The Law of Good Faith in Franchising

Transcription

1 The Law of Good Faith in Franchising Best Practices and Practical Tips to Maximize Compliance and Mitigate Risk Adam Ship and Eli Lederman

2 The duty of good faith and fair dealing arises in different contexts. We will examine: 1. Introduction & General Principles. 2. The duty of honest performance. 3. Communications issues (including the extent of ongoing disclosure obligations). 4. Non-renewal of a franchise agreement. 5. Consent to Franchisee transfer assignment of the franchise to a third party. 6. Termination of a franchise agreement. 7. System-wide decisions (e.g., system change). 2

3 3 1. General principles underlying the duty of good faith and fair dealing: The duty of good faith has not created new, un-bargained for rights or obligations. The duty is implied with a view to securing the performance and enforcement of the contract made by the parties. The duty depends on the bargained objective, the benefit contracted for, and the original expectation of the parties.

4 4 The duty of good faith and fair dealing and the duty to act in accordance with reasonable commercial standards relate to the performance and enforcement of the franchise agreement. The duty is imposed in order to secure the performance of the contract the parties have made. It is not intended to replace the contract with another contract or to amend the contract by altering the express written terms of the franchise contract. It follows from this that in assessing whether a party has demonstrated good faith and fair dealing in the performance and enforcement of the agreement, the party s conduct must be considered in the context of and in conjunction with the contract that the parties have made. It is not a stand-alone duty that trumps all other contractual provisions. Fairview Donut Inc. v. The TDL Group Corp., 2012 ONSC 1252 (affirming Transamerica Life Canada Inc. v. ING Canada Inc., [2003] O.J. No (C.A.))

5 The duty of good faith is context-specific: 5 Good faith may be invoked in widely varying contexts and this calls for a highly context-specific understanding of what honesty and reasonableness in performance require so as to give appropriate consideration to the legitimate interests of both contracting parties. Bhasin v. Hrynew, 2014 SCC 71 [Courts must consider] the knowledge of the parties and the history of the dealings between them. [E]xtensive prior dealings between the parties inform the standard of fair dealing between them Canada Inc. v. Baton Rouge Restaurants Inc., 2013 ONCA 39

6 A finding of causation can determine a breach of the duty of good faith: 6 In Baton Rouge, the court held that no causation was established, since the franchisee would ultimately have been in the same position even had the franchisor acted as the franchisee alleged it ought to have. 1 In Shelanu, the court accepted that the franchisee s damages which were allegedly caused by the franchisor s competing franchise system were actually caused by prevailing economic conditions Canada Inc. v. Baton Rouge Restaurants Inc., 2013 ONCA Shelanu Inc. v. Print Three Franchising Corp., [2003] O.J. No (C.A.)

7 The legal standard for good faith is also best understood in its factual context: 7 The legal standard for good faith is often expressed in broad language, such as commercial reasonableness and the considerations of the legitimate interests of the franchisee. This requires a very context-specific application by the courts and depends on the unique facts at issue. 1. Shelanu Inc. v. Print Three Franchising Corp., [2003] O.J. No (C.A.)

8 8 The content of the duty of good faith and fair dealing has been expressed to include the following: to require the franchisor to exercise its powers under the franchise agreement in good faith and with due regard to the interests of the franchisee; to require the franchisor to observe standards of honesty, fairness and reasonableness and to give consideration to the interests of the franchisees; to ensure that the parties do not act in such a way that eviscerates or defeats the objectives of the agreement that they have entered into ; or destroy the rights of the franchisees to enjoy the fruits of the contract;... Fairview Donut Inc. v. The TDL Group Corp., 2012 ONSC 1252

9 9 to ensure that neither party substantially nullifies the bargained objective or benefit contracted for by the other, or causes significant harm to the other, contrary to the original purpose and expectation of the parties; and where the franchisor is given a discretion under the franchise agreement, the discretion must be exercised reasonably and with proper motive, and may not do so arbitrarily, capriciously, or in a manner inconsistent with the reasonably expectations of the parties. The duty of the franchisor to give consideration to the interests of the franchisee does not require the franchisor to prefer the franchisee s interests to its own [A] party may act self-interestedly, however in doing so that party must also have regard to the legitimate interests of the other party. Fairview Donut Inc. v. The TDL Group Corp., 2012 ONSC 1252

10 10 2. The duty of honest performance: In 2014, the Supreme Court of Canada released its decision in Bhasin v Hrynew 1. This case concerned whether and when parties to a contract owe each other obligations of good faith when performing their contracts, and what it means to say that they do. The dispute was between Heritage Education Funds, a national securities dealer which sells Registered Educations Savings Plans, and Harish Bhasin, an Enrollment Director who sold Heritage RESPs to the public pursuant to an agreement with Heritage. 1. Bhasin v. Hrynew, 2014 SCC 71.

