Published on January 17, 2017
Posted in: Blog, Faye Lucas
Lawyers are often asked to prepare franchise disclosure documents (“FDDs”) for franchisors prior to a location being secured. Practically speaking, some franchisors do not want to undertake the cost and effort and possible risk of finding and securing a site unless they have a committed franchisee. Franchisors consider franchisees to be committed only once they have signed a franchise agreement or at least paid some initial franchise fee or deposit. While this is a common business scenario, the legal framework is fraught with risk as exemplified by the recent Ontario case, Raibex Canada Ltd. v. ASWR Franchising Corp., 2016 ONSC 5575 (“Raibex”).
Question 1: Is it OK to disclose a prospective franchisee before a site has been chosen?
Answer: Leaving the decision in Raibex aside, many would argue that Ontario’s Arthur Wishart Act (Franchise Disclosure) 2000 (the “AWA”) and its regulation clearly states that a franchisor’s disclosure obligation ends when the franchisee signs the franchise agreement or pays any money assuming an FDD has been provided to the franchisee at least 14 days prior to one of those events. On the other hand, the AWA also requires franchisors to disclose all “material facts” together with the amount of any deposit and estimates of the costs for leases and leasehold improvements. The overriding purpose of the FDD is to provide full and accurate disclosure so the franchisee can make a properly informed decision about whether they should make the investment and how much to invest is worth: 1490664 Ontario Ltd. v. Dig This Garden Retailers Ltd. (2005), 2005 CanLII 25181 (ONCA) at para. 16. Without knowing the terms of the lease, a prospective franchisee would arguably not have all “material facts” sufficient to make a properly informed investment decision. The AWA also requires that an FDD include “all copies of all proposed franchise agreements and other agreements relating to the franchise to be signed by the prospective franchisee”. Where the franchisor signs the head lease for a franchisee’s site and then subleases to the franchisee, the form of sublease will typically incorporate all terms of the head lease. In such case, failing to attach the head lease to the FDD is arguably tantamount to failing to attach all agreements relating to the franchise that the franchisee must sign.
Question 2: How did the Raibex decision change the above analysis?
Answer: In Raibex, the court found that a franchisor must disclose information about leasing arrangements to all franchisees. If it is impossible to do so because the information is not yet available, then “the franchisor is not yet ready to deliver the statutorily required disclosure document. The franchisor must wait – it does not get excused from its statutory obligations,” the court concluded. In other words, Raibex suggests that franchisors may not provide interested franchise candidates with their FDD before the terms for a site to be leased are known.
Question 3: How far does the Raibex decision go? Since “material facts” could arise at any time, when can a franchisor feel comfortable that it would not be prematurely disclosing a prospective franchisee?
Answer: Whether all information that is required to be included in the FDD is available will likely depend on the specific franchise being granted. Franchisors should be guided by the purpose of the AWA and ask themselves whether the franchisee is being given all of the information it needs to make a fully-informed investment decision. A distinction should also be made between those “material facts” that are necessary as a matter of course (such as the terms of a lease for franchises with physical storefronts) from “material facts” that may or may not happen (such as litigation against the franchisor). In the former case, franchisors ought to wait for such “material facts” to materialize before disclosing a prospective franchisee. In the latter example, a franchisor’s statutory obligation should be limited to disclosing those material facts it has at the time disclosure is made since it would be unreasonable, and in many cases impossible, for franchisors to wait for such “contingent” material facts to materialize before disclosing a prospective franchisee.
Question 4: Are there any exceptions to the rule that franchisors must wait until a site has been found before disclosing a prospective franchisee?
Answer: The Raibex decision does not provide much guidance as to when a franchisor may safely disclose a prospective franchisee prior to a location being secured although, the court stated that it did not rule out such possibility and that “presumably, a materially complete form of sublease including the provisions said to be incorporated from the head lease could have been included and, provided it was materially accurate, that problem would be addressed” (at para. 77). Accordingly, very large franchisors that are able to dictate the specific parameters of the lease it will commit to or franchisors that exclusively lease space with specific landlords, or franchisors that can disclose the most adverse lease terms that will affect the franchisee’s business would be able to disclose all material terms of leasing arrangements prior to securing a specific location for a franchisee. Franchisors might also use a statement of material change if they secure sites between the time they gave out an initial FDD and before they entered into a franchise agreement or took a deposit. This does not solve the possibility of having a committed franchisee in hand before securing the site. In that situation, the franchisor should include a term in its lease allowing it the option to get out of the lease if the franchisee does not materialize.
Question 5: Should franchisees refuse to sign a franchise agreement or pay any fees if no site has been secured yet?
Answer: Following the decision in Raibex, if a franchisee proceeded without having the site secured, it would likely be in a position to rescind its franchise agreement within two years of signing it. If, on the other hand, the franchisee requested that all of the missing information be provided prior to signing any agreements or paying any money, the franchisee would become a better informed purchaser but likely lose any rights to rescind the agreement. While it may be tempting to a franchisee to effectively have a two-year business insurance policy from the franchisor, it may not be the “get-out-jail-free card” that is appears to be. For example, an appeal court may reverse the decision in Raibex, a future court could choose not follow Raibex where the facts slightly differ, and the franchisor and those personally liable for deficient disclosure may not be solvent at the time a judgment or an action based on rescission can be enforced.
Question 6: What should parties do if an FDD has been provided and a franchise agreement signed before a location is selected?
Answer: The safest way to proceed is for the franchisor to return all money paid by the franchisee and the parties should cancel all signed agreements. The franchisor should then re-disclose the franchisee based on the new FDD being for a new grant. This time, the FDD should contain all material facts related to the head lease and the premises. The FDD should also include a copy of the head lease for the premises. Following this process, a franchisor provides to the franchisee all relevant information about the franchise that it needs to make an informed decision about proceeding with the franchise at the specific location thus fulfilling the purpose of pre-sale disclosure under the AWA.
For questions regarding Raibex and other recent legal developments in franchising, please contact any of the Sotos team.