Ontario Court of Appeal opens door to liability of franchisors’ associates for bad faith

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On May 3, 2016, the Ontario Court of Appeal released an important decision in the case of Addison Chevrolet Buick GMC Ltd. v. General Motors of Canada Ltd. about the liability of franchisors’ associates for bad faith conduct.

The appeal was from the decision of a judge on a motion to strike under rule 21 of the Rules of Civil Procedure. The motion judge dismissed the franchisees’ claim against GM Canada’s parent company, GM US, for breach of the duty of good faith. The Court of Appeal reversed that decision and allowed the case against GM US to continue to trial.

It has been considered by some, who had espoused a strict interpretation based on the plain wording of section 3 of the Arthur Wishart Act (Franchise Disclosure), 2000, that the statutory duty of good faith in franchising is restricted to parties, i.e., signatories, to the franchise agreement.

The Court of Appeal adopted a flexible approach to the interpretation of the common law and statutory duties of good faith in franchising. It expressly left the door open for courts to hold franchisors’ associates liable to franchisees, on appropriate facts, under either the statutory or common law obligation of good faith in franchising.

Procedurally, the rule 21 motion to strike, from which the appeal was made, required the motion judge to apply a relatively low legal threshold and uphold the challenged cause of action unless it was “plain and obvious” that it had no reasonable likelihood of success. In this case, the motion judge failed to apply the correct legal test.

The motion judge, Justice Sean Dunphy, fundamentally misapplied the correct legal test on a motion to strike, as the Court of Appeal had to repeatedly state throughout the decision.

Outline of the key facts

A group of long-standing GM franchisees in the Greater Toronto Area brought an action against various GM companies for breach of the duty of good faith. The franchisees’ action alleged that GM breached the duty of good faith and fair dealings under the Act and at common law. Specifically in respect of the appeal, the allegation in issue was in respect of the Canadian franchisor’s US parent company.

During the 2009 financial crisis, GM and GM Canada approached the US and Canadian governments for financial aid. After that, GM commenced bankruptcy proceedings in the US. As part of the bankruptcy proceeding, GM’s assets were transferred to a new company, GM US.

As part of this reorganization, GM US acquired the shares of GM Canada. As a result of their substantial investments, the Ontario and Canadian governments also became shareholders of GM US.

After that time, GM Canada announced a restructuring of the Canadian dealer network. This included terminating some franchisees and retaining others but only on certain conditions. The conditions involved significant changes in the business model, including the discontinuance of the Pontiac brand and medium duty trucks, significant renovation requirements, and possible dealership relocations.

In 2010, the franchisees signed new dealer agreements with GM Canada for a five-year term. The agreements were substantially identical to the earlier dealer agreements that were signed in 2005.

The franchisees claimed that GM preferred its own profit over their interests. For example, they earned only a small profit on the sale of new vehicles, while GM generated the bulk of the profits. Instead, they had to rely on revenue from ancillary services, such as post-sale service and parts sale.

And they argued that GM’s focus on profits created uncompetitive vehicle offerings and resulted in GM’s refusal to offer incentives to dealers in an effort to increase market share.

Further, the franchisees claimed that GM financially assisted U.S. dealers while ignoring its duty to dealers in the Toronto area.

In the litigation, the franchisees acknowledged that GM US was not a signatory to the franchise agreements. However, they claimed that – because of the extent of its control of GM Canada – GM US was a ‘franchisor’s associate’ under the Act and was bound by the duty of good faith under section 3 of the Act and at common law.

The GM parties advocated for a strict interpretation of section 3 of the Act. They argued that the duty of good faith, whether under the Act or at common law, extended only to parties that were signatories to the franchise agreement.

“Grant of a franchise” may arise out of a renewal or reconstituted franchise relationship

The Court of Appeal held that the motion judge erred in concluding that the 2010 dealer agreements could not constitute a “grant of a franchise”, and that this determination could only be made based on a full record.

