The Ontario Superior Court recently affirmed a Small Claims Court decision returning a franchise fee to a franchisee where the franchise location contemplated was no longer available – in spite of a clause in the franchise agreement stating that the franchise fee “is under no circumstances refundable”. Interestingly, the decision is based on the common law doctrine of frustration of contract, without reference to franchise disclosure legislation.

In Dhillon v. PM Management Systems Inc., 2014 ONSC 5407, the franchisee entered into an agreement with the franchisor to own and operate a specialty health services business at 20 Cottrelle Blvd., Brampton, Ontario, and which granted him an exclusive territory in which to operate the business. The franchisee paid an initial franchise fee of $27,100 under the agreement, which included a clause that stated:

The Franchisee acknowledges and agrees that the initial franchise fee represents payment for the initial grant of the rights to use the Marks and Licensed Methods, that the Franchisor has earned the initial franchise fee upon receipt thereof and that fee is under no circumstances refundable to the Franchisee after it is paid.

The franchisor did not own the contemplated business premises at 20 Cottrelle Blvd., however, and was unable to negotiate a lease with an exclusive-use clause. The parties attempted to find a substitute property without success.

Although the exclusive territory was still available to him, the franchisee asked for a return of his franchise fee, effectively seeking rescission of the agreement. The franchisor refused to refund the franchise fee, and the franchisee commenced an action.

The Deputy Judge in the Small Claims Court held that the franchise agreement had been frustrated, and in those circumstances the agreement did not preclude a refund of the fee.

The Ontario Superior Court upheld the Deputy Judge’s decision, holding:

When an uncontemplated event or circumstance occurs after the signing of a contract that without default of either party makes the performance of the contract impossible or would make performance a radically different thing than what was promised or intended by the parties or that strikes at the root of the agreement, both parties may be discharged from further performance and moneys paid may be restored to the party who paid them…

In the circumstances at bar, the inability to negotiate an exclusive-use lease at the location specifically contemplated in the franchise agreement was sufficient to frustrate the agreement, warranting return of the franchise fee paid under it.

This case provides a useful lesson to franchisors in negotiating franchise agreements. A franchise agreement may be held to be frustrated – effectively resulting in rescission – if the agreement promises something specific, such as a particular business location, and that aspect cannot be delivered due to uncontemplated circumstances.

As arrangements cannot always be finalized before executing the franchise agreement, clear language in the franchise agreement may mitigate this result. If arrangements such as the franchise location are not yet firmly secured, franchisors may wish to include flexible language in the agreement that addresses what will happen with the franchise fee if arrangements fall through, or how the parties will work to make alternative arrangements. By addressing possible contingencies, such language may avoid a finding that performance of the agreement would be radically different than what was promised.