Franchising in the Courts

Franchisors Facing Class Action Certification Should Consider Summary Judgment Option

By:  Jean-Marc Leclerc and Andraya Frith 

While the common features of a franchise agreement may work to a franchisor’s detriment in resisting class action certification, amendments made to Ontario’s summary judgment rule, which came into effect in January 2010, provide more options to franchisors.  In TA&K Enterprises Inc. v. Suncor Energy Products Inc. the court rejected arguments that Suncor was required to pay claimed damages of $200 million due to an alleged failure to deliver a disclosure document to franchisees, holding that a “one year, no non-refundable franchise fee” exemption prescribed by the Wishart Act applied.

A common contract shared by dozens of individual franchisees may be viewed as a perfect vehicle for class action certification. In the last five years, there have been many successful class action certification motions alleging breaches of the Arthur Wishart Act (Franchise Disclosure), 2000, S.O. 2000, c. 3 (Wishart Act) against franchisors. In the summer of 2010, the Ontario Court of Appeal held that “a dispute between a franchisor and several hundred franchisees is exactly the kind of case for a class proceeding” (Quizno’s Canada Restaurant Corporation v. 2038724 Ontario Ltd. v. 2038724 Ontario Ltd., 2010 ONCA 466 at Para. 62).

While the common features of a franchise agreement may work to a franchisor’s detriment in resisting class action certification, amendments made to Ontario’s summary judgment rule, which came into effect in January 2010, provide more options to franchisors.

That is precisely what occurred in a recent decision of the Ontario Superior Court of Justice in TA&K Enterprises Inc. v. Suncor Energy Products Inc., 2010 ONSC 7022, in which Larry Lowenstein and Jean-Marc Leclerc, Partners in the Osler Litigation Group and Adam Hirsh, Associate, Osler Litigation Group, represented Suncor Energy Products Inc. (Suncor).

Justice Peril rejected arguments that Suncor was required to pay claimed damages of $200 million due to an alleged failure to deliver a disclosure document to franchisees, holding that a “one year, no non-refundable franchise fee” exemption prescribed by the Wishart Act applied.

It took less than one year from the launch of the claim to obtain summary judgment. What is the moral of the story? Franchisors should consider seeking summary judgment in franchise class actions. By doing so, a class action can be stopped in its tracks at an early stage, giving franchisors increased business certainty in a cost-effective manner.

The plaintiff has appealed Justice Peril’s decision to the Ontario Court of Appeal.

1250264 Ontario Inc. v. Pet Valu Canada Inc.

By: Jennifer Dolman and Gillian Scott

Volume rebates continue to be a volatile area for franchisors as a Pet Valu franchisee wins a certification decision in 1250264 Ontario Inc. v. Pet Valu Canada Inc. This decision is another victory for franchisees seeking to use class action litigation as a forum to bring about change in their relationships with franchisors.

In his January 14, 2011 decision in 1250264 Ontario Inc. v. Pet Valu Canada Inc., Justice Strathy of the Ontario Superior Court of Justice certified a class action brought by franchisees against Pet Valu Canada Inc. (Pet Valu).  However, not all of the common issues put forward by Pet Valu were certified; only those claims relating to volume rebates.

Certification of Volume Rebate Claims

Justice Strathy certified volume rebate claims in finding that there was some basis for the assertion that the Pet Valu standard form franchise agreement required it to pass on the benefit of volume based rebates, allowances and discounts granted to the franchisor by its suppliers (volume rebates) to its franchisees, and that it failed to do so.

Volume rebates are a key aspect to many franchise relationships, as franchisors are able to exert substantial purchasing power.  Franchisor practices with regard to sharing volume rebates have come under significant fire from franchisees (see 1176560 Ontario Ltd v. Great Atlantic & Pacific Co. of Canada Ltd (2004) (A&P), 2038724 Ontario Ltd. v. Quizno’s Canada Restaurant Corp. (2010 (Quiznos) and 578115 Ontario Inc. v. Sears Canada Inc.). The disclosure of volume rebates, as well as a franchisor’s policy on passing volume rebates on to franchisees is specifically required by Section 8, Ontario Regulation 581/00 under the Arthur Wishart Act.

