Legal Basics Buying a Franchise – Franchise Lawyer’s Role
Basics: What is a Franchise?
A Franchise is a business whereby the owner licenses its operations. The license grants a Franchisee access to a Franchisor’s proprietary business knowledge, processes and trademarks, thus allowing the Franchisee to sell a product or service under the Franchisor’s business name. In exchange, the Franchisee generally pays the Franchisor an initial start-up fee and recurring licensing fees. Franchisors may also seek royalties based on gross sales of the franchise. The franchisee is required to conform to the standards of the system. Depending on the type of business, a Franchisor could set specific prerequisites in terms of experience and qualifications.
Forms of Franchise Businesses
There are about three forms of franchise arrangements:
- Business format franchises: the franchisor, often a manufacturer of supplies, licences an
entire business system to the franchisee. In addition to receiving a licence to use a trademark, the franchisee may be given the right to use a trade-mark, the franchisee may be given the right to use a specified building layout, furnishings, location, marketing techniques, and reporting systems. Typical examples include fast food outlets and hotels.
- Product distribution franchises: The franchisee obtains a licence from the franchisor to market and sell products in a specific location area. Unlike business format franchises (which is commonly understood as a franchise by most people), product distribution arrangements often allow the franchisee some latitude to personalize business operations, with the franchisor generally exerting less control over the format of the franchise. Product distribution franchises are often large independent business operations, including automobile dealers and soft drink bottlers.
- Business opportunities: the franchisee is provided the right to sell goods and services supplied by the franchisor as well as receiving location assistance in terms of retail outlets or accounts. Examples include vending machines, amusement games, and display racks.
The Ontario Law of Franchising
In Ontario, the sale and purchase of a franchise is governed by the Ontario provincial Statute Arthur Wishart Act (Franchise Disclosure), 2000, S.O. 2000, c. 3 – Bill 33 (the “Act“). The Act was drafted to ensure transparency between a Franchisor and a Franchisee. To protect the Franchisee, section 5(1) of the Act provides that a Franchisor must disclose and deliver all important facts relating to the franchise, financial statements, copies of all relevant agreements to be signed by the Franchisee, and any other statements that help in making the investment decision to the Franchisee at least 14 days before signing a Franchise Agreement or any other relevant agreement and before paying anything in relation to the Franchise.
Section 5(5) of the Act also provides that the Franchisor has a duty to disclose to and notify the Franchisee with a written statement of any material change regarding the franchise or the disclosure provided above as soon as reasonably possible before signing the agreement or paying anything in relation to the franchise. These provisions however have a long list of exceptions listed in section 5(7) of the Act.
The penalty for non-disclosure, according to section 6(1) of the Act, is that a franchisee may rescind the franchise agreement, without penalty or obligation, up to two years after entering into the franchise agreement if the franchisor never provided the disclosure document. Rescinding an agreement or contract means, legally, putting all parties back in the position they were before they entered into the contract.
To close the Purchase and Sale of a Franchise in Ontario, the Franchisor and Franchisee come together by signing a Franchise Agreement which includes ancillary documents. A modern franchise agreement package could include:
- An application form;
- A deposit and confidentiality agreement;
- the Franchise Agreement;
- A lease, sublease, and/or conditional assignment of lease;
- Individual shareholder non-competition and confidentiality agreements;
- A general security agreement;
- A shareholder guarantee / Indemnity agreement;
Although most franchisors present the franchise agreement as non-negotiable, some provisions are negotiable. Terms that are negotiable could be:
- Unreasonable restrictive covenants (aka non-competition clauses or agreements)
- Renewal rights
- Punishing all locations for the the failure of one for multi-unit owners.
- Clarifying the territory size
- Extending time to cure franchise defaults
- Limiting liability…etc.
The smaller the franchise system, the more concessions will be made.
Franchise Agreements are long and complicated, they must be read and understood in their entirety by Franchisees. This is your lawyer’s role. We ensure that you understand fully the commitment made, and we assist in the negotiation of changes. A franchise lawyer will attempt to protect your interests as much as possible and advise you of clauses that will tie you to severe liabilities. We draw your attention to red flags and assist you in limiting them to the maximum extent.