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Repercussions of a Franchisor’s Failure to Disclose

Repercussions of a Franchisor’s Failure to Disclose

By:

Posted October 13, 2020

When a prospective franchisee and a franchisor enter into a franchise agreement, the Arthur Wishart Act (The Act) requires the franchisor to disclose all material facts about the business, financial information about the franchisor, costs to establish the franchise, the franchise agreement, and any other ancillary agreements. The purpose of this requirement is to allow a prospective franchisee the opportunity to make an informed investment decision. Where a franchisor fails to adhere to the Act’s disclosure requirements and the franchisee still proceeds with the franchise relationship, the franchisee may be entitled to later rescind the franchise agreement.  The powerful remedy of rescission effectively voids the original contract, frees the parties of liability and restores them to their original position prior to contract formation.

Section 6 of the Act addresses two scenarios where a franchisee may be entitled to rescission where a franchisor fails to disclose in accordance with the Act and the franchisee still proceeds with the franchise relationship.

The first provision is section 6(1) which entitles the franchisee to rescind the franchise agreement no later than 60 days after receiving the disclosure document where the franchisor failed to abide by statutory timelines regarding the delivery of the franchise agreement or where the contents of the disclosure document fail to satisfy statutory requirements.

The second rescission provision is detailed in section 6(2). This section allows a franchisee to rescind the franchise agreement up to two years after entering into the franchise agreement “if the franchisor never provided the disclosure document.” The language of this section of the Act seems to indicate that a franchisee can only rescind the agreement if the franchisee never received a disclosure document. However, the courts have interpreted non-disclosure under this section of the Act to capture a disclosure that is so materially deficient that it effectively amounts to no disclosure since it functionally prevents a prospective franchisee from making an informed decision. Under certain circumstances then, a franchisee may be able to rely on subsection 6(2) despite having received a disclosure document.

Whether a franchisor’s disclosure document is so deficient as to amount to non-disclosure is fact specific and determined by the Court.   In Apblouin Imports Ltd. v Global Diaper Services Inc., 2013 ONSC 2592, the court granted the franchisee rescission under section 6(2) of the Arthur Wishart Act for materially deficient disclosure by the franchisor for two reasons.

First, the franchisor provided a disclosure document with inconsistent references to the identity of the franchisor, citing different names throughout the document. Because the franchisee relied on this information, the franchisee was misinformed as to the corporate structure of the franchisor, breaching section 2 of the Regulations. Second, the disclosed earnings projection failed to specify the location on which the earnings were based. Together, these deficiencies in the disclosure document amounted to non-disclosure.

Further, in 2337310 Ontario Inc v 2264145 Ontario Inc., 2014 ONSC 4370, the failure to disclose was materially and significantly deficient as the disclosure document failed to:

  1. Contain information regarding a lease and sublease. Under the Act, agreements such as leases and their estimated costs are required in disclosure;
  2. Reference any agreements entered into by the franchisee and the first corporation the franchisee dealt with. (In this case the franchisor was two distinct corporations);
  3. Produce directors’ certificates for both corporations making up the franchisor; and
  4. Provide financial statements to the prospective franchisee.

Conversely, in Raibex Canada Ltd. v ASWR Franchising Corp. 2018 ONCA 62, the court denied the remedy of rescission to the franchisee under section 6(2). In this case, the Court focused on the conversion cost of a particular franchise site. Neither the original agreement nor the financial disclosure document specified a location for the franchise.

Instead, the agreement contained a provision stating that a location would be “selected through the ‘reasonable best efforts’ of both parties.” Further, the agreement referred to the uncertainty surrounding a conversion location and the additional costs that might accrue due to unforeseen circumstances surrounding construction. The court, in concluding there was sufficient disclosure, relied on the following in making its decision:

  1. The parties to the agreement knew the location had yet to be selected (pursuant to the terms of the agreement) and that they would work together to find a solution;
  2. The franchisor, through the agreement, was limited with regards to entering into a lease to consider the interests of the prospective franchisee;
  3. There was an opt-out clause. Essentially, if the franchisee felt rent was too high or the location was unsuitable, they had an opportunity to reject. The franchisee chose not to reject, and instead pushed for the franchisor to accept the agreement.

Conclusion

The Arthur Wishart Act places strict disclosure obligations on the franchisor who must take great care when preparing disclosure documents.  Where a franchisor fails to abide by the Act and its regulations, the franchisor remains exposed to the powerful remedy of rescission.

This blog post was written by Mark Fortier-Brynaert, a member of the Business Law and Wills and Estates teams with the assistance of Zach Murray, Articling Student.  Mark can be reached at 613-566-0380 or at mark.fortier-brynaert@mannlawyers.com.

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