On January 14, 2016, the Ontario Court of Appeal released its decision in the case of 1250264 Ontario Inc. v. Pet Valu Canada Inc. This was an appeal and cross-appeal by the franchisees and the franchisor from the decision of a motion judge in a class action against Pet Valu relating to volume rebates.
At its core, the appeal had two parts, procedural and substantive, both revolving around the franchisees’ allegation that Pet Valu was liable for bad faith conduct as a result of failing to disclose in the pre-sale phase that it allegedly did not have significant purchasing power:
- Procedural: Whether the motion judge unduly intervened in the case by essentially helping the franchisees/plaintiffs to add this allegation to the class action common issue, well after the action was certified and the original common issues were defined, to the prejudice of the defendant, Pet Valu.
- Substantive: Whether there was merit to the franchisees’ allegation that Pet Valu was liable for bad faith conduct as a result of failing to disclose that it allegedly did not have significant purchasing power.
The Court of Appeal decided both issues in the affirmative:
- the motion judge unduly intervened in the case and caused prejudice to Pet Valu, and
- Pet Valu could not be held liable for bad faith conduct as a result of failing to disclose that it allegedly did not have significant purchasing power.
As a result, the Court dismissed the case in its entirety.
The decision is important for distinguishing between pre-sale disclosure and the duty of good faith which arises in the context of the performance of the franchise agreement, i.e., post-sale when the relationship is already in place. The Court held that breach by a franchisor of a disclosure obligation in the pre-sale phase cannot amount to breach of the obligation of good faith in the performance of the franchise agreement.
However, the decision does not address some important disclosure issues, which I explain further in this article:
- Whether non-existent volume purchasing power is inherently a material fact (i.e., not that the franchisor receives volume rebates, but to the contrary – that it has no volume purchasing power).
- Whether there is a difference between disclosure in the pre-contractual phase and disclosure in the renewal phase. The Court distinguished the Country Style case simply on the basis that it involved bad faith conduct in the renewal phase, rather than the pre-sale phase. But it did not address the fact that Country Style, where the same Court of Appeal affirmed a rescission against the franchisor for failing to provide disclosure, albeit in the renewal process – was not simply a bad faith case.
The Court of Appeal did not technically need to address these issues in order to dispose of the appeal, and so these issues are left to be addressed in future cases.
Relevant Procedural History of the Case
The class action was comprised of 150 former franchisees. At the class action certification motion, the original motion judge certified only one major head of claim to proceed by way of a class action – claims relating to volume rebates. The motion judge certified seven common issues.
After the certification motion, Pet Valu brought a motion for summary judgment to dismiss the class action in relation to all seven common issues. A new motion judge took over the case by then. He agreed with Pet Valu that, based on the seven common issues, the action of the franchisees should be dismissed entirely.
However, the new motion judge also suggested to the franchisees that they bring a motion to amend their statement of claim to add an eighth common issue, alleging bad faith conduct by failing to disclose that Pet Valu supposedly did not have major purchasing power.
This issue arose only after the CEO of Pet Valu submitted an affidavit in support of its motion for summary judgment. The motion judge misinterpreted the affidavit, as he himself later wrote, that Pet Valu had little to no purchasing power.
As a result, a new allegation arose that Pet Valu should be liable for bad faith conduct in failing to disclose this fact to the franchisees before they purchased their franchises, as an alleged material fact in the pre-sale disclosure phase.
Interestingly, the motion judge also found that the average franchisee’s cost of products was actually about 15% lower then prices available outside the system and that Pet Valu negotiated the best price it could obtain. In other words, Pet Valu did have significant purchasing power.
Ultimately, the motion judge ruled that adding this eighth common issue would be procedurally unfair to Pet Valu, which had defended the case all along based on the original seven common issues. The motion judge held that the case would have otherwise been dismissed with costs on the basis of the existing common issues.
Instead, the motion judge amended one of the existing seven common issues to incorporate into it the gist of what the eighth common issue would have been – the allegation that Pet Valu acted in bad faith in failing to disclose in the pre-sale phase that it did not have significant purchase power.
Procedural Ground of Appeal – Undue Intervention by the Motion Judge
The Court of Appeal held that the motion judge’s procedural conduct and decision in the amendment of the common issues was prejudicial to Pet Valu and that its appeal should be allowed and the action dismissed based on this ground alone.Essentially, the reasons were as follows:
- The motion judge recast an existing common issue on his own initiative after the completion of the summary judgment motion.
- The motion judge did not afford Pet Valu an opportunity to make responding submissions to this new allegation.
- But for the amendment, Pet Valu would have been successful on the entire action.
