In a recent decision1 the Court of Appeal for Ontario provided commentary on the doctrine of “notional severance” as it applies to franchise agreements. This decision highlights the tension that exists between protecting the freedom to enter into commercial contracts and protecting franchisees from the potentially “oppressive and coercive” conduct of franchisors.
The franchise agreement and the Arthur Wishart Act
In this case, the franchise agreement provided that the franchisor’s consent was required before a franchisee could assign the agreement to a third party. To obtain this consent, the franchise agreement set out a number of conditions precedent, which included providing information about the assignee and demonstrating the assignee’s fitness as a franchisee.
At issue in this dispute was a franchise agreement provision that required a franchisee to sign a “general release in a form specified by the franchisor” before receiving consent to the proposed assignment (the Release Provision2. The respondent franchisee argued the Release Provision was contrary to section 11 of the Arthur Wishart Act(the Act), which provides that: “Any purported waiver or release by the franchisee of a given right under this Act or of an obligation or requirement imposed on a franchisor … by this Act is void.”3
The court decisions
The application judge concluded that the Release Provision conflicted with the Act and, by operation of section 11 of the Act, was void and unenforceable.
On appeal, the franchisor argued the application judge failed to consider that the Release Provision did not necessarily amount to a waiver of any rights provided in the Act. It argued the language in the Release Provision allowed the franchisor to determine the scope of the release, including a release that was compliant with the Act. The appellant also argued the application judge failed to consider that the draft release provided to the respondent franchisee only required the release of common law claims against the appellant franchisor.
The Court of Appeal rejected the appellant’s interpretation of the Release Provision and held that the requirement the release be in a “form specified by the franchisor” did not speak to the substance of the release. In contrast to the appellant’s position, this provision did not call for a release of claims to the extent permitted by the Act. The court further held that the appellant could not alter the meaning of the Release Provision by seeking something less than it was entitled to – by only requesting a release that was compliant with the Act.
Court of Appeal analysis – the doctrine of severance
Despite concluding that the Release Provision conflicted with section 11 of the Act, the court diverged from the application judge’s decision and held that the provision itself was not void by operation of section 11. Rather, this provision was unenforceable insofar as it required the franchisee to sign a release that would in turn contravene the Act. This distinction was important. It enabled the Release Provision to be read down or “notionally severed” so as to compel performance by the franchisee to the extent permitted by the Act.
At the outset, the court emphasized that the issue of severance in this case engaged two competing policy concerns: (1) the need to protect the freedom of parties to enter into commercial agreements; and (2) the need to protect franchisees from “abuse and coercion” at the hands of franchisors.
The applicant argued that by holding the release completely unenforceable, the court would deprive the applicant of a contractual right that was bargained for in good faith. On the other hand, the court noted there are important policy concerns in addressing the power imbalance between franchisees and franchisors. Adopting the reasoning from the Supreme Court in Transport North America Express Inc. v New Solutions Financial Corp.,4 the court set out the following factors as relevant to determining the appropriateness of notional severance in the context of franchise agreements:
- Whether the purpose or the policy of section 11 of the Act would be subverted if the Release Provision in question were notionally severed; and
- Whether the franchisee would enjoy an unjustified windfall if the Release Provision in question were struck down in its entirety.5
Applying the first factor, the court held that enforcing part of the Release Provision would raise the potential for abuse by the franchisor and, as a result, undermine the purpose of section 11 of the Act.
Specifically, the court concluded that applying notional severance in this case would provide no incentive to franchisors to ensure franchise agreements are compliant with the Act. Applying notional severance to a clause that calls for a general release of the franchisees’ rights would encourage franchisors to draft overly broad release provisions with the expectation that those provisions would then be read down in the event they are challenged. Finally, the court held that reading down a provision of this kind would increase the potential for franchisees to erroneously conclude that – having signed a release – they are without legal recourse against the franchisor.
As for the second factor, the appellant argued the respondent franchisee would receive a windfall if the provision was struck down in its entirety: “They [the franchisees] bargained to provide a release of all claims in exchange for the appellant’s consent to a transfer of their rights under the franchise agreement, and if the clauses are severed in their entirety, they will not have to provide a release at all.”6
The court conceded that franchisees would benefit from striking down this provision insofar as they would no longer be required to waive their common law rights. However, the court held that the extent of this gain was difficult to assess given the overlap between common law rights and the rights provided under the Act. In any event, the franchisor’s legitimate interests in selecting suitable assignees would not be undermined by striking down the Release Provision given that the other conditions precedent in the franchise agreement would remain in effect.
Having made these findings, the court concluded that the potential for the respondent franchisees to receive a windfall if the Release Provision was struck down in its entirety was not outweighed by the potential abuse and subversion of the Act that would occur if the Release Provision was severed in part. On this basis, the court dismissed the appeal and held that the impugned provision was entirely unenforceable.
The author wishes to thank Jonathan Preece, articling student, for his help in preparing this legal update.