The following is part of a series of short articles to assist individuals and companies who are contemplating buying a franchise.

From the Franchisor

Even though the franchisor may be selling “all” of the assets of a particular franchise location, most franchisors treat the sale of the franchise as a sale of inventory and not the sale of a complete undertaking.  This makes sense if the franchisor is viewed as being in the business of building, developing, and selling franchises. As such, sale of a franchise by a franchisor would be no different than a restaurant selling a meal, all of which would be in the ordinary course of its business.

As a result, the sale of a franchise unit is not treated by most franchisors as a sale in bulk and the franchisor would not be required to comply with the provisions of any bulk sales legislation.  

If the franchise is located in Ontario, Alberta, Prince Edward Island, New Brunswick or Manitoba, the franchisor may have some additional disclosure obligations not typically imposed on a seller of a business.  Due to franchise legislation in those provinces, the franchisor must deliver to the purchaser a disclose document containing all “material facts” related to the business.  A “material fact” is broadly defined as any information that would reasonably have a significant effect on the price by which the franchise is acquired, or upon the decision to acquire the franchise.  Considering the franchisor’s role as owner and operator of the business, the disclosure requirements upon it could be quite broad and a purchaser may be prudent to use this obligation to obtain as much information from the franchisor about the franchise business.

With respect to any security registered against the assets of the franchisor, most franchisors, in obtaining lines of credit or other financing from their lenders ensure that they have the right to sell franchise assets without obtaining the bank’s consent on each occasion.  It is unlikely that the franchisor will want to provide copies of its security with its lenders.  In the event that the franchisor does not wish to do so, at a minimum, a representation should be obtained from the franchisor that it has the right under such agreements to transfer the assets without the consent of the secured party.  A purchaser may also request confirmation from the registered party that its security does not affect the assets being transferred.

From a Franchisee

As mentioned in the previous article regarding preliminary considerations, many representations and warranties in purchase agreements may become difficult to enforce against a seller after closing a relatively small transaction.  As a result, the old adage of a “good defence being the best offence” applies. Besides conducting thorough due diligence and a careful review of the franchisor’s disclosure document, a purchaser should have certain precautions inserted into the purchase agreement in the form of conditions to be satisfied prior to closing.

Regarding conditions on the purchase of an existing franchise business, a purchaser should at least insist on the following:

• Receipt of a copy of the franchise agreement and any other agreements to be entered into with the franchisor and that the purchaser must be satisfied with its terms.
• Receipt of a copy of the existing lease and any amendments and that the purchaser must be satisfied with its terms.
• The right to inspect the business premises prior to closing to review equipment and leaseholds improvements for their suitability and to determine what, if any, repairs should be done prior to closing.
• The right to verify the sales revenues that may have been reported from the existing franchisee in two ways:

• a representative of the purchaser should be permitted to be present at the premises for several business days to determine the actual sales; and
• the purchaser should demand to see sales reports that are filed with the franchisor in order to determine if there is a discrepancy between these numbers and those reported to the purchaser as actual sales.

• The selling franchisee should be required to make any repairs or renovations required by the franchisor prior to the closing and at its own cost.  It should also be required to pay for any transfer fees, legal fees or training costs required by the franchisor.
• The consent of the franchisor to the transaction and to the purchaser as franchisee.
• The franchisee’s successful completion of the franchisor’s training program.
• The purchaser should recognize that almost all franchise agreements have a right of first refusal for the franchisor to purchase the franchise at the same price and under the same conditions.  As a result, once the agreement has been drafted and executed, it will be the obligation of the selling franchisee to provide it to the franchisor and to ensure that the franchisor has rejected the right of first refusal before proceeding.  A condition of the agreement should therefore state that the written refusal of the franchisor shall have been obtained prior to the purchaser being required to perform further obligations under the terms of the agreement.
• Often in small business transactions, financing is an issue and the transaction should be conditional on the purchaser receiving the appropriate financing prior to proceeding.
• On many leases, it may be a requirement that the landlord approve of the transfer and the obtaining of this consent should also be a condition of closing.
• Generally in small businesses there will be a condition of closing that the selling franchisee terminate all of its existing employees and pay any required termination or severance pay to them up to the date of closing.  This leaves it open to the purchaser to re-hire only the employees that it wishes to continue employment.  That being said, the purchaser should be made aware that under the Employment Standards Act, 2000, the purchaser may be considered as a successor employer and if these employees are later terminated, the purchaser would be liable to pay them termination pay calculated from their original start date with the former franchisee.

For more information on franchising, contact Derwin Wong or Hailey Kersey by phone at (416) 368-0600 or by email at dwong@businesslawyers.com or hkersey@businesslawyers.com.

Revised October 2015

© Morrison Brown Sosnovitch LLP, 2015 All rights reserved.