ONTARIO
SUPERIOR COURT OF JUSTICE
COURT FILE NO.: 151513
DATE: 2014-04-03
BETWEEN:
CAFFÉ DEMETRE FRANCHISING CORP.
Plaintiff
– and –
2249027 ONTARIO INC. and WAQAR KHAN
Defendant
J. McNair, for the Plaintiff and the Defendants by Counterclaim
L. Sigal, for the Defendants (Plaintiffs by Counterclaim)
AND BETWEEN:
2249027 ONTARIO INC. and WAQAR KHAN
Plaintiffs by Counterclaim
– and –
CAFFÉ DEMETRE FRANCHISING CORP. and GARY STEVEN THEODORE
Defendants by Counterclaim
HEARD: March 31, 2014 at London
HEENEY R.S.J.:
[1] This is a motion for partial summary judgment, brought by the plaintiff, which seeks to dismiss that portion of the counterclaim which claims rescission of the Franchise Agreement entered into between the parties. The issue before the court is whether there is a genuine issue for trial on this central question: are the alleged defects in the disclosure document delivered to the defendants at the time of purchase so egregious as to amount to no disclosure at all, thereby entitling the defendants to rescind the agreement under s. 6(2) of the Arthur Wishart Act (Franchise Disclosure), 2000, S.O. 2000 c. 3 (“the Act”)?
The Facts:
[2] The plaintiff is the franchisor of thirteen restaurants in and around the Toronto area. It specializes in desserts and ice cream made fresh on the premises.
[3] The defendant Khan, through his company the defendant 2249027 Ontario Inc., purchased the franchise at 3280 Dufferin Street, Toronto, from the previous franchisee for $800,000, through an Agreement of Purchase and Sale dated May 16, 2011. On June 24, 2011 the plaintiff delivered to the defendants the disclosure document mandated by the Act which, in a single document, contained all of the information and documentation required by s. 5(4) thereof. There is no issue as to the plaintiff’s technical compliance with the terms of the Act, save for the allegation in the counterclaim that the disclosure document failed to contain certain “material facts”.
[4] On July 22, 2011 the parties executed a Franchise Agreement. The defendants began operating the restaurant thereafter. This location was a prime location and was one of the highest-grossing restaurants in the system. However, problems between the parties eventually developed.
[5] During the summer of 2012, the plaintiff undertook an inspection of all of its locations with regard to the quality of their furnishings and decorations. This was related to a decision to introduce a more expensive menu system-wide. As a result of these inspections, the plaintiff required that several of the locations, including Dufferin Street, perform painting and repairs. Under Article 8.1 of the Franchise Agreement, the franchisee agrees to effect such refurbishing and renovation as the franchisor requires from time to time. If, in the franchisor’s opinion, the general state of repair, or the appearance or cleanliness of the location do not meet the then applicable image and standards of the franchise, the franchisor may require those deficiencies to be corrected.
[6] The plaintiff provided the defendants on August 12, 2012 with a list of the items that needed to be corrected. The defendants have never done any of the work required.
[7] In November of 2012 the plaintiff conducted an analysis of error rates at the Dufferin Street franchise. This disclosed that customer orders were cancelled at the point of sale at a rate almost three times the frequency observed at other outlets. The plaintiff requested production of the printer journal rolls which would have shed light on the situation, but those were never produced. The plaintiff drew the inference that the defendants were concealing cash sales. This was a matter of great interest to the plaintiff, since franchise fees were payable as a percentage of sales.
[8] On December 12, 2012, March 8, 2013 and July 5, 2013, the plaintiff issued a total of three notices of default. The defaults identified were: the failure to take the required action to improve the condition and appearance of the location; the failure to provide financial statements and tax returns within 90 days of fiscal year end, as required by the Franchise Agreement; and, understating gross sales through excessive error/correct key entries.
[9] An audit and inspection by outside auditors was conducted on July 31, 2013, from which the plaintiff concluded that the defendants had no intention of remedying the defaults that had been identified. Accordingly, the franchisor served a notice of termination of the Franchise Agreement on August 2, 2013, pursuant to Article 21.3 thereof.
[10] In the meantime, the defendants’ lawyer (not Ms. Sigal’s firm) had served a notice of rescission of the Franchise Agreement on July 19, 2013. It specified no grounds for the rescission, but demanded payment of $926,500 within 60 days.
[11] The plaintiff attempted to take possession of the restaurant pursuant to the terms of the Franchise Agreement, but the defendants retook possession and changed the locks, claiming that the plaintiff’s actions constituted an illegal break-in. The defendants continue to operate a competing business at that location under the name “Sugar’n Spice Café” to this day.
