This part of the Law Works Disclosure Document Primer Series explains in more detail the “material facts” requirement.
A franchisor doing business in Ontario is required to deliver to a prospective franchisee a fully compliant Franchise Disclosure Document under the provisions of the Arthur Wishart Act (Franchise Disclosure), 2000 and its Regulation. One of the most difficult disclosure requirements under the Arthur Wishart Act is the material facts disclosure obligation. This is a difficult requirement because the definition of ‘material facts’ is very broad and may cover many issues or scenarios that a franchisor may face.
The Law Works Franchise Law Blog has an introductory blog about material facts, as part of its Disclosure Document Primer series, in a post January 15, 2014, titled Material Facts, Material Changes and Franchisor’s Associates: A Disclosure Document Primer.
As noted in that introductory blog post, based on the definition of material fact in the Act, any information about any aspect of the franchisor, franchisor’s associate, the franchise system or the franchised business to be sold to the franchisee has to be disclosed if it would be reasonably expected to have a significant effect on either (i) the value or price of the franchised business to be sold, or (ii) the prospective franchisee’s decision to buy the franchised business.
Let us break down this definition into its core components:
- First component – type of information: The type of information is the first component. It covers any information about any aspect of the franchisor, franchisor’s associate, the franchise system or the franchised business that is being sold to the franchisee.
- Second component – reasonable standard: The reasonable standard is the second component. This means that whether a particular piece of information may be material is not tied to any particular prospective franchisee’s opinion about its importance. Rather, it is judged on the basis of a reasonable standard, i.e., whether a reasonable person would consider that particular piece of information material. Think of it as your reasonably informed neighbour – whether that reasonably informed neighbour would consider this particular information important.
- Third component – effect on value or decision to buy: The effect on the value of the business or the reasonable prospective franchisee’s decision to buy the franchise is the third component. For a particular piece of information to be material, it needs to reasonably affect the price that any prospective franchisee is willing to pay for the franchise or the decision to make the purchase.
There are infinite scenarios of material facts. Here is one example. The prospective franchisee of what we will call an ‘original location’ will be granted a certain territory protection. At the same time, the franchisor is negotiating with a second prospective franchisee to locate a second retail unit just outside of the territorial radius of the original location.
Based on similar situations in the past, the franchisor knows that the second retail unit will take some of the customer base of the original location.
The franchisor also knows that the prospective franchisee of the original location will likely complain about this loss of sales.
Is this a material fact that should be disclosed in a Franchise Disclosure Document? There is a strong likelihood that indeed this is a material fact.
To properly meet the material fact requirement in the Act, the franchise lawyer and the franchisor client need to work closely to identify the potential issues and facts that are likely to fall under this requirement and determine how to adequately disclose those risks.
Failure by the franchisor to provide the required information in a Disclosure Document – including all material facts – may entitle a franchisee to a rescission of the franchise purchase.
For an overview of the franchise rescission remedy in Ontario under the Act, see the Law Works Franchise Justice Blog Post, dated January 15, 2014, titled Franchise Rescission in Ontario: A Primer.
For more information, please visit Law Works’ Franchise Disclosure Documents Practice or Franchise Rescission pages.