ANDRÉ DROUIN, Appellant, v. HER MAJESTY THE QUEEN,, 2013 TCC 139

Docket: 2011-5(IT)G BETWEEN: ANDRÉ DROUIN, Appellant, and HER MAJESTY THE QUEEN, Respondent . [OFFICIAL ENGLISH TRANSLATION] ____________________________________________________________________ Appeal heard on January 23, 24, 25, 26, 27, 30 and 31; February 1, 2, 6, 7, 8, 9, 13, 27, 28 and 29; March 1, 5 (teleconference), 13, 14, 15, 16, 19, 21 and 23; April 3; and May 8, 9 and 10, 2012, at Montréal, Quebec Before: The Honourable Justice Paul Bédard Appearances : Counsel for the appellant: Guy Du Pont Michael H. Lubetsky Jack J.

Fattal Counsel for the respondent: Michel Lamarre Alain Gareau Vlad Zolia Sara Jahanbakhsh ____________________________________________________________________ JUDGMENT The appeal from the reassessment made under the Income Tax Act for the 2008 taxation year, notice of which is dated August 27, 2009, is allowed, with costs, and the assessment is referred back to the Minister of National Revenue for reconsideration and reassessment in accordance with the attached Reasons for Judgment.

Signed at Ottawa, Canada, this 3rd day of May 2 013. "Paul Bédard" Bédard J. Translation certified true on this 9th day of October 2013.

François Brunet, Revisor Citation: 2013 TCC 139 Date: 20130503 Docket: 2011-5(IT)G BETWEEN: ANDRÉ DROUIN, Appellant, and HER MAJESTY THE QUEEN, Respondent. [OFFICIAL ENGLISH TRANSLATION] REASONS FOR JUDGMENT Bédard J. [ 1 ] This is an appeal from a reassessment, notice of which is dated August 27, 2009, for the 2008 taxation year (the reassessment), whereby the Canada Revenue Agency (the CRA) denied $85,875.33 in deductions that the appellant had claimed as capital cost allowance, eligible capital property and interest in respect of the purchase of a franchise authorizing him to market computer software.

Background [ 2 ] Prospector Networks International Inc. (PIN) was a company based in Barbados. The appellant submits that PIN carried on a business that developed software for business markets in North America and elsewhere (“the software”). [ 3 ] The software consists of the following: (

i) Solutions Prospector: a software package designed to help salespeople identify prospective clients; (ii) Mail it Safe: software designed to secure and track e-mail to help lawyers, health care professionals, public agencies and others who regularly send and receive confidential information; (iii) CashOnTime: a software package designed to help financial officers and collection agents track accounts receivable and payments. [ 4 ] PIN granted licences (in 2003 and 2004) and franchises (from 2005 to 2008) that, according to the appellant, allowed the licensees and franchisees (collectively, “the franchisees”) to use and market the software and any products derived from the software. [ 5 ] According to the appellant, PIN also offered to market the software on the franchisees' behalf under contracts of mandate with PIN's subsidiaries and associated businesses. [ 6 ] The appellant is a software engineer. [ 7 ] In 2007, the appellant bought a franchise and signed an agency agreement with a subsidiary of PIN.

Under the terms of this mandate, the subsidiary undertook to operate the appellant's franchise. I should immediately note that the respondent submits that this agency agreement is a sham. The appellant bought the franchise on the advice of his financial planner. [ 8 ] The purchase price of the franchise in 2007 was $200,000: $10,000 for the franchise rights and $190,000 for the Solutions Prospector and Mail it Safe software. The appellant gave the franchisor a five-year full recourse promissory note bearing interest at a rate of 7.5% per annum.

The respondent submits that this promissory note is a sham. [ 9 ] The contracts signed in 2007 (i.e., the franchise agreement and the agency agreement) were replaced with new contracts in 2008. The cost of the franchise was raised by $30,000 in 2008. When he bought his franchise in 2008, the appellant gave the franchisor a ten-year full recourse promissory note bearing interest at the rate of 4% per annum.

The respondent submits that the 2008 agency agreement and promissory note, too, are shams. [ 10 ] Any dealings that the appellant had with PIN, the agent or any of PIN's affiliated companies were at arm's length. [ 11 ] The respondent's position : The CRA's position is that the appellant bought the franchise solely for the purpose of obtaining tax deductions. This position is based on the following arguments. (

A) Argument I – There was no business [ 12 ] First, the CRA submits that the deductions were not made for the purpose of gaining or producing income, because at no time

during the relevant period did the appellant intend to carry on a business or in fact carry on a business, nor for that matter did Network Prospector or MarketX Services Inc. intend to carry on a business or in fact carry on a business on behalf of the appellant. See the Reply to the Notice of Appeal (the Reply) at subparagraph 26(l). See also the Reply at paragraphs 28, 29 and 36 to 38. See also the Reply at subparagraphs 25(o), (

p) and (r), where the CRA alleges that the appellant never intended to draw income from his business. (

B) Argument II – The sham [ 13 ] Second, the CRA submits that the full recourse promissory note and the agency agreement constituted [ translation] "shams" (see the Reply at subparagraphs 26(l), (m), (p), (x), (y), (z), (aa) and (bb) and at paragraphs 32 and 34). (

C) Argument III – The unreasonable price [ 14 ] Finally, the CRA submits that the [ translation] "fair market value of the franchise and the rights attached to it was nil" (see the Reply, subparagraph 25(s)). The CRA further submits that [ translation] "the fair market value of a franchise of Prospector International Networks Inc. was very low, if not nil" (see the Reply, subparagraph 26(cc)). Issue [ 15 ] The issue in this case is the following: Was the appellant carrying on a business in the year 2008? This issue also raises the following questions: (

a) Did the full recourse promissory note and the agency and management agreement constitute shams? (

b) Did the appellant pay a reasonable price for his franchise? Procedural history [ 16 ] On December 21, 2010, the appellant filed in this Court an appeal against the reassessment; the CRA filed its Reply on March 14, 2011. [ 17 ] After two case management conferences held on May 19 and September 6, 2011, the Court set a tight, expedited

schedule requiring the parties to disclose a considerable volume of documents and to hold examinations for discovery. [ 18 ] On September 14, 2011, the Court rendered a confidentiality order in respect of the exhibits filed by the appellant ( see Drouin v.

The Queen , 2011 TCC 425 , 2012 DTC 1020 ). [ 19 ] On October 21, 2011, the CRA filed a [ translation] " Motion to Amend the Reply to the Notice of Appeal" alleging that the appellant's franchise was a [ translation] "tax shelter" and that the software that he marketed constituted [ translation] " computer tax shelter property", such that the deductions claimed by the appellant were prohibited under the applicable provisions. On November 10, 2011, the Court dismissed the motion ( see Drouin c.

The Queen , 2011 CCI 519 , 2012 DTC 1012 ). [ 20 ] The hearing lasted a total of 30 days, from January 23, 2012, to May 10, 2012. The appellant filed approximately 785 exhibits, totalling around 13,000 pages. The respondent filed 161 exhibits.

[ 21 ] During the hearing, the Court rendered a decision dismissing inter alia an objection by the appellant to the testimonies of five other franchisees and two financial planners whom the CRA wanted to call as similar fact witnesses: [ translation] [44] It is appropriate to reproduce paragraphs 22 to 24 of the written submissions of the respondent, which read as follows: [ translation] 22.

The respondent submits that the testimonies of the franchisees and the financial planners are entirely relevant according to the criteria of the Supreme Court because these people were involved in transactions identical to those involving the appellant and thus will give evidence that may increase the likelihood that the contracts signed by the appellant and the promissory note allegedly given to him are in fact shams. 23.

The testimonies of the franchisees and the financial planners will also increase the likelihood that representations were made to the Prospector franchise buyers to the effect that buying a franchise would give them a tax benefit in excess of the amount paid by them. 24. The testimonies of the franchisees and the financial planners will also increase the likelihood that no businesses were actually carried on through Prospector franchises. ( Drouin c.

La Reine , 2012 CCI 94 [not translated], para. 44 ) [ 22 ] In that same judgment, the Court also ruled on the qualifications of the expert witnesses that each of the parties planned to call after a motion on February 9 and 13, 2012. The Court thus accepted Jean-François Ouellet (Mr. Ouellet) as an expert in management and in innovation marketing. However, the Court refused to accept Denys Goulet as an expert in appraisal, deeming his report to be of no probative value because his opinion was inextricably based on the opinions of an unidentified person who had not been presented to the Court as an expert.

