By Frank Zaid (link to https://adrchambers.com/neutral/frank-zaid/)
July 10, 2012
Q: Are we more likely, today and in the future, to see attempts to resolve franchise disputes through mediation or arbitration?
A: Absolutely, yes. There are many factors behind this trend, including franchise legislation, judicial decisions, industry guidelines and the franchise media.
The franchise relationship is governed principally by the franchise agreement, which is between a franchisor—i.e. the entity that owns the franchise system rights—and the franchisee—i.e. the individual who obtains the right to operate a business in accordance with the franchisor’s business standards and trademarks.
Franchise legislation has been enacted in five provinces: Alberta, Ontario, Prince Edward Island, New Brunswick and Manitoba (in that order). In Quebec, franchising is generally regulated under the Civil Code, which recognizes franchise agreements as contracts of adhesion.
Over the years, franchise disputes have been heard by the courts on an individual basis with relation to the specific franchisee and franchisor. There has also been a rapid escalation of multi-franchisee disputes, however, revolving around issues common to all or virtually all of the franchisees—both past and present—within a system.
At the same time, franchising has become big business in Canada, comprising more than 78,000 units across the country, directly employing more than one million people, generating 10 per cent of the national gross domestic product (GDP) and accounting for one out of every five dollars consumers spend on goods and services—and some 40 per cent of all retail sales.
After the introduction of class action legislation in all provinces except Manitoba, disputes common to distinguishable groups of all or substantially all of the franchisees within well-known systems have become the subject matter of very large and significant lawsuits. With all of this activity, it is highly likely many more franchise disputes will be directed to alternative dispute resolution (ADR)—i.e. a method of resolution outside the usual process of litigation in court.
Principles of legislation
All Canadian franchise legislation is founded on two major principles.
- Disclosure and rescission
The first principle involves the requirement for a franchisor to provide a disclosure document—which outlines in considerable detail the franchise being offered—to the prospective franchisee, unless an exemption is available. The disclosure document must be delivered at least 14 days before any agreement is signed, subject to certain provincial exceptions, or any consideration is paid.
The franchisee then has a statutory right to rescind the agreement within two years, in the case of no disclosure, or 60 days, in the case of deficient disclosure, after the date he/she entered the franchise agreement. If the agreement is indeed rescinded, the franchisor is required to (a) refund any money received from or on behalf of the franchisee to him/her, other than money for inventory, supplies or equipment, (b) purchase any inventory, supplies and equipment at a price equal to the purchase price paid by the franchisee and (c) compensate the franchisee for any losses incurred in acquiring, setting up and operating the franchise, less the amounts paid for the inventory, supplies and equipment.
Given the costs of establishing a franchise in some of the larger industry sectors—such as hotels, car rental facilities, automotive dealerships, full-scale restaurants and discount grocery stores—and multiplied by the number of franchisees operating within a particular system, the potential exposure of a franchisor to rescission claims can easily run into hundreds of millions of dollars.
- Fair dealing
The second principle of franchise legislation provides the statutory obligation of a duty of fair dealing in the performance and enforcement by each party under the franchise agreement. A breach of this duty, coupled with an alleged breach of an obligation or the assertion of a right under the franchise agreement, will expose a franchisor to a significant claim for breach of contract.
Again, if the alleged breach is in respect of a matter common to all or substantially all of the franchisees within a given system, the aggregate potential damages claim against a franchisor can also run into the hundreds of millions of dollars.
In 2005, the Uniform Law Commission of Canada (ULCC) approved a model Uniform Franchises Act, a model Disclosure Regulation and a model Mediation Regulation.
The model Mediation Regulation included detailed provisions allowing either party to a franchise to require a dispute to be submitted to mediation. Of the three provinces—Prince Edward Island, New Brunswick and Manitoba—that have adopted franchise legislation since the ULCC Report, so far only New Brunswick has substantially adopted the mediation process.
While Ontario’s Arthur Wishart Act (Franchise Disclosure), 2000 does not include a mediation process, the province’s Rules of Civil Procedure now include a program of mandatory mediation for managed cases in various areas. Actions placed on the Commercial List—i.e. the division of the Ontario Superior Court of Justice that hears complex commercial cases—in the Toronto region as determined by the court rules are exempted from this procedure. Matters that may be placed on the Commercial List include applications, motions and actions that in essence involve, according to the rules, “suitable complex cases under the Arthur Wishart Act,” among others.
While mandatory mediation does not apply to franchise cases on the Commercial List, the Court practice rules establishing the Commercial List state, “resort to the techniques of ADR, where appropriate, is recognized and encouraged as an effective aid in the disposition of issues and matters on the Commercial List … it is the duty of the case management judge and the obligation of counsel to explore methods to resolve the contested issues between the parties, including the resort to ADR, at the case conferences and on whatever other occasions it may be fitting to do so . . . at any time, particularly on consent of the parties, the case management judge may refer any issue for ADR, as appears appropriate.”
Indeed, government initiatives to promote mediation of franchise disputes are present in all provincial franchise legislation. Taking Ontario’s legislation as an example, regulations under the Arthur Wishart Act dealing with the content of disclosure documents provide that “if an internal or external mediation or other alternative dispute resolution process is used by a franchisor in disputes with a franchisee, the disclosure document must include a description of the mediation or other ADR process, and the circumstances when the process may be invoked.”
In addition, every disclosure document in the regulated provinces is required to include a statement similar to the following passage from the Ontario legislation:
“Mediation is a voluntary process to resolve disputes with the assistance of an independent third party. Any party may propose mediation or other dispute resolution process in regard to a dispute under the franchise agreement and the process may be used to resolve the dispute if agreed to by all parties.”
Also, disclosure documents under all provincial franchise legislation require a statement—including a description of details—indicating if the franchisor has been found liable in any civil action of misrepresentation, unfair or deceptive business practices or violations of laws that regulate franchises or businesses. This would include any failure to provide proper disclosure to a franchisee or a civil action involving such allegations pending against the franchisee. There is no requirement, however, to disclose whether or not a dispute has been submitted to ADR or, if it has, the results or settlement of any such dispute.
Independent mediators, arbitrators and organizations are now recognizing the utility and application of ADR as a means of resolving franchise disputes. ADR Chambers Canada, for example, established an expert panel of ‘neutrals’—including retired judges, experienced lawyers and other dispute resolution professionals—to specialize in franchise disputes as of January 1, 2012.
“I sense that the trend to enter into mediation, whether voluntarily, by contract, or by judicial order, will continue to increase,” writes Mark Kirsch, one of the authors of a recent article in Law Journal Newsletters’ (LJN’s) Franchising Business and Law Alert. “If you compare the cost of mediation with the possible cost of litigation, the resulting ratio clearly favours mediation.”
Indeed, all aspects of franchising today point to the need and desirability of having disputes submitted to ADR and, in particular, to mediation whenever possible. Franchisees and franchisors alike should carefully consider such options, to avoid costly litigation before the courts and to obtain an early resolution agreed to by both sides.
The ADR community, too, should prepare itself for being called upon more frequently to assist in resolving franchising disputes, by ensuring a sufficient number of mediators and arbitrators are well-versed in the dynamics, business issues and legal regulations governing the franchise relationship, so as to develop a better understanding, promote efficiency and encourage practical resolutions that will reflect fair and realistic results for all of the parties concerned.