Recent Developments of Importance in Franchise Law

Alberta

Since the late 70's, the province of Alberta has been the only Canadian province with franchise specific legislation. Prior to November, 1995, the system in Alberta required the qualification and registration of a prospectus or statement of material fact, which became public documents. It was a slow and costly process and of dubious value for franchisees. On November 1, 1995, Alberta moved to a strictly disclosure approach, by passing the Franchises Act, S.A., 1995 c.F-17.1 (the "Alberta Act").

The Alberta Act deals primarily with the disclosure of relevant facts to potential franchisees, before they make contractual commitments. The form of the disclosure is left to franchisors, but the substance must include at least the items enumerated in Schedule 1 of the regulations. However, Schedule 1 is not exhaustive of all matters that must be disclosed, as franchisors must also disclose all material facts, whether or not set out in Schedule 1. All documents which the franchisee will be required to execute must be attached to the disclosure document. Financial disclosure, based on the "review engagement" standard of the Canadian Institute of Chartered Accountants is required by all franchisors, except that larger, more experienced franchisors, may qualify for exemption.

The franchisor must give the disclosure document to the potential franchisee 14 days prior to the potential franchisee becoming contractually committed or paying non-refundable amounts to the franchisor. Failure to comply with the disclosure provisions of the Alberta Act, on the part of the franchisor, gives the franchisee rights of rescission. Misrepresentations in the disclosure document exposes the franchisor and everyone who signs the disclosure document on behalf of the franchisor to liability for damages.

The only "relationship" provisions of the Alberta Act impose on each party to a franchise agreement a duty of fair dealing in the performance and enforcement of the agreement and prohibit the franchisor from interfering with the formation of a franchisee association.

Ontario

The importance and impact of franchising on Ontario's economy today cannot be overstated. Franchising's share of the retail dollar is fast approaching 50%. It has moved from a somewhat novel alternative distribution option to one of the first distribution choices considered by a wide variety of businesses. All of this growth has taken place in Ontario, over almost 3 decades, in an unregulated environment. Now, after successive governments have again and again considered franchise legislation but rejected the idea, on Thursday, December 3, 1998, a government bill (the "Bill") was put forward in the Ontario Provincial Legislature by the Consumer and Commercial Relations Minister, David Tsubouchi, which, if passed, would create the first ever franchise specific legislation in Ontario. The proposed name for the new act is the Franchise Disclosure Act, 1998.

As predicted, the Bill is very similar to the Alberta Franchises Act. However, it is disturbing to see that the drafters of the Bill obviously tried to give an Ontario slant, different from Alberta, by arranging the provisions of the Bill in different order and to use slightly different wording to say the same thing. This will make it more difficult for franchisors to satisfactorily comply with both statutes and will make it more difficult for franchisees and franchisors in interpreting and applying cases, in a consistent manner, that evolve under the two statutes. There are, however, some substantive differences between the two pieces of legislation; a few that are inconsequential and a few that are somewhat troublesome.

Of lesser concern is the fact that Ontario does not require the residency of the potential franchisee for the statute to apply and there exists an exemption from the application of the statute for franchisees investing a substantial amount of money, to be prescribed by regulation. It is understood that this threshold is likely to be so large that it will affect a very small number of prospective franchisees. The franchisee lobby will be concerned, however, about the absence of any mention of the possibility of creating an industry self-management agency. While Alberta has such an enabling provision in its statute, it has chosen, for the time being, not to act upon it.

Ontario franchisors will find the inability to take a "fully refundable" deposit, without making disclosure, cumbersome in their franchise sales efforts. In Alberta, a franchisor can postpone the disclosure requirements, if they take only a fully refundable deposit not exceeding 15% of the front end franchise fee. These deposits are commonly known as "good faith deposits". Another difference in the Ontario approach, that will be welcomed by franchisees, is the requirement that the disclosure provisions be complied with on the renewal of a franchise if there have been "material changes". An entirely unique approach in Ontario, which will be disturbing for franchisors, is the imposition of liability upon the "franchisor's associates" for misrepresentations contained in a disclosure document. The definition of "franchisor's associate" includes the controlling shareholders of a franchisor. Even though the definition hinges on the person being directly involved in the grant of the franchise or exercising significant operational control, with a continuing financial obligation by the franchisee, the concern will be that shareholders of franchisors will be subjected to unwarranted claims for misrepresentations in disclosure documents whether or not they fit within the definition.

