Sandella’s Franchising LLC v. Fuller Landau et al., 2013 ONSC 4418

COURT FILE NO.: 10-CV44925-A1

MOTION HEARD: June 12, 2013

SUPERIOR COURT OF JUSTICE - ONTARIO

RE: 10-CV44925-A1

Sandella’s Franchising LLC v. Fuller Landau et al.

BEFORE: Master Joan Haberman

COUNSEL: Tompkins, D. for the moving party, Fuller Landau

Hartley, T. for the moving parties, Kestenbaum et al.

Lev-Farrell, A. for the moving parties, Gowlings et al.

Mayzel. D. for the responding party

ENDORSEMENT

Master Haberman:

[1] On June 12, 2013, I heard three motions for security for costs in this third party action, brought by each set of third parties against Sandella’s Franchising LLC (hereinafter referred to as “SFRAN”)

[2] I ruled in favour of Fuller Landau in court with reasons to follow and I reserved my decision regarding the other two sets of third parties.

[3] In the course of our discussions, counsel advised that they had set aside 7 days for examinations for discovery in the action, commencing on August 7. As I have three weeks’ of vacation in July and we are already in mid-June, counsel agreed that, in the interest of not having to reschedule these examinations, they would be content with an endorsement rather than detailed Reasons. In view of the number of parties involved, and the difficulty in arranging so much time for discovery of so many parties, my view concurs with theirs, hence the relative brevity of my reasons and my apologies for any typographical errors made in the interest of speed.

THE STORY

[4] The defendant, Michael Stimola, is the president and C.E.O. of SFRAN, a company that is 100% owned by the other co-defendant, Sandella’s LLC.

[5] 697 is a Canadian corporation. According to their pleadings, they responded to outreach from SFRAN, a Delaware based company, for an Ontario franchisee interested in taking on their restaurant franchise within this province. This was apparently SFRAN’s first fore into Ontario, or Canada, for that matter. The parties apparently reached an agreement.

[6] SFRAN has now been sued by 697 for $500,000 as a result of SFRAN’s alleged failure to comply with the Arthur Wishart Act (Franchise Disclosure), 2000, S.O. 2000, c. 3. Misrepresentation regarding a number of factors is also in the list of 697’s complaints.

[7] In view of the alleged deficient disclosure and misrepresentations, 697 rescinded the master franchise agreement by notice dated June 9, 2010, claiming damages on the basis that SFRAN has had the benefit of their efforts in arranging for the necessary insurance and obtaining real estate services.

[8] SFRAN’s defence goes in several directions. First, they claim they were not involved in the negotiations, which were all handled by a third party, Fransmart. Judging by the name, I assume it is a related corporation, but this was not discussed in evidence or raised in argument and nothing turns on it at this stage.

[9] SFRAN also claims that all of the disclosure provided to the Plaintiff contained all the material facts and was accurate, clear and concise. They deny that they were in breach of the agreement and they have counterclaimed against 697 for unjust enrichment.

[10] The main action goes beyond what SFRAN seeks from the third parties. SFRAN’s claim over is restricted to contribution and indemnity arising from alleged deficient or incomplete disclosure caused by negligent performance or oversight provided by the third parties in the course of making disclosure on their behalf.

[11] The third parties are a group of professionals engaged by or on behalf of SFRAN to assist them in setting up this franchise arrangement in Ontario. They were originally added to the action as defendants by counterclaim, but the pleadings were regularized in October 2012 to effectively convert their status to that of third parties.

[12] I will deal with the nature of the allegations as against each set of third parties when I deal with the merits but suffice it to say at this stage that SFRAN’s position, vis a vis the third parties, is essentially that they left all disclosure issues to them to arrange, so that if anything did go wrong, it was their fault and they should bear the loss.

THE MOTIONS

[13] Although it is not clear from their materials, it appears that all three sets of third parties moved pursuant to subrules 56.01 (a) and (d) , on the basis that (a) SFRAN is not ordinarily resident in Ontario and that (d) it is a shell corporation with no assets in this jurisdiction.

[14] SFRAN ultimately conceded both points and their response to all three motions is an unusual one. They claim neither that they have sufficient assets in the jurisdiction nor that they are impecunious. Instead they take the position the “just” order on these motions would be no order for security for costs because:

a) SFRAN is “incapable of posting” security for costs and may no longer be capable of financing its business and financing the litigation if required to post security;

b) The defendant, Sandella’s LCC, owns SFRAN and it has a non-fixed revenue stream in Ontario from its Yogen Fruz franchises;

c) Both co-defendants undertake (as stated in SFRAN’s factum, only) to pay any costs that may be ordered against SFRAN at the end of the day;

d) SFRAN has assets in Connecticut and that state is a reciprocal jurisdiction for the purpose of enforcement of judgements;

e) It would be unfair to require SFRAN to post security for costs in view of the fact that they are in this bind because of the third parties; and

f) There is merit in its claims against these third parties.

