The Dangers of Dabbling in Franchise Law

Franchise Law is a trap for the unwary lawyer.  Given the broad definition of “franchise” under franchise legislation, an unwary lawyer may not identify that a commercial transaction is in substance a “franchise”, which may then impose a disclosure obligation on the party deemed to be a “franchisor”.  Secondly, the preparation of a valid disclosure document, and the circumstances in which a disclosure document must be delivered, are increasingly complex.  The consequences of getting it wrong can be significant, not only to the public, the client, and to various individuals related to the client, but also for the lawyer. According to LawPRO’s most recent statistics the average dollar value of a negligence claim against lawyers in franchise matters was approximately five (5) times the claim value in almost every other area of law. 

Franchise Legislation in Canada

In Ontario, as well as in five (soon to be six) other Canadian provinces^[1], the respective rights and obligations of franchisors and franchisees are in part governed by the Arthur Wishart Act (Franchise Disclosure), 2000^[2] (the “Wishart Act”).   The main policy goals of the Wishart Act are to: (a) provide prospective franchisees with the information they need to make an informed decision about purchasing a franchise; and (b) create a commercial framework that governs the relationship of the parties. The Wishart Act, and other provincial franchise legislation, is remedial and is akin to consumer protection legislation, enacted to rectify a perceived imbalance of power favouring the franchisor.  The courts have generally given it a liberal interpretation.  

Under the Wishart Act, the term “franchise” is broadly defined.   Lawyers need to look at the substance of the business relationship to determine whether it is a “franchise”.  Just because an agreement is described by another name, does not mean it is not a “franchise” agreement and therefore subject to the Wishart Act.  There are, however, certain relationships which are excluded from the application of the Wishart Act. 

As part of achieving the first policy goal, a franchisor must provide a franchise disclosure document (FDD) to each prospective franchisee no later than 14 days before the earlier of the franchisee:

1. signing the franchise agreement or any other agreement relating to the franchise, or

2. paying any consideration relating to the franchise (i.e., collectively, signs or pays). 

The FDD is to be certified by two directors or officers of the franchisor (unless the franchisor has only one person serving as director and officer) as true and complete and must contain the following:

(a) all material facts^[3], including material facts as prescribed by the regulations;

(b)financial statements as prescribed;

(c) copies of all proposed agreements;

(d) the prescribed statements (these are found at the beginning of the disclosure document); and

(e) other information and copies of documents as prescribed.

The disclosure process begins when a franchisor provides a prospective franchisee with the FDD and ends when the prospective franchisee signs the franchise agreement. The time between those two events must be at least 14 days but could continue for additional weeks or months. If during the intervening period there are any “material changes”^[4] to the information provided or that should have been provided in the FDD, the franchisor must deliver a statement of material change to the prospective franchisee as soon as practicable after the material change has occurred, but in any event before the prospective franchisee signs or pays.  There are, as well, a variety of circumstances exempting a franchisor from its obligation to provide a prospective franchisee with an FDD.

The Wishart Act provides that a franchisee may rescind the franchise agreement no later than:

1. 60 days after receiving the FDD if:

(a) the franchisor fails to provide the FDD, or statement of material change within the time requirements.  This includes a situation in which an intermediate step is taken by a prospective franchisee (i.e., the payment of a deposit or the signing of a letter of intent) and who does not receive a disclosure document until after having taken this step; or

(b) the contents of the FDD do not meet the requirements of the Wishart Act but are otherwise not so deficient to permit the franchisee a two (2) year right of rescission (referenced in item 2 below). 

2. 2 years after signing if:

(a) the franchisor never provided an FDD; or

(b) the FDD was so deficient it constitutes non-disclosure i.e. as if the franchisor never provided an FDD.  

Judicial interpretation of the Wishart Act and of provincial franchise legislation by other provincial courts, has resulted in holding franchisors to a relatively high standard of disclosure to ensure that the franchisee “can make a properly informed decision about whether or not to invest in a franchise.”   Examples of this standard include granting a franchisee the right to rescind in the circumstances in which: (a) the franchisor: (i) failed to include a certificate in the appropriate form signed, and dated, by the required number of officers or directors of the franchisor; (ii) failed to provide financial statements as required; or provided stale dated (not current) financial statements, or financial statements which did not contain proper notes; (iii) failed to provide a statement of material change in circumstances where it was required; (b) provided a disclosure document in successive stages and not as one document at one time; (c) did not include copies all agreements that the prospective franchisee was required to sign, in the disclosure document; and (d) the franchised business was the first of its type (i.e. outside of a shopping mall) in the franchisors’ system. 

In the event of a rescission, the Wishart Act requires that the franchisee be placed back in the same position as if the franchisee never signed the franchise agreement.  This requires that the franchisor, and those parties deemed to be a franchisor’s associate, within sixty days of the effective date of the rescission, to:

(i) refund to the franchisee any money received from or on behalf of the franchisee, other than money for inventory, supplies, or equipment;

(ii) purchase from the franchisee any inventory that the franchisee had purchased pursuant to the franchise agreement and remaining at the effective date of rescission, at a price equal to the purchase price paid by the franchisee;

(iii) purchase from the franchisee any supplies and equipment that the franchisee had purchased pursuant to the franchise agreement, at a price equal to the purchase price paid by the franchisee; and

(iv) compensate the franchisee for any losses that the franchisee incurred in acquiring, setting up and operating the franchise, less the amounts set out in (i) to (iii).

The result is that a franchisor, and those individuals who are deemed to be franchisor’s associates, can be liable for hundreds of thousands of dollars in damages.

As well, if a franchisee suffers a loss because of a misrepresentation^[5] contained in the FDD or a statement of material change, or because of the franchisor’s failure to comply with the requirements of Wishart Act, the franchisee has a right of action for damages. In respect of both the foregoing losses there is personal liability involved for a broad category of individuals.