Baton Rouge: Juicy Legal Developments on Disclosure Obligations
[author: Mary Paterson]
Justice Brown of the Ontario Superior Court recently released his decisions on liability and costs in 3574423 Canada Inc. v. Baton Rouge Restaurants Inc.1 giving us an excellent precedent to use in future cases: He made interesting statements about the definitions of “prospective franchisee” and “franchise agreement.” He also carefully considered the “additional franchise” exception to disclosure obligations. Ultimately, he dismissed the franchisees’ claim for $15 million in damages and awarded more than $780,000 in costs to the franchisor.
Facts: The franchisee opened the first Baton Rouge restaurant in Toronto and negotiated a right of first refusal to the next restaurant in the Greater Toronto Area. In accordance with that right, the franchisor offered the franchisee the next proposed restaurant in the Greater Toronto Area. The franchisee exercised the right of first refusal, but the opportunity fell through. The franchisor offered the franchisee another right of first refusal, which the franchisee accepted. The franchisor then offered the franchisee a series of restaurants that the franchisee rejected. After each rejection except for the last, the franchisor offered another right of first refusal. After the franchisee turned down the fourth opportunity, the franchisee requested, but the franchisor did not agree to offer another right of first refusal. When the fifth opportunity arose, the franchisor did not offer a right of first refusal to the franchisee. The franchisee sued.
Key Legal Developments: Among other theories, the franchisee relied on the disclosure obligations in the Arthur Wishart Act (Franchise Disclosure), 2000 (the Act) and alleged that the franchisor breached its disclosure obligations by failing to provide a disclosure document related to the fourth opportunity. The franchisee alleged that its waiver of the fourth opportunity was of no effect and it sought damages. Justice Brown reviewed the disclosure case law, drilled down into the meaning of the Act, and made the following key statements:
A Contractual Notice is Not an Invitation to Franchise under the Act: Section 5(1) requires franchisors to disclose to “prospective franchisees.” The Act defines “prospective franchisee” to include a person “whom the franchisor...invites to enter into a franchise agreement.” Justice Brown suggested that although the franchisor told the franchisee about various opportunities in accordance with the right of first refusal, the franchisor did not “invite”the franchisee to enter into a franchise agreement. Instead, the franchisor was simply providing a contractually required notice (Decision, para 279).
Disclosure Obligations Apply Only to Agreements and Not to Offers: Section 5(1) links the disclosure obligation with the “signing...of the franchise agreement or any other agreement relating to the franchise” and the “payment of consideration.” The Act does not impose disclosure obligations where no agreement is reached. In this case, Justice Brown held that the waiver related to the fourth opportunity was not an agreement; it was an offer that the franchisor did not accept. Justice Brown went further and suggested that the agreement has to be signed by “a person who becomes an actual franchisee” (Decision, para 288, emphasis added). In this case, the franchisee purported to waive the right to become a franchisee. As a result, the disclosure obligations did not apply.
The “Additional Franchise” Exception Applies if there is No Material Change: Section 5(7)(c) says that franchisors do not need to provide disclosure to an existing franchisee receiving an additional franchise where there has been “no material change.” Justice Brown noted that the exemptions generally apply where “the franchisee is already familiar with the operations of the franchise system and the risk of making a further investment is low” (Decision, para 295). Justice Brown therefore rejected the franchisee’s submission that the exception only applied if the franchisee received disclosure with respect to one of its earlier franchises because an existing franchisee gains knowledge through experience in the franchise system regardless of any previous receipt of disclosure. Justice Brown also rejected the franchisee’s submission that the lack of a right of first refusal was material because such a right did not relate to the operational or financial relationship between the franchisor and franchisee.
Practical Tips: In this case, it seems that the relationship between the franchisor and franchisee deteriorated so badly that it affected the way in which the parties conducted the litigation. We can draw three practical tips from this case:
Don’t Take Unreasonable Positions: Justice Brown rejected the franchisee’s evidence because they took unreasonable positions. The Court found that the franchisee’s principals were sophisticated and experienced franchise operators and noted that their attempts to construe the meaning of the word “territory” in an unusual way “significantly undermined their credibility as witnesses” (Decision, para 46). On the other hand, the franchisor’s representatives gave their evidence in a forthright manner and took reasonable positions. The Court accepted the franchisor’s evidence.
Do Comply with the Rules of Civil Procedure: In this case, the Court found that both parties had failed to disclose relevant documents despite their obligations under the Rules of Civil Procedure. As a result, the franchisor received a lower costs award than it otherwise would have received (Costs Decision, para 45).
Do Consider Settlement Offers Carefully: In this case, the franchisor offered to pay the franchisee $750,000 plus costs on a partial indemnity basis to settle the case. The franchisee did not accept the settlement. The Court found against the franchisee and ordered the franchisee to pay the defendants more than $780,000 in costs, providing another example of the risks associated with litigation.
If you have any questions, please contact any member of our Franchise & Distribution Group.
Franchise and Competition Class Actions: Dismissal of Tim Hortons Class Action Is Good News for Franchisors
[authors: Jennifer Dolman, Christopher Naudie, Evan Thomas, Lia Bruschetta]
In a sweeping decision with significant implications for franchises and other vertical distribution arrangements, the Ontario Superior Court of Justice has dismissed a $2 billion franchise and competition class action against Tim Hortons on the merits. This important decision will have application to cases involving the pricing of products within franchise systems, the franchisor’s duty of good faith and fair dealing, and the competitiveness of vertical pricing and distribution arrangements in Canada. The Court also provided significant guidance on the impact of a number of recent amendments to the Competition Act relating to horizontal conspiracies, price maintenance, vertical arrangements as well as strategic joint ventures.
Please click here to review an Osler update that discusses the case, including a summary of the key points relating to the decision.
13574423 Canada Inc. v. Baton Rouge Restaurants Inc., 2011 ONSC 6697 (CanLII), (the “Decision”); and 3574423 Canada Inc. v. Baton Rouge Restaurants Inc., 2012 ONSC 296 (CanLII), (the “Costs Decision”).