Franchising is an increasingly attractive business model for many businesses. However, many companies would prefer to avoid the lengthy and costly process required to prepare and continually update the detailed disclosure document that is mandated by Ontario’s Arthur Wishart Act (Franchise Disclosure), 2000 (the Act), which must be provided by a franchisor to each prospective franchisee. The need to provide disclosure pursuant to the Act is not, however, an absolute requirement, as the Act provides for certain exemptions from disclosure which, if applicable, eliminate the requirement for that particular franchisor to provide disclosure to a particular franchisee in a given situation. For additional information regarding franchise legislation, disclosure requirements thereunder and disclosure exemptions, please see our March 2012 article: Disclosure Requirements of Ontario’s Franchise Legislation and the Rescission Remedy.
Over the past year, two significant decisions have been rendered by the Ontario Court of Appeal regarding the availability of exemptions to franchisors’ disclosure obligations under the Act. In addition, a third case addressing disclosure exemptions was recently released by the Ontario Superior Court of Justice. These three cases provide valuable insight into the judiciary’s current position on the application and availability of disclosure exemptions pursuant to the Act.
Decisions of the Ontario Court of Appeal
In TA&K Enterprises Inc. v. Suncor Energy Products Inc. , the Ontario Court of Appeal (the Court) was asked to consider whether Suncor was exempt from providing a disclosure document by virtue of section 5(7)(g)(ii) of the Act, which excuses the franchisor from this requirement where “the franchise agreement is not valid for longer than one year and does not involve the payment of a non-refundable franchise fee.”
TA & K Enterprises Inc. (TA&K) was a franchisee that operated a Sunoco gasoline service station. On November 11, 2008, TA&K and Suncor signed a Retail Franchise Agreement (the RFA) with a term of one year starting on November 15, 2008 and ending on November 14, 2009. In October 2009, following the Petro-Canada and Suncor merger, Suncor sent a letter to TA&K informing them that when the RFA expired in November 2009, there would be an extension of the RFA on a month-to-month basis upon the same terms and conditions as the original agreement. On January 12, 2010, Suncor sent another letter to TA&K advising them that the RFA would terminate on August 12, 2010. Subsequently, TA&K commenced a class action alongside other franchisees alleging that Suncor had not provided a disclosure document as required under the Act. In response, Suncor brought a motion for summary judgment seeking to have the action dismissed on the basis that no disclosure document was required.
On the motion for summary judgment, Justice Perell found that the section 5(7)(g)(ii) exemption applied to relieve Suncor of the obligation to provide TA&K with a disclosure document. He made this finding based on the fact that the RFA: (1) was not valid for more than one year; and (2) did not involve the payment of a nonrefundable franchise fee.
TA&K appealed the decision, asserting that Suncor did not meet the requirements of section 5(7)(g)(ii) of the Act, as the term of the RFA extended beyond the one-year threshold. They made this argument based on several factors, including:
- relying on the November 11, 2008 signature date to demonstrate that the agreement covered a period longer than one year;
- asserting that the extension letter issued by Suncor in October 2009 should be treated as lengthening the term of the initial agreement; and
- arguing that the survival of certain provisions in the RFA beyond the end of the term of the RFA extended the term of the agreement.
Further, TA&K submitted that the royalty payments made to Suncor over the term of the agreement should be considered to be the payment of franchise fees.
The Court rejected TA&K’s arguments and upheld Justice Perell’s decision. The panel, comprised of Justices Goudge, MacFarland and Watt, relied on the underlying policy of the exemption and found that disclosure was not required in this circumstance, as the period during which the franchisee would be accepting rights and obligations under the RFA was of a short enough duration that they would be at minimal risk. The Court also found that the October 2009 extension letter would not extend the term beyond the one-year threshold to negate the availability of the exemption, but would instead be considered an additional term that followed the initial term. Moreover, the Court held that the survival of certain provisions, such as indemnity and confidentiality provisions, beyond the termination of the agreement, did not extend the term of the franchise agreement itself as an agreement that has been terminated or expired cannot be considered to be valid. Finally, the Court found that a “franchise fee”, a term that is not defined in the Act, “is in the nature of a fee paid for the right to become a franchisee” that would be paid to the franchisor before a franchisee commenced operations and does “not include royalties or payments for goods or services” that a franchisee would pay to the franchisor during the term of the agreement.
