Canada: Ontario Court Of Appeal Narrows The Availability Of Franchise Rescission

Last Updated: January 29 2018
Article by Helen Fotinos and Adam Ship

Most Read Contributor in Canada, September 2018

On January 25, 2018, the Ontario Court of Appeal (the "OCA") released its much-anticipated decision in Raibex Canada Ltd. v. ASWR Franchising Corp. In a business-friendly decision overturning the lower court's decision, the OCA narrowed the availability of rescission for franchisees, reinforcing the importance of recognizing the distinction between "no disclosure" and "imperfect disclosure", and further re-focusing the test for the availability of rescission under s. 6(2) of the Arthur Wishart Act (Franchise Disclosure) (the "Act") to an analysis of whether the franchisee was effectively deprived of the opportunity to make an informed investment decision.

There are four key takeaways from the OCA's decision.

First, the availability of the two-year rescission remedy under s. 6(2)  of the Act will now be considered under a different legal test.  According to the OCA, the fundamental question for two-year rescission is "whether the franchisee has been effectively deprived of the opportunity to make an informed investment decision".

Prior to this decision, the OCA applied an arguably broader test of whether the disclosure document contained a "material deficiency":  see Mendoza v. Active Tire & Auto Inc.. This clarification in Raibex appears to narrow the availability of the two-year remedy by focusing on the effect the deficiency had on the franchisee's ability to make an informed decision.

Second, the OCA rejected the lower court's finding that a disclosure document will be fatally deficient simply because a location for the franchise has not yet been determined.  On the facts of Raibex, the OCA found that the absence of a location and head-lease did not necessarily deprive the franchise of the ability to make an informed decision. The Court held that this was particularly so where, as in Raibex, the franchise agreement required the franchisor to consider the franchisee's interests before securing a location and further afforded the franchisee  a right to opt-out of the franchise agreement and receive a release and full refund of all monies paid to the Franchisor, less the Franchisor's reasonable costs in granting the franchise, if a suitable location was not secured within 120 days of the franchise agreement being signed. The OCA found that these "safeguards" provided a complete defence to the Franchisee's complaint that the Franchisor's failure to disclose the head lease justified rescission under s.6(2) of the Act because they allowed the  franchisee to proceed with the franchise grant without a location and head-lease being available, with the comfort of an available exit if the location ultimately selected was not agreeable. 

This finding is consistent with a long-standing industry practice of providing non-site specific disclosure, pending the identification of a suitable site. As a result of this finding, it is likely that franchisors may continue the industry practice of  granting franchises prior to a location being selected, provided they offer similar safeguards to franchisees in their franchise agreements.

Third, the OCA made important findings concerning the requirement to disclose to a franchisee the costs associated with establishing the franchise.  In Raibex, the franchisee took issue with the fact that the disclosure document only disclosed the costs associated with building the franchise from scratch, rather than the costs associated with converting an existing location to the franchisor's system.  The OCA rejected this concern, finding that the franchisee was able to make a fully informed decision.  The OCA emphasized a number of factors, including that the disclosure document provided the "a strongly worded warning that cost estimates associated with a conversion could vary greatly from site to site". The OCA also emphasized the franchisor's evidence that there was a "wide variance in the costs associated with the Franchisor's three prior conversions", concluding that disclosure of this information would have not have significantly improved the Franchisee's ability to make an informed decision.

This finding suggests that, in future cases, the adequacy of a franchisor's disclosure of establishment costs will be analyzed holistically, based on whether any omitted information would have "significantly improved" the franchisee's ability to make an informed decision.  It also suggests that appropriately phrased disclaimer language and express warnings in a disclosure document may minimize a franchisor of liability where it can be established that the franchisee had notice that the costs associated with its particular location may vary from the numerical estimates disclosed.  The OCA also suggested that a disclosure document should contain estimates that provide a "useful reference point against which to measure the upper range of possible costs associated with" the franchisee's particular location.  Of course, the danger here is that reliance on such disclaimers as a defence to erroneous or misleading establishment costs, may result in the equivalent of no disclosure being provided if the franchisee cannot reasonably rely on the estimates contained in the disclosure document as being accurate estimates of its anticipated costs.  The equity and application of this proposition will need to be carefully evaluated on the specific facts of each case, on a case by case basis.

Fourth and finally, the OCA provided some guidance and clarity around  requiring alleged "de facto directors" not listed on a franchisor's constating documents to sign the franchisor's Certificate of disclosure warranting the contents of the disclosure document when there is no evidence of this individual  exercising any control over the franchisor or holding him/herself out as a director. This finding will provide comfort to senior management employees of franchise systems who may hold officer and director titles, without intending those titles to classify them as "de facto directors" of the franchisor obligated to sign disclosure Certificates and thereby assume joint and several liable with the franchisor for breaches of the Act.  

Raibex is among the most business-friendly of the OCA's decisions on franchise disclosure and should provide franchisors with comfort in continuing to employ the common disclosure practices that the lower court decision brought into question.  This decision will also be important in restoring some balance in the radically swinging pendulum of franchise disclosure cases.

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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