In the past few years, the Courts, especially in Ontario, have had the occasion to review some franchise disclose documents and to consider whether their deficiencies were so material as to amount to the equivalent of no disclosure at all having been made by the franchisor to the prospective franchisee. The consequence of such a finding is to extend the franchisee’s statutory rescission rights from 60 days after disclosure1, to 2 years after signing the franchise agreement2. Among the material deficiencies found in this case, some relate to material facts regarding the specific franchised location. This Article will explore the nature of these location-specific disclosure deficiencies.
In the recent case of Melnychuk v. Blitz Ltd.3, on application to the Ontario Superior Court of Justice, the franchisee was successful in having section 6(2) of the Arthur Wishart Act4 be the operable section giving the franchisee the right to rescind the franchise transaction. The Court found that the disclosure of all material facts as required under section 5(4)(a) of the Arthur Wishart Act5 did not occur, because what was provided by the franchisor to the (then) prospective franchisee amounted in law to no disclosure. The franchisor had made partial disclosure, and argued that it was sufficient, and that section 6(1) of the Arthur Wishart Act6 should apply, giving the franchisee only 60 days following the receipt of the disclosure document, to issue its notice of rescission to the franchisor.
The Court found that the franchisor’s disclosure had many deficiencies, and importantly, that all of the deficiencies were material deficiencies in disclosure. Much was made in this case, as well as in several of the others mentioned in this Article, of the statutory requirement in Ontario that the disclosure document be one document, delivered at one time7.
The disclosure deficiencies found in this case were:
- The disclosure document contained 1 year-old unaudited financial statements. The franchisor had then followed up 2 weeks later with the delivery of its current, but still unaudited, financial statements.
- The franchise agreement schedules were left blank as to the franchised location and territory. This information was provided by the franchisor to the franchisee much later.
- The disclosure document contained no purchase price, franchise fee amount, required deposits amounts, or closing date of the agreement of purchase and sale. Therefore, the disclosure document did not list all of the franchisee’s costs to establish the franchise, as required under section 6 of the Regulations8.
- The disclosure document did not include the lease and the sublease. Therefore, the disclosure document did not disclose the lease term, the rent, the obligation that the subtenant observe and perform all of the terms, covenants and conditions of the head lease, or that the sublease contained an indemnity to the franchisor against losses and damages arising under the sublease.
- The copy of the franchise agreement attached to the disclosure document contained a franchisor covenant not to compete with the franchisee within the territory, and an option to the franchisee to purchase any new location in the territory on terms. These provisions were removed from the final form of the franchise agreement executed by the franchisee.
- The copy of the franchise agreement attached to the disclosure document did not contain a franchisee indemnity to the franchisor. However, the final form of the franchise agreement executed by the franchisee had in it a personal guarantee, as well as an indemnity clause by the guarantor (franchisee principal) in favour of the franchisor.
- The form of General Security Agreement attached to the disclosure document had the last 5 pages missing from it.
Three of these material deficiencies related to the specific franchised location. These were that the disclosure document did not disclose the franchised location and territory; the purchase price, franchise fee, required deposits, and closing date of the agreement of purchase and sale; and the lease and sublease, including their terms as to the lease term, rent, obligation of the subtenant to observe and perform the head lease, and that the sublease contained an indemnity of the franchisor against losses and damages arising thereunder.
Each of these deficiencies was considered by the Court, individually, to be a material one.
The Melnychuk v. Blitz case followed the earlier decisions in 6792341 Canada Inc. v. Dollar It Ltd.9, and 1490664 Ontario Ltd. v. Dig This Garden Retailers Ltd.10. The Court also considered the earlier decision in 1518628 Ontario Inc. v. Tutor Time Learning Centres LLC11.
In the case of 1518628 Ontario Inc. v. Tutor Time Learning Centres LLC12, the franchisor delivered a copy of its United States Uniform Franchise Offering Circular (“UFOC”) to the prospective franchisee but did not include in its disclosure certain material facts regarding the individual franchise which were set forth in 2 site visit reports which were in the possession of the franchisor prior to making its disclosure. This non-disclosure itself, despite any other deficiencies, meant that the franchisor’s disclosure was materially deficient and amounted to non-compliance with the disclosure requirements under the legislation.
Prior to sending the UFOC to the prospective franchisee, which was stated to be for “informational purposes”, the franchisor’s representative had attended at the operating franchised location, which was being operated by a predecessor franchisee, twice. On both occasions, reports were made back to the franchisor which stated serious problems with accounts, billings, financial arrangements with the clients, and overall management. None of these material operational deficiencies was disclosed to the franchisee prior to its purchase of the franchised business from the predecessor franchisee. These too amounted to material location-specific disclosure deficiencies of the franchisor.
