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Franchise Law e-COMMUNIQUÉ - April 2016

Published: 04/13/2016

By Kate Byers, Carly Cohen, Stefanie Holland, Christopher Horkins, Eric Mayzel, Colin Pendrith, Frank Robinson, Derek Ronde, Geoffrey B. Shaw, Rebecca Valo, Larry M. Weinberg

In This Issue

  1. Ontario Releases Regulation under Healthy Menu Choices Act, and Franchisors Are At Risk!
  2. Alberta Government Canvasses Input on Franchise Disclosure Financial Statement Exemption Requirement
  3. Ontario Court of Appeal Shakes Up The Issue of Restrictive Covenant Enforceability

Ontario Releases Regulation under Healthy Menu Choices Act, and Franchisors Are At Risk!

By Larry M. Weinberg, Frank Robinson, Rebecca Valo

Following a consultation period in which the Ontario Government sought input from stakeholders in the food service industry, a new Regulation under the Healthy Menu Choices Act was published in the March 19 issue of the Ontario Gazette. The Healthy Menu Choices Act (the Act) will require regulated food service premises with 20 or more locations in Ontario that are selling prepared ready-to-eat food to post itemized caloric content on menus.

Cassels Brock addressed this new legislation and its potential impact on restaurant and food service franchisors in previous newsletters in May and October of last year.

The Act implicates franchisors by stating that an owner or operator of a regulated food service premise “means a person who has responsibility for and control over the activities carried on at a regulated food service premise, and may include a franchisor, a licensor...”.

While the definition leaves open the possibility that a franchisor is not always liable for compliance, the above reference to responsibility and control (as opposed to ownership) leave open the more likely possibility that the government intends for every franchisor to be caught, as they arguably all exercise some measure of control, and therefore may be open to prosecution.

The failure of the Regulation to elaborate on the meaning of responsibility and control potentially leaves every franchisor exposed to responsibility to ensure franchisee compliance, and prosecution and liability if there is a failure by a franchisee to comply. Accordingly, the ensuing liability under the Act may attach to any franchisors with 20 or more corporate and/or franchised outlets in Ontario as the Regulation may deem them to be an owner or operator of those regulated food service premises even when they are in fact not the owners.

Franchisors and franchisees are independent contractors. It is reasonable to assume that each should be responsible for their own acts or omissions, and government should not be imposing liability on one person for the acts and omissions of someone else. Most people in our society would see that as unfair, and not in keeping with our traditions. That should apply equally to parties in an independent contractor licensing arrangement. From this perspective the Regulation is not helpful to the franchise community. However, it is unfortunately becoming increasingly common for governments to move in this direction.

The Act and its accompanying Regulation are intended to come into force on January 1, 2017.

If you have any questions about the Act or the accompanying Regulations, please contact Larry Weinberg, Frank Robinson or Rebecca Valo at Cassels Brock.

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Alberta Government Canvasses Input on Franchise Disclosure Financial Statement Exemption Requirement

By Larry M. Weinberg, Frank Robinson, Rebecca Valo

In Canada, the five provinces (Alberta, Manitoba, New Brunswick, Ontario and PEI) with franchise legislation (and soon to be six with the addition of British Columbia) require that franchisors disclose specified financial statements from the previous fiscal year in their franchise disclosure document (FDD). Normally, failure to provide the correct financial statement in the FDD provides franchisees with the statutory right to rescind their franchise agreement within two years of entering the agreement. However, all of the Canadian franchise statutes have an exemption that allows large, well established franchisors to avoid disclosing financial statements in their FDD, if certain requirements are met. The requirements for the application of the exemption vary from province to province.

Recently, the Government of Alberta launched a consultation survey to solicit input from stakeholders in the franchise industry regarding Alberta’s Franchises Act Exemption Regulation. The survey focused on two key issues: if large franchisors should continue to be exempt from having to disclose financial statements to prospective franchisees; and if so, if the existing monetary threshold triggering the exemption is appropriate.

