Section 5(7) of the Arthur Wishart Act (Franchise Disclosure), 2000 (the “Act”) contains a number of exemptions which permit the grant of a franchise without the requirement to provide a prospective franchisee with a disclosure document. However, the courts have generally provided a narrow interpretation of these exemptions on the stated need to address the power imbalance between franchisors and franchisees.
In Brister v. 2145128 Ontario Inc., the Ontario Superior Court of Justice considered an application by a franchisee (the “Applicant”) to rescind a franchise agreement approximately 6 months after it had been signed. The Applicant argued that she was entitled to rescission since she was not provided with a disclosure document for the franchise. The franchisor (the “Respondent”) relied on the exemption set forth in Section 5(7)(a) of the Act which provides that the disclosure duties of a franchisor do not apply in the event that there is a grant of a franchise by an existing franchisee if:
- the existing franchisee is not the franchisor, an associate of the franchisor or a director, officer or employee of the franchisor or of the franchisor’s associate;
- the grant of the franchise is for the franchisee’s own account;
- in the case of a master franchise, the entire franchise is granted; and
- the grant of the franchise is not effected by or through the franchisor.
To clarify subsection (d) above, the Act further provides that a grant is not “effected by or through a franchisor” merely because the franchisor has a right to approve or disapprove the grant or that a reasonable transfer fee must be paid to the franchisor in connection with the grant.
In 2011, a then-current franchisee of the Respondent (the “Existing Franchisee”) met the Applicant to discuss the transfer of the franchise from the Existing Franchisee to the Applicant. On August 29, 2011, the Existing Franchisee and the Applicant entered into an asset purchase agreement for the sale of the franchise and agreed that the Applicant would enter into a new franchise agreement with the Respondent. As part of the transfer, the Applicant was required to undergo training from both the Existing Franchisee and the Respondent, to enter into a general security agreement in favour of the Respondent (the “General Security Agreement”) and to assume the rights and obligations of the Existing Franchisee and the Respondent under the lease for the premises as sole tenant in place of the Respondent.
On September 19, 2011, the Respondent provided the Applicant with a disclosure document containing general information in respect of the franchise (the “Respondent DD”).
After a few months of operating the franchise, the Applicant discovered that she was losing money and alleged that the state of the franchise’s financials were different than what she was led to believe. Consequently, she served a notice of rescission on the Respondent on March 26, 2012.
The arguments of the Applicant and the Respondent were focused strictly on whether the Respondent was entitled to rely on the exemption set forth in Section 5(7)(a) of the Act, and, more specifically, Section 5(7)(a)(d) of the Act.
In interpreting Section 5(7)(a)(d) of the Act, the Court held that, in order to rely on this exemption, a franchisor must not be an active participant in the grant and should do nothing other than exercise its right to consent to the transfer.
However, the Court found that the Respondent had, in fact, been an active participant in the grant by requiring that the Applicant:
- successfully pass an interview conducted by the Respondent prior to approving her as the new franchisee;
- be trained by the Respondent and the Existing Franchisee;
- assume and take over the obligations of the Respondent for the lease of the franchised business; and
- sign the General Security Agreement even though the Existing Franchisee had not been required to execute a general security agreement.
The Court also noted that a franchisor relying on the exemption set forth in Section 5(7)(a) of the Act has the burden of proving how it is able to obtain certain advantages in connection with the grant of a franchise from an existing franchisee to a prospective franchisee without having actively participated in the process.
In making use of the resale exemptions set forth in the Act, franchisors should exercise caution. This particular exemption, available in the context of resales by existing franchisees, has received a particularly narrow interpretation by the courts and as a result, franchisors should generally not rely upon this exemption unless they intend to play a very passive role in the resale transaction.