Ontario Court of Appeal Rules Franchisees are not Necessarily Obligated to Deliver Rescission Notice Prior to Suing Franchisors

If a franchisee wishes to rescind its franchise agreement, in what form can the franchisee provide notice? Courts had previously held that the notice of rescission had to be delivered prior to the franchisee commencing a lawsuit against the franchisor. However, a recent decision of the Court of Appeal for Ontario has opened the door for franchisees to assert a notice of rescission within a Statement of Claim.

Ontario’s franchise legislation, the Arthur Wishart Act (the “Act”), sets out a robust inventory of documents and information that a franchisor must include in the disclosure document that it delivers to prospective franchisees. The purpose of the disclosure document is to provide potential franchisees with the information necessary to make an informed decision before entering into a franchise opportunity. However, if the franchisor fails to deliver the disclosure document or if the disclosure document is deficient and the franchisee still proceeds with the franchise relationship, the Act allows a franchisee to later rescind the franchise agreement. The powerful remedy of rescission essentially unwinds the contract, as if the parties never entered into it in the first place.

In order to initiate this extraordinary right of rescission, the franchisee must first serve notice to the franchisor. Under the Act, all that is required is that notice be in writing and be delivered personally, by registered mail, prepaid courier or fax. Once the notice has been served, the franchisor then has 60 days to essentially pay back what the franchisee paid under the franchise agreement. Courts have previously held that this notice must be provided prior to the franchisee commencing a lawsuit against the franchisor for rescission, however the Ontario Court of Appeal recently turned this requirement on its head in the decision of 2352391 Ontario Inc. v. MSI (“MSI”), when it ruled that proper notice can be provided in a Statement of Claim when a franchisor initiates a lawsuit for rescission against the franchisor.

In MSI, the franchisor and franchisee entered into an agreement for the franchisee to purchase and operate a franchise location for The Works Gourmet Bistro. The franchise was not successful, and within seven months of opening its doors, the franchisor re-took possession of the franchise and terminated the franchise agreement. The franchisee took out a loan in order to facilitate the purchase and operation of the franchise and following closure of the franchise location the franchisee went into default under the loan and the lender subsequently commenced an action against the franchisee. The franchisee then commenced a Third Party Claim against the franchisor which included a claim for rescission under the Act and a refund of monies paid under the franchise agreement. The franchisor defended the lawsuit on the basis that the claim for rescission was statute-barred because the franchisee failed to deliver notice of rescission within the statutory time period (in this case two years). Thereafter, the franchisee then commenced a new action against the franchisor and sued its former counsel for professional negligence claiming that counsel failed to take the required steps to deliver a notice of rescission.

On a motion to strike the claim, Justice Nakatsuru held that the notice was not properly delivered and therefore the lawsuit for rescission was statute-barred. Relying previous jurisprudence, Justice Nakatsuru held that a franchisee can bring a claim for rescission only after the franchisee delivers the notice of rescission and the franchisor either: (a) fails to compensate the franchisee within 60 days; or (b) the franchisor communicates its refusal to compensate the franchisee. Justice Nakatsuru further stated that it would be unfair to the franchisor to allow the franchisee to bring an action before the court without first providing the franchisor with an opportunity to consider and respond to the notice of rescission. Accordingly, Justice Nakatsuru concluded that bringing a third party claim for rescission against the franchisor did not constitute proper notice under the Act.

The Court of Appeal reversed Justice Nakatsuru’s decision. Justice Feldman, writing for the court, stated that there is no reason to interpret the Act in a way that requires the franchisee to deliver a separate notice in order for a claim for rescission, issued within the statutory time period, to proceed. Justice Feldman stated that the Act is remedial legislation and should be interpreted generously in order to balance the rights of franchisees and franchisors as well as redress any power imbalance between the parties. Furthermore, Justice Feldman stated that the fact that a claim for rescission may have been brought prematurely, before the franchisor had an opportunity to respond (and comply), does not mean that notice was not properly delivered to the franchisor. In her final remarks, Justice Feldman stated that while written notice of rescission delivered prior to commencing litigation is the “normal and preferable” procedure, bringing a claim for rescission, though not the “ideal or recommended approach” can constitute proper notice under the Act.

While the Court of Appeal likely intended for its decision in MSI to make it easier for franchisees to exercise their rights under the Act the decision comes with additional potential consequences for franchisors. The disclosure document that a franchisor is required to provide under the Act must include details of any litigation in which the franchisor is involved that relates to, among other things, violation of a law that regulates franchises or businesses, including a failure to provide proper disclosure to a franchisee. Allowing franchisees to deliver a notice of rescission in a Statement of Claim, without the franchisor having the ability to properly address the rescission notice beforehand, will result in franchisors being forced to disclose litigation to potential franchisees that could have been avoided entirely if the franchisor had the opportunity to deal with the rescission notice prior to the commencement of the lawsuit.