Business Law

Tales of Flawed Disclosure: The Importance of the FDD Certificate

By March 2, 2020 March 4th, 2020 No Comments
Business Law

Tales of Flawed Disclosure: The Importance of the FDD Certificate

The recent
decision of the Ontario Superior Court of Justice (the Court) in the
case of 2483038 Ontario Inc. v. 2082100 Ontario Inc. (2020 ONSC 475)
(the Fit for Life Decision) highlights the importance of ensuring the
delivery of a compliant franchise disclosure document (a FDD) upon the
grant of a franchise and serves as a reminder to franchisors and their
principals of the significant consequences of failing to do so.

In this case,
the franchisee entered into a franchise agreement with the franchisor for the
operation of a “Fit for Life” restaurant in Ontario. The franchisee opened for
business on or around December 14, 2015 and ceased operating on or around
August 11, 2017 after delivering a notice of rescission to the franchisor. The
FDD delivered by the franchisor to the franchisee contained a signature block
on page 4 of the FDD where there was some corporate information about the
franchisor being disclosed. This was where Mr. Samuel Davis (Mr. Davis),
the sole director and officer of the franchisor, had signed the FDD rather than
the “Certificate of Disclosure” on page 27 of the FDD.

At trial, it was
confirmed that the only deficiency in the FDD that the franchisee was relying
upon for the rescission claim, was that the FDD failed to include a certificate
signed and dated by the sole director or officer of the franchisor as required
by Section 7(2) of the regulations to the Arthur Wishart Act (Franchise
Disclosure)
, 2000 c. 3 (the Act).

In Ontario, a franchisee’s claim for rescission, if successful, would require that a franchisor and/or the franchisor’s associate:

  1. refund to the franchisee any money received from or on behalf of the franchisee, other than money for inventory, supplies or equipment;
  2. purchase from the franchisee any inventory that the franchisee had purchased pursuant to the franchise agreement and remaining at the effective date of rescission, at a price equal to the purchase price paid by the franchisee;
  3. purchase from the franchisee any supplies and equipment that the franchisee had purchased pursuant to the franchise agreement, at a price equal to the purchase price paid by the franchisee; and
  4. compensate the franchisee for any losses that the franchisee incurred in acquiring, setting up and operating the franchise, less the amounts set out in clauses (a) to (c) above.

The primary issues in this case were as follows:

  1. Was the franchisee entitled to deliver a notice of rescission under the Act?
  2. Was Mr. Davis personally liable by virtue of being the “franchisor’s associate”?

First Issue

In tackling the
first issue, the Court noted that the Act requires that a signed certificate
accompany the delivery of an FDD. The Court followed the decision of the
Alberta Court of Appeal in Hi Hotel Limited Partnership v. Holiday
Hospitality Franchising Inc.
(2008 ABCA 276) that “there can be no
disclosure unless a signed and dated certificate is included in the FDD.” In
other words, delivery of a FDD without a properly signed certificate is
tantamount to a complete lack of disclosure.

The jurisprudence
requiring a properly signed certificate to accompany a FDD is informed by two
policy objectives, namely: (i) informed investment decision making; and (ii)
impressing upon those who sign a disclosure certificate the importance of
ensuring the disclosure document is complete and accurate. Consequently, the
absence of a signed and dated disclosure certificate is a fatal flaw in the
disclosure provided to the franchisee. It did not matter that the decision of
the franchisee to invest in this franchise was not affected by any defect or
untrue, inaccurate or misleading statement in the disclosure contained in the
FDD. The Court ruled that the “absence of a disclosure certificate goes to the
very heart of the policy for requiring disclosure to give meaning to the
personal responsibility that is intended to flow from it.”

Second Issue

On the second issue of whether Mr. Davis was the “franchisor’s
associate”, section 1 of the Act defines a “franchisor’s associate” as follows:

“franchisor’s associate” means a person,

(a) who, directly or indirectly,

(i) controls or is controlled by the franchisor, or

(ii) is controlled by another person who also controls, directly or indirectly, the franchisor, and

(b) who,

(i) is directly involved in the grant of the franchise,

(A) by being involved in reviewing or approving the grant of the franchise, or

(B) by making representations to the prospective franchisee on behalf of the franchisor for the purpose of granting the franchise, marketing the franchise or otherwise offering to grant the franchise, or

(ii) exercises significant operational control over the franchisee and to whom the franchisee has a continuing financial obligation in respect of the franchise; (“personne qui a un lien”).

