Bringing Clarity to Franchise Disclosure
From time to time, a case comes along which synthesizes not only some specific rules about conduct, but helps to guide everyone about the fundamental intent and principles behind the franchise legislation. The recent Ontario case, Raibex Canada Ltd. v. ASWR Franchising Corp., decided by Mr. Justice W. Matheson and now subject to appeal, is just such a case.
1. The Essential Facts
While there are additional parties, facts and issues, the following describes only those parties, facts and issues which make this case one of the most important franchise disclosure cases in many years.
ASWR Franchising Corp. (“ASWR”) is a franchisor of the AllStar Wings and Ribs franchise system. An affiliate of ASWR enters into head leases for the franchised locations and subleases to the ASWR franchisees. On October 16, 2012, ASWR delivered a disclosure document to Mr. Ramy Bastaros. There was no head lease attached to the disclosure document, as no location had been selected. A company named Raibex Canada Ltd, (“Raibex”),which is owned by Mr. Bastaros, signed an AllStar franchise agreement on November 21, 2012.
The court accepted that Mr. Bastaros had intended to invest no more than $400,000, but had ultimately agreed to a business plan that called for a $600,000 investment, plus $50,000 for working capital. It was very germane to the decision that Mr. Bastaros had been told that the conversion of an existing restaurant could significantly reduce his investment over what would be required to build from a shell building. The disclosure document stated that the cost of establishing the restaurant from a shell would be in the range of $805,500 to $1,153,286. However, there was no estimate for the cost of establishing the franchise by the conversion of an existing restaurant, even though almost all of the existing AllStar franchises were conversions.
The disclosure document attempted to address the lack of cost estimates for conversion by stating that, “the cost to convert…is highly site specific and can therefore vary dramatically from location to location” and that, “the Franchisor has no reasonable means of estimating or predicting those costs with any certainty”.
Some months later, a location was selected for conversion to an AllStar restaurant, a head lease was executed by the franchisor’s affiliate and construction was commenced. However, the head lease required a substantial and unusual $120,000 payment for prepaid rent and security deposit. Additionally, approximately one month prior to opening in March 2014, Raibex was advised that the cost to convert the restaurant would be over $1,000,000.
2. The Litigation and the Issues
Raibex refused to pay to ASWR the full construction costs or the $120,000 prepaid rent and security deposit. On July 21, 2014 ASWR served a default notice on Raibex, then a termination notice on August 1, 2014 and assumed control over the franchise.
On July 25, 2014, Raibex served a notice of rescission claiming $1,280,000 from ASWR and its affiliates. In December 2014, Raibex commenced an action for this amount and for a declaration that it had validly rescinded the franchise agreement.
Raibex’s position was that it was entitled to rescind the franchise agreement because of the omission from the disclosure document of critical material facts. The disclosure document did not include a copy of the head lease (which included the obligation to pay $120,000 for prepaid rent and security deposit) or an estimate of the costs to convert the premises.
ASWR argued that, as the location had not been selected at the time of disclosure (or even before the franchise agreement was signed) it was not possible to provide the missing facts to Raibex and that the disclosure obligations under the AWA end when the franchise agreement is signed. ASWR also argued that it is a very common practice among franchisors to disclose and have franchise agreements signed prior to finding an appropriate location for the franchised business.
3. The Decision
With the concurrence of all parties, this main issue was disposed of through a summary judgment process. The essence of the judgment, which was rendered in favor of Raibex, was that, where there are facts of sufficient materiality, which are not known to the franchisor, the franchisor is unable to provide the statutorily mandated disclosure and sign a binding franchise agreement. The court held that the terms and conditions of the head lease and the actual costs of converting the premises were such critical material facts. It is obvious that the unusual $120,000 payment under the lease and the franchisor’s representations as to the likelihood of the costs to convert the premises being significantly less than building out a shell played a very important part in the judge’s thinking.
Some pundits have already suggested that this case stands for the proposition that disclosure is not possible until the location is selected and a head lease is available. However, Justice Matheson states clearly “In the circumstances of this case, it was premature to purport to deliver the disclosure document under the AWA and enter into a franchise agreement”. Justice Matheson further states, “The facts before me illustrate the materiality of the Head Lease in this particular case…I leave open the possibility that proper disclosure could be made in those circumstances even though it was not made here.”
It would seem that, if the franchisor could have described the important provisions of a possible head lease (including the large pre-paid rent and security costs) and some reasonable range of conversion costs, complete disclosure could have been possible in this case. So it is submitted that this case stands for the proposition that proper disclosure is not possible until all material facts can be presented to the franchisee. This is a broad and clarifying concept in franchise disclosure and can come into play in other scenarios including when a foreign franchisor has not ascertained the cost of establishing a franchise in Canada and attempts to put that burden on the prospective franchisee.
1 2016 ONSC 5575.
2 Ibid at para. 3.
3 Ibid at para. 75.