By: Mandana Niknejad, Law Works
Editor: Ben Hanuka, Law Works
In 2611707 Ontario Inc. v. Freshly Squeezed Franchise, a decision of the Court of Appeal for Ontario on June 3, 2022, the court dismissed an appeal by the franchisor, Freshly Squeezed, from the decision of the Ontario Superior Court of Justice, which granted rescission under subsection 6(2) of the Arthur Wishart Act (Franchise Disclosure), 2000, based on several material deficiencies in the disclosure document.
Freshly Squeezed delivered the Franchise Disclosure Document (the FDD) to the franchisee on December 18, 2017. The parties entered into a franchise agreement in January 2018 for the operation of a juice store in the RioCan food hall of Mount Sinai Hospital. After just over three months of operation, the franchisee served a notice of rescission on Freshly Squeezed, alleging material non-disclosure in the franchise agreement.
The application judge at first instance granted rescission based on three areas.
- First, the financial statements did not include explanatory notes.
- Second, the disclosure document failed to disclose that Freshly Squeezed had not yet entered into a head lease but had negotiated an agreement to lease, and the franchisee would be bound by the terms of the lease.
- Third, the disclosure document failed to disclose advise that the proposed location was the first non-mall location in the system.
The application judge held that Freshly Squeezed failed to disclose all material facts objectively necessary for the prospective franchisee to make an informed investment decision, and as a result, the franchisor failed to deliver a disclosure document within the meaning of s. 6(2) of the Act.
In its appeal, Freshly Squeezed argued that the application judge had erred in applying an objective test to the assessment of the disclosure deficiencies. It argued that that the test for assessing material deficiencies in a disclosure document had to be subjective, i.e., based on what the prospective franchisee knew.
Court of Appeal – Objective test in assessing disclosure deficiencies
The Court of Appeal held that the legal test for assessing disclosure deficiencies is an objective one – based on the contents of the disclosure document, not based on what the prospective franchisees read or knew.
In doing so, the Court of Appeal referred to its earlier decision in Mendoza v. Active Tire & Auto Inc., in which it held that the test for a rescission based on disclosure deficiencies was objective. In that case, the court held that a franchisor’s disclosure obligations do not change depending on the actions or reactions of a particular franchisee. As such, the legal test focuses on the disclosure document itself, not its recipient. One of the reasons for this rationale is that the Act seeks to ensure that the franchisor provides the same disclosure to every prospective franchisee.
As a result, the Court of Appeal held that the application judge did not err in granting rescission without evidence of actual impairment in the prospective franchisee’s ability to make an informed investment decision.
The three grounds of disclosure deficiencies
The Court of Appeal affirmed the application judge’s reasoning granting rescission on the basis of the three rescission grounds that the franchisee argued, as outlined above – failure to include notes to the financial statements, the negotiated lease and information about the location being the first non-mall location in the system.
With respect to the notes to the financial statements, the court held that they were necessary for a prospective franchisee to assess the health of the franchise financial system.
With respect to the failure to disclose the negotiated agreement to lease and the absence of a headlease, the court held that failing to do so obscured the respondents’ degree of risk and, therefore, prevented an informed investment. In particular, the disclosure document did not disclose that the landlord could terminate the head lease without compensation if a decision was made to demolish or redevelop the franchise’s location. Further, the franchise agreement did not permit the franchisee to back out of the lease should its terms be unacceptable to the franchisee. As a result, the disclosure document had to disclose these material facts, including the negotiated agreement to lease.
With respect to the location being the first non-mall location in the system, the court held that this constituted material fact because, in a sense, the franchisor was “test-driving” this new type of a location in its system and should have disclosed this fact.
Of importance, the court held that it did not matter that the prospective franchisee could have figured out this fact based on other information that it had at its disposal. This did not absolve the franchisor’s obligation to provide full disclosure under the Act in its disclosure document. Failure to do so caused 261 to unknowingly invest in a business model with no track record of success. There was no error in the decision of the application judge on this issue and its determination was also upheld.