Introduction to Ontario's Franchise Legislation
Franchising is not as heavily regulated in Canada as it is in a number of other jurisdictions, including the U.S. In Canada, franchise regulation is purely a provincial matter. Currently, only five Canadian provinces have franchise legislation in place: Ontario, Alberta, Prince Edward Island, New Brunswick and Manitoba (which has received Royal Assent but is not yet in force pending the finalization of the regulations thereunder). While there are certain differences in the legislation and regulatory requirements of each province, they are all derived ultimately from the U.S. model of mandated disclosure by a franchisor to prospective franchisees, coupled with a duty of good faith and fair dealing owed by each party to a franchise agreement to the other, and a right of franchisees to associate freely amongst themselves.
Unlike the U.S., no Canadian province requires either the registration of franchisors or the public filing of their disclosure documents. The legislative requirements are all enforceable only by private rights of action and the right of the franchisee to rescind its franchise agreement in the absence of proper disclosure by the franchisor (as described in further detail below).
Ontario's Arthur Wishart Act (Franchise Disclosure), 2000 (the Act) strives to address the imbalance of power and asymmetry of information typically found in the relationship between franchisors — often large, sophisticated corporations, and franchisees — often less sophisticated individuals. The Act applies to a franchise agreement entered into, or to a renewal or extension of a franchise agreement, on or after July 1, 2000 with respect to franchise locations operated partly or wholly in Ontario. The Act is designed primarily to protect franchisees by giving them the information they need to make an informed decision about whether to invest in a given franchise, as well as a commercial framework that assures they will be treated fairly.
The Act contains three primary elements:
1. disclosure by the franchisor to its prospective franchisees;
2. a duty of good faith and fair dealing on all parties to the franchise agreement; and
3. a right of association on the part of franchisees.
This article provides background information regarding the first of these elements and the remedies available to a franchisee for a franchisor's failure to comply with its disclosure obligations under the Act.
The Ontario Court of Appeal described the purpose of the Act this way in Personal Coffee Cup Corp. v. Beer (c.o.b. Elite Coffee Newcastle): "... the focus of the Act is on protecting the interests of franchisees. The mechanism for doing so is the imposition of rigorous disclosure requirements and strict penalties for non-compliance."
Disclosure Requirements under the Act
Under the Act, a franchisor is required to deliver to each prospective franchisee a disclosure document which contains all material facts about the franchise and the franchisor, and copies of all agreements relating to the franchise to be signed by the prospective franchisee, and which meets the detailed requirements set out in the regulations made under the Act (the Regulations). The information provided in the disclosure document must be accurate, clear and concise. The disclosure document must be delivered not later than 14 days prior to the earlier of the franchisee's signing of the relevant franchise agreement and its paying any consideration to the franchisor in relation to the franchise. The disclosure must be in a single document, delivered as such at one time, and must be certified as true and complete by two officers or directors of the franchisor. In addition, should any "material change" occur, which renders inaccurate the information provided in the original disclosure document, the Act requires the franchisor to provide the prospective franchisee with a clear and concise written statement detailing such material change as soon as possible after it occurs, and, in any event, no later than the earlier of the franchisee's signing of the franchise agreement and its paying any consideration to the franchisor in relation to the franchise.
There is a long list of information included in the Regulations which must be set out in the disclosure document, including details regarding the business background of the franchisor, its finances, its bankruptcy and insolvency history, the franchisee's expected costs associated with establishing the franchise and contact particulars for both current and former franchisees. The overarching requirement is that the document contain all "material facts" related to the franchise, which includes any information about the business, operations, capital or control of the franchisor, or about the franchise system, that would reasonably be expected to have a significant effect on the value or price of the franchise to be granted or the decision to acquire it.
If the franchisee suffers a loss because of a misrepresentation contained in the disclosure document, the franchisee has a right of action for damages against the franchisor and against every person who signed the disclosure document. It should be noted that franchisees are deemed to have relied on any misrepresentation contained in a disclosure document and that a "misrepresentation" is defined to include an untrue statement of a material fact, or an omission to state a material fact that is required to be stated or that is necessary to make a statement not misleading in light of the circumstances in which it was made. More significantly, if the franchisor delivers the disclosure document late or the disclosure fails to meet the requirements of the Act, the franchisee has the right to rescind the franchise agreement, without penalty or obligation, within 60 days after its receipt of the disclosure document. If the disclosure document is never delivered at all, the rescission remedy is available for two years after the date the franchisee entered into the franchise agreement. Of particular interest to franchisors is the fact that, in the event of rescission, the franchisor must compensate the franchisee for any losses it incurred in acquiring, setting up and operating the franchise.
