A recent case from the Ontario Court of Appeal, 2256306 Ontario Inc. v. Dakin News Systems Inc. (Dakin), demonstrates some of the pitfalls that franchisors can face when navigating the treacherous waters of franchise transfers and disclosure.

Background to the Case

In the summer of 2010, the franchise agreement between Dakin News Systems Inc. (Dakin) and its franchisee, Mr. Khalife, expired. There was no formal renewal of the franchise agreement. Rather, Khalife continued to operate the news kiosk franchise on a month-to-month basis after the expiration. In February of 2011, Khalife sold the assets of the franchised business to a third party, Mr. Reda, who had previously acted as the manager of the news kiosk. In response to an inquiry from the lawyer jointly retained to act for Reda and Khalife on the sale, Dakin requested a $10,000 transfer fee and indicated that they had a right of approval. Dakin’s request was ignored and Reda and Khalife proceed to close the sale. Reda took over the franchise and began paying royalties to Dakin.

During a site visit to the franchise one year later, Dakin learned that the transfer had in fact occurred without its approval and demanded payment of the $10,000 transfer fee. Dakin also sent a new franchise agreement to Reda. Eventually, in October of 2012, Reda signed the new franchise agreement but did not pay the transfer fee. No disclosure document was provided. After a dispute with the landlord for the franchise in February of 2013, Reda sought to rescind the franchise agreement.

Dakin resisted the rescission, arguing that two statutory exemptions to the disclosure requirements under theArthur Wishart Act applied: (i) under section 5(7)(a)(iv) where the grant of the franchise is not affected by or through the franchisor, (ii) under 5(7)(g)(ii) where the grant of the franchise is not valid for longer than one year and no non-refundable franchise fee is payable.

Summary Judgment Motions and Appeal

Both parties brought competing summary judgment motions. At first instance, the Ontario Superior Court of Justice found that neither of these exemptions applied and the plaintiff was successful in obtaining an order for rescission. Dakin’s cross-motion was dismissed.

Dakin appealed, arguing that they were denied a fair hearing by the motion judge because they were not heard on the franchisee’s cross-motion. The Court of Appeal dismissed this argument, finding that the motion and cross-motion were intrinsically connected and all of the relevant material was before the court when Dakin’s motion was argued.

The Court of Appeal also noted that, having requested that Reda enter into a new franchise agreement, Dakin could not rely on s. 5(7)(a)(iv) of the Arthur Wishart Act by arguing that they were not involved in the sale and that a franchise agreement was already in place. Further, by requiring the franchisee to pay a transfer fee, Dakin could not argue that they were exempt under s. 5(7)(g)(ii) of the Act on the basis that no non-refundable franchise fee was paid. By requiring the payment of the transfer fee, Dakin was precluded from relying on this exemption, irrespective of the fact it was never paid. Ultimately, the Court of Appeal upheld the lower court’s decision granting an order for rescission.

Key Take-Away Principles

More than anything, Dakin provides franchisors with a helpful guide for “what not to do” when managing transfers within their systems. Franchisors should be careful to monitor any proposed transfers by franchisees to new buyers and carefully exercise their rights of approval. Erring on the side of disclosure is always preferable to relying haphazardly on the exemptions under the Arthur Wishart Act, which, as demonstrated in Dakin and countless other cases, are routinely construed narrowly by courts against franchisors’ interests. Franchisors are well advised to consult with their legal advisors in dealing with any proposed transfer within their system.

The Ontario Court of Appeal’s decision in 2256306 Ontario Inc. v. Dakin News Systems Inc. can be found here and the Superior Court decision can be found here.