Court of Appeal for Ontario Provides Important Clarification About Franchise Rescission Test

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Authors: Evan Ivkovic and Jeff Nguyen, Students-at-Law, Law Works P.C.
Editor: Ben Hanuka

The Court of Appeal for Ontario released an important franchise decision last week in the case of Mendoza v Active Tire & Auto Inc., 2017 ONCA 471, in which it clarified the legal test to apply in franchise rescission cases under the Arthur Wishart Act (Franchise Disclosure), 2000, SO 2000, c 3 (the “Act”).  ­

Active Tire & Auto Inc. o/a Active Green & Ross (“AGR”), the franchisor, entered into a franchise agreement with Mendoza for his purchase and operation of an Active Green & Ross franchised business in Toronto.  Shortly after buying the franchise, Mendoza brought a court action and a motion for summary judgment motion for a rescission of his purchase under subsection 6(2) of the Act, alleging deficiencies in AGR’s disclosure document.

The motion judge dismissed the motion for summary judgment and the entire case, holding that the disclosure deficiencies did not prevent Mendoza from making an informed decision about his purchase, and that therefore he was not entitled to a rescission of his purchase.

The Court of Appeal reversed the decision and granted summary judgment for rescission in favour of Mendoza based on the disclosure deficiencies in AGR’s disclosure document.  It held that the disclosure obligations are not conditional on the knowledge or conduct of a franchisee, and that the disclosure deficiencies in this case were significant.  As a result, it held that AGR had not provided a disclosure document within the meaning of the Act.

Critical Disclosure Document Deficiencies

The Court of Appeal focused its analysis on two key disclosure deficiencies: (i) AGR’s failure to include the signatures of two directors or officers in the important certificate of the franchisor, and (ii) AGR’s failure to include proper financial statements for its the most recent financial year.

• Franchisor’s Certificate

The franchisor’s certificate in AGR’s disclosure document was signed by only one officer or director.  AGR had more than one officer and director and the Regulation to the Act requires that in these circumstances at least two officers or directors must sign the certificate.  The Court of Appeal held that the certificate was invalid as a result.

The Court of Appeal provided the following key reasons:

• Whether Mendoza had extensive information about the background of AGR’s directors did not obviate the need for a proper franchisor’s certificate as required under the Act and Regulation.

• The certificate plays an important role as a liability mechanism under the Act: a director or officer who signs the franchisor’s certificate is personally liable for the franchisor’s disclosure obligations under subsections 7(1)(e) and 8(3) of the Act.

By only including a single signature when two were required, AGR limited Mendoza’s rights and ability to recover damages.  This alone was a significant ground to warrant rescission.

• Franchisor’s Financial Statements

AGR did not include in its disclosure document its most recent financial statements, prepared on at least a review engagement basis.  Under the Act, a franchisor is allowed a 180-day grace period from the end of its most recent fiscal year-end.

Mendoza retained the services of an accounting firm, as well as a legal and financial firm, to review the financial consequences of entering into the franchise agreement.  The Court of Appeal held that this made no difference and that non-compliance with this requirement in the Act and Regulation is fatal.

So-Called “Informed” Purchase

The Court of Appeal stressed that rescission is not conditional on any particular franchisee’s approach in reviewing a disclosure document, or his or her knowledge.  For example, in this case, Mendoza did not read the disclosure document but relied on his professionals to advise him.

The Court of Appeal noted that Mendoza was “not an inexperienced purchaser”, with business degrees and previous employment as an accountant for Canadian Tire.  He retained professional services to review the disclosure document and to provide financial projections.

Yet, it held that as franchisee’s sophistication or his or her ability to make an informed decision about entering into a franchise agreement does not diminish the franchisee’s rescission rights under the Act, or the franchisor’s disclosure responsibilities.  It held that a franchisee’s subjective understanding of the consequences of operating a franchised business is not relevant under the rescission regime.  Franchisors have the sole responsibility to make sure they deliver a disclosure document that fully complies with the Act.

And the Court of Appeal held that there was no necessary connection between disclosure deficiencies and the failure of a franchised business.  A franchisee’s rescission rights only depend on whether the franchisor delivered an adequate disclosure document.

Summary

In some ways, the Court of Appeal in this decision applied the existing law to the facts.  There is a wide body of jurisprudence in Ontario, both at the trial and appellate level, holding that improperly completed franchisor’s certificates and non-compliant financial statements are alone fatal, amounting to “no disclosure at all” and allowing rescission.

However, this decision is also the first Court of Appeal decision expressly holding that the test for a franchisor’s compliance with its disclosure obligations under the Act is objective; that the focus must be on the nature of the deficiency and its impact on the disclosure requirements on a reasonable (not subjective) standard.

 * Ben Hanuka of Law Works PC acted as counsel for Mendoza.

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