Squeezing out the Material Facts: Fresh Guidance on the Franchise Disclosure Document
In 2611707 Ontario Inc. v. Freshly Squeezed Franchise (“Freshly Squeezed”), the Ontario Court of Appeal held that a franchisor did not disclose certain material facts as required under section 6(2) of the Arthur Wishart Act (Franchise Disclosure), 2000 (the “Act”), allowing the franchisee to rescind the franchise agreement.[1] The Court reaffirmed that the test for valid rescission due to material non-disclosure is made on an objective basis.[2]
Background
In Freshly Squeezed, the Ontario Court of Appeal upheld the lower court’s ruling that the franchisor’s franchise disclosure document (“FDD”) was materially deficient, amounting to the franchisor not having provided an FDD at all.[3] On December 18, 2017, Freshly Squeezed Franchise (the “franchisor”) delivered an FDD to 2611707 Ontario Inc. (the “franchisee”). The parties subsequently entered into a franchise agreement on January 8, 2018. Around March 18, 2018, the franchisee began operating the business. It ceased its operations around September 2018, after discovering that the franchisor failed to disclose material facts about the franchise. On September 10, 2018, the franchisee delivered a notice to the franchisor rescinding the franchise agreement.
The Law
Under the Act:
1) Section 5 requires franchisors to provide an FDD containing certain material facts to be disclosed to a prospective franchisee at least 14 days before parties enter into a franchise agreement.[4]
2) Section 6(2) of the Act states that if a franchisor does not provide an FDD, the franchisee may rescind the franchise agreement within two years of entering into it for failing to provide sufficient disclosure.
Case Outcome
The Court found that the franchisor withheld material information that was within its power to disclose, including:
1) Notes referenced in the financial statements, regarding the accounts receivables and customer’s deposits;
2) The absence of a head lease and key terms of the negotiated agreement to lease, such as specific monetary obligations and the landlord’s ability to terminate the head lease without compensating the franchisee; and
3) That the franchise would be the first to be located in a hospital.
Deficient Financial Statements
The first deficiency was that the financial statements referenced important notes for certain items, but these notes were not included as attachments. One note referenced the accounts receivables that were owed to the franchisor from third parties, which represented roughly 73% of the franchisor’s assets. Another note referenced customer deposits, which made up about 60% of the franchisor’s liabilities. Without these notes, the court held that the financial statements were incomplete and prevented the franchisee from assessing the overall financial health of the franchise.[5]
Deficient Leasing Information
The second deficiency was that the franchisor failed to disclose the absence of a head lease and the negotiated agreement to lease. If a head lease is in existence at the time of disclosure, then it must be included in the FDD. However, if there is no head lease, then the franchisee must be made aware of this fact and provided some contractual comfort, such as the ability to cancel the franchise agreement without penalty after receiving the head lease at a later time. Additionally, if there is a negotiated lease agreement, then its key terms such as basic rent, additional rent, common area expenses, utilities, and other obligations must be disclosed.
In Freshly Squeezed, the franchisor failed to inform the franchisee that the head lease was not yet acquired. It also failed to disclose the terms of the negotiated agreement to lease, including provisions that allowed the landlord to unilaterally terminate the head lease without compensation.[6] The court held that it was irrelevant that the franchisee had visited the site and knew that a unit was available to be built by the time the franchise agreement was entered into.[7] The absence of key lease terms prevented the franchisee from making an informed investment decision.
Deficient Disclosure of Franchise Location Details
Finally, the franchisor failed to inform the franchisee that they would be operating the first location that was not located inside a mall. Although the FDD listed all of the other locations and the franchisee could have found out on its own, the Act does not place a duty of due diligence on the franchisee. Rather, the duty is on the franchisor to disclose material facts.[8] As such, the fact that it was the first hospital location for the franchise should have been explicitly referenced in the FDD. Failure to do so meant that the franchisee was unknowingly investing in a business model with no track record of success.[9]
Objective Test for Assessing FDD Deficiencies
The Court of Appeal confirmed that the test to assess deficiencies in a FDD is an objective one. The question is whether the FDD contains sufficient information for a reasonable person to make an informed decision, based on the circumstances of the particular franchise. The focus of the disclosure obligation is on the contents of the disclosure, not its recipient. This does not necessarily mean that all location-specific facts about a franchise must be disclosed in every case. Rather, a franchisor’s disclosure obligations are impacted by the circumstances of each situation, and the test of what is a material fact remains objective.
Conclusion
The FDD is an important obligation on franchisors and franchisors must be careful not to withhold any critical information that could impede a franchisee from assessing the potential franchise. There may be an obligation for franchisors to disclose information that could be considered material for a franchisee to make an informed decision, including information that a particular franchise is different from other franchise locations already in the franchisor’s network. An FDD may now be required to include information that a potential franchise location is different from those in the existing franchise system.
This article is authored by Edward (Ned) Levitt and Richard Schuett and may be published elsewhere, including by Dickinson Wright LLP.
The content of this article is intended to provide a general guide to the subject matter and should not be relied upon for accuracy or for legal advice. Proper legal advice should be sought about your specific circumstances
[1] 2022 ONCA 437 [Freshly Squeezed (ON CA)]; Arthur Wishart Act (Franchiase Disclosure), 2000, SO 2000, c 3.
[2] Freshly Squeezed (ON CA) at para 13.
[3] Freshly Squeezed (ON CA); 2611707 Ontario Inc., et al v. Freshly Squeezed Franchise Juice Corporation, et al., 2021 ONSC 2323 (CanLII) [Freshly Squeezed (ON SC)].
[4] Arthur Wishart Act (Franchiase Disclosure), 2000, SO 2000, c 3 at s 5.
[5] Freshly Squeezed (ON SC) at para 55.
[6] Freshly Squeezed (ON SC) at paras 66 and 73.
[7] Freshly Squeezed (ON SC) at paras 81-82.