In 2189205 Ontario Inc. v. Springdale Pizza Depot Ltd. (Springdale Pizza), the Court’s decision, released on June 22, 2011, provides the latest application of section 5(7)(a)(iv) of the Act, which exempts a franchisor from providing a disclosure document upon a resale of a franchise by a franchisee.
In Springdale Pizza, the prospective franchisee approached the franchisor directly regarding the purchase of a franchise. As a result, the franchisor directed the prospective franchisee to an existing Pizza Depot franchise that was available for sale, and the prospective franchisee subsequently purchased the assets of that franchised restaurant. Although the prospective franchisee purchased the franchise directly from the existing franchisee, evidence at trial indicated that all of the parties (including the franchisor) were involved in the negotiations that culminated in the sale of the franchise. In addition, to complete the transaction, the franchisor required the prospective franchisee to sign supplementary documents in order for the franchisor to provide their consent to the transfer. The franchisor did not provide a disclosure document to the new franchisee and, after operating for several months, the new franchisee brought an action for rescission based upon such non-disclosure.
The franchisor relied on sections 5(7)(a)(iv) and 5(8)(a) of the Act and claimed that it was exempt from disclosure obligations upon the resale of the franchise by the franchisee, as the resale was not “effected by or through a franchisor”. In contrast, the new franchisee submitted that the franchisor’s conduct during the sale, coupled with the franchisor’s requirement that the new franchisee sign additional documents, took the franchisor outside the parameters of this exemption. The Court upheld the lower court’s decision and found in favour of the new franchisee, holding that the exemption was not available in this case as the franchisor was not merely a passive participant in the resale of the franchise.
The Court found that, given the remedial nature of the Act, the disclosure exemption set out in sections 5(7)(a)(iv) and 5(8) of the Act must be narrowly construed. Moreover, the language used in those provisions only provides an exemption when the franchisor is “not an active participant in bringing about the grant and does nothing more than ‘merely’ exercise its rights to consent to the transfer” (emphasis added).
The Court held that a number of circumstances, taken together, supported the conclusion that the resale was brought about or caused to happen by or through the franchisor, specifically:
- the franchisor directed the respondents to this particular purchaser;
- the franchisor negotiated together with the vendor and the respondent to bring about the sale of the franchised business and the assignment of the franchise;
- the agreement of purchase and sale required the respondents to obtain the consent of the franchisor and thus deal directly with the franchisor; and
- the franchisor required execution of documents by the new franchisee that the vendor had not been required to sign.
Note, however, that while the Court found that these factors together amounted to a resale that was “effected by or through the franchisor”, they were careful to point out that, on their own, any of these individual circumstances may not have been sufficient to preclude the use of this disclosure exemption. However, on balance, in the case of transfers, the prudent course would be for the franchisor to provide disclosure to the new franchisee on the basis that this disclosure exemption will be narrowly construed and has been found not to be available in certain cases.
Decision of the Ontario Superior Court of Justice
Although the case was not decided on the basis of the “additional franchise” disclosure exemption referenced in section 5(7)(c) of the Act, 3574423 Canada Inc. v. Baton Rouge Restaurants Inc. (released on November 14, 2011), provides useful insight into the future application of this exemption given the comments of the Ontario Superior Court of Justice (the Superior Court).
