Franchise Law Primer: Ontario’s Resale Exemption

With a consumer-protection focus, Ontario’s Arthur Wishart Act (Franchise Disclosure), 2000[i] (the “AWA”) seeks to ensure that franchisees are able to make an informed investment decision when buying a franchise by requiring franchisors to provide a disclosure document to each potential franchisee before the franchisee candidate signs a franchise agreement or pays any fee[ii] – with some exceptions. One such exception is the topic of this article, known as the Resale Exemption.

After describing the Resale Exemption’s legislative underpinning, this article will discuss how Ontario’s courts have applied the Resale Exemption in three instructive cases, referenced here as Springdale, Dakin News, and Jayasena.

The Resale Exemption in the AWA

The Resale Exemption is intended to apply when an existing franchisee of a franchise system sells its franchise to a third party and the sale is not effected by or through the franchisor. The underlying policy rationale for the Resale Exemption is that in a situation where the franchisor is not making representations or promises to induce the candidate to purchase the franchise, then the franchisor should not be required to provide a disclosure document.

As shown below, Section 5(7)(a) of the AWA sets out four factors that must be met for the Resale Exemption to apply:

5(7) [The disclosure obligations set out above do] not apply to,

1. the grant of a franchise by a franchisee if,
   1. the franchisee is not the franchisor, an associate of the franchisor or a director, officer or employee of the franchisor or of the franchisor’s associate,
   2. the grant of the franchise is for the franchisee’s own account,
   3. in the case of a master franchise, the entire franchise is granted, and
   4. the grant of the franchise is not effected by or through the franchisor;

The final factor, set out in 5(7)(a)(iv), is the most contested one.  It is clarified somewhat by a so-called “safe-harbour” provision found in Section 5(8):

5(8) for the purpose of subclause (7)(a)(iv), a grant is not effected by or through a franchisor merely because,

1. the franchisor has a right, exercisable on reasonable grounds, to approve or disapprove the grant; or
2. a transfer fee must be paid to the franchisor in an amount set out in the franchise agreement or in an amount that does not exceed the reasonable actual costs incurred by the franchisor to process the grant.

The next section of this article will discuss how three Ontario cases have interpreted the Resale Exemption.

Judicial Interpretation

1. 2189205 Ontario Inc. v. Springdale Pizza Depot Ltd., 2010 ONSC 3695 (aff’d 2011 ONCA 467) (“Springdale”)

Facts

In Springdale, two individuals, through their corporation (the “plaintiffs”) contacted the franchisor of the Pizza Depot franchise system to acquire a Pizza Depot franchise. The franchisor directed the plaintiffs to a franchisee in Milton, Ontario.[iii] The plaintiffs signed an asset purchase agreement whereby they agreed to purchase the franchise, pay a $5,000 transfer fee to the franchisor, and obtain the franchisor’s consent to an assignment of lease.[iv]

The selling franchisee’s existing franchise agreement contained an express provision that no transfer or sale was effective without the franchisor’s approval. Clause 18.4 of that franchise agreement set out the franchisor’s conditions for approval, which included that a purchasing franchisee must execute “a franchise agreement and related documents with the franchisor in the franchisor’s then current standard form…”.

In accordance with Clause 18.4, the plaintiffs signed five franchise-related agreements previously signed by the selling franchisees.[v] However, the franchisor also required the plaintiffs to sign two additional documents that had not been required of the selling franchisees: an undertaking for car wrapping on delivery vehicles, and an acknowledgement that provided that the franchisor did not provide financial projections for the purchase of the franchise.[vi] The franchisor did not provide a disclosure document to the plaintiffs.

Several months later, the plaintiffs sought to rescind the franchise agreement. The franchisor relied on the Resale Exemption in its defense. The Ontario Superior Court found that the Resale Exemption did not apply and allowed the rescission claim to proceed. The franchisor appealed.

Analysis

Ontario’s Court of Appeal found that, given the remedial purpose and context of the franchise legislation, the Resale Exemption must be narrowly construed.[vii] Karakatsanis J., as she then was, narrowly interpreted the Resale Exemption language in the AWA, to gain greater insight into the meaning of “effected by or through” the franchisor.  Karakatsanis J. found that the Resale Exemption language applies “only when the franchisor is not an active participant in bringing about the grant and does nothing more than “merely” exercise its rights to consent to the transfer.”[viii]

Notably, the Resale Exemption allows the franchisor to exercise a “right, exercisable on reasonable grounds” to approve or disapprove a grant of a franchise.[ix] In discussing this point, Karakatsanis J. referenced the distinction between a “power” and “right”, formulated by Cumming J. in the Tutor Time decision.[x] Cumming J. found that for the purposes of the Resale Exemption, a “right” (i.e., an expressed condition in a franchise agreement) is different from a “power” (i.e., an unexpressed condition derived from a franchise agreement):

A “right” is different from simply being in a position of “power”. In my view, a “right” means a condition in the franchise agreement, that is, an express contractual right between franchisor and franchisee. TTLC had the “power” to refuse to consent to the transfer on any basis it wished unless a condition imposed by it was met. TTLC might exercise such “power” on reasonable grounds. However, in such instance, the franchisor could not be said to have a “right” to impose the condition within the meaning of the exempting provision, being s. 5(8)(a) of the Act.

