Franchise Disclosure Documents in Canada: How Franchisors may avoid making “Misrepresentations” in them

Introduction

Franchisors are required under Canadian franchise legislation to disclose “all material facts” in their franchise disclosure documents. How can franchisors properly fulfill this requirement, and avoiding misrepresentations? How do franchise statutes define and how do the courts interpret “misrepresentation” of “material facts” and what are some potential consequences of making misrepresentations? What are some examples of complying representations versus non-complying misrepresentations under some reported court cases?

[In this paper, bolding of words has sometimes been added for emphasis.]

A.  Statutory Provisions

In Canada, there is no federal statute governing franchising.  Instead, franchising is governed by individual statutes of six provinces: British Columbia, Alberta, Manitoba, Ontario, New Brunswick and Prince Edward Island.  Ontario is the most populous province and it has had franchise legislation (Arthur Wishart Act) since 2000.  Ontario has the most reported franchise decisions.

 

The Arthur Wishart Act of Ontario (“Wishart”) governs franchising in that province.  Wishart contains the following definitions:

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;

misrepresentation” includes,

(a) an untrue statement of a material fact, or

(b) an omission to state a material fact that is required to be stated or that is necessary to make a statement not misleading in the light of the circumstances in which it was made;

Franchise statutes of the other franchise-regulated provinces have similar definitions.

 

All franchise statutes in Canada require that a properly detailed disclosure document be prepared by a franchisor and delivered to each of its prospective franchisees.  Wishart requires a disclosure document to contain the following details:

Under section 5 (4):

(a) all material facts, including material facts as prescribed; [Note: a franchisor may need to include material facts not listed in the applicable provincial franchise statute(s)/regulations.]

(b) financial statements as prescribed;

(c) copies of all proposed franchise agreements and other agreements relating to the franchise to be signed by the prospective franchisee;

(d) statements as prescribed for the purposes of assisting the prospective franchisee in making informed investment decisions; and

(e) other information and copies of documents as prescribed.

Any failure by a franchisor to fulfill these requirements could result in a “misrepresentation” giving a prospective franchisee the statutory right to sue for misrepresentation and claim damages; often, time elapses before a misrepresentation is discovered by a franchisee and a claim filed in court by it.

Specifically, Wishart provides:

Under section 7 (1):

If a franchisee suffers a loss because of a misrepresentation contained in the disclosure document or in a statement of a material change or as a result of the franchisor’s failure to comply in any way with section 5, the franchisee has a right of action for damages against,

(a) the franchisor;

(b) the franchisor’s agent;

(c) the franchisor’s broker, being a person other than the franchisor, franchisor’s associate, franchisor’s agent or franchisee, who grants, markets or otherwise offers to grant a franchise, or who arranges for the grant of a franchise;

(d) the franchisor’s associate; and

(e) every person who signed the disclosure document or statement of material change.  [The signatories must be two directors or officers of the franchisor; they will have joint and several liability with the franchisor for damages arising from any misrepresentation.]

(2) If a disclosure document or statement of material change contains a misrepresentation, a franchisee who acquired a franchise to which the disclosure document or statement of material change relates shall be deemed to have relied on the misrepresentation and may not waive its right to sue the franchisor for making the misrepresentation;

In addition to statutorily defined “misrepresentation”, case law has also considered what constitutes misrepresentation. It is important to note that the courts have the final say in how any statutory definitions are interpreted and applied.  As guidance, then, let’s have a look at some court cases that decided whether a misrepresentation had or had not occurred.

 

B.  Misrepresentation Found – Two Court Decisions

Here are brief reviews of two court decisions finding that a “misrepresentation” had occurred:

 Zippy Print (1994) BCCA

This case preceded franchise legislation in British Columbia (“BC”).  It involved a representation about pro forma financial statements given by a franchisor to a franchisee that induced the franchisee to enter into a franchise agreement.  The representation was characterized by the court as forming a “collateral contract” preceding and separate from the franchise agreement and which continued in force notwithstanding the “whole agreement” clause in the franchise agreement.  In awarding the franchisee forgiveness of its arrears of both gross sales and advertising royalties, the court found the franchisee’s pro forma statements were misleading misrepresentations which were “at worst intentional and at best negligent”.  [Note: Although this case preceded 2017 franchise legislation in British Columbia, it is still instructive on how courts may determine that a “misrepresentation” has occurred.]

