KerrLaw Logo JAMES D. L. KERR
CLIENT MEMO
TO:           Business Clients FROM:   James D.L. Kerr Lawyer
            17 – 151 Merton St.
            Toronto
, Ont., M4S 1A7
            Tel 416 485-4254
            Fax 416 485-8836
            
E-mail: jkerr@kerrlaw.ca
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            Certified Specialist Civil Litigation
DATE:      November 5, 2003
RE:           FRANCHISING



Franchising is, essentially, a form of trade mark licensing. The franchisor develops a system for the delivery of goods or services in the context of which the franchisor creates a recognizable brand. Typically, the brand is registered as a trade mark. The effect of registration of the brand as a trade mark is to give the franchisor cross-Canada exclusivity. The trade mark is then licensed to franchisees as a major component of a franchise agreement.

 The other fundamental components of a franchise agreement are:

  1. Exclusivity: The franchisee obtains the exclusive right to carry on the franchised business within a defined geographic territory.

  2. Term: The franchise agreement runs for a fixed term; usually the franchisee has the right to renew for one or two renewal terms provided the franchisee is not in default under the franchise agreement.

  3. Initial Franchise Fee: The franchisee pays an initial up front franchise fee. The franchise fee is intended to compensate the franchisor for the investment the franchisor has made in developing the franchise system and creating the brand recognition.

  4. Royalty Fee: The franchisee pays a percentage of the franchisee’s gross revenue to the franchisor on an on-going basis as additional compensation. A typical royalty would be 7% or 8% of gross revenue.

  5. Cooperative Advertising Fee: The franchisee pays a further percentage of the franchisee’s gross revenue to the franchisor on an on-going basis as a contribution to an advertising fund. A typical royalty would be 2% or 3% of gross revenue.

  6. Franchisor’s On-going Services: Typically, the franchisor provides initial training and assistance in setting up the franchise location. In some instances, the franchisor will set up the location completely and sell the location to a franchisee (called a “turnkey” operation). In some cases, the franchisor will provide continuing promotion, marketing, banking and/or management assistance.

  7. Sublease: In some cases, the franchisor will lease the franchise location from the landlord and then sublease the location to the franchisee. This allows the franchisor to retain control of the location in the event that the franchise is terminated.

The Bank of America, in the Small Business Reporter, vol. 9, no. 9 (copyright 1975, 1978), described a franchise relationship as follows:

 
The best franchisee, as far as many franchisors are concerned, is someone who is smart enough to understand and operate the system, but not smart enough to try to improve on it.

 
One franchisor describes the ideal franchisee as the sergeant type -- midway between the general who gives the orders, and the private who merely follows them.  People who want their own business to escape taking orders from others frequently see franchising as the answer.  They are sometimes subsequently frustrated by their lack of autonomy.  For example:



In
Ontario, franchising is governed by both statute law (laws passed by the Province) and common law (law made by judges deciding disputes on a case-by-case basis and thereby creating legal precedents).

 
The applicable statute law in
Ontario is the Arthur Wishart Act (Franchise Disclosure), 2000 ("the Act").

 
THE DISCLOSURE DOCUMENT:

 The Act [section 5(1)] requires the franchisor to provide a prospective franchisee with a disclosure document not less than 14 days before the earlier of the signing of the franchise agreement or the payment of the initial franchise fee (or other up-front payment).

 The disclosure document must be one document delivered at one time and must include copies of all proposed franchise agreements and other agreements relating to the franchise (such as security agreements, supply agreements, lease agreements, and the like).

 The franchisor must provide to a prospective franchisee a written statement of any material change to the disclosure document as soon as possible after the change has occurred and before the earlier of the signing of the franchise agreement or the payment of the initial franchise fee (or other up-front payment).

 All information in a disclosure document and a statement of a material change must be accurately, clearly and concisely set out.

