Since the enactment of the Arthur Wishart Act (Franchise Disclosure), 2000 (the Act), Ontario courts have grappled with a key question: when will disclosure by a franchisor to a franchisee be so deficient so as to constitute no disclosure at all? The recent case of Sirianni v. Country Style, released by the Ontario Superior Court of Justice (the Court) in February 2012, confirms a rescission right of two years under the Act in circumstances where the franchisee is unable to make an informed investment decision due to the franchisor’s failure to disclose a material fact making the disclosure completely inadequate and tantamount to no disclosure at all. Additional information regarding franchise legislation, disclosure requirements and the rescission remedy, can be found in our March 2012 article: Disclosure Requirements of Ontario’s Franchise Legislation and the Rescission Remedy.
A summary of the key facts as found by the Court is briefly set out below.
The plaintiff franchisee entered into a franchise agreement with the defendant Country Style Food Services Inc. (Country Style or the franchisor) to operate a Country Style franchise. The franchisee also subleased its franchise location from the defendant Country Style Realty Limited (the franchisor’s associate which finds and leases locations for franchisees, Country Style Realty) which, in turn, leased the location from 114953 Ontario Limited (the landlord) pursuant to a head lease. Each of the franchise agreement, the sublease and the head lease provided for an initial 10-year term with two five-year renewal options.
From 1996 through 2006, the franchise operated without incident. The franchise did well during its first seven or eight years of operation, substantially broke even during its ninth and 10th years of operation, but had then begun to lose some money due to competing businesses in the area.
At the end of the initial 10-year term in 2006, each of the franchise agreement, the sublease and the head lease were due for renewal.
In February 2006, Country Style Realty gave notice to the landlord of its intention to extend and renew the head lease for five years. Under the terms of the head lease, any lease renewals were subject to the same terms and conditions as the original lease, except that rent was subject to adjustment “... based on the then current rents for similar space in the nearby area.” In response to Country Style Realty’s renewal request, the landlord demanded a significant rental increase. Subsequent negotiations over the rental rate became protracted. In an effort to resolve the impasse, Country Style Realty and the landlord eventually agreed to submit their dispute to arbitration. Arbitration was not scheduled, however, until February 2007.
While Country Style Realty had agreed to arbitration with the landlord, the evidence established that Country Style was concerned that if arbitration went ahead and the rental rate was fixed at a higher rate, Country Style Realty would be required to pay the increased rental rate for five years. As the franchisee had not yet signed a new franchise agreement – it was waiting for a new sublease in order to sign the entire package of renewal documents at the same time – there was a risk to the franchisor that the franchisee could simply walk away from its franchise, leaving the franchisor with a vacant store, no franchisee and a five-year rental obligation.
Beginning in late 2005 and through 2006, the franchisor and the franchisee started to discuss the renewal of the franchise agreement and sublease for the franchise location. As part of these discussions, the franchisor informed the franchisee that Country Style Realty was in the process of negotiating an extension of the head lease with the landlord. The franchisee was further led to believe that Country Style Realty would provide a new sublease for the franchise location to the franchisee as soon as the rental terms with the landlord were finalized.
While renewal discussions were ongoing, in June 2006, the franchisor sent the franchisee a package of “disclosure documents”. This package consisted of all the financial information mandated by the Act, but did not include a new sublease or a copy of a new head lease. Upon receipt of the disclosure package, the franchisee executed a “receipt of document disclosure form” and returned it to the franchisor as requested by the franchisor.
In September 2006, the franchisor sent a package of documents to the franchisee for signature. These documents included a new franchise agreement, but no sublease. The franchisee took the position that it would not sign a new franchise agreement without being in receipt of a new sublease setting out the new rental terms so that the entire package of franchise renewal documents could be signed and returned to the franchisor at the same time.
In February 2007, the franchisee received an offer to purchase the franchise but was unable to proceed without a new sublease in place, as one of the conditions of the offer required the franchisee to obtain consent from each of the landlord and sublandlord (Country Style Realty) to the assignment of the sublease.
With arbitration scheduled for February 2007, Country Style Realty and the landlord negotiated a new lease agreement for the premises that included a new lease term. On April 1, 2007, Country Style Realty and the landlord entered into a lease extension with a term of 21 months. The new lease term was significantly shorter than the five-year extension which Country Style Realty had originally sought from the landlord and which the franchisee believed that Country Style Realty was pursuing in its negotiations with the landlord.
