Two recent Ontario cases - Sovereignty Investment Holdings v. 9127-6907 Quebec Inc et al. (Sovereignty Investment Holdings) and 6862829 Canada Ltd. v. Dollar It Ltd. (6862829 Canada Ltd.) - suggest that the failure to include required information in a disclosure document provided to a franchisee is equivalent in law to providing no disclosure document at all. Given that a franchisor’s failure to provide a disclosure document entitles a franchisee to rescind the franchise agreement at any time within two years of entering into the agreement, the failure to include required information in a disclosure document potentially lengthens the period during which a franchisor is exposed to the risk of rescission of the franchise agreement by the franchisee. In light of this development, franchisors would be well-advised to take extra care when making disclosure to prospective franchisees to ensure that the disclosure document is complete, accurate and up-to-date.
The Rescission Remedy
Section 6 of the Arthur Wishart Act (Act) provides that a franchisee may rescind the franchise agreement in two cases: (1) where no disclosure document is provided; or (2) where a disclosure document has been provided but is incomplete or is provided late. The latter case is addressed by subsection 6(1) of the Act, which provides for rescission within 60 days after receiving the disclosure document if there is non-compliance with the requirements under the Act and associated regulation. On the other hand, subsection 6(2) of the Act provides for rescission within two years after entering into the franchise agreement if a disclosure document was not provided at all.
Franchisor’s Obligations on Rescission
The financial consequences to a franchisor of an effective rescission can be very significant. Subsection 6(6) of the Act provides that if the rescission is effective, the franchisor or the franchisor’s associate must, within 60 days:
(a) refund any money received, other than money for inventory, supplies or equipment;
(b) purchase from the franchisee any inventory purchased pursuant to the franchise agreement at the original purchase price paid by the franchisee;
(c) purchase from the franchisee any supplies and equipment that the franchisee had purchased pursuant to the franchise agreement at the original purchase price paid by the franchisee; and
(d) compensate the franchisee for any losses that the franchisee incurred in acquiring, setting up and operating the franchise (less the amounts set out above).
In Payne Environmental Inc. v. Lord and Partners Ltd., the Ontario Superior Court of Justice observed that the intent of subsection 6(6) of the Act is “to put the franchisee in the position that it was prior to entering into the franchise agreement.”
Inadequate Disclosure or No Disclosure?
Where a franchisee attempts to rescind the franchise agreement, there will often be a dispute about whether the franchisor provided a disclosure document for the purposes of the Act. As a franchisor usually provides at least some written information to a prospective franchisee prior to the execution of a franchise agreement, franchisors in such cases typically take the position that, at worst, they provided a disclosure document that did not meet the statutory requirements and, hence, the shorter 60-day period under subsection 6(1) of the Act applies. On the other hand, franchisees seeking to rescind a franchise agreement often take the position that whatever documentation was provided to them was so deficient as to not constitute a disclosure document at all, in which case the longer two-year period under subsection 6(2) of the Act applies.
Previous Rescission Cases
There have only been a small number of reported decisions in which the Ontario courts have considered whether documentation provided by a franchisor to a franchisee was a “disclosure document” within the meaning of subsection 6(2) of the Act. In each of the cases below, the court found that the franchisor had never provided a disclosure document:
- 1490664 Ontario Ltd. v. Dig This Garden Retailers Ltd. – The franchisor provided various documents separately and at substantially different times. The Court of Appeal rejected the argument that a combination of written and oral information satisfied the disclosure requirement.
- 1518628 Ontario Inc. v. Tutor Time Learning Centres – The franchisor provided a U.S. Uniform Franchise Offering Circular solely for “informational” purposes and only a few days before the franchise agreement was signed.
- Walden v. 887985 Alberta Ltd. (c.o.b. Ag Connexions) – The franchisor’s purported disclosure document lacked financial statements, a list of franchisees and a signed certificate by the franchisor. Furthermore, no disclosure document was provided before execution of a replacement franchise agreement containing different terms.
As the disclosure in these instances was severely deficient, these cases provide limited guidance where the franchisor delivers what appears to be a single disclosure document written for the purpose of complying with the Act but which lacks certain required information. This question was not directly addressed by the Ontario courts until the decisions in Sovereignty Investment Holdings and 6862829 Canada Ltd. v. Dollar It Ltd., both of which were decided in November 2008.
Sovereignty Investment Holdings, Inc. v. 9127-6907 Quebec Inc et al.
