Lender May Enforce Loan Against Franchisee, Despite Pending Rescission Claim

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Author: Peter Radulescu, Law Works P.C.
Editor: Ben Hanuka, Law Works P.C.

In Royal Bank of Canada v. Everest Group Inc., a decision of the Ontario Superior Court of Justice released on August 23, 2018, the Court held that RBC was entitled to a judgment on its loan against a franchisee, on a summary judgment motion, despite the franchisee’s rescission claim against the franchisor. The Court held that the bank was not obligated to defer its enforcement of repayment of the loan while the franchisee was pursuing its recession claim.

The key facts

Everest, the franchisee, borrowed money from RBC through several loans, including a Canada Small Business Loan, to finance its purchase and setup of a Paramount Fine Foods restaurant in Toronto’s Yorkdale Mall.

The loans were governed by RBC’s standard forms. Among other things, the loan agreements included various events of default provisions that permitted the bank to demand repayment of all loans upon a “material adverse change in the financial condition [or] operation of the borrower” or if Everest “ceased to carry on business”.

Although Everest spent more than $2.4 million on the franchised restaurant, including approximately $600,000 borrowed from RBC, the restaurant never made any meaningful profits.  After operating it for about a year, Everest delivered to Paramount, the franchisor, a notice of rescission under section 6(2) of the Arthur Wishart Act (Franchise Disclosure), 2000.  Shortly after that, Paramount took back the restaurant.  Everest advised RBC that it had exercised its right to rescind the franchise agreement and that it was claiming $5.6 million from Paramount.

RBC promptly made a written demand for the repayment of its loans.  Everest offered to continue making payments to RBC while it pursued its claim against Paramount. RBC refused and sued on the loans.

The key arguments

Everest made a novel argument that its rescission claim and loss of possession of the franchised restaurant did not constitute an event of default under its loan agreements with RBC. It alleged that its rescission claim was not an adverse change in the condition of the franchised business, but rather a meaningful material improvement in its financial and operational condition.

Everest also took the position that the “cease to carry on business” clause in the loan agreements should be interpreted very strictly.  It claimed that, based on the surrounding circumstances of the loan agreements at the time of their formation, and the fact that RBC is a sophisticated lender that was likely aware about the Arthur Wishart Act, the “cease to carry on business” clause should not be interpreted to have the effect of penalizing a franchisee and preventing it from exercising its statutory rights to rescission.  In effect, Everest argued that rescission was part of its continued operation of the business.

The decision

The Court granted RBC’s motion for summary judgment for the debt owed under the loan agreements, and, although it was impressed by the “audacity and originality” of Everest’s arguments, it awarded to RBC costs on a full indemnity basis, a rarely high scale in awarding costs.

The Court held that there was no basis for reading into the standard terms a provision that would require RBC to forebear its ability to exercise its rights. Also, the Court held that it was contrary to common sense for a borrower like the franchisee to expect that its lender should forebear enforcing its security while the franchisee was pursuing its rescission claim against the franchisor, particularly since that rescission claim remains undetermined.

Implications

This decision shows that creditors of a franchisee, such as banks, equipment lessors, landlords (where the franchisee is the tenant or the indemnifier), and suppliers, are not legally obligated to delay enforcement of their loans while a franchisee pursues its rescission claim against a franchisor.

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