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Mr. Claude J. Pellan,
L.L.B., B.Comm., Attorney

(450) 674-5551

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Number 21 – September 17, 2010

FRANCHISING
 
CRISIS IN FRANCHISING: THE MIDAS CASE - PART I / II

 

This far-reaching case with possibly devastating effects has the potential of striking the franchise industry across Canada by storm.

On July 6, 2010, the Ontario Court of Appeal handed down a judgement that addressed a number of franchise related issues, but only ONE has franchisors scrambling for an exit strategy.

A. Summary of Facts

The Plaintiff was a Midas franchisee involved in a class action suit against Midas Canada, the franchisor. To determine the applicable law to resolve an issue dealing with a request for a release by Midas Canada, the Ontario Court of Appeal studied the governing law clause in the franchise agreement.  Midas’s standard form franchise agreement provides that the laws from the Province of Ontario are the governing laws for franchises located in Ontario, Alberta, British Columbia, Manitoba, New Brunswick and Nova Scotia.

At Court, while counsel for Midas Canada argued that the Arthur Wishart Act (the franchise law in Ontario) specifically provides that it applies only to franchises operated in the Province of Ontario and persons that live in that Province, the Ontario Court of Appeal concluded that parties to a contract are free to elect the governing laws of any jurisdiction to apply to their legal relationship.

B. Repercussion for Franchisors

The Midas case raises a number of cross-jurisdictional issues dealing with the governing law clause in a franchise agreement, in particular for Provinces that have franchise legislation.

1. Franchise Legislation – An Overview

Presently, Alberta, Ontario and Prince Edward Island have adopted specific franchise legislation. Manitoba and New Brunswick will follow shortly.

Generally speaking, the franchise legislation in Ontario, Alberta and Prince Edward Island provides a number of obligations for franchisors, the most important of which is to provide prospective franchisees with a “Disclosure Document”. This document contains statutory information, information on the franchisor, its activities, its personnel, certain types of judgements rendered against it, information on franchisees that have left the network, extracts from the franchise agreement, a copy of all documents prospective franchisees will be called upon to sign, etc.

Section 5 of the Arthur Wishart Act (the “Act”) provides as follows:

“Franchisor’s obligation to disclose
“5. (1) A franchisor shall provide a prospective franchisee with a disclosure document and the prospective franchisee shall receive the disclosure document not less than 14 days before the earlier of,

(a) the signing by the prospective franchisee of the franchise agreement or any other agreement relating to the franchise; and

(b) the payment of any consideration by or on behalf of the prospective franchisee to the franchisor or franchisor’s associate relating to the franchise.”

In the Midas case, the Ontario Court of Appeal concluded that the parties to a franchise agreement are free to elect the laws that govern their legal relationship. The Court then applied the laws of the Province of Ontario, including the Act, to the franchisee-franchisor relationship.

In this case, the governing law clause dictated the jurisdiction of a class action suit, but more importantly, it determined that franchise legislation adopted in one Province may apply in Provinces where such legislation does not exist and, in such a context, the additional obligations of a franchisor towards its franchisees under that franchise legislation. 

Why is this so important?

For years, franchisors in Alberta, Ontario and Prince Edward Island have drafted their governing law clause in a similar way. The clause provides that the governing laws are those of the Province where they are located … for franchises that are granted in British Columbia, Manitoba, Saskatchewan, Quebec, Nova Scotia and New Brunswick, the whole while not providing prospective franchisees in those Provinces with a Disclosure Document.

The franchise legislation in Albert and Prince Edward Island is almost identical to the Act.

As already mentioned, the Act provides that franchisors must provide prospective franchisees with a Disclosure Document. In the event a prospective franchisee is not provided with a Disclosure Document, the Act provides as follows:

“Rescission for late disclosure

6. (1) A franchisee may rescind the franchise agreement, without penalty or obligation, no later than 60 days after receiving the disclosure document, if the franchisor failed to provide the disclosure document or a statement of material change within the time required by section 5 or if the contents of the disclosure document did not meet the requirements of section 5. 
 
Rescission for no disclosure

(2) A franchisee may rescind the franchise agreement, without penalty or obligation, no later than two (2) years after entering into the franchise agreement if the franchisor never provided the disclosure document.” (the underlining is ours)


The results of the governing law clause are far reaching as they directly affect all franchises granted over the last two (2) years by franchisors in Ontario, Alberta and Prince Edward Island to franchisees in British Columbia, Manitoba, Saskatchewan, Quebec, Nova Scotia and New Brunswick.

