March 5, 2011

“Material Changes” to a Disclosure Document – What do they mean?

For franchisors selling franchises in those provinces with franchise disclosure legislation (Ontario, Alberta, New Brunswick, and Manitoba), 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 all “material facts” in its disclosure document. In our experience, franchisors are quite familiar with the definition of “material fact” – but are less familiar with the franchisor’s obligation to disclose a “material change” once they have given out their disclosure document.

What is a “Material Change”?

The legislation in all of the disclosure provinces defines a “material change” as a change in the business, operations, capital or control of the franchisor or its associate, or a change in the franchise system [New Brunswick and PEI both include any change to the “franchise”], that would reasonably be expected to have a significant adverse effect on the value or price of the franchise to be granted [Alberta uses the term “sold” instead of “granted”] or the decision to purchase the franchise, and includes a decision to implement the change made by the board of directors of the franchisor or its associate or by senior management of the franchisor or its associate who believe that confirmation of the decision by the board of directors is probable.

So what does a franchisor do after it has delivered its disclosure document to a prospect ive franchisee, having ensured that all “material facts” have been disclosed, when it discovers that a “material change” has occurred?

When does a franchisor disclose a “Material Change” to a prospective franchisee?

A franchisor is required to provide a prospective franchisee with a written statement disclosing any “material change” (known as a statement of material change) to the information in its disclosure document as soon as practicable after the change occurs and in any event before the 14-day “cooling off” period expires. If a “material change” occurs, a franchisor must provide a prospective franchisee with a statement of material change setting out the relevant information.

How does a franchisor disclose a “Material Change” to a prospective franchisee?

Although the law doesn’t impose an actual format for the form the statement of material change, both franchisors and prospective franchisees in Ontario should keep in mind the Ontario requirement that disclosure must be “clear and concise”. That is why a statement of material change should either be formatted in the same manner as the disclosure document it modifies, or else it should contain a cross-reference table which points out where the information that is being amended may be found in the disclosure document. The idea is that a prospective franchisee should be able to easily understand the affect of the “material change” to the franchisor’s disclosure document.

Since every person who signs the statement of material change may be sued for any misrepresentation that may exist in the document, by necessary implication a statement of material change must have some sort of “Certificate of Disclosure” that is similar to that found at the back of a disclosure document. Since the law doesn’t specify a format for this certificate, a franchisor’s safest bet is to adapt the form of certificate prescribed for its disclosure document.

How does a franchisor deliver its Statement of Material Change to a prospective franchisee?

To add to all of the confusion, the law does not specify an actual delivery method for a statement of material change by the franchisor to a prospective franchisee. Despite the lack of any guidance from the legislators, a good way to proceed would be for a franchisor to use one of the delivery methods available for the delivery of a disclosure document.

How much time should a franchisor give to a prospective franchisee to consider the Statement of Material Change?

Although the law mandates a 14-day “cooling-off” period following the delivery of a disclosure document before the prospective franchisee makes any payment or signs any agreement relating to the franchise, there is no obligation to provide for any “cooling-off period” following the delivery of a statement of material change. So, what does a franchisor and prospective franchisee do? Obviously some sort of “cooling-off” period would be appropriate, but of course there is nothing sacred about 14 days. If a franchisor can wait 14 days then that would be preferable, otherwise a franchisor should simply wait long enough for the prospective franchisee to absorb the new or modified information presented in the statement of material change and to consider its effect on the intended purchase.

What about negotiated changes?

There seems to be no purpose in a franchisor being required to disclose to a prospective franchisee the very changes which the prospective franchisee may have negotiated. The purpose of disclosure is to require a franchisor to provide a prospective franchisee with material information which might not otherwise be known, and not to waste a franchisor’s time and money on pointless exercises. It is our general practice to suggest that it is not necessary for a franchisor to disclose negotiated changes requested by the prospective franchisee. Of course, if franchisees regularly succeed in negotiating changes to a franchisor’s standard form agreements, that fact would definitely seem to be material and should be disclosed…. but that’s a topic for another day.