The Bill does not describe the specifics that will be required to be disclosed, as these will be contained later in the regulations to the statute. Again, the expected disclosure specifics should be similar to Alberta, including the requirement that financial statements of the franchisor be disclosed, but the standard being only that of a "review engagement" as provided by the handbook for the Canadian Institute of Chartered Accountants. Mirroring Alberta, it is expected that "mature" franchisors will be exempt entirely from the requirement to make financial disclosure. It is expected, as in Alberta, to qualify as "mature" the franchisor will have to have a net worth of $5,000,000.00, twenty-five franchisees conducting business at all times for the previous five years and have conducted the business being franchised for the previous five years. However, Ontario is expected to put its own stamp on this one by requiring that the franchisor remain, for the five previous years, free of any judgment arising out of a breach of the disclosure provisions of the Ontario statute. What happens then during the first five years following the passing of the Ontario statute? To deal with this, it is expected that any franchisor, who would otherwise qualify for the exemption, will be allowed to apply for a ministerial exemption. One can only imagine the potential difficulties this can create.

As anticipated, the statute does very little to regulate the relationship between franchisors and franchisees. While franchisees will be disappointed that there is not more, the Minister did opt to impose a duty of fair dealing in the performance and enforcement of all franchise agreements, which was absent from the government's proposal last June. Of course, this duty is present in the Alberta Franchises Act and, as is the case in Alberta, the right of Ontario franchisees to associate will be protected. It is interesting to note that the Ontario statute, while certainly applying to the sale of franchises after the statute is passed, will also apply to franchise agreements existing prior to its passage with regards to fair dealing and the right to associate.

Franchisees had lobbied for audited financial statements. Franchisees had also lobbied for mandatory mediation and arbitration, but will have to be content with the expected requirement that franchisors will have to disclose the existence or non-existence of mediation and arbitration structures within their franchise systems.

What happens next? It is expected that there will be one more sitting of the Provincial Parliament before an election is called, during which a number of pending government bills would be passed. Bill 93 could be among them. However, it is understood that the Opposition Critics oppose the Bill as not going far enough for franchisees. Without their support, the Bill will not proceed now, because of the time limitations in the Legislature. For these Critics, the choice is between co-operating and getting some real advances for franchisees now or taking responsibility for killing the Bill and maintaining the status quo. Nonetheless, a re-elected Conservative Government would be expected, given all the work on this legislation to date, finish the task after the election.

Most of the rest of the provinces of Canada are expected to follow Ontario's move into franchise legislation. With 60% of the franchisors based in Ontario, the other provinces, by passing similar legislation, would mainly be helping franchisees in their provinces. This would be a very compelling motivator to pass similar legislation. Hopefully, any such moves by the other provinces will be done on a consistent basis. If so, we can look forward to a healthy and smooth operating franchise marketplace throughout Canada.

Quebec

The province of Quebec is regulated by the Civil Code, rather than the common law, as is the case in all of the other provinces and territories of Canada. There is nothing in the Civil Code or in any other statute of Quebec which specifically deals with franchising, however, there are many provisions of the Civil Code which have an impact on the franchise relationship, including a duty to act in good faith, rules regarding contracts of adhesion, personal guarantees, personal property security and regulations regarding leases and subleases. In operating in the province of Quebec, one must be mindful of the Charter of the French Language.

RECENT CASES

Compared with earlier years, there were a relatively large number of cases decided in 1998 in the area of franchise law.

If there is a single theme running through the decisions made by the courts in 1998, it is that the courts have tended to follow the provisions of the contracts before them. Even in cases involving allegations of misrepresentation, the courts have looked to the wording of the contracts signed by the parties as a starting point to establish the intention of the parties to them.

The courts have continued to imply a duty of good faith and fair dealing between franchisor and franchisee as part of the contractual relationship between the parties to franchise agreements.

Decisions made at trial or on motions for summary judgment have tended to favour franchisors whereas decisions rendered on motions for interlocutory injunctions, as one might expect, have not followed any particular pattern.

A summary of significant decisions made in 1998, follows:

Termination and Remedies

Wainbee Ltd. v. Trinova Canada Inc., [1998] O.J. No.3487 (Ont. C.A.)