[12] Litigation was commenced by the plaintiff. In their Statement of Defence and Counterclaim, the defendants claimed a declaration that the Franchise Agreement was rescinded pursuant to provisions of the Act. For the first time they disclosed the grounds for rescission, in paragraph 4 of their pleading. There it alleged that the plaintiff did not provide proper disclosure as required by the Act, in that:
a) The plaintiff failed to disclose that, at the time of the disclosure document, it was involved in litigation against Spin Dessert Ltd., which had owned the franchise prior to the owner who sold it to the defendants;
b) The plaintiff failed to disclose that it was contemplating the implementation of a modified “Tip Out Policy” that would be unilaterally imposed on all franchisees to their financial detriment;
c) The plaintiff failed to disclose that it was contemplating altering the franchisee ice cream manufacturing policy such that the owner principal would be directly responsible for preparing the ice cream; and,
d) The plaintiff failed to disclose that the franchise store would require extensive remodelling and renovations in excess of $50,000.
[13] In addition to its claim for rescission, the defendants relied on these same grounds in support of its claim for damages for misrepresentation, breach of contract and breach of fair dealing. The damages claimed in respect to both are the same: $926,500.
The Relevant Provisions of the Act:
[14] The obligation of the franchisor to provide a disclosure document is set out in s. 5(1) of the Act, which reads as follows:
- (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; 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.
[15] The required contents of the disclosure document are specified in s. 5 (4):
(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] As already noted, the only alleged defect with regard to the disclosure document is with regard to the failure to disclose “material facts”, as required by ss. 5(4)(a), which are particularized above. That term is defined in s. 1(1):
“material fact” includes any information about the business, operations, capital or control of the franchisor or franchisor’s associate, or about the franchise system, that would reasonably be expected to have a significant effect on the value or price of the franchise to be granted or the decision to acquire the franchise;
[17] The Act provides the franchisee with two separate and distinct rights of rescission in s. 6:
Rescission for late disclosure
- (1) A franchisee may rescind the franchise agreement, without penalty or obligation, no later than 60 days after receiving the disclosure document, if the franchisor failed to provide the disclosure document or a statement of material change within the time required by section 5 or if the contents of the disclosure document did not meet the requirements of section 5.
Rescission for no disclosure
(2) A franchisee may rescind the franchise agreement, without penalty or obligation, no later than two years after entering into the franchise agreement if the franchisor never provided the disclosure document.
[18] In this case, the defendants rely on s. 6(2), on the basis that “the franchisor never provided the disclosure document”. The notice of rescission was delivered three days before expiration of the two-year limit specified therein.
[19] The defendants’ complaint about the disclosure document is that it is deficient in content. On the plain wording of the Act, a right of rescission for a deficiency in content is only available within 60 days after receiving the disclosure document. That period would have expired on August 24, 2011, long before the notice of rescission was delivered. A right to claim rescission under s. 6(2) only arises where the franchisor never provided the disclosure document. That is clearly not the case.
[20] The Ontario Court of Appeal, in 4287975 Canada Inc. v. Imvescor Restaurants Inc., 2009 ONCA 308, cautioned against blurring the distinction between the two remedies. Mr. Justice LaForme, speaking for the court, said this, at paras. 37-8:
The Act, interpreted in the light of this modern interpretive approach, is clear that a rescission remedy is available to the franchisee in two separate situations, and that the two situations are not to be blurred into one. This interpretation is further bolstered by the purpose of the Act, which is in part to ensure that the franchisee has at least fourteen days to review a disclosure document before signing an agreement. The legislature clearly chose to reserve the two year remedy for instances of a complete failure to provide a disclosure document.
Section 6(2) of the Act cannot be triggered in cases where a disclosure document is provided, because it expressly applies only when a disclosure document was "never provided". To accept the appellant's submissions as to the applicability of s. 6(2) to this case would be inconsistent with, and contrary to, the inclusion of s. 6(1) in the Act, which speaks directly to the consequences of a franchisor's failure to provide a disclosure document that meets the timing and/or content requirements of the Act.
[21] Having said that, there is authority for the proposition that where there are “stark and material deficiencies” in the disclosure document, it cannot be considered to be a disclosure document at all: 6791241 Canada Inc. v. Dollar It Ltd. (2009), 2009 ONCA 385, 95 O.R. (3d) 291 (C.A.) at para. 74.
