Ontario Court of Appeal Narrowly Interprets Exemptions to Franchisors’ Disclosure Obligations
Franchisors’ disclosure obligations may be triggered even where a franchisee is assigning its interest in a franchise to a third party. The Ontario Court of Appeal recently considered the circumstances in which a franchisor will be exempt from the disclosure obligations contained in the Arthur Wishart Act (Franchise Disclosure) (the Act). The case holds important lessons to franchisors that facilitate the purchase of their existing franchises by new prospective franchisees.
The Court’s decision in 2189205 Ontario Inc. v. Springdale Pizza Depot Ltd. (Springdale Pizza) makes clear that the exemption from disclosure obligations contained in section 5(7)(a)(iv) of the Act — which applies where the "grant of the franchise is not effected by or through the franchisor" — is now limited to situations where the franchisor is nothing more than a "passive participant" in the sale of a franchise.
In Springdale Pizza, a prospective franchisee approached a franchisor with the intention of purchasing a Pizza Depot franchise. The franchisor directed the purchaser to an existing franchisee that was trying to sell its franchise. While the transaction was essentially an assignment of the franchise interest from the previous owner to the purchaser, the franchisor also required the buyer to execute two additional documents: an undertaking to car wrap all delivery vehicles with the Pizza Depot brand, and an acknowledgment that the franchisor was not substantiating or verifying the sales figures reported by the previous owner.
The sale was completed but, several months later the purchaser sought rescission of the agreement on the basis that they had not received a disclosure document from the franchisor. The Act permits rescission of a franchise agreement up to two years after its execution, if the franchisor never provided a disclosure document, unless one of the Act’s exemptions from disclosure applied in the circumstances.
The franchisor maintained that it was not required to provide a disclosure statement on the basis of the exemption in section 5(7)(a)(iv) of the Act. It was the franchisor’s position that this transaction was effected by or through the previous franchisee and that the franchisor only exercised its right, pursuant to section 5(8) of the Act, to act reasonably in approving (or disapproving) the resale of the franchise.
The Court of Appeal disagreed. The Court held that given the objective of the Act, which is to rectify power imbalances in franchise relationships through disclosure obligations, this exemption from disclosure should be interpreted narrowly to apply only where the franchisor is merely a "passive participant" in the sale of the franchise.
In this case, the franchisor’s role in the sale of the franchise exceeded that of a passive participant. In particular, the franchisor:
- directed the prospective buyer to a specific franchisee that was looking to sell its franchise;
- was involved in the negotiations;
- required the purchaser to actively seek its consent, as opposed to merely exercising its right of refusal enshrined in section 5(8) of the Act (even though the agreement stipulated that the franchisors’ consent could not be unreasonably withheld); and
- required the purchaser to execute two additional documents that had not been executed by the previous franchisee.
Collectively, these steps constituted "active" participation such that the "grant of the franchise" was "effected by or through the franchisor." The disclosure obligations in the Act therefore applied. The Court did pause to say that each circumstance on its own may be insufficient to reach this conclusion, but taken together, the circumstances support the finding that the franchisor went beyond a passive role in the transaction.
Franchisors wishing to avoid the obligation to provide disclosure statements to new franchisees in these kinds of buy/sell transactions, must maintain a truly "passive" role in the transaction.
Parties to a franchise relationship should also consider what effect this decision will have on the other exemptions from disclosure obligations in section 5(7) of the Act. It is reasonable to assume that they will also be interpreted in a very narrow manner.