ONTARIO
SUPERIOR COURT OF JUSTICE
COURT FILE NO.: CV-12-470106
DATE: 20130621
BETWEEN:
PRIMA JAVA INC.
Applicant
– and –
JAVA JOE’S FRANCHISE SERVICES INC., JAVA JOE’S INC., COSTA KIRIAKOPOULOS and PETER KIRIAKOPOULOS
Respondents
Michael Kleinman, for the Applicant
Arnold Zweig, for the Respondents
HEARD: April 29, 2013
R. F. GOLDSTEIN J.
[1] Java Joe’s is a chain of coffee franchises. The Respondent Java Joe’s Franchise Services Inc. is the franchisor (“the Franchisor”). The Respondents Costa and Peter Kiriakopoulos are directors of the Franchisor and father and son. In September 2011 the Applicant purchased an existing franchise from a third party. During the course of the negotiations the principals of the Applicant, Min and Walker Liu, received a disclosure document from the Franchisor. On closing the Applicant signed a franchise agreement. It did not take long for the relationship between the Applicant franchisee and the Franchisor to deteriorate. As a result, the Applicant now seeks a declaration that the franchise agreement is rescinded, as well as damages. The Applicant is no longer in the premises, and the franchise agreement is effectively dead.
[2] Normally, when a prospective franchisee buys a franchise, the franchisor must provide a disclosure document. The disclosure document must contain a statement of material fact, financial statements, and other important documents. If the franchisor does not comply with the disclosure rules, a franchisee can obtain an order rescinding the franchise agreement, damages, and other compensation.
[3] The governing legislation in Ontario, the Arthur Wishart Act (Franchise Disclosure), 2000, S.O. 2000, c. 3, contains exceptions to the disclosure rules. One of the exceptions is where “the grant of the franchise is not effected by or through the franchisor”. The Applicant argues that the Respondent failed to make full disclosure, and that at the time of closing of the purchase there were so many conditions imposed by the Respondent that the grant of the franchise was “effected” through it. The Respondent takes the opposing position, arguing that the Applicant purchased the property from a third party and that it played only a minimal role.
[4] Exemptions to the disclosure requirements of the Wishart Act are to be narrowly construed, and the burden of proving an exemption is on the party seeking to invoke it. In my view, there are important material facts in issue engaging credibility issues that cannot be resolved by a judge sitting on an application. Accordingly, the application will be converted into an action. In my opinion this is the only way to meet the remedial objectives of the legislation while being fair to both parties. There is an outstanding action by the Franchisor against the Applicant. I leave it to the parties whether they wish to consolidate or otherwise join the actions.
FACTS
[5] On September 15, 2011 Min Liu and Walker Liu entered into an agreement of purchase and sale for the Java Joe’s Café at #5-2325 Matheson Boulevard East in the City of Mississauga. The purchase price was $245,000.00. The Lius agreed to purchase the assets and business, including the vendor’s rights under the lease of the business premises. The Liu’s later incorporated the Applicant for the purpose of closing the deal and operating the business.
[6] In her affidavit, Min Liu states that she and her husband, Walker, met on a number of occasions with Costa Kiriakpolous and Peter Kiriakopolous. She states that the Kiriakopoulos’s “presented us to the franchised business, acquired our identifications, and handed over the franchise agreement, etc.” In his cross-examination on his affidavit, Costa Kiriakopolous indicated that he and Peter met with the Lius, took identification, and explained to them how the business would run. He stated that they did not pressure the Lius into taking the deal.
[7] On or about September 27, 2011, the Franchisor provided a disclosure document to the Applicant. The next day, September 28, 2011, the solicitor for third party vendor wrote to the Franchisor requesting consent to the sale. On September 29, 2011 the Peter Kiriakopolous, the vice president of the Franchisor, wrote to the third party approving setting out conditions for the sale. The conditions were:
Franchise Agreement with schedules to be executed on date of closing of sale of above location;
Sublease Agreement to be executed on date of closing of sale of above location;
Indemnity Agreement to be executed on date of closing of sale of above location;
A deposit of $6,000.00 CAD + HST for last month’s rent made on date of closing to Java Joe’s Franchise Services Inc. via certified cheque, payable on date of closing;
Payment of $5,000.00 + HST ($650.00), CAD made prior to beginning of training via certified cheque to Java Joe’s Franchise Services Inc. for training;
All utilities and applicable accounts are turned over in your name (hydro, gas, telephone, municipal licenses, suppliers, etc.);
Assumption of lease agreement with POS system equipment supplier and Micros yearly services;
Business insurance transferred into your name;
Provision of information to alarm system monitoring services.