[22] Similarly, in 1490664 Ontario Ltd. v. Dig This Garden, 2005 25181 (ON CA), the franchisor provided only seventy percent of the information required to be disclosed, and did so in “bits and pieces”, rather than in a single document as is clearly required by s. 5(3) of the Act. The trial judge’s finding that no disclosure document had been provided was upheld by the Court of Appeal.
[23] As against that standard, I will analyse the alleged deficiencies particularized in the defendants’ pleading.
The Spin Dessert Litigation:
[24] The operator of Spin Dessert had formerly been a franchisee at the Dufferin Street location. He started a competing business 7.5 km away from the Dufferin Street location, and was allegedly using recipes and other confidential information in its operation that was the property of the plaintiff. At the urging of the plaintiff’s franchisees, the plaintiff sued Spin Dessert on July 22, 2011, claiming $7 million in damages and injunctive relief.
[25] Although this litigation was not commenced until approximately one month after the disclosure document was delivered, there is an email dated June 21, 2011 from the franchisor to one of the franchisees which refers to a lawsuit against Spin Dessert as a priority item. It is clear, therefore, that such litigation was contemplated at the time the disclosure document was delivered. That document makes no reference to this litigation.
[26] It is undisputed that the litigation did not represent a potential liability to the franchisees, but rather was a proactive measure taken by the franchisor to protect the intellectual property of the operation as a whole. This measure was taken at the request of the franchisees and was clearly for their benefit. As such, it is difficult to see how the existence of this litigation could have a significant effect on the price to be paid by the franchisor, as required by the definition of “material fact”.
[27] The defendants learned of this lawsuit no later than September 1, 2011, and raised no concern about it. Given that the location of Spin Dessert was 7.5 km away from the Dufferin Street location, there is no basis to conclude that it had any impact on the defendants’ sales. The defendants were never asked to participate in this lawsuit in any way. Spin Desserts eventually went out of business in December, 2012, and the lawsuit was settled.
The Tip Out Policy:
[28] In June of 2012, an NDP member of the provincial legislature introduced a bill to prevent employers from retaining a portion of the tips collected by their employees. Interviews with staff at the plaintiff’s various franchises indicated that this was occurring. The defendant Khan admitted in his cross-examination that this was his practice, and that it netted him between $5,000 and $10,000 per year.
[29] In compliance with the anticipated legislation, the plaintiff announced a new tipping out policy by memorandum dated August 6, 2012, which prohibited franchisors from taking a share of their employees’ tips.
[30] The defendants refused to implement this new policy. The plaintiff never issued a notice of default arising out of that refusal. As a practical matter, therefore, this change in policy had no impact on the profitability of the franchise.
[31] More significantly, the policy change did not arise until 14 months after the disclosure document was delivered. There is no evidence that it was contemplated by the plaintiff in June of 2011. Instead, the only evidence demonstrates that it did not become an issue until June of 2012 when the matter was raised in the legislature. The policy did not exist at the time the disclosure document was delivered and cannot, therefore, constitute a material fact that should have been disclosed.
The Ice Cream Manufacturing Policy:
[32] Consistency in the quality of ice cream being produced at the plaintiff’s franchises is a feature that is of central importance. The plaintiff became concerned that quality was becoming uneven due to the lack of supervision of staff who were making the ice cream on site. Accordingly, a policy change was announced on February 1, 2013 that required the owner principals of the franchises to assume sole responsibility for ice cream production at their own restaurants.
[33] The announcement of this policy change was made in accordance with the franchisor’s rights under Article 16.2 of the Franchise Agreement, which reads in part as follows:
… Franchisee expressly understands and agrees that Franchisor may from time to time change the components of the System, including but not limited to: altering the products, programs, services, methods, standards, forms, policies and procedures of the System…
[34] Once again, Mr. Khan admitted on cross-examination that he considered the policy to be unreasonable, and declined to implement it. It did not, therefore, have any actual impact, financial or otherwise, on his franchise. No notice of default was issued by the franchisor regarding this breach.
[35] The key point, though, is that this policy change came about fully 20 months after the disclosure document was delivered. It cannot be considered as a material fact that should have been disclosed because it did not exist when the document was delivered.
Remodelling and Renovations:
[36] As already noted, the plaintiff undertook an inspection of all of its locations in the summer of 2012 to assess the general state of repair, appearance and cleanliness of each restaurant. On August 12, 2012, the plaintiff provided the defendants with a list of items that needed to be corrected, in accordance with its rights under the Franchise Agreement. Mr. Khan conceded that the cost of this repainting and refurbishing would be between $40,000 and $50,000. However, he declined to do any of the work required.