In Sovereignty Investment Holdings, the Ontario Superior Court of Justice set out the following propositions regarding a franchisee’s entitlement to rescission pursuant to subsection 6(2) of the Act:
- A putative disclosure document is not a “disclosure document” for the purpose of subsection 6(2) of the Act if a deficiency in the document is “sufficiently material.” Examples of “sufficiently material” deficiencies include:
- failing to include financial statements for the franchisor;
- failing to include a statement specifying the basis for earnings projections;
- failing to deliver documentation in a single document at one time; and
- failing to include the signed certificate of the franchisor.
However, a number of minor deficiencies in a disclosure document cannot, on a cumulative basis, disqualify documentation as a “disclosure document” for the purpose of subsection 6(2) of the Act. In this case, the franchisee argued that the disclosure documentation received from the franchisor was so deficient that the franchisor failed to provide a “disclosure document” for the purposes of the Act. Prior to the execution of the franchise agreement, the franchisor delivered various documents at different times, including a supposed disclosure document. It was not disputed that the franchisor had failed to strictly comply with the disclosure requirements of the Act; but, the parties disagreed about the number of deficiencies in the supposed disclosure document.
The court, per Justice Wilton-Siegel, framed the issue “as whether there are any deficiencies that are sufficiently material that the court should conclude that the alleged disclosure document fails to satisfy the substantive requirements of the Act.” The court found four deficiencies (listed as the examples above), each of which alone was “fatal” to the franchisor’s assertion that it had complied with the requirement to deliver a disclosure document in accordance with the Act. The court did note, however, that: “a number of minor deficiencies cannot, on a cumulative basis, disqualify documentation as a ‘disclosure document’ for such purposes.”
6862829 Canada Ltd. v. Dollar It Ltd.
In 6862829 Canada Ltd., Justice De Sousa of the Ontario Superior Court of Justice reached a conclusion similar to that reached in Sovereignty Investment Holdings, stating:
a disclosure document, which for all intents and purposes meets the formal requirements of s. 5 (that is one document served at one time and served within the correct time frame before the entering into the franchise agreement) can be considered a nullity, and hence no disclosure, if it is materially deficient in its substantive content in breach of the requirements of s. 5.
It was not disputed in this case that the franchisor provided a disclosure document for the purposes of complying with the Act, as one document at one time, and within the required time. The court, however, found that the disclosure document lacked material information, including:
- financial statements;
- a certificate signed by the franchisor and at least one of its directors;
- notice of a pending law suit against the franchisor by one of its franchisees; and
- a copy of the existing Offer to Lease.
Accordingly, the court concluded that no disclosure document had been given within the meaning of subsection 6(2) of the Act and that the franchisee was entitled to rescind the franchise agreement pursuant to that provision.
Interestingly, a previous decision involving the same franchisor and same form of franchise agreement arguably conflicts with the reasoning in 6862829 Canada Ltd. In an unreported decision in 6792341 Canada Inc. v. Dollar It Limited (June 18, 2008), 08-CV-40893, (S.C.J.), the court, per Justice McLean, found that the disclosure document in question complied with the requirements of the Act. The court then went on to say that “even if that were not the case, the court does not find that the want of compliance would in any way void this document ab initio.”
In so stating, the court reasoned that a disclosure document’s want of compliance with the requirements of the Act is addressed by subsection 6(1), which provides for a shorter limitation period. In 6862829 Canada Ltd., Justice De Sousa did consider Justice McLean’s reasoning on this point but declined to adopt it. Justice De Sousa also observed that “[i]t may well be that our Court of Appeal will have to examine again this issue and provide some guidance to trial courts on the interpretation to be given to s. 6 of this new legislation.”
Although the Ontario Court of Appeal may soon provide more definitive guidance on this issue, for the time being, Sovereignty Investment Holdings and 6862829 Canada Ltd. suggest that the courts are inclined to view the inadvertent failure to include a material element of a disclosure document to be the same as providing no disclosure document at all.
In light of the financial consequences of rescission, franchisors should review their disclosure documents to ensure that they contain all required material information prior to providing the disclosure document to prospective franchisees. In particular, franchisors should:
- confirm that the disclosure document includes copies of all franchise agreements and other agreements relating to the franchise to be signed by the prospective franchisee;
- ensure that the financial statements of the franchisor are included and up-to-date and that the basis for any earnings projections is properly described; and
- verify that the certificate of the franchisor is signed and dated in accordance with the regulation.
These steps will reduce the risk that a franchisor will inadvertently fail to include required material information in a disclosure document, thereby permitting a franchisee to successfully rescind the franchise agreement at any time within two years of entering into the agreement.