The Midas Case - Solutions

In the first two articles on the Midas Case, the repercussions for franchisors and franchisees in Canada and abroad were addressed. In this article, the solutions to the challenges stemming from the Midas Case are examined from a legal and a pragmatic perspective.

 

A - Summary

 

The Midas Case applies to franchises granted over the last two (2) years by franchisors in Ontario, Alberta and Prince-Edward-Island (the “Provinces”) to franchisees in other provinces. In the event a franchise agreement provides that the governing laws are those of a Province, the Court of Appeal of Ontario determined, among other conclusions, that the Arthur Wishart Act (the “Act”) applies to the franchisor-franchisee relationship and therefore, that franchisors must provide franchisees in the other provinces with a Disclosure Document. The failure to provide these franchisees with a Disclosure Document gives them the right to rescind their franchise agreement and require the franchisor to repurchase all the assets of the franchise and to compensate franchisees for any losses incurred in acquiring, setting up and operating the franchise.

 

B - Legal Solutions

 

The Act specifically provides for the situation when a franchisor fails to provide a prospective franchisee with a Disclosure Document. The franchisor may remedy the failure by providing the franchisee with a Disclosure Document:

 

“6. (1) A franchisee may rescind the franchise agreement, without penalty or obligation, no later than 60 days after receiving the disclosure document, if the franchisor failed to provide the disclosure document or a statement of material change within the time required by section 5 or if the contents of the disclosure document did not meet the requirements of section 5.”

 

However, this remedy can be a double-edged sword for certain franchisors. While the franchisor may remedy the failure of non disclosure, the franchisee still has the right, for a period of sixty (60) days after receiving the Disclosure Document, to rescind the franchise agreement with the repercussions described above.

 

As already mentioned, the right of a franchisee to rescind a franchise agreement only applies to franchises granted over the last two (2) years. As it is well known, the first two (2) years after having acquired a franchise are not the most prosperous ones for a franchisee. It is also during this period that the “honeymoon” between the franchisor and the franchisee may end.

 

At the end of the day, any dissatisfied or disgruntled franchisee looking for a “way out” may use this situation to exercise its right of rescission under the Act. More specifically, sending the Disclosure Document may have the effect of “waking up” the franchisee. Furthermore, this situation may give certain franchisees, including those in the many class actions across Canada (certified and being certified) additional munitions against the franchisor in on-going and future litigation.

 

Legal pundits may prone the solution of providing franchisees with a Disclosure Document to address the situation, but conventional wisdom may dictate otherwise.

 

I believe it is only one option. I think that greater thought and study is required from a business perspective, one from which I will shed more light on in section C of this article.

 

At this point, suffice to say that moving forward, franchisors have two choices: they can leave the governing law clause in their franchise agreement as is or they can change it to have the governing laws be those where the franchise is granted.

 

In the event a franchisor chooses the first option, it now knows that the franchisor-franchisee relationship will be governed by the laws of the Province concerned and that it must provide prospective franchisees with a Disclosure Document in accordance with the franchise law of that Province which generally reads as follows:

 

“A franchisor shall provide a prospective franchisee with a disclosure document and the prospective franchisee shall receive the disclosure document not less than 14 days before the earlier of,

 

(a) the signing by the prospective franchisee of the franchise agreement or any other agreement relating to the franchise; and

(b) the payment of any consideration by or on behalf of the prospective franchisee to the franchisor or franchisor’s associate relating to the franchise.”

 

If a franchisor chooses the second option, the franchisor-franchisee relationship will not be subject to any franchise legislation and the franchisor will therefore not be obliged to provide prospective franchisees with a Disclosure Document.

 

What are the potential advantages and disadvantages of these two options for a franchisor?

