By Kate Byers, Carly Cohen, Stefanie Holland, Christopher Horkins, Noah Leszcz, Eric Mayzel, Alexandra Murphy, Colin Pendrith, Frank Robinson, Derek Ronde, Geoffrey B. Shaw, Kristin Taylor, Stéphane Teasdale, Rebecca Valo, Larry M. Weinberg
In This Issue
Mendoza v. Active Tire: Ontario Court of Appeal Tightens Law On Franchisor Disclosure Requirements
In Mendoza v. Active Tire & Auto Centre Inc., the Court of Appeal for Ontario reversed a decision of the Ontario Superior Court of Justice and granted rescission to a franchisee under section 6(2) of the Arthur Wishart Act (Franchise Disclosure), 2000 (the Wishart Act).
In the original decision that as overturned by the Court of Appeal, Justice Dow of the Ontario Superior Court of Justice held that certain deficiencies in the franchise disclosure document were not necessarily fatal so as to entitle the franchisee to the two-year rescission window under section 6(2) of the Wishart Act. Rather, in assessing whether the required disclosure had been made, Justice Dow focused on whether the franchisee had made an “informed decision” to enter into the franchise agreement.
The two deficiencies focussed on by Justice Dow were i) the absence of a second officer or director’s signature on the disclosure certificate and ii) the delivery of non-compliant financial statements from the prior year. Justice Dow concluded that the “disclosure document provided was not in full compliance with the Wishart Act but the deficiencies were not significant or misleading. As a result, my conclusion is rescission is not available to Mendoza under Section 6(2).”
As noted in our discussion of this case in our prior newsletter, Justice Dow’s decision appeared to depart from a strictly objective analysis of the disclosure document’s compliance with the Wishart Act, and instead shifted the focus to whether the franchisee made an “informed decision.” Justice Dow’s decision contrasted with prior jurisprudence, which has held that disclosure deficiencies such as the failure to deliver a single disclosure document, the failure to provide financial statements in accordance with the Wishart Act and the failure to provide a certificate signed by two directors, are “fatal deficiencies” that entitle the franchisee to rescission under section 6(2).
On appeal, the Court of Appeal for Ontario put to rest any argument that the franchisee’s subjective knowledge or actions are relevant to the analysis of the disclosure document or the rescission rights available to the franchisee. The Court of Appeal clarified that the franchisor’s disclosure obligations “do not change depending on the actions or reactions of a particular franchisee” and that the rescission remedy is not “conditional on the approach taken by a particular franchisee to the disclosed material.”
Part and parcel of this analysis was a rejection of the franchisor’s argument that the franchisee should not be entitled to a remedy under the Wishart Act because they initially did not seek rescission based on deficiencies in the disclosure document and instead sought rescission later on because the franchise did not do well and the individual appellant regretted his decision. In rejecting this argument, the Court affirmed that “the remedy in s. 6(2) turns only on the failure of the franchisor to deliver a disclosure document. It is not dependent on later conduct of the franchisee.”
In addition to clarifying the general principles above, the Court of Appeal reiterated the rigid requirements under the Wishart Act to i) certify the disclosure document with at least two signatures from directors or officers, and ii) to provide compliant financial statements.
The Two Signature Requirement
Where a franchisor has more than one officer or director, section 7 of the regulations to the Wishart Act requires a disclosure document to be signed by two persons who are officers or directors.
With respect to the two-signature requirement, the Court of Appeal clarified that the failure to comply is not absolved by the fact that the franchisee had additional information available to it, including knowledge of the directors. The Court explained:
the motion judge discounted the failure to provide two signatures because the individual appellant had met most of the directors and had information about their backgrounds in Part II of the disclosure document. However, this misses the point of s. 7(1)(e) of the Act, which is to give the franchisee substantive rights in damages against the directors and officers who sign the document, and by so doing, to impress upon those who sign the importance of ensuring that the document is complete and accurate.
The Court of Appeal further explained that requirement is “clearly material to any franchise agreement” on the basis that “those who sign are personally responsible for the accuracy and sufficiency of the contents of the disclosure document, and that responsibility is backed up by personal liability to the franchisee.”
