Uncertainty for franchisors after Raibex decision
By AdvocateDaily.com Staff
Toronto franchise lawyer Joseph Adler says the bar is up in arms after a judge allowed the rescission of an agreement signed before the location of the proposed franchise was known.
Ontario’s Arthur Wishart Act (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. Several other provinces; most recently British Columbia; have also passed laws that impose similar requirements.
In Raibex Canada Ltd. v. ASWR Franchising Corp., 2016 ONSC 5575, Ontario Superior Court Justice Wendy Matheson found the form of head lease and the disclosure document presented by ASWR were materially deficient. Labelling the document’s overall lack of disclosure “egregious,” she granted Raibex the two-year rescission remedy under the AWA.
Adler, a partner with Hoffer Adler LLP, says until now, it’s been a relatively routine practice for disclosure documents to be turned over to proposed franchisees before the site selection process begins.
“This decision questions that practice, which has been widely embraced by franchisors,” he tells AdvocateDaily.com.
Adler explains that many franchisors prefer to do things in that order because they don’t want to commit themselves to a lease at a particular location without first ensuring the proposed franchisee is on board.
“If you enter into the lease, and then the franchisee decides they don’t want to go through with the agreement, the franchisor could be on the hook for the rent, which many can’t afford to do,” he says.
In Raibex, Matheson found it was not enough for ASWR to warn in its disclosure document that costs “vary dramatically from location to location.”
When the lease was ultimately agreed, it triggered a $120,000 upfront payment by Raibex to cover deposits and prepaid rent.
“It is insufficient for a franchisor to simply say that required material information was not known at the time of disclosure. In the circumstances of this case, it was premature to purport to deliver the disclosure document under the AWA and enter into a franchise agreement,” Matheson wrote.
While emphasizing that there was no suggestion of any abuse in this case, Matheson wrote that allowing ASWR’s argument to succeed could encourage exploitation by unscrupulous franchisors in future cases.
“A franchisor could simply give disclosure at a premature stage, when material matters were not yet known, encourage the signing of the franchise agreement at that stage, and avoid its statutory disclosure obligations. I reject that approach,” Matheson wrote.
Adler says he understands Matheson’s concerns, but worries the decision will make “franchising as a business much more difficult” in practice.
He says the decision does not necessarily put an end to disclosures made before locations are known, noting that the unanticipated $120,000 payment in Raibex may have turned that case in the franchisee’s favour.
“If a franchisor could anticipate the range of costs for a lease, and then negotiates one that falls in the range disclosed, you could make an argument that the proposed franchisee had full knowledge of all anticipated costs, even without the inclusion of the head lease,” Adler says.
The decision is currently under appeal, with a hearing expected in the fall of 2017.
“It’ll be interesting to see how the court rules,” Adler says.
In the meantime, he says franchisors and their legal advisors are left with a degree of uncertainty about how to proceed when potential franchise locations are unknown.
Options include waiting for the appeal court decision to deliver some clarity, or waiting until leases are ready to be signed before making disclosures.
“The other thing you could do is to terminate an existing franchise agreement when a lease becomes available, refund the franchise fee, and then re-disclose and execute a new franchise agreement. But that is a real pain in the neck,” Adler says. “At the very least, franchisors have to take Raibex into account, because otherwise, they are opening themselves up to the potential of a pretty serious attack.”