A recent Ontario court decision reinforces for franchisors the importance of providing comprehensive financial disclosure to franchisees, and the serious repercussions for failing to be completely transparent on the financial status of the franchisor. The case, which was just decided, goes further than any previous decision in finding that a franchisor’s financial statements were materially deficient.

In the lawsuit, a franchisor provided prospective franchisees with “notice to reader” financial statements, which had not been reviewed or audited by an accountant. An Ontario court found this wasn’t adequate, ruling that the franchisees could rescind their agreements and claim significant financial compensation from the franchisor.

In its defence, the franchisor argued that its notice to reader financial statements were not a “material deficiency” – even though they were not fully reviewed or audited. The franchisor’s financial statements were prefaced with a standard disclaimer:

“We have not audited, reviewed or otherwise attempted to verify the accuracy or completeness of such information. Accordingly, readers are cautioned that these statements may not be appropriate for their purposes.”

The court noted that the disclaimer meant the financial statements “did not verify anything.” Without such verification, franchisees could not be expected to rely upon the financial statements of the franchisor. The Disclosure Document was therefore materially deficient.

The requirement for the franchisor to provide a Disclosure Document is prescribed under Ontario’s Arthur Wishart Act.  This case is the latest to affirm that its purpose is to protect franchisees, and strict financial disclosure is an element of this protection.

Every piece of information in a Disclosure Document must be reviewed and certified for its truth and accuracy. In the body of the Disclosure Document, officers or directors of the franchisor must sign a certificate stating that they have reviewed the Disclosure Document and believe all of its contents to be true. In order to certify the truth and accuracy of financial statements, the franchisor cannot rely upon its own officers or directors, meaning a qualified accountant must review or audit a franchisor’s financial statements.

The court does not draw a distinction between providing “notice to reader” financial statements and failing to provide financial statements at all.  Previous franchise rescission cases have involved outdated financial statements, or providing “Quickbook” statements, but no previous case had directly considered whether it was deficient to provide current financial statements prepared on an unreviewed and unaudited basis.

The law is now clear that without reviewed or audited financial statements in the Disclosure Document, franchise agreements are open to the risk of being rescinded by a franchisee. A franchisor must pay attention to this decision and ensure its financial statements are current, audited, and provided to prospective franchisees in accordance with the Wishart Act.

The full decision in 2240802 Ontario Inc. v. Springdale Pizza Depot Ltd.  is available on-line here: https://www.sotosllp.com/wp-content/uploads/2013/12/2240802-Ontario-Inc-v-Springdale-Pizza-Depot.pdf

 

Shane Murphy is litigator who handles cases involving franchises for franchisors and franchisees. Reach him by e-mail at smurphy@sotosllp.com or by phone at 416.572.7311.