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Is Your Store an Accidental Franchise?

Can franchise laws help retail operators exit their brand agreements?

“Worried pot shops have taken over Toronto streets?”

“Rapid growth of Ontario cannabis stores will likely result in some closings, OCS chief says.”

These are recent headlines from the Toronto Star and The Globe and Mail. According to hibuddy.ca, there are 102 cannabis retailers within 3 km of our law firm, located at University and Dundas, in Toronto. Expand the search perimeter to 5 km, and there are 172 retailers. Clearly, cannabis retailing has exploded in the last two years. But is it sustainable? Anecdotal discussions suggest the answer might be “no”. The market may be over-saturated, many stores are not doing well, and some people are looking to exit the cannabis retail sector.

But an exit may not be easy or straightforward. Many store owners have entered into long-term contracts with big-name cannabis brands. Walking away from these contracts may expose store operators to legal liability and financial losses.

However, Ontario’s franchise laws may offer a potential life preserver for overwhelmed cannabis retailers. How? These stores may be “accidental franchises”. Franchised businesses are subject to specific legislation in Ontario. Under the legislation, a franchisor (or brand owner) is required to provide a “disclosure document” to a prospective franchisee (or store owner) before any legal agreements are signed. If disclosure is not provided, a franchisee may have a right to “rescind” the franchise agreement. As part of rescission, the franchisor must financially compensate the franchisee. In plain language, rescission allows a franchisee to get out of its franchise agreements, and get its money back.

What if the legal documents between retailers and brands don’t refer to a “franchise”? That does not matter. Ontario’s franchise legislation will apply if the legal relationship between the parties has all the hallmarks of a franchise. Essentially, if it looks like a duck, and it walks like a duck, it’s probably a duck—even if the agreement is called a licensing agreement or something else. The rapid establishment of cannabis retail outlets had led to numerous “accidental franchises” where brands unknowingly entered into franchise relationships with retailers, rendering these brands a “franchisor”, and the store operator a “franchisee”, under franchise legislation.

Every agreement must be carefully reviewed to determine if the parties created an accidental franchise. However, generally courts will find a franchise relationship where the following criteria are met:

  1. Does the agreement grant the retailer a right to sell goods and services associated with a “brand”?
  2. Does the agreement require the retailer to make payments or continuing payments to the brand?
    For example, does the store owner pay a monthly percentage of its gross sales or a monthly service fee to the brand?
  3. Is the retailer required to operate in association with the brand?
    For example, is the retail operator’s business required to operate using a certain business name, and is it fully and uniformly branded with the brand’s trademarks?
  4. Does the brand exercise significant control over the operation of the retailer’s store, or does the brand owner provide significant assistance to the retailer in its operation of the store?
    This might include the brand telling the retailer how the store design and furnishings should look, or providing advice to the retailer about how its business should operate. In some cases, the brand might actually operate the store on the retailer’s behalf.
    If these tests are met, a retail operator may be able to “rescind” its agreement with a brand. However, there are important deadlines that apply. A rescission claim must be made within two years of the date the retailer signed any agreement with the brand.

This is only a high-level summary of franchise laws. Cannabis store owners should contact an experienced franchise lawyer to determine whether they have a potential franchise rescission claim.

Adrienne Boudreau and Jean-Marc Leclerc are partners at Sotos LLP. They have been repeatedly recognized for their franchise work, most recently in Canadian Legal LEXPERT Directory – Franchise and Best Lawyers in Canada.