OCA decision not a 'get out of jail free' card for franchisors

By Staff

An Ontario appeal court judgment that overturned the rescission of a franchise agreement is only a qualified success for franchisors, Toronto franchise lawyer Joseph Adler tells

A unanimous three-judge panel of the province’s top court ruled that uncertainty over the location and other deficiencies in the franchise disclosure document were not sufficient to trigger the two-year rescission remedy under Ontario’s Arthur Wishart Act (AWA), overturning a lower court judge’s decision in favour of the franchisee.

Adler, a partner with Hoffer Adler LLP, says the lower court decision had the franchise bar up in arms because disclosure documents are routinely disclosed to prospective franchisees before the site selection and lease negotiation process begins.

“This decision brings a level of certainty for franchisors who were concerned that they would be unable to disclose prospective franchisees and enter into franchise agreements unless they had the leases finalized and included in their disclosure documents,” he says, pointing out that it was unrealistic to expect franchisors to negotiate leases and commit themselves to particular locations without first ensuring the proposed franchisees were on board.

But, he adds, franchisors shouldn’t get too carried away by the appeal court’s ruling.

“At the same time, the decision reiterates that the underlying purpose of the Act is to protect franchisees, and begs a number of new, unanswered questions,” Adler says. “The pendulum has swung back in favour of franchisors, but only a little bit. This is not a get-out-of-jail-free card.”

Like legislation in a number of other provinces, Ontario’s AWA requires franchisors to deliver a disclosure document to potential franchisees at least 14 days before signing any binding agreement or receiving the payment of any money from the prospective franchisee.

Late or incomplete disclosure entitles franchisees to rescission within 60 days under s. 6(1) of the AWA, but if it's “materially deficient,” Adler explains that case law has typically held that it will be treated as if no disclosure was made at all, which gives franchisees a full two years to seek rescission under s. 6(2) of the AWA.

In the controversial lower court decision, an Ontario Superior Court judge found that the head lease and the disclosure documents presented by the franchisor were “materially deficient,” dismissing the franchisor’s warning that costs “vary dramatically from location to location” as insufficient. Labelling the document’s overall lack of disclosure “egregious,” the judge granted the franchisee the two-year rescission remedy under the AWA.

However, Adler says the appeal court decision may reflect a shift in judicial approach.

“Perhaps the Court of Appeal is saying that it wishes to move away from the material fact threshold question in favour of whether or not the franchisee was given sufficient information to make an informed decision,” he says.

In its judgment, the appeal court ruled that the lower court judge had erred in failing to consider the terms of the agreement, which provided for a collaborative approach to site selection, strengthened by an opt-out clause that allowed the franchisee to reject the site and find another or receive their money back.

“These safeguards, in my view, provide a complete answer to the complaint that the franchisor’s failure to disclose the head lease justified rescission,” the decision states. “The absence of that information had little impact on the franchisee’s ability to make an informed investment decision.”

Still, Adler says there remains uncertainty in how the law will apply.

“The court appears to be moving from engaging in an analysis that is heavily focused on the contents of the disclosure document to one that is more contextual in nature, as the court makes several references to whether or not the prospective franchisee is capable of making an informed investment decision,” he says.

“It raises questions in my mind about what it means to be fully informed. We will need to wait for more decisions before we gain some clarity in these regards.”

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