DATE: 20020416 DOCKET: M28458

COURT OF APPEAL FOR ONTARIO

IN CHAMBERS

IN THE MATTER OF THE COMPANIES’ CREDITORS ARRANGEMENT ACT, R.S.C. 1985 C.c-36, AS AMENDED

AND IN THE MATTER OF THE COURTS OF JUSTICE ACT, R.S.O. 1990, C.c.-43, AS AMENDED

AND IN THE MATTER OF A PLAN OF COMPROMISE OR ARRANGEMENT OF COUNTRY STYLE FOOD SERVICES INC., COUNTRY STYLE FOOD SEVICES HOLDINGS INC., COUNTRY STYLE REALTY LIMITED, MELODY FARMS SPECIALTY FOODS AND EQUIPMENT LIMITED, BUNS MASTER BAKERY SYSTEMS INC. and BUNS MASTER BAKERY REALTY INC.

APPLICATION UNDER THE COMPANIES’ CREDITORS ARRANGEMENT ACT, R.S.C. 1985 C.c-36

COUNSEL:

Craig R. Colraine and Mitchell D. Goldberg for Tozeng Limited, 1124019 Ontario Ltd. and 665371 Ontario Ltd. (applicants)

Joanna Board for 1304271 Ontario Limited and 995804 Ontario Inc. (supporting the applicants)

Patrick J. O’Kelly and Ashley J. Taylor for Country Style (respondent)

Frank J.C. Newbould Q.C. for the Bank of Nova Scotia (respondent)

Mahesh Uttamchandani for CAI, DIP Lender (respondent)

HEARD:

April 15, 2002

FELDMAN J.A.:

1. [1] This is an application for leave to appeal the order of Spence J. made on March 7, 2002, whereby he sanctioned a Plan of Arrangement (the “Plan” under the Companies’ Creditors Arrangement Act, R.S.C. 1985, c.C-36 (“CCAA”) for the respondent, Country Style Group of Corporations. The application is brought under s. 13 of the CCAA which provides:

s. 13 Except in the Yukon Territory, any person dissatisfied with an order or a decision made under this Act may appeal therefrom on obtaining leave of the judge appealed from or of the court or a judge of the court to which the appeal lies and on such terms as to security and in other respects as the judge or court directs.

2. [2] The application was originally brought before Spence J. but as he was unable to hear it before April 16, 2002, the date scheduled for the closing of the plan transaction, he suggested that the application be brought to this court.

3. [3] All three applicants are Country Style franchisees. Only one, Tozeng Limited, is also a creditor that filed a proof of claim and voted in the proceeding.

4. [4] The applicants concede that on the record before him, Spence J. did not make any error in approving the Plan which was approved by a substantial percentage of the unsecured creditors and by the secured creditor. In fact, no one opposed the approval of the plan at the sanction hearing. The basis for this application is that immediately after the hearing approving the Plan, the applicants became aware of facts which they say vitiate the approval process in three ways:

(1) Over a period of time, some franchisees had contributed to Country Style’s national advertising fund while others had not. The applicants claim that to the extent that some franchisees thereby overcontributed, they were entitled to claim as creditors against the company for unjust enrichment in the Plan process. However, because they did not know about the overcontribution and unequal treatment until it was too late to claim in the plan process, they have been denied both the amount of their claim and the opportunity to vote for or against the Plan and to participate in the process.

(2) The company was offering improper incentives to creditors to vote for the Plan.

(3) The Monitor was in a conflict of interest.

5. The applicants rely on fresh evidence in order to assert these claims and rely on s. 134(4) of the Courts of Justice Act R.S.O. 1990, c.C-43, which allows a court in a proper case, to accept fresh evidence. In R. v. Palmer, 1979 8 (SCC), [1980] 1 S.C.R. 759 at 775, the Supreme Court of Canada set out four criteria for the admission of fresh evidence on appeal, summarized as follows:

(1) by due diligence, the evidence could not have been adduced in the proceeding below;

(2) it is relevant to a decisive or potentially decisive issue;

(3) it is reasonably capable of belief;

(4) if believed, it may reasonably have affected the result.

6. [5] The respondents object to the admission of the fresh evidence on this application and rely heavily on the assertion that the first criterion, due diligence, has not been met in this case. They also suggest that the record discloses that Mr. English, the principal of Tozeng Limited, did know about the differential treatment of franchisees as long as one year ago.