This decision removes any doubt that the failure to comply with the two signature requirement is fatal to a disclosure document and will entitle a franchisee to a two-year rescission window.
Financial Disclosure Cannot Deviate from the Wishart Act
The Court of Appeal also considered the requirement to provide financial statements under section 3 of the Wishart Act. Section 3(1) requires that a disclosure document include a financial statement for the most recently completely fiscal year. Section 3(2) provides a limited exception - where less than 180 days have passed since the most recently completed fiscal year and a financial statement is not yet prepared, the franchisor is entitled to deliver a financial statement from the previous year.
In this case, the franchisor had delivered the prior year’s statement two weeks outside the 180 day “grace period.” The Court rejected the franchisor’s argument that this late delivery was not material, explaining that it “would mean that franchisors would be free to ignore the statutory requirements regarding the obligation to produce current financial statements, and franchisees would be unable to rely on the protections contained in the Act.”
The Takeaway for Franchisors
The Court ultimately rejected the franchisor’s argument that these deficiencies were “insignificant and not misleading,” instead finding that they “represent material deficiencies and are fatal to the ability of the purported disclosure document to be a disclosure document within the meaning of the Act.” Because deficiencies of this nature will entitle a franchisee to a two-year rescission window, this case highlights the well-known but oft-neglected need for franchisors to engage counsel to ensure that their disclosure documents are compliant with the Wishart Act.
Oh Snap!: Franchisors May Be Liable for Human Rights Complaints Initiated By Employees of Franchisees in British Columbia
By Kate Byers
In Reid v. Snap Fitness Cloverdale1, the British Columbia Human Rights Tribunal held that a franchisor who is not directly involved in the employment of a human rights complainant may nevertheless attract liability under the BC Human Rights Code (the Code). Although no liability was found in this case, the Tribunal indicated that a franchisor is a proper party to a complaint unless it can point to provisions in the franchise agreement or other facts which would demonstrate to the Tribunal that the franchisor does not wield sufficient influence over the franchisee employer.
In this case, the human rights complainant was a membership advisor at a fitness club, a “Snap Fitness” franchise location in Surrey, BC, who suffered injuries in a motor vehicle accident which impacted her ability to perform certain physical tasks. The complainant’s direct manager had provided accommodation for her injuries, which were suffered prior to her employment at Snap Fitness, and had otherwise given her positive feedback. However, the complainant was subsequently terminated from her employment. She alleged that her termination was due to her medical issues and limitations. These allegations were supported by text messages from the owner/operator of the franchise location, which stated “...u can’t mop/vacuum/put away weight” and “...the job is too heavy for u and I’m increasing the cleaning duties & with your injuries...”
The complainant commenced her complaint against the individual owner, the franchise corporation, the international franchisor, and its Canadian subsidiary (together with the international franchisor, “Snap Fitness”), alleging they had discriminated against her on the basis of her physical disability.
Snap Fitness moved to dismiss the complaint against the international franchisor and the Canadian subsidiary on the basis they were not the complainant’s employer and the complaint did not further the purposes of the Code. The Tribunal dismissed their motion, making it clear that the Code applied to any “person”, and not just to an “employer”: so long as the subject of the complaint has the ability to interfere with or influence the employment relationship, they are subject to the Code as it applies to employment relationships. The Tribunal had made it clear in previous decisions that liability may be found where a franchisor has the ability to interfere with and influence the franchisee’s employment relationship with its employees and fails to do so (i.e., fails to prevent the discrimination).
In deciding this case, the Tribunal noted that the complainant’s evidence was that her work was directed and controlled according to Snap Fitness policies and directives. Correspondence regarding her employment was on Snap Fitness letterhead; their logo was on her cheques; her employer’s email address was at a “snapfitness.com” domain; Snap Fitness monitored the location; and job postings for the location prominently referred to Snap Fitness and not to the franchise corporation.
