The Ontario Court of Appeal recently confirmed that franchisors do not need to provide a disclosure document to prospective franchisees where the franchise term is one year or less and franchisees do not pay a non-refundable franchise fee. The court's decision in TA & K Enterprises Inc. v. Suncor Energy Products,1 the first to consider the "one-year term/no franchise fee" disclosure exemption contained in Ontario's franchise legislation2, represents a significant victory for franchisors.
If you are in the franchising business in Ontario, the TA&K decision should be required reading. We explain the case, and the significance of the Court of Appeal's ruling, below.
The legislative context
As those of you in the franchise business know, the disclosure obligations under the Act are onerous. Subject to certain exemptions, the Act requires a franchisor to provide prospective franchisees with a disclosure document (containing all material facts about the franchisor and the franchise business) two weeks before the franchisee signs any agreements or makes any payments to the franchisor. Failure to do so can result in rescission of the franchise agreement and expose the franchisor to damages.
One of the statutory exemptions from having to provide a disclosure document arises where:
- The franchise agreement is not valid for longer than one year; and
- does not involve the payment of a non-refundable franchise fee (notably, the Act does not define the term "franchise fee").
TA & K required the court to consider whether this exemption applies where a franchise agreement for a one-year term was subsequently renewed on a month-to-month basis and the franchisee was required to make periodic royalty payments to the franchisor.
The facts in TA & K Enterprises Inc. v. Suncor Energy Products
The plaintiff franchisee operated a gas station under a franchise agreement with Suncor. The franchise agreement was signed on November 11, 2008 and expressly provided that the term of the franchise was one year, commencing on November 15, 2008 and ending on November 14, 2009. The franchise agreement contained no renewal options, and did not require the franchisee to pay a non-refundable franchise fee for the right to become a franchisee (although it did require the franchisee to pay royalties over the course of the agreement). Relying on the above-noted statutory exemption, Suncor did not provide a disclosure document to the plaintiff.
About a month before the one-year term expired, Suncor advised the franchisee that it would extend the franchise on a month-to-month basis on the same terms as set out in the franchise agreement. Subsequently (in January of 2009), Suncor notified the franchisee that the franchise agreement would terminate on August 12, 2010.
The franchisee took the position that it was entitled to rescind the franchise agreement on the basis that Suncor had failed to provide a disclosure document. The franchisee also started a $200 million class action against Suncor, seeking compensation for all amounts it had paid to Suncor and for the losses it had incurred while operating the franchise.
Prior to the certification hearing, Suncor succeeded in having the action dismissed on a motion for summary judgment. The Court of Appeal upheld the motion court's decision, and dismissed the case.
The court of appeal decision
The franchisee first argued that the franchise agreement was valid for longer than one year because the agreement was signed on November 11, 2008 and bound the parties until at least November 14, 2009 – a period of longer than one year. The Court of Appeal quickly dismissed this argument, observing that the one-year or less time frame applied to the "time during which the franchise agreement is valid", regardless of when it was negotiated or executed. The fact that the franchise agreement was signed before its effective date was of no consequence, and did not extend its "validity" beyond one year.
The franchisee next argued that the indemnity and confidentiality provisions of the franchise agreement expressly survived termination of the agreement, and that this extended the validity of the franchise agreement itself. The Court of Appeal swiftly rejected this argument as well because, by definition, these provisions only apply once the agreement has been terminated. The survival of these provisions did not extend the term of the franchise agreement itself.
The franchisee's most intuitively appealing argument was that when Suncor extended the franchise agreement on a month-to-month basis, it stretched it into an agreement that lasted for a term of more than one year.3 The Court of Appeal rejected this argument, however, by referring to the disclosure scheme created by the Act. The Court held that the disclosure scheme requires that the existence of an obligation to provide a disclosure document be known with certainty before any franchise agreement is signed or payment is made to the franchisor. As the Court put it, the disclosure section of the Act "would be unworkable if the obligation can be triggered after the fact by a letter sent some 11 months later". Accordingly, the Court of Appeal found that Suncor's extension letter simply created "new monthly agreements following the expiration of the [franchise agreement]".
The Court of Appeal also went on to find that the second requirement of the disclosure exemption contained in s. 5(7)(g)(ii) of the Act (the franchise does not involve the payment of a non-refundable franchise fee) was satisfied. The franchisee argued that the term "franchise fee" included any amounts required to be paid at fixed intervals, such as the royalty payments required by the franchise agreement. The Court of Appeal confirmed, however, that a franchise fee is "in the nature of a fee paid for the right to become a franchisee", and does not include royalties or payments for goods and services.
In the result, the Court of Appeal found that Suncor was under no obligation to provide the franchisee with a disclosure document, and dismissed the action.
Lessons for franchisors
In an era of cases that typically favour franchisees, the TA& K decision indicates that our courts will uphold franchise agreements structured to take advantage of the "one-year term/no franchise fee" disclosure exemption. The significant lessons from the case are as follows:
- To take advantage of the s. 5(7)(g)(ii) exemption, franchise agreements should be expressly limited to a term of 12 months or less and not require the franchisee to pay any fee to acquire the right to become a franchisee.
- Do not include a provision that causes the franchise agreement to automatically renew after the expiry of the first one-year term. Doing so could result in a court concluding that your agreement is for a term of longer than one year, thereby precluding your ability to rely on the exemption.
- Ensure that any royalty fees to be paid by franchisees over the life of the franchise are just that – royalty fees. Refrain from requiring franchisees to make any payments prior to the granting of the franchise or for the right to acquire the franchise.
1. 2011 ONCA 613 [TA&K]; decision released on September 27, 2011. No leave to appeal the decision to the Supreme Court of Canada was sought.
2. Arthur Wishart Act (Franchise Disclosure), 2000, S.O. 2000, c. 3, s. 5(7)(g)(ii) [the "Act"]
3. The franchisee also argued that an overholding provision in the franchise agreement that provided for a monthly tenancy in the event the franchisee remained in possession and continued to pay rent once the franchise agreement expired extended the term of the agreement. The Court of Appeal found that this provision does not extend the franchise agreement, but rather, simply turns the franchisee's tenancy into a monthly one. As the Court put it, the presence of an overholding provision "that merely creates the possibility of a month-to-month tenancy after the [franchise agreement] expires cannot be taken to extend it".
The foregoing provides only an overview. Readers are cautioned against making any decisions based on this material alone. Rather, a qualified lawyer should be consulted.
© Copyright 2011 McMillan LLP