When buying or selling an existing business, it is essential to ensure the potential buyer is aware of all information relevant to the sale. Sellers must also be mindful of additional requirements set out in industry-specific legislation.
This blog discusses a recent case where the seller of a franchise did not meet applicable disclosure requirements. This resulted in a hefty damages award after the buyer rescinded the agreement a year later.
Buyer wanted to acquire a news franchise
In 1901709 Ontario Inc. et al. v. Dakin News Systems Inc., two parties sought to strike a deal for one to acquire the franchise of another. The plaintiff, Mr. Tan, wanted to increase his income and found an opportunity in Mr. Ashtiani, who operated an International News franchise in Toronto and was looking to sell. The parties entered an Agreement of Purchase and Sale to transfer the franchise to Mr. Tan in trust (through his corporation, the other plaintiff, 1901709 Ontario Inc).
The sale would go through on the condition that the franchisor approved and the landlord consented to the lease being reassigned. The franchisor and landlord, Dakin News, agreed to the sale and had Mr. Tan sign a franchise agreement and a sublease agreement. Mr. Tan provided Dakin News with several fees.
Buyer tried to pull out of purchase a year later
Mr. Tan, through 1901709 Ontario Inc., operated the store from March 2014 to April 2015. In April 2015, he sought to rescind the franchise agreement. Mr. Tan wanted to recoup his losses because, he alleged, Dakin News had not provided him with adequate disclosure as required by the Arthur Wishart Act (Franchise Disclosure). Section 5 of that Act reads 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, other than an agreement described in subsection (1.1); 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, excluding the payment of a deposit if it,
(i) does not exceed the prescribed amount,
(ii) is refundable without any deductions, and
(iii) is given under an agreement that in no way binds the prospective franchisee to enter into a franchise agreement.
Dakin News responded that it did not believe any disclosure was required. Subsection 5(7) of the Arthur Wishart Act waives the disclosure requirement if a third party purchases the franchise from an existing franchisee. As a result, the central issue was whether Dakin News was required to provide disclosure to Mr. Tan and his trust company, 1901709 Ontario Inc.
Was the six-step approval process enough to fulfill disclosure?
In addition to the required approval by Dakin News of the sale of the franchise and assignment of the lease, Dakin News imposed a six-step procedure upon Mr. Tan’s company. The steps were as follows:
- “Email us the lawyers’ (the buyers’ and the seller’s) contact information which includes the name, address, telephone number, fax number and email address.
- Fax or email us a copy of the Purchase and Sale Agreement
- BUYER to provide the following information through the SELLER or its Solicitor:
- The last mortgage statement showing principle [sic], interest amounts and current balance outstanding
- Letter from financial institution confirming cash on hand, stocks, bonds, other investments, debts and loans
- Current credit card balances
- Articles of Incorporation listing of all shareholders and directors
- Completed Franchise application
- SELLER to provide a certified document (from your accountant) showing the total gross sales (which includes HST) for the last 12 months immediately preceding the transfer.
- BUYER to obtain a Bulk Sales Act from the SELLER through your lawyer to make sure all debts (the seller’s) have been settled before the transfer. This document does not have to be handed over to us. BUYER to have their lawyer do a “holdback” on the funds you are going to release to the SELLER to cover any rental adjustments that are still to come. The Landlord does not have the reconciled numbers until at least 3 to 9 months (in the majority of the cases) after the end of the current year.
When we receive all of the above to our satisfaction, the BUYER AND SELLER shall be contacted AND THE BUYER will be asked to come in for an interview.
- A transfer date will then be determined by Operations Department provided there are no more outstanding issues and all funds are in from both parties and the new Franchise and Sublease Agreements are signed.”
Rescission fee demanded from buyer after approval process completed
The plaintiffs completed all the steps on January 27, 2014. In July 2014, Mr. Tan received a letter from Dakin News advising of plans to rebrand the International News franchise. This would require payment of $75,000 in three installments for the refurbishment. Since the franchise agreement and sublease were set to expire in May 2015, Mr. Tan was obligated to accept this, even though 1901709 Ontario Inc. had already paid a renewal fee.
For this reason, the company issued its Notice of Recission in May 2015 under section 5 of the Arthur Wishart Act. Mr. Tan sought refunds of the purchase price, inventory and supply costs, losses incurred from the franchise’s acquisition, and damages under the Arthur Wishart Act.
Dealings between franchisor and new franchisees require disclosure
Under section 6(2) of the Arthur Wishart Act, a franchisee can rescind the franchise agreement without penalty if disclosure requirements are not met. The time limitation to do this is within two years of signing the franchise agreement. If Dakin News believed it to be exempt from disclosure requirements, it would have to prove this fact under section 12 of the Act.
While Mr. Tan’s initial contact with the franchise was through an existing franchisee, Mr. Ashtiani, the Ontario Superior Court found that the deal ultimately struck was with the franchisor, Dakin News. Dakin News required Mr. Tan to enter an entirely new agreement and sublease. It also demanded Mr. Tan pay an inventory fee of $20,000, even though Mr. Tan had purchased Mr. Ashtiani’s existing inventory. The Court found that the exemption set out in section 5(7) of the Arthur Wishart Act as Dakin News was the party that had effected the grant of the franchise. As a result, Dakin News could not use its existing franchisee to shield it from its statutory disclosure obligations.
The franchisor was obligated to pay the franchisee who rescinded the agreement
As a result of the above analysis, the Court concluded that Mr. Tan and 1901709 Ontario Inc. were entitled to rescind the franchise agreement under section 6(2) of the Arthur Wishart Act. The Court ordered that Dakin News and its associates were liable to pay 1901709 Ontario Inc. a sum of $32,048. This sum was to reimburse Mr. Tan and 1901709 Ontario Inc. for training, the security deposit, and royalties. The Court added $1,123 in damages for inventory costs. Finally, Mr. Tan and 1901709 Ontario Inc. were to be reimbursed $51,274 for the operating losses incurred.
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