Subleases and Additional Disclosure: What happens if I have signed a franchise agreement but haven’t yet found a location?
Published on June 17, 2013
Posted in: Blog
For franchisors selling franchises in those provinces with franchise disclosure legislation, the law requires that they must provide all prospective franchisees in those provinces with a disclosure document. In preparing its disclosure document, a franchisor must disclose information about itself, the franchise documents that are to be signed by the franchisee, its financial statements, certain mandatory statements, and all material facts. But what does a franchisor do after a disclosure document has been delivered and a franchise agreement is signed, but a location has not been secured? When does the franchisor’s disclosure obligation end? When does the franchisee’s right to receive additional information end? Unfortunately for both franchisees and franchisors, the franchise disclosure legislation is not always clear.
The following provides a few “best practices” for how franchisors can comply with their disclosure obligations and how a franchisee can ensure that it has obtained all relevant disclosure in order to make an informed decision to purchase a franchise.
Despite providing a proper disclosure document and allowing the 14 day “cooling- off” period to pass, a franchisor should ensure that it does not subsequently have the franchisee sign any additional agreements relating to the franchise that were not part of the disclosure document or sign any agreement that was disclosed but which has been subsequently amended by the franchisor and the nature of those amendments are material. A disclosure document that does not contain all agreements to be signed by the prospective franchisee is deficient disclosure notwithstanding that an agreement was unavailable or inapplicable at the time disclosure was delivered.
A recurring example of this disclosure issue is the disclosure of subleases where a location is not identified until after the franchise agreement is signed. It is not uncommon for a franchisor to provide a prospective franchisee with a generic disclosure document, wait 14 days, get all of the franchise-related documents signed, and then go out and secure a location for the new franchise. In most cases where a location has not been identified in advance, the sublease that is signed by the franchisee contains several blanks and any references to the head lease or the actual location are !err blank. But what happens once a location is secured? Many franchisors take the position that the disclosure obligation ended when the money was paid or the incomplete sublease and other documents were signed by the franchisee. These franchisors will simply fill in the incomplete blanks on the already signed sublease agreement and may also attach the head lease to the previously signed sublease. The danger in doing this is that it does not serve the purpose of the disclosure document unless the franchisor knows in advance and has provided in the disclosure document specific parameters of the lease it will commit to and all material terms of the anticipated leasing arrangement. Since that is rarely the case, disclosure without knowledge of the leasing arrangements does not give prospective franchisees all of the information about the franchisor and the franchise system (including the actual location of the franchise that the franchisee is purchasing) that would allow the franchisee to make an informed decision on whether to invest in the opportunity.
What should the parties do in that situation? The best approach is that, once a location is selected, the franchisor should return all money paid by the franchisee and the parties should rip up all signed agreements. The franchisor should then re-disclose the franchisee. This time, the disclosure document should contain all material facts related to the head lease and the premises. The disclosure document should also include a copy of the head lease for the premises. Now, the purpose of pre-sale disclosure document is fulfilled and the franchisor doesn’t have to worry about the franchisee making a claim that it was not in possession of key business information. Equally, a franchisee will now have all of the relevant information about the proposed franchise that it needs in order to make an informed decision about proceeding with the franchise at the specific location.
Understanding and complying with franchise disclosure obligations in unique circumstances is a difficult endeavour for most franchisors and franchisees. For a franchisor, failing to comply with its disclosure obligations can result in serious consequences, including an obligation that the franchisor pays back every dollar invested by the franchisee in acquiring and operating the business. For the franchisee, being armed with all of the relevant information about a specific franchise that it wants to purchase, and making an informed decision based on that information, is just good business practice. By being aware of these issues, franchisors and franchisees can avoid incomplete disclosure and properly conclude the sale of a franchise.
This article originally appeared in FranchiseCanada.