Superior Court of Québec Confirms Validity of Percentage Royalties Paid by Pharmacist-Owners to Franchisor

by Blake, Cassels & Graydon LLP
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The Superior Court of Québec (Court), presided by Justice M. Monast, recently ruled on an important point of contention for franchise pharmacies, by confirming the validity of a percentage royalty clause contained in a contract between a pharmacist-owner and his franchisor. The decision confirms the validity of the business model recommended by a number of franchisors, for both pharmacists and other professionals that exercise their practice within a franchise framework. Blakes represented Groupe Jean-Coutu (PJC) Inc. (GJC) in this matter.

BACKGROUND

This decision dealt with a dispute originating from an ethics complaint lodged by the Quebec Order of Pharmacists (Order) against Michel Quesnel, a pharmacist-franchisee of GJC in 2008. As a franchisee, Mr. Quesnel remitted royalties to GJC representing three to four per cent of his gross sales, including medication sales, in exchange for the rights, services and benefits provided by his franchisor. The Order argued that in paying this royalty, Mr. Quesnel was effectively sharing the fees and profits derived from the sale of medication with his franchisor, in violation of the Code of ethics of pharmacists, (Code). Section 49 of the current version of the Code reads as follows:

Pharmacists may share the profits from the sale of medications or from their fees only with another pharmacist and to the extent that such sharing is consistent with the division of their respective services and responsibilities.

Before the Order’s disciplinary committee, Mr. Quesnel pleaded guilty to this count because at the time, he thought he had no valid defence to present. The following day, he instituted an action against GJC in which he alleged that the royalty clause contravened section 49 of the Code, was contrary to public policy and was consequentially void. He also claimed the reimbursement of all royalties paid to GJC in the preceding years.

The Court considered whether “a contractual clause, which creates the obligation for a pharmacist to remit to the franchisor a royalty based on the profits derived from the sale of medication, contravene public order and section 49 of the Code of ethics of pharmacists.”

According to the Court, a literal application of this provision would lead to absurd results, given that pharmacists would not be able to use the profits derived from medication sales to pay for expenses related to their pharmacy’s operation. The Court emphasized that the provision’s objective was to preserve pharmacists’ professional independence, to prevent non-pharmacists from becoming pharmacy-owners and to ensure that they would not be able to exert any undue influence on the exercise of the pharmacist profession:

We cannot infer that by using profits derived from medication sales to pay for the operational expenses of a pharmacy, including a royalty for the licences and services received, a pharmacist would be jeopardizing the integrity of their profession or the protection of the public. We also cannot infer that the payment of a royalty threatens the professional integrity of a pharmacist nor their exclusive right of ownership of a pharmacy.

To conclude otherwise would mean that a pharmacist can avoid paying expenses related to the business by simply invoking his or her ethical duties. This interpretation is compatible with that of the Professions Tribunal in the case of Cadrin c. Pharmaciens (Ordre professionnel des).

In this context, the Court reasoned that the fact that a pharmacist uses profits, including profits derived from the sale of medication to pay for franchise royalties, is not contrary to public order, so long as these royalties represented the market value of the services and benefits provided by the franchisor. The Court analyzed the franchise contract between GJC and Mr. Quesnel, as well as the products, services and other benefits that he received in exchange for the royalties. It concluded that the value of this exchange, including the value of the rights of use of the GJC name and trademarks, is reflected in the royalty amount paid by Mr. Quesnel and that the royalty clause, as such, did not contravene section 49 of the Code.

The Court added, as a matter of principle, that the royalty is paid as a percentage of the gross revenue of the franchise, whereas the prohibition contained in section 49 of the Code uses the word “profits” rather than “revenues” — “the English version of this provision uses the word ‘profits’. The lawyers for GJC argued that the French version’s ‘bénéfices’ refers to the accounting notion of net earnings, whereas ‘profit’ corresponds to the accounting notion of net profit.”

In the present dispute, the annual royalty which is paid pursuant to the terms of the franchise agreement is calculated based on gross sales. It is thus not a share of revenues or profits, within the juridical and accounting meanings given to these terms. In addition, the evidence submitted before the Court demonstrated that the franchisees of GJC remitted a royalty in consideration of the rights conferred to them and the services provided.

CONCLUSION

This decision confirms that the pharmacist profession can be validly exercised within a franchise network in Quebec, including the payment of a royalty to the franchisor, based on a percentage of gross sales realized by the pharmacist-franchisee, in exchange for the goods, services and benefits received from the franchisor. This decision is also pertinent for other professionals that exercise their profession as a franchisee, in a network that functions on similar terms and effectively puts an end to the controversy surrounding this issue.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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