Subjective approach to franchise rescission shut down

By Staff

The Ontario Court of Appeal has killed off any hopes franchisors may have harboured for the injection of an element of subjectivity into the test for rescission of a franchise agreement, says Toronto franchise lawyer Joseph Adler.

In Mendoza v. Active Tire & Auto Inc., the province’s top court overturned a motion judge’s order to deny a franchisee a right of rescission after determining he had made an “informed decision” to enter the franchise relationship, despite deficiencies in disclosure.

“It’s a a clear and definitive statement that that the court will not soften its interpretation of the technical requirements for disclosure under the Arthur Wishart Act (AWA),” Adler, a partner with Hoffer Adler LLP, tells “The appeal court has confirmed that the subjective knowledge of the franchisee is irrelevant.”

Ontario’s AWA requires franchisors to deliver a disclosure document to potential franchisees at least 14 days before the signature of any binding agreement or payment of money, Adler explains.

Late or incomplete disclosure entitles franchisees to rescission within 60 days under s. 6(1) of the Act, but if the disclosure is “materially deficient,” case law holds 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 Mendoza, the franchisee operated an Active Tire franchise for about three months at a loss, before providing a notice of rescission. In court, the plaintiff argued that the franchisor’s failure to have two of its officers or directors sign the disclosure certificate and omission of its most recent financial information engaged s. 6(2).

The motion judge recognized those deficiencies but found the rest of the 175-page disclosure document still gave the franchisee enough information to make the “informed decision” to sign up.

The appeal court rejected this looser take on rescission, outlining a more objective approach that focuses on the quality of the disclosure provided by the franchisor.

“The Act imposes significant disclosure obligations on franchisors for the benefit of franchisees. It does not make the rescission remedy conditional on the approach taken by a particular franchisee to the disclosed material,” wrote Justice Kathryn Feldman for the unanimous three-judge panel.

“This is consonant with the intent of the Act, which is to ensure that franchisors who wish to enter into franchise agreements with franchisees must consistently provide the required documentation to every proposed franchisee. Their obligations do not change depending on the actions or reactions of a particular franchisee.”

The appeal court went on to find that both the omitted signature and the outdated financial statements constituted material deficiencies, engaging s. 6(2) rather than 6(1), as the franchisor argued. The panel also rejected the motion judge’s finding that the franchisee’s failure to read the entire disclosure document disqualified him from taking the position that its contents were important to him.

Whether or not they read the disclosure document, franchisees are “entitled to rely on its contents and the ability to later verify what they believed and understood when they decided to proceed with the franchise,” the appeal court concluded.

Adler says the appeal court’s finding that the failure to have two directors or officers sign a disclosure certificate is a material deficiency could cause some franchisors to run into trouble in future since the AWA does not actually define who in a company would be considered in that role.

“Companies will have people who go by the title of something like marketing officer. Does that mean they are an officer for the purposes of the Act?” Adler asks. “If you only have one signatory and the court decides there should have been two, that alone would invalidate the disclosure document.”

He says some franchise lawyers look to corporation statutes for some direction on the issue. For example, the definition of an "officer" under Ontario's Business Corporations Act includes "any other individual who performs functions for a corporation similar to those normally performed by an individual occupying any such office," regardless of their title.

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