We are pleased to advise that A&B litigation partners, Tim Hill and Atoosa Mahdavian, recently obtained a judgment that serves to clarify important issues relating to the Arthur Wishart Act (Franchise Disclosure), 2000, S.O. 2000, c. 3 (the "Act").
Background
In a trial that lasted several weeks, A&B defended a franchisor, Baton Rouge Restaurants Corporation ("BRRC") et al., in an action by a franchisee alleging breach of a right of first refusal for an additional franchise location and breach of the disclosure obligations under the Act. On November 14, 2011, Ontario Superior Court Justice David Brown issued a 109 page decision in which he dismissed the plaintiff's $15 million claim in its entirety as against all defendants (See 3574423 Canada Inc. v. Baton Rouge Restaurants Inc.).
In this action, the plaintiff alleged that its franchisor, BRRC, breached a term of the Franchise Agreement by failing to honour a right of first refusal which would have afforded the plaintiff the opportunity to operate new franchise locations in the Greater Toronto Area. The plaintiff also sought damages under the Arthur Wishart Act, alleging that the franchisor breached the disclosure requirements of section 5 and the duty of fair dealing under section 3 of the Act.
The franchise agreement in this case provided that the franchisee would enjoy a right of first refusal with respect to a second planned franchise location in the GTA. The franchisor's position was that it complied with its obligations under the agreement by offering the planned location, but that the franchisee turned down that offer. In doing so, the franchisee waived its right to that location, with the result that the right of first refusal came to an end. The franchisee contended that any waiver was invalid, as it contended that the franchisor had failed to make full disclosure of the details of the new location. In particular, the franchisee contended that had it been told the details of the territory being assigned to the new location it would have accepted it, rather than waive it. At trial, the franchisee contended that it was a "prospective franchisee" with respect to this new location and that its agreement to waive the second location constituted a "franchise agreement or any other agreement relating to the franchise," such that the franchisor was obligated to provide it full section 5 disclosure relating to the second location, including with respect to the proposed territory. On this basis, the plaintiff argued that it could invoke the remedies of rescission of its waiver under section 6 of the Act and damages under section 7 of the Act.
The Meaning of Any Other Agreement Relating to a Franchise
In his decision, the Honourable Justice David Brown accepted the position advanced by A&B counsel on behalf of the franchisor; and he specifically held as follows:
- That the remedies under section 6 and 7 of the Act are only available to parties that become franchisees, and that the plaintiff did not become a franchisee with respect to the second location and therefore cannot invoke those remedies; and
- That given that the plaintiff never entered into a franchise agreement with respect to the second location, it was not a "prospective franchisee" within the meaning of the Act; and that there was no agreement relating to a franchise that would trigger the section 5 disclosure obligations under the Act.
More specifically, the Court recognized that the section 5 disclosure obligations are "linked to very specific acts – the signing of a franchise agreement or 'any other agreement relating to the franchise' and the payment of consideration." (The Court observed that agreements relating to a franchise would normally refer to ancillary documents entered into by the franchisee related to the main franchise agreement such as an indemnity agreement, a general security agreement or a sub-lease.) If the prospective franchisee fails to sign the franchise agreement, or fails to remit payment, then any consequences flowing from sections 6 and 7 do not arise. While the disclosure obligations relate to prospective franchisees, it is only when a prospective franchisee alters its legal status and becomes a franchisee that it may rely on the remedial provisions of the Act. As the franchisee in this case never became a franchisee with respect to the new location, it could not rely on sections 6 and 7 "based on whatever disclosure information [the franchisor] did or did not provide to it."
The Court's decision offers welcome clarification regarding what types of agreements trigger the disclosure obligations under section 5. Prior to this decision there was a general concern that non-disclosure agreements entered into with prospective franchisees might be subject to rescission and be unenforceable unless a full disclosure document was provided in advance of the non-disclosure document. Such advance disclosure would, of course, defeat the very purpose of the non-disclosure agreement. It appears now that such non-disclosure agreements would be enforceable against prospective franchisees who never become franchisees, as the rescission remedy under section 6 is only available to parties who actually become franchisees. Finally, with respect to those parties that become franchisees, the franchise agreement itself would normally contain ongoing non-disclosure and confidentiality obligations.
The "Additional Franchise" Exemption
At trial, A&B counsel also made an alternative argument that the franchisor was exempted from the disclosure obligations with respect to the second location as it constituted an offer of an "additional franchise" within the meaning of section 5(7)(c) of the Act. Although it was not necessary for the determination of the claim, the Court agreed that the section 5(7)(c) exemption applied in this case. The "additional franchise" exemption under section 5(7)(c) relieves the franchisor from the obligation to deliver a disclosure document when: (i) the additional franchise is substantially the same as the existing franchise; and (ii) there has been no material change since the existing franchise agreement was entered into, or the latest renewal or extension was effected. The Court held that there had been no material change in the franchise's operation since the franchisee entered the system. The Court specifically rejected the plaintiff's contention that a difference in the size of the franchise territories would constitute a material difference, holding that it would not affect the financial or operational arrangements between the parties. The Court also rejected the plaintiff's contention that the fact that the second franchise agreement did not also contain a right of first refusal like the original agreement would constitute a substantial difference.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.