October 12, 2022
BY NED LEVITT, RICHARD SCHUETT, AND LEAH POWELL, DICKINSON WRIGHT LLP
Courts across Canada have long considered the nuances of rescission claims in franchise law. Ontario recently added to this progression, in a recent case exploring the extent of a franchisor’s disclosure obligations where a franchise store location has yet to be acquired within an agreed upon territory.
Background
In 2364562 Ontario Ltd. v. Yogurtworld Enterprises Inc., 2021 ONSC 5112 (“Yogurtworld”), the Ontario Superior Court of Justice highlighted that although the Arthur Wishart Act (Franchise Disclosure), 2000,S.O. 2000 c. 3 (the “Act”) says that disclosure of information is necessary to make an informed decision to franchise a business, franchisors need not share everything. [1]
In April 2013, 2364562 Ontario Ltd. (the “franchisee”), entered into franchise agreements with Yogurtworld Enterprises Inc. (the “franchisor”). Under the franchise agreements (the “Agreements”), the franchisee was granted exclusive rights to develop two Ontario “Menchie’s” brand store locations in King City and Pickering, and was responsible for acquiring the first location within 90 days. The franchisee paid a $75,000 non-refundable development fee pursuant to a Multi-Unit Development Agreement (“MUDA”), and the franchisor suggested possible locations for the franchise locations.
Approximately three months after the deadline expired, the franchisee asked to extend the deadline and to change the designated franchise areas to Fairview Mall in Ontario and Chinook Mall in Alberta. The franchisee still did not acquire a location. As a result, the franchisor terminated the Agreements and retained the development fee.
The Law
Under the Act:
- Section 5 of the Act requires franchisors to provide potential franchisees with a franchise disclosure document (“FDD”) containing all material facts.[2]
- Section 6(2) allows a franchisee to rescind a franchise agreement (without penalty) if the FDD does not comply with section 5. The franchisee has two years to rescind the agreement.
The Case
In Yogurtworld, the franchisee sought to rescind the franchise agreements pursuant to section 6(2) of the Act, alleging that the franchisor failed to make adequate disclosure under section 5. They also sought a refund of the development fee. The franchisee argued that the franchisor failed to disclose a number of, allegedly, material facts:
- The franchisor failed to disclose that there were no suitable locations for the operation of Menchie’s stores in the designated territories agreed upon in the franchise agreements, and that the franchisor knowingly withheld this information.
- The disclosure document did not specify that a landlord might insist on a personal guarantee as part of negotiations for a lease.
- The range of costs associated with the establishment of the franchise was too broad to make an informed investment decision.
- There was an absence of any disclosure about expected earnings or profitability.
- Without an established location, it was not knowable at the time they received the Disclosure Document when the stated fees would apply and what the lease, equipment, and fixturing costs would be.[3]
1) Suitability of Locations
Though the franchisee alleged that the franchisor knowingly withheld information suggesting there were no “suitable” franchise locations within the original territories, the Court found that this was not proven on a balance of probabilities.
2) Lease Guarantees
The franchisee alleged that the franchisor knew about the possibility that a landlord could require a personal guarantee as part of a location’s lease, but the Court held that this was not material non-disclosure. This was not known to be something required by landlords across the Menchie’s franchise system, and the Court found no evidence that any landlord asked for a personal guarantee for any of the prospective locations within the territories specified in the franchise agreements.[4]
3) Prescribed Disclosure – Range of Costs
The Act requires that an FDD shall contain all material facts, and shall contain the following presented together:
1. A list of all of the franchisee’s costs associated with the establishment of the franchise, including,
i. the amount of any deposits or franchise fees, whether the deposits or fees are refundable, and if so, under what conditions,
ii. an estimate of the costs for inventory, leasehold improvements, equipment, leases, rentals and all other tangible and intangible property necessary to establish the franchise and an explanation of any assumptions underlying the estimate, and
iii. any other costs associated with the establishment of the franchise not listed in subparagraph i or ii, including any payment to the franchisor, whether direct or indirect, required by the franchise agreement, the nature and amount of the payment, and when the payment is due.
The franchisee claimed that the disclosure document did not comply with the Regulations, as the disclosure document did not list all the costs associated with establishing the franchise. The franchisee argued that the franchisor provided them with a range of costs that were too broad to help them make an informed business decision.