Karakatsanis J. found that, by requiring the plaintiffs to sign the two additional documents that were not expressly required as a condition of obtaining the franchisor’s consent, the franchisor exercised its power over the plaintiff (rather than its “right, exercisable on reasonable grounds”) and therefore was brought out from the protection of the Resale Exemption.[xi] As a result, the franchisor was required to provide the plaintiffs with a compliant disclosure document, failing which the plaintiffs were entitled to rescind under the AWA.

Karakatsanis J. further noted that the involvement of the franchisor amounted to more than merely passively involvement in the transfer of the franchise[xii], given that the franchisor: (1) directed the selling franchisee to the plaintiffs; (2) had involvement in the negotiations; and (3) shifted the onus of obtaining the franchisor’s consent to the transfer to the plaintiffs, not the selling franchisee. While any of these individual circumstances may individually be insufficient to support a finding that the Resale Exemption did not apply, the totality of the circumstances did.[xiii] The rescission claim was upheld.

Takeaways

• Given the remedial nature of the AWA, the Resale Exemption is to be narrowly construed.
• The Resale Exemption only applies when the franchisor is not an active participant in bringing about the grant and does nothing more than “merely” exercise its rights to consent to the transfer.
• Requiring the execution of the “then-current franchise agreement and related documents” does not automatically render the Resale Exemption unavailable if such obligation is explicitly required in the franchise agreement.
• There is a difference between a “right” exercisable on reasonable grounds to approve a transfer, and a “power” to do so. In the former case alone, the Resale Exemption is available.

2. 2256306 Ontario Inc. v. Dakin News Systems Inc., 2015 ONSC 566 (aff’d 2016 ONCA 74) (“Dakin News”)

Facts

In Dakin News, the selling franchisee’s existing franchise agreement had expired so the selling franchisee was operating on a monthly basis. The selling franchisee entered into a sale agreement with a third party (the “plaintiff”) under the Bulk Sales Act, without the franchisor’s knowledge.[xiv] Prior to the sale closing, the franchisor provided the selling franchisee with general information about its requirements to gain the franchisor’s approval to the transfer, noting that a transfer fee of $10,000 was payable.[xv] Importantly, the decision does not reference any other direction or instruction provided by the franchisor as to how its consent to the transfer could be obtained.

The transaction closed without the franchisor’s approval.[xvi] The plaintiff assumed operations over the franchise and paid royalties to the franchisor for more than 11 months before the franchisor realized a sale had taken place. The franchisor sent a letter to the selling franchisee indicating that the franchisor had learned that a transaction with the plaintiff closed without the franchisor’s consent.[xvii] The letter demanded that the transfer fee be paid and enclosed a new franchise agreement for the plaintiff to sign. When the franchise agreement was not signed, the franchisor followed up 5 months later and sent a new franchise agreement directly to the plaintiff. In October, 2012, some 21 months after the transaction closed, the franchisor re-sent a new franchise agreement to the plaintiff (the “October Franchise Agreement”), yet no application fee or franchise transfer fee was ever paid and no disclosure document was provided.[xviii] The plaintiff signed the October Franchise Agreement.

After the landlord of the premises decided not to renew the head lease, the franchisor informed the plaintiff that the franchise location needed to relocate and the plaintiff had to pay over $75,000 in transfer costs and purchase additional inventory.[xix]

In response, the plaintiff sought to rescind the October Franchise Agreement on the basis that the franchisor had not provided a disclosure document. The franchisor relied on the Resale Exemption in its defense and claimed that the grant was not effected by or through it, but instead through the Bulk Sales Act transfer when the transaction closed.[xx]

Analysis

The Ontario Superior Court rejected the franchisor’s argument and found in the plaintiff’s favour. The Court held that if the Bulk Sales Act transfer had been a valid grant of the franchise, the October Franchise Agreement would have been unnecessary. The court found that the October Franchise Agreement was not “normalizing” the relationship between the parties and that the Resale Exemption did not apply.

