Ontario Bar Association Franchise Law Conference Annual Legal and Legislative Update By John Yiokaris and Derek Ronde 1

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1 Ontario Bar Association Franchise Law Conference Annual Legal and Legislative Update By John Yiokaris and Derek Ronde 1 1 The authors wish to thank Rory P. McGovern of Sotos LLP and Peter Reinitzer of Cassels Brock and Blackwell LLP for their contributions to this paper. 1

2 Contents Breach of the Duty of Good Faith and Related Damages... 3 Body Shop Canada Ltd. v. Dawn Carson Enterprises Ltd Canada Corp. v. Rotisseries Mom s Express Ltd Wrongful Termination of Franchise Agreements... 6 ANC Business Solutions Inc. v. Virtualink Canada Ltd Exemptions from Disclosure Ontario Inc. v. Springdale Pizza Depot... 8 Releases and s. 11 of the Act Ontario Ltd. v. Cora Franchise Group Inc Deficiencies in Disclosure Ontario Inc. v. Springdale Pizza Depot Ontario Inc. v Ontario Inc Caffe Demetre Franchising Corp. v Ontario Inc Vijh v. Mediterranean Franchise Inc Rescission Damages Ontario Inc v. Springdale Pizza Depot Ltd Definition of Franchise Agreement Under the Act MGDC Management Group Inc. v. Monroe Estate Class Actions Ontario Ltd. v. Sears Canada Inc Ontario Ltd. v. Quizno s Canada Restaurant Corporation Arbitration Ontario Ltd v. FOF Franchise Corp Silininkas v. Purrestore Management Services, Inc. o/a Puroclean Canada Franchisors and the Employer-Employee Relationship Lindsey v. McDonald s Restaurants of Canada Limited Lake v Ontario Ltd. o/a Best Western Sword Motor Inn Rescission (Non-Statutory) Ma v. Nutriview Systems Inc

3 Legislation British Columbia Breach of the Duty of Good Faith and Related Damages Body Shop Canada Ltd. v. Dawn Carson Enterprises Ltd. 2 Body Shop Canada Ltd. (the subfranchisor ) brought an action against Dawn Carson Enterprises Ltd. (the subfranchisee ) for damages sustained as a result of the subfranchisee s underpayment of rent to the landlord. In addition, the subfranchisee counterclaimed against the subfranchisor and third-party-claimed against an auditor for breach of the subfranchise agreement and tortuous interference. The franchised business was a retail establishment for soaps, cosmetics and bath products. The subfranchisee operated a store in a mall in Halifax, Nova Scotia. 3 The issue in this case arose when an auditor, on behalf of the Ontario Pension Board (the OPB ) (the landlord of the Halifax Mall at which the franchised business was operating in), performed an audit of the rents paid by the subfranchisee. It found that the subfranchisee had under-reported its gross revenue during the audit period and as a consequence, did not pay the rent it owed to the landlord (the rent was based on a percentage of the tenant subfranchisee s sales). 4 Flowing from this, the OPB sued both the subfranchisor and the subfranchisee. The subfranchisor settled the lawsuit with OPB for $156,388. Thereafter, the subfranchisor terminated the subfranchise agreement, sued the subfranchisee on the sublease, and sued the subfranchisee s principal on a guarantee that was signed when the subfranchise agreement was entered into. 5 Key Issues and Highlights In her defence, the subfranchisee claimed that she had reported her revenues in the way her accountant taught her in the 1980s. She further argued that the understatement resulted from her or her staff inadvertently double subtracting amounts in the calculation of revenue. With regard to the explanation provided by the subfranchisee, Moir J. noted that the calculation of gross revenue in a retail shop is not an esoteric exercise. 6 As such, there is little room for NSSC 239 [Body Shop]. 3 Ibid at paras Ibid at para 5. 5 Ibid at para 6. 6 Ibid at para 10. 3

4 huge differences in revenues reported. 7 Moir J. rejected all of the explanations provided in the subfranchisee s defence. Moir J. further noted that, despite provisions in the lease requiring an annual audit of the business, this was never done by the subfranchisee or was waived by the subfranchisor in the subfranchise agreement. 8 In its sublease agreement with the subfranchisor, the subfranchisee promised the subfranchisor to pay the rent required to be paid by the subfranchisor to OPB in conformity with the method of calculation contained in the lease. Similarly, the subfranchisee obliged itself to observe all other terms, covenants and conditions that the subfranchisor was subject to under the lease and to indemnify the subfranchisor if they did not. 9 After reviewing the methodology of the audit, Moir J. found that the subfranchisee and its principal drastically understated its gross revenues in the reports to the landlord and avoided paying rent that was due. 10 The consequence of this default under the lease was that the termination of the sublease by the subfranchisor was justified. 11 In addition to the above, Moir J. found that the subfranchisee broke faith with the subfranchisor and the landlord by under-reporting its revenues and underpaying rent. This activity established a justifiable reason for the subfranchisor to terminate the subfranchise agreement. In addition, the counterclaim and third party claims were dismissed. 12 Practice Points In keeping with Moir J. s comment that the calculation of gross revenue in a retail shop is not an esoteric exercise, it is advisable for franchisees to establish and maintain accurate financial records. In this case, Ms. Carson, who was the principal of the subfranchisee and a guarantor under the sublease and franchise agreements, was faced with significant liability to the subfranchisor as a result of her underreporting of revenues. From a franchisor s perspective, if the franchise agreement permits it, establishing a practice of regularly auditing franchisees revenues may be advisable, particularly if underreporting can impact lease agreements with third parties. Moreover, a franchisor should ensure that its franchise agreements provide for, and the franchisor requires that, all franchisees install and use adequate point-of sale systems that will at least discourage franchisees from undertaking such action. 7 Ibid at paras Ibid at para Ibid at paras Ibid at para Ibid at para Ibid at paras

