Joseph Hoffman MCCR Statement

…'many cases' of companies selling franchises without providing investors with suitable disclosure documents."" That's under legislation that is similar to the legislation you are asking us to accept as is here today.

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Legislative Assembly of Ontario
March 6, 2000

Public Hearing Testimony
Toronto, Ontario, Canada
Mr. Joseph Hoffman, MCCR

Standing Committee on Regulations and Private Bills
1st session, 37th Parliament

FRANCHISE DISCLOSURE ACT, 1999
Consideration of Bill 33, An Act to require fair dealing between parties to franchise agreements, to ensure that franchisees have the right to associate and to impose disclosure obligations on franchisors

JOSEPH HOFFMAN, Ontario Ministry of Consumer and Commercial Relations, MCCR

Mr Hoffman: Thank you, Mr O'Toole. I thought I would be of most assistance to the committee this morning if I explained what the objectives behind the bill were and tried to accomplish three things. The first would be the highlights of the legislation itself, and the second would be to illustrate or highlight those issues which will be dealt with under regulations under the act. This is an extremely important piece of legislation. Many of the substantive disclosure requirements, for example, or things that will be set out in the regulations, are not in the legislation, and it's important that all members have the benefit of an understanding of what types of issues will be in the regulations and what the ministry has been on public record in terms of the various regulatory proposals.

The last thing I thought I could do is to respond to any questions that committee members may have from the perspective of a government expert who has worked in this area now under three different governments. If that's acceptable, then I will proceed.

First I would like to emphasize that many of the comments I'll make in terms of describing what the
legislation does and does not do should be looked at in contrast to what exists today, which is essentially nothing. That is an important point, that almost every aspect of the bill needs to be compared to the current environment in order to put it in its proper context.

At the highest level, what the legislation in front of this committee will do is define franchise arrangements that will be covered by the disclosure requirements and those that may not be covered. I'll come back to that point, as I will to these other points, in more detail.

It will set out very explicitly the disclosure requirements, as well as the consequences for the failure to disclose.

It will create a statutory obligation to disclose all material facts relevant to a franchise offer, not simply those material facts that are prescribed in the regulations. There is a definition of "material facts." It is very broad and provides a very high standard of disclosure.

The bill will also create a statutory duty of fair dealing on each party to a franchise agreement. This is one aspect of the legislation that will apply, in effect, retroactively. It will apply to all franchise agreements currently in existence today.

It will also create statutory rights of franchisees to associate. This is another aspect of the legislation which can be described as retroactive in the sense that where there are existing franchise agreements that create constraints or prohibitions on the right to associate, the legislation, when passed, will nullify and make void such contractual obligations.

I would like to come back to each of these points, in effect, in succession.

First, what does this legislation apply to? There really are two areas of franchise arrangements that are set out in the legislation. The first is a traditional franchise, and these are the common business format or product distribution arrangements. In order to be affected by the legislation each of the following three aspects would have to apply:

There would need to be the use of a trademark involved, where the franchisor provides a right to distribute goods or services that are substantially associated with the franchisor's trademark or their trade name, advertising or commercial symbols.

In addition to that, there would need to be significant control or assistance where the franchisor exercises significant control over or offers significant assistance to the franchisee in terms of the method of operation of the business. Control or assistance could include, but not be limited to, things like building design, furnishings, locations, training, marketing techniques and so on, so it's really a substantive element of control.

Lastly, the other aspect that would need to apply is payment, where the franchisee is required to make payment to the franchisor or a commitment to make payment as a condition of obtaining the franchise or commencing operations.

That is the first category of franchise arrangements that will be captured by the proposed legislation. I think I can say that in the universe of franchise arrangements, that would occupy the lion's share.

The second category of franchise arrangements that would be captured by this are what are known as business opportunities types of arrangements. Again there are three criteria and each of them would apply; the first is representational or distribution rights. This is different from the first category in that no trademark may be involved. The franchisor may simply provide the right to sell a good or service that's supplied by the franchisor or a supplier which the franchisor requires the franchise to use. The second area would again be location assistance as a more narrowly defined aspect of control, where the franchisor will secure a retail outlet or accounts for the goods or services to be sold or secure locations or sites. For example, vending machines could come under this category, depending on the magnitude of the business, or display racks, or providing the franchisee with the services of someone to do those things. The third category is the requirement for payment, which is essentially identical to the one I described before.