The current exemption for disclosing financial statements in Alberta applies if both of the following requirements are met:

  1. (a) The franchisor has a minimum net worth of $5 million, or;

    (b) The franchisor is controlled by a corporation with a minimum net worth of $5 million and the franchisor has a minimum net worth of $1 million; and
  2. The franchisor has a minimum of 25 franchisees in Canada conducting business continuously for a minimum 5 year period prior to the date of disclosure, and has conducted business that is the subject of the franchise continuously for 5 years or more.

The survey also solicited feedback on whether Alberta, as a precondition to the financial statement exemption, should require a franchisor to be free from any judgment, order or award made in Canada for fraud, unfair or deceptive practices, in the five years immediately preceding the date of the disclosure document. Alberta is currently the only province with franchise legislation that does not have this precondition to the financial statement exemption. As a result, Alberta is viewed as having less onerous requirements for the exemption, although, it is worth noting that New Brunswick and PEI have lower monetary thresholds ($2 million) that trigger the exemption.

Cassels Brock is following the developments on this front and will provide an update if legislative changes are proposed. 
 

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Ontario Court of Appeal Shakes Up The Issue of Restrictive Covenant Enforceability

By Colin Pendrith

In our December newsletter, we wrote about the decision in MEDIchair LP v. DME Medequip Inc. where the Ontario Superior Court of Justice held that a restrictive covenant was reasonable in scope and enforceable against a former franchisee, despite the fact that the franchisor had no immediate plans to re-franchise the territory covered by the restrictive covenant. However, on appeal by the franchisee, the Court of Appeal for Ontario reversed the application judge’s ruling and held that the restrictive covenant was not enforceable.

The case concerned a franchisor operating a network of franchise stores that sell and lease home medical equipment under the name MEDIchair. The franchisee, DME Medequip Inc. (DME), owned and operated the Peterborough store for approximately 20 years.  In 2008, DME was acquired by two individuals through a corporation.  The franchise agreement contained a post-term restrictive covenant preventing the franchisee and its principals from operating a similar store for 18 months within a 30 mile radius.

In the years leading up to the expiry of the franchise agreement, the MEDIchair franchise system was sold to a new corporate owner, which also purchased a group of 24 Motions Specialities stores.  The Motions Specialties stores directly competed with the MEDIchair franchises.  In particular, a Motions Specialties store in Peterborough competed with DME’s franchise. 

Subsequently, the franchisee became dissatisfied with the MEDIchair franchise system.  When the franchise agreement expired in January 2015, the franchisee did not renew the agreement.  The franchisee de-identified the store as a MEDIchair franchise, but continued to operate what was essentially the same business under the name “Living Well Home Medical Equipment.” 

In the decision below, the Superior Court judge granted the franchisor’s application to enforce the restrictive covenant, finding that the restrictive covenant was reasonable for the benefit of the viability of the franchise system as a whole.   The judge did not find that the franchisor’s apparent disinterest in re-franchising the Peterborough area was a bar to enforcing the covenant. The franchisee appealed.

The primary issue on appeal was whether the franchisor was entitled to enforce the restrictive covenant when it had no intention of opening another MEDIchair store within the protected geographic area.

The Court of Appeal did not adopt the application judge’s reasoning that the viability of the franchise system as a whole would be undermined if the franchisee were allowed to compete.  Rather, the Court of Appeal determined that, based on the franchisor’s evidence that it did not intend to operate in Peterborough, the franchisor did not have a “legitimate or proprietary interest to protect within the defined territorial scope of the covenant.”

In construing the reasonableness of the non-competition covenant, the Court considered the parties’ expectations at the time that the covenant was bargained for.  The Court explained that “the clause was reasonable on the assumption and understanding that MEDIchair would want to continue to operate in the protected Peterborough area, but not if it did not.”

The Court ultimately determined that the covenant was neither generally unreasonable nor unenforceable, but was unreasonable as between the parties in the particular circumstances of the case because the franchisor no longer had a legitimate or proprietary interest to protect within the territorial scope of the covenant.

This decision may cause franchisors to pause before seeking to enforce a restrictive covenant covering a territory that they do not plan to re-franchise.  As a best practice, franchisors are encouraged to document their commercial interests in the territory and any future plans to re-franchise before potentially seeking to enforce a covenant.
 

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