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FRANCHISING vs. LICENSING and CHARITIES vs. NON-PROFIT ORGANIZATIONS

The Franchise Relationship & Licensing

Transferring from one person to another, information or industrial or intellectual property rights to enable the transferee to engage in a commercial activity is the basis of franchise and licence agreements, yet simply just another form of contractual relationship. Business entities between them can make a franchise or license agreement of any sort.

In a franchise, the franchisor grants a right to the franchisee to use a distinguishing trade mark or trade name in connection with the supply of goods and services by the franchisee. Due to this arrangement, the franchisee is required to conduct its business in accordance with prescribed operating methods and procedures developed and mostly controlled by the franchisor. An up-front fee is normally paid by the franchisee upon the initial grant of the franchise, and the franchisee’s business makes extensive use of the franchisor’s know-how, expertise, and established business goodwill. Consequently, the franchisor maintains a continuing interest in the franchisee’s business by advising and providing ongoing assistance and expertise, and by checking compliance by the franchisee with common standards and operating techniques required by the franchisor. In turn, the franchisor has a continuing right to receive compensation from the franchisee through fees or lease payments, or by its sale of products to the franchisee for resale.

In contrast, a license is a contract where the owner of a patent, trade mark, copyright, know how or technical data, grants to another (that is, issues a license) the right to use such property for an upfront fee and/or an ongoing royalty fee. Although they are independent contractors, a key distinction between a franchisee and a licensee is the greater ongoing involvement and control exercised by a franchisor in the business of a franchisee, as opposed to that exercised by a licensor in the business of a licensee.

As a result, the franchisor suffers disadvantages from the difficulty of guessing the method and amount of the franchisor’s compensation and the negative effect it could have on the franchisee’s cash flow. The difficulty faced by various franchises in maintaining common standards among them is great, and the transfer of know how does create potential competitors. Bringing to a close a franchise arrangement is not at all easy, and is fraught with the practical difficulties of retrieving confidential information, regaining control over the business location, repurchasing stock and honouring trade debts, as well as the usual conveyancing problems involved in purchasing a business.

Charities & Not-for-profit organizations

Charitable bodies and non-profit organizations are not to be considered as necessarily the same type of entity. Actually, a non-profit organization refers to social clubs, professional groups, recreation or sporting clubs, fraternal organizations and trade groups. If they abide by section 149(1)(l) of the Canadian Income Tax Act (ITA), the incomes of such non-profit organizations is not subject to income tax. As against this, to qualify as a charity, the organization has to satisfy the definition of a “registered charity” given in section 248(1) of the ITA. In order to be considered a charity, the organization has to satisfy the following three conditions:

  1. It must have a charitable object or purpose;
  2. Those objectives or purposes should be exclusively charitable; and
  3. They have to promote a public benefit recognized by the courts, and not a private benefit.

Such non-profits and charitable organizations can be established as unincorporated associations of individuals, trusts or corporations with or without share capital. It is, however, customary that mostly they are started as non-share capital corporations. When set up as a non-share corporation, the not-for-profits/charities enjoy all the benefits and liabilities of a corporation discussed in my Articles about Incorporating. If it is decided to incorporate, the first consideration should be whether to incorporate under Provincial or Federal legislation. Incorporation of such federal organizations are permitted under the Canada Business Corporations Act, only when the objectives are carried on in more than one province. For this reason, in Ontario, such corporations are governed by the Canada Business Corporations Act and the Extra-Provincial Corporations Act. In Ontario, such charitable or not-for-profit organizations are allowed under statutes to incorporate either with or without share capital, while the federal legislation only permits such organizations to incorporate without share capital. There are some problems in incorporating with share capital. For instance, if the shareholders of the corporation die or lose interest in its activities and the corporation holds land, other persons might easily acquire the shares for little or no consideration, and so gain control of the corporation and its real estate. Apparently, a non-share corporation could expel a member for any cause, if permitted by its by-laws. This is not possible in an organization with share capital. It cannot expel a shareholder directly. Normally, a corporation without share capital is financed through the issuance of bonds or debentures, instead of by the sale of shares. Customarily, the operations of a non-profit corporation is to be carried on without monetary gain to its participants, who are known as members instead of shareholders. Nonetheless, section 126(2) of the Ontario Business Corporations Act permits reasonable remuneration and expenses to be paid to a director for their services and to any members for services in any other capacity.

The incorporation of such organizations are by Articles of Incorporation under both the provincial and federal statutes, and the objects of such corporations must exclude any reference to carrying on business for a profit, except as ancillary to the philanthropic, charitable, educational, religious, scientific, artistic, social, professional, fraternal, sporting or athletic nature of the corporation. A board of directors manage the affairs of such a corporation.

If the articles of incorporation do not state otherwise, under provincial statute, the interest of a member in the corporation is not transferable but lapses and ceases to exist upon death or resignation from membership. According to the Ontario Business Corporations Act, the directors could pass by-laws to regulate the suspension and termination of membership by the corporation and its members. The articles of incorporation or by-laws could also stipulate that membership be divided into different classes, like honorary members, life members and ordinary members, and different voting rights attached to different classes of membership.

Considering that these corporations are essentially non-profit organizations, the provincial statute says that a by-law may be passed stating that upon dissolution and after the payment of all debts and liabilities, the remaining property shall be distributed or disposed of to charitable organizations or to organizations whose objectives are beneficial to the community. The Ministry of Consumer and Business Services stipulates that such a clause be included in the Articles of Incorporation of charitable corporations.  If there is no such clause in the articles of incorporation, the provincial statute rules that the property of the corporation, upon dissolution and after the payment of all debts and liabilities, is distributed equally among the members, hence in contrary to the entire objective of a charity or not-for-profit organization.  Once incorporated, and depending how, a charity license needs to be applied for with the Canada Revenue Agency.

Starting a Franchise as a franchisor or purchasing a franchise as a franchisee, as well as founding a charity or not-for-profit organization almost for certain requires the assistance of an expert lawyer like those at Levy Zavet PC.  Contact the business lawyers at Levy Zavet PC the next time you embark on a franchise arrangement or non-profit.

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