By Adam Ship and Brandon Mattalo.¹

Within the past year, the Supreme Court of Canada released two important decisions about the duty of good faith – C.M. Callow Inc. v. Zollinger and Wastech Services Ltd. v. Greater Vancouver Sewerage and Drainage District.² While neither of these decisions are franchise cases, they help clarify the duty of honest performance and the duty to exercise discretion in good faith.

In this article we analyze these two decisions and provide practical tips for franchisors to mitigate their legal risk. The first section of this article will focus on C.M. Callow Inc. v. Zollinger and the assistance this case provides in understanding the duty of honest performance. The second section of this article will focus on Wastech Services Ltd. v. Greater Vancouver Sewerage and Drainage District and the guidance this decision provides about how to exercise contractual discretion in good faith.

What does the duty of honest performance require?

One branch of the duty of good faith is the duty of honest performance. The duty of honest performance requires that parties to a contract do not lie or otherwise knowingly mislead each other about matters directly linked to the performance of the contract.³

For example, in Salah, a franchisor was found to have breached its duty of good faith by deliberately hiding from a franchisee that it had selected a new partner to take overs its location. It conducted secret negotiations with a landlord, refused to answer calls form the franchisee, and instructed the landlord to not discuss the issue with the franchisee.⁴

Similarly, in Pet Valu, a franchisor was found to have breached its duty of good faith by failing to disclose information concerning volume rebates which would have clarified an inaccuracy in the previous Franchise Disclosure Document provided to the franchisee. In this regard, there was a duty to correct a clear misstatement made in writing (in that case, in a disclosure document).⁵

In its recent decision, C.M. Callow Inc, the Supreme Court of Canada provides further guidance on this duty.⁶ In C.M. Callow Inc., a group of condominiums entered a two-year winter maintenance contract with Callow. There was a clause in the parties’ agreement that permitted the condominiums to terminate the contract unilaterally, without cause, upon giving the contractor 10 days’ notice.

During the first winter, occupants of the condominiums raised complaints about the services being provided by Callow.⁷ A representative of Callow attended a condo board meeting to address the concerns, which were received positively. Callow and the condominiums started discussions about renewing the winter maintenance agreement after its two-year term. The discussions left Callow with the impression that the agreements were likely to be renewed.⁸ Callow started doing “freebie” work, hoping that it would be an incentive for the condominiums to renew the contract.[ However, the condominiums had already voted to terminate the winter maintenance agreement.¹⁰ It did not tell Callow about its decision to terminate the agreement until approximately 6-months later, and in the interim, continued to actively engage in renewal discussions and accepted “freebie” work from Callow.¹¹

The Supreme Court of Canada affirmed that, despite the contract providing for the unfettered discretion to terminate the winter maintenance contracts on 10-days’ notice, the condominium corporations had notacted honestly. In coming to that conclusion, the court provided the following guidance.

First, all rights under a contract must be exercised honestly. This means that, whenever you are given discretion under a contract to do or not do something, or given discretion about how to do something, you cannot “lie or otherwise knowingly mislead” your partner to the contract “about matters directly linked to the performance of the contract”.¹²

Second, in determining whether you are lying or misleading, the relevant question is the manner in which you perform your obligations under the contract, not your intent. For example, if you inform your counterparty that you are happy with their work and that the contract is likely to be renewed, it is reasonable for that person to infer that the ongoing contract is in good standing and will not be terminated early.¹³

Third, despite this obligation to not lie or knowingly mislead, there is no duty to inform the other party in advance that you intend to terminate the contract – you can still consider your own self-interests.¹⁴ Importantly, the Supreme Court found that silence can sometimes become “actively misleading or deceiving” if you make an “incomplete statement” or provide “half-truths”.¹⁵ Similarly, dishonesty can occur by failing to correct a misapprehension caused by your own misleading conduct.¹⁶

The Supreme Court of Canada’s decision in C.M. Callow is largely consistent with prior decisions on the duty of honest performance, including Salah and Pet Valu. As a Franchisor, you should ensure that you adopt a broad definition of “misleading” by ensuring that your field staff and others who interact with franchisees do not leaving false impressions with franchisees by providing “incomplete statements” or “half-truths”. By being careful with how you communicate with your franchisees you can lower your risk of facing a bad faith claim in the future.

What does the duty to exercise contractual discretion in good faith require?

A second branch of the duty of good faith is the duty to exercise contractual discretion in good faith. When a contract allows a party to exercise discretion, this duty requires that such discretion must be exercised in good faith.

