Inadequate Disclosure of Rebate Practices Increase Risk of Franchisee Class Actions

Justice Strathy also stated that “In view of the power imbalance between the franchisor and the franchisees, the very concern that the [Arthur Wishart Act] was designed to redress, there is a significant impediment to access to justice by way of individual action, particularly where some of the franchisees remain a part of the system.” He concluded that: “A class action in this case will promote access to justice that is unlikely to be achieved by other means.”

Osler Hoskin & Harcourt LLP
February 10, 2011

Inadequate Disclosure of Rebate Practices Increase Risk of Franchisee Class Actions
Case Reports
Evan Thomas

A recent Ontario Superior Court decision - 578115 Ontario Inc. v. Sears Canada Inc., 2010 ONSC 4571 (Sears Canada) - to certify a franchisee class action based on alleged inadequate disclosure of supplier rebates highlights the importance to franchisors of following best practices for the disclosure of rebates.The decision is also another example of the willingness of the Ontario courts to certify franchisee class actions to “level the playing field” between franchisors and franchisees.

Obligation to Disclose Rebate Practices
The Ontario Arthur Wishart Act and the Alberta Franchises Act require franchisors to deliver a disclosure document to prospective franchisees. The regulation under the Ontario Arthur Wishart Act requires the franchisor to include a description of the franchisor’s policy regarding volume rebates including whether the franchisor receives rebates as a result of purchases by a franchisee and if so, whether such rebates are shared with franchisees. The regulation under the Alberta Franchises Act also requires disclosure of similar information about rebates.

Facts of the Case
In 1998, Sears Canada Inc. (Sears) entered into an agreement with Home Coverings Buying Group Inc. (HCBG) to establish a network of independent floor covering retailers to operate as “Sears Covering Centres.” HCBG recruited independent retailers, who then entered into franchise agreements with Sears. HCBG also recommended approved suppliers to Sears.

HCBG negotiated volume rebate agreements with approved suppliers for supply of floor covering products to both Sears and the franchisees. These agreements provided for allowances and rebates totalling approximately 9% of purchases by Sears and franchisees.

From 1999 to 2002, Sears had essentially identical franchise agreements with its retailers. Certain key terms were as follows:

  • The agreement was for a term of one year, automatically renewing for successive one-year periods;
  • The franchisee purchased only from approved suppliers; and
  • Sears paid the franchisee a rebate of 4% of the total annual net purchases made by the franchisee from approved suppliers.

In 2003, the franchise agreement was changed to provide for a one-year term with the ability to enter into a new agreement for a one-year term, without automatic renewal.

The Plaintiff’s Position
The plaintiff in Sears Canada, a numbered company operating as “McKee’s Carpet Zone” (McKee’s), started the proposed class action on behalf of 73 retailers operating as “Sears Floor Covering Centres.” McKee’s alleged that it and the other class members did not know they were only receiving part of the rebate paid by suppliers to Sears. McKee’s claimed damages based on these alleged “secret rebates” received by Sears.

The plaintiff advanced various theories of Sears’ liability, including breach of implied terms of the franchise agreements, breach of statutory duties of good faith and fair dealing under the Ontario Arthur Wishart Act and the Alberta Franchises Act, non-compliance with statutory disclosure obligations, and unjust enrichment.

All of the theories, however, were based on Sears’ alleged failure to disclose the fact and quantum of rebates received by Sears and/or HCBG from approved suppliers. The plaintiff sought damages based on the actual rebates received from the approved suppliers.

The Decision
As the decision concerned McKee’s motion for certification, Justice G.R. Strathy only had to decide whether the claim was suitable to proceed as a class action and made no findings on the merits of McKee’s claims. Sears opposed certification primarily on the grounds that some of the issues raised by the class members’ claims could only be resolved by individual trials and hence a class action was not the preferable procedure.

Justice Strathy disagreed with Sears, concluding that although individual trials might be required to resolve certain issues, “judicial economy and access to justice would be attained” through a class action.

Justice Strathy also stated that “In view of the power imbalance between the franchisor and the franchisees, the very concern that the Wishart Act// was designed to redress, there is a significant impediment to access to justice by way of individual action, particularly where some of the franchisees remain a part of the system.” He concluded that: “A class action in this case will promote access to justice that is unlikely to be achieved by other means.”

Conclusion
In addition to Sears Canada, the Ontario courts have certified three other franchisee class actions in the past year -Quizno’s, Mayotte v. Ontario and Pet Valu- and certification decisions in other franchisee class actions are expected in the near future. This trend in part reflects the Ontario courts’ view that class actions can address a perceived “power imbalance” between franchisors and franchisees.

Further, following Sears Canada, proposed franchisee class actions based on allegations of inadequate disclosure of rebate practices have a significantly higher likelihood of being certified. Franchisors who wish to invoke best practices to minimize uncertainty and risk of future disputes, particularly class actions, should strongly consider including in their franchise, the following provisions relating to rebates:

  • their entitlement to receive rebates;
  • a description of the types of rebates contemplated; and
  • the requirement, if any, of the franchisor to account for rebates they obtain from authorized suppliers.

In addition, franchisors must ensure that these provisions must be consistent in all agreements and documents (including the disclosure document) and in practice.

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Risks: Access to justice, Can't afford to sue, Franchisee advisory group (lap-dog), Gouging on supplies, Imbalance of information and power, Lawsuits, class action, Must buy only through franchisor (tied buying), Secret kickbacks and rebates, Supply margins are a hidden added royalty payment, Canada, 20110210 Inadequate disclosure

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