NOTE: This paper is not legal advice.

ADVISING THE FRANCHISEE: POST-CONTRACTUAL REVIEW OF THE DISCLOSURE DOCUMENT –

ANALYZING THE BASIS FOR A RESCISSION OR MISREPRESENTATION CLAIM UNDER THE ONTARIO ARTHUR

WISHART ACT (FRANCHISE DISCLOSURE), 2000 (“Wishart Act”).

By Steven H. Goldman, Partner of Goldman Hine LLP, Barristers

www.goldmanhine.com

(with thanks to Jonathan Mesiano-Crookston, partner, and Andrea Wong, student-at-law, for their assistance in preparing this paper)

The Ontario Bar Association Institute 2014

Toronto – February 7, 2014

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ADVISING THE FRANCHISEE: POST-CONTRACTUAL REVIEW OF THE DISCLOSURE DOCUMENT

1 A BRIEF OVERVIEW OF THE DISCLOSURE REQUIREMENTS UNDER THE WISHART ACT ............... 3

2 IS THE CLIENT’S BUSINESS A “FRANCHISE” AS DEFINED BY SECTION 1 OF THE WISHART ACT? .. 5

3 IS THERE AN EXEMPTION FROM THE REQUIREMENT TO DELIVER A DISCLOSURE DOCUMENT? 8

4 RESCISSION UNDER SECTION 6 OF THE WISHART ACT – 60 DAYS OR 2 YEARS TO RESCIND? ...... 9

4.1 60 DAY RESCISSION RIGHTS: SUB-SECTION 6(1) ................................................................... 10

4.2 2 YEAR RESCISSION RIGHTS: SUB-SECTION 6(2) .................................................................... 10

4.3 WHEN IS A DISCLOSURE DOCUMENT NOT A DISCLOSURE DOCUMENT? ...................................... 11

4.3.1 Delivery Deficiencies .............................................................................................. 11

4.3.2 Form Deficiencies .................................................................................................. 11

4.3.3 Content Deficiencies .............................................................................................. 12

4.3.3.1 Dig This Garden ........................................................................................... 12

4.3.3.2 6862829 Canada Ltd. v Dollar It Ltd.............................................................. 12

4.3.3.3 6792341 Canada Inc v Dollar It Limited case ................................................ 13

4.3.3.4 Springdale case ............................................................................................ 14

4.3.3.5 MBCO Summerhill case ................................................................................ 15

5 FRANCHISOR’S ASSOCIATE ....................................................................................................... 15

6 DAMAGES FOR MISREPRESENTATION OR FAILURE TO COMPLY WITH SECTION 5 – SECTION 7, WISHART ACT .................................................................................................................................. 17

7 TACTICS: ARBITRATION, ACTION OR APPLICATION ................................................................. 19

7.1 IF THERE IS AN ARBITRATION CLAUSE ................................................................................... 19

7.2 IF THERE IS NO ARBITRATION CLAUSE ................................................................................... 20

8 CONCLUSION ............................................................................................................................ 21

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While my colleagues Peter Viitre and David Shaw have focused their paper on Acting for a Franchisor – How to Prepare a Disclosure Document and my colleague Dixie Ho has focussed her paper on reviewing the disclosure document and advising the prospective franchisee prior to entering into the franchise agreement, this paper will focus on advising the franchisee of his or her rights after the franchise agreement and related franchise agreements have been signed and the business has been opened

1 A BRIEF OVERVIEW OF THE DISCLOSURE REQUIREMENTS UNDER THE WISHART ACT

Pursuant to the Wishart Act, at least 14 days prior to the signing of any franchise agreement or the receipt of any payment related to the franchise, a franchisor must provide a prospective franchisee with a disclosure document.

In accordance with section 5 of the Wishart Act, the disclosure document must contain:

a) all material facts, including material facts as prescribed;

b) financial statements as prescribed;

c) copies of all proposed franchise agreements and other agreements relating to the franchise to be signed by the prospective franchisee;

d) statements as prescribed for the purposes of assisting the prospective franchisee in making informed investment decisions; and

e) other information and copies of documents as prescribed.1

If the franchisor fails to provide proper disclosure, section 6 of the Wishart Act gives the franchisee a period of time to rescind the franchise agreement without penalty or obligation.

Provided that they are within the time limitations set out in section 6 of the Wishart Act, these rescission rights represent a powerful remedy for franchisees who encounter any number of difficulties after entering into a franchise agreement.

An unsuccessful franchise business may present the franchisee with a myriad of problems including financial challenges, immediate or possible termination of the franchise agreement and lease, threats of termination by the franchisor, demands by unpaid landlords, lenders and suppliers, and various other claims arising out of a failing business and financial stress.

Section 6 of the Act states as follows: (1) A franchisee may rescind the franchise agreement, without penalty or

obligation, no later than 60 days after receiving the disclosure document, if the franchisor failed to provide the disclosure document or a statement of material change within the time required by section 5 or if the contents of the disclosure document did not meet the requirements of section 5.

1 Arthur Wishart Act (Franchise Disclosure), 2000, SO 2000, c 3, s 5(4) (“Wishart Act”).

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(2) A franchisee may rescind the franchise agreement, without penalty or

obligation, no later than two years after entering into the franchise agreement if the franchisor never provided the disclosure document.

(6) The franchisor, or franchisor’s associate, as the case may be, shall, within 60 days of the effective date of the rescission,

(a) refund to the franchisee any money received from or on behalf of the franchisee, other than money for inventory, supplies or equipment;

(b) 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;

(c) 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

(d) 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).

Section 7 of the Act states in part as follows:

(1) If a franchisee suffers a loss because of a misrepresentation contained in the disclosure document or in a statement of a material change or as a result of the franchisor’s failure to comply in any way with section 5, the franchisee has a right of action for damages against,

(a) the franchisor;

(d) the franchisor’s associate; and

(e) every person who signed the disclosure document or statement of material change.

