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This article was originally published in The Lawyer’s Daily as a two-part series on August 20, 2020 and August 24, 2020. The assistance of Anthony Pugh, Associate at Law Works PC, in writing this article is acknowledged with thanks.
When representing a franchisee in either a franchise transaction or a franchise dispute, a lawyer is often called on to provide an independent legal advice certificate at the request of the franchisor. This may be as part of a franchise sale to a franchisee buyer or as part of a settlement of a dispute which could happen at any time in a franchise relationship, from the pre-contractual phase to post-termination.
It is incumbent on the lawyer to document the advice that he or she is providing to the client as part of the giving of an ILA certificate. One important element of the engagement letter is defining who the clients are, in case of affiliates and related parties whose interests may be affected by the transaction or settlement.
Another important element is the scope of the lawyer’s review. The lawyer should be careful to review the text of the ILA certificate and what it says about what the lawyer has done to advise the client. The ILA certificate may purport to expand or limit the scope of review that the lawyer may otherwise consider necessary. The scope of the lawyer’s review should be clearly agreed-on in the engagement letter.
It is probably not a good idea to let the wording of the ILA certificate narrow down the scope of work that the lawyer otherwise deems necessary independently of what is stated in the ILA certificate (unless the lawyer is taking the route of a limited scope retainer and can comply with those professional requirements).
When entering into a franchise agreement, the franchisor may request that the prospective franchisee provide an ILA from his or her lawyer. The prospective franchisee client may present this request to his or her lawyer after the client had already negotiated the franchise terms with the franchisor on his or her own, or the lawyer may have represented the prospective franchisee in the negotiations.
The focus for the lawyer should be on the terms of the franchise and related agreements as well as on the disclosure component and any statutory or common law rights that may arise based on disclosure issues.
While many franchise agreements feel like boilerplate agreements, some clients may be surprised about some terms and conditions if given an opportunity to understand their implications. Some fundamental issues include what is being granted, term, renewal, site-selection, lease rights, advertising obligations, post-termination restrictive covenants, a franchisor’s right to take over the business upon termination, liquidated or other damages, and dispute resolution mechanism. Ancillary agreements should also be reviewed, such as personal guarantees, indemnities, sublease, general security agreement, and payment authorization agreement.
When reviewing a franchise disclosure document, some form of due diligence investigation may be in order based on the information in the disclosure document, depending on the agreed-upon scope of the lawyer’s review. Basic due diligence may require pulling corporate profile and Personal Property Security Act reports. A financial review may be in order, mostly by financial, accounting or other business professionals – based on the franchisor’s setup cost estimates, any earnings or operational cost projections and the franchisor’s financials. Other due diligence investigation may be about the state and track record of the franchise system, based on current or former locations, litigation history, relevant information of the franchisor’s principals, and other material facts.
In a situation where the franchisor has not delivered a disclosure document because it is relying on a statutory disclosure exemption, the lawyer should assess and advise the client about the entitlement to the exemption and the resulting limitation on the client’s statutory rights.
In some situations, the parties may not recognize that the transaction falls within the provincial statutory definition of a ‘franchise’, which typically occurs in a licensing or distribution arrangement. The lawyer should identify whether the proposed relationship falls within the statutory definition of a ‘franchise’, and if so, the resulting rights, such as rescission, etc.
The provincial franchise statutes define a ‘franchise’ as a right to engage in a business where the franchisee is required to make a payment or continuing payments to the franchisor or its associate, where the franchisor grants a right to sell products that are substantially associated with its intellectual property, and where the franchisor exerts significant control over the franchisee or provides it with significant assistance.
An alternative statutory definition, which has exemptions, applies when an agreement provides for the franchisor to grant representation or distribution rights to distribute goods or services supplied by the franchisor or a designated supplier, and where the franchisor provides location assistance.
Settlement of a franchise dispute may happen even before entering into the franchise agreement. For example, a dispute may arise between the franchisor and franchisee about a deposit or other pre-sale payments, especially if the terms of the payments were not in compliance with the requirements of the franchise statute.
More traditional disputes come up during the franchise relationship, about such issues as operational compliance, territorial and location rights, advertising, and support.
A dispute may also arise after the expiry or termination of the franchise agreement. These are typically about restrictive covenants, such as non-competition, non-solicitation, the franchisor’s right to buy assets or take over the lease, confidentiality, etc. Other disputes relate to the right to renew the franchise agreement.
When giving an ILA as part of the settlement of a dispute in a franchise relationship, the focus should obviously be on the terms of settlement and those rights that the franchisee client is giving up as part of the settlement.
A settlement would typically involve at least the document setting out the terms of the settlement as well as a release of the rights of the franchisee or both sides. The lawyer should ascertain whether the release is limited to a discreet set of issues relating to what was in dispute or if it is a broad release of all statutory and other rights. Usually, a franchisor will request a broad release. The release will typically specify that the franchisee understands and acknowledges that it is releasing potential claims under the applicable franchise legislation.
When assessing a release, the lawyer should determine whether it is part of a genuine settlement, i.e., if there is consideration, the parties are knowingly agreeing to give up certain rights, etc. Alternatively, if the deal amounts to a mere waiver or release of statutory right of a franchisee or obligation of a franchisor, it may be caught by the non-waiver provision of provincial franchise statutes.
The lawyer should also ascertain who the releasees are, and whether it includes individuals, such as individual franchisees or individual potential franchisor’s associates, and affiliated companies. If the release does not in fact cover these parties, obviously such a party will remain exposed to liability.
Another potentially important element of the review process is to assess and advise a client about limitation periods that affect their rights under franchise legislation. This mostly relates to rescission rights and deadlines for the delivery of notices of rescission and, after that, commencing legal proceedings.
Most provincial franchise statutes contain two time limits for the delivery of notices of rescission: sixty days from the date of receipt of a disclosure document (s. 6(1)), and two years from the date of entering into a franchise agreement (s. 6(2)). The sixty-day limitation period applies when there are deficiencies in the form, content or timing of disclosure. The two–year limitation period applies when the franchisee never received a disclosure document or when the disclosure document is so deficient that it amounts to no disclosure at all.
If there may be entitlement to rescission, the lawyer should advise the client about any rescission rights, limitation periods for the delivery of a notice of rescission, and general provincial limitation period for commencing an action (or, in the case of mediation and arbitration provisions in the franchise agreement, the process for such alternative dispute resolution). Making sure that a franchisee client understands his or her rescission rights and related limitation periods and legal claims process is important not only because of the obvious risk of missing limitation periods. It may also be important because the client may prefer to back out of a deal rather than proceed with the transaction and preserve rescission rights. If the franchisor is a start–up with little or no proven track record, pursuing rescission down the road may be futile if the franchisee has no reasonable prospect of collecting on a judgment.Tags : Damages, Disclosure, Franchise Agreement, Lease, Non-Competition, Personal Guarantee, Release, Renewal, Rescission, Settlement, Termination, What is a Franchise
*Law Works is a Canadian law firm. It publishes a newsletter to inform subscribers about franchise and arbitration disputes. You may unsubscribe at any time by clicking the ‘unsubscribe’ link in our emails.
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