The Tribunal was clear that each franchise relationship will be governed by the franchise agreement. In this case, Snap Fitness, which bore the onus to prove that they were not proper parties to the complaint, had provided only two pages of that agreement to the Tribunal. In the face of the complainant’s evidence that Snap Fitness had some level of influence, and their inability to determine the full extent of that influence or otherwise rebut the complainant’s contention, the Tribunal was not satisfied that Snap Fitness’ inclusion as a party would not further the purposes of the Code, and declined to exercise its discretion to dismiss the complaint.
This case illustrates that even where franchisors are not considered to be “joint employers” (as discussed elsewhere in this newsletter), they may be vulnerable to human rights complaints against their franchisees, particularly where the franchise agreement or franchise disclosure document discloses that it wields significant influence over its franchisees.
Franchisors in BC should ensure that their franchise agreements do not unduly prescribe or interfere with their franchisees’ employment practices. In the event that they are named in any human rights complaints by franchisees’ employees, franchisors should be prepared to fully argue that their influence over franchisees’ employment practices is not sufficient to confer liability on the franchisor in the event of a human rights complaint, and to ensure that they supply the tribunal with a sufficient record to support that argument.
A Fixed Term of Forever: The Supreme Court of Canada Rules on the Validity of Perpetual Renewal Clauses in Quebec
Franchise agreements often contain automatic renewal provisions. However, can an agreement be renewed automatically where the effect is to put the parties in an endless cycle of renewal? The Supreme Court of Canada recently said yes and confirmed the validity of a clause providing for the automatic renewal of a fixed term contract. In Uniprix,1 the appellant, Uniprix inc. (Uniprix), and the respondent companies (the Pharmacists) entered into a contract of affiliation in 1998 for a fixed term of five years. The contract contained an automatic renewal clause, which was triggered twice, once in 2003 and again in 2008. The clause was entirely for the benefit of, and could only be triggered by, the Pharmacists. In 2012, Uniprix sent the Pharmacists a notice of non renewal, purporting to terminate the contract.
The Trial and Quebec Court of Appeal Decisions
The Pharmacists took the position that they could renew the contract, while Uniprix argued that it could oppose the renewal and terminate the contract upon the expiry of the term. The issue for Uniprix was that this could have the effect of binding the parties in perpetuity, contrary to public order. Both the trial judge and the Quebec Court of Appeal concluded that the renewal clause was clear and that it reserved for the Pharmacists an option to unilaterally renew the contract, which is legal, despite that it may a perpetual effect.
The Supreme Court of Canada Decision
The Supreme Court dismissed the appeal, concluding that the trial judge made no palpable and overriding error in interpreting the contract. The unilateral renewal option was found to be consistent with the other provisions of the contract, the circumstances surrounding its execution, and the parties’ conduct. Despite bearing some similarities, the Court distinguished the contract from a franchise agreement, specifically finding that Uniprix had been created for the benefit of the Pharmacists, who specifically joined together for the purpose of developing their practices. Uniprix would serve its members until the members (i.e., the Pharmacists) themselves decided to withdraw from the group. Further, twice, in 2003 and 2008, Uniprix recognized that the Pharmacists’ silence bound the parties for an additional five-year term. In addition, nothing in Quebec law precludes the parties from agreeing on such a mechanism, despite its perpetual effects. Such a mechanism is not contrary to public order.
On dissent, Justice Côté, raised an interesting question: Can a contract properly be characterized as having a fixed term of five years where that term does not apply to one of the contracting parties who is effectively bound in perpetuity? In the words of Justice Côté, “a court should not forever wed two parties in an unhappy marriage where only one of them has the avenue for exit, in the absence of express vows to that effect.” In characterizing the term of a contract, perpetuity should not be inferred.
Key Take-away Principle
Whether you are dealing with a commercial agreement or a franchise agreement, careful attention needs to be paid to ensure that renewal provisions are not drafted in such a way as to have a perpetual effect at the sole discretion of only one of the contracting parties. If the language of the renewal clause is clear, it will not require an interpretive exercise in order to be applicable, despite having a perpetual effect. Ensuring that renewal provisions are expressly limited will prevent against inadvertent perpetual agreements.
