By W. Brad Hanna and Mitch Koczerginski, McMillan LLP

In Garcha Bros. Meat Shop Ltd. v. Singh, 2021 BCCA 134, the B.C. Court of Appeal granted an interim stay of an injunction (that would have prevented the applicants from operating a competing meat shop) pending leave to appeal. In doing so, the Court exercised wide discretion on a limited record in order to minimize temporary negative business impacts to the applicants.

The respondent, Garcha Bros., is the franchisor of a meat shop franchise system.  It obtained an interim injunction enjoining the applicants from operating a meat shop at leased premises that were allegedly assigned to one of them in a non-arms length transaction by a recently terminated franchisee. The franchise agreement contained a post-term restrictive covenant that the franchisor argued restrained the applicant (as an effective alter-ego of the former franchisee) from operating a meat shop at the premises after termination.  After the court granted the interim injunction, the applicants sought leave to appeal that order and applied on an urgent basis for an interim stay pending a further application for a stay pending appeal that would be heard concurrently with its application for leave to appeal.

Because of the urgency of the application, the Court was required to consider the stay motion on an imperfect record that did not even include the reasons of the judge whose order was being appealed from. The Court noted that the record did not permit a proper determination of the merits of the appeal, but went on to comment that “the interpretation of a franchise agreement and the enforcement of a negative restrictive covenant can be complex” and found that “it is not unlikely that a meritorious issue could be developed on appeal.” The Court went on to grant the interim stay of the injunction on the basis that the applicants would be irreparably harmed if the injunction was enforced and the relative prejudice to the applicants in having their business temporarily shut down outweighed the prejudice to the franchisor in temporarily having a terminated franchisee operate in breach of a restrictive covenant.

This case illustrates that courts are willing to exercise discretion to fashion temporary remedies that preserve the status quo until a full and proper determination on the merits is possible.   

Ontario Superior Court refuses to grant interlocutory injunction restraining franchisee from operating competing business in premises

In Greco Franchising Inc. v. Franco Milito et al., 2021 ONSC 3950, the Ontario Superior Court refused a franchisor’s motion for an interlocutory injunction restraining a franchisee (who had purported to terminate its franchise agreement) from operating a competing business in breach of an in-term restrictive covenant.

The franchisor operates a fitness studio franchise system. The franchisee operated a franchise location in Kanata, which, along with the rest of the franchised businesses in the system, suffered from business closures due to the COVID-19 pandemic. In order to generate revenue during the mandatory government shutdown, the franchisor implemented an online home exercise program that was available to its franchisees’ members. While the franchisor shared the revenue from the new program with its franchisees, the arrangement materially shifted the balance of operational and financial control as between the franchisor and its franchisees.

The franchisee attempted to negotiate an arrangement with the franchisor in which it would terminate the franchise agreement and operate its own “de-branded” fitness centre at the same location. However, before any agreement was reached with the franchisor, the franchisee unilaterally notified its membership that it would be converting to an independent business, which resulted in nearly all of its members cancelling their membership with the franchised business. The franchisee subsequently delivered a notice of termination to the franchisor alleging that the franchisor’s initiation of the online home exercise program constituted a fundamental breach of the franchise agreement entitling the franchisee to terminate.  The franchisor argued that the franchise agreement is in full force and effect and that the franchisee is in breach of its in-term restrictive covenants not to operate a competing business.

The franchisor commenced proceedings and unsuccessfully moved for an interlocutory injunction restraining the franchisee from operating its competing business. The Court held that, to succeed in obtaining an interlocutory injunction, the franchisor must satisfy the more stringent test of showing a strong prima facie case that the franchisee’s termination was unlawful (rather than the less stringent test of showing that there is a serious issue to be tried in this regard). The Court’s rationale for doing so was that there was only three months remaining on the term of the franchise agreement and the injunction, if granted, would practically finally determine the issues in dispute or render them moot.  The Court also found that its consideration of irreparable harm and the balance of convenience favoured the franchisee’s continued operation of the business in the circumstances, in part, to protect the livelihood of the franchisee’s employees.

This case demonstrates that franchisors who have sought to find new revenue streams by adapting to the pandemic may face challenges if franchisees object to the new strategies and attempt to operate their own competing businesses. While courts may ultimately determine that the introduction of a new business strategy does not constitute a fundamental breach of the franchise agreement, they may not prevent franchisees from operating competing businesses in the interim.   The decision also serves as a reminder to franchisors that the test for obtaining an interlocutory injunction will be more difficult to meet when it poses the threat of finally determining the dispute between the parties. 

Ontario Superior Court confirms that deficient disclosure of financial statements and location specific information entitles franchisee to two-year rescission window

In 2611707 Ontario Inc., et al v. Freshly Squeezed Franchise Juice Corporation, et al., 2021 ONSC 2323, the Ontario Superior Court confirmed that failure to provide complete financial statements and location-specific disclosure may entitle a franchisee to rescission under section 6(2) of the Arthur Wishart Act (Franchise Disclosure), 2000, SO 2000, c.3.

Among other things, the Court found that the financial statements contained in the disclosure document were materially deficient because they did not include the auditor’s notes referenced beside certain line items. In so finding, the Court confirmed that franchisors must fully disclose relevant financial information to prospective franchisees so that they can make an informed investment decision. Because the auditor’s notes were referenced in the financial statements but were not disclosed, the Court found that the franchisor failed to provide a complete version of the financial statements thereby resulting in a material deficiency.

The Court also found that the failure to disclose that the head lease had not yet been secured was a material deficiency. The Court held, further to the decision in Raibex Canada Ltd. v ASWR Franchising Corp., 2018 ONCA 62, that in absence of a secured head lease, the franchisor ought to have included contractual language entitling the franchisee to opt-out of the franchise agreement and sublease should the terms of the head lease be unacceptable.

The Court’s decision confirms that the failure to disclose complete financial statements and location-specific information are sufficient to ground a rescission claim under section 6(2). The decision also suggests that a material fact requiring disclosure may relate to something that does not yet exist, such as a head lease; however, a franchisor may mitigate the failure to disclose such information by including contractual language that protects the franchisee from the potential downside of the unknown information.

Ontario Superior Court finds that franchisee remained on hook for royalties long after term of franchise agreement expired

In Coffee Time Donuts v 2197938 Ontario Inc., 2021 ONSC 3109, a franchisor was awarded royalties from a franchisee over six years after the term of the franchise agreement expired because the franchisee continued to pay royalties, operate under the franchisor’s name and use the franchisor’s suppliers.

Even though the franchise agreement expired on July 31, 2014, the franchisee continued to make royalty payments until February 16, 2016. Based on these continued payments and the franchisee’s continued use of the franchisor’s name and suppliers, the Court accepted that the agreement was being followed by both parties until it was terminated on consent on January 25, 2021 (albeit, even though the royalty payments stopped in February of 2016). The franchisee argued, unsuccessfully, that it mistakenly believed that its conduct would not have the effect of continuing the franchise agreement during this period and that it did not intend for this outcome. 

The franchisor sued for the outstanding royalties by statement of claim issued on August 9, 2019. While the Court found that the royalties accruing between February 16, 2016 to August 9, 2017 were statute barred, it awarded the franchisor royalties for the period between August 10, 2017 to January 25, 2021 and 24% interest per year as set out in the franchise agreement.

This case serves as an important reminder to both franchisors and franchisees to make note of the expiry dates of franchise agreements. If the intention is to sever the relationship after expiry of the current term, then it is critical that the parties do not to continue to act in a manner that may result in the continuation of the agreement.