5 Canada Corp. v. Rotisseries Mom s Express Ltd Canada Corp. (the franchisee ) brought an action against Rotisseries Mom s Express Ltd. (the franchisor ) as well as two franchisor s associates for losses and damages related to the rescission of its franchise agreement. At the time the franchise agreement was entered into, the franchisor had represented to the franchisee that it would incur around $150, in expenses related to commencing operation of the franchise which was scheduled to open in June It also represented to the franchisee that it could sell the operation in six months for $400,000. After the expenditures exceeded $226,000 and the franchise had still not opened by October 2012, the franchisee rescinded. 14 After the franchisor failed to respond to a request to admit (see Canada Corp. v. Rotisseries Mom s Express Ltd. 15 ) given to them by the franchisee, the franchisee moved for judgment under Rule 51.06(2) of the Rules of Civil Procedure 16 based on the franchisor s failure to respond to the request to admit facts. Mew. J. heard the motion and found that the facts deemed to be admitted supported the franchisee s right to rescind under the Arthur Wishart Act (Franchise Disclosure), (the Act ). 18 Mew J. ruled that the franchisee was entitled to the amounts quantified therein in the amount of $152, with the balance of the claim proceeding to trial. 19 The amounts left to trial were: claims for salaries of the franchisees principals as well as car and meal expenses, claims for loss of profits and damages under s. 3 of the Act. 20 Flowing from the above, in this proceeding the franchisee sought to establish the following damages as it was found that the franchisor never provided a disclosure document: Motor vehicle/transportation expenses incurred by Ali Rasool, who was required to travel between his home in Markham and the restaurant location, while overseeing the set-up of the franchise operation between April to October 2012: $10, Salary for Ali Rasool, project manager, to setup the operation: $35, Salary for Juliana Swei, principal of 815: $5, Cost of meals provided to suppliers, trades people and networking: $5, Loss of profit while the restaurant was not operational: $113, ONSC 3256 [Mom s Action]. 14 Ibid at para ONSC RRO 1990 Reg SO 2000, c Supra note 13 at para Ibid at para Ibid at paras Mom s Action, supra note 13 at para 12. 5

6 6. Damages for breach of duty of care for fair dealing by the defendants under s. 3 of the Act: $25, After providing testimony in respect of the above damages, the Court awarded all of the damages claimed with the exception of the cost of meals as there were no receipts or documentation provided by the franchisees to establish the damages. 23 The Court also found that in this case, loss of profit damages was compensable under s. 7(1) of the Act as the loss of profits flowed from the franchisor s misrepresentation that the restaurant would be open in June The Court accepted the pro forma projections provided by the franchisor to the plaintiff in this regard. With respect to damages under s. 3, after reviewing the case law, O Marra J. found a litany of deficiencies in the franchisor s conduct including: failure to provide adequate architectural drawings, menus, signage and training; misrepresenting the franchisee s ability to sell the franchise in six months; failure to provide support and guidance; failure to act in a commercially reasonable manner; and failure to provide accurate figures with respect to the costs of opening the operation. In light of the foregoing, O Marra J. awarded the franchisee $25,000 in damages for breach of the duty under s Practice Points This case provides additional commentary on the calculation of damages awards for Wishart Act claims. After the franchisor was deemed to admit several damaging allegations in the request to admit, O Marra J. awarded the franchisee the maximum amount that previous judges had awarded for breaches of s. 3 of the Act. This case serves as a reminder to franchisors that schedules and cost estimates may be the subject of rescission or misrepresentation claims if they are not properly disclaimed or accurately conceived. Wrongful Termination of Franchise Agreements ANC Business Solutions Inc. v. Virtualink Canada Ltd. 25 ANC Business Solutions Inc. (the franchisee ) brought an application for the reinstatement of its franchise as well as damages and other relief, arguing that the franchisor unlawfully terminated its franchise and breached the statutory obligation of fair dealing under s. 3 of the Act. Virtualink (the franchisor ) operates a franchise system whereby it rents out office space under the brand Intelligent Office. In connection with the system, the operators of the various 22 Ibid at para Ibid at para Ibid at para ONSC 1619 [ANC]. 6