In any franchise arrangement, other than those that are clarified or accepted or excluded from the act - and I'll come back to those in a moment - in any of those two franchise arrangements, the disclosure requirements of this legislation would apply. The point of the disclosure requirements is to provide prospective franchisees with clear and sufficient business information upon which to make an informed investment decision. Every franchisor would be required to provide prospective franchisees with a single disclosure document at least 14 days prior to the signing of any agreement or any financial transaction, and that would include a deposit. The franchisor's obligation would include notifying the prospective franchisee of any material change that has occurred in relation to the information provided prior to the signing of the contract or the financial arrangement. That means that if the franchise disclosure document is provided but there is some material change in the information that has transpired subsequent to the provision of the document, there's a statutory obligation on the franchisor to disclose that material change.

Franchisors would be required to disclose all material facts, including material facts related to the matters that are specified in the regulations. I would like to emphasize that this is, in effect, a dual statutory requirement. Material facts, as set out in this legislation, are not limited simply to those things that are prescribed. Material facts other than those things that are prescribed in the regulations are facts that would reasonably be expected to have a significant effect on the price of a franchise or a decision to buy one. The disclosure requirements set out in the regulations would include two baskets, if you will, of information: information on the franchisor, the business or the entity that is offering the franchise; and information on the offer itself, the specific details of the offer.

All the information in the disclosure document under the statute would be required to be accurately, clearly and concisely set out and delivered in a single document at one time. That would eliminate the possibility of piecemeal disclosure or complicated, cumbersome documents that are multi-levelled, where financial information is provided in one document and something else is provided in another document.

This aspect of the legislation, the disclosure requirement, will apply to all franchise agreements that are entered into on or after the legislation comes into force if the franchisee's business is to be operated partly or wholly in Ontario. In fact, the legislation includes two references that are extremely important; first of all, that if there is any attempt in the contract that would affect the jurisdiction of the agreement, then that aspect of the contract would be considered void under the legislation. Also, the legislation is explicit that any of the rights that are provided in this legislation cannot be waived; they cannot be released by a party through a contractual arrangement.

In terms of the detailed disclosure requirements - and here is where my comments will shift out of the legislation itself and more into what the government and the ministry have put on public record as the types of disclosure requirements that would be in the regulations. These are things provided for in the act to be set out in regulations.

The first category, as I mentioned, the first basket, is information about the franchisor. The disclosure document requirements that will be set out in the regulations would include:

Business background of franchisor, directors, general partners, the officers of the franchisor, including ownership, prior experience, the length of time the franchisor has conducted the type of business to be operated by the franchisee;

Litigation history involving the franchisor, the associates or any directors, general partners or officers of the franchisor, and this litigation history would include convictions or pending charges involving fraud, any violation of franchise law, business practice legislation or unfair or deceptive practices law, any injunctive or restrictive orders that are imposed by or pending administrative actions to be heard before a public agency of any jurisdiction, and liabilities in civil action or any pending actions involving the franchise relationship or involving misrepresentation, unfair or deceptive practices. We've tried to keep the scope of this type of proposal broad so that the type of litigation history that would be relevant to a business relationship is clearly captured.

Another category that would be set out is bankruptcy or insolvency information.

The next category is financial history, and there would be an obligation to provide either audited financial statements or statements that are prepared in accordance with generally accepted accounting principles and with standards applicable to what are known as review engagements set out in the Canadian Institute of Chartered Accountants handbook; and, in addition to that, a statement advising franchisees of the availability of commercial credit reports from private credit reporting companies and informing them that these reports may provide information useful in making an informed investment decision.

If I could add a comment here, this is an extremely important aspect of the proposal because of the existence of these commercial credit reports which do not require the consent of the franchisor to
have access to them. They are available literally by telephone and fax for payment of essentially a fairly minor fee and contain all kinds of useful information about the financial affairs and the history and the business conduct of the franchisor. The last aspect of financial history would be that all financial information must be consolidated and presented in one section of the disclosure documents, so all the financials have to be visible in one spot.

Lastly, in terms of the information about the franchisor, a statement describing any internal or external dispute resolution process that's utilized by the franchisor and a brief description of the circumstances under which that process is utilized.

In terms of information on the franchise offer, the disclosure document requirements that are set out in the regulations would include costs; for example, the initial deposit or the franchise fee or whether or not this is refundable, the costs for initial inventory - signs, equipment, leases, rentals - and copies of all proposed franchise agreements. The agreement itself must be part of the disclosure document.

Restrictions: for example, any limitations on the choice of supplier of goods or the goods or services to be offered for sale, or the sales territory.

