Canada: Alberta Court Clarifies Scope Of Duty Of Good Faith In Franchise Context

Last Updated: April 25 2017
Article by Trevor R. McDonald

Introduction

Since the Supreme Court of Canada's decision in Bhasin v. Hrynew (Bhasin),1 the extent of the contractual duties of good faith and honesty have been of significant interest to commercial contracting parties. This is particularly so in the franchise context, where franchisors and franchisees also have a statutory duty of fair dealing in the performance and enforcement of the franchise agreement.2 In Seto v. Wendy's Restaurants of Canada (Seto),3 the Alberta Court of Queen's Bench (the Court) clarified the guidelines for the application of the duties of good faith and fair dealing where a franchisor is contemplating the termination of a franchise agreement.

The Issue

In Seto, the franchisees conceded that they were in breach of the franchise agreement, and that the franchisor, Wendy's, was entitled to exercise its contractual rights of termination. The issue was, in the face of discussions that the franchisees had been having with potential purchasers prior to the termination, whether Wendy's was obligated to permit the franchisees to sell the franchise as a going concern, or to sell it on their behalf, rather than seize the assets and facilitate their liquidation.

The Facts

The franchisees operated a Wendy's restaurant franchise in Camrose, Alberta. On March 1, 2011, after falling into financial difficulty, the franchisees entered into a conditional purchase and sale agreement with a potential purchaser of their franchise business. That same day, in response to a request from the franchisees, Wendy's provided copies of its standard transfer application package. The franchise agreement required Wendy's to act reasonably in considering whether to allow a transfer, and set out a number of criteria that transferees had to meet. On March 8, 2011, the Department of Justice notified Wendy's that it had had issued writs of seizure and sale with respect to the franchisees' assets, which included its restaurant equipment and the franchise license, due to unpaid taxes and source deductions owed to Canada Revenue Agency (CRA). On March 17, 2011, as the franchisees were in default under their franchise and sublease agreements by failing to make timely payment of rent, royalties and other payments owed to Wendy's, and by neglecting to pay taxes to CRA resulting in the asset seizure, Wendy's terminated the agreements. Wendy's took possession of the restaurant and its assets and converted the franchise into a corporate store. The tangible assets were later appraised, and then sold to Wendy's through a private sale by the civil enforcement agency.

Claims of the Franchisee

The franchisees sued Wendy's, claiming that they had suffered substantial losses as a result of Wendy's termination of the franchise in the face of a potential sale. They also claimed that Wendy's was obligated to maximize the return on the assets, by permitting or promoting the sale of the franchise to a new franchisee as a going concern. The franchisees argued that Wendy's had breached its contractual and statutory duties of good faith and fair dealing.

The Decision

The Court reviewed the jurisprudence on fair dealing and good faith in the franchise context, both before and after Bhasin. The Court concluded that to establish a breach of duty, the franchisees needed to show that the termination was contrary to the provisions of the contract, or that it was done dishonestly or for an improper purpose. In this case, the termination was authorized under the default provisions of the franchise agreement, and there was no evidence that Wendy's real purpose was to frustrate the prospective sale. There was also no evidence that the transfer application was ever completed or provided to Wendy's, or that the purchase offer was still valid at the time of the termination. The Court dismissed the franchisees' claims and awarded summary judgment to Wendy's.

The Court held further that the duties of fair dealing and good faith could not be used to alter the express terms of the contract, which in the Seto case, contained a clause stating that any and all goodwill arising from the franchise business would inure to the benefit of Wendy's. This effectively precluded the franchisees from claiming compensation for any goodwill lost as a result of the termination. In the absence of a specific contractual clause, Wendy's had no legal duty to maximize the realization of the assets for the franchisees' benefit and no obligation to sell the franchise business as a going concern.

The Court left open the possibility that, in different circumstances, a franchisor may have a duty to preserve the franchisees' remaining interests in the business and assets. For example, if a specific, binding and imminent sale opportunity is disclosed to the franchisor prior to termination, this could impact the analysis.

Concluding Thoughts

It would be prudent for franchisors considering terminating a franchise agreement in the face of a franchisee's request or known intention to sell or transfer their franchise rights, to carefully review the termination and transfer provisions in the franchise agreement and its transfer policies before deciding on a course of action. Where there is a proposed sale to a qualified purchaser that is ready to close, the franchisor should exercise additional scrutiny and caution. The reasons for the termination and the contractual clauses relied upon by the franchisor should always be clearly expressed to the franchisee in writing to reduce the likelihood of a finding of improper purpose or an absence of fair dealing.

Conversely, franchisees who are contemplating a sale or transfer should request and review the franchisor's transfer policies and procedures, vet prospective transferees in accordance with those criteria and keep the franchisor highly involved in and informed of the application and transfer process.

Footnotes

1 Bhasin v. Hrynew, 2014 SCC 71, [2014] 3 S.C.R. 494 (S.C.C.)

2 See for example the Franchises Act, RSA 2000, c. F-23, section 7.

3 Seto v. Wendy's Restaurants of Canada, 2016 ABQB 493, 43 Alta. L.R. (6th) 96 (Alta. Q.B.).

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