The Whys and Hows of Preparing a Franchise Disclosure Document

Introduction

To date, only Alberta, Ontario, Prince Edward Island and New Brunswick have enacted franchise-specific disclosure laws.  The New Brunswick Regulations have yet to be proclaimed.  In due course, other provinces may decide to follow suit.  While Quebec has no franchise-specific law, the Quebec Civil Code imposes an obligation to negotiate certain types of contracts in good faith.  The remaining Canadian provinces and territories have neither franchise-specific laws nor the equivalent of Quebec's 'negotiated in good faith' requirement.  While the unregulated provinces do not have any specific obligation to disclose, under common law, there are limitations.  For example, a party will not be insulated in making a factually correct statement in the selling process that will be misleading unless other facts are also disclosed.  Finally, franchisor members of the Canadian Franchise Association are required to comply with that organization's pre-sale Disclosure Rule.  Accordingly, those franchisors disclose even in provinces where no franchise-specific disclosure legislation exists.

Common Pitfalls

The scope of required disclosure is very detailed and broad.  In order to properly complete a franchise disclosure document, the information about the franchisor and the opportunity must be made upon careful consideration and reflection, rather than in a perfunctory manner.  The preparer requires some sophistication in order to produce a properly prepared disclosure document.

Many franchisors in Canada have not approached the exercise of disclosure document preparation with the requisite care and attention resulting in courts deciding that what was delivered to franchisees was in fact not a disclosure document according to the law.  As a result, dissatisfied franchisees have been able to rescind franchise agreements for a period of two years after signing with tremendous consequence to the franchisor upon rescission, the franchisees have been able to recover not only their investment but any losses that they may have incurred and any royalties and advertising fund contributions that they may have paid to the franchisor.  In one recent Alberta case, for example, one hotel franchisee was able to rescind a franchise agreement depriving the franchisor of millions of dollars in revenue over the life of the contract.  The source of the rescission right was the failure of the franchisor to date and sign the certificate of an otherwise apparently complete disclosure document.

Other reported decisions have seen franchisees successfully rescind their franchise agreements as the franchisor either failed to provide a disclosure document to their franchisee upon the renewal of an existing franchise or for failing to ensure that its American disclosure document given to a prospective franchisee complied with provincial law. Even in the case of a disclosure doucment that on its face contained all of the items enumerated in the regulations, a franchise agreement can be rescinded if the franchisor has failed to comply with the overriding duty to disclose all material facts or to provide a notice of material change as and when required.  Rescission limited to a period of 60 days is triggered if the franchisor allows for franchise documents to be signed or receives any money before a 14-day grace period has elapsed from the date that proper disclosure was made.  Backdating documents to bring one into compliance does not work.  Many franchisors fail to provide financial statements as mandated by law or include all of the required contracts; even more troubling, many franchisors neglect to obtain receipts from prospective franchisees that they have indeed received disclosure.    The most frequent error we see is franchisors failing to provide required disclosure as one document as stipulated by law.

Doing it Right

For franchising companies, a valid and enforceable franchise agreement is without doubt their most important asset.  Protecting this asset requires investing effort and resources in the preparation and on-going maintenance/updating of the franchise disclosure document.  In-house counsel or a senior officer of the franchisor should be in control of its preparation and all information flow internally and externally.  In sourcing the required answers and information to prepare or update a disclosure document, the providers of information should be made to understand the need for completeness as well as accuracy and held accountable by being required to sign off on any information they produce.  At the same time, franchisors should engage competent and experienced franchise lawyers.  Competent counsel will review the client-provided information and will question information that appears to be inaccurate to assist in ensuring  that material information is not missing.

Conclusion

Although we have focused on the remedy of rescission in the event of the failure of the franchisor to disclose, all four existing pieces of legislation also provide a statutory action for damages if the franchisee suffers a loss due to a misrepresentation in a disclosure document or due to any other failure of the franchisor to comply with the statutory disclosure content, delivery or timing requirements.  As the franchisee does not have to prove reasonable reliance on a misrepresentation, this reinforces further the need for the disclosure document to be prepared correctly.  In addition, the range of possible defendants in a misrepresentation action can include not only the franchisor and those who sign the certificate of disclosure, but also on the franchisor's broker and sales staff and anyone who is the franchisor's associate.  Just as no franchisor would expose itself to risk by operating without proper financial controls in place, similarly, it can avoid the costly risks of improper disclosure by properly controlling its disclosure processes.