Proceedings [ 23 ] At the trial, the appellant presented an overview of the history of PIN from its beginnings to the present day through the testimonies of Thomas L. Jones (Mr. Jones), Michel Vincent (Mr. Vincent), Claude Duhamel (Mr. Duhamel), Paul-André Mathieu (Mr. Mathieu) and Stéphane Teasdale (Mr. Teasdale). [ 24 ] The testimonies of Mr. Jones and Mr. Duhamel reveal that PIN is the successor to Stratsite Inc. (Stratsite), an information technology company founded in 1998 by two young entrepreneurs, Mr. Jones and Carl Phoenix (Mr. Phoenix).

Stratsite was initially involved in providing Web site development, PowerPoint presentation and electronic communications services for companies in the financial sector. Stratsite's clients included Valeurs mobilières Internat, a brokerage firm where Mr. Duhamel worked as a stockbroker. Mr. Duhamel had clients who wanted to invest in new high-tech companies. Being satisfied with Stratsite's work, he decided to approach Mr. Jones and Mr. Phoenix to learn more about their future projects. One of the projects that Mr. Jones and Mr.

Phoenix discussed with him was C-Local, an electronic data bank, similar to the Yellow Pages, that incorporated advanced search engines. However, this project required considerable financing. Mr. Duhamel managed to raise several million dollars in financing from various investors, which allowed Stratsite to go forward with the development of C-Local. [ 25 ] Near the end of 2000 and in early 2001, when the technology bubble burst, C-Local's Web site was online and accessible to the general public, but the product was not being marketed.

The financing needed to roll out C-Local was impossible to come by, and an initial public offering had to be cancelled. The company was soon short of funds and had to reduce its staff considerably.

Solutions Prospector [ 26 ] In spite of everything, Stratsite managed to finalize the tracking and notification system it had been working on. In 2002, Stratsite decided to breathe new life into the company by focusing on this tracking system. Building on their Web site design know-how, their database and the tracking system, Mr. Jones and his associate created a new computer program: Solutions Prospector. This software was designed to allow users to send an e-mail to a select list of recipients, inviting them to visit a Web site.

The software would then track what action the recipients took, if any, after receiving the invitation. [ 27 ] Mr. Duhamel testified that when he was seeking funds for Stratsite, he was referred to Andrew Murray (Mr. Murray), a businessman residing in Barbados who knew people with access to capital around the world. According to Mr. Duhamel, Mr. Murray had expressed an interest in Stratsite and had joined with him in preparing the financing plan and the following business plan with him. Canaventure, a company owned by Mr.

Murray and incorporated in the British Virgin Islands, would ask Stratsite to develop Solutions Prospector on its behalf. Canaventure, which would hold the intellectual property rights for the software to be developed, would sell investors marketing licences for the products developed by Stratsite, and the licensees would in turn ask Stratsite to market the software on their behalf. The money paid to Canaventure would be given to Stratsite to finance the software's development. [ 28 ] Licences were initially priced at $75,000 each.

To maintain a stable cash flow for Canaventure and Stratsite, the licences had to be paid partly in cash and partly by means of a limited recourse promissory note. Mr. Duhamel explained that structuring the licences in this way had the added advantage of significantly reducing their risks by allowing them to claim a capital cost allowance on their licences while still receiving royalties. [ 29 ] In 2002, only a handful of licences were sold. In 2003, the initial price of $75,000 was increased to $100,000, and the initial 30% down payment had to be paid in instalments over two years.

The balance, paid by a limited recourse promissory note, was due 10 years later. Interest was paid out of the income earned. According to Mr. Duhamel, they sold approximately 140 licences in 2003 and 250 in 2004, under the same terms. [ 30 ] In 2003, Canaventure began using the business name Prospector International and then officially changed its corporate name to PIN. On August 1, 2003, PIN incorporated Prospector Network Inc. (Network) to take over Stratsite's activities, and Stratsite was wound up. Mr.

Duhamel explained that from then on, Network played two distinct roles: first, developing software for PIN; and second, marketing this software for the licensees. According to Mr. Duhamel, a third company, Prospector USA, wholly owned by Network, was incorporated in the United States to facilitate marketing efforts in that country. [ 31 ] Development of Solutions Prospector was completed in November 2003. The company's business activities also began to pick up in 2003.

For example, Network tried to do business with resellers of modified products, that is, businesses that were already selling information technology products and could distribute Solutions Prospector through their own networks. The attempt failed: Mr. Duhamel and Mr. Jones explained that the resellers refused to distribute Solutions Prospector because it was still unproven on the market. Network opened offices in Miami and Montréal to try to sell the software.

A business plan identifying target markets was drawn up, and numerous presentations, personalized proposals and competitive analyses of competing products were done. Network made efforts to identify clients, efforts which included using Solutions Prospector. A few paying or prospective clients were using Solutions Prospector. Twelve of them were designated as [ translation] "strategic accounts", that is, well-known businesses that, if encouraged to use Solutions Prospector, could foster market uptake and thus increase sales. Network offered these businesses free or discounted user rights.

In addition, to target more niche clients, Network launched two derivative programs based on Solutions Prospector: "Prospector Finance" and "Prospector Trade Show". Licensees were informed of new releases and upcoming projects through updates. [ 32 ] Despite all this, Network's efforts did not translate into sales. Mr. Jones and Mr. Duhamel attribute these disappointing results to the laborious nature of designing and developing microsites that meet high standards of professionalism.

Clients also expected Network to provide the databases, which are very expensive, while Prospector's business model assumed that clients would provide their own lists. Mail it Safe [ 33 ] In April 2005, new software was announced. Prospect Mail, later renamed Mail it Safe, is described as a productivity and

security tool. Basically, it allows senders to know when their messages have been read, how long the messages were looked at, and whether the attachments were downloaded. It also gives senders' messages added security by using encrypted networks on the Mail it Safe central server and by offering additional options, such as password protection. Initially, Mail it Safe could only be used via the Web as a module of Solutions Prospector, but it was later adapted to make it compatible with Outlook, and eventually with Lotus and BlackBerry, which increased the client base.

Mail it Safe is offered either under a perpetual licence or through the purchase of a limited- time right known as "SaaS" (software as a service). Mr. Vincent described the difference between the two arrangements in the following terms (see Examination of Mr. Vincent, Transcript, January 25, 2012, Question 340): [ translation] Generally, an SaaS solution is hosted. That means that the hardware isn't at the client's offices but is taken care of by the solution provider.

So, for example, with Mail it Safe, the clients who are in SaaS mode use the solution via a server hosted by us, actually, by our partner, who has the specialized infrastructure. As to why we offer two modes, it's because it leaves us—it's a question of business flexibility. There are businesses that don't want to do what in industry jargon is called "capex", capital expenditures, and that prefer to have an operating expense in the budget. Because under their internal procurement approval procedures, it's easier to justify incurring an operational expense than a capital expense.

In other businesses, it's the opposite. So we give ourselves the flexibility to align with the clients' interests. What's more, there are businesses where technology is almost like a religion. There are some that think one thing is the best in the world and another thing is worthless, while others say the opposite. Everyone has their own beliefs. So there are businesses that say there's no way we can have the information from the applications we use be hosted outside our infrastructure. So these companies object to the SaaS mode because they can't accept having their data stored elsewhere.

Other business will tell you the opposite. They don't want anything to do with managing that in house because they don't have the resources in place. [ 34 ] In 2005 and 2006, Network devoted considerable effort and money to marketing Mail it Safe. Marketing consultants were hired to develop Mail it Safe's market image. Specific sectors were identified: legal services, financial services and health services. Network also decided to close the Miami office and open offices with sales teams in New York, Chicago, Los Angeles and Boston. It hired additional staff through the Montréal office.

A “virtual office” was set up in London for about six months, and there were plans to open an office in Paris, according to Mr. Duhamel. There were also discussions with a Mexican associate, according to Mr. Duhamel. [ 35 ] A significant amount of documentation was prepared for prospective clients: presentations, brochures, guides, user manuals, webinars and technical documents. Network created a Web site for Mail it Safe. It did strategic planning and trained in-house salespeople using reports, presentations and analytical documents.

It also attended a number of trade fairs, including the LegalTech Trade Show in New York, and took

part in various events attended by its target clientele. It also conducted a survey of selected members of its clientele to better understand clients' perceptions of the software. [ 36 ] Network also entered into agreements with certain organizations, including the Greater Montréal Real Estate Board, the Corporation de services du Barreau du Québec and the New York County Bar Association. It donated 250 user licences to the Blythedale Children's Hospital, where the software was used.

There were negotiations with Pitney Bowes and the Massachusetts Vietnam Veteran Association towards entering into a business agreement. Network also made IBM its technical associate, meaning that IBM took care of the security reports for Mail it Safe. Moreover, like Microsoft and BlackBerry, IBM allowed its logo to be used for advertising purposes. [ 37 ] Network also tried to find resellers that could sell Mail it Safe to their clients. According to Mr.

