The Court of Appeal for Ontario recently released its decision in Caffé Demetre Franchising Corp. v 2249027 Ontario Inc.1  This was an appeal from a summary judgment concerning the respondent franchisor’s disclosure obligations under the Arthur Wishart Act (the Act). In particular, the issue on appeal was whether the franchisor’s failure to disclose litigation that it had commenced constituted a material deficiency and entitled the appellant franchisees to rescind the franchise agreement.

Background facts

The appellant franchisees and the respondent franchisor entered into a franchise agreement on July 22, 2011. That same day, the franchisor commenced an action against a former franchisee who had been operating a competing business close to the appellant franchisees’ business location (the Ongoing Litigation). By September 2011 the appellant franchisees were fully aware of the Ongoing Litigation but did not express any concerns about it.

The relationship between the appellate franchisees and the franchisor began to deteriorate in 2012 due, in part, to the franchisees’ failure to perform certain renovations and produce financial records at the franchisor’s request. On July 19, 2013, the franchisees served a notice of rescission of the franchise agreement on the franchisor and on August 2, 2013, the franchisor served notice of termination on the franchisees. The franchisor subsequently commenced proceedings against the franchisees claiming damages for breach of contract. In their statement of defence and counterclaim, the franchisees alleged that the franchise agreement was validly rescinded under s.6(2) of the Act on the basis that the franchisor had failed to disclose the Ongoing Litigation among other things.       

The motion judge’s decision

In response to the franchisees’ counterclaim, the franchisor brought a motion for partial summary judgment and sought a declaration that the franchisees were not entitled to rescission under the Act. The motion judge held in favour of the franchisor and dismissed the franchisees’ claim for rescission.2 After reviewing the franchisees’ counterclaim, the motion judge concluded that while the franchisor should have disclosed the Ongoing Litigation to the franchisees prior to entering the franchise agreement, this omission did not constitute the type of disclosure deficiency that entitles franchisees to rescission under s.6(2) of the Act.3 

Referring to the decision in 2240802 Ontario Inc. v Springdale Pizza, the motion judge concluded that litigation involving a franchisor is a material fact and must be disclosed in all circumstances.4 The motion judge went on to cite 6792341 Canada Inc. v Dollar It Ltd. for the proposition that rescission under s.6(2) is only available where there are “stark and material deficiencies” in the disclosure document.5 Applying this standard, the motion judge concluded that the Ongoing Litigation was unlikely to affect the price to be paid by the franchisees – as required by the definition of “material fact” under the Act – because the ligation was not a potential liability but rather a proactive measure that would benefit prospective franchisees.6 As such, this disclosure omission was not a stark and material deficiency and did not entitle the franchisees to rescission.   

The appeal decision

On appeal, the franchisees argued it was unreasonable for the motion judge to conclude that the Ongoing Litigation would not have affected the franchisees’ decision to enter the franchise agreement.7 According to the franchisees, the former franchisee that was the subject of the Ongoing Litigation was a potential threat to the respondent’s franchise business and, as such, this litigation ought to have been disclosed. The Court of Appeal dismissed this appeal but adopted different reasoning than the motion judge.

The Court of Appeal disagreed with the motion judge’s conclusion that all litigation involving a franchisor constitutes a material fact and must therefore be disclosed.8 However, the court noted that neither the Act nor the regulations made under the Act explicitly define the type of litigation that must be included in disclosure documents.

Although Regulation 581/00 identifies a category of litigation that must be disclosed – namely, litigation against the franchisor – the court held that this regulation should not be interpreted so as to conclude that litigation against a franchisor is the only type of legal proceeding that must be disclosed.9 In contrast, the court held that the question of whether particular litigation ought to be disclosed is a fact-specific analysis.

The court noted that in the present case, the Ongoing Litigation was undertaken at the request of and for the benefit of the franchisees. The Ongoing Litigation did not constitute a potential liability and would not have negatively affected the appellant franchisees’ business.10 As such, the franchisor’s failure to disclose the Ongoing Litigation did not deprive the appellate franchisees of the opportunity to make a properly informed decision.11 

On this basis, the Court of Appeal concluded that the Ongoing Litigation was not a material fact and, as such, the franchisor’s disclosure documents were not deficient. The franchisor’s failure to disclose the Ongoing Litigation was not a deficiency at all, let alone a deficiency sufficient to entitle the franchisees to rescind the franchise agreement.

The author wishes to thank Jonathan Preece, articling student, for his help in preparing this legal update.