Other Points of Interest

A.        Franchisee’s Individual Purchasing History and Circumstances Not a Sufficient Bar to Certification

Justice Strathy flatly rejected Pet Valu’s argument that the action was not appropriately certifiable as a class action because an examination of the individual circumstances of each of its franchisees would be required in order to determine what losses, if any, that individual franchisee suffered due to Pet Valu’s volume rebate practices. Individual circumstances identified by Pet Valu as having an effect on a specific franchisee’s losses included: purchasing history, distance from distribution centres, proximity of competitors, product mix and compliance with and participation in promotional programs. Justice Strathy found that because of Pet Valu’s uniform practices in applying volume rebates, determining individual franchisee losses due to these practices was simply a matter of accounting which could be accomplished easily with Pet Valu’s “formidable accounting system.” Alternatively, Justice Strathy found that it might be possible to do a proportionate valuation of each franchisee’s damages.

B.        Internal Franchisee Council Not an Adequate Forum for Addressing Franchisee Concerns

Justice Strathy also flatly rejected Pet Valu’s argument that its Canadian Franchise Council (the CFC), a group representing Pet Valu franchisees, was a more appropriate forum for addressing franchisee complaints than a class action. In his reasoning, Justice Strathy relied on evidence that while franchisees raised their concerns about volume rebates in CFC meetings, and the CFC reported these concerns to Pet Valu management, the concerns were not reflected in the form of Pet Valu’s most recent revised Franchise Agreement. This reinforces the fact that while internal franchisee advisory organizations may function as an effective way of avoiding collective action from franchisees, they will only do so in instances where their input is seen to modify the behaviour of franchisors.

C.        Franchisee Class Appropriately Extends Across Provincial Jurisdictions

In line with the decision in Quiznos, Justice Strathy held that it was appropriate for the class of plaintiffs to include Pet Valu franchisees in Manitoba as well as in Ontario, despite the fact that the complaint as drafted is based in part under Ontario’s Arthur Wishart Act. Justice Strathy found that the bulk of claims as drafted in the action were common to Manitoba franchisees, and that there was “no reason why there should not be a sub-class of Manitoba franchisees who will have an interest only in those common issues that do not depend on the Arthur Wishart Act for their resolution.”

Not All Bad News for Franchisors - Key Conclusions & Practical Applications

In the wake of the recent wave of franchisee class actions, franchisors will be relieved that Justice Strathy accepted Pet Valu’s argument that it is “wrong to simply say that because this is a franchise claim it is appropriate for class action.” Justice Strathy held that: “[t]he lense of judicial economy, access to justice and behaviour modification do not obviate the need for inquiry into whether a class proceeding is a fair, efficient and manageable method of resolving a claim.” It of course remains to be seen whether this test will be rigorously applied in franchise class actions, or whether the David and Goliath perceptions at play in this form of litigation may reduce the test to a cursory examination once it is established that the parties were acting under a common standard form franchise agreement. Furthermore, although this is only a certification decision with no final determination on the merit of the Volume Rebate claims, it serves as a reminder that franchisors need to be careful with how they disclose their rebate policy in their disclosure statements. Furthermore, where franchisors have agreed in their standard form franchise agreements to share Volume Rebates with their franchisees, they must do so.

Inadequate Disclosure of Rebate Practices Increase Risk of Franchisee Class Actions

By: Evan Thomas

A recent Ontario Superior Court decision - 578115 Ontario Inc. v. Sears Canada Inc., 2010 ONSC 4571 (Sears Canada) - to certify a franchisee class action based on alleged inadequate disclosure of supplier rebates highlights the importance to franchisors of following best practices for the disclosure of rebates.The decision is also another example of the willingness of the Ontario courts to certify franchisee class actions to “level the playing field” between franchisors and franchisees.

Obligation to Disclose Rebate Practices

The Ontario Arthur Wishart Act and the Alberta Franchises Act require franchisors to deliver a disclosure document to prospective franchisees. The regulation under the Ontario Arthur Wishart Act requires the franchisor to include a description of the franchisor’s policy regarding volume rebates including whether the franchisor receives rebates as a result of purchases by a franchisee and if so, whether such rebates are shared with franchisees. The regulation under the Alberta Franchises Act also requires disclosure of similar information about rebates.