The Court held that a class proceeding motion judge should not, despite his or her important and challenging role in guiding the evolution of the class proceeding, make a suggestion at the conclusion of an otherwise dispositive motion about how the plaintiff might improve its position.
Franchisees’ Allegation regarding Pre-Sale Disclosure and Bad Faith
The franchisees claimed that Pet Valu failed to disclose that it did not have significant purchasing power, and that this disclosure failure amounted to breach of its good faith duty under section 3 of the Arthur Wishart Act (Franchise Disclosure), 2000.
In other words, the franchisees claimed breach of both sections 5 (disclosure) and 3 (good faith) as a result of the alleged failure to disclose.
The Court held that disclosure failure in the pre-contractual phase could not lead to breach of the good-faith obligation to enforce the franchise agreement because there was no contract in existence during the pre-sale phase. The disclosure obligation arose before the prospective franchisee became franchisees and before they became parties to the franchise agreement. Since a duty of good faith only arises in the performance of an existing franchise agreement, no such duty exists before the sale.
Critique and Analysis: Important Principles Remain Unanswered
The motion judge ruled that non-existent volume discounts constituted a material fact under the Act. The Court of Appeal chose not to deal with this discrete issue and so it remains open.
In my opinion, there is no basis for a court in a future case to find that, all things being equal, this may amount to a material fact. Such an allegation is inherently based on reverse logic: it implies as a starting point that a franchisor is presumed to receive volume rebates, and that absent disclosure to the contrary, a reasonable prospective franchisee assumes so in the normal course.
A more fundamental issue that was not fully developed is the difference between disclosure in the pre-sale and renewal phases.
The Court distinguished the decisions in Salah v. Timothy’s Coffees of the World Inc. and 1159607 Ontario Inc. v. Country Style Food Services Inc. (the author acted as counsel for the plaintiff in the Country Style decision) as cases of bad faith, involving deliberate nondisclosure about the status of the lease in the context of renewal. In other words, the Court characterized Salahand Country Style as bad faith cases arising squarely in the context of the “performance” of the franchise agreement – not in the pre-sale phase.
In my opinion, this is correct but does not tell the full picture. The Salah and Country Style are certainly premised on a fundamentally different factual basis from Pet Valu – a renewal, and therefore an existing contract in place, rather than a pre-sale phase with no existing agreement.
However, the Court did not address the fact that Country Style (but not Salah) does have direct implications to the interplay between disclosure and bad faith. The problem with the Court’s characterization of Country Style as purely a bad faith case is that in Country Style (affirmed on appeal to the Court of Appeal) the franchisor was held liable for concealing the lease termination not only as bad faith conduct but also in its renewal disclosure obligations, resulting in disclosure-based rescission damages.
The Court in Pet Valu did recognize the potential for bad faith resulting from nondisclosure, but of a different kind – the one purely arising from obligations under the franchise agreement, not disclosure-based. It touched briefly on the the impact of the 2014 decision of the Supreme Court of Canada in Bhasin v. Hrynew on the duty of good faith in section 3 of the Act. It summarized the good faith duty imposed in Bhasin in one coherent sentence: “a simple requirement not to lie or mislead the other party about one’s contractual performance.”
In franchising, the Court stated that it was assuming, without deciding, that nondisclosure by a franchisor in the course of the performance or enforcement of the franchise agreement (as distinguished from nondisclosure in the pre-sale phase), could constitute a breach of section 3 of the Act. So, nondisclosure of an important fact in the course of an ongoing franchise relationship under the terms of the franchise agreement may amount to bad faith conduct.
But this principle fails to recognize the renewal disclosure phase under section 5 of the Act. While the Court of Appeal in Pet Valu was correct to find that pre-sale disclosure failure cannot lead to bad faith conduct, it did not acknowledge that the situation in Country Style also involves disclosure failure – albeit in the renewal phase.
In my respectful opinion, the differentiation that the Court of Appeal should have made is that pre-contractual disclosure is fundamentally different from renewal disclosure, and that of course both are governed under the very same disclosure scheme in section 5 of the Act.
In the pre-sale phase, there is no contract in place between the parties, and therefore disclosure failure, however egregious, cannot lead to bad faith conduct. But in the renewal phase, a franchise agreement is in place, and disclosure failure could at the same time result in bad faith conduct, as was held in Country Style.
In a renewal, the continuing obligation on the parties to perform the contract in good faith is on top of, not instead of, the obligation on the franchisor to provide disclosure as part of the renewal process.
The Court of Appeal did not address what is invariably a developing fundamental difference between failure to provide disclosure in the pre-sale and renewal phases.