Machias v. Mr. Submarine Ltd.
Between
George Machias, plaintiff, and
Mr. Submarine Limited, defendant
[2002] O.J. No. 1261
Court File No. 00-CV-186491CM
Ontario Superior Court of Justice
Wilson J.
Heard: December 10-14, 2001 and February 19, 2002.
Judgment: April 2, 2002.
(199 paras.)
Statutes, Regulations and Rules Cited:
Arthur Wishart Act (Franchise Disclosure), 2000, S.O. 2000 c. 3, s. 3(3).
Counsel:
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Fred Tayar, for the plaintiff. |
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1 WILSON J.:— Did representatives of Mr. Submarine Limited (the Defendant) misrepresent the material facts with respect to the St. Catherine Street Mr. Sub location in Montreal (the Franchise) thereby inducing George Machias (the Plaintiff) to enter into the Franchise Agreement dated June 12, 1998 (the Agreement)?
2 As one memo to head office points out, Tony Machias (Tony), the Plaintiff's son, had taken an "eye for an eye" approach in response to the misrepresentations and the failure of the Defendant to rectify the Plaintiff's problems. The Plaintiff failed to pay advertising and royalty fees since the opening of the Franchise. Rent arrears have also accrued.
Relief Requested
3 In this action, the Plaintiff claims rescission of the Agreement or in the alternative, damages for misrepresentation and for breach of the Agreement. Although the Plaintiff claimed exemplary and punitive damages in the pleadings, his counsel did not pursue the issue in his submissions.
4 The Defendant seeks a declaratory Order terminating the Agreement for non-payment of amounts due, and seeks to take back the Franchise without compensating the Plaintiff. As well, the Defendant counterclaims for payment for all arrears of rent, royalty, advertising and promotion payments due and owing up to the date for trial.
5 Both parties agree that relations between the parties have deteriorated to a point that they cannot continue to do business together. The real issue is whether the Plaintiff should be entitled to the return of the $150,000.00 paid for the Franchise.
The Position of the Parties
6 The parties' positions are polarized. They have very different views as to responsibility for the troubled relationship and the remedies available to the parties.
7 First, it is the Plaintiff's position that the Defendant misrepresented the history of the Franchise as well as the financial projections, both with respect to income and to expenses. Even if the projected initial annual income of $300,000 had been achieved, (which did not occur), the Franchise would have been in a serious loss position as the Franchise's actual expenses were much higher than those represented in the pro forma financial statement provided to the Plaintiff. According to the Plaintiff, the misrepresentations justify his request for rescission of the Agreement. The Franchise was not the sound investment as represented by the Defendant.
8 Secondly, according to the Plaintiff, the Defendant's conduct after the Franchise opened further justifies the remedy of rescission, or alternatively damages. It is the Plaintiff's position that they were left largely to fend for themselves. After months of letter writing and frustration, the Plaintiff sought to rescind the Agreement.
9 The Defendant refused to allow the Plaintiff to rescind, resulting in these proceedings. The Plaintiff has continued to operate as a disgruntled franchisee pending trial.
10 It is the Defendant's position that the Plaintiff was a renegade franchisee, unable or unwilling to comply with Mr. Sub's protocol.
11 It is the Defendant's position that prior to signing the Agreement the Plaintiff was provided with a three-year earning profile. The Plaintiff denies receipt of the earning profile. The Defendant acknowledges that the expenses provided were "pro forma" in nature, not specific to the Franchisee. However, there is a disclaimer on the pro forma, upon which the Defendant relies. As well, the Agreement contains an "entire agreement" and an "independent investigation" clause, precluding reliance upon prior representations. The Defendant relies upon these exclusion clauses in the Agreement.
Background Facts
12 The Plaintiff, at the age of 54, decided he wanted to augment his retirement income. He came to Canada from Greece in 1968 and worked briefly in a family-run donut store. He had limited formal education. The Plaintiff drove a taxicab from 1971 to 1996 when he retired. By then, he had acquired 3 taxi licenses. Due to his lack of business experience, the Plaintiff looked for an investment in an established franchise. He knew of an acquaintance who owned several Mr. Sub franchises in Toronto. This acquaintance appeared to be doing well financially. The Plaintiff decided to sell his taxi licenses and invest in a franchise.
13 He contacted the representative for Mr. Sub. His idea, initially, was to manage one Mr. Sub franchise and then expand and acquire and manage several locations. He would hire staff to operate the franchises. He was not interested in becoming the primary operator of a single Mr. Sub location.
14 The Plaintiff's initial contact was with Mr. Kerry Shirakawa (Shirakawa), the vice-president at Mr. Sub head office in charge of franchise development. Initially, the discussion was not focused on acquiring the Franchise in Montreal, but was more general in nature.
15 In 1998, at the age of 23, Tony had just completed his third year at McGill University in a business programme. Tony became involved in the discussions and the Franchise became the focus of discussions. All discussions with respect to the price of the Franchise, projected income, and expenses and specifics of the Franchise took place between Shirakawa and Tony. As well, there was a brief meeting involving Mr. Tobin (Tobin), the president and Chief Executive Officer of the Defendant.
16 The Plaintiff does not dispute that the Agreement is a legally binding document. From the perspective of the Defendant, its terms were not negotiable. It is a classic contract of adhesion. It was clear from the tenor of Tobin's evidence that the Franchise Agreement is a "take it or leave it" proposition for all prospective franchisees.
17 Tony took the Agreement to a lawyer in Montreal. The lawyer expressed the view that the Agreement was one-sided, with all the benefits being with the franchisor. His advice was clear: "If you trust these people, you can sign. They have all the rights. Do you trust that they will be good partners? If they are not straightforward people, I wouldn't sign."
18 There are discrepancies between the parties as to what was said and represented in the discussions between Tony and Shirakawa. Before reviewing specific details, I will outline my impressions and conclusions with respect to the credibility of the witnesses who testified.
Findings of Credibility
19 The Plaintiff presents as an unsophisticated, hardworking, and straightforward person. He was looking for a good investment. He knew of neighbours and acquaintances who had enjoyed financial success owning and managing a series of Mr. Sub franchises. He received the pro forma financial statement from Shirakawa. He was impressed with the projected 26% return on the investment. He relied on Tony for all the details of any discussions or negotiations.
20 Tony is an intelligent, soft-spoken young man. In 1998 when these discussions took place, Tony certainly understood the principles of acquiring a business although he had no practical experience. Tony was cross-examined for a lengthy period of time. His evidence with respect to Shirakawa's representations was credible, consistent and straightforward. An accountant had prepared the profit and loss statements for 1999 and 2000. It was necessary for Tony, during the trial, to clarify certain details with respect to the profit and loss statements by speaking directly to the accountant. Otherwise, he had a good memory for the details of his involvement. Tony came across as a credible, intelligent person who did not exaggerate, with a good memory for detail and specifics.
21 Shirakawa presents as a sincere person who has a very limited memory of what transpired with respect to the negotiations in 1998 specific to the Franchise. During the period in question, he was involved in negotiations with respect to many franchises, as well as numerous re-sales of existing franchises. He does not have any notes of the meetings or discussions with the Plaintiff or Tony. Shirakawa's memory of details was poor. In certain key aspects, his evidence conflicts with the evidence of Tobin. His evidence was also not internally consistent.
22 Tobin appeared to be a bright, tough, and pragmatic business executive. In the fall of 1999, it appears that Tobin tried to rectify some of the problems experienced by the Franchise. However, once the Plaintiff sought to rescind the Agreement in November 1999 and this litigation commenced, this approach became "hardball". After November 1999, it appears that the Plaintiff, as franchisee, was "out in the cold". There was a certain angry, aggressive edge to Tobin's attitude in the witness stand. It appears that he is not used to answering to others. It also appeared that he, like the Plaintiff, is very frustrated with the ongoing problems.
23 Where there is a conflict between the evidence of the Plaintiff and the Defendant, I accept the evidence of the Plaintiff. The Plaintiff's evidence makes sense and is largely confirmed by contemporaneous documentation. The defence evidence was not internally consistent nor did it accord with many of the documents.
The Agreement
24 Although the Plaintiff was initially interested in acquiring Mr. Sub rights for all of Montreal, the Defendant was not interested in selling a master franchise. The Defendant was only prepared to offer the sole Mr. Sub restaurant operating in Montreal at the Ste-Catherine Street West location to the Plaintiff. As well, the Plaintiff was offered the first right of refusal on future Mr. Sub franchises in Montreal. Tony acknowledged that the right of first refusal was conditional upon the Franchise being a success.
