In its September 30, 2008 decision in MDG Kingston Inc. et al v. MDG Computers Canada Inc. et al, the Ontario Court of Appeal considered whether an arbitration clause in a franchise agreement applies even after that franchise agreement has been rescinded under the terms of the Arthur Wishart Act (Franchise Disclosure), 2000 (the Act). In a unanimous decision written by the Honourable Justice Feldman, the court ruled that an arbitration provision in a statutorily-rescinded franchise agreement still governed the dispute resolution process between the parties to the agreement. This decision overturns the findings of the Honourable Madam Justice H.K. MacLeod of the Ontario Superior Court of Justice about the arbitration agreement in the trial decision of this case. That trial decision was discussed in the February 2008 issue of the Osler Franchise Review.

The Facts

The parties were a computer store franchisor and a franchisee in Kingston, Ontario. Their original franchise agreement, which they had entered into in 2000, expired in 2005. The parties entered into a second franchise agreement on the expiration of the first. This second agreement was an extension or renewal of the original agreement. The franchisor did not provide the franchisee with a disclosure document for the second agreement.

The second franchise agreement contained an arbitration provision that dictated that any dispute between the parties was to be resolved by way of arbitration rather than through the courts. In 2007, the franchisee rescinded the second agreement within two years of signing it on the grounds that the franchisor had failed to deliver a disclosure document as required under section 5 of the Act. The franchisee relied on section 6(2) of the Act for the claimed right of rescission.

The Original Motion

The franchisee brought an action for statutory rescission and damages. The franchisor responded by bringing a motion for a stay of the action based on the arbitration clauses in both agreements. The franchisee then moved for summary judgment for rescission. As discussed in the February issue of the Osler Franchise Review, Madam Justice MacLeod found that the franchisee was entitled to rescind the franchise agreement under the Act. The franchisor was not entitled to enforce the arbitration clause in the franchise agreement. Macleod, J. noted that the Act and its regulations required any alternative dispute resolution mechanism (such as arbitration) to be described in detail in the disclosure document. Since there was no disclosure document, the franchisor could not rely on this provision. Madam Justice MacLeod dismissed the franchisor’s motion and granted summary judgment in favour of the franchisee.

The Issue on Appeal

The issue in the Court of Appeal was whether the motion judge erred both by failing to order a stay of the action so that the claims could be referred to arbitration and by proceeding to grant summary judgment on the claim for rescission of the second franchise agreement.

Validity of the Arbitration Clause

The court found that there was nothing in the Act that excluded the application of the Arbitration Act, 1991 (Arbitration Act) that governs arbitrations in the province of Ontario. The Arbitration Act directs courts to stay actions that are commenced in the face of arbitration agreements with only limited exceptions i.e., when the arbitration agreement is invalid or when the matter is a proper one for default or summary judgment. After examining the arbitration clause in the second franchise agreement, the court found that the parties’ dispute (namely, rescission and damages) fell within the ambit of the arbitration clause. As such, unless the exceptions (as discussed above) applied, the motions judge should have stayed the action and referred the claim to arbitration.

The court determined that the arbitration clause was valid. In examining the case law on the matter, the court stated that

[i]n cases where the dispute is about whether the agreement was breached by one party and consequently terminated by the other, and whether that termination has the effect of terminating the arbitration clause as well, the case law makes clear that the court is not to determine the merits of that issue on a stay motion. Instead, the issue of whether the entire contract was properly terminated and the effect of any such termination is for the arbitrator.

However, this was contrasted with situations in which the franchise agreement in question was void ab initio because it was illegal or because no agreement had ever been reached. In those cases, the arbitration clause did not apply because there was no agreement in the first place.

In this case, the court found that the franchisee agreement was not void ab initio as there had not been any fraud. The court held that the agreement was valid. The only problem with the agreement was that it was subject to statutory rescission under the Act, which was not enough to render the agreement void for purposes of nullifying the arbitration clause. The court held that there was nothing in the Act that suggested that the arbitration clause could not survive the statutory rescission of the franchise agreement. The Act did not restrict the parties’ right to resolve their disputes (even disputes about rescission) by way of arbitration.

The Court concluded that Madam Justice MacLeod erred in finding that the arbitration clause was invalid because of the lack of disclosure about alternative dispute resolution in the franchise disclosure documents. The franchise agreement was not invalid at law; instead, it was only statutorily rescinded. Accordingly, the issue of whether the franchisee was entitled to rescind the franchise agreement was an issue for the arbitrator, not the courts.

The Motion Judge’s Decision to Award Summary Judgement was Incorrect

The Court of Appeal noted that an arbitration could be stayed under the Arbitration Act if the matter were one that could be properly disposed of by way of summary judgment. However, this is a limited exception and should only be relied on if there are no issues that require the assistance of an arbitrator. In this case, there was not sufficient evidence that the franchisee’s action could be decided by way of summary judgment. The court pointed to the fact that the motion judge was not able to determine the issue of damages and ordered a full trial on the issue. As such, it was improper to characterize the dispute as one that did not require the assistance of an arbitrator.

The court succinctly summarized the motion judge’s decision on summary judgment:

The effect of the order was to remove the damages issue from arbitration and send it to trial in circumstances where the matter did not fail within [the exceptions outlined in] the Arbitration Act because the whole matter was not a proper matter for summary judgment. The finding of partial summary judgment was, therefore, not a proper basis to refuse the mandatory stay under the [Arbitration Act].

The Court of Appeal allowed the appeal and set aside the summary judgment.

Conclusion

Franchisors in Ontario can take some comfort in this decision. The Ontario Court of Appeal has recognized that arbitration clauses in franchise agreements will still be valid even if such agreements are statutorily rescinded due to the failure of the franchisor to provide adequate (or any) disclosure.