Duhamel, this solution could have led to sales but would have had the added advantage of raising the product's profile with a view to a possible acquisition by a major company. According to Mr. Duhamel, there were talks with Cablevision, Openface, Reach Everywhere, Merrill and BBDO, but nothing came of them. [ 38 ] In 2005, Revenu Québec, which viewed the licensing system more as an investment than a business, threatened to disallow the capital cost allowances claimed. In response, Network and PIN offered the licensees the opportunity to convert the licences into franchises. According to Mr.

Duhamel, approximately 40 licensees, or 20% of them, refused to convert their licences. Two hundred new franchises were sold in 2005. In addition, Mr. Duhamel explained that a special agreement, consisting primarily of a partial interest holiday, was concluded with 14 franchisees who had already invested in another of its business projects that had not turned out well. [ 39 ] Mr.

Duhamel explained that under the terms of the 2005 franchise agreements, the franchisees acquired [ translation] "an operating franchise" giving them [ translation] "the non-exclusive right to distribute, within the territory and to authorized clients, . . . Solutions Prospector and MIS TM software for a term of 25 years beginning January 15, 2005". Under the contract, each of the

franchisees was assigned a specific territory and had access to a data bank on the businesses located in that territory (see also the Solution Prospector and Mail it Safe franchise agreement between Prospector International Network Inc. and Annie Fortin dated December 30, 2005, Exhibit A-55 (1-97), Volume 27, page 10893, at page 10897, paragraphs 2.1 and 3). [ 40 ] Another clause in that contract stipulated that if 75% of the franchisees agreed at a special meeting to sell their franchises to a third party, a franchisee could be required to sell its franchise, on condition that the sale be made under the same terms as for all the franchises. [ 41 ] In response to a question from the franchisees regarding the number of franchises that PIN intended to grant, Mr.

Duhamel answered that PIN had capped the number of franchisees at 1,500 and had divided the United States into 1,500 territories accordingly, by postal code. According to Mr. Duhamel, each territory was supposed to have between 10,000 and 20,000 potential clients entered in the Dun & Bradstreet data bank for businesses and professionals. According to Mr.

Duhamel, the franchisees were told several times how the territories were divided up. [ 42 ] Furthermore, the price of a franchise was raised to $160,000 (including $10,000 in franchise fees to take into account the launch of Mail it Safe), with an interest rate of 7% per annum. The term of the promissory note was four years. [ 43 ] New franchises were sold in 2006 under similar terms. [ 44 ] According to Mr. Duhamel, the money from the franchisees was used for development and marketing.

Moreover, the evidence showed that Network was in regular contact with franchisees, usually by e-mail, but sometimes by regular mail. Most often, these contacts took the form of updates. There were also annual and special meetings, well attended by franchisees, during which presentations on the business situation and development were given. A [ translation] " franchisees' manual" with periodic updates was sent to franchisees by mail and e-mail.

A [ translation] "VIP night" was organized to mark the launch of Mail it Safe, an intranet site was made available to franchisees, and franchisees were invited to refer people they knew to Network. The 2006 appraisal by Wise, Blackman [ 45 ] Mr. Duhamel explained that well after the technology bubble had burst, some financial groups renewed their interest in Mail it Safe and started negotiations. According to Mr. Duhamel, Mr. Murray considered the possibility of taking the company public. Mr. Duhamel also explained that it had become important to have a valuation of the company done (see Examination of Mr.

Duhamel regarding the announcement to franchisees that the company might be taken public, Transcript, February 2, 2012, Questions 519-531; Update (in a bundle), Exhibit A-23.1.16.5, Volume 18, page 7852, at pages 7862-7865,) (announcement to franchisees that the company might be taken public). [ 46 ] In addition, according to Mr. Duhamel, the franchisees started asking whether the franchisor and the agent had the financial capacity to continue developing and marketing the products (Examination of Mr.

Duhamel, Transcript, February 2, 2012, Questions 293, 299 and 302.) [ 47 ] To answer these questions, PIN hired renowned appraiser Richard M. Wise, FCA, FCBV, FASA, MCBA, of the firm Wise, Blackman LLP, which merged with MNP LLP on June 1, 2011 (Examination of Mr.

Duhamel, Transcript, February 6, 2012, Question 88; Valuation of the business of Prospector International Network Inc. as at Sept. 30, 2006, by Wise, Blackman LLP, Exhibit A-21.1, Volume 16, page 6939). [ 48 ] In its report (the 2006 valuation), Wise Blackman concluded as follows: [TRANSLATION] In our opinion, according to the information and documents that we have reviewed and the explanations that were given to us, and

subject to the assumptions and restrictions herein, the fair market value of the business on or about the valuation date was from $147,000,000 to $164,000,000 (rounded). [ 49 ] The franchisees were notified of the conclusions of the 2006 valuation (Mail it Safe 2006 Overview and Forecast for 2007, Exhibit A-22.1.27, Volume 17, page 7298, at page 7301; PIN – Update – July 2009, Exhibit A-22.1.36, Volume 17, page 7419, at page 7421). [ 50 ] Despite all efforts, sales of Mail it Safe were weak. Mr. Jones and Mr.

Duhamel attributed the failure of Mail it Safe to the managers of potential client's information technology departments, who failed to understand the added value of the tracking function and tended to take a lot of time to ensure that Mail it Safe was compliant with their own networks, such that sales became a very long process. Mr. Ouellet, whom I recognized as an expert, explained that the market had a poor awareness of the problem of the lack of security in electronic communications and was therefore less inclined to invest substantial amounts of money in security (Examination of Mr.

Ouellet, Transcript, March 1, 2012, Question 47). Furthermore, according to Mr. Jones and Mr. Duhamel, given the disputes with the tax authorities, Network had to devote more resources to legal fees and liaison activities with franchisees. Finally, according to Mr. Jones, and especially according to Mr. Duhamel, the tax dispute negated the benefits of the partnerships that Network had entered into. [ 51 ] Mr. Duhamel and Mr.

Jones testified that Network took a number of steps to deal with these disappointing sales, including creating a [ translation] "strategic sales committee", conducting surveys and seeking new partnerships. It also changed its human resources policy and required its salespeople to prepare reports when they lost potential sales. The price of Mail it Safe was changed, and new brochures and presentations were developed. In reaction to comments from certain clients, Network added a [ translation] "secure Reply" function to Mail it Safe. [ 52 ] Mr.

Duhamel stated that in 2007, since results were still minimal, Network changed its business plan. He testified that Network decided to close its offices in the United States and focus its efforts on Quebec, a territory that had not been assigned to franchisees, in order to create a virtual storefront that could then be used to gain sales in the United States. Network was able to recruit two key employees: Mohammed Yacoub (Mr.

Yacoub), the former president of a company with 1,200 employees and a turnover of $120 million; and Michel Lamontagne, a member of the ethics board of the Autorité des marchés financiers (AMF) and chairman of the board of the Régie de l'assurance maladie du Québec. Mr. Yacoub commissioned market studies targeting larger businesses. Intensive negotiations were held with IBM's Montréal office with a view to turning a technical partnership into a reseller partnership and to encouraging the use and adoption of Mail it Safe. IBM took steps in this direction with Royal Bank, Bombardier and Desjardins.

Network also entered into an agreement with the Ordre des conseillers en ressources humaines et en relations industrielles du Québec and continued to create new software. [ 53 ] According to Mr. Duhamel, in 2007, Network nevertheless continued its sales efforts in the United States, but from its Montréal office. [ 54 ] Network made several sales in Quebec in 2007. [ 55 ] Mr. Duhamel explained that in August 2007, Mr. Yacoub offered to take over the development and marketing business. According to Mr. Duhamel, Mr.

Yacoub, however, wanted to operate that business through a separate company because he wanted to steer clear of trouble with the tax authorities. MIS International (MIS) was created for this purpose in December 2007. Mr. Yacoub and Mr. Lamontagne became chief executive officer and chairman of the board of MIS, respectively. PIN, which held 70% of the company's shares, tasked him with developing products and creating a virtual storefront for the franchisees (Examination of Mr. Duhamel, Transcript, February 29, 2012, Questions 575 and 577). [ 56 ] According to Mr.

Duhamel, the franchisees were informed of the planned creation of MIS at the annual general meeting in November 2007. [ 57 ] To develop the software, MIS took charge of the technology team and the software's intellectual property. The relationship between MIS and PIN was governed by a series of contracts, some of which were filed in evidence (Exhibits A-132, A-133, A-134 and A-135). Under the terms of these contracts, PIN transferred the intellectual property to MIS for a royalty equal to 12% of the sales.

