The recent amendments to the Arthur Wishart Act (Franchise Disclosure), 2000 (the AWA) include additional flexibility for pre-disclosure contracting, and clarity for various exemptions from the disclosure requirement. However, while the language in some of the amendments now aligns the AWA with other provincial legislation, franchisors should be aware of some potential interpretational issues when relying on them. This article provides an overview of some of these potential issues which, if not managed, could put the franchisor in a worse position had they not relied on the amendments in the first place.
Exemption from the obligation to disclose for confidentiality and site-selection agreements
Section 5(1)(a) of the AWA requires that a franchisor provide a prospective franchisee with a disclosure document not less than 14 days before the prospective franchisee signs a franchise agreement or any agreement relating to the franchise. The AWA’s broad definition of “franchise agreement,” would include confidentiality agreements and site-selection agreements. Accordingly, this section has prevented franchisors from requiring prospective franchisees to sign confidentiality agreements to protect the franchisor’s confidential information that must be shared with a prospective franchisee via a disclosure document, during pre-contractual discussions, or to settle on a specific site for the franchise. Notably, the inability to put a “hold” on a specific site for the franchise was likely equally frustrating to franchisees as it was for the franchisor.
The amendments now permit the execution of either or both of a confidentiality agreement and a site-selection agreement during or before the 14-day disclosure period. However, the agreements must meet certain criteria: They must only contain terms that, as applicable:
- require any information or material that may be provided to a prospective franchisee to be kept confidential;
- prohibit the use of any information or material that may be provided to a prospective franchisee; or
- designate a location, site or territory for a prospective franchisee.
In addition, confidentially agreements cannot:
- impose confidentiality obligations on the franchisee in respect of information that is or comes into the public domain other than as a result of a contravention of the agreement, is disclosed to any person other than as a result of a contravention of the agreement or is disclosed with the consent of all the parties to the agreement; or
- prohibit the disclosure of information to an organization of franchisees, other franchisees of the same franchise system or a franchisee’s professional advisors.
While these changes align the AWA with what is typically seen in the franchise legislation of the other provinces, they raise practical questions about how franchisors should draft their confidentiality and site-selection agreements in order to stay on-side with the new exemptions from the restriction on pre-disclosure contracting.
Specifically, the terms of confidentiality and site selection agreements must “only contain" the provisions described above. As a practical matter, however, any such agreements will typically include other provisions, such as preamble and boilerplate terms. Presumably, the legislature did not intend that such provisions would take a franchisor outside the scope of the exemption. Where the line potentially becomes blurred, however, is where additional provisions are included. For example, confidentiality agreements also typically include injunctive relief in the event of a breach, because breach-of-contract damages are usually too remote and speculative to be a practical remedy. Would this kind of standard provision take the franchisor outside of this exemption?
Similarly, site-selection agreements are often time-limited, and grant the parties various rights to terminate the agreement either for convenience or upon the occurrence of certain events. Such provisions are not, strictly speaking, “designating” a location, site or territory, but are clearly germane to such designation. An agreement that designates a site without any other conditions, restrictions or processes is simply not commercially viable. Without the ability to place some limitations or conditions on the site selection and to, under certain circumstances, be able to take back the site and offer it to other candidates, franchisors may be reluctant to enter into such agreements. The effect may then be to put franchisors back in the same position as they were prior to the amendments. We believe that the better, and more commercially reasonable, view in interpreting “only” in the context of these exemptions, is that including in a site-selection agreement those provisions that are inextricably intertwined with designating a site should not bring a franchisor outside the scope of the exemption. Otherwise, the intent of the legislature in introducing this amendment would be entirely undermined.
It will be interesting to see how the courts interpret these amendments and address these questions in the near future.
