When considering the purchase of a franchise, prospective franchisees may be presented with an opportunity to purchase an established franchise that has already been operated by another franchisee in the chosen system. Buying an existing franchise has a number of potential advantages over buying one brand new. An existing franchise should have an established presence and goodwill in its market, a track record of historical revenues and operating costs, an existing trained staff, and an existing leasehold (or owned) premises with all required leasehold improvements, furniture, fixtures, equipment, etc., already in place. These assets can empower the franchisee to make a better-informed decision prior to the purchase and should also allow the franchisee to start generating revenue immediately upon closing, rather than spending many months searching for a location, negotiating a lease, constructing the premises, recruiting and training staff, etc.
Whether the franchisee buys a new or existing franchise, provincial franchise statutes in seven Canadian provinces[1] (“Franchise Legislation”) place an obligation on franchisors to disclose material information about the franchise opportunity to prospective franchisees. Franchise Legislation exempts franchisors from the obligation to provide a Franchise Disclosure Document (FDD) in connection with the sale of an existing franchise if, among other conditions, the grant to the new franchisee “is not effected by or through the franchisor.” However, in practice, the degree of involvement by franchisors in these transactions frequently places them outside the scope of the exemption and, in those cases, they are required to provide an FDD.[2] While much of the available historical information related to the sale of an existing franchise should be received by the franchisee from the seller—as a result of standard due diligence investigations any buyer of a business would conduct—the franchisee can also expect the franchisor to disclose a significant amount of useful information in its FDD.
What to look for in an FDD
Generally, Franchise Legislation specifies that franchisors must present prospective franchisees with an FDD that includes all material facts, including material facts prescribed (in the associated regulations), prescribed financial statements, copies of proposed franchise agreements and other agreements related to the franchise, and statements to assist prospective franchisees in making informed investment decisions. With only a handful of exceptions, the FDD must be delivered at least 14 days before the franchisee signs any agreement or makes any payment related to the franchise.
The regulations under Franchise Legislation provide detailed lists of the information that franchisors are required to include in their FDDs. In addition, certain information is required to be included because, even though it is not listed in the regulations, it meets the definition of a “material fact” under Franchise Legislation. Some of the key standard information included in an FDD is as follows:
- Business Background: The legal nature (corporation, partnership, etc.) of the franchisor, the name and address of any parent company, a description of the franchisor’s business, biographies of officers and directors, details regarding the legal and financial history of the franchisor and certain persons closely related to it (e.g., law suits, convictions, bankruptcies, etc.), trademarks and other intellectual property it owns or otherwise has the right to use, etc.
- Nature of the Franchise Opportunity: A description of any protected territory rights the franchisee will receive (if the franchisor grants territories), an indication of what training and other support the franchisee can expect to receive, and a description of any purchasing or sale restrictions on franchisees.
- Financial Statements: Unless it is exempt from the requirement to provide its financial statements, financial statements for the franchisor’s last completed fiscal year, which allow the franchisee to judge the financial health of the franchisor.
- An Estimate of Franchisee Start-up Costs and Certain Ongoing Costs: Breakdown of initial deposit, fees, franchise construction and development costs, and expected ongoing costs.
- Contracts and Obligations: Copies of the Franchise Agreement and any other legal agreements, plus all material facts and restrictions such as conditions relating to termination, renewal, and transfer or sale of the franchise.
- Lists of current and former franchisees with contact information, so you can speak to franchisees about their experiences in the system.
Existing franchise disclosure
While Franchise Legislation and regulations do not make any express distinctions between the information that must be contained in an FDD for the sale of a new franchise versus one prepared for the sale of an existing franchise, as matter of interpretation, and as reflected in a number of court decisions, the contents of FDDs prepared for sales of existing franchises should include some additional and/or varying information. Examples of the types of additional information a franchisee should expect to find in such an FDD include:
- Additional Agreements: In cases where the franchisor is selling a corporate-owned location to a franchisee, any purchase and sale agreements or other transactional agreements proffered by the franchisor, in addition to the standard Franchise Agreement package, are considered “other agreements relating to the franchise to be signed by the prospective franchisee” and their disclosure will generally be required in the FDD.[3]
- Historical Financial Information: Although Franchisors are not required to disclose earnings projections or earnings claims in connection with sales of new franchises, some recent case law has confirmed that any historical financial information about an existing location in the possession of the franchisor is considered “material fact” information that must be disclosed in the FDD.[4]
- Lease Disclosure: As in the case of FDDs for new franchises, if a franchisor has entered into a head lease arrangement, whereby the franchisor leases the premises of an existing franchise from a landlord and then subleases them down to the franchisee, the franchisor must disclose a copy of the headlease to the franchisee.[5]
- Other Material Facts: As a consequence of the franchisor’s obligation to disclose “all material facts” in the FDD, there are any number of additional pieces of information about an existing franchise that may constitute “material facts” and be subject to disclosure. This may include information about the operational history of the franchise. For example, in the one past case, a court held that reports of a franchisor’s field representative, detailing “problems with the accounts, billings, financial arrangements with family users and the overall management” of an existing franchise were “material facts” that ought to have been included in the FDD.[6]
As a result of this sort of additional information, the franchisee and any professional advisors (i.e., lawyer and accountant) should be able to gain extra insight into the franchised business being purchased. This information should enable the franchisee to make a better assessment of the wisdom of completing the transaction, the price that could reasonably be paid for the business and any operational or reputational issues that might come with the existing business. Provided the additional information indicates a good investment, the franchisee can continue down the path of franchise ownership with extra confidence and get a “running start” on operating a profitable franchised business.
Chase Wallace
Associate
McInnes Cooper
chase.wallace@mcinnescooper.com
[1] At the time of writing, seven Canadian provinces, namely, NB, PE, ON, MB, AB, SK and BC, have adopted franchise legislation; however, Saskatchewan’s The Franchise Disclosure Act, SS 2024 c 13 has not yet come into force.
[2] See, for example, 2147191 Ontario Inc. v. Springdale Pizza Depot Ltd., 2015 ONCA 116.
[3] 2337310 Ontario Inc. v. 2264145 Ontario Inc., 2014 ONSC 4370 at paras 43-44.
[4] Premium Host Inc. v. Paramount Franchise Group, 2023 ONSC 1507 at para. 421, aff’d I Royal Bank of Canada v. Everest Group Inc., 2024 ONCA 577 at para. 12.
[5] See 6792341 Canada Inc. v. Dollar It Ltd., 2009 ONCA 385
[6] 1518628 Ontario Inc. v. Tutor Time Learning Centres LLC, 2006 CarswellOnt 4593 at paras. 62-63