The contracts also included clauses to ensure that PIN would be able to meet its obligations to the franchisees (see clause 2.1 of the contract entitled "Intellectual Property Licence Agreement", Exhibit A-134).

[ 58 ] The following emerged from the credible testimony of Mr. Vincent. In fall 2007, Mr. Vincent was appointed vice-president of sales of MIS and was instructed [ translation] "to design and rethink the marketing strategy for the Mail it Safe solution". He came up with a new business strategy and restructured the sales team. In addition to capitalizing on its existing partnerships, MIS established new technology partnerships with Microsoft, the seller of Outlook, and RIM, the seller of BlackBerry. Mr.

Vincent also implemented a [ translation] "government strategy" aimed at having the product adopted by public and parapublic agencies that often deal with confidential data and communications. Significant resources were also devoted to training staff and preparing presentations. Some client prospecting was done by telephone. Mr. Vincent's efforts bore fruit, and Mail it Safe started to acquire some prestigious clients, including Revenu Québec. The proceeds from these sales were not shared with the franchisees, whose territories did not include Canada, but were used, according to Mr.

Duhamel, to develop a virtual storefront for the international marketing of Mail it Safe in the franchisees' territories. [ 59 ] Although MIS focused most of its efforts on Quebec and made most of its sales there, there were also some meetings and presentations in the United States, Toronto and abroad, even though no offices had been opened there. The contracts between PIN and MIS were amended in 2009 to make it clear that MIS's marketing rights were limited to Canada. [ 60 ] The following also emerged from Mr. Duhamel's testimony.

In late 2007, further discussions were held with Revenu Québec, this time regarding the promissory notes. Revenu Québec rejected the capital cost allowance claimed for the franchises acquired with limited recourse promissory notes. To rectify this problem, PIN proposed to the franchisees that the notes be converted into full recourse promissory notes. This meant that franchisees would promise to pay the amounts due upon maturity and would no longer be able to simply give back their franchises.

The franchisees' initial reaction to this proposal was mixed, but in the end, after the meeting on November 27, 2007, about two thirds of the franchisees acquired new franchises with full recourse promissory notes. [ 61 ] The main features of the 2007 contract are similar to those of the 2005 and 2006 contracts, with the exception of some significant differences regarding the price and the payment terms: the promissory note became a full recourse promissory note, the interest rate was reduced to 7.5%, and the term was extended to five years. Mr.

Duhamel stated that the amount of the principal was raised to $200,000 to account for the improvements made to Mail it Safe and for the new partnerships. [ 62 ] Mr. Duhamel explained that the territories were precisely defined: each franchisee would be given 20,000 businesses selected from the database according to a unique combination of postal codes and SICs (Standard Industrial Classification numbers). Mr. Duhamel also explained that territories in Florida and France, as well as Zurich, were expressly excluded from the assigned territories because they had been sold by PIN in 2005 and 2006.

Canada was not expressly excluded, but as Mr. Duhamel stated, it was clear that Canada was reserved for the virtual storefront. According to Mr. Duhamel, approximately 1,100 new franchises were sold in 2007, including those assigned to new franchisees (such as the appellant) and those assigned to franchisees as a replacement for others. [ 63 ] Mr.

Teasdale, a lawyer who specializes in franchise law, explained that PIN hired him in 2008 to analyze the contracts and propose changes that would, on the one hand, better [ translation] " reflect the business and operational reality" and, on the other hand, put the contract [ translation] "on the cutting edge of what is being done in contracting in many industries". The 2008 version of the contract, prepared by Mr. Teasdale, included numerous changes and clarifications: (1) the

preamble was changed considerably; (2) an express definition of [ translation] " franchised business" was added (section 1.1.3); (3) a manual was expressly provided for (section 1.1.4); (4) a 10-year time limit was added to the renewal terms, as 10 years was considered to be [ translation] "pretty much the industry standard"; (5) clarifications were added to explain how the exclusive lists work, and to provide for [ translation] "a mechanism whereby if a franchisee sold to a client on someone else's list, compensation would have to be paid" (section 6.2);

(6) [ translation] "additional services provided by Prospector, the franchisor" were spelled out (section 9); (7) clarifications regarding the level of personal participation required of a franchisee were added (section 10); (8) financing terms were largely moved into an appendix, since the financing terms can vary and it is [ translation] " easier to deal with an appendix than to deal with a contract each time" (section 12 and appendix); (9) the franchisee's right to his or her own agent was expressly confirmed, subject to the franchisor's approval (section 13); (10) model clauses were added, as were an arbitration clause and a clause stating that the applicable law would be Quebec law (sections 16-17). (Examination of Mr.

Teasdale, Transcript, January 26, 2012, Questions 408, 409, 413 and 414; Prospector World E & T Network International franchise agreement (comparative version), Exhibit A-36, Volume 26, page 10179.) Furthermore, the franchise price was increased to $230,000, the interest rate on the promissory note was reduced to 4%, and the term was extended to 10 years. As suggested by Mr.

Teasdale, who felt the expression "Prospector" was confusing, the expression [ translation] "Prospector World franchisee" was replaced with [ translation] "E&T Network International franchisee" ("E&T" stands for "Encryption and Tracking"). [ 64 ] According to Mr. Duhamel, the list of possible exclusive clients for each franchisee was reduced to 10,000 more carefully selected businesses. Self-employed workers were removed from the list, for example.

Also, Canada was expressly excluded from the definition of the franchisees' [ translation] " territory". [ 65 ] As regards the mandate, MarketX Services Inc. (MarketX) became the agent. According to Mr. Duhamel, the law firm Fraser Milner Casgrain recommended that the agent should be a company other than Network, so as to maintain [ translation] "a certain distance between the franchisor and the agent" (see court reporter's notes, March 21, 2012, paras. 79 to 81). The evidence showed that MarketX was never incorporated. It was not until March 2009 that Mr.

Bernier (who had bought Prospector) realized that MarketX had not yet been created. I also note that under a resolution dated March 25, 2009, filed in evidence as Exhibit A-80, PIN assumed all of the rights and obligations of MarketX. It also emerged from Mr. Duhamel's testimony that he learned that MarketX did not exist around the same time that Mr. Bernier did. The evidence on this point shows that the appellant did not find out that MarketX did not exist until April 30, 2009 (that is, at the meeting of franchisees).

The appellant explained that at the time, he had assumed that Network was still his agent under the 2007 agency agreement because MarketX was supposed to replace Network. The appellant also testified that Network had been his agent until March 26, 2010, when the franchisees' association replaced Network. [ 66 ] I reiterate that in the 2008 contracts, as compared against the 2007 contracts, the franchise purchase price was increased to $230,000, the interest rate of the promissory note was reduced from 7.5% to 4%, and the term was extended from 5 years to 10 years. Mr.

Duhamel explained that the term was extended in response to pressure from the franchisees and their financial advisers, who were unhappy with the sales of Mail it Safe (Examination of Mr. Duhamel, Transcript, February 6, 2012, Questions 220, 222, 231, 244, 253, 283 and 285). Finally, the combined effect of the 2008 agency agreement and the 2008 franchise agreement increased the royalties payable to franchisees from 6% in 2007 to 12%. [ 67 ] The following also emerged from Mr. Vincent's testimony.

Although MIS succeeded in selling Mail it Safe to credible clients, sales revenues were never as high as hoped because the sales cycle was longer than expected and clients were not prepared to spend considerable sums of money to make electronic communications more secure because they could not measure the benefits in dollar terms. Mr. Vincent stated the following about Mail it Safe and its potential: [ translation] " We have a good thing in Mail it Safe, but it's not clear that it can be turned into a viable business" (Examination of Mr. Vincent, Transcript, January 26, 2012, Questions 39 to 41). CashOnTime

[ 68 ] The decision was, therefore, made in 2008 to develop a new business solution that was based on the tracking technology but [ translation] "would allow us to quantify the benefits and calculate a quick return on investment" (see Examination of Mr. Vincent, Transcript, January 25, 2012, Questions 351 and 516; MIS International Inc. – Management Meeting, August 26, 2008, Exhibit A-22.1.29, Volume 17, page 7314, at page 7326). MIS, inspired by Mr. Mathieu's idea of using Mail it Safe to send invoices to his clients and reduce collection time, created CashOnTime (see Examination of Mr.