Sections 11 and 12 of the Act state as follows:

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.

In any proceeding under this Act, the burden of proving an exemption or an exclusion from a requirement or provision is on the person claiming it.

As my colleagues have indicated, the main policy goals of the Act are twofold: i) to provide franchisees with the information they need to make an informed decision about purchasing a franchise; and ii) to create a commercial framework which governs the relationship of the parties. The Act is remedial

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legislation, enacted to redress a perceived imbalance of power favouring the franchisor, and the courts have generally given it a liberal interpretation.

When retained by a franchisee, counsel must first determine whether in fact a disclosure document was ever delivered to the franchisee. If a disclosure document was never delivered then the determination of a franchisee’s right to rescind is straight forward. Pursuant to subsection 6(2) of the Act, the franchisee has two (2) years from the date that the franchise agreement was executed to rescind the franchise agreement.

However, given the significant rights afforded to franchisees who did not receive any disclosure document there are in the context of a franchisee claiming rescission, the issue of whether or not a franchisor has, notwithstanding the delivery of a document titled “disclosure document”, been deemed not to have had delivered a disclosure document at all as a result of a franchisor’s failure to comply with the specific requirements of franchise legislation, including the Act.

If so, prioritize the post-contractual review of the disclosure document and related franchise agreements to determine whether the client may exercise the right to rescission under section 6 of the Wishart Act or make a claim for damages for misrepresentation or a franchisor’s failure to comply with section 5 or under section 7 of the Wishart Act or both.

In order to provide the prospective franchisee client with any meaningful legal advice, counsel needs to review the disclosure document in the form originally provided to the franchisee by the franchisor (including the mode of delivery of the disclosure document), the relevant franchise agreement, lease or sublease and other materially relevant agreements and gather all material facts.

This paper will serve as an overview to some of the most critical considerations to keep in mind while conducting this review.

2 IS THE CLIENT’S BUSINESS A “FRANCHISE” AS DEFINED BY SECTION 1 OF THE WISHART ACT?

Assuming the business is one that operates wholly or in part in Ontario as the Wishart Act applies only to franchises operated in Ontario, one of the first things counsel must establish is that the business being operated is a “franchise” as defined by section 1(1) of the Wishart Act.

1(1) In this Act,

...

“franchise” means a right to engage in a business where the franchisee is required by contract or otherwise to make a payment or continuing payments, whether direct or indirect, or a commitment to make such payment or payments, to the franchisor, or the franchisor’s associate, in the course of operating the business or as a condition of acquiring the franchise or commencing operations and,

(a) in which,

(i) the franchisor grants the franchisee the right to sell, offer for sale or distribute goods or services that are substantially associated with the franchisor’s, or the franchisor’s associate’s,

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trade-mark, service mark, trade name, logo or advertising or other commercial symbol, and

(ii) the franchisor or the franchisor’s associate exercises significant control over, or offers significant assistance in, the franchisee’s method of operation, including building design and furnishings, locations, business organization, marketing techniques or training, or

(b) in which,

(i) the franchisor, or the franchisor’s associate, grants the franchisee the representational or distribution rights, whether or not a trade-mark, service mark, trade name, logo or advertising or other commercial symbol is involved, to sell, offer for sale or distribute goods or services supplied by the franchisor or a supplier designated by the franchisor, and

(ii) the franchisor, or the franchisor’s associate, or a third person designated by the franchisor, provides location assistance, including securing retail outlets or accounts for the goods or services to be sold, offered for sale or distributed or securing locations or sites for vending machines, display racks or other product sales displays used by the franchisee; (“franchise”)

The characterization of a business as a franchise (or not) is fact-driven and based upon the content of the relevant agreements between the (possible) franchisor and franchisee. Less frequently, the actual operations of the business may be relevant.

The fact that franchisors do not intend to create a franchise relationship is irrelevant to whether one has been created at law. In one case, a court held that “it is not disputed that in law the parties executed a franchise agreement” even though the parties had not discussed franchising, had not referred to a franchise in their contract, and even though the vendor was unaware that a dealership would be considered a franchise until years later.2

Furthermore, the name of the agreement concluded between the parties is entirely irrelevant. Franchisors who believe they are avoiding the provisions of the Wishart Act by calling their agreements something other than a franchise agreement, which often still set out the responsibilities of a “franchise”, including a:

“license agreement,”

“distributorship agreement,”

“dealer agreement,”

“distribution agreement,”

are often sorely surprised to be advised by franchise counsel that their efforts have been for naught and that they are, in fact, operating a franchise system and are subject to the Act.

2 Payne Environmental Inc. v Lord and Partners Ltd., 2006 CanLII 1770 (ON SC) at para. 3.

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There have been few relevant judicial pronouncements by Ontario courts about what exactly constitutes a “franchise” under the Wishart Art and that help explain the various terms used in the definition. In Di Stefano v Energy Automated Systems Inc, 2010 ONSC 493, the plaintiffs, who had bought EASI distributions, alleged they were a franchisee in order to not be subject to a forum selection clause in their distributorship agreements that required legal proceedings happen in Tennessee. Justice Code found them non-exclusive distributors. The franchisor, EASI, admitted payments and the right to sell goods or services. The franchisees had conceded there was no evidence of “significant control”. The question became whether five days of training was “significant assistance”. Justice Code held no.

[26] ... The real issue in the case, and on this Motion, is whether EASI “offers significant assistance in the [Plaintiffs’] manner of operation, including building design and furnishings, locations, business organization, marketing techniques or training.” Counsel for the Plaintiffs conceded during argument that the sole basis on which this test can be met is the five day training program, prior to obtaining an EASI dealership.

