Franchising in Ontario



Ontario Court of Appeal Confirms no Disclosure Document Necessary where Franchise Has Term of One Year or Less and Franchisee Pays no Non-Refundable Franchise Fees

By  Larry Lowenstein and Adam Hirsh

In the first decision to consider the meaning of the “one-year/no-franchise fee” exemption in the Arthur Wishart Act, the Ontario Court of Appeal has confirmed that a franchisor is not required to provide a franchisee with a disclosure document where the franchise agreement has a term of one year or less and where the franchisee does not pay any non-refundable fees in exchange for the franchise. The Court’s decision in T A & K Enterprises Inc. v. Suncor Energy Products Inc. represents a significant victory for franchisors, as the Court recognizes that disclosure is not required for low-risk “one-year/no franchise fee” franchises.  Osler represented Suncor in successfully dismissing this $200 million proposed class action.

Background

T A & K Enterprises Inc. v. Suncor Energy Products Inc. was a proposed class action launched by a former Suncor retailer, T A & K Enterprises Inc. (TAK). TAK operated a Sunoco gas station under a franchise agreement. Its franchise came to an end, and TAK commenced the action alleging that Suncor failed to deliver a disclosure document to 241 proposed class members.  As a result, TAK alleged that Suncor had breached the Arthur Wishart Act (Franchise Disclosure), 2000, S.O. 2000, c. 3 (the Act). For this breach, TAK alleged that class members were entitled to rescind their franchise agreements and were entitled to aggregate damages of $200 million.

Prior to determining whether the case should be certified as a class proceeding, Suncor moved for summary judgment. Suncor relied on the “one-year/no franchise fee” exemption in section 5.7(g)(ii) of the Act, which provides that a disclosure document is not required where “the franchise agreement is not valid for longer than one year and  does not involve the payment of a non-refundable franchise fee.”

Suncor argued that it could rely on the exemption because TAK’s franchise agreement had an express term of one year and did not require TAK to pay any upfront fees in exchange for the right to operate the franchise.

TAK claimed that the franchise agreement was “valid” for longer than one year because (a) the agreement was signed more than one year before the end of the stated term; (b) it was allegedly extended by Suncor beyond the one year term and; (c) it contained certain clauses that made the term of the agreement extend beyond one year. Further, TAK argued that the agreement involved the payment of “non-refundable franchise fees” because it required the franchisee to pay certain royalties.

The motion for summary judgment was heard in December 2010. In a decision released December 17, 2010, the motion judge rejected all of TAK’s arguments and granted summary judgment to Suncor.

An appeal by TAK was heard in June 2011. On September 27, 2011, the Court of Appeal unanimously affirmed the motion judge’s decision, dismissing TAK’s appeal in its entirety.

Key Findings

  • While the exemption refers to “validity,” the key issue is the term of the agreement:  the period during which the franchisee is granted rights and assumes obligations with respect to the franchise. 
    • The purpose of the disclosure requirement in the Act is to protect franchisees by ensuring that they receive a disclosure document before committing to a franchise agreement. However, an exemption is provided where the period in which the franchisee will have rights and obligations under the agreement is of short enough duration that the franchisee is at minimal risk. The Act fixes this duration at one year or less. This is the time frame during which the franchisee is bound to certain rights and obligations. It is during this time frame that the franchise agreement is valid for the purposes of the exemption. TAK’s agreement only had a term of one year, and therefore, was not valid for longer than one year.
  • The fact that the agreement was signed before its stated term did not extend the “validity” of the agreement beyond one year.
    • Once signed, TAK may have sued for anticipatory breach of contract if Suncor had repudiated the agreement. However, the availability of this cause of action differs from the purpose of the exemption, which focuses on the duration of the rights and obligations under the franchise agreement. 
  • The fact that Suncor wrote to TAK before the expiry of its franchise agreement, extending the agreement upon expiry on a month-to-month basis, did not make the franchise agreement valid for longer than one year.
    • This letter simply created a new monthly agreement following the expiration of the one-year franchise agreement.
  • The “overholding” provision in the franchise agreement did not extend its validity beyond one year.
    • This section provided that if the franchisee remained in possession of the premises after the expiry of the term of the agreement and continued to pay a monthly rent, the tenancy became one of month-to-month, subject to the terms of the agreement. This section did not extend the agreement beyond one year; the agreement simply became a monthly tenancy. Further, at the commencement of the agreement, this section only created the possibility that the franchisee would become an over-holding tenant at the end of the term. This possibility did not itself make the agreement valid for longer than one year.
  • Neither the “indemnity” nor the “confidentiality” provisions, which survived the termination of the franchise agreement, extended the agreement beyond one year.
    • By definition, these sections only applied once the agreement had been terminated or expired. The survival of these provisions did not extend the agreement itself.
  • A “franchise fee” is in the nature of a fee paid for the right to become a franchisee. It does not include royalties or payments for goods or services.
    • If fees in the nature of royalties were included in the definition of “franchise fee”, there would be virtually no circumstances in which the exemption could operate. The French version of the Act, which uses the phrase “redevances de franchisage non remboursables” does not support the conclusion that the term “franchise fee” includes royalties. The Regulations, legislative history, and existing jurisprudence all support a distinction between “franchise fees” and royalties.

