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New franchise agreements can extend right of rescission

A recent Superior Court decision suggests franchisors who ask franchisees to sign a new agreement risk extending the period in which it can be rescinded, says Toronto franchise lawyer Joseph Adler

The judge in the case, granted the owners of a Bradford, Ont. tap and grill restaurant almost $1 million in damages after finding they exercised their two-year right of rescission under Ontario’s Arthur Wishart Act (AWA) in time.

The parties initially signed the franchise agreement in June 2010, but an updated version was prepared and executed in September 2010. According to the decision, the plaintiffs were only sent the signature page as the rest of the agreement was substantially the same as the previous version.

When the franchisees delivered their notice of rescission in September 2012, the defendants argued they had missed their window of opportunity by three months, but the judge ruled that the second agreement restarted the clock on their rescission right.

“If you’re a franchisor and you’re going to ask someone to sign a new agreement, you need to recognize that you may be lengthening the period they have to rescind. The definition of an agreement is very broad, so you need to be careful,” Adler, a partner with Hoffer Adler LLP, tells AdvocateDaily.com.

The judge in the case ruled that the new agreement was made at the insistence of the franchisor.

“Having chosen to require the franchisees to sign and enter into a replacement agreement, the franchisor cannot now argue that an existing franchise agreement is already in place such that the protections afforded under s. 6(2) are already partially diluted,” he wrote. “As earlier referenced, this determination must be made under the canopy of the AWA, the intent and purpose of which is to protect franchisees and ensure they receive full and accurate disclosure.”

Adler, who was not involved in the case and speaks generally, says it’s unclear how the judge would have ruled if the new agreement had been instigated by the plaintiff, rather than the defendant.  

“The judge made the point that the legislation is remedial and meant to protect franchisees, so it would be interesting to see what the court would think if it happened the other way around,” he says. “Maybe they would say, ‘You asked for it and you’re getting the benefit of it, so you don’t get to extend the time.’”

The judge found that the franchisor’s failure to include an earnings projection and the underlying basis for it, despite mentioning it in a meeting with the prospective franchisee, was a “material, fundamental and stark omission,” triggering the rescission right.

“This information is potentially the single most important information that a potential franchisee would want to know,” he added. “There are omissions that constitute imperfect disclosure and omissions that are so significant and material as to constitute no disclosure. The earnings projection omission falls squarely in the latter category.” 

“If you make an earnings projection verbally, or outside the four corners of the franchise disclosure document, then you could be offside, without providing the basis for the projection in the document,” Adler says.

Despite finding for the plaintiff overall, the judge also ruled that the failure to provide a head lease in the franchise document would not have been enough for the plaintiffs to claim the rescission.

“There was no head lease in existence and the only lease in place was an offer to lease, which was disclosed when known,” the judge wrote.

Adler says that finding is striking since it stands in contrast to a decision currently under deliberation at the Court of Appeal after another Superior Court judge allowed the rescission of an agreement in similar circumstances.

According to Adler, the appealed decision caused consternation in the franchise bar, because it was a relatively routine practice for disclosure documents to be turned over to proposed franchisees before the site selection process begins.

“Traditionally, you would take the position that you can’t disclose what you don’t know, but the court said you have to wait until you know before you disclose, otherwise the franchisee can’t make an informed decision,” he explains. “But that issue will be settled one way or the other very soon by the appeal court.”

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