Many franchisors provide a disclosure document and subsequently grant a franchise to a prospective franchisee before the franchise location is even selected. A franchisor may be loath to undertake the risks and associated costs of securing a location and entering into a head lease before having a franchisee bound to that location. However, the decision of the Ontario Superior Court of Justice in Raibex Canada Ltd. v. ASWR Franchising Corp. (“Raibex”) has made this common business practice extremely risky.
In Raibex, the franchisee and franchisor signed a franchise agreement before the location of the franchise was known. The franchise agreement contained specific provisions for selecting premises after the franchise agreement was signed.
The franchisee received a disclosure document containing the franchisor’s “standard form” sublease, which stipulated that the franchisee accepts all the terms, covenants, conditions and obligations of the head lease that was to be included as a schedule to the sublease. However, there was no head lease in the disclosure document. Moreover, the disclosure document did not contain an estimate of the development costs associated with refurbishing a franchise location. Rather, it contained only a cost estimate based upon constructing a restaurant from a “shell”, not the conversion of an existing location. The disclosure document did open up the possibility of lower costs for a conversion, but contained a disclaimer that “the franchisor had no reasonable means of estimating or predicting those costs with any certainty”.
A location was secured approximately six months after the franchise agreement was signed. The franchisor was the head tenant and was to sublease the premises to the franchisee. The terms of the sublease included a provision requiring the franchisee to pay a deposit of approximately $120,000. Moreover, the franchisor estimated costs for refurbishing this location at about $1 million, which fell within the costs range in the disclosure document for a “shell”, but this location was a conversion.
The franchisee sought to rescind the franchise on the basis that it did not receive a disclosure document as mandated by Ontario’s franchise-specific legislation, the Arthur Wishart Act (Franchise Disclosure), 2000 (the “Act”). The franchisee claimed that the disclosure document was deficient as it did not contain a head lease or an estimate of the costs associated with refurbishing the franchised location. The franchisor’s position was that the location of the franchise had not been identified when disclosure was provided and it was therefore impossible to make this disclosure.
In finding in favour of the plaintiff franchisee, the Court outlined the relevant provisions of the Act and its Regulations, which mandate that a franchisor must provide a prospective franchisee with a disclosure document that contains all material facts, including all of the franchisee’s costs associated with the establishment of the franchise. The Court noted that “these disclosure requirements are mandatory” and added that “a broad disclaimer was no answer to the mandatory statutory disclosure obligations”. In her decision, Justice Matheson acknowledged that the practice of making disclosure before a location was determined is not unusual, but concluded that:
If it is simply impossible to make proper disclosure because material facts are not yet known, then the franchisor is not yet ready to deliver the statutorily required disclosure document. The franchisor must wait—it does not get excused from its statutory obligations.
This decision not only challenges the effectiveness of broad-based disclaimers when providing cost estimates, but also challenges the common practice of providing disclosure and entering into a franchise agreement before the location is known. As a result, many franchisors will have to reconsider their disclosure practices.
Franchisors are strongly encouraged to consult with a franchise lawyer on how to best manage their disclosure obligations and risks before entering into franchise agreements when the location is not yet known.
Louis Vouloukos 905.452.6883 email@example.com