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Part of cannabis laws and regulations

Chad Finkelstein is a business lawyer and registered trademark agent at Dale & Lessmann LLP in Toronto, with a focus on franchising, licensing, distribution, retail and cannabis.

Last week, the Ontario government released its regulations to the Cannabis License Act, 2018. Cannabis industry stakeholders had been tentatively planning their retail strategies ever since the government previously announced that licensed cannabis producers (LPs) and their “affiliates” would be limited to own one retail store only.

But the legislation did not define what an “affiliate” meant, so LPs and their business partners had no way of knowing whether they could own a minority amount of shares in another retail store and, if so, how much. The regulations say, in essence, that LPs cannot own more than 9.9 per cent of any other retail store.

Beyond ownership, the regulations also say LPs cannot have any influence over a store that would result in “control in fact” of that store, leading the cannabis industry to wonder what “control in fact” means and whether retail stores could be franchised. So allow me to clarify: They can be.

Franchising a business and owning a business are two very different things. A franchisor does not (typically) own any portion of its franchisees’ businesses. A franchisor grants licenses to independently owned and operated businesses to use the franchisor’s brand and operating standards. Franchise agreements permit franchisors to require that those standards are followed. Franchisors do not get involved in, or control, a franchisee’s day-to-day operations, nor do franchisees want them to. Franchising is a proven format where small businesses can succeed by leveraging the strength of a well-known brand and its support infrastructure.

Ontario’s franchise legislation contains a statutory definition for a “franchise” that includes the right to exercise significant control over the franchisee’s “method of operation.” In other words, franchisors provide the playbook that franchisees need in order to maintain a uniform customer experience.

That is not the same thing as the “control in fact” over a retailer. “Control in fact” is a long-established legal concept that relates to one party’s ability to control the corporate governance and ownership interests of another party. In other words, the ability to actually control a business or person.

Those elements do not exist in the franchise relationship. A franchisor does not exercise “control in fact” over an independently owned franchisee. By definition, a franchise instead involves control over a “method of operation”.

These are distinct legal concepts, and I believe the government’s use of “control in fact” is consistent with its objective of restricting vertical ownership of cannabis stores by LPs.

Recently, I volunteered on a task force of the Canadian Franchise Association to meet with the Attorney-General’s office and convey that franchising should not be restricted in retail cannabis regulations. Our message was clear – franchising and ownership are two distinct means of structuring a business relationship, and small business is supported, jobs created and local communities engaged when franchising is permitted to flourish without restriction. Franchisees are small-business owners.

The benefits of franchising are completely aligned with the policy objectives of the provincial government in crafting retail cannabis laws, namely to support and protect small business. When announcing in September that LPs would be restricted from owning more than one retail store, Finance Minister Vic Fedeli said: “We want to open up the marketplace. This is an opportunity for small business to get involved. We want to have as many participants as possible be involved.”

Had the Ontario government intended on restricting LPs from franchising cannabis stores to independent business owners, it would have specified that a “franchise” or “controlling an operator’s method of operation” are prohibited for an LP. These terms already exist in provincial legislation.

The government backstopped its objective of restricting LP ownership by referencing “control in fact” instead, which aligns with the government’s stated aim. If these objectives were to be realized, franchising had to remain an option.

The province opted to restrict relationships where LPs exercise “control in fact” over a retail operator. And that makes sense. The province wants to free the cannabis retail market to competition and small-business participation. An LP’s “control in fact” over a store is no different than the LP owning the store itself. Small business thrives under the franchise model and the brand strength and operating standards (especially for the handling of a regulated product like cannabis) that franchising affords. LPs will not own or control retail stores in Ontario to the exclusion of small business.

The franchising of cannabis retail stores, whether by franchisors owned by LPs or not, is not prohibited in Ontario. The government objective of involving small business will be realized.

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