The Proper Use of Releases to Defeat Franchisee Claims

A recent franchise decision from the Ontario Superior Court of Justice has helped clarify the scope of allowable releases in the franchise context and the exception of the non-waiver provision contained in section 11 of the Arthur Wishart Act.  The decision also touched on several other important disclosure topics.

Facts

The decision, New Vision Renaissance MX Ltd. v. The Symposium Cafe Inc., 2020 ONSC 1119, dealt with the purchase of a Symposium Cafe franchise.  The prospective franchisee first received an FDD in September, 2014.  It received an updated FDD in December, 2014.

Following the delivery of the December FDD but prior to the signing of the franchise agreement, the franchisor provided the prospective franchisee with an updated form of franchise agreement, sublease and a copy of the Offer to Lease for the proposed location.

The franchisee signed the Franchise Agreement on February 23, 2015. At the same time, it also signed an agreement of purchase & sale to purchase the assets from the franchisor, a development agreement and a sublease with an affiliate of the franchisor.

The APS was scheduled to close on June 26, 2015.  Shortly before closing, the franchisee advised that it did not have the necessary financing to close the transaction and would be unable to close the transaction.  The franchisor and franchisee entered into negotiations to resolve this dispute, which resulted in the principal of the franchisor loaning the franchisee the funds to close the transaction.  On June 26, 2015, the parties signed an agreement amending the franchise agreement (the “June Amending Agreement”) which addressed the loan to the franchisee.  The June Amending Agreement also contained a release of all claims existing up to the date of its execution.

The franchise opened for business on June 27, 2015.

On May 13, 2016, the franchisee delivered a notice of rescission for several alleged deficiencies, including that the certificate did not contain the signature of any directors or officers of the franchisor.

Issues

The first issue the court had to decide as a threshold issue was whether the release given in the June Amending Agreement was valid.  The franchisor argued that the release was valid under what has come to be known as the “Tutor Time exception” because it was given: (i) in the settlement of a dispute, (ii) with knowledge of the facts that were relied upon by the franchisee in support of its statutory right of rescission, and (iii) with the benefit of legal advice.

The franchisee argued the Tutor Time exception did not apply and that the release was void under section 11 of the Wishart Act.

In terms of the first requirement under the Tutor Time exception, the franchisee argued that the release had to be in relation to the dispute being settled. As such, the franchisee argued that the release should be limited to the disclosure obligations of the franchisor associated with the June Amending Agreement which resolved the dispute.  The court disagreed and found that there was a dispute over whether the franchisee could close the APS, which dispute was resolved through the provision of a loan to the franchisee. The court held that it would be inequitable for the franchisee to resile from the agreement to release all existing statutory disclosure claims and rely on section 11 after having secured the benefit of the loan and their ability to open up the location without paying funds due on closing.

In terms of the second requirement under the Tutor Time exception, the court found that it is not the subjective knowledge of the franchisee that is required. Rather, what matters is whether the facts and circumstances underlying the rescission claim were known or knowable to the franchisee at the time they signed the release. Since the franchisee was in a position to assert its rescission right prior to signing the June Amending Agreement and the release was specific in identifying the statutory claims that were being released, including the very rescission claim being asserted in the action, the franchisee was able to release the rescission right.

Lastly, in terms of the third requirement under the Tutor Time exception, the court disagreed with the franchisee’s claim that the release had to be supported by a certificate of independent legal advice. Rather, the evidence was that the franchisee had legal advice throughout, and this was acknowledged in the June Amending Agreement even without a certificate of ILA.

Although the court found the release was a complete defence to the rescission claim (and all other claims relating to facts prior to the June Amending Agreement), the court still addressed the alleged disclosure deficiencies in the disclosure document given to the franchisee. This included addressing: (i) the validity of the certificate contained in the FDD; and (ii) the piecemeal disclosure received by the franchisee.

The court found that the certificate only contained the signature and title of the franchisor’s broker, who was not an officer and director of the franchisor.  The franchisor argued that the broker signed the certificate as agent for its two officers and directors, but the court rejected that argument as there was no evidence of any agency agreement and the broker was not signing “per” the officers and directors.  As there was no certificate signed by the officers and directors of the franchisor, the court held that this was a material deficiency which was fatal to the ability of the December FDD to be a disclosure document as mandated. But for the release, the court found that the defective certificate on its own was grounds for the two-year rescission remedy under 6(2) under the Wishart Act.

With respect to the franchisee’s argument that it was provided piecemeal disclosure since it received further drafts of the franchise agreement, its schedules and the Offer to Lease after the FDD was delivered, the court found that in order for this piecemeal disclosure to invalidate the FDD, the franchisee had to demonstrate that it interfered with its ability to make an informed investment decision, which it failed to do.  As such, the piecemeal disclosure was not fatal to the FDD.

The court also found that the requirement to prove that alleged defective disclosure interfered with the ability to make an informed investment decision also applied to other alleged deficiencies such as the requirement to provide all materials facts, the requirement to provide accurate, clear and concise disclosure, and the requirement to provide a list of the franchisee’s costs associated with the establishment of the franchise.

In any event, the court found that even if these deficiencies existed, they were all released in the June Amending Agreement.

Lastly, the court considered whether one of the two principals of the franchisor was a “franchisor’s associate” within the meaning of the Wishart Act.  The court found that although the principal controlled the franchisor, the principal had virtually no contact with the franchisee and only attended a single meeting with the franchisee prior to their execution of the franchise agreements.  This was insufficient to find that the principal was involved in the grant of the franchise in order to be found to be a “franchisor’s associate”.

In the end, the release signed by the franchisee was a complete bar to its claims that were known or knowable at the time the release was given and accordingly, the improper rescission by the franchisee was found to be a repudiation of the franchise agreement.  The Symposium case highlights the importance for franchisors of ensuring that releases given in the franchise context are specific, and only address past or present claims and not future claims. Had the release required by the franchisor overstepped its boundaries or purported to release more than what was available to be released, the result for the franchisor may have been very different and it could have been staring at sizable rescission damages.  Instead, given the validity of the release, it was the franchisee that was liable for the franchisor’s damages for the wrongful repudiation of the franchise agreement.  Franchisors should also be aware of the strict certificate requirements since a defective certificate, on its own, can invalidate an otherwise pristine FDD.

Sotos LLP was counsel to the franchisor in this action.