Franchise Law e-COMMUNIQUÉ – May 2012

Published: 05/17/2012

By Stefanie Baldassarra, Peter Bouzalas, Y. Ken Chun, Catherine M. Dennis Brooks, Deborah S. Grieve, Rebecca Hamovitch, Colin Pendrith, Frank Robinson, Derek Ronde, Geoffrey B. Shaw, Larry M. Weinberg

In This Issue

1. Manitoba’s Franchises Act: Are You Ready?
2. Practical Considerations for Dealing With Financially Troubled Canadian Franchisees
3. “Read It and Weep!” - Is Restaurant Calorie Disclosure an Effective Behaviour Modification Tool?
4. Repositioning Your Business For Change: The Pre-Sale Process
5. Roll Out the Changes to Win: Court Grants Summary Judgment to Tim Hortons in Proposed Class Action
6. What We’re Up To (Spring/Summer 2012)

Manitoba’s Franchises Act: Are You Ready?

By Rebecca Hamovitch, Frank Robinson

As noted in a previous Cassels Brock Franchise Law e-Lert (click here), Manitoba has proclaimed that its Franchises Act will come into force on October 1, 2012. While this date is still some months away, many franchisors have already begun the process of making their franchise documentation compliant with Manitoba’s requirements.
 
If you plan to offer franchises in the province of Manitoba or currently have franchises there which may be transferred, or require renewal on or after October 1, 2012, you need to consider changing your franchise disclosure document (FDD) in order for it to comply with the new Manitoba requirements. Manitoba is the fifth Canadian province to bring in a franchise law, and this law includes the requirement that franchisors provide to prospective franchisees a FDD at least 14 days prior to the prospective franchisee signing any agreement or paying any consideration in respect of the franchise. This new legislation also means that half of all Canadian provinces now have a statutory franchise disclosure regime.

Most franchisors now have a single form of Canadian FDD intended for use in the other four provinces currently mandating pre-sale disclosure, namely Alberta, Ontario, New Brunswick and Prince Edward Island. With some small amount of effort by counsel and franchisor, a franchisor can most likely then have a form of FDD that is compliant with all five franchise law provinces as of October 1, 2012. And that may be good practice, given that the date of Manitoba’s law coming into force is only a few short months away.

If you have not contacted us yet to update your Canadian FDD for use in all provinces, or need assistance in developing a FDD for the province of Manitoba, please contact a member of our Franchise Law Group so that the necessary changes can be made in time.
 

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Practical Considerations for Dealing With Financially Troubled Canadian Franchisees

By Deborah S. Grieve

At some point or another, most franchisors operating in Canada will have to deal with a franchisee in financial difficulty. This article sets out a non-exhaustive checklist of questions and considerations that will assist the franchisor in formulating the appropriate strategy to address this challenge.

1. Assessing the situation

The first step in addressing the problem is a preliminary assessment of the situation. As part of this analysis, the franchisor should first identify the macro-level problems requiring resolution.  These problems can include the failure of the franchisee to pay franchise fees, a “dark” (i.e. abandoned) franchise location, and even bankruptcy or creditor-initiated proceedings against the franchisee.  

In examining the situation, the franchisor should also reflect on the franchisor’s longer-term objectives with respect to the franchisee and the location. The franchisor may consider the degree to which its patience has been strained, and management attention distracted, by repeated defaults and difficulties with respect to the franchisee.

2. Preparation

If it appears that the franchisor will need to pursue a form of remedy against the franchisee, it is necessary to ensure that all potential courses of action are analyzed and that the proper groundwork is set.  Proper preparation will include a review of the relevant documentation, as well as a clear understanding of the repercussions of certain decisions and the impact of applicable insolvency laws and procedures on the rights and remedies of both the franchisor and the franchisee.  A franchisor should always consider obtaining legal advice at this stage.

The following considerations are integral to the preparation process: 

A. Agreements and Contractual Rights 

1. Agreements. Before instituting any action, the franchisor should verify that all documentation is in order and properly signed by the current franchisee.  Even if the franchise agreement was properly signed, the franchisor should double check whether the agreement has expired, as that may have consequences on the proposed course of action.  A review of the franchise agreement is also important because the agreement may provide for certain remedies available to the franchisor.   
    
