Author: Anthony Pugh, Student-at-Law, Law Works P.C.

Editor: Ben Hanuka

In 10313033 Canada Inc. v. 2418973 Ontario Inc., an April 11, 2018 decision of the Ontario Superior Court of Justice in Ottawa relating to a franchise dispute in the Laurier Optical franchise system, the court refused to grant to the franchisor an interlocutory injunction compelling the franchisees to continue paying royalties and marketing fees because the franchisor did not prove that it would suffer irreparable harm.

The franchisor showed that there was a serious matter to be tried, and did not have to meet the more stringent standard of strong prima facie case. However, it merely asserted that it would not be able to meet its financial obligations but for the injunction, and did not produce evidence to support this assertion, the court declined to grant an injunction order.

Finally, the court appointed an arbitrator over the dispute based on an arbitration clause in the franchise agreement and the franchisees’ application to appoint an arbitration. The court refused to pre-emptively limit the scope of issues in dispute that the arbitrator could consider, holding that challenges to jurisdiction should first be resolved by the arbitrator.

Key Facts

The franchisor, 10313033 Canada Inc., purchased the assets of a previous franchisor under an order issued by the Quebec Superior Court authorizing the purchase under the federal Companies’ Creditors Arrangement Act.

Four weeks later, the eight respondent franchisees sent a letter to the franchisor questioning the enforceability of their franchise agreements and leases. None of the franchisees had contested the CCAA order after receiving notice about it.

The franchisees accused both the current and former franchisor of failing to respect their obligations under those agreements, invoked their right to arbitration, and reserved the right to discontinue royalty and marketing payments if the franchisor did not meet their demands.

The franchisor did not respond to the demand to arbitrate, but its two shareholders met with the franchisees to discuss their concerns. The franchisor also provided the franchisees with information about a new marketing campaign and management team. The franchisees ultimately decided to stop remitting royalty and marketing fees.

The franchisees then applied to the court for appointment of an arbitrator. Shortly after that, the franchisor started a court action, seeking an interlocutory injunction for payment of the royalties and marketing fees.

Applicable injunction test is serious issue to be tried, not “strong prima facie case”

The court did not agree with the franchisees’ submission that the franchisor had to show a “strong prima facie case”, which involves a higher burden of proof, to obtain the interlocutory injunction. Instead, it held that the franchisor only had to show that there was a “serious issue to be tried”, which has a lower onus of proof.  The difference is based on whether the injunction is for a mandatory order (which requires proof of the higher onus) or a prohibitory order (which comes with the lower onus).

The court held that while requiring the franchisees to actively respect their contractual obligations would be a mandatory order (an order requiring the parties to take certain steps, and therefore attracting the higher onus of “strong prima facie case”), since the injunction here related only to the continued payment of money, this higher standard did not apply.

In other words, the court held that the more stringent standard of proof did not apply here because the mandatory order that the franchisor was seeking was only for the continued payment of royalties and marketing fees to the franchisor.  If the franchisor’s claim is eventually dismissed, the franchisees could claim back their money.  The court differentiated this obligation to continue paying money from an obligation to continue some conduct – where the latter cannot be undone.  It is unclear if this line of reasoning is supported in the jurisprudence.

Having established the legal onus of “serious issue to be tried”, the court examined the reasons for the ‘royalty strike’ and concluded that the franchisees ceased payments to bring the franchisor to the bargaining table for renegotiations of the franchise agreements.

There was nothing in the franchise agreements which permitted the franchisees to conduct such a ‘royalty strike’. Rather, non-payment of royalty and advertising fees was a ground for termination without notice.

The franchisees also argued that the franchisor fundamentally breached the franchise agreements, or that it had not complied with its disclosure obligations. However, since they continued to operate as franchised stores, their conduct ran counter to their allegations that the agreements were no longer in force. In addition, the franchisees only raised the disclosure argument after ceasing payments to the franchisor.  As a result, the court found that the franchisor met the first leg of the injunction test, which is “serious issue to be tried”.

No irreparable harm

The second part of the interlocutory injunction test is proof of irreparable harm. The court found that the franchisor was unable to prove irreparable harm because it did not produce sufficient evidence.

The franchisor’s principal simply asserted in his affidavit that the franchisor would not be able to meet its financial obligations. He did not provide any evidence supporting his calculation that the franchisor earns 70% of its revenue through franchise fees from the respondent franchisees.

It stands to reason that the franchisor would not be able to satisfy payments because the royalty and marketing fees make up a substantial portion of its revenue. This argument was successful in two previous cases; however, without evidence, it alone was insufficient.

Furthermore, the franchisor’s principal refused to provide the franchisor’s financial statements in cross-examination. Instead, the franchisor sent an estimate of the impact of continued non-payment of fees. The court held that it would be unfair to allow the franchisor to rely on the estimate without the underlying financial statements.

In addition, the franchisor did not provide an undertaking as to damages. This is a requirement under the Rules of Civil Procedure for the moving party (in this case the franchisor) to undertake to compensate the responding party (in this case the franchisees) for any reasonable damages incurred because of the interlocutory order.

The court left it open for the franchisor to reapply for the injunction with the required evidence.

Appointment of Arbitrator

The franchisor conceded that some of the issues in dispute fell within the arbitration clause. However, it argued that the court action should not be stayed as some matters in the dispute were not within the scope of the arbitration clause.

The court rejected this argument and stayed the action, noting that the arbitration clause in question had a very broad scope. Following the Supreme Court decision in Dell Computer Corp. v. Union des consommateurs, it did not pre-emptively limit the scope of the arbitrator’s jurisdiction and held that any challenge to the arbitrator’s jurisdiction should first be resolved by the arbitrator.

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