CANADA: The International Franchise Lawyer's Guide to adapting foreign franchise documents for expansion to Canada.

Dominic MOCHRIE | CANADA | 2012-07-16

Dominic MOCHRIE

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With a diversified consumer base, a stable economy, and a well established legal system, Canada has also become a receptive jurisdiction for foreign franchise systems based in many other countries.

Foreign franchisors and their advisors must appreciate that Canada is a highly regulated country in terms of franchise specific legislation, and there are a number of miscellaneous commercial considerations, some resulting from federal or provincial laws and others resulting from common business practices, which should be considered by franchisors before expanding into the Canadian marketplace. These laws and commercial considerations will inevitably require customization of standard form franchise documents for use in Canada. This article will focus on some of the most often overlooked and most important commercial considerations for Canadianizing foreign franchise documents before they can be used effectively in Canada.

 

Language Differences

Very subtle, and in some cases, not so subtle, differences in the use of the English language in Canada from that in the United States result in requirements for change to United States documentation.

For example:

  1. The word ‘center’ which is often used in United States franchise agreements and in designating locations or, in fact, in or as part of United States trade-marks, is spelled ‘centre’ in Canada.
  2. The word ‘license’ is spelled ‘licence’ when a noun, and ‘license’ when a verb.
  3. The word ‘trademark’ in the United States is spelled ‘trade-mark’ in Canada.

Other key differences in terminology include:

  1. Judicial remedies like ‘temporary restraining orders’ do not exist in Canada, but are effectively replaced by ‘interim or interlocutory injunctions’.
  2. There is no criminal offence known as a ‘felony’ in Canada, but the term ‘indictable offence’ may, in certain circumstances, constitute a substitute.
  3. ‘Offense’ is spelled ‘offence’ in Canada.
  4. ‘Certified’ mail does not exist in Canada, but the equivalent concept of ‘registered’ mail does.
  5. There are no ‘attorneys’ in Canada. Canadian lawyers are formally known as ‘barristers’ and ‘solicitors’ but the more common practice is simply to refer to lawyers as ‘lawyers’.
  6. Hence, while the term ‘attorney’s fees’ is often referred to in a United States franchise agreement, the Canadian replacement would be ‘legal fees’.
  7. With respect to professional designations, there is no designation in Canada of a ‘certified public accountant’. Financial statements, depending upon whether they are audited or unaudited, are reviewed by ‘auditors’ or ‘chartered accountants’.
  8. References to ‘stockholders’ or ‘stock’ should be changed to ‘shareholders’ or ‘shares’, and ‘ordinances’ should be changed to ‘by-laws’.

 

Trade-marks

The Canadian Trade-marks Act does not recognize the concept of ‘service marks’. Therefore, service marks and trademarks, as they are referred to in the United States, are only referred to as ‘trade-marks’ in Canada. The term ‘service marks’ should be deleted in Canadian franchise agreements and ancillary documents.

There are a number of specific provisions dealing with trade-mark ownership, marking, validity, quality control, inspection and the like which should be inserted into Canadian franchise agreements or trade-mark licences to be in accordance with the statutory provisions of the Canadian Trade-marks Act.

Currency Selection

While both Canadian and United States currency use the ‘dollar’ form of measurement, it is important to appreciate that the exchange rate between Canadian and United States currency will fluctuate and can differ substantially. Therefore, if fees provided for in a franchise agreement are expressed in United States dollars, it should be remembered that Canadian franchisees will be earning revenue and paying expenses in Canadian dollars. This may unfairly prejudice a Canadian franchisee and be unrealistic if the Canadian dollar is worth less than the United States dollar. Nevertheless, it is critically important that the agreement specify in which currency all dollar amounts referred to are to be measured and/or paid.

If payments are to be made in United States or other foreign currency, the franchise agreement will need to stipulate the mechanics of the currency exchange. For example, many franchisors require payments to be the foreign currency equivalent on the payment date at the selling rate of a specified bank.

