In 1117304 Ontario Inc. c/o Harvey’s Restaurant v. Cara Operations Limited, the Ontario Superior Court of Justice considered the scope of the statutory duty of good faith in determining whether the franchisor breached that duty by terminating the franchisee’s licence agreements. The franchisor counterclaimed against the franchisee and its two guarantors for non-payment of royalty fees and advertising fees, as well as other costs associated with the default of the licence agreements. The court awarded judgments to both parties – in the amount of $20,480.00 for the franchisee’s claim and $80,477.70 for that of the franchisor.

Facts

Starting in the spring of 1995, the franchisee operated a fast-food restaurant in Ottawa under the name, Harvey’s. Pursuant to a separate licence agreement with the franchisor, the franchisee also served Church’s Chicken products. The restaurant operated at a profit until 1998 or 1999, when sales began to drop steadily. The franchisor issued notices of default on several occasions for non-payment of royalties, advertising and other fees. The franchisee requested financial assistance from the franchisor which the franchisor eventually offered.

In July 2000, the franchisor unilaterally terminated all Church’s Chicken licence agreements due to supply problems and batter issues. All franchisees were offered compensation for the termination of these agreements. The franchisee in this case had two of seven years remaining on the licence when it was terminated.

The franchisor terminated the Harvey’s licence agreement on February 21, 2002 claiming royalty and advertising arrears of $110,275.41. The franchisee’s landlord issued a notice of distress claiming rent arrears of $57,044.53 and, subsequently, terminated the lease on May 16, 2002 and closed the restaurant.

Duty to Act in Good Faith in Franchise Relationships

The scope of the duty of good faith was of significant importance in this case. The franchisee had alleged ten separate breaches of the duty by the franchisor, including the franchisor’s conduct in terminating the Church’s Chicken licence agreement.

The court reviewed the statutory duty of good faith and noted that in franchise relationships, a party may act self-interestedly; however, in doing so, that party must also have regard to the legitimate interests of the other party. As long as that party deals honestly and reasonably with the other party, the other party’s interests are not paramount. Good faith is only breached when a party acts in bad faith; bad faith conduct is conduct that is contrary to community standards of honesty, reasonableness or fairness.

The duty of good faith can be contrasted with the concepts of unconscionability and fiduciary duty. When a party acts unconscionably, it engages in excessively self-interested or exploitative conduct. A fiduciary party, on the other hand, acts solely in the interests of the other party. Such action is entirely selfless. Good faith can be seen as embodying a middle ground between these two categories of selfish and selfless behaviour.

Failed Breach of Good Faith Claims

In his decision, the Honourable Mr. Justice Stanley J. Kershman addressed whether the franchisee had breached its duty of good faith and fair dealing concerning the ten separate issues. For several of the franchisee’s claims, the court held that no breach of the duty of good faith existed where the issues had been addressed by the franchisor through specific contractual representations, obligations and rights.

For example, as for the franchisor’s investigation of the suitability of the restaurant site, the court found that the defendant had sufficiently expressed its concerns about the site through a licence agreement acknowledgement and a letter of intent to the franchisee. Similarly, the court found that the franchisor’s pro forma sales projection clearly stated that the figures were simply “projections” based on “assumptions” and, thus, the franchisee was not to rely on the statement as it did not form a representation, warranty or guarantee. The court also held that the franchisor was well within its rights to open another Harvey’s restaurant outside of the franchisee’s trading radius as set out in the licence agreement.

The court found other claims of bad faith by the franchisee to be flatly unsupported by the evidence. The franchisee alleged that the franchisor failed to meet its duty to provide adequate accounting and managerial training. The court found, however, that there was no evidence of loss of staff or loss of business because of a lack of managerial training and, if there had been any lack thereof, it was so insignificant that it did not affect the overall operation of the restaurant.

The franchisee also alleged that the franchisor’s handling of a complaint by one of its former managers was a breach of the franchisor’s duty of good faith. Justice Kershman held that a resulting internal memo written by an employee of the franchisor expressing concerns about the operator was a justifiable business practice and did not impact the franchisee in any material way from that point forward. The court also found no evidence to support the franchisee’s argument that there was any unfair treatment concerning the franchisor’s operational inspections of the franchisee’s location.

The court also found that there was no breach of the duty good faith on the part of the franchisor in failing to provide the franchisee assistance in settling a dispute with its landlord or in refusing to provide the franchisee financial assistance. Both of these claims lacked evidence of any contractual obligation of the franchisor to provide these forms of assistance. The court also failed to find any merit in the franchisee’s argument that it should be entitled to compensation for past leasehold improvements and for former equipment which had been assumed by the franchisor after termination of the franchise. The franchisee continued to owe both money to its bank for the equipment and royalty arrears to the franchisor.

Termination of the Church’s Chicken Licence

However, the court found that not all of the franchisee’s claims of breach of duty of good faith were without merit. The franchisor’s notice of early termination of the Church’s Chicken licence agreement was accompanied by an offer of compensation in the form of a credit of $7,500.00 plus $2,500.00 for every year remaining. This amounted to $12,500.00 for the franchisee. The franchisor’s ability to unilaterally terminate the contract was not a contractual right of the licence agreement. The franchisee submitted that the cost of the equipment for Church’s Chicken totalled $71,690.00, inclusive of taxes. The franchisor directed that this credit must be applied firstly towards rejuvenation requirements and, secondly, towards any financial obligations owed to it. No evidence was given to suggest that the franchisee opted to take the rebate.

The court found that the franchisor’s offer was effectively a “take it or leave it” proposition. It found that the amount offered by the franchisor was arbitrary and less than fair. Justice Kershman held that the unilateral withdrawal of the Church’s Chicken product and the insufficient compensation offer which accompanied it amounted to a breach by the franchisor of its duty of good faith and fair dealing.

Church’s Chicken was not a stand-alone franchise; it was a co-venture at select Harvey’s locations. The Harvey’s locations that served Church’s Chicken franchisees did not lose their franchised business entirely as a result of the termination of the Church’s Chicken licence agreements. This, however, did not appear to be a mitigating factor for the court in finding that the franchisor failed to act in good faith.

The court held that the franchisee should be entitled to damages for the inability to use the equipment and for the loss of profit stemming from the breach. Because the franchisee was unable to demonstrate that this withdrawal resulted in a loss of profit, the court was only able to award damages calculated at $20,480.00 for the franchisee’s inability to use the equipment.

Conclusion  

This decision is relevant for franchisors as it offers several examples of the application of the duty of good faith. It also helps illustrate the limits of a franchisor’s obligations, providing comfort that certain topics that are clearly set out in an agreement cannot be amended by the duty of good faith.

The case also sets out guidelines for franchisors seeking to discontinue products for which its franchisees have invested in specialized equipment. Franchisors wishing to do so must consider the amount for profit loss and for lost use of equipment for each franchisee and then take this amount into account when compensating each of them.