Lessons Going Forward

Principles Underlying Disclosure and Exemptions

This decision provides important guidance on the principles that underlie the disclosure requirement and the exemptions to that requirement. The Court of Appeal has recognized that where a franchisee does not pay any non-refundable fees for the right to become a franchisee and only commits to operate the franchise for a term of one year or less, the risk to the franchisee is limited and does not warrant a disclosure document. Franchisors who intend to rely on the one-year/no franchise fee exemption or any of the other statutory exemptions to the disclosure requirement should pay careful attention to the reasons of the motion judge and the Court of Appeal.

Summary Judgment and Class Actions

This case also serves as an example of a class action where the merits of the action could be addressed prior to certification through a motion for summary judgment, as the primary issue in dispute was one of statutory interpretation. Given the broader scope of the new summary judgment procedures under Ontario’s Rules of Civil Procedure, and the significant cost of fighting a certification motion and participating in discovery, both plaintiffs and defendants may increasingly consider summary judgment motions as a useful tool in their procedural arsenal for achieving fast and cost-effective results.

 



Pet Valu – A Franchisor’s Ability to Settle Commercial Issues with Individual Franchisees while under the Shadow of a Class Action

By  Gillian Scott

The Decision

In his June 21, 2011, decision in the 1250264 Ontario Inc. v. Pet Valu Canada Inc. class action Justice Strathy of the Ontario Superior Court of Justice denied franchisor Pet Valu Canada Inc. (Pet Valu)’s motion for a declaration that releases between it and certain of its franchisees were enforceable.

Pet Valu had entered into agreements with four of its franchisees to buy-back their franchisees (the Buy-Back Agreements and the Buy-Back Franchisees). Pet Valu also anticipated entering into at least four more such agreements in the near future. Pet Valu was under no contractual obligation to buy-back the franchises. The franchisees, for various different reasons, no longer wanted to continue their businesses and had been unable to otherwise sell them.

As part of the Buy-Back Agreements, Pet Valu sought releases from the Buy-Back Franchisees settling all commercial issues between Pet Valu and the Buy-Back Franchisees, including the Buy-Back Franchisees’ entitlement to recovery in the class action as certified by Justice Strathy in January of 2011 (the Buy-Back Releases). On this motion, counsel to Pet Valu sought a declaration from the Court that the Buy-Back Releases are enforceable. Justice Strathy refused to grant the motion.

Court’s Analysis

In this case the Court:

  • found that in the circumstances both Pet Valu and the Buy-Back Franchisees were acting in their own commercial interests by entering into the Buy-Back Agreements;
  • recognized that the request by the franchisor of a release of future litigation rights by the franchisee in such a context is common and even good business practice; and
  • recognized that the Buy-Back Franchisees:
    • had consideration for the release;
    • were aware of the class action and that they would be foregoing rights in relation to it; and
    • had been advised by legal counsel.

However, the Court ultimately decided not to rule that the Buy-Back Releases are enforceable as, among other things:

  • caution is required in allowing individual settlements with potential class members as such settlements may undermine the class action (although Strathy, J. found in this instance that there was no evidence of such an intent on the part of Pet Valu);
  • none of the Buy-Back Franchisees were before the Court on the motion;
  • the notice period had not passed so the Buy-Back Franchisees had not yet had the opportunity to opt out of the class action (and there would be no concern with an opt out franchisee entering into such a release); and
  • certain material information, namely the potential amount of damages being foregone by the Buy-Back Franchisees was not disclosed at the time of the Buy-Back Releases.

Following this decision, it appears as though a franchisor may only have a reasonable prospect of success at obtaining a release of broad litigation rights on the part of a potential class member franchisee where: i) the franchisee releasing its right has already opted out of the class action; ii) the franchisee releasing its rights attends before the Court on any hearing regarding the approval of the release; or iii) where potential damages award amounts in the class action have been assessed and disclosed by the franchisor.

