Canada: Dealing With The Duty Of Good Faith And Fair Dealing In Franchise Agreements

Last Updated: October 23 2013
Article by W. Brad Hanna, FCIArb., Robert E. Glass and Stuart English

The duty of good faith and fair dealing

Provincial franchise legislation imposes a duty of fair dealing on parties whenever they are performing or enforcing the provisions of a franchise agreement.1 Canadian courts have generally noted that the statutory duty of fair dealing is a codification of the common law duty of good faith, which precludes contracting parties from acting in bad faith when exercising discretionary contractual powers.2

In terms of general principles, the duty of good faith requires contracting parties to:

  • exercise powers with due regard to the interests of the other party, but they are not required to prefer the interests of the other party over their own;
  • observe standards of honesty, fairness and reasonableness; and
  • act with proper motives and not arbitrarily, capriciously or in a manner that is inconsistent with the reasonable expectations of the parties.

Although the law remains in a state of development, thus far the duty of good faith has been held not to create new, unbargained for, rights and obligations or alter the express terms of the contract reached by the parties.3 Rather, the duty is applied to ensure that parties do not act in a way that eviscerates or defeats the objectives of the agreement.

If the statutory duty of fair dealing is a codification of the common law duty of good faith, can the scope and content of this duty be tempered by the terms of a franchise agreement? The answer is, to some extent, yes.

Tempering The Duty Of Good Faith And Fair Dealing In Your Franchise Agreements

Franchise cases in Ontario confirm that neither the common law duty of good faith nor the statutory duty of fair dealing are intended to replace or amend express contractual provisions.4 Consequently, when considering whether a party has demonstrated good faith and fair dealing, the impugned conduct must be assessed in light of the provisions of the franchise agreement (as well as the relevant factual circumstances of any particular case). In two recent Ontario franchise decisions that illustrate this point, Fairview Donut Inc. v The TDL Group Corp. ("Tim Hortons")5 and Spina v Shoppers Drug Mart Inc. ("Shoppers Drug Mart"),6 the court rejected bad faith and unfair dealing claims because they ran up "against the wall" of the express provisions of the relevant agreements.

In Tim Hortons, the plaintiff franchisees alleged that Tim Hortons violated its good faith and fair dealing obligations by, among other things, requiring franchisees to change their baking methods and to make certain items available at all times. The plaintiffs complained that these changes reduced their profits, thereby violating the duty of good faith and fair dealing. Tim Hortons successfully moved to dismiss the proposed class action on a summary judgment motion.

Confirming that the good faith and fair dealing duty does not trump the express language of the franchise agreement, the court held that the agreement permitted Tim Hortons to implement these changes, set the prices for supplies that franchisees were required to purchase and specify the maximum selling prices for all menu items.7 The court noted that its responsibility is to give effect to the agreement between the parties and require them to discharge their obligations fairly, in good faith and in a commercially reasonable manner – not to re-write the contracts.8

Ultimately, the court found that the relevant test is whether a franchisor's conduct, taken as a whole in light of the provisions of the franchise agreement, nullified the bargain made by the parties.9 The court concluded that the changes implemented by Tim Hortons were authorized by the agreement, the result of a commercially rational business decision, and that Tim Hortons had fairly considered the interests of its franchisees (and consulted with them) prior to implementing the changes. At the end of the day, franchisees remained overwhelmingly profitable notwithstanding the changes that made some items less profitable or loss leaders.

In Shoppers Drug Mart, the plaintiff franchisees commenced a class action alleging, among other things, that Shoppers breached its franchise agreements and operated the franchise system contrary to the duty of good faith and fair dealing in several respects. In short, the plaintiffs alleged that Shoppers was not sharing the profits with its franchisees. The franchisor successfully moved, prior to certification, to strike certain of the claims as disclosing no cause of action.

One of the good faith and fair dealing claims the court struck was the plaintiffs' allegation that Shoppers did not share rebates it received from suppliers with franchisees. The court found that the express terms of the agreement, properly interpreted, permitted Shoppers to retain the benefits of any supplier rebates. The court held that the good faith and fair dealing claim for rebates "run[s] up against the wall" of the franchise agreement, and struck the allegation.10

The court refused, however, to strike other alleged breaches of good faith and fair dealing claims where, as a matter of interpretation, it was not plain and obvious that the franchise agreement authorized Shoppers' conduct.11

Drafting Lessons

The decisions in Tim Hortons and Shoppers Drug Mart confirm that the express provisions of a franchise agreement are relevant to assessing breach of good faith and fair dealing claims. These cases stand for the proposition that a franchisor, who acts fairly under an express right or power reserved by it in the franchise agreement, does not violate the duty of good faith and fair dealing.

