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Franchise 2016: Roundtable

Who’s Who Legal brings together Lee Plave of Plave Koch, Penny Ward of Baker & McKenzie and Jennifer Dolman of Osler Hoskin & Harcourt to discuss issues facing franchise lawyers and their clients today.

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 Have there been any developments over the past year that have challenged the franchisor and franchisee relationship?

Lee Plave: Clearly in the US, there have been several developments that have caught the attention of the franchising community.

The “joint employment” issue has captured headlines because of the potential for upending the normal relationship. While all of the facts have not yet been provided, neither franchisors nor franchisees want to trip the wire that would lead to “joint employer” status. To do so would mean that the employees of any one franchised location could conceivably join forces with the employees at other franchised locations and bargain collectively with the franchisor over labour and wage issues. While that concept has some attraction to the employees, it makes no practical sense in a situation where every franchisee is a separate employer, in a separate city, making its own independent hiring and wage decisions. No franchisee wishes to have its discretion to set its staff’s wages overruled, and instead determined by the franchisor or other franchisees in other cities. And no franchisor wishes to become responsible for the employment terms of its franchisees’ staff. The main case in this area – involving an administrative complaint against McDonald’s USA – is winding its way through the National Labor Relations Board (NLRB), and will possibly be initially decided in the next 12 months. However, many years of follow-up appeals are likely, so this issue will remain unsettled for many years to come.

The second development is cybersecurity. In 2015, the Federal Trade Commission (FTC) announced a major settlement with a hotel franchisor, Wyndham Worldwide Corp. This settlement resolved a complaint that the FTC issued that stemmed from a data security breach at branded hotels. The FTC required Wyndham to conduct certain processes and engage professionals to assist in reporting on a comprehensive risk assessment of the entire Wyndham system. While the franchisor managed a significant legal win in this case, the FTC sent a clear signal: the Commission is vigilant and seeking to protect consumers who become the victims of data breaches. The name of doctrine by which the data breach standard becomes widely known will not be “the Wyndham doctrine” – but it will ultimately bear the name of another unfortunate company, which will suffer (or has already suffered) a data breach without taking adequate actions to safeguard its systems.

Penny Ward: Several franchise systems in Australia have been the subject of adverse comments by employment regulators and criticism from politicians that they have failed to take sufficient steps to ensure that their franchisees are complying with local employment laws. At least one franchise system has been tarnished by a widespread and deliberate strategy by a number of its franchisees to flout minimum wage requirements. This has led to a debate regarding whether franchisors have sufficient tools to deal with non-compliant franchisees and whether franchisors who acquiesce in the conduct may become accessories to it.

Jennifer Dolman: There have been a few significant developments on the legislative front. First, there is currently a Changing Workplaces Review taking place in Ontario, which seeks reforms to the Employment Standards Act and Labour Relations Act. The Ontario government released its Interim Report on 27 July 2016. One of the changes being considered is deeming franchisors to be joint employers of their franchisees’ employees. Making franchisors “joint employers” would be a game-changer for the Canadian franchise industry, as it could expose franchisors to employee’s claims, thereby threatening the franchise business model.

Second, franchisors and franchisees are also concerned about Ontario’s Health Menu Choices Act, which comes into force on 1 January 2017, and requires premises with 20 or more locations in Ontario that sell prepared, ready-to-eat food to post itemised caloric and other nutritional content on menus. When the legislation was originally drafted, it was contemplated that franchisors would be liable for the breaches of their franchisees. Fortunately, the Act was changed before it was passed but franchisors still have to be careful that they don’t fit into the category of someone “who has responsibility for and control over the activities”. The Act specifically provides that such a person “may” include a franchisor.

Third, British Columbia now has franchise legislation. Bill 38, the Franchises Act, was given royal assent on 17 November 2015, and will come into force on a later date by regulation of the lieutenant governor in council. British Columbia is the sixth province in Canada to have franchise legislation.

In terms of franchise disputes, franchisees are continuing to try to expand the scope of the duty of good faith and fair dealing. While section 3 of Ontario’s Arthur Wishart Act (Franchise Disclosure), 2000 (the Wishart Act) expressly imposes the duty on “parties to a franchise agreement”, the Court of Appeal for Ontario recently recognised, in the context of a pleadings motion, the potential liability of a corporate parent with sufficient control over the signatory franchisor.

