Seven Lessons From The "Paramount Trilogy"

Nearly seven years after it began, the "Paramount Trilogy" has now concluded.

The trial¹ and appeal² decisions have significantly advanced the law with respect to statutory rescission under Section 6(2) of the Wishart Act.³ This article attempts to identify the most important aspects of these decisions and to identify, where applicable, new developments in the law in this area.

Brief facts

Three "Paramount Fine Foods" franchisees delivered notices of rescission in the fall of 2017. The franchisor rejected the validity of the rescissions, and otherwise relied on several exemptions for its position that it need not have provided disclosure to the franchisees.

The three actions were heard together in a trial that began in late 2021. Vermette J. (the "Trial Judge") found one of the three rescissions valid, and granted the franchisor parties' counterclaims for breach of contract in the other two cases.

All parties appealed nearly every aspect of the Trial Judge's decision in three appeals and three cross-appeals. The appeals were heard by the Court of Appeal for Ontario in June, 2024. In the result, the Court of Appeal dismissed all appeals and cross-appeals, and affirmed all aspects of the Trial Judge's decision.

Lessons Learned

1. The time to rescind runs from the time the franchise agreement was entered into by the franchisee

At the relevant time, the franchisor had a practice of requiring franchisees to enter into a "generic" franchise agreement. The franchisor's witness described this document as a "placeholder" agreement. Its purpose was to evidence and affirm a party's commitment to later becoming a franchisee.

The franchisor's form of franchise grant was tied to location: its grant gave franchisees the right "to establish and operate the Franchised Business solely at the Premises which Premises should be solely situated in the Territory." The generic franchise agreement failed to identify the actual "Premises" or "Territory".

The parties that signed the "generic" franchise agreement later entered into an entirely new franchise agreement. This agreement was not an amendment of the "generic" agreement, but a fresh and separate document that did not refer to the earlier "generic" agreement.

The franchisor later argued that the time to rescind ran from the date that the "generic" franchise agreement was entered into by the parties, and that the franchisee was therefore out of time to rescind.

The Trial Judge rejected the franchisor's argument.⁴ She found that the franchisor's form of grant required the premises and territory to be defined. She found that the failure to identify a "Premises" and "Territory" made the grant of franchise incomplete and ineffective. The parties were not granted a legally enforceable right to operate a franchise. Accordingly, she found the generic franchise agreement was not a "franchise agreement" within the meaning of the Wishart Act, and did not effect a grant of franchise. The franchisee's time to rescind therefore ran from the time it entered into the second (effective) franchise agreement.

While heavily dependent on the facts of this case, franchisors should be mindful of the language of their form of grant. Purported grants that are tied to defined terms that as yet have no meaning (for instance, "Premises" that do not exist and "Territories" that are not defined) may result in no grant, at all. The parties should consider when a grant of franchise is complete and perfected, as this will be the date from which a franchisee's potential right of rescission will run.

2. A franchisee can rescind post-termination

NEW: the Court of Appeal for Ontario has now expressly confirmed that where a franchisor exercises a contractual right of termination under a franchise agreement, the franchisee may later exercise a statutory right of rescission under the Wishart Act.⁵ A franchisor cannot prevent rescission by terminating a franchise agreement.

The Trial Judge relied on the non-waiver provisions of the Wishart Act (Section 11) to conclude that the exercise of a contractual right (termination) cannot unilaterally deprive a franchisee of a statutory right (rescission).⁶ Citing the Midas⁷ case, she found that if contractual termination could pre-empt access to the rescission remedy this would run afoul of the purpose of the Wishart Act, which is to protect franchisees.

The franchisor parties argued on appeal that a terminated contract "ceases to exist" and therefore cannot be rescinded. The Court of Appeal rejected this argument.⁸ It confirmed that termination does not render a contract voib ab initio but rather absolves the non-breaching party from performing future obligations. The Court of Appeal generally agreed with the reasoning of the Trial Judge on this point, and confirmed that the Wishart Act does not make statutory rescission conditional on non-termination, even in circumstances where the franchisee is in breach of the franchise agreement.

This outcome will likely come as no surprise to the majority of franchise practitioners. Notably, several recent rescission cases have proceeded in the Ontario courts notwithstanding the franchisor had earlier purported to exercise contractual termination rights.⁹ However, the issue of whether the rescission right could be exercised, notwithstanding the earlier termination, was not raised or considered by the Court in these earlier cases.

3. Exemptions

The franchisor relied on three different exemptions to advance its argument that it need not have provided a "disclosure document" to the franchisees in these cases. All three of these arguments were rejected by the Trial Judge. Prior to this case, certain of these exemptions had never previously received direct judicial consideration.

