Franchisors (and their lawyers!) are breathing a sigh of relief following the Ontario Court of Appeal decision in Raibex Canada Ltd. v. ASWR Franchising Corp. which overturns the Superior Court of Justice ruling allowing a franchisee to rescind a franchise agreement for, among other things, the franchisor’s failure to identify a location for the franchise prior to providing disclosure.
In Raibex, franchisee contemplated the acquisition of an AllStar Wings and Ribs franchise and discussed with the franchisor options of proceeding with a newly-built location or a conversion of an existing restaurant into the franchise concept. The disclosure document provided by the franchisor contained an estimate of development costs for a newly-built location but did not contain any information for a conversion other than a statement that the costs to convert was highly site-specific and that the franchisor had no reasonable means of estimating or predicting these costs. Since a location had not yet been identified for the proposed franchise, the sublease in the disclosure document did not contain a copy of the head lease which was to be attached as a schedule. Premises were identified 11 months after signing the franchise agreement, and the parties entered into a sublease with the head lease attached.
The franchise was a conversion of an existing restaurant and upon completion, the franchisee refused to pay the development costs and the $120,000 deposit required under the lease. The franchisor subsequently delivered a notice of default, which was followed by a notice of rescission by the franchisee within the 2-year period after signing the franchise agreement.
In a significant departure from previous case law and industry practice, Justice Wendy Matheson of the Superior Court of Justice concluded that the franchisor had not met its disclosure obligations as it did not include a copy of the head lease or provide the costs of conversion – even though this information was unknown to the franchisor at the time of disclosure – and held that it was insufficient for the franchisor to rely upon the fact that the information was not known at that time.
In the unanimous decision of the Court of Appeal, the Court determined that the deficiencies cited by the franchisee were “not so serious that the FDD is tantamount to a complete lack of disclosure” and that the Franchisee was not entitled to rescission under subsection 6(2) of the Arthur Wishart Act (Franchise Disclosure), 2000. In finding that the analysis of subsection 6(2) should be on a case-by-case basis, the Court took into consideration the terms of the franchise agreement which specifically acknowledged that the location had not yet been selected, that the parties would work collaboratively to select a site, and included an opt-out clause allowing the franchisee to terminate the franchise agreement if a location was not agreed upon within 120 days of execution of the franchise agreement.
With respect to the estimated development costs, the Court of Appeal held that “the lengthy and detailed FDD would have put the Franchisee on notice as to the potential risks associated with pursing a conversion opportunity”. While the franchise development was a conversion, the shell estimates provided in the FDD provided a “useful reference point” as to the upper range of possible costs. The Court noted the important legislative distinction between imperfect disclosure and no disclosure. In Raibex, the disclosure was imperfect but not tantamount to no disclosure at all.
What does this mean for franchisors? The debate which has plagued the disclosure process in the year following Justice Matheson’s decision – that is, whether disclosure may be validly delivered in law until a site has been located and lease signed – can be put aside for the time being (assuming the Court of Appeal decision is not appealed to the Supreme Court of Canada). This decision should provide comfort to franchisors that they can provide disclosure without a site selected, provided that the franchise agreement has a site selection process in place (with mutual selection, if possible) and/or an opt-out clause for the franchisee should a suitable location not be determined following execution of the franchise agreement. The decision also reinforces the importance of including various risk statements regarding development costs in a disclosure document.