Uncertainty of Potential Amounts Released

The strongest driving factor behind Justice Strathy’s ruling appears to be the fact that the amount of damages Buy-Back Franchisees might be foregoing by entering into the Buy-Back Releases was undisclosed. Strathy, J. holds that the amount each Buy-Back Franchisee is potentially foregoing is a “material fact” warranting disclosure pursuant to the Arthur Wishart (Franchise Disclosure) Act, 2000, and that disclosure of the amount might influence a decision finding the Buy-Back Releases enforceable. This is somewhat unprecedented, as it appears to require Pet Valu to make full disclosure of potential damages in a pre-discovery stage of a class action. This sets a higher standard than that generally applicable for settlement approval as it is common for proceedings, including class proceedings, to settle in the pre-discovery phase.

Interests of Buy-Back Franchisees not Represented

None of the Buy-Back Franchisees were before the Court on the motion, it was not clear that they had notice of the motion, and class counsel took the position that they could not represent the Buy-Back Franchisees as they were not yet a part of the class. It is perhaps worth considering whether it would have affected the result if the Buy-Back Franchisees had been joined as parties for the purposes of the motion.

Take-Aways for Franchisors

This case highlights the difficulties of maintaining an ongoing and mutually beneficial business relationship between franchisor and franchisee while those parties are subject to an ongoing class action. Justice Strathy’s decision in this case effectively restrains the ability of both franchisor and franchisee from acting in the normal course of their business relationship to resolve a situation in both of their best commercial interests by subordinating those interests to those of a potential future class of franchisees. There can therefore be no guarantee of certainty in settling commercial issues between a franchisor and a franchisee while under the shadow of a class action.

 



Courts Reject Technical Defences and Allow Rescission

By  Mary Paterson

In two recent decisions, the Ontario Courts have made it clear that franchisors cannot rely on technical defences to avoid the rescission remedy available in section 6(2) of the Arthur Wishart Act (Franchise Disclosure), 2000 (the Act). In both cases, the Courts permitted the plaintiffs to rescind agreements because the franchisors had not provided a disclosure document, giving short shrift to the technical defences raised by the franchisors.

In the first case, Grill It Up argued that the Act did not apply because the purported franchisee had refused to sign the draft franchise agreement (he had signed an asset purchase agreement). Rejecting this technical defence, the Court held that the transaction was in substance a franchise transaction and permitted rescission.

In the second case, Springdale Pizza argued that it met the technical requirements of sections 5(7)(a) and 8(a) of the Act and was exempt from providing a disclosure document to a prospective franchisee who purchased an existing franchise. Rejecting this defence, the Court held that the exemption is narrow and that Springdale Pizza had been sufficiently involved in the sale that it was obliged to provide a disclosure document.

As a result, franchisors must carefully consider the very real risk of a franchisee rescinding the agreement and claiming compensation if the franchisor chooses not to provide a disclosure document to a prospective franchisee, including in the resale context.

Grill It Up: The Act Applies to an Asset Purchase Transaction

In 1706228 Ontario Ltd. v. Grill It Up Holdings Inc., 2011 ONSC 2735, the Court held that the asset purchase transaction was a franchise transaction even though the prospective franchisee refused to sign the franchise agreement. In the Court’s view, the substance of the transaction trumped the technicalities.

The plaintiffs (Mr. Fang) invested money to build a Grill It Up restaurant. Mr. Fang and the defendants (Grill It Up) entered into several agreements, including an asset purchase agreement, a sub-lease, and a licence agreement permitting use of trademarks. Mr. Fang refused to sign the draft franchise agreement (as it contained more onerous financial obligations than he had agreed to), and the parties proceeded towards closing without it. Before closing, the relationship fell apart.

Mr. Fang sued for return of his deposits, out-of-pocket expenses and lost income. He argued that the transaction was a franchise transaction subject to the Act and that he was permitted to rescind the transaction because Grill It Up had not provided a disclosure document. Grill It Up argued that it was not a franchise transaction because Mr. Fang refused to sign the franchise agreement.

The Court reviewed the definition of “franchise” in section 1 of the Act and held that the transaction was a franchise, relying on the following facts:

  • the parties understood that they were entering a franchise relationship;
  • the transaction was structured like a typical franchise, including that Grill It Up entered into a head lease for the location and a sub-lease with Mr. Fang;
  • Grill It Up described the relationship as a franchise to Mr. Fang;
  • the licence agreement required Mr. Fang to pay a royalty;
  • Grill It Up provided a menu, trademark “special sauces”, and a list of designated (but perhaps not mandatory) suppliers;
  • Grill It Up granted Mr. Fang the right to sell food that was “substantially associated with” the Grill It Up trademarks and name (which is one part of the Act’s definition of “franchise”); and
  • Grill It Up offered “significant assistance” regarding store design, equipment, location, training and branding (which is another part of the Act’s definition of “franchise”).

