Alberta Court of Queen’s Bench Re-affirms the Need for Full Disclosure

Overview

On March 24, 2016, the Alberta Court of Queen’s Bench released its decision in the case of Essa v Mediterranean Franchise Inc. (2016 ABQB 178). The case dealt with a franchise rescission and looked at the application of the Franchises Act (RSA 2000, c F-23) (the “Act”).

Justice Wayne Renke looked at whether the disclosure document met the requirements of the Act; whether there were misrepresentations; and whether Mediterranean Franchise Inc. (“MFI”) breached its duty of fair dealing under the Act.

Renke J held that the disclosure document was not substantially complete and as such was not proper disclosure. As well, he held that there were misrepresentations relating to the food costs because the actual costs were higher, and MFI breached its duty of fair dealing because it did not ensure that the supply network was operating.  The court awarded damages to Essa and Afifi.

Facts

MFI is the operator of “Taste of Mediterranean”, a franchise network of Greek and Mediterranean fast-food restaurants. Essa opened a Taste of Mediterranean restaurant in Edmonton in August 2010, and Afifi later joined him as co-owner. The restaurant did not succeed and closed its doors after nine months of operations, in April 2011.

The court held that there were four deficiencies in the disclosure document that MFI provided to Essa, including these:

• There was no list of existing franchisees: MFI gave only a main number that prospective franchisees could call to obtain franchisee’s phone numbers. These numbers were also available on the internet. The court held that the list was not substantially complete. MFI controlled the numbers, which allowed them to know which franchisees were contacted. It also caused a time gap which would allow the franchisor to have a discussion with the franchisees before the prospective franchisee could call them. This hindered the free flow of information that a franchisee may need to make their purchasing decision, and increase the power imbalance.
• There was no list of franchisees who left the system.
• The presence of earnings claims: Hussein, the sole director and officer of MFI, told Essa, both before and after the Franchise Agreement was signed, that food costs would be 30%-33% of the selling price. These representations triggered the requirements in Schedule 1 of the Franchises Regulation (Alta Reg 240/1995) (the “Regulation”) to disclose the underlying assumptions since they were cost information.
• Financing arrangements: MFI did not provide information about the arrangement that was available from Sam’s Restaurant Inc (“SRI”). Financing was referred to in the Franchise Agreement, and there is no evidence that MFI provided alternatives. Under the Franchise Agreement, franchisees agreed to buy a turn-key operation from SRI. MFI should have disclosed the terms and conditions of the financing arrangement with SRI, even though MFI did not provide financing directly.

Analysis

Renke J said that it was not mandatory to include outlets in the list of existing franchisees that were “opening soon” but were not yet operational. No notice of material change is required for new outlets that open because they do not have a significant adverse effect on the value or price of the franchise or the decision to buy it.

• Misrepresentations

Hussein promised Essa that MFI would begin a national advertising campaign on TV and newspapers. The advertising did not happen. Justice Renke held that since the representations did not form part of the disclosure document or the Franchise Agreement, there was right to claim breach of contract. As well, he wrote that it made sense for the franchisor to wait until the two other Edmonton-area franchises were viable businesses before putting money toward significant advertising.

There was evidence that the estimate that Hussein provided to Essa relating to food costs was inaccurate. The costs were closer to 54% of the price than the 30%-33% represented. Talk of food costs as a percentage of sales, without elaborating about the factors bearing on sales prices, was misleading.

• Duty of fair dealing

Under the Franchise Agreement, Essa was entitled to one week of training before starting operations, and additional training would be provided at a reasonable cost if he requested it. Hussein provided the initial mandatory training and went through the manual step-by-step. Essa did not ask for more training. Justice Renke held that there was no evidence that Essa and Afifi did not have adequate training or that they were unable to do their jobs, even if they had no restaurant experience, and the duty of fair dealing was not breached.

Justice Renke noted that the training provided was held to be adequate, despite Essa’s lack of knowledge and experience in running a restaurant. He also decided that MFI did not breach any of its responsibilities regarding the advertising since it was simply too early in the life of the franchise network. Renke J limited the rights of Essa and Afifi – he held that MFI followed the Act and used proper commercial reasoning. Despite some problems, MFI did not breach its duty.

A supply disruption in January 2011 caused Essa to acquire its own supplies in the last two months of operation. Renke J held that Hussein should have devoted significant energies to patching the supply disruption problem since that is one of the benefits of entering a franchise. MFI did not act fairly, and their conduct amounted to a repudiatory breach of the Franchise Agreement.

Summary and Commentary

Essa and Afifi were successful at trial. The disclosure deficiencies, which, in isolation, would have been considered serious, meant the disclosure document was not substantially complete. As such, there was no proper disclosure.

Even though the store was purchased from SRI, the claim was for reimbursement from MFI because it required the transaction with SRI. MFI was obligated to compensate Essa and Afifi for their lost investment in the franchise.

This case means that if a franchisee does not have sufficient access to products, he or she will have a claim against the franchisor. However, if the only complaint against a supplier is that it is expensive, this will not be significant enough to entitle damages.

The court recognized the broad protections that the Act gives to franchisees, which the court compared to consumer protection legislation, but was careful not to place additional requirements on MFI beyond those in the Act and the Regulation.

Justice Renke reiterated that full disclosure is required to give franchisees all the information they need to make the purchase decision and that an acknowledgement cannot waive the right to receive information under the Act.

Only $10 per hour was awarded as lost wages, which is approximately the minimum wage. This represented a significant discount over Essa’s rate as an engineer of $300 per hour. However, Essa and Afifi were not working as engineers but rather as the only employees in a fast-food restaurant, managing and operating the restaurant.

Justice Renke chose not to comment on the application of an “entire agreement” clause on the food costs misrepresentation. He summarized the law, as stated by the Ontario Court of Appeal in 2001 in 978011 Ontario Ltd v Cornell Engineering Co, that it is unclear whether a franchisor is under a duty of fair dealing in relation to pre-contractual discussions with a prospective franchisee.

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