Common Pitfalls of Franchise Disclosure Documents in Canada

Author: lvouloukos@lawrences.com

Date: JUL 29th, 2014

Topic: Industry Experts

Franchisors selling franchises must provide prospective franchisees with a pre-sale disclosure document, according to Ontario’s franchise specific legislation, the Arthur Wishart Act (Franchise Disclosure) 2000 (“the Act”). For those unfamiliar with Ontario’s franchise laws, disclosure documents can be full of pitfalls. These are some of the more common ones we encounter in our practice.

1. Piecemeal Franchise Disclosure

The Act requires that a franchise disclosure document be “one document, delivered… as one document at one time”. Too often, franchisors provide disclosure to their franchisees piece by piece—the franchise agreement one day, financial statements on another day, and earnings projections on yet another day. Should a disagreement arise, failure to comply with the Act’s very technical requirement for the franchise disclosure document to be delivered as “one document at one time” will invalidate the franchise disclosure document, with potentially devastating consequences for the franchisor. Recent court cases have confirmed this.

2. Inclusion of All Agreements Relating to the Franchise Opportunity

The Act requires that a franchise disclosure document contain copies of all proposed agreements relating to the franchise that are to be signed by the prospective franchisee. If the deal will include lease, supply, or security agreements, these form part of the disclosure document and must be included with the franchise agreement.

3. Franchise Earnings Projections

Although the Act does not require franchisors to provide earnings projections, if they choose to do so, they must meet the requirements set out in Regulations to the Act. This means that franchisors must provide a statement specifying the basis for the projection, the assumptions underlying the projection, and a location where the information substantiating the projection is available for inspection. Too often, franchisors do not provide this information. Failure to do so will invalidate your disclosure document and again, recent court cases have confirmed this.

4. Franchise Financial Statements

Unless an exemption applies, the Act requires that a disclosure document contain either audited or review engagement financial statements for the most recently completed fiscal year of the franchisor’s operations, prepared in accordance with Canadian accounting standards. We often find that franchisors either neglect to include current financial statements, or, as is often the case with U.S. franchise systems operating in Canada, they include financial statements prepared in accordance with U.S. rather than Canadian accounting standards.

5. All Material Facts

The Act requires that a disclosure document contain “all material facts, including material facts as prescribed”. The phrase in italics refers to the material facts set out in the Regulations to the Act. These are not the only material facts, however. Too often, we encounter disclosure documents that contain only the material facts listed in the Regulations to the Act, but not all material facts. For example, a description of the competition, or how a franchisor will administer an advertising fund, are likely important material facts to the franchisee, but they are not in the list of material facts required by the Regulations. In order to comply with the disclosure obligations set out in the Act, franchisors must go beyond the Regulations and disclose all material facts, in addition to those set out in the Regulations.

The consequences of failing to comply with the Act’s disclosure requirements can be devastating. The best way to avoid common disclosure pitfalls is to ensure that your disclosure document is prepared by an experienced franchise lawyer.