Source: http://www.sotosllp.com/2004/10/some-complex-franchise-law-disclosure-issues/
Timestamp: 2017-08-18 08:52:33
Document Index: 606583468

Matched Legal Cases: ['Art. 6', 'Art. 7', 'Art. 1434', 'Art. 1375', 'Art. 1375', '§ 436']

Some Complex Franchise Law Disclosure Issues | Sotos LLP
Some Complex Franchise Law Disclosure Issues
This article was originally prepared for the OBA Annual Franchise Law Conference, October 2004
1. What is the Scope of the Disclosure Obligation in Canada?
If a franchisor wishes to offer franchises in Canada, how much pre-sale information does it have to give prospective franchisees? The answer depends on whether the franchisor intends to offer its franchises in one of the regulated provinces (Alberta, Ontario and Quebec) or elsewhere in Canada.
(a) The Unregulated Provinces and Territories
Outside Alberta, Ontario and Quebec, the common-law rule of “franchise buyer beware” reigns supreme. According to this rule, mere silence is not a misrepresentation[1], meaning that a franchisor has no duty to disclose material facts which are within its knowledge but which are not known by the prospective franchisee, even if the franchisor knows that the prospective franchisee has formed a wrong impression that would be corrected by disclosure.[2] But if the franchisor voluntarily chooses to provide a prospective franchisee with information concerning a particular matter, then the franchisor may not mislead; this means that the franchisor must also disclose all other material facts within its knowledge that relate to that same matter.
If the franchisor fails to abide by these common-law rules of disclosure, then the franchisee may rescind the franchise contracts, provided that the parties can be restored to their former positions.[3] In addition, if the franchisor’s misrepresentation was made fraudulently or negligently, or if it amounted in law to a collateral warranty, then the franchisee may also recover damages.
Quebec has a civil law system. The Preliminary Provision of the Civil Code of Quebec states:
“The Civil Code of Quebec, in harmony with the Charter of human rights and freedoms and the general principles of law, governs persons, relations between persons and property. The Civil Code comprises a body of rules which, in all matters within the letter, spirit and object of its provisions, laws down the jus commune, expressly or by implication,. In these matters the Code is the foundation of all other laws, although other laws may complement the Code or make exceptions to it.”
The Civil Code of Quebec imports certain good faith obligations into every commercial relationship, including:
Art. 6 Every person is bound to exercise his civil rights in good faith.
Art. 7 No right may be exercised with the intent of injuring another or in an excessive and unreasonable manner which is contrary to the requirements of good faith.
Art. 1434 A contract validly formed binds the parties who have entered into it not only as to what they have expressed in it but also as to what is incident to it according to its nature and in conformity with usage, equity and law.
Art. 1375 The parties shall conduct themselves in good faith both at the time the obligation is created and at the time it is performed or extinguished.
As a natural consequence of this general duty of good faith (which by Art. 1375 applies during the negotiation phase) the franchisor has a duty to provide sufficient pre-sale information to allow the prospective franchisee to make an informed decision about whether or not to invest in the franchise. Similarly, the prospective franchisee has a duty to obtain any necessary professional assistance to enable the franchisee to reasonably assess the risks and rewards of the proposed investment.
The Supreme Court of Canada (considering a non-franchise case) determined that this pre-contractual duty to inform arises whenever one party to a proposed contract knows of significantly important (the Court actually used the word “decisive”) information, and also knows or ought to know that it is not reasonably possible for the other party to obtain this information, or that the other party is reasonably relying on a representation (by word or conduct) made by the first party.[4]
(c) Alberta and Ontario
The statutory scope of disclosure in both Alberta and Ontario is very much broader than the common law requirements. Both the Franchises Act (the “Alberta Act”)[5] and the Arthur Wishart Act (Franchise Disclosure), 2000 (the “Ontario Act”)[6] require a franchisor to disclose all “material facts”, all proposed “franchise agreements”, specified financial statements and other specified documents, information and statements. Both Acts also require a franchisor to disclose any “material changes”.[7] According to subsection 1(1) of both Acts:
“material fact” means [Alberta Act; the Ontario Act says ‘includes’] any information about the business, operations, capital or control of the franchisor or its associate, or about the franchise system, that would reasonably be expected to have a significant effect on the value or price of the franchise to be sold or the decision to purchase the franchise.
