FRANCHISING LAW

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OF IMPORTANCE Prepared by: Peter M. Dillon Tel: (800) 816-8984 " Fax: (519) 672-6065 E-mail: peter.dillon@siskinds.com Siskind, Cromarty, Ivey & Dowler LLP 680 Waterloo Street London, ON, . N6A 3V8 www.siskinds.com " www.franchiselaw.ca LEGISLATIVE STATUS At present, there are only two provinces with franchise legislation, Alberta and Ontario. AMENDMENTS TO THE REGULATIONS OF THE ARTHUR WISHART ACT Ontario Regulation 581/00, which came into effect on March 22, 2004, amended the regulations under the Arthur Wishart Act (Franchise Disclosure), 2000 , S.O. 2000, c.3 by: defining a "co-operative association"; clarifying and further outlining information that disclosure documents must include; and expanding the criteria for a Minister's exemption under section 13(1) (which exempts a franchisor from the requirement of including financial statements in a disclosure document). The amendments elaborated on various areas, such as dis- closing bankruptcy proceedings, financial statements, reporting on the costs of establishing a franchise, and reporting franchise closures. Notably, the amendments make it a requirement that both audited statements and review engagement statements must be prepared in accordance with the accounting principles as set out in the C anadian Institute of Chartered Accountants (whereas previously only review engagement statements had to be prepared in accordance with the CICA standards). The amendments also clarify that disclosure is only necessary in connection with the costs of establishing a franchise, and not to annual operating costs as well (as was previously thought). Finally, the amendments now provide that if a franchisor does not meet the criteria for a Minister's exemption it still may be exempt if it is controlled by a corporation that does satisfy the criteria. Practitioners in this area would be prudent to re- examine their current disclosure documents to ensure compliance with the new standards. NASAA TASKFORCE ON NORTH- SOUTH HARMONIZATION The Franchise and Business Opportunities Project Group of the North American Securities Administrators Association has constituted a committee to study and report on issues affecting cross-border franchising, with a view to increasing compliance, educating stakeholders and increasing the ease ofCanadian franchise systems operating in the US, and vice- versa. NASAA is composed of the securities regulators from all North American jurisdictions, including all US states and Canadian provinces. Peter M. Dillon of Siskinds is a member of the NASAA Advisory Counsel, and chairs the North-South Harmonization Sub-Committee. Franchisors or their counsel who wish to comment on their cross-border experience or propose methods to promote cross-border franchising are invited to forward their submission to Peter at peter.dillon@siskinds.com. FEDERAL TRADE COMMISSION PROPOSED AMENDMENTS TO THE FRANCHISE RULE On August 25, 2004 the FTC released its Staff Report on the proposed amendments to the FTC Franchise Rule. The proposed amendments, consisting of 400-plus pages, affect the form and content of disclosure documents and the procedure by which disclosure is effected. Canadian franchise systems operating in the United States should be aware of these proposed changes, although, from a practical perspective, implementation of the revisions is not likely to occur until at least 2006, as the FTC will certainly provide NASAA adequate time to revise its Uniform Franchise Offering Circular format and guidelines. Very generally, the amendments include: proposed changes to the persons and transactions covered by the Rule (for example, the definition of "business opportunity" has been deleted); proposed changes in the disclosure document itself (for example, the proposed Rule now uses NASAA's UFOC Guidelines as the basic template); proposed changes in the timing and method of making disclosures; and enumerated lists of prohibited practices. The general public was provided with the opportunity to file comments until mid- November, 2004. The staff will review the comments and make a final recommendation to the Commission at which point the Commission will make a determination as to how to amend the Rule, if at all. For further information ,please visit the FTC website at: www.ftc.gov. UNIFORM LAW CONFERENCE OF CANADA The purpose of the Uniform Law Conference of Canada (ULCC) is to harmonize the laws of all Canadian jurisdictions. The ULCC presented a proposed Uniform Franchises Act on FRANCHISINGLAW " B-1 2005 LEXPERT® DIRECTORY PRACTICE SECTIONS Aboriginal to Workplace August 23, 2004. The format of the proposed act largely follows that of the existing Alberta and Ontario statutes, setting out disclosure obligations and rescission rights substantially similar to the existing legislation, and imposing a duty of fair dealing on each party to the franchise agreement. Interestingly, the drafters included specific language