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Franchise Law
Franchise Law e-COMMUNIQUÉ – February 2012
Published: 02/08/2012
By Stefanie Baldassarra, Rebecca Hamovitch, Frank Robinson, Derek Ronde, Geoffrey B. Shaw, Larry M. Weinberg
In This Issue
- Existing Franchisees with a Right of First Refusal Must Actually Exercise that Right in Order to Trigger Franchise Disclosure Obligations
- Federal Court Holds that Intellectual Property Rights Do Not Automatically Transfer in an Asset Sale
- Recent Ontario Court Decision Outlines the Limitation Period for Rescission Claims Under Ontario’s Franchise Legislation
- The New Canada Not-for-profit Corporations Act: What It Might Mean for Your Franchise System’s Ad Fund
- Saskatchewan Court Finds Franchisor Waived Arbitral Termination Decision By Its Post-Termination Conduct
- A Discrepancy Between Disclosure Document and Franchise Agreement Causes Alberta Court to Deny Enforcement of Non-Competition Clause
- What We're Up To (Winter And Spring 2012)
Existing Franchisees with a Right of First Refusal Must Actually Exercise that Right in Order to Trigger Franchise Disclosure Obligations
By Stefanie Baldassarra The Ontario Superior Court of Justice recently dismissed a franchisee plaintiff’s action for $15 million in damages arising out of a franchisor’s alleged failure to honour a right of first refusal and adhere to its disclosure obligations under Ontario’s franchise legislation, the Arthur Wishart Act (Franchise Disclosure), 2000 (the “Act”). The court’s decision provides significant guidance on when statutory disclosure obligations arise in cases where a franchisee has a right of first refusal over a new location.
In 3574423 Canada Inc. v. Baton Rouge Restaurants Inc., the franchisee, 3574423 Canada Inc., was given the opportunity to acquire a second franchise to which it enjoyed a right of first refusal pursuant to the franchise agreement with the franchisor, Baton Rouge Restaurants Inc. In 2000, the franchisee had been given three opportunities to acquire a second franchise prior to the disclosure requirements under the Act having come into force. On each occasion, the franchisee declined the opportunity and signed a waiver to preserve its right of first refusal in the event of a subsequent opportunity. In 2001, following the coming into force of the disclosure requirements of the Act, the opportunity for a second franchise which had previously been offered to the franchisee re-emerged. Once again, the franchisee rejected the opportunity and signed a waiver without prejudice to its right of first refusal but this time, the franchisor refused to extend the right of first refusal and the location was later obtained by another party.
Despite the fact that the franchisee operated an existing franchise, it took the position that it was a "prospective franchisee" in relation to the second franchise. Pursuant to section 5(1) of the Act, franchisors are required to deliver a disclosure document to a prospective franchisee "not less than 14 days before the earlier of: (a) the signing by the prospective franchisee of the franchise agreement or any other agreement relating to the franchise; and (b) the payment of any consideration by or on behalf of the prospective franchisee to the franchisor or franchisor's associate relating to the franchise." The franchisee argued that the signed waiver was an "agreement relating to the franchise" within the meaning of section 5(1), thereby triggering its right to a disclosure document.
The court rejected this argument and held that the Act provides relief to those who become franchisees, not to those who do not. In other words, liability only attaches to inadequate disclosure if a prospective franchisee becomes a franchisee by signing the franchise agreement or any other agreement relating to the franchise. The phrase “any other agreement relating to the franchise" refers to an agreement signed by a person who becomes an actual franchisee. Until a prospective franchisee becomes an actual franchisee, there can be no agreement relating to the franchise and therefore, no right of action based on disclosure information that was allegedly provided or not.
Although the court’s conclusion was sufficient to deal with the franchisee’s claim for damages, it further analyzed the “additional franchise” exemption contained in section 5(7)(c) of the Act, which has yet to be judicially considered. The "additional franchise" exemption relieves a franchisor from its obligation to deliver a disclosure document where (i) the additional franchise is substantially the same as the existing franchise; and (ii) there has been no material change since the existing franchise agreement or the latest renewal or extension was entered into. In this case, the Court found that the difference in the size of franchise locations was not material, as it did not affect the financial or operational arrangements between the parties.
While franchisors must always be mindful of their disclosure obligations when dealing with a prospective franchisee in the event they become an actual franchisee, the court’s decision provides two important guiding principles. Firstly, statutory relief for inadequate disclosure is only available to prospective franchisees who sign an agreement relating to the franchise, consequently becoming a franchisee. Secondly, the additional franchise exemption in the Act can apply even where there is a difference in the size of the locations or type of market, to the extent that the operational and financial relationship is not materially changed. While the jurisprudence provides some guidelines, the breadth of meaning to be ascribed to the term “material change” remains vague.
