By Frank Zaid
Q: Are franchisors required to provide specific location information to prospective franchisees as part of the disclosure document process?
A: It depends on a variety of facts specific to the case, including the terms of the franchise agreement, whether or not the franchise is being operated in a province that has enacted disclosure legislation, how much information the franchisee has about the specific location in any event and whether or not there are any material differences between the actual location and a typical prototype location.
The timing of location disclosure
This issue was recently the subject of an important legal case. It was first heard by the Ontario Superior Court of Justice in late 2016, which decided in favour of the franchisee; but then the franchisor took it to the Court of Appeal for Ontario, which completely overturned the lower court in its decision, which was released on Jan. 25, 2018.
The lower court’s decision considered the common practice, followed by many franchisors, of providing a disclosure document to prospective franchisees that is lacking in details about the specific location for the franchise, and subsequently entering a franchise agreement. The lower court granted the franchisee’s claim for rescission (i.e. cancellation of the franchise agreement), finding it would be premature for a franchisor to provide disclosure and enter a franchise agreement if potentially material facts about the franchise, such as the location, had not yet been determined.
The Court of Appeal’s decision clarifies the obligations of franchisors to provide disclosure under Ontario’s Arthur Wishart (Franchise Disclosure, 2000) Act prior to the signing of the franchise agreement. It also has implications for other provinces that have enacted similar franchise legislation.
In the wake of the Court of Appeal decision, prospective franchisees need to be aware franchisors, in certain circumstances, can provide disclosure documents to them prior to determining a specific location or signing a lease.
A costly conversion
The facts of the specific legal case are common to many franchise situations. The franchisee signed a franchise agreement with the franchisor for the operation of a full-service restaurant. The franchisee had already received a detailed disclosure document before signing the franchise agreement. For its part, the agreement stated the location of the franchise’s premises would be determined after the signing; and a sublease of the location would be entered once the location was determined. If a suitable location were not found within 120 days of the signing the franchise agreement, then the franchisee could terminate the agreement and receive a refund of the initial franchise fee.
The franchisor chose to lease a location previously occupied by another restaurant. As such, it would convert the location into its own format. At the time this location was determined, the franchisee could have terminated the agreement, but did not do so.
After opening and operating the new restaurant for several months, the franchisee owed more than $200,000 for rent and construction costs. The franchisee served a notice of rescission to the franchisor, the affiliates of the franchisor and its principals, in anticipation of termination of the franchise agreement by the franchisor.
The defending parties moved to dismiss the entire action and for judgment of the franchisor’s breach of contract claim relating to termination of the franchise agreement. The lower court judge decided the entire action on summary judgment, stating the franchisor should have waited until a copy of the head lease for the location was available before delivering a disclosure document, even though all of the parties knew a location would not likely be determined any earlier than six months after the franchise agreement was signed.
The lower court also found the disclosure document provided by the franchisor did not comply with the requirements of the Wishart Act because it only included estimates of the costs of a shell location, not the costs of converting an existing restaurant. The lower court judge stated in such a case, the franchisor is not ready to disclose and must wait until all material matters are determined before delivering the disclosure document.
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