3574423 Canada Inc. (the Eaton Centre Franchisee) operated a Baton Rouge Restaurant franchise in the Toronto Eaton Centre starting in 1999. The franchise agreement (the Agreement) between the parties contained a right of first refusal (ROFR), granting the Eaton Centre Franchisee the opportunity to acquire the franchise rights for the second Baton Rouge restaurant planned for the Greater Toronto Area. In 2000, the franchisor offered the Eaton Centre Franchisee a new restaurant opportunity in Thornhill (located just north of Toronto). However, that opportunity lapsed when the landlord cancelled the offer to lease for that property. Two subsequent opportunities were offered, but in each case the Eaton Centre Franchisee declined such opportunity and the Agreement was amended, by the signing of a waiver, to extend the ROFR to the next location planned for the Greater Toronto Area.
In 2001, the Thornhill restaurant opportunity returned. Again, the Eaton Centre Franchisee drafted and signed a waiver which indicated that they declined this particular opportunity, but wished to preserve their ROFR for future opportunities. However, at this time, the franchisor indicated that there would be no further extension of the ROFR. In 2004, another franchise became available in the designated area and the Eaton Centre Franchisee was not offered the ROFR with respect to such location.
The Eaton Centre Franchisee brought a claim against the franchisor under the Act on two grounds: (1) breach of the duty of fair dealing; and (2) breach of disclosure obligations which the franchisee alleged arose when the Thornhill opportunity was presented for the second time. Given that the Act was not in force at the time the original Agreement was entered into, the key issue at trial was whether the disclosure requirements under the Act applied to the franchisor’s 2001 offer to the Eaton Centre Franchisee relating to the revived Thornhill location in accordance with the ROFR. The Eaton Centre Franchisee submitted that the Act’s disclosure requirements applied for several reasons including:
- the franchisor’s “invitation” to the Eaton Centre Franchisee to accept the Thornhill location combined with the executed waiver document formed a “franchise agreement” pursuant to the Act;
- the Eaton Centre Franchisee was a prospective franchisee with respect to the “next” restaurant and was consequently entitled to receive the required disclosure document when the franchisor notified the Eaton Centre Franchisee of the revived Thornhill location;
- the 2001 waiver signed by the Eaton Centre Franchisee as a prospective franchisee was a “franchise agreement or any other agreement relating to the franchise” within the meaning of section 5(1)(a) of the Act; and
- section 5(1)(a) of the Act (the disclosure requirement) applied even though, in the end, the Eaton Centre Franchisee did not become the franchisee for the Thornhill location.
The Superior Court rejected the Eaton Centre Franchisee’s claim pertaining to the franchisor’s alleged breach of disclosure requirements under the Act and held that the 2001 waiver was not a franchise agreement between the parties or “any other agreement relating to the franchise” as defined in the Act. Consequently, since there was no agreement, the Eaton Centre Franchisee was not entitled to the remedies afforded by the Act. The Superior Court stated that “section 5 disclosure requirements are linked to very specific acts – the signing of a franchise agreement or ‘any other agreement relating to the franchise’ and the payment of consideration.” Put another way, though section 5(1) requires disclosure be made to a prospective franchisee, the Superior Court held that the Act only affords remedies for the breach of such requirements to prospective franchisees that become actual franchisees.
The Superior Court also took the opportunity to clarify that the phrase “any other agreement relating to the franchise” in section 5(1) of the Act refers to ancillary documents signed by a franchisee in connection with entering into a franchise agreement. Simply put, the phrase pertains solely to an agreement signed by a franchisor and an actual franchisee and would not capture a document entered into by a prospective franchisee that does not became an actual franchisee.
In obiter (meaning that such comments reflect the judge’s opinion and are not regarded as binding or decisive), the Superior Court opined on the application of section 5(7)(c) of the Act to the case. Section 5(7)(c) of the Act relieves the franchisor from the duty to disclose to an existing franchisee if: (1) the additional franchise is substantially the same as the existing franchise operated by the franchisee; and (2) there has been no material change since the existing franchise agreement, latest renewal or extension was entered into.