Wainbee was a distributor for Vickers products for twenty years. In 1992, Vickers gave 60 days notice of termination of the distributorship agreement. The trial judge determined that the contract ran for a minimum four-year period, following which it could be terminated on reasonable notice of six months. The trial judge found that Vickers breached the contract by terminating it within the four-year period, and awarded damages equivalent to the profits Wainbee would have earned from the date of termination to the end of the four-year period, and for the period of reasonable notice.

An appeal from this decision was dismissed. While earlier contracts between the parties permitted Vickers to terminate the relationship on 60 days notice, the situation changed in 1989 when the parties agreed that Wainbee would phase out the Vickers products it was then carrying, and would take on and build up a new product line for Vickers. To do so, Wainbee was required by the contract to provide a marketing and action plan which it undertook to implement over the next four years. In return, Vickers agreed to support the distributorship for the "foreseeable future". The representatives of both parties contemplated a long-term commitment.

The contract in this case consisted not only of the formal contract but a letter agreement dated October 31, 1989 which incorporated this four year business plan. The Court of Appeal held that it was reasonable for the trial judge to interpret Vickers' contractual commitment to support the distributorship for the "foreseeable future" as having a minimum four-year term matching Wainbee's commitment to take on and build up the new product line over that four-year period.

The Court of Appeal stated that the trial judge was not writing a new term into the contract but rather interpreting it in a way which would appear to advance the true intent of the parties at the time they entered into it.

Prior to the decision in the Wainbee case, the courts have consistently held that parties to a distributorship agreement can rely upon the strict language of termination clauses notwithstanding the fact that the parties to the contract may have had a very lengthy relationship. See, for example, Hardware Agencies Ltd. v. Medeco Security Locks Canada (1995), 39 C.P.C. (3d) 297 (Ont. Gen. Div.). Where an agreement is silent as to the notice to be given on termination, common law principles of reasonable notice apply. The leading case on this point is Paper Sales Corporation Ltd. v. Miller Bros. Co. (1962) Ltd. (1975), 7 O.R. (2d) 460 (C.A.).

Lee v. Lauzen (c.o.b. Comprehensive Business Services of Canada), [1998] O.J. No.623 (C.A.)

The Court of Appeal upheld the trial decision of Mr. Justice Somers in which he ordered the appellant return franchise fees that each of three respondents had paid to the appellant.

The franchisor had represented to each of the three plaintiffs that it would "Canadianize" its ordering system. The plaintiffs successfully argued at trial that the failure to "Canadianize" the system, was a fundamental breach of contract entitling them to rescind the franchise agreements and have their franchise fees returned.

Although the Court of Appeal held that the trial judge had mischaracterized the franchisor's failure to "Canadianize" its system as a "fundamental" breach of contract, it nonetheless held the franchisor's conduct to be a substantial breach of contract entitling the franchisees to rescind their agreements and have their franchise fees returned.

Young Driver's of Canada Enterprises Ltd. v. Mechar, [1998] O.J. No.1304; 58 O.T.C. 385 (Gen. Div.)

This case is a perfect lesson on the importance of a franchisor insisting upon compliance with its franchise agreement and taking steps to ensure that any breaches are remedied on a timely basis.

Here, Young Driver's of Canada Enterprises Ltd. (the "franchisor") successfully obtained an interim injunction preventing the defendant, Mechar, from entering the business premises of two Toronto franchisees pending trial.

Mechar had purchased the two Toronto area franchises in 1992 and early 1993. He intended to pay the purchase price over time by monthly installments. As of February, 1994, Mechar disclosed to the principal of the franchisor that the Toronto franchisees were insolvent; owed debts of over $1.1 million and were unable to meet their payroll, tax and rent obligations.

Rather than immediately terminating the franchises, the franchisor agreed to become a partner of Mechar. The parties agreed to create a new company to operate the franchises ("Newco"). The company would be owned equally by the franchisor and franchisee upon Mechar injecting an additional $200,000.00 of capital.

Rather than injecting this additional capital, Mechar continued to draw monies from Newco at an alarming rate.

The agreement to incorporate and operate a new business had not been reduced to writing and it was necessary for the court to assess the credibility of the parties in order to determine the terms of the contract that had been made.

The court sided with the franchisor after it determined that Mechar had withdrawn in excess of a total of $780,000.00 from the franchised businesses, money which he was clearly not entitled to take, including loans that were never repaid; payment of his personal credit card debts; and payment for personal vacations amongst other questionable transactions.

