In 2337310 Ontario Inc. v. 2264145 Ontario Inc. (DeliMark), the Ontario Superior Court of Justice concluded that the head lease for the franchisee’s particular premises ought to have been disclosed prior to the franchise agreement being executed. This is not a surprising result as it is consistent with prior cases and with recent judicial trends requiring customization of the disclosure document for a particular site. The case is important, however, as it confirms the acceptability of using a statement of material change to disclose material facts that did not exist at the time of initial disclosure.
Pursuant to Section 5(1) of the Arthur Wishart Act (Franchise Disclosure), 2000 (Wishart Act), the franchisor must provide a franchise disclosure document to a prospective franchisee not less than 14 days before the earlier of: (a) the signing by the prospective franchisee of the franchise agreement or any other agreement relating to the franchise; and (b) the payment of any consideration by the prospective franchisee to the franchisor or the franchisor’s associate relating to the franchise. The disclosure document must contain all “material facts,” including prescribed facts, as well as copies of all proposed franchise agreements and other agreements relating to the franchise to be signed by the prospective franchisee. The disclosure document must be one document, delivered at one time.
In addition, pursuant to Section 5(5), the franchisor must provide the prospective franchisee with a written statement of any “material change” as soon as practicable after the change occurs and before the earlier of: (a) the signing of the franchise agreement or any other agreement relating to the franchise; and (b) the payment of any consideration by the prospective franchisee to the franchisor or the franchisor’s associate relating to the franchise. A material change is defined similarly to a “material fact,” but is limited to information that would have a “significant adverse effect” on the candidate’s decision to acquire the franchise or on the value or price of the franchise to be granted.
In response to judicial trends requiring disclosure of site-specific information and other material facts unique to the particular franchise being granted, it has become common practice for franchisors to use a statement of material change to meet their obligation to provide customized information. This practice has developed as an alternative to the otherwise impractical approach of having to provide an updated and customized disclosure document to the candidate each time a new material fact becomes known or there is an update to material facts previously disclosed to the candidate. The DeliMark case is important as it confirms the acceptability of using a statement of material change to disclose material facts that did not exist at the time of initial disclosure.
In the DeliMark case, the plaintiff franchisee acquired a DeliMark Café from the defendant corporations who were the franchisors. In late 2011 or early 2012, the franchisee candidate was shown two prospective DeliMark Café locations and ultimately chose one of the two locations. In January 2012, when the disclosure document was delivered to the franchisee, there was no lease in existence with respect to the proposed franchise location. In fact, the lease was not executed until March 29, 2012. The franchise agreement and a sublease were signed by the parties in September 2012. The head lease was never disclosed to the plaintiff franchisee.
In March 2013, the plaintiff franchisee sought rescission of the franchise agreement pursuant to Section 6(2) of the Wishart Act. The threshold issue before the Court was whether the franchisor had met its statutory disclosure obligations under the Wishart Act. The Court concluded that the proposed sublease was an “agreement related to the franchise” and, accordingly, a copy of the sublease as well as related lease costs ought to have been disclosed.
The Court was aware of the fact that there was no lease in existence when the initial disclosure document was provided in January 2012. The defendant argued that a franchisor cannot be expected to disclose information that does not yet exist. Despite this time frame, Justice Stinson rejected the defendant’s reasoning that the non-existence of the lease at the time of initial disclosure was a sufficient reason for its non-disclosure:
In my view, in the context of franchise disclosure requirements, it is no answer for a franchisor to explain non-compliance on the basis that a document or information did not exist or was unavailable at the time the disclosure statement was prepared. To accept that submission, would be to create a potentially large lacuna in a disclosure system: it would be easy for a franchisor to pare down its disclosure obligations on the basis that certain material or information was simply not available at the time the disclosure statement was prepared; this excuse could be used to respond to a broad range of complaints about non-disclosure. I therefore reject this approach.
Pursuant to this line of reasoning, Justice Stinson went on to say that:
“[...]the correct approach [...] is to impose on the franchisor an obligation to provide an updated disclosure statement (or, at the very least, a written statement of material change) when additional material information or documents become available or come into existence. This is precisely what is contemplated by s.5(5) of the Wishart Act. In other words, the franchisor must update the disclosure statement so that the franchisee has current information upon which to base its decision whether to exercise its right of rescission.” [Emphasis added]
The Court held that the disclosure document was materially deficient as it failed to include a copy of the head lease or sublease and it failed to include an estimate of lease costs for the particular location. Justice Stinson held that “[o]nce the head lease was signed and the sublease was put into final form, the franchisor had the opportunity and obligation to disclose those documents and the information they contained, as part of a written statement of material change, but it failed to do so.”
Given the DeliMark decision, franchisors remain well-advised to provide prospective franchisees with site-specific information, such as a copy of the head lease, form of sublease and related lease costs. Franchisors can take comfort from this decision that where this site-specific information is not known at the time of initial disclosure but becomes known prior to the parties entering into the franchise agreement, a franchisor can meet its disclosure obligations by providing this information through the issuance of a statement of material change.
Part of the October 2014 - Franchise Review