[27] This slender thread is not “a reasonable basis” on which to assert that EASI’s contracts with the Plaintiffs are “franchise agreements” for a number of reasons. First, the five day training program is a condition precedent to obtaining an EASI dealership. It is not ongoing assistance during the pendency of the agreement. The statute uses the verbs “exercises” and “offers”, in the present tense, in relation to the elements of “control” and “assistance”. It does not refer to a one time training program undertaken and completed in the past. Second, the offer of assistance must relate to the business’ “method of operation”. The five day training program, in substance, relates to learning about the products rather than learning about any particular “method of operation”. Third, the statute sets out six examples of what it means by “method of operation” – building design, furnishings, locations, business organization, marketing techniques and training. The first five are clearly inapplicable and the “training” offered does not, in its real substance, relate to “method of operation”. Finally, the result of the Plaintiffs’ submission, if correct, would be that any company selling a sophisticated product, and offering advance training about that product to its nascent distributors, would in law be a “franchisor”. It is unlikely the Legislature intended this result.

However, lessons can perhaps be drawn from cases pronounced in various jurisdictions in the United States with similar laws dealing with franchise relationships. The threshold appears quite low and very little control is required before a licence arrangement will be considered a franchise.

In fact, in one case, it was not even necessary that the franchisor actually exert control over the licensee; as long as the franchisor had the right to do so, the arrangement was legally found to be a franchise.3

Other examples include an NBA basketball team which was found to be a “franchise”, and not a licensee, because it was subject to league requirements and operated in association with the league’s trade-marks.4

3 RJM Sales & Mktg., Inc. v Banfi Products Corp., 546 F. Supp. 1368, 1374 (D. Minn. 1982). As a United States case this decision is not binding on Canadian Courts, of course, but may still be of use.

4 Continental Basketball Association v Ellenstein Enterprises Inc., 669 N.E.2d 134 (Ind. Sup. Ct 1996).

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In another case, the parties entered into a “Master Distributor Agreement” which allowed the distributor to use the manufacturer’s trade-mark, had to maintain a sales force, and had to promote the manufacturer’s products. The court held, on a preliminary motion, that this was a franchise relationship.5

Furthermore, section 2(1) makes it clear that the Wishart Act applies not only to the initial franchise agreements entered into by your client but also to extensions and renewals of the franchise agreements.6

3 IS THERE AN EXEMPTION FROM THE REQUIREMENT TO DELIVER A DISCLOSURE DOCUMENT?

While the client may qualify as a franchisee under the Wishart Act, the franchisor may take still be able to take the position that it was exempt from delivering a disclosure document due to the numerous exceptions created by sub-section 5(7). The disclosure requirements do not apply to:

a) the grant of a franchise by a franchisee, if the grant is for the franchisee’s own account and not effected by or through the franchisor;

b) the grant of a franchise to an officer or director of the franchisor or franchisor’s associate;

c) the grant of an additional franchise to an existing franchisee, if the additional franchise is substantially the same as the franchisee’s existing franchise and there has been no material change since the entry into the existing franchise agreement or most recent renewal;

5 Emergency Accessories & Installation, Inc. v Whelen Engineering Corp., Inc. Action No. 09-2652 (JEI/AMD), 2009 WL 1587888 (D. N.J. June 3, 2009).

6 Wishart Act, supra note, section 2:

Application

2.(1) This Act applies with respect to a franchise agreement entered into on or after the coming into force of this section, with respect to a renewal or extension of a franchise agreement entered into before or after the coming into force of this section and with respect to a business operated under such an agreement, renewal or extension if the business operated by the franchisee under the franchise agreement or its renewal or extension is to be operated partly or wholly in Ontario. 2000, c. 3, s. 2 (1).

Same

(2) Sections 3 and 4, clause 5 (7) (d) and sections 9, 11 and 12 apply with respect to a franchise agreement entered into before the coming into force of this section, and with respect to a business operated under such agreement, if the business operated by the franchisee under the franchise agreement is operated or is to be operated partly or wholly in Ontario. 2000, c. 3, s. 2 (2).

[emphasis added]

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d) the grant of a franchise by a third party on behalf of a person other than the franchisor, such as

an executor, receiver, trustee, or guardian;

e) a fractional franchise, where the parties anticipate that the sales of franchised goods or services will not exceed 20 per cent of the total sales of the prospective franchisee’s business;

f) the renewal or extension of an existing franchise agreement, provided that there has been no interruption in the operation of the business or any material change since the entry into the existing franchise agreement or most recent renewal;

g) a small franchise, where the total annual investment to acquire and operate the franchise is less than $5,000, or where the franchise agreement is not valid for longer than one year and does not involve the payment of a non-refundable franchise fee, or where the franchisor is governed by the multi-level marketing or direct selling provisions of the federal Competition Act; and

h) a sophisticated investor who invests at least $5 million over one year in the acquisition of operation of a franchise.

In addition to the full exemptions noted above, a partial exemption exists that limits the requisite financial disclosure. The mature franchisor financial exemption applies to franchisors with a net worth of at least $5 million and at least 25 franchisees in Canada or in any single jurisdiction, providing the franchisor has not had any judgments against it in the past 10 years relating to fraud, unfair or deceptive practices, or franchise law.

Notably, the Act does not include an exemption for a fully refundable deposit or confidentiality agreement, as is available in the Alberta franchise legislation. Further, it is important to remember that these exemptions apply only to the franchisor’s disclosure obligations. There are no exemptions available with respect to the other obligations imposed by the Act.

4 RESCISSION UNDER SECTION 6 OF THE WISHART ACT – 60 DAYS OR 2 YEARS TO RESCIND?

Assuming your client is in fact in a franchise defined the Wishart Act, and assuming that there is a requirement by the franchisor to deliver a disclosure document, if the franchisor failed to meet its disclosure obligations by either failing to deliver a disclosure document at all or delivering a disclosure document that is wholly deficient in certain material ways (as discussed in more detail below), the franchisee has the right to rescind any franchise agreement to which it and the franchisor were parties.

