Buying a Franchise in Canada. Tony Wilson

for that industry is less in other systems, perhaps this is worthy of discussion with the franchisor. Consulting a publication such as the current year’s edition of The Franchise Annual will give you an overview of what the going rates are in various business categories.

      Note that franchisors will often have a clause in the agreement that provides that under no circumstances will the franchisee “withhold any royalty or other payment due and owing to the franchisor.” It goes without saying then, that in the absence of special circumstances, failure to pay royalties is normally considered a material breach of the franchise agreement that could lead to the franchisee’s termination by the franchisor. (See Chapter 8 for more information about royalties.)

      5. Withholding Taxes on Royalties

      It is important that the US franchisor (or any other non-Canadian franchisor) understands that the Canadian franchisee has an obligation to deduct withholding taxes on the royalties and similar monies owed to the non-Canadian franchisor and remit them to Canada Revenue Agency (CRA). Withholding tax requirements are in place to make sure that the taxes are paid before the funds are paid to the non-Canadian franchisor. As a franchisee, you are required to withhold approximately 15 percent of the royalties or other payments to the franchisor and send them to the CRA.

      Should you, as the franchisee, have to pay more than the stipulated amount of royalties just because the franchisor did not contemplate that withholding taxes would have to be paid? After all, the non-Canadian franchisor could have created a Canadian subsidiary and effectively avoided this problem.

      The US-based franchisor will always take the position that you, the franchisee, are responsible for paying the withholding tax. The addition of this extra tax might not make the venture ecomonic for you. CRA will assess you, the franchisee, in the event the withholding tax is not paid. This is an important issue to address with all non-Canadian franchisors and should be resolved before you sign the agreement.

      6. Limited Liability Company

      Often, the franchisee will be a limited liability company, which is also called a corporation. A limited liability company is a distinct legal entity that exists at law separately from its shareholders, officers, and directors. This means that the shareholders, officers, and directors of a company are not personally responsible for the debts and obligations of their company unless they specifically agree to be responsible for such debts and obligations (e.g., by way of a personal covenant or personal guarantee).

      In very limited circumstances, certain statutes (particularly environmental and tax statutes) can impose personal liability on directors, shareholders, and officers of a company, making such persons liable for the company’s debts, although this “piercing of the corporate veil” is not common.

      The issue here is that you would probably prefer not to sell the house and liquidate the RRSPs if the venture fails. By incorporating a limited liability company and operating the franchised business through that company, personal liability for the company’s debts can be minimized, unless you agreed to assume those liabilities personally by way of a guarantee or personal covenant.

      There are also tax-planning reasons why a franchised business such as this one might be operated through a company (i.e., dividends are treated differently for tax purposes than employment income from wages, and there are potential tax planning strategies that are better suited to a corporate entity).

      Another reason why a company is often used as the franchisee has to do with banks; banks and other commercial lenders sometimes require their business loans to be made to corporations, even though the borrower may be borrowing the money in his or her personal capacity for an inexpensive franchise. The bank’s lending policies may require that the loan originate from its commercial loans department, rather than from the personal loans department (the latter handling your mortgage or car loan).

      The commercial loans department makes all of its loans to corporations; so they normally require you to be incorporated because that’s what the department is streamlined to do. The bank’s own internal policies may dictate that you have to use a company so that it can loan to your company.

      Sometimes, the franchisor will require the franchisee to be a living, breathing person (or persons), not a company. However, the “individual” franchisee will be permitted to assign and transfer the franchise agreement to a company that he or she personally owns. This is one way the franchisor can obtain a personal covenant, like a guarantee, where a living, breathing person (and not an inanimate entity like a corporation) signs on the dotted line and puts themselves personally “on the hook” for any money owing to the franchisor.

      7. Your Personal Liability

      Some franchise agreements will be drafted such that a corporation that you have created is in fact the “franchisee” under the franchise agreement and that the obligations of your corporation under the agreement are guaranteed by you in your personal capacity. In other words, you, as guarantor, will be called on to pay the obligations of your company under the franchise agreement if your company doesn’t pay.

      Other agreements are structured in reverse. That is, you are the individual with whom the franchisor is principally dealing and you are entitled, after execution of the franchise agreement, to assign your interest to a company that you own. In this way, you (being the individual who signed the contract in your personal capacity) will still be personally liable for the obligations of the corporate franchisee if your company fails to pay its obligations to the franchisor, but you are allowed to run the franchise through your company for tax and related reasons. Indeed, through a company you may reduce your exposure and liability to third parties. But as you originally entered the franchise agreement personally, you are still personally responsible even though you “assigned” it to your company.

      Still another form of structure gaining some popularity is one in which both you and your company are collectively referred to as the “franchisee.” Remember, your company is a separate legal personality, just like you are. Here, you and your company are on the hook: your company is the franchisee but you are also the franchisee (e.g., Mr. Smith and Smithco Ltd. both signed on as franchisees and are each liable to perform their covenants and obligations under the agreement). It’s done because there are defences available to guarantors at law that might not be available to franchisees who entered the agreement in their personal capacitates. The franchisor could bring an action against you as “franchisee” or your company as “franchisee,” and it would probably bring an action against both of you, on the basis that if your company has no money, you might.

      Other agreements have far more ephemeral language. They don’t refer to the guarantor of the agreement being a guarantor. Instead, they refer to the person signing the agreement in his or her personal capacity as “associate.” Whether they are called “associate” or otherwise, generally, if someone signs a franchise agreement in his or her personal capacity (i.e., using his or her personal name), he or she will be personally bound (giving credence to the old legal adage “you sign it, you eat it”).

      Obviously, as a prospective franchisee, you should consider speaking to an accountant or tax lawyer about possible tax consequences in respect of each form of organization.

      7.1 Spouses as “franchisee”

      All too often spouses who jointly own the franchisee corporation and jointly guarantee the obligations of the corporation, or the husband and wife jointly sign as “franchisee” in their personal capacities.

      Given that not all such business opportunities succeed, would you, as a prospective franchisee, really wish to have your spouse exposed to this potential liability? This is especially so where only one of you will be actively involved in the franchised business. In other words, if a guarantee or personal covenant is required, must both you and your spouse take on the potential exposure? Or should only one of you be the covenanting party, taking the risk and being prepared to take the loss; the other party being shielded from such loss?

      Too often, one spouse,