By Kate Byers, Carly Cohen, Stefanie Holland, Christopher Horkins, Noah Leszcz, Jessica Lipton, Eric Mayzel, Alexandra Murphy, Colin Pendrith, Frank Robinson, Derek Ronde, Geoffrey B. Shaw, Stéphane Teasdale, Rebecca Valo, Larry M. Weinberg
In This Issue
Reason to be Crabby? Ontario Court Grants Partial Summary Judgment Against Franchisor, but Makes Interesting Finding on Lease Disclosure as Grounds for Rescission
In 2212886 Ontario v Obsidian Group,1 the Ontario Superior Court of Justice considered at what point multiple alleged disclosure deficiencies are so fundamental as to give rise to rescission of the franchise agreement. In examining these alleged deficiencies, the Court held that the failure to provide a copy of a head lease did not constitute grounds for rescission, which appears to run contrary to the recent Ontario Superior Court of Justice decision in Raibex. (We previously wrote about Raibex here.) The decision also provides interesting commentary regarding limitation periods and Wishart Act claims, as well as the treatment of non-disclosed earnings projections for the purposes of statutory rescission.
In this case, the Court granted the franchisee’s motion for partial summary judgment for a declaration that the franchise agreement was properly rescinded under Ontario’s franchise disclosure legislation, the Arthur Wishart Act (Franchise Disclosure), 2000 (the Wishart Act). The plaintiff franchisee and the defendant, the franchisor of the “Crabby Joe’s” restaurant brand, entered into a franchise agreement on June 16, 2010 (the June agreement). On September 7, 2010, at the request of the franchisor, the parties entered into a new franchise agreement (the September agreement). The September agreement consisted of one signing page, since the document was substantially the same as the June agreement. On September 5, 2012, over two years after the June agreement but less than two years after the September agreement, the franchisee served a notice of rescission. The limitation period for rescinding a franchise agreement under the Wishart Act is two years from the date of the agreement.
The franchisee argued it was entitled to rescind the franchise agreement on the basis of several disclosure deficiencies that rendered the franchisor’s disclosure tantamount to no disclosure under the Wishart Act. Specifically, the franchisee took issue with the following alleged disclosure deficiencies:
In respect of the failure to provide a copy of the lease, the Court dismissed this outright, commenting:
The suggestion by the plaintiffs that the head lease was not disclosed, as a basis for the claim for rescission, is unfounded. There was no head lease in existence and the only lease in place was an offer to lease, which was disclosed when known.
This decision therefore arrives at the opposite conclusion of the Court in Raibex, which held that a disclosure document was inadequate because it did not contain a copy of the head lease despite the fact that the head lease had not been entered into at the time of the franchise agreement being executed. Given that Raibex is currently under appeal, it will be interesting to see how the Ontario Court of Appeal decides this issue. Franchisors should continue to exercise caution in respect of their disclosure obligations pending the Raibex appeal decision.
In respect of the other disclosure deficiencies, the franchisee was unsuccessful on all of them except for the franchisor’s failure to disclose the earnings projection table. The Court found this omission to be so significant and material as to constitute no disclosure, giving the franchisee the right to rescind. In reaching this conclusion, the Court found that earnings projections are potentially “the most important information that a potential franchisee would want to know.” The Court contextualized this obligation by noting:
Although I agree with the defendants that they did not have to disclose earning projections, once these projections are provided (both at the meeting in May 2010 and to the bank on June 22, 2010) they must be disclosed as part of or in addition to the disclosure document.
The Court also rejected the franchisor’s argument that the September agreement did not create a new franchise agreement between the parties. Had the Court found differently, the franchisee would be out of time to rescind the franchise agreement because the June agreement was signed more than two years prior to the notice of rescission. In determining that the September agreement constituted a new franchise agreement, the Court focused on the consumer protection aspect of the Wishart Act, coupled with the fact that the September agreement was the franchisor’s initiative.