25 The Plaintiff was not advised that several other Mr. Sub franchises had failed in the Montreal market over the years. The Franchise was not an exciting opportunity in a new market as represented by the Defendant. Mr. Sub hoped to re-enter a market that had failed in the past.
26 I accept Tony's evidence that both Shirakawa and Tobin advised him that the Defendant planned to expand aggressively in Montreal, although the exact plans would not be finalized for a month or two. The plans for expansion suited the Plaintiff's plan to acquire several franchises.
27 There were two or three preliminary meetings. I do not accept Shirakawa's evidence that two application forms, one by the Plaintiff and one by Tony, were submitted. I find that the Plaintiff submitted the sole application form. The Plaintiff's application was approved.
28 According to Tony, Shirakawa requested the signing of the Agreement to "get the ball rolling". The Plaintiff signed the Agreement on June 19, 1998.
29 The price of the Franchise had not been finalized when the Agreement was executed. The parties agreed to cap the maximum price of the Franchise at $150,000.00. I accept Tony's evidence that Shirakawa agreed that any savings in the cost of renovating an existing franchise, and in acquiring used, as opposed to new equipment, would be passed on to the Plaintiff.
30 I accept Tony's evidence that the representations with respect to the projected income and expenses of the Franchise occurred both before and after the Agreement was signed.
31 Shirakawa told Tony that the Plaintiff would receive a "flagship" café style Mr. Sub franchise in anticipation of expansion of Mr. Sub franchises in Montreal. The anticipated changes included both a renovation of the interior of the existing premises, and a new look to the exterior of the premises, in accordance with the sketch provided to Tony. A similar sketch is included in the renovation file for the Franchise. I do not accept Shirakawa's evidence that this café style for Mr. Sub, with a new style of signage, was developed after the Franchise opened. The dated sketches conflict with his evidence.
Misrepresentations with respect to income and expenses
32 Prima facie, the entire agreement and disclaimer clauses apply, unless the plaintiff can prove collateral material misrepresentations were made, or that to enforce the agreement would be unconscionable. I will discuss the law later in these reasons, after reviewing the relevant facts.
33 I must determine what representations Shirakawa made to the Plaintiff and the consequences of those representations. It would be very helpful to have Shirakawa's file. I do not know the contents of his file. There are two reasons for this. First, some documents are missing. Second, all of the Defendant's documents from different sources were co-mingled once this litigation began. It seems trite to say that when legal difficulties arise, it is crucial to preserve all documents and to maintain the documents in their original file format. Any alternative method of organizing documents, be it chronologically or by issue, should be done with photocopies.
34 Complete financial information with respect to the Franchise was retained in the Defendant's files up to 1996, including financial statements.
35 Key documents in Shirakawa's file have apparently been lost or shredded. This includes the Plaintiff's original application, any internal documentation with respect to application approval, a letter written to the Plaintiff's bank in support of his request for an $85,000.00 loan, and financial information with respect to the Franchise for 1997 and 1998. Tobin indicated that the files were purged annually. In light of the lawyer's letter requesting rescission of the Agreement in November, 1999, and the involvement of legal counsel, it appears unlikely that these key documents would have been routinely purged.
36 The Defendant uses a master filing system but maintains discrete files for franchise development, construction, real estate, and credit and accounting. According to Shirakawa, each area is not privy to files in other areas. As the integrity of the original files was not maintained, it is not possible to determine what documents were in Shirakawa's file.
37 I accept Tony's evidence that, prior to signing the Agreement, he requested the financial statements for the Franchise. In his words, "I asked for specifics". Financial statements for the Franchise were in the master filing system for the years 1993 to 1996. I infer that current financial information was also available for 1997 and 1998, although perhaps not distilled into financial statements. The Defendant and the operators had an agreement that profit would be shared between them. It is inconceivable to me that the Defendant would not have insisted upon regular financial reporting. It is apparent from the records that the Defendant expects monthly financial reports. Strangely, the financial information for 1997 and 1998 is not now available.
38 Tony requested financial statements and information that was clearly available and in the Defendant's files. Nothing was provided.
39 Tony acknowledges that Shirakawa told him that the Franchise was not doing as well as it used to. No details were provided. Shirakawa assured him however that the Plaintiff was not buying the present store.
40 Shirakawa and Tobin gave evidence that a three-year written history of earnings was provided to Tony. I do not accept this evidence for two reasons.
41 First, Shirakawa stated that, pursuant to Tony's request for financial information, he went to the accounting department to get the gross earnings figures and that the three-year earnings history was then provided to Tony. Shirakawa acknowledged that if he requested documents from accounting, the documents would be dated by accounting as of the date of the request. He purports to rely upon a document dated May 5, 1997 by accounting with the notation "4:22 pm gus". It appears that the document that Tobin and Shirakawa suggest was provided to Tony was in fact was requested by "gus", as indicated below the date on that document. I infer that the three year comparative financial report probably was part of the report contained in the document brief prepared by Gus Goutos for John Tobin dated May 5, 1997. I note that a similar financial report dated March 21, 1996 is attached to the memo from Brian Colley to Gus Goutos also dated March 21, 1996.
42 Second, the document referred to by the defence was obtained from accounting long before the Plaintiff appeared on the scene. The discussions about the financial status of the Franchise took place between Shirakawa and Tony in the spring and summer of 1998, not 1997. Apart from the problems on the face of the document itself, it makes no sense to provide financial information that is a year out of date. I conclude that the only written financial documentation provided to Tony and the Plaintiff was the pro forma financial statement. As well, oral representations and assurances were made.
43 Shirakawa told the Plaintiff that the projected annual gross income for the Franchise would be $300,000.00, with increases thereafter. The only expense and profit information available was that contained in the pro forma financial statement and the promotion brochure. As well, Shirakawa confirmed orally with Tony that the projected rate of return on an investment of $150,000.00 was 26%, so long as the Plaintiff was a good operator.
44 No evidence has been led by the Defendant nor is there any documentation criticizing the Plaintiff's ability as an operator. The individuals who initially supervised the operation of the Franchise, known as the "business development consultants" (the BDC), were not called on behalf of the defence. In their various reports, there is no criticism of the Plaintiff's competence as an operator. I conclude the Plaintiff was a competent operator.
45 Shirakawa denied advising Tony that he should not contact the operators. His evidence was telling. He stated "If I did say that I would remember it. It sounds like I am hiding something. I can recall not saying that to him". I do not accept Shirakawa's evidence. Tobin acknowledged that Tony was advised not to contact the current operators. I accept that Shirakawa told Tony that the operators could sabotage the restaurant and the deal. I accept Tony's evidence that this clear message prevented him from talking to the current operators.
The Pro Forma financial statement
46 A lynch pin in this litigation is the allegation of the inaccuracy of the pro forma financial statement, as well as the misleading verbal representations made by Shirakawa.
47 Shirakawa prepared the pro forma financial statement with information obtained from the accounting department. According to Shirakawa, the expenses were average expenses for Mr. Sub franchises across Canada. He did not check with accounting and obtain accurate expense figures for the Franchise based upon its past history, although this information was readily available in the files.
48 The pro forma financial statement projects a 26% return on an investment of $150,000.00 when the earnings are $300,000.00. The projected return on investment increases with increased earnings. The promotion brochure promised a "Solid Return on Investment" with a projection of a return of at least 26 % on an investment of $150,000. The promotion brochure is clear:
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We know we can't attract good people unless we can promise a healthy return. |
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49 The available sales and profit history for the Franchise prior to its purchase by the Plaintiff was significantly below the 26% return on investment suggested in the pro forma financial statement and the promotion brochure. The financial statements in the Defendant's files confirm the following:
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Gross Profit |
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1993 |
$ 397,070 |
$ 4,116 |
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1994 |
$ 407,370 |
$ 5,439 |
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1995 |
$ 395,238 |
$ 4,650 |
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1996 |
$ 346,784 |
($ 6,805) |
Mr. Sub protocol for disclosure not followed with respect to sale of existing operation
50 According to defence witnesses, the Defendant appears to have a protocol with respect to preparing estimated expenses prior to the sale of an existing franchise, be they corporate or privately owned. This protocol was not followed.
51 The Franchise was a "one of a kind" operator run store. It was a hybrid between a corporate store and a franchise.
52 Shirakawa confirmed that the protocol for obtaining accurate information when an existing franchise is being sold is that the pro forma financial statement estimating expenses is given to the Franchisee, and the Franchisee is asked to make changes to ensure that the information conveyed to a potential purchaser is accurate. As well, the prospective purchaser is given a written authorization from the Defendant to allow the Franchisee to disclose the confidential financial statements to a prospective purchaser.
