Franchises can be a great way to expand a business based on a strong concept without the risk of debt or the cost of equity. However, when entering into franchise agreements, many terms that appear inconsequential can have unexpected implications for all parties involved. One of the most precarious terms is that of the “franchisor’s associate”.

Under Ontario’s Arthur Wishart Act (Franchise Disclosure), 2000, SO 2000 (the “Act”), a person can be found to be a franchisor’s associate if they satisfy two basic criteria:

1. The person controls or is controlled by the franchisor; and

2. The person is involved in the grant of the franchise, or the person has control over the operations of the franchisor.

While these two basic criteria are further broken out in the Act, this simplified definition creates uncertainty as to whether someone will be considered a franchisor’s associate and personally liable for rescission damages and other claims as stated in the Act. As a result, even those not intending to assume liability when granting franchises have been found to be a franchisor’s associate.

Section 1.1 of the Act reads:

a franchisor’s associate means a person,

a.  who, directly or indirectly:

      i. control or is controlled by the franchisor, or

      ii. is controlled by another person who also controls, directly or indirectly the franchisor, and

b.   who,

       i. is directly involved in the grant of the franchise,

1. by being involved in reviewing or approving the grant of the franchise, or

2. by making representations to the prospective franchisee on behalf of the franchisor for the purpose of granting the franchise, marketing the franchise or otherwise offering to grant the franchise, or

          ii. exercises significant operational control over the franchisee and to whom the franchisee has a continuing financial obligation in respect of the franchise.

Recent Court Decision on the Definition of a Franchisor’s Associate

In most cases, when determining whether someone is a franchisor’s associate, the first part of the test is often satisfied, as the person in question is typically in control or controlled by the franchisor. However, the second part of the test, which deals with the actual granting of the franchise, is the section that can have potentially serious implications for the unwary.

In a recent decision, the Ontario Superior Court of Justice found that both a franchise principal (the “Principal”), as well as the franchise’s franchising director (the “Director”) were found to be franchisor’s associates, despite the Director denying having any control over the granting of the franchise.

First, the Court determined that the Principal clearly satisfied the criteria of a franchisor’s associate. On the first part of the test, the Principal directly controlled the franchisor as the sole officer and director and was the president and CEO of the franchisor. On the second part of the test, the Court found that the Principal was directly involved in the grant of the franchise as he signed the franchise disclosure document (“FDD”) disclosure certificate, signaling that he was making representations on behalf of the franchisor. In turn, the Court concluded that the principal was granting the franchise, marketing the franchise and otherwise offering to grant the franchise.

Second, the Court found that the Director also satisfied the first part of the test because he was directly employed by the franchisor. On the second part of the test, the Court determined that the Director’s actions signaled that he had made representations to prospective franchisees, marketed the franchise and had otherwise offered to grant the franchise. Specifically, the Court concluded that the act of advertising the franchise to generate potential franchisee leads, meeting with potential franchisees to discuss their application, being involved in the marketing and advertising of specific franchise locations, having personal communications with potential franchisees, and providing potential franchisees with the FDD was sufficient to find that he was a franchisor’s associate. Despite denying involvement over the decision of granting the franchise, the Court determined that at a minimum, the Director’s representations for the purpose of marketing the franchise met the definition of a franchisor’s associate.

Finding that the Principal and the Director were franchisor’s associates ultimately makes both personally liable for reimbursement under Section 6 and for damages under Section 7 of the Act.

Franchisor’s Associate Definition Broadens

Previous cases have also highlighted that courts will make a finding that an individual is a franchisor’s associate if they satisfy factors, including whether they are:

• a controlling shareholder, director and officer of the franchisor owning 50% of the shares of the franchisor;

• an individual who owns, is a director and an officer of a franchisor, and who consults other directors and officers on all major decisions when deciding the grant of a franchise; and

• a sub-landlord controlled by the franchisor and to whom the franchisee has a continuing financial obligation.

In addition to these previous cases, the most recent case illustrates that a franchisor’s associate will be considered in matters where the person is in control or controlled by the franchise and does one or more of the following:

• is the sole officer and director, or president and CEO of the franchisor;

• signs the franchise disclosure document disclosure certificate;

• is in a position that involves making representations about the franchise to potential franchisees;

• is involved with and makes representations for the purpose of marketing and advertising specific franchise locations; and

• provides potential franchisees with an FDD.

Whether or not a person expects to be a franchisor’s associate, one thing remains clear: if you participate in the granting or marketing of a franchise, you may fall into this category and be liable for more than what you intended.

This article is authored by Richard Schuett.

The content of this article is intended to provide a general guide to the subject matter and should not be relied upon for accuracy or for legal advice. Proper legal advice should be sought about your specific circumstances.