniformity in the provision of service, each practice may be operated in accordance with some form of operating manual, or there may be some kind of standardized training required of employees.

Truly, under the very expansive Wishart wording, it is easy to imagine a franchise existing almost anywhere and it is the wise practitioner who will consider all aspects of a client's business before dismissing the need to adhere to Wishart.

Not Everything is a Franchise As has been posited before when trying to determine the likelihood of any arrangement being seen to be a franchise relationship, one must always remember that substance prevails over form. In other words, if it walks like a duck, and talks like a duck, it's likely a duck. So too with franchises; despite careful planning to avoid the imposition of the Act on a business arrangement, it is nevertheless very easy to inadvertently incur the Act's obligations as discussed above.

It is a far simpler task to avoid being deemed a franchise in the United States than it is in Ontario, where the requirement for a "marketing plan" or the payment of a "franchise fee" dramatically narrows the applicability of franchise-specific legislation in states that have such language.

Thus, the savvy lawyer or other trusted advisor would be strongly cautioned against assuming a given business organization is not a franchise in this province. The presumption should probably be that a given arrangement is a franchise and then one can address the areas of greatest concern discussed herein, and plan carefully to avoid the imposition of the Act where it may not be desired. While some of the potential pitfalls associated with the exemptions and exclusions available under s. 2(3) and 5(7) of the Act have been covered herein, the vast majority of them have not been addressed in any way by a court of competent jurisdiction, and so it remains to be seen if these sections will afford much certainty when it comes to making a determination about the existence of a franchise in this province.

More information.

For more information on franchising in Canada, the United States and internationally, please contact Peter Macrae Dillon, head of Siskinds Franchise Law Group. Peter is recognized expert in franchising. He is the author of the annotated Ontario Franchise Disclosure Act and the annotated Alberta Franchises Act and over 40 other publications on the subjects of franchising, licensing and distribution. He is licensed in Ontario and New York. Peter can be contacted at 800-816-9596 ext. 389 or by email at peter.dillon@siskinds.com. The information contained in this note is for general reference only, and should not be relied upon as constituting legal advice.

Disclaimer.

This article does not constitute legal advice. If you require assistance with the issues raised in this article, either to determine whether your business constitutes a franchise, to establish a franchise, or to avoid a finding that your business constitutes a franchise, you must obtain competent legal advice. Siskinds would be pleased to assist you in this regard.

The Accidental Franchise - To learn more about this author, visit Peter Macrae Dillon's Website.

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