Some franchisees are taking the position that the duty of good faith and fair dealing imposes on franchisors a duty to protect and enhance the brand. This is as a result of a decision of the Quebec Court of Appeal involving Dunkin’ Brands Canada Ltd (Dunkin’ Donuts) in which the franchisor was found liable for failing to protect its franchisees from the Tim Hortons wave, and ordered to pay approximately CAN$11 million in damages. Leave to appeal to the Supreme Court of Canada was denied. This case, which is actually a breach of contract case (Dunkin’ Donuts was found to have breached certain express and implied obligations of its franchise agreement), has, in my view, limited application outside of Quebec not only because it is not binding on courts outside Quebec but because it is based on concepts contained in the Civil Code of Quebec that are not mirrored in the law of other Canadian provinces.

There also continues to be uncertainty regarding what a franchisor has to do to comply with its disclosure obligations. In Ontario, franchisors are bound to disclose not just the material facts that are prescribed in the Regulation to the Wishart Act but “all other material facts”. If a franchisor fails to disclose a material fact, then depending on the deficiency, there is a real risk that a franchisee will have two years from the date it entered into the franchise agreement to rescind the contract and to recover not just the monies it paid to the franchisor but also any losses the franchisee incurred in acquiring, setting up and operating the franchise. Our courts have described the consequences of improper disclosure as “draconian”. There are no equitable defences available to franchisors in relation to a claim for statutory rescission, and for smaller franchisors or ones just starting out, a mistake can significantly interfere with their ability to operate their business and/or to expand. Fortunately, revisions to the Wishart Act are being considered as part of some business law reform in Ontario. Many business statutes are being reviewed, however, and it is unclear what attention will be given to the Wishart Act. At least, as of 1 July 2016, franchisors, pursuant to an amendment of the Regulation under the Wishart Act, can deliver disclosure documents by prepaid courier and electronically. Prior to the amendment, the only delivery methods specifically identified in the legislation were delivery in person or by registered mail.

How has globalisation affected franchising? What are the popular new jurisdictions for franchisors?

Lee Plave: It is axiomatic that international expansion presents both opportunities and challenges for many franchisors. While some franchisors may find an international market that is a more obvious fit for their kind of business, others look to different opportunities. Clearly there will be a great deal of interest in emerging opportunities as Cuba opens up over the next few years and decades. However, while the travel industry is likely to see the first openings there, Cuba is an example of a country where serious governmental, structural, and economic reform needs to take place before significant development can take place. In a country where demand is limited by citizens’ low wages, and where there are few domestically produced items, franchising activity directed to Cuban consumers will take some time to develop.

Penny Ward: Globalisation is nothing new for franchising. It has been one of the most geographically diverse methods of business expansion since the 1960s. Franchisors from flagging economies or those whose franchise networks are mature look to expand overseas. This is nothing new. The Middle East continues to offer opportunities for franchisors from many different jurisdictions and in Asia growing economies such as Indonesia and Malaysia are of particular interest.

Jennifer Dolman: As a result of globalisation, franchisors have an increasing number of different markets to focus on but may have limited resources to do so. As such, depending on what is transpiring in a particular market and what may be at stake for the brand, a franchisor may have to devote a larger share of its resources there. This may be commercially reasonable and best for the overall system but a franchisor still has to ensure that in markets, where it may be devoting fewer resources and may not even have “boots on the ground”, it is still complying with its contractual obligations, as well as the duty of good faith and fair dealing. It is critical that in such markets, franchisors are at least engaging local counsel to advise them of best practices in their industry, and to help avoid risk.

Globalisation may also involve a franchisor acquiring additional brands. This could result in a resource issue if the infrastructure that was previously used to support only one brand is now being used to support two. The situation may be even more challenging if the existing resources are already being squeezed on account of cost-cutting measures commonly implemented by private equity companies.

Globalisation also threatens local companies that find themselves competing with a global company that has entered their market. In Canada, a good example is Second Cup, which has suffered as a result of Starbucks coming here a number of years ago (and also McDonald’s entering the coffee business).

As for new jurisdictions, there is lots of talk of Cuba being the “next frontier” but there are numerous hurdles that will take years to overcome before Cuba will be open to franchising. Hotels have taken the first step but have been required to sign management agreements that are not your typical franchise agreements as they are signed with governmental entities and must comply with existing law. Tim Hortons, Canada’s iconic brand, has recently announced an expansion in the Philippines. Other international markets in which franchisors are looking to expand include China, South Africa and India.