The court did not hesitate to grant to the franchisor a declaration that it was the beneficial and legal owner of 100% of the issued and outstanding shares of Newco and that Mechar had no beneficial or other interest in these shares.

However, it limited the franchisor's recovery to just over $100,000.00 on the basis that it failed to mitigate its damages by taking steps to terminate the franchise agreements sooner, when it first learned of Mechar's conduct. The plaintiff's damages were limited to the amounts due and owing by Mechar before it became aware of Mechar's defaults.

Pizza Pizza Ltd. v. 805937 Ontario Inc., [1998] O.J. No.1641; 61 O.T.C. 379

Following a decision in favour of the franchisor, Pizza Pizza Ltd., Madame Justice Epstein fixed the costs to be awarded to the franchisor. Her reasons addressed on whether to award costs on a solicitor-and-client or party-and-party basis.

Notwithstanding the fact that the wording of the franchise agreement entitled the franchisor to its costs on a solicitor and his own client basis, the trial judge declined to grant costs on this scale. Relying upon the earlier decision of the Court of Appeal in Bosse v. Mastercraft Group Inc., [1995] O.J. No.884, the learned trial judge held that though as a general proposition where there is a contractual right to costs the court will exercise its discretion so as to reflect that right, the court may refuse to enforce the contractual right where there is a good reason for doing so such as where the case presents special circumstances which renders the imposition of solicitor and client costs unfair or unduly onerous in the particular circumstances. Here, the franchisee's conduct was misguided but not malicious and accordingly, the court ordered costs be paid on a party-and-party scale fixed in the amount of $149,000.00 and disbursements of $120,400.00. First Choice Haircutters (Canada) Inc. et al v. Miller [1997] O.J. No.1940 (Gen. Div.)

Though this case was decided in 1997, it is a significant decision in which the court granted a writ of possession to the franchisor, upholding an earlier notice of termination where the franchisee underreported its gross revenue.

The franchisee owned eight First Choice franchises. Following an investigation by the franchisor, including the use of the services of a private investigator, the franchisor determined that the franchisee was knowingly under reporting revenue. The court held that the reporting of gross revenue in compliance with the franchise agreement is fundamental to a successful commercial relationship in all franchisor-franchisee situations. The consequences of under reporting gross revenue were known to the franchisee as he had signed the agreement.

The franchisee argued that though he had been taking some cash from customers and not issued receipts, the amount involved was so small as to not breach the provision of the franchise agreement which governed that the accuracy of reporting. The court held that the under reporting of gross revenue was not due to clerical error but was a "deceit which undermined the basis on which the commercial relationship was footed."

The court was cognizant of the damages which could result to the franchise system were the court to tolerate the franchisee's practice of taking cash and not issuing a receipt or reporting the income. The court held that the franchisee's practice was a "flagrant violation of the terms of his Agreement and, in any event, undermines and destroys any mutual trust that is fundamental to a continued working relationship between the parties." The court denied the defendant's request for an injunction to restrain the taking of possession on the basis that he had not come to court with clean hands.

Misrepresentation

965833 Ontario Ltd. v. Tsianos, [1998] O.J. No.3818 (Gen. Div.)

The plaintiff, a recent immigrant, had planned to purchase a donut shop, through a numbered company, from the defendants. It was unclear whether the shop would be purchased from the defendant personally or from a corporation controlled by him, Prime Time Donuts Inc. The plaintiff would have been the first franchisee of Prime Time Donuts Inc.

The plaintiff entered into an agreement to purchase the shop and paid a deposit of approximately $75,000.00 for the chattels and first and last month's rent. The defendant innocently, yet wrongly, misrepresented the rent for the premises in a pro forma financial statement and, as well, in the agreement to purchase. In fact, the area of the leased premises was greater than that represented and the amount contemplated for rent in the agreement to purchase was silent on the issue of additional rent which included taxes and the cost of common area maintenance.

The court held that the plaintiff was entitled to rescission of the agreement of purchase and to the return of his deposit. The plaintiff went into possession of the premises prior to closing but the closing never took place as the landlord distrained for arrears of rent. The plaintiff walked away from the premises upon learning of the rent due under the head lease.