In the case of 1490664 Ontario Ltd. v. Dig This Garden Retailers Ltd.13, again the Court had to consider whether or not the operable section of the Arthur Wishart Act14 was section 6(1) or section 6(2). The Court determined that it was section 6(2) which was operable, and that the franchisor had made no disclosure to the prospective franchisee “within the meaning of the Act”.
It was admitted that only 70% of the required information had been provided to the prospective franchisee, and this had been provided to it piece-meal, and over time. The franchisor’s disclosure to the prospective franchisee thus did not amount to the provision of a single disclosure document, all at the same time. The Court considered that providing a single disclosure document, all at one time, was what was required, and not the provision of several documents, or oral communications, not at one time.
This case went on to be heard by the Ontario Court of Appeal, however the Ontario Court of Appeal did not review the deficiencies on a location-specific basis. The Ontario Superior Court of Justice did review the deficiencies on a location-specific basis.
The deficiencies in this case were the following:
Franchise information was given to the prospective franchisee, however it was not in the depth that the Act requires. What had been given was standard franchise information regarding the franchisor owners, the mission statement, the merchandise concept, the customer service level, store design, the city locations of other stores, benefits, new franchisee requirements and estimated costs of a new franchise. This information was provided to the prospective franchisee, and was designed to be provided, before a franchise application was submitted to the franchisor. This information was prepared and provided in order to encourage a prospective franchisee to submit its franchise application to the franchisor, hence its standard, general nature.
In addition to this general information, the prospective franchisee was invited to see a store in operation.
The franchisor provided draft pro forma information regarding new store set up; however, no explanation was given for the figures used.
The franchisor also provided a draft franchise agreement.
A principal of the franchisor went to the franchisee’s lawyer, with the franchisee, to discuss the draft franchise agreement and to answer questions about it.
The franchisee also received training from the franchisee principals.
Clearly, the franchisor had not provided the prospective franchisee with any location-specific information. However, the Court did not specifically find that the lack of location-specific information was material, because it found instead that the overall documents and processes of the franchisor were so materially deficient, that it did not have to consider whether any one, or a few items, triggered the material disclosure deficiency found.
In the case of 6792341 Canada Inc. v. Dollar It Ltd.15, again there were several deficiencies. These were:
There was no franchisor’s Certificate attached to the disclosure document.
There was no information provided regarding a related company to the franchisor.
The description of the franchisor’s policy regarding volume rebates, etc. was not disclosed.
The franchisor’s financial statements were not attached to the disclosure document.
A copy of the head lease was not attached to the disclosure document.
A description of the franchise territory was not included. The disclosure did refer to several specific territorial statements “generally”, or in a 1 kilometre radius.
- There was no description of the licences, registrations, authorizations, or other permissions required to operate the franchise.
- There were no statements regarding the advertising fund and the contributions thereto.
- There was no description of the franchisor’s policy on location proximity between franchises, etc.
The Court did comment that a disclosure document does not become disclosure document, just because it’s called one. The deficiencies were many, and material.
The disclosure document provided had with it, but as separate accompanying documents, a generic franchise agreement, indemnity agreement, general security agreement, and sublease.
The Court considered the purpose of the legislation. In doing so, the Court quoted from the case of Personal Service Coffee Corp. v. Beer16, as follows:
“It is clear, therefore, that the focus of the Act is on protecting the interests of franchisees. The mechanism for doing so is the imposition of rigorous disclosure requirements and strict penalties for non-compliance. For that reason, any suggestion that these disclosure requirements or the penalties imposed for non-disclosure should be narrowly construed, must be met with scepticism.”
In the 6792341 Canada Inc. v. Dollar It Ltd. case17, the location-specific deficiencies in the franchisor’s disclosure document were the head lease; the franchise territory; and the description of the licences, registrations, authorizations, and other permissions that the franchisee would require in order to operate the specific franchised business.
The head lease was considered by the Court to be material and required to be disclosed. In connection with this material, location-specific deficiency, the Court had this to say:
“How, I ask rhetorically, could the franchisee, who is the sub-tenant under the sub-lease, ever comply with its acknowledgement obligation without receiving a copy of the Head Lease? It is expected to accept all of the terms and obligations of the Head Lease and to be bound by them. In my view to suggest, in these circumstances, that the Head Lease is not material and that there is no obligation to disclose it under the Act is absurd. It is obviously material and required to be disclosed.”
With respect to the franchised territory, the disclosure document stated that the territory would be specifically described in the franchise agreement. It then went on to say that the franchise territory would typically be described by specifying boundary streets, highways, community boundaries, or county lines, generally or in a 1 kilometre radius.
Section 6, items 12 and 13 of the Regulations18, require disclosure of a description of any exclusive territory to be granted to the franchisee. The Court stated that this information must be in the disclosure document, and that the disclosure requirements are not met by putting it in a franchise agreement which was not part of the disclosure document.
