By Blaire A. Rebane, Eric C. Little and Dagmara Pawa, Borden Ladner Gervais LLP

Case Law Digest

A.        British Columbia Supreme Court Prohibits Franchisor from Relying On Forum Selection Clause Pursuant to Section 12 of Franchises Act

Canstar Restorations Limited Partnership v. DKI Canada Ltd., 2021 BCSC 951

In Canstar Restorations Limited Partnership v. DKI Canada Ltd., the British Columbia Supreme Court considered the application of section 12 of the Franchises Act, SBC 2015, c 35, whichlimits a party’s ability to rely on terms in a franchise agreement that purport to restrict the application of British Columbia law or restrict jurisdiction to a forum outside of British Columbia.Although the equivalent provision in the Arthur Wishart Act (Franchise Disclosure), 2000, SO 2000, c3, has been judicially considered a number of times in Ontario, this was the first time that a British Columbia court considered section 12 of the Franchises Act.

The dispute arose out of a number of agreements between the plaintiff, Canstar Restorations Limited Partnership (“Canstar”), and the defendant, DKI Canada Ltd. (“DKI”). Both Canstar and DKI were in the business of providing property restoration services. Unlike Canstar, DKI did not provide restoration services to clients directly. Instead, it contracted with other companies to operate DKI restoration businesses. DKI collected fees from those companies in return for the use of the DKI brand, provision of a client base and some assistance. In return, the companies were expected to comply with DKI’s operating requirements and bylaws.

Through its agreements with DKI, Canstar became a member of the “DKI Network”, operating in British Columbia. The agreements contained a forum selection clause, which stipulated that the agreement and the parties’ respective rights and obligations would be governed by Ontario law, and that the courts of Ontario would have exclusive jurisdiction over any action or other legal proceedings relating to the agreement (the “Forum Selection Clause”).

After several years of carrying on business together, a dispute arose between Canstar and DKI when Canstar wanted to expand its operations to Calgary, Alberta. DKI terminated its agreements with Canstar and allegedly contacted Canstar’s clients to inform them that the relationship had ended.

Canstar commenced an action against DKI claiming breaches of contract, the duty of honest performance, and DKI’s obligations of good faith and fair dealing under the Franchises Act. DKI applied for an order to stay the action, which was commenced in British Columbia, on the basis that the Forum Selection Clause mandated that the action be heard in Ontario and be subject to Ontario laws.

Canstar argued that the clause was void pursuant to section 12 of the Franchises Act. DKI took the position that the Franchises Act was not applicable in this case because the agreements were not “franchise agreements” as defined in the legislation, and were therefore not subject to its provisions.

Because this was a preliminary application relating to the issue of jurisdiction, the Court was not required to conclusively determine whether the Franchises Act applied. Rather, the Court determined that it needed only to find “a reasonable basis in the record” for the application of the Franchises Act in order to determine whether the Forum Selection Clause was enforceable. This is a fairly low threshold, which is similar to an “arguable case”.

Turning to the legislation, the Court noted that a “franchise” is defined by reference to three elements: (i) the franchisee is required to make payments to the franchisor in the course of operating its business or as a condition of acquiring the franchise; (ii) the franchisor grants the franchisee the right to sell goods and services that are substantially associated with the franchisor’s trademarks; and (iii) the franchisor exercises significant control over, or offers significant assistance for, the franchisee’s method of operation. DKI conceded that the first two elements were present in this case, but disputed the existence of the third element – namely, that it exercised significant control over, or offered significant assistance for, Canstar’s method of operation. In considering the third element, the Court noted that to determine whether a franchise relationship exists, it must examine the substance of the parties’ agreement and relationship, rather than the form or labels they attached to it.

In this case, the Court found that there was a reasonable basis in the record for finding that the parties were in a franchise relationship. Based on the terms of the agreements and the limited evidence before the Court, it appeared that DKI exercised significant control over and provided significant assistance to Canstar. With respect to control, the Court noted that the agreements set out requirements for Canstar’s advertising, performance of the services and the insurance coverage it must maintain, gave DKI the right to terminate the agreements if Canstar failed to maintain its membership in the DKI Network in good standing, and required DKI’s prior consent for any transfer of Canstar’s interest in the agreements. With respect to assistance, the affidavit provided by Canstar’s president stated that the reason Canstar joined DKI was to gain access to its national client base, and that DKI provided assistance to Canstar in managing its relationship with particular insurance company clients. In light of these factors, the Court concluded there was a reasonable basis to find, for the purposes of the jurisdictional application, that a franchise relationship existed. As a result, DKI was not able to rely on the Forum Selection Clause to prevent the action from proceeding in British Columbia.

