Is It Time To Update The Financial Statements In Your Franchise Disclosure Document? – Corporate/Commercial Law

Is It Time To Update The Financial Statements In Your Franchise Disclosure Document? – Corporate/Commercial Law


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Financial Statement Requirements for Disclosure Documents

Franchise legislation in Canada (currently in the provinces of
BC, Alberta, Manitoba, Ontario, New Brunswick and PEI) contains a
requirement that franchisors include financial statements for their
most recently completed fiscal year. Generally speaking,
franchisors may include either:

  1. audited financial statements; or

  2. review engagement financial
    statements.

Financial statements must be prepared in accordance with the
generally accepted accounting principles in Canada, or standards at
least equivalent to the Canadian standards.1 Franchisors
need to be alert to the fact that not all financial statements meet
the minimum requirements established for audited or review
engagement financial statements. For example, courts have found
that using “notice to reader” financial statements
constitutes a material disclosure deficiency, even where the
difference between the two standards did not alter the quality of
information provided to the prospective franchisee.2

Acknowledging that financial statements take time to prepare,
Canadian franchise legislation contains a 180-day grace period
before a franchisor has to update the financial statements in its
disclosure documents. This means that franchisors have 180 days
from their fiscal year end to have financial statements for that
fiscal year prepared and then include those financial statements in
their franchise disclosure document. For example, a franchisor with
a December 31 fiscal year end date has until June 28 of the next
year to update their franchise disclosure document to include new
financial statements for the previous fiscal year. During the grace
period, franchisors may continue to use financial statements for
the previously completed fiscal year.

New franchisors that have operated for less than one fiscal year
(or if 180 days haven’t passed from the completion of their
first fiscal year end) are subject to a modified requirement to
include the franchisor’s opening balance sheet.

Additionally, larger, well-established franchisors may be able
to take advantage of exemptions from the requirement to include
financial statements altogether. Franchisors should only rely on an
exemption after confirming their eligibility for such exemption
with appropriate professional advisors.

How important is it that financial statements be up to
date?

Unfortunately for franchisors, Canadian courts have consistently
concluded that a franchisor’s financial statements are an
extremely important component of franchise disclosure.3
Financial statements that are even slightly out of date constitute
a material disclosure deficiency that may completely negate
disclosure. The deficient or negated disclosure may provide a
franchisee with a right to sue for damages (if the deficient
information caused the franchisee damages) or to rescind their
franchise agreement and be compensated for all of the costs of
establishing the business. A full discussion of the implications of
rescission is beyond the scope of this post, but it is sufficient
to say that the financial and logistical costs of a franchisee
rescinding their franchise agreement creates a significant enough
incentive for franchisors to ensure that no such right is ever
available.

What else in the disclosure document needs to be updated with
the financial statements?

Certain information that must be included in franchise
disclosure documents must also be updated following a
franchisor’s fiscal year end. This includes:

  1. Statements regarding expenditures of
    advertising fund contributions (which must be made for each of the
    two fiscal years immediately preceding date of the disclosure
    document); and

  2. Information regarding closures and
    terminations (which must be included for up to three fiscal years
    immediately preceding the date of the disclosure document).

Additionally, almost all of the information needs to be current
and complete each time the disclosure document is issued. While a
large portion of the information in the disclosure document will
remain the same, the following disclosure items may require
updating somewhat regularly, if not each time a disclosure document
is issued:

  1. The officers and directors of the
    franchisor and their respective backgrounds;

  2. Information regarding ongoing or
    pending convictions, litigation, administrative proceedings and
    bankruptcies;

  3. The estimated initial investment to
    establish a franchised business;

  4. The amount of any fees payable in
    connection with the operation of the franchise business;

  5. Earnings projections and estimates of
    annual operating costs; and

  6. The table of contents of the
    operations manual.

When else are updates required?

In addition to an annual update to include the previous fiscal
years’ financial statements within 180 days from year end,
franchisors must also update their disclosure document any time
there is a material change. The material change could be to the any
prescribed disclosure item (for example the items listed above) or
any “material fact.”4 If a prospective
franchisee has been disclosed prior to the material change
occurring, it may be acceptable to provide the information in a
Statement of Material Change; however, best practice is still to
make the corresponding update to the current version of the
disclosure document as soon as possible.

Finally, in certain circumstances, it may not be appropriate to
use a generic disclosure document. This occurs when it is necessary
to include information that is specific to a particular offering
– for example on the resale or transfer of an existing
location. In these circumstances, it may be necessary to issue a
site-specific disclosure document. Since some of the prescribed
information in the disclosure document is tied to the issuance
date, that information must also be updated whenever a
site-specific disclosure document is issued.

Need help with your Franchise Disclosure Document?

To ensure you are meeting your disclosure obligations as a
franchisor, you should regularly update your disclosure document
with the assistance of an experienced franchise lawyer. Siskinds’ franchise law group has over 30
years of experience in the franchise sector. As authors of
Franchise Legislation in Canada (published by Thomson
Reuters), we literally “wrote the book” on compliance
with franchise legislation in Canada.

Footnotes

1 The exact requirements vary slightly from province to
province. Franchisors should consult with appropriate professionals
to ensure the financial statements they include meet the
requirements for each jurisdiction.

2 See e.g. 2240802 Ontario Inc.
v. Springdale Pizza Depot Ltd.
, 2015 ONCA 236 (CanLII)
at
paras 54-58.

3 See e.g. Mendoza v. Active
Tire & Auto Inc.
, 2017 ONCA 471 (CanLII)
at para
33.

4 “Material Fact” is not specifically defined
in Canadian franchise legislation, but has been interpreted as a
broader, more general requirement intended to cover other
information that could reasonably be expected to have a material
effect on the value of the franchise or the franchisee’s
decision to acquire the franchise.

Originally published by Siskinds, July 2020

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.

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