53 Tobin confirmed in his examination for discovery that the appropriate method of preparing a reasonably accurate pro forma financial statement in the case of a sale of an existing franchise involves ensuring that the pro forma expenses conformed with actual expenses:
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Q. All right. And the pro formas are based on historical data of that location? |
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If it is an existing one, we based on historical data where you know what, for example, utilities are, what the rent was, when we redid the rent on this place. I know that, because I was involved in that. Number one. |
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Number two, it would take the existing sales and take into consideration the lift when the store is renovated. |
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54 The expected "lift" for gross sales resulting from a renovation is projected to be a 15% and 20% increase from the pre-renovation level of sales. The best evidence of the level of sales at the time of the purchase is a memo to Shirakawa from Paul Ling dated March 26, 1998 indicating gross sales for the Franchise of $4500.00 per week. This translates to annual gross sales of $234,000.00 per year. As the memo was written to Shirakawa, he must have had knowledge at the time of this figure. Another internal memo indicates annual sales of $218,000.00. This information was not conveyed to Tony.
55 Even with the anticipated twenty percent "lift" this does not compute to projected income of $300,000.00 annually.
56 Both Tobin and Shirakawa acknowledged the obvious importance of having accurate information about actual income and expenses when an existing business is being acquired, be it a franchise or a corporate store.
57 I conclude based upon the discovery evidence of Tobin and the evidence of Shirakawa at trial that the protocol for completing an accurate projection of income and expenses for an existing Mr. Sub operation was not followed. Shirakawa did not perform a check to ensure the accuracy of the information conveyed in the pro forma financial statement.
Other misrepresentations with respect to history of Franchise
58 The Plaintiff alleges that he was not informed of other important facts that would be very relevant to making an informed investment decision prior to signing the Agreement.
59 The Plaintiff was in his mid-fifties when he decided to invest in the Franchise. He planned to augment his retirement income by managing the Franchise and later acquiring another franchise to manage. He did not intend to be working full time as an operator. He intended to hire staff to run the day to day operations. After the opening of the Franchise when the financial realities became clear, the Plaintiff and his wife were required to work fifteen to eighteen hour days, seven days a week, as front line operators to reduce the staff expense. This continues to the present. In 1999 and 2000, the Plaintiff and his wife each received management fees in the amount of $20,000.00 per year for their efforts. They could not afford to hire staff. The Plaintiff's evidence was unchallenged. At no time was it suggested to the Plaintiff that it would be necessary to work these long hours with minimal return for the Franchise to survive.
60 Although Tony was told that the sales of the Franchise had declined, he was not made aware of the magnitude of the problem. In an internal memo dated April 22, 1997, the following is stated:
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A couple of serious considerations: |
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1 - Quebec market has been dropping over the last ten years, not going forward in any way. |
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2 - Sales in this store have dropped at a rate of (15 - 20%) over the last three years from $307,000 to $259,000 to $218,000. |
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- No other store is within a 200-mile radius. |
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61 The Defendant prepared a Business Plan for the Franchise dated August 29, 1997. The Business Plan indicated serious problems for the Franchise:
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This location is very old. The sales have been going |
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62 The Defendant's head office had contemplated not renewing the lease for the Franchise. A term of the renewal was that the location would have to be renovated. The Defendant had the option of terminating the lease, or had the right to exercise its option to extend the lease until 2003, on the condition that the premises were renovated. The existing operators were not able to finance the acquisition of the Franchise and the necessary renovations. It appears that before the Plaintiff appeared on the scene, the future of the Franchise was very much up in the air. This is confirmed by Tobin's letter dated May 4, 1998 written to the new owners of the Franchise premises confirming that he wished to renew the lease for the Franchise premises. He states in the letter "I apologize for not getting back to you earlier, there were a number of unknowns we needed to clarify before we made a decision".
63 The existing operators had expressed interest in acquiring the Franchise. They were not able to come up with the required cash. It was clear from the internal documentation that even if they had come up with the requisite capital, in light of the finances of the Franchise, the operators would require a rent-free period and a reduction of royalty and advertising fees during the start up period.
The Performance of the Franchise after its Acquisition in September 1998
64 The projected annual income of $300,000.00 was not achieved for the first two years of operation of the Franchise. Gross income was $251,792.32 and $287,226.19 for the years 1999 and 2000 respectively.
65 The internal memo suggesting the need for a thirty percent increase in sales was more accurate. It appears that the projection of gross income of $300,000.00 was optimistic.
66 In 1999 and 2000, the Franchise reported losses in the amount of $55,012.02 and $50,514.12 respectively.
67 The projected expenses in the pro forma financial statement are not accurate, having regard to the actual expenses incurred by the Franchise both before and after its acquisition by the Plaintiff. I note from comparing the expenses of the Franchise up to 1996, with the Profit and Loss statement of the Franchise for the years 1999 and 2000, that the level of expenses is generally reasonably consistent.
68 There are deductions claimed by the Plaintiff which may well be legitimate deductions for taxation purposes, but which were not included in the prior financial statements. These include deductions for depreciation on leasehold improvements and equipment, and significant expenses for legal fees resulting from this litigation. For the purpose of comparison, these deductions must be backed out of the net loss calculation. However, after making these adjustments, I conclude that the Franchise was not profitable, and certainly did not produce the promised 26% return on the $150,000.00 investment.
69 At trial, defence counsel challenged the accuracy and integrity of the Franchise's financial records. All back up documents appeared to be available although admittedly, the organization resembled a "shoe box" approach to record keeping. The Plaintiff had an accountant on retainer. The Plaintiff and Tony kept all records and the accountant placed the expenses at year end in categories to prepare the financial statements. When cross-examined on certain of the expenses during the trial, Tony sought clarification from the accountant. Tony had inadvertently co-mingled some of his current personal expenses with the historic business receipts. I am satisfied, however, with the exception of three cases of beer purchased at Costco, that the expenses recorded in the profit and loss statements reflect expenses actually incurred by the Franchise. No questions were asked on discovery with respect to this issue. All original receipts were available to counsel for the defence for inspection at the trial.
70 I note that the Plaintiff was charged for a computerized cash system that was never provided by the defendant. This $6810.00 item may have helped with more systematic record keeping.
71 Tobin suggested that the Plaintiff may have been improperly under-reporting his gross income. There is no evidence to support this allegation. I note that the Agreement has remedies available to the Franchisor which may be utilized if there are concerns about inaccurate reporting of income. No such remedies were triggered. I also note that a memo in the Defendant's file makes the suggestion that the former operators were failing to accurately report their income as an explanation for the continuously reducing level of sales. Again, there is no evidence to support this suggestion.
Misrepresentations with Respect to Purchase Price
72 After this litigation commenced, irregularities with respect to the cost of renovations and the cost of equipment were discovered. The Plaintiff was charged for various items that the Defendant had agreed to provide as part of the purchase price, but were never provided.
73 The Plaintiff agreed to pay a maximum price of $150,000 for the Franchise. This was the estimated price for a new franchise. Shirakawa assured Tony that any savings realized in the cost of renovations or in acquiring used, as opposed to new equipment, would be passed on to the Plaintiff.
This did not happen.
74 Notwithstanding Shirakawa's agreement with the Plaintiff, it appears that the Defendant adjusted the figures to ensure the maximum price was paid. Tobin attempted to justify the internal price adjustments by stating that the purchase price agreed to was in the $150,000.00 "period", rather than the capped, or maximum price. This is not consistent with either Shirakawa's evidence, Tony's evidence, or a letter written by the Defendant's solicitor dated June 19, 1998 which confirmed that the maximum price was $150,000, but the exact price could not be finalized until the actual cost of the renovations was known.
75 There are several examples of inflating the purchase price.
76 The actual cost of the renovations was $64,0000.00. The Plaintiff was provided with an invoice and charged $71,000.00. There is a provision in the Agreement that the Defendant could charge a 5% fee associated with the renovations. There was no mention of this fee in the discussions between the parties. Even with the 5% fee, the Plaintiff was deliberately overcharged for the renovations.
77 The amounts wrongfully charged are not large. However, the principle breached is fundamental.
78 The BDC, who had evaluated the state of the Franchise in 1997, commented on the state of the equipment:
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Store is very, very tired and old looking. Every piece of equipment and all fixtures are past saving, they are unusable in extreme poor condition. |
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79 When Mr. Sabetti, the Defendant's representative, attributed value to the equipment, no one inspected or valued the used equipment. I note that he had recently changed responsibilities with the Defendant. I infer that in August 1998, he had little or no experience in valuing used equipment. I do not know where the values for the equipment came from. There was no independent evaluation of the used equipment. I note that an internal document of the Defendant values several items of equipment at zero, yet the Plaintiff paid significant amounts for the equipment, although admittedly less than the cost of new equipment.
