Franchisors’ Disclosure Obligations Triggered Before Execution of Franchise Agreement
Even in the absence of an executed franchise agreement, your business relationship could be characterized as one of franchise and, as a result, subject to disclosure obligations contained in the Arthur Wishart Act (Franchise Disclosure) (the Act). In a recent Ontario decision, Justice Corbett in 1706228 Ontario Ltd. v. Grill It Up Holdings Inc. confirmed that:
A franchise relationship can exist in the absence of an express franchise agreement so long as the substance of the relationship is one of franchise; and
Disclosure obligations of a franchisor under the Act begin at the outset of the business relationship, when money is exchanged between the parties and before the final franchise agreement is executed.
In 2007, Grill It Up, a nascent fast food franchise operation, entered into a licence agreement and an asset purchase agreement with the plaintiff, allowing the plaintiff to use its trademarks and promotional materials. The plaintiff invested $130,000 to open its location.
However, before the parties could execute the franchise agreement, the plaintiff backed out of the transaction. According to the plaintiff, Grill It Up had failed to deliver a disclosure document as required by the Act, and had also previously misrepresented the prospective franchisee’s financial obligations under the agreement. The plaintiff sought a return of its investment, as well as lost income relating to the aborted transaction.
Despite the absence of a franchise agreement, the court held that the relationship between the plaintiff and defendant was a franchise relationship within the meaning of the Act. According to the Court, the parties had agreed through the executed license and asset purchase agreement that:
- The plaintiff would pay a royalty to Grill It Up;
- Grill It Up, in the licence agreement, granted the plaintiff the right to sell goods that were "substantially associated" with Grill It Up’s trademark; and
- Grill It Up provided "significant assistance" in the franchisee’s method of operation: start-up construction costs were borne by the defendant, the store was designed by Grill It Up, the menu was provided by Grill It Up, employees were trained by Grill It Up and Grill It Up provided promotional materials. Additionally, the location of the restaurant was found by Grill It Up, who entered into a head lease with the shopping mall and subleased the space to the plaintiff for its restaurant.
In the circumstances, it was clear to the court that the parties’ conduct amounted to a "franchise" relationship under the Act. As a result, the disclosure requirements in the Act applied to the parties.
The court then considered whether Grill It Up had breached its disclosure obligations. Under section 5, a franchisor is required to provide a prospective franchisee with a disclosure document at least 14 days prior to the signing of a franchise agreement, or any other agreement "relating to" the franchise, and payment of any consideration by the prospective franchisee to the franchisor.
In this case, the plaintiff paid deposits to Grill It Up and executed agreements "relating to" the franchise, such as the licence agreement and asset purchase agreement, even though the plaintiff refused to execute the final franchise agreement itself. As a result, the court held Grill It Up was in breach of its disclosure obligation to deliver a disclosure document to the plaintiff. The plaintiff was entitled to rescission and consequently a return of the lost investment, as well as damages for lost income, due to the fact that the franchisee’s principal resigned from his previous job to pursue the franchise opportunity with Grill It Up.