We would like to ensure that you are still receiving content that you find useful – please confirm that you would like to continue to receive ILO newsletters.
31 October 2006
It is common for a potential franchisee to request that a franchisor provide it with financial data in respect of the franchise so that the potential franchisee may evaluate its profitability. A franchisor should be cautious when complying with such a request by delivering financial statements or budget forecasts to a potential franchisee in order to avoid the possibility of the franchisee misinterpreting the information contained therein as a guarantee of profitability.
In Québec Inc v Le Super Club Vidéotron Ltée (9069-7384) the franchisee's sales were 50% less than initially projected by the franchisor. The court rejected the franchisee's claim against the franchisor on the grounds that positive and encouraging statements made by the franchisor did not obviate (i) the acknowledgement by the franchisee in the franchise agreement of the financial risks, and (ii) the explicit absence of any guarantee of financial results - the franchisee was well aware that the revenue and profitability forecasts were projections rather than guarantees. The court also observed that the franchisee should have obtained professional counsel in order to understand adequately the financial forecasts provided and his rights and obligations with respect to the franchise agreement.
In Les Investissements Stanislas et Patricia Bricka inc v Groupe CDREM inc the franchisor presented the potential franchisee with financial forecasts and financial statements and results for the two preceding years, both of which contained express qualifications to the effect that they did not in any way constitute warranties. The franchise agreement also contained explicit language indicating that no representation or warranty was being made to the franchisee with respect to profitability or the success of the business. The franchise agreement explicitly warned the franchisee that the franchise business contains a degree of risk similar to any other business and that there was no guarantee of profitability. Eighteen months into operations the franchisee realized that the profits were not as had been forecast. In court the franchisee alleged that had it not been for the franchisor's false representations as to profitability, it would have never acquired the franchise. The Quebec Court of Appeal concluded that the financial data provided by the franchisor did not constitute a fraudulent representation or a representation as to profitability.
In Sachian Inc v Treats Inc the Quebec Court of Appeal took a different approach. The franchise agreement in Sachian did not include an explicit qualification with respect to the preliminary financial forecasts presented to the franchisee. The court concluded that both the verbal and written financial forecasts presented to the franchisee were grossly inaccurate. Furthermore, the court concluded that the franchisee, who had no prior business experience, had relied entirely on those forecasts and that the forecasts amounted to fraud. Consequently, it annulled the franchise agreement and awarded damages to the franchisee.
The situation is similar in the rest of Canada. In Khagen Investments Ltd v 710497 Ontario Ltd the Ontario Superior Court of Justice dealt with a case where the acquirer of a franchise alleged that the vendor had made false representations by providing the acquirer with pro forma financial data suggesting profits significantly higher than the franchise was actually capable of realizing. The franchise agreement contained an explicit qualification as to the accuracy of the financial data and provided that the acquirer had been given the opportunity to consult independent financial counsel and to carry out due diligence to its satisfaction. The court concluded that:
In Machias v Mr Submarine Ltd the same court concluded that a franchisor who had presented a future franchisee with pro forma financial statements containing an express qualification with respect to the accuracy of the financial data therein was nonetheless responsible for voluntary verbal representations made to the franchisee with a view to distracting the franchisee from a true state of affairs that the franchisee would have found disappointing.
All financial data provided to a potential franchisee should contain an express reservation to the effect that the information provided is purely informative and does not in any way constitute a guarantee of results or profitability of the business. Furthermore, every pro forma financial statement should clearly state that it is simply a projection rather than a guarantee of profitability.
Financial data should be both recent and accurate. Actual financial results of other franchises may be submitted to the future franchisee (while concealing the identities of the franchisees), but it is best to submit a range of results, not just the most profitable franchises.
Even if an express qualification is contained in the documents presented to the franchisee it is imperative that the franchisor ensure that the information itself is accurate.
All relevant information pertaining to the particular franchise that is to be acquired must be presented to the future franchisee. If there are any circumstances that will change once the franchisee takes over an existing business, and which are not easily determined from the information provided to the franchisee, these should be clearly pointed out to the franchisee. For example, a location that was once run as a corporate store may not yield the same profits if it operates as a franchise, since there may be administrative charges or different profit margins.
The franchisor must avoid making any verbal representations to the franchisee that may lead the latter to believe that the franchisor is guaranteeing the profitability of the franchise. While the franchisor may act positively and encourage the acquisition of the franchise, it must avoid guaranteeing the franchisee future success. The franchisor must be even more cautious in cases where the franchisee is inexperienced and possesses little or no business experience.
The franchisor should also allow the franchisee the opportunity to consult independent financial and legal counsel in order to enable the franchisee to conduct independent verifications.
For further information on this topic please contact Norman Issley at Lapointe Rosenstein by telephone (+1 514 925 6300) or by fax (+1 514 925 9001) or by email (firstname.lastname@example.org).
The materials contained on this website are for general information purposes only and are subject to the disclaimer.
ILO is a premium online legal update service for major companies and law firms worldwide. In-house corporate counsel and other users of legal services, as well as law firm partners, qualify for a free subscription.