In all instances, the Court of Appeal agreed with the Trial Judge's analyses and conclusions on the franchisor's exemption defences.¹⁰

• 5(7)(h) – the "large investment" exemption

NEW: in considering this exemption, each grant of franchise must be considered on its own and cannot be combined with other grants of franchise; the time to assess the quantum of the franchisee's prospective investment is at the time of the grant.

This is the first case to consider this exemption.

At the time of the grants in these cases,¹¹ franchisors did not need to provide disclosure to prospective franchisees who were investing in the acquisition and operation of a franchise, over a one year period, in an amount grater than $5MIL.

In these cases, the franchisor advanced two arguments: 1) the three grants made to the three franchisees should be considered a single "grant" for the purposes of the exemption, and; 2) the franchisees, collectively, invested over $5MIL in the acquisition and operation of the three restaurants in the course of their subsequent operations.

The Trial Judge rejected these arguments.¹²

The foundation of her conclusions rest on the definition of "grant" and "franchise". She found, as fact, that three separate grants of franchise had occurred. She found there was no basis to combine these grants or consider them collectively for the purposes of this exemption.

She also found that the relevant time to assess the quantum of the franchisees' investments is at the time of the grant. In so doing, she confirmed that the expected, prospective costs of acquisition and investment are determinative for the purposes of this exemption. The expenses actually incurred by the franchisees during their operations do not retroactively affect whether or not the franchisor had to provide disclosure to the franchisee.

• 5(7)(c) – the "additional franchise" exemption

NEW: distinct corporate franchisees that operate some aspects of their franchised businesses on a collective basis, or that have overlapping or similar shareholders, will not be considered the "same" franchisee for the purposes of this exemption; a franchisee must already be operating the franchised business for the exemption to apply.

This is the first case to directly consider the application of this exemption.¹³

The Wishart Act states that disclosure need not be provided for "the grant of an additional franchise to an existing franchisee if that additional franchise is substantially the same as the existing franchise that the franchisee is operating and if there has been no material change since the existing franchise agreement or latest renewal or extension of the existing franchise agreement was entered into."

The franchisor argued this exemption applied to it on the basis that the corporate franchisees did not observe separate corporate personality in their operations, and had some common shareholders as among them. In its submissions, the franchisees were therefore "the same".

The Trial Judge rejected these arguments.¹⁴

She found that relevant franchisee was not an "existing franchisee" as it was only ever granted a single franchise.

The Trial Judge then went on to consider whether an "existing franchisee" could be a new corporation with principals who are involved in another corporate franchisee of the same system. She concluded it could not. In relying on the wording of the exemption, she found that the qualifying words "substantially the same" described the relationship between the "existing franchise" and "additional franchise." These words did not apply to the franchisee. In other words, she found that the existing and additional franchise could be substantially similar, but that the franchisee had to be "the same."

The Trial Judge also noted that a plain interpretation of s. 5(7)(c) requires an existing franchisee to be "operating" a franchise for the exemption to apply. The "operation" requirement will not be satisfied if the franchisee has only signed the franchise agreement, or is in the midst of building out/constructing the franchise, and has never actually operated the business that is the subject of the grant. She found that none of the franchisees were operating any franchised business at the time the relevant franchisee signed its franchise agreement. In arriving at this conclusion, the Trial Judge confirmed the underlying policy rationale for this requirement, namely, that disclosure has little utility if the prospective franchisee is already familiar with the operations of the franchise system and for whom the risk of making a further investment of funds is low.

• 5(7)(a)(iv) – the "franchisee transfer" or "resale" exemption

The Trial Judge found the franchisor could not rely on the resale exemption. The Trial Judge's decision¹⁵ follows a long line of case law in which this exemption has been narrowly determined by the courts.¹⁶

The basis of the Trial Judge's decision is factual. First, she found there was no grant of a franchise by a franchisee on the facts. She found that the previous operator's franchise agreement was terminated, and the relevant parties entered into fresh agreements.

Second, and in any event, she found that the franchisor "was directly involved and an active participant" in the relevant grant. Among her findings, she found that the franchisor directed the franchisee to the existing operator, was involved in negotiations between the franchisee and the prior operator, had input on relevant documents, and was involved in discussions about purchase price, and otherwise acted as an intermediary She also found that the franchisor and the franchisee met at the franchisor's head office in the absence of the former operator. Her decision on this defence is generally consistent with prior case law on this exemption.