Section 5(1)(b) of the AWA prevents a franchisor from receiving any consideration before the end of the 14-day disclosure waiting period, which prior to the amendments prohibited the payment of a deposit to the franchisor before or during this period. The amendments provide an exclusion for deposit payments that:
- do not exceed 20% of the franchise fee (to a maximum of $100,000);
- are refundable without any deductions; and
- are given under an agreement that in no way binds the prospective franchisee to enter into a franchise agreement.
What is interesting, however, is that despite allowing franchisors to accept a deposit, the amendments do not expressly allow the franchisor to enter into a deposit agreement with the franchisee. Section 5.1(a) only carves confidentiality agreements and site-selection agreements out of the prohibition on pre-contractual disclosure. However, it seems exceedingly unlikely that the legislature’s intention was to prohibit deposit agreements. As between the franchisee and the franchisor, the franchisee stands to benefit more than the franchisor from having a written agreement that governs the franchisor’s receipt of the money and the circumstances in which it must be refunded. However, given the prescriptive nature of the exemptions in Section 5.1(a), what, if any, restrictions exist in respect of deposit agreements? A prudent approach would be to include the bare minimum in such an agreement in order to memorialize the arrangement, such as the ability for the franchisee to obtain a refund, the application of the deposit if not refunded and an express statement that the franchisee is not bound to enter into a franchise agreement.
The fully refundable nature of the deposit also raises practical questions: Does a deposit make sense or have any real utility when it is refundable and does not bind the franchisee in any way? Nonetheless, the scheme contemplated for deposit payments is similar to that in British Columbia, Alberta, and Manitoba, so national franchisors are able to streamline their approaches to franchising in multiple disclosing jurisdictions. The other disclosing jurisdictions, New Brunswick and Prince Edward Island, still do not permit deposits. Therefore, there is still a need for national franchisors operating in those jurisdictions to continue operating under two different schemes. In any event, these amendments do provide franchisors with some pre-disclosure contracting options.
Clarifying the availability of exemptions
The amendments also clarify and revise a number of existing exemptions to the obligation to provide a disclosure document under the AWA. These changes are aimed at giving franchisors greater clarity about the circumstances in which the exemptions apply.
Grant to a Director or Officer of the Franchisor: The rarely used exemption in section 5(7)(b) of the AWA is available to franchisors disclosing to a prospective franchisee who has been an officer or director of the franchisor or of the franchisor’s associate for at least six months. Some franchisee counsel have argued that this exemption is not clear and does not extend to the principal shareholder of a corporate franchisee where that principal was a director or officer of the franchisor. The basis of the argument is that the grant of the franchise is to the corporate franchisee, which is a separate legal person from the natural person who was the director or officer. This argument has not been tested in court, but leads to the conclusion that this exemption could never be used in connection with the grant of a franchise to a franchisee other than a natural person. It seems unlikely that this was the legislature’s intention.
The amendments address this uncertainty by clarifying that the exemption is available where the grant of the franchise is to a person for the person’s own account or to a corporation that the person controls, if (i) the person has been an officer or director of the franchisor or of the franchisor’s associate for at least six months and is currently such an officer or director; or (ii) was an officer or director of the franchisor or of the franchisor’s associate for at least six months and not more than four months have passed since the person was such an officer or director.
However, what is still unclear is whether this exemption applies to a person who was not on the corporate officer or director registrar of the franchisor, but meets the functional equivalency provision for a director or officer under the Ontario Business Corporations Act. The AWA, unlike the legislation in some of the other provinces, does not include a definition of “officer” or “director”. Nevertheless, with this new language, franchisors should be more confident when relying on this exemption.