11 The facts of Bhasin: 11 The agreement between Bhasin and Heritage provided that the contract was for a 3 year term and would renew automatically for another 3 year term unless either party provided 6 months written notice of the desire not to renew. Heritage exercised the Non-Renewal Clause and Bhasin sued for wrongful termination, inducing breach of contract and conspiracy. The trial judge held that Heritage had breached the Agreement because it had exercised the Non-Renewal Clause in bad faith. The trial judge held that Heritage had exercised the on-renewal for a bad faith reason (i.e., because Bhasin had refused to merge and because he had refused to submit to the audit). The trial judge found that Heritage failed to tell Bhasin certain material facts and had otherwise lied to Bhasin.

12 The Supreme Court s decision: 12 The SCC acknowledged that the impugned conduct in that case did not fit within an existing category where a duty of good faith had been recognized. The SCC then took two important steps as it relates to contract law: First, it recognized and affirmed the growing body of lower court cases that held that there exists a general common law duty to perform and enforce contracts in good faith. Second, it held that the general organizing principle of good faith embraces an overriding duty of honest performance.

13 13 I would hold that there is a general duty of honesty in contractual performance. This means simply that parties must not lie or otherwise knowingly mislead each other about matters directly linked to the performance of the contract. This does not impose a duty of loyalty or of disclosure or require a party to forego advantages flowing from the contract; it is a simple requirement not to lie or mislead the other party about one s contractual performance. Bhasin v. Hrynew, 2014 SCC 71

14 The Supreme Court s decision (cont d): 14 The SCC held that Heritage breached the duty of honest performance because it had been found by the trial judge to have lied to Bhasin and misled him about its intentions with respect to the merger and the audit. This amounted to a breach of the duty of honest performance because the conduct was intimately connected to the performance of the Non-Renewal Clause. It awarded Bhasin damages in the amount of $87,000, but agreed with the Court of Appeal that he was not entitled to the future loss of income.

15 15 3. Communication issues and the duty of disclosure

16 The obligation of responsiveness: 16 The Ontario Court of Appeal has previously identified a duty of repsonsiveness as part of good faith: The duty of good faith comprises a time component. That time component requires the party under a duty of good faith to respond promptly to a request from the other party and to make a decision within a reasonable time of receiving that request. Shelanu Inc. v. Print Three Franchising Corp., [2003] O.J. No (C.A.) This raises some practical challenges for franchisors who may be inundated with requests from franchisee.

17 No duty of ongoing disclosure: 17 In Spina, the court clarified that the duty of good faith does not require a franchisor to make ongoing disclosure to the franchisee for the purpose of allowing the franchisee to evaluate the franchisor s ongoing compliance with the franchise agreement. 1 This was recently affirmed by the Court of Appeal in Pet Valu. The court found that there is no duty of ongoing disclosure under Arthur Wishart Act and that franchisors cannot be burdened with a duty to disclose information that simply verifies whether they are meeting their franchise agreement obligations Spina v. Shoppers Drug Mart, 2012 ONSC Ontario Inc. v. Pet Valu Canada Inc., 2016 ONCA 24 (reversing Ontario Inc. v. Pet Valu Canada Inc., 2015 ONSC 29).

18 Active Concealment of Material Events 18 In Salah v Timothy's Coffees of the World Inc., the franchisor took active steps to ensure that the franchisee was not made aware of its intentions regarding renewal, including by intentionally failing to return phone calls and instructing the landlord to refrain from passing on any information to the franchisee. Similar findings made in Ontario Inc. v Country Style Food Services Inc. McCarthy Tétrault LLP / mccarthy.ca / Docs #123456

19 Best practices for franchisors (competing principles): 19 Conceptually challenging to balance the principles in Pet Valu, Shelanu, Salah and Bhasin in a practical manner No positive obligation to disclose material materials post-agreement (Pet Valu, Bhasin) but franchisors are obliged to respond promptly to reasonable requests by franchisees (Shelanu) and must be honest (Bhasin) Active concealment regarding a live issue which is material to the contract may breach good faith (Salah, Country Style)