7 locations also provide technological support to clients that make use of the service. 26 Approximately two years into the franchise relationship, a dispute arose in regards to a malfunction with the franchisee s voic server, which was a crucial part of the operation of the business. Both the franchisee and the franchisor made efforts to have the server repaired although the franchisor argued that the franchisee was not responsive to the problem. 27 After several weeks of the problem persisting, on October 30, 2013, the franchisor delivered a notice of default to the franchisee. 28 Just over a week later, on the same day that the franchisee received a quote to replace the malfunctioning server, the franchisor terminated the franchise and the sublease alleging that the franchisee had failed to cure the default. 29 The fallout from the actions of the franchisor was significant to the franchisee. When the franchisor took over the premises, it installed a new cloud system and removed the franchisee s old phone system. 30 The franchisor also hired the franchisee s two employees who had access to all of the franchisee s financial and confidential information. 31 After learning of the termination of the franchise, the franchisee s bank demanded the repayment of its loans and advised of its intention to enforce its security and to call the letter of credit it had extended. Key Issues and Highlights The franchisee s main arguments were that the franchisor breached s. 3 of the Act and that it wrongfully terminated the franchise. Perell J. of the Ontario Superior Court of Justice (the OSCJ ) declined to deal with whether the franchisor breached s. 3 of the Act on an application. With regard to the argument that the franchisor wrongfully terminated the franchise agreement, the franchisor argued that the malfunctioning voic and telecommunication system was an extremely serious default that undermined the Intelligent Office Brand. 32 Perell J. rejected this argument finding that it was an after-the-fact attempt by the franchisor to justify its own breach of the franchise agreement. 33 The franchisor also argued that a settlement agreement entered into by the parties in 2012 introduced a one-strike policy that entitled the franchisor to terminate the franchise in the manner in which it did. 34 Perell J. found that the settlement agreement did not change the termination provisions in the franchise agreement or any associated agreement. 35 As such, the 26 Ibid at para Ibid at para Ibid at para Ibid at para The franchisor required the franchisee to pay an additional $2,950 or $3,950 per month for the cloud system. 31 ANC, supra note 25 at para Ibid at para Ibid at para Ibid at para Ibid at para 46. 7

8 franchisor was required to give 30 days notice to the franchisee before it terminated the franchise agreement. It did not. In the end, Perell J. found that the franchisor breached the franchise agreement for failure to give proper notice of termination. It ordered that the franchisee be reinstated immediately and that the franchisee was entitled to damages for the franchisor s breach of the franchise agreement. Practice Points Franchisors should ensure that they have proper contractual grounds to terminate franchise agreements, particularly where there is significant and legitimate dispute about the seriousness of the franchisee misconduct giving rise to the purported default. Further, franchisors should adhere to the termination provisions and processes set out in the applicable agreements. In this case, the judge s finding of an improper termination resulted in a substantial damages award against the franchisor as well as reinstatement of the franchise. Exemptions from Disclosure Ontario Inc. v. Springdale Pizza Depot 36 The plaintiff, Ontario Inc. (the franchisee ) brought a motion for partial summary judgment seeking a declaration that it had validly rescinded its franchise agreement. In this case, the plaintiffs had been assigned the franchise from a former franchisee and argued that the defendant was obligated to provide disclosure to them. The defendant argued that they were not obliged to provide disclosure because the franchise was not purchased from them and as such the plaintiff had no right to terminate or rescind the agreement. As such, Myers J. had to deal with the disclosure exemptions under s. 5(7) and 5(8) of the Act and whether or not the franchisor could avail themselves of them. 37 Key Issues and Highlights Myers J. started with an analysis of s. 5(7)(a)(iv) which provides that: a franchisor is not required to make disclosure in connection with a resale of an existing franchise by an existing franchisee to a new franchisee as long as the grant of the franchise is not effected by or through the franchisor. 38 The Court relied heavily on the Ontario Court of Appeal s decision in Ontario Inc. v. Springdale Pizza Depot Ltd. 39 ( Springdale Milton ) and made the following findings of fact with respect to the role the franchisor played in the assignment of the franchise: ONSC Ibid at paras Ibid at para 7. 8

9 (A) The agreement of purchase and sale between the plaintiffs and the former franchisee provided that it was conditional for ten days "for the Purchaser to obtain franchisor approval to the transfer". That is, although the franchise agreement put the burden of obtaining franchisor approval on the former franchisee, the defendants dealt directly with the plaintiffs for that purpose. (B) The plaintiffs met the defendants three times prior to the signing of the franchise assignment. The meetings occurred either at the premises of the defendants or of other franchisees. (C) The defendants required the plaintiffs to enter into the same form of Acknowledgement as was discussed by the Court of Appeal in Springdale Milton. In Springdale Milton, Karakatsanis J.A. wrote the following concerning the Acknowledgment: The Acknowledgement included a signed statement by the respondents that they did not rely in any way on the representations by the franchisor about the sales figures of the business. I cannot agree with the appellants that this additional protection against recourse for the misrepresentation of financial figures was insignificant to the consent. Myers J. took a purposive approach in his analysis. He found that the purpose of the disclosure requirement is to redress the information disparity and power imbalance in franchise transactions. 40 In this case, Myers J. found that the defendant went beyond a mere passive role given that they had become engaged in the transaction and met with the purchaser/plaintiffs three times personally. They also provided the plaintiffs with an acknowledgment that not only limited their rights under s. 7 of the Act, but that also included a payment of money beyond the fee allowed in the Act. 41 In light of the foregoing, Myers found that the franchisor engaged in the transaction and brought its inherent power imbalance to bear upon the prospective franchisees. 42 Myers J. went on to note that a franchisor will be able to avail themselves of the disclosure exemption in the context of a franchise assignment when and only when it merely passively exercises its consent rights and no more. 43 This may also include an assessment of the prospective assignee s financial situation and operational fitness ONCA Ibid at para Ibid at para Ibid at para Ibid at para 16. 9