The policy regarding what are known as volume rebates where there are requirements to buy from a specific supplier and the franchisor receives a rebate in relation to the volume of goods or services, so the policy regarding volume rebates would be included in the disclosure requirements and would include specific information on the franchisee's buying or inventory obligations, the restrictions, the terms etc.

Territory: for example, policies regarding the exclusivity of the territory or the proximity in which a new franchise may be established and information on what are known as multi-lines or multi-brands that are offered by the franchisor. For example, if a franchisor has one system called ABC Donuts and another system called XYZ Donuts and he's selling ABC Donuts to a prospective investor, he must also disclose the territorial issues related to his second line, even though the contractual obligation is with the first.

Conditions of termination, renewal or transfer of franchises; training or other assistance programs; how the advertising fund, if there is one, is dealt with - for example, the portion of the fund that's spent on administrative costs or on national campaigns versus local advertising. Other obligations would include the current and former franchisees, a list of the current and former franchisees, as well as a statement encouraging the prospective franchisee to seek legal or other advice and to freely contact other franchisees prior to acceptance of the offer.

Last, earnings potential: There is no obligation to describe earnings potential in relation to the franchise offer. That's optional, but if the franchisor chooses to provide earnings information, the information must include a reasonable basis for making that claim, the material assumptions that are involved and a notice of where the substantiating information is available for inspection by franchisees.

What happens if there is non-disclosure or inadequate disclosure under the statute? Failure to comply with the disclosure requirements carries some very meaningful consequences. They would include, first and foremost, a rescission right. This is unprecedented in terms of a shift in the current environment. The franchisee is able to determine whether or not to exercise these rights. They would not need to go to a court in order to exercise a rescission right.

If the disclosure document has not been provided within at least 14 days prior to the signing of the agreement, the franchisee may rescind the agreement without penalty or obligation no longer than 60 days after receiving the document. So a 60-day clock begins once the documents are received.

If no disclosure document has been provided at all, if the franchisor has not provided a disclosure document of any kind whatsoever, then those rescission rights extend without penalty or obligation no later than two years after entering into the franchise agreement.

If the franchisee decides that there has not been disclosure of the material facts or about a material change and elects to exercise the rescission right within 60 days of receiving notice of rescission from the franchisee, the franchisor must refund any money received from or on behalf of the franchisee other than money for inventory supplies and equipment; buy back at the purchase price any inventory remaining at the date of rescission which has been sold in accordance with the agreement; buy back at the purchase price any supplies and equipment that has been sold to the franchisee in accordance with the agreement; and compensate the franchisee for any losses that the franchisee incurred in acquiring, setting up and operating the business. The burden of proof under the statute is on the franchisor to go to court and demonstrate that disclosure has been carried out in accordance with the act, otherwise these obligations are in effect.

In addition to the rescission rights, there are rights of action for damages available under the statute. Franchisees who have suffered a loss as a result of the franchisor's failure to comply with the disclosure requirement or because of a misrepresentation contained in the disclosure document or statement of material change would have the right of action for damages against the franchisor or against the franchisor's associate - this is someone who would control or is controlled by the franchisor and who is directly involved. They must be directly involved in the sale of the franchise or exercising significant operational control over the franchisee. The intention of this is to prevent situations where a franchisor can evade disclosure responsibilities by creating a shell company, for example. In addition, the right of action for damages exists against every person who signed the disclosure document or statement of material change.

Duty of fair dealing: Under the act, a standard of conduct would be set up and a duty of fair dealing is created that is identical to Alberta's legislation. Every franchise agreement imposes on each party a duty of fair dealing in its performance and enforcement. The duty would be enforceable through civil action and it applies to all current franchise agreements.

The right to associate: This ensures that franchisees may freely associate without penalty or threat of penalty. The legislation would prohibit contractual or other interference in this right, override any existing contractual provisions that may exist in this regard and provide franchisees with a right of action for damages against any franchisor attempting to penalize or threatening to penalize a franchisee for exercising this right. Again, this would apply to all current franchise agreements.