20 Best practices for franchisors (considerations): 20 Depending on the issue, the risk to the franchisor in terms of damages is likely small However, in the context of litigation, a pattern of unresponsiveness can colour the court s assessment of a franchisor, even if remote from the key issue. There is a benefit to investing in systems that allow for documented, prompt and courteous communications with franchisees. McCarthy Tétrault LLP / mccarthy.ca / Docs #123456

21 21 4. Non-renewal of franchise agreements: In Ontario, the statutory duty of fair dealing applies with respect to the renewal or extension of a franchise agreement. Failing to adequately communicate in the context of franchise agreement renewal may give rise to breaches of the duty of fair dealing.

22 The test for breaching the duty of fair dealing: 22 Courts have found a franchisor breached its duty of fair dealing where it: (1) Deliberately withheld critical information from the franchisee; (2) Failed to respond promptly to inquiries from the franchisee; and (3) Failed to provide adequate disclosure to the franchisee.

23 However, the failure of a franchisor to renew an agreement does not itself amount to bad faith: 23 The fact that TDL and the defendants have been in a long-term profitable relationship does not convert into an obligation on TDL to renew the agreements. When a party enters into an agreement which contains no right to renew or an option to renew on ascertainable terms there will be no renewal enforceable by a court. If, however, the evidence discloses that a commitment made to renew on terms certain or ascertainable has been agreed to by the parties, or by the parties' conduct, then a court can infer that a contract to renew has been formulated. TLD Group Ltd. v Ontario Inc., [2000] O.J. No (S.C.J.)

24 24 This is consistent with Bhasin 1, where the Court found it was a considerable stretch to turn even a broadly conceived duty of good faith exercise of the non-renewal provision into what was, in effect, a contract of indefinite duration. 1. Bhasin v. Hrynew, 2014 SCC 71.

25 Arthur Wishart Act (Franchise Disclosure), 2000, S.O. 2000, c. 3: 25 Franchisor s obligation to disclose 5. (1) A franchisor shall provide a prospective franchisee with a disclosure document and the prospective franchisee shall receive the disclosure document not less than 14 days before the earlier of, (a) the signing by the prospective franchisee of the franchise agreement or any other agreement relating to the franchise; and (b) the payment of any consideration by or on behalf of the prospective franchisee to the franchisor or franchisor s associate relating to the franchise. Exemptions (7) This section does not apply to, (f) the renewal or extension of a franchise agreement where there has been no interruption in the operation of the business operated by the franchisee under the franchise agreement and there has been no material change since the franchise agreement or latest renewal or extension of the franchise agreement was entered into;

26 26 The determination of what constitutes a material change in the particular circumstances will be central to any allegations of bad faith in the context of purported non-disclosure: Arthur Wishart Act (Franchise Disclosure), 2000, S.O. 2000, c. 3: Definitions 1. (1) In this Act, material change means a change in the business, operations, capital or control of the franchisor or franchisor s associate, a change in the franchise system or a prescribed change, that would reasonably be expected to have a significant adverse effect on the value or price of the franchise to be granted or on the decision to acquire the franchise and includes a decision to implement such a change made by the board of directors of the franchisor or franchisor s associate or by senior management of the franchisor or franchisor s associate who believe that confirmation of the decision by the board of directors is probable;

27 27 5. Withholding consent to a franchisee transfer. Modern franchise agreements commonly contain detailed clauses that require the franchisee to meet very specific requirements as conditions precedent to the transfer. Many older franchise agreements simply provide that the franchisor will not unreasonably withhold its consent.

28 Where a franchisee transfer is subject to the consent of the franchisor, but the agreement is silent on the standard that applies to that decision, the franchisor will be required to meet the standards of good faith and fair dealing before withholding its consent. This standard also applies where the agreement provides that the franchisor will not unreasonably withhold its consent to a transfer. A franchisor will always be permitted to consider the suitability of the proposed transferee in deciding whether to grand consent, including whether the transferee is able to satisfy the financial and other covenants in the agreement. Consent to a proposed transferee cannot be denied for reasons unconnected to the contract. 28

29 A breach of the duty of good faith may be found where 29 the franchise agreement is silent on a requirement for the transferee to adopt the then current form of franchise agreement and the franchisor refuses to consent to the transfer because the transferee declines to sign an updated agreement. a franchisor refuses to consent to a transfer because it prefers to maintain the franchisee s territory/premises for its own purposes or another franchisee (the refusal may be found commercially unreasonably).