10 After the decision regarding the ability of the defendant to avail themselves of the disclosure exemption in the Act was rendered, the issue of the sufficiency of disclosure was straight forward. The document provided to the franchisee by the franchisor was materially deficient and did not include any of the following: the proposed assignment of the franchise agreement, the proposed general security agreement, the proposed sublease and head lease to the franchised premises, the acknowledgment, any reference to the judgment of Wilson J. in the other Springdale litigation, any location specific information, a list of current franchisees and their contact information. 44 As a result, the Court upheld the validity of the plaintiff s rescission and ordered damages in accordance with s. 6(6). 45 Practice Points When a franchisor is involved in the assignment of a franchise between franchisees, it cannot rely on the exemption from section 5 if its involvement goes beyond the passive exercise of its consent. This decision provides further jurisprudence regarding Ontario courts willingness to examine franchisor involvement in assignments in determining whether disclosure ought to have been made. The only fail-safe way to ensure franchisor protection in these circumstances is for the franchisor to always provide proper disclosure to the prospective franchisee in the event of an assignment. Releases and s. 11 of the Act Ontario Ltd. v. Cora Franchise Group Inc. 46 In this case, a franchisee sought a declaration pursuant to s. 11 of the Act that a section of its franchise agreement with the Cora Franchise Group (the franchisor ) was void and unenforceable. 47 Section 11 of the Act reads: Any purported waiver or release by a franchisee of a right given under this Act or of an obligation or requirement imposed on a franchisor or franchisor s associate by or under this Act is void. The impugned section of the franchise agreement required the franchisee to release the franchisor from any claims it had against the franchisor before it could obtain consent to assign the franchise agreement: Franchisee and its directors, officers and shareholders signing and delivering in favour of Franchisor and its directors, officers, shareholders 44 Ibid at para Ibid at para 29 and ONSC Ibid at para 1. 10

11 and employees, a general release in the form specified by the Franchisor of any claims against the Franchisor and its officers, directors, shareholders and employees. 48 The franchisee had commenced litigation in respect of both of its franchised locations. Subsequently, the franchisee sought to sell one of its franchises to a third party and sought the franchisor s consent. The franchisor required that the franchisee execute a release as contemplated by s of the franchise agreement. The franchisor provided a form of release that excluded rights prescribed by the AWA. 49 The franchisee refused to sign the proposed release, arguing that it was contrary to s. 11 of the Act. 50 Key Issues and Highlights The main issue was whether or not s of the franchise agreement and the purported release were void based on the application of s. 11 of the Act. The court found that the ordinary meaning of general release of any claims was that it included rights under the Act. The franchisor argued that the release specifically excluded the release of rights under the Act and, as such, the provision did not run afoul of s. 11. Matheson J. rejected this approach as potentially open to abuse. Matheson J. then addressed whether or not s of the franchise agreement could be read down so as to comply with the Act. Matheson J. held that s. 11 does not contemplate the possibility that a court could read down a provision in a franchise agreement if it was in conflict with s. 11. In arguing that the provision could be read down the franchisor proposed that the court take the approach taken in Seidel v. Telus Communications Inc. 51 which was a case about a provision that ran afoul of s. 3 of the Business Practices and Consumer Protection Act 52 (the BPCPA ). The issue in Seidel was whether or not the plaintiff was bound by an arbitration clause in a cell phone contract requiring her to arbitrate a dispute rather than sue. The plaintiff had a right of action under s. 172 of the BPCPA. The defendant argued the plaintiff ought to be bound by the arbitration clause. As noted by Matheson J. in reviewing Seidel: The majority of the court held that to the extent that the arbitration clause purported to take away a right, benefit or protection conferred by the BPCPA, specifically access to the court under s. 172, it was invalid under s. 3. To that extent, Ms. Siedel retained her claim in court. The arbitration clause was enforceable for the other claims. The majority of the court was therefore prepared to essentially "read down" the arbitration clause. 53 In applying Seidel, Matheson J. declined to read down the impugned provision of the franchise agreement and decided that the most appropriate interpretation of the Act is the one that protects 48 Ibid at para Ibid at paras Ibid at para SCC 15 [Seidel]. 52 SBC 2004 c Seidel, supra note 51 at para