For example, in Shelanu, the franchisor collected money from its franchisees and pooled it in an advertising fund. Despite previously informing the franchisees that the Air Miles would be used to benefit the system, the franchisor reversed course, and transferred the Air Miles to its own employees.¹⁷ While a clause in the franchise agreement granted the franchisor “complete discretion” in how the advertising fund was used,¹⁸ the court held that the discretion still needed to be exercised “reasonably, honestly and in good faith”, which it did not do.¹⁹

On the other hand, in Fairview Donut, the court found that the franchisor did meet its good faith obligations when introducing a lunch menu and change to the method of baking donuts.²⁰ The court found that these were “rational business decisions” that the franchisor was entitled to make, having regard to its own interest and to the interest of its franchisees.²¹ It found that the franchisor had exercised its discretion in good faith since the decisions were not “motivated by improper or extraneous considerations”.²²

The Supreme Court of Canada in Wastech provides additional guidance on this duty. In Wastech, the parties entered into a disposal contract.²³ The agreement contained a target profit margin for the disposal company, but did not guarantee that it would be hit in any given year.²⁴ Under the agreement, the city agency was granted discretion to determine where waste needed to be deposited. One year, it decided to re-allocate the waste to different locations, causing a significant reduction to the disposal company’s profit margin.²⁵ The disposal company argued that the city agency had exercised its discretion in bad faith. The Supreme Court of Canada disagreed.

In coming to its conclusion, the Supreme Court of Canada set out the following principles.

First, the duty of good faith requires parties to exercise their discretion in a manner consistent with the purpose for which it was granted.²⁶ As explained by the court: “[w]here the exercise of discretionary power falls outside of the range of choices connected to its underlying purpose – outside the purpose for which the agreement the parties themselves crafted provides discretion – it is thus contrary to the requirements of good faith.”²⁷

Second, the court will not ask whether the discretion was exercised in a morally opportune or wise fashion from a business perspective. Competition between parties is often to be encouraged and protected.²⁸ Good faith cannot be used as court moralism or “palm tree justice”.²⁹ Instead, the focus is on whether the discretion was exercised for an “ulterior purpose”, disconnected from what the right was granted for in the first place.³⁰ Like the duty of honest performance, this is a highly fact-specific analysis, and ultimately depends on the purpose of the grant of discretion.³¹

Therefore, as a Franchisor, you should ensure that you are only exercising your discretion under a contract for the purpose in which it was included in the agreement. For example, you should not rely on overly technical breaches of the Franchise Agreements for ulterior purpose – such as terminating agreements for technical breaches with the ulterior purpose of opening corporate-run stores or reselling the territory to a new buyer that has approached you.

Conclusion

Overall, the Supreme Court of Canada’s recent decisions on the duty of good faith do not drastically change the playing field but provide some guidance to parties to ensure that they are meeting their good faith obligations. Franchisors should stay apprised of developments in the law of good faith, as it is receiving significant attention from our courts and is developing rapidly.

Bibliography

1250264 Ontario Inc v Pet Valu Canada, 2015 ONSC 29.

Bhasin v Hrynew, 2014 SCC 71.

CM Callow Inc v Zollinger, 2020 SCC 45.

Fairview Donut Inc v The TDL Group Corp, 2012 ONSC 1252.

Salah v Timothy’s Coffees of the World Inc, 2010 ONCA 673.

Shelanu Inc v Print Three Franchising Corp, 2003 CanLII 52151.

Wastech Services Ltd v Greater Vancouver Sewerage and Drainage District, 2021 SCC 7.

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¹Mr. Ship is a partner at McCarthy Tétrault and lead of the firm’s national franchise practice. Mr. Mattalo is an assistant professor in the Policy and Law area at the Lazaridis School of Business and Economics and is a lawyer in Toronto and a member of McCarthys’ MT Align Division, where he practices commercial litigation and franchise law.

²CM Callow Inc v Zollinger, 2020 SCC 45; Wastech Services Ltd v Greater Vancouver Sewerage and Drainage District, 2021 SCC 7.

³Bhasin v Hrynew, 2014 SCC 71 at para 73.

⁴Salah v Timothy’s Coffees of the World Inc, 2010 ONCA 673.

⁵1250264 Ontario Inc v Pet Valu Canada, 2015 ONSC 29 at paras. 47, 56-58.

⁶C.M. Callow Inc. v. Zollinger, supra note 1.

⁷Ibid at para 9.

⁸Ibid at para 11.

⁹Ibid at paras 12–13.

¹⁰Ibid at para 10.

¹¹Ibid at para 14.

¹²Ibid at para 37.

¹³Ibid.

¹⁴Ibid at paras 80–81.

¹⁵Ibid at paras 77 and 89.

¹⁶Ibid at para 90.

¹⁷Shelanu Inc v Print Three Franchising Corp, 2003 CanLII 52151 at para 96.

¹⁸Ibid at para 89.

¹⁹Ibid at para 96.

²⁰Fairview Donut Inc v The TDL Group Corp, 2012 ONSC 1252 at paras 4–7.

²¹Ibid at para 437.

²²Ibid.

²³Wastech Services Ltd. v. Greater Vancouver Sewerage and Drainage District, supra note 1 at para 8.

²⁴Ibid at para 11.

²⁵Ibid at paras 15–17.

²⁶Ibid at paras 63 and 68.

²⁷Ibid at para 71.

²⁸Ibid at para 73.

²⁹Ibid at para 74.

³⁰Ibid at para 75.

³¹Ibid at para 76.