Ontario confirms test for rescission

Case turned on whether disclosure was materially deficient, not sophistication of franchisee
IN EARLY JUNE the Ontario Court of Appeal overturned a lower court’s decision to forgive a franchisor’s deficient disclosure in the sale of a franchise and deny the franchisee’s motion to rescind the agreement.

The decision in Mendoza v. Active Tire & Auto Inc. (2017 ONCA 471) confirmed that the test for rescission under the province’s franchise legislation, the Arthur Wishart Act (AWA), was whether the disclosure made to the franchisee was “materially deficient,” not the actions or sophistication of the franchisee. 

“The Court of Appeal decision was consistent with other decisions,” says Todd Greenbloom at Blaney McMurtry LLP in Toronto, who specializes in franchising and licensing. “The original [motion judge’s] decision was a detour from the way things have been going.”

The Ontario appellate court decision confirmed that the AWA is intended to protect franchisees by imposing requirements on franchisors: if a disclosure document is materially deficient then no disclosure has been made, and rescission is available to the franchisee.

“It’s not a surprising result, but I think it’s important because it puts to rest any notion that a franchisee could be found to be sufficiently informed, having been provided with a materially deficient disclosure document,” says Jennifer Dolman at Osler, Hoskin & Harcourt LLP in Toronto, who works on the franchisor side. “That’s the end of the matter in terms of liability.”

In Mendoza, the appellants had bought a franchise from Active Tire & Auto Inc. in June 2015. However, the individual appellant, who was an experienced businessman, was not able to operate the business successfully and decided to rescind the agreement three months after purchase. The appellants sought rescission under s. 6(2) of the Act which provides that “[a] franchisee may rescind the franchise agreement, without penalty or obligation, no later than two years after entering into the franchise agreement if the franchisor never provided the disclosure document.”

Before the motion judge, the appellants focused on five deficiencies in the disclosure document provided by Active Tire: (1) the fact that the disclosure certificate was signed by only one officer or director and not two, as required by s. 7(2)(c) of Ontario Regulation 581/00; (2) the failure to provide audited financial statements as required by s. 5(4)(b) of the AWA and s. 3(1) of the regulation; (3) the failure to provide the disclosure document at one time as required by s. 5(3) of the Act; (4) the fact that the letter of credit provided did not conform with the disclosure document; and (5) failure to disclose the required assumptions and information as part of the financial projections. 

The franchisor called the appellant a sophisticate who had more than enough information to make an informed decision.

Yet one of the reasons disclosure documents exist is because of “the huge inequity and bargaining position between the franchisee and franchisor,” says Greenbloom. “The franchisor knows more.” In Mendoza, he adds, the motion judge concluded that, as long as there was sufficient information with which the franchisee could make an informed decision, “that’s all that really matters.”

Ontario’s appellate court did not agree. “The scheme of the Act is to impose a number of requirements on franchisors to fully disclose the type of financial and other information a prospective franchisee would normally need in order to decide whether to become a franchisee,” Justice K. Feldman of the Court of Appeal for Ontario wrote in her decision, in finding in the appellants’ favour. “It then provides remedies to the franchisee where the franchisor does not meet the statutory obligations … ”

Dolman says she impresses on US clients thinking of expanding into Canada the importance of providing a disclosure document that is AWA-compliant; any mistakes can be “fatal,” she says, and the courts have awarded “significant damages” to franchisees who received disclosure documents with material deficiencies and decided to terminate the franchise agreement.

But in Mendoza, she adds, the court made clear that proper disclosure documentation is essential. “The franchisee’s right should not be diminished by their sophistication or other subjective factors.”