[37] Once again, this issue arose 14 months after delivery of the disclosure document. Because of that, it cannot be said to be a material fact that should have been disclosed in June of 2011.
[38] The defendants argue that the plaintiff should have been aware in June of 2011 what the condition of the premises was, and what its requirements were with regard to repairs or improvements. There is no evidence to support that allegation. It is clear, however, that the defendants were well aware of the condition of the premises, since Mr. Khan spent a great deal of time there prior to completion of the purchase. In addition, he inserted in the Agreement of Purchase and Sale a term whereby the vendor, Foog Corporation, agreed to:
… bring the store up to date with regards to renovations as per requirements of the franchisor.
[39] It is admitted that the defendants sought no confirmation from the plaintiff as to what repairs or renovations would be required to meet its requirements. It is also admitted that the defendants have taken no steps to enforce the obligation of the vendor to make improvements to the premises in compliance with the franchisor’s requirements.
[40] The fact that repairs or renovations may have been needed in June 2011 cannot constitute a material fact, within the definition in s. 1(1), because it could not have had a significant effect on the price to be paid. Since the Agreement of Purchase and Sale requires the vendor to pay for any such improvements, it is cost-neutral to the defendants.
[41] To recap the above analysis, I conclude that of the four “material facts” that the defendants allege should have been disclosed, three of them can be dismissed for the reasons given. The only one that meets the definition of a material fact is the existence of the Spin Desserts litigation. I accept that if a franchisor is involved in ongoing litigation, this should be disclosed to prospective franchisees: see 2240802 Ontario Inc. v. Springdale Pizza, 2013 ONSC 7288 (S.C.J.) at para. 48. To that extent, the disclosure document was deficient. However, as was made clear in Imvescor, above, a content deficiency only gives rise to rescission rights under s. 6(1). It is only where there are stark and material deficiencies in the disclosure document that a court may conclude that it amounts to no disclosure at all. The sweeping remedy of rescission is restricted to “instances of a complete failure to provide a disclosure document”.
[42] As already noted, the Spin Desserts lawsuit was a protective measure taken by the franchisor, at the request of and for the benefit of the franchisees. It did not constitute a potential liability that might attach to the franchise system as a whole. Given the distance between the competing outlet and the subject premises, there is no basis for inferring that it could have had any economic impact on the defendants’ operation, nor is there any evidence that it did so. The defendants were aware of this litigation by September of 2011, but did not raise it as a concern until their Statement of Defence and Counterclaim was filed on September 24, 2013. If it had been a material fact that could reasonably be expected to have a significant impact on the price the defendants paid for the franchise, one would have expected them to have complained when, or shortly after, they found out about it.
The Test for Summary Judgment:
[43] The approach to be taken by the court on a summary judgment motion has now been clearly articulated by the Supreme Court of Canada in Hryniak v. Mauldin, 2014 SCC 7. There, the court emphasized that a shift in culture is required that emphasizes the principle of proportionality. Summary judgment rules must be interpreted broadly, favouring proportionality and fair access to the affordable, timely and just adjudication of claims.
[44] A party is entitled to summary judgment whenever there is “no genuine issue requiring a trial”: Rule 20.04(2)(a). Karakatsanis J., speaking for the court, explained at paras. 49 - 50 what these words mean:
There will be no genuine issue requiring a trial when the judge is able to reach a fair and just determination on the merits on a motion for summary judgment. This will be the case when the process (1) allows the judge to make the necessary findings of fact, (2) allows the judge to apply the law to the facts, and (3) is a proportionate, more expeditious and less expensive means to achieve a just result.
These principles are interconnected and all speak to whether summary judgment will provide a fair and just adjudication. When a summary judgment motion allows the judge to find the necessary facts and resolve the dispute, proceeding to trial would generally not be proportionate, timely or cost effective. Similarly, a process that does not give a judge confidence in her conclusions can never be the proportionate way to resolve a dispute. It bears reiterating that the standard for fairness is not whether the procedure is as exhaustive as a trial, but whether it gives the judge confidence that she can find the necessary facts and apply the relevant legal principles so as to resolve the dispute.