2. Franchise Disclosure Law Compliance. Just as importantly, the franchisor needs to determine if any actions it plans to take will be met with a franchisee’s claim relating to non-compliance with any of the provincial franchise disclosure laws. If the franchisor failed to properly deliver a franchise disclosure document, then the franchisee may have a 2 year absolute right of rescission from the date the agreement was signed, in which case the franchisee’s claim would often far exceed any amount owing by the franchisee. Any franchisor pursuing a defaulting franchisee should be certain they are on solid ground before taking enforcement steps. 
    
3. Leases.  The franchisor should also review and consider their rights under any lease agreements with the franchisee.  If the franchisor sub-leases to the franchisee, the franchisor should be able to control the lease. However, in a sub-lease situation, the franchisor will remain liable to the head landlord for any arrears in rent, and for continued payment of rent for the term of the lease. If there is not a sub-lease situation, the franchisor should examine whether there exists an option to assume the main lease upon termination of franchise, or whether there is a right of entry or other property rights under the franchise agreement.
    
4. Security Interests.  The franchisor should also consider whether it has a security interest that could be enforced against the business and assets of the franchisee as a secured creditor.  Before enforcement is possible, the franchisor will need to determine what obligations the security interest secures and whether those obligations have in fact been breached.   To avoid other secured creditors gaining priority, the franchisor should ensure that a financing statement been registered in the proper location at the earliest possible time.

B. Defaults

1. Defaults.  The franchisor should carefully consider the nature of the franchisee’s default, as this will dictate the nature and timing of the remedies that are available to it.  Events of default and the remedies available are primarily set out in the franchise agreement, although other agreements, such as leases, will include similar provisions. After identifying the default, the franchisor will need to consider whether the default is material or merely technical.  Generally, a technical default will not likely allow for the same remedies as a material default; however, this determination will require a review of the terms of the franchise agreement.  Finally, the franchisor should consider what operational fixes may be available.  If the default can realistically be cured, the franchisee may have a contractual right to do so within a specific period of time.  Where the default is cured, it is important for the franchisor to identify and address the cause of the default so that it will not be repeated.   
    
2. Notices.  As a pre-condition to enforcement, the franchise agreement may prescribe that notices of default be issued in a specific form and according to specific timelines.  It is integral that any technical notice requirements are followed to ensure the notice is valid. 
   
    
3. Course of Conduct. The franchisor should also examine its own course of conduct to determine if it has waived defaults, either expressly or by conduct.  For example, a franchisor may inadvertently waive default by repeatedly failing to demand timely payment of fees. 

C. Other Stakeholders 

1. Enforceability and Priority.  As discussed above, the franchisor should determine whether it has a security interest.  If such a security interest exists, the franchisor should further determine if it will be enforceable against third parties.   Some legal analysis may be required to determine if the franchisor’s security interest is in first secured position or if other deemed or registered interests take priority.   
    
2. Franchisee’s Bank. The franchisor should be aware of any interest held by the bank.  In the event that the franchisor has given the bank a comfort letter, the franchisor should review this letter to determine its contents and what obligations it imposes. The franchisor may also consider if there is a long-term business objective (i.e. expanding with a particular lending institution providing financing for all franchisees) that trumps a particular termination/enforcement situation?
    
3. Landlord. The franchisor should make inquiries to determine if the rent is current, particularly where the franchisor could become liable for arrears.  It will be valuable for the franchisor to have awareness of the legal rights of the landlord and also whether the landlord is cooperative.
    
4. Employees, Taxes, and Suppliers.  The franchisor should determine whether the franchisee has outstanding tax liabilities or liabilities to employees and suppliers. A full understanding of the franchisee’s debts always places the franchisor in a better position to pursue the appropriate remedy.
    
5. Guarantors.  Finally, a franchisor should consider if there are any guarantors, and if so, the nature and extent of their involvement.  Where a corporate franchisee lacks the assets to satisfy its obligations, guarantors become increasingly important.

