In this article, we highlight the importance of the obligation under Canadian franchise law to disclose all material facts and all material changes.
Franchisors are required by law to disclose certain information to franchisees before those franchisees pay any funds to the franchisor or enter into a franchise agreement.
The provinces of British Columbia, Alberta, Manitoba and Ontario have franchise legislation and associated regulations that identify required disclosure from franchisors to their prospective franchisees. In November 2023, Saskatchewan proposed legislation that will similarly require disclosure of certain information by franchisors.
A common thread
While there are some differences in the disclosure requirements from province to province, this article is intended to highlight a common thread across all of these provinces – the obligation of the franchisor to disclose all material facts in the franchise disclosure document.
The franchisor must provide a franchise disclosure document – containing all material facts and a variety of other information – to each prospective franchisee at least 14 days before that franchisee enters into a franchise agreement. In addition, it must be at least 14 days before the franchisee pays any funds to the franchisor (or any of the franchisor's associates).
After the franchisor provides the disclosure document, if there is any material change in the franchisor's business then the franchisor is required to disclose that material change to the prospective franchisee by providing a written statement of material change. This statement must be provided as soon as practicable after the material change has occurred and, in any event, before the franchisee signs a franchise agreement or pays any funds to the franchisor or their associates.
What is a "material fact"?
Legislation in British Columbia, Alberta and Manitoba provides that "material fact" means "any information about the business operations, capital or control of the franchisor or franchisor's associate or the franchise or the franchise system, that would reasonably be expected to have a significant effect on the franchise's value or price to be granted or the decision to acquire the franchise."
Ontario's definition is very similar. The province's franchise legislation states that "material fact includes any information about the business operations, capital or control of the franchisor or franchisor's associate, or about the franchise system, that would reasonably be expected to have a significant effect on the value or price of the franchise to be granted or the decision to acquire the franchise." The use of the word "includes" rather than "means" in Ontario's franchise legislation suggests the disclosure obligation in Ontario might be broader in scope than in other regulated provinces.
British Columbia, Alberta, Manitoba and Ontario have legislation and regulations governing franchise disclosure that lists many facts that the franchisor must disclose. These facts include (but are not limited to) the amount of any deposits and fees payable by franchisees; information about the franchisor's business; information about current and former franchisees; and a description of any training or other assistance offered to the franchisees. However, while the legislation and regulations provide a starting point for a franchisor's disclosure obligations, it is not enough for a franchisor to only disclose the facts listed in the legislation and regulations. All material facts must be disclosed in the franchise disclosure document (and all material changes in a statement of material change).
The question of whether a fact constitutes a "material fact" is determined on a case-by-case basis. The key question is whether the fact "would reasonably be expected to have a significant effect on the value or price of the franchise to be granted or the decision to acquire the franchise." This question will depend on the nature of the franchised business being granted.
Case law from previous disputes between franchisors and franchisees offers some guidance in determining what facts will likely be considered material. In addition to the disclosure required by the legislation and regulations, Courts have concluded that the following are material facts:
- Important location-specific information, including the terms of the head lease between the franchisor and landlord.
- The fact that a franchisor was engaged in negotiations about early termination of its lease with the landlord – which could potentially impact the future franchisee.
- The fact that a proposed franchise location was going to be the first location in a non-mall setting, which distinguished the proposed franchise location from the other franchises in shopping malls with a proven track record.
- Previous problems with franchise finances and management prior to purchase of the business by the current franchisor.
- The existence of certain litigation between the franchisor and other parties.
This list is not exhaustive and the question of whether a fact is material will ultimately require a case-specific application of the definition of "material fact" outlined above.
What is a "material change"?
In all the regulated provinces, a "material change" is defined as a change in the business operations, capital or control of the franchisor or franchisor's associate or in the franchise or the franchise system, that would reasonably be expected to have a significant adverse effect on the franchise's value or price to be granted or on the decision to acquire the franchise.
Similar to the definition of material fact, the question of whether something is a material change is often highly case-specific.
Why is disclosure of material facts and changes important?
It is critical that franchisors understand their obligation to disclose all material facts and all material changes for several reasons.
The obligation to disclose all material facts and changes is intended to protect franchisees. Disclosure helps franchisees make an informed decision before investing in a franchise. Purchasing a franchise is a significant investment and a franchisee must be allowed to evaluate all the material information before making such an investment.
Rescission remedy
Insufficient or inaccurate disclosure of material facts or changes can have severe consequences for a franchisor due to the significant rescission remedy that is available to franchisees under franchise legislation in British Columbia, Alberta, Manitoba and Ontario (and potentially Saskatchewan).
The rescission remedy allows a franchisee to void its franchise agreement and walk away from its business, without any penalty or obligation, where the franchisor fails to make proper disclosure. As well, the rescission remedy allows the franchisee to obtain compensation from the franchisor after walking away, including a refund from the franchisor for any money paid to the franchisor, a refund for any inventory and equipment purchased by the franchisee, and compensation for any losses that the franchisee suffered in setting up and operating the franchised business. This calculation can sometimes add up to hundreds of thousands, or even millions, of dollars.
There are different timelines for a franchisee to access the rescission remedy in different provinces and scenarios. In British Columbia, Manitoba and Ontario, a franchisee is allowed to seek rescission no later than 60 days after receiving the disclosure document if the franchisor provided the disclosure document or material change after the deadline or if the contents of the document did not meet requirements. This applies in cases where the franchisor failed to disclose all material facts.
Additionally, British Columbia, Manitoba and Ontario law gives franchisees two years to rescind in cases where the franchisor "never provided" a disclosure document. Courts have interpreted this two-year remedy as applying to cases where the disclosure document provided by the franchisor was so flawed that the franchisor effectively never provided a disclosure document. While sometimes a failure to disclose a material fact will not rise to this level, in many cases a failure to disclose one or more important facts was found to rise to the level of "no disclosure," giving the franchisee two years to rescind.
In Alberta, a franchisee is able to seek rescission of the franchise agreement no later than 60 days after receiving the disclosure document or no later than two years after the franchise is granted the franchise – whichever occurs first.
Importantly, a franchisor's directors and officers can be held jointly liable for compensation owed to the franchisee. This increases the potential dangers of failing to disclose all material facts and changes. More information on the potential liability of directors and officers will be provided in a subsequent article.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
