How the Ontario Cannabis Lottery Gave Birth to Cannabis Retail Franchising

The First Cannabis Lottery

It all started on December 13, 2018, the day that the Government of Ontario announced that a temporary cap of 25 Retail Store Authorizations (“RSAs”), would be imposed while domestic cannabis supply stabilized.

The right to apply for one of the 25 RSAs would be awarded via a lottery and, importantly, 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 (e.g. sole-proprietorship to corporation) or effect a change of control for essentially a year after the lottery was conducted.

Many well-known cannabis retail brands who were gearing up to open cannabis stores in the province were devastated. Suddenly their best laid plans to roll out a significant number of locations in Ontario went out the window and their hopes rested, almost entirely, on being lucky enough to win one of the 25 tickets giving them the right to apply to be licensed at a single location. Not to be deterred, many immediately set their minds on how they could still participate in the limited Ontario retail market, if they didn’t win the lottery, despite the fact that the law prohibited a change of control or change of ownership for a year after the lottery was conducted. It was here that the seeds of cannabis franchising in Ontario were sowed.

When the lottery results were announced on Friday, January 11, 2019, there were zero familiar cannabis brands included amongst the winners. In fact, the majority of the people who won were individuals (20) as opposed to corporations (4), with one partnership thrown in for good measure. This is not surprising given that the cost to enter the lottery was a mere $75 and unless someone had a corporation at the ready, spending a few thousand dollars to incorporate a company strictly for entering a lottery with long odds seemed like a poor use of resources.

Cannabis companies sprang into action immediately. By Friday evening lottery winners were inundated with phone calls, emails, text messages, Facebook, Twitter and LinkedIn 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 which would disallow the use of someone else’s branding on a store or which would prohibit the enlisting of service providers who could provide advice and guidance to ensure that these lottery winners (many of which had little to no experience in retail and almost all of which had zero experience in cannabis) would be able to run their stores in a competent and profitable fashion.

As a result, when the store names began being 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. While many people who weren’t privy to the inner workings of the process were outraged and assumed that the brands had somehow sneakily bought the stores, this couldn’t be further from the truth. The Alcohol and Gaming Commission of Ontario (the “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.

Stores were opened relatively quickly because winners were able to draw support from companies that had resources and contacts at their disposal to mobilize quickly. Without the assistance of cannabis companies, which again was heavily scrutinized and entirely permissible within the lottery rules, there is no doubt that stores would have come on line much more slowly. Everyone benefited from these arrangements, the province, consumers, the lottery winners, their employees and the brands themselves.

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 (including the companies that subsequently stepped in to provide support) and preferred a merit based, or first come first serve system. The cannabis companies would have much preferred to simply have opened their own stores as they had planned before the lottery was announced as opposed to launching their brands though stores that were owned and operated by individuals over which the companies 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.

The Second Cannabis Lottery

For most, the arrangements reached in the first cannabis lottery were supposed to be temporary in nature. Certainly the cannabis companies envisioned that in the future they would be opening their own stores as opposed to having to “settle” for a licensing fee for their brand and providing support to store owners for their mutual benefit. While some lottery winners found a passion in having their owns store and quickly determined that their new stores would become a new career path for them, certainly there must have been others who were just waiting for the clock to expire on the lottery period so that a change of control could occur and their store could be sold.

However, in July, 2019, the Ontario Government announced that an additional 42 RSAs would be awarded through a second lottery which would be conducted on August 20, 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 surely disappointing news for most, many cannabis brands sprang into action intending on replicating what had transpired in the first lottery, namely making the best of the situation by attempting to reach permissible agreements with lottery winners to spread their brands further. Again, when the names of the potential stores were publicly announced  many familiar brand names appeared on the list.

The Trend Continues Despite the Shift to the Open Application System

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 legislative definition of a “franchise” is a somewhat long and winded one. For the purposes of this article, we can simplify and distill the definition down to a business relationship in which:

1. one party is granted the right to conduct business under someone else’s trademark, trade name or logo;
2. a fee is charged (whether ongoing or one time, directly or indirectly); and
3. 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 or not is a highly 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 otherwise 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.  

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

Franchising is not, in and of itself, 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. Being engaged 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 (the brand and the store owner) 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.

 

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1.  The lottery rules further ensured that only one winning ticket could be had by any one person or company and their “affiliates”.

2.  The actual new number of RSAs was 50 with 8 RSAs being awarded on a first come first serve basis to First Nations’ Reserves