A recent Ontario Court of Appeal decision has confirmed that only “material facts” must be included in a franchise disclosure document. Whether a fact is considered a “material fact” must be determined on a case-by-case-basis, with important implications for franchisors and franchisees alike.
Background
The Arthur Wishart Act (Franchise Disclosure), 2000 (the “Act”) requires franchisors to disclose to prospective franchisees all material facts, which are information about the franchisor or its system that would have a significant effect on the franchisee’s decision to acquire the franchise and at what price. Based on existing law (see “Fatal Flaws in Disclosure Documents”), if a franchisor fails to disclose certain facts and the court finds that such a failure amounts to fundamental deficiency, the franchisee will be able to rescind or cancel a franchise agreement within two years of signing the franchise agreement on the basis that it did not receive the disclosure document required by the Act.
Lower Court
In Caffé Demetre v. 2249027 Ontario Inc., 2014 ONSC 2133, the franchisee rescinded its franchise agreement with the franchisor, Caffé Demetre, on the basis that the disclosure document it received was fundamentally deficient. Specifically, the franchisee argued that the franchisor failed to disclose the following four “material facts”:
- At the time of the disclosure document, it was involved in litigation against a franchisor of a competitive franchise system.
- It was contemplating the implementation of a modified “Tip Out Policy” that would be unilaterally imposed on all franchisees, to their financial detriment.
- It was contemplating altering the franchisee ice cream manufacturing policy such that the owner principal would be directly responsible for preparing the ice cream.
- The franchise store would require extensive remodelling and renovations in excess of $50,000.
For items 2-4, the lower court judge concluded that since the named policies and renovations were neither contemplated nor implemented by the franchisor at the time of the disclosure document, their omission from the disclosure document could not constitute a ”material fact” that should have been disclosed.
The judge concluded that item 1, the litigation, was a material fact. However, the judge reasoned that because the litigation was not a potential liability, it was difficult to see how the knowledge of such litigation at the time of the disclosure document could have a significant effect on the price the franchisee was willing to pay for the franchise. The non-disclosure of the existing litigation therefore did not fall into the category of a fundamental deficiency that would entitle the franchisee to rescind the franchise agreement within two years of signing the franchise agreement. The franchisee appealed.
Court of Appeal
The appeal focused on whether the franchisor’s failure to disclose the existing litigation in the disclosure document was a fundamental deficiency that would entitle the franchisee to rescind the franchise agreement. Unlike the lower court, the Court of Appeal concluded that the existing litigation was not a “material fact” and the disclosure document was therefore not deficient. The Court reasoned that ongoing or prospective litigation involving a franchisor is not, by definition, a “material fact”. If it falls into the category of litigation that must disclosed under the Act, then it must be disclosed. If the litigation at issue does not fall into that category, then whether it is a “material fact” must be determined on a case-by-case basis.
This decision has important implications for franchisors and franchisees alike. Franchisors should seek experienced franchise counsel to determine what ongoing or prospective litigation should be disclosed. Similarly, franchisees or their legal counsel should seek the advice of experienced franchise counsel to determine whether the alleged non-disclosure of a material fact actually amounts to a fundamental deficiency entitling the franchisee to rescind the franchise agreement within two years of signing it, or whether it is a “material fact” in the first place.
Louis Vouloukos (905) 452-6883 lvouloukos@lawrences.com