This briefing explores the “Accidental Franchise”, a business arrangement governed by law which parties unwittingly and mistakenly fall into as a result of how the parties choose to conduct business operations.
What is a Franchise?
To begin, lets discuss what exactly a franchise is.
According to the International Franchise Association:
A franchise (or franchising) is a method of distributing products or services involving a franchisor, who establishes the brand’s trademark or trade name and a business system, and a franchisee, who pays a royalty and often an initial fee for the right to do business under the franchisor’s name and system.International Franchise Association: https://www.franchise.org/faqs/basics/what-is-a-franchise
Simply put, a franchise is a business relationship where one party, (the “Franchisor“), permits another party (the “Franchisee“) the right to do business under the Franchisor’s name and the right to access the intellectual property and/or proprietary business system in exchange for a financial compensation.
Legal Definition in Ontario
In Canada, the commercial relationship between a Franchisor and Franchisee is governed both by contractual relationships between the parties, such as a Franchise Agreement and by provincial law. In Ontario for instance, the Arthur Wishart Act, 2000 (“Act“) which governs all franchise relationships defines a franchise as a business relationship where one party is obliged to make payments to another party, directly or indirectly, on one occasion or on multiple occasions, in exchange for the right to either
- sell, offer for sale or distribute goods or services in a manner substantially associated with the other party’s intellectual property and Brand and as directed, instructed and controlled by the other party;
- sell goods and services provided by the other party in areas and territories designated by the other party.
Relationships Most at Risk of Being an “Accidental Franchise”
As a consequence of this broad definition, many types of business relationships are at risk of being an accidental franchise including:
- Licensing Relationships
- Distribution Relationships
- Joint Venture Relationships
- Area Representation Relationships
The Consequences of Being an “Accidental Franchise”
The Arthur Wishart Act mandates Franchisors to disclose at minimum all material facts of the commercial relationship, certain financial statements, copies of all proposed legal agreements relating to the franchise and statements that assist the potential Franchisee in making an informed investment decision.
Franchisors who fail in their disclosure obligations risk allowing Franchisees unhappy with the commercial relationship to go to court and blame the poor performance of the enterprise on the Franchisor’s failure to provide adequate disclosure. Conversely, Franchisors who do meet their disclosure obligations will not be blamed for an unprofitable franchise relationship.
So if a business relationship is characterized as a franchise relationship, the party controlling the relationship will be expected to satisfy the duties of a Franchisor under the Act, including being responsible for providing additional disclosure to the party with less control before any legal agreements are signed.
If sufficient disclosure was not provided prior to the start of the business relationship, the party with more control of the relationship is likely to be blamed for a poorly performing commercial relationship as a result of their failure to provide adequate disclosure to the party with less control.
How to Avoid Being an Accidental Franchise
If you are concerned about the potential risk of your business relationship of being an “Accidental Franchise” relationship, consider speaking to your lawyer about the following approaches:
- Limit the ability of any party to control how another party conducts their business operations;
- Clearly define the relationship in all written contracts;
- Ensure that no fee is exchanged for the right to sell goods or services.
If however you remain concerned about the potential of your commercial relationship being an Accidental Franchise, we recommend you seek legal advice with an experienced lawyer. We of course would be glad to assist you in this regard.