Sovereignty Investment Holdings, Inc. v. 9127-6907 Quebec Inc. et al., [2008] O.J. No.4450

62829 Canada Limited v. Dollar It Limited et al., [2008] O.J. No. 4687

In two recent Ontario cases, the Ontario Superior Court of Justice clarified when a franchisee may rescind a franchise agreement if the franchisor has provided a deficient disclosure document. In Sovereignty Investment Holdings, Inc. v. 9127-6907 Quebec Inc. et al [2008] O.J. No. 4450 (the "Sovereignty Case"), released on November 7, 2008, and in 6862829 Canada Limited v. Dollar It Limited et al [2008] O.J. No. 4687, amended reasons released November 27, 2008 (the "Dollar It Case"), the Court held that the franchisee in each case was entitled to rescind its franchise agreement under Section 6(2) of the Arthur Wishart Act (the "Act"), since the disclosure documents provided by their respective franchisors were so deficient, they constituted a failure to deliver a disclosure document.

The Right to rescind under the Act

Under Section 6 of the Act, a franchisee can rescind a franchise agreement in two instances. Section 6(1) of the Act provides that a franchisee may rescind the franchise agreement no later than 60 days following receipt of the disclosure document, if the franchisor failed to provide the disclosure document or a statement of material change within the time required under the Act, or if the contents of the disclosure document did not meet the requirements of the Act. Section 6(2) of the Act provides that a franchisee may rescind the franchise agreement no later than two years after entering into the franchise agreement if the franchisor never provided the disclosure document. Up until the Sovereignty Case and the Dollar It Case, it was not clear whether a materially deficient disclosure document would constitute "no disclosure", and therefore entitle the franchisee to rescind within the two-year period under Section 6(2) of the Act, or whether the franchisee was only entitled to the 60-day rescission period under Section 6(1), since the disclosure document was delivered, even though it did not meet the requirements of the Act.

From a franchisor's perspective, it was beneficial to maintain that a disclosure document was delivered and that the franchisee has 60 days from receipt of the disclosure document to rescind if it is believed that same did not meet the requirements of the Act. Conversely, the franchisee would maintain that if the disclosure document provided was materially deficient, then it does not constitute a "disclosure document" for the purposes of the Act and the two-year rescission period should apply.

Case law prior to the Sovereignty Case and the Dollar It Case did not discuss whether a deficient disclosure document could constitute "no disclosure".

The Sovereignty Case

The franchisee in this case entered into a franchise agreement on May 12, 2006, to operate a "Houston Steaks & Ribs" restaurant in Vaughan Mills Shopping Centre. Prior to signing the franchise agreement, the franchisor delivered to the franchisee, at different times, the following: a sales package and demographic study for the restaurant, an alleged disclosure document, a pro forma financial projection for the restaurant and a draft franchise agreement. After executing the franchise agreement, the franchisee received, among other things, a pro forma opening balance sheet, lease documents for the restaurant premises and a trademark license agreement. On February 29, 2008, the franchisee sent a notice of rescission under Section 6(2) of the Act to the franchisor.

At trial, the franchisee argued that the documents, which were provided prior to execution of the franchise agreement, did not satisfy the requirements of a "disclosure document" for the purposes of the Act. The franchisee identified 19 alleged deficiencies with the disclosure document. The franchisor accepted nine of the alleged deficiencies and claimed that the remainder were not required or were in substantial compliance with the Act. The Court concluded that there were at least four deficiencies in the alleged disclosure document, each of which on its own was fatal to the franchisor's claim that it had delivered a compliant disclosure document. The fatal deficiencies were as follows: (1) the franchisor had failed to provide the required financial statements, (2) there was no statement setting out the basis for or the assumptions underlying the earning projections, (3) there was not a "single" disclosure document delivered at one time, and (4) the document did not contain a signed certificate as required by the Act. In considering the remaining deficiencies, the Court noted that "none are sufficiently material, on their own, to disqualify the alleged disclosure document for the purposes of the Act". The Court then went on to state that "a number of minor deficiencies cannot, on a cumulative basis, disqualify documentation as a ’disclosure document‘ for such purposes." The franchisee was entitled to rescind pursuant to Section 6(2) of the Act.

The Dollar It Case

The franchisor in this case delivered a 'disclosure document' to the franchisee on October 24, 2007. On November 12, 2007, the parties entered into a franchise agreement for a "Dollar It" franchise. On May 8, 2008, the franchisee sent a notice of rescission to the franchisor pursuant to Section 6(2) of the Act.

At trial, the franchisor argued that (1) the disclosure document substantially complied with the Act, but even if it did not, it was not deficient so as to constitute no disclosure, and (2) consequently, Section 6(1) of the Act applied. Thus, since the franchisee had not rescinded within the time permitted under Section 6(1) of the Act, it was no longer entitled to rescind. The franchisee argued that the disclosure document provided was so materially deficient that it amounted to no disclosure, which meant that Section 6(2) of the Act applied. The franchisee identified 14 deficiencies in the disclosure document, none of which were contested.

In reviewing the evidence, the Court found that, based on the number of deficiencies and the nature of the deficiencies, the disclosure document provided was not compliant with the Act and was lacking material information. In particular, the following deficiencies were considered "non-disclosure of material information": (1) there were no financial statements, (2) the certificate was not completed and signed, (3) no notice was given of a pending lawsuit against the franchisor by one of its franchisees, (4) a copy of the offer to lease was not provided, and (5) the identified lawyer for service of process was not so authorized, and declined service of litigation documents. The Court did not state that any of these deficiencies were in and of themselves fatal, as the Court had done so in the Sovereignty Case, but it appears that the cumulative effect resulted in a material deficiency which constituted failure to deliver a disclosure document. As the Court found that no disclosure document was delivered, the franchisee had the right to rescind the franchise agreement pursuant to Section 6(2) of the Act.

In reviewing the applicable case law, the Court noted that "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 null, and hence no disclosure, if it is materially deficient in its substantive content in breach of the requirements of s. 5." (emphasis added).

Interestingly, the Court in the Dollar It Case noted the unreported case 6792341 Canada Inc. v. Dollar It Limited' (the "679 Case") Court File no. 08-CV-40893, released June 18, 2008, which involved the same disclosure document as was at issue in the Dollar it Case. In the 679 Case, the Court found that the disclosure was compliant with the Act and it dismissed the franchisee's application for rescission. The 679 Case is now under appeal.

Conclusion

This new case law specifies that it is imperative for franchisors to comply with the disclosure requirements under the Act, as material deficiencies could give rise to rescission rights within a two-year period. While a franchisor may have previously believed that as long as it provided a disclosure document, the franchisee would only have 60 days to rescind if it believed that the disclosure document was deficient, this could now no longer be the case.