Franchise Rescission – the Schooley Mitchell Telecom Case

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Author: Anthony Pugh, Student-at-Law, Law Works P.C.

Editor: Ben Hanuka

In Giroux et al. v. 1073355 Ontario Limited o/a Schooley Mitchell Telecom Consultants et al., a decision based on a motion for summary judgment released on January 5, 2018, a judge of the Ontario Superior Court of Justice granted rescission under subsection 6(2) of the Arthur Wishart Act (Franchise Disclosure), 2002 (“Act”) to the plaintiff franchisees.

The financial statements in the Franchise Disclosure Document (“FDD”) were not compliant with the requirements of the Act and its accompanying Regulation. This was a sufficient basis for the motion judge to conclude that the plaintiffs had a right to rescind the franchise agreement.

The court also found that financial information included in the FDD regarding the earnings of franchisees in the system were earnings projections. Therefore, that information would have had to comply with the requirements for earnings projections set out in the Regulations.

The plaintiffs would not have been able to rescind the agreement based only on the fact that the franchisor provided two different FDDs. Rather, the judge determined that a second FDD that the franchisor provided started a new process to purchase the franchise.

Key Facts

The plaintiffs sought summary judgment for a declaration that they were entitled to rescind a franchise agreement under subsection 6(2) of the Arthur Wishart Act (Franchise Disclosure), 2002 (“Act”).

The defendant franchisor, 1073355 Ontario Limited (“107”), operated a system of telecom consulting franchises under the name “Schooley Mitchell Telecom Consultants”. Its only registered director and officer was Elizabeth McMillan, one of the defendants.

107 took over operations from Schooley Mitchell Franchise Corp. Dennis Schooley was the founder of Schooley Mitchell and was also named as a defendant.

107 sent a Franchise Disclosure Document (FDD) after a discussion between the plaintiffs and Schooley. The plaintiffs reviewed the FDD and added a short addendum.

Schooley then sent additional documents to the plaintiffs, including a draft addendum, a proposed financing offer, a spreadsheet containing sales growth projections, projection worksheets and testimonial letters.

About a month after sending the FDD, Schooley sent a second FDD to the plaintiffs’ lawyer at the request of the plaintiffs. This document had many changes from the first FDD.

After the plaintiffs’ lawyer reviewed the second FDD, the plaintiffs executed the franchise agreement.

Schooley later sent another financing offer to the plaintiffs and additional addendums.

The plaintiffs delivered a notice of rescission to the franchisor almost two years after signing the franchise agreement.

Improper financial disclosure enough for plaintiffs to rescind agreement

Inadequate financial disclosure was enough for the motion judge to decide that the franchisor had never provided an FDD within the meaning of the Act, following the Court of Appeal for Ontario’s decision in Mendoza v Active Tire and Auto Inc.

The franchisor’s financial statements for its most recently completed fiscal year were not audited or prepared on a review engagement basis, in contravention of subsections 3(1)(a) and (b) of the Regulation. This problem existed in both the first and the second FDD.

The motion judge drew a negative inference against the defendants because they did not produce evidence showing what accounting standard the franchisor used. There was nothing on the face of the balance sheet showing what accounting standards the franchisor adhered to.

The franchisor also tried to argue that there was no evidence before the court to prove what the language in subsection 3(1)(b) of the Regulation, “equivalent to the review and reporting standards applicable to review engagements”, meant. This argument had very little traction with the court.

Second FDD did not invalidate “one document at one time” requirement

Despite the franchisor giving the plaintiffs two FDDs and the sequence of other documents, the motion judge held that there was no failure to deliver one disclosure document at one time in this case. He found that the plaintiffs decided to purchase the franchise based on the second FDD. On the plaintiffs’ receipt of this document, the franchise purchase process started afresh.

The motion judge did not apply a purely objective lens to the two FDDs’ impact on a franchisee. Instead, he looked for evidence showing that the plaintiffs were confused by the disclosure. Here, there was no evidence showing that the plaintiffs were confused, nor was there evidence that the plaintiffs discussed the first FDD with their lawyer. (Note to Readers: it is unclear to us if the court’s finding on this issue is the correct state of franchise law or the correct interpretation of the relevant disclosure requirements under the Act.)

In addition, the court held that it was unnecessary for the franchisor to disclose in the second FDD the financing discussions that it had with the plaintiff because the second FDD started a new process. The second FDD stated that the franchisor did not offer direct or indirect financing, even though Schooley had sent a financing offer to the plaintiffs. The motion judge determined that financing was negotiated independently after the first FDD.

Furthermore, the motion judge found that the franchisor’s list of former franchisees did not breach the Act or Regulation as the list in the second FDD was accurate.

Financial performance representations were earnings projections

The motion judge decided that three graphs in the second FDD contravened subsection 6(3) of the Regulations because it did not include a location of documents to verify their underlying assumptions. If a franchisor includes an earnings projection in its FDD, this subsection requires an accompanying statement providing, among other things, this information.

The franchisor titled the three graphs “financial performance representations”. They showed earnings for all franchisees, for franchisees with a minimum of one-year experience, and for the top 25% of franchisees. The franchisor argued that the graphs were not projections, but simply ‘financial information’.  The plaintiffs alleged that the graphs were earnings projections and that the franchisor did not inform them about where they could inspect information to substantiate the projection.

The motion judge concluded that the graphs were earnings projections. The graphs were designed to show prospective franchisees that they could earn a substantial amount of money through the franchise system. Since the graphs also show reasonable to good growth for the previous 31 to 48 months, a franchisee would also conclude that there was no reason to expect this not to continue.

Based on these significant technical disclosure deficiencies, the court concluded that the franchisor failed to deliver a disclosure document within the meaning of the Act, and that therefore the plaintiff franchisees were entitled to rescission of their franchise purchase.

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