“material change” means a change in the business, operations, capital or control of the franchisor or its associate, or a change in the franchise system, that would reasonably be expected to have a significant adverse effect on the value or price of the franchise to be granted or the decision to purchase the franchise, and includes a decision to implement the change made by the board of directors of the franchisor or its associate or by senior management of the franchisor or its associate who believe that confirmation of the decision by the board of directors is probable.
“franchise agreement” means any agreement that relates to the franchise between a franchisor or its associate, and a franchisee or prospective franchisee.
“franchise system” includes the marketing or business plan of the franchise[8], the use or association with a trade-mark, trade name, logotype or advertising, the obligations of the franchisor and franchisee with regard to the operation of the franchised business, and the goodwill associated with the franchise.
Ontario’s definition of “material fact” uses the word “includes”, and so requires a franchisor to disclose every fact that might reasonably be expected to significantly affect franchise price, value or purchase decision, not just those involving the franchisor, its associate or the franchise system. For example, in Ontario a franchisor may have to disclose facts about affiliates who are not “associates”.
Judging from many disclosure documents on the street, quite a number of franchisors (and their advisors) think that a disclosure document will suffice if it provides the information listed in Schedule 1 of Alberta’s general franchise regulation[9] or in Part II of Ontario’s general franchise regulation.[10] However the scope of disclosure in both Alberta and Ontario goes well beyond that, since as mentioned it extends to all “material facts”. The following are a few examples of material facts that are not included in Schedule 1 of the Alberta Regulation or in Part II of the Ontario Regulation:
Nature of the franchised business, general market for goods and services, and the competition
Material information about predecessors[11], indirect upstream owners, affiliates who are not “associates”[12], individuals who have management responsibility relating to the franchise, and franchise brokers
Material non-franchise business activity of the franchisor
Anticipated openings of company‑owned and franchised units
Routine, material litigation([13])
Material information about the intellectual property, such as oppositions, judgments and pending litigation, contractual restrictions on use and licensing, known infringing uses, obligation to protect franchisee’s right to use, etc.
Pre‑opening and continuing franchisor assistance
Post-opening one-time and continuing payments to franchisor or affiliate, including amounts collected on behalf of third parties, interest and late charges, guarantees, indemnities and security for payment
Purpose, use, allocation, benefits and administration of advertising funds
Site selection, leasing, development, maintenance and remodelling
Warranties and other customer service obligations
Records and reports, inspections and audits
Methodology and obligations concerning system improvements
Material obligations in collateral contracts
Special risk warnings (examples: franchisor inexperienced, leasing affiliate’s operations dependent on franchisee rent streams, out‑of‑province choice of law, forum or venue[14])
Depending on circumstances, there may be many other matters which must be disclosed as material facts but which are not mentioned in either Schedule 1 of the Alberta Regulation or Part II of the Ontario Regulation.[15] For example, although both the Alberta Regulation and the Ontario Regulation require the franchisor to disclose whether or not it (or its associate) receives volume rebates or other benefits as a result of the franchisees purchasing goods and services from third parties[16], they do not require the franchisor to disclose how much is received. But if a significant percentage of the franchisor’s (or its associate’s) annual gross revenue results from these purchases of goods and services, that fact may well significantly affect a prospective franchisee’s purchase decision, and so is a material fact to be disclosed.
