Ontario’s Pretense at Franchise Regulations

…the government proposal for legislating in the franchise sector represents a virtual total abdication of its stated objective. To maintain as this Consultation Paper attempts, that it wants marketplace fairness but is unwilling to establish basic standards of conduct, it is being highly disingenuous. Disclosure alone masks the problem if it does not outright make it worse. What this industry needs is solutions not placebos. The legislative initiative outlined in the Consultation Paper will only lull investors and franchisees into a false sense of security and create more damage to the investing public.

Anonymous
July 17, 1998

Ontario’s Pretense at Franchise Regulations
Unpublished Essay
Anonymous

On June 15, 1998, the Minister of Consumer & Commercial Relations produced a consultation document (the “Consultation Paper”) entitled “Ontario Franchise Disclosure Legislation”… In fact, the government proposal for legislating in the franchise sector represents a virtual total abdication of its stated objective.

Introduction
On June 15, 1998, the Minister of Consumer & Commercial Relations produced a consultation document (the “Consultation Paper”) entitled “Ontario Franchise Disclosure Legislation”. As it’s title indicates, the Ontario Franchise Disclosure Legislation provides for a low level type of disclosure similar but inferior to that of Alberta. The stated objective of the government is “to ensure that small business investors in Ontario are better able to make an informed investment decision prior to signing any Franchise Agreement or making any payment”. In doing so, the Consultation Paper states that the government wants to balance the need for consumer and marketplace fairness against unnecessary regulations or added costs of small businesses. “To find this balance, the government drew on the views agreed by business groups and individuals as well as Alberta and the United States…”

In fact, the government proposal for legislating in the franchise sector represents a virtual total abdication of its stated objective. Either the government has not understood the issues or succumbed to the wiles of those not interested in bringing some balance to the “wild west” of business as franchising has been often described. Disclosure alone which has been in existence for 30 years in the United States has not resolved the most pressing problems in the franchise industry. Legislative intervention through the enactment of fairness standards has been necessary to ensure a somewhat level playing field. The legislative proposal fails to provide for marketplace fairness and therefore fails to deliver on its primary premise.

Identifying The Problem
According to the Consultation Paper the following is a list of major problem areas in franchising:

1. The Franchisee typically invests the bulk of the capital, yet the Franchisor has the right to determine how that capital is used.

2. Unlike other investors, many Franchisees make their investment from personal or retirement savings rather than discretionary funds which they can afford to lose. In fact, Franchisees invest in the franchised business as an alternative to wage employment. In other words, the only reason the investment is being made in the first place is to ensure that the Franchisee has employment for presumably employment did not otherwise exist.

3. Franchise contracts are “different from other commercial contracts” and require specialized knowledge which Franchisees to do not obtain.

4. The cost and time involved in arbitrating or litigating and franchise dispute is considerable and Franchisees typically have far pure resources and less access to legal remedies.

5. Typically, franchise relationships involve one party having more influence or control than the other.

6. High Franchisor attrition rates.

The Proposed Solutions
1. Statutory disclosure requirements of information about the Franchisor and the franchise offering similar to the Alberta Franchises Act but this may be implemented through amendment to the Business Practices Act. This may include a requirement to provide audited financial statements. The Consultation Paper states hat no particular form of disclosure will be mandated and Franchisors can attempt to meet this requirement in any way that each Franchisor deems appropriate. The consequences for failure to provide a disclosure document may result in the Franchise Agreement being null and void but false disclosure would not lead to the same penalty.

2. Right of Franchisees to Associate.

3. Gathering of statistical information as to the number of franchisors and franchisees doing business in the province at any particular time.

How Does The Proposed Legislation In The Consultation Paper Measure Up Against It’s Stated Objectives?
As the Consultation Paper has recognized, the problems in Franchising can be categorized as follows:

(a) problems relating to “Information Imbalance” arising before the investment decision is made; and

(b) problems relating to the “Power Imbalance” arising following the signing of the contract.

Obviously, the Consultation Paper deals only with the first and does not even purport to address the problem relating to the Power Imbalance even thought it recognizes that most industry problems stem from the relationship following contract execution.

