Franchising is an increasingly attractive business model for many businesses. However, many companies would prefer to avoid the lengthy and costly process required to prepare and continually update the detailed disclosure document that is mandated by Ontario's Arthur Wishart Act (Franchise Disclosure), 2000 (the Act), which must be provided by a franchisor to each prospective franchisee. The need to provide disclosure pursuant to the Act is not, however, an absolute requirement, as the Act provides for certain exemptions from disclosure which, if applicable, eliminate the requirement for that particular franchisor to provide disclosure to a particular franchisee in a given situation. For additional information regarding franchise legislation, disclosure requirements thereunder and disclosure exemptions, please see our March 2012 article: Disclosure Requirements of Ontario's Franchise Legislation and the Rescission Remedy.
Over the past year, two significant decisions have been rendered by the Ontario Court of Appeal regarding the availability of exemptions to franchisors' disclosure obligations under the Act. In addition, a third case addressing disclosure exemptions was recently released by the Ontario Superior Court of Justice. These three cases provide valuable insight into the judiciary's current position on the application and availability of disclosure exemptions pursuant to the Act.
Decisions of the Ontario Court of Appeal
In TA&K Enterprises Inc. v. Suncor Energy Products Inc., the Ontario Court of Appeal (the Court) was asked to consider whether Suncor was exempt from providing a disclosure document by virtue of section 5(7)(g)(ii) of the Act, which excuses the franchisor from this requirement where "the franchise agreement is not valid for longer than one year and does not involve the payment of a non-refundable franchise fee."
TA & K Enterprises Inc. (TA&K) was a franchisee that operated a Sunoco gasoline service station. On November 11, 2008, TA&K and Suncor signed a Retail Franchise Agreement (the RFA) with a term of one year starting on November 15, 2008 and ending on November 14, 2009. In October 2009, following the Petro-Canada and Suncor merger, Suncor sent a letter to TA&K informing them that when the RFA expired in November 2009, there would be an extension of the RFA on a month-to-month basis upon the same terms and conditions as the original agreement. On January 12, 2010, Suncor sent another letter to TA&K advising them that the RFA would terminate on August 12, 2010. Subsequently, TA&K commenced a class action alongside other franchisees alleging that Suncor had not provided a disclosure document as required under the Act. In response, Suncor brought a motion for summary judgment seeking to have the action dismissed on the basis that no disclosure document was required.
On the motion for summary judgment, Justice Perell found that the section 5(7)(g)(ii) exemption applied to relieve Suncor of the obligation to provide TA&K with a disclosure document. He made this finding based on the fact that the RFA: (1) was not valid for more than one year; and (2) did not involve the payment of a non-refundable franchise fee.
TA&K appealed the decision, asserting that Suncor did not meet the requirements of section 5(7)(g)(ii) of the Act, as the term of the RFA extended beyond the one-year threshold. They made this argument based on several factors, including:
- relying on the November 11, 2008 signature date to demonstrate that the agreement covered a period longer than one year;
- asserting that the extension letter issued by Suncor in October 2009 should be treated as lengthening the term of the initial agreement; and
- arguing that the survival of certain provisions in the RFA beyond the end of the term of the RFA extended the term of the agreement.
Further, TA&K submitted that the royalty payments made to Suncor over the term of the agreement should be considered to be the payment of franchise fees.
The Court rejected TA&K's arguments and upheld Justice Perell's decision. The panel, comprised of Justices Goudge, MacFarland and Watt, relied on the underlying policy of the exemption and found that disclosure was not required in this circumstance, as the period during which the franchisee would be accepting rights and obligations under the RFA was of a short enough duration that they would be at minimal risk. The Court also found that the October 2009 extension letter would not extend the term beyond the one-year threshold to negate the availability of the exemption, but would instead be considered an additional term that followed the initial term. Moreover, the Court held that the survival of certain provisions, such as indemnity and confidentiality provisions, beyond the termination of the agreement, did not extend the term of the franchise agreement itself as an agreement that has been terminated or expired cannot be considered to be valid. Finally, the Court found that a "franchise fee", a term that is not defined in the Act, "is in the nature of a fee paid for the right to become a franchisee" that would be paid to the franchisor before a franchisee commenced operations and does "not include royalties or payments for goods or services" that a franchisee would pay to the franchisor during the term of the agreement.
In 2189205 Ontario Inc. v. Springdale Pizza Depot Ltd. (Springdale Pizza), the Court's decision, released on June 22, 2011, provides the latest application of section 5(7)(a)(iv) of the Act, which exempts a franchisor from providing a disclosure document upon a resale of a franchise by a franchisee.
