Quebec Court Rejects Application to Dismiss Claim Against Franchisor’s Directors, but Dismisses Claim by Franchisee’s Shareholder

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By: Anthony Pugh, Law Works
Editor: Ben Hanuka, Law Works

In 10001325 Canada Inc. v. Cacao 70 Inc., a December 8, 2020, decision of the Superior Court of Québec, the court allowed part of the defendant franchisor’s motion to dismiss a franchisee’s claim.

Key facts

The first plaintiff, 10001325 Canada Inc., operated a Cacao 70 franchise in Gatineau.

The second, Likeli Inc., was a shareholder of two Cacao 70 franchises in Vancouver.

Cacao 70 ultimately took possession of all three locations after the franchisees stopped making payments.

The plaintiffs sued Cacao 70 and three of its directors.  They claimed that Cacao 70 and its directors gave them misleading earnings projections and mismanaged the operation of the franchise system.  They also alleged that the Cacao 70 franchise system was a fraudulent scheme, and that Cacao 70 took possession of the three franchised locations through this fraudulent scheme.

Cacao 70 and the related defendants argued that the Gatineau franchisee’s claim against the directors was vague and should be dismissed.  They also argued that Likeli’s claim should be dismissed entirely because the plaintiff had no interest in the claim.

The Gatineau franchisee’s claim against the directors was not clearly unfounded

The Gatineau franchisee alleged that the representations of Cacao 70’s directors were extra-contractual faults that gave rise to personal liability.  It also claimed that the corporate veil should be lifted because the franchise system was fraudulent.

Cacao 70 claimed that the Gatineau franchisee’s allegations were insufficient to give rise to personal liability, and that there was no evidence at the examination for discovery of the franchisee’s principal that could give rise to personal liability against the directors.

Under Articles 51 and 52 of Quebec’s Civil Code of Procedure, a court may dismiss a claim that is clearly unfounded.  The legal test is whether the claim has no reasonable chance of succeeding.  Courts may examine the allegations and all evidence.

The court refused to dismiss the Gatineau franchisee’s claim against the directors.  It held that the directors may be liable if they made representations for the purpose of misleading the franchisee or if they developed a scheme to defraud franchisees.  The court could not foreclose the possibility that the franchisee would be able to prove this.  It also held that the evidence was incomplete, and examination transcript of the franchisee’s principal was not necessarily the full evidence of the franchisee.

The court dismissed Likeli’s claim

As noted earlier, Likeli Inc. was a shareholder of two Cacao 70 franchises in Vancouver, but it was not the corporate franchisee.

Under Quebec’s Civil Code of Procedure, a person must have sufficient interest to bring an action. A person must have a direct and personal interest.  For a shareholder to bring an action, it must show that there was a breach of a distinct obligation to that shareholder, and that it suffered a loss that is distinct from the loss of the corporation.

Likeli based its claim on misrepresentation, mismanagement of the franchise system, failure to provide support, and billing anomalies.  The court held that Cacao 70 did not legally owe any of these alleged obligations to Likeli, but, rather, to the corporate franchisees of the Vancouver franchise locations.

Likeli also sued for psychological distress.  The court held that this would have been suffered not by Likeli Inc., but its shareholders.

The overarching problem was that the other shareholders of the Vancouver franchisees had refused to authorize an action.  Instead, they sold their shares to Cacao 70.  There could be no cause of action arising from this, and Likeli did not bring a derivative action.

Finally, the court held that Likeli’s damages were because of the failure of the business, not any alleged fault of Cacao 70.  These damages are indirect and non-compensable.

The court therefore dismissed Likeli’s claim, holding that it was unfounded and appeared to be abusive.