As well, section 1 of the Wishart Act broadly defines a franchise agreement to include any agreement that relates to a franchise between a franchisor or franchisor’s associate and a franchisee, and so the rescission may apply to agreements such as a sub-lease, non-competition or non-solicitation agreement and many other types of agreements not normally considered actual “Franchise Agreements” under normal parlance.

If the franchisee properly exercises its rescission rights in writing under section 6 of the Wishart Act, depending upon the nature and extent of the failure to comply with the disclosure obligations, the franchisor has either 60 days or 2 years from the effective date of rescission to fulfil a set of financial obligations compensating the franchisee. The financial obligations are set out in section 6(6) and are aimed at restoring the franchisee to the financial position held prior to entering into the franchise agreement.

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Subsection 6(6) of the Act requires that the franchisor and the franchisor’s associate, as the case may be, shall within sixty days of the effective date of rescission:

(a) Refund to the franchisee any money received from or on behalf of the franchisee, other than money for inventory, supplies or equipment;

(b) 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;

(c) 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

(d) 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). [underlining added]

If the franchisor fails to fulfil its financial obligations, the franchisee must commence an action within two years of the earlier of the expiry of the 60-day period and any date on which the franchisor or its associates refuse to make the payments. This two-year period arises pursuant to the Ontario Limitations Act, 2002, SO 2002.

4.1 60 DAY RESCISSION RIGHTS: SUB-SECTION 6(1)

Sub-Section 6(1) of the Wishart Act provides:

A franchisee may rescind the franchise agreement, without penalty or obligation, no later than 60 days after receiving the disclosure document, if the franchisor failed to provide the disclosure document or a statement of material change within the time required by section 5 or if the contents of the disclosure document did not meet the requirements of section 5.

This means that if the franchisor has failed to provide the franchisee with a disclosure document at least 14 days prior to entering into the franchise agreement or if certain contents are absent from the disclosure document, the franchisee only has 60 days from the date of entering into the franchise agreement to exercise its rescission rights.

However, due to the time required to close the acquisition of the franchised business and begin operating a franchise, there are very few instances in which a franchisee will exercise rescission rights within the 60 days as set out under sub-section 6(1). Franchisees are often not in a position to determine whether they wish to rescind before the expiration of the allotted 60 days, which is reflected in the rarity of any cases where a franchisee has successfully exercised rescissions rights pursuant to sub-section 6(1). Vijh v Mediterranean,7 a case argued by our firm, is one such case, in which e-mail delivery of a disclosure document was held not to trigger two year rescission.

4.2 2 YEAR RESCISSION RIGHTS: SUB-SECTION 6(2)

In contrast, franchisees who never received a disclosure document (or received such a materially defective document that the law has deemed there to have been no disclosure provided) have access to

7 Vijh v Mediterranean, 2013 ONCA 698 [Vijh].

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rescission rights for a period of 2 years after entering into the franchise agreement as set out in Sub-Section 6(2) of the Wishart Act, which provides:

A franchisee may rescind the franchise agreement, without penalty or obligation, no later than two years after entering into the franchise agreement if the franchisor never provided the disclosure document.

While in its literal reading this provision appears restricted to the limited situations where no disclosure document was ever produced, the Ontario courts have expanded the scope of this provision by finding that a disclosure document can be so deficient as to amount to no disclosure at all.

Courts have thereby made the extended time period for rescission contemplated by section 6(2) available not only to franchisees who never received a disclosure document, but also to franchisees who received a deficient disclosure document. Accordingly, the preponderance of contentious rescission cases turns on whether a franchisor’s disclosure document exhibits deficiencies severe enough to render the disclosure ineffective at law and entitle the franchisee to rescission rights under section 6(2).

4.3 WHEN IS A DISCLOSURE DOCUMENT NOT A DISCLOSURE DOCUMENT?

4.3.1 Delivery Deficiencies

Delivering a disclosure document late or by the wrong method have been held not to be a sufficiently significant breach of the Wishart Act to trigger the 2-year rescission rights under sub-section 6 (2). Only the 60 day rescission remedy is available under sub- section 6(1).

In the recent Ontario Court of Appeal decision of Vijh v Mediterranean,8 a case which my partner and I recently argued, the court found that while email delivery of the disclosure document was not expressly permitted by the Wishart Act, assuming that the disclosure document was otherwise compliant, such a default would not entitle the franchisee to 2-year rescission rights under sub-section 6 (2); rather, the franchisee would only have been entitled to 60 day rescission rights under sub-section 6 (1).

4.3.2 Form Deficiencies

The Ontario courts have acknowledged several types of significant deficiencies that invalidate a franchisor’s disclosure document.

Basic imperfections relating to the method of presentation can be fatal to the franchisor regardless of the disclosure document’s content. In 1490664 Ontario Ltd v Dig this Garden Retailers Ltd.,9 the franchisee received disclosure over several months in the form of several documents in addition to information conveyed orally. The franchisor therefore violated sections 5(3) and (6) of the Act, which state that a disclosure document must be delivered as one document at one time and contain only accurate, clear, and concise information. The Court of Appeal emphasized that the “requirement that disclosure occur in the form of a single document is not an empty formal requirement,” but a constraint that fulfils the purpose of the Act to ensure that a franchisee’s “decision to enter into a franchise

8 Vijh v Mediterranean, 2013 ONCA 698, supra note 7.

9 1490664 Ontario Ltd v Dig This Garden Retailers Ltd, 2005 CanLII 25181, (2005), 256 DLR (4th) 451 (Ont CA) [Dig This Garden].

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agreement is an informed one.”10 Having provided a disclosure document “in bits and pieces over time,” the franchisor “did not provide disclosure as required by s 5 of the Act,” which allowed the franchisee to claim rescission under section 6(2).11 It should be noted that the Court indicated that “at best” 70% of the information that was required pursuant to the Wishart Act had been provided.

