Jumbo Systems Inc. v. Short

Between
Jumbo Systems Inc. and 1053585 Ontario Inc., plaintiffs,
defendants to the counterclaim, and
John Short, Fred Short and Robert Short, defendants,
plaintiffs by counterclaim

[2000] O.J. No. 56
Court File No. 97-CV-127262

Ontario Superior Court of Justice
Rivard J.

Heard: January 4-7, 2000.
Judgment: January 13, 2000.
(53 paras.)

Counsel:

1      RIVARD J.:— The plaintiff, Jumbo Entertainment Inc. ("Jumbo") claims from the defendants the payment of arrears of royalties and advertising levies pursuant to the defendants' guarantee of the obligations of 912661 Ontario Limited contained in a franchise agreement.

2      The plaintiff 1053585 Ontario Inc. ("1053585") claims from the defendants the payment of arrears of rents pursuant to the defendants' guarantee of the obligations of 912661 Ontario Limited contained in the franchise agreement.

3      There is no issue relating to the execution of the guarantee by the defendants.  The parties have also agreed that the arrears owing for royalties, advertising levies and rents, inclusive of interest to December 21, 1999 are as follows:

4      The plaintiffs ask for judgment in these amounts. The defendants counterclaim for damages and for a release of their obligations under the guarantee on the basis of misrepresentations, non performance of the agreement, breach of fiduciary obligations and a failure to disclose secret profits by the plaintiffs.

5      The facts are as follows:

6      The defendants and the other investors in the Timmins store were then approached by Mr. Kushner, one of the investors to become involved in a Jumbo video franchise in Niagara Falls.  A pro forma statement, prepared by Jumbo Video Inc. was produced and reviewed by the defendants.  Several sites for the video store were considered and, on the advice of Jumbo Video Inc. representatives, it was decided to situate the store at the Thorold Stone Mall.

7      Jumbo Video Inc. had already secured premises at the Thorold Stone Mall pursuant to an offer to lease dated July 31, 1991.  Pursuant to paragraph 17 of schedule B of this offer to lease, the landlord agreed to pay to Jumbo Video Inc. an inducement of $50,000.

8      The defendants and their follow investors caused 912661 Ontario Limited ("912661") to be incorporated.

9      A franchise agreement dated October 11, 1991 was then entered into between Jumbo Video Inc. and 912661.  The three defendants and their co-investors all signed the franchise agreement, guaranteeing the obligations of 912661.

10      912661 also entered into a sublease dated October 11, 1991 with Jumbo Video Inc. agreeing to accept the obligations of Jumbo Video Inc. under the offer to lease.

11      The franchise agreement, sublease and offer to lease were bound together in a black folder and given by Jumbo Video Inc. to Mr. Kushner and to Mr. Robert Short.

12      It is the position of the defendants that the $50,000 inducement paid to Jumbo Video Inc. by the landlord pursuant to the offer to lease, was not disclosed to them. Both John Short and Robert Short testified that they were not aware of this inducement prior to signing the franchise agreement.

13      Robert Short produced the black folder which contained the offer to lease and sublease given by Jumbo Video Inc. to Mr. Kushner.  That black folder was marked as Exhibit number 5.

14      Schedule B of the offer to lease found in Exhibit 5 only has 16 paragraphs and does not refer to the $50,000 inducement.  On the other hand, the offer to lease produced at Exhibit 1, tab 6 does contain a paragraph 17 which contains the landlord's obligation to pay to Jumbo Video Inc. the $50,000 inducement.

15      It is admitted by the plaintiffs that the $50,000 inducement was paid to Jumbo Video Inc. by the landlord.  The plaintiffs cannot explain why paragraph 17 in Schedule B of the offer to lease has been deleted from the offer to lease in Exhibit number 5.  It is the plaintiffs' evidence that there was no intention or effort to mislead the defendants or to withhold information from them.

16      On all of the evidence, I accept that the defendants were not informed by Jumbo Video Inc. or by anyone else, prior to signing the franchise agreement, of the $50,000 inducement.  I find that this information was withheld from the defendants by Jumbo Video Inc.

17      The defendants delegated the management of the video store to John Short.

18      Prior to the store's opening, Jumbo Video Inc. provided Mr. John Short and the store employees with training. There is an issue raised by the defendants with respect to this training not having been completed.  If the training was not, in fact, completed, I am not satisfied that this contributed, in any material way, to the subsequent failure of the business.

19      The franchisee was obliged to purchase its video library from Prefex, a supplier chosen by Jumbo Video Inc. This video library cost $215,000.  The defendants were not satisfied with the videos selected.  They subsequently discovered that this video library was not "state of the art" as they believed they would be receiving.  The top selling movie video at the time of the store opening was "The Terminator".  The franchise only received one copy of this movie.  Approximately 30 copies had to be purchased from the Timmins store to service the franchisee's customers.

