By David Lucenti, Associate
So, you are considering buying into a new franchise business and you have just met with the potential franchisor and things sound and look great, until the franchisor hands you a stack of documents and suggests that you take it home and review it. All you want to do is start a new business and now you have all these documents to review.
What do you do?
The simple answer may be to sign and return the documents to the franchisor and start running the business as soon as possible. This is not a wise approach. The documents given to you by the franchisor probably include the franchise agreement and disclosure document. These documents should be carefully reviewed by your lawyer so you can be properly advised of your rights and obligations as a franchisee.
In 2001, Ontario became only the second province in Canada to regulate the franchise industry. The Arthur Wishart Act (Financial Disclosure), 2000 (the “Act”) imposes on each party to a franchise agreement a duty to act in accordance with reasonable commercial standards. The Act imposes the following 3 key duties in each franchise agreement, whether already in existence or new:
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each party to a franchise agreement must act fairly in its dealings with one another;
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the franchisor is not permitted to interfere with or restrict the franchisee’s right to associate with other franchisees; and
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the franchisor must provide a prospective franchisee with a disclosure document, including all material facts and financial information (my emphasis).
The focus of this blog will be the third requirement – the disclosure document.
With respect to the disclosure document, the Act requires a franchisor to provide a prospective franchisee with an accurate, clear, and concise disclosure document at least 14 days before the earlier of the prospective franchisee signing an agreement or, making a payment. The disclosure requirement is quite extensive and includes the following:
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it must be a single, bound document, delivered to the franchisee at one time. Piecemeal disclosure is not permitted;
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it must contain a certificate signed by at least 2 persons who are officers or directors;
- it must contain copies of all agreements related to the franchise. This includes not only the franchise agreement but any sublease (and head-lease if the franchisee is bound to comply with the head-lease), general security agreement and personal guarantee. In essence, any agreement which the franchisee will be required to sign or comply with on closing must be included in the disclosure document;
- it must include the franchisor’s financial statements on an audited or review engagement standard; and
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it must contain all material facts related to the purchase of the franchise. The term ‘material fact’ is defined broadly as any information about a business that would reasonably be expected to have a significant effect on the value or price of the franchise or the decision to acquire the franchise.
But what happens if their disclosure is inadequate or defective?
Under section 6 of the Act, where a disclosure document is provided but is “defective”, a franchisee has 60 days after execution of the agreement to rescind the franchise and any related agreements.
Conversely, if no disclosure document is provided or, if the disclosure document is “materially deficient” in the sense that one of the required elements of a disclosure document is missing, the franchisee has a period of 2 years after execution of the franchise agreement to rescind the agreement. Upon rescission, the franchisor must refund the money paid by the franchisee, purchase the franchisee’s remaining inventory, supplies and equipment and compensate the franchisee for losses relating to acquiring, setting up and operating the franchise.
Although each case is different and must be assessed in light of the requirements of the Act, the courts have been very stringent in insisting on proper disclosure by franchisors.
In my opinion, the solution is simple. Before letting the excitement of starting your own business get the best of you (and your investment!), I suggest you consult with your lawyer before signing any documents provided to you by the franchisor. The cost of having your lawyer read and explain to you your rights and obligations under the agreement could potentially save you the cost of protracted litigation later on.