This case is also notable because the court awarded significant partial indemnity costs in favour of the defendant franchisor in an amount exceeding $780,000.00.
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Federal Court Holds that Intellectual Property Rights Do Not Automatically Transfer in an Asset Sale
By Frank Robinson The Federal Court Trial Division recently held that intellectual property rights do not automatically transfer in an asset sale. Moreover, the Court enforced a registered trademark in restaurant trade dress and copyright rights in restaurant menus.
In 1429539 Ontario Limited v. Café Mirage Inc., the plaintiff franchisor agreed to convey the assets of two of its cafés to a creditor. The creditor agreed to include a covenant in any subsequent purchase agreement which provided that should the cafés be sold to a buyer who would not operate them as a franchise, that the purchaser would remove the plaintiff’s signage. The creditor made such a sale to the defendant, who then declined an offer to enter the franchise system. Nevertheless, the defendant ran the cafés using copies of the plaintiff’s menus, trademarks and restaurant trade dress. An infringement claim was therefore brought by the plaintiff.
The defendants argued they had acquired an implied license to use the trademarks and copyrighted menus through the plaintiff’s consent. The Court held that the consent to the use of the plaintiff’s trademarks only applied within the franchise system. Thus, this implied right dissolved when the defendants refused to join. In addition, the Court held that the defendants had an implied license to use the plaintiff’s menus, since copies were purchased as assets, but that the defendants had breached the plaintiff’s copyright by reproducing a substantial part of them.
The defendants argued that copyright and trademark rights were included in the asset purchase. The Court held that intellectual property rights do not automatically transfer in an asset sale, and as such, any intended transfer should have been dealt with explicitly in the sale agreement. Without such rights having been conveyed, the Court held that, by using their logos and trade dress, the defendants had breached the plaintiff’s trademark rights, and ordered the signs be returned.
This case is a reminder that copyright and trademark rights can be protected if properly enforced, and that special attention must be given to intellectual property rights in an asset purchase if they are intended to be transferred.
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Recent Ontario Court Decision Outlines the Limitation Period for Rescission Claims Under Ontario’s Franchise Legislation
By Derek Ronde In a recent decision of the Ontario Superior Court of Justice, 2130489 Ontario Inc. v. Philthy McNasty’s (Enterprises) Inc. (2011 ONSC 6852), the court examined the issue of limitation periods in respect of statutory rescission claims under the Arthur Wishart Act (Franchise Disclosure), 2000 (the “Act”).
The Act appears straightforward with respect to the limitation period for a franchisee delivering a notice of rescission (two years from the date of execution of the franchise agreement, or sixty days from delivery of the franchise disclosure document, depending on the reason for rescission).
However, once the notice of rescission is delivered, the Act is unclear as to how long a franchisee has to bring an action in court with respect to the franchisor’s failure to abide by the notice of rescission.
In this case, the franchise agreement was executed on October 9, 2007. The franchisee issued a notice of rescission under the Act on September 23, 2009, just under two years after the agreement was executed. The court noted that under the Act, the franchisor has sixty days in which to satisfy the Act’s rescission obligations under the Act. By November 3, 2009 (and within the sixty days), the franchisor advised the plaintiff franchisee that the notice of rescission was being disputed. The plaintiff franchisee commenced an application seeking rescission of the franchise agreement on November 29, 2010.
The court held that the franchisee had properly issued its notice of rescission within the two year limitation period outlined in the Act. The court then addressed when the cause of action arose in regards to the franchisor’s failure to respond to the notice of rescission. The court held that under the Limitations Act, 2002, the franchisee had two years from when the franchisor rejected the rescission claim to bring an action against the franchisor. In this case, the court found the claim against the franchisor was discoverable on November 3, 2009, which was the date on which the franchisor advised the franchisee that it was disputing the rescission claim. As such, the application brought on November 29, 2010 was commenced in time and was not barred by the Limitations Act, 2002.
This decision is helpful in clarifying the limitation period with respect to rescission actions. Even if a franchisee issues a notice of rescission within the appropriate time allowed, the franchisee still has to ensure that an action is brought as soon as that franchisee is aware that the franchisor will be disputing the rescission claim. Franchisors should pay close attention to this limitation period as a defence when dealing with rescission claims under Ontario’s franchise legislation.
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The New Canada Not-for-profit Corporations Act: What It Might Mean for Your Franchise System’s Ad Fund
By Rebecca Hamovitch In many franchise systems, franchisors administer (or reserve the right to later establish and administer) an advertising fund. These ad funds may be administered directly through the franchisor entity, or through a separate corporation or trust set up by the franchisor. If your ad fund is administered through a federally incorporated not-for-profit corporation, you will have to comply with certain requirements set out in the new Canada Not-for-profit Corporations Act (the “New Act”).
