The Use of Financial Performance Representations by Canadian Franchisors – Part I: Past Historical Data
In this ongoing Legal Insight series, we will discuss some of the regulatory requirements and legal issues concerning the making by Canadian franchisors of financial performance representations, or “FPRs” as they are sometimes referred to in the United States. This installment in the series will focus on the disclosure of past historical data.
What Are Financial Performance Representations?
Prospective franchisees who are considering whether to join a franchise system are typically concerned with what investment they will be required to make, what their ongoing costs of operating the franchise are likely to be, and what profits they can expect to generate.
The answers to those questions will usually be found in a mixture of (i) historical financial performance by other franchisees or by the franchisor and (ii) projected costs and earnings. When such data originates from the franchisor, it can be described as a “financial performance representation”; that term is not used in Canadian franchise legislation, but is defined in the United States federal franchise legislation. FPRs can be generally defined as any representation given to the prospective franchisee that provides information about actual or potential sales, income, costs or profits.
Although the term financial performance representation is not used in Canadian franchise legislation, the provision of such representations by franchisors is nonetheless highly regulated. Some financial data must be disclosed by franchisors to prospective franchisees, whereas other financial data (mainly in the nature of projected earnings) may be disclosed.
The Franchisor’s Past Finance Performance Must Be Disclosed
Each of Canada's provincial franchise statutes requires that the franchisor’s past financial performance be disclosed (if available). Past financial performance must be disclosed in the form of financial statements.
Moreover, financial statements must:
- Contain all material facts;
- Be prepared in accordance with generally accepted accounting principles;
- Be prepared in accordance with at least a minimum “review engagement” standard;
- Correspond to the franchisor’s most recently completed fiscal year, if available; and
- Correspond to the franchisor’s previous completed fiscal year if 180 days have not yet passed since the end of the most recently completed fiscal year and more current statements have not yet been prepared.
- For new franchisors that have no financial statements, an opening balance sheet must be disclosed instead.
The franchisor’s certificate required by some of the provinces expressly require a statement that every financial statement required by the legislation is contained in the disclosure document
Estimated Costs Must Be Disclosed
In addition to financial statements, the Canadian provinces’ franchise statutes generally require the disclosure of other financial information:
- Estimated costs for inventory, leasehold improvements, equipment, leases, rentals and all other tangible and intangible property necessary to establish the franchise and an explanation of any assumptions underlying the estimate;
- The projected amount of:
- any contribution required to an advertising fund;
- the percentage of the fund to be spent on national or local advertising campaigns for the current fiscal year, and
- the percentage of the fund to be retained by the franchisor, the franchisor’s parent or the franchisor’s associate in the current fiscal year
The franchisor may also elect to estimate annual operating costs, but if it chooses to do so, it must also provide the franchisee with a statement specifying the basis for the estimate, the assumptions underlying the estimate and a location where information is available for inspection that substantiates the estimate.
In the next installment of this series, we will discuss the legal requirements that govern a franchisor's optional disclosure of future projections.