Franchising in the Cannabis Sector
In the wake of Canada’s legalization of recreational cannabis use and Ontario’s release of the licensing schemes for private cannabis sale, a number of cannabis companies have organized franchise systems to capitalize on this new market. As a result, potential franchisees and franchisors are seeking answers to a variety of questions with respect to cannabis retail franchises.
- What are the potential benefits of purchasing a cannabis retail franchise?
- What limitations does the existing cannabis legislation have on the franchise model in this sector?
- What factors should franchisors and franchisees in this industry consider when negotiating and preparing to sign a franchise agreement?
What are the potential benefits of purchasing a cannabis retail franchise?
A franchisee who enters into a franchise agreement with a franchisor who is knowledgeable and experienced in the cannabis industry may be afforded a variety of benefits such as: (i) strategic site selection and an understanding of applicable municipal zoning restrictions; (ii) assistance in obtaining the necessary cannabis licences and approvals from the Alcohol and Gaming Commission of Ontario (the “AGCO”); (iii) store layout, product selection and merchandising tactics; (iv) brand recognition and goodwill; (v) effective online marketing; (vi) financial management; and (vii) human resources, such as hiring and training staff.
What limitations does the existing cannabis legislation have on the franchise model in this sector?
In Ontario, the sale of recreational cannabis through retail stores is a highly regulated industry, which imposes certain requirements on its participants, including retail operator licences, retail store authorizations, cannabis retail manager licences, security clearances and regular reporting obligations. The Cannabis Licence Act, 2018 (the “CLA”), the regulation under the Act (Ontario Regulation 468/18), and the Registrar’s Standards for Cannabis Retail Stores, passed under the CLA and the Regulation, impose certain restrictions on cannabis businesses and retail operations, which may impact cannabis franchises in a variety of areas such as:
- store premises, equipment and facilities, including surveillance and security;
- safeguarding the business against unlawful activities;
- advertising and promotion;
- staff training standards;
- protection of store assets; and
- record keeping and confidentiality.
What factors should franchisors and franchisees in this industry consider when negotiating and preparing to sign a franchise agreement?
There are a number of factors that a franchisor and franchisee should consider when negotiating and preparing to sign a franchise agreement in the retail cannabis sector, including, but not limited to:
- the roles of the franchisee and other stakeholders in the franchise, the current lack of clarity surrounding whether a franchisor has the right to control the retail operator licence and retail store authorization, and the legal requirement that a retail operator and retail manager each obtain a retail manager licence if these roles are assumed by two different parties;
- the location of the retail store, compliance with the AGCO’s site-selection requirements, and the impact of the selected site and the AGCO’s requirements on proximity between franchise locations in the franchise system;
- restrictions on leasing rights, the Registrar’s requirement that the holder of a retail operator licence control the store’s assets, and the unanswered question regarding whether the franchisor has a right to hold the head lease and subsequently sublease the premises to the franchisee without violating this requirement;
- the responsibility of obtaining the necessary licence(s) and approvals from the AGCO, potential delays in the completion of a franchise deal due to the complexity of the franchise structure and pending approvals, and the continuing obligation of the parties to notify the AGCO of any material changes to the information submitted during the licencing process;
- the impact of the Registrar’s authority under the CLA to establish standards and requirements with respect to the operation of cannabis retail stores;
- discrepancies between the requirements in the Arthur Wishart Act, 2000 and the CLA regarding scope of franchise disclosure;
- the extent to which the franchise agreement permits the franchisor to alter the business model of the franchise system and whether it may be preferrable to allow for more local store customization than what may typically be afforded in a different franchise system, given the novelty of the cannabis retail industry and its rapid evolution;
- the impact of termination of the franchise agreement on the cannabis licence and the agreement being conditional on obtaining and maintaining all required authorizations and licences in good standing;
- the franchisee’s risk of being non-compliant under the CLA and/or losing its cannabis licence due to the franchisor violating its own obligations (i.e. with respect to record keeping, marketing or promotion, confidentiality, etc.) and the potential inclusion of a requirement in the franchise agreement that the franchisor indemnify the franchisee against costs and damages incurred as a result of such violations;
- enforceability of restrictive covenants, such as a non-compete restriction that is inconsistent with the Registrar’s requirement that the holder of the retail operator licence be in control of customer lists and other records; and
- whether there are limits on the franchisor’s right to access the information in the store’s point-of-sale system and how to reconcile the Registrar’s requirement that retail operators maintain security and confidentiality of records with the franchisor’s desire for access.
Unlike in the United States where the growth of cannabis retail franchises may be impeded by varying state laws, Canada’s federal legalization of the sale of recreational cannabis through retail stores has provided franchisors and franchisees with more opportunities to develop expansive retail systems and to build well-known brands across the country. As touched on in this blog, there are a number of factors to consider and requirements to fulfil when purchasing/selling a cannabis retail franchise, when entering into a franchise agreement and while operating a retail cannabis store. The most successful businesses in the Canadian cannabis industry will be guided by comprehensive legal advice that is responsive to the complexities and evolving nature of cannabis law.