Recent Franchise Case Law Developments. CFA Law Day, January 28, 2016

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1 Recent Franchise Case Law Developments CFA Law Day, January 28, 2016 Jean-Marc Leclerc, Sotos LLP and Chris Horkins, Cassels Brock and Blackwell LLP 1 (a) Class Actions and Group Actions Trillium Motors World Ltd. v. General Motors of Canada Ltd. 2 A group of former General Motors dealer franchisees commenced a class action lawsuit against their former franchisor, General Motors of Canada Ltd. ( General Motors ), regarding General Motors decision to aggressively reduce its dealership network. In order to secure financial support from the federal government and to avoid filing for protection under the Companies Creditors Arrangement Act 3, General Motors commenced a restructuring plan that involved the winding down of a large number of dealerships. General Motors delivered Notices of Non- Renewal and Wind-Down Agreements to 240 dealers across the country in an attempt to terminate the relationship between the dealers and General Motors. Of the 202 dealers who accepted the Wind-Down Agreements, 181 commenced a class action against General Motors for breaching its common law and statutory duties to the franchisees. 1) General Motors did not breach its statutory duty of fair dealing owed to its franchisees; given the commercial reality faced by General Motors, their actions were reasonable. 1 Follow us on We would also like to thank Noah, Leszcz, Articling Student at Cassels Brock and Blackwell LLP for his assistance in preparing this paper and presentation ONSC 3824 < [Trillium]. 3 R.S.C. 1985, c. C-36.

2 - 2-2) General Motors did not breach the franchisees statutory right to associate. There is no positive obligation on franchisors to facilitate or encourage association, although the releases preventing franchisees from participating in a class action were found to be unenforceable. 4 3) General Motors did not breach its disclosure requirements to the franchisees; the Wind- Down Agreement was not a franchise agreement and therefore didn t require disclosure. 4) The Arthur Wishart Act was not precluded from applying to franchises operating outside of Ontario. 5 There are four key practice points that can be highlighted from this decision: 1) First, the duty of fair dealing owed to franchisees is context-specific. Decisions made by a company during a period of instability can be interpreted through the lens of the commercial reality faced by the franchisor. 6 2) Second, a franchisor is only obligated to inform franchisees of a planned restructuring of its business once the plan has crystallized. 7 3) Third, a franchise agreement that agrees to rely on the Arthur Wishart Act as the governing law for the franchise relationship is enforceable in Ontario, regardless if the franchisee or their business is located outside of Ontario. 4 Contrast this finding, however, with the decision in Pillar to Post summarized below. 5 S.O. 2000, c Trillium, supra, at para Ibid at para 181.

3 - 3-4) Finally, a signed release prohibiting franchisees from participating in a class action is unenforceable as it infringes upon the franchisees right to associate. The decision has been appealed by all parties Ontario Inc. v. Pet Valu Canada Inc. 8 Summary Judgment Motion This class action involved a claim against the franchisor, Pet Valu Canada Inc. ( Pet Valu ), for failing to share volume rebates or discounts with franchisees, as was required under their franchise agreement. Initially, Pet Valu was largely successful on its motion for summary judgement dismissing much of the plaintiffs claims. In substantially granting Pet Valu s summary judgment motion, the motions judge found that Pet Valu was contractually obligated to reasonably share volume rebates with franchisees, but also that it had met this obligation. The court then considered if there was a breach of the duty of good faith, even though there was no breach of contract. The court held that the franchisor had a duty to provide ongoing disclosure with respect to purchasing power and volume rebates, based on the duty of good faith and fair dealing imposed by s. 3 of the Wishart Act and that Pet Valu had breached this duty by failing to provide disclosure correcting the earlier representations made regarding its purchasing power and volume rebates. Appeal Both sides appealed the summary judgment decisions. On appeal, the Ontario Court of Appeal found in favour of Pet Valu and dismissed the action against it entirely. The Court of Appeal ONSC 6056 (CanLII), < additional reasons at 2015 ONSC 29 < reversed on appeal, 2016 ONCA 24, < [Pet Valu]

4 - 4 - found that the motions judge erred by reading language into the common issue to ask whether Pet Valu had a duty, under common law or section 3 of the Wishart Act, to disclose to class members whether it received a significant level of volume rebates from suppliers. The Court also reined in the lower court s findings with respect to ongoing disclosure, finding that section 3 of the Wishart Act does not include a duty to disclose information to franchisees necessary for franchisees to verify whether the franchisor is meeting its obligations under the franchise agreement and that a failure to include all material facts in a disclosure document does not constitute unfair dealing in breach of section 3. Further, an alleged non-disclosure cannot breach the duty of good faith where the franchisees are not adversely affected by it. In this case, the Court found the information the motions judge found should have been disclosed did not relate to the performance or enforcement of the franchise agreement, which is a requirement under section 3 of the Wishart Act. 1) While the duty of good faith and fair dealing may impose a duty of ongoing disclosure during the franchise relationship, the duty is limited by the following: a. Franchisors are not required to disclose information against their own interest on the basis that such information is necessary for franchisees to determine whether the franchisor is meeting its obligations; b. The failure to include material facts in a disclosure document is not a breach of section 3 of the Wishart Act; c. Non-disclosure must have an adverse affect on the franchisee in order to be a breach of section 3; and

