Failure to provide a disclosure document
NUMBER 12 – May 21st, 2008
Question from a franchisor (Quebec): A potential franchisee that resides in Ontario approached me to purchase a franchise. He has the financial resources, retail experience, an offer to rent a site in Ontario and is prepared to sign a franchise agreement. What are the consequences of not providing a Disclosure Document to a franchisee prior to the granting of a franchise?
Answer: In Ontario, the Arthur Wishart Act (Franchise Disclosure) (the “Act”) applies to all franchises located in that province, even if the franchisor has a place of business in another province.
There are effectively important consequences related to the decision of granting a franchise to be operated in Ontario before providing a prospective franchisee with a Disclosure Document.
Prior to answering your question, hereafter you will find certain articles of the Act that apply to the situation you described:
“5 (1) A franchisor shall provide a prospective franchisee with a disclosure document and the prospective franchisee shall receive the disclosure document not less than 14 days before the earlier of,
a) the signing by the prospective franchisee of the franchise agreement or
any other agreement relating to the franchise; and
b) the payment of any consideration by or on behalf of the prospective
franchisee to the franchisor or franchisor’s associate relating to the
franchise.
6(6) The franchisor, or franchisor’s associate, as the case may be, shall
within 60 days of the effective date of rescission,
a) refund to the franchisee any money received from or on behalf of the
franchisee, other than money for inventory, supplies or equipment;
b) the purchase form the franchisee any inventory that the
franchisee had purchased pursuant to the franchise agreement
and remaining at the effective date of rescission, at a price
equal to the purchase price paid by the franchisee;
c) purchase from the franchisee any supplies and equipment that the
franchisee had purchased pursuant to the franchise agreement, at a price
equal to the purchase price paid by the franchisee; and
d) compensate the franchisee for any losses that the franchisee incurred in
acquiring, setting up and operating the franchise, less the amounts set
out in clauses (a) to (c).”
It should be noted that all provinces that have franchise legislation (Alberta, Prince Edward Island and New Brunswick) have almost identical articles as those contained in the Act.
Article 5 (1) of the Act provides that a franchisor must provide a prospective franchisee with a Disclosure Document not less than 14 days before the earlier of: the signing of the franchise agreement or any other agreement relating to the franchise AND to the payment of any consideration to the franchisor relating to the franchise. This article may not be waived, not even by an agreement between a franchisor and a prospective franchisee.
Article 6 (6) of the Act outlines the possible consequences for a franchisor that does not provide a Disclosure Document to a prospective franchisee. It may be summarized as “putting the prospective franchisee back in the same financial situation he was in prior to the granting of the franchise”.
On the basis of this article, the amount a franchisor is obligated to pay a prospective franchisee will vary, depending on the cost of the franchise, the investment by the prospective franchisee in inventory, supplies and equipment and the losses the prospective franchisee incurs in acquiring, setting up and operating the franchise. For certain franchisors, the amount will represent millions of dollars.
Hereinabove, I underlined the word “possible” when qualifying the consequences for a franchisor of granting a franchise to a prospective franchisee prior to providing a Disclosure Document. It should be noted that the prospective franchisee has a maximum period of two (2) years to exercise the recourse available under Article 6 (6) and to rescind the franchise agreement.
To trigger this recourse, the prospective franchisee must send the franchisor a notice of rescission demanding namely, the amount claimed and the termination of the franchise agreement. In the event the prospective franchisee does not send the said notice before the expiry of the said two (2) year period, the prospective franchisee loses the recourse available under article 6 (6) of the Act.
Furthermore, in the event the franchisor provides the prospective franchisee with a Disclosure Document prior to the expiry of the two (2) year period hereinabove mentioned, the prospective franchisee may only avail itself of the recourse available under Article 6 (6) of the Act and rescind the franchise agreement for a period of sixty (60) days as of the date of the reception of the Disclosure Document. After the expiry of the sixty (60) day period, if the prospective franchisee has not sent a notice of rescission to the franchisor, the prospective franchisee loses the recourse available under Article 6 (6) of the Act.
It follows from the two (2) aforementioned limits imposed on the recourse of a prospective franchisee that, if a prospective franchisee does not send the notice of rescission within the first two (2) years or within sixty (60) days if the prospective franchisee has been provided a Disclosure Document during the first two (2) years, as the case may be, it loses the recourse available under Article 6 (6) of the Act. It is for this reason I qualify the consequences as “possible”.
Personally, I don’t believe the legislator should have opened the door by providing franchisors with a “remedy” in the context where they don’t provide a prospective franchisee with a Disclosure Document. It is “inviting” franchisors to take a risk while letting them think it can be remedied within a short period of time. The financial and legal repercussions described above remain and may be important.
From a practical perspective, if during the first months of operation of a retail unit in a new site, the financial results falls short of those anticipated by the prospective franchisee and/or of the representations made by the franchisor, the chances the prospective franchisee will exercise the right to rescind the franchise agreement are high. Even if the unit produces satisfactory results, the prospective franchisee may use the right to rescind the franchise agreement to obtain financial or other concessions from the franchisor. It should also be noted that it usually takes 2-3 years for a retail unit to be well established in a new site.
Having said that, given that a Disclosure Document can be prepared within a short delay (2-4 weeks), it is difficult to conceive that a new project could not be delayed until such time as the documentation was prepared and provided to a prospective franchisee.
Every franchisor knows the approximate costs associated with the construction of a retail unit and the costs of purchasing the inventory, supplies and equipment necessary to operate the unit. To that amount is added the losses that the prospective franchisee incurs in acquiring, setting up and operating the franchise. The amount of the costs related to this risk is fairly easy to calculate.
Cordially,
Claude J. Pellan, Attorney and Consultant
Franchise and Business Law
www.claudepellan.com
N.B.: My answer to this question addresses only the consequences provided for in the Act with respect to the decision by a franchisor not to provide a prospective franchisee with a Disclosure Document in the province of Ontario prior to the granting of a franchise. It does not address the implications with respect to the corporate strategy of a franchisor, the introduction of a franchise concept in another province, the relationship between the franchisor and its suppliers of products and/or services, etc.
IMPORTANT NOTE: As previously mentioned, I do not give a legal opinion in answers to questions in QUESTION CORNER. I provide my thoughts, comments and/or practical advice on issues that arise in the normal course of the activities of a franchisor. Therefore, I strongly advise that you consult an attorney for a legal opinion on the answers to questions asked in QUESTION CORNER.
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