Andraya Frith, Christine Jackson
Canadian franchise laws require that all material facts relating to the franchise be included in a franchise disclosure document. After more than 10 years of judicial interpretation and application of franchise laws, many franchisors still struggle with the breadth of the definition of “material fact” and the position of some franchisees that the obligation to disclose all material facts should be interpreted as an obligation to disclose “every fact.”
With only a handful of cases on point, determining what is or is not a material fact is a difficult question to answer and must be determined on a case-by-case basis. However, while the question of what is or is not a material fact is difficult to answer, not every fact is a material fact.
What Is a “Material Fact”?
In Alberta, Prince Edward Island, New Brunswick and Manitoba, for example, a “material fact” is not every fact but is defined to mean only those facts about the business, operations, capital or control of the franchisor or franchisor’s associate, or about the franchise or the franchise system, that would reasonably be expected to have a significant effect on the value or price of the franchise to be granted or the decision to acquire the franchise. It should be highlighted, however, that the definition of “material fact” only requires that the information have a “significant” effect as opposed to the higher threshold of a “material” effect or a “substantial” effect on the value or price of the franchise or the decision to acquire the franchise.
Ontario’s franchise legislation includes a similar definition for what is a “material fact” with one important distinction. In Ontario’s franchise legislation, the word “means” in the definition of “material fact” is replaced with “includes” thus making the definition non-exhaustive. In Ontario, this means that what is or is not a material fact may extend beyond those facts about the business, operations, capital or control of the franchisor or franchisor’s associate, or about the franchise or the franchise system, that would reasonably be expected to have a significant effect on the value or price of the franchise to be granted or the decision to acquire the franchise.
Balancing the Obligation to Disclose All “Material Facts” with the Realities of the Franchise Sales Process
Given that there is little case law analyzing the definition of material fact, franchisors may wish to adopt a conservative approach, and if a fact could possibly be considered material to a particular franchisee candidate, it should be disclosed. With that said, the uncertainty of what is or is not a material fact should not halt business or paralyze a franchisor from proceeding with a particular grant. Franchisors should avoid adopting the “every fact” is a “material fact” approach and limit the disclosure of “material facts” to those “material facts” that the franchisor has in its possession or ought reasonably to have in its possession. While franchisors must exercise reasonable judgment and weigh the likely significance of the information from the prospective franchisee’s point of view when determining materiality, there is no express positive obligation on the franchisor to seek out information on behalf of a prospective franchisee. The franchisor’s obligation to provide a prospective franchisee with disclosure does not absolve the franchisee from its responsibility to perform its own independent due diligence.
Given the serious repercussions for failure to disclose a material fact, franchisors should nonetheless take every effort to ensure that its management, field representatives and other employees are clearly aware of the definition of “material fact” and the requirement to include such facts in the disclosure document. The franchisor should have its management, field representatives and other employees review the template disclosure document and consider whether any “material facts” are missing. When deciding whether a particular piece of information is a material fact, franchisors should first consider whether the fact falls within the categories of information covered by the definition of material fact. If so, franchisors should further consider whether the fact could reasonably have a significant effect on the value or price of the franchise or the prospective franchisee’s decision to purchase the franchise. When performing this analysis, franchisors must exercise reasonable judgment, and weigh the likely significance of the information from the prospective franchisee’s point of view. If the answer to both of these questions is yes, this fact is material and must be disclosed. If not, the franchisor is not required to disclose this fact. A franchisor should also consider whether its field representative or sales team intends to use or provide this information to a prospective franchisee during the franchise sales and disclosure process. If the answer to this question is yes, this information is likely important, regardless of whether it has a positive or negative impact, and will likely constitute a “material fact” that should be disclosed.
Guidance from the Courts
A franchisor should also note that despite some differences across the provincial legislation, the judicial trend is to broadly interpret the definition of “material fact” with what appears to be nothing more than a common sense approach to determining materiality. The following list provides some examples of information that the courts have determined to be a “material fact” in the franchise law context:
- in the context of a resale, the fact that there were serious problems with the financial processes and arrangements and the overall management of the franchise to be acquired;
- the precise scope of a non-competition covenant;
- the head lease for the franchise location where the sublease incorporates the terms of the head lease by reference;
- information about the precise location, territory, purchase price, franchise fee, lease, sublease, restrictive covenant and non-competition covenant;
- in the context of a renewal, significant changes to the term of lease;
Where this kind of site-specific information is not available at the time of initial disclosure, many franchisors use a statement of material change to provide prospective franchisees with these site-specific “material facts.” It should be noted that this approach has not been considered by the courts, and must not be taken where the site-specific information is available at the time of initial disclosure.
While yet to be considered by the courts, the following list provides some examples of information that may be considered a material fact in the franchise law context beyond the scope of the required disclosure set out in the regulations:
- the franchisor’s decision to significantly alter the brand image of the franchise system;
- the franchisor’s decision to expand into a new channel of trade which may impact the traditional franchise delivery model (e.g., online business, kiosks);
- significant adverse changes in the franchisor’s financial situation;
- information known by the franchisor about a specific location including prior system closures, bankruptcies or store failures in that location.
This above list provides only a small subset of the type of information that might be considered to be a material fact. The analysis for any specific franchisor must be performed on a case-by-case basis and franchisors should focus on identifying and evaluating information not currently included in its disclosure document. If the legal or business team has any reasonable doubt about whether an item of information should be disclosed, that information should be thoroughly discussed by the franchisor’s management, field representatives and employees involved in the disclosure process, because collective judgment will greatly assist in determining materiality. If consensus cannot be reached, the safe approach is to disclose the information.
Part of the May 2014 - Franchise Review