D. What Laws Apply

Before any legal proceeding is commenced, the franchisor must be aware what franchise, competition, debtor/creditor, tax, insolvency, or other laws apply to the situation.  The applicable law is generally set out in the franchise agreement, but jurisdictional clauses have sometimes been ousted by the court.  The application of these laws may provide some surprising results, as different jurisdictions may have their own particular foibles. A further consideration is whether an agreement calls for mandatory arbitration or mediation of disputes.  Such a clause may limit the franchisor’s recourse by preventing a court action.

If the matter involves a franchisee bankruptcy, the franchisor should be aware of the potential reversal of certain interests in bankruptcy, and be alert to the possibility that the franchisee’s trustee in bankruptcy might seek to assign the franchisee’s rights without the consent of the franchisor.

Any legal analysis should take into account the historical relationship between franchisor and franchisee, as the franchisor must consider, anticipate, prepare for and be ready to rebut any defences raised by the franchisee (meritorious or otherwise). One should examine whether the franchisee has been cooperative or whether the relationship has been troubled, as any past complaints are likely to surface again.

E. Strategic Objectives and Ramifications

Outside of the legal considerations, a franchisor must decide whether it wishes to fix the problems, or simply terminate the relationship.  A forbearance agreement may be appropriate if the parties wish to work together as this will allow the franchisor to continue to pursue its remedies if the problem is not rectified.

Even in situations where a default is been cured and legal action is avoided, there may be lingering issues.  The franchisor should consider whether the franchisee has a complaint that has not been properly addressed, and if so, how it can be fixed.   In certain cases, mediation may be appropriate, or even mandated.  If a resolution will eventually require an in-depth exploration of both sides of a course of conduct or series of issues, it is often best to tackle the issue earlier, rather than later when it reappears.

Where it appears that the relationship is unsalvageable and termination is necessary, the franchisor must decide whether it wishes, or may even be obligated, to keep the premises.  Other considerations come into play, such as the impact on other stakeholders, including other franchisees.  The potential public relations impact should also be assessed.

Finally, the franchisor will need to address the intellectual property issues that arise from the termination of a franchise, including the use of signage, trademarks, licensed products and proprietary methods.

The above considerations are by no means exhaustive. Each franchisee situation is unique and legal advice is necessary to deal with specific situations. Please give us a call.  We would be happy to help.situation is unique and legal advice is necessary to deal with specific situations. Please give us a call.  We would be happy to help.

* Deborah S. Grieve (dgrieve@casselsbrock.com) is a partner of Cassels Brock & Blackwell LLP.  She is a specialist certified in Bankruptcy and Insolvency Law by the Law Society of Upper Canada, with extensive experience in franchise situations.  © 2012

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“Read It and Weep!” - Is Restaurant Calorie Disclosure an Effective Behaviour Modification Tool?

By Stefanie Baldassarra, Catherine M. Dennis Brooks

A report recently published by a Canadian advocacy group, the Centre for Science in the Public Interest (“CSPI”), titled Writing on the Wall: Time to Put Nutrition Information on Restaurant Menus, has taken on the highly debated issue of restaurant menu calorie disclosure, advocating the listing of calorie counts and sodium levels next to every menu item.

The report points out that although disclosure of nutritional information including calories and 13 nutrients has been required by legislation in Canada on all pre-packaged foods since 2005, restaurant menus are not covered by the legislation and rarely provide nutritional information. The CSPI report notes that restaurant foods comprise at least one-fifth of the average Canadian’s daily diet and states that menu labelling would help health-conscious consumers make healthier meal choices and would encourage restaurants to provide healthier menu options.

The CSPI report recommends legislation:

1. requiring chain restaurants to disclose on menus and menu boards next to each food item the number of calories along with symbols flagging foods with high levels of sodium;
    
2. requiring that all chain restaurants provide free brochures that disclose all of the nutritional information required on the labels of pre-packaged goods, including calories, saturated fat and trans fat;
    
3. exempting small restaurant operations (chains with less than $10 million in annual sales or less than 10 locations) and short-term menu items (those offered for less than 31 days per year); and
    
4. requiring chain restaurants to provide and continuously update complete nutrition and ingredient information posted on a publicly accessible government database.