5 - 5 - d. The information alleged to have not been disclosed must relate to the performance and enforcement of the franchise agreement. The duty of good faith and fair dealing is very fact-specific and may impose an ongoing obligation to disclose material facts in certain circumstances. The Court of Appeal s decision however provides helpful guidance with respect to the limits of such a duty. Where material changes occur during the franchise relationship that may have an adverse affect on franchisees, franchisors should take care to consider whether this information ought to be disclosed Ontario Inc. v. Pillar to Post Inc. 9 A class action was commenced by a group of franchisees against the franchisor alleging that the franchisor had breached its obligations under the Arthur Wishart Act by unilaterally making fundamental changes to the franchise system. Further, they alleged that this unilateral change was not in compliance with the franchisor s statutory disclosure obligation. The franchisor commenced a motion to stay the proceedings, on the grounds that the franchisees had ignored the arbitration clause in their franchise agreements and were prevented from bringing their claims in court by way of the class action. 1) The franchisor succeeded and the class action was stayed. The arbitration clause in the agreement was enforceable. As a result, the franchisees were required to pursue their claims individually through arbitration rather than in the class action ONSC 7400 < [Pillar to Post].

6 - 6 - To determine whether a court proceeding should be stayed on the basis of an arbitration clause, the court must interpret the arbitration clause and analyze whether the claim falls within the scope its terms. Where the dispute is contemplated by the arbitration clause, the court shall defer to the arbitrator and, on motion of another party to the arbitration clause, stay the proceeding. Class actions cannot function to circumvent an arbitration clause as the Wishart Act does not expressly protect the right to bring a class action. If drafted properly, arbitration clauses can be a useful option for franchisors to avoid class actions. Dunkin Brands Canada Ltd. v. Bertico Inc. 10 In 2012, a group of 21 Dunkin Donuts franchisees in Quebec sued their franchisor for $16.4 million for damages for loss of profits. The plaintiff franchisees alleged that beginning in the early 1990 s, Dunkin Donuts failed to meet their contractual obligation to protect and enhance the Dunkin Donuts brand in Quebec in the face of rising competition from Tim Hortons. As a result of an aggressive expansion by Tim Hortons in the late 1990 s and early 2000 s, Dunkin Donuts historically strong market share in the province plummeted from 12.5% in 1995 to 4.6% in The franchisees alleged that as a result of the franchisor s failure to reprimand underperforming franchisees, the value of the brand had been devalued. The trial judge awarded the group of franchisees $16.4 million in damages. Dunkin Donuts appealed the decision, and this year the Quebec Court of Appeal affirmed the trial judge s decision on liability but reduced the damages to $10.9 million QCCA 624 < [Dunkin Donuts].

7 - 7-1) Dunkin Donuts breached the express terms of the franchise agreement. Dunkin Donuts did not uphold its obligation to protect and enhance the value of the brand by failing to assist the franchisees and by failing to ensure that other franchisees maintained standards of cleanliness and quality. It must be kept in context that this decision from the Quebec Court of Appeal is not binding outside of Quebec and arises in the unique, civil law context of that province. It is not clear if principles from the decision would apply in common law provinces. Under the Québec Civil Code, franchise agreements create implicit contractual obligations. In the context of franchising, this includes an obligation for franchisors to undertake reasonable steps to protect and enhance their brand through supporting franchisees in the face of stiff competition. This implied obligation did, however, stem from the express language of the franchise agreement, which stated that Dunkin Donuts would protect the demand for its products in the Quebec market. Franchisors outside of Quebec should be careful about including representative statements in the recitals of their agreements since what might be intended as mere puffery could actually lead to real and onerous positive obligations for the franchisor. (b) Disclosure and Rescission The Springdale Saga In 2015, a number of disclosure-related decisions were released involving Springdale Pizza Depot Ltd. ( Springdale ), adding to the already long list of cases involving the troubled franchise system.