The Supreme Court of Canada Dismisses Franchisee Attempt To Avoid Guaranty Obligations
In September 2017, the Supreme Court of Canada (SCC) dismissed an application by a franchise agreement guarantor for leave to appeal a decision of the Ontario Court of Appeal. In this case, the Court of Appeal had upheld the decision of Justice O’Marra of the Ontario Superior Court of Justice to grant summary judgment in favour of The Cora Franchise Group (Cora). The original claim involved Cora seeking to enforce a guarantee of a franchise corporation which was in default of its financial obligations to Cora. The guarantor, who was the principal of the franchisee, sought to bring a multi-million dollar counterclaim for damages it claimed the franchise corporation had suffered as a result of Cora’s actions.
The guarantor argued that the company’s losses should be set off against the amounts the guarantor owed to Cora under the guaranty. Justice O’Marra had originally found in favour of Cora in respect of its claim and the guaranty and 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. Finally, the Court of Appeal accepted Cora’s argument on a cross-appeal that Justice O’Marra had erred in failing to order damages up until the date of the hearing of the summary judgment motion, and ordered a reference in respect of those additional amounts owing by the guarantor to Cora.
The Supreme Court of Canada panel, composed of the Honourable Justice Moldaver, the Honourable Justice Karakatsanis, and the Honourable Justice Wagner, subsequently dismissed the guarantor’s application for leave to appeal the Court of Appeal decision.
Key Take-away Principle
The takeaway for franchisors is that Ontario courts are willing to enforce guarantees related to financial obligations under franchise agreements, and will also scrutinize attempts by franchisee guarantors to use set-off and counterclaims as means to complicate simple collection matters. These decisions are reassuring for franchisors who are owed significant sums by their franchisees, and support the idea that summary judgment can be an effective method to obtain judgment in this type of case.
Cora was represented in this matter by Derek Ronde and Kate Byers of Cassels Brock.
Cora also was successful in repelling an attempt by the guarantor to stay the effect of the Court of Appeal’s judgment pending the application for leave to appeal to the Supreme Court of Canada. A copy of this decision can be found here. Cora was represented by Derek Ronde and Alexandra Murphy on this motion.
BC Court Toasts Claim Against Franchisor for “Defective Sandwich”
In one of the great opening lines of modern jurisprudence, the British Columbia Supreme Court recently stated in Chow v Subway Franchise Restaurants of Canada Ltd.: “This case concerns a claim for personal injury damages caused by a defective sandwich.”1 The plaintiff in this case alleged that she purchased a sandwich from a franchised Subway restaurant in Victoria, British Columbia and, while consuming the sandwich, found blood on the bun and the wrapper. The plaintiff alleged that this caused her to suffer personal injury damages for mental distress, shock and similar claims. The plaintiff’s claim, however, was not directed at the individual franchisee or any of its employees. Instead, she advanced a claim against the franchisor and its affiliates, without specifically pleading a theory of vicarious liability.
In response, the franchisor brought a motion for summary judgment and put forward evidence that the location was operated by a separately-owned franchisee corporation and that all of the employees of the location, including management, were employees of the franchisee. The franchisor further explained that all of the day-to-day operations of the restaurant, including training employees on food preparation, inspection and work safety procedures, were handled by the franchisee.
After reviewing the well-established legal principles surrounding vicarious liability, the court concluded that the plaintiff’s claims could not succeed, given that the plaintiff did not sue the “direct tortfeasor” (namely, the franchisee employee who prepared the allegedly defective sandwich) or their employer, the franchisee, and made no claim that could extend any liability by the direct tortfeasor to the franchisor. The claim was dismissed with costs.
