Years of work count for nothing

“Franchise contracts are unilateral contracts which put one party in a superior position with a lot of discretion to change the contract unilaterally. There are no ground rules. Anyone can do anything they want. As soon as they have your money, you are at their mercy if they are rapacious.”

The Record
August 26, 1998

Years of work count for nothing
Guelph woman lost her business when franchisor changed locks
Ron DeRuyter

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Les Stewart of the Canadian Alliance of Franchise Operators says the relationship between operators and franchisors needs to be regulated.

Anne didn’t want to join the ranks of disgruntled franchisees.

The 52-year-old Guelph woman worked hard after she bought a retail electronics products franchise eight years ago. Backed by a large, reputable company, she was confident her business would succeed.

Anne did do well, or so it seemed. Her sales increased. She was named franchisee of the year twice, most recently in 1996. Two years ago, she opened a second store.

But Anne wasn’t making money, or at least not much. The industry had become fiercely competitive. Her margins shrank and it became more difficult for her to pay for her inventory, not to mention her operating costs.

She asked for help from the company and put together a revised business plan. It would be hard, but she was optimistic things would turn around.

She had to be optimistic – she had borrowed more than $300,000 to set up and expand the business. She was counting on the venture to eventually provide her with the means to retire.

But everything went awry in June, when a company official showed up at the store.

He asked Anne if she could cover her debts. When she said no, he told her the company was taking over.

The locks were changed and Anne was out of business. She came away with nothing other than the impression she was on the hook for a lot of money.

“My financial and emotional health disappeared in seven hours, just like that. That is pretty difficult to take.”

Three months later, Anne still has nothing. She is unemployed and flirting with bankruptcy. And she fears the company will come after her for money it says she owes – and for talking to other franchisees about what happened.

It wants her to sign an agreement that releases her from her debts to the company, but only if she agrees to take not legal action against it, and to not say or do anything that could adversely affect its business.

Anne, who won’t use her real name or identify the company because of the threat, says she has been made to feel like she did something terribly wrong.

“It’s like they are thinking, she will go away and won’t talk. She will be ashamed and won’t want to be seen in public. That is all part of it. I am sure it is the same for anyone who goes through this type of thing.”

Les Stewart, a Barrie-area resident who started the Canadian Association of Franchise Operators because of problems he ran into with the franchisor of his lawn care business, says Anne’s situation isn’t unusual.

Franchise owners “think they own their business,” he says.

“In reality when they come to the point they want to sell it, or the term is being renewed, or there is an accusation of termination, there really is no solution other than to accept what the franchisor wants to give you or you can take them to court.

“And most franchisees don’t have the $200,000 that it takes to prove there is some kind of wrongdoing.”

The fear and isolation Anne feels aren’t unusual either, Stewart says.

“She is just by herself. She thought she messed up. But when you start to accumulate these stories you see it is a systematic issue.”

Anne doesn’t blame the company for the difficulties her business experienced.

She may have over-extended herself – for example, she opened the second store because she thought contract purchases would come her way, but they didn’t – and perhaps she stuck it out too long in an industry where margins keep shrinking.

She renewed her franchise agreement last year because her sales were growing. But her best year produced a profit of only two per cent.

“You believe volumes will eventually make it work,” she says. “But the margins get smaller and smaller.”

Had to decorate
Anne expected to recoup her initial investment in the franchise within four or five years. But then she had to redecorate the store to keep it fresh looking. Last year, when she had to move the store because her lease ran out, she had to pay for leasehold improvements.

“Of course, you have to go into debt to do that. That makes it very hard. It is a system which is set up so that you can never get out.”

“If you can’t sell it and make a profit, all you can do is keep working hard and try to do things and save a penny here and there… You always hold out the hope it is going to turn around. You keep kidding yourself that it will get better.”

If Anne doesn’t blame the company for her business woes, she is still outraged that it took over the franchise without assuming her debts or providing any compensation whatsoever.

What about the money she invested, she asks. What about the goodwill she developed? What about the unsold inventory she bought? What about the credit notes she was entitled to for excess inventory?

“I don’t’ expect to walk away with millions and millions,” she says. “I would like to walk away with at least something to live on for a little while, long enough to see me through the period of getting a job.”

Anne, who formerly ran a bookkeeping business, says that taking the company to court isn’t an option. She doesn’t have the money to pay the $30,000 she owes other creditors, let alone a lawyer specialized in franchise law.

“It seems to me it is a no-win situation when you get into an argument. The franchisor holds all the cards. There aren’t many for the stupid person who invests everything they have.”

Anne says the Ontario government needs to enact legislation that compels franchisors to deal fairly with franchisees.

“I can’t believe that in Ontario, in a province like this, a person who invests their money and works very hard can be thrown out without severance, without notice and without any help in transition, " she says.

“They can’t pretend it isn’t happening. It is happening to thousands of people, which means it is affecting thousands of families and all their employees.”

“The province is considering legislation, but it is focusing on making sure people who want to buy a franchise are given the information they need to make an informed decision.

Anne says that doesn’t go far enough.

Before she bought her franchise, the company gave her financial information that seemed realistic. However, it didn’t reflect the huge cost of carrying debt, she says. She also got favorable reports from other franchisees.

“I talked to three and they said they were happy. Two of them are gone now. There is one who is still there, but he never had to get financing.”

