March 29, 2021

No such thing as “one size fits all” disclosure: the Ontario court provides guidance on the disclosure of non-prescribed material facts

The Freshly Squeezed[1] case contains an important reminder for franchisors:  every franchise disclosure document must be tailored to the specific franchise opportunity for which disclosure is being provided.

It is well-known that franchisors must disclose all material information (“materials facts”) relating to the grant of a new franchise, or the renewal of an existing franchise.  Material information will, of course, include information that is prescribed by the Wishart Act[2] and the associated Regulation.[3] However, it will also include any information that would reasonably be expected to have a significant effect on the decision to acquire the franchise, or information that will have a significant effect on the value or price of the franchise, whether or not that information is expressly prescribed.  Failure to disclose all material facts creates a risk that a franchisee can later rescind its franchise agreements and look to the franchisor for significant compensation.

Facts

In the Freshly Squeezed case, Freshly Squeezed Franchise Juice Corporation (the “Franchisor”) took the position that it had provided a “disclosure document” to the principal of the franchisee, 2611707 Ontario Inc. (the “Franchisee”), prior to the Franchisee entering into any franchise agreements.

The Franchisee’s franchise business was to be located in the “RioCan Food Hall” of Mount Sinai hospital in Toronto.  This was going to be the first time that a “Freshly Squeezed” franchise would be located outside of a shopping mall setting.

The Franchisee entered into a franchise agreement in January 2018, and began operating its “Freshly Squeezed” franchise business in March 2018.  In the fall of 2018, the Franchisee delivered a notice of rescission pursuant to Section 6(2) of the Wishart Act, on the basis that it had not received a disclosure document.  The Franchisor took the position that disclosure had been provided.  The Franchisee later commenced an application seeking rescission and compensation.

The Court ultimately found that the Franchisor had failed to disclose certain material facts to the Franchisee, including facts that were “material” but not specifically prescribed by the Wishart Act and the Regulation.  The Court granted the Franchisee’s rescission application, and ordered the Franchisor and its principal to pay over $300,000 in statutory compensation.

Comments on rescission, generally

In reaching her decision, the application judge relied on the Ontario Court of Appeal’s decision in Raibex.[4]

At the application hearing, the Franchisor had argued that Raibex “changed the law”, and that now franchisees seeking rescission must prove the alleged non-disclosure actually impacted their ability to make an informed investment decision. The application judge rejected this submission.

After carefully reviewing Raibex, and earlier Ontario Court of Appeal decisions, the application judge found the test for determining whether an alleged disclosure deficiency entitled a franchisee to rescind remained objective.  Accordingly, she confirmed that rescinding franchisees need not lead evidence that, in their own specific case, their ability to make an informed investment decision was actually impaired by the alleged non-disclosure.

However, the application judge found that, per Raibex, this objective analysis does not occur in a vacuum.  Rather, the Court will consider the particular facts and circumstances of the underlying grant of franchise.  In so finding, she confirmed that the key question on a rescission is whether the subject deficiency is so serious that it deprived the franchisee of an opportunity to make an informed investment decision (about whether or not to purchase the franchise business) in the particular circumstances of the case.

Findings in the case[5]

Financial Statements.  The alleged disclosure document in issue in this case included financial statements, which were prepared to a “review engagement” standard.  However, certain line items in the financial statements referred to the notes of the financial statements, and these notes were not included in the disclosure document.

The application judge recognized previous Ontario Court of Appeal case law confirming that disclosure of a franchisor’s financial statements is a “foundational part of disclosure”, and that failure to provide compliant financial statements will generally result in a finding of non-disclosure.  She found the Franchisor’s failure to include the notes to the financial statements meant that the Franchisor had failed to comply with the Regulation, and to fully disclose the required financial information.  Incomplete financial statements deprived the Franchisee of information that was necessary for it to assess the Franchisor’s financial status and provided the basis for the Court’s first finding of material non-disclosure.

Site-specific disclosure.  At the time the disclosure document was provided, the head lease had not been entered into, and so could not be included with the disclosure document.  The disclosure document did not disclose that no head lease was in place.  However, the Court found this non-disclosure was mitigated by the fact that the Franchisee was aware of this fact.