The CSPI report may have had an impact as a private member’s bill was introduced in the Ontario legislature on May 8, 2012. Bill 86, the Healthy Decisions for Healthy Eating Act, 2012, would require all persons who own or operate a food service premise that is part of a chain with a minimum of 5 locations and gross annual revenue of over $5 million to:

1. display the number of calories contained in the food and drink items sold or served for immediate consumption;
    
2. make available brochures that provide nutritional information for the food and drink items sold or served for immediate consumption; and
    
3. indicate high sodium content of food and drink items sold or served for immediate consumption.

The bill makes it an offence to contravene these requirements and imposes fines of up to $500 per day on which the offence occurs or continues for first offences and up to $5000 per day on which the offence occurs or continues for subsequent offences.

Bill 86 is currently scheduled for Second Reading on November 1, 2012 and, if passed, would then be referred to a committee for further review, amendment and Third Reading. At this point it is unclear if Bill 86 has any support from the government, as without government support, it would have little chance of being passed into law.

Bill 86 Reflects a Trend Already Underway in the US

Since March 2008, New York City has required restaurants to provide calorie information on menus and menu boards. The state of California has imposed requirements for calorie disclosure on menus of US chain restaurants. Seattle and Philadelphia also require sodium, saturated fat and carbohydrate content disclosure.

These local requirements in the US will soon be replaced with federal legislation. In March 2010, the US Congress passed a law requiring chain restaurants with 20 or more locations in the US to provide calorie disclosure on menus and menu boards. The regulations are expected to be finalized and take effect in 2012.

Do Such Disclosure Requirements Work?

There have been numerous studies conducted in the jurisdictions that were early adopters of menu disclosure requirements relating to calories. The results appear to be inconclusive as to whether such disclosure makes any difference in consumer behaviour. A Stanford University study involving New York City Starbuck’s concluded that calorie levels of non-beverage food transactions declined 14%. A small study conducted at six full-service restaurants in Seattle concluded that there was a small decline (15 calories per transaction) following the disclosure of calorie information. However, another small study in New York observed a small increase in calories per transaction following the implementation of calorie disclosure on menus.

The studies conducted to date suggest that consumer decisions relating to food are complex. It may be too early to gauge how calorie disclosure on menus will affect caloric intake and that such an analysis will require monitoring of consumer food choices over a longer period of time. There are an abundance of factors, aside from calorie count, that affect the menu items chosen by customers, such as advertising and marketing. However, as the CSPI report points out, requiring the disclosure of calorie information on menus may have the greatest impact by prompting restaurants to reformulate menu items with fewer calories and less sodium.

What Are the Implications for Food Service Companies in Canada?

Although the Canadian government has been slow to impose the menu requirements that are soon to be implemented in the US, Canadian restaurant chains should be aware of the many advocates of calorie and sodium disclosure and the pending legislation in Ontario. The following issues will be of keen interest to restaurant chain franchisors and franchisees:

1. Most franchise agreements require franchisees to comply with all applicable laws, which would include any requirements imposed for the disclosure of nutritional information, yet it is often the franchisor that has a proprietary interest in recipes, resulting in franchisors bearing the burden of ensuring compliance with the applicable menu label laws.

2. If, as in the US, menu label laws require the food service establishment to have a reasonable basis for the nutritional information that they disclose, will it be considered to be reasonable for a franchisee to rely on the information provided by its franchisor or will independent nutrition analysis be required?

3. Will both franchisors and franchisees be fined for non-compliance with menu disclosure requirements?

The push towards legislating this matter in Canada means that it is only a matter of time before Canadian franchisors and franchisees are required to turn their minds to such concerns.

For further information regarding this matter, please contact Catherine M. Dennis Brooks and Stefanie Baldassarra.

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Repositioning Your Business For Change: The Pre-Sale Process

By Peter Bouzalas, Y. Ken Chun

When a business owner profitably sells his business, you often hear people speak about this being a lucky break, or about how that person was in the right place at the right time to take advantage of an opportunity.  However, successful sales are most frequently the result of careful preparation to make sure the business is ready for various opportunities. When the business owner is proactive from the beginning in maintaining the corporation’s records and documenting its affairs, the pre-sale process can be an opportunity to showcase the success of the business rather than highlight its problems. The following article provides guidance on how franchisors can plan for strategic events such as a sale opportunity or liquidity event from the earliest stages of a corporation’s life.