12 franchisees, which meant that the general release was void and unenforceable due to the operation of s. 11 of the Act. 54 Notwithstanding the foregoing, Matheson J. did not rule out the approach in Seidel being appropriate in a franchise case, but did not identify the circumstances under which it would be applicable. 55 Practice Points The franchisor s appeal of this decision was heard by the Ontario Court of Appeal on September 24, The Court reserved its decision, which should provide definitive guidance regarding the extent to which franchisors must specify within their franchise agreements that releases sought as part of renewals and assignments exclude the release of claims under the Act. Deficiencies in Disclosure Ontario Inc. v. Springdale Pizza Depot 56 In this proceeding, Ontario Inc. (the franchisee ) moved for partial summary judgement against Springdale Pizza Depot (the franchisor ). Previously the franchisee had delivered a notice of rescission to the franchisor alleging that the franchisor had failed to comply with the requirements set out under s. 5 of the Act. 57 The plaintiff argued that the disclosure document was so deficient that it did not amount to a disclosure document within the contemplation of s. 5 of the Act and the regulations pertaining thereto. 58 In response, the franchisor took issue with the materiality of the deficiencies allegedly contained in the disclosure document and argued that the real issues in this case ought not to be decided in a summary judgment motion. 59 Key Issues and Highlights After applying the full appreciation test from Combined Air Mechanical Services v. Flesch 60 (which has now been replaced with the test in Hryniak v. Mauldin 61 ) Greer J. granted the franchisee partial summary judgment. Greer J. found that the franchisee put its best foot forward 54 Ibid at paras Ibid at para ONSC 7288 [Springdale]. 57 Ibid at paras Ibid at para Ibid at para ONCA SCC 7. 12

13 on the motion and that there were too many significant deficiencies in the documentation received by the franchisee. First, Greer J. decided that the notice to reader financial statements provided to the franchisee did not comply with the regulations under s. 5 of the Act. Greer J. also questioned the accuracy of the financial statements provided to the franchisee observing that the preparer of the financial statements did not carefully read either the statements prepared for it or the regulations under the Act. 62 Secondly, Greer J. noted that the Certificate, which should have been signed by two directors or officers of the franchisor, was only signed by Mahil, the President of the franchisor. 63 This deficiency has been held to be fatal in other franchise cases. 64 Thirdly, Greer J. found that the documents given to the plaintiff were not presented as one single bound document. 65 With regard to the franchisor s obligation to provide information related to the state of the franchise system, Greer J. also found that the franchisor failed to disclose a list of names and contact information of former franchisees which had left the franchise system or were terminated. In addition, Greer J. found that the franchisor failed to disclose that it was involved in litigation with other franchisees. 66 Another argument advanced by the defendant was that the franchise relationship was terminated on February 23, 2012 when it delivered a notice of termination to the franchisee about one week after the franchisee delivered a notice of rescission to the franchisor. Ultimately, Greer J. found that the deficiencies in the disclosure provided to the franchisee were major deficiencies. Her Honour specifically noted the notice to reader financial statements were inadequate to give the franchisee a true financial picture. 67 With regard to the personal liability of Mahil and Khakh, the former who is the president of the franchisor and the latter who is the franchisor s treasurer and secretary, Greer J. found that they were both franchisor s associates within the meaning of s. 1(1) of the Act and as a result were jointly and severally liable with the corporate defendant for the franchisee s rescission damages. 68 Practice Points This case affirms that franchise rescission cases may be appropriate cases for Ontario courts to determine on summary judgment. The Supreme Court of Canada s decision in Hryniak v. 62 Springdale, supra note 56 at paras Ibid at para For example, see Alberta Inc. v. Asian Concepts Franchising Corp., 2013 ABQB Springdale, supra note 56 at paras Ibid at para Ibid at para Ibid at paras

14 Mauldin 69 has provided a clear pathway for franchise counsel to potentially address rescission claims in a quick and efficient manner. In addition, this case adds to existing jurisprudence concerning the types of disclosure failures that collectively amount to non-disclosure for the purposes of section 6(2) of the Act. Franchisors and their counsel should ensure that the Act and its regulations are rigorously followed in respect of pre-contractual disclosure Ontario Inc. v Ontario Inc Ontario Inc. (the franchisee ) brought a motion for partial summary judgment seeking a declaration that it had validly exercised its right to rescission under s. 6(2) of the Act and was entitled to damages in respect of the same. 71 The defendant corporations Ontario Inc. ( 226 ) and Ontario Inc. ( 135 ) were the franchisors of Delimark Cafes, a franchise that caters breakfast and lunch for office buildings in the Greater Toronto Area. The franchisee received a disclosure document that defined the franchisor as 135 and/or 226. Two of the directors or officers of 135 signed the certificate and included it with the disclosure document. Unaudited statements for 135 were similarly provided. No certificates or financial statements were provided for The final franchise agreement that was entered into was between 226 as franchisor and 233 as franchisee. The sublease was appended but the head lease was never disclosed. 73 About 18 months after the franchise had been in operation, the franchisee sought to rescind the agreement. Key Issues and Highlights Stinson J. determined that the franchise agreement ultimately signed by the parties was between 226 as franchisor and 233 as franchisee. As such, the court considered the extent to which 226 complied with the Act rather than 135, despite the fact that many of the earlier agreements signed by the franchisee were with Flowing from the determination that 226 was the franchisor, not 135, Stinson J. found that 226 had not complied with the Act in several significant ways. First, 226 failed to disclose its financial statements and was unable to rely on an exemption from doing so under the Wishart Act, O. Reg. 581/00 (the Regulations ) Supra note ONSC Ibid at para Ibid at para Ibid at para Ibid at para Ibid at para

