Court Grants Rescission where No Site-Specific Disclosure

Article Content

In the decision of Raibex Canada Ltd. v ASWR Franchising Corp., released on September 7, 2016, the Ontario Superior Court of Justice reiterated franchisors’ obligation to include in their disclosure documents material facts specific to the location of the franchised business.

Outline

The plaintiffs were franchisees in a franchise system called ‘AllStar Wings and Ribs’.  They brought an action for damages and a motion for partial summary judgment against the franchisor, ASWR Franchising Corp., and related parties based on disclosure failures under the Arthur Wishart Act (Franchise Disclosure), 2000.

As part of the franchise purchase, the plaintiffs bought a refurbished restaurant that was converted to a franchised restaurant.  The plaintiffs’ main allegations were focused on the failure of the franchisor to disclose site-specific information about the restaurant location – mainly material information about the head lease and an estimate of development costs of the refurbished restaurant.

In respect of the rescission claim, the franchisor took the position that it was unable to disclose the information because a location had not been identified at the time that it gave the disclosure document to the plaintiffs.

The key events were as follows:

October 2012: The franchisor provided its disclosure document to the plaintiffs.

November 2012: The plaintiffs signed franchise and related agreements and paid an initial franchise fee.

October 2013: The franchisor’s affiliate entered into the head lease.

November 2013: Work on conversion of the premises started.

March 2014: The plaintiffs started to operate the restaurant.

July 2014: The plaintiffs delivered a notice of rescission under the Act.

Madam Justice Matheson rendered the decision.  She had no difficulty concluding that the disclosure deficiencies amounted to material breaches of the franchisor’s disclosure obligations under the Act and that the plaintiffs were therefore entitled to rescission.

In addition to the site-specific franchise rescission analysis, Matheson J. also addressed in her decision the issue of who was required to sign the franchisor’s certificate, and in what capacity; as well, whether various affiliated parties, including a sales representative, were liable for rescission together with the franchisor, in their alleged capacity as the franchisor’s associates.

Failure to disclose head lease and related information

The disclosure document did not contain the head lease and any material information relating to the head lease.

Matheson J. cited an earlier decision of the Court of Appeal in Dollar It, where it held that a head lease was material and that any suggestion to the contrary was absurd.  She held that the terms of the lease were a critical component of the franchise disclosure.

She also rejected the franchisor’s assertion about having provided the disclosure document before a location was finalized.  Relying on another Superior Court decision, the court reiterated the key factors relevant to the analysis, which are: the rigorous disclosure requirements in the Act, the strict penalties for non-compliance, and the Act’s objective of protecting the interests of franchisees.  Relying on these factors, Matheson J. held that the franchisor provided the disclosure document at a premature stage and that its assertion would allow it to defeat the purpose of the Act by avoiding the rigorous disclosure requirements that it imposes on franchisors.

The court stated that, if allowed, the franchisor’s approach would be open to ‘substantial abuse’:

76  …A franchisor could simply give disclosure at a premature stage, when material matters were not yet known, encourage the signing of the franchise agreement at that stage, and avoid its statutory disclosure obligations

However, Matheson J. also left the door open for a franchisor to comply with this obligation before a head lease is signed by including in sublease material information about the head lease.  She stated that, if done properly, this method could meet the obligation on franchisors to provide adequate disclosure about material facts relating to the head lease.

Failure to disclose costs of establishing the franchise

A second significant disclosure failure related to the cost of setting up the franchised restaurant.

Section 6 of the Regulation to the Act requires that the franchisor disclose, among other things, any deposits, leases and any other costs associated with the setup of the franchised business.  In this case, the disclosure document failed to disclose the fact that the head lease required a substantial additional deposit.

Further, the restaurant in the case, as well as all existing franchised restaurant in the system, were also conversions.  The disclosure document did not provide setup costs relating to a conversion of a restaurant – it only provided the costs of setting up a restaurant from a shell.

Accentuating this significant disclosure failure was a statement in the disclosure document that a conversion could cost significantly less than the cost of building a restaurant from a shell, that those costs varied significantly from location to location, and that the franchisor had no reasonable means to estimate those costs.  The court noted that a broad disclaimed did not absolve the franchisor from its disclosure obligations.

The franchisor took the position that this issue was immaterial because the actual conversion cost of the restaurant came just under the high-end of the cost that the disclosure document set out, even though it related to the cost of building a restaurant from a shell location.  Matheson J. held that this was not an answer to the franchisor’s disclosure obligation because the conversion cost had to be set out in detail, similar to how the disclosure document set out the shell setup cost.

Franchisor’s certificate

Where the franchisor has two or more officers or directors, section 7 of the Regulation to the Act requires that at least two of them personally sign the franchisor’s certificate.

Matheson J. reiterated principles developed in earlier decisions about the purpose of the certificate, namely “to bring home to the directors the need to make disclosure as required by the [Act] and the Regulation”.  In addition, the court highlighted another important reason for the certificate, which is to enable franchisees to pursue a remedy against the directors who signed the certificate personally.

In citing the Dollar It Court of Appeal decision, Matheson J. stated that the mere absence of a signed and dated certificate was enough to permit the franchisee to rescind the franchise agreement.