7. [6] Mr. O’Kelly on behalf of Country Style, points to the fact that a creditor, Tarragon Mercantile Inc., did propose to oppose the sanction order until an out-of-court settlement was reached on the evening before the sanction motion. Tarragon filed a motion record with the court that contained affidavits outlining some of the allegations on which the applicants now rely (in particular, the alleged irregularities with the proxy solicitation process and the alleged conflict of interest of the Monitor) and raised other matters as well. I am told that Spence J. was advised on the return of the motion that Tarragon was withdrawing its opposition. The plan was thereupon sanctioned by the court. I am advised that no one opposed the order.

8. [7] Mr. O’Kelly’s submission is that because Tarragon was in a position to find out the information necessary to bring forth some of the allegations now asserted by the applicants, the applicants could have done so as well had they exercised due diligence. In my view, on the face of it, there is merit in that submission.

9. [8] The one issue which is not fully detailed in the Tarragon material is the national advertising fund issue. However, the information relied on in respect of the fund is contained in an affidavit of Catherine Mauro dated March 25, 2002 and filed on this application. She is the former director of marketing and product development who was terminated by Country Style on February 4, 2002. Ms Mauro also provided one of the affidavits which is included in the Tarragon material. Again, therefore, it appears that the applicants could have discovered further information from Ms. Mauro prior to the March 7 hearing had they acted with due diligence in speaking with her.

10. [9] Even more significant, however, is the fact that in his affidavit filed in connection with the original material seeking court protection, Mr. Gibbons, the President of Country Style, disclosed as part of his description of the financial status of the debtor companies that one of the historical responses by management when a franchisee developed financial difficulties was “deferring or accepting reduced royalty, advertising and/or sign rental payments for a period of time” (affidavit para. 37). This information was also included in the Management proxy circular which was sent out to all creditors, of which Mr. English was one.

11. [10] The applicants’ position is that until they talked to Catherine Mauro after the sanction hearing, they did not know that some franchisees were not paying the full 3.5% of monthly gross sales to the national advertising fund, and that the 13 corporate stores, taken over from failed franchisees, paid nothing into the fund. The applicants also take the position that the company and the monitor made it impossible for the franchisees to learn of this by failing to disclose it to the franchisees. Their evidence is that representations were made to franchisees by senior management that all franchisees paid the same percentage of their sales into the national advertising fund.

12. [11] However, it appears that there was disclosure of the differential treatment of franchisees in respect of the advertising fund in Mr. Gibbons’ affidavit and the Management circular. Counsel also pointed out that franchisees could ask to be added to the service list for all of the documentation and that some were added, including Ms. Board’s clients who have been represented by her here in support of the application.

13. [12] I conclude, based on the material currently before the court, that it cannot be said that there was non-disclosure of the differential treatment of franchisees in respect of the contribution to the national advertising fund, or that the applicants could not have discovered this evidence if they had exercised due diligence. Although it appears that the potential significance of the different contributions as a possible claim against Country Style based on unjust enrichment, may not have been considered by the applicants until after the sanction motion, a failure to appreciate the significance of information does not meet the due diligence test.

14. [13] Finally, the respondents point to the fact that Mr. English has deposed that in May 2000, he sought and obtained differential treatment in respect of the royalty fees he was paying and that he has been trying to retain the so-called “tiered store” status for his stores which allows them to pay lower fees. Therefore, Mr. English was aware of differentiation among franchisees in respect of some of the amounts payable to the franchiser and wanted to preserve that differentiation when it benefited him. The respondents say this shows that the new evidence should not be accepted and that furthermore, there is no merit to the suggestion that the franchisees have any claim against the debtor company based on alleged overpayments. As a result, they argue that the new evidence would not have affected the outcome of the sanction hearing had it been available at that hearing.

15. [14] I am satisfied that I need not deal with this part of the submission on this motion, as the due diligence criterion is not met.

