A: If you’re looking to purchase a franchise business, the Franchise Disclosure Document (FDD) is a key document you’ll encounter. Required by the Arthur Wishart Act (AWA) in Ontario, the FDD is a document provided to prospective franchisees by franchisors. Despite its length, the FDD is a valuable tool that helps prospective franchisees review and assess the business viability of the franchise and marks the starting point of the franchise relationship.
It’s important to highlight a few important items in the FDD that only an experienced franchise lawyer would be able to point out during its review.
Statement of material change
“Material change” is defined in the AWA as any change that would reasonably be expected to have a significant adverse effect on the value or price of the franchise being offered or on the prospective franchisee’s decision to purchase the franchise. As a potential franchisee, it’s important to know that the franchisor is legally obligated to provide you with a written statement of any “material change” to its FDD as soon as possible after the change has occurred, and before the earlier of:
(i) the signing of the franchise agreement by the prospective franchisee or any other agreement relating to the franchise; and
(ii) the payment of any consideration by or on behalf of the prospective franchisee to the franchisor.
This obligation also extends to correcting deficiencies or omissions, and supplementing new information discovered after delivery of the FDD. So, if a long time has elapsed between when you first received the FDD and the time you sign the franchise agreement, you should be on the lookout for a statement of material change from the franchisor.
Failing to meet such disclosure requirements could provide a franchisee with the right to rescind (cancel) the franchise agreement no later than 60 days after receiving the disclosure document.
If a franchisor fails to disclose that the proposed location of your franchise substantially differs from the prototypical franchise locations, the franchisee may have a valid claim for rescission within two years from when the franchise agreement was signed, on the basis that the FDD was materially deficient or fatally flawed.
In recent case law, courts have nullified an FDD when franchisors failed to disclose that the location the franchisee was buying was an untested retail concept in that franchise system.
The FDD’s information on the franchisor’s business is typically based on standard specifications derived from tested retail concepts in the franchise system. However, the costs to open a franchise that differs from these standards may not be accurately reflected in the FDD.
Obtain the most recent financial statements
The disclosure document must include the franchisor’s full financial statements for its most recently completed year-end. Franchisors have 180 days from their fiscal year-end to include the updated financial statements in their FDD. For example, a franchisor with a December 31, 2022 fiscal year-end date has until June 28, 2023 to include new financial statements for the previous fiscal year.
Considering financial statements must be updated annually, it’s not uncommon to see a franchisor forget its obligation to include updated financial statements in its FDD. Failing to do so could provide a franchisee with a valid claim for rescission within two years from when the franchise agreement was signed, on the basis that the FDD was materially deficient or fatally flawed. It’s also possible that the same conclusion could be met on the basis that the prospective franchisee has effectively been deprived of the opportunity to make an informed investment decision based on the lack of material facts being provided about the franchise opportunity.
Ensure that trademarks are registered
If the franchisor’s trademarks are at the application stage and have yet to be registered, franchisees have no protection against trademark infringement. Therefore, you should ensure that all the trademarks are registered and have an active status with the Canadian Intellectual Property Office. Often, new franchisors may only have made an application for a trademark and are awaiting the actual registration, which can sometimes take as long as two years.
Term of the franchise agreement must match the lease agreement
It’s essential that the franchise agreement and the lease agreement have matching terms for the lengths of the agreements. For instance, if the franchise agreement is set for 10 years with the option to extend for another 10 years, the lease agreement should reflect the same time frame, including the option for renewal. When there’s a discrepancy between the two agreements, it can result in adverse outcomes, such as difficulties in selling your franchise to a prospective buyer.
The items mentioned in this article are just a few of the key considerations that every franchisee should consider before committing to a franchise agreement. It’s important to work with an experienced franchise lawyer to ensure you understand all the terms and conditions of the franchise relationship, and to protect your investment. Arturo R.
Partner, Corporate & Commercial
Loopstra Nixon LLP