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The rise of cannabis retail franchising

The right to apply for one of the 25 retail store authorizations (RSAs) in Ontario was awarded via a lottery and rules were put in place to ensure that the people who won and were subsequently licensed would not be permitted to change their entity structure or effect a change of control for essentially a year after the lottery was conducted.

When the lottery results were announced in January 2019, there were zero familiar cannabis brands amongst the winners. Cannabis companies sprang into action immediately. Lottery winners were suddenly inundated with phone calls and messages from various companies looking to help them out with their soon-to-be store.

While the lottery rules prohibited change of control and change of ownership, there were no prohibitions on the use of someone else’s branding on a store or the enlisting of service providers who could provide advice and guidance to ensure that these lottery winners would be able to run their stores in a competent and profitable fashion.

As a result, when the store names were disclosed to the public later in the licensing process, an overwhelming number of them were the names of recognized (or soon to be recognizable) cannabis brands. The Alcohol and Gaming Commission of Ontario (AGCO) took an exceptionally conservative view of what constituted a change of control or a change of ownership. In many cases, this required what were otherwise commercially reasonable business arrangements to be reworked significantly to alleviate any concerns the AGCO may have had.

Although the arrangements were, in my view, beneficial to everyone, the arrangements were arguably not ideal to anyone. Many people despised the idea of a lottery altogether and cannabis companies would have much preferred to simply have opened their own stores, as they originally planned, as opposed to launching their brands though stores that were owned and operated by individuals over which they could exert little control. Quite a scary proposition entrusting the reputation of your relatively new brand to someone who was essentially a complete stranger and who legally had final say over everything that occurred at the store. The lottery winners I am sure some would have liked nothing more than to have cashed out instantly, or handed over the keys and taken a hands-off approach while they went back to their existing lives, but the AGCO ensured that was not going to happen and that the winners would need to continue to play an active and controlling role in their stores.

Second lottery
On July 2019, the Ontario Government announced that an additional 42 RSAs would be awarded through a second lottery – which was conducted in August 2019. While the rules for the second lottery would differ slightly from the first, the result would be the same; the ability to own and open a new cannabis retail store would depend entirely on the luck of the draw.

While the announcement of a second lottery and the further postponement of an open application system was disappointing news for most, many cannabis brands simply replicated what had transpired in the first lottery. Again, when the names of the potential stores were publicly announced many familiar brand names appeared on the list.

Continuing trend
On December 12, 2019, the Ontario Government unexpectedly dropped the news that everyone had been waiting for all year, a shift to an open application system would begin starting January 6, 2020. However, the announcement came with a small but important caveat. Companies and their “affiliates” (a technically defined term in the regulations), would only be permitted to own and operate up to 10 store locations up until September 2020, up to 30 store locations up to September 2021 and up to 75 stores thereafter. This cap on locations meant that companies looking to have an immediate presence beyond 10 stores would need to look into a licensing or franchise model. What some of those companies may not have known is that they may already have been living that relationship through the arrangements they had made in the first and/or second lottery.

Franchising in Ontario
Many people erroneously think that a franchise relationship only exists if both parties knowingly create such a relationship. This is not the case and parties can unwittingly find themselves in a franchise relationship if they meet certain criteria that is set out in provincial legislation.

The legal definition of a “franchise” is somewhat long and winded. For this article, we can simplify the definition as a business relationship in which:

One party is granted the right to conduct business under someone else’s trademark, trade name or logo;

A fee is charged (whether ongoing or one time, directly or indirectly); and

The party granting the rights to use the trademark, trade name or logo exercises significant control or offers or exercises significant assistance to the operator.

Determining whether a particular relationship constitutes a franchise is a fact-specific analysis. Not every brand who has licensed its logo and name to a store owner is necessarily a franchisor. Even relationships which may appear to look like a valid franchise relationship may fall under certain limited exceptions that are provided for by law, rendering them immune from the provisions of the legislation.

Depending on the content of the contractual arrangements, and most importantly the level of advice and support provided, it is possible that some companies and store owners unwittingly entered into franchise relationships without either ever intending to do so.

Franchising is not necessarily a bad thing. However, it does mean that certain fundamentally important rights, responsibilities, obligations and remedies are automatically imposed on both parties over and above (and potentially despite) what the contracts state. Engaging in a long term business relationship where one or both sides are not fully aware of the rights and obligations imposed on themselves and on the other side is a recipe for disaster.

Thankfully, given the current cap on RSAs, many brands are looking to expand their presence and foothold in the market through franchising and are starting to get proper advice so that both sides enter the relationship with their eyes wide open, instead of stumbling into unexpected legal realities mid-way through a lengthy relationship.

Cannabis retail franchising in Ontario was born out of unique regulatory circumstances. Those same regulatory circumstances will ensure that franchising remains a large portion of the provincial retail cannabis model for some time to come.

Matt Maurer is the vice-chair of the Cannabis Law Group at Torkin Manes LLP in Toronto.