Ontario Court of Appeal Clarifies What Amounts to “No Disclosure” in Franchise Sales (Part I)

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By Ben Hanuka 

This article, written by Ben Hanuka, was originally published by The Lawyer’s Daily on January 31, 2018. Click here to view the published article. https://www.thelawyersdaily.ca/articles/5796/raibex-decision-ontario-court-of-appeal-clarifies-no-disclosure-  

In an important decision released on January 25, 2018, followed closely by the franchise Bar, the Court of Appeal for Ontario reversed a controversial decision of a Toronto Superior Court motion judge in Raibex Canada Ltd. v. ASWR Franchising Corp. in favour of the franchisor which operates the AllStar Wings & Ribs franchise.   

The court held that the franchise disclosure document (“FDD”) did not contain significant enough disclosure deficiencies which, individually or collectively, would amount to no disclosure at all – that the deficiencies were not “tantamount to a complete lack of disclosure”. 

As a result, it held that the franchisee was not entitled to rescission under subsection 6(2) of Ontario’s franchise legislation, the Arthur Wishart Act (Franchise Disclosure), 2000.  Subsection 6(2) of the Act (and its equivalent in the other provincial franchise statutes) allows a franchisee to rescind a franchise agreement within two years of entering into the agreement if the franchisor has never provided an FDD, or if the FDD is so deficient as to amount to no disclosure under the statute. 

For the many practitioners who were concerned about not having a site in place at the time of a franchise sale, and therefore not having a head lease and accurate construction costs, the Court of Appeal held that not disclosing this site-specific information does not amount to a significant disclosure deficiency: where the parties agree from the outset that a site is to be located by both parties working together, or as the court put it, “collaboratively”, and where the franchisee has a contractual right to get out of the deal before a lease is finalized. 

About construction costs, not disclosing accurate estimates for the cost of converting space, where a franchisor discloses its standard costs of building a restaurant from a ‘shell’ and the significant risks of conversion, does not void an FDD. 

Key facts 

The FDD in this case did not specify a location and did not include a draft head lease.  It cautioned franchisees that the cost of converting a location to a franchised outlet was highly site specific, and that significant cost overruns could occur. It also recommended that the franchisee maintain a “significant contingency fund”.   

The franchise agreement indicated that the outlet would be in Mississauga and required the parties to use their “reasonable best efforts” to find a location acceptable to ASWR.   If ASWR failed to negotiate a lease within 120 days, Raibex, the franchisee, could terminate and receive a refund of all amounts paid, less any costs and expenses. 

Working together, Raibex and ASWR agreed on a location in Mississauga for conversion. The head lease required an initial deposit of $120,000.  Shortly before completion, the franchisee was informed about the costs, which fell within the costs estimate range in the FDD, albeit for building from a shell.  The franchisee refused to pay the required lease deposit and balance of the construction costs and sued for rescission.  Both parties brought a motion for summary judgment. 

Absence of head lease had little impact on purchase decision  

Referencing the court’s earlier decisions, Madam Justice Epstein, writing for the court, held that disclosure deficiencies justify rescission under subsection 6(2) of the Act if the franchisee has been ‘effectively deprived … of the opportunity to make an informed [investment] decision.’  She emphasized that the purpose of the franchisor’s disclosure obligations under the Act is to ensure that franchisees “can make a properly informed decision on whether to invest in the franchise.”   

This focus on the ability to make an informed decision seems to provide a workable framework for applying the meaning of “tantamount to complete lack of disclosure”, which appears to be the test for a rescission under subsection 6(2). (This legal test is not to be confused with the Mendoza line of cases which deal with recognized major deficiency grounds under subsection 6(2), such as financial statements, projections, certificate, etc.) 

Epstein J.A. also consolidated the various descriptions in the jurisprudence of a complete disclosure failure: “materially deficient”, “serious non-compliance”, “fundamentally inadequate and deficient disclosure”, and “stark and material deficiencies”.  She wrote that whatever terminology is used, the degree of deficiency must be measured against the objective of the statute and the disclosure obligation. 

Here, the parties both knew all key facts – that there was no location, that they were to work collaboratively, and that the franchisee’s legitimate interests had to be considered before finalizing the site.  Also, the franchisee had a right to reject a proposed site and get its money back.  It chose to go ahead with the site.   

These safeguards answered Raibex’s complaint that failure to disclose the head lease justified rescission. The absence of information about the head lease had little impact on its ability to make an informed decision.   

It is unclear what would happen if the franchisee had no say and no role in the site selection process and lease agreement negotiations. 

Conversion risks disclosed in FDD 

The FDD disclosed the significant potential risks of buying a conversion-type outlet. Previous conversion costs were not needed because their wide variance would not have significantly improved Raibex’s ability to make an informed decision.  And the cost of building an outlet from a shell was a useful reference point for Raibex. 

Part II of this article will be posted next week. 

* The assistance of Anthony Pugh, student-at-law, is appreciated.  

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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 in Ontario at (855) 978-5293 and in British Columbia at (604) 262-1711.