 
Specific Requirements:

 Under Part II of Ontario Regulation 581/00 ("the Regulation") passed under the Act, every disclosure document must include the following:

 1.          The following statements together in one section at the beginning of the disclosure document:

a)                 A commercial credit report.

b)                 A statement that:

 i.                    independent legal and financial advice in relation to the franchise agreement should be sought prior to entering into the franchise agreement;

ii.                  the prospective franchisee is strongly encouraged to contact any current or previous franchisees prior to entering into the franchise agreement; and

iii.                the cost of goods and services acquired under the franchise agreement may not correspond to the lowest cost of the goods and services available in the marketplace.

 2.      Information regarding the business background of the franchisor, including the following:

a)                 The name and address of the franchisor;

b)                 The name under which the franchisor engages in, or intends to engage in business;

c)                  The principal business address of the franchisor and, if the franchisor's principal address is outside Ontario, the name and address of a person authorized to accept service in Ontario on the franchisor's behalf;

d)                 The business form of the franchisor, including whether the franchisor is a sole proprietorship, partnership or Corporation and, if incorporated, the jurisdiction where the franchisor is incorporated;

e)                 If the franchisor is a subsidiary, the name and principal address of the parent;

f)                    The length of time the franchisor has engaged in the line of business associated with the franchise;

g)                 The length of time the franchisor has offered franchises in the line of business associated with the franchise; and,

h)                  If the franchisor has offered a franchise in another line of business, a description of every franchise in each line of business, including for each franchise:

i.                    The length of time the franchisor has offered the franchise to prospective franchisees; and,

ii.                  The number of franchises sold in the five years immediately preceding the date of the disclosure document.

 3.      Information regarding the business background of the Directors, the General Partners and the Officers of the franchisor, including the following:

a)                 The name and current position of each person;

b)                 A brief description of the prior relevant business experience of each person;

c)                  The length of time each person has engaged in the line of business associated with the franchise; and,

d)                 The principal occupation and the employers of each person during the five years immediately preceding the date of the disclosure document.

 4.      A statement, including a description of details, indicating whether, during the ten years immediately preceding the date of the disclosure document, the franchisor, the franchisor's associate or a Director, General Partner or Officer of the franchisor has been convicted of fraud, unfair or deceptive business practices, or a violation of a law that regulates franchises, or business or if there is a charge pending against the person involving such a matter.

 5.      A statement, including a description of details, indicating whether the franchisor, the franchisor's associate or a Director, General Partner or Officer of the franchisor has been subject to an administrative order or penalty imposed under a law of any jurisdiction regulating franchises, or business or if the person is the subject of any pending administrative actions to be heard under such a law.

 6.      A statement, including a description of details, indicating whether the franchisor, the franchisor's associate or a Director, General Partner or Officer of the franchisor has been found liable in a civil action of misrepresentation, unfair or deceptive business practices, or violating a law that regulates franchises or businesses, including a failure to provide proper disclosure to a franchisee, or if a civil action involving such allegations is pending against the person.

 7.      Details of any bankruptcy or insolvency proceedings, voluntary or otherwise, in the six years immediately preceding the date of the disclosure document,

a)                 Against the franchisor or the franchisor's associate;

b)                 Against a corporation whose Directors or Officers include or included a current Director, Officer or General Partner of the franchisor;

c)                  Against a partnership whose General Partners include, or included, a current Director, Officer or General Partner of the franchisor; and,

d)                 Against a Director, General Partner, or Officer of the franchisor in their personal capacity.

 8.      An audited financial statement for the most recently completed fiscal year of the franchisor's operations.

 9.      A financial statement for the most recently completed calendar year of the franchisor's operations, prepared in accordance with generally accepted accounting principles and which complies with the review and reporting standards applicable to review engagements set out in the Canadian Institute of Chartered Accountants Handbook. 

