Canada: Franchise Update – Court Of Appeal Considers Scope Of Basket-Clause Disclosure Of Material Facts Under Ontario Franchise Legislation

In its recent decision in Caffé Demetre Franchising Corp. v. 2249027 Ontario Inc., 2015 ONCA 258, the Ontario Court of Appeal upheld the Superior Court's decision (which we previously wrote about here) granting partial summary judgment dismissing a franchisee's claim seeking rescission of a franchise agreement approximately one year after purchase.

The lower court decision in Caffé Demetre was one of the first franchise rescission claims decided since the Supreme Court of Canada's decision in Hryniak v. Mauldin, which mandated a "shift in culture" toward increased summary judgment in Canada. In upholding the summary judgment, the Court of Appeal provides helpful guidance as to how Hryniak applies to a motion where only partial summary judgment is sought.

Franchisors and franchisees will also be particularly interested in the Court's consideration of the basket-clause requirement in s. 5 of the Arthur Wishart Act (Franchise Disclosure), 2000, SO 2000, c 3 (the "Act") to disclose "all material facts".

The Court's decision provides two key takeaways (described in more detail below):

  1. Caffé Demetre suggests that a partial summary judgment motion may be the appropriate mechanism to dispose of a rescission claim, even where other disputes and claims will remain outstanding between the parties after the summary judgment motion.
  2. Caffé Demetre provides guidance as to when a franchisor is required to disclose "material facts" other than those that fall within the specific list of discloseable facts that are enumerated in the Regulation passed under the Act. At issue in Caffé Demetre was whether litigation commenced by the franchisor to protect the brand, which was not specifically required to be disclosed under the Regulation, must be disclosed in any event as a "material fact". While the Court of Appeal held that ongoing litigation may in theory be discloseable under the basket clause even if it does not fall within the list of required disclosure under the Regulation, it suggested that such litigation cannot be material unless it constitutes a potential liability that could attach to the franchise system or otherwise financially impacts the prospective franchisee. Since the litigation at issue in Caffé Demetre did not meet these requirements, the Court held that it was not material.

Summary judgment was appropriate

The franchisee argued that it was not in the interests of justice to determine its rescission claim on summary judgment, as other matters in dispute arising out of the franchise agreement were proceeding to trial in any event. In particular, the franchisee argued that its misrepresentation claim would effectively be foreclosed by the summary judgment, and that there was a risk of inconsistent findings. The Court of Appeal disagreed.

First, the Court found the franchisee's counterclaim did not, in fact, advance a misrepresentation claim. Further, the Court agreed there was no risk of inconsistent findings of fact, as the facts were essentially undisputed on the motion.

Most importantly, the Court of Appeal agreed that "using the summary judgment mechanism to deal with the discrete matter of the franchisees' right to rescission was an expeditious and effective approach to resolving an important issue".

The Court of Appeal found this approach was consistent with the Supreme Court's holding in Hyrniak that "the resolution of an important claim against a key party could significantly advance access to justice, and be the most proportionate, timely and cost effective approach."

When does a franchisor's ongoing litigation constitute a "material fact"?

The Court of Appeal's decision reversed a controversial finding by the motion judge that the litigation commenced by the franchisor against a competitor constituted a material fact, and further clarified when the existence of ongoing or contemplated litigation ought to be included in a disclosure document.

The Court noted that s. 2(5) of O. Reg 581/00 (the "Regulation") requires disclosure of litigation pending against the franchisor and those associated with the franchisor based on claims of unfair or deceptive business practices or violating a law that regulates franchises or businesses. However, the Court clarified that this provision did not require disclosure of the omitted litigation at issue, since it had been brought by the franchisor against a competitor.

As a result, according to the Court, the litigation at issue would constitute a "material fact" only if it fell within the basket-clause provision in s. 1(1) of the Act, which requires disclosure of any "information about the business, operations, capital or control of the franchisor or franchisor's associate, or about the franchise system, that would reasonably be expected to have a significant effect on the value or price of the franchise to be granted or the decision to acquire the franchise". The Court noted this question must be considered on a case-by-case basis, using a "highly fact specific analysis".

On the facts of the case before it, the Court concluded that the litigation at issue was not a material fact, as it was a protective measure taken by the franchisor at the request of and for the benefit of franchisees, and did not constitute a potential liability that might attach to the franchise system or otherwise financially impact the franchisee.

Rescission rights under s. 6(1) and s. 6(2)

The Court held that, even if the failure to disclose the ongoing litigation amounted to a deficiency in the franchisor's disclosure, it was not sufficiently significant that the franchisees would be entitled to rescission beyond the 60-day period provided in s. 6(1) (for failing to meet all stated requirements of what must be included in a disclosure disclosure). The franchisee would not be entitled to rescission for the two-year period provided by s. 6(2) of the Act, for never providing a disclosure document.

The Court agreed with the motion judge that omitting ongoing litigation from the franchise disclosure document "falls well short of putting the document into the category of no disclosure at all as contemplated by s. 6(2) of the Act". Failing to mention litigation commenced against a competitor for the purpose of protecting franchisees' interests had not "effectively deprived the franchisees of the opportunity to make a properly informed decision to invest in [the franchise]."

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