The case provides an interesting contrary view to the disclosure obligations discussed in Raibex in respect of leases but by no means should serve as a definitive position on this topic, as the final word will lie with the Court of Appeal. Moreover, it addresses the need for franchisors to be careful in respect of the disclosure of earnings projections and indicates how Ontario courts may treat staggered or multi-part franchise agreements for the purposes of limitation periods.
International Update: Proposed Franchise Legislation in Saudi Arabia
It is no secret that Saudi Arabia is becoming a hot spot for franchising in the Middle East. Opportunities abound and Saudi Arabian companies are increasingly interested in attracting North American, European and other foreign brands.
On January 1, 2017, the Ministry of Commerce and Investment (MOCI) of the Kingdom of Saudi Arabia (KSA) released a proposed Commercial Franchise Law [Royal Decree No. M/5 dated Jumada II 1389 (August 1969)], which aims to regulate franchising in the KSA.
The proposed legislation would address various issues including:
o Requiring that franchise systems be in operation for at least one year by at least one company;
In addition, the legislation would consider timelines for releasing or sharing the contents of a FDD prior to executing a franchise agreement.
The legislation also considers a proposal for certain mandatory clauses as well as essential rights and obligations for both franchisor and franchisee, such as the franchisor’s right to protect its reputation and its right to enter the franchised premises as well as the right to determine system standards and the right to directly or indirectly supply the franchisee with franchised products to name a few.
Finally, the proposed legislation aims to exclude certain types of agreements from the ambit of the legislation, such as those for the distribution of products, the licensing of intellectual property as well as employment and lease agreements. Further, the proposed legislation aims to provide guidance on such subjects as ad-fund contributions, terminations, assignments and renewals in addition to compensation in the event of a dispute.
It remains to be seen whether the proposed legislation will ultimately encompass all of the aforementioned elements. It will also be interesting to see if this proposed legislation sets a trend for other neighbouring Middle Eastern countries.
If you have questions regarding this proposed legislation, please contact Stéphane Teasdale.
Ontario Court of Appeal Upholds Collection of Amounts Owed by Franchisee Under Guaranty
In Cora Franchise Group Inc. v. Watters,1 the Ontario Court of Appeal upheld the decision of Justice O’Marra of the Ontario Superior Court of Justice to grant summary judgment to a franchisor, the Cora Franchise Group (Cora), against the guarantor of a franchisee corporation that was in ongoing default of its obligations to Cora.
The success on summary judgment extended to the striking of a significant portion of a multi-million dollar counterclaim asserted by the guarantor against Cora for damages it claimed the franchise corporation had suffered as a result of Cora’s actions. The guarantor argued that the company’s alleged losses should be set off against the amounts the guarantor owed to Cora under the guaranty. Justice O’Marra had dismissed the counterclaim, accepting Cora’s arguments that set-off was precluded by the franchise agreement and did not apply to the claimed losses, and that the counterclaim was statute-barred under the Limitations Act. In upholding the decision, the Court of Appeal held that Justice O’Marra had not erred in dismissing the guarantor’s claim for a set-off against Cora because the right to damages asserted was that of the franchisee, not the guarantor, and the franchise agreement clearly precluded set-off. Further, the Court of Appeal also found no error in Justice O’Marra’s dismissal of the guarantor’s purported counterclaim as statute-barred: the guarantor and franchise corporation were well-aware of its claim more than two years prior to asserting the counterclaim.
The decision provides a helpful assurance to franchisors that Ontario courts will assist franchisors in enforcing their contractual rights against guarantors.
Just Desserts: British Columbia Finds in Favour of Franchisor in Termination Case
Following a three-day summary trial in the Supreme Court of British Columbia, in Dairy Queen Canada, Inc. v. M.Y. Sundae Inc.,1 Justice DeWitt-Van Oosten granted claims by the franchisor, Dairy Queen Canada, Inc., against a franchisee for breach of contract and passing off, while dismissing the franchisee’s counterclaim for breach of contract and various breaches of the Arthur Wishart Act (Franchise Disclosure), 2000 (Wishart Act), including breach of the duty of good faith and fair dealing.
