Franchisees operating in any of the six (soon to be seven) Canadian provinces that have enacted franchise legislation enjoy a statutory right to rescind their franchise agreements in circumstances where they were not provided with adequate pre-contractual financial disclosure by their franchisors. The exercise by a franchisee of its rescission remedy entitles it to be released from its contractual obligations under its franchise agreement and to be restored by the franchisor to the franchisee's pre-contractual financial position. The statutory rescission right is intended to offer franchisees some protection of their often-considerable investment in the franchise.
In practice, however, there exist a number of significant impediments to the ability of a franchisee to exercise its statutory rescission remedy. Primarily, these impediments arise as a consequence of the fact that a franchisee will typically have incurred liabilities to third parties in the course of the operation of its franchise.
The delivery by a franchisee of a notice of rescission to its franchisor does not extinguish those creditors' claims; in fact, the franchisee's cessation of its franchised business will typically constitute a breach of the franchisee's contracts with its creditors.
1. Claims By the Landlord: One of the franchisee's most significant third-party liabilities tends to be its lease obligations owed to the landlord (if the franchisee is a tenant under a head lease).The franchisee's cessation of business will typically constitute a default under the lease, entitling the landlord to claim against the franchisee the landlord's unpaid future rents. A franchisee's rent obligations are often personally guaranteed by its principals, such that the fact of a franchisee's insolvency will usually not extinguish the landlord's claim. Even in cases where a new tenant can be found to assume the franchisee's former tenancy, the landlord will typically require of the franchisee to pay fees in connection with the assignment. While the franchisee may eventually seek to recover such fees as part of its rescission claim against the franchisor, the franchisee is obligated to pay those at first instance.
2.Claims By the Lender: Another significant liability commonly owed by franchisees is to their lenders. Again, the franchisee's cessation of business will ordinarily constitute a default under the lending agreement, entitling the lender to demand immediate repayment of any unpaid balance. Franchisees whose businesses have been financed through government-sponsored small business loans (such as the Canada Small Business Financing Loan) can confront a unique challenge in asserting rescission claims: any payment made by the franchisor to the franchisee to settle a rescission claim (whether by way of settlement or satisfaction of judgment) can form the subject of a claim by the lender.
3.Claims By the Government: A franchisee who is in arrears on its taxes will confront a claim by the government for recovery of that liability. The government will ordinarily enjoy priority over other creditors. Where owing, a debt to the government for significant funds can make it difficult, for instance, to settle a rescission claim for anything short of the amount being claimed by the government.
4. Delays In Recovery: Franchisees can seldom expect to make any early recovery on their rescission claims. To begin with, franchisors in the Canadian franchise provinces enjoy a 60-day period following delivery of the franchisee's rescission notice before they are required to make any payment. In practice, few franchisors make immediate payment even following the expiration of that 60-day period, and even when confronted by strong rescission claims; more commonly, and perhaps to leverage the rescinding franchisee's lack of funds, franchisors will enter in a prolonged period of litigation and/or negotiation. Systemic delays in the courts and a shortage of qualified arbitrators also serve to delay any timely recovery by franchisees who pursue their claims through litigation or arbitration, respectively. Claims that proceed before the courts and that may have once been considered suitable for summary and early disposition cannot now be timely heard by the courts owing to the courts' limited resources. As a result, a full trial is typically the only procedural mechanism for the resolution of a rescission claim short of settlement, and trial dates are typically not available until years after the rescission notice is delivered.
5. Costs of Recovery: The considerable cost of litigation or arbitration makes the recovery of modest rescission claims uneconomical. This is particularly true of rescission claims that are more speculative in nature and not guaranteed to succeed.
6. Multilateral Disputes: It is not uncommon for the franchisor's, or franchisee's, former lawyers to be named as defendants in a rescission dispute, in circumstances where those lawyers allegedly failed to provide competent advice concerning disclosure. The addition of lawyers (and their insurer) to the dispute introduces further delay and expense to the litigation.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
