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Ontario Court of Appeal Distinguishes Between Royalties and Fees for Purposes of Statutory Disclosure Exemptions

Franchisors looking to avoid the onerous costs of preparing disclosure statements can look to a recent Ontario Court of Appeal case for guidance. The decision clarifies the disclosure exemption for franchise agreements of one year or less that do not require the payment of an up-front franchise fee.

The Ontario Court of Appeal’s decision in TA & K Enterprises v. Suncor Energy clarifies the scope of the exemption from disclosure found in section 5(7)(g)(ii) of the Arthur Wishart Act (Franchise Disclosure), 2000 (Act). Under this provision, a franchisor does not have to deliver a disclosure statement to a new franchisee where "the franchise agreement is not valid for longer than one year and does not involve the payment of a non-refundable franchise fee." This decision provides three important lessons to franchisors wishing to take the benefit of this provision:

First: the term of a proposed franchise agreement should be expressly limited to 12 months or less.

Second: to assess the length of an agreement’s term, the courts will look to the period during which the parties are legally bound by their rights and obligations under the agreement. Other factors — such as when the agreement is actually executed or a subsequent offer to extend the agreement — will not extend the term of the agreement for the purposes of exemption. Based on the court's analysis, it could be risky to insert a renewal term into the agreement that is automatically triggered at the end of the term, as this could be construed by the courts as contemplating a longer term than one year.

Third: to be exempt from disclosure under the provision, the franchise agreement cannot require any form of fee to be paid for the right to become a franchisee. Such fees are considered risky for the franchisee, therefore taking the relationship outside the exemption. By contrast, ongoing "royalties or payments for goods and services" are permitted under the exemption, as these are not considered to be a "non-refundable franchise fee."

The issue in TA & K Enterprises was whether Suncor, the franchisor, was exempt from the statutory obligation to provide a disclosure document to one of its franchisees, TA & K Enterprises Inc. (TAK). The two companies signed a franchise agreement on November 11, 2008. Suncor did not provide a disclosure statement to TAK.

The term of the agreement was one year, commencing on November 15, 2008 and ending on November 14, 2009, with no option to renew. During the term of the agreement, Suncor went through a merger with Petro Canada that required it to divest some of its franchises. In October 2009, 11 months after the agreement was signed, Suncor wrote to TAK informing it that, after the agreement expired, there would be a month-to-month extension on identical terms and conditions. Shortly after receiving the second letter from Suncor, TAK purported to exercise the right of rescission under section 6 of the Act and sought refunds of monies paid to Suncor under the agreement.

The Superior Court of Justice granted Suncor’s motion for summary judgment on the basis that it satisfied both requirements under section 5(7)(g)(ii) and was therefore exempt from the disclosure obligation. TAK appealed the decision and argued that neither requirement was met.

The Court of Appeal affirmed the lower court decision. According to the Court, the duration of the agreement was twelve months, despite the fact that it was executed before its term began. What mattered was the length of the enforceable grant of a franchise, not when the agreement was signed. The fact that confidentiality and other provisions remained binding was also not relevant, as this was not the franchise grant. Moreover, an agreed-to extension on a month-to-month basis after expiry did not trigger the disclosure requirement. The disclosure obligation needs to be assessable when the agreement is first signed.

TAK also argued that its obligation to pay royalties constituted a "franchise fee" under the provision. This was rejected by the Court of Appeal. A "franchise fee" was a "fee paid for the right to become a franchisee," and this did not include "royalties or payments for good or services."