Missed in Translation: Bringing Your U.S. Franchise Agreement to Canada

The Duty of Good Faith and Fair Dealing

In the United States, the duty of good faith and fair dealing is implied. In Canada, the duty of good faith and fair dealing is expressly codified in franchise legislation in certain provinces or under the Civil Code in Quebec and is implied through the common law of contracts in others. The courts in Canada have applied the duty of good faith and fair dealing to concretely impact the manner in which franchisors and franchisees deal with each other. These courts have said that the duty of fair dealing means that a franchisor must act in a commercially reasonable manner when performing its obligations, enforcing its rights or exercising its discretion under a franchise agreement; must take a franchisee's interests into account; and, most obviously, must not act in bad faith towards a franchisee.

This specific application of the duty of good faith and fair dealing has two implications for translating a U.S. agreement into the Canadian context. First, in Canada, U.S. franchisors cannot have “sole,” “unfettered” or “absolute” discretion; franchisors must act in good faith in exercising their discretion, regardless of what the contract says. These phrases should be removed from franchise agreements. Second, U.S. franchisors should ensure that their franchise agreements reflect the rights, obligations and discretions that they need for their Canadian operations to thrive, including considering and potentially expressly listing the situation in which franchisors will consult with the franchisees. Such consultation helps to show compliance with the duty of good faith and fair dealing.

Choice of Venue and Choice of Law

Provincial franchise legislation requires the franchisor and franchisee to litigate or arbitrate disputes in the province in which the franchise is operated. The legislation, in essence, renders void any choice of venue or choice of law clause that would require the parties to leave the jurisdiction to resolve a dispute governed by the legislation. In provinces with such legislation, the franchise agreement should be drafted to select the local jurisdiction and local governing law to avoid disputes later on.

In provinces that do not have franchise legislation, a Canadian court may refuse to enforce a choice of venue or choice of law clause if there is “strong cause” not to enforce the clause. Strong cause can include the extreme examples of fraud, improper inducement to enter the clause or the selected court refusing jurisdiction. It can also include considerations of public policy or circumstances arising that are outside what was reasonably contemplated by the parties when they agreed to the clause. Given these potentially malleable concepts, a franchisor should carefully consider whether choosing a venue or governing law outside the province in which the franchisee is operating is worth the risk of losing a jurisdiction motion.

As a result of franchise legislation or courts invalidating choice of law or choice of venue clauses, a franchisor operating across Canada may have franchise agreements governed by multiple provinces with differing law. These differences should be considered and incorporated into the standard franchise agreement to avoid a court invalidating an agreement or interpreting it in an unexpected manner.

The Right to Associate, Arbitration, and Class Action and Jury Waivers

Provincial franchise legislation provides franchisees with an express “right to associate.” This right to associate permits franchisees to form franchisee associations, prevents the franchisor from interfering with the formation of a franchisee association, renders void any provision of a franchise agreement (or other agreement) that interferes with a franchisee's right to associate, and grants a right of action for damages for any such interference.

This right to associate may impact the enforceability of arbitration clauses and class action waivers. As a result, a franchisor should consider whether the dispute resolution approach or class action waiver it uses in its U.S. agreement is enforceable in the Canadian province in which the franchisor intends to operate. Addressing these issues before the franchise agreement is finalized ensures that the dispute resolution mechanism proposed by the franchisor does not get bogged down in procedural challenges.

In general, Canadian courts will not interfere with an arbitration agreement between commercial parties, leaving them to arrange by contract their own dispute resolution mechanisms. Arbitration can provide procedural flexibility and cost-effective dispute resolution, particularly if the province in which the franchises are operating has a well-established arbitral community. Depending on the language in the franchise legislation and the future policy choices made by the legislature, a franchisee may argue that the franchise legislation demonstrates a legislative intent to interfere with the operation of an arbitration clause. At the moment, however, courts generally enforce arbitration provisions in respect of disputes between a single franchisee and the franchisor.