Hyundai (2009) ONSCJ

This case involved an application by a franchisee for an injunction forcing the franchisor not to terminate the parties; franchise agreement. For a long time, Hyundai had asked the franchise to find better premises for its Hyundai dealership.  The franchisee had several times suggested relocation to a nearby “Saturn site”, which the Hyundai rejected as unacceptable.  Hyundai then made a settlement proposal to the franchisee allowing it to continue in its existing location (and restricting it from operating elsewhere).  Unbeknownst to the franchisee, Hyundai had obtained a right of first refusal for the Saturn site and had entered into discussions with a third party to become its franchisee there.  Hyundai’s failure to disclose such activities to the original franchisee was found by the court to amount to a material misrepresentation [by omission] which induced the original franchisee to enter into the settlement agreement.  Given the improper activities of Hyundai, the court cancelled the settlement agreement, thereby allowing the original franchise agreement to continue in force.

 

C.  No Misrepresentation Found – Two Other Court Decisions

Here are brief reviews of two other court decisions.  These ones found that a misrepresentation had not occurred:

Healey v. Canadian Tire (2012) ONSCJ

Canadian Tire (“CT”) appealed an arbitration decision awarding Healey $250,000 against CT for breach of statutory duties of “fair dealing” and “good faith” based on CT’s forecasts of future sales and profits of a re-sale location that had been losing money.  On the facts, the court found that Healey would have bought a franchise at the location even if the forecasts had been worse (therefore, no real reliance on the forecasts).  Also, that Healy himself could have done better ‘diligence’ on the store’s operating results.  The court held that the forecasts made by CT were made within the realm of reasonableness and had not been negligently formed.  Finally, the court found that the forecasts were not really “representations” at all, because they dealt with future potentialities and not present facts. CT’s appeal was therefore allowed, the court finding that no misrepresentation had occurred.

Sharbern v. Vancouver Airport Centres Ltd. (2011) SCC

Vancouver Airport Centres ltd. (“Developer”) was a commercial real estate developer that built two condominium hotels, one a Marriott and the other a Hilton, near the Vancouver Airport.

The Marriott hotel’s real estate disclosure document offered potential investors a guarantee of 12% p.a. return for 5 years under a hotel management agreement. The later disclosure document for Hilton investors did not mention the Marriott guarantee nor did it provide a similar one.

A class action was commenced by Hilton investors alleging that a misrepresentation by omission had occurred in the Hilton disclosure document which entitled them to compensation from the Developer.  However, the court held that a “material false statement” (by omission) had not occurred.  It applied a standard of “materially” that inquired whether there was a “substantial likelihood” that a reasonable investor would consider such an omission to be vitally important, in the mix of substantial other information provided in the Hilton disclosure document.  The Supreme Court of Canada decided in favour of the Developer, in holding that no misrepresentation had occurred.

 

Closing Comments

 This paper provides general information only as at April, 2018 and may not be relied upon as specific legal advice for any particular case.

The author, John L. Rogers, thanks Ethan Plato of Clark Wilson LLP, who kindly conducted case law research for this paper.

FRANCHISING IN CANADA – TIPS FOR INBOUND FRANCHISORS

Franchising in Canada – Tips for Inbound Franchisors

Canadian Market[1]

Franchising is healthy and expanding in Canada.  If you are a foreign franchisor considering an expansion to Canada, reading this article will provide you with good, basic information.

In Canada, an estimated 1,300 franchise brands are operating and approximately 1 in every 14 Canadians is directly or indirectly involved in the franchise industry.  Canadian franchising generates about $68 billion in annual revenue.

Canadian Franchise Association1 (“CFA”)

CFA is the recognized authority on franchising in Canada and was founded 50 years ago.  CFA’s paid members represent 750 brands and over 40,000 franchised outlets across the country. Joining CFA is a solid investment for franchisors, franchisees, professional advisors and suppliers.  View www.cfa.ca for the benefits of membership.

Some of the Essentials of Canadian Franchising

Any foreign franchisor intending to expand its system to Canada must deal with the following matters:

