1901709 Ontario Inc. and Bingyang Tan v. Dakin News Systems Inc. et al.

COURT FILE NO.: CV-16-546372

DATE: 2022-11-10

ONTARIO SUPERIOR COURT OF JUSTICE

BETWEEN:

1901709 Ontario Inc. and Bingyang Tan

Plaintiffs

– and –

Dakin News Systems Inc., Dakin West Inc., Samuel Davis and Warren Smagaren

Defendants

COUNSEL:

Mesiano-Crookston, for the Plaintiffs

Hanuka, B, for the Defendants

HEARD: April 19-25, 2022

REASONS FOR JUDGMENT

Sugunasiri, J.:

Overview and Brief Conclusion:

[1] In 2013, Mr. Tan was looking to augment his income and was introduced to Mr. Abbas Ashtiani who operated an International News franchise at College Park in Toronto. Ashtiani was looking to sell the franchise. After negotiations between their respective real estate agents, Tan and Ashtiani entered into an Agreement of Purchase and Sale (“APS”) for an asset sale and transfer of the franchise to Tan in trust for what became 1901709 Ontario Inc. (“190 Inc.”). The sale was conditional on the franchisor, Dakin News, approving Tan, and the landlord, Dakin West, consenting to a lease assignment.

[2] Ultimately Dakin News approved Tan after reviewing his financial information, signing franchise and sublease agreements with him and receiving several fees. 190 Inc. operated the store from March of 2014 to April of 2015 when 190 Inc. sought to rescind the franchise agreement and recover its losses on the basis that the franchisor failed to provide the required disclosure document under section 5 of the Arthur Wishart Act (“AWA”). Dakin News submits that no disclosure was required by operation of section 5(7) of the AWA. That subsection waives the disclosure requirements where a third party buys a franchise from an existing franchisee, as long as the grant was not effected by or through Dakin News. The issue in this trial is whether Dakin News’ six-step transfer procedure implemented by its employees required it to provide a disclosure document to 190 Inc. and Tan.

[3] I conclude that Dakin News does not fall within the exemption and should have provided 190 Inc. and Tan with a disclosure document. In the transfer process, Dakin News required 190 Inc. to enter into a new franchise agreement with it and required it, among other things, to pay the same upfront inventory fee that was required of Ashtiani when he became a Dakin News franchisee. In pith and substance 190 Inc.’s transaction with Ashtiani was not merely an assignment. It was a whole new contract that required the protection afforded to potential franchisees under the AWA. Dakin News effected the grant of the franchise by requiring the six-step process and charging a new inventory fee. Further, Dakin West and Davis are franchisor’s associates and also liable to the Plaintiffs. Finally, Dakin News, Dakin West and Davis shall pay the Plaintiffs damages in the amount of $33,796.

Analysis:

[4] The facts are largely not in dispute. Dakin News operates a franchise system of quick-service retail stores including ones under the banner “International News”. The Defendant Mr. Smagaren manages real estate and acquisitions for Dakin News Systems Inc. and Dakin West Inc.. The Defendant Samuel Davis is the sole office and director of Dakin News, and Dakin West. Davis is also the sole shareholder of both companies, either directly or indirectly through his holding companies.

[5] On or about April 22, 2013, 8468168 Canada Inc. (“846”) and its principal, Ashtiani, bought the store at 777 College Park in Toronto and entered into a franchise agreement with Dakin News Systems Inc.. They also entered into a sub-lease agreement with Dakin West Inc. who was a lessor with the head landlord, 777 Bay Street Associates, LP. 846’s franchise term was to expire on May 30, 2015.

[6] Around October or November of 2013, Ashtiani advised Smagaren that he was moving to the Middle East. Smagaren suggested that one option was for him to sell the store. Ashtiani chose to do so. On November 27, 2013, 846 entered into an APS first with Tan in trust and then with the Plaintiff 190 Inc. There were various negotiations on purchase price and the closing date for the transaction. Ashtiani and Tan finally landed on a sale price of $140,000.