The Court quoted from the opening words of section 6 of the Regulations19, which it stated were “important”, and which provide that for the purposes of section 5(4) of the Act20, every disclosure document “shall include the following [listed items] presented together in one part of the document”.
The Court went on to say, about this material location-specific deficiency, that:
“It is not enough to meet this requirement to simply send with the disclosure document, the franchise or other related agreements where the required information is found and reference those agreements.”
In the subsequent case of 6862829 Canada Ltd. v. Dollar It Ltd.21, a case heard by the Ontario Superior Court of Justice, it was stated that the documents before the court were the same contractual documents and disclosure document as were used and delivered by the franchisor to the prospective franchisee in the earlier case of 6792341 Canada Inc. v. Dollar It Ltd.22.
The material non-disclosures were as follows:
There was no Certificate of the franchisor.
There was no disclosure of a pending lawsuit against the franchisor by a franchisee.
There was no disclosure of the offer to lease, and subsequently, of the lease.
There was no disclosure that the sub-landlord under the proposed sublease was a subsidiary of the franchisor.
The lawyer listed in the disclosure document as being the franchisor’s attorney authorized to accept servic of process, was in fact not so authorized, and when the litigation between the parties ensued, that lawyer declined service of the litigation documents on behalf of the franchisor.
In this case, the location-specific disclosure deficiencies were the failure to disclose the offer to lease, and later, the lease, and the failure to disclose that the sub-landlord under the sublease was a subsidiary of the franchisor.
In the recent case of 2189205 Ontario Inc. v. Springdale Pizza Depot Ltd.23, which was decided on June 29, 2010 in the Ontario Superior Court of Justice, the alleged disclosure document was given to the prospective franchisee, by the outgoing franchisee on a resale of the operating franchised business, and not by the franchisor.
The Court determined that disclosure was required in this case, as it had been in the Tutor Time case24, even though it involved the resale of an operating franchised business, because the franchisor was requiring more than just a simple right of approval of the franchise transfer, namely, that the new, incoming franchisee sign various documents and agreements with the franchisor directly.
The disclosure document given by the outgoing franchisee, was the one which had been given to the first franchisee at the time of its purchase of the original franchise, and there was no updating.
The material disclosure deficiencies found in this case were as follows:
The disclosure document did not reflect that the franchise had been operating for more than one year, and no information was included as to the current financial status of the franchise.
The financial statements of the franchisor were not for its most recent fiscal year.
There was no Certificate of the franchisor.
There was no copy of the head lease.
In addition, the Court, curiously, stated that the disclosure document “did not contain earnings projections”.
In this case, the material, location-specific deficiencies were that the disclosure documents given did not reflect that the franchise had been operating for more than one year, nor did it reflect the current financial status of the already operating franchise, or provide a copy of the all-important head lease.
Now that the pre-franchise disclosure obligations upon franchisors have been in place in Ontario for almost a decade, i.e. since January 31, 2001, there is a growing body of jurisprudence arising from the cases decided under the Act25. This includes the several cases here, which highlight the material disclosure deficiencies of franchisors which specifically focus upon location-specific or franchise-specific information as being considered “material facts” required to be disclosed to each prospective franchisee.
The comments and findings of the Courts are clear, as highlighted by the case which is the subject matter of this Article, together with the cases which it followed and considered, as well as the subsequent cases mentioned above. Disclosure to a prospective franchisee, in order to be found to be proper disclosure within the disclosure requirements of the legislation, must include location-specific material facts, some of which are highlighted by these cases.
No doubt other cases may find additional location-specific disclosure deficiencies which a Court, whether in Ontario or another disclosure province26, will find to be material.
The findings, and the required processes now appear to be clear. The days of generalized disclosures by a franchisor using a standardized disclosure document prepared for multiple uses, and multiple disclosures to multiple prospective franchisees about multiple proposed franchise locations or territories, appear to be over.
These cases make it abundantly clear that, going forward with disclosures under Canadian law, the franchisor must include in its individual disclosure documents, the material location-specific information which it has available to it at the time of making its initial disclosure to a prospective franchisee. Further, in cases where there is a time lag between
disclosure and opening of the franchised business, the franchisor may well also be obligated to provide the prospective franchisee with further formal disclosure, by way of one or more Statements of Material Changes, each having a signed and dated Certificate of the franchisor attached, as soon as practicable after the change in information has occurred, or the newly-acquired information has been received by the franchisor, where the franchisee has not yet signed all of the agreements relating to the franchise, or paid all of the consideration for or relating to the franchise to the franchisor or the franchisor’s associate.
These processes are more onerous than many franchisors would like, but the current state of the cases clearly indicates that the lesson to be learned from them is that location-specific, or territory-specific, or franchise-specific information in the possession of the franchisor, is material information which requires disclosure. The penalties for a materially deficient disclosure to a prospective franchisee, namely, the opening up of a 2-year window for the exercise of a statutory right of rescission, are clearly too significant to be ignored.