Canada: Ontario Court Overturns Wrongful Termination Of Franchise Agreement By Franchisor

In the recent case of ANC Business Solutions Inc. v. Virtualink Canada Ltd. in the Ontario Superior Court of Justice, Justice Perell considered whether Virtualink, the franchisor of a franchise system offering "executive office suites," had unlawfully terminated ANC, one of its franchisees.

This cautionary case illustrates the risk to a franchisor that terminates a franchisee without complying with the notice requirements in the governing franchise agreement. The case also shows that a settlement agreement will not supersede or modify the notice requirements in a franchise agreement, unless it is explicit.

Virtualink's franchise system, which operated under the brand "Intelligent Office," involved renting office suites and providing various office support services, including (and importantly to this case) a voicemail system.

The parties entered into a Franchise Agreement on April 22, 2010.  Setting up the franchise required a significant investment, which included a $60,000 franchise fee and leasehold improvement costs of approximately $500,000. ANC was also required to purchase a technology system, which included phones and voicemail system, for approximately $80,000.  After making investments which totalled approximately $1 million, ANC opened its business in early 2011.

Although it received only a passing mention in the Court decision, ANC served a Notice of Rescission on April 20, 2012, just two days before the expiry of the two year period in which a franchisee can assert a rescission claim under section 6(2) of the Arthur Wishart Act. Not long after the service of the Notice of Rescission, in June 2012, the franchisor purported to terminate the franchise. 

In July 2012, the parties entered into a Settlement Agreement, pursuant to which the franchisor agreed to retract its Notice of Termination and the franchisee agreed to retract its Notice of Rescission. Importantly, the Settlement Agreement did not alter or supersede section 18 of the Franchise Agreement, which required that the franchisor give thirty days' notice of termination. During the thirty day notice period, the franchisee could cure the default and avoid termination.

On October 17, 2013, ANC had a technical malfunction in its voicemail system. The system could not be immediately fixed, and on October 30, 2013, the franchisor delivered a Notice of Default.  While the franchisee was making efforts to fix the voicemail system and cure the default, the franchisor terminated the franchise and the sublease on November 7, 2013, less than 30 days from both the malfunction and the Notice of Default.

ANC commenced an application, seeking immediate reinstatement as a franchisee, as well as the right to re-enter its subleased premises and resume its franchise's business operations.  ANC also sought damages for breach of the Franchise Agreement.  As alternative relief, ANC sought relief from forfeiture under the Commercial Tenancies Act.

The franchisor argued that the Settlement Agreement introduced a "one-strike policy" which gave it the right to terminate the franchise immediately. The franchisor also argued that the seriousness of the breach and the risk to the "integrity of the franchise system" entitled the franchisor to immediately terminate this franchisee. Justice Perell disagreed.

Justice Perell found that the franchisor did not give thirty days' notice, as required by section 18 of the Franchise Agreement. In doing so, the franchisor breached the Franchise Agreement.  The judgment is clear that "nothing in the 2012 Settlement Agreement that alters the provisions in the Franchise Agreement or in the associated Agreements that requires the Franchisor to provide the franchisee with an opportunity (or an extended opportunity) to remedy a default."

Justice Perell further held that "the notion that ANC's alleged default went to the core of the franchise system and compelled the franchisor to terminate the franchise is an after-the-fact attempt by the franchisor to justify its own breach of the Franchise Agreement."

In the result, Justice Perell reinstated the Franchise Agreement and held that ANC is entitled to damages due to the franchisor's breach. Justice Perell ordered that there be a trial to determine the quantum of damages, whether the franchisor breached their duty of fair dealing under section 3 of the Arthur Wishart Act  and whether the franchisor could require ANC to operate with a new Cloud-based phone message system.

The clear instructive point to be taken from this case is that franchisors run a major risk in terminating a franchisee without complying with the applicable notice requirements in the franchise agreement, and that franchisors should be careful to ensure that they have proper grounds to terminate in accordance with their franchise agreements. 

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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