Historically, when considering whether or not to open a franchise, a potential franchisee would have only the information provided by the franchisor company to rely on. Without any regulatory oversight, franchisors would often only disclose incomplete, or sometimes even inaccurate information, and due to their very limited bargaining power, most franchisees would often have no choice but to rely on this information, only to find out too late that things are not what they seemed and that the new franchise is not as profitable as they had been led to believe.

It is in this context that the Arthur Wishart Act (Franchise Disclosure) 2000, S.O. 2000, c.3 (the “Act”) came into force. The key thrust of the Act is that it requires franchisors to disclose very detailed and specific information to each potential franchisee. This includes all material facts about the business, including any information that would reasonably be expected to have a significant effect on the value the franchise or the decision to acquire it (for a more thorough explanation of these requirements see Hugues Boisvert’s very informative article on the subject here).

Recent Decision: Mendoza v. Active Tire

As with any piece of legislation, the Act is being continuously refined by the courts based on the various fact scenarios that come before them. A recent example of this is the case of Mendoza v. Active Tire[1]. In that case, the franchisee purchased an Active Tire franchise in June of 2015. Between the beginning of negotiations in March of 2015 and the purchase, the franchisor claimed to have provided the franchisee with the information required under the Act.

Soon after the purchase it became clear that the business was not successful and the franchisee decided to rescind the franchise agreement. There are a number of circumstances that allow a franchisee to rescind a franchise agreement and walk away without any penalty. The one claimed by the franchisee was that if the franchisor never provided the disclosure document, the franchisee may rescind the agreement at any time within the first 2 years of entering into it. Previous decisions have expanded this rule such that where a disclosure document is “materially deficient”, then the franchisor is deemed to have not made any disclosure at all.

At trial the court found that there were two principal deficiencies in the disclosure made by the franchisor. The first was the fact that the disclosure certificate was not properly signed by the franchisor (the Act requires that two directors/officers sign the certificate; in this case only one had signed); and the second was that the financial statements provided to the franchisee were for an earlier fiscal year than the Act allows, and were provided more than two weeks after the end of the statutory grace period that would have permitted them to be used.

Despite the judge’s finding that the franchisor’s disclosure did not comply with the requirements, he maintained that these failures were not material enough to find that no disclosure document had been provided. As a result, the franchisee was not entitled to rescind the agreement, and the court found in favour of the franchisor. The decision was appealed to the Ontario Court of Appeal.

Analysis on Appeal

In its analysis, the court of appeal agreed with the trial judge that the main issues with the disclosure related to the missing signature and the out of date financial statements. However, the Court of Appeal found that these deficiencies were material, and as such were sufficient to substantiate the finding that the disclosure document had not been provided.

With respect to the missing signature the court found that this was material because the requirement that two directors or officers sign the document is not simply related to ensuring the certificate is properly signed, it also indirectly imposes legal liability on the directors or officers signing it. This gives the franchisee a right to sue the signing parties if there are any issues with the information disclosed. According to the Court of Appeal this is an important protection granted to the franchisee, and denying that protection is a material omission.

With respect to the financial statements, the court found that financial statements are “clearly an extremely significant component of the information a prospective franchisee requires in order to assess the viability of the franchisor’s franchise operations”. The Act sets out clear and specific rules regarding the timing in which financial statements of previous years can be provided, and in this case, the franchisor simply did not comply with those rules. Given the importance of financial statements in the assessment of a potential franchise opportunity, the court found that this failure to comply was clearly material.

Effect of the Decision

Present throughout the Court of Appeal’s decision is the concept that the purpose of the Act is to protect franchisees, and that any derivation from that, particularly where such a derivation infringes on the rights of a franchisee or on information that is important to a franchisee when assessing a franchise opportunity, will not be permitted.

As the Court of Appeal noted when discussing the financial statements requirements, to accept the arguments of the franchisor in this case, would require the court to acknowledge that a franchisor is free to ignore certain requirements under the Act, and accordingly that a franchisor in unable to rely on the protections that Act provides.

Fortunately, the Court of Appeal did not accept this proposition, and instead opted to reinforce the protections that the Act provides to franchisees. Franchisors should take note of this decision, as it is a clear signal from the Court that unless they are able to meet the strict requirements imposed by the Act, they should not be engaging potential franchisees at all, lest they risk having the resulting agreements rescinded by the courts.

[1] 2017 ONCA 471.