A recent decision made in a high-profile case in the Ontario Superior Court will likely have an impact on franchising in the province and possibly the entire Canadian franchise industry.
In this case, the court found that a franchisee was legally entitled to cancel its agreement with a franchisor because the head lease and franchise's location were not set before the franchisee received the disclosure document. In 2012, the franchisee received the disclosure document for a new location without a head lease in place or a set geographical spot. There was a draft lease included with the disclosure, which required the franchisee to accept all the conditions and terms of the head lease once it was negotiated by the landlord and the franchisor.
The location was determined about seven months after the franchisee received the disclosure, and the head lease had a term that called for prepayment of five months of rent, which was to be released at the rate of one month annually over the first five years. This, coupled with the security deposit, gave the franchisee a total cost of $120,000.
Once the franchisee's location opened, they were invoiced for outstanding building costs and the prepayment of rent. The franchisee refused to pay and served the franchisor with a notice of rescission five months later, intending to end the franchise agreement. The reason given by the franchisee was that the disclosure was deficient, while the franchisor took the position that lease terms cannot be disclosed before they exist.
It is common practice in Canada for franchisees to enter into agreements before a location is set because franchisors do not want to take on the burden of a head lease without having a franchisee in place for it. Usually, the franchisee and franchisor agree that the franchisor will put forth its "best effort" to find a location, with a franchisee giving his or her input. After a location has been decided on, the franchisor often enters into the head lease for the location and then sublets to the franchisee because this allows the franchisor to step in and take the business over if it ever becomes necessary.
The court's decision in this case was that the franchisor failed to meet the disclosure standards set out in the Arthur Wishart Act, which is Ontario's set of franchise laws, because the head lease and store location weren't known and were not disclosed as a result. It's too early to tell what impact this decision will have on franchisees in Ontario going forward, but it's certainly a ruling that is turning heads.
