::this post ID is 12034::::in categories of ..Legal Corner..::

Ontario’s Court of Appeal decision gives insight on disclosure obligations

Businessman Writing A Letter Or SigningThe Ontario Court of Appeal recently made a final decision in a case where Toronto Caffé Demetre co-franchisees attempted to rescind their franchise agreement with the franchisor.

According to Marc Kestenberg, a partner at Norton Rose Fullbright LLP, the appeal focused on the franchisor’s disclosure obligations under Ontario’s Arthur Wishart (Franchise Disclosure, 2000) Act. The issue was whether the franchisor’s failure to disclose litigation constituted a material deficiency and entitled the appellant co-franchisees to a rescission of their franchise agreement.

The co-franchisees entered the franchise agreement on July 22, 2011. On the same day, the franchisor commenced an action against a former franchisee who had been operating a competing business close to the appellant co-franchisees’ business location on Dufferin Street. By September 2011, the co-franchisees knew of the ongoing litigation, but did not show concern.

In 2012, the relationship between the co-franchisees and the franchisor began to diminish when the co-franchisees failed to undertake renovations and produce financial records upon the franchisor’s request. On July 19, 2013, they served a notice of rescission of the franchise agreement to the franchisor. Then, on August 2, the franchisor served them with a notice of termination, claiming damages due to breach of contract.

In the defence statement, as Kestenberg explains, the co-franchisees claimed the franchise agreement was validly rescinded on the basis the franchisor had not disclosed the ongoing litigation, among other things. The franchisor then responded with a motion for partial summary judgement and sought a declaration the co-franchisees were not entitled to rescission under the Act.

The motion judge ruled in favour of the franchisor, dismissed the co-franchisees’ claim for rescission and concluded it was unlikely the ongoing litigation would have affected the price paid by the co-franchisees for their franchise because litigation was not a potential liability, but a proactive measure to benefit prospective franchisees. Therefore, it was not a material deficiency and franchisees were not entitled to rescission.

On appeal, the co-franchisees argued it was unreasonable for the motion judge to conclude the ongoing litigation would not affect their decision to enter the agreement. They said the former franchisee’s competing business was a potential threat to their franchise business, so the litigation should have been disclosed.

The Court of Appeal ruled that all litigation involving a franchisor constitutes a material fact and must be disclosed. Although Regulation 581/00 under the Act identifies a category of litigation that must be disclosed (i.e. litigation against the franchisor), the court said this should not be interpreted as a conclusion that it is the only type of legal proceeding needing to be disclosed.

The court found the ongoing litigation was undertaken at the request of and for the benefit of the co-franchisees, which did not constitute a potential liability and would not have negatively affected the franchise business. Therefore, this did not deprive the co-franchisees of the opportunity to make a properly informed decision about entering the agreement. Overall, the court ruled the ongoing litigation was not a material fact and the franchisor’s disclosure documents were not deficient.

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