The Arthur Wishart (Franchise
Disclosure) Act was introduced in
Ontario almost 10 years ago. It
seeks to protect often unsophisticated purchasers of franchise
rights by requiring that certain
disclosures be made to franchisees
prior to entering into a franchise
agreement. If these disclosures are
later discovered to have been deficient, the Act also provides the
franchisee with the right to rescind
the franchise agreement. Section
6( 6) of the Act outlines the specific
financial remedies that are available to the franchisee in the event
of rescission.
There have been few reported
decisions dealing with issues of
quantification under this section
of the Act. These remedies are
often a source of confusion for
both plaintiffs’ and defendants’
counsel.
Section 6( 6) of the Act
requires that, upon rescission,
the franchisor:
(a) Refund the money paid by
the franchisee to the franchisor;
(b) Purchase the franchisee’s
remaining inventory at its original cost;
(c) Purchase the franchisee’s
supplies and equipment at their
original cost; and
(d) Compensate the franchisee
for all losses incurred in acquiring, setting up and operating the
franchise not included in clauses
(a) through (c).
Though not explicitly stated,
the underlying goal of this section of the Act appears to be to
restore the franchisee to its financial position at the date of acquisition. This understanding of the
legislation was made explicit by
Justice Murray in Payne Environmental Inc. v. Lord and Partners
Ltd., [2006] O.J. No. 273, one of
the few reported decisions dealing explicitly with the issue of
quantification. This is accomplished by two main steps.
Under clause (d) the Act
requires the franchisor to com-
pensate the franchisee for any
losses incurred in operating the
EPHRAIM
STULBERG
franchise. Once this step is com-
pleted, the owner’s equity section
of the balance sheet will have
been restored to its original level.
However, the Act also recognizes that upon rescission, assets
such as leasehold improvements,
specialized equipment and
inventory and certainly the franchise rights, are of minimal value
to an individual who no longer
wishes to engage in the business
of the franchise, and that these
will be difficult to sell to a third
party. Clauses (a) through (c)
therefore allow the franchisee to
sell these assets to the franchisor
at their original cost.
The end result of these remedies is to return the franchisee
to his or her financial position
immediately prior to entering
into the franchise agreement.
This can be illustrated through a
simple example.
Suppose John Jones purchases
a franchise for an initial franchise
fee of $100,000; there are no
ongoing royalty payments. In
order to set up the franchise,
Jones purchases $100,000 of
equipment and $10,000 of inventory; he also spends $50,000 to
renovate his leased premises.
Finally, the business also requires
a cash balance of $5,000 on hand
to fund operations. These assets,
which total $265,000, are purchased with $100,000 of Jones’s
own money (i.e. equity) and
$165,000 of bank financing. (See
balance sheet in Table 1.)
In its first year of operations,
the franchise is unsuccessful and
suffers operating losses of
$200,000; to finance these
losses, Jones takes out an additional bank loan of $200,000. At
the end of the year, the owner’s
equity section of the balance
sheet has decreased from positive
$100,000 to negative $100,000.
(See balance sheet in Table 2.)
Upon reviewing his franchise
disclosure document at the end of
the year, Jones realizes that certain
required information is absent. He
files a notice of rescission.
Under subs. 6( 6) of the Act,
Jones is entitled to $460,000,
as follows:
(a) Franchise rights: $100,000;
(b) Repurchase of inventory:
$10,000;
(c) Repurchase of equipment:
$100,000;
(d) Reimbursement for startup
costs (Leasehold improvements
and operating losses: $50,000 +
$200,000).
Jones uses the $460,000 to
pay off his bank loan of $365,000,
leaving him with $95,000 in
excess cash; all of his assets, with
the exception of the $5,000 in
cash on hand, are sold to the franchisor. His balance sheet now
shows owner’s equity of $100,000.
(See balance sheet in Table 3.)
The $100,000 in cash,
unencumbered by any liabilities, is precisely the amount of
money put into the franchise by
Jones. He pays himself a tax-free dividend of $100,000 and
walks away from the franchise
as though it never existed.
50,000
100,000
Total Assets
n;Table 2: Franchise’s first year
Assets
Cash
Inventory
Equipment
Leasehold
Improvements
Franchise Rights
Total Assets
Liabilities and Equity
$5,000 Liabilities
10,000 Bank Loan
100,000
$165,000
50,000 Equity
100,000 Share Capital
$265,000 Total Liability and Equity
$100,000
$265,000
Assets
Cash
Inventory
Equipment
Leasehold
Improvements
Franchise Rights
Liabilities and Equity
$5,000 Liabilities
10,000 Bank Loan
100,000
$365,000
Equity
Share Capital
Retained Earnings
$265,000 Total Liability and Equity
$100,000
(200,000)
($100,000)
$265,000
Common errors
In our experience, rescission
claims under the Act often belie a
lack of understanding of the inter-
action between the four clauses of
s. 6( 6), resulting in a duplication
of various items. Once the funda-
mental principles underlying the
wording and mechanics of the Act
are understood, proper quantifi-
cation of the remedy becomes
more manageable. n
n;Table 3: Impact of recission
Assets
Cash1
Inventory
Equipment
Leasehold
Improvements
Franchise Rights
$100,000
-
-
Liabilities and Equity
Liabilities
Bank Loan
$0
-
-
Equity
Share Capital
Retained Earnings
Ephraim Stulberg is a super-
visor with the forensic accounting
firm Matson, Driscoll & Damico
Ltd. in Toronto. His practice
focuses on economic damage
quantification related matters,
including franchise rescission cal-
culations.
Total Assets
$100,000 Total Liability and Equity
$100,000
-
($100,000)
$100,000
1 Equal to original balance of $5,000 plus remedy of $460,000, less bank
loan of $365,000
FOCUS NEXT WEEK
• Labour & Employment Law• Immigration Law