At no time thereafter, however, did Country Style Realty or the franchisor inform the franchisee about the material terms of Country Style Realty’s new lease agreement with the landlord and, in particular, the 21-month term and agreement that the premises would be vacated on December 31, 2007.
Rather, in May 2007, the franchisor wrote to the franchisee to (1) advise that an agreement had been reached with the landlord on the rents payable (with no reference to the term or the termination date) and (2) request that the franchisee acknowledge various terms upon which the renewal of the sublease would occur. Believing that the lease with the landlord had been renewed for a further five years and that the renewal of the sublease would be for a five-year term on the terms outlined in the May 2007 letter, the franchisee signed the May 2007 letter and returned it to the franchisor.
Between April 2007 and January 2008, the franchise continued to operate without an executed franchise agreement and sublease in place. However, having confirmed its agreement to the terms set out in the May 2007 letter, the franchisee believed that a new sublease reflecting those terms would be provided by Country Style Realty and that it was not appropriate to sign a new franchise agreement until that occurred.
Instead of providing a new sublease, however, in January 2008, the franchisor wrote to the franchisee to inform it that the franchise was now operating on a month-to-month basis, as the franchisee had failed to execute a new franchise agreement or sublease. No mention was made in this letter of the 21-month rental term with the landlord or the fact that the head lease had expired on December 31, 2007.
Following the receipt of the January letter, the franchisee met with the franchisor. At this meeting, the franchisee made it clear that it would not sign the franchise agreement without a copy of the sublease. Again, no mention was made by the franchisor of the 21-month term or the fact that the head lease was now at an end, with the result that both Country Style Realty and the franchisee were now leasing the space month to month. Nor did the franchisor mention that Country Style Realty intended to reopen negotiations with the landlord, with a view to potentially putting in place a new franchisee at the location. The evidence suggested that the franchisor now viewed this franchise location as substandard and in need of change.
At the end of January 2008, the franchisee received another offer to purchase the franchise, but once again was not able to proceed since no sublease was in place. Further, unbeknownst to the franchisee, the franchisor had decided not to approve any transfer that would be required to facilitate any sale of the franchisee’s business.
In February 2008, the franchisor wrote to the franchisee to indicate that a $100,000 renovation to the location would be required upon renewal. This was followed by a letter alleging operational non‑compliance and a default letter from the franchisor. At this point, the franchisee had fallen behind in its payment of rent to Country Style Realty.
In March 2008, the franchisee delivered written notice to the franchisor setting out its intention to rescind the franchise agreement for non-disclosure pursuant to the Act and vacated the store. Subsequently, it brought an action against the franchisor for a declaration that it had a right to rescind its franchise agreement and for a refund of all monies paid to the franchisor or the franchisor’s associate. The franchisee also claimed damages for misrepresentation and breach of the franchisor’s obligations of good faith under the Act.
Failure to Disclose Material Facts
The Court noted that the Act is a “franchisee friendly” piece of legislation that is designed specifically to protect the interests of franchisees “... particularly when it comes to the issue of disclosure.”
Despite the fact that a new franchise agreement and sublease were never signed, the Court found that the May 2007 letter effectively established a new five-year term for both the franchise agreement and the sublease. Since the initial 10-year terms of the franchise agreement and sublease had expired in February 2006, the Court found that these agreements had been renewed on a month-to-month basis during the intervening period.
With respect to the intervening period, the Court found that no disclosure was required under the Act as the month-to-month renewal qualified for a disclosure exemption on the basis that the term was less than one year and did not require the payment of any additional franchise fee.
With respect to the franchise agreement renewal marked by the May 2007 letter, the Court considered the availability of a disclosure exemption for renewal or extension where there has been no material change since the franchise agreement was entered into.
The Court found that changing the term of the lease extension with the landlord from five years to 21 months was a material change that would “have an impact on a franchisee’s decision to renew” and negated the availability of the disclosure exemption in this case. Having determined that an exemption from the disclosure requirement was not available under the Act, the Court then turned its attention to the adequacy of the disclosure provided to the franchisee in this case. The Court found that Country Style had deliberately concealed the state of affairs relating to the renewal of the lease, which the Court found to be a fundamental piece of information that would be of significant importance to the franchisee in making an informed decision. The Court concluded that withholding such a material fact from disclosure “makes the disclosure completely inadequate and tantamount to no disclosure”. Despite the fact that section 6(1) of the Act provides for a 60-day rescission period in cases where the disclosure fails to meet the requirements of the Act, the Court found that the non‑disclosure of this material fact equated to no disclosure at all and, consequently, the two-year rescission period mandated by section 6(2) of the Act for cases of non-disclosure applied.