The federal government proclaimed the New Act into force effective October 17, 2011. The New Act is the first revision of the statutory law governing federal not-for-profit corporations in more than 60 years. As a result, it is game-changing legislation, intended to bring greater transparency and accountability into the federal not-for-profit sector. Franchisors who have incorporated a not-for-profit company should be aware of some of the immediate implications of the New Act.
Until your corporation applies to Industry Canada to be continued (i.e. transferred) under the New Act, it will continue to be governed by the Canada Corporations Act (the “Old Act”). As a result, it will be “business as usual” for your corporation until you complete that application. Your corporation does not have the right to continue under any legislation other than the New Act. This means that if an existing not-for-profit corporation no longer wishes to be a federal not-for-profit corporation, it must first continue under the New Act and then continue a second time under the legislation of a province or other jurisdiction with continuance rights that are reciprocal to those in the New Act.
However, there is a sunset date for operations under the Old Act. Significantly, if your existing not-for-profit corporation does not apply for articles of continuance under the New Act by October 17, 2014 (three years from the date the New Act came into force), the federal government will cancel your corporation’s charter with no opportunity for revival. It will then cease to exist.
Industry Canada has provided forms for applications for articles of continuance. One of the mandatory requirements for the articles of continuance will be a statement of “purposes” for the applying corporation, though Canada Revenue Agency has not provided any guidelines as to what such a statement must entail. There is no filing fee charged for the continuance filing. As long as the form is completed with the required information, the articles of incorporation will be issued.
It should be noted that there is also new provincial legislation dealing with not-for-profit corporations. The Ontario Not-for-Profit Corporations Act, 2010 (the “Ontario Act”) has received Royal Assent, and it is anticipated that it will be proclaimed into force in late 2012. In contrast to the New Act, the Ontario Act, once proclaimed in force, will immediately apply to all then existing Ontario not-for-profit corporations without any requirement for action on their part.
One of the goals of the New Act is to conform the rules governing federal not-for-profit corporations as closely as possible to the rules governing for-profit corporations, and as such, there are significant parallels between the New Act and the Canada Business Corporations Act. Among other things, this will mean that after your corporation continues under the New Act, it will have all of the capacity of a natural person.
After continuance under the New Act, your corporation will also be subject to stricter audit and reporting obligations. This requirement is intended to create greater transparency and more fulsome disclosure to members of the corporation, Industry Canada and Canada Revenue Agency. As a result, you should consider budgeting additional funds for accounting expenses. Of course, there are a large number of other changes to governance and other aspects of your corporation which will apply after it continues under the New Act.
An advertising fund can be critical to a franchise system’s brand awareness, profitability, and overall success. Given that failure to continue under the New Act within the proscribed timeframe will result in the automatic and permanent dissolution of any existing federal not-for-profit corporation, it is crucial that franchisors fully inform themselves and comply with the New Act. We would be happy to advise on and facilitate the planning and transition from the Old Act to the New Act in a timely and cost-effective manner.
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Saskatchewan Court Finds Franchisor Waived Arbitral Termination Decision By Its Post-Termination Conduct
By Derek Ronde A 2011 decision from the Saskatchewan Court of Queen’s Bench suggests that a franchisor may risk inadvertently waiving its ability to enforce an arbitral decision terminating a franchisee if that franchisor’s post-termination conduct re-affirms the franchise relationship.
In Subway Franchise Systems of Canada Ltd. v. Laich, the franchisor, Subway, sought to terminate a Saskatchewan franchisee due to breaches of the parties’ franchise agreement. Subway’s franchise agreement also required that all disputes be resolved by arbitration to be held in Bridgeport, Connecticut. Accordingly, an arbitration was held in Connecticut. The arbitrator ultimately decided in favour of Subway, upheld the franchisee’s termination and ordered the franchisee to pay the costs of the arbitration along with damages of $250 for each day she continued to operate her restaurant after the arbitral award.
Despite the arbitral award, the franchisee’s restaurant remained open. This prompted Subway to bring an application in the Saskatchewan court to recognize and enforce the award. Saskatchewan, like Ontario, has adopted both the UNCITRAL Model Law and the UN New York Convention on the recognition and enforcement of international arbitral awards through provincial legislation. This statutory regime is deferential and generally favours the recognition and enforcement of awards, unless they fit into a narrowly construed set of exceptions.
In this case, while the court found no deficiencies in the arbitration process or the award itself, it declined to recognize and enforce the award under the umbrella exception contained in Article 36(1)(a)(i) of the New York Convention, finding that enforcement would be “contrary to the public policy” of Saskatchewan.