On appeal, the Ontario Court of Appeal affirmed the lower court’s ruling, noting that the Term of the October Franchise Agreement was backdated to include the 21 month period between the closing of the transaction and the signing of the October Franchise Agreement.  The appellate court found that “having chosen to require a franchise agreement with [the plaintiff], the [franchisor] cannot now argue that a franchise agreement was already in place with [the plaintiff], such that [the plaintiff is] exempted from the disclosure requirement by s. 5(7)(a)(iv).” [xxi]

The courts’ analyses suggest that the Resale Exemption will not apply if a franchisor requires a franchise agreement to be signed without a clear basis to do so in the selling franchisee’s franchise agreement. Conversely, the Resale Exemption may have applied if the franchisor had a clear list and structure required to obtain its consent to the transfer, grounded in the selling franchisee’s existing franchise agreement that the franchisor followed without becoming more than merely passively involved in the transaction.

Takeaways

• While not explicitly expressed to be so doing, Dakin News aligns with the approach taken in the Springdale case:
  • The franchisor did not have clear rights to require the selling franchisee to obtain the franchisor’s consent to the sale, yet the franchisor imposed such a requirement anyway. In doing so, the franchisor made the Resale Exemption unavailable, such that the franchisor should have provided a disclosure document to the plaintiff.
• Dakin News shows the importance of a stable, clear transfer process.

3. 2355305 Ontario Inc. (c.o.b. Jayasena Management Corp.) v. Savannah Wells Holdings. Inc. 2023 ONSC 1008 (“Jayasena”)

Facts

Jayasena is another rescission case, this time involving a Wild Wing franchise. The plaintiffs were a married couple who made inquiries of the defendant Wild Wing franchisor, with a view to purchasing a Wild Wing franchise location. An individual representing the franchisor, Mr. Chandiok, responded to the plaintiffs and offered to meet with them. During the meeting, Mr. Chandiok took the plaintiffs on a tour of a Brampton Wild Wing franchise location that was for sale and showed them detailed financial projections for the franchise location.[xxii]

After this meeting, the plaintiffs signed an agreement to purchase the Brampton franchise location from the selling franchisee. The purchase agreement was amended numerous times, including to require the selling franchisee to pay a $25,000 transfer fee to the franchisor.[xxiii] Additionally, the franchisor provided a letter signed by the acting CEO of the franchisor, Mr. Smiciklas, advising that the plaintiffs were the “approved franchisees” of the franchisor and in the process of purchasing the Brampton franchise location.[xxiv]

Despite the franchisor arguing otherwise, the court found that a franchise agreement was signed.[xxv] The plaintiffs subsequently issued a rescission claim and, in response, the franchisor relied on the Resale Exemption in the event that the disclosure provided was found non-compliant.

Analysis

Akbarali J. of the Ontario Superior Court of Justice found that the rationale in Dakin News applied. Specifically, the franchisor’s “usual practice was to consent to the transfer of a franchise by way of a letter like the one [Mr. Smiciklas] signed on January 10, 2013. However, for whatever reason, the franchisor went further than that in this case.”[xxvi] The court went on to say that by “requiring the plaintiffs to sign a new franchise agreement, the [franchisor] cannot now argue that a franchise agreement was already in place between the plaintiffs and the franchisor.”[xxvii]

Akbarali J. found that, if the court is “wrong, and the signing of the franchise agreement alone is not sufficient for the grant of the franchise to have been effected by or through the franchisor, I would, in any event, find that the franchisor did not play a merely passive role in the transfer or grant of the franchise.”[xxviii] The court noted that Mr. Chandiok’s actions as representative of the franchisor was more than mere passive involvement in the grant. Based on these factors, the court found that the Resale Exemption did not apply and that the plaintiffs were entitled to rescind since no compliant disclosure document was provided.

By deviating from the established and clear practice to consent to a resale and require additional obligations (notably, the signing of a franchise agreement), the franchisor was unable to rely on the Resale Exemption. Moreover, the involvement by Mr. Chandiok was more than merely passive, which further precluded the franchisor from relying on the Resale Exemption.  

Takeaways

• Deviating from an established/clear transfer procedure and requiring additional obligations not expressly set out in the franchise agreement increases the risk that the Resale Exemption will not be available to franchisors.
• When evaluating the applicability of the Resale Exemption, courts especially look at the evidence as to whether the franchisor played a passive role “limited to the specific requirements mandated for its consent under the franchise agreement”[xxix].

These three cases show that for a franchisor to rely on the Resale Exemption is often precarious. Therefore, when in doubt, disclose. If a franchisor has a compliant franchise disclosure document, the safest course in a resale context is to issue a disclosure document to the purchasing franchisee.

Any article or other information or content expressed or made available in this Section is that of the respective author(s) and not of the OBA.