As items a) – e) are common to all three motions, I will deal with them first, weaving the evidence and the law together in each section. I will then examine the merits (item f) regarding each of the three sets of third parties and set out my conclusions, along with the order, with respect to each.

a) Is SFRAN incapable of posting security for costs?

[15] Whenever a party takes the position that the just order under Rule 56.01 is that no order requiring them to post security should be made, one of the things they must demonstrate to the court is why they are not able to post security for costs. They usually begin the process by asserting that they are impecunious and making full and detailed disclosure of their current financial picture, including production of source documents. In order to provide the court with the means of testing the strength of such an assertion regarding their financial status, a party who takes this position must be completely open and forthcoming with information as to the existence and real value of their assets and income, as well as the nature and extent of their liabilities and expenses.

[16] Similarly, where impecuniosity cannot be established, the evidentiary onus on the responding party is very high, as is the level of financial disclosure expected.

As I stated in Elliott v. Turbitt [2011] OJ No. 3116:

Where impecuniosity cannot be established and the respondent relies, instead, on hardship, again, it is up to him to demonstrate it with solid evidence, not simply a bald statement to that effect. A court must be able to review and assess the strength of the statement in the context of that person’s financial reality.

[17] Thus, in Pritchard v. Advante Solutions Inc.¸ [2005] OJ No. 2718, the master found against a responding party who sought to rely on his financially precarious position to avoid having to post security. In reviewing what little evidence was provided, the master concluded:

Finally, he does not say that if he must post security this action will come to a halt, only that it “may” affect his ability to continue.

[18] Similarly, in J.T. Stewart & Associates Inc. v. Cash, Lehman & Associates, [2005] O.J. No. 4234 the master stated:

In essence full and frank disclosure is required to persuade the court that an order for security for costs will necessarily bring the action to a halt. The shareholders have not made the level of disclosure and it is not sufficient to rely on the bald assertions of Ms. Stewart that this will be the result.

[19] In Uribe v. Sanchez, [2006] OJ No. 2370, the master stated that as the responding party’s financial worth is something that is solely within his knowledge, the onus is on him to provide the court with:

...supporting documents as to his income, expenses, assets and liabilities.

[20] Finally, in Morton v. Canada (Attorney General) 2005 6052 (ON SC), 2005, 75, OR (3d) 63, the court held that the financial evidence of the responding party must be set out with robust particularity”, leaving no “unanswered questions”. This was expressed as follows:

Full financial disclosure is required and should include the following: the amount and source of all income; a description of all assets (including value); a list of all liabilities and other significant expenses; and an indication of the extent of the ability of the plaintiff to borrow funds; and the details of assets disposed of or encumbered since the action arose.

[21] Financial disclosure is an even more detailed exercise when one is dealing with a corporate respondent. In that case, the responding party is required to look beyond the confines of its own coffers for help. Here, the court expects the responding party to canvas all possible persons with an interest in the outcome of the litigation for assistance and to explain to the court why they are unable to come to their aid before they seek to be exempted from the application of this Rule.

[22] The court discusses this onus and the policy behind the approach in Aviaco International Leasing v. Bowing Canada Inc. 48 CPC (4th) 366:

I believe the plaintiffs are correct that the use of the words “as is just” in Rule 56.01 does allow the court to have a consideration of the merits of the claim in determining whether there should be an order granting security for costs to be posted. Where I find myself in disagreement with the plaintiffs is the assertion, which is inherent in their position that it could be just not to require a corporate plaintiff, who has access to resources, to post security just because it has a meritorious claim. While accepting that anything is possible, it is difficult for me to conceive of circumstances where such a conclusion would be a just or appropriate result. Here, for example, we have plaintiffs who are advancing a claim for damages which, by any definition, involves a huge sum of money and whose principle shareholder is admittedly possessed of considerable resources such that it could allow the plaintiffs to post security if it so chose. In such circumstances, could it be said to be just to remove that requirement just because the plaintiffs may have a meritorious claim? I do not believe so.

[23] What the court is essentially saying here is that, regardless of how meritorious a claim may appear to be, if there are others in the picture who could post security where a responding party cannot or would find it a hardship do so to do so, those others who stand to benefit must come to the table with their cheque books.

[24] In view of the onus on these motions, all of the evidence demonstrating financial hardship should have been in SFRAN’s responding record. In fact, there was very little there at all regarding even their own financial circumstances and the financial status of most of its principals was ignored.

[25] In paragraph 32 of his affidavit, Stimola states that SFRAN has:

...no assets or income. Its liabilities far exceed it profits.

[26] According to Stimola’s affidavit, for the past several years, Sandella’s LLC has been lending money to SFRAN to enable it to meet its liabilities without having to resort to bankruptcy or reorganization.

[27] In paragraph 33, we are told that SFRAN is in a precarious financial position and that it is unable to post security for costs. An order to the effect that it must post security for costs will likely result in the Defendants all having to declare bankruptcy or file for reorganization.

