Expanding Your Franchise System Into Canada
A variety of key legal and business steps must be taken into account before expanding into Canada.
By Larry Weinberg, CFE
Canada has always been seen as an easy and natural first step for U.S.-based franchisors considering international expansion. There are obvious reasons that make Canada attractive, including geographic proximity, standard of living and consumer behavior, common language, and similar legal system. Also, the vast majority of the population lives close to the U.S. border. But, it is important for franchisors expanding into Canada to note the differences in the Canadian market, so as to better strategize a more effective and efficient entry. Often, American franchisors are pulled into Canada by interested prospects. Regulation of franchise sales has served to discourage this kind of passive entry, although this reason for entry into the Canadian market is still often cited. Nevertheless, most franchise professionals agree that a proactive strategy plan is the most likely to succeed. This article seeks to provide U.S. franchisors with a better understanding of the Canadian market, by discussing a variety of key legal and business steps one must consider and take in advance of expanding into Canada.
Trademark Protection
One of the first steps that should be taken by any brand owner is to apply for registration of its principal trademarks. Just because a trademark is registered and used in the United States, one cannot assume it can be used and registered in another country. The federal government in Canada has exclusive jurisdiction over trademarks, under the Trade-Marks Act, which means that one registration is good across Canada. Generally, registration should be done as soon as possible to minimize the risk that an individual who has observed the trademark or franchise's value abroad will seek to register first.
Structural and Tax Issues
There are several ways U.S. franchisors can enter the Canadian market. Franchisors can directly franchise from the Unites States into Canada or use a joint venture structure, in any case using an existing or new U.S. entity. While these structures have benefits and drawbacks, franchisors are also increasingly using a Canadian affiliate or subsidiary to then grant rights. At the outset it is critical for a U.S. franchisor planning any international expansion to obtain corporate and tax structuring advice from their U.S. and Canadian tax advisors, in addition to advice from franchise counsel. It used to be quite common for U.S. franchisors to expand into Canada through a single-unit franchise model. While still common, franchisors now will also often consider a multi-unit expansion strategy, mostly due to the realistic costs of expansion. A multi-unit strategy allows U.S.-based franchisors to delegate functions to an entity of their choice, with local expertise. Multi-unit franchisees or area representatives typically assume many of the functions normally done by the franchisor, such as site selection, construction, training and operational support, and where appropriate, subfranchisee recruitment. While these arrangements can be beneficial, franchisors should be mindful that they come at the cost of decreased control, and if the multi-unit candidate has a large territory, the choice of the multi-unit candidate can be that much more critical. But if the territories and unit expectations are too small, then the franchisor may still be left performing many of the functions of franchisor in the market. Tax issues cannot be ignored. At the very least, consideration needs to be given to the fact that nonresident withholding taxes will typically apply and require Canadian franchisees to pay at least 10 percent of the U.S. resident franchisor’s royalty payments and initial franchise fees to Canadian income tax authorities, as the nonresident franchisor’s income in Canada (there may be an offsetting credit in the United States). But that is but one issue, as others will arise depending on whether the franchisor is U.S. based or Canadian, the nature of the rights granted and whether the franchisor requires that funds be repatriated to the United States or used to fund operations in Canada or in other countries.
“Canadianizing” Your U.S. Franchise Documents
It is inevitably true that some changes are almost always needed or recommended to the standard forms of any U.S. franchisor's franchise agreements to comply with the laws and practices of the Canadian franchise marketplace. In some instances it is because local law requires that agreements contain provisions that differ from what would be usual in a U.S. agreement, while in other cases practices have evolved differently.
Franchise Law Compliance
At the present time, five of the 10 Canadian provinces have franchise legislation. They are Alberta, Manitoba, New Brunswick, Ontario and Prince Edward Island. A sixth province, namely British Columbia, will likely also have a franchise law within a few years. The remaining four Canadian provinces have yet to express an intention to legislate in the area of franchising. The provincial franchise laws are relatively similar, in that they mandate pre-sale disclosure through a Canadian franchise disclosure document, impose on franchisors and franchisees a duty of fair dealing, provide franchisees with a right to associate and prescribe certain limited relationship provisions that mandate what law and courts will govern the contract. However, unlike the United States, there is no registration requirement in Canada. If franchises are to be offered in one or more of the regulated provinces, then a FDD will be needed. Case law has made clear already that delivering a U.S. FDD is not in compliance with the Canadian franchise laws. A so-called “wrap around” will usually not work, if for no other reason than it is not permitted by Ontario’s franchise law, and there is a trend to a single cross Canada FDD. So, a U.S. franchisor will need Canadian counsel to prepare a compliant FDD. In provinces with franchise legislation, franchisors are required to deliver disclosure documents at least 14 days before the earlier of: the party’s entry into any agreement related to the franchise (with some very limited exceptions in certain provinces) or the payment by the franchisee of any money.
Other Considerations
There are often myriad business-specific issues that need to be considered before expanding to Canada. And while Canada may be relatively similar to the United States in many respects, the differences should not be discounted. For instance, in a food service franchise, the franchisor will need to consider product sourcing and supply chain. In other industries, licensing requirements for franchisees may differ greatly from that which exists in the United States. In the end, finding legal and other local consultants may turn out to be a key consideration in making sure the process of expansion goes as smoothly as possible. Lastly, special consideration should be made when expanding a franchise system into Quebec. One of the most practical considerations is the fact that consumers by and large live and work in the French language. So, a franchisor will often consider using a multi-unit strategy, and thereby delegate many of the language compliance issues. As seen throughout this article, there are several important differences between franchising in Canada, as opposed to the United States. While franchisors can exploit the numerous similarities, it is crucial to carefully consider the impact of differences across the business, laws and practice of franchising.
Larry Weinberg, CFE, is a partner in the Toronto office of the law firm Cassel Brock & Blackwell LLP. Find him at fransocial.franchise.org.