[7] To sell the franchise to 190 Inc. and Tan, Ashtiani was required under section 15 of his franchise agreement to seek the approval of Dakin News. In turn, Dakin News required Ashtiani and 846 to impose a six-step procedure on 190 Inc. as part of its approval process. Ms. Yelisyeyenko was Dakin News’ point person for the procedure but she did not have direct contact with Tan. Dakin News’ transfer procedure is central to the parties’ dispute as to whether Dakin News was required to provide disclosure to Tan and 190 Inc. before buying the franchise. I set it out in its entirety:

[8] Ultimately the Plaintiffs completed the steps, signed a franchise agreement and sub-lease agreement with Dakin News and Dakin West respectively on January 27, 2014, and started operating the store in March of 2014. Smagaren’s role was to sign the documents provided to him, but he was otherwise not involved in the transfer of the franchise.

[9] In July of 2014, Tan received two letters from Dakin News advising him that it planned to rebrand its International News franchises. Tan’s store was in phase 1 of that plan and required 190 Inc. to pay $75,000 in three installments. A second letter advised that the franchise agreement and sublease were going to expire on May 30, 2015 and that to continue Tan would have to accept the refurbishment requirements notwithstanding 190 Inc.’s pre-payment of the renewal fee.

[10] Due to these issues, 190 Inc. served its Notice of Recission on May 13, 2015 on the basis that 190 Inc. and Tan did not receive disclosure from Dakin News as required under section 5 of the AWA. 190 Inc. and Tan now seek refund of the purchase price, cost of inventory and supplies, losses incurred in acquiring the franchise, and damages pursuant to subsection 6(6) of the AWA. The Statement of Claim also seeks damages for misrepresentation under section 7 of the AWA but the Plaintiffs did not seek any amounts at trial under that head of damage.

Issues:

[11] There are three issues in this case:

a. Did Dakin News Systems Inc. effect the transfer of the franchise through its imposition of the transfer procedure or any other requirements? Yes. Dakin News’ effected the transfer of the franchise from Mr. Ashtiani to 190 Inc. and Tan by imposing its transfer procedure and requiring new consideration.

b. Are the landlord, Dakin West, Mr. Davis and Mr. Smagaren franchisor’s associates as defined in section 1 of the AWA and therefore also liable for any damages sustained by 190 Inc. and Tan? Yes, Dakin West and Mr. Davis are franchisor’s associates. Mr. Smagaren is not.

c. Is 190 Inc. and Tan entitled to any amounts set out in sections 6 of the AWA as remedies for non-disclosure? Yes, 190 Inc. and Tan are entitled to amounts under section 6.

A. Dakin News has not met its burden of proving on a balance of probabilities that it did not effect the transfer of the franchise

[12] Section 5 of the AWA sets out the specific disclosure obligations for franchisors and s. 6 provides the consequences for failure to strictly comply with those requirements, including rights of rescission and compensation. Exemptions from the disclosure requirements are set out in ss. 5(7)(a) and (d) and 5(8) where grants are from an existing franchisor:

5(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;

5(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.

[13] Pursuant to s. 6(2), the failure to provide any disclosure permits a franchisee to rescind the Franchise Agreement without penalty within two years of the Franchise Agreement. 190 Inc. and Tan served their Notice of Recission within two years of signing their franchise agreement. Section 12 of the AWA requires Dakin News to prove that a disclosure exemption applies to them.

[14] The central issue is whether Dakin New “effected” the transfer of 777 College Park franchise from 846 to 190 Inc. by imposing its transfer procedure. In 2189205 Ontario Inc. v. Springdale Pizza Depot Ltd., 2011 ONCA 467, Justice Karakatsanis writing then for the Court of Appeal stated out the approach to assess whether a franchisor falls within the disclosure exemption:

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.