Franchise Law Applies

 

  

 

Advantages                                                               Disadvantages

 

- limited obligations for a franchisor                         - finding a franchise attorney in the

- less rights for franchisees                                       provinces where franchises are

- limited representations from a franchisor               granted, if there is any litigation

- less legal and management costs for a franchisor

- more flexibility in managing/operating a

 

From a first glance of the disadvantages of having a franchise law apply to the franchisor - franchisee relationship, it shows clearly that they far outweigh the advantages of not having a franchise law apply.

 

Why then, since the Midas judgement, are many franchisors from the Provinces choosing the option to send their current and new franchisees across Canada a Disclosure Document?

 

While I can understand that they may want to remedy the situation of franchisees that were granted a franchise over the last two (2) years, for new franchisees now being granted a franchise, I will limit my comments to “It would appear that legal opinion trumps business savvy”.

 

C - Pragmatic Solution

 

As I mentioned above, sending a Disclosure Document to franchisees that were granted a franchise over the last two years is only one option.

 

The other options will be different from one industry to another, from one franchisor to another, from one banner to another and even from one franchisee to another. By a pragmatic solution, I refer to a formal process that includes an evaluation phase, a study of available options, a strategic implementation and an analysis of the results.

 

This is a more systematic and global approach then just sending a Disclosure Document to franchisees. It starts with a verification of franchise agreements that were executed over the last two (2) years that fall within the gambit of the Midas Case. It entails knowing how many franchisees are involved, who they are, where they are, how the franchisor-franchisee relationship is with these franchisees, etc. Is it just two (2) franchisees with less than two months left before the two-year period to rescind the franchise agreement expires? If so, maybe the solution is to do nothing.

 

This process also includes using the internal and external, formal and informal, communication structures in a franchise network, perhaps including existing franchise associations, to better understand franchisees and therefore, the available options and strategy to implement by the franchisor. There has never been a better time to check the “pulse” of franchisees.

 

The franchisor-franchisee relationship is also very important to evaluate. If a franchisor has a “strenuous” relationship with its franchisees, chances are greater that certain franchisees will jump on this occasion to have the franchisor repurchase their franchise. If that is the case, why send a Disclosure Document when it could and probably will be used against the franchisor?

 

What is crucial is for a franchisor to evaluate its current situation with all the information it has and will be able to gather and then determine its options and the strategy to implement, to all or part of its network.

 

One franchisor has recently sent a new Disclosure Document to all its franchisees, including those in the Provinces … to “update” them on the franchisor and its activities, to present them a new franchise agreement, to introduce new franchise personnel, etc.

 

Another has gone the litigation route to avoid having to repurchase a certain amount of franchises in a short period of time.

 

For certain franchisors, the conclusions of the evaluation phase will be that certain franchisees will rescind their franchise agreement. In that context, the strategy phase may involve increasing its financial ressources to repurchase franchises (including paying rent), hiring new personnel to operate franchises that are repurchased, preparing a marketing strategy to sell those franchises, advising landlords of the situation (if required to under the lease), etc. Under this scenario, most of the departments of a franchisor company will be affected. Therefore, it will be important for the franchisor to obtain their input and involve them in the process.

 

At the end of the day, not two franchisors will find themselves in the same situation or with the same options. What is important is to follow a process that provides the franchisor with a clear picture of the situation, the options available to it, the steps to follow to implement the options and to monitor the results.

 

 

D - Conclusions

 

I have always advised franchisor clients to have the governing laws in a franchise agreement be those of the province in which the franchise is granted. To have the governing laws in a franchise agreement be those of one of the Provinces when the franchise is granted in another province unduly increases the legal, financial and other risks of the business of a franchisor. The Midas Case has proven that.

 

In retrospect, while the Midas Case has hit the franchise world by storm and has had important repercussions on certain franchisor-franchisee relationships, franchisors are handling this challenge by adopting well-planned strategies that involve the legal solution, the pragmatic solution and sometimes a combination of the two solutions.

 

There is no panacea and, as mentioned above, each franchisor should adopt a systematic and global approach to properly evaluate its challenge, prepare its response and then implement its strategy across the board.