By Christopher Horkins, Danielle DiPardo and Priya Gill, Cassels, Brock & Blackwell LLP

In determining an appeal from an arbitrator’s ruling, the Alberta Court of King’s Bench recently provided helpful clarification and guidance on some of the legal implications for parent companies on corporate acquisitions within the franchise context.[1]

In 2021, Sundial Growers Inc. (“Sundial”) acquired Spirit Leaf Inc. (“Spirit Leaf”), which owns a franchise system of recreational cannabis retailers (the “Spirit Leaf Acquisition”). In 2022, Sundial acquired Alcanna Inc. (“Alcanna”), which owns a 63% interest in Nova Cannabis, which operates a discount chain of retail cannabis stores under the “Value Buds” banner (the “Alcanna Acquisition” and together with the “Spirit Leaf Acquisition” the “Acquisitions”).

Upon learning of the Alcanna Acquisition, four Spirit Leaf franchisees, all of whom entered into their franchise agreements in 2019, prior to the Acquisitions, brought arbitration proceedings against both Spirit Leaf and Sundial alleging that Sundial and Spirit Leaf had breached or induced the breach of their franchise agreements and the duty of good faith as a result of the Alcanna Acquisition, which resulted in Sundial, the parent company of Spirit Leaf, becoming an indirect majority owner of a competing retail cannabis chain.

The arbitrator rejected nearly all of the Spirit Leaf franchisees’ claims, and, in a decision that will be helpful to franchisors on a number of issues, her decision was subsequently upheld by the Court on appeal.

Sundial was neither a “franchisor” or “franchisor’s associate”

The Spirit Leaf franchisees argued that Sundial was either a “franchisor” or, alternatively, a “franchisor’s associate” as defined by the Alberta Franchises Act and, as such, ought to be bound by the obligations of franchisors and franchisor’s associates under that Act. The arbitrator did not accept the franchisees’ arguments and the Court upheld the arbitrator’s decision in this respect.

The arbitrator found that Sundial could not be a “franchisor” because it was not involved in granting the franchises by virtue of the fact that the franchise agreements were entered into prior to the Acquisitions, and Sundial was not yet associated with Spirit Leaf.

Further, the arbitrator found that Sundial did not meet the definition of a “franchisor’s associate” under the Alberta Franchises Act, which may be found where “there are continuing financial obligations by the franchisee to that person and significant operational controls by that person on the franchisee.” The arbitrator found that, although monies paid by the franchisees would ultimately end up with Sundial, as the parent company, and there was evidence of Sundial employees sending royalty invoices to the franchisees on Spirit Leaf’s behalf, this did not demonstrate a financial obligation owed by the franchisees to Sundial. Rather, the financial obligations under the franchise agreements were owed to the franchisor, Spirit Leaf, and there was uncontroverted evidence that the franchisees paid the invoiced amounts to Spirit Leaf, and that Spirit Leaf maintained separate accounts from Sundial.

In addition, the arbitrator also dismissed the franchisees’ argument that there was a separate implied or verbal franchise agreement between Sundial and the franchisees. The fact that Sundial provided strategic and business advice, shared corporate services, and other functions to Spirit Leaf and its franchisees was not enough, even under the liberal interpretation of a franchise agreement under the Alberta Franchises Act, to constitute an implied or verbal franchise agreement.

As a result, Sundial was not bound by the terms of the franchise agreements since it did not meet the definitions of either “franchisor” or “franchisor’s associate”, and there was no evidence to support an implied or verbal franchise agreement.

Sundial did not cause Spirit Leaf to breach the Franchise Agreements

The Spirit Leaf franchisees argued that Sundial, in proceeding with the Alcanna Acquisition, caused Spirit Leaf to breach the franchise agreements. However, the arbitrator found, to the contrary, that Spirit Leaf had committed no breach at all since it did not own, operate or control the “Value Buds” stores. In addition, the arbitrator found that (a) there was nothing in the franchise agreements that expressly prohibited Spirit Leaf from operating competing stores within the same territory as the Spirit Leaf franchisees, provided those stores did not use the Spirit Leaf franchise system; and (b) one of the express rights in the franchise agreements permitted the acquisition of Spirit Leaf by an entity who also owns an interest in a company that owns a competitive business.

Finally, the arbitrator clarified that even if a breach of contract by Spirit Leaf were proven, she would not conclude that Sundial had caused that breach, as this would require an additional factor over and above inducement. This decision was upheld by the Court.

The circumstances did not warrant piercing the corporate veil between Spirit Leaf and Sundial

The franchisees also argued that the corporate veil ought to be pierced between Spirit Leaf and Sundial in order to establish liability against Sundial as Spirit Leaf’s parent company. After reviewing the case law, the arbitrator determined that it would require “fraud or some other conduct that rises to a similar level of impropriety” to ignore corporate separateness and pierce the corporate veil. The arbitrator found that the allegations and evidence did not justify piercing the corporate veil in this case. In particular, the arbitrator found that breach of the duty of good faith by Spirit Leaf would not be enough to justify such a remedy. The Court upheld the arbitrator’s decision in this respect.