The Court held that Mr. Fang’s refusal to sign the franchise agreement was not relevant because the right to disclosure arises before a franchise agreement is signed and the Act began to protect Mr. Fang as soon as he paid his first deposit.

Finally, the Court dismissed Grill It Up’s technical argument that Mr. Fang was not entitled to rescind the transaction because the Notice of Rescission was not delivered in accordance with section 6(3) of the Act.

Springdale Pizza: The Exemptions from Disclosure Obligations are Narrow

In 2189205 Ontario Inc. v. Springdale Pizza Depot Ltd., 2011 ONCA 467, the Court of Appeal considered a franchisor’s disclosure obligations in the franchise resale context and narrowly interpreted the exemption from such obligations. The Court held that a franchisor would only be exempt from providing a disclosure document to the purchasing franchisee if the franchisor did nothing more than merely exercise its rights to consent to the transfer.

Franchisors’ obligations to disclose are set out in section 5 of the Act. Franchisors are exempt from this obligation if (among other things) “the grant of the franchise is not effected by or through the franchisor” (paragraph 5(7)(a)(iv) of the Act). Subsection 5(8) clarifies that a grant is not effected by or through a franchisor merely because the franchisor has the right to approve the grant or because the franchise agreement contemplates a transfer fee.

In Springdale Pizza, the franchisor argued that the grant was not effected by or through it. The Court of Appeal disagreed, relying on several facts that show how limited the franchisor’s role must be if the franchisor wants to be exempt from disclosure obligations in the resale context.

First, the Court noted that Springdale Pizza admitted that “[a]ll of the parties of this action negotiated together to bring about the sale of [the vendor’s business] to [the purchaser] and for [the purchaser] to become a franchisee of Springdale as a result”. Based on existing cases, this admission supported the Court’s conclusion that Springdale Pizza was actively involved in the sale. (See MAA Diners Inc. v. 3 for 1 Pizza & Wings (Canada) Inc., 2003 CanLII 10615.)

Similarly, Springdale Pizza required the purchaser to sign an acknowledgement that the purchaser did not rely on Springdale Pizza in confirming, substantiating or reporting the sales figures of the business. This undertaking was neither signed by the vendor nor contemplated by the franchise agreement and fell within the existing cases as support for the conclusion that the franchisor was actively involved in the transaction. (See 1518628 Ontario Inc. v. Tutor Time Learning Centres, LCC, 2006 CanLII 25276.)

More problematically, the vendor’s franchise agreement said that the franchisor’s consent was conditional on the purchaser executing the then-current franchise agreement and related documents, undertaking to bring the franchise immediately into conformity with the then-current Retail Marketing Plan. Regardless, the Court held that the franchisee need only sign related documents that had been signed by the vendor. Because the vendor had not signed an undertaking of car wrapping, the franchisor’s requirement that the purchasing franchise do so, even though it was contemplated by the vendor’s franchise agreement and was necessary to bring the franchise into compliance with the then-current Retail Marketing Plan, supported the Court’s conclusion that the franchisor was actively involved in the sale.

With this restrictive approach, a Court might even conclude that a franchisor cannot require a prospective franchisee to sign a new form of franchise agreement.

Most problematically, the Court also relied on the following facts:

  • (as often happens) the purchaser contacted Springdale Pizza’s head office and it directed the purchaser to the vendor;
  • (as usually happens) the agreement of purchase and sale required the prospective franchisee to obtain Springdale Pizza’s consent and thus deal directly with Springdale Pizza; and
  • (as always happens) Springdale Pizza had detailed financial information about all franchisees. It seems that mere possession of the information was a fact that made Springdale Pizza actively involved in the sale.

The Court noted that “[i]t may be that any of these individual circumstances would not have been enough” to support the Court’s conclusion that the grant was effected through the franchisor. However, as one or more of these facts will be present in the majority of franchise transfers, franchisors must very carefully consider whether to take the risk of not providing a disclosure document.

Franchisors Must Abide by the Remedial Spirit of the Act

In both of these cases, the Courts rejected the technical defences advanced by franchisors and ordered rescission of the transactions as well as damages. These decisions are consistent with the trend of franchisee-friendly decisions as well as the remedial purpose of the Act. Franchisors should continue to take the obligation to disclose seriously and should ensure that their procedures for interacting with prospective franchisees comply with the remedial spirit driving the Courts’ interpretation of the Act.