The Accidental Franchise: A Ticking Time Bomb

There are many businesses that operate under a scheme whereby the individual business pays to acquire some rights in a business system and operates under a known “brand”.  These businesses were often called things like “dealerships”, “distributorships”, “licences” or “franchises”.  Until five years ago, what you called it didn’t matter.  There were no consequences attached to any of the definitions or the different business models.  All that has changed, and drastically so.

There is a law called the Arthur Wishart Act (Franchise Disclosure), 2000.  Wishart defines the term “franchise” (the definition is too long to include in this column).  Now, under Wishart, it really matters if you are a franchise. 

(For those of you loophole-seekers, it does not matter if you call your business a “franchise” or something else: it is the substance of the contract that will be considered, not the name that you use.)

If the Wishart definition means that you are a franchisor, LOOK OUT.  You have a lot of rules and regulations determining how you sign up and do business with your franchisees.

The most important of these obligations is the obligation to provide a “disclosure document” to a potential franchisee.  The disclosure document is intended to allow a potential franchisee to make an informed decision about the financial wisdom of entering into the franchise.  The contents of the disclosure document are set by the Regulations under the law.

There are serious consequences if the franchisor does not provide the necessary disclosure.  The franchisee has the right, within two years, to cancel the deal, without penalty or obligation.  If he does, he is entitled to all his money back that he paid for the franchise rights, the franchisor has to re-purchase any equipment or remaining inventory that the franchisee has, AND the franchisee is entitled to compensation for any losses incurred during that time.

One judge described this remedy as “mind-boggling”.  He was right.

If you are running a business and are thinking of expanding it in a manner whereby you would be selling someone rights to use your business model, you need to start thinking about whether or not you will be a “franchisor” under Wishart.  As far as I am concerned, the only way to do that is to get legal advice.

I’m not urging you to get legal advice in order to create work for lawyers.  The definition of “franchise” in the Act is broad and not written in the plainest of English.  The layperson will typically not have access to the few cases that have been decided after Wishart and will not likely be able to make a useful analysis of the question.

Most importantly, the risks of being wrong are too great not to get advice.  Recall the right of the franchisee for compensation for losses.  The franchisee may be a terrible businessperson and they are the reason their business has lost money.  It doesn’t matter.  No disclosure equals the right to cancel and compensation for losses, no matter what might be responsible for the losses.