The Court found that the cost range provided in the disclosure document was appropriately broad. The Court commented that the Act stipulates that variables and assumptions must also be disclosed, as they were in this case, and that the franchisor adequately listed these in the disclosure document.
4) Absence of Expected Earnings and Profitability
The Court held that the franchisee was correct in that the franchisor did not disclose information about expected earnings or profitability, but this is not a disclosure deficiency. Under section 6, item 3, of the Regulations, if the franchisor provides an earnings projection then the franchisor must meet additional disclosure requirements. There is no requirement for the franchisor to provide such projections, and the Court held that the franchisor did not have to meet these additional disclosure requirements.
5) Costs Unknowable until Location Established
The franchisee argued that they should not have to decide whether to invest in a franchise before knowing the specific costs of what that franchise location would be, which could only be determined once they decided on a particular location.
The franchisees relied on Raibex Canada Ltd. v. ASWR Franchising Corp. (“Raibex”), where the courts interpreted s. 6(2) of the Act to allow a franchisee to claim non-disclosure and rescind the franchise agreement within two years from the date of signing if it is found so deficient or inadequate so as to effectively amount to material non-disclosure.[5] However, the circumstances of Yogurtworld were different, and it was determined that “when considered in context, the information disclosed to the plaintiffs was sufficient to enable them to assess the potential costs and risks of establishing and operating a Menchie’s franchise location”.[6] Further, if the franchisee was concerned regarding the location details and associated lease costs, it had the option to rescind within 60 days of the franchise agreement, but they did not avail themselves of this clause. [7]
Summary of Outcome
The Court dismissed the action saying the franchisor provided adequate disclosure and that location-specific disclosure does not fall into the category of a fatal disclosure deficiency. The Court held that the Act “does not require that the franchise location be known or that disclosure be site specific, nor does it foreclose the use of estimates or ranges of anticipated costs”.[8]
The disclosure document was therefore compliant with section 6(2) of the Act and not deficient to the extent that it would warrant rescission. The franchisees proceeded with the agreements and, therefore, did not have a claim to rescission or a refund of the development fee.
The Court also noted the a distinction regarding lease guarantees between the situation in Yogurtworld and the Ontario Superior Court’s decision in 2611707 Ontario Inc., et al v. Freshly Squeezed Franchise Juice.
The points of distinction between Freshly Squeezed and this case bring into focus the broader distinction between s. 6(2) Wishart Act cases involving the recognized categories of fatal disclosure flaws and cases where the impugned disclosure is not in a recognized category. Unlike in Freshly Squeezed (and Raibex), the Menchie’s franchise system is not a system where the franchisor enters into a head lease that the franchisees are bound to through subleases signed without knowledge of the lease terms or the ability to be relieved from their obligations if they are not satisfied with the lease terms later agreed to by the franchisor. In the Menchie’s franchise system, the Franchisee was the party responsible for securing a location and negotiating its own lease terms and there was, therefore, no head lease to disclose. This does not fall within the fatal disclosure category of an as of yet undetermined head lease with unknown terms to be imposed on the franchisor.[9]
Conclusion
The ruling follows the previous decisions in both Freshly Squeezed and Raibex, adding that location-specific disclosure is not always required in disclosure documents. The Ontario Superior Court of Justice in Raibex noted “[w]hether deficiencies in a disclosure document are so serious as to amount to no disclosure for the purposes of the [Arthur Wischart Act] must be determined on the facts of each case.”[10]
4867-1294-3406 v7 [99998-3882]
[1] 2364562 Ontario Ltd. v. Yogurtworld Enterprises Inc., 2021 ONSC 5112 [Yogurtworld].
[2] Arthur Wishart Act (Franchise Disclosure), 2000,S.O. 2000 c. 3.
[3] Yogurtworld, supra note 1.
[4] Yogurtworld, supra note 1 at para 50.
[5]Yogurtworld, supra note 1 at para 30.
[6]Yogurtworld, supra note 1 at para 66.
[7]Arthur Wishart Act (Franchise Disclosure), 2000,S.O. 2000 c. 3, s. 6(1)
[8]Yogurtworld, supra note 1 at para 11.
[9] Yogurtworld, supra at para. 42; 2022 ONCA 437 [Freshly Squeezed].
[10] Raibex, supra at para 48.