8 Ontario Inc. v. Springdale Pizza Depot Ltd. 11 The franchisee took an assignment of an existing Springdale Pizza location from a former franchisee. The new franchisee tried to rescind the franchise agreement soon thereafter, alleging that Springdale breached its statutory disclosure requirements. Springdale responded by attempting to avail themselves of a statutory exemption from the disclosure requirement for only being passive participants 12 in the transfer. The franchisees succeeded in their motion for partial summary judgment for an order rescinding the franchise agreement. Springdale appealed this decision to the Ontario Court of Appeal. 1) On appeal, the lower court s decision was affirmed. The franchisee was entitled to rescind its agreement. One must look to the contextual factors of each franchisee-to-franchisee transfer to determine if the franchisor s involvement is merely passive. Passive participation by the franchisor will not, generally, require disclosure to be made. However, if a new franchise agreement is required, or in this case, if a franchisee is led to believe that a new franchise agreement will be required, then the franchisor s involvement moves beyond a passive role and the disclosure requirements will be engaged. Practically, franchisors are advised to err on the side of disclosure in close cases rather than relying on the statutory exemptions, as even a successful defence relying on the exemptions will exceed the cost of making preventative and precautionary disclosure ONCA 116 < [Springdale Brampton]. 12 Springdale Brampton, supra, at para 2.

9 Ontario Inc. v Springdale Pizza Depot Ltd. 13 The franchisees succeeded in their attempt to rescind the franchise agreement on the grounds that they did not receive adequate disclosure. The franchisees alleged 3 major disclosure deficiencies: 1) the financial statements had not been audited, reviewed or otherwise attempted to verify the accuracy or completeness ; 14 2) the certificate affirming the accuracy of disclosure was not signed by at least two officers or directors of the franchisor. Although Springdale produced a second certificate signed by the missing director, the court found the wording of the Regulation required a single certificate signed by all required parties; and, 3) the disclosure document did not reference any of the ongoing litigation involving Springdale. Springdale appealed the decision arguing that the deficiencies in disclosure did not justify a rescission of the franchise agreement. 1) The disclosure document was found to be deficient and the franchisees were entitled to rescind the franchise agreement ONCA 236 < [Springdale Toronto]. 14 Ibid at para 38.

10 Franchisors must be diligent in their disclosure document to ensure compliance with the Arthur Wishart Act. Providing financial statements that are unverified and unaudited, failing to ensure the certificate is signed by at least two officers or directors if required and failing to disclose litigation against the franchisor 15 will be considered so deficient as to amount to no disclosure. 16 This decision appears to confirm that any of these decisions may, on their own, entitle a franchisee to rescind within the two year window under section 6(2) of the Wishart Act. Caffé Demetre Franchising Corp v Ontario Inc. 17 A year after entering into the franchise agreement the franchisor terminated the agreement due to difficulties in the relationship and sought damages for breach of contract. The franchisee counterclaimed for rescission of the franchise agreement. The franchisee alleged that the disclosure document they received at the time of the purchase was deficient, citing a pending trade-mark infringement lawsuit by the franchisor, amongst other alleged deficiencies. The court found in favour of the franchisor, granting partial summary judgment dismissing the franchisee s rescission claim. The franchisee appealed the decision to the Ontario Court of Appeal. 15 See however, the court s decision in Caffe Demtre, summarized below, which indicates that not all litigation involving the franchisor is a material fact that must be disclosed. 16 Springdale Toronto, supra, at para ONCA 258 < [Caffé Demetre].

11 - 11-1) The appeal was dismissed. The pending litigation by the franchisor was not found to be a material deficiency, as the litigation was commenced by the franchisor to protect the brand. Further, the litigation was not a potential liability, but rather a proactive measure for the benefit of the franchisees. 18 As such, it was not a material fact that had to be disclosed. Not all litigation involving the franchisor is a material fact that must be disclosed. Litigation commenced by the franchisor for the benefit of the franchise system, will not be considered a material fact requiring disclosure. Of course, erring on the side of inclusion is still the recommended best practice Ontario Ltd. v. Cora Franchise Group Inc. 19 The plaintiff franchisee commenced an action in 2011 raising a myriad of allegations and numerous causes of action, including misrepresentation, breach of contract and various claims under the Arthur Wishart Act, in a 53 page, 128 paragraph, amended claim, even after a successful preliminary motion to strike brought by the franchisor. Faced with what amounted to a kitchen sink claim, purporting to raise issue with many aspects of the franchise relationship, including disclosure, construction, training and support, the franchisor brought a motion for partial summary judgment to narrow the issues. 18 Caffé Demetre, supra, at para ONSC 1265 < [Cora Summary Judgment].

