the duty of good faith and fair dealing

Provincial franchise legislation imposes a duty of fair dealing on parties whenever they are performing or enforcing the provisions of a franchise agreement.1 Canadian courts have generally noted that the statutory duty of fair dealing is a codification of the common law duty of good faith, which precludes contracting parties from acting in bad faith when exercising discretionary contractual powers.2

In terms of general principles, the duty of good faith requires contracting parties to:

  • exercise powers with due regard to the interests of the other party, but they are not required to prefer the interests of the other party over their own;
  • observe standards of honesty, fairness and reasonableness; and
  • act with proper motives and not arbitrarily, capriciously or in a manner that is inconsistent with the reasonable expectations of the parties.

Although the law remains in a state of development, thus far the duty of good faith has been held not to create new, unbargained for, rights and obligations or alter the express terms of the contract reached by the parties.3 Rather, the duty is applied to ensure that parties do not act in a way that eviscerates or defeats the objectives of the agreement.

If the statutory duty of fair dealing is a codification of the common law duty of good faith, can the scope and content of this duty be tempered by the terms of a franchise agreement? The answer is, to some extent, yes.

tempering the duty of good faith and fair dealing in your franchise agreements

Franchise cases in Ontario confirm that neither the common law duty of good faith nor the statutory duty of fair dealing are intended to replace or amend express contractual provisions.4 Consequently, when considering whether a party has demonstrated good faith and fair dealing, the impugned conduct must be assessed in light of the provisions of the franchise agreement (as well as the relevant factual circumstances of any particular case). In two recent Ontario franchise decisions that illustrate this point, Fairview Donut Inc. v The TDL Group Corp. ("Tim Hortons")5 and Spina v Shoppers Drug Mart Inc. ("Shoppers Drug Mart"),6 the court rejected bad faith and unfair dealing claims because they ran up "against the wall" of the express provisions of the relevant agreements.

In Tim Hortons, the plaintiff franchisees alleged that Tim Hortons violated its good faith and fair dealing obligations by, among other things, requiring franchisees to change their baking methods and to make certain items available at all times. The plaintiffs complained that these changes reduced their profits, thereby violating the duty of good faith and fair dealing. Tim Hortons successfully moved to dismiss the proposed class action on a summary judgment motion.

Confirming that the good faith and fair dealing duty does not trump the express language of the franchise agreement, the court held that the agreement permitted Tim Hortons to implement these changes, set the prices for supplies that franchisees were required to purchase and specify the maximum selling prices for all menu items.7 The court noted that its responsibility is to give effect to the agreement between the parties and require them to discharge their obligations fairly, in good faith and in a commercially reasonable manner – not to re-write the contracts.8

Ultimately, the court found that the relevant test is whether a franchisor's conduct, taken as a whole in light of the provisions of the franchise agreement, nullified the bargain made by the parties.9 The court concluded that the changes implemented by Tim Hortons were authorized by the agreement, the result of a commercially rational business decision, and that Tim Hortons had fairly considered the interests of its franchisees (and consulted with them) prior to implementing the changes. At the end of the day, franchisees remained overwhelmingly profitable notwithstanding the changes that made some items less profitable or loss leaders.

In Shoppers Drug Mart, the plaintiff franchisees commenced a class action alleging, among other things, that Shoppers breached its franchise agreements and operated the franchise system contrary to the duty of good faith and fair dealing in several respects. In short, the plaintiffs alleged that Shoppers was not sharing the profits with its franchisees. The franchisor successfully moved, prior to certification, to strike certain of the claims as disclosing no cause of action.

One of the good faith and fair dealing claims the court struck was the plaintiffs' allegation that Shoppers did not share rebates it received from suppliers with franchisees. The court found that the express terms of the agreement, properly interpreted, permitted Shoppers to retain the benefits of any supplier rebates. The court held that the good faith and fair dealing claim for rebates "run[s] up against the wall" of the franchise agreement, and struck the allegation.10

The court refused, however, to strike other alleged breaches of good faith and fair dealing claims where, as a matter of interpretation, it was not plain and obvious that the franchise agreement authorized Shoppers' conduct.11

drafting lessons

The decisions in Tim Hortons and Shoppers Drug Mart confirm that the express provisions of a franchise agreement are relevant to assessing breach of good faith and fair dealing claims. These cases stand for the proposition that a franchisor, who acts fairly under an express right or power reserved by it in the franchise agreement, does not violate the duty of good faith and fair dealing.

Accordingly, although the duty of good faith and fair dealing cannot be excluded by a franchise agreement,12 the scope and effect of this duty may be tempered by the terms of a well-drafted contract since the duty does not override unambiguous provisions of a franchise agreement.

Some drafting points and best practices to consider:

  • Clarity is Critical – Avoiding uncertainty is important when drafting any contract, but more so for franchise agreements because, as they are contracts of adherence (i.e. non-negotiable), ambiguity will generally be resolved in favour of franchisees.13 An express provision in a franchise agreement authorizing a franchisor's actions will only be an effective defense to a claim for breach of the duty of good faith or fair dealing if that provision is clear and its terms are followed by the franchisor. Uncertainty can arise from ambiguous or vague wording, as well as conflicts and inconsistency among the documents forming the franchise agreement (including manuals or policy statements that are incorporated by reference).
  • Be Specific – Using broad wording to describe a franchisor's rights or powers leaves more room for a court to fill in the details, or otherwise limit the scope of a franchisor's authority.14,15 While franchisors need broad powers for system control and to adapt and respond to competition and market changes, and it is difficult to anticipate the many actions they may need to take, it pays to be specific, particularly with respect to matters having a significant impact on franchisees' profits. The challenge for drafters is to be specific without constraining the scope of a franchisor's rights, including making system changes, or creating an excessively long and detailed franchise agreement.
  • Disclose, Consult and Get Input – It will be easier for a franchisor to demonstrate it had due regard for the interests of franchisees if, prior to a franchisor implementing changes, franchisees are given information about the impact and an opportunity to provide feedback. Having a franchisee advisory committee composed of respected franchisees who are to communicate with other franchisees about prospective changes provides an effective alternative to dealing with all individual franchisees, particularly if the consultation process involves due consideration and adaptation, as appropriate, in response to committee feedback.16 Some franchisors are hesitant to establish franchisee advisory committees, but knowing of franchisee concerns at an early stage gives franchisors an opportunity to address them before relationships have deteriorated unduly.
  • System Change – Include a provision in the franchise agreement acknowledging the need for system changes over time and the franchisor's right to adapt the system.
  • Limit Definition of Franchise Agreement – Franchisors generally incorporate by reference key aspects of their franchise system without including them within the signed franchise agreement (often done through manuals which are adapted over time), and need to be able to implement changes without always getting new agreements or amendments signed by each franchisee. However, the "franchise agreement" (which determines the nature and scope of a franchisor's rights and obligations) does not necessarily include any and all documents and information subsequently provided to franchisees. There is a risk if documents distributed to franchisees are prepared without the necessary level of care or attention to the legal consequences, and may lead to an interpretation contrary to the franchisor's intent.17

In light of these recent franchise cases, it may prudent for franchisors to revisit the wording of their franchise agreements and their practices, with a view to lessening the risk of litigation.