For many foreign franchisors, the decision to expand into Canada eventually leads to a practical question: what exactly has to be included in a Canadian franchise disclosure document?
This is an important question because Canadian franchise legislation does not simply require that a disclosure document be delivered. It requires that the document contain prescribed information and disclose all material facts relating to the franchise offering. If the disclosure document is incomplete or materially deficient, the consequences can be significant, including statutory rescission rights and, in some circumstances, personal liability for directors and officers.
The good news is that Canadian disclosure requirements are generally well understood and can be managed effectively with proper planning. The challenge for foreign franchisors is recognizing that a U.S. franchise disclosure document, or a disclosure package prepared for another jurisdiction, will not necessarily satisfy Canadian requirements.
This article provides a high-level overview of the principal components of a Canadian franchise disclosure document.
The purpose of the disclosure document
The objective of franchise disclosure legislation is straightforward: to provide a prospective franchisee with sufficient information to make an informed investment decision.
Canadian franchise statutes seek to reduce the informational imbalance that naturally exists between an established franchisor and a prospective franchisee. The disclosure document is intended to provide a comprehensive picture of the franchisor, the franchise opportunity, and the legal and commercial framework governing the relationship.
It is not merely a sales document. It is a statutory disclosure instrument, and courts generally expect it to be complete, accurate, and transparent.
Corporate information about the franchisor
A Canadian franchise disclosure document will typically begin with information describing the franchisor and its business.
This commonly includes:
• the legal name and business address of the franchisor;
• the business organization and corporate structure;
• the history and development of the franchise system;
• the experience of the franchisor and its management team; and
• information concerning any parent or affiliated entities that play a material role in the franchise system.
For foreign franchisors, it is often important to explain how the Canadian expansion will be structured and whether a Canadian subsidiary or affiliate will be involved.
Directors, officers, and key management personnel
Canadian disclosure documents generally identify the directors, officers, and senior management personnel of the franchisor and describe their business experience.
The purpose is to provide the prospective franchisee with a reasonable understanding of the people responsible for the operation and management of the franchise system.
As discussed in an earlier article in this series, this section has additional significance because directors and officers may, in certain circumstances, face personal liability for disclosure deficiencies.
Litigation and insolvency history
Canadian franchise legislation generally requires disclosure of certain litigation involving the franchisor and, in some cases, its directors and officers.
The purpose is not to catalogue every dispute in which the franchisor has ever been involved. Rather, the legislation seeks disclosure of litigation that may reasonably be considered relevant to a prospective franchisee’s investment decision.
Similarly, disclosure may be required with respect to certain insolvency events involving the franchisor or related individuals.
Foreign franchisors should carefully review these requirements, as the scope of disclosure may differ from what they are accustomed to in other jurisdictions.
Initial investment and ongoing fees
A Canadian franchise disclosure document will generally describe the financial commitments associated with the franchise.
These commonly include:
• the initial franchise fee;
• royalties and continuing fees;
• advertising and marketing fund contributions;
• technology fees;
• training fees;
• renewal or transfer fees; and
• other recurring charges payable by the franchisee.
The disclosure document will also typically include an estimate of the initial investment required to establish and commence operation of the franchise business.
Prospective franchisees should be able to understand, from the disclosure document itself, the principal costs associated with acquiring and operating the franchise.
Territory and operating restrictions
Canadian disclosure documents generally include a description of the franchisee’s territorial rights and any limitations that may apply.
This may include information concerning:
• exclusive or protected territories;
• the franchisor’s right to operate through alternative channels;
• internet and e-commerce rights;
• reservation of rights by the franchisor; and
• circumstances in which territorial protections may be modified.
Restrictions affecting the operation of the business — including approved products, designated suppliers, and operating standards — are also commonly addressed.
Financial statements
In most cases, Canadian franchise legislation requires that the disclosure document include financial statements relating to the franchisor.
These financial statements are intended to provide prospective franchisees with information concerning the financial condition of the franchisor and its ability to support the franchise system.
The specific requirements, including possible exemptions, can be technical and should be considered carefully during the preparation of the disclosure document. Foreign franchisors should not assume that financial statements prepared for another jurisdiction will automatically satisfy Canadian requirements.
The financial statement requirements for Canadian franchise disclosure will be examined in greater detail in a subsequent article in this series.
Copies of franchise agreements and related documents
A Canadian franchise disclosure document generally includes copies of all agreements that the prospective franchisee will be required to sign in connection with the franchise relationship.
These may include:
• the franchise agreement;
• guarantees;
• confidentiality agreements;
• software or technology licences;
• development agreements;
• leases or subleases, where applicable; and
• other ancillary documents.
The objective is to ensure that the prospective franchisee has a complete understanding of the contractual framework before making an investment decision.
The requirement to disclose “all material facts”
Perhaps the most distinctive feature of Canadian franchise disclosure legislation is the requirement to disclose all material facts.
A material fact is generally understood to be any information about the business, operations, capital, or control of the franchisor or the franchise system that could reasonably be expected to have a significant effect on the value or price of the franchise or the decision to acquire it.
This is not a closed list. The obligation extends beyond prescribed disclosure items and requires franchisors to consider whether there are additional facts that ought reasonably to be disclosed.
For many foreign franchisors, this broad and principles-based obligation is one of the most significant differences between Canadian franchise law and the legal framework in their home jurisdiction.
Accuracy and currency matter
Preparing a disclosure document is not simply an exercise in collecting information. The information must also be current.
If a material change occurs after the disclosure document has been delivered, but before the franchise agreement is signed, the franchisor may be required to provide updated disclosure.
Similarly, disclosure documents should be reviewed and updated regularly to ensure that they continue to reflect the current state of the franchise system.
An outdated disclosure document can create the same risks as an incomplete one.
Practical considerations for foreign franchisors
Foreign franchisors are often tempted to adapt an existing U.S. or international disclosure document for Canadian use. While that may be a sensible starting point, it should not be viewed as a complete solution.
Preparing a Canadian franchise disclosure document typically involves:
• reviewing existing disclosure materials;
• identifying differences between Canadian and foreign legal requirements;
• adapting franchise agreements and ancillary documents;
• ensuring compliance with Canadian financial statement requirements; and
• implementing internal procedures to keep disclosure materials current.
Approached properly, the process is straightforward. The key is to undertake the exercise before franchises are offered or sold.
The importance of complete and accurate disclosure
A Canadian franchise disclosure document is much more than a marketing package or a collection of standard form agreements. It is the foundation of the legal relationship between franchisor and franchisee and the principal mechanism through which Canadian franchise legislation seeks to protect prospective investors.
For foreign franchisors, the challenge is not simply assembling the required documents. It is understanding the breadth of the Canadian disclosure obligation, including the requirement to disclose all material facts and the potential consequences of getting it wrong.
A carefully prepared and regularly updated disclosure document is one of the most effective tools available to reduce legal risk and facilitate a successful expansion into the Canadian market.
This article forms part of a series on franchising in Canada for international brands considering expansion into the Canadian market.