[28] The details of SFRAN’s position are set out in paragraph 34. We are told that SFRAN has made no profits in either Canada or the US in the past three years, and that it has had net losses from 2012 onwards. They also state that their assets have declined steadily over the course of those three years while their liabilities have risen.

[29] SFRAN completes this picture by referring to the out-of-court settlements they have had to make in the US arising from litigation involving three of their franchise arrangements there.

[30] No details regarding any of these assertions are provided in the evidence filed by Stimola on behalf of SFRAN, nor does he say who prepared the documents he appends to illustrate his points, or when they were prepared.

[31] Starting with SFRAN’s “profit and loss” sheet, this appears to show quarterly income and expenses from January 2010 on. According to this material, the fee income for January – March 2010 was $300,000, but it then stopped completely. No explanation is provided.

[32] Similarly, franchise royalties were $57,307 for the last quarter of 2010 and these stopped abruptly, too – again, without explanation. For all intents and purposes, SFRAN does not appear to have carried on any business at all from 2011 onward.

[33] Despite that, they incurred creative and marketing expenses in excess of $1000 for the last quarter of 2010, along with travel and entertainment expenses in excess of $1600. Throughout the entire period, their litigation expenses have gone up and down.

[34] The next document provided is SFRAN’s balance sheet for each year from 2010 to 2012. No effort was made to show current status, either by way of first quarter results, projections or otherwise.

[35] There is no explanation for why the company’s assets in their Wachovia checking account went from $17,075 in 2010, down to $4,478 in 2011 and then back up again to $7,748 in 2012 when the company was not doing business.

[36] The balance sheets show interest receivables of over $42,000 for 2010 and 2011, which are no longer listed for 2012. Was that amount collected or written off? No explanation is provided.

[37] Although Stimola states in his affidavit that SFRAN has stayed afloat as a result of loans from Sandella’s LLC advanced over the past several years, there is no reference to any such loans until the 2012 balance sheet, which shows a loan of $90,520, so where did the money loaned to SFRAN from Sandella’s LLC go and why was none of it recorded until 2012?

[38] Again, though Stimola suggests that liabilities have steadily increased over the course of the last few years due to settlement of law suits in the US, only the 2012 balance sheet shows payments made towards litigation.

[39] The third document produced is not even identified on its face, aside from the words “franchise loan repay”. It appears to be a schedule of payments made or to be made from January 2013 - 2016 towards settlement of the three US law suits, as well as legal bills for two of them. The total amount paid and projected (this does not include legal bills past May 2013) is $220,805.

[40] Although other documentation was produced in response to undertakings given in the context of cross-examination, the minimal disclosure voluntarily made by SFRAN at the outset of this process can hardly be viewed as full and fair, and it cannot be said that it was made with robust particularity. The few documents that were produced conflict with Stimola’s own evidence and with one another in several areas and it is unclear where any of these materials came from.

[41] During the course of SFRAN’s submissions, I was not taken to any of the documents produced by Stimola in satisfaction of his undertaking to add to this picture or clarify the apparent inconsistencies.

[42] I find that the evidence of SFRAN’s financial situation is vague, not well supported by documents and inconsistent within itself and with Stimola’s evidence in some respects. It cannot be called solid evidence and it does not approach the level of disclosure required from a responding party that seeks to be exempted from the application of Rule 56.01.

[43] There also appear to be others involved with SFRAN who may be capable of posting security in their place but disclosure regarding these possible sources of funds has been vague or non-existent. I will deal with this under item (e).

b) Can SFRAN escape having to post security in view of their assertion regarding Sandella’s income stream within Ontario from Yogun Fruz?

[44] In that Sandella’s LLC owns SFRAN, their assets and income should to be made available to SFRAN to assist them in posting any security that may be ordered (see Aviaco supra).

[45] Instead, SFRAN seeks to rely on Sandella’s LLC’s income stream in Ontario, such as it is, to avoid having to post security for costs. In that regard, SFRAN says that, though Sandella’s LLC owns no assets in Ontario, they do have a “non fixed” asset, in the form of a revenue steam from other franchise locations in Ontario, such as Yogen Fruz in an amount of $5000 - $6000 per month. They put this forward, not for the purpose of posting it as security but as a means of providing the third parties with an indication of where they can turn to satisfy a cost order that may be made at trial. But again, SRFAN appear to be speaking out of both sides of its mouth.

[46] A document entitled “Sandella’s Canadian Revenue” has been appended to Stimola’s affidavit. Again, no information is provided as to who prepared this or when it was prepared.

[47] The document shows numbers for two Yogen Fruz locations, as well as a Sysco’s in Toronto and one in Thunder Bay and one Sodexo location. The numbers start in September 2012 and are uneven.