2. Does Counsel Have A Due Diligence Obligation?
Does counsel who participates in preparing a disclosure document have a “due diligence” obligation, that is, a duty to independently investigate and verify the information provided by the franchisor for inclusion in the disclosure document? Canadian counsel who practice in the securities regulation area would likely answer this question affirmatively, although as yet no judicial answer has been given to the question.[17]
Let us consider “outside” counsel first. If one assumes that such an obligation should be imposed on outside securities counsel, then why not as well on outside franchise counsel? After all, the purpose of both types of regulation is to promote adequate disclosure. True, but this argument fails to recognize some critical differences between the securities and franchise contexts. A prospective investor in securities has virtually no opportunity to independently investigate the underlying business, and so must rely almost entirely on the prospectus. In contrast, the prospective investor in a franchise can readily meet with existing franchisees to ask about the franchisor, the system, the market for the goods and services, whether the franchisee would buy a second franchise, and many other questions. The potential franchisee can also meet with the franchisor’s personnel to ask questions and to judge their abilities. Yet another difference between a securities and a franchise offering is that the legal costs typically incurred in a securities offering far exceed the range of costs that franchisor can afford, because the profit component of anticipated initial franchise fee revenue is infinitesimal in comparison to the capital which will be generated if the typical securities offering is successful. Another important difference is that, unlike a securities offering, a franchise offering continues in time, so that franchise counsel would be involved in a never-ending due diligence review. Finally, we must recognize that outside counsel typically is retained only to advise on the disclosure obligations and to draft the disclosure document, and has no authority to control the franchisor’s selling practices. All of these factors militate against imposing a due diligence obligation on outside franchise counsel.[18]
Consider next the position of “inside” counsel. If inside counsel is privy to extensive management information, or has authority to direct or control the franchisor’s selling practices, or is otherwise in a position similar to “inside” directors and senior managers, then it is likely that counsel has an obligation to take reasonable steps to independently verify the information in the disclosure document.[19] On the other hand, and for the reasons already stated, there seems to be no justification for imposing a due diligence obligation on inside counsel who is not privy to such information and does not have that authority.
Should counsel decide that it is appropriate to undertake an independent investigation to verify information supplied by the franchisor, then the nature and extent of that investigation is a matter for counsel’s good judgment, having regard to all of the circumstances. Among other things, it would be most prudent for counsel to maintain a “due diligence” file, in which to record the actions which counsel took during the disclosure process, such as steps taken to gather information and track sources of information, and those steps (if any) which counsel took to independently verify information. The file should include such things as copies of engagement and “non-engagement” letters, copies of signed and completed questionnaires and other material which counsel used to gather information, notes of important points discussed and advice given at formal or informal meetings or in telephone conversations, correspondence dealing with important matters, copies of the contracts and other documents which counsel reviewed for disclosure purposes, copies of draft disclosure documents and notes of feedback received on those drafts, any other written material which counsel deems to be important.
If counsel is asked to “expertise” part of the disclosure document, then counsel’s engagement letter to the client should clearly state that the client must obtain counsel’s separate, written consent to the use of counsel’s (or the firm’s) name in the disclosure document, and include that consent in the disclosure document, before the client may use the document to sell franchises. That written consent, if given, should state that consent will automatically be revoked should any amendment be made to the disclosure document, or should a statement of material change be used in conjunction with the disclosure document. Of course counsel should also ensure that his, her or the firm’s name appears in the disclosure document, if at all, only in that part of the document which counsel has “expertised”.
3. Is There a “General” Due Diligence Defence in Ontario?
Both the Alberta Act and the Ontario Act give a franchisee a statutory right of action for damages if the franchisee suffers a loss because the disclosure document contained a misrepresentation. In Alberta this action lies against the franchisor and everyone who signed the certificate of disclosure, while Ontario adds brokers, agents and associates to this statutory list of defendants. Both the Alberta Act and the Ontario Act provide the non-franchisor defendant (the franchisor is absolutely liable) with several defences, including three limited “due diligence” defences:[20]
The disclosure document was given without the defendant’s knowledge or consent, and upon becoming aware of that fact, the defendant promptly notified the plaintiff of that fact.
Although the defendant consented to the disclosure document, the defendant learned of the misrepresentation only after the disclosure was delivered, and before the franchise was acquired the defendant withdrew consent and so notified the prospective franchisee.
The misrepresentation was in an “expertised” part of the disclosure document and the defendant did not believe and had no reasonable grounds to believe that there was a misrepresentation or that the expertised part did not fairly represent the expert’s opinion.