Payment Mechanics

In addition, foreign franchisors should be aware that the Canadian postal service (particularly trans-border services) can be slow, and franchisee payments and required reports may take longer to arrive than anticipated. Therefore, for example, a foreign franchisor may wish to consider the means by which payments will be made. Setting up automatic bank depository arrangements might facilitate payment and avoid potential disputes as to the timeliness of payments. However, the Canadian Payments Association introduced new rules applicable to preauthorized debit (PAD) agreements (i.e., the Canadian version of an Automated Clearing House (ACH) authorization), which came into force in February 2010. The revised rules prescribe many disclosure items including a clear authority to debit the account, amount and timing of the PAD, how the PAD is triggered, payee contact information, and certain prescribed statements. For set interval PADs, such as monthly royalty fees or advertising contributions, the payee is required to notify the payor of the amount to be debited and the date of such debiting at least 10 days prior to the PAD for both fixed and variable amount PADs. In addition, the rules require that each sponsoring member (i.e., the payee’s financial institution) have the payee (i.e., the franchisor) sign a Payee Letter of Undertaking in respect of all PADs which will be issued. The rules apply to all business PADs, including payments between franchisees and franchisors. If a franchisor wishes to have enforceable covenants or agreements from franchisees who signed franchise agreements after these changes came into effect, the franchisor should ensure that its covenants or agreements contain the new mandatory language.

Interest Rates

There is no practical concept under Canadian law of a ‘maximum interest rate allowed by law’ other than to restrict usurious rates above 60%. As a result, interest on overdue amounts should be expressed as a specified percentage rate. Further, the rate should be expressed as an annual rate, since interest rates expressed only on a monthly basis will not be enforceable, except to a minimal interest rate set by the federal Interest Act. It is often a common practice, as an alternative, for interest rates to be specified by reference to a defined measurement of ‘prime rate.’ In such cases, the term ‘prime rate’ should be defined by reference to the commercially acceptable defined term of a particular bank.

Repatriation of Funds and Withholding Taxes

In most typical foreign franchisor-Canadian franchisee relationships franchise fees, royalties, and interest payable to the franchisor will be subject to withholding taxes. To ensure that the franchisee fulfils the withholding tax requirements, a specific provision should be included in the payment section of the franchise agreement requiring the franchisee to pay these taxes to the appropriate tax authorities and to provide the franchisor with copies of receipts (or other suitable documentation) from the tax authorities. The franchisee should also be required to take all reasonable steps to assist the franchisor in obtaining any tax credits arising from such withholding taxes that are available to the franchisor in its home country.

Pricing of Supplies and Inventory

Foreign franchisors specifying prices for supplies and inventory, based on applicable local prices, should determine the relevant selling prices of such supplies and inventory in Canada, after taking into account currency exchange, transportation costs, insurance, and any applicable value added taxes, customs tax or duty. Further, with the applicable requirements of the Consumer Packaging and Labelling Act and provincial language laws, it will likely be necessary to re-package and re-label inventory for resale in Canada, which could increase costs.

Mandatory Purchase of Products and Supplies

Under Canada’s Competition Act it is not an illegal or a criminal offence for a franchisor to require franchisees to purchase products or supplies from designated sources or suppliers, including the franchisor or its affiliates. However, the practices of market restriction, tied selling and exclusive dealing are reviewable under certain circumstances by the Competition Tribunal and, if certain anti-competitiveness tests are met, the Competition Tribunal may order that any of these practices cease to be carried on.
It is only following an order being issued and a franchisor failing to comply that the continuation of the practice would constitute a criminal offence. Accordingly, provisions in Canadian franchise agreements dealing with tied selling and exclusive dealing, particularly in respect of the mandatory purchase of products and supplies, are often less stringent than the counterpart provisions found in foreign franchise agreements.
A leading Supreme Court of Canada case determined that it is permissible for franchisors to obtain and retain rebates, allowances and other amounts from suppliers of products to the franchisor’s franchisees. Franchisors can generally obtain significant volume rebates from designated suppliers and are not required to share such rebates or allowances with their franchisees. However, it is necessary that the franchisees be obliged (via their franchise agreements or otherwise) to purchase from designated suppliers. The same case also determined that a franchisor is not a fiduciary of a franchisee in respect of such activities and that it is not even necessary for franchisors to disclose the fact that they will be obtaining such rebates or allowances in their franchise agreements (although specific provincial franchise legislation does require some degree of disclosure). Nevertheless, it has become common practice in Canadian franchise agreements for franchisors to specifically deal with this issue by indicating whether or not they intend to retain for their own use such rebates or allowances, or share them in some manner with their franchisees.

