Franchise

If it looks like a franchise, it’s a franchise

By Peter Dillon for AdvocateDaily.com

In another decision in the line of “accidental franchisor” cases, Justice Mary E. Vallee, of the Ontario Superior Court of Justice, granted summary judgment on the basis of non-disclosure to plaintiffs who purchased the rights to operate an alcohol delivery service under an established trademark.

This decision reiterates that a business relationship may be subject to the disclosure requirements of the Arthur Wishart Act (the AWA), regardless of whether it is called a “franchise.” Ontario courts take a substance-over-form approach in determining whether a contractual arrangement constitutes a franchise.

The principal operating the business attempted to avoid its characterization as a franchise. In a pre-contractual email to the plaintiffs, the principal stated that it’s “not a franchise.” The parties later signed an exclusivity agreement, which also stated that the transaction was not the purchase of a franchise. The agreement gave the plaintiffs the right to operate under the company name in Richmond Hill and neighbouring territories.

After operating the business without a profit for several months, the plaintiffs delivered a statement of claim alleging that the defendant sold them a franchise without making proper disclosure and seeking rescission under s. 6(2) of the AWA.

The primary issue was whether the business satisfied the statutory definition of “franchise” in s. 1(1) of the AWA. The parties agreed that no franchise disclosure document had been provided; thus, if the business was, in fact, a “franchise,” the plaintiffs would be entitled to rescind the agreement.

Vallee reiterated that the title given to the document signed by the parties is irrelevant. She said the substance of the relationship must be examined to determine whether it is a franchise relationship. The statement in the agreement that it was not the purchase of a franchise is therefore ineffective if the statutory definition of “franchise” is satisfied.

She concluded that all three requirements under paragraph (a) of the “franchise” definition were satisfied. First, the payment requirement was met: the plaintiffs were required to make a $40,000 payment as a condition of acquiring the business and to make continuing payments in the form of a $3 management charge for each delivered order.

Second, Vallee found that the defendant had granted the plaintiffs the right to sell or distribute goods or services that were substantially associated with the defendant’s trademark.

The defendant argued that he did not have the authority to grant the plaintiffs the right to sell, offer to sell or distribute goods; the plaintiffs were required to apply for their own licence from the Alcohol and Gaming Commission of Ontario in order to deliver alcohol. Vallee dismissed this argument, finding that regardless of the requirement to apply for a licence, the plaintiffs “would not have been able to distribute in the territories that they purchased from the defendant using the defendant’s trademark unless they had entered into an agreement with the defendant that permitted them to do so.”

With respect to the third requirement, the court found that the defendant exercised significant control over the important aspects of the plaintiffs’ business. It controlled taking orders and referring those orders to the plaintiffs, the logo, marketing material, web design, phone line billing, telemarketing and telephone book advertising.

Concluding that the parties had a franchise relationship and the agreement between them was a franchise agreement, Vallee awarded rescission under s. 6(2) of the AWA. The plaintiffs were therefore entitled to a refund of the $40,000 fee they paid to the defendant. The remainder of the plaintiffs’ rescission damages could not be determined, as the plaintiffs did not provide any evidence relating to the total amount of management fees paid to the defendant.

The plaintiffs also sought damages under s. 7 for misrepresentation and failure to disclose. While the misrepresentation claim was dismissed, Vallee accepted the plaintiffs’ evidence that they would not have entered into an agreement with the defendant had proper disclosure been provided. The plaintiffs were thus entitled to damages as a result of the expenses incurred in setting up and operating the business.

The plaintiffs moved to pursue this business opportunity, which involved one of the plaintiffs giving up a job with an annual salary of $50,000. Interestingly, Vallee awarded the plaintiffs $50,000 for the loss of this income and $4,874.24 for their moving expenses, although it's debatable as to whether it was appropriate to award damages for the full salary where the plaintiff made his own decision to leave that job.

The remainder of the damages claimed by the plaintiffs could not be awarded on summary judgment, with the judge stating that a trial on the issue of damages would be necessary.

As with the management fees, the plaintiffs’ failure to prepare sufficient documentary evidence to corroborate their losses limited the amount they were able to recover on summary judgment. The court noted that many of the amounts claimed were not specific or did not include proof of payment.

Potential litigants are reminded that any losses being claimed must be supported by documentation.

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