Franchise Law: Three Important Appeal Decisions (Part I)

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This article, written by Ben Hanuka, originally appeared in the August 11, 2022, issue of The Lawyer’s Daily.

By: Ben Hanuka

Between October 2021 and June 2022, the Court of Appeal for Ontario released a trio of franchise rescission decisions, all upholding rescissions granted by the Superior Court of Justice under section 6(2) of Ontario’s franchise legislation, the Arthur Wishart Act (Franchise Disclosure), 2000, on the basis that the legal test for rescission under s. 6(2) is an objective one: franchisees are not required to show evidence that they were deprived of the ability to make an informed investment decision on how disclosure failures impacted them — i.e., an objective test, not a subjective test.

The first, 2619506 Ontario Inc. v. 2082100 Ontario Inc., 2021 ONCA 702, released on Oct. 12, 2021, upheld rescission based on defective financial statements.

The second, 2611707 Ontario Inc. v. Freshly Squeezed Franchise, 2022 ONCA 437, released on June 3, 2022, upheld rescission based on defective financial statements, as well as disclosure failures about the lease and the novelty of the franchise location.

The third, 2483038 Ontario Inc. v. 2082100 Ontario Inc., 2022 ONCA 453*, released on June 9, 2022, upheld rescission based on failure to provide a signed franchisor’s certificate.

These issues are worthy of a discussion but most striking is another element of two of these decisions which imposed personal liability against the franchisor’s officer and director solely on the basis that he signed part of the disclosure document — in one case, he signed the franchisor’s certificate, and in the other case, he signed another part of the disclosure document, and was thus the “franchisor’s associate” under the Act.

In the first, 2619506 Ontario Inc. v. 2082100 Ontario Inc., two individuals were found to be personally liable as franchisor’s associates: first, the director of franchising, who was involved in the sale but was at arm’s length from the shareholder of the franchisor; second, and this is the one worth a close look, the franchisor’s officer and director solely because he signed the disclosure document — and was thereby deemed directly involved in the review and approval of the sale, and thus a franchisor’s associate.

In the third, 2483038 Ontario Inc. v. 2082100 Ontario Inc., the franchisor’s officer and director was found liable on the basis that he signed a section of the disclosure document that contained representations about the franchise system (not the certificate), therefore making him directly involved in the marketing of the franchise.

Background: Perceived tension between Mendoza and Raibex

These trio of decisions build on the Court of Appeal’s 2017 decision in Mendoza v. Active Tire & Auto Inc., 2017 ONCA 471 ** which had already then confirmed that the rescission test under s. 6(2) of the Act was an objective one. However, that decision did not deal with personal liability issues.

A year later, in 2018, the Court of Appeal released its decision in Raibex Canada Ltd. v. ASWR Franchising Corp., 2018 ONCA 62, where it held that the informed investment decision analysis applies in all disclosure cases. The court ruled that the legal test for assessing whether facts omitted from the disclosure document were so fundamental as to render the disclosure document void centres around the inability to make an informed investment decision: the legal test for assessing whether the failure to disclose those facts entitled the franchisee to a rescission was whether that failure effectively deprived the prospective franchisee from the ability to make an informed investment decision.

This implied to many that perhaps the earlier lines of cases culminating in Mendoza no longer applied; that the informed investment decision legal test that the Court of Appeal imposed in Raibex had now opened the door to requiring evidence from franchisees about how the disclosure deficiencies impaired their ability to make an informed investment decision. One of the questions for franchise lawyers was how to reconcile the decisions in Mendoza and Raibex; whether so-called fundamental disclosure failures resulted in rescission on a strict basis, i.e., on an objective standard, or whether it now required proof of the inability to make an informed investment decision.

The trio of decisions

Not so, it turns out.

The Court of Appeal in its recent trio of decisions would have none of that. For the court, these disclosure failures were fundamental and resulted in open and shut cases of rescission. No informed investment decision test applies.

Of similar fate were the issues of personal liability. For the Court of Appeal of Ontario, the individual signing the disclosure document, or any noteworthy part of the document, is deemed directly involved in either the approval/review, or the marketing, of the franchise sale, and is thus personally liable.

The objective legal test

In 2611707 Ontario Inc. v. Freshly Squeezed Franchise, the disclosure document did not include the notes to the franchisor’s financial statements. Further, it failed to disclose the fact that there was no head lease but that there was a negotiated agreement to lease. Unlike in Raibex, the franchise agreement did not permit the franchisee to back out of the lease, which made it binding and highly material. At first instance, the application judge granted rescission on the basis of a so-called strong presumption that certain disclosure deficiencies made it impossible for a prospective franchisee to make an informed investment decision.

On appeal, the franchisor argued that Raibex required the application judge to conduct a detailed analysis of whether the prospective franchisee was unable to make an informed investment decision. In dismissing the franchisor’s appeal, the Court of Appeal relied on its earlier decision in Mendoza and 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. As such, the franchisee was not required to show evidence of actual inability to make an informed investment decision as a result of the deficiencies.

An interesting policy rationale that the Court of Appeal expressed, in addition to the usual one of redressing the power imbalance between franchisors and franchisees, was the need to ensure that the franchisor provides the same disclosure document to every prospective franchisee.

This is the first of a three-part series. Read the second article: Franchise law: Three important appeal decisions (Part II); the third: Franchise law: Three important appeal decisions (Part III).

(* The author acted as counsel for the franchisor parties both at trial and on appeal.)
(** The author acted as counsel for the franchisee parties both at trial and on appeal.)