In addition, the Court ruled that the motion judge erred in relying on documentation as evidence in support of his finding that GM US did not exist when the 2010 dealer agreements were signed. In particular, the evidence did not indicate when GM US was created.

Franchisors’ associates may owe duty of good faith

The franchisees alleged that GM US was the real decision maker in the grant and operation of the franchises.

There was evidence to indicate that the Canadian and US markets were tightly integrated as essentially one market and one network of dealerships. This was on many levels, including internal decision making, communications with franchisees and communications with governments.

In respect of the correct legal issue, the Court of Appeal ruled that the motion judge significantly erred by framing the issue as: whether a franchisor’s associate is deemed to be a party to the franchise agreement.

The Court held that the motion judge should have framed the question as: whether the duty of good faith could apply to a franchisor’s associate.

Specifically, the issue was not whether the franchisees were likely or unlikely to succeed. The Court noted that whether this cause of action was weak or strong could not be a factor on a motion to strike.

Rather, the issue was whether it was plain and obvious on the facts as pleaded that GM US could never owe a duty of good faith to the franchisees.

More broadly, the Court stated that the question was whether it was plain and obvious that a parent company and a franchisor’s associate which controls the market and sets the terms of the franchise agreement, like GM US, could never be considered a party to the agreement for purposes of the duty of good faith.

The answer to that could only be decided on a full record, not on a rule 21 motion to strike. This was even more so because there was limited jurisprudence and little appellate authority on the scope of the duty of good faith. As well, the decision on a full record would likely have important precedential value.

The Court cited with approval the 2010 decision of Cameron J. in the case of WP (33 Sheppard) Gourmet Express Restaurant Corp. v. WP Canada Bistro & Express Co. It followed Cameron J.’s interpretation of the statutory duty of good faith, namely, that the definition of a ‘party’ under this section incorporates a ‘more flexible approach’.

Further, the Court reasoned that a strict interpretation of the statutory duty of good faith under section 3 of the Act was also contrary to the overall remedial nature of the Act.

More bluntly, the Court stated that just because the real party in control did not sign the franchise agreement should not mean that it could escape liability for breach of the duty of good faith.

It ruled that GM US could be found to owe a duty of good faith to the franchisees under section 3 of the Act, even if there was no direct contractual relationship between GM US and the franchisees.

The special feature of a franchise relationship in this context was the vulnerability of the franchisee. The Court reasoned that where sufficient levels of control are alleged against the franchisor’s associate, and given the unique nature of the franchise relationship, it was possible that the common law duty would attach to the franchisor’s associate. The Court held that this was a novel argument, and since the scope of the duty has not yet been fully explored in the jurisprudence, the claim should not have been dismissed on a motion to strike.

The motion judge’s misconception of the test under rule 21

The Court of Appeal decision was a sharp rebuke of the decision of the motion judge, Dunphy J., who the Court found to have repeatedly misapplied the test under rule 21, and to have embarked on a flawed approach (at paras 47-49):

The motion judge’s approach to this issue demonstrates a continued misapplication of the rule 21 test… By framing the issue in the way he did, the motion judge embarked on a flawed approach…. It appears as though the judge approached the motion as if it were a motion for summary judgment.

The Court also noted that some of Dunphy J.’s reasoning was circular. It further expressed its disapproval of Dunphy J.’s approach in weighing the evidence and concluding that the franchisees would not succeed based on his assessment of the evidence (which cannot be done under a rule 21 motion to strike). It appears that, as the Court of Appeal noted, Dunphy J. mixed up the test for a summary judgment motion under rule 20, with the very strict test on a motion to strike under rule 21.

It is regrettable when a motion judge fundamentally misapplies well-established legal tests under the Rules of Civil Procedure, such as the test under a rule 21 motion to strike. It should be noted that this is a relatively rare occasion in Canadian courts.

This article is provided for information purposes only. Law Works’ Franchise Law Blog does not provide legal advice.

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