Franchising in the Courts
Franchisor’s Unilateral, Significant Changes to Franchise System Require Good Faith
By Derek Ronde
In Landsbridge Auto Corp. v. Midas Canada Inc.,  O.J. No. 1279 (S.C.J.), the plaintiff franchisees (on behalf of the entire class of franchisees) claimed that the defendant franchisor made unilateral and fundamental changes to the franchise system that breached the franchisor’s contractual and statutory duties of good faith to the franchisees. While not making any findings of fact about the plaintiffs’ allegations, the court agreed that the case was suitable for a class proceeding and certified the action accordingly. One of the two representative plaintiffs (405) would represent the entire class of franchisees at trial.
Facts of Case and Claims of Franchisees
The dispute between the parties centred on royalties paid to the franchisor and discounts provided to the franchisees. Before 1981, the Midas Canada Inc. (Midas) franchise agreement provided that each franchisee would pay a royalty of 5% on its retail sales of products and services. However, in 1981, the royalty rate was increased to 10%. In exchange for the increased royalty payments to the franchisor, the franchisees were to receive a 14.5% discount on prices paid by them for products purchased from the franchisor; but, this discount arrangement did not form part of the franchise agreement.
For twenty years, this discount was included on all price lists and invoices that the franchisor provided the franchisees. However, in 2001, the franchisor stopped disclosing the discount, indicating that it was simply deducting the discount from the price. This allegedly meant that the franchisees lost the ability to verify whether a discount was, in fact, being applied. In their claim against Midas, the franchisees argued that Midas began eliminating the 14.5% discount, which caused the franchisees to lose a significant competitive advantage.
Additionally, between 2003 and 2006, the franchisor commenced and completed its withdrawal from the sale and distribution of products to its franchisees. A third party, Uni-Select, was named the exclusive supplier to the franchisees. The plaintiff franchisees claimed that Uni-Select was an inadequate substitute for the products previously supplied by Midas.
The franchisees claimed that the failure to properly disclose the discount, in concert with the elimination of the discount and the switching of suppliers, constituted breaches by Midas of the franchise agreement, the contractual duty of good faith owed to the franchisees and the statutory duty owed to the franchisees under the Arthur Wishart Act. The franchisees also claimed that Midas was unjustly enriched by its alleged conduct.
Findings at Trial
The court found that the plaintiffs’ claim did not disclose any breach of contract and was “certain to fail” on this basis. Specifically, the franchise agreement between the parties provided that Midas could set the prices at which it sold products to the franchisees, could change prices at any time without notice and could cease selling products. Also, the 14.5% discount was not included as a term of the agreement. However, the court did find that the issues of the breach of duty of good faith (statutory and contractual) and unjust enrichment were suitable for a class proceeding, and certified the plaintiffs’ action accordingly.
Significance for Franchisors
Franchisors should be extremely careful when making unilateral changes to their franchise systems that could “destroy the rights of the franchisees to enjoy the fruits of [their Franchise Agreements].” Franchisors must exercise their contractual discretion reasonably and with proper motives, and should not act in a manner inconsistent with the reasonable expectations of the parties. Although there has not been a finding of liability in this case, the franchisor is facing an action by a large group of franchisees claiming a breach of the duty of good faith. To avoid such potential liability, franchisors must act very prudently to ensure that their conduct is reasonable and compliant with their contractual and statutory duties to their franchisees.
Ontario Court of Appeal Continues Trend Toward Application of Two-Year Rescission Period
By Andraya Frith Jordan Toye
In 6792341 Canada Inc. v. Dollar It Ltd. (Dollar It No. 1), the Ontario Court of Appeal continued a recent judicial trend in finding that, although it appeared that a single disclosure document had been delivered, the document was so deficient that it did not constitute disclosure at all under the Arthur Wishart Act (Act). The franchisee successfully relied on s. 6(2) of the Act which allows for a two-year rescission period from the date of the franchise agreement where a disclosure document was not delivered. The franchisor had argued that although there were deficiencies in the disclosure document, the deficiencies did not constitute a complete lack of disclosure under s. 6(2). The franchisor argued that, instead, the shorter 60-day rescission period found in s. 6(1) – which had expired – should apply.
At trial, the judge of the Superior Court of Justice agreed with the franchisor, holding that where any disclosure document is given, s. 6(1) must be applied unless the disclosure document was void ab initio. The disclosure document at issue in this case is the same as the one considered by the Superior Court in 6862829 Ontario Inc. v. Dollar It (Dollar It No. 2). (For a summary of this case, please see the February 2009 issue of the Osler Franchise Review.) The Court of Appeal overturned the trial judge’s decision - agreeing with the judge in Dollar it No. 2 – finding that deficiencies in the disclosure document were substantial enough to find that no disclosure was provided.
McFarlane J.A. of the Court of Appeal held:
- A document does not become a disclosure document for the purposes of the Act just because it is called a disclosure document. Put another way, calling something a disclosure document doesn't make it one ... On the application judge's reasoning, the provision of any document purporting to be a disclosure document would meet the s. 6(2) requirement. No matter how deficient that document was, a franchisee would only have the right to rescind for 60 days after receipt of that document. This cannot be the intent of the legislation. Such an interpretation would lead to absurdity.
