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Not all forms of litigation have to be disclosed in the disclosure document

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In recent years, the franchisor's disclosure obligations and the franchisee's right to rescind as a result of the franchisor's failure to meet said obligations have been the subject of many disputes. Under section 5(4) of the Arthur Wishart Act (the "AWA") the franchisor must provide to the prospective franchisee a disclosure document which must disclose to the franchisee "all material facts". Material fact is defined in the Act to include "any information about the business, operations, capital or control of the franchisor or franchisor's associate, or about the franchise system, that would reasonably be expected to have a significant effect on the value or price of the franchise to be granted or the decision to acquire the franchise".

One of the remedies available to the franchisee is provided in S. 6(2) of the AWA, which allows the franchisee to rescind the franchise agreement without penalty within two years from entering into the franchise agreement. This right becomes available to the franchisee if the franchisor fails to provide a disclosure document. The courts have been generous in finding that the disclosure provided was deficient and therefore did not amount to disclosure at all, thus entitling the franchisee to rescind.

In its recent decision, the Court of Appeal in Caffé Demetre Franchising Corp v. 2249027 Ontario Inc., (2015 ONCA 258) found that ongoing or prospective litigation involving the franchisor is not, by definition, a material fact.

In this case, the franchisor commenced litigation again a competitor. This litigation was intended to benefit the franchisees and was commenced at the franchisees' request. The franchisee claimed, amongst other things, that failing to disclose the litigation was a material deficiency entitling them to rescind the franchise agreement pursuant to S. 6(2) of the AWA.

The Court of Appeal dismissed the claim and held that ongoing or prospective litigation involving the franchisor is not, by definition, a material fact and that not all forms of litigation must be disclosed to a prospective franchisee. Only when the litigation falls within the description contained in s. 2(5) of the regulations made under the AWA, it must be disclosed. S. 2(5) of the regulations provides that the disclosure document shall contain "a statement, including a description of details, indicating whether the franchisor, the franchisor's associate or a director, general partner or officer of the franchisor has been found liable in a civil action of misrepresentation, unfair or deceptive business practices or violating a law that regulates franchises or businesses, including a failure to provide proper disclosure to a franchisee, or if a civil action involving such allegations is pending against the person". In the case at hand, the litigation was not against the franchisor rather it was commenced by the franchisor for the benefit of the franchisees. It had no economic impact on the prospective franchisee's operations. The litigation did not involve allegations of unfair or deceptive business practices or alleged breach of franchise laws and was not based on claims of unfair or deceptive business practices. Under these circumstances, the Court of Appeal found that there was no duty on the part of the franchisor to disclose the litigation to the potential franchisee.

When the litigation does not fall under the definition of s. 5(2) of the regulation, the question of whether it is a material fact or not, will be a question of fact determined on a case-by-case basis. There can be no bright-line rule.

This case is a cautionary tale for franchisees not to assume that any deficiency in the disclosure document will automatically entitle them to rescission and damages.

For more information, please contact Chuck Merovitz at 613-563-6690 or by e-mail at chuck@mpottawa.com or Yasmin Vinograd at 613-563-6685 or by e-mail at yasmin@mpottawa.com

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