November 22, 2015

Insurance as a protection for franchisors and others against statutory remedies for bad disclosure

The remedies for bad disclosure by a franchisor to a franchisee under Ontario’s franchise legislation have been called “draconian” by the Ontario Court of Appeal.

Not only the franchisor but also its officers and directors who signed the disclosure certificate and its associates including its selling agent involved in the sale to the franchisee have liability for the remedies.  A successful rescission claim can result in a requirement to pay a franchisee hundreds of thousands of dollars or more.

Canadian subsidiaries of American franchisors and their officers, directors and associates have had the benefit of insurance procured by their parent American franchisor against disclosure claims made against the franchisor.  Reasonably priced franchise insurance with manageable retention amounts has long been available in the United States.  More recently developed products have also come onto the American market reflecting sophistication in their application to claims made against franchisors.

Canadian insurers were very slow to create products responsive to disclosure claims. Fortunately, the market has evolved.  Reasonably priced insurance with similarly manageable retention amounts are now available to Canadian franchisors.

Typically, a franchisor will apply for general liability insurance and a director and officer liability policy.  This insurance would be as applicable to a franchising business as any other.  A franchisor’s insurance broker, however, should also apply for a franchise claims specific rider to cover disclosure claims.

It is important that the insurance broker or counsel for the franchisor be requested to carefully examine the available policy riders to ensure that they cover the types of claims that are made by franchisees for bad disclosure.  It is also critical that the insurance covers the franchisor’s sales brokers, both corporately as well as those individuals involved in the selling process.  Directors and officers’ coverage must cover the individuals who signed the disclosure certificate.  When an officer or director of a franchisor signs the certificate he or she does so in his or her personal capacity and not in a corporate capacity.  The policy must cover these individuals from actions done in their personal capacities as well.

Every franchisor is advised to investigate the availability of this insurance for its business.  Because disclosure claims and judgments resulting therefrom must be disclosed by a franchisor in its disclosure document, the handling of a disclosure claim by the insurer is important to the franchisor even if the insurer is looking after the financial aspects of the claim (less the retention).  Insurers typically retain their own counsel to represent their insureds.  Franchisors will want to carefully vet the insurer’s list of preferred counsel to be satisfied as to counsel’s expertise to defend these claims or seek to have their own counsel added to the approved roster.  Insurers tend to pay their counsel at lower hourly rates than are usually paid to counsel by parties directly.  Franchisor’s preferred counsel must be asked to agree to accept the insurer’s rate if retained to defend any insured claim.

Our litigators at Sotos LLP are experienced in representing franchisors and their insurers in defending claims for alleged bad disclosure and advising on available insurance and specific policies.