Accordingly, although the duty of good faith and fair dealing cannot be excluded by a franchise agreement,12 the scope and effect of this duty may be tempered by the terms of a well-drafted contract since the duty does not override unambiguous provisions of a franchise agreement.

Some drafting points and best practices to consider:

  • Clarity is Critical – Avoiding uncertainty is important when drafting any contract, but more so for franchise agreements because, as they are contracts of adherence (i.e. non-negotiable), ambiguity will generally be resolved in favour of franchisees.13 An express provision in a franchise agreement authorizing a franchisor's actions will only be an effective defense to a claim for breach of the duty of good faith or fair dealing if that provision is clear and its terms are followed by the franchisor. Uncertainty can arise from ambiguous or vague wording, as well as conflicts and inconsistency among the documents forming the franchise agreement (including manuals or policy statements that are incorporated by reference).
  • Be Specific – Using broad wording to describe a franchisor's rights or powers leaves more room for a court to fill in the details, or otherwise limit the scope of a franchisor's authority.14,15 While franchisors need broad powers for system control and to adapt and respond to competition and market changes, and it is difficult to anticipate the many actions they may need to take, it pays to be specific, particularly with respect to matters having a significant impact on franchisees' profits. The challenge for drafters is to be specific without constraining the scope of a franchisor's rights, including making system changes, or creating an excessively long and detailed franchise agreement.
  • Disclose, Consult and Get Input – It will be easier for a franchisor to demonstrate it had due regard for the interests of franchisees if, prior to a franchisor implementing changes, franchisees are given information about the impact and an opportunity to provide feedback. Having a franchisee advisory committee composed of respected franchisees who are to communicate with other franchisees about prospective changes provides an effective alternative to dealing with all individual franchisees, particularly if the consultation process involves due consideration and adaptation, as appropriate, in response to committee feedback.16 Some franchisors are hesitant to establish franchisee advisory committees, but knowing of franchisee concerns at an early stage gives franchisors an opportunity to address them before relationships have deteriorated unduly.
  • System Change – Include a provision in the franchise agreement acknowledging the need for system changes over time and the franchisor's right to adapt the system.
  • Limit Definition of Franchise Agreement – Franchisors generally incorporate by reference key aspects of their franchise system without including them within the signed franchise agreement (often done through manuals which are adapted over time), and need to be able to implement changes without always getting new agreements or amendments signed by each franchisee. However, the "franchise agreement" (which determines the nature and scope of a franchisor's rights and obligations) does not necessarily include any and all documents and information subsequently provided to franchisees. There is a risk if documents distributed to franchisees are prepared without the necessary level of care or attention to the legal consequences, and may lead to an interpretation contrary to the franchisor's intent.17

In light of these recent franchise cases, it may prudent for franchisors to revisit the wording of their franchise agreements and their practices, with a view to lessening the risk of litigation.

Footnotes

1 Arthur Wishart Act (Franchise Disclosure), 2000, SO 2000, c. 3, s. 3; Franchises Act, RSA 2000, c. F-23, s. 7; The Franchises Act, SM 2010, c. 13, s. 3; Franchises Act, SNB 2007, c. F-23.5, s. 3; Franchises Act, RSPEI 1988, F-14.1, s. 3.

Lansbridge Auto Corp. v Midas Canada Inc., [2009] OJ No. 1279 (SCJ); Machias v Mr. Submarine Ltd., 2002 CanLII 49643 (OSCJ); 1117304 Ontario Inc. v Cara Operations Ltd., [2008] OJ No. 4370 (SCJ).

Transamerica Life Canada Inc v ING Canada Inc, 2003 CarswellOnt 4834, 68 OR (3d) 457 (OCA) at para. 53. See also Agribrands Purina Canada Inc v Kasamekas, 2011 ONCA 460, 2011 CarswellOnt 5034 at paras. 50-51.

