October 31, 2008

Lynchpin of Disclosure: The Certificate

Of the many requirements of a valid disclosure document, the dual-signature certificate has received little attention.  A recent case out of Alberta confirms the central importance of the certificate by holding that an unsigned certificate entitles the franchisee to rescind the franchise agreement, even if the disclosure document is otherwise completely valid.  David Sterns reviews the strict requirements for a valid disclosure document and consider whether a certificate signed by only one officer or director, in circumstances where two signatures are required, would meet a similar fate.

The Regulations under Ontario’s Arthur Wishart Act (Franchise Disclosure), 2000, S.O. 2000 (“AWA”), c. 3,[1] Alberta’s Franchises Act, R.S.A. 2000, c. F-23 (“Alberta Act”),[2] and Prince Edward Island’s Franchises Act, R.S.P.E.I. 1988, c. F-14.1 (“PEI Act”)[3] all require disclosure documents or statements of material change given to prospective franchisees to include a certificate that is dated and signed by at least two officers or directors of the franchisor, or by one officer or director where there is only one.[4]

The certificate is designed to ensure that the information given to prospective franchisees is accurate, complete and timely.  It ensures accuracy by imposing personal liability for misrepresentations on the individuals who sign the certificate, regardless of whether those individuals had any involvement in the actual sale of the franchise to the prospective franchisee.[5] This is intended to ensure a high degree of personal accountability that the information contained in the disclosure document is entirely truthful.

It ensures completeness by requiring the individual signing the certificate to certify that all of the information required by statute is contained in the disclosure document, including not only the prescribed information, but also all material facts concerning the franchise.  Because of the broad definition of “material fact” in the legislation, the signer of the certificate must certify that the disclosure document provides the prospective franchisee with all of the information which would potentially affect either the franchisee’s desire to purchase the franchise, or the price paid for the franchise.[6] In hierarchical franchise organizations, knowledge of all material facts may not reside in the individuals who sign the certificates.  Since these individuals have personal liability for material fact omissions, the liability attaching to the certificate motivates these companies to adopt a set of internal procedures to ensure accurate and complete disclosure, with someone at each level of the organization attesting to accuracy and completeness of the information.

The legislation ensures the timeliness of the information contained in the disclosure document or statement of material change by requiring that the certificate be dated.

Who Must Sign the Certificate?

The regulations under the AWA, the Alberta Act and the PEI Act each require, as a general principle, that the certificate be signed by two officers or directors of the franchisor.  In exceptional circumstances, where the franchisor has only one director and officer, the regulations allow franchisors to give to potential franchisees disclosure documents that only contain one signature.

Unlike the Alberta Act, the AWA does not define the term “officer”.  This leaves open the question of whether a person’s status as officer will be determined with regard to the internal corporate resolutions of the franchisor, or by how the person is held out to the outside world, in other words, the “indoor management rule”.[7]

Black’s Law Dictionary refers to an officer, in corporate law, as a person elected or appointed by the board of directors to manage the daily operations of a corporation.[8] Accordingly, if the issue is to be determined according to the indoor management rule, any person who holds him or herself out to be an officer (say, for example a Vice-President) could be an officer for the purposes of the AWA, even if that person has not been formally appointed as such by the directors.  The rather informal way in which many small companies use titles such as “Vice President”, without properly approving such status at the directors’ level, raises the issue of whether such unappointed individuals should be considered officers for the purposes of signing the disclosure document.

The Alberta franchise legislation defines an “officer” as:

  1. the chair or vice‑chair of the board of directors or the president, vice‑president, secretary, assistant secretary, comptroller, assistant comptroller, treasurer, assistant treasurer or general manager of a corporation,
  2. any individual who performs functions or acts in a capacity similar to the functions or capacities referred to in subclause (i), or
  3. any individual designated as an officer of a corporation by bylaw or similar authority of the corporation;[9]

This broad definition indicates that a person’s status as an officer can be determined by the title the person uses in his or her communications with the outside world, the actual functions the person performs, or the person’s formal status according to the by-laws or resolutions of the company.  In other words, officer status can be determined by having regard to the indoor management rule or the formal status of the individual according to the company’s records.  It is quite likely that even in the absence of a legislative definition such as in the Alberta Act, the substance-over-form standard would apply in Ontario, Prince Edward Island and New Brunswick.  To hold otherwise would be to allow corporate formalities to override the intention of the legislation which is to ensure at least dual accountability for the contents of the disclosure document by the senior management of the franchisor.

The significance of this is that the number of franchise systems which have only one true officer and director will be few and far between.  Most franchise system require more than one key individual to operate, even at the start-up phase.  Even the smallest franchisor will likely employ one or two lieutenants to assist in carrying out the many daily requirements of the system such as overseeing franchise operations, negotiating with landlords, and signing banking documents.  Extra care should therefore be taken when preparing disclosure documents to inquire into the actual roles of key persons within the organization rather than simply relying on the corporation’s public filings or directors’ resolutions to ascertain whether there are two or more individuals who are required to sign the disclosure document.

By not having at least two officers or directors sign the certificate when at least two people are, objectively speaking, carrying out those roles, the certificate may be open to serious challenge.  The Regulations under the AWA, the Alberta Act and the PEI Act all state that the disclosure document “shall” include a certificate which “shall” be signed by two officers or directors where there is more than one.  In light of the recent Alberta Court of Appeal decision, discussed below, the implications of a defective disclosure document may be quite far-reaching.