In Springdale Pizza, the prospective franchisee approached the franchisor directly regarding the purchase of a franchise. As a result, the franchisor directed the prospective franchisee to an existing Pizza Depot franchise that was available for sale, and the prospective franchisee subsequently purchased the assets of that franchised restaurant. Although the prospective franchisee purchased the franchise directly from the existing franchisee, evidence at trial indicated that all of the parties (including the franchisor) were involved in the negotiations that culminated in the sale of the franchise. In addition, to complete the transaction, the franchisor required the prospective franchisee to sign supplementary documents in order for the franchisor to provide their consent to the transfer. The franchisor did not provide a disclosure document to the new franchisee and, after operating for several months, the new franchisee brought an action for rescission based upon such non-disclosure.
The franchisor relied on sections 5(7)(a)(iv) and 5(8)(a) of the Act and claimed that it was exempt from disclosure obligations upon the resale of the franchise by the franchisee, as the resale was not "effected by or through a franchisor". In contrast, the new franchisee submitted that the franchisor's conduct during the sale, coupled with the franchisor's requirement that the new franchisee sign additional documents, took the franchisor outside the parameters of this exemption. The Court upheld the lower court's decision and found in favour of the new franchisee, holding that the exemption was not available in this case as the franchisor was not merely a passive participant in the resale of the franchise.
The Court found that, given the remedial nature of the Act, the disclosure exemption set out in sections 5(7)(a)(iv) and 5(8) of the Act must be narrowly construed. Moreover, the language used in those provisions only provides an exemption when the franchisor is "not an active participant in bringing about the grant and does nothing more than 'merely' exercise its rights to consent to the transfer" (emphasis added).
The Court held that a number of circumstances, taken together, supported the conclusion that the resale was brought about or caused to happen by or through the franchisor, specifically:
- the franchisor directed the respondents to this particular purchaser;
- the franchisor negotiated together with the vendor and the respondent to bring about the sale of the franchised business and the assignment of the franchise;
- the agreement of purchase and sale required the respondents to obtain the consent of the franchisor and thus deal directly with the franchisor; and
- the franchisor required execution of documents by the new franchisee that the vendor had not been required to sign.
Note, however, that while the Court found that these factors together amounted to a resale that was "effected by or through the franchisor", they were careful to point out that, on their own, any of these individual circumstances may not have been sufficient to preclude the use of this disclosure exemption. However, on balance, in the case of transfers, the prudent course would be for the franchisor to provide disclosure to the new franchisee on the basis that this disclosure exemption will be narrowly construed and has been found not to be available in certain cases.
Decision of the Ontario Superior Court of Justice
Although the case was not decided on the basis of the "additional franchise" disclosure exemption referenced in section 5(7)(c) of the Act, 3574423 Canada Inc. v. Baton Rouge Restaurants Inc. (released on November 14, 2011), provides useful insight into the future application of this exemption given the comments of the Ontario Superior Court of Justice (the Superior Court).
3574423 Canada Inc. (the Eaton Centre Franchisee) operated a Baton Rouge Restaurant franchise in the Toronto Eaton Centre starting in 1999. The franchise agreement (the Agreement) between the parties contained a right of first refusal (ROFR), granting the Eaton Centre Franchisee the opportunity to acquire the franchise rights for the second Baton Rouge restaurant planned for the Greater Toronto Area. In 2000, the franchisor offered the Eaton Centre Franchisee a new restaurant opportunity in Thornhill (located just north of Toronto). However, that opportunity lapsed when the landlord cancelled the offer to lease for that property. Two subsequent opportunities were offered, but in each case the Eaton Centre Franchisee declined such opportunity and the Agreement was amended, by the signing of a waiver, to extend the ROFR to the next location planned for the Greater Toronto Area.
In 2001, the Thornhill restaurant opportunity returned. Again, the Eaton Centre Franchisee drafted and signed a waiver which indicated that they declined this particular opportunity, but wished to preserve their ROFR for future opportunities. However, at this time, the franchisor indicated that there would be no further extension of the ROFR. In 2004, another franchise became available in the designated area and the Eaton Centre Franchisee was not offered the ROFR with respect to such location.