The Chow decision highlights an interesting intersection between franchise and product liability law. One of the benefits of the franchise model is that it disperses legal risks to the franchisee. Often, misunderstandings about the nature of the franchise business structure lead to poorly pleaded claims such as this one. The monolithic appearance of a franchised chain lead many to believe that locations are all operated by the same entity – after all, the franchise model is in part designed to give an appearance of uniformity between separately owned businesses under the same licensed brand. Chow is yet another decision that can be pointed to by franchisors when they are faced with defending such claims. Often, when the nature of the relationship is properly explained to plaintiffs’ counsel, these claims can be resolved early without going to court.
Good Faith, Early Termination and Vendor Rebates All At Issue in the Target Canada CCAA Proceeding
By Eric Mayzel
In the recent decision of Target Canada Co. (Re), 2017 ONSC 2595,1 the Ontario Superior Court of Justice – Commercial List affirmed a series of rulings by a Claims Officer in the Companies’ Creditors Arrangement Act (CCAA)2 proceedings of the Target Canada Co. group of companies.3 The decision provides interesting insight into the interplay between the rights and obligations of franchise parties in an insolvency context.
The decision involved franchisees who operated in-store Target-branded pharmacies under franchise agreements with Target Canada Pharmacy Franchising LP (the Franchisor).
In January 2015, the Target Canada Co. group of companies obtained court protection for wind down proceedings under the CCAA. The Franchisor subsequently disclaimed all of the franchise agreements,4 which constituted a breach of those agreements.
A key issue in the decision was the proper method for calculating the period of time for which any franchisee should be entitled to claim losses. In turn, that issue involved a fact-specific consideration of the relationship between the duty of good faith, at common law and under s.3 of the Wishart Act,5 and the exercise of an early termination provision in a franchise agreement.
Each franchise agreement had an initial term of five years, but contained an early termination provision that permitted the Franchisor to terminate after three years, without cause. The Franchisor relied upon the early termination provision to argue that the maximum period of time for which any franchisee should be entitled to claim losses arising from the breach of a franchise agreement is three years.
The franchisees argued that the Franchisor would not have been able to avail itself of the early termination provision in good faith, based upon certain surrounding circumstances. In particular, after the execution of the franchise agreements, the Franchisor introduced an “EBIT Support Program,” which was intended to provide financial support and benefits to franchisees throughout the full, initial five-year term of the franchise agreements.
The franchisees characterized the EBIT Support Program as comprising “clear and unequivocal commitments” by the Franchisor to provide EBIT payments throughout the initial term, such that “it would have been a breach of the duty of good faith for the Franchisor to exercise its right of early termination.”6
Calculation of the Loss Period: Early Termination and the Duty of Good Faith
In the decisions below, the Claims Officer appointed to assess and determine each creditor claim applied the principle for calculating breach of contract damages formulated by the Supreme Court of Canada in Hamilton v. Open Window Bakery.7 That principle provides that, where an agreement has multiple modes of performance (such as an early termination provision), damages are to be based on the mode of performance that is least burdensome to the defendant.
Therefore, the Claims Officer framed the issue as follows: In order for a franchisee to succeed on its good faith argument, it would be necessary to show that, as a result of the parties’ interactions relating to the EBIT Support Program, the Franchisor could not possibly have exercised its right of early termination in good faith. Otherwise, it must be assumed that the Franchisor would have terminated the franchise agreements after three years.
The Claims Officer concluded that the parties’ dealings with respect to the EBIT Support Program did not prevent the Franchisor from terminating early in good faith.8 Although the program demonstrated a clear intention on the part of the Franchisor to continue the program during the initial five-year term, it did not supersede the Franchisor’s right to early termination. Properly interpreted, the Franchisor undertook to provide EBIT payments during the initial five-year term, under those franchise agreements that remained in effect during that period.
The Claims Officer based that conclusion on a number of findings, including the following:
Therefore, the Claims Officer limited the period for which the franchisees could claim losses for breach of their franchise agreements to three years. On appeal, the Superior Court of Justice – Commercial List affirmed the decision of the Claims Officer.
Disclosure of Vendor Rebates
The decision also involved a request by franchisees for greater information from the Franchisor about the amount of rebates it received from a vendor as a result of the vendor’s sales to franchisees.
