Franchise Review - Oct 2013: Franchising in the Courts

In this issue:

Franchising in the Courts

Apblouin Imports Ltd. v. Global Diaper Services Inc.: Reminder to Franchisors of the Importance of Strict Compliance with Disclosure Requirements

By  Aislinn Reid

In Apblouin Imports Ltd. v. Global Diaper Services Inc., the Ontario Superior Court of Justice held that a franchisor’s disclosure obligations do not change when dealing with sophisticated franchisees, and reaffirmed that there is no substitute for disclosure requirements under the Arthur Wishart Act (Franchise Disclosure), 2000 (the Act).

Under the Act, a franchisee can rescind the franchise agreement within 60 days if the franchisor does not provide a disclosure document or statement of material change at least 14 days before the prospective franchisee signs the franchise agreement, or any agreement relating to the franchise, or before a prospective franchisee makes a payment to the franchisor or the franchisor’s associate. However, if a franchisor never provides a franchisee with a disclosure document, the franchisee has up to two years after entering into the franchise agreement to rescind that agreement.

Key Facts and Findings

In Apblouin Imports, the franchisee brought a motion for partial summary judgment in a franchise dispute against the franchisor, Global Diaper Services, claiming that it (Apblouin Imports) validly rescinded its franchise agreement with the franchisor. The franchisee argued that the franchisor’s disclosure had been so deficient that it amounted to no disclosure at all, entitling the franchisee to rescind the agreement within two years. The Court agreed, finding that the franchisee had validly rescinded its franchise agreement and granting the franchisee partial summary judgment. Among the fatal deficiencies that led the Court to conclude that the franchisor’s disclosure was so deficient as to amount to no disclosure included that the franchisor failed to provide:

  • disclosure on behalf of the correct corporate entity
  • a location where information substantiating the earnings projections would be available for inspection
  • financial statements that met the requirements under the Act
  • a properly signed certificate

Importantly, the Court rejected the franchisor’s argument that because the franchisee was a sophisticated businessperson with considerable franchise experience, he should not be able to complain of deficiencies in the franchisor’s disclosure. There was evidence that the franchisee had pointed out several errors in the franchisor’s disclosure materials. The Court held that the franchisor’s suggestion that it should be held to different disclosure requirements based on the sophistication of the franchisee “was not a suitable approach” to the issue, although it was “superficially attractive.” The Court observed that the effect of the franchisor’s proposed approach would be to vary the form and level of the franchisor’s required disclosure according to the level of sophistication of a prospective franchisee, requiring subjective, case-by-case assessment, which is not contemplated by the Act.

With respect to financial statements, the franchisor argued that because it provided the prospective franchisee with access to the franchisor’s electronic financial data, including a printout of electronic statements, the franchisee had been provided with the most up-to-date financial information to enable it to make an informed decision. The Court did not accept that the electronic access to financial information and statements provided was any substitute for the financial statement requirement under the Act’s regulations. Under the Act, every disclosure document must include a financial statement for the most recently completed fiscal year of the franchisor’s operations, prepared in accordance with generally accepted accounting principles.

Apblouin Imports serves as another recent reminder to franchisors of the importance of strict compliance with disclosure requirements under the Act and of the significant remedy available to franchisees for non-disclosure.

For more information on the importance of disclosure requirements under the Act and of the significant remedy available to franchisees for non-disclosure, please contact a member of Osler’s Franchise Team.


Court-Approved Settlement Means Justice for Class Members, but No Trial of Issue of Arthur Wishart Act Duty of Good Faith

By  Gillian S.G. Scott

On September 12, 2013, in 405441 Ontario Limited v. Midas Canada Inc., the Ontario Superior Court of Justice approved an $8.5M settlement in favour of class members in the class action brought by Midas franchisees against Midas Canada Inc. (Midas) in May 2007. While Justice Lax unequivocally held that the proposed settlement was fair, reasonable and in the best interests of the class members, the franchise bar won’t have the benefit of seeing judicial consideration of the application of the duty of good faith and fair dealing in the context of system-wide change under section 3 of the Arthur Wishart Act (Franchise Disclosure), 2000 (the AWA).