Mathieu, Transcript, February 28, 2012, Questions 578 to 581; Examination of Mr. Duhamel, Transcript, February 6, 2012, Questions 177 and 184). According to Mr. Vincent, this program used the tracking technology to automate invoicing and track accounts receivable effectively. A team of specialists was hired in mid-2008 to create the program as quickly as possible. Like Mail it Safe, CashOnTime is offered under one of two arrangements: a perpetual licence or a limited-time right (software as a service). [ 69 ] Mr.

Ouellet testified that CashOnTime is definitely much easier to sell than Mail it Safe because it meets an easily measured need, although because of the nature of software as a service, this takes time: [ translation] JUDGE: . . . [44] Q. In that sense, CashOnTime is easier to sell. A. In that sense, CashOnTime, in fact, the large part . . . there are two, to answer the question directly, two components of CashOnTime that make it perhaps more difficult.

There is a component that really stands out, in my mind, and as I was starting to tell you yesterday, the reason why I personally, if I were to invest in this business, would be very interested in CashOnTime, it's because it meets a need that is, I think, not difficult to promote, to stimulate. It's based on something that is . . . [45] Q. That is easily measured. A. That is measurable, that can be defined, you see, in terms of the return on investment from the standpoint of the buyer, the client, that is. But the trade-off, again, is that it's "Software as a Service".

If I had a business with accounts receivable, I'm not sure that I would want to send that information out onto the Web to be held by someone I know but I don't know, being vulnerable to that business being hacked by malicious individuals who then have access to my data, which are pretty secret and important for my business. So "Software as a Service" makes that more complicated.

The other dimension that's probably just as important is that, again, if you are an SME that has always had some kind of paper record with your accounts in it, moving from that to a computerized notice system, from "Don't forget collect X from Y," well, that's something that isn't compatible with their current way of doing things. It's less critical than in the case of the SAX than for the SaaS dimension of that product. But that can explain why it takes a lot more time anyway.

In the case of Mail it Safe, in the case of Prospector, well, in fact, what slows things down, the main factor slowing things down, once again, is this incompatibility with. . . with the current way of doing things. And the main factor speeding things up, usually, is the perceived relative advantage. In the case of CashOnTime, you can see the advantage. In the case of Mail it Safe, you can see it, but it's less obvious because it's not just a more roundabout way than exiting and going. . .

There's more hands-on work involved in sending an e-mail by Mail it Safe, but the relative advantage is hard to see because there hasn't really been a scandal. I think that was already raised, when I was here at the beginning. [46] Q. Disaster.

A. There wasn't any. . . That's it. There's nothing that makes. . . It's a bit like fire insurance, if you've never experienced. . . Everyone has fire insurance, but every time I pay for it, I ask myself why I have it. Because nobody in my circle or close to them has had a fire, you know, but as long as you haven't experienced it. But when it happens to you, however, then it becomes essential. I didn't have any insurance for my hot tub because I told myself, at the cottage, no one can steal a hot tub; it's always full. Well, son of a gun! One weekend, I get there, and guess what had disappeared? My hot tub.

I bought a new one, and it's been insured ever since. But I had to get robbed before taking out the insurance, the rider. Who steals a hot tub? So there you go! So there's that. And as for Prospector, well, there, the relative benefit or advantage is less obvious. So there are even more disadvantages than advantages from the consumer's point of view, probably. I've gone a bit off topic. Examination of Mr.

Ouellet, Transcript, March 1, 2012, Questions 44 to 46. [ 70 ] In the end, four [ translation] " sectors" were targeted for marketing CashOnTime: the manufacturing sector, the distribution sector, the transportation sector and the professional services sector. The sales efforts for CashOnTime began in 2008, when the program was still "vapourware" (Examination of Mr. Vincent, Transcript, January 25, 2012, Questions 526 and 537 to 539; Exhibit A-22.1.30, Volume 17, page 7347; and Exhibit A-22.1.31, Volume 17, page 7358).

The first sale was made on October 31, 2008, to Client B (Exhibit A-31, Volume 25 (confidential), page 9993). Again, a vast array of presentations, brochures and Web sites, in English and French, was prepared. Mr. Vincent made adjustments to the sales team, took charge of training the salespeople and used the services of external consultants that specialize in presenting software. He prepared a [ translation] " sales manual" and kept it up to date. According to Mr. Vincent, the sales cycle lasted from 6 to 12 weeks, sometimes longer. [ 71 ] Twelve sales of CashOnTime were made from 2008 to 2011.

In addition, from 2009 to 2011, there were four new sales of Mail it Safe. [ 72 ] In December 2008, Mr. Yacoub, on behalf of MIS, sent the franchisees an update announcing the creation of Mail it Safe (MIS update by Mr. Yacoub, December 10, 2008, Appellant's Undertaking, Appendix 60.B, Exhibit A-109, page 11508, at page 11509). [ 73 ] On February 16, 2009, Mr. Yacoub and Mr. Vincent sent the franchisees notice of a general meeting to be held on April 30, 2009.

At the annual general meeting, the CashOnTime software was unveiled, and the franchisees were given financial statements detailing the various expenses incurred over the years. There was also some discussion of the marketing efforts for Mail it Safe and of the decision to focus on CashOnTime. Finally, the franchisees were told that MarketX had not been incorporated and that Network would continue to act as agent (Examination of Mr. Vincent, Transcript, January 25, 2012, Questions 262 to 267 and 643; Examination of Mr.

Duhamel, Transcript, February 6, 2012, Question 318; Examination of the Appellant on January 30, 2012, Questions 264, 265, 371 and 372; Examination of Mr. Duhamel, Transcript, February 6, 2012, Questions 15, 357, 362 and 363). [ 74 ] The franchisees received the minutes of the meeting in July 2009. The minutes state: [ translation] "The current objective is to create a virtual storefront for the CashOnTime service by the end of 2009 by having MIS enter into contracts with major Canadian businesses" (Examination of Mr.

Duhamel, Transcript, February 7, 2012, Questions 289 to 296; PIN – Update, July 2009, Exhibit A-22.1.36, Volume 17, page 7419). [ 75 ] According to Mr. Duhamel, Mr. Murray's interest and participation in Prospector and MIS waned after 2007 because of his wife's illness. Mr. Duhamel discussed this situation with Richard Lange, a long-time family friend, who in 2007 introduced him to Marc Bernier (Mr. Bernier), a senior manager. Mr. Duhamel told Mr. Bernier all about Mr. Murray's lack of interest and the difficulties they were having in marketing the software. Mr. Bernier told him that he wanted to buy PIN.

In March 2009, following discussions between Mr. Duhamel and Mr. Bernier, and several months after having external experts conduct an audit first, Mr. Bernier bought PIN. Mr. Duhamel stepped down as Network's president and became a consultant. [ 76 ] According to Mr. Duhamel, Mr. Bernier chose not to go ahead with the incorporation of MarketX, and on March 15, 2009, PIN adopted a resolution whereby it assumed all the obligations entered into by MarketX (see Examination of Mr.

Duhamel, Transcript, March 21, 2012, Question 85; resolutions of Prospector International Networks Inc. of March 15, 2009, regarding MarketX Services Inc., Exhibit A-80, Volume 29, page 11139).

[ 77 ] According to Kevin Klein (Mr. Klein), a South African lawyer living in Cyprus, Mr. Bernier asked him in June 2009 to review PIN's contracts. Mr. Klein testified that he had a lot of experience in franchising, having been a member of the board of directors of the Franchise Association of South Africa, which belongs to the International Franchise Association (Examination of Mr. Klein, Transcript, April 3, 2012, pages 57, 58 and 139). [ 78 ] Mr. Klein explained that he was also asked to improve the contracts governing the relationship between MIS and PIN, a task which was completed on December 14, 2009, with the signing of the following clarification agreements:

(1) Clarification to the Option to Acquire Certain Intellectual Property Rights (Exhibit A-136, Volume 33)

(2) Clarification to the Assignment of Intellectual Property (Exhibit A-137, Volume 33)

(3) Clarification to the Intellectual Property Licence Agreement (Exhibit A-138, Volume 33). [ 79 ] Mr. Klein also testified that he found [ translation] "confusion over roles" and that he thought it necessary to clarify that MIS's role had always been to develop and market the software in Canada alone, whereas PIN's role was to market the software abroad through its network of franchisees (Examination of Mr. Klein, Transcript, April 3, 2012, pages 65 to 68). [ 80 ] Accordingly, Mr. Klein proposed changes to clear up some issues, particularly the following:

(1) The marketing rights that MIS granted to PIN in countries other than Canada were exclusive , in that MIS could not sell abroad. These changes were designed to [ translation ] "counteract a possible irregularity apparently stemming from the

interpretation, be it accurate or not, or from the previous agreement, that MIS had a joint right, which could compete with the franchisees and their rights" (page 73). Examination of Mr. Klein, Transcript, April 3, 2012, pages 73, 75, 76, 80 to 82 and 87.