The franchisees asserted that they required the information to assess whether the Franchisor had complied with the duty of good faith and fair dealing in the manner in which it had shared such rebates with the franchisees.
The Claims Officer dismissed the franchisees’ request for greater information about the rebates received by the Franchisor, on the following two grounds:
Notably, the Franchisor’s disclosure documents did specify a percentage of those rebates to be shared with franchisees. However, the Claims Officer noted that the franchisees were able to calculate whether the Franchisor shared that level of rebates, because the percentage is based on their own purchases. Therefore, the franchisees did not require any further information.
The Claims Officer also ruled out any argument that the Franchisor may have breached the duty of good faith in exercising its discretion as to how to share the rebates for generic prescription drug products as follows: “... the discretion, if there was one, was exercised before the Franchisees entered into the Franchise Agreement and was fully disclosed to the Franchisee at that time.”11
On appeal, the Court affirmed the conclusion of the Claims Officer.
Although Target Canada Co. (Re) is a fact-specific decision issued in the context of a CCAA proceeding, it offers guidance to franchisors, franchisees, and counsel regarding: (1) the method for calculating damages for breach of a franchise agreement containing an early termination provision; (2) whether the exercise of an early termination provision by a party to a franchise agreement could give rise to a claim for breach of the duty of good faith and fair dealing; and (3) issues to consider relating to the sharing of vendor rebates and the circumstances in which a court may order a franchisor to disclose information about such rebates to franchisees.
Ontario Government Introduces Proposed Amendments to Franchise Legislation
On September 14, 2017, the Ontario Government introduced Bill 154, “An Act to cut unnecessary red tape by enacting one new Act and making various amendments and repeals,” an omnibus bill that proposes to amend a number of Ontario statutes with the purported goal of “reduc[ing] regulatory burdens and practices that cost businesses time and money, while protecting environmental, health, and worker safety standards.”
Bill 154 is relevant to Ontario’s franchise industry stakeholders because it proposes various amendments to Ontario’s franchise legislation, the Arthur Wishart Act (Franchise Disclosure), 2000.
A Bigger Slice of Post-Judgment Interest: Ontario Court Upholds Franchise Agreement Provision Entitling Franchisor To Higher Interest
By Derek Ronde
In a recent decision of the Ontario Superior Court of Justice, 241 Pizza (2006) Ltd. v. Loza, a franchisor was entitled to post-judgment interest of 24% per year in accordance to the terms of the parties’ franchise agreement. This decision provides franchisors with helpful reassurance that the interest provisions in their agreements may be upheld by Canadian courts.
In this case, the franchisor was successful on a motion for summary judgment to collect amounts owed from the defendant franchisee for unpaid royalties and other amounts. In seeking the final order from the Court regarding their judgment, the franchisor sought post-judgment interest on the damages at a rate of 24% per annum. This amount was in accordance with the terms of the franchise agreement.
The Court commented that although the 24% rate “seems excessive,” it is the amount that was contracted for between the parties. The court noted a purported imbalance of power between the parties, but held that the clause formed a part of the standard agreement and that the franchisee had legal advice when entering into the franchise agreement. The Court held that, “To fail to enforce this clause in the absence of exceptional circumstances would be to impose a rule that all such clauses are in the nature of a penalty. Without further evidence, I cannot do that. Furthermore, to fail to enforce this clause would be to interfere with the freedom of contract of the parties.”
Although it would be open for a franchisee to challenge such a provision as unconscionable, this case is evidence that a significant post-judgment (and likely pre-judgment) interest provision may be enforceable in Ontario.
Quebec Court Rejects Franchisor’s Bankruptcy and Insolvency Act Proposal
By Noah Leszcz
In a recent case out of Quebec, Liquid Nutrition Franchising Corporation (the Franchisor) was deemed to have made an assignment pursuant to the Bankruptcy and Insolvency Act, R.S.C. 1985, c. B-3 (BIA), after failing to obtain approval of its BIA proposal.1 Specifically, in May 2017, the Quebec Superior Court denied the Franchisor’s Trustee’s motion for approval of the Franchisor’s proposal to its creditors (the Proposal). The Court’s refusal to approve the Proposal resulted from a motion by two franchisees (the Claimants).