[15] In my view, the purchase of the 777 College Park International News franchise was not a franchisee-franchisee transaction; rather, it was a franchisor-franchisee transaction in disguise. It was entirely guided by Dakin News. Dakin News was involved beyond “merely” exercising its rights to consent to the transfer under section 15 of its franchise agreement with Ashtiani. In particular, Dakin News required 190 Inc. and Tan to enter into a whole new franchise agreement and sub-lease and pay a new inventory fee of $20,000 despite 190 Inc.’s purchase of Ashtiani’s existing inventory. These requirements go beyond Dakin News’ right to approve of a proposed franchisee and collect a transfer fee and reasonable actual costs incurred by Dakin News to process the grant. The payment of $20,000 is new consideration – it is not 190 Inc. simply stepping into 846’s shoes. That franchisee already paid the $20,000 inventory fee. Despite best efforts of Dakin News employees to distance themselves from the process by indicating to Ashtiani that they did not want to deal with the buyer directly, such efforts cloak what in pith and substance was a transfer effected by Dakin News. Through its guided process, Dakin News was able to control every aspect of a transfer from an existing franchisee without any of the obligations to imposed in the AWA towards the transferee. The mere fact that Dakin News uses the existing franchisee as its agent to impose its detailed transfer process does not shield it from its obligations nor does is strip Tan and 190 Inc. from the protections afforded them by the AWA.

[16] Given the foregoing, 190 Inc. and Tan were entitled to rescind the franchise agreement pursuant to subsection 6(2) of the AWA.

B. Dakin West and Mr. Davis are franchisor’s associates

[17] Subsection 1(1) of the AWA defines a franchisor’s associate as a person who directly or indirectly is controlled by the franchisor and who is directly involved in the grant of franchise by exercising significant operational control over the franchisee and to whom the franchisee has a continuing financial obligation in respect of the franchise. On this definition and accepting the need to apply a flexible interpretation to the provision to ensure a level playing field (WP (33 Sheppard) Gourmet Express Restaurant Corp. v. WP Canada Bistro & Express Co., 2010 ONSC 2644 at para. 126) I find that Dakin West is a franchisor’s associate. It is the sub-tenant with whom 190 Inc. has a lease agreement and it was a dispute about renovations to the property and 190 Inc.’s contributions to it that triggered Tan’s decision to rescind the franchise agreement. The lease agreement is part and parcel of the grant of franchise.

[18] Mr. Davis is the principle of both Dakin News and Dakin West. He is also the sole indirect shareholder through a series of holding companies. Mr. Davis directly controls Dakin News as the franchisor and has set up the franchisee approval system that is implemented by his employees. Mr. Smagaren reports to Mr. Davis regularly and Davis retains ultimate control over who is approved as a franchisee. In my view, the AWA is not intended to allow Davis to escape liability by hiding behind an approval structure that removes him from the day-to-day aspects of the grant of franchise. At the end of the day, he is the source and directing mind of the grant process and in this way is “directly involved in the grant of franchise by being involved in approving the grant of the franchise.”

[19] On the other hand, I do not find Smagaren to be a franchisor’s associate. Smagaren is not “controlled” by Dakin News in the sense understood by the legislation. In my view, the legislation is not intended to include employees of the franchisor whose very job description it is to approve franchisees for its employer franchisor. Smagaren and indeed Ms. Yelisyeyenko (who is not named but very much involved in the franchisee approval process) are forced to implement a franchisee approval process over which they have no control. Neither are “controlled” by Dakin News. Rather, they are part of Dakin News and are shielded as its employees. It might be different if Smagaren was an independent contractor hired by Dakin News to find and approve franchisees on its behalf. It cannot be that employees of a franchisor company are liable simply because their job is to implement the franchisor’s process for granting franchises. Otherwise, no one would work for a franchisor company without the company indemnifying them for any such liability. Here, the parties agree that there is no such indemnification.

