Rescinding Your Franchise Agreement

Introduction The purpose of section 5 of the Arthur Wishart (Franchise Disclosure) 2000 Act (the “Act”) is to protect the franchisee by providing him or her with disclosure of all material facts prior to purchasing a franchise. The Ontario Legislature has given “teeth” to section 5 of the Act by permitting the franchisee to rescind the franchise agreement (s. 6) or to seek damages (s. 7) if the requirements of section 5 are not fully complied with. Unfortunately, the Legislature has drafted the Act in such a way that it is ambiguous whether a franchisee may seek a remedy under both sections 6 and 7 of the Act in the event that the franchisor fails to meet its obligations under section 5. However, permitting a court to award a remedy to a franchisee under both sections of the Act is contrary to the common law and equitable approach to the remedy of rescission.

Remedies for the Breach of Section 5 In summary, in the event that a franchisor provides late disclosure or no disclosure, the franchisee has the following remedies: first, the franchisee is entitled to rescind the franchise agreement, pursuant to section 6 of the Act, and the franchisor shall, within 60 days of the date of rescission, (a) refund to the franchisee any money received from the franchisee; (b) purchase from the franchisee any inventory that the franchisee had pursuant to the franchise agreement at a price equal to the 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 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; or second, the franchisee may commence an action against the franchisor and its representatives pursuant to section 7 of the Act.

Judicial Application of Sections 6 and 7 To date, the interplay between sections 6 and 7 of the Act was most fully canvassed in 1490664 Ontario Ltd. v. Dig This Garden Retailers Ltd. (“Dig This Garden”) . The courts’ decisions illustrate the ambiguity in the drafting of the Act and is inconsistent with the traditional approach to the remedy of rescission.

The Facts In Dig This Garden, the applicant franchisee entered into a franchise agreement with the respondent franchisor, Dig This Garden Retailers Ltd., which is a British Columbia corporation. The respondent was unaware of the Act, including the duty to provide a disclosure document, at the time of entering into the franchise agreement. The franchisee opened for business on November 9, 2001. The franchisee’s business was doing poorly. On December 5, 2002, the franchisee sent a letter to the franchisor rescinding the franchise agreement due to the failure of the franchisor to provide a disclosure document. Prior to entering into the franchise agreement, the franchisee was provided with a document entitled “Franchise Information”, which included information about the system, owners, merchandise concepts, customer service, store design and the locations of other franchise stores. The respondent argued that the “Franchise Information” package constituted a disclosure document, which satisfied the requirements of section 5 of the Act.

Trial Decision Justice Horkins flatly rejected the respondent’s argument that the “Franchise Information” package constituted a disclosure document pursuant to section 5 of the Act. Horkins J. stated that the argument put forward by the respondent ignores the spirit of the Act and the clear obligation of the franchisor to provide one complete disclosure document. The Legislature would have made it clear had it intended that the franchisor have an alternative method of satisfying the disclosure obligation under the Act. Horkins J. found that the respondents were liable for a breach of section 5 of the Act.

Justice Horkins next dealt with the argument put forward by the respondents that the franchisee must elect to rescind the franchise agreement under section 6 or to seek damages under section 7 of the Act. Horkins J. stated, “[w]hen a franchisee is entitled to rescind, as I have found in this case, notice is given according to the Act. Notice was properly given. Once rescission is effective then section 6(6) is triggered and the ‘franchisor or franchisor’s associates as the case may be’ is given sixty days to make the required payments. In this case no payments were made, requiring the franchisee to consider relief available under the Act. This takes us to section 7 which sets out the right of action against the various parties… If they do not make these payments then the franchisee moves on to sections 7 and 8…” Justice Horkins held that the applicant franchisee is entitled to rescission pursuant to section 6(2) and damages pursuant to section 7 as the franchisor failed to make payments pursuant to section 6(6) of the Act.

In support of her position, Justice Horkins cited the decisions of Speigel J. in MAA Diners v. 3 for 1 Pizza and Wings and Pitt J. in 1368741 Ontario Inc. v. Triple Pizza .