Suggested Pricing of Products and Services

If a franchisor directly or indirectly attempts to influence upwards, or to discourage the reduction of, the price at which a franchisee offers to supply or advertises a product within Canada, this is a reviewable trade practice under the applicable price maintenance provisions of Canada’s Competition Act. Under this civil provision, upon application to the Commissioner of Competition, the Competition Tribunal may make an order where it has found that the conduct has had, is having, or is likely to have an ‘adverse effect on competition’. The Competition Tribunal’s remedial powers are generally limited to an order prohibiting the conduct.
One of the most important provisions relating to price maintenance which affects franchising is that concerning ‘suggested retail prices’. The Competition Act provides that a franchisor’s suggestion of a resale or minimum resale price is — in the absence of proof that the franchisor also made it clear that there was no obligation to accept the suggestion and that business relations would in no way suffer for the franchisee’s failure to do so — proof of an attempt to influence the franchisee. Since it is common for franchisors to suggest resale prices to franchisees, it is the recommended practice for a franchisor issuing suggested resale prices to include the statutory disclaimer language in the franchise agreement or, if not, then in price lists or other related material. The suggested price provisions of the Competition Act do not include maximum pricing. Therefore, a franchisor may suggest maximum prices and in fact deem the franchisee to be in default under the franchise agreement if the franchisee sells above such maximum prices without offending the price maintenance provisions of the Competition Act and without being required to include the necessary disclaimer language.

The price maintenance provisions also affect mass advertising placed by a franchisor. The Competition Act states that the publication by the product’s supplier (other than a retailer) of an advertisement that mentions a resale price is an attempt to influence upwards the selling price of any person into whose hands the products comes for resale. This holds unless the price is expressed so as to make it clear to any person reading the advertisements that the product may be sold at a lower price. Therefore, a franchisor that engages in mass or national advertising in which a resale price is mentioned for articles or services available at franchisee outlets should include the words ‘or less’ after the words ‘suggested resale price.’ Alternately, the advertisement should indicate that a suggested retail price is a maximum price and that franchisees may sell for less.

Advertising Funds

Foreign franchisors should carefully consider the structuring of their advertising programs in Canada and, in particular, how contributions to advertising funds will be made by Canadian franchisees. Naturally, Canadian franchisees will expect that advertising contributions made to a foreign advertising fund will be used for advertising in Canada. It’s important to be aware that national advertising placed on United States television will be blocked on reception in Canada and be replaced by Canadian-sourced advertisements. The result is that virtually all franchisor advertising on television in the United States will not be received in Canada by cable television subscribers.

Foreign franchisors should consider establishing a Canadian advertising fund for Canadian franchisees, or segregating Canadian advertising contributions into a separate fund. It may be the case that Canadian advertising contributions will be used, in part, to defray production costs and source materials paid for out of the foreign advertising fund. However, since some of these materials may not be appropriate for use in Canada (for language and cultural reasons in particular), the amount of Canadian advertising contributions allocated to cover a share of these costs should only be a specified percentage of the total Canadian contribution. All of these issues should be considered and disclosed in the Canadian version of the franchise agreement and/or disclosure document.