The Court found that Mr. David, by virtue of his position as the
sole director and officer of the franchisor, directly controlled the
franchisor. Further, the Court found that, Mr. Davis, by signing page 4 of the
FDD, made statements intended to promote the franchise system and therefore
made, on an objective reading, representations to the franchisee for the
purpose of granting the franchise, marketing the franchise or otherwise
offering to grant the franchise.

Ultimately, the
Court ruled that:

 

  1. the certificate provided by the
    franchisor to the franchisee was fatally flawed since it was not signed or
    dated in accordance with the requirements of the Act;

 

  1. the flaws in the Certificate also meant that the FDD was fatally flawed and was tantamount to their having been a complete lack of disclosure to the franchisee;

 

  1. that these flaws entitled the franchisee to cancel its franchise agreement without penalty; and

 

  1. that the franchisee was entitled to reimbursement of approximately $475,908.00 from both the franchisor and Mr. Davis representing: (i) the purchase price and royalties paid by the franchisee to the franchisor during its approximate twenty (20) months of operations; (ii) the costs incurred by the franchisees for business inventory; and (iii) the costs incurred by the franchisee for the business supplies and equipment. In addition, the Court permitted the franchisee the opportunity to also pursue a claim for $148,911.00 from both the franchisor and Mr. Davis to recover lease payments made by the franchisee to its third-party landlord.

The Fit for Life Decision reiterates the importance of strict compliance with franchise legislation. At the same time, however, franchisees must be careful in exercising an alleged right to rescission since, at it was in the Fit for Life Decision, such a claim by the franchisee is highly contentious and will likely result in a counter-claim for wrongful rescission along with potential allegations by the franchisor of default of the terms of the franchise agreement. It is recommended that an experienced franchise lawyer be engaged by a franchisor and a franchisee in circumstances involving rescission.

I would like to thank Kenny Okunola for his assistance in writing this article.

Invitation for Discussion:

If you would like to discuss this article in greater detail, or any other business law matter, please do not hesitate to contact one of the lawyers in the Business Law group at Nerland Lindsey LLP.

Disclaimer:

Note that the foregoing is for general discussion purposes only and should not be construed as legal advice to any one person or company. If the issues discussed herein affect you or your company, you are encouraged to seek proper legal advice.

 

The recent
decision of the Ontario Superior Court of Justice (the Court) in the
case of 2483038 Ontario Inc. v. 2082100 Ontario Inc. (2020 ONSC 475)
(the Fit for Life Decision) highlights the importance of ensuring the
delivery of a compliant franchise disclosure document (a FDD) upon the
grant of a franchise and serves as a reminder to franchisors and their
principals of the significant consequences of failing to do so.

In this case,
the franchisee entered into a franchise agreement with the franchisor for the
operation of a “Fit for Life” restaurant in Ontario. The franchisee opened for
business on or around December 14, 2015 and ceased operating on or around
August 11, 2017 after delivering a notice of rescission to the franchisor. The
FDD delivered by the franchisor to the franchisee contained a signature block
on page 4 of the FDD where there was some corporate information about the
franchisor being disclosed. This was where Mr. Samuel Davis (Mr. Davis),
the sole director and officer of the franchisor, had signed the FDD rather than
the “Certificate of Disclosure” on page 27 of the FDD.

At trial, it was
confirmed that the only deficiency in the FDD that the franchisee was relying
upon for the rescission claim, was that the FDD failed to include a certificate
signed and dated by the sole director or officer of the franchisor as required
by Section 7(2) of the regulations to the Arthur Wishart Act (Franchise
Disclosure)
, 2000 c. 3 (the Act).

In Ontario, a franchisee’s claim for rescission, if successful, would require that a franchisor and/or the franchisor’s associate:

  1. refund to the franchisee any money received from or on behalf of the franchisee, other than money for inventory, supplies or equipment;
  2. purchase from the franchisee any inventory that the franchisee had purchased pursuant to the franchise agreement and remaining at the effective date of rescission, at a price equal to the purchase price paid by the franchisee;
  3. purchase from the franchisee any supplies and equipment that the franchisee had purchased pursuant to the franchise agreement, at a price equal to the purchase price paid by the franchisee; and
  4. compensate the franchisee for any losses that the franchisee incurred in acquiring, setting up and operating the franchise, less the amounts set out in clauses (a) to (c) above.