Since no case law on the application of section 5(7)(c) existed, the Superior Court considered cases that discussed the “renewal exemption” in section 5(7)(f) of the Act and the “no longer than one year exemption” in section 5(7)(g)(ii) of the Act. Upon reviewing such case law, the Superior Court came to the conclusion that the exemptions reflect a legislative view that “where the franchisee is already familiar with the operations of the franchise system and the risk of making a further investment of funds is low, no need for the full disclosure requirements of section 5 exist.” In other words, the asymmetry of information that often exists between a franchisee and franchisor is considerably reduced by the franchisee’s knowledge and experience regarding the operation of its current franchise, significantly curtailing the need for disclosure and no longer aligning with the policy rationale behind the Act’s disclosure requirement.
The Superior Court applied this view to the “additional franchise exemption” and held that the difference in the size of territories was not a material difference as it did not affect the operational or financial relationship between the parties. Further, the fact that the Thornhill franchise agreement did not contain a ROFR did not make the two locations substantially different in terms of their operation or prudency of investment. As such, the Superior Court held there was no material change to the Agreement and, moreover, the additional franchise would have been substantially similar to that already operated by the Eaton Centre Franchisee. In the result, if needed, the franchisor could have relied on the application of the exemption found in section 5(7)(c) of the Act in support of the fact that the franchisor was not obligated to provide disclosure to the Eaton Centre Franchisee in this case.
Franchisors and franchisees alike should take note of the decisions in the Suncor, Springdale Pizza and Baton Rouge cases as they provide useful insight into the courts’ continuing journey to protect the interests of franchisees and balance the rights of franchisors and franchisees under the Act. While the Springdale Pizza decision confirms the commonly held view among franchise practitioners that it is prudent to disclose to prospective franchisees on franchise re-sales, both the Suncor case and the Baton Rouge case evidence the courts’ willingness to confirm the availability of the Act’s disclosure exemptions in situations where franchisees have sufficient information to make an informed investment decision or sufficiently limited risk that such potential franchisees do not require the protection of the Act.
Disclosure Requirements of Ontario’s Franchise Legislation and the Rescission Remedy
Introduction to Ontario’s Franchise Legislation
Franchising is not as heavily regulated in Canada as it is in a number of other jurisdictions, including the U.S. In Canada, franchise regulation is purely a provincial matter. Currently, only five Canadian provinces have franchise legislation in place: Ontario, Alberta, Prince Edward Island, New Brunswick and Manitoba (which has received Royal Assent but is not yet in force pending the finalization of the regulations thereunder). While there are certain differences in the legislation and regulatory requirements of each province, they are all derived ultimately from the U.S. model of mandated disclosure by a franchisor to prospective franchisees, coupled with a duty of good faith and fair dealing owed by each party to a franchise agreement to the other, and a right of franchisees to associate freely amongst themselves.
Unlike the U.S., no Canadian province requires either the registration of franchisors or the public filing of their disclosure documents. The legislative requirements are all enforceable only by private rights of action and the right of the franchisee to rescind its franchise agreement in the absence of proper disclosure by the franchisor (as described in further detail below).
Ontario’s Arthur Wishart Act (Franchise Disclosure), 2000 (the Act) strives to address the imbalance of power and asymmetry of information typically found in the relationship between franchisors — often large, sophisticated corporations, and franchisees — often less sophisticated individuals. The Act applies to a franchise agreement entered into, or to a renewal or extension of a franchise agreement, on or after July 1, 2000 with respect to franchise locations operated partly or wholly in Ontario. The Act is designed primarily to protect franchisees by giving them the information they need to make an informed decision about whether to invest in a given franchise, as well as a commercial framework that assures they will be treated fairly.
The Act contains three primary elements:
- disclosure by the franchisor to its prospective franchisees;
- a duty of good faith and fair dealing on all parties to the franchise agreement; and
- a right of association on the part of franchisees.
This article provides background information regarding the first of these elements and the remedies available to a franchisee for a franchisor’s failure to comply with its disclosure obligations under the Act.
