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    Is a Disclosure Document Required if a Franchise is being Assigned by the Franchisee?

    Franchise Dispute

    Pursuant to subsection 5(1) of the Arthur Wishart Act (Franchise Disclosure), 2000, S.O. 2000 c. 3 (the “Act”), franchisors must provide prospective franchisees with a disclosure document. However, subsection 5(7) of the Act exempts the franchisor from this requirement in the event of a grant of a franchise by a franchisee if the grant “is not effected by or through the franchisor”. Subsection 5(8) of the Act clarifies that a grant of a franchise “is not affected by or through a franchisor merely because,

    (a) the franchisor has a right, exercisable on reasonable grounds, to approve or disapprove the grant; or

    (b) a transfer fee must be paid to the franchisor in an amount set out in the franchise agreement or in an amount that does not exceed the reasonable actual costs incurred by the franchisor to process the grant.”

    Before the franchisor decides to rely on this exemption and chooses not to provide a prospective franchisee with a disclosure document, the franchisor should consider the recent decision in the following case. In 2147191 Ontario Inc. v. Springdale Pizza Depot Ltd., 2014 ONSC 3442, the original franchisee assigned an existing franchise to the plaintiffs (the “Assignees”). The Assignees then sought to rescind the franchise agreement, claiming that they were entitled to receive a disclosure document from the franchisor under the Act in connection with the franchise assignment and that no disclosure was provided to them. The franchisor’s position was that the Assignees were not entitled to receive disclosure because the Assignees acquired the business from an existing franchisee and not from the franchisor itself.

    Relying on subsection 5(8) of the Act, the court stated that a franchisor is not required to provide a disclosure document to franchise assignees where the franchisor is not involved in the transaction (aside from approving the transaction and receiving a transfer fee), and this is merely a passive participant in the assignment.

    However, the court found that the franchisor, in this case, went beyond a merely passive role. The court relied on the following facts in reaching its decision:

    • The franchisor met with both the original franchisee and the Assignees three times in connection with the assignment of the franchise.
    • The franchisor required the Assignees to sign an acknowledgement, which included a statement by the Assignees that they did not rely on the representations by the franchisor about the sales figures of the business.
    • The franchisor initially told the original franchisee that the franchisor would require a new franchise agreement, as opposed to an assignment document. It was later decided that the transaction would proceed as an assignment from the original franchisee.

    The judge held at paragraph 15 that “once the franchisor became engaged in the transaction and required additional consideration that limited the rights of the prospective franchisee under the statute, it was no longer passively exercising its approval rights. Rather, it was negotiating for itself concerning the allocation of statutory and common law rights and responsibilities as between franchisor and franchisee.” The judge then went on to say at paragraph 17 that “when a franchisor leads the parties to believe that it is starting down the path or requiring a new franchise agreement, meets the prospective franchisees multiple times, and requires extra consideration that limits the exercise of the prospective franchisee’s rights, I do not think it can be said to have been merely passive.” Accordingly, the court found that the Assignees were entitled to disclosure from the franchisor.

    The franchisor appealed the decision of the Superior Court of Justice. The Court of Appeal in 2147191 Ontario Inc. v. Springdale Pizza Depot Ltd., 2015 ONCA 116, affirmed the lower court’s decision, stating that the decision recognized the overall purpose of the Act – redressing the imbalance of power as between the franchisor and franchisee. Importantly, the Court of Appeal held that the disclosure exemptions in the Act, including the exemption set out in subsection 5(7) of the Act, must be narrowly construed.

    For more information, please contact the Franchise Law Team at Merovitz Potechin LLP.

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    Posted By: Merovitz Potechin

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