30 Guidance for franchisors: 30 A franchisor should ensure that it carefully evaluates the suitability of the proposed transferee and that any decision to withhold consent is reasonably with respect to the criteria set out in the franchise agreement. Franchisors seeking to mitigate their risk can do so by documenting the decision-making process and ensuring that ultimate decisions are based on the circumstances of the franchisee, the proposed transaction, and the proposed transferee.

31 31 6. Termination of franchise agreements: Parties are entitled to terminate a franchise agreement in accordance with its terms. Issues that arise in the context of termination include: (1) Whether the agreement requires notice prior to termination; (2) Whether the agreement requires a particular notice period; and (3) In the absence of a specified notice period, what constitutes reasonable notice in the circumstances.

32 The duty of good faith in the context of termination: 32 Courts have considered the duty of good faith in the context of termination of franchise agreements. The duty of good faith will not impose new obligations on parties when terminating that are inconsistent with the franchise agreement.

33 For example: 33 In C.M. Takacs Holdings 1, the franchise agreements permitted termination without notice upon the franchisee committing an act of bankruptcy. The franchisor terminated the agreements without notice on the basis that the franchisee was in arrears in respect of multiple obligations (incl. unpaid rent and tax arrears). The court rejected the submission that the duty of fair dealing required a notice requirement in this circumstance, as: (1) The agreement itself precluded it; and (2) The franchisees were sophisticated business entities. 1. C.M. Takacs Holdings Corp. v Canada Ltd., 2015 ONSC 5358.

34 Contractual Termination Without Cause 34 The Ontario Court of Appeal has suggested that there is no requirement to exercise without cause termination rights in good faith: The contract provided that Purina had the unconditional right to cancel the contract at any time on 60 days' notice. There is no doubt that this is the least burdensome mode of performance for Purina. [B]y finding an implied duty of good faith on Purina and then finding that Purina could not [terminate] because it breached that duty, the trial judge erred by using the good faith to alter the express terms of the contract Agribrands Purina Canada Inc v Kasamekas, 2011 ONCA 460 McCarthy Tétrault LLP / mccarthy.ca / Docs #123456

35 35 7. System changes that economically affect franchisees: The system-wide context generally entails greater deference shown by the courts to the decisions that franchisors make, with the context and circumstances facing the franchisor often playing a leading role in the court s analysis.

36 The circumstances of the franchisor plays a leading role in the court s analysis: 36 The specific context of [the franchisor s] conduct was that it was making crucial business decisions very quickly during a time of instability and flux for both [it] and its dealers. When considering each of the [specific alleged breaches of the duty of good faith] below I will review the statutory duty of fair dealing through the lens of commercial reality that is, [the franchisor s] conduct in that context. Trillium Motor World Ltd. v. General Motors of Canada Limited, 2015 ONSC 3824

37 Rational business decisions of the franchisor vs. the interests of franchisees: The Ontario Court of Appeal has indicated that it will consider whether a system change was a rational business decision made by the franchisor for valid economic and strategic reasons, having regard to both its own interests and the interests of its franchisees. The key to good faith compliance in this context is for the franchisor to illustrate both a rational business purpose and meaningful consideration of the interests of the network of franchisees. System changes that turn out to be incorrect or unprofitable should be protected from liability. 37 See Fairview Donut Inc. v. The TDL Group Corp., 2012 ONSC 1252 for all of the above.

38 Consultation as risk mitigation: 38 Franchisors can mitigate risk when making system changes through consultation with franchisees. 1 While the gold standard of consultation will not always be feasible or possible, it is worth considering if a substantial system change is contemplated. The court recognizes that change may not occur from within the system, but in response to wider market or industry forces, or may arise in situations of exigency or financial distress. Full-scale consultation may not be practical in these circumstances Fairview Donut Inc. v. The TDL Group Corp., 2012 ONSC Trillium Motor World Ltd. v. General Motors of Canada Limited, 2015 ONSC 3824.

39 Best practices from Fairview Donut: 39 The Fairview Donut case had a large evidentiary record that showed ongoing and transparent consultation throughout the development and implementation of system changes. The franchisor had a formal system in place for nonbinding consultation, which included a franchiseeelected advisory board and one-on-one consultation with individual franchisees. The Court of Appeal noted positively the franchisor s process for considering franchisees position. See Fairview Donut Inc. v. The TDL Group Corp., 2012 ONSC 1252 for all of the above.