Maintaining Corporate Records

All too often, business owners neglect to keep their corporate records, such as the minute book and applicable corporate filings, up-to-date. As a result, at the time a transaction takes place, it is up to the lawyers and accountants to reconstruct whatever issuances, transfers and redemptions may have taken place.  Unfortunately, in these circumstances, the parties that need to sign resolutions or produce share certificates are often no longer available.

If share issuances and the chain of election of directors and appointment of officers are not kept up-to-date in the minute book, when this information needs to be updated as part of a major transaction or financing, it can often be problematic locating the various signatories to complete the gaps in the records. This can affect the ability of a lawyer to give an unqualified legal opinion, and it can also affect the unqualified major representations and warranties that the corporation is able to give.

Updating Government Filings

Similarly, it is important to ensure that government filings are up-to-date.  Nothing gives a worse impression than when, as part of its due diligence process, a prospective purchaser does a search with the relevant governmental authorities and finds that the records filed with the government do not match the information provided by the corporation.  This is also true with respect to registrations where the corporation is carrying on business.  Although these deficiencies are curable, they impact the impression given to a prospective purchaser about the way your business is carried on.  The deficiencies also affect the process of completing a transaction, as the rectification of these small issues gets in the way of dealing with the primary transaction at hand.

Preparing for Due Diligence

Due diligence is the process by which a potential buyer examines all of the critical financial, legal and operational aspects of the business in order to ensure that there are no hidden problems with the business, to verify pricing on the transaction and to ensure that they wish to proceed with the transaction.  Companies that maintain their records well are able to efficiently and quickly pull together documents that are required for a due diligence process. You need to make sure that you always keep signed copies of contracts. Your lawyers, accountants or both should also have signed copies of documents that are related to the work that they have done for you.  You should ensure that the terms of loans, debt financing arrangements, credit facilities, or any other evidence of indebtedness are documented. In addition, when banking or leasing arrangements are terminated, for which security registrations have been registered against the corporation, it is critical to ensure that these registrations are actually discharged.  In any kind of transaction, one of the first things which will happen is that personal property security searches and other lien searches will be made against the corporation. If a number of registrations arise which are no longer current, more time and effort will have to be spent tracking down contact people at these companies to discharge the registrations.  These extra steps may lead to a number of questions by the potential purchaser and can result in uncertainty, wasted time, and unnecessary costs.

In closely held corporations, the affairs of the major shareholder and the corporation may be commingled.  This is not an optimum situation for a potential purchaser.  If this is the case, you need to make sure that you at least draw minimum boundaries on your personal and corporate affairs. This will allow you to demonstrate to a purchaser that any arrangements that are in place have been in place and are well documented from inception.  Fulsome historical documentation makes it harder for the purchaser to protest about the arrangement and complain that it is something that has just been documented for the purpose of the transaction at hand.

As well, if your business has access to confidential information that are subject to various privacy laws, the purchaser will want to know that you have complied with these laws and have put appropriate privacy policies in place.  Similarly, with records retention, which is also now part of good corporate governance, the purchaser will want to know that the corporation has considered these issues, is maintaining its records for the appropriate period of time and has thought about the question of how long and in what form to keep records going forward.

In the context of the sale of a franchisor company, keeping records on franchise law compliance can be critical. Franchisees who do not receive any or an adequate franchise disclosure document can have up to 2 years to rescind their franchise agreements. If a franchisor does not have adequate information in their files regarding compliance with provincial franchise laws, then the price and perhaps the entire deal can be severely impacted. In addition, franchise agreements are a unique form of asset, representing both a stream of cash flow to a franchisor, but also an ongoing relationship with a person, the individual franchisee. Due diligence needs to examine not only the contracts, but the nature and state of that relationship with franchisees, to ensure that that the buyer is getting a system with a harmonious franchisor/franchisee relationship as opposed to one that is based on conflict.

