A franchisor’s comprehensive guide to updating an FDD

Five Elements at the Foundation of Valid FDD

Creating a robust FDD is a legal commitment to transparency and compliance. There are five key elements that form the legal backbone of a valid FDD, without which the FDD is probably legally void:

1. A franchisor’s certificate signed and dated by the franchisor’s officer or director. If the franchisor has two or more officers or directors, it must be signed by at least two of them. Signing the FDD is their attestation, as of that date, that the document contains no untrue information, representations, or statements, and that every “material fact”, financial statement, and other required statements and information are included in the FDD.
2. The franchisor’s full financial statements for its most recently completed fiscal year-end that are prepared on a review-engagement accounting standard at a minimum. (There are some exceptions for recent start-ups and FDDs issued close to the end of the fiscal year before financial statements can be complete where a 180-day rule apply – please refer to our article, Certificate, Financial Statements And Costs: A Disclosure Document Primer, for more on this).
3. The FDD must disclose all key information in one piece, at one time. Franchisors must not disclose information to franchisees over multiple documents or agreements over time.
4. It must disclose all material facts about the lease and the location of that franchised business.
5. In a resale, it must disclose material facts about that specific franchised location’s store sales.

Additionally, there should be a complete list of all of the franchisee’s costs associated with the establishment of the franchise inclusive of deposits, franchise fees, estimates of costs such as inventory, leasehold improvements, equipment and other expected start-up costs. This information is critical for prospective franchisees to have when assessing whether or not to invest in the franchise.

In the past few years, the Court of Appeal for Ontario has released a number of cases where FDDs have omitted some of this key information or have been otherwise defective in the disclosure of this information. These decisions have solidified and further developed franchise rescission grounds. Our article, Fix It or Nix It: The 5 Key Elements of a Valid FDD, elaborates on the errors the franchisors made, which resulted in these rescission cases.

Among the many court decisions that we have analyzed where disclosure errors and omissions took center stage include the frequently cited Ontario decision of Mendoza v Active Tire & Auto Inc, and other more local cases such as the Alberta court decisions in Premium Host Inc. v. Paramount Franchise Group, and Essa v Mediterranean Franchise Inc.

The Predicament of Omitted Material Facts

Many costly disclosure errors have to do with the omission of information that the court considers material fact. Why is this such a difficult disclosure requirement for Canadian franchisors? The problem is that material fact has a very broad definition and covers many issues and scenarios that a franchisee may face.

In Ontario’s Arthur Wishart Act (Franchise Disclosure), 2000, “material fact” is defined as including:

“any information about the business, operations, capital or control of the franchisor or franchisor’s associate, or about 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”.

We discussed this definition in greater length in Material Facts Explained: A Disclosure Document Primer. Law Works has also prepared industry specific e-Books that identify what might be defined as material fact in QSR and retail franchises, and in daycare franchises. Our article, Reducing the Risk of Rescission Claims: Key Information to Give to your Franchise Lawyer when Preparing an FDD, focuses on lease and site-specific information that franchisors should provide to a franchise lawyer who prepares their FDDs, and references the outcomes of some notable cases where omissions were made.

Franchisors looking to update their FDDs need to take careful consideration of what franchise, industry and location specific information can reasonably impact a prospective franchisee’s investment decision and build this information into each individual FDD.

How Franchisors Can Fix Errors and Minimize their Rescission Risk

In Canadian provinces that have franchise disclosure legislation (Ontario, British Columbia, Alberta, Manitoba, New Brunswick and PEI), franchisees who do not receive a compliant FDD can exercise their rescission rights if they are within their statutory limitation period. If successful, a rescission claim will entitle a franchisee to get out of the franchise agreement and receive compensation for their entire franchise investment and losses in buying, setting up and operating their franchised business.

A successful rescission claim (or series of claims) can be devastating for franchisors, their individual principals, and their franchise systems, resulting in court or arbitration awards that can reach hundreds of thousands of dollars of liability per location, and significant harm to the reputation and goodwill of the franchisor and the franchise system. Given the potentially destructive impact of a rescission claim, franchisors who are updating their FDDs should take all due diligence with their franchise legal counsel to mitigate this risk.

How do franchisors go about correcting FDD errors and omissions? Our article, 5 Tips to Identify Disclosure Risk for Growing Franchisors, explains the most common errors and omissions we have encountered so that you can identify them:

1. Accidental piecemeal disclosure
2. Providing documents that may be considered “earnings projections”
3. Omission of site-specific information
4. Omission of prior sales revenue and renovation requirements for a resale location
5. Omission of information about third party financing.

We have also outlined a Four-Step Plan to Mitigate Rescission Risk that provides guidance for franchisors who suspect that their FDDs may not be compliant so that they can repair them:
1. Identify Franchise Grants in the Past Two Years
2. Identify Disclosure Deficiencies
3. Strategically Assess Which Franchisees to Approach
4. Make the Fixes

Applying this structured approach with your franchise lawyer can help you break the daunting task of an FDD update into manageable steps, identify franchisees that pose the highest rescission risk, and bring your FDDs up to the required legal standards.

Conclusion

In the ever-evolving world of franchise law, your FDD is not a one-off legal obligation; it is a living document that requires ongoing attention and customization. It is not a one-size-fits-all document that can be given every time, to every franchisee for every location. Rather, it is a thorough document that contains updated and specific information that enables a prospective franchisee make an investment decision about the franchise business under consideration.

As you navigate the daunting task of an FDD review and update, remember that it is not a solo journey. Collaborate with your franchise lawyer, break down the complexities into manageable steps, and elevate your FDD to comply with legal standards.
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The information contained in this article is provided for informational purposes only and does not constitute legal advice. Readers should not act on this information without seeking professional legal advice from a lawyer experienced in this area. The content in this article may not reflect the most current legal developments, and the application of law can vary in different provinces and territories. As such, the information in this article is not guaranteed to be complete, correct, or up to date. The author and the publisher of this article disclaim all liability for any actions taken or not taken based on any or all of the contents of this site.

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