In agreeing with Dairy Queen’s submission that a Mutual Cancellation and Release Agreement was a complete bar to the Counterclaim, the Court affirmed the “very strong public interest in the enforcement of contract,” a fundamental principle of contract law that has sometimes been overlooked in the franchise context.
The decision confirms the enforceability of mutual cancellation agreements as a means of terminating struggling franchise relationships, and highlights how such agreements can be used to limit franchisors’ liability on termination.
The case concerned a franchisee with a lengthy history of failing to meet its obligations under the franchise agreement. The franchisee was noted in default when the franchisor determined that it had repeatedly failed to meet its cleanliness standards, facilities standards and menu requirements. In particular, the franchisee refused to add Orange Julius® products to its menu, despite a system-wide requirement to do so.
When the franchisor determined that the defaults had not been remedied during the cure period, it proceeded to termination. However, rather than immediately exercising its termination rights under the franchise agreement, the franchisor offered to enter into a “Mutual Cancellation and Release Agreement” with the franchisee.
The Mutual Cancellation and Release Agreement was essentially a forbearance agreement that suspended what would otherwise be an immediate termination for a period of six months, during which the franchisee was permitted to continue operating the franchise and market it for sale. The agreement was intended to provide a final opportunity for the franchisee to recoup part of its investment.
The Mutual Cancellation and Release Agreement provided that the franchisee’s rights would automatically terminate at the end of the six-month period. In exchange for the franchisor’s agreement to delay immediate enforcement, the franchisee agreed to abide by the franchise agreement, remit its monthly reports and royalties on time, and, importantly, to release the franchisor of any and all claims.
The franchisee and its principals signed the Mutual Cancellation and Release Agreement. However, during the six-month period of the agreement, the franchisee became delinquent in remitting its monthly reports and royalties. In consequence, the franchisor accelerated the termination to be effective approximately three weeks before the six-month period was to expire. Despite the accelerated termination, the franchisee refused to stop operating.
The Litigation is Commenced to Enjoin the Franchisee
The franchisor commenced litigation to enjoin the franchisee from operating as a Dairy Queen beyond the termination date. An initial injunction was scheduled, but was ultimately avoided when the franchisee stopped operating on the eve of the hearing.
Shortly after the franchise was de-identified, it was converted into a new business called “Chicago Grill & Creamery.” The franchisor asserted that this new business was a competitor of the Dairy Queen franchise system and that its operation contravened the non-competition covenants in both the Franchise Agreement and Mutual Cancellation and Release.
The franchisor then brought a second injunction to enjoin the franchisee and its principals from being involved in Chicago Grill & Creamery. The second injunction was resolved by consent order, which required the principals of the franchisee to refrain from owning or operating Chicago Grill & Creamery and required that the business be operated as a sports bar.
Several months later, the franchisee commenced a counterclaim against the franchisor, seeking damages in excess of $1 million for breach of contract and various claims under the Wishart Act, including non-disclosure and breach of the duty of good faith.
The Summary Trial Decision
At the summary trial, the franchisor argued that the Mutual Cancellation and Release Agreement, which contained a robust release of the franchisor, was a complete answer to the counterclaim.
In response, the franchisee claimed that the Mutual Cancellation and Release Agreement was unenforceable on the basis that it had been entered into under economic duress and was an unconscionable bargain. In particular, the franchisee claimed not to have the benefit of legal advice when it signed the agreement.
The Court rejected the franchisee’s claims, explaining that “The mere fact that the Cancellation and Release was entered into between a franchisor and a franchisee does not make it inherently suspicious, or presumptively cast doubt on the voluntariness of the franchisee's signature.”