Pointts Advisory Ltd. v 754974 Ontario Inc., [2006] OJ No. 3504 at para. 55 (SCJ); Agribrands Purina Canada Inc. v Kasamekas, [2011] OJ no. 2786 at para 51. (C.A.); Fairview Donut Inc. v The TDL Group Corp., 2012 ONSC 1252 (CanLII) at para 500, aff'd 2012 O.C.A. E67 (CanLII); and Spina v Shoppers Drug Mart Inc., 2012 ONSC 5563 (CanLII) at paras 148 and 206. A similar statement was made by the court in another Shoppers case: Robert Moore Pharmacy Ltd. et al v Shoppers Drug Mart Inc, 2012 ONSC 7351 (CanLII).

Fairview Donut Inc. v The TDL Group Corp., 2012 ONSC 1252 (CanLII), aff'd 2012 ONCA E67 (CanLII).

Spina v Shoppers Drug Mart Inc., 2012 ONSC 5563 (CanLII). This was only a decision on motions regarding certification and pleadings, but provides useful commentary on the duty of good faith.

Tim Hortons, at paras 516, 521- 532 and 672.

Tim Hortons, at para 516.

Tim Hortons, at para 527.

10 Shoppers Drug Mart, at paras 206 and 221 - 242.

11 Shoppers Drug Mart, at paras 208 - 210.

12 For example, section 11 of Ontario's Arthur Wishart Act (Franchise Disclosure), 2000 (the "Ontario Act") states that a waiver or release by a franchisee of a right under the Act is void. Section 10 of the Ontario Act and section 17 of Alberta's Franchises Act render void any provision in any franchise agreement restricting the application of Ontario or Alberta (as applicable) law or the jurisdiction of their courts.

13 Franchise agreements require greater clarity (that is, the absence of ambiguity) given that the contra proferentem rule will be applied against a franchisor to interpret ambiguous provisions in favour of the franchisee: Spina v Shoppers Drug Mart Inc., at para. 140. In Shoppers Drug Mart several of the plaintiffs' claims were not struck due, in part, to ambiguity in the franchise agreement.

14 While a franchisor may desire broad powers and discretion, the duty of good faith and fair dealing require a franchisor to exercise those rights reasonably. Indicating that a franchisor may exercise a right "in its sole discretion" is unlikely to be of assistance (and such wording may actually be harmful). Prescribing the circumstances in which, or bases upon which, a franchisor may exercise its rights should help demonstrate that it acted reasonably.

15 A franchisor must give "due regard to the interests of the franchisee" (Tim Hortons, at 502), which is one of the hallmarks of acting in good faith. This aspect of the duty of good faith may give rise to an implied duty to disclose financial or operational information. While the plaintiffs in Shoppers Drug Mart were unsuccessful in their claims that the failure to disclose financial information to franchisees amounted to a breach of the duty of good faith, a franchisor will be on stronger ground defending these types of claims if the franchise agreement spells out what financial disclosure a franchisee is entitled to; or that a franchisee is not entitled to disclosure of certain financial information the franchisor does not intend to provide.

16 Franchisors need to be able to make changes affecting franchisees without the necessity of obtaining the consent of franchisees. However, when making changes, it will be helpful if a process under the franchise agreement is followed that allows for franchisees to provide input, in order to demonstrate that the interests of the franchisees are taken into account. Tim Hortons was able to demonstrate that it gave due regard to the interests of the franchisees by soliciting their input, through its advisory board composed of franchisees and other meetings with franchisees.

17 In order to provide a franchisor with flexibility and ease in updating policies and procedures, there is a temptation to very broadly incorporate ancillary documents into the franchise agreement. However, the Shoppers Drug Mart case illustrates the risks of an overly broad definition. The plaintiff relied on wording of memorandums, as well as another document describing the introduction of Shoppers' Distribution Centre, which were arguably incorporated by reference into the franchise agreement, in support of several claims. While not necessarily fatal to Shoppers in this case (one of claims was struck), they introduced uncertainty that might have been avoided. In this respect, franchisors must also be mindful of the definition of "franchise agreement" in the applicable legislation, which may include any agreement between the franchisor and franchisee relating to the franchise agreement.

The foregoing provides only an overview. Readers are cautioned against making any decisions based on this material alone. Rather, a qualified lawyer should be consulted.

© Copyright 2013 McMillan LLP

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W. Brad Hanna, FCIArb.
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