Prospective franchise clients often ask when they should retain a lawyer. My answer is almost always the same. A franchisor client should retain a franchise lawyer from the moment they try to franchise their business. Conversely, a franchisee client should retain a franchise lawyer as one of the last steps in the process.
For the franchisor client, a franchise lawyer will provide valuable advice and guidance that will be necessary from the outset of the development of their franchise system. For the franchisee client, they should only seek advice from a franchise lawyer once they have done their due diligence (i.e., spoken to other franchisees, met with their other professional advisors such as accountants, secured financing, etc.). Lawyers are costly. Why should the franchisee client spend the money on a franchise lawyer if they’re not fully certain that they will proceed with the franchise opportunity?
Franchise legislation in Canada
Franchise legislation is now present in six (soon to be seven) Canadian provinces. The main policy goals of franchise legislation in Canada are: (a) to provide prospective franchisees with the information they need to make an informed decision about purchasing a franchise; and (b) to create a commercial framework that governs the relationship of the parties. Provincial franchise legislation is remedial legislation and is akin to consumer protection legislation, enacted to rectify a perceived imbalance of power favouring the franchisor. The courts have generally given it a liberal interpretation.
This liberal interpretation has resulted in holding franchisors to a relatively high standard of disclosure to ensure that the franchisee can make a properly informed decision about whether or not to invest in a franchise. Examples of this standard include granting a franchisee the right to rescind (i.e., walk away) in the circumstances in which: (a) the franchisor failed to: (i) include a signed and dated certificate in the appropriate form, signed by the required number of officers or directors of the franchisor; (ii) provide financial statements as required or provided stale dated (not current) financial statements, or the financial statements did not contain proper notes; or (iii) provide a statement of material change in circumstances where it was required; or (b) the disclosure document was provided in successive stages and not as one document at one time; (c) the disclosure document did not contain copies of all agreements that the prospective franchisee was required to sign; and (d) the franchised business was the first of its type (e.g., outside of a shopping mall) in the franchisors’ system.
As well, the term “franchise” is broadly defined, with the result that there are several relationships which could deem the parties to be subject to franchise legislation. The parties need to look at the substance of the business relationship to determine whether it is a franchise under franchise legislation. Just because you call an agreement by another name, does not mean it is not a franchise agreement.
As part of achieving the first policy goal of provincial franchise legislation, a franchisor must provide a franchise disclosure document (FDD) compliant with the relevant provincial statute to each prospective franchisee no later than 14 days before the earlier of the franchisee:
- signing the franchise agreement or any other agreement relating to the franchise, or
- paying any consideration relating to the franchise (i.e., collectively signs or pays).
The FDD is to be certified by two directors or officers of the franchisor (unless the franchisor has only one director and officer) as true and complete and must contain the following:
a) all material facts, including material facts as prescribed by the regulations;
b) financial statements as prescribed;
c) copies of all proposed agreements;
d) the prescribed statements (these are found at the beginning of the disclosure document); and
e) other information and copies of documents as prescribed.
The disclosure process begins when a franchisor provides a prospective franchisee with the FDD and ends when the prospective franchisee signs the franchise agreement. The time between those two events must be at least 14 days but could continue for additional weeks or months. If during the intervening period there are any material changes to the information provided or that should have been provided in the FDD, the franchisor must deliver a statement of material change to the prospective franchisee as soon as practicable after the material change has occurred, but in any event before the prospective franchisee signs or pays.
Franchise legislation in Canada provides that a franchisee may rescind the franchise agreement no later than 60 days after receiving the disclosure document if:
- the franchisor fails to provide the disclosure document or statement of material change within the time requirements, or
- the contents do not meet the requirements of the relevant provincial statement, but they later receive a disclosure document.
A franchisee is also entitled to rescind the franchise agreement no later than two years after signing if the franchisor never provided an FDD, which also includes a disclosure document that is so deficient it constitutes non-disclosure.
There are two broad categories of exemptions that are available under franchise legislation. The first category excludes certain relationships from the application of franchise legislation. The second category affords the franchisor an exemption, in a variety of circumstances, from the obligation to provide a prospective franchisee with an FDD.
Why you should see a franchise lawyer
Franchise legislation can be a trap for the unwary client and/or lawyer. This trap presents itself in one of two ways:
- The failure to appreciate that the commercial relationship is a “franchise” which then imposes on the party granting the rights (the franchisor) the obligation to provide an FDD.
- The failure of the franchisor to provide an FDD that meets the obligations set forth in the provinces franchise legislation.
With respect to a lawyer licensed to practice law in a province of Canada, however, the consequences of not properly advising a franchise client of their rights and/or obligations under franchise legislation could result in a finding of negligence against the lawyer and exposure for substantial damages. Most often when the lawyer finds that their advice to a franchise client was negligent, the damages have already been suffered and cannot be rectified. The payouts on lawyer negligence claims have historically arisen due to a franchisee’s entitlement to post-rescission damages under franchise legislation.
A franchisee may have a claim against their lawyer for negligence if the franchisee either did not receive an FDD, or received a non-compliant FDD, and the lawyer did not advise the franchisee of their rights, resulting in the franchisee missing the opportunity to rescind its franchise agreement within the time provided under franchise legislation.
A franchisor client may similarly have a claim against their lawyer if the franchisee subsequently rescinds its franchise agreement and claims rescission damages from the franchisor, who then claims against its (former) lawyer for negligence and indemnification for the post-rescission damages claim. The circumstances in which this could occur are as follows:
- The lawyer did not advise the franchisor client of its obligation under franchise legislation to provide a compliant FDD to a prospective franchisee. This could arise because the lawyer:
- did not advise the franchisor client that the business relationship between the parties to the agreement was a franchise as defined under provincial franchise legislation,
- advised the franchisor client that an exemption from provincial franchise legislation was available when it was not, or
- advised the franchisor client that an exemption from the delivery of an FDD was available when it was not.
- The lawyer prepared an FDD for its franchisor client that failed to comply with the requirements of franchise legislation.
- The lawyer fails to instruct the franchisor client of the importance of updating the FDD on an as-required basis to include all material facts, including those material facts prescribed by the regulations.
Although the lawyer may be directly liable for the post-rescission damages that the franchisee would otherwise have been able to claim against the franchisor, or has been paid out by the franchisor, it is often of little comfort to the franchisee/franchisor client that they have a claim against their former lawyer. Whether you are a franchisor or franchisee, a lawyer specializing in franchise law can help you determine the next steps in your franchise journey.
David Kornhauser
Partner
Loopstra Nixon LLP
dkornhauser@LN.law