The court accepted the plaintiff's position that it was most important for him that the gross rent not exceed $6,000.00 per month. He was concerned about the impact of the rent on the bottom line profitability of the donut shop. Notwithstanding the acceptance of the plaintiff's position, it based its decision on an interpretation of the agreements that were signed by the parties. While the franchisor may have intended for a sublease to be prepared on the same terms as the head lease or for the head lease to be assigned directly to the plaintiff, the agreement of purchase did not include a provision that rent was payable in accordance with the terms of head lease. Since the agreement to purchase was silent on the issue of additional rent, the defendant could not bind the plaintiff to pay these additional costs and expenses. Since the deposit monies were paid to both the individual defendant, in trust and to the corporate defendant, judgment was granted for return of the deposits against both.

Belanger-Fontaine v. Molly Maid Home Care Services Ltd., [1998] O.J. No.1981; 62 O.T.C. 389 (Gen. Div.)

The plaintiff was a university graduate who responded to a Molly Maid franchise advertisement. In early 1998, the plaintiff entered into negotiations with Molly Maid in which the plaintiff was provided with a financial projection which the court held was "not based on any analysis of the financial reports of operating franchises and were nothing more than an arbitrary goal set by Molly Maid that a franchisee should try to achieve for financial success." Relying upon this financial projection, the plaintiff purchased a Molly Maid franchise. She soon learned that another franchisee had operated within her territory for approximately nine months, without success.

Upon learning of the previous unsuccessful franchise, the plaintiff then had six years within which to commence an action against Molly Maid. The action was not commenced until after six years had elapsed and, accordingly, the court held that the plaintiff's action was statute barred notwithstanding that she would have been successful in making out her claim of misrepresentation.

The standard clause in the Molly Maid franchise agreement which disclaimed responsibility for misrepresentations could not, but for the limitation argument, have been relied upon by Molly Maid. The court held that the disclaimer clause in the contract did not negate the duty of care owed to the plaintiff. In addition, the court held that the tort was independent of the contract and liability was not limited by the exclusion clause in the franchise contract.

Midas Canada Ltd. v. 799136 Ontario Ltd. (c.o.b. J.J. & T. Muffler Co.), [1998] O.J. No.2988 (Gen. Div.)

The plaintiff, Midas Canada Ltd., successfully moved for summary judgment on account of goods sold and delivered to the defendant. The defendant pleaded set-off and a counterclaim based upon three alleged misrepresentations made by the plaintiff to the defendants at the time of entering into assignments of franchise agreements.

These misrepresentations were as follows: First, that the sales price of Midas franchises was equal to 75% of the previous year's sales plus the cost of inventory and equipment on hand. Second, that in respect of a Bloor Street location, it was represented that no new franchises would be created in Toronto or Etobicoke. Last, in respect of a Georgetown location, the pro forma operating statements were alleged to have been misrepresented.

The court considered each of these three misrepresentations. As no affidavit evidence had been filed in response to the first alleged misrepresentation, and as competing businesses had been established in Toronto and Etobicoke, the court held that there were genuine issues for trial with respect to these alleged misrepresentations. There was insufficient evidence placed before the court to establish the last alleged misrepresentation. What is interesting in this decision is that after granting summary judgment in the action, the court refused to stay execution of that judgment pending a determination of the defence of set-off and a determination of the counterclaim.

Mr. Justice Ground held that:

such a stay of execution could only be justified on the basis of equitable set-off and it appears to me that the claims of the defendants in the counterclaim are for damages for losses incurred by the defendants as a result of their reliance upon the alleged representations, and that such claims are, at this stage, tenuous and unquantifiable, whereas the summary judgments granted are for specific amounts for goods sold and delivered which the defendants acknowledge are due and payable.

In other words, while there may have been genuine issues for trial on the counterclaim, there were no genuine issues for trial in the main action and the court held that the claim and counterclaim were not sufficiently connected to stay the judgment in the main action pending a decision in the counterclaim.

Injunctions

Great Lakes Harvestore Systems Ltd. v. A.O. Smith Engineered Storage Products Co., [1998] O.J. No.873 (Gen. Div.)

The parties had a relationship of longer than twenty years. The last agreement between the parties was signed in 1997. In November, 1997, the defendant, A.O. Smith purported to terminate the agreement under the strict wording of the contract. It subsequently alleged that the plaintiff, Great Lakes, breached the agreement. Great Lakes took the position that it did not breach the agreement. It sought and obtained an interlocutory injunction.

