Before a franchisor signs up a new franchisee, it must disclose information about the franchise system and business in a disclosure document. Franchise law in Ontario places strict requirements on the contents, form and timing of disclosure. Failure to provide a disclosure document as required by the Arthur Wishart Act (Franchise Disclosure) (the “Act”) can lead to devastating consequences for a franchisor – including the exercise of the franchisee’s right of rescission. The recent decision in the Ontario Court of Appeal, Mendoza v Active Tire & Auto Centre, is a prime example of the importance of properly providing a compliant disclosure document.
Rescission is the right to cancel an agreement as and from the beginning. The object of rescission is to put the parties back in the position they would have been if there was no agreement.
The Act requires a franchisor to provide disclosure to prospective franchisees. If that disclosure is deficient, the franchisee has 60 days from the date of receipt of disclosure to rescind a franchise agreement. However, if the franchisor does not provide a disclosure document, the franchisee has two years from the date of signing a franchise agreement to rescind it.
In Mendoza, the franchisee sought to rescind his franchise agreement after operating a franchised business for three months. The franchisee claimed that the disclosure document he received was deficient and sought rescission under the Act. Specifically, the franchisee claimed that disclose did not meet the following requirements of the Act:
- The disclosure certificate was not signed by two officers or directors;
- The financial statements were not in the form required;
- The required information and documents were not delivered in a single disclosure document at one time;
- The letter of credit described in the application varied from what the franchisee signed; and
- The franchisor did not disclose information underlying financial projections as required.
The Superior Court of Ontario disagreed with the franchisee and dismissed the claim. Prior to signing the franchise agreement, the franchisee met with key employees and officers of the franchisor, retained an accountant to advise on the financial forecast of the franchise, and obtained independent legal advice. The lower court acknowledged that while there were deficiencies in the disclosure document, these were not significant or misleading enough to prevent the franchisee from making an informed decision about entering the franchise agreement. This, together with the fact that the franchisee did not even read the disclosure document, led the lower court to hold that the franchisee was not entitled to rescind the franchise agreement.
The Court of Appeal rejected this line of reasoning and reversed the lower court’s decision. The franchisor argued on appeal that the franchisee did not seek rescission because of disclosure deficiencies, "…but rather, because the franchise did not do well and the individual appellant regretted his decision." The Court of Appeal found that the remedy of rescission "…turns only on the failure of the franchisor to deliver a disclosure document." The franchisee’s subjective knowledge of the franchise or the disclosure document is irrelevant to the availability of rescission.
Ultimately, the Court of Appeal held that (1) the failure to provide a disclosure document with a certificate signed by at least two officers or directors, and (2) the failure to include in the disclosure document the requisite current financial statements each constituted a material deficiency entitling a franchisee to rescind the franchise agreement, and were "…fatal to the ability of the purported disclosure document to be a disclosure document within the meaning of the Act." It was as if the franchisor had not provided disclosure at all, and the franchisee was entitled to rescind the agreement at any time up to two years after signing it.
The major takeaway from this case is clear: franchisors must provide a disclosure document that strictly complies with the requirements under the Act. If your instinct tells you this case turned on technicalities, then you need to note that technicalities matter in franchise law – an area of law that is driven by protecting franchisees.
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