[48] The gross margin for 2010 was only $21,225, not surprising as these arrangements had only been in place a short time. Gross margin rose to $47,360 for 2011, but were down to only $37,619 in 2012. This amounts to just a little over $3000 per month, not the $5000 - $6000 that Stimola speaks of. In fact, gross sales were only just over $5000 per month.

[49] Further, several locations are not doing well. Sysco Toronto reported no income for 6 months in 2012, Sysco Thunder Bay reported none for 9 months.

[50] The profits from these operations is clearly a fluctuating number and it is questionable where it will be if and when the third parties’ position prevail at trial and SFRAN is called upon to pay costs. These numbers really do not provide the third parties with the sense of security they are entitled to regarding payment of their costs.

[51] Furthermore, Stimola’s own evidence effectively hangs Sandella’s LLC out to dry. He states in paragraph 33 of his affidavit that both SFRAN and Sandella’s LLC are in a very precarious financial position and that neither is able to post security for costs. His evidence also indicates that they have no fixed assets in Canada, either, and that their small revenue stream is invested back into the business. Their balance sheets are also attached to demonstrate their position. In that context, what comfort can a small and fluctuating precarious revenue stream provide?

[52] According to their 2012 balance sheet, Sandella’s LLC loaned $94,164 to MJS (Michael Stimola) and $90.520 to SFRAN that year, while investing a further sum of $122,897 in the latter. It is not at all clear where that investment went, in view of the fact that that company appears to have stopped doing business in early 2011. Stimola states in his affidavit that he has taken his salary as a loan for the last three years for tax efficiency purposes, and that Sandella’s LLC will not be able to recover these funds, but the loan only appears in the 2012 figures. Again, the paper provided raises considerable questions but provides few answers.

[53] I therefore find that this asset, such as it is, does not assist SFRAN’s position.

c) Can an undertaking from Sandella’s LLC and Stimola to pay cost orders extricate SFRAN from having to post security?

[54] I note that the undertaking regarding these parties appears nowhere in the evidence, though Stimola, himself, swore two responding affidavits.

[55] I have already dealt with Sandella’s LLC’s financial position above. The third parties would obviously not take comfort in knowing that a company in a “precarious financial position” is prepared to pay their costs at the end of the day should they succeed. An undertaking from them to pay costs if SFRAN is ordered to do so is therefore of little value.

[56] I turn to Stimola. Stimola says little about his own financial circumstances in his first or supplementary affidavit. This is a gaping omission, in view of his place in the company. Essentially, the majority of the evidence regarding Stimola’s personal financial status is derived from the transcripts of his cross-examination, and from responses provided later to undertakings giving during the course of that event. These responses are contained in two thick volumes, 3 inches in height. This serves to highlight how sparse SFRAN’s initial disclosure was with respect to this critical issue.

[57] In the course of cross-examination, the third parties learned that Stimola’s home is owned in trust and carries a mortgage, though he gave them no indication of how much equity the trust has in the home. They also learned that the families’ other assets are in his wife’s name.

[58] Stimola and his wife earned $155,023 in 2011, an income most would view as healthy, and one which would afford the family a relatively comfortable standard of living. According to Stimola, all their earnings are pegged to their expenses (this information is contained in SFRAN’s factum, not Stimola’s affidavit).

[59] Though the Stimolas file a joint tax return, Mrs. Stimola is listed as a housewife each year, so all of the income reported would therefore be attributable to her husband. What is odd about these returns is the fact that Michael Stimola’s salaried income increased considerably between 2009 and 2011, despite the fact SFRAN appears to have ceased to carry on business by early 2011.

[60] In 2009, the Stimolas reported wages and salary of only $1,826, with an additional $75,000 in business income. By 2010, wages and salary had increased to $109,061, with an additional $60,000 in business income received. In 2011, however, the Stimolas received wages and salary of $155,023 and they report no business income. It is unclear how Stimola paid himself that year, but he clearly did so despite SFRAN’s declining fortunes.

[61] Further, Stimola’s position, presented through SFRAN’s factum, to the effect that he is prepared to undertake to pay costs if any are ordered against SFRAN is at odds with what he also says in the factum regarding his ability to post security for them. He is effectively “sucking and blowing” at the same time. Either he will be able to raise these funds at the end of the day or he won’t be. If he can do so then, why can’t he post security now? This is yet another question that comes to mind for which no response has been provided.

[62] Stimola has tried to respond to that by saying as time goes on, SFRAN’s obligations to make payments towards the settlement of three US suits will decline and disappear so they may be better able to handle a cost order later rather than post security now.

[63] One of the few financial documents produced as an exhibit to Stimola’s first affidavit is a sheet setting out SFRAN’s payment obligations with respect to the settlement of the three US law suits. Payments continue into 2016 however, the timing of those payments is interesting. In June and July of this year, for example, they are required to pay $6834 per month and that figure declines to $5834 per month for the rest of 2013.

