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This article, written by Ben Hanuka, originally appears in the May 31, 2017, issue of The Lawyers Daily. Click here to view the full article.
By Ben Hanuka
The recent decision of the Ontario Superior Court of Justice in Raibex v. ASWR Franchising has made waves throughout the franchise community since its release in September 2016. The decision granted to the franchisee a rescission of its purchase of a franchised restaurant under Ontario’s franchise disclosure legislation, the Arthur Wishart Act (Franchise Disclosure), 2000 (the “Wishart Act”), on the basis that the franchise disclosure document (the “FDD”) was materially deficient.
There were several grounds for the finding that the FDD was materially deficient. The most notable was the lease-related ground and that is the aspect of the case that has caused controversy. The decision held that an FDD which does not contain a lease agreement for a specific location where the proposed franchised business is to be located is fatally deficient. This entitles the franchisee to a rescission
Strictly speaking, this is not new to franchise disclosure jurisprudence in Ontario. Rather, in so far as disclosure of a lease is concerned, the new element that the decision seems to introduce, and that is what appears to have taken so many by surprise, is the requirement that a franchisor have a location in place before it gives out an FDD to a prospective franchisee. The Raibex case held that a franchisor must have a location secured and a lease agreement for the location in the FDD; that without both, the FDD is fatally deficient.
Many in the franchising legal and industry communities are seemingly upset about this finding because it expressly requires franchisors to secure a location before finding a franchisee for that location. They prefer to do it the other way around, which is to first secure a franchisee and then look for a site. The issue appears to be controversial for obvious business reasons, because securing a location requires a significant financial commitment, which many franchisors do not want to incur before putting in place a franchisee for that would-be location.
But has Raibex really created a new legal obligation on this issue? Is this decision genuinely the first one in Ontario that requires a franchisor to have a location in place before handing out an FDD? Or is it merely the first decision to simply articulate this principle in express terms, based on established franchise disclosure principles that have developed in Ontario since the coming into force of the Wishart Act’s disclosure obligations in 2001?
There is reason to argue that the Raibex decision merely applied existing franchise disclosure principles. The governing principle of disclosure under the Wishart Act is that franchisees are entitled to full disclosure of all key documents and material facts, and that includes, as earlier decisions have held, whether implicitly or expressly, information about the location and the head lease.
It should be noted that while many small and mid-size franchisors seem to have difficulties with the requirement to locate a site before locating a franchisee, many large franchisors have for years already implemented the practice of securing a location and negotiating a head lease before giving out an FDD to a prospective franchisee.
Franchise disclosure jurisprudence in Ontario has long held that so-called “site-specific” disclosure of material facts was critical to an FDD because a prospective franchisee is entitled to all material information to make an informed decision.
For example, where a franchisee is required to sublease space from a franchisor or its affiliate, Ontario courts have held that the head lease and sublease must be disclosed in the FDD. The courts held that lease-related information, including the key financial and legal obligations relating to the location, must be disclosed. The Ontario Court of Appeal held in 2009 in a case called 6792341 Canada v. Dollar It that it was “absurd” to suggest a head lease was immaterial where the franchisee was bound to its terms. It should be noted that in that case a location had already been in place.
In a 2014 decision of the Ontario Superior Court of Justice, in 2337310 Ontario v. 2264145 Ontario, the franchisor signed a head lease with a landlord after giving an FDD to the franchisee. The franchisee signed the franchise agreement after that time, without having received the head lease or sublease. The court held that the franchisor had an obligation to provide a statement of material change or an updated disclosure document once it signed the head lease. It stated that the non-existence of the head lease at the time of disclosure was not an excuse since it would “create a potentially large lacuna in the disclosure system” by allowing a franchisor to “pare down its disclosure obligations”.
But in all those cases, a location was in place at the time that the franchisor gave an FDD to a franchisee. The franchisor in those cases did not disclose the necessary information about the location – most notably the head lease. Raibex is the first decision to confront head-on the issue of whether a site must be in place to begin with.
One could argue that it is sufficient to disclose the fact that there is no location and no head lease in place – that this is sufficient site-specific disclosure. Perhaps doing so discloses all material facts about a franchised business to allow a franchisee to make an informed decision. Or perhaps it cannot amount to proper disclosure because eventually a lease will be put in place, and so a prospective franchisee must receive the information to be able to make an informed decision. The Raibex case is headed for an appeal in the Court of Appeal and we will find out in which direction this path unfolds.
Ben Hanuka practices commercial and franchise litigation at Law Works Professional Corporation.
For more information about Law Works’ expertise and how we may be able to help you, please contact Ben Hanuka at email@example.com or by phone at (855) 978-5293.