Canada: Ontario Court Of Appeal To Franchisors: "Comply With Your Disclosure Requirements, Or Else..."

Last Updated: June 12 2017
Article by W. Brad Hanna, FCIArb. and Mitch Koczerginski

The Ontario Court of Appeal recently confirmed that the test for rescission under s. 6(2) of the Arthur Wishart Act (Franchise Disclosure), 2000, S.O. 2000, c. 3 (the "AWA") (which permits a franchisee to rescind a franchise agreement for up to two years after entering it if the franchisor "never provided the disclosure document")[1] is whether the purported disclosure document is materially deficient.  The Court of appeal also confirmed that this is so regardless of whether a franchisee even reads the disclosure document, or otherwise has sufficient information to make an informed decision about investing in the franchise.

In Mendoza v. Active Tire & Auto Inc.,[2] the Ontario Court of Appeal overturned a lower court's ruling[3] that a franchisor's non-compliance with its disclosure obligations could be forgiven if the franchisee nonetheless made an informed decision to enter into the franchise agreement. While the lower court's ruling was applauded by franchisors, it stood in stark contrast to several prior decisions on the point.  This bulletin explains the significance of the Court of Appeal's decision in Mendoza.

The Lower Court Decision in Mendoza – An "Informed Decision" trumps Deficient Disclosure  

Following six months of negotiations and after receiving numerous documents and information related to the franchise from the franchisor (Active Tire & Auto Inc.), the franchisee (Mendoza) signed a franchise agreement. Before doing so, the franchisee met with the franchisor's CEO, Director of Franchise Development and Operations Manager, retained an accounting firm who compiled financial plans that projected a positive forecast over the first three years of operations and obtained independent legal advice.

A short three months later, however, and after unsuccessfully operating the franchise at a loss, the franchisee sought rescission under s. 6(2) of the AWA claiming that the disclosure document was deficient and moved for summary judgment.  In particular, the franchisee complained that:

  1. only one officer and director signed the disclosure certificate, contrary to subsection 7(2)(c) of Regulation 581/00;
  2. the financial statements included in the disclosure were not on an "audited or "review engagement" basis, contrary to subsection 3(1) of Regulation 581/00;
  3. all of the requisite disclosure documents were not delivered at one time, contrary to subsection 5(3) of the AWA;
  4. the irrevocable letter of credit described in the application varied significantly from what the franchisee actually signed; and
  5. the franchisor did not disclose the required assumptions and information underlying financial projections, contrary to subsection 6(3) of Regulation 581/00.

The motion judge acknowledged that there were deficiencies in the disclosure document, but went on to find that the franchisee was nevertheless able to make an "informed decision" about entering into the franchise agreement and dismissed the rescission claim.  The motion judge held that the extensive documents and information provided by the franchisor were sufficient to permit the franchisee to make an informed decision, and the deficiencies with the disclosure document were neither significant nor misleading.  The motion judge also accepted the franchisor's argument that, because the franchisee acknowledged he had not read the entire disclosure document (and refused to answer questions about what parts of the disclosure document were deficient or misleading), the franchisee could not take the position that its contents were important.

The motion judge's approach focussed on the subjective knowledge of the franchisee (and whether he or she could and did make an "informed decision" about buying into the franchise), rather than assessing whether the franchisor provided a disclosure document that complies with the AWA requirements. This approach diverged from prior cases holding that where there are "material deficiencies" in a disclosure document, the document is not a disclosure document within the meaning of the AWA (making rescission under s. 6(2) an available remedy). [4]

The Court of Appeal Decision in Mendoza – Materially Deficient Disclosure Warrants Rescission

In reversing the lower court's decision, the Court of Appeal underscored that the purpose of the AWA is to protect franchisees and rejected the motion judge's subjective, "informed decision", approach.

The Court of Appeal focused on two deficiencies that, in its view, were material: (1) the disclosure certificate was only signed by one, instead of two, officers of the franchisor; and (2) the disclosure failed to include financial statements in the manner prescribed by the AWA. The Court of Appeal referred to other deficiencies, including that the disclosure was not provided in one document at one time, but did not analyze whether these also amounted to material deficiencies.[5]  

Importance of the Requirement For Two Officers' or Directors' Signatures on the Certificate

The Court of Appeal emphasized that the requirement for two officers' or directors' signatures on the disclosure certificate is not merely technical, but instead facilitates an important right granted to franchisees. By signing the disclosure document, officers and directors become personally responsible for the accuracy and sufficiency of its contents, and personally liable for damages resulting from any misrepresentations contained therein.

The Court of Appeal found two errors in the motion judge's reasoning that missed the point of the right afforded by two signatures on the disclosure document. First, the motion judge improperly discounted the failure to provide two signatures because the franchisee had become familiar with most of the officers and directors during the negotiation process.  Second, the motion judge erroneously accepted the argument that since the franchisee had not read the disclosure document he could not take the position that its contents were important. The Court of Appeal noted that the rescission right is not conditional on the approach taken by a particular franchisee to the disclosed material.

