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The Objective Approach to Rescission in Franchise Disclosure Cases - Mendoza v Active Tire & Auto Centre Inc.

Purchasing a franchise is a major business decision. The Arthur Wishart Act (Franchise Disclosure) ("the AWA") recognizes this fact and seeks to assist prospective franchisees by imposing strict financial and other disclosure requirements on franchisors. The legislation is aimed at ensuring that franchisees have sufficient information to decide whether or not they wish to enter into a franchise purchase transaction. If a franchisor fails to abide by the disclosure requirements contained in the AWA, then the franchisee may elect to "rescind" the franchise agreement altogether. Depending on the circumstances, the franchisee may also be entitled to damages.

In a recent decision, Mendoza v Active Tire & Auto Centre, the Ontario Court of Appeal clarified the approach that is to be taken by courts when determining whether or not to grant rescission to a franchisee under section 6(2) of the Arthur Wishart Act (Franchise Disclosure).

Section 6(2) states 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."

Specifically, the Court of Appeal confirmed that "where there are a number of material deficiencies, the purported disclosure document is not a disclosure document within the meaning of the Act, and rescission under s. 6(2) is available."

In Mendoza, the franchisee sought rescission of the franchise agreement as a result of 5 alleged deficiencies in the disclosure document:

1) The franchisor failed to have the disclosure certificate signed by two officers and directors of the franchisor. Instead, the certificate was signed by only one.

2) The financial statements provided by the franchisor did not contain the level of detail required by the AWA.

3) The franchisor failed to deliver all of the requisite documents at one time in accordance with section 5(3) of the AWA. Although all required documents were eventually received, they were all delivered separately.

4) The terms of the letter of credit signed by the parties did not conform to the disclosure document.

5) The franchisor failed to disclose the relevant assumptions and information underlying the financial projections provided.

[1] 2017 ONCA 471 [Mendoza]. 

This case came to the Court of Appeal after the motion judge in the court below diverged from prior case law and held that even though the disclosure in this case was deficient, the particular deficiencies were not "significant or misleading." Instead of upholding the strict requirements of the AWA, the court below applied a more subjective approach and considered whether the franchisee was able to make an "informed decision" based on the disclosure provided and the surrounding circumstances. For example, in applying this approach, the motion judge discounted the franchisor's failure to provide two signatures (deficiency #1 noted above) due to the fact that the franchisee had "met most of the directors and had information about their backgrounds." Additionally, the motion judge accepted the franchisor's argument that the contents of the disclosure document must not have been of importance to the franchisee because he did not personally read it in its entirety.

At the Court of Appeal, this approach was explicitly denounced.

Instead of approving the franchisor-friendly and subjective approach employed by the court below, the Court of Appeal stated the following at paragraph 26 of its decision:

"The Act imposes significant disclosure obligations on franchisors for the benefit of franchisees. It does not make the rescission remedy conditional on the approach taken by a particular franchisee to the disclosed material. This is consonant with the intent of the Act, which is to ensure that franchisors who wish to enter into franchise agreements with franchisees must consistently provide the required documentation to every proposed franchisee. Their obligations do not change depending on the actions or reactions of a particular franchisee. Nor are those obligations diminished when a franchisee does not study the contents of the disclosure document. Franchisees are entitled to rely on its contents and the ability to later verify what they believed and understood when they decided to proceed with the franchise."

As a result of this decision, the Court of Appeal has brought the law back in line with its previous decisions and has confirmed that the relevant test in such cases is an objective one.

This case serves as a reminder that the AWA acts as a checklist for both franchisors and franchisees. Each requirement outlined in the AWA must be strictly complied with - otherwise the agreement will be vulnerable to rescission. Given the significance of this remedy, it is advisable for franchisees and franchisors alike to consult with an experience business law lawyer to ensure that their rights are adequately protected.

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