[20] Dakin News, Dakin West and Mr. Davis are jointly and severally liable for damages owing to 190 Inc. pursuant to sections 7 and 8 of the AWA.

C. Dakin News, Dakin West and Mr. Davis must pay 190 Inc $33,796

Amounts paid directly to Dakin News – para. 6(6)(a) AWA

[21] Paragraph 6(6)(a) of the AWA allows 190 Inc. to recover amounts that they paid directly to Dakin News other than money for inventory, supplies or equipment. Dakin News does not dispute that amount to be $22,048 which includes the $3500 training fee, $10,000 security deposit and $8,548 in royalties. The Plaintiffs are entitled to payment of $32,048 pursuant to paragraph 6(6)(a) of the AWA. There was an issue about whether 190 Inc. pre-paid a $10,000 renewal fee. I am satisfied that it did. The company received a receipt for it from Ms. Yelisyeyenko.

Inventory purchase – para. 6(6)(b) AWA

[22] Paragraph 6(6)(b) if the AWA requires Dakin News to purchase from 190 Inc. any inventory that 190 Inc. had purchased pursuant to the franchise agreement. Mr. Stulberg relied on a “roll forward” calculation to conclude that the cost of existing inventory at the time of recission was $32,703. In performing this roll forward calculation, Mr. Stulberg calculated the closing balance by adding inventory purchases to the opening balance less sales at cost. He explained that if this amount was inflated, it would mean that there would be a corresponding under-estimate the cost of goods. As such there is no effect on the ultimate damages number.

[23] Dakin News argues that in fact it did conduct an inventory count. In that inventory count, there were many products that were expired or near expiry. I accept Dakin News’ evidence found at Trial Exhibit 1, Tab 38. Based on this evidence, Dakin News suggests that the value of the “unexpiring” inventory is $1,123. The onus is on 190 Inc. to prove and quantify its damages. Given that Mr. Stulberg based his calculations on a theoretical roll forward calculation and not the actual ending inventory, I limit damages under this head to $1,123.

Supply and equipment purchase – para. 6(6)(c) AWA

[24] Paragraph 6(6)(c) requires Dakin News to reimburse 190 Inc. for any supplies and equipment it purchased pursuant to the franchise agreement at a price equal to the purchase price. Mr. Stulberg calculated this amount at $8102 to account for a vehicle that Tan allegedly purchased to transport supplies to the store and scrapped it when the store closed. I reject this amount. Tan was cross-examined about this vehicle. Dakin News submits that he did not produce any documents to support his claim. Mr. Stulberg relied entirely on the entry in the Trial Balance in his calculation and Tan’s evidence. I do not accept Tan’s evidence without documentary corroboration. He was not credible in his testimony on this point.

Losses incurred to acquire, set up and operate the franchise – para. 6(6)(d) AWA

[25] Paragraph 6(6)(d) requires Dakin News to compensate 190 Inc. for any losses it incurred to acquire, set up and operate the franchise. Mr. Stulberg calculated this amount to be either $208,221 or $294,659 depending on whether I accept using an average wage expense for Tan and his wife’s labour, or minimum wage. Of these amounts, Mr. Stulberg calculated $156,494 to represent operating losses with the balance representing unpaid owner labour.

[26] Dakin News correctly submits that Mr. Stulberg’s loss assessment is based on a largely unsubstantiated trial balance. Mr. Stulberg was provided with 15 invoices and much of the underlying documentation was illegible. Tan was unable to explain the trial balance or provide most the supporting documents to substantiate the enumerated expenses therein. His wife Ms. Sun apparently did the books but did not deliver an affidavit. Dakin News also notes that the reported sales in the trial balance is $25,000 lower than what 190 Inc. reported on its HST returns. Mr. Stulberg explained on cross-examination that while he did not verify the smaller expenses noted on the trial balance, he did verify the larger amounts like rent and goodwill which correlates with the known purchase price.