4.3.3 Content Deficiencies

The Ontario Courts have repeatedly found that a disclosure document that omits material elements in its content is no disclosure document at all, and therefore triggers the two-year limitation period rescission right under section 6 (2) in which to rescind the franchise agreement (including all related agreements).

However, absent a significant deficiency independently capable of undermining the disclosure document, “a number of minor deficiencies cannot, on a cumulative basis, disqualify documentation as a ‘disclosure document’ for such purposes.”12

4.3.3.1 Dig This Garden

Dig This Garden, discussed above, is one of the first cases dealing with s. 6(2) rescission granted for the franchisor not having provided a “disclosure document”, but where some form of disclosure had been provided. As noted, only about 70% of what was required had been provided, which was likely the key to this case.

4.3.3.2 6862829 Canada Ltd. v Dollar It Ltd.

In 6862829 Canada Ltd. v Dollar It Ltd., 2008 CanLII 60699 (Ont SCJ; affd OntCA), delivery of a single document which was materially deficient was found to be no disclosure at all, and warranted section 6(2) rescission. The Court noted, at para. 27:

I consider the following deficiencies to be the non-disclosure of material information:

(a) the absence of financial statements ...

(b) absence of a Certificate duly completed ...

(c) absence of notice of pending law suit ...

(d) absence of copy of existing Offer to Lease ...

(e) the lawyer stipulated on the disclosure document as being the person authorized to receive service of process in Canada ... was not ...

Later, at paragraphs 57 and 66, the Court noted that:

[57] Based on all of the principles enunciated in the above cases, I come to the conclusion that a disclosure document, which for all intents and purposes

10 Ibid at para 18.

11 Ibid at para 15.

12 Sovereignty Investment Holdings, Inc v 9127-6907 Quebec Inc, 54 BLR (4th) 277 (available on CanLII) at para 21.

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meets the formal requirements of s. 5 (that is one document served at one time and served within the correct time frame before the entering into the franchise agreement) can be considered a nullity, and hence no disclosure, if it is materially deficient in its substantive content in breach of the requirements of s. 5.

…

[66] For the reasons stated earlier the disclosure document on the facts of this case has been found to be materially deficient. Because of those material deficiencies, it is far from meeting the requirements of s. 5 of the Act even though it may have been given at one time, in one document and on time. For that reason, I conclude that no disclosure has been given within the meaning of s. 6(2) of the Act.

4.3.3.2.1 Tutor Time case

In 1518628 Ontario Inc. v Tutor Time Learning Centres LLC (2006), CanLII 25276 (ON SC) (“Tutor Time”), providing an Ontario based franchisee with the U.S. equivalent of a disclosure document (a “Uniform Franchise Offering Circular” or “UFOC”) was no disclosure at all under the Wishart Act in the circumstances of that case. Although whether a UFOC would always be non-compliant or not, might be highly fact specific. The franchisee was entitled to s. 6(2) rescission.

4.3.3.2.2 Sovereignty case

In Sovereignty, the following deficiencies in the disclosure document were found by the court to be materially deficient, warranting section 6(2) rescission.

No financial statements (para. 16).

No statement specifying the basis for earnings projections (para. 17).

Disclosure document was not a single document and was not delivered at one time (para. 18).

Disclosure document did not include a signed certificate.

Each of these four particular deficiencies, on its own, would disqualify the franchisor from having complied with the requirement to deliver a disclosure document (para. 15). However the court noted that “a number of minor deficiencies cannot, on a cumulative basis, disqualify documentation as a “disclosure document” for such purposes.

4.3.3.3 6792341 Canada Inc v Dollar It Limited case

In the leading case of 6792341 Canada Inc v Dollar It Limited, 2009 ONCA 385, the Ontario Court of Appeal found that a disclosure document, which otherwise met the form and delivery requirements of the Act, nevertheless displayed material deficiencies, described in detail below, which were severe enough to trigger rescission rights under section 6(2).13

The “purpose of the legislation was to protect franchisees and the mechanism for so doing is the imposition of rigorous disclosure requirements and strict penalties for non-compliance. The legislation must be construed and interpreted in light of this purpose.” [para 72]

13 6792341 Canada Inc v Dollar It Limited, 2009 ONCA 385, 173 ACWS (3d) 121 (available on CanLII).

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The court held that the following material deficiencies precluded the disclosure document from meeting the requirements of section 5:

a) the absence of financial statements, or opening balance sheet where the franchisor had operated for less than a year, to inform the franchisee about the financial situation of the franchisor;

b) the absence of a Certificate certifying that the disclosure document was complete or accurate duly completed and signed by the franchisor and at least one of its directors. The court stated [para 31] that “the failure to include the mandated Certificate alone would be enough to conclude that there was not disclosure as required by the Act”;

c) the absence of notice of a pending law suit against the franchisor by one of its franchisees;

d) the absence of disclosure about the sub-landlord, a corporation associated with the franchisor, that was owned and controlled by the same person who owned and controlled the franchisor;

e) the absence of the relevant head lease where the sub-lease requires the franchisee to assume the obligations of the head lease;

f) the absence of statements pertaining to the advertisement fund and contributions thereto as required by section 6(6) of the Ontario Regulations 581/00 which are detailed and specific;

g) the absence of the description of the actual territory to be granted and a description of the franchisor’s policy, if any, as to whether the continuation of the franchisee’s rights to exclusive territory depends on the franchisee achieving a specific level of sales, market penetration or other conditions and under what circumstances these rights may be altered (as set out subsections 12 and 13 of section 6 of O. Reg. 581/00);

h) the absence of a description of Licence, registration authorization or other permission required to be obtained to operate the franchise;

i) the absence of a description of the franchisor’s policy, if any, regarding volume rebates, and whether or not the franchisor or the franchisor’ associate receives a rebate, commission, payment or other benefit as a result of purchases of goods and services by a franchisee and if so, whether rebates, commissions, payments or other benefits are shred with franchisees, either directly or indirectly as set out in section 6(8) of O.Reg. 581/00;

j) the lawyer stipulating on the disclosure document as being the person authorized to receive service of process in Canada on behalf of the franchisor when in fact he was not so authorized and declined service of litigation documents.14

The Court of Appeal upheld the lower court’s decision that rescission was available to the franchisee under sub-section 6 (2) of the Wishart Act but noted as well [para 78] that “each case will fall to be considered on its own particular facts.”