There are several exclusions from the proposed legislation. Because franchise arrangements take a wide variety of forms, and in order to avoid confusion, there are a number of commercial relationships which, while on the face of it they may look like a franchise agreement, are intended to be excluded from the legislation. These would include employer-employee relationships or business partnership arrangements; memberships in a bona fide co-operative association - that would have to be set out in the regulations; agreements with a certification or testing service that authorizes the use of a certification mark like a CSA standard, for example; agreements between a licensor and a single licensee to license just a trademark, like the use of a logo on a coffee cup or T-shirt; leased departments, relationships in which a franchisee leases space inside the premises of another retailer and is not required or advised to buy goods or services it sells from that retailer or an affiliate of that retailer; oral agreements; and crown entities, service contracts or franchise-like arrangements between crown entities and other parties which are typically subject to public tendering or procurement guidelines, freedom-of-information legislation or other statutory provisions which do not apply to franchise arrangements between private parties.

There are exemptions from the disclosure requirements that are set out in the legislation, and some that will be spelled out in the regulations. These would include things like transfers, the sale of an existing franchise by a franchisee that is not effected through the franchisor; a master franchise arrangement, where the rights to sell a franchise throughout an entire region or province are involved; the sale of a franchise to an officer or director of the franchisor, if that person has been in the position for at least six months; the sale of an additional franchise to an existing franchisee if it is substantially the same as the existing franchise; sales or transfers in a bankruptcy situation where an executor, administrator, sheriff and so on is involved; a renewal or extension of an existing franchise where there has been no interruption in the operation of the business and no material change has occurred since the franchise agreement was reached. It would also include fractional franchises, which refers to where the franchise arrangements may involve a product or service operated within another business at a very low volume. An example might be a little franchise kiosk selling coffee inside a large retail complex.

There are minimum investment thresholds that will be set out under the exemption requirements. This is intended to ensure that a lot of the small or one-year types of arrangements aren't captured, so if the total annual investment to acquire and operate the franchise doesn't exceed a prescribed amount - that amount has yet to be set in the regs - or if the franchise contract is no longer than a year in length and does not involve payment or any non-refundable fee or there is a multi-level marketing contract, for example, in direct selling arrangements that is covered under the Competition Act or a specific section of the Competition Act.

Last are what are known as "sophisticated investor" franchise exemptions, where the franchise investment is above a threshold and the parties to the agreement can be considered reasonably sophisticated business entities. The amount that is expected to apply there is around the $5-million mark.

There is also in the legislation what is known as a "mature franchisor" exemption. This is an exemption only from the requirements to disclose the audited financial statements; it is not an exemption from all the disclosure requirements. So a franchisor may be exempted by regulation from the requirement to disclose financial statements if that franchisor meets the criteria prescribed by regulation. These criteria will require that a franchisor have a net worth of at least $5 million, have at least 25 franchisees conducting business at all times during the five-year period immediately preceding the date of the disclosure document, and have conducted business for at least five years in the province immediately preceding the date of the disclosure document. Those three conditions are essentially identical to those in the Alberta statute. Then there is a fourth one that will exist in Ontario, and that is that the franchisor not be the subject of any judgment related to any disclosure requirements under this act during the five-year period. Obviously that aspect can't be applied until the act has been in place for five years, so as a transitional measure the minister will be able to, by regulation, exempt any franchise from providing financial statements based on an application from a franchisor if the franchisor meets criteria prescribed by regulation, which would be essentially similar to this. The regulation power itself in this area and this specific ability to grant these ministerial exemptions would sunset after five years as this last aspect of the mature franchisor exemption kicks in. Franchisors who are eligible for the mature franchisor exemption would remain obligated to meet all other disclosure requirements and would also remain subject to all other provisions of the legislation, including the duty of fair dealing and the right to associate.

That, I believe, covers the landscape in terms of the act itself and how it interacts with the regulations. At this point, if there are any technical questions I can respond to, I'll leave it at that.

The Acting Chair (Mr George Smitherman): Are there any questions from members of the committee?

Questions

Mr. Martin: I want to thank you for taking the time to come and share with us the details of the act as it is proposed. I understand the effort that went into making sure there was a fairly comprehensive disclosure requirement in franchise dealing in Ontario.

One of the questions I have is around how that would actually happen and what vehicle will be put in place by the government to make sure the disclosure statement is actually prepared and delivered, that it meets the requirements, and that the franchisee isn't left out on his own trying to decide whether he has got what he needs or what he is supposed to have under legislation.

Mr Hoffman: The best way I can answer that question would be to compare it with other important areas where disclosure requirements are typically dealt with in legislation and there is a reliance, once the disclosure requirements clarify the obligations of parties, on any problems in relation to that disclosure being dealt with through the marketplace, through the identification of an inadequacy in the disclosure and then dealt with between private parties.

