Financial Statement Requirements for Disclosure Documents
Franchise legislation in Canada (currently in the provinces of BC, Alberta, Manitoba, Ontario, New Brunswick and PEI) contains a requirement that franchisors include financial statements for their most recently completed fiscal year. Generally speaking, franchisors may include either:
- audited financial statements; or
- review engagement financial statements.
Financial statements must be prepared in accordance with the generally accepted accounting principles in Canada, or standards at least equivalent to the Canadian standards.1 Franchisors need to be alert to the fact that not all financial statements meet the minimum requirements established for audited or review engagement financial statements. For example, courts have found that using “notice to reader” financial statements constitutes a material disclosure deficiency, even where the difference between the two standards did not alter the quality of information provided to the prospective franchisee.2
Acknowledging that financial statements take time to prepare, Canadian franchise legislation contains a 180-day grace period before a franchisor has to update the financial statements in its disclosure documents. This means that franchisors have 180 days from their fiscal year end to have financial statements for that fiscal year prepared and then include those financial statements in their franchise disclosure document. For example, a franchisor with a December 31 fiscal year end date has until June 28 of the next year to update their franchise disclosure document to include new financial statements for the previous fiscal year. During the grace period, franchisors may continue to use financial statements for the previously completed fiscal year.
New franchisors that have operated for less than one fiscal year (or if 180 days haven’t passed from the completion of their first fiscal year end) are subject to a modified requirement to include the franchisor’s opening balance sheet.
Additionally, larger, well-established franchisors may be able to take advantage of exemptions from the requirement to include financial statements altogether. Franchisors should only rely on an exemption after confirming their eligibility for such exemption with appropriate professional advisors.
How important is it that financial statements be up to date?
Unfortunately for franchisors, Canadian courts have consistently concluded that a franchisor’s financial statements are an extremely important component of franchise disclosure.3 Financial statements that are even slightly out of date constitute a material disclosure deficiency that may completely negate disclosure. The deficient or negated disclosure may provide a franchisee with a right to sue for damages (if the deficient information caused the franchisee damages) or to rescind their franchise agreement and be compensated for all of the costs of establishing the business. A full discussion of the implications of rescission is beyond the scope of this post, but it is sufficient to say that the financial and logistical costs of a franchisee rescinding their franchise agreement creates a significant enough incentive for franchisors to ensure that no such right is ever available.
What else in the disclosure document needs to be updated with the financial statements?
Certain information that must be included in franchise disclosure documents must also be updated following a franchisor’s fiscal year end. This includes:
- Statements regarding expenditures of advertising fund contributions (which must be made for each of the two fiscal years immediately preceding date of the disclosure document); and
- Information regarding closures and terminations (which must be included for up to three fiscal years immediately preceding the date of the disclosure document).
Additionally, almost all of the information needs to be current and complete each time the disclosure document is issued. While a large portion of the information in the disclosure document will remain the same, the following disclosure items may require updating somewhat regularly, if not each time a disclosure document is issued:
- The officers and directors of the franchisor and their respective backgrounds;
- Information regarding ongoing or pending convictions, litigation, administrative proceedings and bankruptcies;
- The estimated initial investment to establish a franchised business;
- The amount of any fees payable in connection with the operation of the franchise business;
- Earnings projections and estimates of annual operating costs; and
- The table of contents of the operations manual.
When else are updates required?
In addition to an annual update to include the previous fiscal years’ financial statements within 180 days from year end, franchisors must also update their disclosure document any time there is a material change. The material change could be to the any prescribed disclosure item (for example the items listed above) or any “material fact.”4 If a prospective franchisee has been disclosed prior to the material change occurring, it may be acceptable to provide the information in a Statement of Material Change; however, best practice is still to make the corresponding update to the current version of the disclosure document as soon as possible.
Finally, in certain circumstances, it may not be appropriate to use a generic disclosure document. This occurs when it is necessary to include information that is specific to a particular offering – for example on the resale or transfer of an existing location. In these circumstances, it may be necessary to issue a site-specific disclosure document. Since some of the prescribed information in the disclosure document is tied to the issuance date, that information must also be updated whenever a site-specific disclosure document is issued.
Need help with your Franchise Disclosure Document?
To ensure you are meeting your disclosure obligations as a franchisor, you should regularly update your disclosure document with the assistance of an experienced franchise lawyer. Siskinds’ franchise law group has over 30 years of experience in the franchise sector. As authors of Franchise Legislation in Canada (published by Thomson Reuters), we literally “wrote the book” on compliance with franchise legislation in Canada.
1 The exact requirements vary slightly from province to province. Franchisors should consult with appropriate professionals to ensure the financial statements they include meet the requirements for each jurisdiction.
2 See e.g. 2240802 Ontario Inc. v. Springdale Pizza Depot Ltd., 2015 ONCA 236 (CanLII) at paras 54-58.
3 See e.g. Mendoza v. Active Tire & Auto Inc., 2017 ONCA 471 (CanLII) at para 33.
4 “Material Fact” is not specifically defined in Canadian franchise legislation, but has been interpreted as a broader, more general requirement intended to cover other information that could reasonably be expected to have a material effect on the value of the franchise or the franchisee’s decision to acquire the franchise.