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Author: Anthony Pugh, Student-at-Law, Law Works P.C.
Editor: Ben Hanuka
In franchise resales, i.e., transferring a franchised business by a franchisee seller to a prospective franchisee buyer, there is not necessarily the same power imbalance as there usually is between franchisors and franchisees. For this and other reasons, the legislature has given franchisors a conditional exemption from their usual disclosure obligations under subsection 5(7)(a)(iv) of the Arthur Wishart Act (Franchise Disclosure), 2000 (‘Act’) in cases of resales.
Under this exemption, if the grant of the franchise, i.e., the resale, is not ‘effected’ by or through the franchisor, then the franchisor is exempt from its disclosure obligations – it does not need to provide a franchise disclosure document to the franchisee buyer.
Subsection 5(8) states that a grant is not ‘effected’ by the franchisor if it simply exercises a ‘right’ to approve or disapprove the grant and charge a transfer fee.
What does it mean for a franchisor to ‘effect’ the transfer of a franchise? Only a few Ontario cases have substantively considered the meaning of this provision.
There are two main circumstances when a court may find that a franchisor has ‘effected’ the transfer. The first is when a franchisor requires the prospective franchisee to agree to additional conditions that were not contemplated in its franchise agreement with the franchisee seller – including in the franchise agreement’s transfer provisions.
The second is when the franchisor participates actively in negotiations between the seller and buyer about the resale.
Courts have interpreted the resale exemption narrowly, given the Act’s purpose as protective legislation for franchisees. The focus is on the role of the franchisor during the resale.
‘Right’ versus ‘power’
In 1518628 Ontario Inc. v. Tutor Time Learning Centres, LLC, the franchisee, 1518629 Ontario Inc. (the buyer) bought a Tutor Time Learning Centres franchise in Burlington through a share purchase with 1557935 Ontario Inc. (the seller), the previous franchisee. For the transfer to happen, the seller had to get the consent of the franchisor.
After discovering that the buyer had a single shareholder, the franchisor requested that the buyer’s principals’ husband sign a Personal Guaranty and Subordination and Nondisclosure commitments as a condition of the transfer.
The franchisor typically required spousal guarantees in similar circumstances. However, this requirement was not listed as a condition for consent to transfer in its franchise agreement, or anywhere else in the franchise agreement with the seller.
The franchisor argued that it had ‘a right’ to determine whether it would consent to the grant. Cumming J., for the Ontario Superior Court of Justice (Commercial List), disagreed by differentiating between ‘right’ and ‘power’.
In the judge’s view, a ‘right’ meant an express contractual right in the franchise agreement between franchisor and the selling franchisee. ‘Power’, on the other hand, refers to the franchisor’s ability to refuse consent on any basis it wished. If the franchisor exercises a ‘power’ that is not a ‘right’, then the franchisor is ‘effecting’ the transfer.
Franchisor imposes additional conditions
The franchise agreement in Tutor Time gave the franchisor the right to ask for the personal guarantee of the sole shareholder and officer of 151. It did not give the franchisor the right to ask for her spouse’s guarantee. For this reason, Cumming J. found that the franchisor had ‘effected’ the transfer.
In another case, 2189205 Ontario Inc. v. Springdale Pizza Depot Ltd., the respondent franchisee purchased the assets of a pizza business from a previous franchisee in Milton. Springdale Pizza required the franchisee to sign two documents that had not been required of the sellers for its consent to the transfer.
The first document was an undertaking for car wrapping on any delivery vehicles, which also provided that a breach of the undertaking was considered a breach of the franchise agreement. The second was an acknowledgement, providing that the franchisees did not rely on Springdale Pizza in confirming, substantiating or reporting the sales figures of the business.
Karakatsanis J. of the Ontario Superior Court (as she then was) held that these conditions, taken individually, did not necessarily mean that the franchisor ‘effected’ the resale. However, the conditions taken together, along with Springdale Pizza’s active participation in negotiations, supported the conclusion that the franchisor ‘brought about’ the resale.
Franchisor’s active participation
Springdale Pizza also took an active role in the negotiations between the selling and buying franchisees. The franchisor directed the franchisees to the particular business and all parties negotiated together in the sale and for the buyers to become franchisees.
Furthermore, the agreement of purchase and sale required the selling franchisees to obtain the consent of Springdale Pizza, thus requiring them to deal directly with the franchisor.
In Brister v. 2145128 Ontario Inc., 2014 ONSC 6714, the prospective franchisee, Brister, entered into an Asset Purchase Agreement with the vending franchisee for a dry-cleaning outlet. The parties agreed on a new lease for the premises. The motion judge did not determine whether this was on the franchisor’s request.
Under the new lease, Brister became the tenant in place of the franchisor. This was a significant change because the franchisor was no longer party to the lease. In addition, the franchisor presented Brister with a security agreement, granting the franchisor an interest in all her property and assets.
The Franchisor’s representatives interviewed Brister personally before approving her as a franchisee. It also required Brister to be trained by its personnel, as well as by the former franchisee.
The motion judge held that the franchisor had the burden of demonstrating how it managed to accomplish the advantages it did here without its active participation. The presence of a power imbalance was obvious on the facts. Therefore, the motion judge found that the franchisor had ‘effected’ the transfer.
These cases establish that a franchisor runs the risk of ‘effecting’ the transfer when it uses its power to impose new conditions on the resale that were not part of its franchise agreement with the franchisee seller. A franchisor may also effect the transfer if it participates actively in negotiations with the franchisee buyer.
Frequently, franchisors require, as a condition of transfer, that the franchisee buyer execute a new franchise agreement which may differ substantially from the franchisor’s agreement with the franchisee seller. Even if this is a condition of transfer, the execution of a new franchise agreement may nonetheless imply the kind of involvement by a franchisor as having ‘effected’ the transfer.
For more information about Law Works’ expertise and how we may be able to help you, please contact Ben Hanuka at email@example.com or by phone in Ontario at (855) 978-5293 and in British Columbia at (604) 262-1711.Tags : Disclosure, Franchise Agreement, Franchise System, Resale
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