Canada: Quebec Court Rejects Franchisor's Bankruptcy And Insolvency Act Proposal

Last Updated: October 24 2017
Article by Noah Leszcz

In a recent case out of Quebec, Liquid Nutrition Franchising Corporation (the Franchisor) was deemed to have made an assignment pursuant to the Bankruptcy and Insolvency Act (BIA), after failing to gain approval of their BIA proposal.1 Specifically, in May 2017, the Quebec Superior Court denied the Franchisor's Trustee's motion for ratification of the Franchisor's proposal to their creditors (the Proposal). The Court's refusal to ratify the Proposal resulted from a motion from two franchisees (the Claimants) seeking dismissal of the Trustee's motion, and a declaration of refusal to approve the Proposal.

The Court rejected the ratification of the Proposal because the director of the Franchisor would have benefited from the Proposal and escaped liability for claims against him by the franchisee Claimants. The case provides an interesting example of the steps courts will take to preserve franchisee rights to seek financial recourse for their statutory claims.

To understand the reasoning behind the decision, it is helpful to examine the relationship between the Franchisor and its franchisees, as well as the rationale behind the Proposal.

The Background

The Franchisor, along with their parent corporation, Liquid Nutrition Group Inc. (LNGI), offer franchises for health food and drink retail outlets. The Claimants alleged that the Franchisor and LNGI had been inducing franchisees to purchase franchises based on misleading or false representations.

For this reason, the Claimants, along with several other disgruntled franchisees, had previously filed separate lawsuits against the Franchisor and LNGI, totalling several millions of dollars under various heads of damages under the Arthur Wishart Act (Franchise Disclosure (2000) (the Wishart Act). The Claimants also claimed against the directors and officers of the Franchisor and LNGI under the Wishart Act. One of the claims was initiated by a former franchisee known as 2308818 Ontario Limited (2308818).

In the face of several franchisee lawsuits, the Franchisor decided to submit the Proposal to shed its liabilities. If the Proposal was approved, the Franchisor and LNGI would not only purge themselves of their debts and liabilities, but also cause its directors and officers to be released from their personal liabilities under the Wishart Act.

The Claimants alleged that the Proposal was a scheme put forward by Chamandy, a director and officer of the Franchisor and LNGI, for his own personal benefit. It is important to note that LNGI, the parent of the Franchisor, was the largest creditor of the Franchisor, and would not ordinarily obtain any dividends from the approved Proposal, as LNGI's claim was subordinate to all other claims against the Franchisor.

The Franchisor reached out to its second largest creditor, 2308818, and offered $210,000 to settle their $2.3 million claim against the Franchisor. In exchange for the settlement, Chamandy and the Franchisor negotiated that 2308818 would vote in favour of the Proposal, and forfeit their entitlement to dividends payable if the Proposal was approved. By 2308818 forfeiting their right to dividends from the Proposal, LNGI, which happened to be the Franchisor's largest creditor, would move up the ladder of creditors and obtain dividends if the Proposal was approved.

In essence, by settling the claim with 2308818, and thereby having them forfeit their right to dividends, Chamandy ensured that he would no longer be personally liable from the AWA claim, and that he would personally receive a substantial portion of the dividends payable to LNGI from the approved Proposal.

The Rejection of the Proposal

Under the BIA, related persons, as defined in the BIA, are not entitled to vote on a proposal. This is why LNGI, despite being the largest creditor of the Franchisor, was not able to vote on the Proposal in the first place.

The question was then raised: Did 2308818 enter its vote on the Proposal for its own benefit, in its capacity as creditor, or rather, in its capacity as agent for Chamandy? If 2308818 was voting in its capacity as agent for Chamandy, then 2308818 would be considered a related person, and should not have been entitled to vote on the Proposal. Furthermore, without 2308818's affirmative vote, the Proposal would not have obtained the requisite number of votes to pass.

The Court's reasoned analysis succinctly summarized the series of events: "Chamandy enters into a series of contracts pursuant to which he literally purchases the third party's rights, title and interests into a very substantial claim (more than 2.3 million) for roughly 10% of its face value. In exchange for cash, 2308818 agrees to vote its full unliquidated claim in favour of the Proposal as well as surrendering its right into any dividend resulting from the approval of the Proposal.  In the opinion of the undersigned, Chamandy is now in full control of the 2308818 claim and, therefore, Chamandy is in the exact same position of a person voting in favour of the Proposal."2

Accordingly, the Court declared that 2308818 was voting as agent for Chamandy, was a related party to the Proposal, and refused to ratify the Proposal. The Claimants were successful, and the motion to ratify the Proposal was dismissed. As a result, the Court declared that the Franchisor was deemed to have made an assignment under the BIA.

The Takeaway from Franchisors

The decision in Liquid Nutrition provides some guidance to franchisors who are attempting to work through potential insolvency issues. Franchisors will have to be extremely careful when attempting to craft solutions to deal with outstanding litigation, as the purchase and settlement of claims may not permit the franchisor to generate support for any BIA proposal they make. Commercial courts will closely examine such transactions and will consider the interest of all creditors in determining whether such proposals are accepted.


1 A proposal is an offer to creditors to pay a percentage of what is owed over a specific period of time, or to extend the amount of time to pay off the debt, or a combination of both. Creditors vote to accept or reject the proposal. Following a successful vote, the courts must ratify the proposal.

2 Proposition de Liquid Nutrition Franchising Corporation, 2017 QCCS 1928 (CanLII) at para 68.

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.

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