With respect to franchise legislation generally, McFarlane J.A. stated:
- The purpose of the legislation is to protect franchisees and the mechanism for so doing is the imposition of rigorous disclosure requirements and strict penalties for non-compliance. The legislation must be considered and interpreted in light of this purpose.
Specific Deficiencies in the Dollar It Disclosure Document
There were many deficiencies in the disclosure document at issue; however, McFarlane J.A.’s analysis of three deficiencies is particularly noteworthy. The provision of an unsigned, undated certificate was held to give rise to the longer two-year rescission period, as was the failure to provide financials. In addition, the failure to provide a copy of the head lease to the franchisee was found to constitute an undisclosed material fact which, at a minimum, would trigger the shorter, 60-day rescission period.
A. Certificate Neither Dated nor Signed
In adopting the decision of the Alberta Court of Queen’s Bench in Hi Hotel Ltd. Partnership v. Holiday Hospitality Franchising Inc., McFarlane J.A. held “...that the failure to include the mandated Certificate alone would be enough to conclude that there was not disclosure as required by the Act.” As a result, the longer two-year rescission remedy was available to the franchisee.
B. Financial Statements not Included
The franchisor provided no financial statements in the disclosure document. Again, this deficiency was sufficient on its own to give rise to the two-year rescission right. McFarlane J.A. held:
When one considers that the purpose of disclosure is to enable a prospective franchisee to make an informed decision about whether or not to invest in a franchise, financial disclosure is of the utmost importance. In relation to this disclosure obligation, the respondents' actions in no way resembled "substantial" compliance. There was a complete failure on their part to make disclosure as required by the Act.
C. Head Lease not Produced
The franchisee was required to enter into a sub-lease with an affiliate of the franchisor but was not provided the head lease between the franchisor and its affiliate. The Court of Appeal held that the head lease was material as it contained acknowledgments of the franchisee sub-tenant which the franchisee could not possibly accept without reviewing the head lease. The Court also stated that it is important that the franchisee be able to satisfy itself that the affiliate sub-landlord had the right to enter into a sub-lease.
This decision highlights the importance of having a fully compliant disclosure document as the courts are continuing to apply the two-year rescission remedy, even where there may be only a single deficiency in the disclosure document. The treatment of the head lease as a material fact also serves as a warning to franchisors that certain facts, information or documents, which may seem innocuous, could later be considered material, thereby providing the franchisee, at a minimum, with access to the 60-day rescission period for failure to disclose.
Quizno’s Certification Refusal Overturned
By Derek Ronde
In the May 2008 issue of the Osler Franchise Review, we summarized the decision of the Ontario Superior Court of Justice in 2038724 Ontario Ltd. v. Quizno’s Canada Restaurant Corp.,  O.J. No. 833 (S.C.J.). The franchisees in that case argued that the franchisor, Quizno’s (a sandwich chain franchise), and supplier companies had conspired to dictate the prices that the franchisees paid for products and merchandise. The court refused to certify the action as a class proceeding, ruling that the preferable procedure requirement under s. 5(1) of the Ontario Class Proceedings Act, 1992 could not be satisfied due to the predominance of individual issues in the proposed action.
In April 2009, the Divisional Court overturned that decision, certifying the plaintiffs’ action as a class proceeding. (See: 2038724 Ontario Ltd. v. Quizno’s Canada Restaurant Corp.,  O.J. No. 1874 (Div. Ct.).) The Divisional Court found that the motions judge had failed to appreciate that there were significant common issues among the members of the proposed class of plaintiffs. The court also found that the plaintiffs’ claim was “systemic in nature.” Although losses to each franchisee might be individual in nature, the conduct that gave rise to liability was systemic. The court found that there were a multitude of common issues that arose, including whether there had been a breach of the Competition Act, a common law conspiracy to control prices paid by franchisees, and a breach of contract by the franchisor, and whether damages could be proven in the aggregate.
Significance for Franchisors
The Divisional Court’s decision in this action may be an indicator of the willingness of the Ontario courts to certify actions where there are prima facie individual issues concerning the calculation of damages. The Ontario courts may take a holistic view of the disputes at issue to determine whether the conduct complained of is “systemic in nature” and, therefore, suitable to be tried as a class proceeding. Franchisors should be wary of such conduct, particularly concerning pricing/competition law issues and significant changes to their franchise systems. These are common areas for franchisee litigation and disputes about conduct in these areas could lead to certifiable class proceedings in Ontario.
Applications for Leave to Appeal Dismissed
In the October 2008 issue of the Osler Franchise Review, we included an analysis of the decision by the Ontario Superior Court of Justice in 4287975 Canada Inc. v. Imvescor Restaurants Inc. The Ontario Court of Appeal dismissed the franchisee’s appeal in April 2009 and the Supreme Court of Canada dismissed the franchisee’s further application for leave to appeal on October 1, 2009.