Documenting Agreements with Shareholders

Putting in place an effective shareholders’ agreement is also an important step in ensuring that a corporation is ready for change. In particular, when an entrepreneur issues shares as an incentive to a number of his employees without requiring the employees to enter into any kind of shareholders’ agreement, if the employees quit the corporation, go their separate ways and are never seen again, it may become difficult for the majority shareholder to negotiate an ultimate sale of the corporation or even to carry on its day-to-day corporate functions.

Early Tax Planning

Tax planning can provide you with opportunities for income splitting. It is important to document any tax planning strategies that have been implemented by the business, as it may lend substance and credibility to the situation if it can be shown that the arrangement has been in place for some time.

Protecting Intellectual Property

Depending on the nature of your business and your assets, protection of intellectual property can also be a significant area where you can properly prepare your business.

Employment and Succession Planning

Employment arrangements are also the subject of scrutiny in a due diligence situation.  In particular, a purchaser will want to know that employees have signed confidentiality agreements and, where appropriate, non-competition agreements.  Once again, it gives the purchaser an increased level of comfort to know that these arrangements have been in place since inception rather than knowing that the documents were signed at the time, or in contemplation, of closing.  Similarly, if they are required at the time of transaction, it may be more difficult to get employees to sign these kinds of documents after they have been employed for a period of time and at that stage they may consult independent legal advice, which can have the effect of holding up the transaction. A prospective purchaser will want to know that the key management personnel are going to be around following an acquisition and one way to ensure this is to have appropriate employment terms in place.  Therefore, it is not uncommon to provide retention bonuses to employees to ensure that they stay around for a minimum period of time after an acquisition takes place.

As well, as part of your ongoing business process, you should make sure that you have succession planning in mind.  If after a sale there is no one who is capable of running your company if you leave, it makes your business less saleable in the long term.  Without this kind of succession planning in place, it can be difficult to find strategic purchasers for the corporation.

Retaining Intermediaries

Intermediaries are professional service providers who, among other things, assist buyers and sellers of companies to find each other, or assist companies to obtain financing.  If you are the seller of a company, the intermediary will assist you in determining a range of values for the company and in putting together a sale package or pitch book which provides the potential buyer with a snapshot of all the information they would need to know about your company.  Intermediaries are typically very well connected to the financial community and have a wide variety of contacts that will enable them to maximize your opportunity to sell your business. However,  the involvement of an intermediary is not always necessary and should be determined on a case-by-case basis. Choosing an intermediary is much the same process as choosing any professional service provider.  The best way to find one is by word of mouth through your colleagues, accountant, lawyer, banker or other professional advisor.  You should always ensure that you interview several intermediaries and make sure that you find one that has experience in your particular business area, if possible. 

Conclusion

The value of your corporation is probably the single most important thing to you. Franchisors should attend to the steps discussed above to preserve and even increase the value of their business. We would be pleased to advise on the appropriate steps and documentation that will prepare your business to take advantage of a potential sale opportunity.

The next edition of the Franchise Law E-Communiqué will discuss some of the main considerations and core documents that form part of the sale process.
 

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Roll Out the Changes to Win: Court Grants Summary Judgment to Tim Hortons in Proposed Class Action

By Colin Pendrith, Frank Robinson, Derek Ronde, Geoffrey B. Shaw, Larry M. Weinberg

Earlier this year, Cassels Brock sent out a Franchise Law e-Lert regarding the recent Ontario Superior Court of Justice decision in Fairview Donut Inc. v. The TDL Group Corp. In this case, the court granted summary judgment to Tim Hortons, a national Quick Service Restaurant (QSR) franchisor, with respect to a class proceeding brought on behalf of its franchisees in regards to changes to the Tim Hortons franchise system and allegations that Tim Hortons wrongly profited from these changes. Franchisors operating in Canada should be aware of this decision and its holding that franchisors have the right to make changes to their franchise systems and to profit from product distribution within these systems.

A copy of this e-Lert can be found here.

Geoffrey Shaw will be speaking about the decision at the upcoming Ontario Bar Association Franchise Law dinner program, “Wake up and Smell the Coffee! - What You Need Know About the Tim Horton's Decision” on May 29, 2012 in Toronto, Ontario. A link to the event can be found here.
 

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What We’re Up To (Spring/Summer 2012)

(a) What We’ve Done

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