80 The Plaintiff was charged $6,810.00 for a new computerized cash register. It was never provided.
81 He was charged $500 for uniforms. They were not provided.
82 The Plaintiff was charged $12,000 for the existing exterior signage when he had been assured that he would receive the new look for the signage reflected in the "café style" sketch provided to Tony. The exterior of the Franchise was not touched.
83 At the time of the closing, the Plaintiff's bank inadvertently paid the Defendant $6,918.65 more than was due. The additional funds provided some start up capital for the new Franchise. The Plaintiff requested reimbursement of the overpayment. The Defendant refused to reimburse the funds and kept the funds as a credit against future advertising and royalty payments. It appears in the Defendant's records that the credit was processed three years after the overpayment was received.
84 The Plaintiff paid $5,000 for a "grand opening". In the words of Mr.Garner, the person in charge of Mr. Sub advertising, the grand opening is meant to be a "spectacular event" to advertise and promote the opening of a franchise in its community.
85 The BDC worked with the Plaintiff to come up with ideas for the grand opening. The plans were not approved by Mr. Garner. He viewed the expense as not being justified for a single franchise. It appears that the Defendant was very reluctant to invest its money to promote the Montreal market. Instead of suggesting a modified plan, or making other suggestions, the Defendant simply retained the $5,000.00 grand opening fee.
86 I note that the Defendant's financial records show a profit in excess of $46,000.00 for the sale of the Franchise to the Plaintiff. A part of this profit is linked to the inflated purchase price and the "grand opening" fee. I conclude that the Defendant deliberately inflated the component parts of the purchase price to ensure the Plaintiff paid the "capped" or maximum price. These facts were discovered by the Plaintiff after this litigation commenced.
Continuing Problems Experienced by the Franchise
87 When the Franchise opened, the Plaintiff was unaware of the misrepresentations.
88 After the opening, the Plaintiff experienced significant problems. The Defendant failed to fulfill its obligations to complete the renovations in a timely manner, and failed to provide bilingual menu boards and advertising in conformity with Quebec language laws.
89 The Defendant initially supplied advertising material in English only. The menus provided were in French only. The Plaintiff had difficulties with the Quebec language authorities. There were delays in obtaining bilingual menus. The bilingual menus initially provided in conformity with the Quebec language law did not reflect the current menu, or current prices. The current bilingual menu boards were not produced until after August 1999, almost one year after the opening of the Franchise.
90 The renovations were problematic. Although they were substantially complete when the Franchise opened, they were not finally completed until eleven months after the opening. The Plaintiff was told not to arrange to complete the renovations themselves but to await the arrival of "Jimmy", the contractor from Toronto. Jimmy was busy doing other work on other franchises in Toronto as directed by the Defendant. Completion of the renovations to the Franchise was not a priority to the Defendant. Jimmy did not appear for months.
91 The stools and the eating counter were not installed for many months. The stools were placed in the restaurant, but were not attached to the floor. A customer attempted to use the unattached stool, causing one of the stools to go through the glass window. Thankfully, no one was hurt. The Plaintiff paid for the repairs to the window.
92 The toilets were backing up. This created an unpleasant odour. At times, the Plaintiff was forced to close the toilets to customers. One can safely infer that the closures would have a negative effect on business. Finally, the Plaintiff arranged to have the toilets replaced at their expense. The Defendant did agree to accept responsibility for these charges. It is not clear to me whether this amount has been paid.
93 The soup and bread display area was not completed for a considerable period of time.
94 The Defendant's representative acknowledged that there was no excuse for the considerable delay in completing the renovations.
95 I note in the promotion literature the Defendant promises ongoing support from Mr. Sub and a BDC who would act as a liaison to the National Office, making operational suggestions, and bringing opportunities and ideas to promote the Franchise. The Franchise however was isolated. The Plaintiff had to fend for himself. There were several changes in the BDC responsible for the Franchise. The BDC representatives were based in Toronto and visited the Franchise perhaps once a month. David Fine, in particular, did attempt to bring the problems experienced by the Franchise to the attention of head office in a series of memos.
96 Frustration mounted. The Plaintiff failed to pay royalty and advertising fees. Then, he stopped paying rent, until ordered to do so by the Quebec Superior Court.
97 There is no doubt that Tony took an "eye for an eye" approach to the situation. Looking at the income statements, however, it appears probable that due to the problems at the Franchise, funds were not available to make these payments.
98 The May 26, 1999 memo written by the BDC David Fine is telling:
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... I am going to have to send them a letter and show some muscle (I have been working out) if I cannot get any commitment from this pair. The downside to this is, that we as you know, have to clean up our act before I can really start pushing them for info., OR DO I HAVE TO WAIT? It's a little bit of a delicate situation for many reasons. John Tobin mentioned to me in the regional, that he does not want to lose the restaurant. I don't think he cares so much about the people in the restaurant, he just doesn't want to lose the location, but I won't ignore the fact that they aren't fulfilling their side of the agreement. Any comments? |
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99 Tony wrote two comprehensive letters in April and August 1999 detailing the problems experienced. He also spoke to Tobin. Finally, in November 1999, the Plaintiff's counsel wrote a letter outlining the various problems and the misrepresentations, and sought rescission. This litigation commenced in March 2000.
100 I accept Tony's evidence that since this litigation commenced, there has been no contact or assistance rendered by a BDC. Perhaps there is a BDC notionally assigned to the Franchise, but since the deterioration of the relationship, the Franchise has not received any guidance or benefit from the designated BDC.
Law with respect to Exclusionary and Disclaimer Clauses
101 I turn to consider the "entire agreement" and the "independent investigation" clauses contained in the Agreement, as well as the disclaimer clause found at the bottom of the pro forma financial statement.
102 The entire agreement clause is found at article 24.01 of the Agreement. It states:
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This agreement constitutes the entire agreement between the parties and supersedes all previous agreements and understandings in any way relating to the subject matter hereof between the parties. It is expressly understood and agreed that no representations, inducements, promises or agreements, oral or otherwise, between the parties not embodied herein shall be of any force or effect. |
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103 The independent investigation clause if found in article 24.12 of the Agreement:
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The Franchisee acknowledges that he has conducted an independent investigation of the business franchised hereunder and recognizes that the business venture contemplated by this agreement involves business risks and that its success will be largely dependent upon the ability of the Franchisee as an independent business person. The Franchisor expressly disclaims the making of and the Franchisee acknowledges that he has not received, any warranty or guarantee, express or implied, as to the potential volume, profits or success of the business venture contemplated by this agreement. |
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(b) |
The Franchisee acknowledges that he has received, has had an ample time to read, and has read this agreement and fully understands its provisions. The Franchisee further acknowledges that he has had an adequate opportunity to be advised regarding all pertinent aspects of this franchise and the franchise relationship by advisors of his own choosing, including but not limited to independent legal counsel and/or chartered accountants. |
104 The disclaimer clause found on the bottom of the pro forma financial statement provides:
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These projections of sales, profits or earnings are based on figures and, where necessary, estimates provided to Mr. Submarine Limited. Mr. Submarine makes no warranties or representations as to potential profit or operating expenses of any particular franchise business. Accordingly, the performance of any given restaurant is heavily dependent upon Operator Management. |
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105 These are strongly worded clauses typically found in contracts of adhesion.
106 There are several cases where courts have found exclusion clauses not to be determinative in the context of franchise agreements. These include Zippy Print Enterprises Ltd. v. Pawliuk, [1994] B.C.J. No. 2778 ( C.A.), online: Quicklaw (BCJ) (Zippy Print), a decision of the British Colombia Court of Appeal, Atlas Supply Co. of Canada Ltd. v. Yarmounth Equipment Ltd. et. al. (1991), 37 C.P.R. (3d) 38 (N.S. C.A.), online: Quicklaw (Atlas Supply), a decision of the Nova Scotia Court of Appeal, and Perfect Portions Holding Co. v. New Futures Ltd., [1995] O.J. No. 2113 (Gen.Div.), online: Quicklaw (OJ) (Perfect Portions), Shelanu Inc. v. Print Three Franchising Corp., [2000] O.J. No. 4129 (S.C.J.), online: Quicklaw (OJ) (Shelanu), 1005633 Ontario Inc. v. Winchester Arms Ltd., [2000] O.J. No. 2404 (S.C.J.), aff'd [2000] O.J. No. 4711 (C.A.), online: Quicklaw (OJ) (Winchester Arms) and Chung v. Lite-Way Subs and Deli Inc., [2001] O.J. No. 3746 (S.C.J.), online: Quicklaw (OJ) (Chung), all decisions of this Court.