4.3.3.4 Springdale case

In 2189205 Ontario Inc. v Springdale Pizza Depot Ltd., 2010 ONSC 3695, the disclosure provided did not contain a signed certificate, audited financial statements, the head lease for the premises, and earnings

14 Ibid at para 27.

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projections as required by the Arthur Wishart Act and its regulations. (See para. 16.) Overall, the judge stated that he had:

“no difficulty in concluding that the alleged disclosure document was deficient in numerous material ways and that it did not comply with the requirements under the Act and Regulations.” (para. 19)

4.3.3.5 MBCO Summerhill case

In MBCO Summerhill Inc. v MBCO Associates Ontario Inc., 2010 ONSC 5432, the franchisee argued it was entitled to rescind its agreement under sub-section 6(2) of the Wishart Act because the disclosure document it had been given was so deficient that it was deemed at law to not be a disclosure document within the meaning of the Wishart Act. This follows from a line of earlier franchise decisions including the Ontario Court of Appeal decision in Dollar It.

The Court was clearly unimpressed with the disclosure document, which it described,

… as a flyer of four and one-half pages, containing two pages of photographs; one page setting out general information concerning the neighbourhood as well as a four-item investment summary and projected financial information based on three possible scenarios.

The Court pointed out that the disclosure document “contain[ed] numerous deficiencies” (para. 14), including (a) no proper financial statements or balance sheets; (b) no head lease; and (c) no signed certificate, which the Court described as “an important deficiency”.

In the end, the Court granted rescission of the franchise agreement against the franchisor, rescission of the sub-lease and related sub-lease documents against the sub-landlord, and ordered the franchisor and its 50% shareholder to pay the amounts due to the franchisee under sub-section 6 (6) of the Wishart Act which totalled $128,226.69 (para. 32, 33).

5 FRANCHISOR’S ASSOCIATE

Among the post-contractual review of the disclosure documents and material facts is to determine which parties might be liable to the franchisee client. Apart from the obvious choice of the franchisor, the review must consider what other “franchisor’s associate” parties might be liable for either or both s. 6 rescission damages or s. 7 misrepresentation damages.

Typically the parties that need to be considered as potential defendants are the franchisor, the landlord/sub-landlord where related to the franchisor, and according to the definition in the Wishart Act of “franchisor’s associate”, the potential defendants includes parties who might not realize they are related to the franchisor or have liability to the franchisee for damages under the Wishart Act.

The definition of “franchisor’s associate” in the Wishart Act reads:

“franchisor’s associate” means a person,

(a) who, directly or indirectly,

(i) controls or is controlled by the franchisor, or

(ii) is controlled by another person who also controls, directly or indirectly, the franchisor, and

(b) who,

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(i) is directly involved in the grant of the franchise,

(A) by being involved in reviewing or approving the grant of the franchise, or

(B) by making representations to the prospective franchisee on behalf of the franchisor for the purpose of granting the franchise, marketing the franchise or otherwise offering to grant the franchise, or

(ii) exercises significant operational control over the franchisee and to whom the franchisee has a continuing financial obligation in respect of the franchise; (“personne qui a un lien”) [underlining added]

Examples of entities that have been found to be franchisor’s associates include:

officers and directors who sign the disclosure document or who may have been involved in the grant of the franchise

persons who admit holding 50% of the shares in the franchisor;15

a 50% shareholder of the franchisor, who was not a director or officer but who was directly involved in the grant of the franchise.16

a sub-landlord corporation where the sub-landlord was operated by the same person who operated the franchisor and had also been referred to in the franchise agreement as both “franchisor” and “sub-landlord”. The judge held that the sub-landlord exercised “significant operational control” over the franchisee and that “the franchisee has a continuing financial obligation to it for rental payments for the property where the franchise is run.”17

In addition parties involved in selling the franchise and making representations to the franchise may also be liable.

For many purposes, the Wishart Act treats franchisors and franchisor’s associates as related parties that share duties and liabilities.

For example:

A franchisee must be given a disclosure document at least 14 days before paying any fees to the franchisor or to a franchisor’s associate. This is intended to avoid structuring franchise sales such that compensation is paid to a related company or sales agent in order to avoid the effect of the Wishart Act.

If a franchisee becomes entitled to rescission, the “franchisor, or franchisor’s associate, as the case may be, shall, within 60 days” [of the rescission] refund the franchisee all its fees, invested money, and losses. Note that it is an open question whether this allows a franchisee to recover

15 1490664 Ontario Ltd v Dig This Garden Retailers Ltd, 2005 CanLII 25181, (2005), 256 DLR (4th) 451 (Ont CA).

16 MBCO Summerhill Inc v MBCO Associates Ontario Inc, 2010 ONSC 5432.

17 6792341 Ontario Inc et al. v Dollar It Ltd et al (2009), 95 OR (3d) 291, 2009 ONCA 385 (Ont CA), para. 42.

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against either party, or whether the franchisee can only recover against the party who received the money. In at least one case, however, the Ontario Court of Appeal (in the Dig This Garden case) noted that a failure to provide the s. 6(6) rescission damages may give rise to damages under section 7, which are joint and several.

