Court Rejects Oral Agreement to Reduce Royalty Payments

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Author: Jeffrey Nguyen, Student-at-Law, Law Works P.C.
Editorial Committee: Law Works P.C.
Editor: Ben Hanuka

On September 2, 2016, the Ontario Superior Court of Justice granted summary judgment in Arnold Hennessy Holdings v Flapperless, 2016 ONSC 6341, for the payment of unpaid royalties under a licence agreement. The case analyzed important issues about defenses that franchisees tend to raise when defending claims for unpaid royalties.

The case dealt with evidence to prove the existence of an oral agreement; the number of short payments needed to trigger the limitation period; the appropriateness of summary judgment; and whether the parties had reassigned the right to collect royalties.

Justice Graeme Mew decided in favour of the plaintiff, Arnold Hennessy Holdings Inc. (“Holdings”), because the evidence supporting an oral agreement to reduce royalties was not sufficient. Holdings brought the action within the limitation period because a single reduced payment does not trigger the limitation period. Summary judgment was appropriate because the arguments against it were “more tactical than substantive”.

Outline of the Facts

An individual by the name of Arnold Hennessy assigned the rights in his invention to Holdings. In 1998, Holdings licensed the right to commercialize the invention to Flapperless Inc., a company owned in part by Arnold’s nephew Philip Hennessy. Under the licence agreement, Flapperless had to pay $120,000 in royalties per year to Holdings.

Philip claimed that Holdings and Flapperless entered into an oral agreement in 2012 to reduce royalty payments by 50% during Arnold’s lifetime, and stop payments after his death. Flapperless began paying the reduced royalties in 2013 and stopped payments altogether when Arnold passed away in 2014.

On April 30, 2015, Holdings disputed that an oral agreement existed and brought a motion for summary judgment for royalties owing to them since 2013. Flapperless raised the following issues in response to Holdings’ motion:

• There was no evidence that Holdings and Flappers agreed to reduce royalty payments in 2012.
• The limitation period expired because Flapperless made the first reduced payment in March 2013 (more than two years after Holdings brought the action on April 30, 2015), which was when Holdings should have discovered the claim.
• Summary judgment was not appropriate because Holdings did not disclose and produce various records. Holdings’ lawyer was also a potential witness because he had represented Arnold personally, and should not have been Holdings’ lawyer of record on the motion.
• The estate of Arnold Hennessy, rather than Holdings, was the proper plaintiff because Arnold personally received payments under the licence agreement. This payment arrangement showed that the parties agreed to reassign the payment rights from Holdings to Arnold personally.

No evidence of an oral agreement to reduce royalty payments

Arnold and Philip had previously amended the licence agreement in writing many times. The licence agreement also had a clause that excluded oral agreements (called an “entire agreement” clause).

Mew J. found that there was not enough evidence to show that an oral agreement existed. Although Flapperless argued that the parties amended the licence agreement because of its declining sales, Mew J. decided that an oral agreement to reduce royalties was not consistent with their previous practice of amending the licence agreement in writing. Philip should have known that there would be no evidence of the oral agreement after Arnold’s death.

Mew J. rejected Flapperless’ argument that the Ontario Court of Appeal in Shelanu v. Print Three Franchising (2003), 64 O.R. (3d) 533, enforced an oral amendment despite a similar clause. He distinguished the Court’s decision because both parties in Print Three admitted that an oral agreement existed, and the parties showed an intention to amend the franchise agreement through their conduct. Mew J. also said that Holdings and Flapperless, both sophisticated parties of equal bargaining power and represented by lawyers, should have known to amend the licence agreement in writing.

While this was not a genuine franchise case, it is still relevant to franchise law because it stands for the fact that any agreement to modify royalty payment obligations under a franchise agreement should be in writing.

One reduced payment does not trigger the limitation period

Mew J. decided it was likely that Holdings did not become aware of the first reduced royalty payment until around May 2013 – within the limitation period. He also stated that in any event, it is reasonable to not discover a claim until a party receives “at the earliest, more than one reduced payment”. Mew J.’s comments are helpful to franchisors who may not become aware of shortages in royalty payments until several years after the first payment.

Summary judgment was appropriate

Mew J. decided that summary judgment was appropriate, despite the fact that Holdings did not produce its corporate profile, Arnold’s medical information, and other records. He said that Flapperless would have brought a motion to produce the records if it really felt that it needed the documents. Because it did not bring a motion to produce the records, Mew J. dismissed Flapperless’ argument against the appropriateness of summary judgment for being “more tactical than substantive”.

On the issue of whether Holdings’ lawyer was in conflict as a potential witness, Mew J. decided that while the lawyer may be a potential witness, there was not sufficient evidence to disqualify him on the motion for summary judgment.

No reassignment of rights to royalty payments

Arnold personally received payments as an employee of Flapperless for several years, and Flapperless remitted CPP and EI contributions and deducted income tax from payments to Arnold. Mew J. rejected Flapperless’ argument that this payment arrangement showed an intention to replace Holdings as the party entitled to receive royalties. He explained that Arnold was allowed to nominate anyone to receive royalties on Holdings’ behalf, including himself, so the evidence did not support the fact that Holdings gave up its right to seek enforcement of the royalty payments.

Summary

This case shows the need to have solid evidence to back up positions that a party makes in court. It also reminds us that a court will look at the substance of events that happened between the parties and whether their positions are reasonable in light of that evidence.

For more information about Law Works’ expertise and how we may be able to help you, please contact Ben Hanuka at https://www.lawworks.ca/book-a-consultation or by phone at (855) 978-5293.

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