Executive Summary and Client Advisory
This case, decided late in the late Fall of 2016 and currently under appeal, is potentially highly problematic to franchisors who sign franchise agreements with prospects before a site has been selected.
In essence, the trial judge found that doing so is not in compliance with the Ontario’s franchise disclosure law, because the disclosure document provided does not contain all material facts relative to the franchise being sold.
Based on the logic of this judge, in order to comply with Ontario’s law, a franchisor who signs a franchise agreement with a prospect prior to having concluded a headlease (and potentially other material contracts) for a location must terminate the signed franchise agreement, return any monies received, then re-disclose to the prospect once all of those documents are received. Following redisclosure, the franchisor must then redo the process: sign a new franchise agreement, and collect the franchise fee once again.
Alternatively, disclosure using a “generic” (i.e. non-site-specific) form of disclosure document could be made, and a statement of material change containing the headlease and any other material facts relative to the specific location would then be provided. This procedure would not require an additional 14 day cooling off period.
Any franchisor utilizing this procedure should make any offer to lease signed with a landlord conditional on execution of a franchise agreement by the prospect within, say a week or two of the date of the offer to lease.
Given the increasingly burdensome case law interpreting provincial franchise disclosure laws, including technical requirements, availability of disclosure exemptions, and site-specific disclosure obligations, we urge our clients to contact us should any doubt arise as to the adequacy of the disclosure made 20 prospect.
In Raibex Canada Ltd. v ASWR Franchising Corp., 2016 ONSC 5575, the franchisor complied completely with its disclosure obligations under Ontario’s franchise disclosure act. There was no argument that the disclosure document provided to the franchisee was non-compliant in all respects at the time it was provided.
The franchisor then waited 14 days before collecting monies and signing a franchise agreement that contained a site selection agreement. However, at the time of signing the franchise agreement, no site had been selected, and no headlease for a restaurant had been entered into. Accordingly, although the franchisee received the franchisor’s standard form of sublease, it did not obtain a copy of the headlease until sometime later, when lease negotiations were entered into, in which the franchisee participated.
After a few months of operating its location, the franchisee claimed for rescission and brought a summary judgment motion. The franchisee’s claim for rescission was based on a number of alleged deficiencies in the franchisor’s disclosure document, including a failure to include a copy of the headlease, a failure to disclose adequate estimates for the development costs of the franchise, deficiencies in the disclosure certificate, which was signed by the sole officer and director of the franchisor, and a failure to deliver the disclosure document as one document at one time.
The trial judge found that the franchisee was entitled to rescind the franchise agreement both because the disclosure document did not include a copy of the headlease for the location, and because there was insufficient disclosure with respect to the estimated development costs of the restaurant.
The trial judge acknowledged that the practice of selecting a location after signing a franchise agreement “may not be unusual”, but nonetheless found that it gave rise to a material deficiency in the disclosure provided. She based her finding on what she described as the potential for franchisors to abuse prospective franchisees by disclosing “prematurely” and thus avoid the requirement to disclose material facts which are not yet known. However, the judge found no evidence of any such “abuse” by the franchisor in this case.
The judge gave little or no weight to the fact that the franchisee in this case was given an option to decline the location in question and receive his deposit back, or continue to look for a different location. The franchisee opted to accept the location.
The judge also found that the development cost estimate provided to the franchisee was materially deficient, and itself formed the basis for a valid rescission claim. Although the actual development cost was in line with the pro forma development cost contained in the disclosure document, the development cost in the disclosure document related to construction from a “shell” structure, as opposed to the conversion of an existing location, which this franchisee developed.
The judge once again stated that disclosure ought to have followed a determination that the development would be made relative to an existing structure, rather than from a shell. The disclosure document in question did contain broad disclaimers concerning cost estimates. The judge, however, stated that disclaimers do not excuse a franchisor from its mandatory disclosure obligations and furthermore, may themselves amount to an admission that the franchisor could not meet its statutory disclosure obligations.
The franchisor’s suggestion that one of the plaintiffs was a sophisticated purchaser with legal experience (he was a lawyer) was also rejected. The court stated that the sophistication of a franchisee does not reduce the disclosure obligations of the franchisor.
The franchisee also sought to attack the sufficiency of the certificate forming part of the disclosure document. The bases for attack were that other directors ought to have signed, and that the individual signing had signed on behalf of the Corporation, and not in his personal capacity. The court rejected these arguments. One director was found to have remained on the public record despite having resigned prior to the time of disclosure. The second director did not become a director until after disclosure was made. With respect to the manner of signing, the court found that a format requiring a director to sign in his personal capacity was not mandated by the Act. The franchisor also succeeded in defeating the franchisee’s attempts to include other corporate affiliates as franchisor’s associates. One of the affiliates entered into head leases and sub leased to franchisees. The other affiliates were controlled by the sole director of the franchisor, but not had no direct relationship with franchisees. The court refused to find that such entities constituted franchisor’s Associates.