Saturday, June 9, 2018

Three Critical Points All Franchisors Need to Understand about Earnings Projections

Many franchisors in Canada find that they can't close franchise sales without providing earnings information to prospective franchisees. While this information is often indispensable from a sales perspective, franchisors must be very careful how they deliver this information to their prospects. 

In provinces that regulate franchising, namely New Brunswick, Prince Edward Island, Ontario, Manitoba, Alberta and British Columbia, franchisors expose themselves to significant risk of statutory rescission claims if they don't deliver this information in strict compliance with franchise legislation. Below are three key points franchisors should bear in mind when giving any earnings-related information to prospective franchisees. 

1.    Any type of information that relates to potential earnings will be considered “earnings projections” or “earnings claims”.

The definition of an “earnings projection” in Prince Edward Island, New Brunswick, Manitoba and British Columbia and the language around “earnings claims” in Alberta is very broad.  It covers any information “from which a specific level or range of actual or potential sales, costs, income or profit[s]…can be easily ascertained”. In Prince Edward Island, New Brunswick, Manitoba and British Columbia, it includes information of this sort that is given “indirectly”. 

Ontario’s Arthur Wishart Act (Franchise Disclosure), 2000 (the “Wishart Act”) uses the term “earnings projection” without defining it; however, recent case law suggests Ontario courts will interpret this term broadly. In Giroux et al v. 1073355 Ont Ltd et al, 2018 ONSC 143, 287 ACWS (3d) 64 (“Giroux”), a franchisor tried to argue that several graphs in its disclosure document showing franchisee earnings over the past 31-48 months were not “earnings projections” because they contained only historical information. The Court dismissed the franchisor’s argument and found that the graphs were “earnings projections”. 

Accordingly, franchisors should assume that any information they provide about past or future earnings will be subject to the disclosure requirements for “earnings projections” or “earnings claims”.

2.    Earnings information provided verbally or otherwise without delivering documentation will still be considered “earnings projections” or “earnings claims”.

Moreover, information regarding earnings will be considered “earnings projections” or “earnings claims”, even if provided verbally and even if no earnings-related documentation is delivered to the prospective franchisee.

In the Alberta case of Essa v Mediterranean Franchise Inc, 2016 ABQB 178, 266 ACWS (3d) 597 (“Essa”), the principal of the franchisor verbally stated to the prospective franchisee that foods costs were typically 33% of the selling cost of products sold from its franchises (30% in Alberta). The court held that this information was captured by the “earnings claims” language of the Alberta Franchises Act since it was information “given…to a prospective franchisee from which a specific level…of actual or potential…costs can easily be ascertained…”.  It was therefore required to be disclosed in accordance with the regulation under the Alberta Franchises Act.

In the Ontario case of 2212886 Ontario Inc. v. Obsidian Group Inc., 2017 ONSC 1643, 278 A.C.W.S. (3d) 63 (“Obsidian Group”) the franchisor’s salesperson was found to have “showed or flashed” an earnings projection at a meeting with the prospective franchisee, without delivering a copy. The court had no trouble finding that, by doing so, the franchisor had provided the franchisee with an earnings projection.

3.    Failure to properly disclose and substantiate “earnings projections” or “earnings claims” is a fatal flaw in the franchisor’s franchise disclosure document and exposes the franchisor to statutory rescission claims for up to two (2) years.

The disclosure requirements for “earnings projections” and “earnings claims” require that they be disclosed in the disclosure document (or possibly in a statement of material change, if applicable) and be accompanied by certain substantiating information listed in provincial franchise regulations. The required substantiating information varies somewhat from province to province and will differ in its details depending on the sort of “earnings projection” or “earnings claim” being provided.

Failure to disclose earnings projections in the franchise disclosure document and to include the required substantiating information is a fatal flaw that will, in and of itself, invalidate the disclosure document (Obsidian Group, supra, at paras. 50-53 and para. 65; see also Sovereignty Investment Holdings Inc. v. 9127-6907 Quebec Inc, 303 DLR (4th), [2008] OJ No 4450 (Ont Sup Ct) at paras. 15-17 (“Sovereignty”), Apblouin Imports Ltd v Global Diaper Services Inc, 2013 ONSC 2592, 229 ACWS (3d) 412 at paras. 28-32, Giroux, supra, at paras. 122-128 and Essa, supra, at para. 108).  If the franchisor’s disclosure document is invalidated in this way, the franchisor will be considered, in law, to have given no disclosure at all. In these circumstances, the franchisee will be entitled to rescind the franchise agreement for up to two (2) years.

In New Brunswick, Prince Edward Island, Ontario and British Columbia, disclosing earnings projections outside of the disclosure document (or statement of material change, if applicable) also exposes the franchisor to statutory rescission claims on the basis that the disclosure was not given “as one document at one time”. The obligation to give disclosure as one document at one time is an express statutory requirement in these provinces.  Failure to observe this statutory requirement is a fatal flaw that will also, in and of itself, invalidate the franchisor’s disclosure document and expose the franchisor to statutory rescission claims for two (2) years after the franchise agreement is signed (See 1490664 Ontario Ltd. v. Dig This Garden Retailers Ltd., 2005 CarswellOnt 3097 and Sovereignty, supra 

There is no question that providing earnings projections or earnings claims to prospective franchisees creates significant statutory rescission risks under franchise legislation, as well as other common law and statutory risks that are beyond the scope of this article. However, franchisors that find, as a practical matter, that they cannot close franchise sales without giving earnings information are far better off acknowledging this fact and disclosing this information in compliance with franchise legislation than disclosing it haphazardly. As always, franchisors are strongly urged to consult with experienced franchise counsel regarding the preparation of their earnings-related disclosure.

No comments:

Post a Comment