The Ontario Court of Appeal described the purpose of the Act this way in Personal Coffee Cup Corp. v. Beer (c.o.b. Elite Coffee Newcastle): “... 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.”
Disclosure Requirements under the Act
Under the Act, a franchisor is required to deliver to each prospective franchisee a disclosure document which contains all material facts about the franchise and the franchisor, and copies of all agreements relating to the franchise to be signed by the prospective franchisee, and which meets the detailed requirements set out in the regulations made under the Act (the Regulations). The information provided in the disclosure document must be accurate, clear and concise. The disclosure document must be delivered not later than 14 days prior to the earlier of the franchisee’s signing of the relevant franchise agreement and its paying any consideration to the franchisor in relation to the franchise. The disclosure must be in a single document, delivered as such at one time, and must be certified as true and complete by two officers or directors of the franchisor. In addition, should any “material change” occur, which renders inaccurate the information provided in the original disclosure document, the Act requires the franchisor to provide the prospective franchisee with a clear and concise written statement detailing such material change as soon as possible after it occurs, and, in any event, no later than the earlier of the franchisee’s signing of the franchise agreement and its paying any consideration to the franchisor in relation to the franchise.
There is a long list of information included in the Regulations which must be set out in the disclosure document, including details regarding the business background of the franchisor, its finances, its bankruptcy and insolvency history, the franchisee’s expected costs associated with establishing the franchise and contact particulars for both current and former franchisees. The overarching requirement is that the document contain all “material facts” related to the franchise, which includes any information about the business, operations, capital or control of the franchisor, or about the franchise system, that would reasonably be expected to have a significant effect on the value or price of the franchise to be granted or the decision to acquire it.
If the franchisee suffers a loss because of a misrepresentation contained in the disclosure document, the franchisee has a right of action for damages against the franchisor and against every person who signed the disclosure document. It should be noted that franchisees are deemed to have relied on any misrepresentation contained in a disclosure document and that a “misrepresentation” is defined to include an untrue statement of a material fact, or an omission to state a material fact that is required to be stated or that is necessary to make a statement not misleading in light of the circumstances in which it was made. More significantly, if the franchisor delivers the disclosure document late or the disclosure fails to meet the requirements of the Act, the franchisee has the right to rescind the franchise agreement, without penalty or obligation, within 60 days after its receipt of the disclosure document. If the disclosure document is never delivered at all, the rescission remedy is available for two years after the date the franchisee entered into the franchise agreement. Of particular interest to franchisors is the fact that, in the event of rescission, the franchisor must compensate the franchisee for any losses it incurred in acquiring, setting up and operating the franchise.
In particular, the Act provides that within 60 days of the effective date of the rescission, the franchisor must:
- refund to the franchisee any money received from or on behalf of the franchisee, other than money for inventory, supplies or equipment;
- purchase from the franchisee any inventory that the franchisee had purchased pursuant to the franchise agreement and remaining at the effective date of rescission at a price equal to the purchase price paid by the franchisee;
- purchase from the franchisee any supplies and equipment that the franchisee had purchased pursuant to the franchise agreement, at a price equal to the purchase price paid by the franchisee; and
- compensate the franchisee for any losses that the franchisee incurred in acquiring, setting up and operating the franchise, less the amounts set out in clauses (1) to (3) above.
Disclosure Exemptions under the Act
The disclosure obligations under the Act are not applicable in all cases. Section 5(7) of the Act provides a number of exemptions from mandatory disclosure, even where the relationship is found to be a “franchise” and the Act applies generally (with similar exemptions from disclosure typically available in other Canadian jurisdictions with franchise legislation). Salient disclosure exemptions which may be available to a franchisor in certain cases include the following:
- One year, no payment exemption (Section 5(7)(g)(ii) of the Act): Where the franchise agreement to be entered into between the parties is not valid for longer than one year, and does not involve the payment of a non-refundable franchise fee, an exemption to disclosure is available in Ontario. An analogous exemption is not available under the Alberta Franchises Act. The New Brunswick Franchises Act, Prince Edward Island Franchises Act and Manitoba Franchises Act allow for a similar exemption; however, in addition to the limited term (not more than one year) and no payment of a non-refundable franchise fee requirements, the franchise legislation of each of New Brunswick, Prince Edward Island and Manitoba also requires that the franchisor or franchisor’s associate provide location assistance to the franchisee for this exemption to be available.