15 Second, despite the fact that a lease did not come into effect until after the disclosure document was provided, Stinson J. found that the proposed sublease was an agreement relating to the franchise to be signed by the prospective franchisee under s. 5(4)(c) of the Act and as such, decided that it ought to be disclosed. Counsel for the defendant argued that the lease and sublease should not have come under the purview of the Act because neither document existed and that a party should not be expected to disclose something that does not yet exist. In rejecting this approach, Stinson J. notes: In my view, in the context of franchise disclosure requirements, it is no answer for a franchisor to explain non-compliance on the basis that a document or information did not exist or was unavailable at the time the disclosure statement was prepared. To accept that submission, would be to create a potentially large lacuna in the disclosure system: it would be easy for a franchisor to pare down its disclosure obligations on the basis that certain material or information was simply not available at the time the disclosure statement was prepared; this excuse could be used to respond to a broad range of complaints about non-disclosure. I therefore reject this approach. 76 Stinson J. went on to note that the remedy for the situation that the franchisor found itself in is to simply provide an updated disclosure statement when the material information (e.g. the lease and the sublease) come into existence, together with a statement of material change. 77 Third, flowing from the determination that the franchise agreement was between 226 and 233, Stinson J. found that 226 had failed to provide the franchisor s certificate. This is a fatal deficiency that the courts have dealt with in Sovereignty Investment Holdings Inc v Quebec Inc 78 and several other notable cases. 79 In addition to the foregoing, the Court also found that the franchisor had failed to provide a comprehensive package of documents as part of the disclosure to the franchisee. The Court noted that in disclosing several agreements in piecemeal fashion after the disclosure document was provided (e.g. the agreement of purchase and sale, the franchise agreement, the amendments to the agreement of purchase and sale), the disclosure document was deficient. 80 Stinson J. noted that disclosing these agreements in piecemeal fashion is contrary to the spirit of the legislation, which requires the franchisor to disclose the contents of those agreements in the disclosure 76 Ibid at para Ibid at para BLR (4th) See Burnett Management Inc. v. Cuts Fitness for Men, 2012 ONSC 3358, Alberta Inc. v. Asian Concepts Franchising Corp., 2013 ABQB 221, Apblouin Imports Ltd. v. Global Diaper Services Inc., 2013 ONSC 2592 and others. 80 Ibid at paras

16 document before they are signed. 81 significant. The Court considered this error to be material and Ultimately, the franchisee was successful on its motion for partial summary judgment and was entitled to rescind its franchise agreement under s. 6(2) of the Act. 82 Practice Points In respect of agreements that ought to be included in a disclosure document given to a prospective franchisee, the Court decided that a piecemeal approach to disclosure is a significant and material disclosure deficiency by a franchisor. This case provides direction to franchisors that if any agreements are entered into or come into existence after the disclosure document is given to the franchisee (e.g. a lease) and which were not included in the disclosure document, the proper approach is to send a form of the agreement to the franchisee together with a material change statement. If there are several problems of this kind during the disclosure period or amendments are added to any of the agreements, a franchisor may want to consider re-disclosing to the franchisee after all of the forms of the various agreements have finally materialized. Caffe Demetre Franchising Corp. v Ontario Inc. 83 Caffe Demetre Franchising Corp (the franchisor ) brought a motion for partial summary judgment seeking to dismiss the portion of the defendant s counterclaim which claimed rescission of the franchise agreement pursuant to s. 6(2) of the Act. The franchisor operates a franchise specializing in desserts and ice cream. 84 The defendant, Ontario Inc. (the franchisee ), purchased its franchise from a previous franchisee. At the time of the purchase, the franchisor delivered a disclosure document that technically complied with s. 5(4) of the Act. The only alleged deficiency identified by the franchisee was that the disclosure document omitted certain material facts. About one year into the operation of the franchise, the franchisor undertook to inspect all of its franchised locations and determine whether or not any repairs or painting needed to be done. In connection with its inspections, the franchisor provided a list of deficiencies to the franchisee. The franchisee refused to cure any of the noted deficiencies. 85 Shortly after this issue arose, the franchisor conducted an analysis of the franchisee s error rates and after reviewing the data obtained, suspected that the franchisee was concealing cash sales by cancelling transactions at the point of sale. This was significant because the franchise fees that were payable to the franchisor were based on the sales of the franchisee. The franchisor requested further information 81 Ibid at para Ibid at para ONSC Ibid at para Ibid at para 6. 16