Franchisees have rights of action as against franchisors as well as franchisor’s associates for any misrepresentations made in disclosure documents or statements of material change. This liability is found in section 7 of the Wishart Act. Section 8, furthermore, imposes joint and several liability on franchisors and franchisor’s associates for breaches of section 7.

Finally, a franchisor has a duty not to prohibit franchisees from associating and a franchisor’s associate shares this duty. If a franchisor and an associate are found to have interfered with the right to associate, they are jointly liable for such breach, see section 8(2) of the Wishart Act.

6 DAMAGES FOR MISREPRESENTATION OR FAILURE TO COMPLY WITH SECTION 5 – SECTION 7, WISHART ACT

In addition to reviewing potential rescission claims, counsel also needs to canvass whether there has been any misrepresentations made to your client either set out in the disclosure document itself or in other documents (such as inaccurate sales forecasts or financial projections).

There may be misleading facts either expressly set out in the disclosure document or perhaps misleading because they were material and omitted from the disclosure document (in contravention of section 5 of the Wishart Act). These misrepresentation can form the basis of a claim for damages against the Franchisor and various other parties under section 7 of the Wishart Act.

Section 7 of the Wishart Act is potentially another powerful statutory remedy available to a franchisee, to be used in addition to or instead of the rescission remedy.

7 (1) Damages for misrepresentation, failure to disclose - If a franchisee suffers a loss because of a misrepresentation contained in the disclosure document or in a statement of material change or as a result of the franchisor’s failure to comply in any way with section 5, the franchisee has a right of action for damages against,

(a) The franchisor;

(b) The franchisor’s agent;

(c) The franchisor’s broker, being a person other than the franchisor, franchisor’s associate, franchisor’s agent or franchisee, who grants, markets or otherwise offers to grant a franchise, or who arranges for the grant of a franchise;

(d) The franchisor’s associate, and

(e) Every other person who signed the disclosure document or statement of material change.

(2) Deemed reliance on misrepresentation – If a disclosure document or statement of material change contains a misrepresentation, a franchisee who acquired a franchise to which the disclosure document or statement of material change relates shall be deemed to have relied on the misrepresentation.

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(3) Deemed reliance on disclosure document – If a franchisor failed to comply with section 5 with respect to a statement of material change, a franchisee who acquired a franchise to which the material change relates shall be deemed to have relied on the information set out in the disclosure document.

(4) Defence – A person is not liable in any action under this section for misrepresentation if the person proves that the franchisee acquired the franchise with knowledge of the misrepresentation or of the material change, as the case may be.

(5) Same – A person, other than a franchisor, is not liable in an action under this section for misrepresentation if the person proves,

(a) that the disclosure document or statement of material change was given to the franchisee without the person’s knowledge or consent and that, on becoming aware of its having been given, the person promptly gave written notice to the franchisee that it was given without that person’s knowledge or consent;

(b) that, after the disclosure document or statement of material change was given to the franchisee and before the franchise was acquired by the franchisee, on becoming aware of any misrepresentation in the disclosure document or statement of material change, the person withdrew consent to it and gave written notice to the franchisee of the withdrawal and the reasons for it; or

(c) that with respect to any part of the disclosure document or statement of material change purporting to be made on the authority of an expert or purporting to be a copy of or an extract from a report, opinion or statement of an expert, the person had no reasonable grounds to believe and did not believe that,

(i) there had been a misrepresentation;

(ii) the part of the disclosure document or statement of material change did not fairly represent the report, opinion or statement of the expert, or

(iii) The part of the disclosure document or statement of material change was not a fair copy of or extract from the report, opinion or statement of the expert.

The right to recover damages under section 7(1) requires that the franchisee prove that:

a. it has suffered a loss;

b. there has been a misrepresentation or failure to disclosure in accordance with section;

c. the loss was incurred as a result of a misrepresentation or as result of the franchisor’s failure to comply in any way with section 5; and

d. The misrepresentation relied upon was contained in the disclosure document or statement of material change.

The deemed reliance provision set out in section 7(2) makes it easier for a franchisee to prove its claim for damages as it removes the franchisor’s defence that, even though there was a misrepresentation or omission, the franchisee didn’t rely upon same. Accordingly the sub-section suggests that there may not

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need to be a causal relationship between the loss suffered and the misrepresentation, although section 7(1) states that the franchisee must demonstrate that the loss was suffered because of the misrepresentation.

The section also broadly includes many potential parties who can be liable. As noted above, misrepresentation claims render liable all of the following persons.

(a) The franchisor;

(b) The franchisor’s agent;

(c) The franchisor’s broker, being a person other than the franchisor, franchisor’s associate, franchisor’s agent or franchisee, who grants, markets or otherwise offers to grant a franchise, or who arranges for the grant of a franchise;

(d) The franchisor’s associate, and

(e) Every other person who signed the disclosure document or statement of material change.

As can be seen, this is wider than the duty on franchisors and franchisor’s associates to reimburse franchisees their 6(6) damages after a successful rescission remedy claim.

7 TACTICS: ARBITRATION, ACTION OR APPLICATION

I always recommend attempting to resolve any claim through negotiations or even pre-claim mediation. In certain circumstances this may be possible particularly where liability is clear, damages are reasonably assessable and there is a desire by both parties for a quick and confidential resolution.

However, if no resolution can be negotiated with the franchisor or its lawyers to resolve either a section 6 rescission claim or section 7 misrepresentation claim, the next step is to determine whether the claim is to be resolved through the court system or through arbitration. It is therefore essential to review the Franchise Agreement (and related franchise agreements, including the sub-lease and other agreements relating to the franchise) to determine whether they contain an operative arbitration clause.

7.1 IF THERE IS AN ARBITRATION CLAUSE

If an arbitration clause is included and, if appropriate, counsel will draft and serve a Demand for Arbitration. The issue becomes somewhat more complicated if one or more of the proposed Defendants/Respondents include “franchisor’s associates”, who are not parties to the agreement containing the provision requiring arbitration.

