Anonymised, illustrative composite. A franchisee holding an unexercised rescission right holds an asset worth its cost base, whatever the unit trades for. That is a valuation fact, not a negotiating point.
At a glance
A buyer looking for a first operating business agreed to buy the shares of a corporation running one unit of a mid-sized franchise system in an Ontario suburb. It traded badly: $1,600,000 of revenue, $96,000 of adjusted EBITDA after a market-rate owner salary, about $310,000 of value on earnings at 3.2 times. The seller had opened it and wanted out. Diligence turned up what the vendor's counsel had noticed and treated as small: the franchisor had never provided a disclosure document, the agreement was sixteen months old, and the vendor was passing on a $25,000 transfer-fee reduction.
That is not what the right is. Where a franchisor never provided a disclosure document, s.6(2) of the Arthur Wishart Act (Franchise Disclosure), 2000 lets the franchisee rescind “without penalty or obligation, no later than two years after entering into the franchise agreement”. What follows is not a walk-away: s.6(6) requires the franchisor, or its associate, within sixty days of the effective date of the rescission, to do four things.
It must “refund to the franchisee any money received from or on behalf of the franchisee, other than money for inventory, supplies or equipment”. It must “purchase from the franchisee any inventory that the franchisee had purchased pursuant to the franchise agreement and remaining at the effective date of rescission, at a price equal to the purchase price paid by the franchisee”. It must “purchase from the franchisee any supplies and equipment that the franchisee had purchased pursuant to the franchise agreement, at a price equal to the purchase price paid by the franchisee”. And it must “compensate the franchisee for any losses that the franchisee incurred in acquiring, setting up and operating the franchise, less the amounts set out in clauses (a) to (c)”.
Read together those four paragraphs are a put option struck at historic cost with a loss top-up, exercisable at the franchisee's election and settled in sixty days. Nothing in them refers to what the business is worth. A franchisee with a live rescission right holds an asset valued at its cost base regardless of how the unit trades — which is why the right is worth most where the unit trades worst.
The cost base, from the corporation's own records: $40,000 initial franchise fee and $12,000 training fee, both paid to the franchisor; $218,000 of leasehold improvements paid to third-party contractors; $268,000 of production and service equipment purchased pursuant to the franchise agreement; $19,000 of smallwares and supplies; $15,000 of permits, professional fees and opening marketing; $31,000 of inventory on hand; and $164,000 of cumulative operating losses since opening. Total incurred: $767,000.
Mapped onto s.6(6): paragraph (a) captures the $52,000 of fees paid to the franchisor, being money received other than for inventory, supplies or equipment. Paragraph (b) captures the $31,000 of inventory at the price paid. Paragraph (c) captures the $287,000 of equipment and supplies at the price paid. Paragraph (d) is the residue — total losses of $767,000 less the $370,000 already covered by (a) to (c), or $397,000. The four paragraphs add back to $767,000, which is the point of the words “less the amounts set out in clauses (a) to (c)”: they prevent double counting, they do not cap the claim.
The right belongs to the franchisee, which here is the corporation, not its shareholder, and that decides how it moves. On a share purchase the corporation is unchanged, so the right travels with it. On an asset purchase it would have stayed behind with the vendor corporation along with the franchise agreement. A vendor holding a live rescission right therefore has reason to prefer an asset sale and a buyer to prefer shares — the reverse of the usual preferences in why vendors prefer shares and buyers prefer assets.
It also cannot be sold off, released or contracted around. Section 11 provides that “Any purported waiver or release by a franchisee of a right given under this Act or of an obligation or requirement imposed on a franchisor or franchisor's associate by or under this Act is void.” The words are not qualified by timing or by consideration. The prudent reading, and the one both sides' counsel took here, is that a franchisor cannot buy the right off in advance and a buyer cannot obtain a covenant that it will never be exercised.
Three things limit its value, and none is legal. Exercising destroys the business: a buyer who rescinds has $767,000 and no unit, which is a good outcome only where the unit is worth less than that. The sixty-day obligation in s.6(6) is an entitlement, not a collection, and is worth the franchisor's covenant strength and no more. And the franchisee must establish that no document was ever provided: s.12 puts the burden of proving an exemption on the franchisor, but the underlying failure is the franchisee's case to make.
Once the valuation was on paper the parties argued not about it but about who owned the upside. The vendor said it had created the right and should be paid for it. The buyer said it was buying a business, would not exercise, and would not pay $457,000 for an option it intended to let expire.
They split it structurally rather than by number. The shares changed hands at $310,000 — the trading value, unadjusted — with a contingent payment of $200,000 to the vendor if a notice of rescission is served and the s.6(6) amounts are received within fourteen months of closing. If the buyer runs the unit, the vendor gets what the business is worth. If the buyer exercises, it recovers $767,000, pays the vendor $200,000, and is $257,000 ahead having given up a business it did not want. The vendor's counsel had tried to convert an option into a discount; the structure paid for the option in the only currency that reflects it.
Closing at $310,000 with a $25,000 reduction, and no analysis, would have transferred a $457,000 option to the buyer for nothing. That is the vendor's loss here, and it is the commoner direction of the error: the party holding a rescission right is usually the one least likely to have valued it.
In Alberta the same file would be worth materially less. Section 14(2) of the Franchises Act requires the franchisor, within thirty days of a notice of cancellation, to “compensate the franchisee for any net losses that the franchisee has incurred in acquiring, setting up and operating the franchised business”. There is no enumerated obligation to repurchase inventory, supplies or equipment at cost, so no cost-based floor. The Act does not define net losses, which means the Alberta claim cannot be computed from the statute the way the Ontario one can — and a number that cannot be computed is a number that gets negotiated down.
The tell was that the vendor's counsel had raised the disclosure failure with the franchisor and had been offered a transfer-fee concession. A party that answers a statutory rescission right with a fee discount has priced the conversation rather than the right. The size of the offer tells you nobody had opened s.6(6).
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