Background to the case

A recent decision from the Alberta Court of Queen’s Bench provided some insight into how courts will interpret disclosure requirements in franchise legislation. This case emphasizes that courts intend to treat franchise legislation as consumer protection legislation requiring franchisors to carefully consider the level of detail necessary for legally compliant disclosure documents. The case also discusses misrepresentation claims and the obligation of fair dealing, however this article only deals with the disclosure document issues.

In this case, Hesham Essa and Enas Afifi (collectively, the Essas) brought an action for breach of contract against the franchisor, Mediterranean Franchise Inc. (MFI).[1] In 2009, Mr. Essa submitted an application to acquire a Taste of the Mediterranean franchise. Sam Hussein, president & director of MFI, sent a disclosure document on November 1, 2009 to Mr. Essa (the November 2009 Disclosure Document). Mr. Essa however, did not proceed with the franchise due to a lack of funds. Subsequently, in February 2010, Mr. Essa’s business partner, Abed Ataoui, contacted MFI to establish a franchise with Mr. Essa. Mr. Essa and Mr. Ataoui signed the franchise agreement in February 2010.

There was a dispute whether a second disclosure document was provided. However, the Court concluded that it was not provided to either Mr. Essa or Mr. Ataoui before they signed the franchise agreement in February 2010. As such, the rights and liabilities of the parties were decided based upon the November 2009 Disclosure Document alone. In August 2010, the relationship between Mr. Essa and Mr. Ataoui broke down and the decision was made to replace Mr. Ataoui with Ms. Afifi, Mr. Essa’s wife. Mr. Ataoui was bought out by Mr. Essa and Ms. Afifi for $36,000. An amendment to the franchise agreement was signed on September 29, 2010 to bring this change into effect.

The restaurant was not financially successful and closed after nine months of operation in April 2011. The Essas brought this action against MFI for damages and rescission of the franchise agreement. The Essas also claimed for misrepresentation and breach of the duty of fair dealing under the Franchises Act (RSA 2000) (the Act). MFI counterclaimed against the Essas for lost royalties and defamation. The defamation claim was abandoned at trial.

Disclosure requirements

In interpreting the provisions of the legislation and the disclosure claims advanced by the franchisees, the Court stated: “protective consumer legislation should not be interpreted narrowly,” or “through the lens of freedom of contract and competition.” Furthermore, the Court went on to say that “the Act, the Regulation and the Schedule must be interpreted in a large and liberal fashion that best accords with the achievement of the consumer protection objectives of the Act.” In so doing, the Court concluded that, after assessing the deficiencies described below, the disclosure document was “seriously deficient” and “not substantially complete.”

  • Failure to provide telephone numbers of extra-provincial franchisees: Pursuant to the Franchises Regulation (Alta Reg. 240/1995) (the Regulation), franchisors are required to provide details regarding existing franchisees. In 2009 there were no Taste of the Mediterranean franchises in Alberta. However, according to the Regulation, where there are fewer than 20 franchisee outlets in operation in Alberta and there are outlets operating outside of Alberta, the franchisor is required to provide “information” on the 20 outlets closest to Alberta. The Court interpreted the requirement to provide “information” as a requirement to provide the phone numbers of the extra-provincial outlets, which MFI did not provide. The court rejected MFI’s arguments that the numbers were available elsewhere, and found that the failure to include the phone numbers meant that the disclosure was not “substantially compliant.”
  • Earnings claims: The Regulation requires that where information is given to a prospective franchisee from which a specific level or range of actual or potential sales, costs, income or profit from franchisee outlets or franchisor outlets can be easily ascertained, the information must: (a) have a reasonable basis at the time it is made; include the material assumptions underlying its preparation and presentation and indicate the place where substantiating information is available for inspection by the franchisee. The Court found that Mr. Hussein’s statement to the franchisee — both before and after the franchise agreement was signed — that “food costs were typically 33% of the selling price of the product,” fell within the scope of information contemplated by section 16, such that MFI was required to provide the supporting documentation, and that failure to do so rendered the disclosure incomplete.
  • Financing arrangements: A franchisor is also required to “disclose the terms and conditions of each financing arrangement that the franchisor offers directly or indirectly to the franchisee.” Financing was provided to the franchisees through a separate corporation, SRI. On this basis, MFI’s position was that since financing was provided by another party, SRI, further information was not required. However, the Court noted that: Mr. Hussein was the sole director and shareholder of both MFI and SRI; there was no evidence that a non-SRI financing option was presented to or was available for Mr. Essa and Mr. Ataoui; and both the disclosure document and the franchise agreement referred to financing from SRI. On this basis, the Court determined that MFI indirectly offered financing through SRI and thus the terms and conditions of the financing arrangement or arrangement with SRI should have been disclosed. The Court determined that the disclosure deficiencies “in isolation from one another would have been serious deficiencies. Cumulatively, the disclosure was seriously deficient. The disclosure was not substantially complete.” Since the Court determined that no proper disclosure was provided, the Essas were entitled to the two-year rescission remedy.

Implications and practical considerations

This case is an important one for dispelling assumptions that may have been made about how courts will look at what might be characterized as unimportant or superficial disclosure requirements, phone numbers, financing and inadvertent earnings claims. Franchisors are ill-advised to forego including telephone numbers of their current franchisees. Likewise, if any financing or assistance in obtaining financing is provided to franchisees, it should be carefully reviewed and disclosed if it qualifies under the applicable regulation. This is especially the case where the assistance is provided by a person related to or controlled by the franchisor or its owners. Furthermore, franchisors and their salespeople must be extremely vigilant to avoid giving earnings claims and to recognize when they have done so. If an earnings claim was made verbally (or otherwise) in pre-contractual, pre-disclosure discussion, that claim and all underlying assumptions must be in the disclosure document along with a description of where information to substantiate the claim can be found. Courts will enforce these requirements.