The Alberta Act goes on to provide the defendant with a “general” due diligence defence: the defendant is not liable for a misrepresentation in the disclosure document unless the defendant believed that there was a misrepresentation, or did not conduct an investigation sufficient to provide reasonable grounds for believing that there was no misrepresentation.[21] Surprisingly, the Ontario Act does not provide this general due diligence defence. Does this mean that associates, brokers, agents and certificate signers will be liable if an Ontario disclosure document contains a misrepresentation, even if they were unaware of its existence and no possible investigation by them would have disclosed the problem? That would be a very unreasonable result: if innocent associates, brokers, agents and certificate signers are to be liable, then why not also innocent directors, officers and other franchisor personnel who have management responsibility regarding the franchise? The lack of such a general due diligence defence would certainly seem to offend principles of natural justice, and we believe that if the question comes before the court, the court will hold that the legislator’s failure to include such a defence in the Ontario Act will not bar a non-franchisor defendant from raising such a defence at common law.[22][23]
4. Disclosure of Litigation Settlements
Both the Alberta Regulation and the Ontario Regulation require the franchisor to disclose details of any civil judgements or pending action against the franchisor, its associates and certain individuals regarding misrepresentation, unfair or deceptive acts or practices and comparable actions.[24] However if such an action was settled before judgement, then neither Regulation requires disclosure the action or the terms of settlement. Nevertheless, the Alberta and Ontario requirements to disclose all “material facts”[25] will require the franchisor to disclose the terms of a litigation settlement (even if the action did not involve misrepresentation, unfair or deceptive acts, etc., and even if the litigants have agreed to a confidential settlement) if the fact of settlement or the terms of settlement (whether favorable or unfavorable to the franchisor) would reasonably be expected to significantly affect the price or value of the franchise or a reasonable prospective franchisee’s purchase decision.[26] For example, a confidential settlement with a material number of franchisees which would see the franchisees paying a significantly reduced royalty would have to be disclosed if it would affect the franchisor’s cash flow to the material detriment of the franchise system.
5. May A Franchisor Use Financial Statements from Other Jurisdictions?
Section 3(1) of the Ontario Regulation requires a disclosure document to include the franchisor’s financial statement for its most recently completed fiscal year of operations, either prepared in accordance with Canadian generally accepted auditing standards (“Canadian GAAS”) or else prepared in accordance with Canadian generally accepted accounting principles (“Canadian GAAP”) and reviewed and reported on in accordance with Canadian review engagement standards[27]. As a result, a foreign franchisor who wishes to grant franchises in Ontario but who does not qualify for special regulatory exemption must provide the working papers used in its foreign audit to a “Canadian-qualified” auditor or accountant, and have him either do a Canadian GAAS audit or a Canadian GAAP review. For an American franchisor with a Uniform Franchise Offering Circular (“UFOC”)[28], this Ontario audit/review requirement is a waste of time and money, because current U.S. auditing and reporting standards are considerably higher than the Canadian standards.
This problem does not arise in Alberta, because the Alberta Regulation requires the franchisor’s financial statements to be prepared in accordance with the franchisor’s “home GAAP”, and permits those statements to be audited or reviewed in accordance with the “home” GAAS or review/reporting standards, provided that the “home” standards are at least equivalent to Canadian GAAS or review/reporting standards.[29]
Until Ontario sees fit to amend its financial statement requirements along the lines of the Alberta Regulation, what is a U.S. franchisor to do? Of course the franchisor could have two audited statements prepared each year, the one under Canadian standards for disclosure use in Ontario, and the other under ‘home standards’ for disclosure use elsewhere, but that would be very expensive.[30] Another possibility would be to establish a Canadian subsidiary to grant the Canadian franchises, and provide Canadian review-level financial statements of the subsidiary, but that might be unpalatable for many reasons.
The primary purpose of requiring franchisors to provide financial statement disclosure to prospective franchisees is to ensure that those prospects receive material financial information in a form that is readily comprehensible and that lends itself readily to comparison with financial information provided by other franchisors. The statutory requirement to apply GAAP in preparing the financial statement adds to the consistency and comparability of different disclosure documents, since the GAAP of jurisdictions that set accounting standards are reasonably well established in the business accounting world. Of course there will be a problem if the standards of one jurisdiction result in financial information that is not easily compared with financial information prepared using the standards of another jurisdiction. However that problem should not arise if the disclosure document includes a proper reconciliation of the material differences between the two standards, and explains how those differences affect the financial information presentation.
For the U.S. franchisor, then, a viable option might be to include the UFOC audited statements in the Ontario disclosure document together with the auditor’s reconciliation of US to Canadian GAAP in those areas where the difference in accounting principles has a material impact on the preparation or presentation of the financial information.[31] Of course this means that the Ontario disclosure document will not comply with the requirements of the Ontario Regulation, allowing the franchisee to invoke the statutory rescission remedy. To avoid this, the franchisor would have to wait at least 60 days after delivering the disclosure document before it took any money from the prospective franchisee or had him sign any agreement relating to the franchise.[32]
6. How Ought One Disclose Material Changes?
Subsection 4(4) of the Alberta Act and subsection 5(5) of the Ontario Act both require a franchisor to provide the prospective franchisee with a written statement disclosing any material change to the information in the disclosure document, as soon as practicable after the change occurs and in any event before expiry of the 14-day “cooling off” period prescribed by those Acts[33].
