Debtor Franchisor Cannot Evade Debts By Transferring Assets

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Author: Evan Ivkovic, Student-at-Law, Law Works P.C.         
Editorial Committee: Law Works P.C.
Editor: Ben Hanuka

In Struik v Dixie Lee Dixie-Systems Ltd. (2017 ONSC 551), a former franchisee won a summary judgment motion against an affiliate of its franchisor, to enforce a judgment obtained earlier against the franchisor.

Background

In 1978, the former franchisee, Maria Struik and her now deceased husband started operating the Northern Ontario area of the Dixie Lee fried chicken franchise chain as franchisees of the franchisor, Dixie Lee Food Systems Ltd. (“Dixie-Systems”).  The Struiks were also sub-franchisors that marketed to and supervised new franchisees for a share of royalties.

Later the relationship soured, and the parties were involved in arbitration.

In 2011, Maria Struik and Dixie-Systems settled their arbitration case and signed minutes of settlement.  Under the settlement, Dixie-Systems was required to pay to Struik $1.3 million over 25 years.

The minutes also stated that the payment obligation was to be secured by a guarantee: if Dixie-Systems transferred the franchise business to a related entity, that entity would be obligated under the guarantee.

In 2012, Dixie-Systems defaulted on the payments.  Struik obtained judgments in 2012 and 2013 for the outstanding balance against various companies including Dixie-Systems and Dixie Lee Capital Corporation (“Capital”).

The companies did not have any assets at the time.  Among other assets, Dixie-Systems had transferred the franchise assets to an affiliate, Dixie Lee Ontario Ltd. (“Dixie-Ontario”).

The present action

In her present action, Struik sought to enforce her judgment in respect of two main assets: (1) the franchise system and, (2) the 50% shareholding interest in 1462103 Ontario Inc. (“146”), which owned the Dixie Lee trademarks used by the franchise system – each of these assets had been earlier transferred.

Struik’s motion for summary judgment was made against Dixie-Ontario.  She alleged that because Dixie-Systems transferred the franchise assets to Dixie-Ontario and since the two companies were affiliated, Dixie-Ontario (the transferee) should be liable to satisfy her unpaid judgment award.

The court ruled in favour of Struik.  There was no genuine issue requiring a trial.  The main issues were whether a transfer was made to Dixie-Ontario, the time frame of the transfer, whether Dixie-Ontario was related to Dixie-Systems, and whether Dixie-Ontario had to guarantee Dixie-Systems’ obligations under the minutes of settlement.

The court did not accept the evidence of Dixie’s principal that he was executing a plan starting in 2007 to take the franchise public and manage his estate, and that part of this plan involved transferring the franchise assets to Capital in 2007.  The court found that a 2007 declaration of trust under which Capital was to hold the Canadian trademarks of the Dixie Lee Chicken franchise was legally invalid.  Capital did not own shares in 146 in 2007 and the shareholder agreement prohibited the transfer of 146’s shares.  A related resolution of directors assigning all rights to the Dixie Lee trademarks missed a director’s signature.

The assets transfers happened after the minutes of settlement were signed.  The court held that the earliest that Capital could have received 146’s shares was in October 2011.  Dixie-Ontario was incorporated in April 2012.  Both of these dates were after the date of the minutes of settlement in April 2011.

The court held that the guarantee of an unnamed affiliate in the minutes of settlement was a valid guarantee.  The term “related entities” in the minutes of settlement referred to any entity sufficiently connected to Dixie-Systems or Capital and the Dixie Lee franchise system.  The fact that Dixie-Ontario (the transferee of the assets) was solely owned by another shareholder was not sufficient to make this company unrelated.  Dixie-Ontario had a close relationship with the other Dixie corporations and their shareholder.

Further, the court did not accept the argument that because Struik allegedly breached the minutes of settlement, Dixie-Ontario should be released from its obligations under the guarantee.  Dixie-Ontario claimed that Struik was engaged in competition.  The Dixie companies had earlier started an action against Struik, but it was dismissed after they failed to comply with an order requiring them to post security for costs.  The court relied on a clause in the minutes of settlement which stated that the obligation to make payments was absolute and unconditional and that Dixie-Systems could not withhold payments on the basis of any allegations.

The court also rejected Dixie-Ontario’s argument that third party creditors of Capital would be affected if the court granted the relief to Struik.  Struik was requesting relief against Dixie-Ontario, not Capital.  Thus Capital’s potential bankruptcy was irrelevant.  Also, no creditors made a claim against Dixie-Ontario.

This case demonstrates that the courts will not allow leeway to parties transferring assets under suspicious circumstances where the end-result is to evade an award or agreed-upon settlement and in the face of a guarantee by all affiliate companies.

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 at (855) 978-5293.

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