For franchisors in Ontario, the standards for disclosure to comply with franchise legislation was literally turned on its ear in the recent decision in Raibex Canada Ltd. v. ASWR Franchising Corp. This was somewhat expected with the recent activism among judges to expand the list of deficiencies that would allow a franchisee a 2-year rescission period, but Madam Justice Matheson in Raibex has taken it to another level.
The franchisee in Raibex contemplated the acquisition of an AllStar Wings and Ribs franchise. In its early discussions with the franchisor, the parties discussed either proceeding with a newly-built location or a conversion of an existing restaurant into the franchise concept. Pursuant to the Arthur Wishart Act (Franchise Disclosure), 2000, the franchisor delivered a franchise disclosure document that contained, among other documents, a draft form of franchise agreement, as well as a draft form of sublease. The disclosure document also contained an estimate of development costs for a newly-built location but did not contain any information for a conversion other than a statement from the franchisor that the cost to convert was highly site-specific and that the franchisor had no reasonable means of estimating or predicting these costs.
The franchisor’s usual practice was to have its affiliated corporation enter into a lease for the restaurant and then sublease the premises to a franchisee. Accordingly, 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.
Following execution of the franchise agreement, premises were identified 11 months later, 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 franchisor made a demand for payment of the development costs. The franchisee refused and the franchisor 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.
Breaking away from the case law to date, Justice Matheson concluded that the franchisor had not met its disclosure obligations by failing to include a copy of the head lease or providing the costs of conversion – even though this information was unknown to the franchisor at the time of disclosure. The judge specifically stated that it was insufficient for the franchisor to rely upon the fact that the information was not known at that time and that it was “premature” to have delivered the disclosure document and entered into the franchise agreement.
Justice Matheson also relied upon a statement previously made by Mr. Justice Stinson in 2337310 Ontario Inc. v. 2264145 Ontario Inc. (DeliMark Café) that a franchisor could not avoid its disclosure obligations on the basis that certain information was not available at the time the disclosure statement was prepared. However, it should be noted that in that case the franchisor deliberately failed to deliver a statement of material change to disclose a lease that was signed after the disclosure statement was delivered but before the franchise agreement was signed.
The decision in Raibex is a significant departure from the conventional understanding of the duration of a franchisor’s disclosure obligations. It was commonly accepted that a franchisor had to disclose all material facts from the delivery of the disclosure document until the earlier of the signing of the franchise agreement and the payment of any consideration for the franchise. Changes to any material facts contained in the disclosure document during this time period must be disclosed to the prospective franchisee by way of a statement of material change. Once the franchise agreement was signed and fees paid, the franchisor’s disclosure obligations ended. The decision in Raibex however now makes the franchisor responsible for the disclosure of material facts that may occur after the signing of the franchise agreement which, in our view, was not contemplated in section 5 of the Wishart Act.
The decision in Raibex also is not consistent with the practices of many franchisors regarding the leasing of premises for their franchises. For many of these franchisors, the execution of a lease does not typically take place until a franchise agreement is signed with a franchisee who will develop and operate the location. Otherwise, if a franchisee cannot be identified, these franchisors may unexpectedly find themselves committed to certain premises which they will have to develop and operate with their own resources.
As a result, franchisors will find themselves in a difficult predicament to expand their systems by having to either take a chance and execute a lease beforehand with the hope that a franchisee will be identified to take the location, or wait until a location is found before delivering a disclosure document which runs the risk that a franchisee may change their mind and not proceed with the execution of the franchise agreement.
The other concern is that, in principle, the list of information that may be considered critical and that the franchisor ought to have included in the disclosure document – or otherwise have its delivery be deemed “premature” – may be expanded in subsequent cases making it even more difficult, or impossible, for a franchisor to determine whether or not it has complied with its statutory disclosure obligations.
It may also be interesting to note that Mr. Justice Penny in the subsequent case of 2122994 Ontario Inc. v. Lettieri referred to and agreed with the decision in Raibex.
The Raibex case is currently being appealed, and hopefully the Ontario Court of Appeal will provide some clarification on these issues.
For more information or assistance, contact Derwin Wong or Hailey Kersey by phone at (416) 368-0600 or by email at dwong@businesslawyers.com or hkersey@businesslayers.com.
© Morrison Brown Sosnovitch LLP, 2016. All rights reserved.