Large Investment and Small Investment Exemption: Furthermore, both the small and large investment exemptions have been reworked under the amendments to make each more clear and accessible. The small investment threshold has been increased to $15,000 (from $5,000), while the large investment exemption has been lowered to $3,000,000 (from $5,000,000). At present the small investment exemption refers to the “total annual investment” of the franchisee and the large investment exemption refers to the “acquisition amount.” The amendment simplifies the language in both exemptions by referring to the single concept of a “total initial investment,” which is specified to be all of the franchisee’s costs associated with establishing the franchise. A broad list of the types of costs associated with the total initial investment are also set out and include the amount of any deposits or franchise fees; an estimate of the costs for inventory, leasehold improvements, equipment, leases, rentals and all other tangible and intangible property necessary to establish the franchise; and any other costs or estimates of costs associated with the establishment of the franchise, including any payment to the franchisor, whether direct or indirect, required by the franchise agreement.
While the new approach provides a lot more clarity, it also raises a number of questions related to how “total initial investment” will be judicially treated. Interestingly, Section 9(1) of the regulation, which sets out how total initial investment is calculated, includes references to “estimates”. What is the result if the actual costs exceed the estimates such that the small investment exemption threshold is exceeded, or if they are less than expected such that the large investment exemption threshold is not met? Consistent with Raibex, there should be a strong argument that the exemptions should still be available to the franchisor in such cases as long as the franchisor was providing bona fide estimates and believed them to be accurate at the time they were determined.
Similarly, how should the franchisor approach deposits or franchise fees that are based on formulas where the variables of such formulas are not known at the time, or may change after the franchise agreement is signed? For example, if the franchise fee is based on a formula tied to territory size and the franchisee chooses a territory that is larger (and more expensive) than what the franchisor had anticipated when calculating the small investment threshold, would this retroactively bring the franchisor outside the scope of the exemption? There is uncertainty about how a franchisor would proceed when this happens and whether the franchisor would have to halt operations to provide a disclosure document, assuming that the franchise agreement has not already been signed by that point. Or should the franchisor deny the franchisee the larger territory? Equally imperfect solutions. A more conservative approach would be to calculate the estimates using a variety of scenarios, and decide using that information whether the exemptions may apply or whether to disclose based on whether the most conservative scenario would qualify for the exemption.
Statement of material change
The amendments now also set out what must be included in a statement of material change. Specifically, a statement of material change must include a certificate certifying that the statement of material change contains no untrue information, representations or statements, whether of a material change or otherwise, and includes every material change. Moreover, the certificate has to be signed and dated:
- by the franchisor personally, in the case of an unincorporated franchisor;
- by one officer or director, in the case of a corporate franchisee with only one officer or director; and
- by two or more officers or directors, in the case of a corporate franchisee with two or more officers or directors.
This amendment is straightforward. Notably, the inclusion of a franchisor’s certificate in statements of material change has been a best practice for many franchisors for years.
The amendments expand the scope of the standard of audit or review engagement for the financial statements that must be included in the disclosure document. Previously, audited or review engagement financial statements had to be prepared in accordance with Canadian GAAP. This is no longer the case: US GAAP and corresponding auditing standards can now be used. More specifically, the disclosure document must include either:
- an audited financial statement for the most recently completed fiscal year of the franchisor’s operations, prepared in accordance with generally accepted auditing standards as set out in the CPA Canada Handbook – Assurance, by the Auditing Standards Board of the American Institute of Certified Public Accountants or the Public Company Accounting Oversight Board of the United States, or by the International Auditing and Assurance Standards Board, as applicable; or
- a financial statement for the most recently completed fiscal year of the franchisor’s operations, prepared in accordance with generally accepted accounting principles that meet the review and reporting standards applicable to review engagements as set out in the CPA Canada Handbook – Accounting, by the Financial Accounting Standards Board of the United States, or by the International Accounting Standards Board, as applicable.
While this is a welcome change for franchisors offering franchises in Ontario, it will have less utility for franchisors offering franchises across the country until the other provinces amend their regulations to align with what is likely the new gold standard in the country.
Overall, the recent amendments to the AWA update the disclosure regime and align it more with the disclosure requirements in other provinces. However, franchisors should consider the amendments carefully and consult with their legal counsel prior to implementing any changes to their disclosure practices.
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