By: Alex Sinenko, Law Works
Editor: Ben Hanuka, Law Works
In 2611707 Ontario Inc., et al. v. Freshly Squeezed Franchise Juice Corporation, et al., a March 26, 2021, decision of the Ontario Superior Court of Justice, the court granted an application by the franchisee for rescission under subsection 6(2) of the Arthur Wishart Act (Franchise Disclosure), 2000, based on multiple material deficiencies in the franchisor’s disclosure document.
On January 8, 2018, the franchisee entered into a franchise agreement with the franchisor. The franchise began operations in March 2018. About six months later, the franchisee sought to rescind the franchise agreement, alleging the disclosure document that it had received from the franchisor had multiple fatal flaws.
The alleged deficiencies were as follows. The financial statements were missing notes referenced beside certain line items relating to such items as accounts receivable and customers’ deposits. The franchisor’s certificate did not contain the signature of the second officer listed in the franchisor’s corporate profile report at the time that the agreement was signed. The franchisor did not disclose the absence of a head lease and that it had negotiated an agreement to lease with the landlord. The franchisor delivered the disclosure document in piecemeal fashion. And the franchisor failed to disclose that this franchise location would be the first “non-mall” location.
Notes in the financial statements
The court held that the franchisor was required to disclose the financial statement notes that were attached to the original Review Engagement Report. This information, which was not included in the disclosure document, referred to significant amounts representing large portions of the company’s finances and were reflective of the business’ financial health. Therefore, omitting them was a fatal flaw.
The franchisor’s certificate
The franchisee claimed that the certificate had to be signed by the second officer listed on the franchisor’s corporate profile report at the time the parties signed the franchise agreement. The franchisor provided evidence that the second officer had resigned before the franchise agreement was signed, and his name appeared on the corporate profile register by error. Therefore, it argued that this person’s signature was not required. The court accepted this explanation and held that this was not a disclosure deficiency.
Agreement to lease
Although the franchisee knew that the unit was available to be built out and that a head lease had not yet been signed, the court held that the franchisor was required to disclose the partially signed agreement to lease that it had negotiated with the landlord.
In addition to containing the franchisee’s specific monetary obligations, such as basic rent, additional rent, common area expenses, etc., there were two provisions in the agreement to lease that the court found of particular concern. One, the agreement gave the landlord the right not to complete the construction of the food hall where the proposed kiosk was to be located, or any part of it, “for any reason whatsoever in its sole discretion.” Therefore, it permitted the landlord to unilaterally terminate the head lease.
Two, the agreement entitled the landlord to terminate the lease following three months’ notice without any compensation or contribution from the landlord if a decision was made to demolish, renovate or redevelop the food hall. The sublease that the franchisor provided in the disclosure document was a template which omitted these terms.
This was a material disclosure issue because the franchise agreement did not protect the franchisee had the lease agreement not been finalized. Since the franchisor knew that the lease agreement had not been finalized, it could have allowed the franchisee to back out of the franchise agreement and the sublease had the franchisee ultimately found the terms of the lease unacceptable. By not doing so, failing to disclose the agreement to lease was material.
The court found that the franchisor only relied on one disclosure document and therefore there was no piecemeal disclosure.
The first “non-mall” location
Although the disclosure document listed all addresses of all the current and terminated franchises, the court found that the franchisor was required to point out in the disclosure document that this store would be the first one to be in a non-mall setting. It reasoned that the lack of track record of such business in a non-mall setting could pose a risk to the financial viability of this franchise. This information was important to enable the prospective franchisee to make an informed investment decision.
Inability to make an informed investment decision
The court rejected the franchisor’s argument that the franchisee had to demonstrate that its ability to make an informed investment decision was actually impaired as a result of the disclosure deficiencies, as part of the franchisee’s rescission claim under section 6(2) of the Wishart Act. The court held that the legal test for determining whether alleged deficiencies meet the required rescission standard under subsection 6(2) is an objective one.
On the issue of the individual franchisee’s claim for personal loss of income, the court directed a reference to a master to determine the proper personal loss of income-based compensation under the ‘unpaid labour model’ that was set out by the franchisees’ expert witness.
The calculation under this model was based on the wages that the corporate franchisee would have paid to someone else for the work of the individual franchisee principal. The franchisee’s expert witness based his calculation on data from the 2016 Canadian Census published by Statistics Canada using the median annual salary for a manager in the food service and accommodation industry in Toronto, which was $53,000. He multiplied this annual salary by .83, which is the portion of the year that the individual franchisee operated the franchise for the sum of $43,395.
The court stressed that the franchisor withheld information that was within its power to disclose. This failure to act in a transparent manner deprived the franchisee of the opportunity to make an informed investment decision and amounted to non-delivery of an effective disclosure document within the meaning of subsection 6(2) of the Wishart Act.