stating that the duty of fair dealing includes the exercise of a right under the franchise agreement. Another item of note is that the proposed Act provides an exemption for the Crown from the requirement of including financial statements in its disclosure document. For further information and a copy of the draft model law, access the ULCC website at: www.ulcc.ca. WASTE DIVERSION ACT The Waste Diversion Act , 2002 and its Blue Box Wastes Regulation were developed as industry-funding mechanisms to collect fees and are aimed at all material that could potentially end up in consumers' Blue Boxes ("Blue Box Waste"). The Act and its regulations apply to all brand owners (private brand and label owners), first importers (of the product into Ontario) and franchisors. Franchisors are obligated to register with Stewardship Ontario if they supply all, or substantially all, of the packaging and printed material that could result in Blue Box Waste to their franchisees in Ontario. Where franchisees or sub-franchisees distribute the material, they are obligated to register. The contribution required of each "Steward" (as registrants are called) is determined using a weight-based system of assessment, with each type of waste assigned different levies. Failure to comply with registration will attract significant penalties and interest. Exemptions are available under the Act, provided companies had Ontario sales of less than $2 million in 2002, or if Ontario sales were greater than $2 million in 2002, the Steward must have generated less than 15 tonnes of Blue Box Waste in 2002. For more information, visit the Stewardship Ontario website at: www.stewardshipontario.ca. RECENT CASE LAW OF SIGNIFICANCE TO FRANCHISING TAXATION Payments by a Canadian corporation of a "one time licence fee" to a U.S. franchisor, paid in relation to acquire a franchise, do not constitute a rent or royalty that is subject to Canadian withholding taxes of 25%. The franchisee was granted a non-exclusive licence to use the Holiday Inn system and pursuant to the agreement was to pay a royalty of 4.5% of gross rooms revenue as well as other fees for service contributions, travel agent commissions, etc. The franchisee argued that the one-time payment, in the amount of $78,717.60, was not a "rent" or a "royalty" such that it would fall under the withholding tax provisions of the Income Tax Act. The court found that feespaid at the time of an application for a franchise, as opposed to a payment made after a franchise has been granted, are not within the scope of foreign withholding tax. Such one-time payments are a form of compensation for the franchisor to compensate it for extensive services performed prior to the entering of the agreement ( Zainul and Shazma Holdings Ltd. (c.o.a. Holiday Inn Hinton) v. Canada , [2004] T.C.J. No. 391 [T.C.C.]). DISCLOSURE/RESCISSION The purpose and intent of the Arthur Wishart Act is to afford protection to persons contemplating an investment in a franchise operation and to provide disclosure of material facts with respect to such operation to the prospective franchisee. The plaintiffs sought rescission of their management agreement against a franchisee (a numbered corporation) of the franchisor (3 for 1 Pizza & Wings Canada Inc.) claiming they were not provided with a disclosure document. The Act defines "franchisor" to include sub-franchisors, and specifically contemplates that there will be sub-franchises granted by a franchisee to a sub-franchisee. The court held that in order to give effect to the stated purpose of the Act, the definition of "franchisee" must be given a contextual interpretation. Therefore, the relationship between the plaintiffs and numbered corporation was one of sub-franchisor and sub- franchisee and the management agreement between the parties constituted a franchise agreement. As no disclosure was provided to the plaintiffs as required under the Act, the plaintiffs were entitled to rescission and were entitled to the return of their deposit and losses they incurred while operating the store ( Ahmed v. 3 for 1 Pizza & Wings (Canada) Inc. , [2004] O.J. No. 144 [S.C.J.]). A disclosure document must be presented to franchisees as one complete document delivered on one occasion and cannot be satisfied by the provision of oral disclosure or by delivering several documents. The court was unequivocal in finding that the Arthur Wishart Act does not provide alternative ways for complying with its disclosure obligations. In this case, the franchisor provided multiple information packages to the prospective franchisee which taken as a whole, it was argued, substantially fulfilled the requirements on the Act. This argument was rejected by the court as there was no single document presented where all the required information was located. Therefore, the court held that the franchisee was entitled to rescind its franchise agreement within the two- year period provided for in section 6(2) of the Act ( 1490664 Ontario Ltd. v. Dig