[64] In 2014, however, the payments increase to $70,008. In 2015, SFRAN will be required to repay $42,508 and in 2016, the figure will be $16,630. Thus, it appears that when one reviews SRFAN’s obligations for the next three years, they are currently in no worse position to fund the posting of security for costs than they may be if ordered to pay costs down the road.

[65] Accordingly, I am not prepared to order that no security need be posted simply because Stimola does not wish to be burdened with this additional expense at this stage. He has failed to establish hardship or to provide a convincing case for postponing payment of costs to some future date if required. This defeats the purpose of a security for costs order.

[66] There is also no certainty that his assets, to the extent that there is or will be anything in his name if and when he is called upon to fund a cost order, will be easily exigible (another requirement). He appears to have done a good job of insulating his current assets so far, by placing them in trusts and using other vehicles to make it appear as if he, personally, owns few if any of the assets that he uses. Execution on a cost order could be a lengthy and expensive operation as a result.

[67] The fact that Stimola was not prepared to give this undertaking within his affidavit in the form of a statement under oath, is also troubling

[68] Accordingly, I do not accept this submission as an appropriate response to this motion.

d) Does the fact that companies related to SFRAN have assets in Connecticut, a reciprocal jurisdiction, change anything?

[69] The material filed regarding this issue is not clear. The discussion throughout the factum is to the effect that SFRAN’s unit holders cannot assist as they are coping with their own financial issues. In this regard, the factum discusses Nantucket Roost. I was taken to no evidence during the hearing regarding this entity and it is not discussed in Stimola’s evidence.

[70] There is also reference to Sandella’s Coffeee Cafe in the same section of the factum which again, was not discussed during the hearing and does not appear in Stimola’s evidence. If a party relies on responses they provided during cross-examination or by way of compliance with undertakings, it is up to them to bring this information to the court’s attention when making oral submissions, particularly in a case like this one, where there are three inches of responses contained within two fat bound volumes. Neither of these entities was mentioned so I am not even aware if they are Connecticut-based operations.

[71] I was eventually taken to some evidence regarding both the Coffee Café and Nantucket Roost, by the moving third parties. No undertaking was given by either of these entities to pay costs at the end of the day if SFRAN is so ordered so it is unclear why SFRAN has put them into the frame.

[72] Despite this, a supplementary affidavit was filed, containing a very brief legal opinion from one Stephen Kindseth of Zeisler & Zeisler, a law firm situated in Bridgeport, Connecticut. Mr. Kindseth states that he is a licensed and practicing attorney in Connecticut, yet his opinion is not restricted to that state.

[73] He states that both Connecticut and New York have adopted statutes incorporating the Uniform Foreign Money Judgements Recognition Act, such that:

...a valid final judgment entered by a Canadian court would be enforceable in New York and Connecticut, as long as the statutory parameters are satisfied.

[74] Unfortunately, Mr. Kindseth says nothing about what those parameters are. In their factum, SFRAN quotes from the Act, but only insofar as pointing out that the requirements are found in section 50A-32. Once again, however, the wording of that section has not been provided so I cannot assess the ease or difficulty of the process.

[75] I also have no idea why the opinion extends to the situation in the state of New York as I was taken to no evidence of assets in that state and Stimola says nothing about this in either of his affidavits.

[76] I fail to see how, on the evidence filed, this factor can assist SFRAN.

e) Is it fair to require SFRAN to post security for costs in view of their assertion that they are “in this bind” because of the third parties or would it be unfair for them to avoid having to post security for any other reason?

[77] Whether or not SFRAN will be able to pass along liability to the all or any of the third parties remains to be seen. They are not in a position to say, at this stage, that it is a fact that they are “in this bind” because of the third parties. This assertion remains to be established, one way or the other, at trial. They are in no different position than any plaintiff from whom security for costs is sought.

[78] While a plaintiff stands to gain by winning a law suit and being awarded damages, SFRAN stands to gain by avoiding having to fund the full damage award in 697s favour if one is made if they succeed against the third parties. Similarly, SFRAN’s owners stand to gain by avoiding the full force of a judgment against SFRAN in favour of 697 if they can prove their third party claims. In view of SFRAN”s current financial situation, their failure to come to the table now could result in SFRAN’s demise and the loss of their respective investments in that entity. That is the investment they should now seek to protect.

