If it looks like a duck, swims like a duck, and quacks like a duck, then it probably is a duck. – The Duck Test

Even though it has been about 15 years since franchise legislation came to Ontario, there are still business concepts walking the tightrope and claiming to be licensing arrangements to avoid the requirements and expense of preparing and delivering a franchise disclosure document.  The recent decision of the Ontario Superior Court of Justice released on March 14, 2016 in Chavdarova v. The Staffing Exchange Inc. is a prime example of the perils of taking this course of action for a potential franchisor.

By way of background, the Staffing Exchange Inc. (“TSE”) billed itself as a service provider to the employment recruitment industry and provided a shared database called the Multiple Career Listing Service where recruiters could list organizations looking for potential employees, and where potential employees could search such listings for any desired positions.  However, in order for a recruiter to use the database, it had to enter into a Certification and Training Agreement as well as a Brokerage License Agreement.

The Certification and Training Agreement was a standard form contract, and although it specifically stated that it did not in any way create a franchisor/franchisee relationship, it did contain the following provisions which were later relied upon by the trial judge:

1. The recruiter was referred to as “The TSE Career Broker”;
2. The TSE Career Broker agreed to pay a Certification and Training Fee of $29,500 plus applicable taxes upon signing;
3. TSE would provide The TSE Career Broker with all technical training, business cards, marketing materials, manuals, guidelines, a resource kit, concepts and methodology to conduct the business as a TSE Career Broker;
4. All materials and information provided were the exclusive property of TSE and only to be used as a TSE Career Broker and would be returned to TSE upon request; and
5. All recruiting revenues from employers would be paid to TSE with The TSE Career Broker only being paid 85% of such fees collected by TSE.

Similarly, the Brokerage License Agreement was a standard form contract and again stated that the licensee was an independent contractor and not a franchisee.  As if to specifically avoid Ontario’s franchise legislation, the agreement also stated that the licensee was not required to “make a payment or continuing payments, whether direct or indirect, or a commitment to make such payment or payments, to [TSE], or to any person related to or affiliated with [TSE], in the course of operating the Licensed Business or as a condition of obtaining or maintaining the license granted.”  It just so happened that this wording almost exactly mirrored the wording in Ontario’s franchise legislation of what constitutes a “franchise”.  The License Agreement also contained the following provisions which were later relied upon by the trial judge:

1. The licensee could only use TSE’s trademarks in operating the business;
2. The licensee had to operate the business in “strict conformity” with TSE’s standards and specifications and only use the materials supplied by TSE in the business; and
3. TSE would collect all revenues for the business and remit only 85% to the licensee.

The plaintiff in the case ultimately signed both of these documents and became a TSE Career Broker.  As is typical of most franchise rescission cases, the business did not flourish and TSE eventually terminated the agreements and the relationship for numerous defaults committed by the plaintiff.

In response, the plaintiff claimed that the business constituted a “franchise” under Ontario’s franchise legislation, the Arthur Wishart Act (Franchise Disclosure), 2000 (the “AWA”), and served a notice of rescission upon TSE for failure to provide a proper franchise disclosure document, as well as to claim reimbursement and damages for all amounts spent on establishing the business.

Under subsection 1(1) of the AWA, three main elements had to be present in order to have the TSE business be deemed a “franchise”:

1. a requirement by contract for the plaintiff to make a payment or continuing payments, or a commitment to make such payments, to TSE in the course of operating the business, or as a condition to acquiring the franchise or commencing operations, and
2. the grant by TSE to the plaintiff to sell or offer for sale goods or services associated with the TSE’s or its associate’s trademark, and
3. TSE exercising significant control over the plaintiff’s operations.

If so found, TSE then had an obligation under section 5 of the AWA to provide the plaintiff with a disclosure document at least 14 days’ before she signed the agreements, failing which the plaintiff would have a right to rescind the agreements within 2 years of their signing under subsection 6(2) of the AWA and obtain a full refund of all amounts paid to TSE and compensation for any losses to acquire, set up and operate the business.

Despite the fact that neither of the signed agreements were called a “franchise agreement”, and the fact that both agreements specifically denied that any franchisor/franchisee relationship existed between the parties, the trial judge had no problem in finding that the arrangement between the plaintiff and TSE constituted a franchise.  He based his findings on the requirement that the so-called training fee was in fact a payment for the right to enter into the relationship as a “TSE Career Broker”, as supported by the additional requirement to return all materials if the plaintiff did not enter into the relationship.  It was also apparent to the judge that although the License Agreement claimed that no payments would be made, the fact that TSE collected all revenues and retained 15% for itself constituted a “payment” no matter how it was portrayed. Finally, there was little doubt that the business operated was substantially associated with TSE’s trademarks, and that TSE exercised significant control over the business by requiring the plaintiff to operate in strict conformity to its standards and specifications.

Accordingly, since TSE admittedly did not provide the plaintiff with a disclosure document, it did not comply with the AWA thereby providing the plaintiff with a right to rescind the agreement and recover all amounts invested or lost in the business.  It may be interesting to note that although the judge thought that the plaintiff’s assessment of her damages were sketchy at best, TSE did not forward any evidence to challenge the information, and as such, the plaintiff was awarded damages of $99,835.

Using a modification of the Duck Test noted above, if it looks like a franchise, operates like a franchise, and payments are made like a franchise, then it probably is a franchise.  It is clear from this case at least that the court will not tolerate mischaracterizations of franchise situations as licensing schemes to avoid the disclosure requirements required by law.  In addition, it may be important for licensors to take a close and detailed look at their own licensing arrangements to ensure that they are not accidently caught within the definition of a “franchise”.  Otherwise, a licensor may find itself the recipient of a rescission notice within 2 years of signing a license agreement and a very expensive lesson in franchise laws of Ontario.

For more information on franchising, contact Derwin Wong or Hailey Kersey by phone at (416) 368-0600 or by email at dwong@businesslawyers.com or hkersey@businesslayers.com.

© Morrison Brown Sosnovitch LLP, 2016. All rights reserved.