20      The franchisee spent substantially more on its video library maintenance in 1992 as a result of the video library not being initially properly stocked.

21      Jumbo Video Inc. was paid by Prefex, a rebate of $10,000 is a result of the franchise's purchase of this video library.  This rebate was not disclosed to the franchisee or to the defendants until after the examinations for discovery in this case.

22      In 1993, the lease for the premises was assigned from Jumbo Video Inc. to 1053585.  Jumbo Video Inc. felt it was necessary to protect "the system" and its franchisees from claims arising out of lease agreements between Jumbo Video Inc. and landlords, where the subtenant franchisees had closed business or become insolvent.  Leases were transferred to separate corporations with the result that if a franchisee failed to meet its obligations under the lease, this failure did not impact the Jumbo franchise system or the other franchisees.

23      I accept the evidence of the plaintiffs' witnesses to the effect that this transaction did not impact on the franchisees as is alleged by the defendants.  In fact, there is no evidence before me that this assignment of lease and the subsequent transfer of the assets of Jumbo Video Inc. to Jumbo Entertainment Inc. had any impact on the franchisees.

24      There were other corporate changes completed by Jumbo Entertainment Inc.  In 1996, Jumbo Entertainment Inc. was sold to Lincoln Capital Corp., a publicly traded company. As a result of a reverse take over, Lincoln Capital Corp. then became Jumbo Entertainment Inc.

25      Jumbo System Corp. had been a wholly owned subsidiary of Jumbo Entertainment Inc.  Subsequent to the change of name of Lincoln Capital Corp. to Jumbo Entertainment Inc., Jumbo Systems Corp. was amalgamated with Jumbo Entertainment Inc. and operated as one company.

26      The defendants allege that these corporate changes were inconsistent with representations made to them to the effect that the franchiser was a stable, growth oriented company.  I am not satisfied, on the evidence that such representations were in fact made.  In any event, I do accept the evidence adduced by the plaintiffs that these were restructuring transactions which were "seamless" and had no impact on the franchisees.  For the most part, these were tax driven arrangements.

27      In approximately 1994, the defendants' co-investors sold their interest in the franchise to the defendants.  The franchiser approved this sale and released the selling co-investors from their guarantee obligations.

28      The defendants submit that the plaintiffs undertook to have a national advertising program with funds collected from the franchisees for this purpose.  The defendants complain that there was no such national advertising program and no accounting by the franchiser for the funds collected.

29      On the evidence before me, I am satisfied that a national advertising program did exist.  At the quarterly meetings of the franchisor-franchisees, financial statements were provided by the franchisor, and answers were given to questions relating to the national advertising program.  I am not satisfied that the plaintiffs breached their obligations to the defendants in relation to the national advertising program.

30      From 1992 until 1997, the gross revenues of the franchisee were as follows:

31      The pro forma prepared by the franchisor and given to the defendants before the execution of the franchise agreement, estimated the break-even total gross revenues at $657,755.  In the five years from 1992 to 1996 inclusive, the franchisee's gross revenue averaged $662,874 per year.  This is very close to the projected gross revenue, in the pro forma, needed to break-even.

32      I do accept the evidence of the defendants to the effect that they did not invest in this franchise only to break even.  On the other hand, the defendants clearly understood that the pro forma was only an estimate, or a projection by the franchisor and, was not a guarantee of total gross revenues or of net profit.  Two of the defendants were familiar with this business, having invested in the Timmins Jumbo store franchise.  I accept the evidence of John Short when he said that because the investors already operated another store, they knew what the costs were and, although given the pro forma, they understood there was no guarantee that the income figures in the pro forma would be achieved.

33      Although the franchisee's gross revenue was slightly greater than the projected break-even total gross revenue in the pro forma, the franchisee suffered substantial annual deficits for every year of operation.  I do not accept that these deficits were due to John Short's poor management of the business.  The evidence discloses that John Short may have been slow in accepting and implementing suggestions from the franchisor.  His wages costs may have been higher than wage costs of similar businesses.  However, his marketing and his customer service were excellent.  I do not accept that this franchise business failed because of the management of John Short.

34      Craig Sexsmith, employed as a senior business advisor by the plaintiff testified as to his substantial experience in the video movie business.  He said, on cross-examination, that in the video business, "location is one of the conditions of a successful video store".

35      Robert Short testified that he initially had reservations about the site which had been proposed by the franchisor.  He preferred other sites which were available, but, those sites were downplayed and not preferred by the franchisor.  As a result, they were not selected.

