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After getting off to a shaky start, the Ontario Court of Appeal seems to be finding its feet in the interpretation of franchisors’ disclosure obligations as mandated by the Arthur Wishart Act (Franchise Disclosure) 2000, S.O. 2000 c. 3, and its General Regulation.

In the case of Caffé Demetre Franchising Corp. v. 2249027 Ontario Inc., 2015 ONCA 258 (CanLII), Justice Gloria Epstein established some very helpful parameters for the interpretation of the definition of “material fact” under the Arthur Wishart Act and the test for the determination of issues by way of summary judgment.

The decision also reinforced the distinction between disclosure for content deficiencies in the disclosure document that would permit rescission within 60 days of following receipt of a disclosure document, and the level of deficiency in a disclosure document that would amount, effectively, to no disclosure, permitting a franchisee to rescind within two years following receipt of a disclosure document.

In May 2011, the franchisee acquired a Caffé Demetre franchise on Dufferin Street in Toronto. In July of that year, the parties executed a franchise agreement. On the same day as the franchise agreement was signed, the franchisor commenced an action against a former Caffé Demetre franchisee who was operating a competing business called Spin Dessert, some 7.5 km away from the franchisee’s location.

In 2012, the franchisor introduced a new upscale menu, which required the franchisee to perform upgrades estimated at $50,000. The franchisee did not perform any of the required work. Later that same year, the franchisor discovered underreporting of sales by the franchisee and commenced a series of default proceedings. The franchisee did not respond to any of the franchisor’s inquiries for information regarding the alleged underreporting.

In July 2013, the franchisee served a notice of rescission of the franchise agreement, changed the locks on the location, rebranded the operation, and continued under a different trade name, in competition with the franchisor. The franchisor commenced proceedings claiming termination of the franchise agreement and damages.

In its statement of defence, the franchisee claimed that the franchise agreement was validly terminated in reliance upon subsection 6(2) of the Act, on the basis that the franchisor was obliged to disclose but did not disclose:

  1. that the franchisor was involved in the Spin Dessert litigation;
  2. that the franchisor was contemplating implementing a policy prohibiting franchisees from taking a share of their employees’ tips;
  3. that the franchisor was contemplating altering the ice cream policy to make franchisee owner principles directly responsible for the production of ice cream; and
  4. that the Dufferin Street location would require $50,000 in renovations. The franchisor brought a motion for summary judgment seeking a declaration that the franchisee was not entitled to rescission.

The motions judge applied the test from Hryniak v. Mauldin, 2014 SCC 7 (CanLII), and held that he had the evidence required to fairly and justly adjudicate on the rescission issue in a timely, affordable and proportionate manner. The Court of Appeal agreed. Because the facts were essentially undisputed, there was no risk of inconsistent findings if the matter at issue were to proceed to trial. Finally, the Court of Appeal endorsed the trial judge’s finding that if the rescission claim were dismissed, the landscape for resolution would be fundamentally altered and the prospects for avoiding a lengthy trial would be greatly enhanced.

The motions judge summarily dismissed three of the four bases for rescission, and the Court of Appeal upheld these findings. With respect to the tip-out policy, he found that the issue arose 14 months after the disclosure document was discovered, was at least in part in response to proposed legislation that would also prohibit employers from taking a share of employee tips, and found that as a practical matter, the change in policy had had no impact on the franchisee’s profitability, since the franchisee had refused to abide by the policy.

With respect to the ice cream manufacturing policy, the facts revealed that the policy arose some 20 months following the delivery of the disclosure document and, once again, the franchisee had suffered no financial loss as a result of the policy, since he had refused to implement it. Accordingly, it did not amount to a disclosure deficiency.

With respect to the remodeling renovations, the policy was not announced until some 14 months after the delivery of the disclosure document. The franchisee had not undertaken any of the required repairs and therefore had not incurred any cost. Interestingly, the motions judge also reasoned that because the franchise agreement obliged the franchisee to conduct such repairs, that such a contingent liability would have been factored into the original purchase price of the franchise.

