If the seat is properly adjusted your legs should be almost completely extended when the cranks are parallel to the downtube (the part of frame from cranks to the seat itself).
It sounds as though this bike shop is more interested in selling the bike that selling you one that fits. If they had to remove the reflector to get the seat low enough for you to ride it and it is all the way down, the frame is too large. Don't buy that bike. See if you can find another bike shop that has the smaller one in stock. Call or email nearby bike shops and ask if they have the smaller frame available. Try REI if there is one near you. They the Townie models on sale through next Monday and I doubt they would sell you one that doesn't fit. If you are a member (lifetime $20) you get a rebate at the end of the year.
After looking at the Electra Townie at REI, I see only one frame size. You might also try other brands that have similar designs. I'm no expert on this type of bike as it isn't "my cup of tea". Look at Performance Bikes for similar designs
http://www.performancebike.com/webap...&storeId=10052