Privacy Laws

Foreign franchisors should review and revise their disclosure documents and franchise agreements in order for such documents to be in compliance with applicable Canadian privacy legislation. Typical franchise disclosure documents in Canada contain certain personal information which is disclosed to prospective franchisees, including the business name, address and telephone number of existing franchisees.

Canada’s federal privacy legislation, the Personal Information Protection and Electronic Documents Act (‘PIPEDA’), applies to all organizations that collect, use or disclose personal information in the course of commercial activity, except to the extent that provincial privacy legislation has been enacted and declared ‘substantially similar’ to PIPEDA. The only provinces in Canada that have enacted ‘substantially similar’ privacy legislation to PIPEDA are British Columbia, Alberta, and Québec.

Under PIPEDA and the substantially similar provincial legislation, personal information may be used or disclosed without consent if it is required by law. Franchise legislation in the regulated provinces prescribe specific information which must be disclosed to a prospective or, in some cases, existing franchisee in the form of a disclosure document. As a result, franchisors may rely on the fact that the disclosure of a franchisee’s personal information is required by law and, therefore, franchisee consent to the disclosure is not required.

However, outside of Alberta, Manitoba, Ontario, New Brunswick and Prince Edward Island, a disclosure document may be provided on a voluntary basis to new or existing franchisees. There is no requirement by law in these provinces to disclose specific information, including personal information. It is, therefore, recommended that franchisors include a provision in their franchise agreements acknowledging consent from the franchisee to disclose the franchisee’s personal information in a disclosure document, whether required by law to be provided to a prospective franchisee or made available on a voluntary basis. Where such consent cannot be obtained, the personal information of franchisees should be excluded from the disclosure document when distributed outside of a regulated province.

Good Faith and Fair Dealing

In the United States the duty of good faith and fair dealing is implied, but not expressly mandated by legislation. The duty of fair dealing in Canadian franchise law is a creation of both common law and statute, and has very practical applications to the manner in which franchisors and franchisees deal with each other, and to franchise agreements and related documents in general. As interpreted by Canadian courts, the duty of fair dealing means that a franchisor must not act in bad faith towards a franchisee, and must act in a commercially reasonable manner, when performing its obligations or enforcing its rights under a franchise agreement.

Foreign franchisors should review their documents used in Canada to ensure they are compliant with the duty of fair dealing as interpreted by the Canadian courts and as defined by provincial franchise legislation. Franchisors should modify their franchise agreements for use in Canada by eliminating rights or obligations that are not necessary or are outdated, remove qualifications to the exercise of discretion, and consider areas where franchisee representation or input may be useful or desirable. Franchise agreements should not have older-type clauses providing for ‘sole’, ‘unfettered’, or ‘absolute’ discretion. These clauses do little, if anything, to give franchisors in Canada enhanced rights beyond their statutory and common law obligations to deal fairly and to take their franchisees’ interests into account.

Termination Procedures

Provincial franchise legislation does not deal with termination of franchise agreements except in the possible context of the duty of fair dealing and good faith in connection with the enforcement of a franchise agreement. Accordingly, there are no statutory requirements with respect to notice periods, defaults, cure periods or terminations. The right of a franchisor to issue a default notice and to terminate a franchise agreement will be generally construed according to the specific written provisions of the franchise agreement. Accordingly, it is possible in Canada to specify more stringent default and termination requirements in a franchise agreement and to eliminate the common concept used in United States agreements for termination only in connection with ‘material’ defaults.