In MAA Diners, on April 23, 2001, the plaintiff, Gill, and the defendant, Triple Pizza, executed an offer to purchase all assets of a pizza business. The plaintiff signed the agreement, which was a standard form document, in trust for MAA Diners Inc. In June 2001, Triple Pizza executed a bill of sale under which Triple Pizza sold MAA Diners Inc. assets of the restaurant and the “goodwill” of the franchise business. The premises were to be refurbished according to the agreement, however, they were in a deplorable state. In August 2001, MAA Diners Inc. returned the keys of the premises and delivered a notice of rescission to Triple Pizza. The plaintiff brought an application for rescission pursuant to section 6 and for damages pursuant to section 7 of the Act as the defendants failed to provide a disclosure document. Justice Spiegel held that the defendants had, in fact, failed to provide a disclosure document, therefore, she granted a rescission of the franchise agreement, general security agreement and sublease and awarded damages in the amount of $115,058.59 pursuant to section 7 of the Act. Although this decision does support Justice Horkins’ decision in Dig This Garden, Spiegel J. did not expressly discuss the interplay between the remedies available in sections 6 and 7 of the Act.

In 1368741 Ontario Inc. v. Triple Pizza, the defendants failed to provide the requisite disclosure document to the franchisee, therefore, the franchisee sought the rescission of the franchise agreement pursuant to section 6 of the Act. Justice Pitt found in favour of the franchisee and rescinded the franchise agreement and awarded the franchisee the return of his deposit pursuant to section 6(6)(a) of the Act. Justice Pitt’s decision does not support the decision of Justice Horkins in Dig This Garden as Justice Pitt’s decision did not award damages pursuant to section 7 of the Act.

Court of Appeal Decision The franchisor appealed the decision of Justice Horkins on numerous grounds, including, an error in law in interpreting and applying the principle of rescission in the Act.

Justice MacFarland, speaking for the Court of Appeal, upheld the trial decision. MacFarland J. relied upon the Court of Appeal’s decision in Stephan v. Insurance Corporation of British Columbia for the principle that “the principles of equitable rescission do not apply in a case of statutory rescission”, which includes the principle that a party is not entitled to double recovery. It is clear from Justice MacFarland’s discussion of the interplay between sections 6 and 7 that the principle of double recovery does not apply to a remedy of statutory rescission. MacFarland J. stated, “In addition, s. 7 clearly provides that if a franchisee suffers a loss as a result of a franchisor’s failure to comply in any way with s. 5, the franchisee has a right of action for damages… In circumstances where a franchisor fails to make the payments required of it under s. 6(6), those damages could include such amounts. As well, if a franchisee suffered any other loss as a result of the franchisor’s failure to comply with s. 5, the franchisee may sue for such damages under s. 7”.

With respect, Justice MacFarland incorrectly applied the Court of Appeal’s decision in Stephan, supra. In Stephan, supra., the insurance company failed to provide the plaintiff with written notice under the Insurance Act. The purpose of the written notice was to provide the plaintiff with all of his options prior to signing a settlement agreement. The Insurance Act stated that the settlement agreement may be rescinded if the insurer fails to provide the written notice. In this case, the plaintiff signed the settlement agreement and then collected approximately $32,000.00 from the insurer. The plaintiff found out that the agreement may be rescinded as he did not receive written notice so he provided the rescission notice to the insurer and sued for statutory accident benefits. The insurer demanded the return of the $32,000.00 and refused to acknowledge the rescission until the money was repaid. The insurer argued that the equitable principles of rescission requires all the parties to be placed back into the same position as before the settlement agreement was executed.

Justice Abella, speaking for the Court of Appeal, stated that the case does not involve an equitable right to rescission but, rather, the application of a statutory right to rescind. The implication that Justice MacFarland is drawing from this statement is that equitable principles of rescission are somehow treated differently than statutory rescission. It must be noted that Abella J. does not explicitly make this connection. The point of her statement should be gathered from the following paragraph wherein she discusses the purpose of the statutory right to rescind under the Insurance Act. Abella J. stated that the purpose of statutory rescission in the Insurance Act is in the nature of consumer protection. The Court of Appeal lays the risk on the insurer in this case. The insurer knows that the agreement is voidable if it does not provide the proper notice, therefore, it must bear the loss until a court determines the overall rights of the parties. Justice Abella’s decision is consistent with the principles of equitable rescission in that the Court still does not permit double recovery. Abella J. is clear in stating that the two issues (i.e. (i) whether the agreement is rescinded; and (ii) whether the plaintiff must return the settlement funds) are two “discrete and severable” issues. Moreover, Abella J. is clear that any settlement funds paid to the plaintiff become immediately due and owing. The plaintiff is required to pay the settlement moneys back, however, he does not have to do it before the rescission takes effect. The moneys paid to the plaintiff will be deducted from any judgment obtained by the plaintiff in the future. In the event that the plaintiff was entitled to less then he has already received, he will become liable to pay the difference back. It is extremely important to note Justice Abella’s comments later in the decision where she stated, “Interpreting the legislation in this way does not condone double recovery”.