The franchisor’s certificate in the disclosure document was signed by its sole officer and director, Athanasios (Tom) Anastopoulos.

However, a corporate profile report of the franchisor showed that at the relevant time, i.e., fall 2012, another individual, Stilianos Costidis, was a director.  The plaintiffs took the position that he was also required to sign the franchisor’s certificate, and that therefore the franchisor’s certificate was materially deficient.

The franchisor and Costidis took the position that he resigned as director years before 2012, even though he was listed as director in the franchisor’s corporate profile report.  The court found that the record showed ample evidence that Costidis had resigned years earlier, including requests to the company’s lawyer, all of which took place well before any involvement with the plaintiffs.

Since the Act does not define the meaning of “director”, Matheson J. applied the applicable sections under the Business Corporations Act (“BCA”).  Section 262(3) of the BCA creates a rebuttable presumption that a person whose name is listed in a corporate profile report is presumed to be a director at that time.  However, the court found that Costidis was not a director at the relevant time because of the evidence that he had in fact resigned years earlier.

The plaintiffs claimed that another individual, Perry Maisonneueve, a franchise consultant, was a de facto director.  The court found that there was no authority to find that a de facto director was required to sign the franchisor’s certificate.  Further, there was no evidence that Maisonneueve exercised control over the franchisor company.

Anastopoulos, the only individual who signed the certificate, did so on behalf of the corporation.  The plaintiffs alleged that since he did not sign the certificate in his personal capacity, the franchisor’s certificate was invalid.

Matheson J. held that an individual ought to sign the certificate in his or her personal capacity.  However, she did not find this issue of any consequence on the basis that Anastopoulos did not suggest that he was absolved of any personal responsibility simply because his signature appeared on behalf of the corporate franchisor.

Claims against other parties as franchisor’s associates

The plaintiffs also sought rescission claims against other parties – the franchisor’s affiliated leasing company, its trademark holder and its parent company, as well as the franchisor’s sales representative.  The plaintiffs claimed that each was a franchisor’s associate under the Act and therefore liable for rescission under subsection 6(6) of the Act.

In order to prove that a party was a franchisor’s associate, a plaintiff is required to show the following under the definition of a ‘franchisor’s associate’ in subsection 1(1) of the Act:

– first, the person or company controlled, or was controlled by, the franchisor (or that both were controlled by another party), and

– second, the person or company was either,

(i) directly involved in the grant of the franchise – by either (A) being involved in the review or approval of the franchise, or by (B) making representations to the prospective franchisees for the purpose of marketing or offering the franchise to them, or

(ii) (A) it exercised significant operational control over the franchisee, and (B) the franchisee owed to that person or company a continuing financial obligation in respect of the franchise.

– Claim against affiliate sublessor

The court found the leasing company which acted as the plaintiffs’ sublessor, fell within the definition of a franchisor’s associate.  It met the first part of the test because it was controlled by the franchisor.  It also met the second part of the test because it held the sublease (through which it exercised significant operational control); also, presumably rent payments flowed to it, although the court did not address this latter point.

– Claim against affiliate trademark holder

The court held that while each of the affiliate companies that owned the trademark and the shares in the franchisor satisfied the first part of the test, i.e., each controlled or was controlled by the franchisor, neither one was involved in making representation to the prospective franchisees.  As a result, none of these companies was a franchisor’s associate.

– Claim against sales representative

The plaintiffs sued Maisonneuve, the franchisor’s sales representative, under both subsections 6(6) and 7(1) of the Act.

The court found that he was extensively involved as the franchisor’s sole representative in dealing with the plaintiffs in respect of the franchise sale.

In addition, the plaintiffs paid the initial franchise fee of $30,000 to Maisonneuve’s company, Northern Lights Franchise Consultants Corp.

Maisonneuve formally became a director and the chief financial officer of the franchisor and the company that owned the shared in the franchisor in 2014, well after the pre-sale time in the fall of 2012.  He also signed and certified a franchise disclosure document for another prospective franchisee in early 2014, indicating that he was a director and officer of the franchisor as of that time.  In late 2013, he became a director of the company that owned the corporate flagship restaurant.

Matheson J. held that Maisonneuve met the second part of the test – that he was very involved in making representations to the plaintiffs on behalf of the franchisor for the purpose of marketing the franchise.  However, she was not satisfied that Maisonneuve controlled or was controlled by the franchisor.

The franchisor had an agreement with Maisonneuve’s company for sales and marketing services.  The franchise disclosure document described Northern Lights as “the Franchisor’s development group”.  And indeed the court noted that it was not necessary to prove that Maisonneuve was an officer or director of either the franchisor or a related entity.

However, she held that while there was some evidence of a close relationship, it did not amount to evidence that Maisonneuve or his company controlled the franchisor.  The plaintiffs did not advance evidence to prove that Maisonneuve or his firm controlled the franchisor in a manner that was beyond that of an independent contractor.  As a result, she held that Maisonneuve was not a franchisor’s associate at the relevant pre-sale period.

This finding did not relate to Maisonneuve’s potential liability under subsection 7(1)(b) and (c) of the Act.  Matheson J. expressly held that Maisonneuve remained potentially liable under those provisions.  The decision did not deal further with this issue, presumably because it was beyond the scope of the plaintiffs’ motion for partial summary judgment.

***