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Supreme Court Decisions Impacting Franchisors: Contractual Interpretation and Contractual Duty of Honesty

Author(s): Mary Paterson, Catherine Gleason-Mercier

April 2015

Two recent Supreme Court of Canada decisions have been making waves in the law of contract. In Sattva Capital Corp. v Creston Moly Corp., 2014 SCC 53 (Sattva), the Supreme Court found that, generally, decisions made by either judges or arbitrators interpreting contracts should attract deference by appellate courts. Then, the Supreme Court found that it was time for the common law to embrace a duty of honest performance with regards to contractual obligations in Bhasin v Hrynew, 2014 SCC 71 (Bhasin). As noted below, both these decisions are likely to impact how franchisors approach their agreements with franchisees.

Sattva and Contractual Interpretation

Contractual interpretation used to be a question of law. Now, according to the Court, in Sattva, “contractual interpretation involves issues of mixed fact and law as it is an exercise in which the principles of contractual interpretation are applied to the words of the written contract, considered in light of the factual matrix.” This factual matrix, or surrounding circumstances, are those objective facts that were known or ought reasonably to have been known by the parties at the time of contracting. 

Sattva changes the landscape for franchisors:

  1. Because contractual interpretation is no longer a pure question of law, it will be harder to get leave to appeal, where leave to appeal is needed. This difficulty is magnified in the case of arbitration, where appeal rights can be limited to questions of law alone.
  2. It will be harder to succeed on appeal because the appeal court will show deference to the trial court. The Supreme Court found that the standard of review for a matter of contractual interpretation is reasonableness – that is, as long as the decision falls within the spectrum of reasonable outcomes, the reviewing court will not interfere. Again, where the decision has been made by an arbitrator, this deference is magnified to reflect the expertise of that decision-maker.
  3. It remains to be seen whether courts will admit more evidence about what the parties ought to have known at the time they entered into the franchise and other agreements. An increase in the amount of evidence may increase the cost of litigation.

Sattva has created an uphill battle for parties seeking to challenge decisions regarding the interpretation of a contract, especially where those decisions have been made by an arbitrator.

Sattvaand Dispute Resolution Clauses

Given that Sattva requires more deference to decision makers at first instance, dispute resolution clauses in the franchise agreement may be more important for franchisors. In particular:

  • Draft your dispute resolution clause carefully. Since it is almost always the case that a dispute between the franchisor and a franchisee will involve interpretation of the franchise agreement, the entity adjudicating the dispute will likely have the last say. Remember, unless the reviewing court is able to find a question of law, deference will be owed to the decision maker and an appeal very unlikely to succeed.
  • Choose your dispute resolution procedure carefully. As a result of this deference, franchisors should decide at the time of drafting the franchise agreement what kind of process they desire with regards to dispute resolution. An arbitration clause can be beneficial because of the often shorter time periods associated with adjudication, but since an appeal is very unlikely, careful thought as to who should be selected as an arbitrator and what procedures regarding the arbitration should be in place is paramount.
  • Build in an appeal mechanism, if you want one.  Given that the default approach seems to be great deference to the decision maker, if a franchisor wishes to preserve an appeal right, it is best to explicitly acknowledge such a right in the clause. Some jurisdictions, such as Ontario, allow parties to specifically allow appeals of questions of fact or questions of mixed fact and law. Careful consideration and explicit drafting is required to ensure that the proper appeal rights are preserved (or excluded).

Bhasin and the Common Law Duty of Honest Performance

The Supreme Court in Bhasin found that the development of the common law necessitated the recognition of a general duty of honest contractual performance. Indeed, in summarizing its findings, the Court noted that:

  1. There is a general organizing principle of good faith that underlies many facets of contract law.
  2. In general, the particular implications of the broad principle of particular cases are determined by resorting to the body of doctrine that has developed which gives effect to aspects of that principle in particular types of situations and relationships.
  3. It is appropriate to recognize a new common law duty that applies to all contracts as a manifestation of the general organizing principle of good faith: a duty of honest performance, which requires parties to be honest with each other in relation to the performance of their contractual obligations.

The Court was careful to note that this duty of honest performance does not impose fiduciary duties on the parties, but simply means that “parties must not lie or otherwise knowingly mislead each other about matters directly linked to the performance of the contract.”

Why does BhasinMatter to Franchisors?

The duty in Bhasinis a common law duty that supplements and does not override those duties found in the governing legislation, such as the duty to disclosure and the duty of good faith and fair dealing. As such, franchisors will be subject to their current duties under their respective franchise legislation in addition to this new common law duty.

However, the Supreme Court expressly limited this common law duty of honest performance of contractual obligations to “not lie or mislead the other party about one’s contractual performance.” It does not create a positive duty on the parties to the contract; rather it creates a duty not to do something (i.e. not to lie or mislead). In Bhasin, the Court found a breach of the common law duty of honest performance given the consistent pattern of active misleading, and underhanded and dishonest conduct.

Based on Bhasin, it seems that franchisors can expect to find themselves facing allegations of a breach of this common law duty of honest performance in addition to breaches of the franchise legislation. However, as in the statutory duty of good faith and fair dealing, this common law duty of honest performance cuts both ways, and franchisors may find themselves in a position to advance claims against franchisees who have actively misled the franchisor with regards to the franchisee’s performance under the franchise agreement.

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