36      John Short also had reservations about the site proposed by the franchisor.  John Short testified that the business failed because of its location.

37      I accept that the location of this franchise operation had a significant impact on its lack of success.  I find that the site was recommended by the franchisor, at least in part, because of the $50,000 inducement being paid by the landlord.

38      Mr. James Anas, the president of both plaintiff companies, agreed, upon his cross-examination, that it was fundamental to the franchisor/franchisee relationship that Jumbo Video Inc. exhibit the utmost good faith, openness, and honesty.  This duty existed because the business relationship was for the mutual benefit of the parties.

39      In my view, this duty of utmost good faith included an obligation on the franchiser to disclose all material facts.  Such a material fact was the payment of the $50,000 inducement by the landlord.  The franchiser did not disclose this material fact to the defendants.  In the normal course, this ought to have afforded the defendants the remedy of a release of their obligations under the guarantee because I accept they probably would not have entered into the agreement had disclosure of this fact been made.

40      By letter dated April 20, 1994 from the landlord to Jumbo Video, Inc., a copy of which was sent to John Short (see Exhibit 1, Tab 36), the defendants first learned of the $50,000 inducement paid by the landlord to Jumbo Video Inc. The defendants did not immediately do anything about the secret profit.

41      By letter dated August 30, 1995, Mr. Leikin, for the franchisor, wrote to the defendants demanding payment of royalty and ad fund arrears.  He pointed out that the defendants, as guarantors, were personally responsible for these debts (see Exhibit 2, Tab 59).

42      The defendants then retained the Levitt Beber law firm who responded by letter dated September 12, 1995 (see Exhibit 2, Tab 61).  In that letter, the defendants raised the issue of the $50,000. "secret tenant inducement".

43      Negotiations between the parties followed.  At Exhibit 2, Tab 73 is a letter from Jumbo Systems Corp. to the defendants, which refers to an arrangement agreed to at a meeting held on November 29, 1995.

44      By letter dated January 3, 1996 (Exhibit 2, Tab 81) the defendants made formal settlement proposals to resolve the issues.  The plaintiffs responded by letter dated January 5, 1996, proposing some amendments (Exhibit 2, Tab 83).  The defendants signed this letter accepting and agreeing to the amendments.

45      I conclude from this evidence that the parties did settle all issues between them including issues which arose as a result of the payment of secret profits which contributed to the site selection.

46      The defendants continued to operate the franchise video store.  By the end of 1996, arrears in the payment of royalties, ad fund contributions and rent had again begun to accumulate.  This resulted in demand letters from the plaintiffs to the defendants, found at Exhibit 3, Tabs 106 and 118.

47      On April 8, 1997, the franchisee, 912661 Ontario Limited made an assignment in bankruptcy.

48      On all of the evidence before me, I conclude that if the defendants were entitled to any remedy, including a release of their obligations on the guarantee and a rescission of the agreement entitling them to damages, these claims arose from the plaintiffs' failure to disclose the secret profits as they relate to the $50,000 inducement from the landlord.  The defendants have, in my view, waived their right to claim these remedies by entering into the settlement in January of 1996.

49      I am satisfied that by January of 1996, the defendants knew of the $50,000 rent inducement.  They sought and obtained legal advice.  They allowed time to pass without asserting a claim.  They then affirmed the terms of the original franchise agreement by entering into the settlement agreement.  By choosing to settle their differences with the plaintiffs, the defendants elected to continue their relationship with them and did, thereby, waive or relinquish their right to claim on the basis of breach of duty or misrepresentation by the plaintiffs.

50      The $10,000 rebate paid by Prefex was not disclosed to the defendants until after discoveries in this action.  However, paragraph 15.5 of the franchise agreement did clearly contemplate discounts volume rebates and other concessions or allowances that the franchiser may obtain from supplier.  In light of this term in the franchise agreement, I conclude that the failure by the plaintiff to disclose to the defendants the details of this secret profit, does not entitle the defendants to a release on their guarantee or to a rescission of the agreement.  I do not believe that this franchise business failed as a result of the payment of this $10,000 rebate.

51      The plaintiff Jumbo Entertainment Inc. will therefore recover from the defendants the sum of $142,662.75 together with interest at prime plus 5% per annum from December 21, 1999 to the date of judgment.

52      The plaintiff 1053585 Ontario Inc. will recover from the defendants the sum of $59,467.23 together with interest at prime plus 3% per annum from December 21, 1999 to the date of judgment.

53      I ask counsel to make written submissions with respect to costs wiring 15 days of the release of these reasons.

RIVARD J.