Equitable Remedies

The normal equitable remedies available to a franchisor prior to trial consist of interim or interlocutory injunctions and orders for specific performance. An interim injunction is a remedy given by a court ex parte (i.e., without notice to the franchisee) and is available only in extreme circumstances. An interlocutory injunction requires the franchisor to establish that there is a serious issue to be tried, that the franchisor will likely suffer irreparable harm if the injunction is not granted, and that the balance of convenience is in the franchisor’s favour.
It is difficult for franchisors to obtain interlocutory injunctions when a franchisee can demonstrate that damages would be an adequate remedy to the franchisor, and that the balance of convenience does not rest with the franchisor. Nevertheless, in appropriate cases, interlocutory injunctions may be issued in favour of the franchisor depending upon the nature of the default by the franchisee. Orders for specific performance or enforcement of positive covenants are also available in appropriate cases.
Foreign franchise agreements must be amended for use in Canada to incorporate appropriate language with respect to equitable remedies, and to remove terms or remedies that do not apply in Canada.

Further, penalty clauses are not enforceable in Canada. Accordingly, where a foreign franchise agreement contains specific financial remedies, in the nature of a penalty, it will be necessary for the agreement to be rewritten to state that the amounts specified are a genuine pre-estimate of damages and in the nature of liquidated damages in order for there to be a likely possibility of enforcement.

Judicial Procedures

<pSeverability provisions must be carefully drafted to comply with Canadian common law requirements. A provision attempting to substitute valid provisions into an agreement will not generally be enforceable. Similarly, a provision stating that an unenforceable provision should be substituted in order to make the modified provision enforceable to the greatest extent possible will also not likely be enforceable.

Entire Agreement Clauses and Disclaimers

Canadian courts have found remedies for franchisees in connection with pre-contractual representations on the basis of the contractual theory of collateral warranty. Therefore, it is necessary for a typical foreign entire agreement provision to be redrafted for use in Canada to deal with the concept of collateral warranty.Further, disclaimer provisions should also be redrafted to distinguish between implied conditions versus implied warranties in respect of any disclaimers pertaining to the sale or supply of goods or products, particularly in standard franchise software license agreements.

Legal Fees

As indicated in the sub-section on Language Differences, there is no concept in Canada of ‘attorney’s fees.’ In most civil cases in Canada, the prevailing party is entitled, by right, to have costs awarded in its favour against the unsuccessful party. Costs can be determined on two scales:

  1. Party -and -party or partial indemnity; or
  2. Solicitor -and -client or substantial indemnity.

In most cases, party -and -party or partial indemnity costs, the lowest scale of costs, will be awarded. In more extreme cases (for example, when a judge determines that an action was brought without merit or was frivolous or vexatious), the court may order solicitor -and -client or substantial indemnity costs which are determined on a higher scale basis. Finally, if the parties agree in the franchise agreement or otherwise that costs should be awarded on a solicitor and its own client basis, a court may order that costs are recoverable on the basis of actual fees and costs expended by the prevailing party.

Mediation and Arbitration

Mediation and arbitration provisions contained in United States or other foreign franchise agreements must be amended to provide for an appropriate forum for mediation, and the rules, forum and jurisdiction for arbitration, if either of these alternate dispute remedies are to be pursued.

Governing Law

It is the normal practice of United States and other foreign franchisors and their professional advisors to insist upon governing law of their home jurisdiction in a Canadian franchise agreement. Apart from the difficulty of introducing expert evidence in a Canadian court to establish the principles of the domestic governing law, there is also the difficultly of enforcing a foreign judgment in Canada if a United States or other foreign forum is mandated for determination of disputes and remedies.

While the courts of most common law jurisdictions in Canada may recognize a United States or other foreign governing law clause, nevertheless such a provision will often result in difficulties which will outweigh perceived advantages. For example, United States franchise laws, anti-trust laws, common law principles and other applicable statutes are generally more onerous to a franchisor than those in Canada. One should question why it is of use to a franchisor to voluntarily insist upon the application of such principles. Further, franchisors frequently need to seek injunctive relief against franchisees, particularly following termination of the relationship, in order to restrain a franchisee from breaching restrictive covenants respecting trade-marks and the like, and from breaching non-competition covenants. It is highly unlikely that a foreign court will grant injunctive relief with respect to the conduct of a franchisee in Canada, and further unlikely that a Canadian court would recognize and enforce such a judgment.