While the report of this decision does not contain much in the way of background facts, the court did find that Great Lakes had raised a serious issue to be tried with respect to the interpretation of an automatic renewal clause in the new agreement and that, given the length of the relationship between the parties, it expressed a concern as to whether the termination was in good faith.

The court determined that there was "cogent evidence" that 95% of Great Lakes Business was with A.O. Smith. Accordingly, if the injunction were not granted, Great Lakes would have suffered irrevocable damage to its business representation and permanent market loss which it held could not be quantified in monetary terms or cured by damages.

Last, the court concluded that the balance of convenience favoured Great Lakes. While A.O. Smith did not wish to continue its relationship with Great Lakes the fact that 95% of Great Lakes business was based upon the sale of A.O. Smith products was enough to tip the balance in favour of Great Lakes until the issues could be tried.

Madame Justice Greer held that:

In my view, the damages award would simply not be appropriate and it would be difficult to calculate because there would be no way of knowing what contracts Great Lakes would enter into or what sales it would enter into if [an] injunction had not been granted.

Stewart purchased a Nutrilawn franchise. He paid some but not all of the purchase price for the franchise and admitted to owing $15,000.00 in this regard. He also admitted owing $16,000.00 for product and a further $36,000.00 for royalties and interest covering five years of doing business with the plaintiff.

The plaintiff terminated the contract because of the outstanding arrears just a few months before the contract would have been expired.

Stewart continued to solicit customers developed through the franchise notwithstanding a restrictive covenant prohibiting him from doing so. He also refused to assign the telephone lines designated to his Nutrilawn business notwithstanding that the assignment was a requirement of the contract.

In his defence, Stewart alleged that there were misrepresentations made to him by the plaintiffs when the provided him with pro forma statements upon which he relied which, in retrospect, grossly inflated the income he would have received as a result of entering into the contract. The wide disparity in the income in fact produced by the business and the income proposed by the pro forma statements raised, in the mind of the judge, a genuine issue for trial.

Given Stewart's admissions of his indebtedness to the plaintiff, he was ordered to pay Nutrilawn $16,000.00 for the cost of product pending trial. The court did not order him to pay any other amounts pending a determination as to whether the contract was binding. An injunction sought by the plaintiff pending trial, which presumably would have required Stewart to assign the telephone lines and cease carrying on business, was dismissed.

Atlantic Corrosion Control Ltd. v. Rust Check Canada Inc. (1998), 167 N.S.R. (2d) 310 (N.S.S.C.)

This was an application for an interim injunction. The applicant, Atlantic Corrosion, negotiated an exclusive agreement with the respondent, Rust Check, for distribution of anti-corrosion chemicals. Rust Check contended that the agreement allowed it to set up its own distribution system in the Halifax area. Atlantic Corrosion opposed Rust Check's distribution system. A further dispute arose concerning the operation of a warranty program. Atlantic commenced an action against Rust Check over the warranty program. Although a settlement was reached, problems with the warranty program persisted. Atlantic commenced a new action. Rust Check acted to terminate the distribution agreement and to set up its own distribution system. Atlantic sought an interim injunction preventing Rust Check from terminating the agreement pending determination of its action.

The application was granted. Atlantic's warranty program claims and other possible breaches of the distribution agreement were serious issues for trial. Atlantic's claims had merit. Atlantic would have suffered irreparable harm without the interim injunction. It would have been unable to remain in business. Its losses could not be remedied by an award of damages and the balance of convenience favoured granting an injunction. The injunction was limited to preventing termination of the distribution agreement for any reason raised during the injunction application, namely:

1. The funding and administration of warranties and warranty claims;
2. The pricing of the Rust Check chemicals;
3. The degree of or physical area of exclusivity; that is, whether Rust Check has the right to commence supplying directly the Halifax/Dartmouth region;
4. Advertising;
5. The provision of office, warehouse and training facilities; and
6. The exchange of invoices and invoice information.

The court permitted the plaintiff to seek to extend its injunction or to amend the order granted in the event that Rust Check purported to terminate the agreement for other causes pending trial.