4. Piecemeal disclosure remains a fatal flaw

The franchisee that validly rescinded, Premium Host Inc., did so on the basis that the Franchisor provided it with material information outside of a "disclosure document". In upholding the Trial Judge's decision, the Court of Appeal confirmed a very long line of cases confirming that disclosure must be provided to a franchisee "as one document, at one time," and that piecemeal disclosure provides a franchisee with valid grounds to rescind.¹⁷

Although not directly addressed, this decision also confirms a related line of case law that financial information relating to the operation of the subject unit under a previous operator will generally be "material" within the meaning of the Wishart Act.¹⁸

5. A franchisee bears the burden of proving a valid rescission and its entitlement to statutory compensation

NEW: the Court of Appeal for Ontario has now expressly confirmed that a franchisee bears the burden of proving that it rescinded on valid grounds.¹⁹ Accordingly, a franchisee must prove: 1) what it received from the franchisor; and 2) that the purported "disclosure document" contained a defect that is so material as to render the disclosure document no disclosure at all.

On appeal, the franchisees argued that the franchisee need not prove it received materially deficient disclosure. They took the position that upon delivery of a notice of rescission in accordance with the Wishart Act, a franchisor could defeat a statutory rescission by demonstrating that it fulfilled its disclosure obligations under the Wishart Act by providing compliant disclosure document to the (then-prospective) franchisee.

In rejecting this argument, the Court of Appeal cited its earlier decision in Raibex, in which the Court (arguably in obiter) stated: "the Franchisee must not only demonstrate that the FDD was deficient, but also show that it was so deficient that the Franchisor effectively 'never provided [a] disclosure document.'"²⁰

In the result, the Paramount Trilogy cases are somewhat unusual in that the Trial Judge found that no purported "disclosure document" relied on by any party at trial had actually been provided to any franchisee but, notwithstanding, two of the franchisees were not entitled to rescission. Arguably, this result is at odds with the Court of Appeal's decision in MAA Diners, in which the Court of Appeal confirmed the lower Court's decision that a franchisee had validly rescinded its franchise agreement in the absence of any evidence that a disclosure document was provided to that franchisee.²¹

6. Provided the franchisee proves that the expenses it claims were actually incurred in connection with the franchised business, a court may reclassify expenses as between subsections 6(6)(a)-(d)

NEW: the Trial Judge expressly confirmed that compensation claimed by franchisees under various subsections of 6(6) could be reclassified and recovered under subsections 6(6)(a)-(d).²² While various earlier decisions have permitted the recharacterization of amounts claimed,²³ this is the first case to expressly address whether this practice is permissible.

At trial, the franchisor parties argued that the franchisees should not be permitted to reclassify any portion of their statutory compensation claim. For instance, they argued that amounts originally characterized by the franchisees under 6(6)(a), 6(6)(b), and 6(6)(c) should not be permitted to be reclassified and claimed under 6(6)(d). The need for reclassification in these cases arose largely as a result of the Trial Judge's findings about which franchisor parties were and were not "franchisor's associates" within the meaning of the Wishart Act.

The Trial Judge rejected these arguments and permitted the recharacterization of certain elements of the franchisees' compensation claim.²⁴

7. An employee of the franchisor may be found to be a "franchisor's associate" on the basis that they were involved in reviewing or approving the grant of franchise

NEW: The Court of Appeal upheld the Trial Judge's finding that a non-director/non-officer employee of a franchisor can be "involved in reviewing or approving the grant of a franchise" for purposes of satisfying the second element of the definition of a "franchisor's associate" under section 1(1) of the Wishart Act.

At trial, the franchisees submitted that the franchisor's Manager of Franchising was a franchisor's associate because the individual was controlled by the franchisor (this fact was admitted at trial by the franchisor parties) and because the individual was involved in reviewing or approving the grants of franchise.

The Trial Judge accepted this submission. In so doing, the Trial Judge relied on the fact that the individual's role included: (a) vetting new franchisees for the initial phase of the recruitment process; (b) reviewing and evaluating franchise applications; (c) advising the franchisor's principal about the results of this review; (d) initially meeting with prospective franchisees; and (e) advising the franchisor's principal about these meetings.²⁵ In addition to performing these duties in the context of these cases, the Trial Judge also noted that the individual was in "constant communication" with the prospective franchisees, including to discuss the progress of their transactions to purchase the franchises.

On appeal, the franchisor parties submitted that the individual should not be found liable as a franchisor's associate on policy grounds. They took the position that insofar as individuals are concerned, the definition of a franchisor's associate should be read to only apply to directors and officers of the franchisor. They argued that failing to do so would create potential liability for all clerical and junior employee that perform rote functions in the grant process.

The Court of Appeal rejected the franchisor parties' proposed interpretation of the Wishart Act.²⁶ Moreover, while the individual was not a director or officer of the franchisor, "neither was she a clerical or junior employee". She performed a significant role in the process of reviewing the franchisees' applications, exercising professional judgment, and advising the ultimate decision-makers.

Sotos LLP was trial and appellate counsel to the franchisees.