Although neither Alberta nor Ontario prescribe a format for this statement of material change (“SMC”), because both disclosure statutes require that disclosure be clear and concise[34], an SMC should either be formatted in the same manner as the disclosure document it modifies, or else should contain a cross-reference sheet which shows where the information being amended may be found in the disclosure document.
Since the Ontario Act’s statutory rights of action for misrepresentation may be asserted against “every person who signed the…statement of material change”, by necessary implication an Ontario SMC must have some sort of Certificate of Disclosure.[35] Since neither the Ontario Act nor the Ontario Regulation specify a format for this Certificate, it would be prudent to adapt the form of Certificate prescribed for the disclosure document itself.[36]
Although the Ontario Act does not prescribe a delivery method for an SMC, it would be prudent to use one of the delivery methods specified for a disclosure document.[37]
While the Ontario Act prescribes a 14-day “cooling-off” period following delivery of a disclosure document, before the franchisee makes any payment or signs any agreement relating to the franchise, the Act does not provide for any cooling-off period following delivery of an SMC. Obviously some sort of cooling-off period would be appropriate, but of course there is nothing magic about 14 days. It should be sufficient if the franchisor waits for “reasonable” time in the circumstances, that is, long enough for a reasonable person to absorb the new or modified information presented in the SMC and to consider its effect on the intended acquisition.
What about negotiated changes? While at first glance the definitions of “material fact” and “franchise system” in both the Alberta Act and the Ontario Act seem to require disclosure of negotiated changes, there is no utility to disclosing to a prospective franchisee the very changes which he or she has negotiated. Surely the purpose and spirit of the legislation is to require a franchisor to provide a prospective franchisee with material information which he or she might not otherwise know, and not to waste time, money (and trees) on non-useful activity. Therefore it is unnecessary to disclose negotiated changes requested by the prospective franchisee (although “quid pro quo” changes demanded by the franchisor should perhaps be disclosed). Of course if franchisees regularly succeed in negotiating changes to the “standard forms”, that fact is material and should be disclosed.
7. What About Making Earnings Claims?
The Province of Alberta and those U.S. jurisdictions which have chosen to require franchise pre‑sale disclosure regulate the use of what they call “earnings claims”, by requiring that the earnings claim: (i) have a reasonable basis at the time it is made, (ii) describe that basis and all underlying assumptions made (except for matters of common knowledge), (iii) be included in full in the disclosure document, (iv) permit the reader to review information which substantiates the claim, and (v) if the claim is based on historical results of units, state the percentage of units that have actually achieved the claimed result.
These jurisdictions define an “earnings claim” as any information from which the reader can easily ascertain a specific level or range of actual or potential sales, costs, income or profit from company‑owned or franchised units. “Basis” means the factually‑significant information on which a prudent business person would rely if making an investment decision[38], and a basis will be “reasonable” if those facts reasonably support the earnings claim as it is likely to be understood by a reasonable prospective franchisee.
In contrast to Alberta and these American jurisdictions, the Ontario Regulation purports to regulate an “earnings projection”.[39] However, since neither the Ontario Act nor the Ontario Regulation defines the term “earnings projection”, we are left to guess whether the intention is to regulate use of earnings projections only, or to regulate use of any future-oriented financial information[40], or to regulate earnings claims generally[41]. The purpose of regulating the use of earnings information (by requiring that it be included in the disclosure document together with statements of the basis and underlying assumptions) is to arm a prospective franchisee with sufficient information to allow the prospect to independently evaluate the reliability of the information. Since both future-oriented financial information and financial information based on historical results can be very misleading in the hands of the unsophisticated reader[42], an Ontario court might well decide to interpret the term “earnings projection” widely, and to include historically-based financial information within its meaning. In any event, since the Ontario Act preserves the franchisee’s common-law remedies[43], a franchisor choosing to provide either future-oriented or historical financial information would be prudent to follow the Alberta requirements for making an earnings claim[44].
Finally, since the Ontario Act requires the franchisor to disclose any material changes to the information in the initial disclosure, it should be possible for a franchisor to make a supplementary earnings claim[45] through an SMC.