In particular, the Act provides that within 60 days of the effective date of the rescission, the franchisor must:
1. refund to the franchisee any money received from or on behalf of the franchisee, other than money for inventory, supplies or equipment;
2. purchase from the franchisee any inventory that the franchisee had purchased pursuant to the franchise agreement and remaining at the effective date of rescission at a price equal to the purchase price paid by the franchisee;
3. purchase from the franchisee any supplies and equipment that the franchisee had purchased pursuant to the franchise agreement, at a price equal to the purchase price paid by the franchisee; and
4. compensate the franchisee for any losses that the franchisee incurred in acquiring, setting up and operating the franchise, less the amounts set out in clauses (1) to (3) above.
Disclosure Exemptions under the Act
The disclosure obligations under the Act are not applicable in all cases. Section 5(7) of the Act provides a number of exemptions from mandatory disclosure, even where the relationship is found to be a "franchise" and the Act applies generally (with similar exemptions from disclosure typically available in other Canadian jurisdictions with franchise legislation). Salient disclosure exemptions which may be available to a franchisor in certain cases include the following:
- One year, no payment exemption (Section 5(7)(g)(ii) of the Act): Where the franchise agreement to be entered into between the parties is not valid for longer than one year, and does not involve the payment of a non-refundable franchise fee, an exemption to disclosure is available in Ontario. An analogous exemption is not available under the Alberta Franchises Act. The New Brunswick Franchises Act, Prince Edward Island Franchises Act and Manitoba Franchises Act allow for a similar exemption; however, in addition to the limited term (not more than one year) and no payment of a non-refundable franchise fee requirements, the franchise legislation of each of New Brunswick, Prince Edward Island and Manitoba also requires that the franchisor or franchisor's associate provide location assistance to the franchisee for this exemption to be available.
- Large investor exemption (Section 5(7)(h) of the Act):An exemption exists under the Act for instances where the franchisee will invest more than C$5-million in one year in the acquisition and operation of the franchise. This exemption is not available in any of the other provinces with franchise legislation in effect.
- Exemption upon renewal or extension of the franchise (Section 5(7)(f) of the Act): In cases of renewal or extension of a franchise agreement where there has been (1) no interruption in the operation of the business operated by the franchisee under the franchise agreement and (2) no material change since the franchise agreement or latest renewal or extension of the franchise agreement was entered into, an exemption from disclosure is available under the franchise legislation of each of Ontario, Alberta, Prince Edward Island, New Brunswick and Manitoba. It should be noted that the Alberta legislation does not condition the availability of this exemption on there not being any material change. "Material change" is defined in subsection 1(1) of the Act as "... a change in the business, operations, capital or control of the franchisor or franchisor's associate, a change in the franchise system or a prescribed change, that would reasonably be expected to have a significant adverse effect on the value or price of the franchise to be granted or on the decision to acquire the franchise and includes a decision to implement such a change made by the board of directors of the franchisor or franchisor's associate or by senior management of the franchisor or franchisor's associate who believe that confirmation of the decision by the board of directors is probable."
- Exemption where the grant of the franchise is not effected by or through the franchisor (Section 5(7)(a)(iv) of the Act): An exemption also exists for grants of a franchise by a franchisee, for the franchisee's own account, where the grant is not effected by or through the franchisor. Section 5(8) of the Act clarifies that a grant is not effected by or through a franchisor merely because (1) the franchisor has a right, exercisable on reasonable grounds, to approve or disapprove the grant or (2) 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. This exemption may be available in cases where a franchisee sells its business to a new franchisee. This exemption is available for franchises in each of Ontario, Alberta, Prince Edward Island, New Brunswick and Manitoba.
- Exemption upon the grant of an additional franchise to an existing franchisee (Section 5(7)(c) of the Act): An exemption from the Act's disclosure requirements is available in the case of a grant of an additional franchise to an existing franchisee if that additional franchise is substantially the same as the existing franchise that the franchisee is operating and if there has been no material change since the existing franchise agreement or latest renewal or extension of the existing franchise agreement was entered into.
- Fractional franchise exemption (Section 5(7)(e) of the Act): An exemption from the Act's disclosure requirements is available in the following circumstance: The granting of a franchise to a person to sell goods or services within a business in which that person has an interest if the sales arising from those goods or services, as anticipated by the parties or that should be anticipated by the parties at the time the franchise agreement is entered into do not exceed, in relation to the total sales of the business, a prescribed percentage. Each Canadian jurisdiction with franchise legislation in effect has a comparable exemption available and the "prescribed percentage" is 20%. Thus, if sales from a particular franchisor's products are anticipated by the parties, at the time the agreement is made, to account for less than 20% of the overall sales of a franchisee's business, the franchisor can avail itself of the fractional franchise disclosure exemption.
It is important to note that the Act places no express obligation on a franchisor to advise a prospective franchisee that it is relying on a specific disclosure exemption as the reason for not delivering a disclosure document to the prospective franchisee. However, if the franchisee challenges the applicability of an exemption, the onus will be on the franchisor to demonstrate that such disclosure exemption applied.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.