Principles of Rescission Traditionally, rescission is a remedy that was available both in common law and in equity. Rescission at common law was restricted to very narrow circumstances and a party entitled to rescission had the right to treat the contract at an end and to claim for damages for its total breach. This permitted the court to enter into an accounting for any benefit that the person received.

Equitable rescission on the other hand involves the restoration of the parties to their original position prior to the formation of the contract. The equitable remedy of rescission has a wider scope as it enables the court to order adjustments so as to approximate restitutio in integrum. Equitable rescission enables the court to provide judgments which are practically just by providing the parties with “substantial” restoration as opposed to precise restoration, which was required in order to obtain the common law remedy of rescission.

Section 6 of the Act adopted the equitable remedy of rescission as opposed to the common law approach. Section 6 provides that the franchise agreement is void ab initio and the franchisor is required to place the franchisee back into the position that he or she would have been in prior to the franchise agreement. Subsection 6(6) requires the franchisor to purchase any inventory or equipment from the franchisee, return any deposits and to compensate for lost operating costs, however, it does not require the franchisor to compensate the franchisee for the loss of future benefits, which would be available under the common law remedy of rescission.

The Application of the Remedy of Rescission in Canada It is a well established principle of law that a plaintiff may sue for rescission and damages, however, the plaintiff must elect at trial the remedy that he or she wishes to receive.

Canadian jurisprudence is replete with decisions wherein the court expressly puts the plaintiff to the election between rescission or damages. In Campbell v. Munro, the Alberta Court of Appeal held that the defendant fraudulently misrepresented that there were no outstanding taxes or assessments on furniture that he sold to the plaintiff, therefore, the plaintiff was entitled to either sue for rescission of the transaction or for the damages to compensate him for the actual loss that he may have suffered. The plaintiff was not entitled to receive both remedies.

In Beaulne v. Ellenor, the Alberta Court of Appeal held that the defendant vendor was liable for an error in substantialibus for failing to disclose to the plaintiff purchaser that the septic tank on the property was unusable and was pumping human waste onto the property. The Court of Appeal held that the plaintiff was entitled to rescission of the purchase agreement or to damages equivalent to the cost of repairing the sceptic tank.

In American National Red Cross v. Geddes Brothers, the Supreme Court of Canada put the plaintiff to an election between rescission or damages when the defendant was unable to deliver goods pursuant to an agreement.

The Rescission Remedy in Other Statutes In Peel Condominium Corp. No. 505 v. Cam-Valley Homes Ltd., the Ontario Court of Appeal had to determine whether the defendant provided proper disclosure to the plaintiff pursuant to section 52 [now section 74] of the Condominium Act . The defendant developer marketed a condominium project designed around an outdoor recreation area that was to be conveyed to the condominium corporation once the development of the condominiums were completed. The developer later decided to develop the outdoor recreational area due to changes in the economy. The condominium corporation commenced an action claiming, inter alia, a lack of adequate disclosure. The trial judge enjoined the developer from developing the outdoor recreational area and the developer appealed the trial decision. Justice Finlayson, speaking for the majority, dismissed the claim against the developer and held, in obiter dictum, that “the remedy for inadequate disclosure in an appropriate case is either rescission or damages”.

Legislation in Ontario either expressly, or through interpretation, requires an applicant to elect between either the remedy of rescission or damages.

Purpose of the Election The purpose of the election is to prevent inconsistent remedies which would permit double recovery by the plaintiff. The equitable remedy of rescission provides the plaintiff with restitution as it restores the plaintiff to his or her pre-contractual position. On the other hand, damages are intended to place the plaintiff in the position that he or she would have been in but for the breach of contract.

