former wrestlers, and watches The Apprentice to relax. Needless to say, you may discover a change in the corporate culture from the charming and helpful sales force. In other words, you may have to deal with reality, and the reality may be different than you expected. It is important then, for you to know whom you will inevitably be dealing with in the franchising relationship and, to the extent possible, to be comfortable with those persons. If you aren’t comfortable, why would you proceed?
Some franchisors have instigated what is euphemistically referred to as a “debunking” session (or a “discovery day”), whereby, prior to the execution of the franchise agreement (but after a deposit agreement has been signed, a deposit provided, and the prospective franchisee is ready to “sign on”), the president or senior managers of the franchisor send the sales force “out of the room” and tell the prospective franchisee words to the effect that, “I don’t know and I don’t care what he told you. He’s just a commissioned sales guy. This is the way it is in this franchise. There are no guarantees you are going to make any money and it’s hard work. And by the way, sign here, acknowledging that you understand this.”
These sort of debunking sessions serve as a “reality check” for overeager franchisees who have been won over by the sales process and the salesperson, or have otherwise sold the deal to themselves. But these sessions also assist the franchisor by allowing a franchisor to claim that there were no representations or warranties made to the franchisee that weren’t contained in the franchise agreement (i.e., “I told him the way it was”).
2. Deposit Agreements
Deposit agreements containing confidentiality covenants are, on the whole, an encouraging sign within the franchise relationship. Franchisors have legitimate interests to protect. The franchisor wishes to separate the serious contenders from the “tire kickers,” and the litmus test for that purpose is the execution of a deposit agreement and the placing of a deposit. The tire kickers will move on to other franchises; the serious contenders will take the process further.
From the perspective of the franchisor, it not only wishes to separate the genuinely interested from the marginally interested, it also wishes to protect its system, concept, and intellectual property rights. The franchisor does not wish to enter into negotiations with you, provide you with a franchise agreement, a disclosure document, perhaps financial statements, and other confidential information, thus educating you on the secrets that led to the franchisor’s success in the marketplace, only to have you back out of the deal and form a competing business across the street.
In Ontario, there can be no deposit agreements entered and no deposit made until the franchisor has made disclosure according to the Arthur Wishart Act, and waited the requisite 14-day period after disclosure.
In Alberta, a deposit can be taken before disclosure and a deposit agreement entered (usually with confidentiality provisions included), but the deposit must be no more than 20 percent of the franchisor’s initial franchise fee and it must be fully refundable if the franchisee chooses not to proceed.
2.1 Who holds the deposit?
The most important practical problem at this stage is, who holds the deposit and how do you get it back if the deal falls apart? The deposit is going to be held by either the franchisor or the franchisor’s commissioned salespersons. If you decide not to go further in the process, cannot acquire bank financing, or do not approve the location the franchisor has subsequently chosen and you request the deposit monies to be returned, the money may be difficult to get back. In some systems, the franchisor or its sales agents have already spent the deposit monies and are waiting for other deposit monies or initial franchise fees from other franchisees that will be used to repay you if you are seeking your money back. This could take months, and legal action respecting return of deposit monies is not cost-effective for you if you are forced to hire a lawyer to commence legal proceedings. So when you ask for the money back, it’s gone, and it may be gone for some time. (By the way, this does not usually happen with Canada’s established franchisors.)
One option is that if you are able to approach your lawyer in advance of signing the deposit agreement, deposit monies could be placed either in trust with your lawyer or in trust with the franchisor’s lawyer on undertakings to return these monies immediately upon you deciding not to enter into the franchise agreement. Be aware that franchisors or their sales agents may delay the return of deposits for the aforementioned reason or to give one more try at the sales process.
For lawyers, nothing speaks louder than an undertaking, which is a contract between the lawyer accepting the undertaking and the person putting the lawyer on the undertaking. Lawyers who fail to comply with undertakings risk disciplinary action by their Law Society. Although some franchisors aren’t fond of this approach, it is an efficient means of ensuring that the franchisor knows that you are serious while at the same time ensuring that if the deal does not proceed, the money hasn’t been spent and can be returned quickly to you. It shows that if you’re still just a tire kicker, you’re a smart one!
Undertakings placed on lawyers have a way of focusing a lawyer’s attention. Lawyers aren’t keen on receiving disciplinary letters from their Law Societies, let alone disbarment. So its probably fair to consider holding the deposit in trust with a lawyer — even the franchisor’s lawyer — when dealing with a start-up franchisor with a limited or non-existent track record, or if you are dealing with a start-up regional franchisee (i.e., a master franchisee for a province that is not the same entity that controls the US franchise rights), or if you’re dealing with commissioned sales agents in the previously cited circumstances.
The well-known and established franchise companies don’t normally spend the deposit monies before they receive the initial franchise fee. They aren’t adding much to the bottom line by trying to keep $1,000 of your deposit money. I’d probably take the established franchisor’s word that your money will be returned forthwith and I probably wouldn’t put the deposit money in trust with a lawyer. (Most of Canada’s established franchise community are members of the Canadian Franchise Association. If the franchisor you’re dealing with isn’t, ask why.)
The established and reputable franchisors will return the monies forthwith; however, certain deposit agreements may contain a provision whereby the franchisor is entitled to deduct a portion to compensate it for its administrative time. This portion may vary. Usually the agreement will say a reasonable amount and the parties are left figuring out what reasonable is. For example, if a franchisor kept $1,000 out of a $5,000 deposit, it wouldn’t be unreasonable unless the deposit agreement said “fully refundable.” This depends on the costs the franchisor has incurred.
As an aside, if there are significant conditions in the future to be satisfied by the franchisor (e.g., securing a location), having all or a portion of the initial franchise fee held in trust by your lawyer or the franchisor’s lawyer may also be a means of “getting it back quickly” in the event the condition is not satisfied but the money has been paid.
2.2 Ontario and Alberta regulations on deposits
As noted above, Ontario and Alberta have specific regulations on deposits for the acquisition of franchises. In particular, no deposit can be taken by a franchisor for an Ontario franchise, and no agreement can be signed unless disclosure has been made pursuant to the Ontario Arthur Wishart legislation and the requisite time period has passed. A deposit agreement will be deemed to be a franchise agreement under that statute. (For more information about disclosure agreements, see Part 3.)
In Alberta, fully refundable deposits may be taken prior to disclosure by the franchisor, but only in an amount not more than 20 percent of the franchisor’s initial franchise fee, and only where any deposit agreement is limited to dealing
