The effects of the COVID-19 pandemic have been felt across many industries and in businesses both large and small, including those within franchise systems. As the pandemic continues, and as governments across Canada enact legislation to combat its effects, franchisors will need to ensure that their disclosure reflects the impact of COVID-19 on their franchise system.
The Importance of Disclosure during a Pandemic
Even before the onset of the global pandemic, franchise disclosure obligations (governed by several pieces of legislation across the provinces) were considered critical for all parties.
A disclosure document needs to provide a prospective franchisee with all of the information necessary for it to make an informed investment decision about becoming a franchisee. Failure to make such adequate disclosure could expose the franchisor to various potentially expensive claims by the franchisee, including a claim for rescission (by which the franchisee would demand reimbursement of the franchisee’s investment and expenses associated with the franchise). The pandemic has likely forced many franchisors to reconsider and to implement changes to all or portions of their franchise systems, often as a result of legislation enacted by the municipal, provincial, and/or federal government(s) to combat the pandemic. As such, franchisors’ pre-pandemic disclosure documents should be updated to reflect any post-pandemic changes and to ensure that prospective franchisees (or renewing franchisees) have all the information necessary to make an informed decision in the context of a global pandemic.
Addressing COVID-19 in the Disclosure Document
In what ways should a franchisor update its disclosure document to ensure that it is compliant with its disclosure obligations during the pandemic? This is a challenging question to answer, given how rapidly the course of the pandemic continues to change, as well as its effects on franchise systems. Below are some general considerations.
First, franchisors should consider drafting and including a general statement in regard to the effects of the COVID-19 pandemic on their particular system. This statement should provide a broad description of the COVID-19 pandemic as well as a warning as to any particular effects that the prospective franchisee could and should expect in regard to its potential operation of a franchise during the pandemic.
In addition to a general statement of impact, franchisors should also consider whether any of the prescribed items in their disclosure document need to be updated in light of new legislation or changes to the franchise system as a result of the COVID-19 pandemic. Prescribed items are those that contain information which the disclosure legislation in Canada specifically enumerates as being required in a disclosure document. For example, franchisors may consider updating items in the disclosure document which deal with the following:
- General description of the market and competition;
- Costs associated with establishing the franchise and other fees;
- Terms and conditions of financing arrangements offered by the franchisor;
- Earnings projections;
- Restrictions on the goods and services that a franchisee may sell;
- Restrictions on the source of the goods and services that a franchisee may sell;
- Financial statements; and
- Licenses, registrations, authorizations or permissions that a franchisee is required to obtain to operate the franchise
Beyond the prescribed information, franchisors must consider whether there are any other material facts that need to be disclosed. Material facts include any information about the franchisor 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.” Some examples of additional information that may meet the definition of a “material fact”, but that would not necessarily be included in the prescribed information, include:
- the known and anticipated effects of the pandemic on costs and revenues;
- modified terms to any lease or sublease;
- temporary fee reductions or waivers designed to assist the franchisees during the pandemic;
- modified methods for the delivery of goods and services;
- modified timelines or expected delays in regard to either the construction of the premises or operation of the franchise;
- changes to layout- or design-requirements in regard to the premises of the franchise (whether temporary or permanent);
- changes to hours of operation; and
- known and anticipated disruptions in the supply chain.
It is important to note that, although the effects of the COVID-19 pandemic have been felt across all industries, the specific effects of the pandemic on individual franchise systems will vary and changes to some or all of the above-described information may or may not be necessary. Determining what amendments to make to a franchise disclosure document in regard to COVID-19 will require an analysis of the individual system and its own specific responses to the pandemic.
The disclosure obligation does not require franchisors to predict every last effect of the pandemic on its system, but franchisors should be careful to update their disclosure documents to disclose at least those effects that are already known or that may be reasonably expected at the time of disclosure. Should you require assistance in updating your disclosure document in this regard, please do not hesitate to contact us.