- Large investor exemption (Section 5(7)(h) of the Act): An exemption exists under the Act for instances where the franchisee will invest more than C$5-million in one year in the acquisition and operation of the franchise. This exemption is not available in any of the other provinces with franchise legislation in effect.
- Exemption upon renewal or extension of the franchise (Section 5(7)(f) of the Act): In cases of renewal or extension of a franchise agreement where there has been (1) no interruption in the operation of the business operated by the franchisee under the franchise agreement and (2) no material change since the franchise agreement or latest renewal or extension of the franchise agreement was entered into, an exemption from disclosure is available under the franchise legislation of each of Ontario, Alberta, Prince Edward Island, New Brunswick and Manitoba. It should be noted that the Alberta legislation does not condition the availability of this exemption on there not being any material change. “Material change” is defined in subsection 1(1) of the Act as “... a change in the business, operations, capital or control of the franchisor or franchisor’s associate, a change in the franchise system or a prescribed change, that would reasonably be expected to have a significant adverse effect on the value or price of the franchise to be granted or on the decision to acquire the franchise and includes a decision to implement such a change made by the board of directors of the franchisor or franchisor’s associate or by senior management of the franchisor or franchisor’s associate who believe that confirmation of the decision by the board of directors is probable.”
- Exemption where the grant of the franchise is not effected by or through the franchisor (Section 5(7)(a)(iv) of the Act): An exemption also exists for grants of a franchise by a franchisee, for the franchisee’s own account, where the grant is not effected by or through the franchisor. Section 5(8) of the Act clarifies that a grant is not effected by or through a franchisor merely because (1) the franchisor has a right, exercisable on reasonable grounds, to approve or disapprove the grant or (2) a transfer fee must be paid to the franchisor in an amount set out in the franchise agreement or in an amount that does not exceed the reasonable actual costs incurred by the franchisor to process the grant. This exemption may be available in cases where a franchisee sells its business to a new franchisee. This exemption is available for franchises in each of Ontario, Alberta, Prince Edward Island, New Brunswick and Manitoba.
- Exemption upon the grant of an additional franchise to an existing franchisee (Section 5(7)(c) of the Act): An exemption from the Act’s disclosure requirements is available in the case of a grant of an additional franchise to an existing franchisee if that additional franchise is substantially the same as the existing franchise that the franchisee is operating and if there has been no material change since the existing franchise agreement or latest renewal or extension of the existing franchise agreement was entered into.
- Fractional franchise exemption (Section 5(7)(e) of the Act): An exemption from the Act’s disclosure requirements is available in the following circumstance: The granting of a franchise to a person to sell goods or services within a business in which that person has an interest if the sales arising from those goods or services, as anticipated by the parties or that should be anticipated by the parties at the time the franchise agreement is entered into do not exceed, in relation to the total sales of the business, a prescribed percentage. Each Canadian jurisdiction with franchise legislation in effect has a comparable exemption available and the “prescribed percentage” is 20%. Thus, if sales from a particular franchisor’s products are anticipated by the parties, at the time the agreement is made, to account for less than 20% of the overall sales of a franchisee’s business, the franchisor can avail itself of the fractional franchise disclosure exemption.
It is important to note that the Act places no express obligation on a franchisor to advise a prospective franchisee that it is relying on a specific disclosure exemption as the reason for not delivering a disclosure document to the prospective franchisee. However, if the franchisee challenges the applicability of an exemption, the onus will be on the franchisor to demonstrate that such disclosure exemption applied.