What changes legally and in due diligence when buying an existing franchise location versus opening a new one in Canada?

Anyone who wants to buy an existing franchise faces a choice that looks like a matter of price and location but is also a legal one. Opening a new unit means dealing with the franchisor, which grants the franchise and, unless an exemption applies, owes you a disclosure document. Buying a franchisee’s existing unit means dealing with a seller who already operates the business, and you will need to find out how far the franchisor’s agreement and system still shape what you are buying. Franchise disclosure is regulated provincially, and the notes below use Ontario’s Act as the main example. Other provinces with a franchise Act have their own wording, and not every province has one.

Who owes you disclosure

Ontario’s Arthur Wishart Act requires a franchisor, subject to the exemptions in section 5(7), to provide a prospective franchisee with a disclosure document, received not less than 14 days before the earlier of signing the franchise agreement or any other agreement relating to the franchise (with some limited exceptions) and paying any consideration to the franchisor or its associate relating to the franchise, with some deposits excluded. New Brunswick’s Act uses the same period in similar words. For a new location, the franchisor is plainly the party that must comply. For a resale, Ontario’s Act defines granting a franchise to include the sale or disposition of the franchise or of an interest in it, including shares in the corporation that owns it, so the question of who must give what has to be answered for your particular transaction.

The exemption question on a resale

Ontario’s Act contains exemptions from the disclosure requirement, including one for the grant of a franchise by a franchisee where conditions are met. Those conditions include that the franchisee is not the franchisor, an associate of the franchisor or a director, officer or employee of either, that the grant is for the franchisee’s own account, and that the grant is not effected by or through the franchisor. The Act says a grant is not effected by or through the franchisor merely because the franchisor has a right, exercisable on reasonable grounds, to approve or disapprove it, or because a transfer fee set out in the franchise agreement or not exceeding the franchisor’s reasonable actual costs must be paid. The Act also puts the burden of proving an exemption, in any proceeding under the Act, on the person claiming it. If the seller or the franchisor says no disclosure document is needed, ask which exemption it relies on and have your lawyer check the conditions against the facts, and ask for the answer in writing.

Remedies if disclosure was required and missing

Where disclosure is required, Ontario’s Act lets a franchisee rescind without penalty or obligation no later than 60 days after receiving the disclosure document if it or a statement of material change was late or the document did not meet the Act’s requirements, and no later than two years after entering the agreement if the franchisor never provided it. Do not count on that right in place of asking the questions before you sign. The Act also imposes a duty of fair dealing on each party to a franchise agreement. Our guide to what a franchisor can do about your location covers the franchisor’s powers after you buy.

What an existing location adds to due diligence

BDC says due diligence gives crucial information on a target’s finances, prospects and legal issues. A new location has no history to examine, so that work shifts to the franchisor’s document and the site. An existing location adds accountant-prepared financial statements, tax returns, leases, licences and permits, and whether key contracts such as leases can be assigned to you. BDC also suggests searching the Personal Property Security Registry for liens on the assets you are buying. BDC states that purchasing shares comes with a very different set of responsibilities compared to purchasing assets, and suggests an indemnity agreement from the seller for unforeseen liability arising for a period after the sale. In Ontario, the Act’s definition of granting a franchise also reaches an interest in the franchise, including shares in the corporation that owns it, so the structure of the deal matters for disclosure as well. For the franchise itself, what to know before buying an existing franchise unit goes further.

• New location: the franchisor’s disclosure document, the site and the build-out are the main items to review
• Existing location: add the unit’s own financial statements, tax filings, lease and permits
• Existing location: ask what approval the franchisor must give, and whether it charges a fee to process a transfer
• Both: record the date any disclosure document was received, and check the period your province’s Act sets (Ontario’s and New Brunswick’s Acts set 14 days)
• Both: get a lawyer to compare the franchise agreement you would sign with the one the seller holds

The Canadian Franchise Association advises that franchisors should seek advice from qualified legal counsel on compliance in each province where they sell franchises. A buyer in either position benefits from the same step, because the right answers depend on the province, the structure of the sale and the exemptions in play.