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A world of unknowns in franchising cannabis retail outlets

Interest in franchising cannabis retail outlets is growing ahead of proposed legalization of recreational use this fall, but both prospective franchisors and franchisees need to be aware of the current risks and lack of clarity in this space, Calgary franchise lawyer Sam Khajeei tells AdvocateDaily.com.

“There are a few things they have to keep in mind. The first is that the retail sale of cannabis products hasn’t been legalized yet. So, we can’t permit franchisees to commence actual operations under their franchise agreements until formal legalization,” says Khajeei, an associate with Nerland Lindsey LLP.

“The other is because the laws really haven’t been flushed out yet, we don’t actually know some of the things that a prospective franchisee would want to know about setting up the franchise,” he adds.

Indeed, although Khajeei is working with companies looking to franchise their model upon legalization of the actual retail sale of cannabis, he says the difference between franchising a cannabis retail outlet and any other business is the amount of uncertainty in the sector at the moment.

Generally, in provinces with franchising legislation, namely B.C., Alberta, Manitoba, New Brunswick, Ontario and P.E.I., following the completion of due diligence, franchisors are required to send a franchise disclosure document to anyone interested in taking on a franchise. Once the disclosure document is sent out, nothing can be signed and no money advanced to the franchisor for 14 days.

“The franchise disclosure document contains all sorts of information on how to set up the franchise, the risks related to setting it up and a whole slew of disclosure on what it means to be a franchisee, including details on what the costs might be to set up in a particular area,” Khajeei says. "That document’s very helpful for a franchisee. But the issue is, for a cannabis franchisor, it also has some uncertainty in it, because, for example, some of the fees that the franchisee will have to pay are not as clear as it is for other franchises.

“The reality is, no one has set up a shop to sell legal recreational cannabis to retail consumers. The laws aren’t there yet, so there may be costs to incur or permissions to procure that we're not yet aware of.”

There are also unknowns when it comes down to territory, says Khajeei, because in a typical franchise arrangement, the parties agree on a location and enter into a lease.

“In our case, we’re not actually able to do that, because we don’t know what the exact rules and regulations will be as it relates to the location,” he says. “So there are some uncertainties relating to territory and exclusive territory of a franchisee and the location of the premises.

Despite the uncertainty in the sector at the moment, Khajeei says clients interested in franchising cannabis businesses are still moving forward with the preparation of documentation in accordance with franchise laws, but with two important caveats.

“What I’m seeing right now is people basically entering into agreements such that if the legalization passes, then those agreements kick in. But they are contingent on certain things,” he says.

“The first is that the contractual obligations are conditional on legalization; in the event that legalization doesn’t happen in the particular jurisdiction the franchisee is asking for, then there’s a return of their initial franchise fee, akin to a refundable deposit.

“The second is there’s a strong risk acknowledgement at the beginning of these agreements that really highlights for the franchisee the inherent risks. So if they're not prepared to go forward on the basis of that, they do not get involved,” Khajeei says.

Ultimately, he expects more certainty after the proposed legalization date of Oct. 17. But even then, he says, it will also come down to applicable provincial and municipal laws.

“Just because the government of Canada proceed with legalization doesn’t necessarily mean that there will be permitted operation in the province or in the city that the franchisee is proposing to locate their store,” Khajeei says.

“We also need the provincial and municipal level to give us some guidance, and that will impact how a cannabis franchisee business really works,” he adds.

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