On September 8, 2008 the Québec Superior Court rendered judgment in the case of 9102-5486 Québec Inc. v. Café Suprême Canada Inc. et al, Qc. Sup. Ct., 500-17-021352-045. This case is an excellent example of the need for franchisors in Québec to act with due care when dealing with their franchisees, particularly where the franchisor is also the franchisee’s sublandlord.

The Facts

In 2001, Naoras Hammoud, president, director and shareholder of the plaintiff, 9102-5486 Québec Inc. (collectively, Hammoud), approached John Essaris, the president and sole shareholder of a group of companies headed by the defendant, Café Suprême Canada Inc., (collectively, Café Suprême), to explore the possibility of acquiring a franchise from Café Suprême. Eventually, Café Suprême introduced Hammoud to an existing franchisee who operated a franchise in a commercial building on Sherbrooke Street in downtown Montréal (the Building) and who was interested in selling its franchise. Ultimately, Hammoud bought the franchise from the existing franchisee for $240,000 and entered into a franchise agreement and sublease with Café Suprême for a term ending in May 2009.

In the summer of 2002, a limited partnership controlled by Jack Berkovic (Berkovic) acquired the Building for $6,410,000. At the time, the Building was almost fully rented. In early 2003, however, Hammoud noticed an increasing number of commercial tenants leaving the Building. Unbeknownst to Hammoud at the time, most of these tenants were affiliated with the Quebecor group, which group had decided to relocate. As occupancy declined, so did the franchisee’s sales. After trying to find replacement tenants for several months, Berkovic decided to sell the Building at a loss to Société Immobilière 801 Sherbrooke East (Immobilière) on April 2004 for $5,000,000.

The deed of sale did not require Immobilière to assume Berkovic’s existing leases. This situation would not have been a problem for either Café Suprême or Hammoud had Café Suprême registered its head lease as permitted under Article 1887 of the Civil Code of Québec (the Code). This article provides that the purchaser of a building may not terminate an existing lease if the existing lease was registered on the property prior to the sale. If the existing lease was not registered, the purchaser could terminate the lease on twelve months notice. Since Café Suprême had never registered its head lease, Immobilière was now empowered to terminate the rights of Café Suprême (and Hammoud) in the premises on twelve months’ notice.

On May 5, 2004 Immobilière delivered its twelve-month termination notice for the head lease such that the lease would terminate in May 2005 – approximately four years earlier than Hammoud’s original expiration date. In the following months, Café Suprême made numerous proposals to Hammoud; Café Suprême was willing to waive franchise fees, allow Hammoud to buy another Café Suprême franchise or relocate Hammoud to another location (presumably at a more advantageous rate). For financial reasons, Hammoud did not agree to any of these options and insisted on the original deal that had been agreed to in 2001.

In July 2004, Hammoud instituted a lawsuit seeking damages, termination of the franchise and a refund of the $240,000 original investment. Despite the lawsuit, Café Suprême pressed on with its efforts to find a solution to Hammoud’s predicament. In fact, in late 2004, Café Suprême negotiated a deal with Immobilière whereby a new lease – with rent essentially 50% lower – could be entered into for the original term (i.e., through May 2009). Hammoud refused to consider this offer.

In the meantime, things went from bad to worse for Hammoud. In late 2004, Immobilière decided to convert the Building into condominiums which resulted in the Building being empty from 2005 to 2007. Hammoud eventually closed shop in the winter of 2005 and joined the former property owner, Berkovic, as co-defendant in the proceedings against Café Suprême. In September 2008, Hammoud prevailed on the merits in its case against Café Suprême. As of the date of writing this case comment, no appeal has been filed.

The Decision

While the judgment addresses several interesting secondary points of law (some of which are discussed below), the court’s decision is principally based on one ground: as sub-lessor and franchisor, Café Suprême had to ensure that it provided Hammoud peaceful enjoyment of the franchise premises for the full duration of the sub lease (i.e., through May 2009), in the same general environment as had been envisaged by Hammoud when acquiring the franchise.

By failing to register the head lease against the property, which would have permitted Hammoud and Café Suprême to enforce the lease against Immobilière, Café Suprême breached its legal and implied obligations as sub-lessor and franchisor. Café Suprême had no leverage against Immobilière and was thus unable to either negotiate adequate compensation for Hammoud or seek damages when the Building was converted into condominiums.

The court stated that Café Suprême’s inaction resulted in Hammoud’s inability to exploit the franchise for the duration and in the environment originally contemplated. Café Suprême should have provided a viable alternative or solution to the problem at hand; offering to relocate Hammoud, reduce his franchise fees or negotiate a new lease in an empty Building at a reduced rent were inadequate proposals. The court found that Café Suprême’s failure to offer an adequate solution made it liable for Hammoud’s damages.

As part of its reasoning, the court reached a number of additional conclusions relevant to the franchise environment, including the following:

  • The court held, as is now most often the case in Québec case law, that the franchise agreement was a contract of adhesion (i.e., a contract in which the essential terms are imposed by one party and are not negotiable), which type of contract empowers a court to annul, modify or re-write any provision it finds to be abusive, incomprehensible or illegible;
  • Primarily relying on its broad powers under the adhesion-contracts regime, the court narrowly interpreted a standard disclaimer of warranty found in the franchise agreement (i.e., that the franchisor did not warrant the viability or profitability of the franchise) and stated that such disclaimer was inapplicable, given the facts at hand. The disclaimer, the court stated, could only protect Café Suprême from liability to the extent that the general environment in which the franchise operated remained the same. The disclaimer was of no effect where the sub lease was terminated and the Building emptied of its tenants for conversion into condominiums;
  • This is one of the first Québec franchising cases to apply the general civil law pre-contractual duty to inform first elaborated by the Supreme Court of Canada in Bank of Montreal v. Bail, [1992] 2 S.C.R. 554 and later codified in 1994 as part of Articles 6, 7 and 1375 of the Code. While the discussion on this issue in the case was not a determining factor in the outcome, it sends a strong signal to franchisors that pre-contractual disclosures must be carefully considered in the province of Québec;
  • The court also found Berkovic, as former landlord and vendor of the Building, liable to Hammoud for 30% of the damages. Because Berkovic did not include in the April 2004 deed of sale a provision requiring Immobilière to assume Berkovic’s obligations under existing leases (including the head lease with Café Suprême), Berkovic had acted negligently and committed an extra-contractual fault (i.e., a tort) against Hammoud. The soundness of this conclusion is doubtful. Given that Article 1887 of the Code enables lessees to protect their leases through registration against the landlord’s property, it is questionable whether the court should impose an implied duty on Berkovic, as former landlord and property owner, to protect Café Suprême’s rights in the head lease when Café Suprême failed to exercise the most basic degree of care and register its own rights against the property. This equitable finding by the court appears just short of revolutionary in light of the current Québec real estate market.

Conclusion

Many of the statements made and the principles applied in this case should not be taken for more than what they really are: strong judicial statements against inequality of bargaining power and equity in the franchising context. However, franchisors should take note of the general principles discussed. This is certainly not the last case in which the Québec courts will intervene to inject balance and fairness in relationships between unequal parties. In particular, if there is one lesson from this case for a franchisor, it is probably that a franchisor should make absolutely sure, when it acts as sublessor to a franchisee, that it registers its head lease against the relevant property. And, when a franchisor actually owns the franchised premises, it will want to think twice before selling the premises to a third party without getting the third party to agree to be bound by the existing leases.