 10.A list of all of the franchisee's costs associated with the establishment and operation of the franchise presented together in one part of the disclosure document including the following:

 a)                 The amount of any deposits or franchise fees, whether the deposits or fees are refundable, and if so, under what conditions;

 b)                 An estimate of the costs for inventory, leasehold improvements, equipment, leases, rentals and all other things necessary to establish the franchise and an explanation of any assumptions underlying the estimate; and,

 c)                  Any other costs associated with the franchise not listed in the above paragraphs, including any payment to the franchisor, whether direct or indirect, required by the franchise agreement, the nature and amount of the payment, and when the payment is due;

 d)                 If an estimate of annual operating costs for the franchise is provided, the disclosure document must include a statement specifying the basis for the estimate, the assumptions underlying the estimate, and a location where information is available for inspection that substantiates the estimate;

e)                 If an earnings projection for the franchise is provided, the disclosure document must include a statement specifying the reasonable basis for the projection, the assumptions underlying the projection and a location where information is available for inspection that substantiates the projection;

 f)                    The terms and conditions of the financing arrangements that the franchisor or the franchisor's associate offers directly or indirectly to franchisees;

 g)                 A description of any training or other assistance offered to franchisees by the franchisor or the franchisor's associate, including whether the training is mandatory or optional, and if the training is mandatory, a statement specifying who bears the costs of the training;

 h)                  If the franchisee, as a condition of the franchise agreement, is required to contribute to an advertising fund, then the disclosure document must include the following:

 i.                    A statement describing the percentage of the fund that has been spent on national campaigns, and local advertising in the two fiscal years immediately preceding the date of the disclosure document;

ii.                  The percentage of the fund, other than the percentage described in sub-subparagraph i, that has been retained by the franchisor, the franchisor's parent or the franchisor's associate in the two fiscal years immediately preceding the date of the disclosure document; and,

 iii.                A statement describing the following:

 A)    The projected amount of the contribution;

B)    A projection of the percentage of the fund to be spent on national or local advertising campaigns for the current fiscal year;

 C)    A projection of the percentage of the fund to be retained by the franchisor, the franchisor's parent or the franchisor's associate in the current fiscal year; and,

 D)    An indication of whether reports on advertising activities financed by the fund will be made available to the franchisee.

 i)                    A description of any restrictions or requirements imposed by the franchise agreement with respect to the following:

 i.                    Obligations to purchase, or lease, from the franchisor, the franchisor's associate or suppliers approved by the franchisor or the franchisor's associate;

 ii.                  The goods and services the franchisee may sell; and,

 iii.                To whom the franchisee may sell goods or services.

 j)                    A description of the franchisor's policy, if any, regarding volume rebates, and whether or not the franchisor or the franchisor's associate receives a rebate, commission, payment or other benefit as a result of purchases of goods and services by a franchisee and, if so, whether rebates, commissions, payments or other benefits are shared with franchisees, either directly or indirectly;

 k)                  A description of the rights the franchisor, or the franchisor's associate, has to the trade-mark, service mark, trade name, logo, or advertising, or other commercial symbol associated with the franchise;

 l)                    A description of every license, registration, authorization or other permission the franchisee is required to obtain, under any applicable federal or provincial law or municipal by-law, to operate the franchise;


m)               A statement indicating whether the franchisee is required to participate personally and directly in the operation of the franchise or, if the franchisee is a corporation, whether the principals of the corporation are so required;

 n)                  A description of any exclusive territory granted to the franchisee;

o)                 If the franchise agreement grants the franchisee rights to exclusive territory, a description f the franchisor's policy, if any, as to whether the continuation of the franchisee's rights to exclusive territory depends on the franchisee achieving a specific level of sales, market penetration, or other condition, and under what circumstances these rights may be altered;

 p)                 A description of the franchisor's policy, if any, on the proximity between an existing franchise and,

 i.                    Another franchise;

 ii.                  Any other distributor using the franchisor's trade-mark, service mark, trade name or logo or advertising or other commercial symbol;

 iii.                A franchise owned or operated by the franchisor that distributes similar products or services under a different trade-mark, service mark, trade name or logo; and,

 iv.                 A franchise granted by the franchisor that distributes similar products or services under a different trade-mark, service mark, trade name or logo.