DKI went on to argue that even if the Forum Selection Clause was unenforceable, the Supreme Court of British Columbia should still decline jurisdiction on the basis that it was not the convenient forum and that Ontario was clearly the more appropriate jurisdiction for this proceeding. The Court disagreed, based on a number of factors including Canstar’s nearly-exclusive operation in British Columbia.

The Canstar case is significant because it is the first time that a BC court has considered the application of section 12 of the Franchises Act to a forum selection clause in a franchise agreement. The decision establishes that a party seeking to rely on section 12 has a relatively low threshold to meet in order to persuade the court that the provision applies for the purposes of establishing jurisdiction over a proceeding. While the Franchises Act has been in force since 2017, and similar provisions to section 12 have been in force in other provinces for longer, the case is nonetheless a good reminder to franchisors (or potential franchisors) doing business in British Columbia to be mindful of section 12 and to consider whether any forum selection or governing law provisions in their form of franchise agreement could raise enforceability concerns.

B.         Ontario Superior Court of Justice Prevents Franchisor from Terminating Franchise Agreement Based on Selective and Excessive Inspections

9925350 Canada Inc. v. Kevito Ltd., 2021 ONSC 4898

In 9925350 Canada Inc. v. Kevito Ltd., the plaintiff franchisee and its principal obtained an injunction against the defendant franchisor preventing the franchisor from terminating their franchise agreement or interfering with their ability to operate their franchised business pending the trial of the underlying dispute between the parties.

The plaintiff, 9925350 Canada Inc. (“992”) and its principal, Hong Thuy Thi “Teresa” Nguyen (“Teresa”), entered into a franchise agreement with the defendant, Kevito Ltd. (“Kevito”), whereby they were granted the right to operate a Chatime bubble tea shop. The franchise agreement set out the operating obligations that the franchisee was required to adhere to, including the requirements set out in the franchisor’s operations manuals. The operating manuals and system standards were subject to change at any time at Kevito’s sole discretion. The Court noted that the range of Kevito’s discretion to control everything done by the franchisee was extraordinary: “It can, and does, seek to control not just whether a drink is to be shaken or stirred, but whether [it] is to be stirred in a circular or figure eight motion, or how many times it is to be shaken in its preparation. And all such details can be changed at [Kevito’s] whim.”

The franchise agreement permitted Kevito to terminate for any default, including violation of any operating manual or system standard, upon notice and failure to cure within 15 days. The franchise agreement also allowed Kevito to exercise self-help remedies upon termination, including seizing the franchisee’s entire business.

Once 992’s franchise was up and running, it went on to become one of the most profitable locations in Kevito’s entire network. Teresa suspected that Kevito wanted to take over 992’s profitable location and embarked on a campaign of conducting ultra-rigorous inspections in order to set up this takeover.

During the 2020 holiday season, Kevito conducted numerous intense inspections of 992’s franchise. On one occasion, Kevito’s inspectors spent six and a half hours at 992’s location, scrutinizing everything from sink faucets to teabags stored in the cupboards. The inspections identified a lengthy list of alleged infractions, many of which were very particular or technical matters that did not amount to real health and safety concerns.

After a series of email exchanges and a meeting between Kevito and Teresa, Kevito delivered a notice of termination, which the plaintiffs disputed. The plaintiffs applied for an injunction to prohibit Kevito from terminating their franchise or acting on this termination until their underlying dispute could be heard on the merits.

According to the plaintiffs, Kevito purported to rely on very broad rights under the franchise agreement to scour their location looking for infractions and deficiencies in order to set up its desired termination of their franchise. Although Kevito presented its inspection and reporting regime as providing franchisees with the opportunity to cure any deficiencies, the plaintiffs said that in reality there was no opportunity to do so, as complete adherence to Kevito’s standards was practically impossible. In this regard, the plaintiffs argued, and provided some evidence to support, that they had been “singled out” for deficiencies that were present throughout the system. These included strict cleanliness standards that even Kevito did not adhere to at its own corporate-run locations.

In this case, the Court found that the first requirement for obtaining an injunction – establishing a “serious question to be tried” – was easily met. The case concerned the outright termination of the plaintiffs’ franchise, and the severe terms of the franchise agreement, combined with Kevito’s ability to unilaterally change and impose new terms at its discretion, engaged the very issues that the Arthur Wishart Act and the common law duty of good faith were intended to address. There was a serious question as to whether Kevito’s conduct leading up to the termination of the plaintiffs’ franchise amounted to a breach of its duty of good faith and fair dealing.