The court found that Subway had, by its actions, waived the termination by continuing to work with and support the franchisee in a profitable partnership. In the six months between the arbitral award and Subway’s application for recognition and enforcement in Saskatchewan, Subway and the franchisee had continued to operate normally under the terms of the franchise agreement. The franchisee had even received an automatically generated letter from Subway congratulating her on record-breaking sales and a “job well done.” The letter went on to say, “we hope the great sales trend and momentum continues.” Further, since the franchisee had continued to pay all remittances and royalties to Subway after the award, the court found that enforcing the $250 per day damages award would result in a double recovery by Subway contrary to the public policy and law of Saskatchewan.
Following this decision, franchisors operating in Canada should take care to ensure that their interactions with terminated franchisees are not out of step with the decision to terminate, as even an inadvertent acknowledgement that the franchise relationship still lives on may be construed as waiving the termination.
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A Discrepancy Between Disclosure Document and Franchise Agreement Causes Alberta Court to Deny Enforcement of Non-Competition Clause
By Derek Ronde The Alberta Court of Queen’s Bench recently issued a reminder to franchisors of the consequences of inaccurate disclosure. In Mapleleaf Franchise Concepts, Inc. v. Nassus Frameworks Ltd. the plaintiff, a franchisor of framing and art supply stores, was denied enforcement of the non-competition clause in their franchise agreement against a former franchisee for having misstated the contents of the clause in their franchise disclosure document.
Like Ontario’s Arthur Wishart Act, Alberta’s Franchises Act requires franchisors to deliver a disclosure document to all prospective franchisees at least 14 days prior to signing a franchise agreement. Under the Alberta regulations, franchisors are required to disclose, among other things, the existence and location in the franchise agreement of terms that deal with renewal, termination and transfer of the franchise. Under both the Alberta and Ontario regimes, franchisees are deemed to rely on the contents of the disclosure document and any misrepresentation of a material fact in a disclosure document can give rise to a claim for damages.
In this case, the franchisor provided a disclosure document that incorrectly described the non-competition clause in the franchise agreement as prohibiting the franchisee from operating a competing business within three kilometres of another franchise for two years after termination or expiry.
The franchise agreement, a draft copy of which was attached to the disclosure document, contained a slightly different provision. The actual clause prohibited the franchisee from operating a competing business within 10 kilometres of another franchise or the franchisee’s former designated territory for two years after termination or expiry.
The franchisee subsequently signed a franchise agreement containing the more restrictive 10 kilometre non-competition clause. Despite testifying that he received and read the agreement, the franchisee claimed he only read it briefly and believed it would reflect the disclosure document. After his franchise agreement expired, the franchisee simply disassociated his store from the franchisor’s brand and continued to operate in the same location as an independent framing and art supply store.
The court found the franchisor was required to ensure their disclosure document was accurate. Since it was not accurate with respect to the description of the non-competition clause, a material fact of the agreement, the franchisee was not prohibited from carrying on business in his present location. Despite the franchisee’s admission at examinations for discovery that he did not pay attention to the disclosure document and that it was unimportant to him, the court found that he had sufficiently relied on the misrepresentation to negate the enforcement of the non-competition clause against him.
This case should stand as a warning to franchisors operating in Canadian jurisdictions with statutory disclosure regimes. Even a small discrepancy between the disclosure document and the franchise agreement can have dire consequences on the enforceability of the terms of the agreement.
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What We're Up To (Winter And Spring 2012)
The lawyers in the Cassels Brock Franchise Law team are looking forward to a busy winter and spring in 2012. Here is a sample of their recent and upcoming activities:
- Larry Weinberg was recently honoured by Franchise Times Magazine by being chosen as one of only 100 Legal Eagle franchise lawyers in North America
- Derek Ronde spoke on the topic of “The Franchisor’s Obligation to Provide Support” at the Canadian Franchise Association’s Legal Day in Toronto, Ontario on February 2, 2012.
- Larry Weinberg is chairing the upcoming 2012 Ontario Bar Association Institute on Franchise Law, “Dealing With and Litigating Disputes Involving Franchises” on Thursday, February 9, 2012 in Toronto, Ontario.
- Derek Ronde will speaking on the topic of “Rescission 101: An Introduction to the Statutory Rescission Remedy under the Arthur Wishart Act (Franchise Disclosure), 2000” at the 2012 Ontario Bar Association Institute on Franchise Law on Thursday, February 9, 2012.
- Larry Weinberg, Frank Robinson and Derek Ronde will be attending the International Franchise Association Annual Conference in Orlando, Florida in February 2012.
- Geoff Shaw will be speaking on the topic of “Defendant Interaction with Absent Class Members” at the 9th Annual Osgoode Hall National Symposium on Class Actions on April 26, 2012 in Toronto, Ontario.
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