In my last blog post I wrote about the “Myth of the ‘personal services contract’ in automotive dealer relations.”  In it, I explained how almost all automotive dealer agreements qualify as franchise agreements under Canadian provincial franchise laws.  This is true despite many manufacturers portraying their agreements as “personal services contracts” and not franchise agreements.  In this article, I will explain why the application of franchise laws to the dealer relationship is extremely important, especially for recent dealers.

The franchise laws of Ontario, Alberta, Prince Edward Island, New Brunswick and, most recently, Manitoba all regulate the way in which a franchisor (or in the case of the automotive dealership, the manufacturer) sells franchises to prospective franchisees.  They do this by requiring franchisors to deliver disclosure documents to prospective franchisees at least 14 days before the prospective franchisee signs any agreement or pays any money related to the franchise.

The disclosure document is a fundamentally important tool because it provides the prospective franchisee with all of the information needed to make an informed decision about whether to sign the franchise agreement. For instance, it contains copies of all agreements to be signed by the prospective franchisee and copies of the franchisor’s financial statements. In addition, it must state all “material facts” relating to the franchise and the franchise system, including information about the background of the franchisor, and addresses and contact information of current and certain former franchisees.

If information could lead the franchisee either to decide not to purchase the franchise or to pay less for the investment, then that information is considered “material” and must be disclosed in the disclosure document.  All of the information contained in the disclosure document must be certified as true and complete by two officers or directors of the franchisor (unless the company only has one officer or director).  Those individuals face personal liability for any inaccurate or incomplete information contained in the disclosure document.

If a franchisor fails to provide a disclosure document, then the franchisee has two potent remedies under the laws.  The first remedy is known as the right of rescission. It entitles the franchisee to end the relationship with without penalty or obligation, obtain a full refund of all amounts paid for the franchise, and recover all losses incurred in operating the business simply by sending to the franchisor a notice of rescission.  The right of rescission may be exercised up to two years after the date the franchisee first signs a franchise agreement.[1]

The second remedy is the right to sue for misrepresentation. This allows the franchisee to sue for all losses incurred as a result of inaccurate contained in a disclosure document or as a result of any failure to comply with the disclosure requirements.  The franchisee may sue not only the franchisor corporation but also individuals who involved in selling the franchise.  If the franchisor failed to provide a disclosure document to the franchisee, or if it provided inaccurate or incomplete disclosure, then the franchisee is deemed to have relied on this misinformation when it entered into the franchise relationship.

Some manufacturers still maintain that they are not bound by the provincial franchise acts (because of the “personal service contract myth” as I call it) and therefore do not provide disclosure documents to prospective franchisees.  This is a serious error on their part.  As I stated in my last blog post, the fact that a franchisor does not consider itself a franchisor or calls its agreement as a personal services contract and not a franchise agreement has no bearing at all on whether or not provincial franchise legislation applies.  So long as the three elements of a franchise are present (as to these, see my last blog post), the franchisor is bound by the franchise acts and must provide proper disclosure or face the consequences. The law is clear that automotive dealership agreements are typically governed by the franchise acts.[2]

The courts have described the right of rescission based on failure to receive a disclosure document as a draconian and punitive remedy.  It is intended to be just that.  Franchisors that flout the law and sell franchises without disclosure deprive the prospective franchisee of a vital tool needed to assess whether or not to enter into the manufacturer/dealer relationship.  Because of this, the law, in effect, imposes an obligation on a franchisor to give a money-back guarantee to the franchisee for a two-year period.  Even after that two-year period is over, franchisees who can show that they suffered harm as a result of a misrepresentation or a failure to comply with provincial franchise legislation might still be entitled to sue depending on when they first became aware of the misrepresentation or failure to comply.

In conclusion, automotive manufacturers face significant liability rescission or misrepresentation claims by a number of its franchisees when they failed to provide disclosure to their dealers/franchisees as required by law.

[1] See our webpage entitled Right of Rescission for more information.

[2] While the majority of cases affirm this, a recent case questioned whether a dealer agreement between Mitsubishi and its dealer was governed by the Ontario franchise law. This decision was contrary to previous cases and legal commentary and, in my opinion, was incorrect in this regard. Although the decision was appealed to the Ontario Court of Appeal, the court did not address the question because it found that the dealer’s claim was commenced after the limitation period had expired.