A Checklist for Franchise Causes of Action – Statutory Claims

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This article was originally published in The Lawyer’s Daily on March 13, 2020, under the same title.  The assistance of Anthony Pugh, Associate at Law Works PC, in writing this article is acknowledged with thanks.

 This article provides an outline of frequently claimed substantive causes of action in franchise disputes.  The causes of action addressed in this article are statutory claims.

(As with the previous article, references to statutory sections are to provisional franchise Acts in British Columbia, Manitoba, Ontario, New Brunswick and P.E.I.; the Alberta statute has somewhat different provisions.)

Rescission

Most claims appear to center around rescission based on allegations of failure to provide a disclosure document.  Here are some of the key questions to consider:

1. Was there a statutory obligation to deliver a disclosure document?
2. Is it clear that the business is a ‘franchise’ within the meaning of the Act?
3. Do any exemptions to the applications of the Act apply? These are different from statutory disclosure exemptions, and include such relationships as employer/employee, partnership, single trademark licence, etc.
4. Do any of the statutory exemptions apply (see further on that below)?
5. What is the extent or magnitude of the alleged deficiency that underpins the allegation that no disclosure document was provided? What material facts or material changes are alleged to have been omitted? Is there an allegation of an inability to make an informed investment decision?  Questions that deal with the extent of the deficiency or material facts or changes may require evidence about the relevancy and impact of those alleged failures.
6. Is there evidence in dispute? For example, a franchisor typically relies on a signed receipt that lists all documents purportedly contained in the disclosure document. Sometimes, a franchisee will deny that the disclosure document contains the documents listed in the receipt. This may raise questions of evidence and credibility.

Misrepresentation and Failure to Comply Under Section 7

Some claims are brought under section 7 of the Act, for misrepresentation or failure to comply with the disclosure obligations.  These may be brought exclusively or concurrently with a rescission claim.  Here are some scenarios where a franchisee may opt for a claim under this section:

1. The disclosure document is not fatally deficient.
2. The franchisor is alleged to have failed to comply with other disclosure obligations than content, such as delivery time, method of delivery, etc. (assuming that the franchisee is beyond the 60-day limitation period for the delivery of a notice of rescission in those circumstances).
3. The disclosure document is fatally deficient but the franchisee is beyond the two-year limitation period for the delivery of a notice of rescission in those circumstances.
4. Additional defendants are brought in, other than the franchisor or franchisor’s associates, such as the persons who signed the disclosure document, agents, brokers (in some provinces), etc.
5. The franchisee does not wish to rescind the franchise purchase, but rather to continue the relationship and claim damages for losses as a result of any number of discreet misrepresentations or disclosure failures.

Section 7 provides several defences (which do not appear to have been used thus far in jurisprudence).

The section also provides for a deemed-reliance on the alleged misrepresentation or disclosure failure.  However, it is unclear if a franchisee is required to prove causation (see further on causation under Damages below).

Disclosure Exemptions

The provincial statutes provide for various exemptions to the obligation to provide a disclosure document.  The party claiming the exemption, i.e. the franchisor, has the burden of proving the exemption.

Some of the common ones are the following (there are several other exemptions, which have thus far been rarely used):

1. Resale exemption. The key here is whether the franchisor ‘effected’ the resale. This involves factual questions about the degree and significance of the alleged involvement in the transaction.
2. Renewal or extension of a franchise. The key consideration here is whether there has been a material change (which is a defined term and is different from ‘material fact’) since the last franchise agreement or renewal was signed.
3. The purchase is excluded from disclosure because either the total investment is below a prescribed amount or the term of franchise is less than one year and does not involve a non-refundable franchise fee (a key point here is that those words have been interpreted strictly, which favours the franchisor because it allows other similar features that do not take away from the entitlement to this exemption).
4. The franchisee’s total investment is above a prescribed amount. The key here is that the amount includes the acquisition and operation of the franchise, and the word franchise seems to have been interpreted liberally to include the entire investment in the business, including real estate.

Good Faith

Claims for the breach of the duty of fair dealing and good faith are based on the mutual obligation of parties to the franchise agreement to perform their respective contractual obligations in a commercially reasonable manner.  These claims center around, first,  an interpretation of what the contractual obligation is, and second, whether it is being enforced or performed in a commercially reasonable manner.

Right to Associate

This claim is typically brought in class action or group claim alleging interference by franchisor with the right to associate.  Franchisees need to show evidence of interference, whether direct or indirect, including interference, prohibition or restriction.  It covers activities of penalizing, attempting to penalize, or threatening to penalize the exercise of this right.

Claims Against Individuals

A franchisee’s claim against a franchisor may be in addition to claims against related parties, such as franchisor’s associates.  This may include individuals.  The statutes define “franchisor’s associate” as a party that (a) controls or is controlled by the franchisor (or is controlled by another person who also controls the franchisor), and (b) is directly involved in the grant of the franchise, or alternatively exercises significant operational control and has the right to receive payments from the franchisee.

There are also potential claims against individuals under section 7, addressed earlier.

Waivers and Settlements

Some disputes may arise about the impact of a settlement between the franchisee and the franchisor and whether it bars future claims by the franchisee.  Provincial statutes bar the waiver or a release by a franchisee of statutory rights or franchisor’s obligations, but settlements are not prohibited.  The key factor is whether a true settlement is involved, rather than a waiver or a release.  This issue may require an analysis and evidence about typical common law elements of what constitutes a settlement.

Damages

In cases of rescission, refunds as mandated by the statute tend to be easily quantifiable.  If a franchisee also claims losses on top of that, these tend to be more contentious and may require forensic accounting evidence about net losses.  This may also raise issues about operation by the franchisee, i.e. alleged failures to comply with system standards, etc.

For claims under Section 7 for alleged misrepresentation or failure to comply with disclosure obligations, it is remains unclear based on jurisprudence whether a damages claim under this section are automatic is there is also entitlement to a rescission.

It also remains unclear if these damages require proof of causation, i.e. that damages were caused by the alleged failure, or whether damages for all of a franchisee’s losses automatically flow once the liability is established without the need to prove causation.