17 from the franchisee in regard to this suspicion but its requests were refused. The franchisor then sent the franchisee three notices of default in December 2012, March 2013 and July 5, 2013 noting the following defaults: failure to take the required action to improve the condition and appearance of the location; failure to provide financial statements and tax returns within 90 days of fiscal year end, as required by the Franchise Agreement; and, understating gross sales through excessive error/correct key entries. 86 Key Issues and Highlights A notice of rescission was served on the franchisor on July 19, 2013 and a notice of termination was sent to the franchisee on August 2, The grounds for rescission, as appeared in the statement of defence and counterclaim, were as follows: The plaintiff failed to disclose that, at the time of the disclosure document, it was involved in litigation against Spin Dessert Ltd., which had owned the franchise prior to the owner who sold it to the defendants; The plaintiff failed to disclose that it was contemplating the implementation of a modified "Tip Out Policy" that would be unilaterally imposed on all franchisees to their financial detriment; The plaintiff failed to disclose that it was contemplating altering the franchisee ice cream manufacturing policy such that the owner principal would be directly responsible for preparing the ice cream; The plaintiff failed to disclose that the franchise store would require extensive remodelling and renovations in excess of $50, Heeney R.S.J. of the OSCJ noted that the franchisor failed to disclose the Spin Dessert litigation. However, Heeney R.S.J. found that the litigation did not represent a potential liability to the franchisees but was related to the franchisor acting to protect its intellectual property. Given that the litigation would not have a significant impact on the price to be paid by the franchisee, Heeney R.S.J. did not find that it constituted a material fact. 89 His Honour further noted that the kind of litigation which the franchisor failed to disclose was only a content deficiency that would have given rise to a right of rescission under s. 6(1). 90 With regard to the tip out policy, the franchisor sought to implement it to prohibit franchisees from taking a share of their employees tips. This was in contemplation of provincial legislation 86 Ibid at para Ibid at paras Ibid at para Ibid at para Ibid at para

18 that the NDP wanted to pass and was not contemplated at the time the disclosure document was delivered. With regard to the ice cream manufacturing policy and the renovations, Heeney R.S.J. noted that both these issues arose after the disclosure document was delivered and as such could not possibly entitle the franchisee to rescission under s. 6(2). 91 Ultimately, after applying the test from Hryniak v. Mauldin, Heeney dismissed the rescission counterclaim of the franchisees but allowed the franchisees to pursue their claims for misrepresentation, breach of fair dealing and breach of contract at trial. Practice Points Once again, this decision indicates that Ontario courts are willing to address rescission issues on a summary judgment basis based on the guidance provided by the Supreme Court of Canada in Hryniak. This case advances the law on whether or not a failure to disclose litigation will allow a franchisee to always rescind pursuant to s. 6(2) of the Act. In this particular case, the litigation was not understood to be a material fact as it would not have affected the purchase price of the franchise. However, as was the case in Ontario Inc. v. Springdale Pizza Depot, 92 the litigation may have been more appropriately characterized as a material fact as it related to a rescission case in which the plaintiff alleged almost identical deficiencies in disclosure as were at issue in the styled proceeding. Vijh v. Mediterranean Franchise Inc. 93 This was an appeal from the decision in Vijh v. Mediterranean Franchise Inc. 94 in which the franchisee moved for partial summary judgment arguing that it had a right to rescind under s. 6(2) of the Act because the franchisor, with the consent of the franchisee, delivered its disclosure document by Section 5(2) of the Act requires that the disclosure document be delivered personally or by registered mail. 96 On the partial summary judgment motion, Belobaba J. held that a franchisee had no right to rescind a franchise agreement under s. 6(2) of the Act simply because the disclosure document had been delivered to them by rather than personally or by registered mail. The appeal of this decision was dismissed. 91 Ibid at paras 35 and ONSC ONCA 698, 234 ACWS (3d) 101 [Vijh] ONSC Ibid at para Ibid at para 2. 18

19 Key Issues and Highlights The franchisee argued that any breach of the Act that relates in any way to the disclosure document, including a breach of s. 5(2) would entitle a franchisee to rescission under s. 6(2). 97 In support of this argument, the franchisee argued that s. 6(2) should be interpreted to mean, the franchisee may rescind the franchise agreement even after almost two years if the franchisor never provided the disclosure document as required by the Act. Thus, if the disclosure document was only provided by , then the franchisee argued it ought to have a right to rescind under s. 6(2). Belobaba J. rejected this interpretation given that there are two distinct rights of rescission in the Act. In finding that the franchisee was not entitled to rescission under s. 6(2), Belobaba J. relied on the Ontario Court of Appeal s decision in Canada Inc. v. Imvescor Restaurants Inc. 98 where the Court held that not every breach of section 5 justifies rescission under section 6(2). Rather, the two-year right of rescission is reserved for the more serious scenario in which no disclosure document is provided. 99 Practice Points The decision to dismiss the franchisee s appeal reinforces the decision of Belobaba J. and provides additional jurisprudence in respect of determining whether a deficiency in a disclosure document will entitle a franchisee to a rescission under s. 6(1) or s. 6(2). Although this case holds that a minor technical breach of section 5 of the Act may not be sufficient to allow the franchisee to rescind its franchise agreement under section 6(2), franchisors would be wise to deliver their disclosure document personally or by registered mail in order to avoid unnecessary disputes. Rescission Damages Ontario Inc v. Springdale Pizza Depot Ltd. 100 This was a motion for directions in relation to a prior proceeding in which Master R. A. Muir had ordered Springdale Pizza Depot Ltd, Ranjit Singh Mahil, and Dilawar Singh Khakh (the Springdale Defendants ) to pay $226, under s. 6(6) of the Act to the plaintiffs for supplies and equipment. The Springdale Defendants claimed that they were not obligated to pay compensation because the equipment was in very poor condition and that the plaintiffs were therefore unable to return 97 Ibid at para ONCA Vijh, supra note 93 at para ONSC