(2) The marketing rights that MIS granted to PIN in countries other than Canada were transferable , [ translation] "which they had to be so that the network of franchisees could take advantage of them" (page 73). These changes reflected the fact that [ translation ] "in the case of a business operated by franchise, franchisees come and go". Examination of Mr. Klein, Transcript, April 3, 2012, pages 73, 75, 77, 82, 83 and 87.

(3) The marketing rights that MIS granted to PIN covered [ translation] "everything that had been developed by MIS", so [ translation ] "that it would be clear that the franchisees expected everything that had been developed by MIS . . . . In the world of IT, software isn't set in stone. It evolves. You'll have to take advantage of changes and version upgrades, and the intention was that everything that was produced would benefit the franchisees". Examination of Mr. Klein, Transcript, April 3, 2012, pages 70 and 71.

(4) The contracts between PIN and MIS did not derogate from the franchisees' rights, since the changes expressly recognized that PIN and MIS [ translation ] "did not at any time intend to withdraw or restrict the rights of Prospector franchisees or licence holders". As Mr. Klein explained, [ translation ] "the reason for this was that we wanted to emphasize the fact that we wanted to maintain the franchisor-franchisee relationship, that we wanted the franchisees to be able to turn a profit on their investment". Examination of Mr. Klein, Transcript, April 3, 2012, pages 74 and 78 to 80.

Clarification to the Assignment of Intellectual Property entered into by Prospector International Networks Inc., Prospector Network Inc. and Mail it Safe International Inc., December 14, 2009, Exhibit A-137, Volume 33, page 12015 The CRA search [ 81 ] In October 2009, the CRA carried out a vast search at the offices of Network, MIS and Mr. Duhamel, among others. [ 82 ] According to Mr. Klein and Mr. Duhamel, the search threw the files and records of Network and MIS into disarray; two servers were corrupted while under the CRA's control, which caused a significant number of files to be lost.

The CRA also seized some cheques, and Mr. Klein had to travel to Montréal to get them back (Examination of Mr. Duhamel, Transcript, February 27, 2012, Questions 176 and 182; Examination of Mr. Klein, Transcript, April 3, 2012, pages 89 and 90). [ 83 ] The search was very upsetting for the employees and senior management. On December 11, 2009, Mr. Yacoub resigned, and Mr. Klein was appointed director in his place. On December 14, 2009, Mr. Vincent became the interim head of operations at MIS (Examination of Mr. Vincent, Transcript, January 25, 2012, Question 233. See also the Examination of Mr.

Vincent, Transcript, January 26, 2012, Question 100; Examination of Mr. Klein, Transcript, April 3, 2012, pages 63, 64 and 100; Examination of Mr. Vincent, Transcript, January 26, 2012, Question 97). The Association period (2009–2010) The 2010 reorganization [ 84 ] After the search, Mr. Bernier decided to reorganize the business to give it [ translation] "a fresh start" with a view to [ translation] "maximizing business potential" on a global scale. The firms Gowlings and Raymond Chabot Grant Thornton recommended a new structure, which was implemented in March 2010 (Examination of Mr.

Vincent, Transcript, January 25, 2012, Questions 233 and 241 to 246; Examination of Mr. Vincent, Transcript, January 26, 2012, Question 100). [ 85 ] Under the new structure, the intellectual property rights were held by Luxemburg-based companies, namely CashOnTime S.A.R.L. and Mail it Safe (Examination of Mr. Vincent, Transcript, January 25, 2012, Questions 248, 249 and 253; Examination of Mr.

Vincent, Transcript, January 26, 2012, Questions 11 and 25). [ 86 ] Marketing was done by subsidiaries or associates in the countries where the business activities took place: CashOnTime Inc. (Delaware), CashOnTime Ltd. (England), CashOnTime Inc. (Quebec) and Courriel Sécuritaire Inc. (Examination of Mr. Vincent, Transcript, January 25, 2012, Questions 249 and 254; Examination of Mr.

Vincent, Transcript, January 26, 2012, Questions 11, 12, 19, 25 and 26). [ 87 ] Separate structures were created for Mail it Safe and CashOnTime, on the one hand, because each type of software was aimed at a distinct market, and on the other, because this made it easier to sell one or the other separately to a potential buyer (Examination of Mr. Vincent, Transcript, January 25, 2012, Questions 250 to 252). [ 88 ] Espeo Inc. carried on with the development of the software. Espeo is a distinct company belonging to Mr. Vincent (Examination of Mr.

Vincent, Transcript, January 26, 2012, Questions 12, 13 and 26). [ 89 ] After the reorganization, the organization chart for the Prospector group of companies looked like this:

Organization chart downloaded from the intranet site of Prospector International Networks Inc., Exhibit A-42, Volume 26, page 10306. Organization chart prepared by Mr. Vincent, Exhibit A-35, Volume 26, page 10177. The intranet [ 90 ] The Association des franchisés Network Prospector (the Association) was founded on March 26, 2010, to [ translation] "find sellers and buyers and to market the latest solutions . . . that have been developed". The Association was established at Mr. Bernier's request, and PIN saw to its financing through another company, Gestion Viso Inc. The Association was a non-share capital corporation incorporated under

Part II of the Companies Act , RSQ, c. C-38. Its founders consisted of Mr. Duhamel and a number of financial planners. PIN played no

part in the Association's management (Examination of Mr. Duhamel, Transcript, February 6, 2012,

Question 406; Examination of Mr. Duhamel, Transcript, February 27, 2012, Questions 87, 88, 91, 95 and 96; Examination of Mr. Duhamel, Transcript, March 21, 2012, Question 125). [ 91 ] Starting in April 2010, the franchisees were notified of the Association's creation and the fact that it would be replacing Network, and membership applications began arriving in May 2010 (Examination of Mr. Duhamel, Transcript, February 7, 2012, Questions 85 and 86; Examination of Mr. Duhamel, Transcript, April 3, 2012, pages 164 and 166; letter from Mr.

Bobby Doyon dated May 18, 2010, regarding membership in the Association, Exhibit A-111, Volume 31, page 11563). [ 92 ] Since the Association was a non-profit corporation, it could not carry on business activities. Consequently, it tried to enter into agreements with resellers who could take care of the marketing for the franchisees. It thus entered into a contract with Onix to do marketing in the United States, beginning in New York City (Examination of Mr. Jones, Transcript, January 24, 2012, Questions 415 et seq. ; Examination of Mr.

Jones, Transcript, January 25, 2012, Question 107 (back in 2010); Examination of the Appellant, Transcript, January 30, 2012, Questions 488 to 491; Examination of Mr. Duhamel, Transcript, February 7, 2012, Questions 47, 48, 57, 69, 70, 71, 73, 83, 87, 88 and 90; Examination of Mr. Duhamel, Transcript, February 27, 2012, Questions 93 and 107; Examination of Mr.

Duhamel, Transcript, April 3, 2012, pages 167 and 173; Authorized Reseller (VAR) Agreement between Association Franchise Prospector and Onix Service Inc., May 15, 2011 (Appellant's Undertakings, Appendix 58), Exhibit A-44, Volume 27, page 10652; [ translation] "List of potential clients currently being prospected by Onix Services Inc." (Appellant's Undertakings, Appendix 66), Exhibit A-45, Volume 27, pages 10653 to 10658). [ 93 ] Onix was founded by Jeff Dana, one of Network's salespeople in Miami at the time Solutions Prospector was being marketed.

He made a presentation to the Association in March 2011 to explain a marketing strategy for Mail it Safe and CashOnTime ("Onix Go to Market Strategy", March 28, 2011, Exhibit A-141, Volume 33, page 12026; Examination of Mr. Duhamel, Transcript, April 3, 2012, page 161). [ 94 ] The franchisees were notified of the agreement with Onix by mass e-mail on April 15, 2011, and the final contract was signed on May 5, 2011 (Examination of Mr.

Duhamel, Transcript, April 3, 2012, pages 158 and 159; contract between Association Franchise Prospector and Onix Services Inc., May 15, 2011 (Appellant's Undertakings, Appendix 58), Exhibit A-44, Volume 27, page 10652; e-mail from the Association des Franchisés Network Prospector to the appellant regarding [ translation] "News from the agent", April 15, 2011, Exhibit A-139, Volume 33, page 12020). [ 95 ] The Association instructed Mr. Jones to assist Jeff Dana in his consulting work.

