March 5, 2011

Confusing Renewal Clauses and the Duty of Fair Dealing – Ontario Court of Appeal Addresses Both

A right of renewal of a franchise agreement can very rarely be inferred from the surrounding circumstances of the franchise relationship and the statutory duty of fair dealing. With respect to express rights of renewal, the Ontario Court of Appeal recently affirmed the lower court’s decision in Salah v. Timothy’s Coffees of the World Inc. This decision serves as a caution to franchisors.

The plaintiff was a franchisee operating a Timothy’s coffee shop franchise in the food court of an indoor shopping complex. The franchisee entered into a franchise agreement and a sublease agreement with the defendant franchisor for a term commencing in 2001 and expiring in 2005. The franchisee had an express right of renewal, albeit one spread across the franchise agreement and sublease agreement. Prior to signing the franchise agreement, the franchisor represented to the plaintiff that if it was able to renew the head lease at the same location within the shopping complex it would extend an offer to renew the franchise documentation to the plaintiff. Once the head lease expired, however, the franchisor terminated its relationship with the franchisee and entered into new franchise agreements with a new franchisee in another location within the same shopping complex.

The plaintiff argued that it had a right to renew its franchise agreement at the new location, or at the very least, was entitled to damages due to the franchisor’s breach of the duties of good faith and fair dealing. The plaintiff submitted that if the franchisor was able to secure a head lease in the same shopping complex that was sufficient to trigger any promise of renewal. The franchisor argued that there was no right of renewal in the franchise agreement and if in fact there was a right of renewal, it was contingent upon the franchisor securing a head lease at the exact same location within the shopping complex and did not extend to other parts of the complex. It argued that since it was unable to ecure a head lease in the exact same location within the shopping complex, it was entitled to treat the franchise agreement as expired and was thus free to enter into a new franchise agreement with a new franchisee at the new location.

The Courts agreed with the plaintiff, holding that the franchisor breached its duties by failing to communicate adequately with the franchisee and by actively misleading the franchisee into thinking that the franchisor would permit the franchisee to renew its franchise agreement. In the period leading up to the expiration of the franchise agreement, the franchisor was lackluster in its communications. The franchisor did not advise the franchisee that it would be unable to secure a new head lease in the franchisee’s food court location until very late in the term of the franchise agreement. Even then, it was only by accident that the franchisee discovered that a new location in the shopping complex was being considered by the franchisor. The Courts held that the franchisee was given insufficient notice that its franchise agreement was going to end and was misled into thinking that the relationship was going well and that it would have an opportunity to renew its franchise agreement and sublease agreement.

The sublease agreement in Timothy’s was unclear as to whether it referred to the entire shopping mall as the “location” or whether it referred only to the specific location in the food court where the plaintiff’s business was originally located. The Courts chose to interpret the head lease in favour of the franchisee, finding that the right of renewal was triggered if a head lease was secured anywhere in the shopping complex. In interpreting the franchise agreement, the lower court stated:

In applying rules of contract interpretation to a franchise agreement, it must be noted that there are significant differences between a franchise agreement and an ordinary commercial contract.

A franchise agreement is a contract of adhesion. It involves, in essence, a “take it or leave it” position adopted by the franchisor. Therefore, this type of contract is subject to being interpreted against its author, in this case, the franchisor…

The franchisee was also awarded damages which were non- compensatory in nature pursuant to the finding that the franchisor breached its statutory duty to the franchisee. The decision in Timothy’s signals that renewal expectations and clauses will be interpreted in favour of franchisees where there is any ambiguity. Franchisors are also cautioned to be forthright and unambiguous when communicating with their franchisees.