[79] This is some of the evidence relevant to the point that emerged during Stimola’s cross-examination:

• SFRAN is 100% owned by Sandella’s LLC;
• Both SFRAN and Sandella’s LLC were incorporated in Delaware;
• Stimola is the president of SFRAN, Sandella’s LLC and Sandella’s Coffee Cafe and he resides in West Redding, Connecticut. All three businesses work out of the same office, owned by Sandella’s LLC, located in Redding, Connecticut;
• Sandella’s LLC has 4 owners: three are holding companies (Sandella’s Coffee Café, Nantucket Roost and Snake River Hospitality), and the 4th owner is a Saudi Arabian investor, Abulaziz Alqahtani;
• Alqahtani invested $750,000 in Sandella’s LLC for a 20% interest as recently as 2011. He has not provided any financial information or the name of his holding company;
• Both Sandella’s Coffee Café and Nantucket Roost are owned by Michael Stimola and Joe Montgomery;
• Joe Montgomery was and is an officer and/or director of Sandella’s LCC and also owns 60% of Nantucket Roost Associates, LLC. That company has assets of $385,000 as of 2012. Montgomery has refused to provide any financial information;
• Snake River Hospitality is owned by Mark Lievich and possibly others;
• Mark Leivitch resides in Idaho, which is also where Snake River Hospitality was incorporated. He has refused to provide any financial information;

[80] On the basis of Aviaco (supra), both Sandella’s LLC and its 4 owners are all persons to whom SFRAN should be looking for assistance with this motion. If they are unable to obtain help, it is up to them to explain why that is the case.

[81] Yet, little information has been provided regarding the financial status of any of these individuals or the related corporations. In that the moving parties are entitled to look to the owners of SFRAN to post security on its behalf, failure to include disclosure regarding the owners is a significant omission. In my view, it would be unfair to the third parties to deny them the security for costs that they seek in view of the very poor disclosure made regarding the financials circumstances of SFRAN’s owners.

f) SFRAN asserts that there is merit in their third party claims

[82] While case law speaks of the importance of considering the merits of the case in all motions for security for costs, it is also clear from the cases that the significance of the merits increases as one moves from Rule 56.01(a) down to (f) (see Padnos v. Luminart Inc., [1996] OJ No. 4549).

[83] In Padnos, Kitely J. was careful, when speaking of the need to consider the merits, to point out that the inquiry was not akin to the one in which the court embarks when hearing a summary judgment motion. Rather:

The analysis is primarily on the pleadings with recourse to the evidence filed on the motion, and in appropriate cases, to selective reference to excerpts of the examination for discovery where available.

[84] In reviewing the evidence in Padnos, Kitely J. concluded that the merits were a neutral factor, in that it was apparent to her that credibility was going to be a critical to the outcome of the case.

[85] This approach is the one generally employed by the courts. The evidence is reviewed in order to get a sense of the merits, but where credibility issues appear likely to be determinative of the ultimate result, the court usually finds the merits to be a neutral factor. As I stated in Sirron Systems Inc. v. North America Construction )1993) Ltd. [2009] OJ No. 3609:

Where the merits of the case turn largely on credibility, they will generally be less important, as that is an issue best left for trial in most cases.

[86] In those cases under subrule 56.01(e), however, where the moving party claims that their motion for security for costs is based on there being good reason to find that action is frivolous and vexatious, the merits factor most significantly. In such cases, it is clear that the merits must be a turning point, as the success of the motion, from the moving party’s perspective, hinges on the merits. The moving party has the initial onus, in such cases, of demonstrating that the case appears to be frivolous and vexatious – and hence, without merit – in order for the responding party to have a case to answer. Unless the moving party can establish that there is good reason to believe the action is frivolous and vexatious – without merit - their motion will fail.

[87] Thus, in a motion under subrule (e), the court expects the affidavit of the moving party to be filed by someone who actually has firsthand knowledge of the issues he discusses in his evidence. This is not generally the case where the motion arises in the context of subrule (a) or (d). Unlike a motion for summary judgment, the moving party need not put his best foot forward with respect to the merits under these subrules, as he does not have the onus of demonstrating that there is no merit to the case. He need only respond to the issue of merits if and as raised by the responding party.

[88] Thus, I do not agree with SFRAN’s position that their evidence regarding the merits should prevail as the affidavits delivered by two of the third parties were sworn by counsel, rather than by the parties, themselves. The onus regarding merits, in this motion, was on SFRAN, as they raised it in to avoid having to post security though they are not impecunious. This was their route to what they claim is the order that is just in the circumstances.

Fuller Landau

[89] Fuller Landau’s evidence was put in by way of an affidavit from Trevor Tynan, counsel at the firm handling the defence of the third party claim in that party’s behalf. Although Tynan does not have first-hand knowledge of what transpired between the parties, he was careful to restrict his comments regarding the merits of the action vis a vis his client to his review of the documents in the file. I have no difficulty with that, as these parties appear to have dealt with one another by e-mail, so the paper effectively tells the story. He appends copies of the exchange to his affidavit to enable the court to review it all and reach its own conclusions.

[90] My review of the evidence suggests that there was no meeting of the minds between this third party and SFRANS. Though SFRANS sought a quote to “canadianize” SFRAN’s financial statements on April 15, 2009, the response they received from Fuller Landau less than two hours later was with respect to the preparation of an equivalence report, only. Thus, for $3,000, Fuller Landau indicted that it would give them a report, setting out what SFRAN had to do in order to make their statements compliant with Canadian law. Fuller Landau never indicated, however, that they would actually perform that work for that price.