Background of the Action and Approved Settlement

While this class action against Midas by certain Midas franchisees was initially brought on broader terms, as well as against Midas’s U.S. parent company, certification was granted solely against Midas on a much narrower set of issues. The certified issues centred on whether or not Midas had acted in breach of its duties of good faith and fair dealing under section 3 of the AWA by making certain system-wide changes to its franchise. A key issue was whether Midas ought to have adjusted the royalties payable by its franchisees when it stopped distributing parts and outsourced that distribution to a third party in 2003.1

Highlights of the proposed settlement approved by Justice Lax include the following:

  • an $8.5M payment (inclusive of interest, legal fees, disbursements, administration expenses and taxes) by Midas for the benefit of class member franchisees;
  • distribution of the settlement payment to class member franchisees based on a formula applied to gross sales figures with a progressive adjustment reduction favouring smaller franchisees (who suffered proportionately greater harm than larger franchisees who were able to negotiate volume discounts from the new parts distributor); and
  • counsel fees of $2,125,000 plus HST and disbursements (representing approximately 25% of the total settlement payment, which was both in line with the retainer agreement between counsel and the representative plaintiffs, and a 1.3 multiplier premium on actual rates for hours docketed on the case).

Reasons for Settlement Approval

In order to approve a class settlement, the Court must be satisfied that the settlement is fair, reasonable and in the best interests of the class members. Justice Lax held unequivocally that the proposed settlement in this case was all of these things, primarily because it offered class members a reasonable alternative to the significant risk they would have assumed by proceeding to trial, particularly in light of the complexity of applying the section 3 AWA duties of good faith and fair dealing to the issue of system-wide change.

In her reasons, Justice Lax emphasized in particular:

  • Justice Cullity’s recognition on certification that balancing the “detriment suffered by the franchisees as a result of the change in the products supply system, in light of the undoubted right of Midas to give consideration and weight to its own interests would be a difficult task”;
  • the high level of uncertainty inherent in assessing the amount of damages that might flow to franchisees, even if they were able to establish such a breach of section 3 of the AWA;
  • that the plaintiffs’ risk inherent in moving forward with the action had increased in light of developments in franchise law since the inception of the Midas case, and in particular the decision in Fairview Donut Inc. v. The TDL Group Corp2 (TDL);3
  • that each class member could expect to recover between approximately $14,000 and $392,000 under the settlement; and
  • that class counsel fees were reasonable given the risks it undertook in conducting the litigation and the result achieved for the class. Justice Lax emphasized that the risk assumed by class counsel was magnified since the action was not certified against the U.S. parent, and that any judgment against Midas may not have been enforceable if Midas had filed for bankruptcy or restructured its operations.

It is also worth noting, however, that Justice Lax emphasized several procedural points in her decision that weighed in the balance of her approval of the settlement, namely that the action was a “mature” one that had been ongoing for seven years and that although the action was ready to be set down for trial, it would be another two before it could be heard, given the bottleneck on Toronto’s long trial list. In this case, the realities of the civil trial list in Toronto appear to have weighed significantly in the balance of a decision that proceeding to trial was not the preferable procedure.

Implications

While Justice Lax held that the settlement was clearly to the advantage of class members, the franchise bar has missed an opportunity for a full hearing on the application of section 3 of the Arthur Wishart Act, and the balancing act between a franchisee’s rights and a franchisor’s rights to make changes to its system in a post TDL world. This settlement-approval decision also highlights the disadvantages of a busy civil trial list, which means that despite an action being ready for trial, no trial could be heard for another two years at the earliest. The settlement was considered fair and reasonable and in the best interest of the parties in lieu of a risk of “justice postponed” for at least another two years.


1  A copy of Justice Cullity’s March 26, 2009 decision on certification can be found here, and earlier Osler commentary on the decision can be found here.

2012 ONSC 1252 (aff’d 2012 ONCA 867).

3  In summary, in TDL the Court granted summary judgment to the franchisor, Tim Hortons, in holding that its wide-reaching changes to its franchise system were not in breach of its statutory duties of good faith and fair dealing under section 3 of the AWA as these decisions were made honestly and reasonably for legitimate business purposes and in accordance with its rights under the franchise agreement.