[27] I find the trial balance of limited use and heavily discount the loss claim due to Tan and 190 Inc.’s failure to provide useful supporting documentation. Mr. Stulberg’s assessment is only as good as the trial balance, which is woefully inadequate. I agree with the Defendants that there is a difference between damages that cannot be easily calculated because of the nature of the damages sought and damages that cannot be calculated because the plaintiffs have failed to tender the appropriate evidence. This case is the latter. However, I also consider the commercial reality that 190 Inc. would have incurred some of the unsubstantiated expenses set out in the trial balance to operate the franchise for 1.25 years. Aside from rent and goodwill, I reduce the trial balance amounts by 75% - in other words I allow 190 Inc. 25% of its purported expenses. I reduce the cost of sales by 50% based on the reasonable inference that the franchise must have bought at least some of the goods noted in Note 2 of Appendix A to Mr. Stulberg’s report to generate the sales reported on its HST returns.

[28] 190 Inc. and Tan also claim owner labour costs. Dakin News takes issue with the hours Mr. Tan’s wife claims to have worked at the franchise. During the franchise period, Sun worked as a senior financial analyst with the Ontario government. Tan testified that Sun handled the bookkeeping for the franchise which she did after her regular work hours. It is clear from the few source documents that 190 Inc. provided, and emails found in Exhibit 1 between Sun and Yelisyeyenko that Sun did some financial work for the franchise including providing financial information to Mr. Stulberg. Tan attested that Sun worked from 7-9:30 am, during the lunch hour and from 5 to 7 pm. Mr. Stulberg calculated the total unpaid owner labour figure on the basis of 95 hours per week for 50 weeks/year for 1.25 years. I accept that Sun worked approximately 20 hours per week. I have no evidence on Tan’s hours but assume that the store was open for at least 8 hours per day from Monday to Friday. That allows him a 40-hour work week. I allow lost wages of for a combined amount of 60 hours per week for 50 weeks, for 1.25 years, at the minimum wage rate of $11/hour for a total of $41,250 in lost wages.

[29] Taking Mr. Stulberg’s calculation at Schedule 5 of his report, I recalculate net operating loss as follows:

Sales $ 297,826 (250,369 + commissions of $ 47,457)

Cost of Sales $ 95,201

Gross Margin $ 202,625

Less: Rent $ 56, 892

Goodwill loss $119,823

Goodwill amortization $23,177

25% of all other expenses $12, 757 (25% of 51,028)

Unpaid wages $ 41, 250

Total: All expenses $ 253,899

Net income (before taxes): $ (51, 274)

[30] In total, Dakin News, Dakin West and Mr. Davis are liable to pay the Plaintiffs damages for operating losses of $51,274.

Conclusion:

[31] I grant 190 Inc. and Tan’s action as against all defendants except Mr. Smagaren. Dakin’s transfer procedure does not shield it from its disclosure obligation under the Arthur Wishart Act. I dismiss the action as against Smagaren. He was a mere employee of Dakin News and not a franchisor’s associate. In the absence of cogent and complete evidence on damages, I award the Plaintiffs total damages of $85,100 owed jointly and severally by the Dakin Defendants and Mr. Davis.

Costs:

[32] To reduce further costs, I expect the parties to resolve costs. If they cannot, they shall contact my assistant Roxanne.Johnson@ontario.ca to arrange for a 20-minute costs hearing.

P.T. Sugunasiri, J.

Released: November 10, 2022

COURT FILE NO.: CV-16-546372

DATE: 20221110

ONTARIO

SUPERIOR COURT OF JUSTICE

BETWEEN:

1901709 Ontario Inc. and Bingyang Tan

Plaintiffs

– and –

Dakin News Systems Inc., Dakin West Inc., Samuel Davis and Warren Smagaren

Defendants

REASONS FOR JUDGMENT

P. Tamara Sugunasiri J.

Released: November 10, 2022