The question becomes more complex when the franchisee wishes to join with other franchisees in a group or class action and the franchisor seeks to require franchisees to participate in individual arbitrations. First, such franchisees have argued that the right to associate renders the arbitral provision void. The success of this argument depends on the language in the arbitration clause as well as the language in the franchise legislation. To date, some courts have refused, based on the right to associate, to enforce an arbitration clause that would otherwise prevent franchisees from participating in a class action. Second, the enforceability of class action waivers in general (i.e., outside the franchise context) is somewhat uncertain in Canada as there is conflicting case law. As the law develops, franchisors should carefully consider whether to include a class action waiver ' or an arbitral provision that purports to prevent a franchisee from joining a class action ' in their franchise agreements.

Finally, one of the key differences between the U.S. and Canadian legal systems is that jury trials are extremely rare in Canada. As a result, jury trial waivers may not be necessary.

Insolvency

Foreign franchisors establishing Canadian franchise operations should be aware of the implications of Canadian insolvency law on the rights of franchisors. While Canadian insolvency law does not contain specific rules dealing with franchises, there are a number of consequences of an insolvency that are relevant in the context of a franchising relationship. For example, a franchisor may be unable to exercise its rights and remedies against an insolvent franchisee or principal because a bankruptcy proceeding or other insolvency proceeding may result in an automatic stay of the exercise of rights and remedies that secured creditors, unsecured creditors or a franchisor may have against an insolvent franchisee or principal.

In addition, depending on the type of insolvency proceeding, a franchisor may be unable to terminate its franchise agreement with an insolvent franchisee or principal. Although it is common to include a provision in a franchise agreement that the agreement automatically terminates upon the occurrence of certain insolvency events, depending on the proceeding, Canadian insolvency law may render such provisions unenforceable, thereby prohibiting a franchisor from discontinuing or terminating the franchise agreement.

Certain insolvency proceedings may also permit an insolvent franchisee or principal, a trustee in bankruptcy or a receiver to apply to the court to obtain an order authorizing the assignment of a franchise agreement to a third party upon satisfaction of certain requirements. This assignment may be ordered to occur over the franchisor's objection, even in circumstances where the franchisor's consent to assignment is contractually required. This forced assignment can lead to the franchisor being in a long-term contractual relationship with a franchisee not of their choosing. Understanding the implications of Canadian insolvency law is particularly important if the profitability of a franchise system in the Canadian commercial context is not fully understood before the cross-border expansion begins.

Withholding Tax

Foreign franchisors expanding to Canada through a non-Canadian franchisor entity should also take note that franchise fees, royalties and interest payable to the franchisor will be subject to withholding taxes. To ensure that the franchisee fulfils the withholding tax requirements, a specific provision should be included in the payment section of the franchise agreement requiring the franchisee to pay these withholding taxes to the appropriate tax authorities and to provide the franchisor with copies of receipts (or other suitable documentation) from the tax authorities. The franchisee should also be required to take all reasonable steps to assist the franchisor in obtaining any tax credits arising from such withholding taxes that are available to the franchisor in its home country.

Canada Awaits

As can be seen from this overview, franchising in Canada can be quite different from franchising in the U.S. or other countries. Although the U.S. and Canada have similar customs, language, economic trends, common law and judicial principles, there are differences that can trap a franchisor crossing the border. These differences can be addressed through a one-time careful legal translation of the franchisor's standard franchise agreement and practices. Failing to properly translate the franchise agreement can lead to costly litigation as well as challenges in administering and enforcing the franchise agreement. Investing in a proper legal translation, however, that helps the franchisor and its system to comply with Canadian laws, practices and customs will allow foreign franchisors to successfully expand into ' and take advantage of ' the diverse and stable Canadian marketplace.

Mary Paterson is a Litigation partner at Osler, Hoskin & Harcourt LLP, with experience in franchise litigation. Christine Jackson is an associate in the firm's Franchise & Distribution practice. She has extensive experience 'Canadianizing' U.S. standard form franchise agreements. The authors thank Caitlin Fell, an Osler associate with extensive experience in Canadian insolvency matters, for her contributions to this article.

With a diversified consumer base, a stable economy, and a well-established legal system, Canada is a receptive jurisdiction for expanding U.S. franchise systems, as long as the U.S. franchisor plays by Canada's rules.

Several Canadian provinces have franchise-specific legislation imposing obligations not usually found in the U.S.; other provinces rely on the common law or the civil law to regulate the franchisee-franchisor relationship. Although Quebec is the only province in Canada that requires a franchisor to translate the language (i.e., English to French) of its franchise agreements and related documents, in all provinces a U.S. franchisor must translate the legal terms of its franchise agreements and related documents into the Canadian legal context.