Cost-of-credit disclosure is a good example in this regard, where there is legislation in every province, including Ontario, which basically sets out how financial institutions or automobile leasing companies, for example, must calculate the cost of credit and how that information must be presented to consumers. There have been recent amendments proposed in Ontario that would include leasing arrangements in that regard. There is not, associated with that, a filing obligation or a mechanism which some government department somewhere reviews pro forma for every credit card company's calculation method etc, or a review of all lease agreements or filing requirement. But as a mechanism, over the years it has proven to be extremely useful, and there has not been any evidence that there has been abuse of the legislation or any kind of comprehensive or systemic problem in terms of the marketplace providing the types of disclosure anticipated by the bill.

That said, there is no question that anyone who is of fraudulent intent may choose to try to sell a bogus franchise or may make assertions around credit arrangements that are essentially fictitious in an effort to get money. Those are dealt with, essentially, through Criminal Code enforcement.

Mr Martin: All of that excepted, there is certainly a provision also, though, in Ontario legislation that, for example, when securities that are traded on the market are presented there is some effort to make sure they are correct, and that piece of legislation continues to evolve and unfold. We're talking somebody like myself or Mr Gilchrist buying stocks worth maybe $1,000 or $2,000; somebody else may be buying stocks worth $1 million.

In franchising, typically a person is investing some, let's say, bottom line, $50,000 to maybe $200,000 worth of their life's savings. Why wouldn't you see that as a serious enough investment when you consider some of what has gone on, particularly when you look at some of the stories and you hear some of the details, to have something a bit more concrete that the government would have some control over to make sure these exchanges of information are happening and that they are correct and that people aren't exposed any more than they have to be to the fraud artists who are out there and only too willing to take advantage of some poor soul who has absolutely no experience whatsoever in business, which is so often the case where franchising is concerned?

Mr Hoffman: Frankly, I think the policy intention of the bill clearly recognizes the importance of disclosure and ensuring that the right information is in the right individual's hands in a timely fashion in order for them to make an informed investment decision.

I suppose one can argue whether or not having the same information reviewed by a third party is useful, and indeed that's contemplated. The disclosure requirements would include quite a strong statement advising the person to, in effect, take the disclosure requirement and the contract itself and use a good third party to help guide a prospective investor in making a decision.

Certainly the trend in Canada, given that there are only two provinces that are legislating in this area, has been away from requirements to basically have on file in a government office somewhere the same information that would be statutorily provided to the franchisee. There was certainly a policy intention to try to have Ontario's legislation and Alberta's legislation broadly comparable so that a company that is complying with the requirements in one province is, broadly speaking, complying with the requirements of the other.

Mr Martin: But those who have some knowledge of what's unfolding in Alberta will tell you that in fact that system isn't working, in some instances precisely because there is no vehicle in place to make sure it is going to work.

I have an article here from the Globe and Mail of Thursday, October 22, 1998, where a Mr Stainton is stating that the act is being ignored because there is no third party from the government overseeing and checking this out. He says: "Under the old system, franchisors had to file disclosure documents with the Alberta Securities Commission; today, there's no such requirement." It goes on to say that he sees "'many cases' of companies selling franchises without providing investors with suitable disclosure documents." That's under legislation that is similar to the legislation you are asking us to accept as is here today.

Mr Hoffman: I can't comment on the assertions of this individual, whether they're in the media or not. I know that in providing the policy advice to the government on the bill, one of the things we tried to do was to communicate very directly with our counterparts in the Alberta government and indeed outside Canada. There is no information that was ever presented to us, and we specifically asked for it, that suggested there was any systematic ignoring or violation of the disclosure legislation in the province. We certainly sought examples of litigation or information around what may be going on in the courts in this regard.

The Acting Chair: We're going to need to stop questioning due to the time. I think there will be lots of opportunities through the week to follow up on those.

Just before we move on to opposition statements, I'll ask for a brief closing comment.

Mr O'Toole: Thank you very much, Mr Hoffman, for a broad overview of the intents of this legislation. Also, I just want to reassure members of the committee that there will be ministry policy staff in attendance throughout the hearings to answer the more technical questions.

This document is a verbatim copy of this witness’ oral testimony. To review the original transcript: http://www.ontla.on.ca/web/committee-proceedings/committee_transcripts_details.do?locale=en&Date=2000-03-06&ParlCommID=1&BillID=740&Business=&DocumentID=19737#P33_4190

Copyright (c) 2000
Office of the Legislative Assembly of Ontario
Toronto, Ontario, Canada


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