Franchise Law: Three Important Appeal Decisions (Part III)

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This article, written by Ben Hanuka, originally appeared in the August 15, 2022, issue of The Lawyer’s Daily.

By: Ben Hanuka

This is the third 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*.

Lease and lease materials

As noted earlier, in Freshly Squeezed there was a failure to disclose the negotiated agreement to lease and the absence of a headlease. The court held that this obscured the franchisees’ degree of risk and, therefore, prevented the ability to make an informed investment decision. In particular, there was a failure to disclose the fact that the landlord could terminate the head lease without compensation if a decision was made to demolish or redevelop the franchisee’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.

Other deficiencies, pilot location

Another rescission ground in Freshly Squeezed was the nature of the location: it was the first non-mall location in the system. The court held that this constituted material fact. The franchisor was “test-driving” this new type of a location in its system and should have disclosed this fact.

The court noted 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 the franchisee to unknowingly invest in a business model with no track record of success.

Last but not least, personal liability for signing franchise disclosure document or any part of it

In 2483038 Ontario Inc. v. 2082100 Ontario Inc., the franchisor contested the trial judge’s imposition of personal liability for signing part of a disclosure document that contained representations on the basis that it did not amount to “direct involvement” in the sale, based on the statutory definition of a “franchisor’s associate” under the Act.

The Court of Appeal disagreed and characterized the franchisor’s argument as “unnatural,” as standing for the proposition that the representation itself had to be direct (as opposed to “direct involvement”). The court held that this argument sought to add the word “direct” to the word “representation,” yet it only existed in relation to “representation” (“direct representation”).

The Court of Appeal also relied on the trial judge’s finding that the statements which the officer and director signed in the disclosure document were “representations” for the purpose of granting, marketing, or offering to grant the franchise. In addition, the court relied on the fact that the officer and director testified that he intended to be personally liable with his signature. Based on these facts, it held that he was directly involved in the grant of the franchise and was thus a “franchisor’s associate.”

In 2619506 Ontario Inc. v. 2082100 Ontario Inc., the Court of Appeal upheld the application judge’s finding that the officer and director was a franchisor’s associate because he signed the certificate in the disclosure document (he undoubtedly also controlled the franchisor, so that was not in issue). As such, he was “directly involved in the grant of the franchise,” within the definition of “franchisor’s associate” under the Act.

The court held similarly with respect to the other individual defendant, who was the director of franchising. It rejected the franchisor’s argument that he was merely an employee. It upheld the finding that he was “controlled by another person who also controls directly or indirectly the franchisor,” that is the franchisor’s officer and director, and therefore fell within the first part of the definition for franchisor’s associate. Based on the evidence, it found that the individual also met the second part of the definition of direct involvement in the sale: by marketing on behalf of the franchisor and meeting with the franchisee to discuss its application.

Summary and takeaways

There was some uncertainty in the franchise bar after Raibex Canada Ltd. v. ASWR Franchising Corp., 2018 ONCA 62 in how that decision would be applied in future rescission cases in light of the earlier line of Mendoza-type cases (Mendoza v. Active Tire & Auto Inc., 2017 ONCA 471 **). The trio of Court of Appeal decisions has restricted Raibex’s application, particularly when it comes to fundamental disclosure deficiencies, such as franchisor’s certificate, financial disclosure and lease disclosure, all of which were recognized as fatal flaws in previous Mendoza-type line of authorities. A franchisee need not lead evidence to support rescission under those grounds.

Of equal importance, there are now clear grounds of imposing personal liability against officers and directors of a franchisor who sign either the certificate page or any other meaningful part of the disclosure document — that has not been legally recognized in the jurisprudence up until this point.

Somewhat difficult to reconcile is the Court of Appeal’s rationale about the importance of a franchisor’s office or director reading the document before signing it. It seems perhaps to open the door to arguments that, even signing the certificate may possibly not be enough where the officer and director had not reviewed the document in a while.

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

(* 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.)