  • Registration of Trade-mark(s) – As a first step, apply to register a word mark and, if possible, a logo or design mark in Canada under the federal Trade-marks Act. Canada has a single, federal trade-mark registration system.  A registered Canadian trade-mark is enforceable across all of Canada.  Only a Canadian registered mark provides this protection; a foreign registration does not.
  • Franchise Disclosure Document (“FDD”) – There is no statutory form of FDD required by franchise legislation in any of the 6 of 10 Canadian legislated provinces, namely (from west to east), British Columbia, Alberta, Manitoba, Ontario, New Brunswick and Prince Edward Island. Canada has no federal franchise statute.  Franchisors are not required to register in any province and no statutory authority exists to approve franchise documents.  It is left to each franchisor and its lawyer to draft a FDD and franchise agreement (“FA”) that comply with the franchise legislation of each province where the franchisor wishes to sell franchises.  If a franchisor wishes to sell franchises nationally, a national form of FDD can be prepared.
  • Pre-FA Contract(s) – Most of the provincial franchise statutes allow a franchisee to sign one or more pre-franchise agreement contracts providing for payment of a fully refundable deposit up to 20% of the initial franchise fee, designating a location and/or a protected territory and a confidentiality covenant.
  • Delivery of FDD – Each prospective franchisee must receive a FDD 14 clear days before a franchise agreement may be signed.
  • Some Disclosure Requirements – A FDD is required to provide disclosure of all “material facts”, including a franchisor’s latest annual financial statements and copies of all FA-related contracts, as well as lists of its existing and closed franchises. A Certificate of Franchisor signed by two of its directors or officers must be attached.  The signatories and the franchisor itself will be liable, jointly and severally, for any misrepresentation(s) – errors or omissions – related to the FDD.
  • Registration of Franchisor – Although none of the provincial franchise statutes requires a franchisor to register as such (nor is any governmental vetting of franchise documents required), if the franchisor is “carrying on business” in a province, basically by having an office or an employee or agent there, then it must register in that province as an “extra-provincial corporation” and must file simple-form annual reports.
  • Franchise Agreement (“FA”) – Usually, most provisions of a FA prepared in the franchisor’s home jurisdiction can be used in a Canadian form of FA. Otherwise, the existing form of FA  will require revisions to become “Canadianized” for use in Canada.  Some revisions include:
  • Spelling – Numerous English words are spelled differently in Canada. For example: favour, cheque and labour.
  • Fair dealing – Statutory obligations of “fair dealing” and “good faith … in accordance with reasonable commercial standards” means that most absolute discretions given to a franchisor must be revised (e.g., substitute “reasonable discretion”).
  • Post-term non-competition covenants – to be enforceable in Canada, they must go no further than reasonably necessary to protect the essential elements of the franchise system.
  • Employees – Add a confirmation that the franchisee is solely responsible for recruiting, hiring, compensating, training, disciplining and terminating its employees. To avoid a potential “co‑employer” designation whereby the franchisor could be deemed jointly liable for employees of the franchisee, the franchisor must abide by this confirmation and remain “hands off” of such matters, leaving them entirely to the franchisee.
    • Security Agreement – If the franchisor or its designate is to supply substantial assets or inventory (or both) on credit, then a Canadian form of Security Agreement should be exhibited to the FA, signed concurrently and registered in the Personal Property Registry (-ies) where the franchisee involved will do business.
    • Tax Matters – Whether to establish a Canadian subsidiary to manage the Canadian operation or directly franchise from the home jurisdiction, withholding tax, sales taxes, employee remittances are most of the tax matters.
    • Location and Territory – These must be settled. Often, a map outlining an exclusive territory of the franchisee is exhibited to the FA.
    • Currency– A provision must be added to confirm which type of currency will govern and, if not Canadian currency, then currency exchange must be dealt with.
    • Immigration – If one or more employees of the franchisor are to move to Canada to manage the franchisor’s Canadian operation, appropriate Canadian visa(s) will be required.
    • Governing Law – All of the provincial franchise statutes require that the laws of the province of operation of the franchisee govern the franchise relationship and that the courts of such province have exclusive jurisdiction to hear disputes under the franchise legislation.
    • Termination – Again, the franchise statutes in Canada require “fair dealing” and “good faith” in the performance and enforcement of a FA. Therefore, termination provisions should be fair, including, whenever reasonable, time given to a franchisee to cure a default.
  • Advertising Fund – Disclosure of a franchisee’s required contribution to an advertising fund and the administration of the fund must be made. Generally, Canadian franchisees will want any advertising fees to be used in Canada.
  • Training – Program, place and costs to be disclosed.
  • Operations Manual – Revise to comply with Canadian requirements.
  • Dispute Resolution – A mediation and an arbitration provision may need t be included.

Privacy Legislation and CEMs

Privacy legislation exists throughout Canada.  It prevents anyone from using personal information without consent.  “Commercial electronic messages” (emails) may not be sent to persons without consent.  Corporations need to publish privacy policies and have a privacy officer.  Particularly sensitive information includes medical history, banking and financial transactions.  Sometimes a consent form can be included in an initial information form.

Franchise Lawyer

It is important for a franchisor expanding its system to Canada to engage the services of a Canadian lawyer well-experienced and current in the franchise laws of Canadian provinces and the preparation of the documents mentioned, as well as trademark registration.

PLEASE NOTE:  This paper is not to be taken as actual legal advice.  It only provides an overview of some of the more important details of expanding a franchise system to Canada.  Legal advice will only be given pursuant to a formal engagement letter providing for advice and documents to be prepared for a specific franchise system.

[1] Statistics provided in CFA’s 2018 Policy Briefing.

This paper has been prepared by:

John L. Rogers, Canadian Franchise Lawyer
www.likewise.law
john@likewise.law
604.209.6451