Application of the Principle of Election to the Arthur Wishart Act The decision of the Court of Appeal in Dig This Garden is contrary to the established application of the remedy of rescission in Canada. The Court permits a franchisee to rescind an agreement while at the same time seeking damages without ever having to elect between the two remedies.

Section 6 of the Act is in itself a complete remedy for a franchisee who has failed to receive the proper disclosure required by section 5 of the Act. Subsections 6(1) and (2) permit a franchisee to rescind a franchise agreement which puts an end to the relationship between the franchisee and franchisor. Furthermore, subsection 6(6) permits the franchisee to receive compensation to put him or her back into the same position that he or she would have been in but for the franchise agreement. Section 6 of the Act provides complete and total restitutio in integrum for the franchisee, therefore, there is no need for a court to refer to or rely upon section 7 of the Act.

Section 7 of the Act, on the other hand, provides the franchisee with an altogether different remedy and for altogether different reasons. Whereas, section 6 provides for strict liability, section 7 requires proof of causation and harm (loss). It is entirely inappropriate for the court to “back door” the agreement by finding harm under section 6. That is not the intention of section 6 and it does not satisfy the plain wording of section 7. The purpose of section 7 is to provide the franchisee with a remedy in situations where the remedy of rescission is not available (i.e. more that two years has elapsed since the execution of the franchise agreement) or where rescission is not desirable (i.e. where the franchisee wants to continue to operate the franchise). Section 7 is akin to the plaintiff who affirms the contract and seeks damages in a case involving a fundamental breach of contract.

The Court’s finding that a franchisee may elect to receive rescission and damages is problematic. For example, a franchisee may rescind an agreement and actually receive compensation pursuant to section 6(6) within 60 days as required, however, the franchisor is left with the uncertainty that it may be sued for damages as well, pursuant to section 7, despite the fact that the franchisee has been made “whole”. The franchisee would be receiving double recovery. There is no evidence that the Legislature intended to apply the principles involving statutory rescission in any manner that is different from the principles in common law and equity. There is no jurisprudence, including Stephan, supra., that would suggest that statutory rescission ought to be applied to include the right of double recovery. The Court of Appeal’s decision will effect much more than franchisors as many other Ontario statutes, such as the Securities Act and the Condominium Act, provide for statutory rescission as well.

The proper interpretation of the Act is that a franchisee has the right to sue for rescission under subsections 6(1) and (2), with the right to compensation under subsection 6(6), and for damages under section 7, however, the franchisee must elect which remedy he or she wants at the time of trial. There are obvious benefits to electing either remedy, for example, the remedy of rescission under section 6 permits the franchisee to end his or her relationship with the franchisor, on the other hand, the remedy of damages under section 7 continues the relationship of the parties, however, it permits the franchisee to seek damages from additional defendants, such as the franchisor’s agent, broker or anyone who signed the disclosure document.

This interpretation is consistent with other courts interpretation of the Act. In Ahmed v. 3 for 1 Pizza and Wings (Canada) Inc., Justice Ground held that the franchisor did not comply with section 5 of the Act, therefore, he rescinded the franchise agreement and awarded compensation pursuant to subsection 6(6). As stated earlier, in 1368741 Ontario Inc. v. Triple Pizza, Justice Pitt rescinded a franchise agreement and awarded compensation pursuant to subsection 6(6) of the Act.

The remedy that the applicant was seeking in Dig This Garden was available under section 6 of the Act. The franchise agreement may be rescinded for the failure to comply with section 5 of the Act and the franchise associates may be held liable for any compensation awarded pursuant to subsection 6(6).

More information. For more information on franchising in Canada, the United States and internationally, please contact Peter Macrae Dillon, head of Siskinds Franchise Law Group. Peter is the author of the annotated Ontario Franchise Disclosure Act and the annotated Alberta Franchises Act and over 30 other publications on the subjects of franchising, licensing and distribution. He is licensed in Ontario and New York. Peter can be contacted at 800-816-9596 ext. 7818 or by email at peter.dillon@siskinds.com. Please visit our website at www.franchiselaw.ca The information contained in this note is for general reference only, and should not be relied upon as constituting legal advice.

peter macrae dillon franchise franchisor franchising lawyer attorney Toronto Ontario Canada

Rescinding Your Franchise Agreement - To learn more about this author, visit Peter Macrae Dillon's Website.

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