[8] There is no evidence of any negotiation over these conditions, or that any further conditions were imposed. The Applicant had counsel to represent it in dealing with the third party. Costa Kiriakopolous deposed that he and Peter did not have a part in the negotiations as between the Applicant and the third party vendor. Min Liu states the opposite in her affidavit.
[9] The deal closed on October 7, 2011. The Lius executed the franchise agreement on behalf of the Applicant, as well as the sublease and an indemnity agreement. The Applicant began to operate the franchise, pay royalties, and pay rent.
[10] Problems began to develop between the Franchisor and the Applicant almost immediately. On June 20, 2012 the Franchisor delivered a Notice of Default to the Applicant and the Lius alleging various breaches of the franchise agreement and demanding rectification. On July 26, 2012, the Franchisor issued a statement of claim seeking a declaration that the franchise Agreement was terminated, on order enforcing the termination provisions of the franchise agreement, and damages. On July 27, 2012, the Applicant delivered a Notice of Recission under the Wishart Act, setting out alleged breaches by the Franchisor and demanding damages. The Applicant and the Lius filed a statement of defence in September, 2012. This Application was issued on December 14, 2012.
ANALYSIS
[11] There are three issues to be determined:
- Was the purchase of the franchise effected by or through the Franchisor?
- Is the Applicant entitled to recission of the franchise agreement?
- Is the Applicant entitled to damages?
- What is the appropriate remedy?
[12] If the purchase of the franchise was not effected by or through the Franchisor, then it is unnecessary to answer the second and third issues.
1. Was the purchase of the franchise effected by or through the Franchisor?
[13] The Applicant’s position is that the Franchisor did not play a passive role in the sale of the franchise. The Applicant says that additional costs and obligations were involved, so as to trigger the Franchisor’s disclosure obligations under the Wishart Act. The Applicant says that the disclosure document provided by the Franchisor was inadequate in multiple respects. Since the disclosure document did not comply with the Wishart Act, the Applicant is entitled to recission of the franchise agreement and damages.
[14] The Wishart Act is designed to promote fair dealing as between a franchisor and a franchisee, prevent the exploitation of franchisees, and ensure that potential franchisees are fully informed about the costs and benefits of purchasing a franchise. This purpose is reflected in s. 3(1), which is imposes a duty of fair dealing in the performance and enforcement of any franchise agreement. As Winkler C.J.O. stated in Salah v. Timothy’s Coffees of the World Inc., 2010 ONCA 673, [2010] O.J. No. 4336, 268 O.A.C. 279, 74 B.L.R. (4th) 161 (C.A.):
26 … The Wishart Act is sui generis remedial legislation. It deserves a broad and generous interpretation. The purpose of the statute is clear: it is intended to redress the imbalance of power as between franchisor and franchisee; it is also intended to provide a remedy for abuses stemming from this imbalance.
[15] The purpose of the Wishart Act is reflected in the disclosure requirements. A prospective franchisee must receive a disclosure document not less than 14 days before the earlier of the signing of the franchise agreement or any other document relating to the franchise; or payment by the franchisee to the franchisor or franchisor’s associate relating to the franchise. Section 5(4) sets out the contents that every disclosure document is required to contain:
- (4) The disclosure document shall contain,
(a) all material facts, including material facts as prescribed;
(b) financial statements as prescribed;
(c) copies of all proposed franchise agreements and other agreements relating to the franchise to be signed by the prospective franchisee;
(d) statements as prescribed for the purposes of assisting the prospective franchisee in making informed investment decisions; and
(e) other information and copies of documents as prescribed.
