David Sterns and Andy Seretis
Published on June 19, 2007
Posted in: Blog
Last year, the English Court of Appeal rendered a decision applying a doctrine that has been traditionally reserved for real property issues to a franchise dispute: the doctrine of derogation from the grant. After reviewing the facts of the case and the diverging conclusions of the trial and appellate courts, David Sterns and Andy Seretis go on to explain the potential significance of this decision for franchising disputes in Canadian common law provinces. Does this doctrine represent a lower threshold for proving repudiation of the franchise agreement by the franchisor?
With the recent English Court of Appeal decision of Fleet Mobile Tyres Ltd. v Stone & Anor, franchisors should exercise caution when trying to implement a system-wide change to the franchisee’s primary line of business. Such changes may put into play the doctrine of derogation from the grant, a long-standing principle that holds that if a person agrees to confer a particular benefit on another, he or she must not do anything which substantially deprives the other of the enjoyment of that benefit because, as stated by Lord Denning, that would be to take away with one hand what is given with the other. Just as the franchisor in the Fleet Mobile decision learned, to derogate from the grant given to the franchisee is an unlawful repudiation of the franchise agreement and allows the franchisee to elect to treat the contract and all post-termination restrictions as at an end.
Fleet Mobile Tyres was a national company offering mobile tire fitting services. The franchise agreement allowed its franchisees to operate under two trade names, Fleet Mobile Tyres and eTyres. The franchise agreement also contained general provisions regarding the obligations of the franchisee to carry on business in accordance with terms and conditions set by the franchisor.
At the outset of the franchise agreement, the primary line of business was the Fleet Mobile Tyres brand with little profits coming by way of the eTyres branch. Under the eTyres brand, the franchisor set the prices and orders were placed by the customers over the internet. The franchisor would then contact the nearest franchisee to go out and perform the service. This differed from the Fleet Mobile Tyres brand in which franchisees were free to set their own prices after being contacted directly by the customer. As a result, the Fleet Mobile Tyres brand was much more profitable for the franchisees.
Although the franchisee got what it bargained for at the outset of the franchise arrangement, problems arose when the franchisor wished to change operations by placing greater emphasis on the eTyres brand. The franchisor wanted the franchisee to change all the livery on their vans and other promotional materials to greater highlight the eTyres brand, with only minor advertising placed on the traditional Fleet Mobile Tyres business. The franchisee, Stone, argued that the franchisor’s requests amounted to a wholesale change of the franchise concept sold to them and was a derogation from the grant of rights offered in the franchise agreement.
At the trial level, the court held that if a franchisor requires the franchisee to desist entirely from using a trade name granted to him in any circumstances at all, that would be such an extreme act as to involve non-derogation from grant. The judge held that the measures imposed by Fleet Mobile Tyres did not have that extreme effect as the franchisee was still allowed to operate under the Fleet Mobile Tyres brand as well.
However, at the Court of Appeal Lord Justice Keene overturned the trial decision and established a lower threshold of breach in order to establish derogation from the grant. The test of desisting ‘entirely’ was held to be too high of a standard and the correct test to apply was that of substantial impediment. That is to say, general clauses in the franchise agreement cannot be exercised so as to impede substantially the exercise of the franchisee’s rights under the agreement. Since Fleet Mobile was essentially requiring franchisees to change their primary line of business to the eTyres brand, this was held to substantially deprive the franchisee of the grant given, which constituted an unlawful repudiation of the franchise agreement.
The Importance of the Court of Appeal Decision
If derogation from the grant allows the franchisee to walk away from the contract, why haven’t more franchisees asserted it when a conflict has arisen? In Canada, franchisees looking to get out of a franchise agreement gone sour have typically argued fundamental breach by the franchisor. This was seen in the cases of Majdpour v M&B Acquisition Corp as well as Shelanu Inc. v. Print Three Franchising Corp where in both cases the court held that if the franchisee was able to carry on the commercial purpose of the contract after the alleged breach by the franchisor, there is no fundamental breach and consequently the franchisees are not entitled to treat the agreement as at an end.
The test of fundamental breach for franchising cases echoes the one applied at the trial decision of Fleet Mobile Tyres, one that was assuredly rejected by the English Court of Appeal. Proving fundamental breach in Canada has always been a tough hurdle to prove, as it only arises when a party is deprived of substantially the whole benefit to which he or she was entitled to receive. Derogation from the grant applies a lower standard; the breach does not have to be total deprivation, but rather “substantial deprivation”.
The British Columbia Court of Appeal, in Firth v B.D. Management Ltd., recognized the difference between derogation from the grant and fundamental breach in the leasing context. The court held that to constitute derogation from the grant there must be some act rendering the premises substantially less fit for the purposes for which they were let. On the other hand, to constitute fundamental breach the landlord’s conduct must go to the very root of the contract – not merely part of it – so as to make further performance impossible or deprive the tenant of substantially the whole benefit of the tenancy. Even though this comparison was done in a real property case and not a franchising case, the Court clearly acknowledged that of the two doctrines, derogation from the grant sets a lower threshold to meet.
Derogation from the grant is a recognized concept in Canadian common law even though its application so far has been limited to real property cases. The authors submit that it can prove to be an important principle for franchisees for several reasons. First, it offers remedies that may not be available through a simple breach of contract. As seen in Fleet Mobile Tyres, derogation from the grant by a franchisor amounts to an unlawful repudiation of the franchise agreement which allows the franchisee to walk away from the agreement free of the restrictive covenants that are usually included for the franchisor’s benefit. In Fleet Mobile Tyres, the judge noted that had the franchisor ended the agreement under the termination provisions in the contract, then the franchisee would still be bound by the restrictive covenants. Because of the operation of the doctrine of derogation from the grant, the restrictive covenants were no longer enforceable.
Second, derogation from the grant by a franchisor may be grounds to argue for a prospective royalty abatement. A similar proposition was seen in the English case of Yankwood Ltd. v. London Borough Council of Havering, where the court granted rent abatement against a landlord that derogated from his grant to the tenant. This is analogous to an order for royalty abatement against the franchisor, a remedy which can be useful if the franchisee still wishes to be part of the franchise agreement and does not elect to accept the franchisor’s repudiation.
Finally, the doctrine gives expression to fundamental business terms of the franchise relationship which may not be expressly set out in the terms of the contract. This is because derogation from the grant is based on obligations by the grantor that are regarded as necessarily implicit to the contract, with regard to the particular purpose of the transaction at the time entered into. Similar to the contra proferentem doctrine, this doctrine can protect the franchisee’s legitimate contractual expectations where they are fundamental to the business relationship yet not reduced to writing in the governing agreement.
Although derogation from the grant has been argued since the middle of the 19th century, it has primarily been asserted in the law of real property regarding grants made by a landlord to his tenant. However, the English Courts have recognized that while derogation from the grant is usually applied to sales or leases of land, it has wider application.
With the recent decision of Fleet Mobile Tyres, there is no reason why derogation from the grant cannot be asserted in a franchise setting in the Canadian courts. Given the evidentiary difficulties for franchisees in proving fundamental breach, derogation from the grant allows a franchisee to treat the agreement as at an end if it can prove that the franchisor has substantially impaired its original legitimate contractual expectations. After all, to hold otherwise would be to allow the franchisor to give with one hand, only to take away with the other.
 (2001), 56 O.R. (3d) 481 (C.A.). See also Cash Converters Canada Inc. v. 1167430 Ontario Inc.  O.J. No. 5860 (S.C.J.), for a further discussion on fundamental breach in the franchising context.