While the Ontario Court of Appeal dismissed the franchisor’s appeal in all respects in Salah and 1470256 Ontario Inc. v. Timothy’s Coffees of the World Inc., and left the trial judge’s findings intact, its decision did little to expand upon some very important legal principles which were considered in the case.

We reported on the trial decision in this case in the May 2010 Franchise Review,“Damages Awarded for Breach of Duty of “Fair Dealing.” The trial judge found that the franchise agreement provided the franchisees with a conditional right of renewal and that the franchisor denied them this right. The trial judge found that the individual franchisee and the franchisee’s corporation were both franchisees of the franchisor, despite an express assignment of the agreement to the corporate franchisee. The trial judge not only awarded the individual franchisee damages for future loss of income flowing from the franchisor’s breach of contract, but also awarded, for the first time in a franchise decision, an additional amount for breach of the duty of good faith and mental distress.

Individual versus Corporate Franchisee

The first ground of appeal was that the trial judge erred in failing to distinguish the individual franchisee from his corporation. Since the corporation was a distinct entity from its owner, and the owner assigned the franchise agreement to the corporation, the franchisor submitted that only the corporate franchisee could assert contractual rights against the franchisor. The court of appeal did little to analyze this submission other than to support the trial judge’s finding that the franchisor “maintained a relationship with both the individual franchisee and its assignee corporation” and “never intended to accept the corporation in the place of [the individual franchisee] for all purposes.” The reasons of the court of appeal agreeing with this finding are far from analytical:

“In the context of this dispute between franchisor and franchisee, it would be incongruous, not to mention unfair to Mr. Salah, if he and his corporation were treated as one entity for the purposes of franchise liabilities, but were treated as separate entities when the question of enforcing franchisee rights under the franchise agreement is at issue.”

One may wonder how the concept of “unfairness” is relevant.

Correct Interpretation of the Documents

The second ground of appeal was that the trial judge improperly construed the documents as providing an option to the franchisee of renewing the franchise agreement, and accordingly there could not have been a breach of contract leading to damages.

On this ground of appeal the court of appeal did go to some length to review basic principles of commercial contractual interpretation in supporting the trial judge’s decision. The court saw no error in the manner in which the trial judge applied principles of construction of commercial agreements, and determined that the trial judge considered all of the relevant documents and found that the key document, the franchise agreement, was not ambiguous. Further, the court of appeal noted that to the extent that any discrepancy existed between the head lease and the franchise agreement, it agreed with the trial judge that the franchise agreement should be interpreted against the interests of the franchisor as it had control over the drafting of the documents. The court of appeal supported the findings of the trial judge that the franchise agreement and other relevant documents, along with the conduct of the franchisor, effectively amounted to a refusal to allow the franchisee the option of renewing the franchise agreement, and accordingly constituted a breach of contract.

Breach of Duty of Fair Dealing

The third ground of appeal argued by the franchisor was that its conduct leading up to the expiration of the franchise agreement could not constitute a breach of the statutory duty of fair dealing because Section 3(1) of the Arthur Wishart Act only imposes the duty of good faith and fair dealing in the “performance or enforcement” of the franchise agreement. The franchisor argued that a terminated agreement is not caught by the section. The trial judge, on the facts, found that there could be no doubt that the conduct of the franchisor arose squarely within the “performance or enforcement” of the franchise agreement. However, since the court of appeal found no error in the trial judge’s conclusion that the documents as a whole provided the franchisee with a right of renewal, which was triggered, the franchisor’s submission on this point could not succeed. The findings of fact at the lower court more than supported the conclusion that there was a breach of the duty of fair dealing that the franchisor owed to the franchisee under Section 3(1) of the Arthur Wishart Act.

Damages Award

The final substantive ground of appeal argued by the franchisor was that it was not open to the trial judge to award damages under the Arthur Wishart Act for anything other than compensatory damages relating to pecuniary losses. The franchisor argued that damages flowing from the breach of a duty of fair dealing are limited to lost profits, and in particular to the lost profits of the franchisee’s corporation.

The court of appeal supported the reasoning of the trial judge which treated the individual franchisee and the franchisee’s corporation as a single entity for the purpose of determining losses flowing from the breach of contract. The court of appeal did make some interesting observations with respect to possible limitations applicable to damage awards under the Act in respect of the breach of the duty of fair dealing under Section 3(2) of the Arthur Wishart Act.

The court of appeal stated that the legislation is remedial in nature, and deserves a broad and generous interpretation as its purpose is to redress the imbalance of power as between franchisor and franchisee, and to provide a remedy for abuses stemming from the imbalance. An interpretation of the legislation which would limit damages to compensatory damages, related solely to proven pecuniary losses, “would fly in the face of this policy initiative.” As stated by the court of appeal “by enacting legislation that addresses the particular relationship between franchisors and franchisees, the legislature has clearly indicated that such relationships give rise to special considerations, both in terms of the duties owed and the remedies that flow from a breach of those duties.” Therefore, the court of appeal agreed with the trial judge that the legislation permits an award of damages for the breach of the duty of good faith, separate and in addition to an award in compensation of pecuniary losses. Further, any such award must be commensurate with the degree of the breach or offending contract in the circumstances.

The court of appeal affirmed the approach of the trial judge in which damages were awarded on a merged basis for the breach of duty of good faith and mental distress, and observed that the trial judge’s findings as to the breach of the duty of good faith alone, without the component of mental distress, would support the amount of the award. This latter statement seems to be a gratuitous comment justifying the fact that the trial judge did not separate the damages award into two separate components.

In summary, the court of appeal’s decision in this case leaves us with some important new principles in franchise law and interpretation of the Arthur Wishart Act:

  1. An individual franchisee assigning a franchise agreement to a corporation may be treated together with the corporate franchisee as a single franchisee for purposes of relief under the Arthur Wishart Act.
  2. he courts will interpret franchise agreements to accord with sound commercial principles and good business sense and to avoid commercial absurdity. Where a transaction involves the execution of several documents that form parts of a larger composite whole – like a complex commercial transaction, and each agreement is entered into on the faith of the others being executed, then assistance in the interpretation of the main agreement may be drawn from the related agreements.
  3. The collective group of documents which constitute the franchise arrangement may be considered to be equal to a franchise agreement in totality which will allow an award of damages in an appropriate case for breach of the duty of fair dealing in the “performance or enforcement” of the franchise agreement.
  4. Damages flowing from a breach of the duty of fair dealing may include damages for mental distress.

While the facts of the Salah case may have been particularly egregious in respect of the franchisor’s conduct, nevertheless these basic principles, and the findings in the case, should be considered by all franchisors to signal the attitude of the courts in expanding the duty of fair dealing to allow a remedy (i.e., mental distress) not normally associated with a breach of contract.