“The reason I went into franchising was I felt the experience and knowledge the franchisor would give would be most beneficial,” she says.

“It was, except they always have the right to take it away when they want to. You don’t think about that. You ask about it and they assure you they would never do that to you.”

Warning to others
Anne says she needs to tell her story to warn people who are considering buying a franchise.

Think carefully about what you are getting into because there isn’t any legislation,” she says. “there isn’t anything set up to protect you or even consider your rights.”

Anne is bitter, but she remains optimistic. She hopes to get a job and gradually pay back her creditors.

“All I am grateful for is we don’t have small children,” she says. “Our children are grown up. It is just my husband and I. If we lose everything we will start over again… We will make it somehow or other.”

(overview article)

Proposals for franchising law don’t go far enough, critics say

The Ontario government believes that an informed franchisee is a happy franchisee.

That’s why its solution to problems in the franchise industry is disclosure legislation. A consultation paper it released in June recommends that franchise companies be required to provide information on a wide range of matters to people who are considering buying a franchise – from its financial statements, to its litigation history, to the names of existing franchisees.

But absent from the recommendations is a principle that critics of the franchising industry says is necessary to protect franchisees – the duty of franchisors to deal with franchisees honestly, in good faith and in a commercially reasonable manner.

“Right now, we are looking at disclosure,” says Lillian Ross, parliamentary assistant to the Minister of Consumer and Commercial Relations. “We think that is going to alleviate a lot of the problems we have heard.”

Ross, the MPP for Hamilton West, says the government will take another look at the issue of fair dealing because of feedback it has received from franchisees. However, it believes disclosure rules will enable people who are investing in franchises to make informed decisions and avoid problems.

But critics say the government’s own estimate of 5,000 civil cases involving disputes between franchisors and franchisees are filed in Ontario every year proves that tougher legislation is required.

“Although disclosure is going to help some investors from making improvident investment decisions, it is not going to help the vast majority of franchisees in the problems that are plaguing them,” says John Sotos, a franchise lawyer in Toronto who acted for Pizza Pizza franchisees in a successful lawsuit against the company.

The fundamental problem of franchising is that the business relationship is so one-sided, says Sotos.

“Franchise contracts are unilateral contracts which put one party in a superior position with a lot of discretion to change the contract unilaterally. There are no ground rules. Anyone can do anything they want. As soon as they have your money, you are at their mercy if they are rapacious.”

“The relationship between franchisor and franchisee has to be regulated,” says Les Stewart, president of the Canadian Association of Franchise Operators.

“If you go and buy stocks you will be protected by securities legislation… That is what is needed in franchising. We need a standard of conduct called fair dealing.”

Ross, who hopes legislation will be introduced in the fall or spring, says the government modeled its recommendations on Albert’s franchise legislation.

It contains a duty of fair dealing clause, but “there is no definition of what fair dealing really means. They left it up to the courts. We weren’t sure we wanted to do that.”

The Canadian Franchise Association, which represents about one-third of the 1,300 companies that operate franchises in Canada, says the government made the right call because of the difficulty determining what is fair.

“It is your opinion and my opinion,” says its president, Richard Cunningham. “It would be very difficult. It is not quantified. All it ends up doing is opening a hornet’s nest of lawsuits.”

Cunningham says disclosure rules will expose unethical franchisors who make a quick buck by “just churning them (franchisees) over and over” and ensure that anyone investing money in a franchise will get “all the viable information they need to make a sound business decision.”

Tom Hunter, a franchise lawyer in Gowling, Strathy and Henderson’s Kitchener office, says fair dealing legislation isn’t necessary or practical.

“I don’t see how they can legislate a business relationship,” he says.

The biggest problem in franchising is unrealistic expectations, he says.

“The impression you get is generally people underestimate the costs of running a franchise, both in terms of dollars and cents and in time”

“And they overestimate the revenue… You can legislate as much as you want, but you will never protect people like that because they are so naïve.”

The principles of honesty, good faith and commercial reasonableness may seem vague, but they aren’t, says Sotos.

For example, commercial reasonableness would dictate that before a franchisor requires franchisees to spend $100,000 to upgrade their outlets, it would ask whether they will generate enough additional business or have enough time left in their agreements to earn a return on their investment.

“Those are obvious questions,” he says.

“Good franchisors do that. If you don’t care about your reputation or the long term, you don’t.”

Courts ultimately will determine what those principles mean, but they become self-enforced because franchisors know they will pay the consequences if they don’t, says Sotos.

“Once you have a standard in law, and once the standard is breached, that automatically gives rise to relief without necessarily even proving damages,” he says.

The bottom line, says Stewart, is that without legislated standards, problems will continue to persist.

“Until you set a standard of quality and let the courts determine those standards, you are only giving the impression there is protection. If there is no standard of fairness, franchisees are not protected.”

(insert box)

FRANCHISE INDUSTRY CONTACTS

Canadian Franchise Association
(represents franchise companies)
Richard Cunningham, president, 1-800-665-4232
Web: www.cfa.ca/

Canadian Association of Franchise Operators
(represents franchisees)
Les Stewart, president, 1-705-737-4635
Web: www.cafo.net

Ontario Ministry of Consumer and Commercial Relations
Joseph Hoffman, directory policy and agency relations branch
1-416-326-8501
Web: www.ccr.gov.on.ca


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