Another Signal From the Court That Disclosure Obligations Will Be Broadly Interpreted and Rigorously Enforced
October 14, 2011
Jane A. Langford
A recent decision of the Alberta Court of Queen’s Bench (Court) in Mapleleaf Franchise Concepts, Inc. v. Nassus Frameworks Ltd. (Mapleleaf) sends a strong message to franchisors: everything in a disclosure document must be accurate, regardless of whether the information included is specifically required to be disclosed by law.
In particular, the Mapleleaf decision carries three important lessons for franchisors:
1. Summaries of contractual provisions, policies or procedures must be accurate, even if the documents themselves are also included in the disclosure document.
2. The Supreme Court of Canada’s recent interpretation of material misrepresentation in the securities context is being applied in the franchise context. A misrepresentation is material, if there was a substantial likelihood that the disclosure of the fact would have assumed actual significance in the deliberations of a reasonable investor.
3. Although by no means determinative, it is prudent to include disclaimer/non-reliance language warning the prospective franchisee against accepting information included in the disclosure, such as pro formas or summaries, without independent due diligence.
In Mapleleaf, the franchisor learned these lessons the hard way.
Mapleleaf Franchise Concepts, Inc., a franchisor of framing and arts supplies stores, brought a claim to enforce a restrictive covenant against its former franchisee, Nassus Frameworks Ltd. and its owner Mr. Drouin, (collectively, Mr. Drouin).
In 2009, after 10 years of operation, the Franchise Agreement (Agreement) terminated. The Agreement contained a restrictive covenant, or "non-compete" clause. The clause stated that upon termination of the Agreement Mr. Drouin could not operate a similar business from the franchise location, or within a 10 km radius of that location (or any other franchise). Despite this clause, Mr. Drouin continued a similar framing and art business on the premises of his old store, using the same telephone number and, impliedly, Mapleleaf’s customer lists.
Mapleleaf sought a prohibition on Mr. Drouin and his company from carrying on business in breach of the non-compete clause in the Agreement. The Court refused to grant the relief, finding that Mapleleaf could not rely on the restrictive covenant due to a breach of its statutory disclosure obligations.
Prior to signing the Agreement, Mapleleaf gave Mr. Drouin a disclosure document. The disclosure document contained, inter alia, a draft of the proposed Agreement and a chart summarizing important information in the Agreement regarding the term, renewal and transfer of the franchise.
The chart summarized the restrictive covenant in simple terms: "no competing business for 2 years within 3 km of another franchise." However, the non-compete clause in the actual Agreement was more robust. It included a prohibition on operating a similar business from the same location or within a 10 km radius of that, or any other, franchise location.
Mr. Drouin’s understanding, based on the summary chart, was quite different from the clause found in the Agreement. He finally became aware of the full extent of the contractual restrictions shortly before termination of the Agreement in 2009. Unsurprisingly, Mr. Drouin claimed that he would never have entered into the Agreement had he been aware that he would not be able to carry on business anywhere within a 10 km radius or operate a business within 10 km of another franchise.
The Court’s reasons for refusing to enforce the restrictive covenant are demonstrative of the strict approach to disclosure obligations we have come to expect in recent franchise jurisprudence. Under the Alberta Franchises Act, a disclosure document must comply with the requirements of the Alberta Franchises Regulations. The regulations require that, inter alia, a franchisor disclose to a prospective franchisee whether provisions in the Agreement address renewal, termination, or transfer of the franchise, and if so, where in the contract these provisions can be found. Had Mapleleaf simply directed Mr. Drouin to the relevant provisions of the Agreement, this case may have ended quite differently. Instead, Mapleleaf went beyond its legal obligations by including a summary chart that, unfortunately, contained both a mistake and an omission. According to the Alberta Court of Queen’s Bench, the incorrect summary constituted a misrepresentation.
Mapleleaf proffered three arguments to avoid the effect of its misrepresentation. First, it argued that since it was under no obligation to produce a summary of the contents of the Agreement, any errors contained therein were irrelevant. The Court acknowledged that Mapleleaf was under no obligation to summarize the Agreement: but having done so, Mapleleaf was required to ensure that the summary was accurate.
Second, Mapleleaf appears to have argued that the misrepresentation was not material to Mr. Drouin’s decision to enter into the Agreement, or the price of the franchise. However, the Court relied on the Supreme Court of Canada’s decision in Sharbern Holding Inc. v. Vancouver Airport Centre Ltd., which concluded that a misrepresentation in the securities context is material, if there was a substantial likelihood that the disclosure of the fact would have assumed actual significance in the deliberations of a reasonable investor. The Alberta Court of Queen’s Bench found that the contents of the restrictive covenant were ‘significant’ facts to a prospective franchisee. Moreover, the Court noted that there was no statement in the summary warning the prospective franchisee against accepting the information as accurate, suggesting that if such a disclaimer had been present, the Court might have entertained the argument that the summary was immaterial.
Finally, Mapleleaf argued that Mr. Drouin admitted on discovery that he did not rely on the disclosure and as such, Mapleleaf’s misrepresentation was moot. However, section 9(2) of the Alberta legislation provides that a franchisee who purchases a franchise to which the disclosure document relates, is deemed to have relied on the misrepresentation. The Court rejected the suggestion that this deeming provision was rebutted concluding that there was sufficient evidence of some reliance, notwithstanding alleged inconsistent statements on the part of Mr. Drouin.