[16] Section 5(7) sets out the exemptions to the disclosure requirements. The key provisions in this case are s. 5(7)(a)(iv) and 5(8):
- (7) This section does not apply to,
(a) the grant of a franchise by a franchisee if,
(iv) the grant of the franchise is not effected by or through the franchisor…
(8) For the purpose of subclause (7) (a) (iv), a grant is not effected by or through a franchisor merely because,
(a) the franchisor has a right, exercisable on reasonable grounds, to approve or disapprove the grant; or
(b) a transfer fee must be paid to the franchisor in an amount set out in the franchise agreement or in an amount that does not exceed the reasonable actual costs incurred by the franchisor to process the grant.
[17] The onus of proving that an exemption under the Wishart Act applies falls on the person claiming it: s. 12.
[18] In 2189205 Ontario Inc. v. Springdale Pizza Depot Ltd., 2011 ONCA 467, [2011] O.J. No. 2821, 336 D.L.R. (4th) 234 the Court of Appeal considered the exemption in s. 5(7)(a)(iv) of the Wishart Act. The franchisee contacted the franchisor’s head office in order to acquire a franchise. They directed the franchisee to a restaurant that was already for sale. The franchisee purchased the existing franchise. The franchisee essentially stepped into the shoes of the vendor existing franchisee, although the franchisor required that the new franchisee sign two additional documents. Karakatsanis J.A. (as she then was) for the Court of Appeal found that given the purpose and context of the Wishart Act exemptions to the disclosure rules must be “narrowly construed”. She then analyzed the use of the verb “effect” in s. 5(7)(a)(iv) of legislation. She stated:
33 The Concise Oxford English Dictionary defines the verb "effect" as "cause to happen, bring about": Concise Oxford English Dictionary, 11th ed., sub verbo "effect". Taken together, the language of ss. 5(7)(a)(iv) and (8) exempt a franchisor from its disclosure obligations only when the franchisor is not an active participant in bringing about the grant and does nothing more than "merely" exercise its rights to consent to the transfer. In such circumstances, the power imbalance does not bear upon the decision to become a franchisee and plays no role in effecting the grant.
[19] After reviewing the cases, Karakatsanis J.A. stated:
42 In this case, the franchisor directed the prospective vendor to this particular business. The franchisor had detailed financial information about all franchises and the right of first refusal. Further, the franchisor had some involvement in the negotiations for the agreement of purchase and sale of the assets of the business. As noted above, all of the parties of this action negotiated together to bring about the sale of the vendor's business to the respondents and for the respondents to become a franchisee of Springdale as a result. Furthermore, the agreement of purchase and sale required the respondents to obtain the consent of the franchisor, and thus deal directly with the franchisor. In conclusion, the franchisor was directly involved with the respondents in the purchase of this business. The franchisor was not merely a passive participant in this resale.
[20] I analyze this issue in this manner: what level of involvement by the franchisor constitutes “effecting” a sale or transfer so as to trigger the exemption? It is clear that on one end of the spectrum, merely requiring consent, is not enough. It is equally clear that where the franchisor is more than a passive participant in the resale and is directly involved that it cannot rely on the exemption. Where does this case lie?
[21] In 1518628 Ontario Inc. v. Tutor Time Learning Centres LLC, 2006 25276 (ON SC), [2006] O.J. No. 3011, 2006 CarswellOnt 4593 (Sup.Ct.) the plaintiff purchased an existing franchise. The franchisor was a United States corporation and had a network of tutoring centres in the United States. The plaintiff purchased the only Canadian franchise. The franchisor provided a disclosure document that complied with relevant U.S. federal and state laws, although it pointed out to the plaintiff that the U.S. disclosure document did not comply with the Ontario requirements under the Wishart Act. When the business failed the plaintiff sought recission of the franchise agreement. The franchisor argued that disclosure was not necessary because the sale of an existing franchise was not effected by or through the franchisor. Cumming J. found that the exemption did not apply. The spouse of the principal of the plaintiff, who was not a director or officer, was required by the franchisor to sign a personal guarantee. Cumming J. found that by imposing this condition the sale was effected by or through the franchisor.