More specifically, he helped the Association to prepare [ translation ] "a business plan on the distribution and sale of these products, particularly in New York. He also took

part in efforts already under way to recruit salespeople (Examination of Mr. Jones, Transcript, January 23, 2012, Questions 414 to 427). The 2010 general meeting [ 96 ] The 2010 annual general meeting was held on June 15, 2010, at the Sofitel Hotel in Montréal (Examination of Dr. Ngô, Transcript, March 14, 2012, Question 548). [ 97 ] The incorporation of the Association was announced at that meeting, and the franchisees were invited to join it online by visiting the "Franchise Information Centre" Web site.

The franchisees were also given an update on the tax dispute, after which there was discussion of the marketing efforts and of the market study that had been prepared by "D". There was also a presentation on the latest version of CashOnTime, which, in the opinion of the appellant, who attended the meeting, [ translation] "had been improved . . . to target large companies" (Examination of Mr. Vincent, Transcript, January 25, 2012, Questions 629, 646 and 648; Examination of the Appellant, Transcript, January 30, 2012, Questions 388, 392 to 395, 726 and 727; Examination of Dr.

Ngô, Transcript, March 14, 2012, Question 550; Examination of Mr. Duhamel, Transcript, April 3, 2012, page 162). [ 98 ] The franchisees' committee, the formation of which had also been announced at the 2010 general meeting, consisted of seven franchisees and was responsible for following up on all general information regarding the marketing efforts and the disputes with the tax authorities (Examination of the Appellant, Transcript, January 30, 2012, Questions 396 to 410 and 420). The new contracts

[ 99 ] In 2010, Mr. Teasdale was asked to revise the franchise agreements again. Mr. Teasdale explained that he was instructed to [ translation] "once again change the contract to reflect the reality of what was going on between the franchisor and the franchisees" (Examination of Mr. Teasdale, Transcript, January 26, 2012, Questions 427 and 449). [ 100 ] The 2010 revisions were much broader in scope than the 2008 revisions, and the final contract was much more detailed than the previous ones.

For example, appendices were added regarding franchisee territories, the list of trade marks, the software concerned and prices (Examination of Mr. Teasdale, Transcript, January 26, 2012, Questions 434 and 444; Contract entitled PIN Franchise 2010 Version Franchise Agreement (comparative version), Exhibit A-37, Volume 26, page 10222). [ 101 ] The new contract also added clauses regarding user licence contracts and the "Franchise Information Centre (FIC)", an intranet site hosting the operations manual and other communications between the franchisor and franchisees.

In addition, the new contract contained [ translation] "rather substantial additions regarding additional obligations or services that would be provided by the franchisor, particularly in terms of promotion and advertising and the assistance that the franchisor would give the franchisees" (Examination of Mr. Teasdale, Transcript, January 26, 2012, Question 444). [ 102 ] The 1,500 territories in the United States were redefined (Examination of Mr. Duhamel, Transcript, February 6, 2012, Questions 606 and 607; Examination of Mr.

Duhamel, Transcript, February 7, 2012, Question 11). [ 103 ] The new contracts were announced at the 2010 annual general meeting, and the franchisees were invited to approve them online through the FIC Web site. The vast majority of franchisees agreed to the proposed new contracts (Examination of the Appellant, Transcript, January 30, 2012, Questions 485 and 486; Examination of Mr. Duhamel, Transcript, February 7, 2012, Questions 3, 4 and 105). Changes to the promissory notes [ 104 ] According to Mr.

Duhamel, because of the disappointing sales and the increasingly bitter dispute between the tax authorities and the franchisees, and after discussions with Mr.

Duhamel and the financial planners, PIN agreed to make significant changes to the terms of the promissory notes, including the following: (1) the interest rate was reduced to 1.75%, retroactively to 2007; (2) the annual payments were set at $3,500, retroactively to 2007; (3) any amount paid in a given year (that is, a period of 12 consecutive months from the date the promissory note was signed) that exceeded the interest and the amount of the principal (in this case, $1,500) due would constitute an advance payment of interest and capital that the franchisees could apply against interest and capital in a subsequent year.

As a result of these changes, each franchisee had to pay $3,500 in 2010 and 2011, including $1,500 in capital and $2,000 in interest. After 2011, they would owe nothing before the maturity date, when a final lump-sum payment became due (Examination of Mr. Duhamel, Transcript, February 7, 2012, Questions 12, 29 to 33; see also the Examination of the Appellant, Transcript, January 30, 2012, Question 516; Examination of the Appellant, Transcript, January 31, 2012, Questions 107, 109 and 110; Examination of Mr. Duhamel, Transcript, February 27, 2012, Questions 124, 133 and 139 et seq. ). The appellant's testimony A.

The appellant's background

[ 105 ] The appellant is an engineer and a member in good standing of the Ordre des ingénieurs du Québec. After completing a university degree in electrical engineering with a specialization in automation in 1991, he founded his own consulting business. He went on to develop software for a company called Softec. Later, he worked for Noranda, where he worked primarily in mining automation. In 2000, he accepted a position at Nortel, where he worked to ensure that all equipment was ISO 9001 compliant. In 2001, Nortel laid him off.

After his layoff, he worked for CAE checking software provided by the United States Navy. In 2002–2003, he founded a business that marketed an anti-moss agent to farmers. He wound up that business in 2005. B. The purchase of the franchise [ 106 ] The following also emerges from the appellant's testimony. (

a) He first heard of Prospector from Claude Legault (Mr. Legault), his financial planner since the mid-1990s. Mr. Legault looked after his investments, such as his RRSP and his life insurance policy. The appellant trusted him and still does business with him. (

b) He met with Mr. Legault each year. At their 2005 meeting, Mr. Legault introduced him to the Mail it Safe software and proposed buying a franchise. The appellant declined the offer, feeling that he did not have the necessary funds, and made RRSP contributions instead. (

c) At their 2006 meeting, Mr. Legault again proposed buying a Prospector franchise. Once again, the appellant opted instead to contribute to his RRSPs. (

d) In 2007, at their annual meeting, Mr. Legault proposed for a third time that the appellant buy a Prospector franchise. This time, Mr. Legault explained that the Mail it Safe software had gained important clients, including Revenu Québec, the Barreau du Québec and its New York counterpart. In addition, Mr. Legault explained that 2007 would likely be the last year that such franchises would be offered. (

e) Mr. Legault gave him two brochures at this meeting: (1) [ translation] "Franchise Prospector World TM : 2007 Edition" (Exhibit A-3.1, Volume 1, page 59); (2) [ translation] " Mail it Safe: 2006 Launch and 2007 Vision" (Exhibit A-3.2, Volume 1, page 101). The brochure [ translation] "Franchise Prospector World TM : 2007 Edition" was 41 pages long, approximately 6 pages of which (mostly in an appendix) discussed the tax implications.

The rest of the brochure dealt with the history of PIN and Network; the partnership with IBM; the software being marketed (Solutions Prospector and Mail it Safe); the nature of the franchise (that is, the exclusive marketing rights in a given territory, the terms of payment and the payment of royalties); the marketing strategy; the 2006 valuation by Wise, Blackman; a copy of the contracts; and a

summary of the contracts. The brochure [ translation] " Mail it Safe: 2006 Launch and 2007 Vision" discussed the adaptation of Mail it Safe to various platforms (Lotus Notes, BlackBerry and Mail it Safe Freedom); Network's participation in trade fairs targeting the legal market; the partnerships with organizations such as the Corporation de services du Barreau du Québec, the Greater Montréal Real Estate Board, IBM and the New York County Lawyers' Association; the valuation by Wise, Blackman; the vision for 2007; the research and development activities; and the franchisee recommendation program. There was no mention of the tax implications of the franchises. (

f) The appellant did not give an immediate answer to Mr. Legault's suggestion. He went home and, after thinking it over, contacted Mr. Legault to ask him for additional information. Mr. Legault sent him the documentation, including the contracts. The appellant explained that he read everything in full before making a decision. (

g) The appellant accepted Mr. Legault's proposal and opted to buy one single Prospector franchise in 2007 instead of contributing to his RRSPs: [ translation] "I put all my eggs in one basket" (Examination of the Appellant, Transcript, January 30, 2012,

Questions 82 and 108.) He explained his reasons for buying the franchise in the following words: [ translation] [109] Q. And why did you opt to invest in Prospector? A. Well, it was a long-term investment with the expectation of getting a lot of sales and getting dividends. [110] Q. You said to be able to get dividends. A. Yes. . . . [112] Q. What were the benefits you hoped to get from this investment? A. Well, the benefits. . . Well, there was a tax component, an investment, like all the investments I had made since the beginning. There was that component.