Scope, Approach And Necessity Of Legislative Regulation Of The Informational Imbalance Problem
Although no statistical information exists, a large proportion of the Franchisors already provide the same or a higher level of disclosure than that proposed in the Consultation Paper. U.S. based Franchisors provide prospective Franchisees with the Uniform Franchising Offering Circular which is much more stringent and detailed than the proposals in the Consultation Paper. The UFOC also requires that information be provided in a pre-determined manner and in plain English. This permits relatively unsophisticated investors to make comparisons between competitive offerings easy and meaningful. Canadian based Franchisors doing business in Alberta in large part, provide their Alberta Disclosure document to all their Franchisees. Finally, members of the Canadian Franchise Association which represents the largest and most active Franchisors doing business in Canada and Ontario outside of the automotive and grocery distribution industries, already mandates that its members comply with the provision of a disclosure document modeled more or less after that of the Province of Alberta. Quite obviously, the only people in the franchise community that will be impacted to any extent will be the small minority of franchised opportunity sellers that cannot or will not qualify or Canadian Franchise Association membership and are not doing business in Alberta or the United States – a very small number indeed.

The absence of a plain language requirement is a very important omission from the proposed legislation. Franchisors can make their disclosure document as obscure or as difficult to comprehend as they like. Thus making it useless to anyone other than sophisticated investors who are not likely to require it in the first place. Combined with the absence of a required format and detail of what is to be disclosed by each Franchisor, the proposed Disclosure Document will permit a wide range of formats with an even larger variance as to what is being disclosed. As a result, prospective investors who are largely unsophisticated will be faced with a lot of difficult to use information. If the legislation is enacted as contemplated, the information imbalance for a franchisee investor will become more complicated and confused. It appears disingenuous therefore for the Ministry of Consumer & Commercial Relations Onario to claim it does in the Consultation Paper that it is addressing a problem.

Power Imbalance Problem
The Consultation Paper indicates that there are approximately 5,000 lawsuits initiated every year between Franchisors and Franchisees. No statistical break down exists as to the break down of those lawsuits between those arising out of the information imbalance problem and those arising out of the power imbalance problem. What can be safely stated however is that the vast majority of such lawsuits do not involve return of initial deposits and other precontractual claims. Most claims are based on problems arising following the execution of the franchise contracts between Franchisor and Franchisee. If the assumption is correct, the overwhelming majority of problems are post contractual yet the Consultation Paper calls for legislation to deal with the relatively minor issues arising before the contract is made. Indeed, five out of six problems identified in the Consultation Paper speak of problems arising after the franchise agreement has been signed – in other words during not before the relationship begins.

Each of the problems identified relates to the power imbalance not information. The government explicitly recognizes that franchise agreements are different from other commercial contracts. In what ways are they different? Franchise contracts differ from others because many material terms are subject to unilateral changes by the Franchisor subsequent to their execution. The situation is akin to a landlord in a lease agreement having the right to alter the rent unilaterally, increase or decrease the leased premises at will and at the expense of the tenant without compensation. Clearly, no one would sign such a lease. Yet franchising requires that the Franchisor maintain the flexibility to change the system including the rights of individual franchisees. This extraordinary power is implicitly granted on the expectation that it will be used fairly and prudently in a commercially reasonable manner in the best interests of the system as a whole, not the best interests of the Franchisor only. Mountains of advance disclosure will not assist a franchisee where a Franchisor decides to discount sale prices in order to increase the sale of supplies to the system (and its own profit as the exclusive supplier) as well as increased royalty revenue. Power imbalance problems cannot be addressed by disclosure. It is not good enough for a Franchisor to respond to a self-preference complaint that it had disclosed that it could do so.

In every industry of significance where a power imbalance is inherent in the relationship, legislatures have stepped in. That is why we have banking and security laws with very specific guidelines to regulate unfair conduct by the party in the superior power position. To maintain as this Consultation Paper attempts, that it wants marketplace fairness but is unwilling to establish basic standards of conduct, it is being highly disingenuous. Disclosure alone masks the problem if it does not outright make it worse. What this industry needs is solutions not placebos. The legislative initiative outlined in the Consultation Paper will only lull investors and franchisees into a false sense of security and create more damage to the investing public.

The government said it wants to balance marketplace fairness with excessive red tape and regulations. Disclosure requires a fair degree of red tape. The government if it is true to its word, can scrap disclosure but enact a fairness standard of conduct. It will cost nothing to administer and force parties to act in accordance with their promises and good business practices.

Finally, for a government that has adopted alternative dispute resolution as the dispute resolution vehicle of choice, and to the point of mandating it in most litigious proceedings, it is curious that it did not think it appropriate for franchising. Curious indeed!


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