 q)                 The name, last known address and telephone number of each franchisee in Ontario who operated a franchise of the type being offered that has been terminated, cancelled, not renewed, or reacquired by the franchisor, or otherwise left the system within the last fiscal year immediately preceding the date of the disclosure document;

 r)                   For each closure of a franchise of the type being offered within the previous three years immediately preceding the date of the disclosure document, the reasons for the closure, including whether,

 i.                    The franchisor, or franchisor's associate, terminated, or cancelled the franchise agreement;

 ii.                  The franchisor, or franchisor's associate, refused to renew the franchise agreement; or,

 iii.                The franchisee refused to renew the franchise agreement or otherwise left the franchise system.

 s)                  A list of the locations of all franchises in Ontario of the type being offered, including the business address, telephone number and name of the franchisee who operates the franchise and, if there are less than 20 franchises in Ontario, the list must include those franchises which are geographically closest to Ontario, until information on 20 franchises is provided;

 t)                    A description of all restrictions or conditions in the franchise agreement related to the termination or renewal of the agreement, and the transfer of the franchise.

 11. If an internal or external mediation, or other alternative dispute resolution process is used by a franchisor in disputes with a franchisee, the disclosure document must include the following:

 a)                A description of the mediation or other alternative dispute resolution process, and the circumstances when the process may be invoked; and,

 b)                 The following statement: Mediation is a voluntary process to resolve disputes with the assistance of an independent third party. Any party may propose mediation or other dispute resolution process in regard to a dispute under the franchise agreement, and the process may be used to resolve the dispute if agreed to by all parties.

12.   The disclosure document must include a certificate certifying that the disclosure document:

 a)                 Contains no untrue information, representations or statements;

 b)                 Includes every material fact, financial statement, statement and other information required by the Act and the Regulation;

 
Registration:

 The dsclosure document need not be registered.

 
Cost:

 Law firms typically charge between $4,000.00 and $8,000.00 for the preparation of the disclosure document. This is in addition to any collateral costs such as trade mark registration.


Exemptions:

 Under section 5(7) of the Act, the following transactions are exempt from the requirement to provide a disclosure document:

 1.      The resale of a franchise;

 2.      The sale of a franchise to a person who has been an officer or director of the franchisor or of the franchisor's associate for at least six months, for that person's own account;

 3.      The grant of an additional franchise to an existing franchisee if that additional franchise is substantially the same as the existing franchise that the franchisee is operating and if there has been no material change since the existing franchise agreement or latest renewal or extension of the existing franchise agreement was entered into;

4.  The grant of a franchise by an executor, administrator, sheriff, receiver, trustee, trustee in bankruptcy or guardian on behalf of a person other than the franchisor or the estate of the franchisor;

5.      The grant of a franchise to a person to sell goods or services within a business in which that person has an interest if the sales arising from those goods or services, as anticipated by the parties or that should be anticipated by the parties at the time the franchise agreement is entered into do not exceed, in relation to the total sales of the business, 20%;

 6.      The renewal or extension of a franchise agreement where there has been no interruption in the operation of the business operated by the franchisee under the franchise agreement and there has been no material change since the franchise agreement or latest renewal or extension of the franchise agreement was entered into;

 7.      The grant of a franchise if,

 a)                 The prospective franchisee is required to make a total annual investment to acquire and operate the franchise in an amount no more than $5,000.00;

 b)                 The franchise agreement is not valid for longer than one year and does not involve the payment of a non-refundable franchise fee; or,

 c)                  The franchisor is governed by section 55 of the Competition Act (Canada) (that is, a "multi-level marketing plan", which means a plan for the supply of a product whereby a participant in the plan receives compensation for the supply of the product to another participant in the plan who, in turn, receives compensation for the supply of the same or another product to other participants in the plan).

 6.    8.  The grant of a franchise where the prospective franchisee is investing in the acquisition and operation 
of the franchise, over one year, an amount greater than $5,000,000.00
.

DISCLAIMER: The foregoing is not intended to be a comprehensive guide to the applicable law. General Client Memoranda and mailings from James D.L. Kerr ● Lawyer are intended to inform clients and acquaintances with respect to current issues that may be of interest to them. Memos are current to the date shown on the Memo. The law is constantly changing, however, and for that reason a Memo may not be completely accurate after it's stated date. Where circumstances warrant, the advice of a lawyer or other qualified professional should be obtained.

2005 James D.L. Kerr