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Ontario Court of Appeal Considers Scope of Franchisor’s Duty to Disclose Outside Mandatory Disclosure Context

Date

February 4, 2013


Published by the Franchise & Distribution Group

In an important new decision for franchisors, 3574423 Canada Inc. v. Baton Rouge Restaurants Inc. (Baton Rouge), the Ontario Court of Appeal (ONCA) recently considered the scope of informational disclosure a franchisor is required to provide to one of its franchisees outside the context of statutory disclosure obligations. In Baton Rouge, the ONCA considered the scope of a franchisor’s duty of good faith when supplying an existing franchisee with information concerning a new location.

This appeal was from a 2012 trial decision of Justice Brown, which we previously discussed here. The trial decision clarified a number of issues regarding Ontario franchise law. The appeal, however, focussed only on the trial judge’s finding that the franchisor had not breached the duty of good faith and fair dealing by failing to provide certain information to an existing franchisee that was considering an opportunity to invest in a new franchise location.

Background and Summary

The appellant, 3574423 Canada Inc., became a Baton Rouge franchisee in 1999 when it assumed ownership of the Eaton Centre location in downtown Toronto. As part of the negotiations for the Eaton Centre franchise, the franchisee obtained a contractual right of first refusal (ROFR) over the next franchise location to be granted in the Greater Toronto Area. On several occasions during the years after 3574423 Canada Inc. acquired the Eaton Centre franchise, it was offered the opportunity to invest in new Baton Rouge locations. Each time it declined to exercise its ROFR.

The dispute that led to these proceedings involved a proposed Baton Rouge franchise to be opened in Thornhill. In 2001, in keeping with its ROFR, the appellant considered the Thornhill franchise was offered to the appellant. As it had in the past, the appellate franchisee considered the materials provided to it by the franchisor and decided to pass on the new location. The Thornhill location was eventually granted to another franchisee. After the deal had closed, discrepancies came to light between the information contained in the materials provided by the franchisor to the appellant and the agreements that eventually governed the new franchise. The discrepancies included the terms of the final lease for the property and the size of the territory for the new location. At trial, the appellant claimed, among other things, that such discrepancies amounted to the withholding of information critical to its decision-making process and that the franchisor had thus breached its duties of good faith and fair dealing. The trial judge disagreed, holding that the discrepancies were immaterial and that the appellant franchisee had sufficient information to waive its ROFR at the time it made its decision to do so. The franchisee appealed, arguing that Justice Brown had misapplied the law regarding a franchisor’s duty of good faith.

The ONCA dismissed the appeal, holding that there was no merit to the claim that the franchisor had withheld critical information. The ONCA upheld the trial judge’s decision that there was no breach of the franchisor’s duties of good faith and fair dealing.

Statutory Disclosure Requirements Not Applicable

Importantly, the ONCA’s analysis took place outside the franchisor’s disclosure duties found in section 5 of the Arthur Wishart Act (Ontario) (Act). At trial, Justice Brown had determined that since the appellant had not become a franchisee in relation to the Thornhill franchise where it was arguing insufficient disclosure, it was not entitled to rely on the statutory remedies for inadequate disclosure; these remedies were only available to parties who had, in fact, become franchisees on the basis of the disclosure at issue. Accordingly, the appellant was not entitled to the high standard for pre-investment disclosure set out in the Act.

Prior Dealings Between the Parties Can Inform the Standard of the Franchisor’s Duties

In assessing the standard for the duties of good faith and fair dealing, the ONCA noted that: "[t]he extensive prior dealings between the parties in this case inform the standard of fair dealing between them." This is consistent with earlier case law, which suggests that franchise duties are flexible standards, coloured by their context and informed by the expected norms that have developed over the course of the parties’ relationship. In this particular case, the ONCA noted that the franchisee’s principals were sophisticated businessmen with considerable experience in the restaurant business. Given this context, the ONCA held that the appellate franchisee possessed sufficient information upon which to base its decision to decline the Thornhill franchise opportunity.

Imperfect Provision of Information Will Not Necessarily Result in a Breach of the Franchisor’s Duties

There were certain discrepancies between the information in the materials given to the appellate franchisee and the franchise agreements eventually executed by the subsequent franchisee. The ONCA held that such discrepancies were not material; they manifested the reasonable exercise of the franchisor’s diligence and did not play an important factor in the appellant’s decision to waive its ROFR. The ONCA also noted that the missing details could not have been important to the franchisee’s decision as it did not seek to obtain any further information on these issues.

This point is instructive as it illustrates the important distinction between the standard of disclosure for prospective investors who become franchisees and that of those that do not. When a prospective investor becomes a franchisee, the courts have strictly enforced the disclosure obligations outlined in the statute. Where such a prospective investor does not acquire the franchise in issue, as in the present case, the standard for pre-investment disclosure appears to be lower, even in the context of an existing franchise relationship where the parties are bound by the duties of good faith and fair dealing.

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