Contract Interpretation

1017933 Ontario Limited v. Robin's Foods Inc., [1998] O.J. No.1110; 57 O.T.C. 43 (Gen. Div.)

The applicant, 1017933 Ontario Limited, purchased a Robin's Donut Store in Barrie, Ontario in 1993. A franchise renewal agreement was entered into in 1994.

In 1995, the principal of 1017933, Richard MacKay, decided to start selling wholesale donuts to other donut shops for resale. The court characterized these sales as a "bootleg" operation in that the donuts in question were not identified in their boxes as Robin donuts; the mix for the donuts was not that specified by Robin's in its rigorous specifications; the sales were made to a group of non-Robin's donut stores; and the dealings for the sale of these wholesale donuts was conducted in great secrecy and on a cash basis. The sales were never recorded on the store cash register.

The relationship between the parties deteriorated to the point where Robin's issued a default notice in early 1997. At that time, there were arrears of royalties; monthly sales reports were not being submitted on a timely basis; approved shortening and flour were not being used and large volumes of donuts were being sold to third party retailers without Robin's consent. The court carefully considered the provisions of the Robin's franchise agreement which governed, in detail, the operation of a Robin's Donuts franchise. The court held that Mr. MacKay was obligated to comply in good faith with the agreement notwithstanding that its language may be a "draconian regime of control over every detail of the franchised business operation".

The court held that Mr. MacKay's secretive backdoor operation clearly contravened the restrictive covenants set out in the agreement not to operate a business competitive with that of Robin's. The court held that this conduct was a serious and substantive breach of the agreement.

The court concluded that MacKay and 1017933 had seriously and fundamentally breached the agreement. It ordered that the franchise agreement be terminated; the sublease agreement be terminated; vacant possession be granted to Robin's; and that 1017933 deliver up forthwith to Robin's all advertising materials, bulletins, manuals and other documentation required by the post-termination provisions of the franchise agreement.

Fotini's Restaurant Corp. v. White Spot Ltd. (1998), 38 B.L.R. (2d) 251

This was an application to dismiss the plaintiff's claim.

The plaintiff claimed damages for misrepresentations made concerning the profitability of the restaurant being purchased. The restaurant did not generate the income anticipated by the plaintiff and, because of their financing costs, they sustained significant losses. With the consent of the defendant, the franchise and restaurant business were sold to a third party.

At the time the business was sold, the plaintiff executed a general release in favour of the defendant and the franchise agreement was terminated on consent of the parties.

The court interpreted the releases in accordance with the general principles for interpreting contracts. The court relied upon the decision of the New Brunswick Court of Appeal in White v. Central Trust Company Co. (1984), 54 N.B.R. (2d) 293 where Mr. Justice La Forest J.A. as he then was, held that:

Like other written documents, one must seek the meaning of a release from the words used by the parties. Though the context in which it was executed may be useful in interpreting the words, it must be remembered that the words govern. As in other cases, too, the document must be read as a whole. This is particularly important to bear in mind in construing releases, the operative parts of which are often written in the broadest of terms. Thus reference is frequently made to recitals to determine the specific matters upon which the parties have obviously focused to confine the operation of general words.

The court determined that the alleged negligent or fraudulent misrepresentation was in contemplation of the parties at the time the release was given. Accordingly, the release was upheld, the application allowed and the franchisee's action dismissed.

Hunt v. Robin's Foods Inc., [1998] O.J. No.607 (Gen. Div.)

This action involved a Robin's Donuts franchise operated in Winnipeg, Manitoba.

The franchise agreement provided that upon the second renewal term, the franchisee shall, prior to such renewal term, commence making such capital expenditures as may be reasonably required to renovate and modernize the location, equipment and signs so as to reflect the then current image of Robin's Donuts outlets.

In 1996, the franchisee gave the requisite 12 months notice of its intention to renew the agreement.

In early 1997, the franchisor sent the franchisee a list of the required renovations. The cost of these renovations was estimated at approximately $61,000.00. The franchisee failed to provide any security or evidence that it was able to pay or prepared to pay the cost of these renovations and accordingly, a notice of intention to seize the store was given.

The franchisees alleged that they could not raise the $61,000.00 and disputed the reasonableness of the request being made by Robin's. The franchisee sought and obtained an interlocutory injunction pending trial. They established a prima facie case by suggesting that when they first entered into the agreement, they did not contemplate a change of the franchise system from a coffee and donut system to one which involved the operation of a deli counter.