107 Many of the noted cases share a common theme. Specific misrepresentations were made to a potential franchisee with respect to projected earnings and/or expenses of the franchise. The result was a distorted, overly optimistic financial projection that did not accord with reality. In all of these decisions, the courts refused to apply the entire agreement, independent investigation or disclaimer clauses and found that the independent tort of misrepresentation had been established. Alternatively, the courts concluded that to strictly enforce the governing agreement would be unconscionable. The franchisees in these cases were successful in their claims for rescission or damages.
108 These cases are also part of a recent trend to define duties of good faith between bargaining parties to prevent abuse or obvious unfairness in the context of the franchise relationship.
109 A recurrent theme in these cases is the inherent inequality of bargaining power between an established franchisor and an individual franchisee, as well as the unique inter-dependant relationship between franchisor and franchisee.
The Arthur Wishart Act
110 The recurring problem with respect to inequality of bargaining position, and in particular the accuracy of financial disclosure in the context of acquiring a franchise has now been recognized and rectified by statute. On May 17, 2000, the Ontario Legislature passed its first franchise-specific legislation: the Arthur Wishart Act (Franchise Disclosure), 2000, S.O. 2000 c. 3 (the Act). A portion of this Act came into force on July 1, 2000, and the regulations dealing with disclosure came into force on January 31, 2001.
111 The Act imposes a duty of fair dealing on each party to a franchise agreement. It defines fair dealing as including the duty to act in good faith and in accordance with reasonable commercial standards.
112 The Act also creates disclosure requirements for Ontario franchises acquired after January 31, 2001. Franchisors are required to provide franchisees with a disclosure document containing all material facts, financial statements, copies of the franchise agreement and ancillary documents and certain statements as prescribed by the regulation. Liability is imposed on all persons who breach the duty of fair dealing, for interfering with the freedom of franchisees to associate, and for misrepresentation in a disclosure document.
113 The provisions of the Act cannot be waived by the terms of the governing agreement.
114 The Act responds to the recurring situations such as this one, where inadequate or misleading disclosure is made by the franchisor. However, the Act, and the disclosure provisions, do not apply to this case. The Act imposes prospectively the duty of good faith upon existing franchises carrying on business in Ontario. As the Franchise carries on business in Montreal, the good faith provisions of the Act do not apply. Counsel for the defence acknowledges, however, that the good faith requirements of common law apply to define the duties and obligations between franchisee and franchisor in this case. From a practical point of view, the Act simply codifies the common law.
Defining the rights, duties and obligations between franchisor and franchisee
115 In Jirna Ltd. v. Mister Donut of Canada Ltd., [1975] 1 S.C.R. 2 aff'g [1972] 1 O.R. 251 (C.A.), online: Quicklaw (SCR) (Jirna), the Supreme Court of Canada confirms that the relationship between the parties to the franchise agreement is not a fiduciary relationship. Jirna did not deal with the requirements of accurate disclosure by a franchisee at the time of the acquisition of a franchise.
116 It appears clear from the caselaw, that although the parties to a franchise agreement are not in a fiduciary relationship, they are in a relationship that imposes upon the parties the duties of utmost good faith.
117 The characterization of the nature of the relationship between the contracting parties largely determines their obligations to each other. A useful theoretical framework in the commercial context defining the graduated obligations between contracting parties is found in T.G. Youdan, ed., Equity, Fiduciaries and Trusts (Toronto: Carswell, 1989). At p. 3. P.D. Finn describes a three-tiered hierarchy of standards of conduct governing consensual relationships. The demarcation where one standard of behaviour ends and another begins is not always clear, as reflected in tensions and developments in the law:
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These, in ascending order of intensity, I will describe as "the unconscionability standard," "the good faith standard," and the "fiduciary standard." These labels, I should emphasize, are ones of convenience. Lest it be thought that there are clear lines of demarcation separating the three, it will later be indicated that they merely represent the dominant shades on a spectrum; that the points of transition are often indistinct though they are sometimes contrived -- primarily for reasons of remedy; and that each in what it exacts, shares characteristics with the others. |
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118 Finn confirms, at p. 4, that each of the three standards places different demands on a contracting party with respect to the extent that he or she is required to acknowledge or protect the interests of the other:
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Common to all three standards mentioned is a concern with the extent to which one party to a relationship is obliged to acknowledge and to respect the interests of the other. But each, in setting its own limits, proceeds from a different premise. "Unconscionability" accepts that one party is entitled as of course to act self-interestedly in his actions towards the other. Yet in deference to that other's interests, it then proscribes excessively self-interested or exploitative conduct. "Good faith," while permitting a party to act self-interestedly, nonetheless qualifies this by positively requiring that party, in his decision and action, to have regard to the legitimate interests therein of the other. The "fiduciary" standard for its part enjoins one party to act in the interests of the other -- to act selflessly and with undivided loyalty. There is, in other words, a progression from the first to the third: from selfish behaviour to selfless behaviour. Much of the most contentious of the trio is the second, "good faith." It often goes unacknowledged. It does embody characteristics to be found in the other two. |
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119 Franchisors fall into the second category in the progression of rights, duties and obligations.
120 Franchisors are not required to act selflessly placing the interests of the franchisee ahead of their own. However, it appears clear from the case law that a franchisor is subject to the duty to act in utmost good faith towards a franchisee.
121 In Perfect Portions, Fleury J. confirms the special nature of the relationship between the parties in a franchise agreement. At para 14, Fleury J. writes:
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A franchise agreement creates a different type of relationship than the usual purchase and sale transaction. In some ways, the parties become partners in one venture. In some ways, the franchisee has to continue to rely on the integrity of the franchisor with respect to information privy only to the franchisor. A duty of utmost good faith can be implied in any purchase such as the one described in this case. |
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122 Part of the obligations in this special relationship with the franchisee includes a positive obligation to disclose accurate financial information and facts to a prospective franchisee at the time of entering into a franchise agreement. Misrepresentations may result from silence or omissions. In Perfect Portions, Fleury J. held that the common law duty of the franchisor included a clear obligation to provide accurate financial disclosure and to advise the prospective purchasers of difficulties which could reasonably be foreseen in light of the information available to it.
123 Similarly, in Shelanu, Nordheimer J. noted at para 25, that the franchisor/franchisee relationship is more akin to a partnership rather than a pure commercial arrangement. It is a relationship to which the duty of good faith should apply in terms of dealings between the franchisor and the franchisees. Nordheimer J. commented upon the specific good faith obligations under the Act, namely that the duty of fair dealing includes the duty to act in good faith and in accordance with reasonable commercial standards as provided by subsection 3(3) of the Act. However, Nordheimer J. also confirmed that, even in the absence of the Act, there exists a common law obligation of the parties to a franchise relationship to act in good faith towards one another.
124 Nordheimer J. states that the duty of good faith imposed upon franchisees and franchisors includes community standards of honesty, reasonableness and fairness. He quotes Kelly J. in Realty Ltd. v. Arton Holdings Ltd. and LaHave (No. 3) (1991), 106 N.S.R. (2d) 180 (S.C.), aff'd (1992), 112 N.S.R. (2d) 180 (C.A.), and held, at para 27, that:
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The law requires that parties to a contract exercise their rights under that agreement honestly, fairly and in good faith. This standard is breached when a party acts in a bad faith manner in the performance of its rights and obligations under the contract. `Good faith' conduct is the guide to the manner in which the parties should pursue their mutual contractual objectives. Such conduct is breached when a party acts in `bad faith' - a conduct that is contrary to community standards of honesty, reasonableness or fairness. |
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125 In Country Style Food Services Inc. v. Hotoyan, [2001] O.J. No. 2889 (S.C.J.), online: Quicklaw (OJ) (Country Style), Dilks J. agreed with Nordheimer J., at para 54, holding that, "... the Arthur Wishart Act (Franchise Disclosure) S.O. 2000 c. 3 ... does little else than codify the common law rule in that regard." Like Nordheimer J., Dilks J. confirmed the common law duty of the franchisor of utmost good faith in its dealings with the franchisee, even though the relationship did not amount to a fiduciary one.
126 I adopt these principles.
The independent tort of misrepresentation
127 In Zippy Print, Lambert J.A., of the British Colombia Court of Appeal concluded that the specific misrepresentations made by a franchisor constituted an independent tort, precluding reliance upon the general exclusion clause.
