By Ben Hanuka, Law Works

This article was originally published in The Lawyer’s Daily as a two-part series on January 22 and 26, 2021.  The assistance of Anthony Pugh, associate at Law Works PC, in writing this article is acknowledged with thanks.

System-wide changes in franchising are more prevalent these days, as Covid is changing operational needs and consumer behaviour.  Franchisors may be considering system changes, some relatively minor while others significant, affecting the business model.  Some companies may be even setting up different brands or systems to meet new consumer demands that were difficult to foresee only a few years ago.  This raises issues about contractual rights and obligations to implement such changes, and the related duty of good faith and fair dealings, which is found both in franchise statutes and in the common law.

Brief background on the duty of good faith

This duty imposes a mutual obligation on franchisors and franchisees to perform and enforce their contractual rights and obligations in good faith and through fair dealings, in a commercially reasonable manner – see section 3 of most provincial franchise statutes (the provisional franchise Acts in British Columbia, Manitoba, Ontario, New Brunswick and P.E.I.; the Alberta statute has somewhat different provisions – see subsection 2(c) and section 7 of the Alberta statute).  It does not impose a fiduciary duty (i.e., a duty to prioritize the other’s interests), but rather a duty to have regard for the other’s legitimate interests.

There are two decisions from the Supreme Court about the good faith obligations in general commercial dealings: the well known 2014 decision of Bhasin v. Hrynew and very recent decision from December 2020 in C.M. Callow Inc. v. Zollinger.  Both emphasize the importance of honestly and genuine interests of the parties.  Misleading the other side or taking actions driven by ulterior motives will probably amount to bad faith conduct.

The duty in the franchise context

The number of court decisions that analyze the good faith obligation in franchising is sparse but a line of legal elements can be woven through them.

First, courts may look at the urgency of the situation to assess how much leeway, the benefit of a doubt, to give a franchisor in assessing good faith compliance.  Urgency here means that the franchisor, the system, other franchisees or an individual unit franchisee, as the case may be, will likely suffer imminent and significant harm.  In an urgency, there is less time for the franchisor to engage in consultation; the franchisor must make quick decisions in a commercially reasonable manner and with the best of intentions, but there is no time to engage with franchisees in extensive consultations.

Second, courts may look at the impact of the changes on the franchisees – how severe are the changes that are in dispute; how damaging are there to franchisees?  If the franchisees remain profitable or cannot prove damages caused by the changes, there is likely no serious impact.

Third, impact may have another dimension and that is scope in the system, rather than severity – are the changes system-wide or more confined, perhaps to a single unit franchisee? If franchisor only needs to consider the interests of a single franchisee or a small group of franchisees, it may perhaps be better equipped to do so even in urgent situations (barring aside situations where the urgency is the result of defaults by the franchisee).

Consulting with franchisees

A good practice is for franchisors to consult with franchisees before making any significant changes that may impact those franchisees.  Consulting with franchisees, in the context of the duty of good faith and fair dealings, is an important aspect of gauging whether the franchisor is compliance with this obligation.

However, consultation is not a duty in and of itself – it is not a standalone objective.  Rather it can be an effective means of showing that a franchisor has duly considered the interests of the franchisees who will be impacted by the planned changes.  A good consultation process should be designed to, at the very least, communicate the franchisor’s planned changes and the reasons for that, obtain and listen to the franchisees’ input about these proposed changes, and demonstrate a genuine level of consideration of the franchisees’ concerns.

Here is that thread from the sparse caselaw that we have so far in Canada.

Urgency, system-wide

The 2015 decision of the Ontario Superior Court (affirmed by the Court of Appeal on the findings of franchise good faith) in Trillium Motor World Ltd. v. General Motors of Canada Limited shows that in exigent circumstances where the franchisor must make urgent and very important decisions that affect the system, the courts will attribute considerable weight to these circumstances when assessing whether the franchisor has complied with its good faith obligations.

The case involved the aftermath of the 2008 financial crisis.  The franchisor, GM, had to make major decisions about the system very quickly because of the economic crisis and pressure from governments to shed parts of its system.  GM sent wind-down agreements to some of its dealers with a seven-day period of acceptance.  It took some steps to consult with franchisees.  But given the significant time constraints, the dealers had little time to make a decision whether to accept the winddown.

The courts held that this timeframe was reasonable, considering the emergency situation and the fact that GM’s existence was on the line.  Further, there was no certainty about the dealers’ best interests – it was possible that GM would have had to enter a CCAA provision, which would have put payments under the wind-down agreements at risk.

The dealers also made various allegations that GM mislead them about the wind-down agreements.  But the courts held that GM could not know what was in the best interests of the dealers, considering the emergency and uncertainty about whether GM would have to enter a CCAA proceeding.  Any slight misrepresentations from GM were ultimately immaterial, the courts ruled.

No urgency, system-wide

Unlike in Trillium, the 2012 decision of the Ontario Superior Court in Fairview Donut Inc. v. The TDL Group Corp. points to a much more extensive consultation process that a franchisor must engage in when implementing system-wide changes over a long period of time – when urgency is not a factor at all.

The decision in Fairview Donuts dealt with TDL’s business model (the Tim Hortons franchise), allegations about profit margins and business decisions that the franchisor was making over the course of a long period of time.  The plaintiff franchisees sought to certify a class action claim.  They alleged, among other things, that TDL acted in bad faith by implementing pricing that rendered some of their products unprofitable.

The court dismissed the plaintiffs’ claim on the summary judgment motion mainly because the allegation that TDL breached its duty of fair dealing was not rooted in contract – there was no connected to any contractual provision that was in breach.  There was no right for a franchisee to make a profit on any specific product and the pricing did not eviscerate the benefit of the franchise agreement.

The evidence showed that TDL was taking reasonable steps to look after its brand’s long-term interests and that it had considered the impact on franchisees.  TDL documented its decision-making process.  TDL took significant steps to consult with franchisees about the system changes.  This included attempting to obtain the support of franchisees and offering training to franchisees about the system changes.

The changes had benefits for all parties, even if it could be argued that TDL benefited more.  Numerous franchisees in fact supported the changes.

These key facts thwarted any allegation that TDL did not take the franchisees’ legitimate interests into consideration.  While TDL was not required to prioritize the franchisees’ interests over its own, it took extensive steps to involve the franchisees in the process.

Impact on franchisees

In assessing the threshold for demonstrating that a franchisor has considered the interest of the franchisees, the courts may also look at the impact that the changes have on franchisees.  In Fairview Donut, it was important that the franchisees were generally profitable.  The franchisor’s changes to the system did not come close to eviscerating the benefit of the franchise agreement.  There was no significant impact on the franchisee.  And TDL engaged in significant consultations with the franchisees.

In the 2003 decision of the Ontario Court of Appeal in Print Three v. Shelanu, the franchisee could not show any losses from some of the alleged bad faith conduct.  The franchisor set up a system of express print stores catering to small businesses and individuals under a different brand.  The franchisee claimed that the franchisor set up this system in bad faith.  There was no evidence that a decline in franchisee revenues was because of competition with this brand.  Instead, the decline in revenues was the result of economic conditions at the time.  There was no evidence of consultation by the franchisor, but the franchisee was not entitled to damages because it had failed to prove any losses caused by the alleged bad faith conduct.

Ben Hanuka Principal of Law Works PC (Ontario)/Law Works LC (British Columbia)