By failing to have two officers or directors sign the disclosure certificate, the Court concluded that the franchisee was deprived of an important right that is clearly material to any franchise agreement.

Importance of the Requirement to Provide the Most Recent Financial Information

The Court of Appeal also highlighted the importance of providing the most recent financial information in the form and within the times prescribed by the AWA. 

Under the General Regulation to the AWA, disclosure documents must include either an audited financial statement for the franchisor's most recently completed fiscal year or a financial statement for the most recently completed fiscal year. If 180 days have not yet passed since the end of the most recent fiscal year and a financial statement has not been prepared for that year, the disclosure document must instead include a financial statement for the previous fiscal year. If the franchisor has not operated for a full year or 180 days have not yet passed since the end of the first fiscal year and a financial statement has not been prepared, then the disclosure document must instead include the opening balance sheet.

In Mendoza, the franchisor did not deliver its most recent financial statement, as required, or its previous year financial statement. It instead produced a financial statement for the period ending 18 months earlier, two weeks beyond the 180 day grace period for doing so. 

The Court of Appeal disagreed with the motion judge that this non-compliance with the AWA was insignificant.  It noted that the AWA and regulations prescribe what financial statements must be provided and the time parameters for doing so, and that the effect of these requirements is that franchisors must be in a position to provide the prescribed information within the prescribed time.  If a franchisor cannot do so, then it cannot proceed to engage with prospective franchisees.  The Court of Appeal noted that if it accepted that the deficiency was not material because the former year's financial statements were only delivered a couple of weeks after the statutory grace period, "franchisors would be free to ignore the statutory requirements regarding the obligation to produce current financial statements, and franchisees would be unable to rely on the protections contained in the AWA".

Franchisee's Reason for Rescission Not Relevant

The Court of Appeal also rejected the franchisor's argument that, because the franchisee did not read the entire disclosure document, he could not make the argument that its contents were important.  The franchisor argued that the real reason the franchisee sought to rescind the franchise agreement was not because of deficient disclosure, but because the franchise did not perform well and the franchisee regretted his decision.  In rejecting this argument, the Court of Appeal noted that one cannot know whether the failure of the business was connected to deficiencies in disclosure.  More importantly, the Court of Appeal noted that "the remedy in s. 6(2) turns only on the failure of the franchisor to deliver a disclosure document" and that the rescission remedy is not dependant on later conduct of the franchisee. 

Key Takeaways

The Court of Appeal sends a very clear message to franchisors with its Mendoza decision: strictly comply with your disclosure obligations, or risk rescission.  If the disclosure document contains material deficiencies it will not constitute a disclosure document at all and franchisees will be permitted to rescind their agreements under s. 6(2) of the AWA for up to two years after entering into a franchise agreement.

The Court of Appeal confirmed that the failure to: (1) have at least two officers/directors sign the certificate attesting to the truth of information contained in the disclosure document; or (2) strictly comply with the financial statement requirements are fatal – they each constitute a material deficiency entitling a franchisee to rescind up to two years after entering into a franchise agreement.

But perhaps the most important lesson learned from Mendoza is that where the disclosure document is deficient, the conduct and subjective knowledge of the franchisee does not matter. The franchisor is on the hook even if the franchisee did not read or rely on the disclosure document or if its reasons for seeking rescission do not relate to the disclosure provided.

Franchisors should review their disclosure practices and the contents of their disclosure documents to ensure compliance with applicable franchise legislation. Mendoza serves as a reminder that courts are unlikely to relax enforcement of the AWA's technical requirements even where the facts and circumstances of the case seem to call for it.

 

[1] Subsection 6(1) of the AWA permits a franchisee to rescind a franchise agreement within 60 days after receiving the disclosure document if its contents do not meet the requirements of s. 5 of the AWA.

[2] 2017 ONCA 471 (decision release on June 8, 2017).

[3] 2016 ONSC 3009.

[4] See, for example, 6792341 Canada Inc. v Dollar It Ltd., 2009 ONCA 385, Caffe Demetre Franchising Corp. v. 2249027 Ontario Inc., 2015 ONCA 258 and 4287975 Canada Inc. v. Imvescor Restaurants Inc., 2009 ONCA 308.

[5] Though we note that previous case law has found that a franchisor's failure to deliver disclosure in a single document at one time constitutes a material deficiency. See, for example, 1490664 Ontario Ltd. v. Dig this Garden Retailers Ltd., [2005] O.J. No. 3040.

The foregoing provides only an overview and does not constitute legal advice. Readers are cautioned against making any decisions based on this material alone. Rather, specific legal advice should be obtained.

© McMillan LLP 2017

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
W. Brad Hanna, FCIArb.
Similar Articles
Relevancy Powered by MondaqAI
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions