Franchise E-Review: September 2012 - Franchising in Ontario

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In This Issue:

Settlement Agreements: Steps to Protect Enforceability

By Lia Bruschetta

On March 3, 2012, the Ontario Superior Court of Justice released its decision in Dodd v. Prime Restaurants of Canada Inc. (2012 ONSC 1578). The decision acts as a caution to franchisors to ensure their franchisees are fully informed and properly advised prior to entering into settlement agreements. Without such steps, franchisors may find releases rendered ineffective against subsequent statutory claims by the application of section 11 of the Arthur Wishart Act (the Act).

Background

In Dodd v. Prime Restaurants, a franchisor and franchisee made a voluntary assignment in bankruptcy, with the franchisor agreeing to take over operation for the poorly performing franchisee. This agreement included a mutual release for any claims, debts or actions. Subsequent to the agreement the franchisee notified the franchisor of its intent to seek rescission of the franchise agreement. The franchisor took the position that this was contrary to the agreement between the parties as set out in the mutual release, and continued to operate the franchisees’ business in accordance with the terms of the agreement and release.

In June 2007, the franchisee commenced this action against the franchisor claiming damages for breach of contract, negligence, misrepresentation, and rescission of the franchise agreement. The franchisor responded by bringing a motion for summary judgment on the basis that the action was barred by the mutual release entered into by both parties.

Analysis

The Ontario Superior Court applied the “full appreciation” test as recently laid out in Combined Air Mechanical Services Inc. v. Flesh, ultimately determining that summary judgment was not appropriate. In coming to this decision, the Court spoke at length regarding the application of section 11 of the Act, which provides:

         11.   Any purported waiver or release by a franchisee of a right given under this Act or of an obligation or requirement imposed on a franchisor or franchisor’s associate by or under this Act is void.

The franchisee in this instance argued the mutual release entered into between the parties was unconscionable. Further, the franchisee argued that even were the release not unconscionable, it was rendered void due to the application of section 11 of the Act and could not prevent the bringing of this action against the franchisor. The Court quickly determined there were evidentiary issues with respect to unconscionability that could not be resolved on summary judgment. In particular, the franchisor and franchisee had led conflicting evidence as to whether the franchisee had received independent legal advice prior to entering into the release. 

With regard to the application of section 11 of the Act, the franchisor took the position that on a proper construction the section could not be relied upon to render ineffective the agreement between the parties, which was intended to settle claims arising out of any breach the statute. In making this argument, the franchisor relied upon the Superior Court decision in 1518628 Ontario Inc. v. Tutor Time Learning Centres LLC. In Tutor Time, the Court held a settlement agreement inclusive of mutual releases of all rights and claims between a franchisor and franchisee could be valid, despite the application of section 11 of the Act:

         ... s.11 does not have application to a release given (with the advice of counsel) by a franchisee in the settlement of a dispute for existing, known breaches of the Act by the franchisor in respect of its disclosure obligations, which would otherwise entitle the franchisee to a statutory rescission.

Applying a narrow read of the Tutor Time decision, the Court in this case held the release entered into between the franchisor and franchisee did not clearly avoid the application of section 11 of the Act. In particular, the court noted that unlike Tutor Time it was not clear that the franchisee in this instance had the advice of counsel prior to entering into the release, nor was it clear that the franchisee was aware of rescission rights. For the purposes of summary judgment, therefore, the Court was unable to find the release acted as a bar to statutory claims under the Act. That said, the Court did acknowledge the statutory limits of section 11, recognizing the release would still be effective to prevent the franchisee from asserting any common law or equitable claims against the franchisor.

Lessons for Franchisors

Narrow Reading of Tutor Time Decision. The Court applied a narrow read of the Tutor Time decision, holding that it was unable to grant summary judgment in this case due to dissimilar facts. In particular, the Court focused on the fact that, unlike in Tutor Time, it was unclear that the franchisee in this instance had received legal advice prior to entering into the release at issue, nor was it clear that the franchisee had full knowledge of the Act claims being released. To avoid this outcome in future, franchisors would be wise to ensure franchisees are fully informed and properly advised prior to entering into a settlement agreement and release. Franchisors may also require franchisees provide a certificate of independent legal advice to prevent subsequent claims that the franchisee was not properly advised.

Mutual Releases Effective Against Common Law Claims. While section 11 of the Act may be invoked by franchisees seeking to overturn the release of their statutory claims, they will be unable to utilize section 11 to pursue released claims in common law and in equity. Franchisors would be wise to continue the practice of including a full and final release in all settlement agreements as they will, at the least, effectively bar common law and equitable claims. That said, it will always be open to franchisees to argue a release is unconscionable and therefore wholly unenforceable.

Summary Judgment in the Franchise Context. A summary judgment motion can be a useful tool for franchisors seeking to expedite proceedings, with recent decisions in Suncor and Tim Hortons highlighting the success that franchisors may have. There are, however, cost consequences to losing a summary judgment motion and a franchisor runs the risk of an adverse finding. In this case, the franchisor was ultimately ordered to pay costs for its summary judgment motion on a partial indemnity basis, to the tune of $50,000. These risks must be weighed against any potential benefit.


In or Out? A Bold Re-Opening of the Opt-Out Period in a Franchise Class Action

By Jennifer Dolman

On July 27, 2012, Justice Strathy of the Ontario Superior Court of Justice released a decision in the 1250264 Ontario Inc. v. Pet Valu Canada Inc. (Pet Valu) franchise class action setting aside certain opt-out notices obtained from potential franchisee class members as a result of the “irreparable impairment” of the opt-out process (the Opt-Out Decision). Although the right of a class member to opt-out of a class action has been recognized by Ontario courts as fundamental, Justice Strathy found that the unique circumstances of this case warranted the “extraordinary measure” of judicial intervention in the opt-out process. The “irreparable impairment” in this case was found to be a campaign on behalf of an influential subgroup of franchisees intent on convincing other potential franchisee class members to opt-out of the class action. The Opt-Out Decision is particularly remarkable as the Court decided to intervene in circumstances where it found that neither party to the class action instigated or was directly involved in the actions giving rise to the “irreparable impairment.” The Opt-Out Decision also highlights the challenges that class action defendants, and specifically franchisors, face when they must maintain ongoing business relationships with class members and potential class members over the course of a protracted class action.

For further details on this decision, please refer to the Osler Update authored by Jennifer Dolman, Gillian Scott and Lia Bruschetta, released on August 2, 2012.


What Happens When an Ontario Franchise Disclosure Document is Delivered Electronically?

By Andraya Frith

In the July 6, 2012 decision of the Ontario Superior Court of Justice in Vijh et al v. Mediterranean Franchise Inc. et al (2012 ONSC 3845), the court answered the often posed question of what happens if a franchisor delivers an Ontario franchise disclosure document electronically.  Unlike the franchise legislation in PEI, New Brunswick and Manitoba, electronic delivery of a franchise disclosure document is not expressly permitted under the Ontario Arthur Wishart Act (the Act).  Indeed, Section 5(2) of the Act requires that the disclosure document be delivered by only one of two methods:  personally or by registered mail.

In this case, the franchisee (after consenting to receiving the disclosure document by e-mail and after operating the “Taste of the Mediterranean” franchise for nearly two years) sought to rescind the franchise agreement under Section 6(2) of the Ontario Act and recover costs and damages because of the “improper delivery method”.  In this motion for partial summary judgment, both sides agreed that there were no other deficiencies with the disclosure document and that the franchisor had otherwise fully complied with its disclosure obligations. 

Relying on the decision of the Ontario Court of Appeal in Imvescor (4287975 Canada Inc. v. Imvescor Restaurants Inc., [2009] O.J. No. 1508 (C.A.)), which held that breaches of the timing requirements or non-material deficiencies with the contents of the disclosure document gives rise only to the shorter 60 day right of rescission under Section 6(1), the court rejected the franchisee’s argument that the two year rescission remedy should be available for the “much less significant” breach of the method of delivery requirement.  Justice Belobaba reasoned that the “obvious legislative intent” of providing for two different rescission remedies “is to make clear that the two-year rescission right is reserved for the much more serious situation where no disclosure document is provided.”  The court went on to state that the franchisee’s only statutory remedy in the circumstances was limited to the damages remedy under Section 7 and tended to agree with the suggestion by the franchisor’s counsel that these damages may well be limited to “the cost of printing the emailed disclosure document”.

While this decision is a welcome one for franchisors as it reinforces that the longer two year rescission remedy should only be available in limited circumstances where no disclosure document is provided at all or where there is a material deficiency with the contents of the document, it implies that the 60 day rescission remedy would likely still be available where a disclosure document is provided electronically.  It also serves to highlight the need to amend the Act (enacted more than a decade ago) to expressly allow for electronic delivery of the disclosure document. 


Burnett Management Inc. v. Cuts Fitness For Men Reminds Franchisors That They Must Have Their Disclosure Documents in Shape

By Aislinn Reid

Burnett v. Cuts serves as an important reminder to franchisors - in particular American franchisors operating in Canadian provinces with franchise disclosure legislation - of the significant risks of failing to provide proper disclosure to prospective franchisees and of keeping franchisees and prospective franchisees “in the dark.” 

Facts

Burnett, the president of the plaintiff corporation, and the U.S. franchisor of the Cuts Fitness for Men franchise system entered into negotiations regarding a Canadian master franchise license to expand the Cuts Fitness system to the provinces of Ontario, New Brunswick, Newfoundland, Nova Scotia and Prince Edward Island.

Under Ontario’s franchise disclosure legislation, the Arthur Wishart Act (the Act), franchisors are required to provide prospective franchisees with a disclosure document not less than 14 days before the earlier of the signing by the prospective franchisee of the franchise agreement or any other agreement relating to the franchise or the payment of any consideration relating to the franchise (such as a franchise fee).

During negotiations, the franchisor provided the plaintiffs with a Uniform Franchise Offering Circular (a UFOC), the form of franchise disclosure document which was at that time required under United States franchise disclosure laws, now the Franchise Disclosure Document. The franchisor subsequently provided the plaintiffs with a draft disclosure document.

Following delivery of the draft disclosure document, the plaintiffs and the franchisor entered into a letter of intent (the LOI) setting out the terms under which the franchisor would grant master franchise rights to the plaintiffs in Ontario.

After entering into the LOI and prior to signing a master franchise agreement, the plaintiffs paid US$100,000 in franchise fees to the franchisor and commenced selling Cuts Fitness franchises in Canada. Although the parties were operating as if the plaintiffs were already master franchisees, no final disclosure document had been delivered and the master franchise agreement had not been signed.

Approximately six months after the parties entered into the LOI, the franchisor delivered a purported disclosure document which was deficient in a number of ways. Following receipt of that purported disclosure document, the plaintiffs signed the master franchise agreement. After the agreement was signed, the franchisor stopped communicating with the plaintiffs and ignored their requests for information and assistance. The plaintiffs learned that the franchisor was preoccupied with dealing with the failure of its U.S. franchise system and developing another brand. The plaintiffs rescinded the master franchise agreement, and, when the franchisor refused to reimburse the plaintiffs for the franchise fees and their operating losses, the plaintiffs commenced an action for rescission and damages for breach of the duty of fair dealing.

Deficient disclosure is no disclosure at all

Under Ontario franchise disclosure law, there are two types of situations that may give a franchisee the right to rescind a franchise agreement. Generally, if a franchisor does not provide a complete or accurate disclosure document, the franchisee has 60 days from the date the disclosure document is provided to the franchisee to rescind the franchise agreement. If a franchisor does not provide a disclosure document at all, the franchisee has up to two years from the date of signing the franchise agreement to rescind the franchise agreement. However, a number of recent decisions by Ontario courts have made it clear that even if a franchisor has provided a disclosure document, in circumstances where that disclosure document does not contain certain information and documents that are required under the Act, it is equivalent to the franchisor not providing a disclosure document at all. In those cases, the franchisee has up to two years from the date of signing the franchise agreement to rescind the franchise agreement. Burnett v. Cuts is the most recent in that growing list of cases where deficient disclosure has been found to be equivalent to no disclosure. Justice Whitaker found that the purported disclosure document was so deficient that it was as if no disclosure had been provided, and accordingly, the plaintiffs were entitled to rescind the master franchise agreement and recover the franchise fees they had paid and the operating losses they incurred. In particular, His Honour noted that the delivery of a UFOC does not meet a franchisor’s disclosure obligations in Ontario.

The court highlighted several critical deficiencies by the franchisor, including that the disclosure document:

  • was delivered after the execution of the LOI. As noted above, the Act requires delivery of a disclosure document at least 14 days before the signing of an agreement relating to a franchise;
  • was delivered in piecemeal fashion. The Act requires that a disclosure document be provided as one document (including all of the required contents) at one time;
  • did not have any financial statements. The Act requires that a disclosure document include an audited financial statement for the most recently completed fiscal year of the franchisor’s operations, unless an exemption applies;
  • did not include copies of all proposed franchise agreements and other agreements relating to the franchise to be signed by the plaintiff, as required by the Act;  and
  • was delivered to the plaintiff by email, which is not permitted under the Act.

Additionally, Justice Whitaker highlighted the franchisor’s failure to include in the disclosure document a signed and dated certificate certifying that the disclosure document contained no untrue information, representations or statements and includes every material fact, financial statement, statement and other information required by the Act. His Honour referred to earlier decisions of the Ontario and Alberta Courts of Appeal in which failure to provide a signed certificate in and of itself was held to be fatal to disclosure and therefore gave rise to a two-year rescission remedy.

Separate damages Awarded for breach of duty of fair dealing

Burnett v. Cuts is also significant as the third Ontario case (following Salah v. Timothy’s Coffees and 1159607 Ontario Inc. v. Country Style Food Services) in which separate damages for a franchisor’s breach of its duty of fair dealing under the Act have been awarded (in addition to damages awarded to compensate a franchisee for losses arising from deficient disclosure).  In addition to the damages awarded to reimburse the franchisees for the franchise fees they paid and the losses they incurred, Justice Whitaker awarded the plaintiffs $25,000 for the franchisor’s failure to disclose the true state of affairs of the franchise system, and in particular the fact that it was in a state of rapid decline, and for failing to respond to the plaintiffs’ reasonable requests for information and assistance after the LOI was signed and franchise fees paid.

Burnett v. Cuts serves as another warning to franchisors of the importance of the substance of disclosure as well as the form of disclosure required under the Act, and the consequences of withholding information from franchisees. Burnett v. Cuts also underscores that franchisors and franchisees who sign a letter of intent prior to entering into a franchise agreement will be subject to the same duty of good faith and fair dealing as when they execute a franchise agreement.

In addition to total damages of approximately $201,000, Justice Whitaker awarded the plaintiffs $70,000 in costs. Franchisors who face significant exposure for deficient disclosure and/or other clear breaches of the Act should carefully weigh the costs and benefits of litigating claims by franchisees and should evaluate the benefits of settling those claims before trial to avoid a significant adverse costs awarded as in Burnett v. Cuts.

Finally, it is important to note that although Burnett v. Cuts was an action commenced in Ontario for rescission of the master franchise agreement under the provisions of the Ontario’s franchise disclosure legislation, the defendant franchisor was required to provide similar disclosure relating to the franchise operations in New Brunswick and Prince Edward Island. Currently, four Canadian provinces (Ontario, Alberta, New Brunswick and Prince Edward Island) have franchise disclosure legislation in effect. Manitoba’s The Franchises Act comes into force on October 1, 2012.


How the Limitation Periods in the Arthur Wishart Act and the Limitations Act Work Together

By Gillian Scott and Patrick Welsh

Introduction

On June 6, 2012, the Ontario Court of Appeal dismissed the Philthy McNasty’s (Enterprises) Inc. (Philthy) appeal of the decision of Justice Whitaker of the Ontario Superior Court of Justice in 2130489 Ontario Inc. v. Philthy McNasty’s (Enterprises) Inc, 2011 ONSC 6852 (the Philthy Decision).