Facts of the Case

In 1998, Sears Canada Inc. (Sears) entered into an agreement with Home Coverings Buying Group Inc. (HCBG) to establish a network of independent floor covering retailers to operate as “Sears Covering Centres.” HCBG recruited independent retailers, who then entered into franchise agreements with Sears. HCBG also recommended approved suppliers to Sears.

HCBG negotiated volume rebate agreements with approved suppliers for supply of floor covering products to both Sears and the franchisees. These agreements provided for allowances and rebates totalling approximately 9% of purchases by Sears and franchisees.

From 1999 to 2002, Sears had essentially identical franchise agreements with its retailers. Certain key terms were as follows:

  • The agreement was for a term of one year, automatically renewing for successive one-year periods;
  • The franchisee purchased only from approved suppliers; and
  • Sears paid the franchisee a rebate of 4% of the total annual net purchases made by the franchisee from approved suppliers.

In 2003, the franchise agreement was changed to provide for a one-year term with the ability to enter into a new agreement for a one-year term, without automatic renewal.

The Plaintiff’s Position

The plaintiff in Sears Canada, a numbered company operating as “McKee’s Carpet Zone” (McKee’s), started the proposed class action on behalf of 73 retailers operating as “Sears Floor Covering Centres.” McKee’s alleged that it and the other class members did not know they were only receiving part of the rebate paid by suppliers to Sears. McKee’s claimed damages based on these alleged “secret rebates” received by Sears.

The plaintiff advanced various theories of Sears’ liability, including breach of implied terms of the franchise agreements, breach of statutory duties of good faith and fair dealing under the Ontario Arthur Wishart Act and the Alberta Franchises Act, non-compliance with statutory disclosure obligations, and unjust enrichment.

All of the theories, however, were based on Sears’ alleged failure to disclose the fact and quantum of rebates received by Sears and/or HCBG from approved suppliers. The plaintiff sought damages based on the actual rebates received from the approved suppliers.

The Decision

As the decision concerned McKee’s motion for certification, Justice G.R. Strathy only had to decide whether the claim was suitable to proceed as a class action and made no findings on the merits of McKee’s claims. Sears opposed certification primarily on the grounds that some of the issues raised by the class members’ claims could only be resolved by individual trials and hence a class action was not the preferable procedure.

Justice Strathy disagreed with Sears, concluding that although individual trials might be required to resolve certain issues, “judicial economy and access to justice would be attained” through a class action.

Justice Strathy also stated that “In view of the power imbalance between the franchisor and the franchisees, the very concern that the [Arthur Wishart Act] was designed to redress, there is a significant impediment to access to justice by way of individual action, particularly where some of the franchisees remain a part of the system.” He concluded that: “A class action in this case will promote access to justice that is unlikely to be achieved by other means.”

Conclusion

In addition to Sears Canada, the Ontario courts have certified three other franchisee class actions in the past year -Quizno’s, Mayotte v. Ontario and Pet Valu - and certification decisions in other franchisee class actions are expected in the near future. This trend in part reflects the Ontario courts’ view that class actions can address a perceived “power imbalance” between franchisors and franchisees.

Further, following Sears Canada, proposed franchisee class actions based on allegations of inadequate disclosure of rebate practices have a significantly higher likelihood of being certified. Franchisors who wish to invoke best practices to minimize uncertainty and risk of future disputes, particularly class actions, should strongly consider including in their franchise, the following provisions relating to rebates:

  • their entitlement to receive rebates;
  • a description of the types of rebates contemplated; and
  • the requirement, if any, of the franchisor to account for rebates they obtain from authorized suppliers. 

In addition, franchisors must ensure that these provisions must be consistent in all agreements and documents (including the disclosure document) and in practice.

Salah and 1470256 Ontario Inc. v. Timothy’s Coffees of the World Inc., (Court of Appeal for Ontario)

By: Frank Zaid

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. The 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.