12 - 12-1) The Court found in favour of the franchisor and dismissed 14 causes of action (some of which were unopposed by the franchisee) on the basis that they were statute-barred under the Limitations Act and/or without any basis in law or fact. 2) The Court confirmed that there is no common law tort dealing with the form and content of a franchise disclosure document that exists separate and apart from the statutory obligations imposed by the Wishart Act. 3) Franchisees will be held to the strict two year limitation period under the Limitations Act, which runs from the time they knew or reasonably ought to have known a claim arose, in this case, from when they received invoices for opening and construction costs. Franchisees cannot rely on the statutory duty of good faith and fair dealing in disputing the adequacy of a disclosure document, rather, such challenges must stem from sections 5-7 of the Wishart Act. This decision also confirms that partial summary judgment motions may be useful where a franchisee commences an unwieldy kitchen sink action and there are discrete issues amenable to being decided without a full trial. The potential tactical and cost saving benefits of such a motion are significant. An early finding on certain claims may bring the parties closer to a resolution and/or significantly narrow the issues for documentary disclosure and discoveries and, ultimately, for trial.

13 (c) Duty of Good Faith and Fair Dealing Addison Chevrolet Buick GMC Limited et al. v. General Motors of Canada Limited et al. 20 This is another action arising from the 2009 restructuring of General Motors. Unlike the Trillium case summarized above, the Addison claim was commenced by a group of Canadian GM dealers who were retained and continued as dealers following the restructuring. In the summer of 2009, General Motors Corporation filed for bankruptcy in New York. As a result, the ownership of General Motors Canada Ltd. ( GM Canada ), a subsidiary of General Motors Corporation, was transferred to newly incorporated entities, General Motors Company and General Motors LLC (collectively GM US ). The bankruptcy filing led to the Ontario government, in addition to the Federal government, investing substantial public funds in GM US and GM Canada, which the plaintiffs described as a bailout. 21 The plaintiffs alleged that GM Canada and its US parent companies, GM US, breached their duties of good faith and fair dealing by failing to adequately support and consider the interests of the retained Canadian dealer network following the restructuring, and failed to use the bailout funds to support them, resulting in reduced sales and profitability for these dealers. The franchisees alleged that GM Canada and GM US breached their duty of good faith and fair dealing, by: 1) putting their own interests ahead of the Canadian franchisees interests; 2) failing to offer the Canadian franchisees the same support that was offered to American franchisees; and, ONSC 3404 < [Addison]. 21 Addison, supra, at para 2.

14 - 14-3) failing to consider the franchisees interests by requiring them to spend substantial funds on renovations as a result of the re-imaging obligations in the franchise agreements. The franchisees pursued liability against GM US on the basis that the US companies were franchisor s associates or, alternatively, a request to pierce the corporate veil. GM US brought a motion to strike all of the claims made against it. GM Canada brought a concurrent motion to strike certain of the good faith claims made against it. 1) A franchisor s associate is only liable for statutory good faith claims if they are a party to a franchise agreement, which GM US was not. In any event, GM US did not meet the definition of a franchisor s associate under the Wishart Act. 2) The courts did not choose to pierce the corporate veil and assign contractual liability to GM US as a result of its relationship with GM Canada. 22 3) GM Canada did not breach its common law duty of good faith; the duty of good faith is not breached by preferring one s own interest over another. Also, there is no fiduciary duty between a franchisor and franchisee. Franchisors do not owe their franchisees a fiduciary duty. Each party is legally entitled to act in their own best interests. Nevertheless, as long as franchisors act honestly and don t undermine the franchisee s interests in bad faith, the duty of good faith will not be breached. This case also demonstrates the difficulty faced by franchisees seeking to pursue a claim for breach of the duty of good faith and fair dealing against a franchisor s parent company. 22 Addison, supra, at para 34.

15 (d) Enforceability of Releases Ontario Ltd. v. Cora Franchise Group Inc. 23 Two franchisee plaintiffs attempted to have a section of the franchise agreement requiring the execution of a general release upon assignment declared void and unenforceable. In 2011 and 2012 the franchisees commenced litigation against Cora, the franchisor, asserting claims under the Arthur Wishart Act, breach of contract, negligence and misrepresentation. In an effort to mitigate their damages, the franchisees sought to sell their businesses and assign the franchise agreements to new owners. In exchange for consent to the transfer, Cora requested that the franchisees sign a release, only with respect to non-wishart Act claims, in compliance with the terms of the franchise agreement. The franchisees refused to sign any release on the basis that section 11 the Wishart Act prohibited and rendered void any release of claims under the Act and commenced an application to have the provision declared unenforceable. 1) The term requiring a general release was found to be void and unenforceable. Although the actual release requested by Cora was not void pursuant to the Wishart Act, the term of the franchise agreement requiring a general release which Cora relied upon was found to be unenforceable, even with respect to requesting a release of only non- Wishart Act claims ONCA 152 < [Cora Releases].

16 In order to ensure that contractual terms requiring a release of claims upon assignment, renewal or transfer are enforceable, franchisors should be careful to limit the contractual requirement to releases of claims only to the extent permitted by applicable law, especially with respect to the Wishart Act. Otherwise, the term may be ineffective, even with respect to requiring a release of non-statutory claims.