The Court was also satisfied that the plaintiffs would suffer irreparable harm if the requested injunction was not granted. The Court referred to various cases which recognized that irreparable harm can arise from the irretrievable loss of a business, and held that in this case it was necessary to preserve the franchise in the hands of the plaintiffs in order to prevent the trial of the underlying dispute between the parties from being rendered moot.

With respect to the balance of convenience, the Court rejected Kevito’s argument that its highly valuable business reputation, trademarks and goodwill were at risk of being run down if the plaintiffs were to be permitted to continue operating their location. The Court found that the plaintiffs had done a better job of demonstrating that the alleged infractions of Kevito’s system standards were minimal and unimpactful than Kevito had done in demonstrating that the health and safety concerns it cited were realistic. Instead, what the evidence established was that a successful and highly profitable franchised business was at risk of being lost if it were not permitted to stay in operation pending trial. In light of this, the Court held that the balance of convenience was in the plaintiffs’ favour.

A temporary injunction was granted, restraining Kevito from terminating 992’s franchise agreement or interfering with 992’s business pending the trial of the parties’ dispute or further order of the court.

The Kevito case is interesting because it shows that even though a franchisor may have very broad rights and unfettered discretion under the terms of its franchise agreement, it must ensure that it exercises those rights reasonably and in accordance with its duty of good faith and fair dealing. Among other things, franchisors should ensure that they do not take unreasonable, arbitrary or unduly harsh steps in enforcing their system standards, and should be careful to avoid “singling out” particular franchisees or treating them differently than other locations within the system when it comes to enforcing compliance. Otherwise, the franchisor could be prevented from exercising or enforcing its contractual rights against a franchisee, as we saw in the Kevito case (albeit on a preliminary basis only).

C.        Ontario Superior Court of Justice Rules that Rebranded Fitness Studio May Continue to Operate Pending Trial Despite Potential Violation of Franchise Agreement

Greco Franchising Inc. v. Franco Milito et al., 2021 ONSC 3950

In Greco Franchising Inc. v. Franco Milito et al., the plaintiff Greco Franchising Inc. (“Greco”), the franchisor of a chain of fitness studios, applied for an injunction to stop the defendants, a former franchisee and its principals, from operating a competing business at the same premises as their former Greco studio. Greco considered the operation of this competing business to be a breach of the restrictive covenants in the parties’ franchise agreement. The defendants argued they were no longer bound by the franchise agreement, having purportedly terminated it on the basis of a fundamental breach by the franchisor, which they claimed deprived them of the entire benefit of the agreement.

The onset of the COVID-19 pandemic created a crisis for the personal fitness industry. Government-mandated lockdowns and restricted openings prevented all forms of in-studio workout activities, which had a devastating effect on businesses such as Greco fitness studios, which were dependent on such activities. In response to the pandemic, Greco quickly introduced an on-line at home exercise program called “Greco Method At Home” (“GMAH”). According to Greco, the purpose of the GMAH program was to “maintain value” for Greco fitness memberships so that franchisees and the system as a whole could survive.

The GMAH program was the basis of the dispute between Greco and the defendants. Unlike Greco’s other programming, which was offered and provided by franchisees in-studio, the GMAH program was offered on-line by Greco directly to the members of its franchisees’ studios. Franchisees were not permitted to offer any form of on-line programming to their own members.

The financial arrangements for the GMAH program differed significantly from Greco’s other programs. Prior to the pandemic, franchisees charged for the in-studio programming they offered to their members, and collected and retained all membership fees, subject only to payment of the fixed monthly franchise fee payable to Greco under the terms of the franchise agreement. Under the GMAH program, members paid Greco directly for the on-line programming, and Greco shared half of the net program revenues with the respective franchisees after crediting the monthly franchise fee.

The GMAH program and Greco’s control of the revenues derived from it, combined with the government-mandated cessation of all in-studio activities, resulted in a fundamental change to the manner in which the franchise system operated. Greco now had much greater operational and financial control as franchisor. While the GMAH program was rolled out in response to the pandemic, Greco planned to implement it permanently. Greco circulated a draft amending agreement to system franchisees to amend the franchise agreement to reflect the GMAH program. The defendants objected to the GMAH program and refused to sign the amending agreement.