16. [15] Even if the fresh evidence met the test for admission, which it does not on the due diligence criterion, the court must be satisfied that this is a case where leave to appeal ought to be granted. The jurisprudence in this area dictates that leave to appeal in CCAA proceedings should be granted sparingly: Re Consumers Packaging Inc. (2001), 2001 6708 (ON CA), 27 C.B.R. (4th) 197 at 199 (Ont. C.A.); Re Blue Range Resources Corp. (1999), 1999 ABCA 255, 12 C.B.R. 186 at 190 (Alta. C.A.). In order to grant leave the court must be satisfied that there are “serious and arguable grounds that are of real and significant interest to the parties”: Re Multitech Warehouse Direct Inc. (1995), 1995 ABCA 304, 32 Alta. L.R. (3d) 62 at 63 (C.A.). This is determined in accordance with a four-pronged test as follows:

(a) whether the point on appeal is of significance to the practice;

(b) whether the point is of significance to the action;

(c) whether the appeal is prima facie meritorious or frivolous;

(d) whether the appeal will unduly hinder the progress of the action.

17. See Blue Range Resource Corp., supra at 190; Cineplex Odeon Corp. (2001), 2001 32746 (ON CA), 24 C.B.R. (4th) 201 at 202 (Ont. C.A.)

18. [16] As I understand it, the main issue on appeal is the submission that the applicant franchisees and other franchisees, some of whom have filed affidavits in support, over-contributed to the national advertising fund in relation to other franchisees and the company in connection with its corporate stores. This overcontribution entitled them to make a claim against the company for unjust enrichment. However, because they did not know about this potential claim until after the sanction hearing, they did not file claims in the process; they therefore did not have the right to participate as unsecured creditors, and they did not have the right to vote for or against the Plan.

19. [17] Counsel for the applicants concedes that there is no evidence in the record to demonstrate that had the affected franchisees made claims and voted, the Plan would have been defeated or amended in any way.

20. [18] Counsel also concedes that no alternative plan has been proferred at any stage. He suggests, however, that because of the circumstances set out, the Plan cannot be considered fair and reasonable. The Monitor has made it clear in its reports that the only alternative to the Plan is bankruptcy or receivership, whereunder there would be nothing for the unsecured creditors. Counsel suggested in argument that his clients would be prepared to see the debtor company go bankrupt rather than proceed with the sanctioned Plan. There is no affidavit evidence to this effect, and I frankly find it hard to accept that franchisees with viable operations would prefer to see the corporate entity with which they are associated be liquidated in a bankruptcy or receivership.

21. [19] Based on the record, there is nothing to suggest that the Plan as sanctioned and approved by the court is not “fair and reasonable.” If leave to appeal is granted, the progress of the action will clearly be hindered and the restructuring may not go ahead at all. If the appeal were to be successful and the process reopened, the applicants do not propose any alternative to the plan, so that the significance to the action appears to be procedural but not substantive.

22. [20] For all of these reasons, the applicants have not satisfied the test for the court to exercise its discretion to grant leave to appeal.

23. [21] During argument, counsel for the applicants suggested that one of the problems facing his clients is that they owe money to the debtor company, but are not able to make a claim against the company in respect of the overpayment into the advertising fund because of the orders made in the CCAA process. In response, counsel for Country Style took the position that s. 18.1 of the CCAA preserves the applicants’ ability to assert a right of set-off against the company in respect of their claims against any monies which they may owe to the company. In other words, their claims against the company are not necessarily barred.

24. [22] As this was not an issue for resolution on this leave to appeal motion, I make no comment on (1) the effect of s. 18.1 of the CCAA on post- Plan claims by or against the debtor company; or (2) on the effect of the claims bar order in respect of claims by people who were not listed or served as creditors in the proceeding, or people who did not know that they had claims against the company.

25. [23] Finally, I note that the franchisees as a group were not considered to be people to be officially served with and included in the CCAA process. I was advised by a representative of the Monitor who was present in court for this appeal, that Mr. Gibbons did send a letter to all franchisees enclosing the original stay order and advising them of the Monitor’s website where much of the CCAA material would be posted. Although the process under the Act contemplates the participation and protection of creditors, the debtor company, and possibly the shareholders, in cases where the debtor company is a franchisor, the franchisees may have an interest in the ultimate structure of the franchise operation as proposed by the Plan process. It may therefore be appropriate where a franchisor seeks CCAA protection, to consider whether the franchisees ought to be given notice of the proceedings and the opportunity to request the ability to participate on an appropriate basis.

CONCLUSION

26. [24] Leave to appeal is denied.

Signed: “K. Feldman J.A.”