In the July 5, 2007 decision in MDG Kingston Inc. et al v. MDG Computers Canada, et al the Honourable Madam Justice H.K. MacLeod of the Ontario Superior Court of Justice granted the franchisee’s motion for summary judgment in part. She also declared that the franchise agreement at issue had been properly rescinded by the franchisee due to the franchisor’s failure to provide a disclosure document to the franchisee. This is the first case to decide the issue of when a franchisor is obliged to deliver a disclosure document to a franchisee on renewal of a franchise agreement.

The Facts

The franchise agreement in question was not the original agreement entered into between the franchisor and franchisee. That agreement, dated February 17, 2000, had expired on February 17, 2005. Rather, the agreement in issue was the second franchise agreement. It was signed on February 17, 2005, the day the original franchise agreement had expired, and was an extension or renewal of the first agreement. The franchisor did not provide the franchisee with a disclosure document with respect to the second franchise agreement.

Section 5(7)(f) Exemption

The franchisor relied on section 5(7)(f) of the Arthur Wishart Act (Franchise Disclosure), 2000, S.O. 2000, c. 3 (the Act), which provides the only exemption from disclosure relating to the renewal of a franchise agreement as follows:

(f) the renewal or extension of a franchise agreement where there has been no interruption in the operation of the business operated by the franchisee under the franchise agreement and there has been no material change since the franchise agreement of latest renewal or extension of the franchise agreement was entered into ...

The Court’s Findings On Material Change

As there had been no interruption of the business operated by the franchisee, the only issue before the court was whether there had been a material change since the original franchise agreement had been entered into on February 17, 2000.

After reviewing the two franchise agreements, the court was satisfied that there was a series of changes and differences in the second franchise agreement affecting costs of services, allocation of expenses among franchisees, punitive penalty provisions, purchase price of goods and warranty service provisions. In the court’s estimation, these provisions were fundamental to business operations and would have reasonably been expected to have an effect on the decision of the franchisee to acquire the franchise or to continue in operation. As such, the franchisor had been obliged to provide a disclosure document to the franchisee in respect of the second franchise agreement. Since the franchisor failed to do so, the franchisee was entitled to rescind the second franchise agreement. What is interesting in this case is the fact that the franchisee had rescinded the agreement exactly two years less one day from the date of execution of the agreement. Significantly, the court commented that it would be “exceptionally rare” for no material changes with respect to a franchise business to have occurred within a period of five years.

As a possible means for the franchisor to rely on the exemption, the court remarked that the franchisor could have obtained an acknowledgment stating presumably that the changed items would not have affected the decision of the franchisee to renew. However, since the discussion about an acknowledgement was taken somewhat out of context from an article on disclosure exemptions reviewed by the court, it would be unwise for a franchisor to follow this approach alone without any disclosure.

The Court’s Comments on the Purpose of the Act

In the course of finding that the franchisee was entitled to rescind the second franchise agreement within two years of the date of renewal, the court commented on the focus of the Act. Citing the Ontario Court of Appeal decision in 1490664 Ontario Ltd. v. Dig This Garden Retailers Ltd., (2005) Can LII 25181, the court stated that the focus of the Act is to protect the interests of franchisees and that the Act is remedial legislation. As such, the Act must be given a “broad and purposeful reading as it is a form of consumer protection legislation.”

The Arbitration Provision Does Not Apply

The franchisor had moved to stay the entire proceeding on the basis that the original franchise agreement contained an arbitration provision and that the court therefore had no jurisdiction to hear the matter. The court noted that the first franchise agreement had been signed before the Act was in force. Further, the franchisor could not rely on the franchisee’s knowledge of the arbitration provision in the first franchise agreement to obviate the franchisor’s lack of financial disclosure on the renewal of the franchise agreement. Rather, if an alternate dispute resolution mechanism is to be relied on, the Act requires that it be detailed in a disclosure document. Accordingly, the franchisor’s stay motion was dismissed.

Damages for Rescission

The court ordered a trial on the issue of damages arising from the rescission of the second franchise agreement.

The court ordered costs to the franchisee in the amount of $7,000 to be paid within 60 days. The court so ordered in spite of the fact that there was no prior case law on the issue of when a franchisor needs to provide a disclosure document in respect of a renewal.

Conclusion

To avoid the risk of a franchisee rescinding a renewed or extended franchise agreement, a franchisor should act prudently and prepare and deliver a disclosure document on the renewal or extension of a franchise agreement.