::this post ID is 16600::::in categories of ..Legal Corner..::

Beginning the due diligence process

By Tony Wilson
When British Columbia’s provincial government was developing its new Franchises Act (which came into effect on Feb. 1, 2017), an advisory committee was formed to provide input. Among the issues this committee considered was whether or not to legislatively require franchisors to add ‘risk warnings’ to their franchise disclosure documents (FDDs) for use within the province, which was a question of whether or not the province really needed them.

So, the committee looked into the risk warning language that was already required in other Canadian provinces with franchise legislation, under their respective statutes. These warnings included
the following:

  • The prospective franchisee should seek information about the franchisor’s business background, banking affairs, history and trade references.
  • The prospective franchisee should seek expert independent legal and financial advice about the franchise opportunity and the franchise agreement.
  • The prospective franchisee should contact current and previous franchisees listed in the FDD, to become better-informed before signing the franchise agreement.

All of this is true and helpful, but the most important risk warning is not mandated by any provincial franchising statute: the prospective franchisee should read the FDD … and then read it again!

Reading the FDD is the ideal place to begin the process of due diligence. In all Canadian provinces with franchise legislation, the franchisor is required to provide the FDD to the prospective franchisee at least 14 days before the franchisee can sign the franchise agreement and related documents. And given that franchisors pay their lawyers tens of thousands of dollars to prepare these documents, it is important for them to be read not only by prospective franchisees, but also by those franchisees’ lawyers.

Multiple documents in one
An FDD is actually a number of different documents. Fundamentally, it is a legal document that, pursuant to provincial law, requires the franchisor to disclose all material facts relating to the franchise opportunity, so the franchisee can make an informed decision. It must also contain: the franchise agreement and all other documents the franchisee is obliged to sign; the franchisor’s most recent financial statements that have either been audited or been subject to a formal review by an accountant; and a certificate signed by the principals of the franchisor verifying everything contained within the FDD is true and correct and there has been no failure to disclose any information that is legally required to be disclosed.

While the franchisor is required to disclose all material facts in the FDD so the prospective franchisee can make an informed design before acquiring the franchise rights, the FDD also protects the franchisor. Full disclosure could assist the franchisor, for example, in defending against misrepresentation claims or rescission actions by disgruntled franchisees.

Accordingly, it would be unwise for the franchisor to dance around any unpleasant facts without actually disclosing them, ‘warts and all.’ That would only give fuel to unhappy franchisees and their lawyers looking for any undisclosed—or poorly disclosed—material facts to warrant a claim.

Lastly, an FDD can in some ways be considered a marketing document. It gives the franchisor an opportunity to show off its financial statements and number of franchisees in a particular marketplace, so as to more fully convince the interested prospect—and his/her lawyer—an investment in the franchise is a good business decision because the franchisor is in financially solid condition.

Sometimes, however, there are facts the franchisor finds unhelpful or prejudicial within the context of marketing. In such cases, it becomes the franchisor’s lawyers’ job to express those facts in as glowing a light as possible, while still meeting the legal requirements for full, frank and true disclosure. These lawyers are often called upon to ‘make a silk purse out of a sow’s ear’ through the magic of legal wordsmithing.

In turn, it is up to prospective franchisees and their own lawyers to recognize these instances of ‘spin,’ ‘marketing speak’ and ‘alternative facts’ when reviewing the FDD.

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