Whenever a franchisee is claiming rescission, a central question is almost always whether the franchisee has a 60-day or a 2-year period to claim rescission.  In reality, rarely will a franchisee be seeking to rescind because of a relationship souring early on in the 60-day period.  Most franchisees considering a rescission remedy will generally be beyond this 60-day period.  As such, a rescission remedy would be available before the 2-year anniversary of the franchise agreement if the franchisee fits within subsection 6(2) of the Arthur Wishart Act (Franchise Disclosure), 2000 (the “Wishart Act”).

On a plain reading, whether the franchisee fits within subsection 6(2) of the Wishart Act seems relatively simple: if the franchisor never provided the disclosure document, the franchisee can rescind within this 2-year period.  However, judges have broadly interpreted “never” having received a disclosure document to include certain circumstances where the franchisee receives a disclosure document, but still has 2 years to rescind because the disclosure document contains deficiencies that are “fatal” to the disclosure document.  For a review of these circumstances, please see our article Franchise Disclosure: To be or not to be.  The list of fatal deficiencies seemed to be expanding over time to the benefit of franchisees.

It now appears that the pendulum has started swinging back towards the franchisor with the recent case of Caffé Demetre Franchising v. 2249027 Ontario Inc.  In that case, the franchisee’s rescission claim was based on the franchisor’s failure to disclose certain material facts regarding litigation in which it was involved in with a former franchisee, as well as certain changes in policies and remodelling and renovation expenses to be incurred.  As usual, the court was asked whether the franchisee was entitled to a 60-day rescission period – which had long expired – or a 2-year rescission period for never having received a disclosure document.

In arriving at his conclusion to deny the franchisee’s rescission claim, the trial judge reviewed the definition of “material fact” in the Wishart Act and, based on the definition, whether the undisclosed information had a significant effect on the value or price of the franchise or the decision to acquire it.  Since the changes in policies and renovation requirements did not exist at the time of disclosure, they could not have had a significant effect on the price to be paid and did not constitute material facts that were required to be disclosed.

The judge stated that the only information that met the definition of a material fact was a lawsuit by the franchisor against a former franchisee for operating a competing business and using the franchisor’s confidential recipes.  The non-disclosure of this information was found to only give rise to a 60-day rescission period and would only result in a 2-year period to rescind if the franchisee could show that the omission of the lawsuit resulted in “stark and material deficiencies” in the disclosure document that would amount to no disclosure at all.

The judge further concluded that the lawsuit was a protective measure by the franchisor at the request of and for the benefit of all franchisees.  As such, it did not constitute a potential liability to the franchise system as a whole and had no economic impact on the franchisee in particular.  In addition, the franchisee became aware of the litigation about a month and a half after signing the franchise agreement and raised no concern about it until claiming rescission.  Accordingly, the failure to disclose the litigation did not come anywhere close to the type of deficiency that would amount, in law, to no disclosure at all to warrant a 2-year rescission period.

Although the trial judge appeared to arrive at the correct result, it may be important to note three areas of concern in his judgment:

1. For information to be considered as a “material fact” under the Wishart Act, it must significantly effect the price of the franchise or the decision to acquire it.Although the judge initially considers the litigation to be a material fact, he later dismisses its economic impact and effect on the price of the franchise. Hence, it is questionable whether the litigation was a material fact in the first place as initially considered.
2. The regulations to the Wishart Act specifically only require a franchisor to disclose civil actions in which the franchisor, or its directors, general partners or officers, have been found liable or alleged to be involved in misrepresentation, unfair business practices, or violating a law that regulates franchises or businesses. Therefore, it is unlikely, that the litigation against the former franchisee in this case was required to be disclosed by the regulations.
3. The trial judge considered the litigation as a material fact although it was not commenced until a month after the disclosure was delivered.The judge based this conclusion on an email from the franchisor to one of its franchisees that the lawsuit against the former franchisee would be a priority and that it was contemplated at the time disclosure was delivered.It is questionable whether a lawsuit contemplated but not formally commenced would constitute a material fact at the time of disclosure.If the franchisor disclosed the contemplated litigation but then refrains from proceeding with it, would this then be a misrepresentation in the disclosure?

That said, the direction to be taken from the Caffé Demetre case is that in any potential rescission claim for failure to disclose a material fact, a two-tiered analysis is necessary:

1. Is the undisclosed information about the business, operations, capital or control of the franchisor, or about the franchise system, that would reasonably be expected to have a significant effect on the value or price of the franchise or the decision to acquire it?; and
2. Is the deficiency (or deficiencies) of a stark and material nature to amount to no disclosure at all to warrant a 2-year rescission period?

In order for a franchisee to succeed on its rescission claim, both of these questions must be answered in the affirmative.

Note that this decision is currently being appealed.  We will continue to follow this decision closely for additional guidance on “material facts” and perhaps for clarification on the questions areas of concern identified above.

For more information, contact Derwin Wong by phone at (416) 368-0600 or by email at dwong@businesslawyers.com.

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