The court held that the balance of convenience favoured the granting of the injunction and that the franchisee would suffer irreparable harm if their franchise and goodwill, which the court described as a "mom & pop" operation was lost. As a condition of making its order, the court required the franchisee to deliver the usual undertaking as to damages; deposit the sum of $10,000.00 with their solicitor, in trust, either to be used towards the renovations to be made or to be held as security for the franchisee's undertaking to pay damages; and to keep current in its regular payments under the franchise agreement.

Jain v. Pot Pourri Systems Inc., [1998] O.J. No.13; 49 O.T.C. 221 (Gen. Div.)

In this case, the plaintiff, Jain, brought a motion for summary judgment seeking repayment of an initial franchise fee. The motion was granted. The initial franchise fee was paid on the understanding that it would be reimbursed in the event that the franchisor did not enter into a lease commitment with its landlord for the location contemplated to be purchased by the franchisee.

No binding commitment of any sort was made with the landlord. Subsequently, the franchisee entered into a lease with the same landlord from which it later resiled.

The franchisor argued that by entering into a lease with the landlord, the plaintiff changed the agreement to one whereby the defendants had no obligations to negotiate the lease and the conditions of the agreement were waived.

The court disagreed. It held that the franchisor was estopped from asserting the fact of the executed offer to lease by the franchisee with the landlord as a ground for refusing to return the franchise fee. The franchisee later obtained the full release from the landlord in respect of the lease executed by it. There was nothing standing in the way of the franchisor returning the initial franchise fee to the franchisee and judgment was granted accordingly.

Kentucky Fried Chicken Canada, a division of Pepsi-Cola Canada Ltd. v. Scott's Food Services Inc. et al, [1998] O.J. No.4368 (C.A.)

The trial decision of this case was reported in the 1997 update. An appeal from the trial decision was heard on May 4 and 5, 1998. The Court of Appeal's reasons for judgment were released on November 2, 1998.

At trial, the court considered two issues: First, whether Scott's Food Services Inc. ("Scott's Food") could sell its interest in a license agreement without the consent of Kentucky Fried Chicken Canada ("KFC") and second, whether Scott's Food was in breach of the license agreement in failing to upgrade its outlets in conformity with KFC's world-wide image as required by the license agreement.

At trial, Mr. Justice Steele held that the failure on the part of Scott's Foods to obtain the consent of KFC to the change in ownership of the franchisee gave rise to a right, on the part of KFC, to terminate the license agreement. The Court of Appeal allowed the appeal on the transfer issue. The question to be determined was one of contractual interpretation, namely whether the license agreement required KFC's consent to the transfer of shares to Laidlaw. In considering this question, the Court of Appeal approved the approach of the trial judge to consider the words of the documents and their ordinary meaning in the general context that gave birth to the document or its "factual matrix". It approved of the trial judge's consideration of the relationship between the parties and the custom of the industry.

Mr. Justice Goudge, speaking for the court held, inter alia, that the document under consideration should be construed in accordance with sound commercial principles and good business sense and that care must be taken to do this objectively rather than from the perspective of one contracting party or the other. With these broad principles of interpretation in mind, the court interpreted the license agreement as not granting to KFC the right to approve a change in the controlling shareholder of its franchisee, Scott's Food. The intention of the relevant clause of the license agreement was to give KFC a right to approve the shareholders of the franchisee at the time that the license agreement was signed. There is nothing to suggest a right to approve a change in those shareholders some seven years later.

On the enhancement issue, the Court of Appeal held that the relevant clauses of the license agreement merely set out a procedure of formal notice in the event that Scott's Food did not meet its enhancement obligations. It did not accord to KFC a substantive right to terminate for any failure by Scott's Food to discharge its enhancement obligations. Further, the license agreement permitted notice to be given if their was a failure "in a material and substantive manner" to meet the franchisee's enhancement obligations. The court, at trial, held that where 5-10% of the outlets fell below the required standard, Scott's Food was in substantial breach of this paragraph. The Court of Appeal held that all Scott's Food need do is correct the failure by enhancing at least enough outlets so that there was no possibility of the "material and substantive manner" line being crossed. Scott's Food did not need to correct all of the defaults within a period of three months, as the trial judge suggested but rather needed only to ensure that no more than 5% of its outlets were substandard.

By Edward N. Levitt and Jeffrey P. Hoffman.