[91] In the end, Fuller Landau appears to have delivered what they said they would. The document has various columns, the last one entitled “additional Disclosure Required.” Fuller Landau appears to have gone through the statements that SFRAN provided, section by section, indicating where further disclosure was needed and explaining what that involved in order to ensure compliance with this jurisdiction’s disclosure requirements.

[92] It should have been clear to Stimola that what he got was not a “canadianized” financial statement, but rather, a manual of sorts telling him how to go about having that work done for him in the US. His counsel concedes that this was all he got from this accounting firm.

[93] How it came to pass that Stimola thought he was getting what he needed and why he was not aware that what he got was something less than what was required are matters to be sorted out at trial. I therefore find that the merits are a neutral factor.

Gowling LaFleur Henderson and Levitt

[94] The defendant, Levitt, filed the supporting affidavit for the motion brought by the Gowlings defendants, so SFRAN was not critical of them for not having provide the best available evidence.

[95] Levitt is quite specific in his evidence as to the nature and extent of his and Gowlings’ retainer. He states that their work was:

…specifically and expressly limited to the review and revision of its franchise disclosure document used in the United States of America to ensure that it could be used in Canada and, in particular, that it complied with the Arthur Wishart Act (Franchise Disclosure) 2001, as well as the “Canadianization” of several appended agreements. This retainer was fully satisfied and completed.

[96] Levitt stresses, however, that the factual content of these documents was provided by SFRAN directly or indirectly, and that the latter repeatedly reviewed and approved it. As a result, if there are any inaccuracies or misrepresentations contained within these documents, they are the result of the content provided by SFRAN, rather than the work performed by the Gowlings defendants. He also points out that Gowlings simply performed the tasks which they were retained for and that they were not involved with respect to the manner in which disclosure was ultimately made to 697.

[97] Turning to SFRAN’s response, Stimola concedes that neither Levitt nor Gowlings were retained to carry out the entirety of the transaction but he maintains that certain aspects of the work they did was non-compliant with the legislation or that they failed to convey certain requirements of it to him. In addition, he asserts that they failed to note that the product of Fuller Landau was not sufficient to insert into the MFDD and that it did not comply with Canadian franchise law.

[98] At the end of the day, one of these two perspectives as to what went wrong or some combination of the two will prevail at trial. It is, however, premature to assess which is the more likely outcome at this stage, as much will turn on credibility, as well as a thorough review of the documents in issue. That is not the sort of inquiry that should be undertaken in the context of a motion of this kind, which is not on all fours with a motion for summary judgments.

[99] As a result, I find that the merits are a neutral factor at this stage of the proceeding.

The Kestenbaum third parties

[100] Kestenbaum is a US attorney, who was retained by Stimola and SFRAN to provide ongoing legal advice and services in relation to franchising Sandella’s Café around the world.

[101] The Kestenbaum third parties’ supporting affidavit was provided by Alana Abells, an associate of their counsel’s firm. Unlike Fuller Landau, who used a similar approach when selecting a deponent, these third parties make no submissions at all regarding the merits of the case in their affidavit. Instead, they refer to what Kestenbaum has pleaded without appending any of the paper that flowed between the parties to demonstrate what Kestenbaum believed he was tasked with doing for SFRAN.

[102] I note that the third party, Levitt, stated in his affidavit that he took what he was given and assessed it for sufficiency with Canadian standards. He was clear that he had no input with respect to the factual content of the documents or the manner in which disclosure was made.

[103] While none of the third parties have cross-claimed against one another, one would have expected the Kestenbaum affidavit to address the issues of the content of the documents that SFRAN submitted for review and assessment, as well as the manner of disclosure, as well. Neither issue, however, is dealt with in the affidavit they submit in support of their motion.

[104] In their pleading, the Kestenbaum third parties make an effort to turn the tables, asserting that Stimola is a sophisticated, experienced and knowledgeable businessman and they plead that Stimola and SFRAN provided all of the information contained within the disclosure document. They also allege that Stimola reviewed all the documents and signed the certificate regarding proper disclosure before the materials were sent to 697. This is akin to what Levitt asserts, in that it suggests the information contained within the disclosure documents was provide by Stimola, who knew what he was doing. However, these third parties filed no evidence to this effect.

[105] SFRAN, on the other hand, did address the merits, to some extent, in their responding materials. Stimola claimed that Kestenbaum and his paralegal:

…were involved with, contributed to, and supervised, the entire process of preparation and execution of the MFDD with 697 Inc. in Canada.

[106] However, although Stimola goes into some detail regarding what Kestenbaum was charged with doing for SFRAN, he never states unequivocally that the US lawyer performed an audit function or that he had any involvement with obtaining or ensuring the accuracy of the factual content of any of the materials that made up the disclosure package.