The Alcanna Acquisition did not amount to a breach of the duty of good faith

The duty of good faith and fair dealing imposed on parties to a franchise agreement at common law and under the Franchises Act requires, among other things, that a franchisor perform and enforce the franchise agreement in good faith and with due regard to the interests of the franchisee. However, as noted by the arbitrator in her decision, this does not require the franchisor to prefer the franchisees’ interests to its own.

In this case, the arbitrator found that the Alcanna Acquisition did not give rise to a breach of the duty of good faith and fair dealing since Sundial, as noted above, was not a party to the franchise agreements and therefore not subject to the duty of good faith. Even if Sundial was found to be a party, the arbitrator found that no breach of that duty would have occurred because: (a) Sundial did not own and operate “Value Buds”, but rather Nova Cannabis did, and (b) Nova Cannabis is controlled and operated by an independent board of directors. The arbitrator found that while Sundial seeks to exert influence over Nova Cannabis by virtue of its ownership interest in Alcanna, it does not have the ability to operate or control Nova Cannabis and therefore the “Value Buds” stores. The arbitrator also found that Spirit Leaf had not breached its duty of good faith since the Acquisitions were expressly permitted by the franchise agreements.

Further, the arbitrator noted that Spirit Leaf had taken steps to respond to issues raised by the Spirit Leaf Franchisees, and although they had not been satisfied with these offerings, Spirit Leaf had recognised the challenges presented by the increased competition and had attempted to assist their franchisees. The arbitrator contrasted this to the “business as usual” approach taken by the franchisor in the Quebec Court of Appeal’s landmark decision in Dunkin Brands Canada Ltd. c Bertico Inc.[2] Notably, this appears to be the first application outside of Quebec of the Quebec Court of Appeal’s finding of a duty for franchisors to protect and enhance the brand, and the first application of that duty as a “shield” to validate the actions of a franchisor.

The Court upheld the arbitrator’s decision in this respect.

A Pyrrhic Victory? Spirit Leaf did breach its duty of good faith by employing the CEO of Nova Cannabis

One “win” for the franchisees in this decision is that the arbitrator found (and the Court upheld) a breach of the duty of good faith due to Spirit Leaf having employed the CEO of Nova Cannabis concurrently as a director of Spirit Leaf, following the Acquisitions. Since Nova Cannabis was a competitor to Spirit Leaf, employing its CEO to “perform key roles for the franchisor” was “clearly contrary not only to the interests of the franchisee but to the franchise relationship itself.” The arbitrator did not go so far as to find this was a fundamental breach of the franchise agreements entitling the parties to treat the franchise agreements at an end as the Spirit Leaf Franchisees had hoped, but did find that it amounted to a breach of Spirit Leaf’s duty of good faith. This is a novel finding, in that a court has never found the engagement of a competitor’s management level employee to be a breach of the franchisor’s duty of good faith. However, the impact of the breach was ultimately negligible, as the arbitrator awarded only nominal damages in the amount of $1,000 per Spirit Leaf franchisee for the breach. The franchisees’ appeal of this damages award was dismissed by the Court.

The Upshot

This decision offers valuable insights for franchisors and their parent companies seeking to proceed with corporate acquisitions in the franchise context. In particular, the mere ownership or influence of a parent company over a franchisor is not likely to provide a basis for direct liability under franchise legislation or for a parent company to be bound by terms of franchise agreements. However, this decision serves as a reminder to parent companies of franchisors that the threshold of being found to be a “franchisor” or “franchisor’s associate” under franchise legislation is a fact specific analysis guided by the criteria and definitions afforded under franchise legislation.

Finally, and generally for franchisors, this decision highlights the nuanced and fact-specific application of the duty of good faith and fair dealing within franchise relationships. The decision helpfully confirms that actions permitted by the specific terms of a franchise agreement will generally not provide a basis for a breach of the duty of good faith. Franchisors should be careful, however, not to employ key personnel from competing entities or otherwise allow a similar conflict of interest to arise as it will put them at risk of breaching the duty of good faith (and may attract damages as a result). On the other hand, franchisors should bear in mind the importance of taking steps to recognize and respond to challenges presented by its franchisees, as this may serve to be an important defensive measure in evidencing their good faith.

ABOUT THE AUTHOR
Cassels Brock & Blackwell LLP is a full-service business law firm with offices in Toronto, Vancouver, and Calgary. Our lawyers provide knowledgeable advice on all legal and practical aspects of franchising, including franchise agreements, disclosure law compliance, dispute resolution, and litigation. The Chair of our group, Larry Weinberg, is past Chair of the Ontario Bar Association’s Franchise Law Section and received Who’s Who Legal’s worldwide award for Franchise Lawyer of the Year multiple years in a row. 

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[1] 1010805 Alberta Ltd. v Sundial Growers Inc., 2024 ABKB 173.

[2] Dunkin’ Brands Canada Ltd. c. Bertico Inc., 2015 QCCA 624 [Dunkin Donuts].