The duty of fair dealing in Canadian franchise law is a creation of both common law and statute, and has very practical applications to the manner in which franchisors and franchisees deal with each other, and to franchise agreements and related documents in general. Franchisors in particular should review their documents regularly to ensure that they are compliant with the duty of fair dealing as interpreted by the courts and as defined by franchise statutes.
The duty of fair dealing in franchise legislation is really a codification of the common law duty of good faith and fair dealing between contracting parties, in this case between franchisors and franchisees. The common law duty includes the duty to act in good faith and in accordance with reasonable community standards of honesty and integrity. As interpreted by the courts, this means that a franchisor must not act in bad faith towards a franchisee, and must act in a commercially reasonable manner, when performing its obligations or enforcing its rights under a franchise agreement.
The common law concept of fair dealing is enshrined in franchise legislation in Alberta, Manitoba (not yet in force), Ontario, Prince Edward Island and New Brunswick. Although it is defined with increasing particularity in the order of those provinces, essentially the duty applies to the performance or enforcement of a franchise agreement by either the franchisor or the franchisee. The duty of fair dealing is generally defined as including the duty of good faith and the duty to act in accordance with reasonable commercial standards, and applies to discretionary rights under the franchise agreement. It does not mean that the parties are required to “act fairly” towards each other as it is specifically geared to obligations and rights under the franchise agreement. Under the franchise statutes of the relevant provinces, a “franchise agreement” is defined to include any agreement relating to the franchise. Therefore, the duty of fair dealing applies to all agreements, not just the primary franchise agreement. In addition, since most franchise agreements incorporate an operations manual or the like by reference, it would apply to the performance or enforcement of obligations and rights by either party under those agreements and the manual. Typical agreements might include a lease or sublease, a guarantee or indemnity, a general security agreement, a software license, internet/intranet policies, social media policies and non-competition agreements.
So What Does All of This Mean for Franchisors?
First, franchise agreements and related documents should be clear and precise with respect to obligations and rights of the parties. The courts will apply the duty to the relevant provisions of the agreement, and consider the conduct of the parties with reference to those provisions.
Second, franchise agreements should not have older-type clauses providing for “sole”, “unfettered”, or “absolute” discretion. These modifiers do not add to or amend the duty of fair dealing, but do enhance a finding by the courts that franchise agreements are “contracts of adhesion.” Since the duty will be interpreted in accordance with reasonable commercial standards, use of these terms will be tempered in any event to be determined in accordance with what a court considers to be commercially reasonable.
Third, since every franchise agreement contains rights and obligations, consistent language should be used when providing for these rights and obligations. If it is intended for an obligation to be mandatory, the word “shall” is commonly used: e.g., “The Franchisee shall make royalty payments weekly”, or: “The Franchisor shall conduct an initial training program”. If a right or obligation is discretionary, the word “may” is commonly used: e.g., “The Franchisee may purchase supplies from sources approved by the Franchisor”, or: “The Franchisor may develop a gift card program”. The word “may” by itself connotes discretion, and therefore if an agreement uses phrases like “may, in its discretion”, as well as “may”, there could be some difference attributed to the different expressions. Consistency is recommended whatever approach is adopted.
Finally, since the duty of fair dealing includes the obligation to act in accordance with reasonable commercial standards, franchisors should be able to assemble supporting information as to objective standards used by other franchisors or similar suppliers or manufacturers in related industry segments when enforcing rights or performing obligations under their agreements, especially when major or significant commitments or expenditures by franchisees are involved. Further, when interpreting or enforcing rights of renewal, transfer or termination, franchisors must always be wary of the specific language in the franchise agreement and the application of the duty of fair dealing to the relevant provisions of the agreement as the duty of fair dealing will always apply in these situations.
Canadian courts have considered the application of the duty of fair dealing in a number of franchise cases, more often than not finding in favour of franchisees. Preventive action by a franchisor will go a long way towards avoiding such disputes.