This Garden Retailers Ltd. , [2004] O.J. No. 3008 [S.C.J.]). The purchase of a franchise transaction does not need to have closed for the parties to be entitled to protection under the Arthur Wishart Act as franchisees. Although the transaction had not officially closed in this instance, the purchase price had been paid and all of the documents necessary to complete the transaction were executed by the franchisee. Therefore, the franchisee was entitled to the disclosure and rescission rights under the Act ( 136871 Ontario Inc. v. Triple Pizza [Holdings] Inc. , [2004] O.J. No. 3562 [O.C.A.]). Franchisees claiming misrepresentation against their franchisor must demonstrate that oral or written statements were made by the franchisor and reliance was placed on those statements as the material basis for entering into the franchise agreement. Where plaintiffs cannot demonstrate this and there is no evidence of an unconscionable transaction or inequality of bargaining power, courts will not make a finding of misrepresentation ( Salem v. Priority Building Services , [2004] B.C.J. No. 2110 [B.S.S.C.]). CONTRACT LANGUAGE/INTERPRETATION The terms of a franchise agreement will be strictly enforced in order to give effect to the intention of the parties. The franchisees executed a franchise agreement and paid the required deposit and initial payment, which included a system licence fee. Ultimately the franchisees were unable to obtain financing and sought a refund of the deposit and initial payment. The court held that the franchisor was justified in refusing to return the payments. The franchise agreement clearly provided that the system licence fee was not-refundable and that no portion of the initial franchise fee was refundable. Furthermore, the franchisor expended considerable time and Leading Canadian Law Firms & Practitioners B-2" FRANCHISINGLAW money arranging the construction, development and equipping of the franchise, including development of alternative sites, negotiating leases, and so on, and therefore it was clearly the intention of the parties that the franchisor be reimbursed for its time and expense, as reflected by the terms of the franchise agreement ( Sawal v. Gone Hollywood Video Ltd. , [2004] O.J. No. 4055 [S.C.J.]). INJUNCTIONS AND NON-COMPETITION COVENANTS The defendants were franchisees of Telemark Inc. ("Telemark") and were licensed to use certain Telemark trademarks. The defendants sued Telemark for a breach of the franchise agreement and obtained an injunction against it. Telemark subsequently made an assignment into bankruptcy and its assets were purchased by the plaintiff, Osiris Inc. ("Osiris"). The defendants sought continued use of the marks and the plaintiff brought an action for an interlocutory injunction restraining the defendant from using the marks. Osiris claimed that the franchise agreements were terminated as a result of Telemark's bankruptcy. The court rejected this submission, holding that Telemark could not have successfully repudiated the agreements without the defendants accepting the repudiation. No such acceptance was given and therefore the agreements remained in full force and effect. The court ultimately found that neither the balance of convenience nor irreparable harm arguments advanced by either party jus- tified the granting of an injunction, and due to the nature of the outstanding issues, a trial was the preferred method of resolving them ( Osiris Inc. v. 1444707 Ontario Ltd. , [2004] O.J. No. 344 (S.C.J.)). The plaintiff, as area franchisor for the defendant corporation, began experiencing considerable difficulty with the franchisor in that it began interfering with the plaintiff's relationships with its franchisees by waiving defaults under various franchise agreements and by requiring money payable to the plaintiff to be paid directly to the defendant. Upon requesting an accounting of the funds owed to it, the plaintiff received notice of application by the defendant requesting a court to declare the master license agreement terminated. The plaintiff commenced an action seeking an order enjoining the defendant from interfering in its economic relations and declaring the master license agreement in force. The court found that the plaintiff clearly would suffer irreparable harm were an injunction not granted and the defendant permitted to act as though the agreement had been terminated. The plaintiff would be unable to carry on business in such an event.The balance of convenience also favoured the granting of an injunction because if it was to be subsequently determined at trial that the agreement was properly terminated, then damages would adequately compensate the defendant ( Mega Wraps B.C. Inc. v. Mega Wraps Holdings Inc. , [2004] O.J. No. 4059 (S.C.J.)). GOOD FAITH In the franchisor-franchisee context, there is an applicable duty of good faith, though not a fiduciary duty, and franchisors ought to reasonably foresee that carelessness in making projections of income might