August 10, 2015

The “grant” of a franchise: Ontario court considers whether shareholders of master franchisee can make Arthur Wishart Act claims

It is not usually particularly difficult to determine the persons involved in a franchise: a franchisor sells business concepts to franchisees, and franchisees carry out or operate the business.

However, embedded throughout Ontario’s Arthur Wishart Act are references to a franchisor “granting” a franchise to a franchisee. “Grant” is defined as including “the ownership of shares in the corporation that owns the franchise.”

There are many ways to structure an investment in a franchise. Some are driven by tax planning strategies, particularly arrangements involving master franchisees.

A recent court decision described one such scenario, in which three individuals incorporated a numbered company. The numbered company, in turn, owned 50 percent of the master franchisee, with the franchisor owning the remaining 50 percent.

The issue the court was required to consider was whether the individuals investing in the numbered company had the right to bring Arthur Wishart Act franchise claims against the franchisor on the basis they met the definition of “grant”: they owned shares in the corporation that owned the franchise.

The Superior Court of Justice rejected the shareholders’ arguments, holding the effect of the overall arguments could extend franchise rights to any shareholder of a franchisee, leading to unexpected consequences. The court concluded that if such a change was warranted, it should be made by the legislature, not the courts.

The Superior Court left open the possibility for a different result in a different case, noting several times in its decision that the shareholders’ record was “entirely deficient” in describing the purpose of the various investments made by the shareholders. The court had no basis to analyze how the shares were acquired, the purpose of the payments made by the shareholders, payments made by the numbered company and the purpose of those payments.

The effect of the Superior Court’s judgment in JM Food Services is that shareholders of a franchisee have a challenging, but not impossible road to establish rights under the Arthur Wishart Act.

A copy of the decision can be found here: 2313103 Ontario Inc. et al. v. JM Food Services Ltd. et al., 2015 ONSC 4029