Ontario court dismisses two of Three Paramount rescission claims

The three locations and the parties

The trial involved claims by three franchised Paramount Fine Foods locations in the Greater Toronto Area (commonly called locally as the “GTA”), owned by related parties.

• Versatile Holdings was the franchisee of the location at Front Street in Toronto.
• Everest was the franchisee of the location at the Yorkdale Shopping Centre in Toronto.
• Premium Host was the franchisee of the location in Mississauga.

Versatile and Everest bought new locations, which they constructed through Paramount’s construction management affiliate, called Fakih Group. Premium Host purchased an existing Paramount location on a resale from another franchisee.

Mohammed Fakih was the directing mind of the franchisor, Paramount, as well as the directing mind of Fakih Group and another company which acted as Paramount’s main supplier.

The key factual dispute in the case was what franchise disclosure document was given to the franchisees. Neither the franchisees nor Paramount had particularly strong evidence that the disclosure document they were relying on at trial was the disclosure document that Paramount actually provided to the franchisees. Paramount had a highly convoluted disclosure process which involved providing multiple versions of the disclosure document to the franchisees.

The court allowed only one rescission claim (on the resale) and dismissed the claims of the other two locations

The trial judge held that the franchisees of the two newbuild locations failed to prove, on a balance of probabilities, that the disclosure documents that they were relying on at trial were the documents that they had ultimately received from Paramount.

It appears that at the heart of the problem was that the franchisees agreed, perhaps implicitly, that it was acceptable for Paramount to deliver several versions of an FDD, and that a rescission claim could only be based on the final version that Paramount had provided. The parties agreed that Paramount could legally cure a deficient disclosure document if starting the process afresh by delivering a new disclosure document.

Further, there were serious discrepancies between the testimony of the franchisees’ main witness and the emails.

The court ruled that the franchisees failed to prove their alleged fatal flaws to the disclosure document, including alleged failure to include a signed and dated certificate and the head lease.

At the same time, the court also rejected the disclosure documents that Paramount relied on.  Among other things, the trial judge found that these disclosure documents could not possibly have existed at the time that they were supposedly delivered.

Paramount did not have a reliable disclosure process. Among other things, its sole director, Mr. Fakih, admitted to pre-signing disclosure certificates, i.e., signing the certificate before the disclosure document was assembled and delivered. There was also evidence that Paramount had backdated the various receipts and certificates, so as to attempt to fit within the statute.

As to the Mississauga resale location, the court was satisfied that Paramount failed to include the location’s sales information financials in its disclosure document. Instead, the franchisor delivered the sales information after the fact in a separate email. This constituted a failure to deliver one disclosure document at one time and entitled the franchisee to rescission.

Other alleged deficiencies did not deprive the franchisees of the ability to make an informed investment decision

The court rejected the franchisees’ argument that they were entitled to rescind the two newbuild purchases based on purported deficiencies that were present in all versions of the disclosure document.

The first allegation was that that the disclosure documents wrongly identified numerous officers and directors. The franchisees argued that this gave the false impression of a large and sophisticated franchisor. The court held that this deficiency was not so important as to prevent the franchisees from making an informed investment decision and, in any event, the certificate required only Mr. Fakih’s signature.

The second purported deficiency was that the disclosure documents failed to identify Fakih Group or to include a copy of the construction management agreement. Since the franchisees were not required to use Fakih Group or sign the construction management agreement, this purported disclosure deficiency was not considered fatal.

About the alleged construction overruns, the court ruled that this was due to unforeseen circumstances and that the disclosure documents stated that the range of expenditures may vary.

Disclosure exemptions did not apply

Paramount sought to rely on various exemptions to the requirement to provide a disclosure document in the Wishart Act.

First, it argued that the franchisees invested over five million dollars in the acquisition and operation of the three restaurants, and that therefore the franchisor was exempt from disclosure under the version of section 5(7)(h) of the Wishart Act that was in force at the time.  Paramount argued that the franchisees did not observe separate corporate personalities.