The Act provides the following consequences in the event a franchisor does not provide a prospective franchisee with a Disclosure Document:

“Franchisor’s obligations on rescission

(6)The franchisor, or franchisor’s associate, as the case may be, shall, within 60 days of the effective date of the rescission,

(a) refund to the franchisee any money received from or on behalf of the franchisee, other than money for inventory, supplies or equipment;

(b) 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;

(c) 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

(d) 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).

Damages for misrepresentation, failure to disclose

7.(1)If a franchisee suffers a loss because of a misrepresentation contained in the disclosure document or in a statement of a material change or as a result of the franchisor’s failure to comply in any way with section 5, the franchisee has a right of action for damages against,

(a) the franchisor;

(b) the franchisor’s agent;

(c) the franchisor’s broker, being a person other than the franchisor, franchisor’s associate, franchisor’s agent or franchisee, who grants, markets or otherwise offers to grant a franchise, or who arranges for the grant of a franchise;

(d) the franchisor’s associate; and

(e) every person who signed the disclosure document or statement of material change.”

As mentioned above, the effects may be financially devastating for franchisors.  Having to repurchase franchises is a very costly expense. Furthermore, this situation may also affect suppliers, financial institutions, the franchisor-attorney relationship, etc.

C. Area Developers and Master Franchisees

Before addressing the other cross-jurisdictional issues raised by the Midas case, it is important for franchisors to review their agreements with area developers and master franchisees as well as the franchise agreements that the latter have had signed by franchisees over the last two (2) years in the above-mentioned Provinces to assess if:

1) Franchisors have entered into area development and/or master franchisee agreements that raise the same issue as in the Midas case;

2) Franchisors have required area developers and master franchisees to sign franchise agreements with franchisees that contain a clause similar to the one in the Midas case.

D. Overview of Cross-Jurisdictional Issues

As already mentioned, three (3) provinces have specific franchise legislation, Alberta, Ontario and Prince Edward Island.

Whenever a franchisor from one of these provinces grants a franchise to a franchisee in that Province, it provides a Disclosure Document to its prospective franchisee, drafted according to the franchise legislation of that Province. The governing laws are the ones of the Province concerned.

In Provinces where franchise legislation does not exist, British Columbia, Manitoba, Saskatchewan, Quebec, New Brunswick or Nova Scotia, a franchisor that grants a franchise in its Province is not required to provide a prospective franchisee with a Disclosure Document.  Again, the governing laws are the ones of the Province concerned.

However, if a franchisor from one of those Provinces were to grant a franchise in the Provinces of Alberta, Ontario and/or Prince Edward Island, they would also have to provide prospective franchisees with a Disclosure Document. It is a business call as to the choice of the governing laws. Keep in mind that the franchise legislation of the Province in which a franchisor grants a franchise shall apply to the franchisor-franchisee relationship.

Then there are franchisors from Provinces that have franchise legislation that wish to grant franchises to prospective franchisees in other Provinces that also have franchise legislation.

In this context, franchisors have two (2) options:

- provide prospective franchisees in the other Province with a Disclosure Document drafted according to the laws of that Province; or

- provide prospective franchisees in the other Province with a Disclosure Document drafted according to the laws where the franchisor is located, amended to reflect the requirements of the franchise legislation of the other Province.

Whichever option you choose, make sure the governing law clause in the franchise agreement reflects your intent knowing that the franchise legislation in the Province where the franchise is granted SHALL APPLY. The only question is whether or not you wish to also have the laws of the Province where you are located also apply.

In my humble opinion, to have two (2) governing laws only complicates a legal relationship. Keep it simple!

E. Conclusions

For the purposes hereof, I reviewed the governing law clause in twenty-three (23) franchise agreements from franchisors that operate in Canada. While this has no statistical value, fifteen percent (15%) of the franchise agreements I reviewed have the same issue as in the Midas case. However, I ponder as to whether or not this is not just the tip of the iceberg.

As already mentioned, the Midas case may have far reaching repercussions for franchisors, master franchisees, area developers, suppliers, financial institutions, etc. across Canada.

As for franchisors that may be in the same situation as in the Midas case, I strongly suggest that, as a first step, they have their franchise and other agreements reviewed by a franchise attorney to determine whether the governing law clause falls within the gambit of the Midas case. If it does, it must be immediately redrafted.

As for franchises granted over the last two (2) years by franchisors in Ontario, Alberta and Prince Edward Island to franchisees in Provinces that don’t have franchise legislation, a legal and practical evaluation of different scenarios leading to different strategic options will be presented in Part II of this article.

Claude J. Pellan, Attorney
Franchise Law
www.claudepellan.com



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