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Q&A with Frank Zaid: Location information in the disclosure document

Rescession rights allow the franchisee to cancel the franchise agreement under certain circumstances.

Clarifying rescission rights
In its decision, the Court of Appeal clarified the distinction between rescission for deficient disclosure, which must be exercised within 60 days of receipt of a disclosure document, and rescission for failure to provide a disclosure document, which can be exercised up to two years after signing the franchise agreement.

Previous inconsistent court decisions have considered the extent to which a deficient disclosure document can be considered equivalent to no disclosure at all, thus allowing rescission for up to two years. In this case, for a disclosure document to amount to no disclosure, the Court of Appeal stated the franchisee must effectively be deprived of the opportunity to make an informed investment decision to acquire the franchise in the first place. The court stated this determination must be made with reference to the terms of the franchise agreement and all relevant surrounding circumstances of the granting of the franchise.

The Court of Appeal found the lower court’s failure to consider the terms of the franchise agreement, specifically its location selection provisions, amounted to an error of law. The facts of the case were particularly relevant, in that all parties were aware the franchise location had not yet been selected at the time the franchise agreement was signed; and the agreement required the parties to use their “reasonable best efforts” in selecting a location.

As the court put it, this best efforts clause “contemplated the franchisee’s active participation in the selection of the premises to which the head lease would apply and constrained the franchisor’s ability to enter a lease without considering the franchisee’s legitimate interests.”

If the franchisee did not want to accept the lease, there was an option to reject the location, seek another location or terminate the agreement and obtain a refund of the initial franchise fee. These contractual provisions were sufficient to negate the franchisee’s claim suggesting non-disclosure of the head lease constituted failure to disclose and thus allowed the franchisee to rescind for up to two years.

With respect to the disclosure of development costs, the court found the cost estimates in the disclosure document for a shell restaurant were sufficient to put the franchisee on notice of the costs and risks associated with a conversion restaurant. Specifically, the court highlighted a strong warning within the disclosure document that conversion costs could vary greatly, depending on location, and franchisees should maintain a significant contingency reserve.

Also, given the wide variations in costs for previous franchise conversions, the court held disclosing a separate estimate based on those costs would not have improved the franchisee’s ability to make an informed investment decision. The shell estimate, as disclosed, provided a useful reference point and an accurate reflection of the franchisee’s actual costs.

Some franchise locations are newly constructed, while others convert existing premises formerly occupied by other businesses.

Significant implications
This decision is important to both franchisors and franchisees, in that it confirms the Wishart Act does not impose a requirement on when a franchisor may provide disclosure, other than the statutory requirement for it to be provided at least 14 days before the signing of the franchise agreement or the payment of consideration by the prospective franchisee. Rather, Ontario’s legislation states what information must be disclosed. The decision suggests the obligation to disclose does not extend to material facts that are not known or do not exist at the time of the franchise agreement’s signing.

As in this case, if the determination of a location is postponed until after the signing of the franchise agreement, it is sufficient for the franchisor to disclose the details of the procedure for determining the location, together with an estimate of the expected costs of leasing and developing the franchise. This finding is commercially sensible and reflects the typical arrangements of franchisors operating in Ontario.

The Court of Appeal emphasized the important legislative difference between the 60-day and two-year rescission remedies and warned against frustrating clear legislative intent by failing to distinguish between the two remedies. The court stated rescission is an “extraordinary remedy” and “imperfect disclosure does not necessarily stand in the same position” as no disclosure, the latter being found only where the franchisee has been effectively deprived of the opportunity to make an informed investment decision.

As a result of this case, lower courts will likely act more carefully in the future when considering the relevant facts before finding “material deficiencies” that would entitle a franchisee to the two-year rescission remedy when the 60-day remedy should apply. Prospective franchisees, meanwhile, should ensure they have whatever information is available as to the location selection process if a disclosure document is provided before the actual location
is known.

Frank Zaid practised franchise law for 40 years and has advised franchise systems and appeared as an expert witness in franchise disputes. Today, he is a franchise mediator, arbitrator and private franchise system ombudsman with Alternative Dispute Resolution (ADR) Chambers in Toronto; operates his own business, Frank Zaid FRANlegal Support Services; and is a principal with Total Franchise Solutions, a consulting firm. For more information, contact him at (416) 322-8300 or via e-mail at fzaid@frankzaid.com.

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