In addition, this means of injunctive relief would unquestionably be more time consuming than if an injunction was sought directly in a Canadian court. If, on the other hand, a franchisor were to ignore the exclusive jurisdiction provision and apply directly to a Canadian court when seeking an injunction, then it would be open to the franchisee to seek a stay of the action on the basis that the franchisor must bring its action in the state of jurisdiction, again resulting in delay and increased uncertainty.

Additional problems will arise with respect to the province of Québec, which is a civil law jurisdiction. Before a Québec court will enforce a foreign judgment, the defendant will be afforded an opportunity to raise any defence available in the initial action. In other words, if the franchisor had brought and won an action in its home jurisdiction, it could be faced with the expense and uncertainty of litigating the same issue twice. Because of these uncertainties and potentially undesirable results, it is generally suggested that foreign franchisors ensure their franchise agreements and related documents are governed by the laws of the province in which the franchised business is located and the laws of Canada applicable therein, and that no choice of jurisdiction provision be included or that the choice of jurisdiction be the province in which the franchised business is located. Franchise legislation in Alberta, Manitoba, Ontario, Prince Edward Island and New Brunswick requires, in any event, that the laws of those provinces must govern the franchise agreement in respect of any rights provided for in the applicable franchise legislation.

Jurisdiction and Venue

Although a foreign franchisor may prefer to choose the jurisdiction of the franchisor’s home state, the choice of jurisdiction provision in a Canadian franchise agreement should be the province in which the franchised business is located. Under the franchise legislation of Alberta, Manitoba, Ontario, Prince Edward Island and New Brunswick, any provision in any agreement purporting to restrict jurisdiction or venue to a forum outside each province is void. Any governing law clause or arbitration clause (with a specified venue) must refer to Alberta, Manitoba, Ontario, Prince Edward Island or New Brunswick laws.

Guarantees

Personal guarantees of franchise agreements entered into by a corporate franchisee must be reviewed in Canada to determine that they comply with Canadian practice and common law requirements. Waivers of defences, jurisdiction clauses and enforcement covenants may have to be amended to comply with Canadian practice and requirements. Further, in the Province of Alberta, a guarantee will not be valid unless it is sworn and notarized in a special form required under the Alberta Guarantees Acknowledgement Act.

Operations Manuals

Virtually every franchise system uses operations manuals to establish system standards, specifications and procedures. Many manuals contain legal provisions, or references to statutes or applicable laws. Accordingly, all operations manuals used by foreign franchisors should be reviewed and, if necessary, modified or adapted for use in Canada, particularly where legal requirements are provided for. For example, references to income tax issues, labour and employment laws, workplace and safety matters, trade-mark standards, and ownership of system improvements, to name a few, should be modified to comply with Canadian requirements.

Summary

For a foreign franchisor to enter into an agreement with a Canadian franchisee based solely or substantially on the franchisor’s standard domestic franchise documents is not only inappropriate, but perhaps irresponsible, given the difficulties which will ensue later in the administration and enforcement of the franchise agreement and the franchise system. As in doing business in any other foreign jurisdiction, foreign franchisors must appreciate that Canada is a foreign country, and that compliance and respect for the domestic laws, practices and customs of Canada are necessary for the successful expansion of a franchise system into the country. It is estimated that Canadian franchise system sales generate over $100 billion annually and that approximately 40% of all retail sales in Canada emanate from franchised systems. The Canadian economy continues to be extremely receptive to the introduction and expansion of foreign franchise systems. With proper research, understanding, advice, flexibility and conformity to Canada’s laws, customs and practices, foreign franchisors should find the Canadian marketplace a land of opportunity for successful expansion.

 

 

Frank Zaid, IDI franchising Country Expert for Canada, with the assistance of Andraya Frith and Dominic Mochrie, Partners, and Michelle Malecki, Associate, Osler, Hoskin & Harcourt LLP.

 

 

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