Is your disclosure document “fatally flawed”? – The Certificate

A recent decision of the Superior Court of Ontario serves as a strong reminder that franchisors must pay close attention to the content of the disclosure document that they provide to prospective franchisees and the manner in which that disclosure is provided.

In the decision of Sovereignty Investment Holding, Inc. v. 9127-6907, Justice Wilton-Siegel found that the disclosure document provided by the franchisor to the prospective franchisee contained four fatal defects. Each defect, considered by itself, was enough to allow the judge to find that no disclosure document had been provided to the prospective franchisee.

Subject to some limitations, when a franchisor fails to provide a disclosure document that meets the requirements of the Ontario franchise legislation, the Arthur Wishart Act (Franchise Disclosure), a franchisee may be entitled to rescind its franchise agreement. As some franchisors have found out the hard way, this rescission remedy provides a powerful recourse to franchisees against their franchisor. Once this remedy is triggered, a franchisor will, generally speaking, be required to pay to the franchisee all amounts invested by the franchisee in the franchised business as well as all amounts paid to the franchisor, including royalties, rent payments, and advertising fees.

The four deficiencies identified by the judge in the Sovereignty case were (i) lack of a dated and signed certificate from the franchisor attesting to the truthfulness of the disclosure document; (ii) failure of the franchisor to include up to date financial statements; (iii) failure to provide a disclosure document as one document at one time to the franchisee (i.e. in piecemeal fashion); and (iv) failing to include a statement which provided the basis for earnings projections provided by the franchisor to the franchisee.

The fatal defects listed by the judge in Sovereignty do not comprise a closed list of the ways in which a disclosure document might be flawed so as to entitle a franchisee to the rescission remedy.

Failure by a franchisor to include a signed and dated Certificate in its disclosure document is a particularly interesting defect of disclosure, given the importance of the Certificate and the relative ease with which a franchisor might neglect this crucial aspect of the disclosure document.

The statutory requirement relating to Certificates is set out at section 7 of the regulation to the Arthur Wishart Act, which requires that every disclosure document include a Certificate certifying that the document contains no untrue information, representations or statements and includes every material fact, financial statement, statement and other information required by the Act and this Regulation. The Certificate must be signed and dated (i) in the case that a franchisor is not incorporated, by the franchisor, (ii) in the case of a franchisor that is incorporated and has only one director or officer, by that person, or (iii) in the case of a franchisor that is incorporated and has one officer or director, by at least two persons who are officers or directors. It is important to note that who is an officer and director may well not be limited to officers and directors of record filed with the government registries.

The purpose of the Certificate is to assure the franchisee that a senior person within the franchisor’s organization has taken the time to check the accuracy of the representations that are made in the disclosure document about the franchise system. It also provides a clear identification to the prospective franchisee of “who” the franchisor really is. Because those who sign the Certificate may be held personally liable for mis-statements contained in the disclosure document, the certificate is one means of encouraging the necessary fact checking with respect to the content of the disclosure document.

From the franchisor’s perspective, because the Certificate must contain a date, it enables the franchisor to assess the validity of its disclosure at different points in time and may assist the franchisor in availing itself of the limitation periods that exist under the Act.

A franchisor’s failure to include a properly signed and dated Certificate in its disclosure document creates serious legal exposure – the court’s award in the Sovereignty case, it might be pointed out, was in excess of $1 million. In future articles, this space will discuss the more common of the “fatal defects of disclosure” and highlight best practices in disclosure design.