Feb 8, 2021
Don’t Count Your Chickens Before They Hatch: Taking Deposits Under the Arthur Wishart Act
While established franchisors often have years of franchise fees, royalty payments and advertising fund contributions to fund their ongoing operations, up until recently new franchisors in Ontario had to essentially cover their startup costs from their own pockets and recover those costs down the road when they started collecting payments from franchisees. This changed on September 1, 2020, when amendments made to the Arthur Wishart Act and its accompanying regulation (collectively the “Act”) came into force. These amendments now permit franchisors in Ontario to accept a deposit from a prospective franchisee before receiving the disclosure document or entering into the franchise agreement. The amendments can assist franchisors with sourcing the capital required to cover startup costs, however franchisors should be aware of the particular nuances of the Act before accepting a deposit.
Under the Act, a franchisor is required to provide a disclosure document to a prospective franchisee 14 days prior to the payment of any consideration to the franchisor or its associate, or the signing of the franchise agreement or any other agreement relating to the franchise (the amendments now also create an exception for entering into non-disclosure agreements). Historically, this requirement effectively prohibited franchisors from accepting deposits from prospective franchisees given that it would put the franchisee in a position to rescind the relationship in the future. However, the amendments create an exception for the payment of a deposit in advance of receiving the disclosure document so long as three conditions are met.
First, the deposit must be 100% refundable without any deductions.
Second, the deposit must be given under an agreement that does not obligate the prospective franchisee to enter into a franchise agreement.
Third, the amount of the deposit cannot exceed 20% of the initial franchise fee, up to a maximum of $100,000.
Franchisors can satisfy the first two requirements by explicitly stating that the deposit is fully refundable and the prospective franchisee can walk away at any time. However, the third requirement can be trickier to navigate. In the early stages of building the franchise structure, it is often the case that the franchisor has not quantified the initial fees it will be seeking from its franchisees. In these situations, where the franchisor wishes to take a deposit from an eager prospective franchisee, the franchisor must estimate what it expects to charge the franchisee later. Estimating too high may turn the prospective franchisee off from the relationship. Estimating too low may result in the franchisor running afoul of the Act.
The fully refundable nature of the deposit also entails that franchisors must be careful in how and when they make use of the funds. Many franchisors would prefer to put the funds to use immediately, but doing so puts themselves at risk of having to come up with the funds from elsewhere in order to return the deposit if the franchisee elects to exit the relationship. So while it is welcome news that deposits can now be accepted at the outset of the relationship in Ontario, the fully refundable nature of the deposits means that in practical terms, they are of relatively limited use until such time as the relationship goes firm.