Also at the time of disclosure, the Franchisor had signed, and delivered to the landlord, a negotiated agreement to lease.  This agreement to lease had not been countersigned by the landlord or returned to the Franchisor at the time of disclosure.

The agreement to lease contained a provision that, in certain circumstances, the landlord could terminate the lease at any time on three months’ notice, without compensation.  This termination provision was included in the final head lease.  Pursuant to the franchise agreement, the Franchisee was bound by the terms of the head lease.

The disclosure document did not reveal that an agreement to lease had been negotiated.  The disclosure document also did not contain a summary of the material terms of the agreement to lease, including the termination provision, and did not append a copy of the agreement to lease.

The Franchisee took the position that the termination clause was material because, if exercised, it could adversely affect its expected return on investment in the franchise business.

The Franchisee was not involved in any lease negotiations and had no ability to cancel either the franchise agreement or sublease, as did the franchisee in the Raibex case.

In all the circumstances, the Court found that the failure to disclose the agreement to lease, or to at least provide a summary of its material terms, was a material fact that ought to have been disclosed pursuance to Section 5(4)(a) of the Wishart Act.  This combined with the lack of any “contractual comfort” to the Franchisee that would permit it to exit the franchise relationship if the lease terms were not to its satisfaction, resulted in the Court’s second finding of material non-disclosure.

Entry into a new market.  As noted above, the Franchisee’s franchise business was to be the first “Freshly Squeezed” franchise in a “non-mall” retail location.  This fact was not disclosed to the Franchisee in the disclosure document, or otherwise.

Prior to entering into the franchise agreement, the Franchisee had visited several operating “Freshly Squeezed” franchise businesses.  The disclosure document contained a list of all currently operating “Freshly Squeezed” locations, which the Franchisee had telephoned.  At the application hearing, the Franchisor argued that this list provided the raw data from which the Franchisee could have “extrapolated” the fact that its unit was to be the first in a non-mall location.

The Court rejected this argument.  It found that the fact that this was to be the first non-mall location was a material fact that ought to have been explicitly disclosed pursuant to Section 5(4)(a) of the Wishart Act.  The Court noted that there was “no track record for the success of this franchise business in non-mall settings and that, in and of itself, could pose a risk to the financial viability of this particular venture.”  This was the basis for the Court’s third finding of material non-disclosure.

Important lessons for franchisors

The Freshly Squeezed case serves as an important reminder to franchisors that disclosure should not be approached as a rote or mechanical exercise.  There is no standard disclosure “template”.  The unique qualities of the specific unit to be granted, and the features and characteristics of the franchise system, need to be considered in determining what information must be disclosed relating to each franchise opportunity.  What facts are “material”, and therefore required to be disclosed, may vary with each grant of franchise.  A disclosure document that is adequate for one franchise opportunity may be materially deficient in respect to another.

In addition, the Court will look to all the circumstances of the underlying grant of franchise in assessing whether or not the disclosure standard has been met.

Failing to properly disclose a prospective franchisee can be a costly mistake.  Franchisors are well-advised to seek the advice of experienced franchise counsel to assist with the disclosure process.  Competent counsel should carefully review information provided by the franchisor, question information that appears to be inaccurate, and identify any apparent information gaps to assist in ensuring that all material facts are included in each disclosure document.

 

Sotos LLP acted as counsel to the applicants in this matter.

Adrienne Boudreau is a partner with Sotos LLP in Toronto, home to Canada’s largest group of franchise lawyers.  She provides counsel to many franchised businesses, for both franchisors and franchisees, and has extensive experience litigating franchise rescission cases.


[1] 2611707 Ontario Inc., et al v. Freshly Squeezed Franchise Juice Corporation, et al., 2021 ONSC 2323.
[2] Arthur Wishart Act (Franchise Disclosure), 2000, S.O. 2000, c. 3.
[3] O. Reg. 581/00.
[4] Raibex Canada Ltd. v. ASWR Franchising Corp., 2018 ONCA 62.
[5] Certain of the application judge’s findings were the product of a unique, evidentiary agreement, to which the parties agreed at the beginning of the application hearing, in order to determine the matters at issue by way of application (as opposed to by way of trial).  This bulletin will therefore consider only those findings made that were not impacted by this unique agreement.