40 Two words of caution: The analysis must always begin with the franchise agreement. Courts are careful to ensure that franchisors do not attempt to circumvent specific contractual rights of franchisees by relying on general or catch-all reservation of rights clauses in favour of franchisors The Fairview Donut decision may be distinguishable due to the fact that the franchisor had obtained broad franchisee support for the proposed system change. Notably, the level of franchisee support has been incorporated into the analysis of U.S. courts Fleet Mobile Tyres Ltd. v. Stone, [2006] EWCA Civ (Eng. C.A.); Ontario Inc. v. Pizza Pizza Ltd., [1995] O.J. No. 936 (S.C.J.). 2. Fairview Donut Inc. v. The TDL Group Corp., 2012 ONSC 1252; E. Dunham and K. Toomeh, The Evolution of the Species: Successfully Managing Franchise System Change ( ) 24 Franchise Law Journal 231.

41 Conclusion 41 The case law dealing with the duty of good faith continues to evolve, especially in the context of franchising relationships. We have attempted to group the relevant cases according to their subject matter in order to reflect the general principle that the circumstances and context of a good faith dispute will determine its outcome. We have attempted to provide practical tips and best practices for franchisors and their counsel to comply with the duty and mitigate risks.

42 Thank You Adam Ship Partner, Co-Chair Franchise & Distribution Group McCarthy Tétrault LLP Phone: Eli Lederman Partner Lenczner Slaght Royce Smith Griffin LLP Phone:

43 Further Reading Jurisprudence Ontario Inc. v. Cara Operations Ltd., [2008] O.J. No (S.C.J.) Ontario Inc. v. Country Style Food Services Inc., 2012 ONSC 881, aff d 2010 ONCA Ontario Inc. v. Pizza Pizza Ltd., 2013 ONSC Ontario Inc. v. Pet Value Canada Inc., 2015 ONSC 29, rev d by 2016 ONCA Canada Inc. v. Baton Rouge Restaurants Inc., 2013 ONCA Ontario Ltd. v. Sobeys Inc., [2001] O.J. No. 723 (S.C.J.). ANC Business Solutions Inc. v. Virtualink Canada Ltd., 2014 ONSC Bhasin v. Hrynew, 2013 SCC 71. Camrad Inc. v. Café Supreme F& P Ltd., [1995] O.J. No (Gen. Div.). C.M. Takacs Holdings Corp. v Canada Ltd., 2013 ONSC Fairview Donut Inc. v. The TDL Group Corp., 2012 ONCA 867. Fleet Mobile Tyres Ltd. v. Stone, [2006] EWCA Civ (Eng. C.A.). France v. Kumon Canada Inc., 2014 ONSC Perfect Portion Holdings Co. v. New Futures Ltd., [1995] O.J. No (Gen. Div.). Pointts Advisory Ltd. v Ontario Inc., [2006] O.J. No Salah v. Timothy s Coffees of the World, [2009] O.J. No. 4444, aff d 2010 ONCA 673. Shelanu Inc. v. Print Three Franchising Corp., [2003] O.J. No (C.A.). Spina v. Shoppers Drug Mart Inc., 2012 ONSC TLD Group Ltd. v Ontario Inc., [2000] O.J. No Transamerica Life Canada Inc. v. ING Canada Inc., [2003] O.J. No (C.A.). Trillium Motor World Ltd. v. General Motors of Canada Ltd., 2012 ONSC 463. Other Materials Dunham, E. and Kimberly Toomey, The Evolution of the Species: Successfully Managing Franchise System Change, ( ) 24 Franchise Law Journal 231. Fotinos, H., A. Ship, and A. Aliferis, Ontario Court of Appeal Dismisses Pet Value Class Action, Clarifies the Scope of the Duty of Good Faith and Fair Dealing and Calls for Greater Judicial Restraint (21 January 2016), Canadian Appeals Monitor. Horkins, C. and D. Ronde, Change Before You Have To: Franchise Lessons from Canada s Donut Wars (21 May 2013), Mondaq.com. Ship, A. and M. Sohail, Franchise Renewals and Transfers in Canada s Common Law Provinces (2015) 35(2) Franchise Law Journal 237.