Disclosure Requirements When There Is A Sale Of An Existing Franchise/Assignment Of The Franchise Agreement

When a Franchisee Sells their Franchise, is the Franchisor Obliged to Provide a Disclosure Document to the Prospective Franchisee Buyer?

That depends. Section 5(7)(a)(iv) of the Arthur Wishart Act (Ontario's franchise legislation) provides an exemption to the obligation of delivering a disclosure document when the grant of the franchise is not effected by or through the franchisor. Furthermore, section 5(8) of the Arthur Wishart Act provides that a grant is not effected by or through the 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.

There is an exemption to delivering a disclosure document when the grant of the franchise is not effected by or through the franchisor. However, it is a risk to the franchisor relying on this exemption and not providing a disclosure document to the prospective franchisee purchaser, as the franchisor's conduct may be found to cross the threshold and the grant of the franchise being found to have been effected by or through the franchisor, thereby providing the franchisee two years from entering into the franchise agreement, to rescind the franchise agreement.

Whether a grant of the franchise will be found to be effected by or through a franchisor is determined by looking at the specific franchisor's involvement: was the franchisor actively participating in the grant of the franchise to the prospective franchisee purchaser or was the franchisor only passively involved with the grant?

Indicia that Courts have found support a finding that the grant of the franchise was effected by or through the franchisor, include:

1. the franchisor directing the purchaser to the selling franchisee; 2189205 Ontario Inc. v. Springdale Pizza Depot Ltd., 2011 ONCA 467 and Jayasena Management Corp et al v Savannah Wells Holdings Inc et al, 2023 ONSC 1008;
2. the franchisor being involved with the negotiations of the purchase and sale transaction of the franchise business; 2189205 Ontario Inc. v. Springdale Pizza Depot Ltd., 2011 ONCA 467;
3. the agreement of purchase and sale required the purchasing franchisee to deal directly with the franchisor, rather than, the existing franchisee/seller dealing with the franchisor to obtain the consent to the assignment;2189205 Ontario Inc. v. Springdale Pizza Depot Ltd., 2011 ONCA 467;
4. the franchisor requiring the purchaser to execute additional documents that were not executed by the vendor franchisee, even though these additional documents were signed by other franchisees as part of its then current business plan; 2189205 Ontario Inc. v. Springdale Pizza Depot Ltd., 2011 ONCA 467;
5. meetings regarding the transfer of the franchise taking place at the franchisor's office, a manager of the franchisor preparing certain documents in relation to the transfer; MAA Diners Inc. v. 3 for 1 Pizza & Wings (Canada) Inc. 2003 CanLII 10615 (ON SC);
6. the franchisor requiring the purchaser's spouse to sign a personal guarantee, thereby imposing conditions beyond the requirements specified in the franchise agreement.Justice Cumming said "in my view, a franchisor who exercises the power, albeit on reasonable grounds and pursuant to its usual practice, to require a non-officer, non-shareholder spouse ... to in effect become a co-franchisee is not merely engaging in the relatively passive act of approval of the transfer of the franchise as between the parties contemplated in the agreement between the transferor franchisee ... and intended transferee franchisee ... Rather, the grant is being effected by or through the franchisor"; 1518628 Ontario Inc. v. Tutor Time Learning Centres, LCC , [2006] O.J. No. 3011; and
7. requiring the purchasing franchisee to sign a new franchise agreement with the franchisor; Jayasena Management Corp et al v Savannah Wells Holdings Inc et al, 2023 ONSC 1008 and Ontario Inc. v. Dakin News Systems Inc., 2016 ONCA 74.

If a franchisor is seeking to rely on the exemption to providing a disclosure document to a prospective franchisee purchasing from an existing franchisee, then the franchisor needs to refrain from participating in the grant of the franchise, the franchisor should consent to the franchise agreement being assigned and take a reasonable transfer fee, nothing more. If a franchisor wishes to be more involved with the grant of the franchise, such as having the purchasing franchisee enter into a current form of franchise agreement, having additional documents signed by the purchasing franchisee that were not signed by selling franchisee or if the franchisor just generally wants to be involved with the sale process, then the franchisor needs to deliver to the prospective franchisee purchaser a disclosure document and comply with the disclosure requirements set out in the Arthur Wishart Act.

In 2189205 Ontario Inc. v. Springdale Pizza Depot Ltd. supra, the Court stated that individually the franchisor's actions may not have resulted in the finding that the grant was effected by or through the franchisor but in totality, the franchisor's actions resulted in a finding that the grant of the franchise was effected by or though the franchisor.

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.