8. How Does One Disclose Master Franchises?
“Master franchise” is defined in both the Alberta Act and the Ontario Act as the right granted by a franchisor to another person (called a “subfranchisor”) to engage in the business of offering, selling and servicing unit franchises to a third person (called the “subfranchisee”), for the subfranchisor’s own account[46]. A master franchise should not be confused with the seemingly similar “area representation franchise”, in which the franchisor grants another person (the “area representative”) the right to offer or sell and service unit franchises to a third person, but this time for the franchisor’s account. The master franchise is a three-tiered arrangement, the franchisor (top tier) granting the master franchise to the subfranchisor (middle tier), who in turn grants the unit franchise to the subfranchisee (bottom tier). In contrast, an area representation franchise is only a two-tiered arrangement, the franchisor (top tier) granting the unit franchise directly to the franchisee (bottom tier), with the area representative acting merely as “headhunter” to recruit the franchisee, and as the franchisor’s representative to service and police the franchisee.[47]
In most master franchise scenarios franchisor and subfranchisor have comparable bargaining power, which means that the terms of the master franchise arrangement are completely “up in the air”. How, then, can the franchisor provide a disclosure document to the prospective master franchisee? Franchisor and its counsel will be scratching their heads when they try to disclosure the following material facts:
term/renewal/termination
territorial development quotas
cost of establishing the master franchise
franchisor financing of part of initial master franchise fee
sharing of revenue (examples: unit initial fees, royalties and supplier rebates)
sharing of costs (example: the cost of adapting the system to the territory)
level of franchisor assistance
subfranchisee restrictions
subfranchisor liability for non‑performing subfranchisees
personal guarantees of upstream owners of subfranchisor
As well, both the Alberta Act and the Ontario Act require that the master franchise agreement and any other agreements relating to the franchise be included in the disclosure document.[48]
Of course, until the parties have agreed on the basic business terms of the master franchise it is impossible to provide meaningful disclosure in any of these areas: we have a classic “chicken and egg” situation. There are at least two possible solutions to the conundrum, although neither is very satisfactory. First, the franchisor could instruct its counsel to draft a master franchise agreement containing all of the terms and conditions which the franchisor would like to see in place, and then to draft the appropriate disclosure document (including disclosing that almost all of the contact terms are negotiable).[49] Second, franchisor and the prospective subfranchisor could negotiate (orally) all of the substantive terms of the master franchise agreement and related contracts; the franchisor would then draft the contracts and disclosure document, deliver the disclosure and wait for the 14-day cooling-off period to pass.[50]
9. Can a Disclosure Problem be Cured After the Fact?
If a misrepresentation in a disclosure document (or, in Ontario, a failure to follow some other disclosure requirement) is not discovered until after the deal has closed, can the franchisor correct the problem? Theoretically, no, because the franchisee’s statutory rescission and damages remedies arose the moment that the disclosure document was delivered, and they cannot be waived or released.[51]. But if the franchisee is willing to continue with the franchise, then there is a practical way to deal with the problem. The franchisor makes a written offer of rescission to the franchisee, and at the same time provides a corrected disclosure document. Then, at least 14 days later, the franchisor delivers to the franchisee copies of replacement franchise contracts (same terms as those originally signed) which have been signed by the franchisor, and which bear the date of their actual delivery to the franchisee. The franchisee’s execution of these replacement contracts will create a novation, eliminating at once both the original contracts and the problem of the franchisee’s rescission or damages claim.[52]
[1] “The failure to disclose a material fact which might influence the mind of a prudent contractor does not give the right to avoid the contract”: Bell v. Lever Brothers, Ltd., [1932] A.C. 161, per Lord Atkin at 127. See also Smith v. Hughes(1871), L.R.6 Q.B. 597 (“Yup, them’re good oats”).
[2] There are several important common-law exceptions to this “no duty to disclose” rule. In the franchising context the most important exceptions are:
(a) If the franchisor voluntarily discloses a fact, then it must disclose any other material fact that is necessary to make the volunteered statement not misleading in the circumstances in which it was made.
(b) If the franchisor voluntarily discloses a fact, and before the franchise is granted a subsequent event happens which makes that disclosure false to the franchisor’s knowledge, then the franchisor must disclose the material facts which caused the change in circumstance.
