Franchise Rescission Does Not Impact A Franchisor’s Right To The Business Assets

Introduction

A franchisor has a right to preserve the value of the franchised business, even in a rescission case.

The rescission obligation of a franchisor to repurchase the business assets from a franchisee under subsection 6(6) of the Arthur Wishart Act (Franchise Disclosure), 2000, does not impact a franchisor’s inherent right to preserve the value of the franchised business.

This analysis typically involves a mixture of rights under the Arthur Wishart Act, the Commercial Tenancies Act, and the Personal Property Security.

The Arthur Wishart Act Does Not Impact Rights to the Premises

The common law imposes a duty to mitigate damages.

Section 9 of the Arthur Wishart Act states that the rights under it are in addition to, and do not derogate from, any other right or remedy a franchisee or franchisor may have at law.  Here, the common law duty of mitigation is preserved.

This is not to say that a franchisee waives or releases any rescission rights.

Rather, Ontario franchise jurisprudence has confirmed that the right of rescission is inconsistent with a franchisee’s continuing possession of the franchised business.

A franchisor’s rescission obligation to repurchase the business assets from a franchisee under subsection 6(6) of the Arthur Wishart Act does not impact the inherent right of a franchisor to deal with the business assets in order to preserve the business.

The Arthur Wishart Act does not grant security rights to ‎a franchisee in the franchised business. Neither the wording in subsection 6(6) of the Arthur Wishart Act in requiring the purchase of assets, nor anything else in this statute gives a franchisee (i) a security interest in the assets, (ii) right to possession of the business, or (iii) right to hamper a franchisor’s ability to otherwise deal with the store assets.

Impact of the Commercial Tenancies Act

Where a franchisor is also a sub-landlord under the lease of the premises, its interest in the store assets is not limited to its status as franchisor.

A franchisee would typically choose to hand over possession of the store premises to the franchisor when pursuing rescission damages under the Arthur Wishart Act, particularly where ongoing operating losses are claimed.

Where a franchisee hands over possession of a franchised business to a franchisor, it does so in a manner recognized under the provisions of the Commercial Tenancies Act, as giving up possession of the premises.

As noted earlier under section 9 of the Arthur Wishart Act, nothing in that Act takes away a franchisor’s rights under theCommercial Tenancies Act to deal with the store assets.

As sub-landlord under the Commercial Tenancies Act, a franchisor has a right to deal with the store assets, including exercising a landlord’s distraint rights.

Impact of the Personal Property Security Act

Secured creditor rights – whether by the franchisee’s third party lender or even its principal – do not always impact the rights of the franchisor as sub-landlord.

With respect to the chattels of the store assets, the common law has recognized a landlord’s (or in this case, a sub-landlord’s) right to distrain chattels to the exclusion of secured creditors.

With respect to the fixtures of the store assets, section 34 of the Personal Property Security Act expressly recognizes a landlord’s interest as competing with that of a secured creditor.

Subsection 34(1)(a) of the Personal Property Security Act gives priority to a landlord over the rights of a secured party with respect to fixtures – where the fixtures were installed before the security interest was registered.

It is not always the case that a franchisor installs store fixtures before a security interest is registered.  For example, it is common for franchisors to require franchisees to first enter into a sublease, complete the entire purchase transaction and prepay for at least some of the construction costs, before store construction starts.  In this typical scenario, fixtures are normally installed after a security interest is registered by the third party lender or franchisee’s principal.  Here, the franchisor loses its priority rights to the fixtures as sub-landlord.

However, in those situations where a franchisor enters into a head lease with the head landlord and constructs the store beforeentering into a sublease with a franchisee, the store fixtures are installed as part of the franchisor’s construction of the premises; this inevitably means before the security interests of the franchisee’s creditors are registered.  Here, the franchisor maintains its priority rights to the fixtures as sub-landlord.

Summary

A franchisee’s rescission right under the Arthur Wishart Act – which is an absolute right where proper rescission grounds exist – does not take away from a franchisor’s right to preserve the value of the franchised business.

Subject to lease and security interest rights, the Arthur Wishart Act does not absolve a franchisee’s obligation to take reasonable commercial steps to cooperate in a franchisor’s attempts to preserve the value of the franchised business.  This includes an obligation to take reasonable steps and preserve the value of a franchised business as a going concern after delivering a notice of rescission.