[45] At para. 66, Karakatsanis J. provided a roadmap for the court to follow in addressing this question:
On a motion for summary judgment under Rule 20.04, the judge should first determine if there is a genuine issue requiring trial based only on the evidence before her, without using the new fact-finding powers. There will be no genuine issue requiring a trial if the summary judgment process provides her with the evidence required to fairly and justly adjudicate the dispute and is a timely, affordable and proportionate procedure, under Rule 20.04(2)(a). If there appears to be a genuine issue requiring a trial, she should then determine if the need for a trial can be avoided by using the new powers under Rules 20.04(2.1) and (2.2). She may, at her discretion, use those powers, provided that their use is not against the interest of justice. Their use will not be against the interest of justice if they will lead to a fair and just result and will serve the goals of timeliness, affordability and proportionality in light of the litigation as a whole.
[46] The material upon which the plaintiff relies on this motion consists of documents, the pleadings of the defendants, uncontested facts and admissions made by the defendant Khan on his cross-examination. The task before the court is to analyse those facts as against the applicable law to determine whether there is a genuine issue for trial as to the defendants’ right to claim rescission. Given the nature of the evidence, I am able to make that determination without using any of the new powers provided under the amendments to the Rules. I am satisfied that the summary judgment process provides me with the evidence required to fairly and justly adjudicate this portion of the dispute in a timely, affordable and proportionate procedure.
[47] At outset of counsel’s submissions, I expressed concern as to whether it was a cost-effective expenditure of court resources and counsel’s time to adjudicate on this motion for summary judgment when it is conceded that a trial will be required in any event. In my view, the answer to that question can be found in para. 60 of Hryniak:
The "interest of justice" inquiry goes further, and also considers the consequences of the motion in the context of the litigation as a whole. For example, if some of the claims against some of the parties will proceed to trial in any event, it may not be in the interest of justice to use the new fact-finding powers to grant summary judgment against a single defendant. Such partial summary judgment may run the risk of duplicative proceedings or inconsistent findings of fact and therefore the use of the powers may not be in the interest of justice. On the other hand, the resolution of an important claim against a key party could significantly advance access to justice, and be the most proportionate, timely and cost effective approach.
[48] This motion seeks to dismiss the defendants’ counterclaim for rescission of the Franchise Agreement. That is an important claim against the plaintiff, since it involves retroactively terminating a legal contract that was in operation for over two years. The task of this court is only to determine whether the alleged defects in disclosure amount, in law, to no disclosure at all. That is a discrete and separate issue from the ones that will be argued at trial as to whether these same facts give rise to a cause of action in breach of contract, misrepresentation or breach of fair dealing. Furthermore, since the facts upon which this issue turns are essentially undisputed, there is no risk of inconsistent findings of fact.
[49] I accept Mr. McNair’s submission that if this motion is successful and the rescission claim is dismissed, the landscape for resolution will be fundamentally altered and the prospects for avoiding a lengthy trial greatly enhanced.
[50] I am satisfied that it is in the interests of justice to adjudicate on the issue before the court within the summary judgment procedure. Indeed, I am in as good a position as a trial judge would be to determine that issue.
[51] I find that the one item of information relating to the Spin Desserts litigation fails to come anywhere close to the type of deficient disclosure that amounts, in law, to no disclosure at all. There is no genuine issue for trial in this regard.
[52] I therefore conclude that the defendants have no right to rescission under s. 6(2) of the Act, since the disclosure document was provided by the franchisor as required. It follows that the counterclaim for rescission of the Franchise Agreement must be dismissed.
[53] The defendants remain free to pursue at trial their counterclaims for breach of contract, misrepresentation and breach of fair dealing, arising out of these same facts.
[54] If the parties cannot agree on costs, I will accept written submissions from the plaintiff within 15 days, with the defendants’ response within 10 days thereafter, and any reply within 5 days thereafter. Failing that, the parties will be deemed to have resolved the issue of costs between themselves.
“T. A. Heeney R.S.J.”
T. A. Heeney R.S.J.
Released: April 3, 2014
Caffé Demetre v. 2249027 Ontario Inc., 2014 ONSC 2133
COURT FILE NO.: 151513
ONTARIO
SUPERIOR COURT OF JUSTICE
BETWEEN:
CAFFÉ DEMETRE FRANCHISING CORP.
Plaintiff
– and –
2249027 ONTARIO INC. and WAQAR KHAN
Defendant
AND BETWEEN:
2249027 ONTARIO INC. and WAQAR KHAN
Plaintiffs by Counterclaim
– and –
CAFFÉ DEMETRE FRANCHISING CORP. and GARY STEVEN THEODORE
Defendants by Counterclaim
REASONS FOR JUDGMENT
T. A. Heeney R.S.J.
Released: April 3, 2014