[22] Whether or not the Franchisor has met the burden of bringing itself within the exemption is, in the circumstances of this case, a question of fact that largely turns on issue of credibility. At first blush, the Franchisor’s actions appear to lie closer to the passive participant end of the scale. The Franchisor did not impose any additional conditions on the Liu’s beyond execution of the standard agreements. The Franchisor did not require that the Lius pay a transfer fee, although it could have demanded one. Other than requiring the execution of the Franchise Agreement, the Sublease Agreement, and the Indemnity Agreement – routine documents that any franchisee would have had to execute – there is no evidence that the Franchisor required much beyond that. That said, the Franchisor certainly did meet with the Lius, had discussions with them, and imposed at least some conditions. For that reason, I am simply unable on this record to say that whether the Franchisor has met the burden.
2. Is the Applicant entitled to recission of the franchise agreement?
[23] There is no question that a failure to make disclosure as required by the Wishart Act results in an unconditional right to recission of the franchise agreement: Personal Service Coffee Corp. v. Beer, 2005 25180 (ON CA), [2005] O.J. No. 3043, 256 D.L.R. (4th) 466 (C.A.).
[24] Since I have concluded that the appropriate result of this application is to convert it into an action, it is not necessary to decide this issue. For the sake of completeness, however, whether or not there was disclosure at the level demeanded by the Wishart Act is also factual question that depends to a certain degree on credibility. The following facts bear on the analysis:
• A disclosure document that is provided must be done so as a single document: 1490664 Ontario Ltd. v. Dig This Garden Retailers Ltd., 2005 25181 (ON CA), [2005] O.J. No. 3040, 256 D.L.R. (4th) 451 (C.A.) at paras. 18-19; 6792341 Canada Inc. v. Dollar It Ltd., 2009 ONCA 385, [2009] O.J. No. 1881, 95 O.R. (3d) 291 (C.A.) at paras. 16-17, 20. It appears that documents were provided to the Applicant piecemeal.
• In the cross-examination on his affidavit, Costa Kiriakopolous agreed that sales figures for the franchise were not provided to the Applicant as part of the disclosure document. In fairness, Mr. Kirakopolous took the position that since the exemption was available, he was not required to provide that information and that it was up to the Applicant to obtain it from the vendor of the franchise as part of their due diligence. That said, if the exemption does not apply then the disclosure was inadequate.
• It appears that two officers or directors of the Franchisor did not sign the disclosure document as required by the regulations to the Wishart Act. This requirement is not a mere formality, but is rather a substantive requirement designed to encourage full, fair, and frank disclosure: Hi Hotel Limited Partnership v. Holiday Hospitality Franchising Inc., 2008 ABCA 276, [2008] A.J. No. 892, 296 D.L.R. (4th) 335 (C.A.).
[25] It is common for franchisors to sign leases with landlords, and then sublet the premises to the franchisee. The franchisor then remains in control of the franchisee’s premises. The head lease, therefore, is an important document to a franchisee. The head lease is an issue in this case. The Applicant says that the head lease was never provided. In the franchise agreement, however, the Applicant also acknowledges having received the head lease. This is obviously a factual issue that must be resolved, and a credibility finding will be critical.
3. Is the Applicant entitled to damages?
[26] Given that I have decided to convert the application into an action, it is not necessary for me to decide this issue. Obviously if I had granted the application I would have assessed damages.
4. What is the appropriate remedy?
[27] Given that the critical issue in this case requires resolving factual issues based on based on credibility findings, and the secondary issue also brings credibility issues in play, the appropriate remedy is the conversion of the application into an action: Collins v. Attorney General of Canada, 2005 28533 (ON SC), [2005] O.J. No. 2317, 76 O.R. (3d) 228 (Sup.Ct.).
DISPOSITION
[28] The Application is converted into an action. The parties may prepare an appropriate draft order.
COSTS
[29] I would encourage the parties to settle the issue of costs. If they are unable to do so, they may each submit brief (no more than two pages) submissions and a costs outline.
R. F. Goldstein J.
Released: June 21, 2013
COURT FILE NO.: CV-12-470106
DATE: 20130621
ONTARIO
SUPERIOR COURT OF JUSTICE
BETWEEN:
PRIMA JAVA INC.
Applicant
– and –
JAVA JOE’S FRANCHISE SERVICES INC., JAVA JOE’S INC., COSTA KIRIAKOPOULOS and PETER KIRIAKOPOULOS
Respondents
REASONS FOR JUDGMENT
R. F. Goldstein J.
Released: June 21, 2013