By: Anthony Pugh, Law Works
Editor: Ben Hanuka, Law Works
In 55668 Newfoundland and Labrador Limited v. Sullivan, a decision of the Supreme Court of Newfoundland and Labrador released on August 1, 2022, the court held that a franchisee who took over the assets of a terminated franchisee without the agreement of the terminated franchisee was liable to the terminated franchisee for the value of the equipment (based on conversion).
The court also held in favour of the franchisor on its counterclaim against the terminated franchisee for unpaid royalties.
Finally, the court held that the successor franchisee (who took over the terminated business) was entitled to a setoff for what he owed to the terminated franchisee, based on what he paid for the equipment to the terminated franchisee’s creditors.
The trial took about 28 days and was spread over the course of 18 months, due to the COVID pandemic.
In 2005, the individual plaintiff, Mike Hall, and his company, Eastern Restorations Limited, signed a franchise agreement with the franchisor, Paul Davis Systems of Canada, for the operation of a franchised restoration business in St. John’s Newfoundland. This initial franchise was financially unsuccessful, and Mr. Hall declared personal bankruptcy.
Despite that, Paul Davis Systems supported another attempt. Mr. Hall incorporated a new company, the plaintiff, 55668 Newfoundland and Labrador Limited (“556”), to operate the franchise. This time, he operated the franchise together with a business partner – Chris Winsor – who became the minority shareholder and a director of 556.
In 2007, the parties signed a franchise agreement. The franchise agreement prohibited the franchisee from engaging in any business not directly related to the agreement and required the franchisee to only conduct the franchise business from its location. Further, the franchise agreement contained an arbitration clause, requiring any dispute related to the agreement to be settled by arbitration.
The new franchised business initially struggled. The franchisee also expanded into the area of cleaning industrial clothing and asbestos remediation. After two years, it brought on two large insurers, and became financially viable, reaching annual gross revenues of over $3M.
After that, its principals, Messrs. Hall and Winsor, set up another company – Canadian Roofing Solutions – to take on subcontract work from the franchised business. They did not advise the franchisor of this.
In 2009, the franchised business started to struggle financially again, which was also around the same time that it signed onto a new lease for a larger, more expensive, location. It ran into issues with some of its projects and lost the business of the insurers. It also fell into arrears with regards to its payment obligations to the franchisor.
In 2010, Mr. Hall started taking steps to force Mr. Winsor out (notwithstanding the terms of the shareholders agreement). He also transferred funds from 556’s bank account to Eastern Restoration’s bank account. Later, the franchisor asked Mr. Winsor if he could change the locks of the franchised business, which he did.
Shortly after that time, the franchisor terminated the franchise agreement with 556 based on its failure to pay royalties. It did not give 556 an opportunity to cure this default, even though the franchise agreement required that. It also relied on the franchisee’s operation of Canadian Roofing Solutions.
Two weeks after that, the franchisor signed a new franchise agreement with another existing franchisee from Newfoundland, Robin Sullivan, and his new company, which took over the St. John’s territory that used to belong to 556, including taking over the equipment and the lease. Mr. Winsor continued to work for the new franchised business under Mr. Sullivan.
There was a dispute about the purchase of the equipment. Messrs. Sullivan and Winsor proposed that their purchase price of the equipment be used to pay 556’s creditors. However, 556 and Mr. Hall did not agree and took the position that the equipment sale proceeds should be paid to him directly.
556 and Mr. Hall brought an action against the successor franchisee (Mr. Sullivan and his company) and the franchisor, alleging conspiracy, unlawful interference with economic relations, conversion, breach of the shareholders agreement, and unjust enrichment, among other things. They also alleged that the franchisor breached its duty of good faith in planning to end the franchise agreement and grant the territory to Mr. Sullivan.
The franchisor counterclaimed against 556 and Mr. Hall for unpaid royalties. It also claimed that Mr. Hall was barred by a limitation period from amending his claim to include conduct that occurred during the term of the franchise agreement. It alleged that this caused prejudice since the dispute was governed by the arbitration agreement.
In his defence, Mr. Sullivan took the position that any amounts owing to Mr. Hall should be set off by what he paid to 556’s creditors.
The amended claim was not statute-barred
The court rejected the franchisor’s claim that the amended claim was barred by a limitation period. It held that there was nothing stopping the franchisor from alleging that the dispute was subject to arbitration in its defence – particularly based on the plaintiffs’ original unspecific pleading and court decisions in Ontario holding that there was a continuing obligation to refer disputes to arbitration, even after termination or rescission of a franchise agreement.
556 and Mr Hall were successful on the conversion claim, but unsuccessful otherwise
The court held that Mr. Hall did not consent to the terms of the sale of the equipment. It held that Mr. Hall intended that the funds be paid to him directly. It also held that Mr. Sullivan and his company converted about $20,000 in funds from 556’s bank account to the new company’s bank account.
The court also held that any amounts owing to Mr. Hall should be set off by what Mr. Sullivan’s company paid to 556’s creditors.
The court dismissed the various other claims that 556 and Mr. Hall brought. About the good faith allegations, the court held that it was not appropriate in these circumstances when the main allegation was tortious conduct outside of the corners of the contract. It also held that the dispute was covered by the arbitration clause.
The court also allowed the franchisor’s claim for unpaid royalties – which does not appear to have been seriously disputed.
In the end, the court awarded damages of about $85,000 to 556 and Mr. Hall, and damages of about $61,000 to the franchisor. As to costs, the court awarded costs to the franchisor, but did not award costs to 556 and Mr. Hall because it had divided success in its claim against Mr. Sullivan.