20 the equipment. The Springdale Defendants attributed the poor condition to its improper removal and storage by the plaintiffs who had stored the equipment in a barn in Caledon since Key Issues and Highlights The court held that section 6(6)(c) of the Act makes it mandatory that when a franchisee rescinds, the equipment be repurchased regardless of its condition. 102 Furthermore, Master Muir found that the poor condition was caused in part by the Springdale Defendants decision to oppose the plaintiffs attempts to rescind the franchise agreement at every step. 103 Master Muir stated that the Act is remedial, that the franchisee is entitled to be made whole, and that there is no duty on the franchisee to mitigate. Furthermore, the Springdale Defendants provided no evidence that the franchisee deliberately damaged the equipment. 104 Master Muir found the plaintiffs to be entitled to the $226, and, upon receipt of payment, were to make the equipment available for pick-up by the Springdale Defendants. Practice Points The decision provides additional insight into whether there is an obligation on rescinding franchisees to mitigate damages and preserve equipment and inventory that are the subject of the rescission claim. Parties to a rescission claim may need to take steps to ensure that such assets are preserved and/or purchased by the franchisor during the litigation process. Definition of Franchise Agreement Under the Act MGDC Management Group Inc. v. Monroe Estate 105 MGDC Management Group Inc. (the Applicant ) sought rescission under the Act of a license agreement entered into with the respondents that licensed the name Marilyn Monroe as a trademarked name for use in the Applicant s restaurants. 106 The applicants argued that the license agreement was a franchise agreement and as such they were entitled to disclosure under the Act. In response, the respondents moved to dismiss the application arguing that the license agreement was not a franchise agreement. 101 Ibid at para Ibid at para Ibid. 104 Ibid ONSC 4584 [Monroe Estate]. 106 Ibid at para 1. 20

21 Key Issues & Highlights In article 20(a) of the license agreement both parties each of whom were sophisticated parties that negotiated the agreement with the assistance of their lawyers agreed that franchise disclosure laws would not apply in respect of the agreement. 107 Further, s. 2(3)5 of the Act provides that the Act does apply to: An arrangement arising from an agreement between a licensor and a single licensee to license a specific trade-mark, service mark, trade name, logo or advertising or other commercial symbol where such licence is the only one of its general nature and type to be granted by the licensor with respect to that trade-mark, service mark, trade name, logo or advertising or other commercial symbol. 108 The Court characterized the agreement as a grant of a non-transferrable, non-assignable, nondivisible right and license to use the trade-mark "Marilyn Monroe". It is the only license of its general nature and type to be granted by the Respondents with respect to these properties anywhere in the world. 109 Flowing from this characterization, the Court determined that the essential character of the agreement was a trade-mark licensing agreement. 110 As such, the Court held that the license agreement nestled cozily into s. 2(3)5 of the Act and that, as such, the Act did not apply. In obiter, the Court noted that while trade-mark licenses may commonly be present in franchise agreements, there are other essential hallmarks of a franchise agreement that would need to be present in order to bring an agreement under the purview of the Act. For example, one hallmark the Court noted was the exercise of significant control or significant assistance by the franchisor or the franchisee s method of operating its business. 111 In the end, Morgan J. dismissed the application and awarded costs to the respondents. 112 Practice Points This decision indicates that a trade-mark license alone is insufficient to constitute being a franchise agreement for the purposes of the Act. Parties ought to examine the precise nature of their commercial relationship before seeking to rely on the statutory rights and obligations outlined in the legislation. 107 Ibid at para The Act, supra note 17 at s. 2(3) Ibid at para Monroe Estate, supra note 105 at para Ibid at para Ibid at paras

22 Class Actions Ontario Ltd. v. Sears Canada Inc. 113 This was a motion to certify a class action lawsuit against Sears Canada Inc. and Sears Roebuck and Co. (together Sears ) on behalf of persons that had contracts with Sears to operate Sears Hometown Stores (the Dealers ). 114 The thrust of the plaintiff s claim is that Sears has exploited its contractual relationships with the Dealers such that they cannot sustainably run their Hometown Store businesses. In the claim, the plaintiff alleges the following: That the Hometown Store Contracts are franchise agreements within the meaning of the Act and as such the Dealers were entitled to disclosure; 115 That Sears has concealed the economic reality of the Hometown Store program from prospective Dealers; 116 That the Hometown Store program is administered in a way that maximizes the profitability for Sears by downloading the costs associated with running the stores onto the Dealers; 117 That Sears has exercised its unilateral discretionary power under the contracts in bad faith and has failed to alter the agreements in a way that would increase compensation to the Dealers to a sustainable level; That Sears has reduced the average retail commission rates paid to the Dealers; 118 That Sears has competed with the Dealers within their exclusive market areas by selling goods directly to customers who reside therein; 119 That Sears charges an unauthorized handling fee on goods purchased online or by telephone and which are shipped to the Dealers stores; and 120 That Sears has breached its duty of good faith and statutory duty of fair dealing under the Act to exercise their discretion in a manner which is fair and commercially reasonable ONSC Ibid at para Ibid at para Ibid at para Ibid at para Ibid at para Ibid at para Ibid. 121 Ibid at para