ARE YOU READY TO DISCLOSE? THE RISK OF “PREMATURE” DISCLOSURE

 

Does this scenario sound familiar?

You provide a prospective franchisee with your standard Franchise Disclosure Document (“FDD”) - a location has not yet been determined, but you plan to enter into a lease for a location sometime after the franchise agreement is signed and the franchise fee is paid.

You will sublet the premises to the franchisee and have even attached the form of sublease to your FDD which will eventually be used once a head lease has been entered into. You would have set out the material terms of the lease in your FDD, if you had one at the time of disclosure, but you just don’t have this information yet and the franchisee is well aware of this.   

Similarly, in the FDD, you have set out a range of estimated costs for a new build – this might be a conversion rather than new build – it is hard to say, since the location hasn’t been identified.

Question: Can you be liable for failing to provide information that you simply did not and could not have had at the time of disclosure, such as the costs to develop the specific premises and the terms and conditions of the lease?

Answer: Yes – according to a recent decision of the Ontario Superior Court.

 

The Importance of Site-Specific Disclosure

Raibex Canada Ltd. v. ASWR Franchising Corp.[1] presented a very similar fact scenario. The Court was asked to determine, among other things:

  1. whether the franchisor failed to meet its disclosure obligations under the Arthur Wishart Act (Franchise Disclosure), 2000 (“AWA”); and
  2. if so, whether this failure was so egregious that it gave rise to the franchisee’s 2-year right of rescission (i.e. it was as if no disclosure was made).

The franchisee argued that the FDD should have (a) specified a location or exclusive territory, (b) included the draft sublease with the head lease attached, and (c) set out the estimate of the development costs for a refurbished franchise location (not just those of a new build, as this was a conversion). The franchisor argued that the location had not been determined at the time of disclosure and it did not have knowledge of these items; therefore, it was not possible to make this disclosure.[2]

In response to the franchisor’s argument, the Court clearly stated that:

If it is simply impossible to make proper disclosure because material facts are not yet known, 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.

Ultimately, the Court found that the FDD did not contain all material facts and was materially deficient with respect to the lease and development costs, such that it amounted to no disclosure[3] and that under these circumstances, “it was premature to purport to deliver the disclosure document under the AWA and enter into a franchise agreement”.[4] Therefore, the franchisee’s 2-year right of rescission was properly exercised and damages should be awarded to the franchisee.

What this means for Franchisors

The Courts continue to underscore that the purpose of the AWA is to address the inherent imbalance between franchisors and franchisees, and it does so by imposing a strict and rigorous disclosure regime. The decision in the Raibex case underscores a franchisor’s existing statutory obligations to ensure each FDD is site-specific and contains all material facts, and in particular that:

  • there are real and significant risks to “premature” disclosure;
  • development costs of the specific site and other related financial information are material facts;
  • if a prospective franchisee intends to convert an established commercial space, providing the estimated costs for a newly constructed turn-key location will not be sufficient disclosure;
  • franchisors cannot rely on general and vague disclaimers in the FDD along the lines that “each location is fact-specific and costs could vary from location to location”;
  • if a sublease is to be entered into, it ought to include the head lease, as well as a summary of the materials terms and conditions of the lease, as these are material facts; and
  • the Court is prepared to expand the circumstances under which the 2-year right of rescission may be exercised by franchisees.

Conclusion

There appears to be a judicial trend to look critically not only at the contents of an FDD, but also at the timing of disclosure, relative to when a franchise agreement is signed and franchise fee is paid.

It is likely that not all material facts will be known when you commence discussions with a prospective franchisee and this is a business reality of the industry. However, when presented with this scenario – where certain financial obligations have not yet been determined, a head lease and sublease have not been finalized, or other material facts are simply unknown at the time of the original disclosure – it is important to take a moment and reassess the factual landscape. If and when additional information becomes available, it must be disclosed to the prospective franchisee, whether by way of a statement of material change or the delivery of a fresh FDD.

While this decision is likely to be appealed, it is a strong reminder that franchisors are nonetheless obliged to make full, comprehensive, and site-specific disclosure prior to a franchisee paying any consideration for the franchise or entering into a franchise agreement. 

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Questions? Dale & Lessmann LLP invites you to contact our experienced Franchise and Distribution Law Practice Group for assistance and guidance in connection with your franchise matters.

 

Chad Finkelstein

416-369-7883

cfinkelstein@dalelessmann.com

 

Jeffrey Hoffman

416-369-7806

jhoffman@dalelessmann.com

 

Cassandra Da Re

416-369-7843

cdare@dalelessmann.com

 

[1] 2016 ONSC 5575 (“Raibex”).

[2] para 59, Raibex.

[3] para 114, Raibex.

[4] para 3, Raibex.