128 In Zippy Print, the franchisees were provided with pro forma financial statements that were inaccurate. The actual gross sales did not turn out to be as high while the cost of sales was much higher than projected. Lambert J.A. noted that exclusion clauses contained in standard form contracts of adhesion, that is, contracts that are offered on an essentially "take it or leave it" basis without affording a realistic opportunity to negotiate its terms, will not always operate to exclude liability. Beginning at para 41, Lambert J.A. wrote:
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In short, apart from the application of an exclusion clause, a commercial enterprise cannot make an intentional oral representation designed to persuade a customer or other party to enter into a standard form contract of adhesion and then, by invoking the Parol Evidence Rule, rely on the fact that the contract is in writing to escape liability flowing from the fact that the representation is untrue. In those circumstances, the oral representation will be regarded as forming an essential element in the relations between the parties, either on the basis that the written contract document was not intended to form the entire agreement between the parties (the one contract theory), or, alternatively, on the basis that the oral representation, when it was acted upon by the person to whom it was made entering into the written contract, became a separate or collateral contract on which liability may be founded (the two contract theory). |
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Accordingly, Lambert J.A. concluded, at para 45:
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A general exclusion clause will not override a specific representation on a point of substance which was intended to induce the making of the agreement unless the intended effect of the exclusion clause can be shown to have been brought home to the party to whom the representation was made by being specifically drawn to the attention of that party, or by being specifically acknowledged by that party, or in some other way. |
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129 I note again that Greer J. adopted these principles in Zippy Print in her decision in Winchester Arms. Zippy Print does not specifically refer to the duty of good faith between franchisor and franchisee. However, Greer J. discusses the nature of the relationship between the parties as a factor to consider at para 82 of Winchester Arms . She states with respect to exclusionary clauses "Each contract must be examined in light of the particular relationship between the parties. In franchise cases, the Courts have looked beyond the language of the formal agreement where it is necessary to do justice between the parties".
Inequality of bargaining power and unconscionability
130 In Atlas Supply, the Nova Scotia Court of Appeal looked at the exclusionary clause issue somewhat differently. The Court refused to apply the exclusion clause in the franchise agreement on the basis of inequality of bargaining power and principles of unconscionability. Matthews J.A., for the majority, noted that historically, the common law sought to give effect to the presumed intention of contracting parties by enforcing the written contract. However, the Court will intervene when the party desiring to enforce its exclusionary clause has engaged in unconscionable conduct.
131 In Atlas Supply, the agreement was entered into by a large national company as franchisor, and a small businessman with little retail experience, as franchisee. The franchisor gave a promotional brochure, including financial projections, to the franchisee with the intent that he rely upon it. The franchisor knew the financial projections were inaccurate. As well, the franchisor knew that the franchisee did not have the resources to verify the inaccuracy of the financial forecast. Inequality of bargaining power clearly existed. As a result, the franchisor had an obligation to inform the franchisee that the projections were flawed and the extent to which the project was not viable. Matthews J.A. concluded that to enforce the exclusionary clause in these circumstances would be to produce an unconscionable bargain. Although misrepresentations clearly had been made by the franchisor, the Court did not rely upon the analysis of an independent tort of misrepresentation in reaching its conclusion.
132 These principles confirmed in Atlas Supply have recently been adopted by Greer J. in Winchester Arms where, at para 85, she quotes from Atlas Supply stating:
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Exclusionary clauses are often fair and necessary. However, when evidence discloses otherwise, courts have devised various methods to avoid injustice. For example, the contra proferentum principle, collateral warranty, fundamental breach and unconscionability. |
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133 The appeal from Greer J.'s decision in Winchester Arms was dismissed without reasons by the Ontario Court of Appeal (see [2000] O.J. No. 4711 ( C.A.), online: Quicklaw (O.J.)).
134 The Defendant relies on Khagen Investments Ltd. v. 710491 Ontario Ltd., [1999] O.J. No. 2152 (S.C.J.), online: Quicklaw (O.J.) (Khagen Investments). In Khagen Investments, Mossip J., at para 80 of her reasons, refers to a franchise agreement and noted that, "... its terms cannot be ignored simply because the plaintiff's business failed." Mossip J. refers to the decision of Rutherford J. in Elwyn Lister Ltd. v. Dunlop Canada Limited (1978), 85 D.L.R. (3d) 321, (Ont. H.C.) (Elwyn Lister) which held, at para 81, that the disclaimer clause in the franchise agreement was fatal to the plaintiff's claim. Mossip J. concludes:
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Paragraph 25.11 of the franchise agreement could not be clearer in placing full responsibility on the shoulders of the plaintiff, for investigating himself all aspects of the finances of the franchise prior to buying same, for accepting guarantees, express or implied, about the volume, profits or success of the franchise. |
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135 Each of these cases is very factually driven. In Khagen Investments, the plaintiff sought relief based on, among other things, alleged fraudulent and negligent misrepresentations. Mossip J. concluded that there was insufficient evidence to draw the inference of fraudulent intent (that is knowledge of falseness or recklessness) on the part of Baker's Dozen or its employees, either with respect to the pro forma document, or generally, in relation to other alleged statements about the franchise. Mossip, J. concluded that the pro forma document provided to the plaintiff in Khagen Investments was only a forecast, not a clear representation of fact.
136 In this case, the pro forma was a representation of fact. When the Plaintiff asked for specifics, Shirakawa reconfirmed orally the promised 26% return on investment as outlined in the promotional literature and the pro forma financial statement. I conclude that the findings of fact in Khagen Investments are easily distinguishable from the facts of this case. The principle of unconscionability outlined in Atlas Supply applies.
The test for fraudulent misrepresentation
137 The Plaintiff asserts that the Defendant fraudulently misrepresented the facts.
138 The elements of fraudulent misrepresentation are set out in the decisions of both Mossip J. in Khagen Investments and Spence J. in Chung. At para 56 of Chung, Spence J. set out the elements required in order to make out a claim for fraudulent misrepresentation. In order to make out a claim for fraudulent misrepresentation against a defendant, a plaintiff must prove:
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a false representation was made by that defendant; |
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which was knowingly false; |
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was made with the intention of deceiving the plaintiff; and |
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which materially induced the plaintiff to act, resulting in damage. |
139 In Chung, Spence J. found that the defendant made a fraudulent misrepresentation to the plaintiff as he was reckless as to whether pre-contractual representations were true or false. The facts are not dissimilar to the facts of this case.
140 The defendant had prepared a pro forma estimate in 1994 based on his previous experience in operating franchises, on his general business experience, and on his experience with another franchise location. The pro forma was not based upon sales and expenses of the franchise in question. Spence J. concludes at para 110:
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Accordingly, although Mr. Aneja may have continued to be hopeful, I do not accept that Mr. Aneja had a belief in the truth of the statement in the Pro Forma at the time the deal with the plaintiff was being negotiated and concluded. He left the statement unaltered, without any reason for doing so. In doing so, he was acting without regard for the risks that the continued publication of the statement created. That was reckless on his part. |
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141 In finding that the plaintiff had established the claim of fraudulent misrepresentation, Spence J. commented, at para 158, upon the knowledge and intention elements of the claim and noted that recklessness is enough to make out the claim:
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Whether a false statement is fraudulent depends on whether it is made knowingly or recklessly. Thus it need not be made with an intent to deceive; it is sufficient if it is made without regard for its truth, with a view to obtaining the reliance of the recipient upon it. |
142 The findings of fact in Chung with respect to the financial misrepresentations are similar to the facts of this case. In Chung there were no other misrepresentations made. Such is not the case in this matter.
Conclusions with respect to misrepresentation
143 Although I am not prepared to find that Shirakawa deliberately lied to the Plaintiff, I cannot help but conclude that Shirakawa was reckless with respect to representations made. Civil fraud includes both deliberate lies and reckless representations.
144 I do not reach this conclusion lightly. The dividing line between negligence and recklessness is not always clear.
145 In Black's Law Dictionary, 6th ed., s.v. "negligence" is defined as the failure to use such care as a reasonably prudent and careful person would use under similar circumstances. It is the doing of some act which a person of ordinary prudence would have done under similar circumstances.
146 "Recklessness", on the other hand, is referred to in Black's Law Dictionary as being a stronger term than mere or ordinary negligence. To be reckless, the conduct must disregard or be indifferent to consequences. Recklessness is often considered in the criminal context with respect to mens rea and is not often considered in the civil context. Words & Phrases, ( Toronto: Carswell, June 2001), defines "recklessness" in the civil context as more than mere negligence or inadvertence. While it is not necessarily a criminal or even morally culpable matter, it does mean the deliberate running of an unjustified risk. Recklessness contains two elements. First, it involves acting in such a manner as to create an obvious and serious risk. Second, it involves doing so without giving any thought to the possibility of there being any such risk, or having recognized that there was risk involved, nevertheless decided to take the risk.