This article highlights five key concepts that are often missed or misunderstood when a U.S. franchisor translates its U.S. agreements into the Canadian legal framework. As you will see, these concepts can trap U.S. franchisors in part because they do not have simple solutions. That said, asking the right questions is the first step to managing the risks, and therefore reaping the rewards, of expanding a franchise system in Canada.

The Duty of Good Faith and Fair Dealing

In the United States, the duty of good faith and fair dealing is implied. In Canada, the duty of good faith and fair dealing is expressly codified in franchise legislation in certain provinces or under the Civil Code in Quebec and is implied through the common law of contracts in others. The courts in Canada have applied the duty of good faith and fair dealing to concretely impact the manner in which franchisors and franchisees deal with each other. These courts have said that the duty of fair dealing means that a franchisor must act in a commercially reasonable manner when performing its obligations, enforcing its rights or exercising its discretion under a franchise agreement; must take a franchisee's interests into account; and, most obviously, must not act in bad faith towards a franchisee.

This specific application of the duty of good faith and fair dealing has two implications for translating a U.S. agreement into the Canadian context. First, in Canada, U.S. franchisors cannot have “sole,” “unfettered” or “absolute” discretion; franchisors must act in good faith in exercising their discretion, regardless of what the contract says. These phrases should be removed from franchise agreements. Second, U.S. franchisors should ensure that their franchise agreements reflect the rights, obligations and discretions that they need for their Canadian operations to thrive, including considering and potentially expressly listing the situation in which franchisors will consult with the franchisees. Such consultation helps to show compliance with the duty of good faith and fair dealing.

Choice of Venue and Choice of Law

Provincial franchise legislation requires the franchisor and franchisee to litigate or arbitrate disputes in the province in which the franchise is operated. The legislation, in essence, renders void any choice of venue or choice of law clause that would require the parties to leave the jurisdiction to resolve a dispute governed by the legislation. In provinces with such legislation, the franchise agreement should be drafted to select the local jurisdiction and local governing law to avoid disputes later on.

In provinces that do not have franchise legislation, a Canadian court may refuse to enforce a choice of venue or choice of law clause if there is “strong cause” not to enforce the clause. Strong cause can include the extreme examples of fraud, improper inducement to enter the clause or the selected court refusing jurisdiction. It can also include considerations of public policy or circumstances arising that are outside what was reasonably contemplated by the parties when they agreed to the clause. Given these potentially malleable concepts, a franchisor should carefully consider whether choosing a venue or governing law outside the province in which the franchisee is operating is worth the risk of losing a jurisdiction motion.

As a result of franchise legislation or courts invalidating choice of law or choice of venue clauses, a franchisor operating across Canada may have franchise agreements governed by multiple provinces with differing law. These differences should be considered and incorporated into the standard franchise agreement to avoid a court invalidating an agreement or interpreting it in an unexpected manner.

The Right to Associate, Arbitration, and Class Action and Jury Waivers

Provincial franchise legislation provides franchisees with an express “right to associate.” This right to associate permits franchisees to form franchisee associations, prevents the franchisor from interfering with the formation of a franchisee association, renders void any provision of a franchise agreement (or other agreement) that interferes with a franchisee's right to associate, and grants a right of action for damages for any such interference.

This right to associate may impact the enforceability of arbitration clauses and class action waivers. As a result, a franchisor should consider whether the dispute resolution approach or class action waiver it uses in its U.S. agreement is enforceable in the Canadian province in which the franchisor intends to operate. Addressing these issues before the franchise agreement is finalized ensures that the dispute resolution mechanism proposed by the franchisor does not get bogged down in procedural challenges.

In general, Canadian courts will not interfere with an arbitration agreement between commercial parties, leaving them to arrange by contract their own dispute resolution mechanisms. Arbitration can provide procedural flexibility and cost-effective dispute resolution, particularly if the province in which the franchises are operating has a well-established arbitral community. Depending on the language in the franchise legislation and the future policy choices made by the legislature, a franchisee may argue that the franchise legislation demonstrates a legislative intent to interfere with the operation of an arbitration clause. At the moment, however, courts generally enforce arbitration provisions in respect of disputes between a single franchisee and the franchisor.