This can lead to a situation where it may be necessary to both serve a Demand for Arbitration against the parties bound by the arbitration provision and to issue a Statement of Claim against those franchisor’s associates who are not parties, or otherwise contemplate attempting to bring them all into arbitration by arguing that while the franchisor’s associates may not be parties to the Franchise Agreements, they are “related parties” with a sufficiently close nexus to the contracting parties such that they are properly within the arbitrator’s jurisdiction. This can lead to contested proceedings before the prospective arbitrator to determine whether these associates are proper parties, which can in turn lead to proceedings before the Ontario Superior Court of Justice to review the decision of the arbitrator, all of which can delay and increase costs.

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Typically, counsel for the franchisor and the franchisor’s associates will agree to a common

process, such as all parties proceeding to arbitration, in order to avoid a duplication of proceedings and to keep costs down. In those circumstances, a separate arbitration agreement should be prepared and signed by all parties with the benefit of counsels’ advice.

However, if the basis of the rescission claim relates to deficiencies in the Disclosure Document that are believed to be sufficient to warrant an order of rescission, are system wide, and where there have been a significant number of new Franchise Agreements signed within the preceding 2 years, from a tactical standpoint a franchisee may not want to proceed with arbitration and may be able to avoid doing so, even in the face of an arbitration provision in the franchise agreement.

There has been jurisprudence setting out under what circumstances an arbitration clause may not be enforceable. One such circumstance is where the claim being asserted is against a party to the agreement containing the arbitration and a third party, not a signatory to the agreement in issue.18 In those circumstances, an Action or Application may be brought, thereby placing the dispute concerning the rescission deficiencies in a public forum. Depending on the strength of the franchisee’s position, significant pressure will then be brought to bear on the Franchisor to settle the claim and hope that other Franchisees do not discover the same deficiencies for at least 2 years.

7.2 IF THERE IS NO ARBITRATION CLAUSE

If there is no arbitration clause, the issue to be determined is whether the matter should proceed by way of Application, commenced by Notice of Application or by way of Action, commenced by the issuance of a Statement of Claim.

The advantages of proceeding by way of an Application with supporting Affidavits, includes the fact that Applications are designed to be a summary process and accordingly, will often result in an earlier determination of the issues.

However, the Franchisee’s lawyer must make a careful assessment at the outset to determine whether there are material facts in dispute, because Applications are only proper where there are no contested facts, and there does not need to be a trial with live witnesses. He or she should also determine whether all of the contentious key evidence can be adduced from parties with direct knowledge. Often overlooked by counsel is the fact that Rule 39.01(5) of the Ontario Rules of Civil Procedure provides that an affidavit for use on an Application may contain statements of the deponent’s information and belief “with respect to facts that are not contentious”. Facts that are, therefore, contentious are not properly made in an affidavit in support of an Application. Often however, problems arising in this regard can be rectified by examining those third parties who have direct knowledge as witnesses on a pending Application pursuant to the provisions of Rule 39.03.

A far more serious and far reaching danger in bringing an Application arises if there are matters in dispute which a Court determines cannot be adjudicated in a summary proceeding. Should that occur, then instead of having the matter resolved quickly and expeditiously, the Franchisee/Applicant may be faced with an order directing that a trial of an issue or issues take place. Even a dispute as simple as whether the Disclosure Document was delivered as one document at one time, might result in the Court ordering the trial of an issue. While the Courts are often inclined to substitute, in whole or in part, the examinations and cross examinations for examinations for discovery, the resulting delay and

18 Frambordeaux Developments Inc v Romandale Farms Ltd [2007] OJ No 4917 (SCJ).

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increased costs may act to encourage the franchisee to accept a lesser amount immediately, rather than waiting and possibly recovering a larger award at a later time.

Accordingly, the franchisee’s lawyer must thoroughly analyze the nature and bases of the rescission claims prior to any proceedings being commenced. Where there are undisputed deficiencies in the Disclosure Document of a type which the Courts have previously held to be fatal (triggering a 2 year rescission right under subsection 6 (2) of the Act), the obvious choice would be to proceed by way of Application. The evidence in these cases is often document intensive and not contested, making them largely suitable for resolution by Application The same rationale might also apply even when the alleged deficiency or deficiencies are novel or have not been the subject of prior adjudication, as long as they can largely be determined on the face of the documents before the Court as opposed to viva voce testimony. Also, since most claims for relief in Applications include a reference to the Master to determine and quantify damages under subsection 6 (6) of the Wishart Act, another advantage (or disadvantage, depending on perspective) is that if the franchisee is unsuccessful, he or she will only be liable for a portion of the costs of a full trial since the issue of damages would, by definition, have been bifurcated to be addressed only if the franchisee was granted judgment. In effect, bifurcating the trial into a liability and a separate damages phase.

To summarize, there is no “one size fits all” answer to this issue. It is the job of the franchisee’s lawyer, with the benefit of their knowledge and experience, including their experience with opposing counsel,, to determine the best path to be taken.

8 CONCLUSION

Reviewing the disclosure document post-contractually and advising the franchisee about their rights of rescission and potential misrepresentation claims under the Wishart Act arising out of that review is becoming increasingly common. The monetary amounts involved in these claims can be substantial. This paper was written to provide some insights into the types of issues that franchise counsel ought to consider when providing franchisee clients with advice after things have gone wrong.

As with most areas of law, new cases dealing with the interpretation of rescission and misrepresentation claims are heard and decided constantly by the Ontario courts, and so it is also very important to be up to date with the direction that the jurisprudence is taking.

A careful review and gathering of the material facts, an analysis of whether there have been misrepresentations for which remedies are available under section 7, and reviewing whether there has been strict compliance with the material disclosure requirements under section 5 of the Wishart Act are all important aspects of that process.