147 In my view, Shirakawa's actions and attitude fall within the definition of recklessness.
148 Shirakawa was aware of the poor gross earning performance of the Franchise as evidenced by the memo dated March 26, 1998 which suggested weekly sales of $4500.00, or annual sales of $234,000.00. Shirakawa deliberately chose not to provide this information to the Plaintiff.
149 When the Plaintiff asked for specifics, Shirakawa failed to investigate and disclose both the details of the troubled history of the Franchise and the financial statements of the Franchise.
150 He did not follow the protocol with respect to preparing a pro forma statement for an existing franchise to ensure that the expenses and the projected profit could be made with accuracy. The inaccuracies in the pro forma financial statement were significant.
151 Notwithstanding the "independent analysis" clause found at 24.12 of the Agreement, it was not possible for the Plaintiff to make their own inquiry with the existing operators due to the clear "no contact" requirement between the Plaintiff and the operators imposed by the Defendant. It appears that this order came from Tobin, but was enforced by Shirakawa. Not only was the Plaintiff recklessly provided with inaccurate information, he was prevented from obtaining accurate information.
152 Shirakawa was a vice-president of the Defendant in a responsible position. He was not simply an employee. I conclude that Shirakawa had access to this important information and recklessly did not inform himself with respect to the material facts as to the history and finances of the Franchise.
153 Shirakawa's lack of diligence in obtaining accurate information with respect to expenses and the history may be reckless slippage in a busy period of expansion and resale of the Mr. Sub franchises.
154 Regardless of whether or not Shirakawa had the damaging facts and information about the problems and financial picture of the Franchise, all the documentation was clearly in the Defendant's files. Tobin, as president and CEO of the Defendant, had, at least, imputed knowledge of all of the facts and information at his disposal. It is not possible for the Defendant to screen itself from responsibility by having a poorly informed person conduct the negotiations and to recklessly misrepresent the financial picture and history of the Franchise to the Plaintiff.
155 The Plaintiff believed and relied upon the pre-contractual verbal and written representations made by Shirakawa and Tobin. I accept Tony's evidence that had he known the true facts with respect to the finances and the history of the Franchise, the Plaintiff would not have signed the Agreement. Looking at the past expenses, as well as the expenses actually incurred after the Franchise opened, it appears that the Franchise would not have been profitable even if the estimated projected sales of $300,000.00 had been achieved. Certainly, the return on investment was nowhere near the promised 26%. The misrepresentations with respect to both income and expenses were material.
156 I conclude that the Defendant, by selective and inaccurate disclosure, created a grossly misleading picture of the financial viability of the Franchise even if the projected earnings of $300,000 had been achieved. As well, the history of the Franchise and of other Mr. Sub franchises in Montreal which failed was not disclosed. There is no rational explanation for this material non-disclosure.
157 The overcharging and the retention of funds without providing the service or the wares may not, on its own, give rise to the right to rescission. However, when considered together with the misrepresentations made with respect to the finances and history of the Franchise, these additional facts reinforce the Plaintiff's claim for rescission.
158 The Defendant failed to provide the promised support to the Franchise after it opened. The litany of post-contractual problems cumulatively illustrates conduct on behalf of the Defendant that appears high handed in light of the obligations of good faith and fair dealing between franchisor and franchisee.
159 I conclude that the elements of fraudulent misrepresentation are present on the facts and circumstances of this case.
Availability of the remedy of rescission
160 The Plaintiff seeks rescission of the Agreement. In the alternative, he seeks damages.
161 The Defendant's position is that unless fraud can be proved, the Plaintiff's claim cannot succeed. Rescission of a fully executed contract is possible in the case of a fraudulent misrepresentation. The law is less clear with respect to an executed contract, absent fraud.
162 First, I have concluded that the Plaintiff has proved a fraudulent misrepresentation, and therefore the remedy of rescission is available.
163 From a practical point of view, although the Defendant objects to the remedy of rescission, the parties acknowledge that their troubled relationship must be brought to an end.
164 It is the Defendant's position that the Plaintiff breached the Agreement, and therefore they can take over the Franchise without payment to the Plaintiff of the $150,000.00 and sue for arrears of royalty and advertising fees, subject to certain items that they have admitted are owing. If the defence claim for termination fails, counsel is somewhat vague with respect to what remedy is available, given the parties' agreement to end their relationship.
165 Even if I had not concluded that the Defendant's representatives were reckless, I would have come to the conclusion in these circumstances that rescission is an available remedy for two reasons.
166 Firstly, I find that the Agreement is not a fully executed contract. The limits on the availability of the remedy of rescission do not apply to ongoing contracts. (Senanayake v. Cheng, [1966] A.C. 63 (P.C.) (Senanayke)). The relationship between franchisor and franchisee is implicitly an ongoing relationship intended to continue into the future. These themes are echoed in the analogy of Fleury J. in Perfect Portions and Nordheimer J. in Shelanu. The relationship of franchisee and franchisor is compared to that of a partnership. The applicable franchise agreement defines rights and responsibilities for both parties that are ongoing. It is not a fully executed contract. I conclude that the remedy of rescission is available between franchisor and franchisee as this is not a fully executed contract.
167 The traditional limit upon the remedy of rescission is both a historic and a practical one. In the case of a fully executed contract it may be very difficult to restore the parties to their original position. It is not possible to "unscramble the egg". Such is not the practical difficulty and dynamic in this case. Franchises can be bought or sold. If both parties mutually wish to end their relationship rescission is the most practical remedy, subject to the inevitable accounting between the parties to ensure fairness.
168 Secondly, I adopt the reasons of the British Colombia Court of Appeal decision in S-244 Holdings Ltd. v. Seymour Building Systems Ltd., [1994] B.C.J. No. 598 (C.A.), online: Quicklaw (B.C.J.) (S-244 Holdings ) which takes a practical, robust approach to the availability of the remedy of rescission.
169 This decision reflects a loosening of the rigid rules with respect to executed contracts and the availability of rescission. S.M. Waddams in The Law of Contracts, 3rd ed. (Toronto: Canada Law Book, 1993) (Waddams) suggests at para 416 that the execution of the contract is only one of the factors to consider when determining the appropriate remedy:
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The explanation of the conflicting decided cases seems to be that execution is, in practice, taken into account as one factor only in deciding whether rescission should be denied. It is submitted that execution should be recognized as a relevant, but not a decisive, factor in determining whether, in all the circumstances, rescission should be denied because it might affect third parties or because of the plaintiff's undue delay in seeking his remedy. |
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170 The principles outlined by S.M. Waddams were adopted by the Court in S-244 Holdings at paras 21-22. The execution of the contract should be recognized as a relevant, but not decisive factor in deciding whether the remedy of rescission is available. In that case, the Court held, in accordance with a recent trend in the case law, that execution was not a bar to rescission. In my view, this practical approach makes good common sense, particularly in the facts of this case.
171 The Defendant appears to take the position that if the Plaintiff's claim for rescission fails, so too does his claim for damages. Simply put, this is not correct.
172 It appears that counsel for the defence has misinterpreted aspects of the Khagen Investments decision. He places great reliance upon a statement by Mossip, J. at paragraph 68. If the franchisor making the representation honestly believes the statement complained of is true, he or she cannot be liable in deceit, even though he is "ill-advised, stupid, credulous, or even negligent".
173 This strict test requiring the prerequisite of fraudulent misrepresentation may apply to a fully executed contract, limiting the remedy available to damages. For the reasons previously outlined, I do not agree with this assertion in all factual circumstances. Regardless, whether or not the remedy of rescission is available, does not preclude that plaintiff from recovering damages.
174 Waddams confirms that historically the Courts of Equity simply required that the misrepresentation should be "material" for equitable relief. He states at para 413, that an innocent misrepresentation,
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... might, for purposes of relief in equity, be entirely honest and careful; there is no need for any kind of promissory "intention", the negligence of the party seeking relief is no defence, and there is a presumption that a material representation did in fact cause the misrepresentee to enter into the transaction. |
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175 The Defendant is not correct in the suggestion that if the Plaintiff's claim for rescission fails, so too does his claim for damages.
176 As well, the defence suggests that the Plaintiff cannot pursue rescission due to delay. I do not accept this argument.
177 The Plaintiff sought rescission thirteen months after acquiring the Franchise, and after the preparation of the first year end statements. This appears to be the first reasonable opportunity to make the claim. The Plaintiff acted promptly. It would be premature to make the claim for rescission before giving the Defendant an opportunity to rectify the various problems. Clearly the Plaintiff was trying to bring matters to the attention of Tobin in August, 1999. As well, the financial picture of the Franchise would not be clear until the first annual income and loss statement was completed. The first statement was prepared in October 1999. After realizing the significance of the problem, the Plaintiff promptly retained counsel, and made his position clear in correspondence sent in November, 1999.