Footnotes

1. Premium Host Inc v Paramount Franchise Group, 2023 ONSC 1507.
2. Royal Bank of Canada v Everest Group Inc, 2024 ONCA 577.
3. Arthur Wishart Act (Franchise Disclosure), 2000, SO 2000, c 3.
4. Premium Host Inc v Paramount Franchise Group, 2023 ONSC 1507 at paras 354-361.
5. Royal Bank of Canada v Everest Group Inc, 2024 ONCA 577 at para 11.
6. Premium Host Inc v Paramount Franchise Group, 2023 ONSC 1507 at para 368.
7. 405341 Ontario Limited v Midas Canada Inc, 2010 ONCA 478.
8. Royal Bank of Canada v Everest Group Inc, 2024 ONCA 577 at para 11.
9. See 2352392 Ontario v MSI, 2019 ONSC 4055 at para 6, overturned on other grounds 2352392 Ontario Inc v Msi, 2020 ONCA 237, and 2364562 Ontario Ltd v Yogurtworld Enterprises Inc, 2021 ONSC 5112.
10. Royal Bank of Canada v Everest Group Inc, 2024 ONCA 577 at para 10.
11. We note that the language of this exemption has subsequently been amended, and now exempts a franchisor from disclosure in circumstances where a franchisee's total initial investment is in excess of $3MIL.
12. Premium Host Inc v Paramount Franchise Group, 2023 ONSC 1507 at paras 326-334.
13. Bark & Fitz Inc v 2139138 Ontario Inc, 2010 ONSC 1793 at para 26 briefly touches on whether this exemption can be relied upon where the principals of two different corporate franchisees are the same. However, this discussion occurs in the context of evaluating whether there is a "serious issue to be tried" in an injunction hearing. Karakatsanis J., as she then was, does not decide the matter. 3574423 Canada Inc v Baton Rouge Restaurants Inc, 2011 ONSC 6697, aff'd 3574423 Canada Inc v Baton Rouge Restaurants Inc, 2013 ONCA 39 discusses this issue in obiter, starting at para. 290. The discussion relates primarily to whether the franchisee to whom a franchise is granted had to have previously received compliant disclosure from the franchisor to rely on this exemption.
14. Premium Host Inc v Paramount Franchise Group, 2023 ONSC 1507 at paras 335-342.
15. Premium Host Inc v Paramount Franchise Group, 2023 ONSC 1507 at paras 343-352.
16. See, for example, 2189205 Ontario Inc v Springdale Pizza Depot Ltd, 2011 ONCA 467 at para 32.
17. Premium Host Inc v Paramount Franchise Group, 2023 ONSC 1507 at para 421; Royal Bank of Canada v Everest Group Inc, 2024 ONCA 577 at para 12.
18. See, for example, 2212886 Ontario v Obsidian Group, 2017 ONSC 1643 at paras 46-53, overturned on other grounds 2212886 Ontario Inc v Obsidian Group Inc, 2018 ONCA 670, leave to the SCC denied at 2212886 Ontario Inc, et al v Obsidian Group Inc, et al, 2019 CanLII 16450. In the within case, the franchisor provided Premium Host Inc. with the weekly gross margin statements of the previous operator, which showed the business' remaining revenue after subtraction of direct costs. The Trial Judge's findings that this information was "material" can be found at Premium Host Inc v Paramount Franchise Group, 2023 ONSC 1507 at para 421.
19. Royal Bank of Canada v Everest Group Inc, 2024 ONCA 577 at para 4.
20. Raibex Canada Ltd v ASWR Franchising Corp, 2018 ONCA 62 at para 40.
21. MAA Diners Inc v 3 for 1 Pizza & Wings (Canada) Inc, [2003] OJ No 430 (Sup Ct J), aff'd Maa Diners Inc v 3 for 1 Pizza & Wings, 2004 CanLII 19240 (Ont CA).
22. The franchisor parties pursued this matter on appeal. In upholding the Trial Judge's decision relating to the validity of the Premium Host Inc. rescission, the Court of Appeal by implication also affirmed the Trial Judge's reasoning on this point, although it did not specifically comment on this matter in its Reasons for Decision.
23. See, for example, 2122994 Ontario Inc v Lettieri, 2016 ONSC 6209 at paras 76-77, aff'd 2122994 Ontario Inc v Lettieri, 2017 ONCA 830, and 2483038 Ontario Inc v 2082100 Ontario Inc, 2020 ONSC 475 at paras 72-76.
24. Premium Host Inc v Paramount Franchise Group, 2023 ONSC 1507 at paras 461-465.
25. Premium Host Inc v Paramount Franchise Group, 2023 ONSC 1507 at para 458.
26. Royal Bank of Canada v Everest Group Inc, 2024 ONCA 577 at para 13.