Introduction
Reported decisions dealing with the quantification of the
rescission remedy under the various provincial franchise disclosure acts are
rare. Of the few reported cases, most have come out of Ontario. The trial
decision in Essa v. Mediterranean Franchise Inc 2016
ABQB 178 provides
a welcome opportunity to see the rescission remedy of the Alberta Franchises Act (“AFA”) in action. In this article, I analyze
the financial concepts behind the different categories of expenditures that
comprised the trial judge’s award.
Background
Mr. Essa and his business partner purchased a “Taste of Mediterranean”
franchise in Edmonton in 2010. The business was not successful, and closed
after nine months of operation.
The trial judge found that the disclosure document provided
was deficient in several respects, including:
- Failing to disclose telephone numbers of existing franchisees
- Failing to disclose a list of all unit closures within the past three years
- Failing to comply with disclosure requirements regarding earnings claims
- Failing to comply with disclosure requirements regarding financing arrangements
For these reasons, statutory rescission
was granted under section 13 of the AFA.
Unlike all of the other provincial
franchise disclosure legislation, the AFA
does not break down the rescission remedy into four separate components or "buckets". Section 14(2) of the AFA states simply that in the event of a
rescission due to non-disclosure:
“The franchisor or its
associate, as the case may be, must, within 30 days after receiving a notice of
cancellation under section 13, compensate the franchisee for any net losses
that the franchisee has incurred in acquiring, setting up and operating the
franchised business" (emphasis added)
In Essa,
while the evidence was that the plaintiff lost money operating the business, the
plaintiff did not present a calculation based on the overall results of the
business; though not stated in the decision, this may be because detailed
accounting records were not kept. Instead, Mr. Essa presented the following
claims for losses:
These amounts were all accepted by the trial judge.
Analysis
Do the above amounts overcompensate or undercompensate the
franchisee? It is not possible to say, based on the information contained in the decision. However,
we can offer the following conceptual commentary:
In general, businesses spend money to either a) buy assets
or b) fund operating losses. In a franchise rescission, assuming the assets are
no longer of any value, the franchisee is entitled to receive an amount equal
to what it paid to fund its assets and operating losses. Broadly speaking, this is how Ontario's Arthur Wishart Act works, and there is
no reason the AFA would not work the
same way. The only difference is that under the AFA, these two categories can be offset against one another; thus,
if a franchisee paid $100,000 for the assets of her business and made a $30,000
profit, the rescission remedy in Alberta would be $70,000, whereas in Ontario
it would be $100,000.
With that introduction, we can now analyze the rescission
award in Essa.
- The franchise fee and store purchase amounts are moneys paid for assets that are of no value following a rescission. Given that it was established that the plaintiff did not make any money running the business (i.e. there is no offsetting profit), the amounts awarded under these categories make ample sense.
- In Ontario, a separate claim for royalties and ad fund payments would be uncontroversial; there is a separate subsection (6(6)(a)) for amounts paid to the franchisor. In Alberta, however, the only reason to include these as separate heads of claim would be if it were established that the business broke even (or lost money) prior to considering these amounts. This may have been the evidence before the court; it is difficult to tell.
- The claims for capital infusions are amounts paid into the business, not out of the business. These infusions would be used to either buy assets or fund losses. Strictly speaking, if a franchisee is already claiming for amounts paid for a) assets and b) operating losses, it cannot also claim for the cost of funding those cash outflows; to do so would likely result in double-counting. That is, if the business incurred $100,000 in operating losses and borrowed $100,000 to fund those losses, it can only claim a rescission remedy of $100,000, not $200,000. This is an error I have seen in many rescission claims.
- That said, in cases where it is very difficult to quantify the amounts spent based on the accounting records, it may be possible to arrive at a reasonable estimate of the franchisee’s losses by looking at how much money the franchisee invested (both debt and equity) in the business; that is, if you can't measure the money going out of the business, you can measure the money going in. It appears that in this case the cash infusions were being used by the trial judge in precisely that manner, as a proxy for operating losses.
- Finally, the claim of $36,000 for unpaid owner/manager labour was based on an hourly wage of $10. Based on 9 months of operating the business, this works out to around 50 hours per week for each of Mr. Essa and his wife. The court noted that Mr. Essa’s hourly rate as an engineer was $300, and concluded that the claim for unpaid wages was “properly compensable as part of their net loss just as much as actual payments to employees would have been compensable had they any other employees” (para. 230).
All in all, the overall rescission remedy appears reasonable.
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