The court rejected this argument, holding that there were three separate franchise grants – one for each restaurant. Since none of the individual grants involved an investment of over five million dollars, the exemption did not apply.

Second, Paramount sought to rely on the additional franchise exemption found in section 5(7)(c) of the Wishart Act with respect to the Mississauga location – likewise arguing that Premium Host was not genuinely a separate legal personality from Versatile (which had already started operating the Front Street location).

The court rejected this argument on the basis that the Mississauga location was Premium Host’s first franchise.  Versatile had only been operating for a month and half at the time of the grant to Premium Host and had barely started constructing the restaurant. Premium Host and Versatile had different shareholders, and Paramount had required a personal guarantee from the additional shareholder involved in Premium Host.

The court noted that the purpose of the exemption was to apply to a franchisee that was already familiar with the franchise system.

Finally, Paramount argued that the resale exemption applied to Premium Host’s purchase of the franchise from the selling franchisee. In rejecting this argument, the court held that the selling franchisee had not granted the franchise – since its franchise agreement and sublease had been terminated, and Paramount required Premium Host to enter into a new franchise agreement and sublease. Further, Paramount was significantly involved in the sale, including directing Premium Host to the seller.

The franchisee was entitled to rescind a franchise agreement that Paramount had terminated

Paramount argued that the franchisees could not rescind any of the franchise agreements, since Paramount had already terminated them by the time that the franchisees delivered the notices of rescission. The court held that this interpretation of the Wishart Act would run contrary to its purpose, which was to protect franchisees. It also held that this would essentially waive the franchisee’s right to rescission, contrary to the no-waiver provision in section 11 of the Wishart Act.

Franchisor’s associates

Based on established caselaw, the court held that the sublandlord, which was an affiliate of the franchisor’s, was a franchisor’s associate under the Wishart Act, as it exercised control over the franchisees and was owed regular payments in the form of rent.

Also found as a franchisor’s associate was Paramount’s manager of franchising. This person was heavily involved in communications with the franchisees, put together the disclosure documents, and received a minor commission from each franchise grant. This is notwithstanding the fact that this individual did not have authority to approve the grant of the franchise.

However, the court held that Paramount’s main supplier, which was also affiliated with the franchisor, was not a franchisor’s associate, since it was possible for the franchisees to choose a different supplier – which they in fact did. The court rejected an argument that the supplier’s approval would have been required as part of the franchise grant.

For similar reasons, the court rejected the claim that the franchisor’s construction management company was a franchisor’s associate: the franchisees were not required to use this company to build out the restaurants. In any event, this company was not involved in the resale process – which was the only location that had a successful rescission claim.

The court granted the franchisor’s counterclaim for various unpaid liquidated amounts owing by the newbuild locations.  Its counterclaim for unpaid amounts owing by the resale location was denied, since the rescission claim was granted for that location.

Summary

This case reinforces the need for franchisors to scrupulously obtain and maintain records of receipts and other evidence about the delivery of their disclosure documents.

It also showcases the need for franchisors to put in place a well organized and legally compliant disclosure process.

With respect to resale locations, the case again illustrates the critical importance of disclosing store financials in the disclosure document.

As to the two unsuccessful newbuild rescission claims, the decision shows that if the disclosure document contains all legally recognized fundamental components (certificate, financials, key document, one-document at one time, etc.), it may be an uphill battle for a franchisee to successfully prove a rescission claim on the basis that the disclosure document is of no effect (i.e., that no disclosure had been delivered, under section 6(2) of the Wishart Act). The franchisee must prove on an objective basis an inability to make an informed investment decision because of the alleged deficiencies.

With respect to the exemptions to disclosure, this decision is another example of how narrowly the disclosure exemptions under the Wishart Act are construed. Based on the reasoning in this decision and how franchise sales are typically done in Canada, it is difficult to see where a disclosure exemption can apply.

Finally, the parties to this case appear to have embarked on costly litigation strategies. None of the parties had the confidence of the trial judge because of significant contradictions between their oral testimony and the documentary evidence.