Among the questions that constantly haunt us, we have the dismal conditions of our roads, changing temperatures, countless road work sites, income tax, rising rates and, in the franchise world, franchisors’ right to collect from their franchise networks suppliers rebates and discounts and to receive other forms of income arising from the purchase by their franchisees of goods and services.
Over the past few years, some large American and Canadian franchisors have been confronted to several important lawsuits filed by franchisees, some of which included claims regarding the illegality of such ancillary income set up by the franchisor for its own benefit.
Are such rebates, discounts and other sources of income legal or not?
Given that Quebec has no specific legislation governing franchising, the law does not prohibit, at least in principle, a franchisor from receiving and retaining rebates, discounts and other income from its franchise network suppliers.
However, this principle is not absolute and is nevertheless subject to some important rules.
Firstly, it is important for the franchisor to disclose to its new franchisees, before or when signing the franchise agreement, the fact that it will receive, and retain for its own benefit, such income from the franchise network suppliers. This disclosure should also be clearly provided for in the franchise agreement.
As opposed to what happens in provinces that legislate franchises where such disclosure is required in the franchise disclosure, this disclosure is not formally required in Quebec under any article of a specific act; however, the rules of the Civil Code of Quebec require any party to a contract (e.g. a franchisor) to disclose to the other party (e.g. the franchisee), prior to signing the contract, all material facts (namely, those likely to have an impact on the other party’s decision to sign the contract under the proposed terms) of which it is aware and that the other party may not easily learn on its own.
Secondly, the franchisor must ensure that its franchise agreement does not contain any provision limiting its right to receive such income.
For example, a clause stipulating that one of the advantages, for the franchisee, of the franchise consists in benefiting from the franchise network purchasing power, a clause stipulating that the franchisor must act in the interest of its franchisees or a clause stipulating that goods and services sold to franchisees must be at a competitive price may be interpreted as obstacles to or, at least, as restrictions to the right of the franchisor to collect and retain any rebates, discounts or other financial advantages from the franchise network suppliers.
Thirdly, certain laws may also impose limitations on the right of a franchisor to receive any rebates, discounts and other advantages.
For example, the laws and regulations governing the distribution of prescription drugs in Quebec prevent a franchisor of a pharmacy network from receiving rebates, discounts and other income from drug manufacturers supplying its franchised pharmacies.
Fourthly, even if the franchisor has clearly stipulated, in its franchise agreement, the right to receive and retain rebates, discounts and other advantages from the franchise network suppliers, this does not mean that this right is limitless.
Under the rules of the Civil Code of Quebec, a person must exercise its rights “in accordance with the requirements of good faith.”
In the franchising context, case law has also clearly established the principle that a franchisor must, when making decisions, take into consideration the interests of its franchisees as well as, in the words of the Court of Appeal of Quebec in the renowned Provigo case (which you can read by clicking here), “[translation] keep the contract binding it [the Franchisee] relevant so that the underlying reasons for the affiliation do not become void or inoperative.”
By applying this principle to the particular question of a franchisor’s rebates, discounts and other sources of income, such income must not prevent the franchisees from acquiring the goods and services required to operate their businesses at reasonable prices which allow them, when reselling them at competitive prices, to earn sufficient profit margins to allow them to benefit from their affiliation with the franchise network. This principle is even more important when, under their contract, the franchisees are required to purchase their goods and services exclusively from suppliers prescribed by the franchisor or from the franchisor itself.
Three practical tips:
- Be clear
Clearly disclose, in your franchise recruitment documents as well as in your franchise agreement, the fact that the franchisor receives and retains for its own benefit (if it is the case), rebates, discounts and other sources of income from the franchise network suppliers.
If you reinvest these amounts, or a portion thereof, in your franchise network, or if you share a portion of it with your franchisees, this should also be disclosed to future franchisees and provided for in your franchise agreement.
- Be reasonable
Regardless of disclosure, and despite the amounts paid by suppliers, it is important that your franchisees benefit from competitive pricing when purchasing their goods and services and so that, at least to a certain extent, they are able to benefit from being part of a franchise network.
The franchisor must also ensure a proper balance between, on the one hand, its desire to maintain and improve its own profitability and, on the other hand, its legal and business obligations towards its franchisees.
Being too greedy can become a significant source of serious disagreements within the franchise network, which can easily degenerate into a lawsuit or trigger the setting up of an aggressive franchisees’ association.
- Share or reinvest
An excellent way to avoid difficulties with your franchisees is by sharing, in a variety of ways, with your franchisees the amounts received from suppliers or by reinvesting a portion of these in improving the tools, resources and services that you offer to your franchisees.
This doesn’t necessarily mean giving money directly to franchisees (although this could be an option), but rather using a portion of the rebates, discounts and other sources of income from the franchise network suppliers to benefit the whole franchise network, for example, by making a special contribution to the franchise network collective advertising fund, by offering training services free of charge or at a lower cost, etc.
Fasken has the expertise and necessary resources to advise and support you in all aspects of starting-up, managing and expanding your franchise network, including drafting personalized contracts that best fit your needs and business model.