178 The Defendant refused the Plaintiff's request for rescission and the litigation commenced in March 2000. As well, the Defendant refused to let the Plaintiff sell the Franchise to third parties. The Plaintiff had no choice but to continue operating the Franchise to mitigate his damages pending the trial.
179 I conclude therefore, from a review of the applicable contractual principles that the remedy of rescission is available. First, I have concluded in the facts and circumstances of this case that the Defendant was reckless, and hence fraudulent. Secondly, in the alternative, rescission is available as a remedy in the case of negligent misrepresentation as this contract is not fully executed. Finally, I adopt the reasoning of S.M. Waddams, and the British Colombia Court of Appeal in S-244 Holdings that concludes that execution of the contract is one of several factors to consider when assessing the appropriate remedy. There is no valid issue with respect to delay.
The Defendant's counterclaim
180 The Defendant has counter-claimed for various relief. Their first claim is that they are entitled to terminate the Agreement in accordance with clause 20.01 due to the Plaintiff's failure to pay the royalty and advertising payments. They claim that they are entitled to take over control of the Franchise without compensating the Plaintiff for the $150,000.00 that he paid. Apparently, there is an interested purchaser for the Franchise in the wings that would like to acquire a master franchise for Quebec. As well, the Defendant seeks payment for the unpaid advertising and royalty payments. They acknowledge certain credits are owed to the Plaintiff including the grand opening fee, the charges for the new computer that never materialized, the replacement costs for the toilets, the charges for uniforms and the overpayment made when the Franchise was acquired.
181 The Defendant at no time provided the Plaintiff with written notice of their intention to terminate the Agreement. Clause 20.01 requires both default, and notice of termination. Apart from the technical problems, in light of my conclusions with respect to the misrepresentations, I conclude that the Defendant's claim for termination with the forfeiting of the Plaintiff's purchase price cannot succeed. This conclusion does not determine the issue of the Defendant's claim for arrears of the rent, advertising and royalty payments which I have specifically dealt with in the calculation of the credits and debits between the parties.
Conclusions
182 There are two lines of cases, Atlas Supply and Zippy Print, which have been developed in the appellate courts dealing with obligations between a franchisee and a franchisor. I conclude on the facts of this case that the Plaintiff's claim for misrepresentation must succeed whether the analysis derives from principles of unconscionability guided by community standards of honesty, reasonableness or fairness as discussed in Atlas Supply or based upon a separate tort of misrepresentation canvassed in Zippy Print.
183 The notion of unconscionability is very fact specific. Clearly inequality of bargaining position exists in the facts of this case. To enforce the exclusionary clauses in the Agreement, in light of the facts and circumstances of this case, would be unconscionable. There were serious written and oral pre-contractual, as well as post contractual misrepresentations with respect to both history and financial issues.
184 The caselaw is clear that the franchisor was under a clear obligation to advise the Plaintiff of the history of the Franchise, as well as the failure of several Mr. Sub locations in Montreal. This background would allow the Plaintiff to consider the proposed investment in light of the facts. As well, the franchisor is under a duty to provide accurate financial information. The Plaintiff requested financial statements. He, quite sensibly, wanted specifics. The requested information was readily available but was not provided. The Plaintiff was provided with a pro forma financial statement, which underestimated the actual expenses of the Franchise. As well, the Plaintiff was warned not to contact the existing operators, as the defendant suggested that they would try to undermine the deal. They may well have undermined the deal, by disclosing to the Plaintiff the truth about the financial difficulties of the Franchise.
185 As well, the Defendant took advantage of its position to inflate the purchase price. After the Franchise opened, the Defendant failed to fulfil its obligations to complete the renovations in a timely manner, to provide bilingual menus and promotional material, and to support the new Franchise.
186 I conclude that to enforce the exclusionary clauses in the Agreement in this case would offend community standards of honesty and fairness. The Defendant breached their duty of good faith and fair dealing with the Plaintiff. The Defendant engaged in a pattern of selective and inaccurate disclosure creating a grossly misleading picture of the history and financial viability of the Franchise.
187 The Defendant's conduct was at least reckless. I conclude that the elements of fraudulent misrepresentation have been proved. The Defendant knew, or is imputed to have known the true facts. The misrepresentations were made by the Defendant intending the Plaintiff to rely upon them. The Plaintiff did rely upon them. I accept the Plaintiff's evidence that had he known the facts, both with respect to the history and the finances of the Franchise, that he would never have entered the Agreement.
188 The Plaintiff's claim for the remedy of rescission is appropriate. First, I have concluded that the Defendant was reckless in the misrepresentations made, justifying a finding of civil fraud. Alternatively, I conclude that the Agreement was not an executed contract, and therefore the limits on the availability of the remedy of rescission do not apply. Finally, I adopt the reasons of the British Colombia Court of Appeal in S-244 Holdings, as endorsed by Waddams, which advocates the view that the execution of the contract is only one of several factors to consider when determining the appropriate remedy.
189 With respect to the Plaintiff's claim for rescission, I conclude that he is entitled to the following:
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the return of the purchase price of $150,000.00 |
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the return of the overpayment made in the amount of $6,918.65 |
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expenses for the move to Montreal $3000.00 |
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compensation for losses experienced in the 1999 and 2000 Statement of Income and expense, subject to the following guidelines: |
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the losses claimed include the expenses for advertising and royalty payments, which have not been paid. If they are deducted as part of the loss, then they must be notionally paid. |
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The unpaid rent arrears should be paid. |
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The Defendant acknowledged responsibility for paying for the repairs to the washrooms |
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Any legal fees that have been deducted as expenses should come out of the calculation. Costs of this proceeding will be dealt with as a separate issue at the conclusion of the trial. |
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Half of the car expenses appear to be reasonable expenses of the business, rather than the full amount claimed. |
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The Plaintiff was overcharged for hydro in the second year of operation. If the Plaintiff resolves the problem with the additional charges for hydro prior to relinquishing the Franchise, then any readjustment shall reduce the Plaintiff's losses. If the issue has not been resolved, then the Defendant, once in possession of the Franchise can pursue the issue with the utility company. |
190 For the period of time after October, 2000 to the date of trial, in my view the Plaintiff should not be required to pay advertising and royalty payments to the Defendant, but should be required to pay rent. The Plaintiff is not claiming any losses for this period.
Damage Claim
191 I will comment briefly on the Plaintiff's alternative claim for damages. In light of my conclusions with respect to rescission, I do not intend to go into any detail with respect to the Plaintiff's alternative claim.
192 Tony presented the calculation of damages. There was no expert report calculating the damages. Bluntly put, the Plaintiff was probably unable to finance the cost of a report and an expert witness. The calculation of damages is therefore somewhat vague, without the usual precise and specific calculations.
193 Even though counsel for the Defendant suggests that rescission is not available, the parties agree that there must be a parting of the ways. The Plaintiff does not wish to continue as a Mr. Sub franchisee. From the defence perspective, the feeling appears to be mutual.
194 Mr. Tobin gave evidence that the Franchise is presently worth at least $150,000.00. Apparently there is a corporate purchaser that is interested in a master franchise for Quebec. Although there will have been a deterioration in the value of the equipment, in light of Tobin's evidence had I found that rescission was not available, then I would have permitted the Defendant a reasonable period of time to acquire the Franchise for this price.
195 It appears conceptually that the Plaintiff's damage would have been more conventionally calculated if the effect of the misrepresentation was calculated, rather than attempting to calculate the value of the individual wrongs allegedly committed by the Defendant.
196 The starting point in this analysis is misrepresentations made. Shirakawa assured the Plaintiff that the Franchise would attain gross sales of $300,000.00 annually, and that the rate of return on the investment of $150,000.00 would be 26%. In this calculation, the Plaintiff would be responsible for paying the outstanding rent arrears, royalty and advertising fees. Had I proceeded with an assessment of damages, this would have been the starting point for the analysis.
197 In argument the Plaintiff did not pursue the claim for punitive or exemplary damages. The Plaintiff did take an "eye for an eye" approach to their problems. The difficulties have been frustrating for the Plaintiff and the Defendant alike. In my view this is not a case that would warrant punitive or exemplary damages.
198 If the parties are unable to agree, they may make written submissions with respect to the issues of pre-judgment interest and costs in writing within thirty days of the release of this judgment.
199 I thank counsel for their able and courteous submissions.
WILSON J.
