By Edward (Ned) Levitt
Introduction
Half of Canada’s provinces now have franchise legislation, with more likely to follow suit. To this new reality, add a rapidly growing body of decided cases and it is no wonder that those in franchise organizations or the legal community responsible for franchise regulatory compliance are feeling a lot more stress and worry these days.
The courts have been very clear that this type of legislation is remedial and intended to address the imbalance of power in the franchisor-franchisee relationship. Some of these decisions have applied a very strict interpretation of the wording of the statutes and their regulations. As a result, even minor administrative errors can result in unexpected and costly consequences. How do you protect yourself against such consequences? The answers are: a) know the legislation thoroughly, b) understand the court interpretations of the legislation, c) stay current with new cases interpreting and applying the legislation and d) take great care in the preparation of the disclosure documents and their attachments.
This article will examine some of the traps waiting for the uninformed and some tips on how to stay safe in this increasingly dangerous world of franchise disclosure.
Who Should be Disclosed?
Where the prospective franchisee is an individual or several individuals, i.e. a partnership, then each of them should be disclosed separately. Where the prospective franchisee is an existing corporation, the safest approach is to disclose the corporation and everyone who owns shares in the prospective franchisee, although this is not strictly required by the statutes. In practice, however, this often occurs because the shareholders are also the guarantors of the franchise agreement and, based on existing case law, disclosure is required or the guarantors would have the right to rescind their guaranties for up to 2 years.
It is not uncommon for individuals to be disclosed and then they form a corporation just prior to the franchise agreement being executed. In this situation, the counsel of perfection is to disclose the new franchisee corporation and wait the 14 days. In real life, however, expectations are running high and everyone just wants to finalize the deal. If so, then the recommended course of action is to at least disclose the new corporation, even if the 14 day rule is not going to be followed. In this way, the corporate franchisee’s remedy of rescission will be extinguished after 60 days.
Delivery of the FDD
The typical way in which FDDs are delivered is personally or by registered mail. The New Brunswick statute, Manitoba statute and the PEI statute also specifically allow delivery by courier. The PEI, Manitoba and New Brunswick statutes are the only provincial statutes which permit delivery of disclosure documents electronically. Multiple requirements attach to this option however.
Even where the statute specifically permits delivery by courier, if the FDD is being delivered in this manner, it is wise to have the party effecting the delivery ask for picture ID and execute a brief affidavit as to whom they delivered the FDD. While not required by any of the provincial statutes, it is a common and highly recommended practice to have all recipients of an FDD sign and date a receipt of delivery. An exact copy of the FDD, with a copy of the signed certificate and the original receipt should be retained in the files of the franchisor.
An FDD must contain all required information and attachments delivered as one document at one time. One exception to this rule exists under the Manitoba Franchises Act which allows a franchise disclosure document to be delivered in parts at different times. In such circumstances, the date of delivery of the disclosure document is the date of the delivery of the last document.
Contents of an FDD
(a) Material Facts
Each Canadian franchise statute requires the full disclosure of all “material facts” relating to the franchise. This is a broadly defined term. The key aspect of the definition is a test as to whether or not the fact being considered for inclusion in the FDD would have a significant impact on the decision of a prospective franchisee to purchase the franchise or the price the prospective franchisee would be willing to pay. The courts have held that material facts include a wide array of information that could have a potential impact upon a prospective franchisee’s decision as to whether or not to invest in a franchise system. The conservative approach is to disclose any fact that could possibly have such results.
A challenge lies in the fact that the knowledge of the officers, directors, agents and employees of the franchisor is the knowledge of the franchisor. As a result, it is imperative that everyone who could learn of a material fact be canvassed about their knowledge each time an FDD is to be delivered. In smaller franchise organizations, this can be a challenge. In larger franchise organizations, it can be a nightmare. There are no easy solutions, but the more systematized and thorough the enquiry is of these people, the less likely that material facts will be missed. In larger franchisors, enquiries can be done more efficiently on a departmental basis.
(b) Earnings Projections
Although earnings projections are not required to be provided to prospective franchisees under the Canadian franchise statutes, if a franchisor does choose to make an earnings projection, the FDD must include a statement indicating the reasonable basis for the projection, all assumptions that substantiate the projections and the location where the underlying information is available for inspection by the prospective franchisee. A danger lies in the fact that an earnings projection can be an oral statement made by someone in authority or ostensible authority. As a result, anyone involved in the franchise sales process should be schooled about not discussing any such matters beyond what is authorized by the franchisor.
(c) Certificate of Disclosure
An FDD must be accompanied by an originally signed and dated certificate of the officers and/or directors of the franchisor warranting that all material facts have been provided and that the information provided is true. Questions have been raised as to whether or not certificates can be signed in advance or sent for signature by someone who is a distance away, without providing those individuals with the final copy of the FDD. While the statutes do not specifically deal with such questions, these are dangerous practices, as they may lead to the impeachment of the certificate once it is proven that the signatory did not in fact review the FDD before signing the certificate. Based upon the decided case, this could render the FDD a nullity and allow the franchisee a two year window in which to rescind it.
(d) Existing Franchises and Corporate Units
Across the various statutes, there are differing approaches and formulae for the disclosure of existing units in the system. In PEI, New Brunswick and Manitoba, for example, depending upon the number of existing units in the particular province, disclosure may have to be made regarding existing units in contiguous provinces. For franchisors operating in multiple provinces, this can become challenging and fraught with opportunities for mistakes. Unless there are compelling reasons to do otherwise, the best policy is to disclose in a Canadian FDD the existence of all franchised and corporate units throughout Canada.
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Originally published in the Spring 2013 issue of The FranchiseVoice.
ABOUT THE AUTHOR
Edward (Ned) Levitt is a partner of Dickinson Wright LLP, Toronto, Canada. He served as General Counsel to the Canadian Franchise Association from 2000 to 2007 and, as a member of the Ontario Franchise Sector Working Team, was instrumental in the creation of Ontario’s franchise legislation. Among his many publications is Canadian Franchise Legislation published by Butterworths/LexisNexis.