The defendants emailed all of their members announcing that they were converting their Greco studio into a “TG Athletics” studio and promising a smooth transition for all members. In response to this email, nearly all of the defendants’ members cancelled their Greco memberships.

The defendants then sent a letter to Greco purporting to terminate their franchise agreement. They alleged that Greco had fundamentally breached the franchise agreement by unilaterally implementing the GMAH program without their prior knowledge or consent. They argued that the imposition of the GMAH program violated their exclusive territory rights under the franchise agreement, as well as their right to collect revenue from their members and to set prices. They also argued that the payment policies and procedures associated with the program adversely impacted the cash flow of their studio and their ability to conduct their business. According to the defendants, these breaches effectively deprived them of the benefits they bargained for in the franchise agreement and made it impossible for them to continue operating their franchise.

Greco, on the other hand, maintained that the franchise agreement was still in force and that the defendants’ conduct in establishing their competing TG Athletics business at the location of their former Greco studio was a breach of the non-competition covenants in the franchise agreement and the provisions prohibiting solicitation of Greco employees and customers. Greco applied for an injunction to prevent the defendants from operating their competing business pending trial of the parties’ underlying dispute.

The Court considered whether Greco’s application satisfied the three-part test for the granting of an interlocutory injunction. With respect to the first part of the test, the Court determined that in this case Greco was required to show a strong prima facie case (meaning almost certainty of succeeding), rather than the usual requirement of a serious question to be tried. There were only three months left in the term of the franchise agreement and it would not be possible to have the issues between the parties brought to trial prior to expiration of the franchise agreement. Therefore, the injunction sought would likely serve to finally determine or render moot some of the issues between the parties.

The Court found that it was very clear that the defendants’ actions in opening TG Athletics were in direct violation of the non-competition and non-solicitation provisions in the franchise agreement. However, the key question was whether Greco had committed a fundamental breach of the franchise agreement, and whether the franchise agreement survived. In the Court’s view, the defendants had raised a serious issue as to whether Greco, by unilaterally imposing the GMAH program, marketing it directly to the defendants’ members, restructuring the financial terms of the parties’ arrangement, and making major changes to the role of the franchisee, had undermined the fundamental basis of the franchise arrangement. In these circumstances, the Court was not satisfied that Greco had established a strong prima facie case in support of the requested injunction.

While not necessary given the Court’s finding on the first part of the test, the Court went on to consider the requirements of establishing irreparable harm and whether the balance of convenience favoured granting the relief sought. The Court noted that closing TG Athletics would likely put the defendants out of business immediately and eliminate the possibility of Greco recovering any compensation. This would cause irreparable harm to both parties. Meanwhile, any damage to Greco’s goodwill, reputation and membership allegiance arising from the defendants’ rebranding had already occurred and may be compensable in damages. The Court also noted Greco’s prior willingness to allow the defendants to de-brand, which suggested that Greco did not think that operating a competing fitness studio from the defendants’ location would necessarily harm its business. In addition, there were other interests that would be affected by the closure of the studio. The studio’s 21 employees might lose their livelihood if the it were forced to close, and its 190 members would stand to lose their membership fees. The Court also noted that a court-ordered closure of a fitness facility during a pandemic, for non-health related reasons, would create a very poor optic to the public. In light of these concerns and Greco’s failure to prove that it would almost certainly succeed at trial, the Court declined to grant the requested injunction. The defendants were permitted to continue operating TG Athletics pending trial of the parties’ dispute.

The Greco Franchising case is notable because it shows some of the issues that can arise when a franchisor purports to implement a significant system change on short notice to its franchisees. It is unclear from the decision whether Greco consulted franchisees about the GMAH program at all prior to its introduction. It is notable that the Court found there was a serious question as to whether the introduction of the program constituted a fundamental breach of the franchise agreement. While the decision only relates to a preliminary application and the Court did not make any findings on the substantive issues in the case, the outcome is still noteworthy because the significant changes that Greco introduced to its system and the manner in which it implemented them ultimately prevented Greco from obtaining an injunction to restrain what would otherwise be a clear violation of the non-competition and non-solicitation provisions of its franchise agreement.

About the Authors

Blair A. Rebane is a partner at Borden Ladner Gervais LLP (“BLG”) and the National Leader of the firm’s Franchise and Distribution Group.  Eric C. Little is a partner in the Corporate Commercial Group at BLG, who practices corporate commercial law with an emphasis on franchising, licensing and distribution. Dagmara Pawa is an associate in the Disputes Group at BLG, who practices civil litigation with an emphasis on commercial disputes.