The Court further rejected the franchisee’s argument that the agreement was unconscionable as a result of unequal bargaining power. The Court explained:
Counsel for the defendants made much of the difference between a franchisor and a franchisee in his submissions at the trial, which I appreciate is a factor that I should be mindful of; however, as indicated, I do not find that the defendants' suggested coercion or duress in the signing of the Cancellation and Release, economically or otherwise, is borne out on the evidence. Moreover, I agree with the plaintiff that the Cancellation and Release is more generous on its face than the Agreement itself, allowing the franchisee time to recoup its investment through the sale of an operating franchise rather than immediate termination of the Agreement and an accompanying demand to cease and desist.
The ruling highlights the reluctance Courts will have to set aside mutual cancellation agreements, particularly when such agreements are more favourable to the franchisee than the termination rights under the existing franchise agreement.
Importantly, the decision confirms that an enforceable release can be built into mutual cancellation agreements and that such releases can be effective in limiting a franchisor’s liability. In addition, from a franchisee-relations standpoint, a mutual cancellation presents an opportunity for a win-win corporate divorce by giving the franchisee a chance to sell their business.
Before exercising a termination right under a franchise agreement, franchisors should consider whether a mutual cancellation and release can be used to both limit risk and preserve goodwill with the franchisee.
Dairy Queen Canada, Inc., was represented by Colin Pendrith of Cassels Brock at the summary trial.
Alberta Court Puts Brakes on Franchisee Rescission Action
In Hanewich v. Budget Brake & Muffler Franchising Ltd.,1 the Court of Queen’s Bench of Alberta summarily dismissed the claims made by the plaintiff franchisee against defendant franchisors, Budget Brake & Muffler Franchising Ltd. (BB Franchising) and Budget Brake & Muffler Distributors Ltd. (BB Distributors). The case serves as an interesting example of a Canadian court rejecting a franchisee’s creative attempt to revive an expired potential right to statutorily rescind a franchise agreement.
From 2006 onwards, the franchisee carried on business as both a franchisee and subtenant of BB Franchising pursuant to a franchise agreement and sublease due to expire July 2016. In 2012 and 2013, the franchise was unprofitable and the franchisee purported to terminate the franchise and sublease by notice to BB Franchising effective December 31, 2013, after which date it argued it had no obligation to pay any royalties or rent. As a result, BB Franchising purported to terminate the relationship by notice and counterclaimed for damages. While the franchisee asserted various grounds for relief, in the end it focused on whether the franchise agreement was mistakenly signed by BB Distributors, the parent company of BB Franchising, rather than BB Franchising. The franchisee asked the court to declare that there was a mutual mistake made by the parties. As a result of this alleged mutual mistake, the franchisee sought the rectification of the franchise agreement. The franchisee proposed that its agreement should be with ‘BB Franchising,’ not ‘BB Distributors.’ The rectification would create a new agreement, and the franchisee’s right to rescind the franchise agreement under the Alberta Franchises Act would run from the date of rectification. Despite the creativity of this argument, the Court found no merit to these submissions.
The Court held that there was no mistake and therefore, no need to rectify the franchise agreement. BB Distributors’ signature was simply a typographical error that was only on the signature page and that did not prevent the parties from carrying on business for seven years. It was clear from the evidence of conduct between the parties that the franchisor was BB Franchising. The Court also found that pursuant to section 13 of Alberta’s Franchises Act, the franchisees’ statutory rescission rights had expired in 2008, two years after entering into the franchise agreement, and therefore the franchisee was not entitled to rescind.
While franchisors ought to be mindful that the correct entities are accounted for as signatories when executing their franchise agreements, this decision supports the notion that courts will be hesitant to order the rectification of a franchise agreement based on a typographical error, especially where there is no evidence, logic or authority suggesting that such an error would lead to the conclusion that the franchise had not been granted to the franchisee. Evidence of the parties’ conduct may be enough to demonstrate a franchise relationship and a typographical error should not prevent the parties from carrying on their franchise operation.
What We’re Up To - Spring 2017
(a) What We’ve Done