The Court refused to approve the Proposal because the director of the Franchisor would have benefited from the Proposal and been released from liability for claims against him by the franchisee Claimants. This case demonstrates that a franchisor cannot use the BIA to achieve an inequitable result with respect to its franchisees in a proposal proceeding.
To understand the reasoning behind the decision, it is helpful to examine the relationship between the Franchisor and its franchisees, as well as the rationale behind the Proposal.
The Franchisor, along with its parent corporation, Liquid Nutrition Group Inc. (LNGI), offer franchises for health food and drink retail outlets. The Claimants alleged that the Franchisor and LNGI had been inducing franchisees to purchase franchises based on misleading or false representations.
For this reason, the Claimants, along with several other disgruntled franchisees, had previously filed separate lawsuits against the Franchisor and LNGI, totalling several millions of dollars under various heads of damages including claims under the Arthur Wishart Act (Franchise Disclosure), 2000, S.O. 2000, c. 3 (the Wishart Act). One of the claims was initiated by a franchisee known as 2308818 Ontario Limited (2308818) and Kurt Khan (collectively, the 230 Creditors).
In the face of several franchisee lawsuits, the Franchisor decided to make the Proposal to compromise its liabilities. If the Proposal was approved, the Franchisor and LNGI would not only compromise their debts and liabilities, but also release the directors and officers from any personal liability they may have had under the Wishart Act in the aforementioned actions.
The Claimants alleged that the Proposal was a scheme put forward by Chamandy, a director and officer of the Franchisor and LNGI, for his own personal benefit. It is important to note that LNGI, the parent of the Franchisor, was the largest creditor of the Franchisor, but could not vote in favour of the Proposal because it was a “related person” under the BIA. Its claim was also subordinated to all other claims against the Franchisor. As such, it would not have received any dividends under the Proposal.
The Franchisor reached out to its second largest creditors, the 230 Creditors, and offered $210,000 to settle the 230 Creditors’ $2.3 million claim against the Franchisor, if the 230 Creditors voted in favour of the Proposal. The settlement funds were paid into trust, and if the Proposal was approved by the Franchisor’s creditors, the funds would be paid to the 230 Creditors. The 230 Creditors also agreed to transfer and assign any entitlement the 230 Creditors had to dividends under the Proposal to a party related to the debtor.
The Trustee valued the 230 Creditors’ claim at the full amount of $2.3 million. The remainder of the claims that had been accepted by the Trustee were valued at $390,000. As such, the 230 Creditors would receive a substantial portion of the dividends under the Proposal.
By virtue of the assignment by the 230 Creditors, Chamandy would receive a substantial portion of the $150,000 Proposal payment back in the form of a dividend and the Franchisor’s other creditors would receive pennies on the dollar.
In essence, by settling the claim of the 230 Creditors, and the 230 Creditors’ assignment of their entitlement to dividends, Chamandy ensured that he would no longer be personally liable for the Wishart Act claim, and that he would personally receive a substantial portion of the dividends payable under the Proposal.
The Rejection of the Proposal
Under the BIA, related persons, as defined in the BIA, are not entitled to vote in favour of a proposal. As such LNGI, despite being the largest creditor of the Franchisor, was not entitled to vote in favour of the Proposal.
The question was then raised: was the 230 Creditors’ vote in favour of the Proposal their own vote, in their capacity as creditor, or rather, in their capacity as agents for Chamandy? If the 230 Creditors were voting in their capacity as agent for Chamandy, then Chamandy was in control of the claim of the 230 Creditors and was in the same position as a creditor voting in favour of the Proposal. Further, without the 230 Creditors’ vote in favour of the Proposal, the Proposal would not have been approved as the Claimants would have been able to vote down the Proposal.
