Franchise Agreement
Advice & TipsAsk an ExpertJuly/August 2023Previous Issues

Q: I am buying a franchise from an existing franchisee. Is the franchisor required to provide me with a disclosure document?

The answer to this question really depends on the extent to which the franchisor is involved in bringing about the sale. All franchise legislation in Canada provides franchisors with a conditional exemption from providing a disclosure document on the sale of a franchise by a franchisee where the sale is “not effected by or through the franchisor.”

The legislation also specifically provides that a sale is not effected by or through the franchisor “merely because” it has the right to reasonably approve or disapprove of the sale. For example, Ontario’s Arthur Wishart Act (Franchise Disclosure), 2000 states that franchisors are not required to provide disclosure documents to prospective franchisees if:

  • The franchisee is not the franchisor, an associate of the franchisor, or a director, officer, or employee of the franchisor or of the franchisor’s associate;
  • the grant of the franchise is for the franchisee’s own account;
  • in the case of a master franchise, the entire franchise is granted, and
  • the grant of the franchise is not effected by or through the franchisor;

Under a separate subclause of the act (subclause (7)(a)(iv)), a grant is not effected by or through a franchisor merely because:

  • the franchisor has a right, exercisable on reasonable grounds, to approve or disapprove the grant; or
  • a transfer fee must be paid to the franchisor in an amount set out in the franchise agreement or in an amount that does not exceed the reasonable actual costs incurred by the franchisor to process the grant.

The emphasized clauses state that if the sale is not “effected by or through the franchisor,” the franchisor does not need to provide you (as a purchaser of the franchise business from an existing franchisee) with a disclosure document.

What, then, is a sale “effected by or through the franchisor?” There have only been a handful of decisions interpreting these exemption provisions. Courts interpret disclosure exemptions very narrowly, given that franchise statutes are remedial legislation designed to protect existing and prospective franchisees.

The courts generally regard this exemption as applying only when the franchisor is not an active participant in bringing about the sale and does nothing more than “merely” exercise its right to consent to the transfer. In such circumstances, the courts have held, the power imbalance that typically exists between franchisors and franchisees does not bear upon the purchaser’s decision to become a franchisee.

In short, there are generally two circumstances where a court may find that a franchisor has “effected” the transfer. The first is when a franchisor requires the purchaser to agree to additional conditions or sign additional documents that were not contemplated in the original franchise agreement with the seller. The second is when the franchisor actively participates in the resale negotiations between the seller and buyer. Here are some examples:

  • In one case, the franchise agreement gave the franchisor the right to require a personal guarantee of the sole shareholder of the franchisee company. When the original franchisee sold the business to another by way of a share purchase agreement, the franchisor required the purchaser’s husband to provide a guarantee as a condition of permitting the sale.
    – The court found that by imposing this additional requirement the franchisor had “effected” the transfer, and thus, a disclosure document was required to have been provided to the purchaser;
  • Similarly, in another case, the franchisor directed a prospective franchisee to an existing franchisee who wanted to sell. The person ended up buying the existing franchise, but the franchisor required the new owner to sign additional documents that had not been required of the previous owner, and had some involvement in the negotiations between the parties.
    – The additional documents the franchisor required the purchaser to sign, coupled with its participation in the negotiations between the seller and purchaser, caused the court to conclude that it had “effected” or “caused or brought about” the sale; and
  • In yet another case, the franchisor required, as a condition of approving the sale of a franchise by one of its franchisees, that the seller provide it with: a copy of the purchase and sale agreement; contact information for the parties’ lawyers; financial information on the purchaser; and the seller’s total gross sales for the last 12 months. The franchisor also required the purchaser to execute a new franchise agreement and pay it a $20,000 inventory fee to be put towards initial orders for inventory post-closing. The court found that, even though the franchisor distanced itself from direct contact with the purchaser, the above made the exemption unavailable.

It is relatively clear that, on one end of the spectrum, a franchisor that does nothing more than provide its consent to the sale can rely on this exemption. However, in cases where the franchisor requires the purchaser to sign additional documents or agree to additional conditions, or is more than a passive participant in the resale, it likely cannot rely on the exemption.

If a dispute arises as to whether the exemption applies, in addition to narrowly interpreting the exemption, the court will carefully examine the role the franchisor played in facilitating the transaction and the requirements it imposed as a condition of permitting the sale to take place.

W. Brad Hanna

Partner and Co-Chair of the Franchising & Distribution Group

McMillan LLP