The second part, well, it was mostly to give me income in the long term; it was really a long-term investment for. . . I had an expectation that the. . . knowing the information technology field and the possibilities of Mail it Safe, I really saw a potential for sales. JUDGE: [113] Q. So, to sum up, your investment was both a long-term investment that you hoped. . . or you still hope, I don't know, will pay you dividends, and evidently, there was a tax benefit attached to this product. A. Exactly. MICHAEL H. LUBETSKY: [114] Q. At the time, what was your assessment of Mail it Safe? A.

Well, it was an innovative product that was really in terms. . . computer security that was really a necessity. I still believe it's a truly necessary product because now, as Mr. John demonstrated, when you send an e-mail, well, it travels all over the place in the world before it gets to the recipient.

To date, I think. . . we haven't heard of a major scandal in that respect, but it's just a matter of time because now that there are doctors and lawyers sending information to their clients, if the information ends up, so to speak, in the wrong hands, well, the information could be disclosed, and there could be consequences. (Examination of the Appellant, Transcript, January 30, 2012, Questions 109, 110 and 112 to 114) . . . GUY DU PONT:

[420] Q. So, my colleague asked you whether this—I don't remember the exact words, but more or less—that this investment, this franchise purchase was much more than any other investment you had made before? Is that correct? A. Yes. [421] Q. And could you explain to the Court why you agreed to such an investment that was bigger than all the investments you had made up till now? A. The main reason, it's really because I had. . . according to the presentation I was given on Mail-it-Safe, I really saw significant income-earning potential in terms of the long-term performance. It's really a long-term investment. (Examination of the Appellant, Transcript, January 31, 2012, Questions 420 and 421) (

h) The purchase of the franchise was a long-term investment. The appellant added that he did not expect to make a profit in the short term. His testimony on this point is worth quoting: [ translation] [380] Q. Is that why you weren't worried about the slow pace of the marketing? MICHEL LAMARRE: Leading the witness, Your Honour. GUY DU PONT: Maybe. This time at least I'll withdraw. He's right. [381] Q. Is that a factor you considered? A. When I bought the franchise, yes. [382] Q. And in your assessment of the product's performance, is that a factor you considered? There's no objection. A.

O.K., yes, in effect, it's a. . . I knew that it was a company, that it was a start-up, and that the return on investment could be long term. (Examination of the Appellant, Transcript, January 31, 2012, Questions 380 to 382) (

i) Mr. Legault had explained to him that he could [ translation] "delegate the marketing to an agent with a team of salespeople already set up in the United States and in Montréal" (Examination of the Appellant, Transcript, January 30, 2012, Question 63; Examination of the Appellant, Transcript, January 31, 2012, Questions 220 and 228). (

j) On December 21, 2007, he signed the following four documents and then gave them to Mr. Legault: (1) a franchise agreement (the 2007 franchise agreement), whereby he acquired the right to market Solutions Prospector, Mail it Safe and their derivative products in a designated territory ([ translation] "Contract of Sale of a Prospector World Franchise",

Exhibit A-1.1.1, Volume 1, page 1); (2) an agency and management agreement (the 2007 agency agreement), whereby he gave Network a mandate to operate his franchise for 94% of the gross revenue (section 3.1 of the [ translation] "Agency and Management Agreement", Exhibit A-1.1.3, Volume 1, page 16); (3) a promissory note (the 2007 promissory note), whereby he undertook to pay PIN $200,000 by no later than December 15, 2012, with lump-sum interest at a rate of 7.5% per annum paid annually in advance (promissory note, Exhibit A-1.1.2, Volume 1, page 15); (4) a cheque for $15,000 to the order of PIN for the first interest payment (cheque dated December 21, 2007, Exhibit A-2.1, Volume 1, page 54). (

k) The 2007 franchise agreement and the 2007 agency agreement were countersigned by Mr. Duhamel on behalf of Network on December 28, 2007 (Examination of the Appellant, Transcript, January 30, 2012, Questions 157 et seq. ). (

l) When the 2007 promissory note was signed, the appellant understood that he had to pay the amount due upon maturity. He added that nobody told him otherwise. His testimony on this point is worth quoting: [ translation] [163] Q. When you signed the contract, how much money did you expect to pay Prospector International before the note's maturity date? How much money did you expect to pay before 2012? A. The amount of the promissory note, which was $200,000. But yes, I intended to pay, but I hoped to have sales to justify. . . to finance that investment. [164] Q. And what suggestions or representations did Mr.

Legault or anybody else make to you to indicate that this. . . to indicate that you did not have to pay this amount? A. No representations were made to me in that regard. I had really . . . I had a debt at that time, when I signed this contract for $200,000. (Examination of the Appellant, Transcript, January 30, 2012, Questions 163 and 164; Examination of the Appellant, Transcript, January 31, 2012, Question 422) (

m) He financed the initial payment of $15,000 with a short-term loan that he later repaid with the tax refund he received a few months later (Examination of the Appellant, Transcript, January 30, 2012, Questions 170 to 176; Undertaking Number 3, contract of loan dated January 29, 2008, Exhibit I-24). (

n) In November or December 2008, Mr. Legault sent him the new contracts. He then called Mr. Legault for an explanation of the changes, and Mr. Legault told him, among other things, that the term of the note had been extended to 10 years to better reflect the life span of the product, and that this meant the balance due had been increased to $230,000. Mr.

Legault also explained to him that [ translation] "updating contracts on a regular basis was a normal practice with franchises" (Examination of the Appellant, Transcript, January 30, 2012, Questions 235 to 237 and 744; Examination of the Appellant, Transcript, January 31, 2012, Questions 233 to 251; Examination of the Appellant, Transcript, March 21, 2012, Questions 6 to 10; Undertaking 60 E, letter from Mr. Legault dated November 25, 2008, Exhibit I-30). (

o) The appellant was satisfied with Mr. Legault's explanations, and on December 19, 2008, he agreed to the changes and signed a new franchise agreement (the 2008 franchise agreement), the new agency and management agreement (the 2008 agency agreement) and

a new promissory note (the 2008 promissory note) (Examination of the Appellant, Transcript, January 30, 2012, Questions 239, 241, 244 and 253; franchise agreement (including promissory note), Exhibit A-1.2.1, Volume 1, page 24; agency and management agreement, Exhibit A-1.2.2, Volume 1, page 47; 2008 promissory note, Volume 1, page 108). (

p) As was the case with the 2007 promissory note, the appellant understood, when he signed the 2008 promissory note, that he had to pay the amount due upon maturity. The appellant adds that no one told him otherwise (Examination of the Appellant, Transcript, January 31, 2012, Questions 422 and 423). (

q) On December 31, 2009, he wrote PIN a cheque for $15,000 (Examination of the Appellant, Transcript, January 30, 2012, Question 508; Examination of the Appellant, Transcript, March 21, 2012, Question 27; cheque dated December 31, 2009, Exhibit A-2.3, Volume 1, page 58). (

r) He attended the 2009 annual general meeting and the 2010 annual general meeting (Examination of the Appellant, Transcript, January 30, 2012, Questions 338, 339, 343, 345, 388 and 389). (

s) After the 2010 annual general meeting, he became a member of the franchisees' committee so that he could keep closer tabs on his investment: [ translation] [423] Q. Why did you submit your name for membership in this committee? A. Well, I wanted to keep tabs on my investment. For me, this was a lot of money, and I wanted to know exactly where it was going. (Examination of the Appellant, Transcript, January 30, 2012, Question 423) (

t) He also joined the Association (Examination of the Appellant, Transcript, January 30, 2012, Questions 440 and 441). (

u) In 2010, he was notified that a new Web portal had been set up, and he started visiting it once or twice a month (Examination of the Appellant, Transcript, January 30, 2012, Questions 622 and 627). (

v) On August 18, 2010, he agreed to the new 2010 franchise agreements by signing them electronically through the intranet site (Examination of the Appellant, Transcript, January 30, 2012, Question 485; "PIN Franchise Agreement, 2010 Version" (Appellant's Undertakings, Appendix 28), Exhibit A-41, Volume 26, page 10278; Examination of the Appellant, Transcript, March 21, 2012, Question 31). (

w) He then noticed an error in the territory assigned to him in the new contract (a territory in Idaho had been given to him instead of his territory in New York), so he asked Mr. Duhamel to correct it. [ translation] [102] Q. Could you explain to the Court why the list, the territory appearing on page 10,302 mentions the state of Idaho and why the list on page 10,660 ( sic ) talks about New York? A. Yes. When the franchisor, Mr. Bernier, redid the territories in 2010 in a way that was, as I said, more scientific, with Deloitte, at that time, there were, in his view, the territories all had the same weight.

So, he made changes, and some kept the same territories while others had their territories changed. He also mentioned to everyone at the 2010 meeting that if anyone wanted a different territory for whatever reason, all they had to

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