(c) A person may represent a state of facts simply by conduct, without ever speaking a word. Therefore if a franchisor makes a representation by conduct and does not correct the impression given, then it will be bound by its conduct.
[3] The court will not insist on an exact return to the status quo ante: “…the court can take accounts of profits and make allowance for deterioration. And I think the practice has always been for a court of equity to give [rescission] whenever, by the exercise of its powers, it can do what is practically just, though it cannot restore the parties precisely to the state they were in before the contract”. Erlanger v. New Sombrero Phosphate Co. (1878), 3 App. Cas. 1218, per Lord Blackburn at 1278-9.
[4] Bank of Montreal v. Bail Limitee, [1992] 2. S.C.R. 554.
[5] S.A. 1995, c.F-17.
[6] S.O. 2000, c.3.
[7] Alberta Act: ss4(3) and 4(4); Ontario Act: ss5(4) and 5(5).
[8] See Alberta Act: s.1(1)(l).
[9] A. Reg. 240/95 (the “Alberta Regulation”).
[10] O. Reg. 581/00 (the “Ontario Regulation”).
[11] By “predecessor” we mean a person from whom the franchisor directly or indirectly acquired the majority of its assets.
[12] By “affiliate” we mean a person who directly or indirectly controls the franchisor or is controlled by the franchisor, or who is controlled by another person who also directly or indirectly controls the franchisor. Under this definition, a franchisor’s “associate” would be an affiliate of the franchisor who is either directly involved in granting the franchise or who exercises significant operation control over the franchisee and to whom the franchisee owes a continuing financial obligation regarding the franchise.
[13] Examples: a “routine” action involving material damages, several routine “immaterial” actions that, taken together, expose the franchisor to material damages.
[14] While both s. 17 of the Alberta Act and s. 10 of the Ontario Act seem at first glance to void a contractual choice of foreign law, venue or forum, in fact these section void such choices only “with respect to a claim otherwise enforceable under the Act in [Alberta or Ontario]”. Therefore one may use a foreign choice of law, venue and forum clause if it is carefully drafted, for example:
“Except for a claim by the franchisee which is otherwise enforceable under the Franchises Act in Alberta, this Agreement shall be governed by and construed in accordance with the laws of Ancient Mesopotamia.”
[15] The best example is the startling fact that Schedule 1 of the Alberta Regulation does not require disclosure of trade-marks!
[16] Alberta Regulation: Schedule 1, s. 12; Ontario Regulation: s. 8. The Ontario Regulation also requires the franchisor to disclose any policy it has regarding these rebates and benefits.
[17] The question was considered in the securities context (but not answered) by a U.S. court in Escott v. Barchris Construction Corp., 283 F. Supp. 643 (S.D.N.Y. 1968).
[18] While outside counsel who prepares a disclosure document may not have an obligation to independently investigate the accuracy of the information provided by the franchisor, there is little doubt that counsel has a duty to take care in preparing the disclosure: see, for example, Haig v. Bamford, (1977) 1 S.C.R. 466, and Courtney v. Waring (1987), 191 Cal.App.3d., 1434. Therefore counsel must never provide a disclosure document that counsel knows (or has reasonable grounds to believe) contains a misrepresentation.
[19] See, for example, Kerr v. Danier Leather Inc., [2004] O.J. No. 1916 (Sup. Ct. of Justice).
[20] Alberta Act: ss. 10(2); Ontario Act: ss.5(5).
[21] Alberta Act: ss.10(3).
[22] See Ontario Act: s.9 and the reasoning in R. v. Sault Ste. Marie (City), [1978] 2 S.C.R. 1299 and Canada (Attorney General) v. Consolidated Canadian Contractors Inc., [199] 1 F.C. 209 (C.A.). We recognize that this line of cases deals with whether there is a common law due diligence defence to a regulatory offence or administrative penalty, whereas the purpose of s.7(1) of the Ontario Act is compensatory, not penal.
[23] In the U.S., federal and state franchise disclosure laws require a franchisor to state the actual amount received by it (or its affiliate) as a result of franchisee purchases or leases of goods and services from third parties. See, for example, Disclosure Requirements and Prohibitions Concerning Franchising and Business Opportunity Ventures, 16 C.F.R. § 436.1(a)(11), and the Guideline instructions to Item 8 of the Uniform Franchise Offering Circular.
