The Ongoing Perils of Inaccurate Disclosure - Invalidation of Post-Termination Restrictive Covenant
The Alberta decision in Mapleleaf Franchise Concepts, Inc. v Nassus Framework Ltd., serves as a reminder to all franchisors and their principals to ensure that they provide an accurate disclosure document to prospective franchisees. This case led to the invalidation of a post-termination restriction; it could have been much worse.
Mapleleaf was a franchise operation dealing with the sale of framing and art supplies and services under the name ‘Framing and Art Centre’. Following termination of the Nassus franchise, Mapleleaf sought to prohibit Nassus from carrying on a framing business at the same premises and location as the franchise operation, in breach of a restriction in the franchise agreement.
At the time of signing the franchise agreement Nassus was asked to review and return a disclosure document that stated, in part, that no competing business was to be run for two years within three kilometres of another Framing and Art Centre franchise. Attached to the disclosure document was a draft franchise agreement that contained a prohibition referring to a radius of 10 kilometres of the premises or location of any other Framing and Art Centre or The Framing Experience in existence on the date of termination or expiration of the franchise agreement.
The franchise agreement was subsequently forwarded to Nassus and it contained the ten kilometre restriction. An addendum to the agreement was included which also described the franchisee’s exclusive territory to be an area of ten kilometres around the Nassus store.
The sole shareholder of Nassus (Mr. Drouin) subsequently signed the franchise agreement, which provided for a restrictive covenant prohibiting Mr. Drouin and Nassus from having or engaging in any similar business within ten kilometres of the original store or carrying on business within a radius of ten kilometres from the original store, in the event that the franchise agreement was terminated.
It was only shortly before termination of the franchise in 2009 that Mr. Drouin realised that the area covered by the restrictive covenant was ten kilometres as opposed to three kilometres. Mr Drouin’s testimony was that he was misled by the summaries in the disclosure documents, and that he believed that what he was prohibited from doing was entering into any agreement with any other retailer whose business dealt in frames within a radius of three kilometres from his store. Mr. Drouin maintained that he was not aware that he could not continue carrying on business from his store or within a radius of ten kilometres from his store for a period of two years.
Under Alberta’s Franchises Act, RSA 2000, c-F23 (the Franchises Act), a misrepresentation is deemed to include an untrue statement of a material fact and an omission of a material fact1. Under supporting regulations the franchisor is obligated to disclose whether or not there are provisions in the franchise agreement that deal with renewal, termination and transfer of the franchise and, if so, where in the franchise agreement the provisions can be found.2
Under the Franchises Act, if a franchisee suffers a loss because of a misrepresentation in a disclosure document, the franchisee has a statutory right of action for damages against the franchisor and anyone that signed the disclosure document3. Further, if a franchisee purchases a franchise based on a misrepresentation in a disclosure document the franchisee is deemed to have relied on the misrepresentation4.
Mapleleaf was seeking to rely on a statutory exemption that states that a franchisor, or other person, is not liable under the Franchises Act if it is proved that the franchisee purchased the franchise with knowledge of the misrepresentation.5
The inaccurate summary in the disclosure document was, according to Justice Hawco, “by definition, a misrepresentation.” Whether a franchisee could continue in business in the same place a franchise had operated in for ten years was also, in his view, a “material fact that would reasonably be expected to have significant effect upon the value or price of the franchise or the decision to purchase it.”
Significantly, it was also held that Mapleleaf had not proved that Mr. Drouin was aware of the misrepresentation, therefore removing Mapleleaf’s ability to rely on the statutory exemption, and that the Plaintiff had a duty to ensure that the information it gave out in its disclosure document was accurate. Accordingly Nassus and Mr. Drouin were not prohibited from carrying on business from its present location.
Implications of the Decision for Franchisors
While this is a straightforward decision it shows in simple terms how a franchisor can run into difficulties though the simple step of not ensuring that its disclosure document is accurate, which in this case led to the loss of the benefit of a valuable post-termination restrictive covenant. There could have been more significant issues for the franchisor had this been discovered by the franchisee prior to termination of the franchise and the franchisee had brought a damages claim.
In any event, franchisors and their principals should be aware of the requirement to provide a signed certificate that accompanies the disclosure document6 under the Franchises Act whereby the franchise principals confirm that they are not aware of any misrepresentations (generally, also see Jennifer Dolman’s August 27, 2012 post “Why a Signature Matters in Franchise Disclosures.”
For these reasons it is good practice for franchisors to develop internal processes to ensure that disclosure documents are checked against franchise agreements for accuracy before the accompanying certificates are signed off by franchise principals and sent to franchisees. Mistakes or material changes should also be corrected in writing as soon as practicable after the change has occurred7, or mistake has been noticed, and before the signing of the franchise agreement or payment of any consideration by the prospective franchisee, whichever is earlier8. Notably, any material change to a disclosure document must also be accompanied by a signed certificate.
1 Section 1(1)(q) Franchises Act
2 Section 17(1), Schedule 1, Franchises Regulation, Alta Reg. 240/1995
3 Section 9(1) Franchises Act
4 Section 9(2) Franchises Act
5 Section 10(1) Franchises Act
6 Section 2(3), Franchises Regulation, Alta Reg. 240/1995
7 Section 4(4) Franchises Act
8 Section 4(5) Franchises Act