By: Anthony Pugh
Editor: Ben Hanuka

In 9925350 Canada Inc. v. Kevito Ltd., a July 12, 2021, decision of the Ontario Superior Court of Justice, the court granted an interlocutory injunction to the plaintiff franchisee restraining the franchisor from terminating or acting upon its purported termination of the franchise agreement.  The court also ordered the franchisor to not interfere with the franchisee’s continued operation of its business.  In addition, to ensure the franchisor did not single out the franchisee through unfairly stringent standards, the court prescribed unusually detailed instructions on how and when the franchisor was to carry out inspections of the franchisee’s business.

Key Facts

The parties had entered into a franchise agreement for a five-year term with three options to renew, each for a further five years.  The franchisee’s principal had invested $500,000 to acquire the franchise. The plaintiff franchisee’s business was one of the most profitable in the system.

Around the winter holidays of 2020/21, the franchisor conducted a series of inspections of the franchisee. The franchisee alleged that its staff was put under a microscope and that the franchisor was using a campaign of “ultra-rigorous” inspections as a pretext to take over the business.

On one occasion, the franchisor’s representatives spent 6.5 hours in the franchisee’s shop scrutinizing what allegedly were insignificant details.  Those included sink faucets, the tea in the cupboards and the accuracy of the refrigerator thermometer.

Another example noted by the court was a stringent requirement that drinks be stirred in a circular or figure-eight motion.  The franchisor could also change those instructions on a whim.

After the inspections, the franchisor stationed its inspector full time at the franchisee’s shop.  The inspector often noted such cleanliness errors as the floor of the shop being wet right after a customer had walked in and out on a rainy or snowy day.  There was evidence that the non-stop cleaning demands had exhausted the franchise staff and prevented it from properly attending to customers.

The evidence also showed that the franchisor did not apply the same standards to its own stores or other franchisees.  Photographs of corporate stores showed wet floors from customers tracking in rain and snow just as much as the franchisees’ premises did.

Under the franchise agreement, the franchisor had a right to terminate the agreement for any default, including violation of operating standards, on notice and failure by the franchisee to cure within 15 days.  On termination, the franchisor had a right to take over the business.

Shortly after, on January 6, 2021, the franchisor sought to terminate the franchise agreement and demanded all keys and security passwords so that it could begin operating the location itself.  The franchisor also presented the franchisee with a Surrender and Release agreement, giving the franchisee only 90 days to attempt to sell the franchise, with only two days to seek legal advice.  Failure to accept it would have resulted in the franchisor terminating the franchisee without a further opportunity to sell.

On top of all this, the termination dispute also hatched a financial dispute between the parties, as the franchisor began to charge the franchisee for the inspection personnel and legal fees it incurred in pursuing the matter.  After the franchisee objected to these amounts, the franchisor started withholding funds owed to the franchisee from online sales and gift cards.

The franchisee brought this injunction motion, to restrain the franchisor from interfering with its continued operation of the franchised business.

Commercial Reasonableness and Good Faith

The franchisee framed its injunction motion on the basis of breach of commercial reasonableness and the good faith obligation.  It took the position that the duty of good faith prevented the franchisor from taking the standards and procedures to the extreme, making them virtually impossible to adhere to.  It was especially so when the franchisor did not hold itself or its other franchisees to the same high standards.

The franchisee also argued that commercial reasonableness should have been interpreted in the business context, which took into the consideration the potential alternative motives of the franchisor.  Viewed in that light, the franchisor spending six hours scouring for infractions and deficiencies could show an attempt to create a false pretense for terminating the franchisee.

The franchisor argued that this accusation was false, and stricter health and safety standards were needed to be put in place as a result of the impeding COVID pandemic.

The court reiterated that the duty of fair dealing and good faith was imposed by the Arthur Wishart Act (Franchise Disclosure), 2000, and, at common law.  It also cited an earlier decision of the Court of Appeal which limited the extent to which a franchisor could impose its own interests to the detriment of the franchisee, even if the franchise agreement entitled it to do so.  Good faith required a party acting in self-interest to have regard to the legitimate interest of the other. The franchisor owed a duty to act in a way that was not only honest, but also commercially reasonable.  The evidence presented by the franchisee tended to show the opposite about the franchisor’s conduct.

The injunction

The court held that the severity of the terms of the franchise agreement and the franchisor’s ability to unilaterally add new terms by enacting new system standards raised serious questions about the franchisor’s commercial reasonableness and good faith.

Despite the franchisor’s argument that the case was purely about money, the court held that failure to grant the injunction would result in irreparable harm to the franchisee.  The court cited earlier franchise cases holding that irreparable harm happens if a business closes down.

It did not matter that the franchisor planned to continue to operate the business out of the same location or that the franchisee’s principal had another trade to fall back on.  It was important that the franchisee’s principal could continue operating the store should she succeed at trial.

Also important were several five-year renewals that the franchisee had under the franchise agreement.  This potentially long term made the impact of the potential termination more severe.

Finally, the failure to preserve the business in the franchisee’s hands risked rendering the trial moot in some respect, which would have deprived the franchisee of an opportunity to have its case determined on the merits.

The court also held that the franchisor’s health and safety concerns did not seem to be supported by evidence.  The franchisor seemed to enforce its standards more strictly against the franchisee than anyone else, including its own corporate-run stores.  On the other hand, the franchisee stood to lose a successful and highly profitable franchised business with a significant future if it were not permitted to stay in operation pending trial.

In a later costs award, the court awarded costs of $95,000 to the franchisee for the injunction motion.

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Anthony Pugh Associate