The Court’s reasoned analysis succinctly summarized the series of events: “Chamandy enters into a series of contracts pursuant to which he literally purchases the third party’s rights, title and interests into a very substantial claim (more than 2.3 million) for roughly 10% of its face value. In exchange for cash, 2308818 agrees to vote its full unliquidated claim in favour of the Proposal as well as surrendering its right into any dividend resulting from the approval of the Proposal. In the opinion of the undersigned, Chamandy is now in full control of the 2308818 claim and, therefore, Chamandy is in the exact same position of a person voting in favour of the Proposal.”2
Accordingly, the Court declared that the 230 Creditors were voting as agent for Chamandy, that Chamandy was in control of the claim of the 230 Creditors and was in the same position as a creditor voting in favour of the Proposal. The Claimants were therefore successful, and the motion to approve the Proposal was dismissed. As a result, the Court declared that the Franchisor was deemed to have made an assignment under the BIA.
The Takeaway from Franchisors
The decision in Liquid Nutrition provides some guidance to franchisors that are attempting to work through potential insolvency issues. Franchisors will have to be extremely careful when attempting to craft solutions to deal with outstanding litigation, as the purchase and settlement of claims may not permit the franchisor to generate support for any BIA proposal they make. Courts will closely examine such transactions and will consider the interest of all creditors in determining whether such proposals are accepted.
1 A proposal is an offer by a debtor to its creditors to compromise its debts and often involves the payment of a percentage of what is owed over a specific period of time, or to extend the amount of time to pay off the debt, or a combination of both. Creditors vote to accept or reject the proposal. Following a successful vote, the trustee must apply to a court for approval of the proposal.
The Cost of Doing “Biznex”: Quebec Superior Court Rules on Contractual Clarity During Negotiations
A recent franchise decision from the Superior Court of Québec highlights that franchisors should clearly disclose anticipated costs when negotiating with a prospective franchisee. In Placements Biznex inc. c. Sobeys Québec inc.1, the Court awarded damages to a prospective franchisee after determining that contractual ambiguity regarding equipment costs should favour the prospective franchisee. The province of Quebec does not have a statutory disclosure regime that would address matters like the cost of setting up a franchise.
By way of background, on May 7, 2009, the prospective franchisee, Les Placements Biznex (Biznex) signed a letter of intent (LOI) with Sobeys Québec inc. (Sobeys) to establish a franchised convenience store under Sobeys’ “Voisin” brand on land already owned by Biznex. The LOI included the steps necessary to establish a “Voisin” franchise, including the financing and acquisition of equipment to operate the franchise.
The equipment financing component proved to be contentious; the parties disagreed with respect to who bore the financial responsibility for equipment acquisition under the LOI. From Biznex’s perspective, Sobeys was responsible for equipment financing since it marketed the franchise to Biznex as “turnkey” and conducted all equipment negotiations on Biznex’s behalf. For its part, Sobeys interpreted the LOI as requiring the prospective franchisee to finance the equipment. In considering the evidence put forward by the parties, the Court noted credibility concerns with regards to Sobeys’ witness, who failed to answer simple questions and was deemed by the Court to be non-credible.
In reaching its decision to award damages to Biznex, the Court held that from the outset of the relationship, Sobeys was aware of the equipment financing misunderstanding and had multiple opportunities to clarify its interpretation of the LOI to Biznex. Instead, Sobeys opted to remain silent on the matter. By failing to address the ambiguity, the Court determined that Sobeys did not meet its disclosure obligations to Biznex. Further, the Court determined that the LOI did not specify which party was responsible for equipment financing, and therefore the ambiguity favoured Biznex.
The case provides guidance for franchisors in Quebec, who are encouraged to determine whether there is any ambiguity regarding the prospective franchisee’s financial responsibilities prior to signing a letter of intent, and to resolve it if it exists.
The Ontario Labour Relations Board Opens the Door to Franchisee Unionization in the Canada Bread Certification Case
Earlier this month, Cassels Brock published an e-Communiqué on the Ontario Labour Relations Board’s Canada Bread decision, in which ostensible franchisees of Canada Bread were found to be dependent contractors (and therefore employees) for the purposes of a union certification drive.
What We're Up To - Fall and Winter 2018