[24] Alberta Regulation: Schedule 1, s. 3; Ontario Regulation, ss. 2(3). The Alberta requirement differs considerably from the Ontario requirement.
[25] Alberta Act, ss. 4(3)(a) and Alberta Regulation: s.2(1); Ontario Act: ss.5(4)(a).
[26] See definitions of “material fact” in Alberta Act: ss.1(1)(o) and Ontario Act: s.1(1).
[27] ss. 3(2) provides a limited exception if the franchisor’s year-end statements are not yet ready, ss.3(3) provides an exception for “start-up” franchisors, and ss.3(1) itself provides a complete exemption by special regulation.
[28] The UFOC must contain the franchisor’s comparative audited statements for three fiscal years, and also an unaudited interim statement if the franchisor’s balance sheet or income statement is more than 90 days old.
[29] Alberta Regulation: ss. 3(1) AND (3).
[30] No doubt the added cost would be borne ultimately by the franchisees, through increased franchise fees.
[31] The franchisor would also be wise to include a prominent risk warning that the reader should consult a qualified accountant regarding the financial statements and the reconciliation statement.
[32] There is still a small risk that a court might find that a document that does not comply with the s.3 financial statement requirements is not a “disclosure document” in the first place, so that the franchisee has a two-year rescission period. Note that the franchisee could also invoke the statutory damages remedy in the Ontario Act, but if proper disclosure of the effect of the differences in accounting standards has been made and the recommended risk warning given, what loss would the franchisor’s non-compliance have caused the franchisee?
[33] The 14-day cooling-off period is found in ss.4(1) of the Alberta Act and ss.5(5) of the Ontario Act.
[34] Ontario Act: ss.5(6). The Alberta Act does not expressly state a “clear and concise” requirement, but that requirement necessarily follows form the Act’s “purpose statement” (s.2).
[35] Ontario Act: ss. 7(1)(e).
[36] See Ontario Regulation: ss.7(1).
[37] See Ontario Act: s.5(2).
[38] This would include, for example, general economic and ascertainable market conditions.
[39] Ontario Regulation: s.6(1) 3.
[40] Future-oriented financial information includes both “projections” and “forecasts”. Projections are future-oriented outcomes all of which are reasonably possible, while a forecast is that single future-oriented outcome which management believes to be the most probable.
[41] That is, both future-oriented financial information and historically-based financial information.
[42] See also the discussion above about using financial statements from another jurisdiction, where similar concerns govern. We should also distinguish between actual historical results of operations and statistics derived from such results. While both types of information will be unreliable if inappropriate accounting methods were used, statistically-derived information has a further potential for unreliability if the statistician is unqualified, or fails to take appropriate care when choosing which statistical method to use. We also need to distinguish between information volunteered by the franchisor to induce a sale, and information provided by the franchisor with a disclaimer of applicability in response to a request by the prospective franchisee.
[43] Ontario Act: s.9.
[44] Alberta Regulation: Schedule 1, s. 16.
[45] For example, historical or future-oriented information concerning a specific outlet which the franchisee is considering, but which the franchisee has identified only after receiving the initial disclosure.
[46] Alberta Act: s. 1(1)(m); Ontario Act: s.1(1).
[47] A master franchise requires two disclosure documents: that given by the franchisor to the subfranchisor in order to disclose the master franchise, and that given by the subfranchisor to the subfranchisee in order to disclose the unit franchise. An area representation franchise normally needs only one disclosure document: that given by the franchisor to the franchisee to disclose the unit franchise. Of course if the area representation arrangement requires the area representative to pay any money to the franchisor, or imposes restrictive supply arrangements on the rare representative, then the arrangement may be a “franchise” requiring pre-sale disclosure to the area representative.
[48] Alberta Act: clause .4(3)(b); Ontario Act: clause 5(4)(c).
[49] Obviously this procedure will be very costly for the franchisor unless the subfranchisor agrees (after receiving disclosure, of course) to share the cost of disclosure even if the parties ultimately fail to reach a deal.
[50] See Ontario Act: clause 2(3) 7, which presumably reflects a policy of avoiding evidentiary problems in enforcing rights under the Act (note the requirement that there be no written evidence of the arrangement). See also the previous footnote.
[51] Alberta Act: s. 18; Ontario Act: s.11.
[52] There is now nothing left to rescind, and damages will be nominal.