Franchise Law: Three Important Appeal Decisions (Part II)

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This article, written by Ben Hanuka, originally appeared in the August 12, 2022, issue of The Lawyer’s Daily.

By: Ben Hanuka

This is the second of a three-part series on the Court of Appeal for Ontario’s recent 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. The three decisions are: 2619506 Ontario Inc. v. 2082100 Ontario Inc., 2021 ONCA 702;  2611707 Ontario Inc. v. Freshly Squeezed Franchise, 2022 ONCA 437; and 2483038 Ontario Inc. v. 2082100 Ontario Inc., 2022 ONCA 453*.

Franchisor’s certificate

In 2483038 Ontario Inc. v. 2082100 Ontario Inc., the franchisor’s officer and director did not sign the franchisor’s certificate, but rather another page in the disclosure document that contained representations about the franchise system. The trial judge held that the informed investment decision test did not apply to rescission cases that are based a deficient franchisor’s certificate. Instead, she held that the obligation to provide a signed certificate was a self-standing obligation on the franchisor to incentivize the signatories to ensure that the contents of the franchise disclosure document are accurate.

On appeal, the franchisor argued that the trial judge erred in not applying the informed investment decision test to the missing signature on the certificate; it argued that the failure to sign the certificate page, in light of the other signed page in the document, was not enough to hold that there was no disclosure and this entitlement to rescission.

In upholding the decision of the trial judge, the Court of Appeal held that Raibex Canada Ltd. v. ASWR Franchising Corp., 2018 ONCA 62 did not import the “informed investment decision” analysis into the analysis of a defective certificate in a disclosure document. It held that a franchisee does not require to show that it was unable to make an informed investment decision where a disclosure document contained a deficient certificate.

The double standard — subjective test in franchisor’s failure to review disclosure document. Is it really necessary?

Here comes the interesting, and some may say perhaps controversial, aspect of the reasons for judgment in 2483038 Ontario Inc. v. 2082100 Ontario Inc. (as noted below, the author acted as counsel for the franchisor in this decision). One of the Court of Appeal’s grounds for upholding rescission in this case based on the failure to sign the certificate, even though the franchisor’s officer and director signed another page, was evidence that the officer and director had not reviewed the contents of the disclosure document before signing the page that he did sign, although he testified that he intended to endorse the whole document.

For the Court of Appeal, this was a key reason why signing one part of the document, but not the certificate, was not good enough; that there was no evidence that the officer and director reviewed the whole document. It held that holding otherwise would undermine one of the purposes of the Act, which is to attach personal liability to the signatories to ensure the contents of the disclosure documents are accurate. It held that the attachment of personal liability to signatories of a disclosure document is a free-standing objective.

In a sense, the Court of Appeal applied elements of a subjective analysis to the franchisor’s certificate — ensuring that the franchisor’s officer and director read the entire document before signing it.

It is perhaps arguable that, in light of this case, it is now required to ensure that a franchisor’s officer and director carefully reviews the disclosure document before signing it, and that evidence is available to back it up.

One may ask why that is legally important at all. Sure, it is prudent, and it makes sense that an officer and director would and should read a disclosure document before certifying its contents. But that is a little removed from reality — officers and directors read the document, but not every day or every time signing this monster of a package. They rely on their legal counsel, executives and staff to ensure that the contents are accurate every time. If personal liability attaches to the signature, isn’t the relevant object of the Act met — imposing personal liability on the person signing the certificate?

Non-compliant financial statements

In Freshly Squeezed, as noted earlier, the financial statements were missing notes. The court held that the notes to the financial statements were necessary for a prospective franchisee to assess the health of the franchise financial system. Likewise, in 2619506 Ontario Inc. v. 2082100 Ontario Inc., the Court of Appeal agreed with the application judge that the franchisor’s failure to provide up-to-date, compliant, financial statements (it provided unaudited stale-dated financial statements) deprived the franchisee of the ability to make an informed investment decision.

Thus, the standard for compliance with financial statements is very high. By the same token, the threshold for rescission based on this failure is low.

Historic store sales

The court had more to say about financial statements. In 2619506 Ontario Inc. v. 2082100 Ontario Inc., the Court of Appeal also tackled the fact that the franchisor did not disclose historic sales for the location (this was a resale). For the court, the historical store sales were critical to the prospective franchisee’s ability to make an informed investment decision.

This decision thus likely implies a requirement on resales of franchise locations to include historic store sales in the disclosure document, or risk rescission.

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