In the recent decision of Raibex Canada Ltd. v. ASWR Franchising Corp., the Ontario Superior Court of Justice allowed a franchisee to rescind its franchise agreement on the basis that it signed the agreement at a time when critical information regarding the costs to develop the franchise and leasing obligations had not yet come into existence. As a result, the Court found that the franchise grant was "premature" and the disclosure document provided to the franchisee deficient.
At issue in this case, was the franchisor's failure to provide details relating to a sublease and franchise development costs, as required by the Arthur Wishart Act ("AWA"). The plaintiffs, Raibex Canada Ltd. ("Raibex"), approached the defendant franchisor, ASWR Franchising Corp. ("ASWR"), to discuss franchising an AllStar Wings restaurant. The plaintiffs had a maximum budget of $400,000 for the franchise. The franchisor provided them with a franchise information package. The package explained that restaurants could either be constructed anew, or converted from pre-existing restaurants. The costs associated with each approach were not detailed, although the franchisor advertised that renovating existing restaurants could cut development costs by one third to one half.
The plaintiffs agreed to pursue the franchise. Accordingly, a franchise disclosure document was provided, as required by the AWA. However, the document failed to disclose two points, which the Court found to be material.
First, it did not provide a cost estimate to convert a pre-existing restaurant. It only mentioned that costs could be "significantly less" in comparison to building from scratch, which it estimated would cost between $800,000 to $1,000,000.
Second, the disclosure document failed to specify the location of the proposed restaurant. In fact, the restaurant's location remained uncertain even at the time the franchise agreement was signed (a common practice in the franchising industry). Accordingly, no head lease was included with the disclosure document or the subsequent Franchise Agreement signed by the plaintiffs. The Court found these omission were 'egregious" given that the franchisor's disclosure document acknowledged costs would "vary dramatically from location to location."
After signing the franchise agreement, and still without a location, the franchisor entered into a head lease for an existing restaurant. The terms of the head lease were onerous, requiring the franchisee to commit $120,000 in prepaid rent. The franchisee was not aware of this commitment at the time disclosure was made, nor when it signed the franchise agreement. A month before the restaurant's completion, the franchisor informed the franchisee that development costs exceeded $1,000,000 ¬¬¬- well beyond the development range originally represented to the franchisee and outside the development range represented in the disclosure document. Additionally, the plaintiffs were billed $120,000 for the prepaid rent and a security deposit for the premises which they were, similarly, not previously made aware of. The plaintiffs refused to pay and served a Notice of Recession under the AWA.
The plaintiffs successfully argued that the franchise agreement should have specified a location as well as a draft sublease, that included the head lease, as it involved significant cost consequences. The Court agreed. According to Justice Matheson, "when key information is missing, a properly informed decision is not possible." As a result, the Court found ASWR's disclosure document to be incomplete and premature. The fact a lease agreement could not exist without first choosing a location, ignores the statutory requirement for disclosure, said the Court.
There are a number of takeaways from this decision, including the following:
- The Court's decision makes it risky for franchisors to grant franchises in Ontario before a location is determined, as the disclosure document may be missing material facts regarding development costs and leasing obligations that would otherwise be disclosable. In other words, according to the Court, the grant of the franchise may be "premature" if the disclosure document cannot yet be populated with critical material facts.
- Standard disclaimer language contained in disclosure documents may not protect the franchisor. In Raibex, the Court criticized, and dismissed, qualifications and disclaimers such as "costs are highly site-specific and therefore vary dramatically from location to location" as being sufficient. According to Justice Matheson, these disclaimers were "no answer to the [franchisor's] statutory disclosure obligations [under the AWA]."
Subject to an appeal, this case may impact and alter the current disclosure practices of many franchisors. We will monitor this case with interest and report any future developments in this case, including how it is interpreted and applied in future decisions. To learn more about the Raibex case and how to better manage your potential risks, please contact us
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.