There seem to be more high-profile cases regarding joint-employer status on the agenda at the moment. Is this a trend you have noticed in your jurisdiction? What does this mean for clients and their franchising agreements?

Lee Plave: The “joint employment” issue is crucial in the US. However, before taking drastic actions to change the contractual nature of franchise relationships, the proper course of action is to evaluate what the franchisor and its staff do – in operational terms – regarding their existing franchisees and their staffs. While contract clauses may be important here, assessing how a franchisor and its team interact with its franchisees and their staff is likely to have far more impact on whether there is a “joint employment” relationship between the franchisor and its franchisees. That said, we have revised certain clauses in our clients’ franchise agreements to make clear that, as between the parties, the franchisee has sole responsibility for hiring, HR decisions, setting wages and hours, and so on. Working with our clients, we try to help them adopt best practices in their day-to-day operations that parallel those contract terms.

Penny Ward: In Australia the debate has not been around the status of a franchisor as a “joint” employer with a franchisee, nor has there been concern about a franchisor being vicariously liable for the acts of its franchisees. However, the violation by franchisees in some systems of local employment laws has led to the suggestion that a franchisor should be jointly responsible for the acts of its franchisees, at least for complying with such laws. The Australian government has suggested that it will introduce changes to workplace legislation to make franchisors who fail to deal with non-compliance with their franchisees liable for breaches by their franchisees when they should reasonably have been aware of the breaches and could reasonably have taken action to prevent them from occurring. Time will tell if this legislative change is introduced and if it will cause any practical concern. Some years ago it was a live issue in Australia as to whether some franchise systems with individuals as franchisees in fact constituted employees of the franchisor or whether the franchisor was otherwise responsible for them under tax legislation. The new wave of disrupters such as Uber and Deliveroo is reigniting this debate.

Jennifer Dolman: As mentioned above, the joint employer issue is definitely a hot topic in Canada. This is because one of the changes being proposed to the Employment Standards Act and Labour Relations Act, as part of Ontario’s Changing Workplaces Review, is to deem franchisors to be joint employers with their franchisees for certain statutory purposes. This change has not been made and hopefully, for the Canadian franchise industry’s sake, won’t be made. The Ontario government has only recently released the Ontario Changing Workplaces Review’s Interim Report.

It should be noted that there have always been disputes where franchisors have been alleged to be joint employers. I don’t think that because of the proposed change there are necessarily more “high-profile” cases now but there is certainly a greater awareness of the issue, with the result that there are likely more cases out there in which franchisees are alleging that franchisors and franchisees are joint employers. The current legal test is a fact-based inquiry into the extent to which a franchisor controls its franchisees’ day-to-day operations.

In light of the changing landscape of the Canadian workplace and to protect their franchise systems, franchisors need to take action to mitigate their risk of being found to be a joint employer. This means taking steps to assess their systems’ exposure to joint employer claims through a review, with the assistance of legal advisers who are well versed in franchising as well as labour and employment, of their key agreements, policies and operational practices. Franchisors should be wary of language in their agreements and/or operations manuals that include or imply control over employment, and also adjust any practices that put them at risk of being considered a joint employer with their franchisees such as running training programmes for their franchisees’ employees, setting incentives or awards programmes for top-performing employees of their franchisees, requiring their franchisees to obtain the franchisor’s approval in hiring employees or sub-contractors, setting the hours of work or employee timetables at their franchisees, and requiring their franchisees to use a specific scheduling tool or software program.

What do you consider to be the top priority for firms to enable them to compete successfully in this sector?

Lee Plave: Without a doubt, franchisors need to put their emphasis on operational excellence. Marketing and development are necessary, but those actions cannot take place in a vacuum nor without the solid foundation that comes from functional success.

Jennifer Dolman: Firms need to be responsive and pragmatic, and to have: real expertise and experience (you can’t dabble in franchise law) among an integrated team of commercial and litigation franchise experts; national coverage; “go-to” experts in a variety of other practice groups who understand the franchise model and can support franchisor clients’ broader needs; an understanding of the client’s business and their objectives; and pricing that gives clients as much certainty as possible so that they can budget accordingly. This is harder on litigation matters but even on those files, firms need to be open to alternate fee arrangements and be able to deliver services efficiently with a focus on practice management and real-time reporting/tracking.

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