The question becomes more complex when the franchisee wishes to join with other franchisees in a group or class action and the franchisor seeks to require franchisees to participate in individual arbitrations. First, such franchisees have argued that the right to associate renders the arbitral provision void. The success of this argument depends on the language in the arbitration clause as well as the language in the franchise legislation. To date, some courts have refused, based on the right to associate, to enforce an arbitration clause that would otherwise prevent franchisees from participating in a class action. Second, the enforceability of class action waivers in general (i.e., outside the franchise context) is somewhat uncertain in Canada as there is conflicting case law. As the law develops, franchisors should carefully consider whether to include a class action waiver ' or an arbitral provision that purports to prevent a franchisee from joining a class action ' in their franchise agreements.

Finally, one of the key differences between the U.S. and Canadian legal systems is that jury trials are extremely rare in Canada. As a result, jury trial waivers may not be necessary.

Insolvency

Foreign franchisors establishing Canadian franchise operations should be aware of the implications of Canadian insolvency law on the rights of franchisors. While Canadian insolvency law does not contain specific rules dealing with franchises, there are a number of consequences of an insolvency that are relevant in the context of a franchising relationship. For example, a franchisor may be unable to exercise its rights and remedies against an insolvent franchisee or principal because a bankruptcy proceeding or other insolvency proceeding may result in an automatic stay of the exercise of rights and remedies that secured creditors, unsecured creditors or a franchisor may have against an insolvent franchisee or principal.

In addition, depending on the type of insolvency proceeding, a franchisor may be unable to terminate its franchise agreement with an insolvent franchisee or principal. Although it is common to include a provision in a franchise agreement that the agreement automatically terminates upon the occurrence of certain insolvency events, depending on the proceeding, Canadian insolvency law may render such provisions unenforceable, thereby prohibiting a franchisor from discontinuing or terminating the franchise agreement.

Certain insolvency proceedings may also permit an insolvent franchisee or principal, a trustee in bankruptcy or a receiver to apply to the court to obtain an order authorizing the assignment of a franchise agreement to a third party upon satisfaction of certain requirements. This assignment may be ordered to occur over the franchisor's objection, even in circumstances where the franchisor's consent to assignment is contractually required. This forced assignment can lead to the franchisor being in a long-term contractual relationship with a franchisee not of their choosing. Understanding the implications of Canadian insolvency law is particularly important if the profitability of a franchise system in the Canadian commercial context is not fully understood before the cross-border expansion begins.

Withholding Tax

Foreign franchisors expanding to Canada through a non-Canadian franchisor entity should also take note that franchise fees, royalties and interest payable to the franchisor will be subject to withholding taxes. To ensure that the franchisee fulfils the withholding tax requirements, a specific provision should be included in the payment section of the franchise agreement requiring the franchisee to pay these withholding taxes to the appropriate tax authorities and to provide the franchisor with copies of receipts (or other suitable documentation) from the tax authorities. The franchisee should also be required to take all reasonable steps to assist the franchisor in obtaining any tax credits arising from such withholding taxes that are available to the franchisor in its home country.

Canada Awaits

As can be seen from this overview, franchising in Canada can be quite different from franchising in the U.S. or other countries. Although the U.S. and Canada have similar customs, language, economic trends, common law and judicial principles, there are differences that can trap a franchisor crossing the border. These differences can be addressed through a one-time careful legal translation of the franchisor's standard franchise agreement and practices. Failing to properly translate the franchise agreement can lead to costly litigation as well as challenges in administering and enforcing the franchise agreement. Investing in a proper legal translation, however, that helps the franchisor and its system to comply with Canadian laws, practices and customs will allow foreign franchisors to successfully expand into ' and take advantage of ' the diverse and stable Canadian marketplace.

Mary Paterson is a Litigation partner at Osler, Hoskin & Harcourt LLP, with experience in franchise litigation. Christine Jackson is an associate in the firm's Franchise & Distribution practice. She has extensive experience 'Canadianizing' U.S. standard form franchise agreements. The authors thank Caitlin Fell, an Osler associate with extensive experience in Canadian insolvency matters, for her contributions to this article.