The really interesting part of the decision focused on the nondisclosure of the Spin Dessert litigation. Both the motions judge and the Court of Appeal agreed that the test for rescission under ss. 6(2) of the Act for failure to provide a disclosure document must be distinguished from the test under ss. 6(1) of the Act for rescissions where the contents of the disclosure document did not meet the requirements of the Act. The motions judge and the Court of Appeal cited 6792341 Canada Inc. v. Dollar It Limited, 2009 ONCA 385 (CanLII) for the proposition that “stark and material deficiencies” in a disclosure document are required for a court to find that the disclosure document amounts — effectively — to no disclosure, permitting a rescission under ss. 6(2) for a period of two years following signature of the franchise agreement.

However, the motions judge was of the view that the Spin Dessert litigation constituted a material fact and ought to have been disclosed. Notwithstanding this fact, he was of the view that such nondisclosure was a “content deficiency” that would give rise to rescission rights under s. 6(1) if identified within 60 days of signing the franchise agreement, but was not a “stark and material deficiency” such as to permit rescission under s. 6(2) of the Act within two years of signing the franchise agreement.

On this point, the Court of Appeal disagreed. The court commenced its analysis by stating that there was no specific provision of the Act or Regulation requiring disclosure of franchisor-initiated litigation. As such, disclosure would only be required if the litigation fell within the definition of a “material fact” in the sense of being “information about the business, operations, or control of the franchisor or franchisor’s associates, or about the franchise system, that would reasonably be expected to have a significant effect on the value or price of the franchise to be granted or the decision to acquire the franchise,” as contemplated by ss. 1(1) of the Act.

The court continued its analysis by stating that, although there was no specific requirement to disclose franchisor-initiated litigation, ss. 2(5) of the Regulation did identify specific categories of litigation that must be disclosed; namely, litigation against the franchisor or those associated with the franchisor based on claims of unfair or deceptive business practices, or violating a law that regulates franchises or businesses. In the court’s view, the type of litigation required to be disclosed pursuant to ss. 2(5) “does inform the fact-specific analysis of whether the litigation in issues material.”

The court reviewed the motion judge’s consideration of 2240802 Ontario Inc. v. Springdale Pizza, 2013 ONSC 7288 (CanLII), where the motions judge stated: “I accept that if a franchisor is involved in ongoing litigation, this should be disclosed to prospective franchisees.” The court then reviewed the motion judge’s summary of the instant facts when he stated, “the Spin Desserts lawsuit was a protective measure taken by the franchisor, at the request of and for the benefit of the franchisees. It did not constitute a potential liability that might attach to the franchise system as a whole. Given the distance between the competing outlet and the subject premises, there is no basis for inferring that it could have had any and economic impact on the [franchisee’s] operation, nor is there any evidence that it did so.”

The court stated that the decision of the Superior Court in Springdale Pizza does not stand for the proposition identified by the motions judge; i.e. that any litigation involving a franchisor amounts to material fact — no matter what the nature and circumstances of the litigation. Rather, the court stated that “ongoing or prospective litigation involving the franchisor is not, by definition, a material fact. … If the litigation in issue does not fall within [ss. 2(5) of the Regulation] then whether it is a material fact, as contemplated by the Act, will be a question of fact determined on a case-by-case basis.”

The court went on to state that given the protective nature of the litigation, the fact that it did not constitute a potential liability that might attach to the franchise system, and would not financially impact the Dufferin Street location of the franchisee, that the lawsuit did not constitute a material fact and hence its disclosure was not required. Moreover, stated the court, the failure to disclose or mention the Spin Dessert litigation did not effectively deprive the franchisee of the opportunity to make a properly informed decision to invest in the Caffé Dimitre franchise system.

The high-handed and callous behaviour of the franchisee in this case surely contributed to the court being able to analyze the legal issues without the hindrance of the usual judicial inclination to “help the little guy.” Such bad conduct by the franchisee also no doubt motivated the court to decide the issue by way of summary judgment.

In any event, the case provides considerable assistance to those who must weigh, on an item-by-item basis, whether a particular fact rises to the level of materiality. Although considerable danger still exists for franchisors and their counsel who omit to disclose facts, the implication of the Caffé Demetre decision is that helpful or positive facts will not be considered material, and therefore their omission will not be grounds for rescission. The result is a fairer and more level playing field, and that’s good for everyone involved in franchising.

This article was orginally published on AdvocateDaily.com

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