Canada: Just Desserts: British Columbia Finds In Favour Of Franchisor In Termination Case

Following a three-day summary trial in the Supreme Court of British Columbia, in Dairy Queen Canada, Inc. v. M.Y. Sundae Inc., Justice DeWitt-Van Oosten granted claims by the franchisor, Dairy Queen Canada, Inc., against a franchisee for breach of contract and passing off, while dismissing the franchisee's counterclaim for breach of contract and various breaches of the Arthur Wishart Act (Franchise Disclosure), 2000 (Wishart Act), including breach of the duty of good faith and fair dealing.

In agreeing with Dairy Queen's submission that a Mutual Cancellation and Release Agreement was a complete bar to the Counterclaim, the Court affirmed the "very strong public interest in the enforcement of contract," a fundamental principle of contract law that has sometimes been overlooked in the franchise context.

The decision confirms the enforceability of mutual cancellation agreements as a means of terminating struggling franchise relationships, and highlights how such agreements can be used to limit franchisors' liability on termination.

Facts

The case concerned a franchisee with a lengthy history of failing to meet its obligations under the franchise agreement. The franchisee was noted in default when the franchisor determined that it had repeatedly failed to meet its cleanliness standards, facilities standards and menu requirements. In particular, the franchisee refused to add Orange Julius® products to its menu, despite a system-wide requirement to do so.

When the franchisor determined that the defaults had not been remedied during the cure period, it proceeded to termination. However, rather than immediately exercising its termination rights under the franchise agreement, the franchisor offered to enter into a "Mutual Cancellation and Release Agreement" with the franchisee.

The Mutual Cancellation and Release Agreement was essentially a forbearance agreement that suspended what would otherwise be an immediate termination for a period of six months, during which the franchisee was permitted to continue operating the franchise and market it for sale. The agreement was intended to provide a final opportunity for the franchisee to recoup part of its investment.

The Mutual Cancellation and Release Agreement provided that the franchisee's rights would automatically terminate at the end of the six-month period. In exchange for the franchisor's agreement to delay immediate enforcement, the franchisee agreed to abide by the franchise agreement, remit its monthly reports and royalties on time, and, importantly, to release the franchisor of any and all claims.

The franchisee and its principals signed the Mutual Cancellation and Release Agreement.  However, during the six-month period of the agreement, the franchisee became delinquent in remitting its monthly reports and royalties. In consequence, the franchisor accelerated the termination to be effective approximately three weeks before the six-month period was to expire. Despite the accelerated termination, the franchisee refused to stop operating.

The Litigation is Commenced to Enjoin the Franchisee

The franchisor commenced litigation to enjoin the franchisee from operating as a Dairy Queen beyond the termination date.  An initial injunction was scheduled, but was ultimately avoided when the franchisee stopped operating on the eve of the hearing.

Shortly after the franchise was de-identified, it was converted into a new business called "Chicago Grill & Creamery." The franchisor asserted that this new business was a competitor of the Dairy Queen franchise system and that its operation contravened the non-competition covenants in both the Franchise Agreement and Mutual Cancellation and Release.

The franchisor then brought a second injunction to enjoin the franchisee and its principals from being involved in Chicago Grill & Creamery.  The second injunction was resolved by consent order, which required the principals of the franchisee to refrain from owning or operating Chicago Grill & Creamery and required that the business be operated as a sports bar.

Several months later, the franchisee commenced a counterclaim against the franchisor, seeking damages in excess of $1 million for breach of contract and various claims under the Wishart Act, including non-disclosure and breach of the duty of good faith.

The Summary Trial Decision

At the summary trial, the franchisor argued that the Mutual Cancellation and Release Agreement, which contained a robust release of the franchisor, was a complete answer to the counterclaim.

In response, the franchisee claimed that the Mutual Cancellation and Release Agreement was unenforceable on the basis that it had been entered into under economic duress and was an unconscionable bargain. In particular, the franchisee claimed not to have the benefit of legal advice when it signed the agreement.

The Court rejected the franchisee's claims, explaining that "The mere fact that the Cancellation and Release was entered into between a franchisor and a franchisee does not make it inherently suspicious, or presumptively cast doubt on the voluntariness of the franchisee's signature."

The Court further rejected the franchisee's argument that the agreement was unconscionable as a result of unequal bargaining power. The Court explained:

Counsel for the defendants made much of the difference between a franchisor and a franchisee in his submissions at the trial, which I appreciate is a factor that I should be mindful of; however, as indicated, I do not find that the defendants' suggested coercion or duress in the signing of the Cancellation and Release, economically or otherwise, is borne out on the evidence.  Moreover, I agree with the plaintiff that the Cancellation and Release is more generous on its face than the Agreement itself, allowing the franchisee time to recoup its investment through the sale of an operating franchise rather than immediate termination of the Agreement and an accompanying demand to cease and desist.

The ruling highlights the reluctance Courts will have to set aside mutual cancellation agreements, particularly when such agreements are more favourable to the franchisee than the termination rights under the existing franchise agreement.

Importantly, the decision confirms that an enforceable release can be built into mutual cancellation agreements and that such releases can be effective in limiting a franchisor's liability. In addition, from a franchisee-relations standpoint, a mutual cancellation presents an opportunity for a win-win corporate divorce by giving the franchisee a chance to sell their business.

Before exercising a termination right under a franchise agreement, franchisors should consider whether a mutual cancellation and release can be used to both limit risk and preserve goodwill with the franchisee.

Dairy Queen Canada, Inc., was represented by Colin Pendrith of Cassels Brock at the summary trial.

Footnote

Dairy Queen Canada, Inc. v. M.Y. Sundae Inc., 2017 BCSC 358

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