Another Ontario Case Shows the Need for Franchisors to Provide a Record of Disclosure

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Author: Evan Ivkovic, Student-at-Law, Law Works P.C.
Editorial Committee: Law Works P.C.
Editor: Ben Hanuka

The decision of the Ontario Superior Court of Justice in 2122994 Ontario Inc. v Lettieri 2016 ONSC 6209 once again puts to the forefront the importance for franchisors to comply with their disclosure obligations under the Arthur Wishart Act (“AWA”).

Because of critical deficiencies with disclosure, Justice Penny determined that the franchisor made no disclosure at all, triggering s. 6(2) of the AWA, which allowed the franchisees to rescind the franchise agreement and obtain close to $300,000 in damages.

The case highlights the need for franchisors to include full disclosure in a single document with clear documentation of the transaction.

Background

Raisa Baila and Jim Papadopoulos, who were in a common-law relationship in 2006, worked as business associates in the running of a café franchise. Lettieri Bars Ltd. was the franchisor and John Lettieri was its president. Lettieri provided a disclosure document to Papadopoulos. Baila signed the franchise agreement on behalf of 2122994 Ontario Inc. (“212”). Baila was the sole officer and director of the company.

The café was unsuccessful. There was also a breakdown in the business and personal relationship between Baila and Papadopoulos. Baila and 212 proceeded with an action for rescission and damages, naming Lettieri, Lettieri Bars Ltd., and Papadopoulos as defendants. Shortly before the trial took place Baila and 212 settled with Papadopoulos.

The material deficiencies of disclosure amounted to no disclosure

Penny J identified three main problems with the franchisor’s disclosure: issues with the financial statements, the lack of a signed certificate and the absence of a head lease. The material deficiencies were not cured. Penny J did not comment on whether material deficiencies of this kind might have been cured in other circumstances. Because of inadequate disclosure, Penny J also chose not to comment on whether disclosure to Papadopoulos, as opposed to Baila or 212, counted as disclosure to the prospective franchisee.

With respect to the financial statements, Penny J found no evidence that the 2005 financial statements were clipped to the back of the document. Either way, the franchisor was required to include statements from the most recent financial year, which was 2006. Penny J clarified that even if the franchisor did not have 2006 financials, it was required to wait until the 2006 financials became available to bind the franchisee to the agreement.

Also, Penny J concluded that Lettieri, a franchisor’s associate, did not include a signed certificate with the disclosure document. He refused to accept Lettieri’s allegation that Baila and 212 tampered with the evidence. Penny J did not give any weight to Lettieri’s testimony that his lawyer lost the signed certificate.

Penny J raised similar evidentiary problems about the head lease. The head lease was not included in the disclosure document. Penny J did not accept Lettier’s testimony that the offer to lease was available and included all material terms of the lease. The offer to lease was not in the disclosure document, nor was it proved at trial.

Receipt of disclosure is not proof of adequate disclosure

Paragraph 18.19 of the franchise agreement stated that the franchisee acknowledges timely receipt of disclosure, but Penny J did not think this clause was a bar to the relief sought by Baila and 212. Penny J recognized the evidentiary value of clauses like paragraph 18.19. Still, he emphasized the purpose of the AWA as consumer protection legislation, stating that clever drafting would seriously undermine this purpose. He also noted that s. 11 of the AWA, which does not allow franchisees to waive their rights under the AWA, was designed to address contractual provisions like paragraph 18.19.

Lettieri was not misled in its dealings with Baila and 212

Penny J did not think that Baila and 212 breached their duty of good faith. There was no evidence of impropriety. There was a private trust agreement between Baila and Papadopoulos and the franchise agreement did not name Papadopoulos. But the trust agreement was prepared because of Papadopoulos’ poor credit rating. Lettieri knew that Baila and Papadopoulos were in fact business associates. He did not show evidence that the trust agreement prejudiced him.

Franchisors liable for leasehold improvements but not rent paid to arm’s-length landlord

Penny J stated that Lettieri Bars Ltd. and Lettieri were not liable for rent money that Baila and 212 paid for the café premises. Under a successful rescission, s. 6(6)(a) of the AWA requires a franchisor or franchisor’s associate to refund money it received from a franchisee. Yet, Baila paid rent directly to the landlord, which was at arm’s-length from Lettieri Bars Ltd. and Lettieri. Penny J said that based on the language of s. 6(6)(a) of the AWA, a franchisor or franchisor’s associate could not “refund” money that it had not received. Still, Penny J said that s. 6(6)(a) of the AWA applied to leasehold improvements.

Summary

This case shows how important it is for franchisors to meet their disclosure obligations. Also, to claim damages for breach of good faith, a franchisee must show that he or she was deliberately misled and prejudiced. Lastly, franchisors may be liable for reasonable leasehold improvements.

For more information about Law Works’ expertise and how we may be able to help you, please contact Ben Hanuka at https://www.lawworks.ca/book-a-consultation or by phone at (855) 978-5293.

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