Background to the Dispute
Against the backdrop of a bitter family dispute, the Fabutan decision1 reinforces the maxim that business and family often do not mix. This case considered whether the tanning system franchisor, Fabutan Corporation, run by the president (Mr. McNabb), was justified in refusing to renew a franchise agreement held by the president’s sister (Ms. McNabb).
Ms. McNabb held two Fabutan franchises, but was also a creditor of Fabutan. Ms. McNabb and Mr. McNabb fell out over a dispute regarding a franchise system competition that was won by Ms. McNabb and that led to bitter personal accusations. Ms. McNabb eventually requested that her loans to Fabutan, as well as some unconnected loans, be repaid.
In the midst of this dispute Ms. McNabb requested that one of her franchise agreements be renewed. Dispensing with standard renewal protocol, Mr. McNabb refused to renew the franchise agreement. Adding to the dispute were a significant dividend payment to Ms. McNabb relating to an unconnected tanning franchise, the siblings’ estranged father’s inflammatory comments, and damaging communications sent by the siblings to the Fabutan franchisees. Certain franchisees also attempted to mediate the dispute.
Fabutan made a half-hearted attempt to settle and agree to renew the franchise agreement on the basis of seven onerous terms and conditions, including requesting from Ms. McNabb a security agreement that required registered liens on all assets, a $50,000 security bond, a non-standard assignment of leases to the franchisor, an acknowledgment with respect to past, present and future communications relating to the estranged father, and terms regarding the unconnected franchise dividend payment. Counter proposals followed, eventually resulting in Fabutan formally terminating Ms. McNabb’s two franchise agreements and disconnecting her franchises from the Fabutan IT network and, in so doing, deleting client information.
A subsequent court order restored the status quo, restrained both parties from making disparaging comments, enjoined Fabutan from terminating the agreements, reinstated the Fabutan software and restored the Internet connections of the franchisees.
Madam Justice Romaine considered that the only aspect that may have been relevant to Fabutan’s right to terminate the franchise agreements was the failure to meet the standards of cleanliness, subject to notification and an opportunity to cure. Fabutan purported to use this as a reason for termination, but no opportunity to cure was given; nor was any evidence led to establish this as a valid ground for termination. Therefore the issue was whether the various rationales for termination posed by Fabutan were “good cause,” under the terms of the franchise agreements, sufficient to allow Fabutan to terminate the franchise agreements in accordance with their terms. Justice Romaine decided that they were not and, unsurprisingly, it was held that Ms. McNabb’s conduct as a creditor, in validly exercising her right to call loans, did not constitute good cause to terminate the franchise agreements, which were unrelated contracts.
Justice Romaine found that other Fabutan franchise agreements were always renewed for 10-year terms using the current standard form of renewal agreement. Therefore the issue remained whether the form of renewal contract and seven onerous terms and conditions that Fabutan required from Ms. McNabb met the requirement of being a standard form of renewal agreement in use at the time. The duty of good faith was central to this analysis.
Duty of Good Faith and Renewal
The Franchises Act, R.S.A. 2000, c. F023, s. 7, imposes on each party to a franchise agreement a duty of fair dealing in its performance and enforcement. Justice Romaine cited Shelanu Inc.,2 which serves as a useful reminder of some of the key requirements of the duty:
- The franchisor must take into account the interests of the franchisee in the exercise of its discretion.
- A decision by a franchisor not to renew for alleged good cause is an exercise in discretion.
- Whether or not a party under a duty of good faith has breached the duty will depend on the circumstances of the case, including whether the party subject to the duty conducted itself fairly throughout the process.
- Compliance with the terms of a franchise agreement does not necessarily mean that a franchisor has discharged its duty of good faith.
- A franchisor cannot exercise its power or discretion out of vindictiveness or to gain leverage or a bargaining advantage over a franchisee.
Application of the Duty of Good Faith to the Facts
Applying the duty of good faith to the facts of the case, Justice Romaine held that the conduct of Fabutan, through its president Mr. McNabb, breached the obligation of good faith. Examples of bad faith included the following:
- the circumstances of the initial denial to renew the franchise agreement;
- the constantly changing decisions on the renewal and the variety of largely unsubstantiated reasons for non-renewal;
- the attachment of onerous terms of renewal that were not imposed on other franchisees in the absence of reasonable or rational grounds;
- the failure to provide Ms. McNabb with a proposed form of standard agreement until well into the process, and then only when accompanied by onerous terms and conditions;
- the imposition of unreasonable time periods to review documentation;
- the unjustified linking of the renewal to the dividend and buy-out issue relating to an unconnected franchise;
- the misrepresentation of Ms. McNabb’s position to other franchisees; and
- the conduct of Fabutan personnel when purporting to terminate the franchise agreements under notices to terminate that Fabutan conceded were invalid.
Justice Romaine found the following:
- The requirements for renewal and the imposition of seven onerous terms and conditions did not meet the contractual requirement for renewal to be based on the standard form of franchise agreement in use at the time.
- Mr. McNabb, without reasonable justification, acted in a way that would “substantially nullify the bargained objective or benefit contracted for by the other, contrary to the original purpose and expectation of the parties.”
- It was legitimate for Ms. McNabb to question whether the franchise agreement that she finally received was a standard franchise agreement in use by Fabutan, and to question the imposition of the seven onerous terms and conditions.
- While Ms. McNabb’s conduct was inappropriate, it did not justify the severe penalty of termination of her franchise agreements.
- Fabutan did not establish “good cause” to terminate the franchise agreements and refuse the renewal of the franchise agreements.
Notwithstanding the bitter family dispute, Justice Romaine determined that the business relationship between Ms. McNabb and Fabutan could continue, particularly if Mr. McNabb ceased interfering in decisions and communications that would, in the normal course, be within the scope of employment of others at Fabutan. Accordingly, Justice Romaine ordered specific performance to require renewal of the subject franchise agreement for 10 years upon the terms and conditions contained in the standard form of Fabutan’s franchise agreement, with no requirement for additional security and no assumption of the leases by Fabutan. The purported termination of the second franchise agreement was vacated, with no additional security measures.
Fabutan’s arguments were not helped by some unclear termination and renewal provisions in the franchise agreement, particularly in light of the court’s strict construction. The following practical points should also be noted by franchisors to keep onside the duty of good faith:
- Be cognizant at all times (including when renewing franchise agreements) of the duty – and acknowledge the need – to consider the interests of the franchisees, even if this means putting aside personal grievances.
- Ensure that decisions to renew are made in accordance with standard processes, and not based on personal judgments.
- Once a decision is made it should be consistently followed and based on substantiated reasons that accord with the franchisor’s rights under the franchise agreement.
- Do not impose non-standard and onerous terms of renewal on a franchisee that are not required of other franchisees in the absence of reasonable or rational grounds.
- Promptly provide the form of renewal franchise agreement when a decision to renew has been made.
- Allow the franchisee a reasonable period to review documentation and, at a minimum, in accordance with applicable franchise legislation.
- Do not link renewal of the franchise agreement to unconnected matters.
- Avoid making statements to the franchise network that could be reviewed as misrepresentations, particularly in the midst of a dispute with franchisees.
- In light of Justice Romaine’s analysis, be aware that franchise agreements, as contracts of adhesion, must be interpreted strictly against franchisors as drafters, regardless of whether there is any ambiguity. Therefore, franchisees are entitled to the benefit of the most favourable interpretation.