In the Philthy Decision, Justice Whitaker held that the limitation period for a claim of rescission damages starts to run, or is discoverable, at the point at which the franchisee knows that the franchisor will not be honouring a claim as set out in a Notice of Rescission. The Philthy Decision was the first ruling of an Ontario court on the issue of the intersection of damages for rescission under the Arthur Wishart Act (the Act) and the discoverability principles of the Limitations Act, 2000, (the Limitations Act). Until the Philthy’s Decision it was an open issue as to how courts would apply the principle of discoverability to a claim for rescission damages in the face of the clearly and strictly time-limited statutory rescission remedy under the Act.

In its dismissal of Philthy’s appeal, the Court of Appeal confirmed the manner in which limitation periods are calculated with regard to claims for rescission damages. While there were other issues dealt with in the Philthy Decision, this review and comment focuses solely on the limitation period issue.

Key Facts

On October 9, 2007, 2130489 Ontario Inc. (the Franchisee) entered into a franchise agreement with Philthy, a chain of restaurant/pubs, and the Franchisee was not provided with any disclosure document at that time. The franchise failed, and on September 23, 2009, the Franchisee served Philthy’s with a Notice of Rescission and demanded compensation pursuant to s. 6 of the Act.  On November 3, 2009, Philthy’s advised the Franchisee that it would be disputing the Notice of Rescission. The Franchisee commenced its application on November 29, 2010.

Decision on the Initial Application

The Franchisee brought an application under Rule 14.05(3) seeking declaratory and other relief, in particular a declaration affirming its right to rescission and rescission damages under the Act.  Justice Whitaker held that the Franchisee was entitled to issue a Notice of Rescission pursuant to s. 6(2) of the Act up to October 9, 2009, two years following the signing of the franchise agreement.  Justice Whitaker further held that the Franchisee’s claim for rescission damages did not crystallize until the franchisor advised the franchisee of its intention to dispute the Notice of Rescission on November 3, 2009.

The franchisor appealed Justice Whitaker’s decision on several grounds, including that Justice Whitaker erred in determining that the Franchisee’s application was not barred by the interaction of the limitation periods in the Act and the Limitations Act.

Appeal Decision on the Interaction between the Act and the Limitations Act

Philthy’s argued on appeal that the Franchisee’s application was barred by way of the interaction of relevant limitation periods in the Act and the Limitations Act.  The franchisor argued that the two-year limitation period for issuing a Notice of Rescission under the Act coincided with the general two-year limitation period under the Limitations Act for bringing a claim in damages.  Consequently, although the Franchisee may have delivered its Notice of Rescission within the mandated two-year window, the claim for statutory damages – which the Franchisee brought fourteen months later – was time barred.

However, the Court affirmed Justice Whitaker’s holding that the Franchisee’s claim did not crystallize until Philthy’s advised the Franchisee that it would not be fulfilling its statutory obligations with regard to the claim set out in the Notice of Rescission, and that before that time the Franchisee had at best only a “latent or potential cause of action.”

The Philthy Appeal confirms that a claim for rescission damages does not arise until a franchisor either:

  • advises the franchisee that it is denying its claim as set out in a Notice of Rescission; or
  • allows the 60-day period for responding to the claim in a Notice of Rescission to expire without honouring it. This effectively means that as long as a franchisee serves its Notice of Rescission on time, it may have up to four years and 60 days from the date of entering into a franchise agreement to claim damages for rescission.

Practice Point: The common practice of including claims for both the enforcement of rescission as well as for rescission damages in one Statement of Claim, and serving that Statement of Claim at the same time as the Notice of Rescission (or at another time prior to the expiry of the 60-day period under subsection 6(6) of the Act) is incorrect. A more appropriate approach would be for a franchisee to issue its Notice of Rescission within two years after entering into the franchise agreement in order to ensure its claim is not statute-barred.  The franchisee could then bring an action to enforce rescission, and later amend that action, as necessary, to incorporate claims for compensatory rescission damages.