The primary issues in this case were as follows:

A. Was the franchisee entitled to deliver a notice of rescission under the Act?

B. Was Mr. Davis personally liable by virtue of being the “franchisor’s associate”?

First Issue

In tackling the
first issue, the Court noted that the Act requires that a signed certificate
accompany the delivery of an FDD. The Court followed the decision of the
Alberta Court of Appeal in Hi Hotel Limited Partnership v. Holiday
Hospitality Franchising Inc.
(2008 ABCA 276) that “there can be no
disclosure unless a signed and dated certificate is included in the FDD.” In
other words, delivery of a FDD without a properly signed certificate is
tantamount to a complete lack of disclosure.

The jurisprudence
requiring a properly signed certificate to accompany a FDD is informed by two
policy objectives, namely: (i) informed investment decision making; and (ii)
impressing upon those who sign a disclosure certificate the importance of
ensuring the disclosure document is complete and accurate. Consequently, the
absence of a signed and dated disclosure certificate is a fatal flaw in the
disclosure provided to the franchisee. It did not matter that the decision of
the franchisee to invest in this franchise was not affected by any defect or
untrue, inaccurate or misleading statement in the disclosure contained in the
FDD. The Court ruled that the “absence of a disclosure certificate goes to the
very heart of the policy for requiring disclosure to give meaning to the
personal responsibility that is intended to flow from it.”

Second Issue

On the second issue of whether Mr. Davis was the “franchisor’s
associate”, section 1 of the Act defines a “franchisor’s associate” as follows:

“franchisor’s associate” means a person,

(a) who, directly or indirectly,

(i) controls or is controlled by the franchisor, or

(ii) is controlled by another person who also controls, directly or indirectly, the franchisor, and

(b) who,

(i) is directly involved in the grant of the franchise,

(A) by being involved in reviewing or approving the grant of the franchise, or

(B) by making representations to the prospective franchisee on behalf of the franchisor for the purpose of granting the franchise, marketing the franchise or otherwise offering to grant the franchise, or

(ii) exercises significant operational control over the franchisee and to whom the franchisee has a continuing financial obligation in respect of the franchise; (“personne qui a un lien”).

The Court found that Mr. David, by virtue of his position as the
sole director and officer of the franchisor, directly controlled the
franchisor. Further, the Court found that, Mr. Davis, by signing page 4 of the
FDD, made statements intended to promote the franchise system and therefore
made, on an objective reading, representations to the franchisee for the
purpose of granting the franchise, marketing the franchise or otherwise
offering to grant the franchise.

Ultimately, the
Court ruled that:

 

  1. the certificate provided by the
    franchisor to the franchisee was fatally flawed since it was not signed or
    dated in accordance with the requirements of the Act;

 

  1. the flaws in the Certificate also meant that the FDD was fatally flawed and was tantamount to their having been a complete lack of disclosure to the franchisee;

 

  1. that these flaws entitled the franchisee to cancel its franchise agreement without penalty; and

 

  1. that the franchisee was entitled to reimbursement of approximately $475,908.00 from both the franchisor and Mr. Davis representing: (i) the purchase price and royalties paid by the franchisee to the franchisor during its approximate twenty (20) months of operations; (ii) the costs incurred by the franchisees for business inventory; and (iii) the costs incurred by the franchisee for the business supplies and equipment. In addition, the Court permitted the franchisee the opportunity to also pursue a claim for $148,911.00 from both the franchisor and Mr. Davis to recover lease payments made by the franchisee to its third-party landlord.

The Fit for Life Decision reiterates the importance of strict compliance with franchise legislation. At the same time, however, franchisees must be careful in exercising an alleged right to rescission since, at it was in the Fit for Life Decision, such a claim by the franchisee is highly contentious and will likely result in a counter-claim for wrongful rescission along with potential allegations by the franchisor of default of the terms of the franchise agreement. It is recommended that an experienced franchise lawyer be engaged by a franchisor and a franchisee in circumstances involving rescission.

I would like to thank Kenny Okunola for his assistance in writing this article.

Invitation for Discussion:

If you would like to discuss this article in greater detail, or any other business law matter, please do not hesitate to contact one of the lawyers in the Business Law group at Nerland Lindsey LLP.

Disclaimer:

Note that the foregoing is for general discussion purposes only and should not be construed as legal advice to any one person or company. If the issues discussed herein affect you or your company, you are encouraged to seek proper legal advice.

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