cause damage to franchisees. Here the plaintiff franchisees claimed damages against the regional franchisor and its parent company. The plaintiff was provided with pro-forma statements, was discouraged from retaining a lawyer, and was assured they would only have to work six days a week to meet projected earnings. The plaintiff experienced lower than projected sales, which forced it to reduce the number of employees and the number of hours the baker worked, and eventually forced it out of business. The court held that the defendants ought to have foreseen the consequences of making careless financial projections and that the plaintiff would reasonably rely on the representations in the pro formas . In holding that the defendants owed the plaintiff a duty of care, the court noted that the defendant franchisor and its principal held themselves out as experts whose opinion could be relied upon. The statements provided were much more than mere pro forma as they were specific and personal to the plaintiff. The defendants were found jointly and severally liable ( Ismail v. Treats Inc. , [2004] N.S.J. No. 21 [S.C.]). Punitive damages are properly awarded against franchisors who act in a high-handed and abusive manner in their dealings with their franchisees. The franchisee purchased a fast food franchise and was locked out by the franchisor alleging that the franchisee breached the terms of the franchise agreement. The franchisor claimed that the franchisee had fallen into arrears of its rent, whereas the court found that not only had the rent been fully paid by the franchisee but it had been overpaid. Further examples of the franchisor's high-handed behaviour were: by the time the franchisee was given possession of its location, three of its four months of free rent had expired; and, when the franchisee found a third-party purchaser for its location the franchisor had sold the franchise to a different party at a profit when there was already an application pending before the court for relief from forfeiture to prevent the sale. The court stated this conduct was "an arrogant abuse of [the franchisor's] contractual powers and overreaching to the nth degree." The court held that the franchisor's actions amounted to fraud and that the franchisee did not get what it had bargained for. The franchisee was awarded $224,457 in damages and $350,000 in punitive damages ( Triple 3 Holdings Inc. v. Jan , [2004] O.J. No. 2749 [S.C.J.]). CLASS ACTIONS Pursuant to the terms of their franchise agreements, franchisees were obligated to purchase product inventory exclusively from the defendant franchisor, as well as pay the defendant for accounting services. Franchisees commenced this action, alleging that the franchisor withheld rebates owing to the franchisees and that the franchisor was in breach of the franchise agreements. The defendant franchisor argued against certification and argued that the interests of the class were far too divergent on economic measures. In granting certification, the court held that the common issue between all franchisees was the enforcement of the franchise agreement, as all franchisees were under the same form of franchise agreement ( 1176560 Ontario Ltd. v. Great Atlantic and Pacific Co. of Canada , [2004] O.J. No. 865 [S.C.J.]). To approve a settlement of a class proceeding, the court must find that in all circumstances the settlement is fair, reasonable and in the best interests of those affected by it. This action involved a claim against the defendant for breach of its dealer agreements, for infringing on current dealers' territories in breach of their territorial boundaries. In approving this settlement, the court noted that a broad variety of input from the class was sought, experts in forensic accounting were retained, and there was a right to opt out of the settlement for other class members wishing to claim more than the settlement provided ( Mont-Bleu Ford Inc. v. Ford Motor Co. of Canada , [2004] O.J. No. 1270 [S.C.J.]). JURY TRIALS In circumstances where a claim is made against a corporation for a breach of contract and a claim is made against FRANCHISINGLAW " B-3 2005 LEXPERT® DIRECTORY PRACTICE SECTIONS Aboriginal to Workplace an officer or senior employee of the same corporation for negligent misrepresentation, the matter is not of sufficient complexity such that it should not go before a jury. The franchisee sought damages against its franchisor for breach of contract in failing to renew the franchise agreement and commercial lease, and for misrepresenting its intention to do so. The court found that neither the termination of a franchise agreement and commercial lease, nor the concept of negligent misrepresentation was so complicated that a jury, properly instructed, could not understand the issues to be decided ( Kawkaban Corp. v. Second Cup Ltd. , [2003] O.J. No. 5169 [S.C.J.]). n Leading Canadian Law Firms & Practitioners B-4" FRANCHISINGLAW

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