[107] This is the nub of Kestenbaum’s defence and it does not appear to be addressed by Stimola in his evidence. Thus, in my view, the fact that Kestenbaum ignored the merits is of little consequence in the context of this motion as SFRAN did not raise a case on the merits that had to be answered in his evidence. There is, in effect, no evidence from either party regarding the critical issue of where the information for these documents came from. I therefore find that the merits are a neutral factor.

CONLUSIONS

[108] At the end of the day, I find each of the moving party has made out a case for being awarded security for costs.

[109] Each has shown a prima facie case with respect to both subrules 56.01(1) (a) and (d). As a result, the onus of the motion shifted to SFRAN. In that regard, they had options they could have pursued in order to meet that onus. First, they could have tried to demonstrate that they had sufficient assets in Ontario to pay costs at the end of the day if so ordered. Their efforts in that direction failed.

[110] Alternatively, they could have tried to show that SFRAN had sufficient assets in a reciprocating jurisdiction. Here, too, the evidence filed was deficient as the legal opinion they obtained failed to address the most important aspect of the issue.

[111] A third option was to claim impecuniosity. Despite the fact that SFRAN appears to have money going out, in the form of payments to settle its franchise litigation in the US, but no money coming in, SFRAN has not relied on impecuniosity on this motion. Instead, they claimed hardship, a difficult road to hoe in view of Stimola’s position with the company and his personal earnings. While having to post security for costs may well result in a tightening of the household belt, his income does not allow for a submission of this kind to be advanced successfully.

[112] SFRAN has also failed to provide any or any meaningful evidence regarding the ability of any of its other investors to post security for cots at this time.

[113] In the absence of having satisfied any of these factors, SFRANS would have to show a very strong case on the merits (some cases have gone so far as to set the standard at “overwhelming chance of success”) before the court would be convinced that the just order in the circumstances would be no order as to security for costs with respect to any of the moving parties. The onus regarding merits is entirely on SFRAN in the context of these facts.

[114] For the reasons set out above, I am of the view that they have failed to meet that onus in each of the three motions.

[115] As a result, each of the three sets of third parties is entitled to an order for security for costs.

[116] The costs orders will vary from one third party to the next in view of their alleged involvement with these events. For example, the allegations against Fuller Landau are far less sweeping than those against either of the lawyer third parties, so it is expected that their ultimate costs will be less. Accordingly, less security should be posted with respect to that party.

[117] Also, I have followed the common practice of making a “pay as you go” order, thereby awarding costs in tranches. Rather that require the partiers to return after the completion of the events contemplated within the first tranche, I have set out the two further tranches of costs to be posted with respect to each third party and when those costs shall be posted. This will allow SFRAN to see its total exposure at one time and also save costs for all parties as they won’t have to return after each series of events.

THE ORDER

1. It is therefore ordered and adjudged that SFRAN shall post security for costs to the credit of its their third party claims as follows:

a. To Fuller Landau, the sum of:

i) $30,000 within 30 days from the date of this order, to cover costs already incurred and all costs to be incurred up to and including examinations for discovery, including any motions arising therefore;

ii) $5,000 within 45 days from the completion of oral examinations for discovery (excluding motions arising therefrom) to cover all costs arising from the end of item i) up to the end of mediation; and

iii) $42,000 within 45 of the completion of mediation, to cover all costs from the end of that event, up to the end of trial;

b. To Levitt/Gowlings, the sum of:

i) $40,000 within 30 days from the date of this order, to cover costs already incurred and all costs to be incurred up to and including examinations for discovery, including any motions arising therefore;

ii) $5,000 within 45 days from the completion of oral examinations for discovery (excluding motions arising therefrom) to cover all costs arising from the end of item i) up to the end of mediation; and

iii) $ 85,000 within 45 days of the completion of mediation, to cover all costs from that event, up to the end of trial; and

c. To Kestenbaum, the sum of:

i) $ 40,000 within 30 days from the date of this order, to cover costs already incurred and all costs to be incurred up to and including examinations for discovery, including any motions arising therefore;

ii) $ 5,000 within 45 days from the completion of oral examinations for discovery (excluding motions arising therefrom) to cover all costs arising from the end of item i) up to the end of mediation;

iii) $42,000 within 45 of the completion of mediation, to cover all costs from that event, up to the end of trial ( note that this third party provided a partial draft bill of costs, only, so I have had to estimate their costs based on what the others have indicated);

2. This action shall be stayed unless and until the first tranche of costs have been posted, save and except for any rights of appeal any of the parties may wish to exercise;

3. Thereafter, the action shall be stayed between tranches unless and until that portion of the costs have been posted within the time specified in this order;

4. In the event that SFRAN fails to post costs as ordered with respect to any of the third parties within the specified period for each tranche, those third parties can move, on notice, to have the action dismissed as against them;

5. In the event that the parties are unable to agree as to costs with respect to any of these three motions, I can be spoken to within 30 days from the release of this endorsement.

Master Joan M. Haberman

Released: June 27, 2013