The Eaton Centre Franchisee brought a claim against the franchisor under the Act on two grounds: (1) breach of the duty of fair dealing; and (2) breach of disclosure obligations which the franchisee alleged arose when the Thornhill opportunity was presented for the second time. Given that the Act was not in force at the time the original Agreement was entered into, the key issue at trial was whether the disclosure requirements under the Act applied to the franchisor's 2001 offer to the Eaton Centre Franchisee relating to the revived Thornhill location in accordance with the ROFR. The Eaton Centre Franchisee submitted that the Act's disclosure requirements applied for several reasons including:
- the franchisor's "invitation" to the Eaton Centre Franchisee to accept the Thornhill location combined with the executed waiver document formed a "franchise agreement" pursuant to the Act;
- the Eaton Centre Franchisee was a prospective franchisee with respect to the "next" restaurant and was consequently entitled to receive the required disclosure document when the franchisor notified the Eaton Centre Franchisee of the revived Thornhill location;
- the 2001 waiver signed by the Eaton Centre Franchisee as a prospective franchisee was a "franchise agreement or any other agreement relating to the franchise" within the meaning of section 5(1)(a) of the Act; and
- section 5(1)(a) of the Act (the disclosure requirement) applied even though, in the end, the Eaton Centre Franchisee did not become the franchisee for the Thornhill location.
The Superior Court rejected the Eaton Centre Franchisee's claim pertaining to the franchisor's alleged breach of disclosure requirements under the Act and held that the 2001 waiver was not a franchise agreement between the parties or "any other agreement relating to the franchise" as defined in the Act. Consequently, since there was no agreement, the Eaton Centre Franchisee was not entitled to the remedies afforded by the Act. The Superior Court stated that "section 5 disclosure requirements are linked to very specific acts – the signing of a franchise agreement or 'any other agreement relating to the franchise' and the payment of consideration." Put another way, though section 5(1) requires disclosure be made to a prospective franchisee, the Superior Court held that the Act only affords remedies for the breach of such requirements to prospective franchisees that become actual franchisees.
The Superior Court also took the opportunity to clarify that the phrase "any other agreement relating to the franchise" in section 5(1) of the Act refers to ancillary documents signed by a franchisee in connection with entering into a franchise agreement. Simply put, the phrase pertains solely to an agreement signed by a franchisor and an actual franchisee and would not capture a document entered into by a prospective franchisee that does not became an actual franchisee.
In obiter (meaning that such comments reflect the judge's opinion and are not regarded as binding or decisive), the Superior Court opined on the application of section 5(7)(c) of the Act to the case. Section 5(7)(c) of the Act relieves the franchisor from the duty to disclose to an existing franchisee if: (1) the additional franchise is substantially the same as the existing franchise operated by the franchisee; and (2) there has been no material change since the existing franchise agreement, latest renewal or extension was entered into.
Since no case law on the application of section 5(7)(c) existed, the Superior Court considered cases that discussed the "renewal exemption" in section 5(7)(f) of the Act and the "no longer than one year exemption" in section 5(7)(g)(ii) of the Act. Upon reviewing such case law, the Superior Court came to the conclusion that the exemptions reflect a legislative view that "where the franchisee is already familiar with the operations of the franchise system and the risk of making a further investment of funds is low, no need for the full disclosure requirements of section 5 exist." In other words, the asymmetry of information that often exists between a franchisee and franchisor is considerably reduced by the franchisee's knowledge and experience regarding the operation of its current franchise, significantly curtailing the need for disclosure and no longer aligning with the policy rationale behind the Act's disclosure requirement.
The Superior Court applied this view to the "additional franchise exemption" and held that the difference in the size of territories was not a material difference as it did not affect the operational or financial relationship between the parties. Further, the fact that the Thornhill franchise agreement did not contain a ROFR did not make the two locations substantially different in terms of their operation or prudency of investment. As such, the Superior Court held there was no material change to the Agreement and, moreover, the additional franchise would have been substantially similar to that already operated by the Eaton Centre Franchisee. In the result, if needed, the franchisor could have relied on the application of the exemption found in section 5(7)(c) of the Act in support of the fact that the franchisor was not obligated to provide disclosure to the Eaton Centre Franchisee in this case.
Franchisors and franchisees alike should take note of the decisions in the Suncor, Springdale Pizza and Baton Rouge cases as they provide useful insight into the courts' continuing journey to protect the interests of franchisees and balance the rights of franchisors and franchisees under the Act. While the Springdale Pizza decision confirms the commonly held view among franchise practitioners that it is prudent to disclose to prospective franchisees on franchise re-sales, both the Suncor case and the Baton Rouge case evidence the courts' willingness to confirm the availability of the Act's disclosure exemptions in situations where franchisees have sufficient information to make an informed investment decision or sufficiently limited risk that such potential franchisees do not require the protection of the Act.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.