The Court also found that the franchisee had properly rescinded its franchise agreement and, therefore, was entitled to recover damages in accordance with the Act, including “... any money received from or on behalf of the franchisee, other than money for inventory, supplies or equipment”. The Court rejected the franchisor’s argument that “money” for the purposes of the Act excludes rents and associated costs paid by the franchisee to the franchisor or the franchisor’s associate (in this case, Country Style Realty as the sublandlord).
In addition, the Court disagreed with the franchisor’s assertion that “the Act merely seeks to compensate a franchisee for its losses, namely expenses above income” on the basis of the clear wording of the Act. Consequently, in assessing what was to be included in the calculation of “any money received from or on behalf of the franchisee, other than money for inventory, supplies or equipment” pursuant to section 6.6(a) of the Act, the Court took a broad approach and found that a franchisee is entitled to a return of any money it has paid to a franchisor or a franchisor’s associate. In this light, the Court held that “money” should be interpreted in its “every day usage”. As a result, the franchisor was required to refund the franchisee for the rent and associated expenses paid to Country Style Realty. The Court went further and stated that, if the Act had intended to exempt rent from the calculation of a franchisee’s entitlement on rescission, it would have done so explicitly, which it did not. In this case, the rescission damages were calculated and found to be payable to the franchisee under the following categories: base rent; common area maintenance charges; tax instalment; sign rent; loan (for cappuccino machine); advertising/service fees; and equipment purchase.
It is important to note, however, that the Court was clear that a franchisee is not entitled to double recovery. Therefore, the Court declined to award damages in relation to money purportedly advanced by a guarantor to the franchisee, as the Court had no way of knowing whether such money was used to pay for the expenses which already formed part of the franchisee’s rescission damages in the aggregate amount of $187,730.05.
With respect to the claim of misrepresentation for failing to disclose the new lease terms, the Court found that while the franchisor had misrepresented the lease terms, the franchisee had suffered no additional losses for the misrepresentation over and above those it was entitled to recover under the rescission provisions of the Act. It seems clear that the Court would have awarded damages for misrepresentation to the franchisee in this case had it not awarded rescission damages.
The Court granted the franchisee $25,000 in damages for breach of the franchisor’s duty of good faith as the decision to keep “critical lease information” from the franchisee “while actively leading the franchisee to believe the lease had been renewed” constituted a breach of this duty. The Court was not persuaded that Country Style’s “commercially driven motive” to prevent itself from being left with an empty store and an on-going lease obligation took the actions outside of the “realm of failing to deal in good faith.” Put simply, the Court found that the whole issue of good faith dealing is to be understood in the context of the rights and obligations of the Act. By favouring its own business needs at the expense of the obligations imposed under the Act, Country Style did not act in good faith. The Court noted, however, that the conduct of the franchisor in this case was not as egregious as in other cases and the franchisee made no claim for additional damages for mental suffering. A counterclaim by the franchisor with respect to money owed by the franchisee to the franchisor, which were not disputed by the franchisee, was also allowed.
As has been found by the Ontario courts in other cases on rescission, Sirianni v. Country Style re-affirms that where there has been a failure on the part of a franchisor to disclose material facts to the franchisee in a manner that renders the disclosure so deficient as to be functionally equivalent to no disclosure at all, it will give rise to a two-year rescission period under the Act.
This case also highlights yet another specific example of a fact so material that its non-disclosure, absent any other disclosure deficiencies, is enough to render any other disclosure provided effectively moot, as if no disclosure had been provided at all.
The decision also stands as a reminder that an exemption from the disclosure obligations in the Act may not be available to a franchisor upon renewal or extension of the franchise agreement if there has been a material change. This case highlights the fact that it is very important for a franchisor to consider whether there have been any changes to itself, the business or to franchise operations since the previous franchise agreement was entered into that could be considered material in assisting the franchisee to make its decision to renew or extend its agreement.
Franchisors are well advised to ensure that they are meeting their disclosure obligations at the time of renewal as well as prior to entering into the initial franchise agreement. In those cases where a strong possibility exists that an exemption may not be available and disclosure may be required, it is often the most prudent course for franchisors to make full and complete disclosure to the prospective franchisee in accordance with the requirements of the Act to limit (and, subject to the adequacy and timeliness of the disclosure, hopefully eliminate) the risk of a rescission claim from that particular franchisee.