Economic Duress

By John Sotos & Adil Abdulla

For many reasons including the need to control their brands, franchisors exert considerable control over franchisees’ businesses. Usually, that control is explicitly authorized by the franchise agreement. Sometimes, however, franchisors make demands beyond their strict rights under the franchise agreements. Franchisees may feel pressured to accede to these demands because their livelihoods depend on cooperating with their franchisors. In some circumstances, this can amount to economic duress, justifying franchisees’ refusals to comply. This article summarizes the test for economic duress, how it has been applied in the franchise context, what questions remain unresolved, and some takeaways.

The Test for Economic Duress

Economic duress, also known as lawful act duress, can be raised as a defence to a claim for breach of contract. This doctrine recognizes that, where one party extracted a promise via a “coercion of the will”,[1] the other party did not truly consent. Thus, it has no obligation to perform.

To establish economic duress, a party must show that:

• The other party applied illegitimate pressure; and
• It was in a position where it had “no realistic alternative but to submit”.[2]

(1) Illegitimate Pressure

The doctrine of economic duress does not prohibit exploiting terms of an existing agreement to pressure a party into making concessions. This is normal and acceptable commercial pressure, which courts have regularly accepted. For instance:

• It is legitimate to insist on performance of any terms of a franchise agreement, even if those terms are “onerous”;[3]
• It is legitimate to threaten to terminate a franchise agreement where the franchisee breached the agreement and the franchisor has a right to terminate for that breach;[4] and
• It is legitimate to threaten to refuse to renew an agreement at the end of its term if the other party has no right to extend it.[5]

On the other hand, it is illegitimate to refuse (or threaten to refuse) to perform obligations already incurred to pressure a party into making concessions. For instance:

• It is illegitimate to threaten to refuse to perform terms of an agreement unless the other party provides additional consideration, i.e. demanding to re-write the contract;[6]
• It is illegitimate to threaten to terminate a franchise agreement unless the franchisee pays a fee not listed in the franchise agreement;[7]
• It is illegitimate to threaten to terminate a franchise agreement unless the franchisee makes a staffing change not required under the franchise agreement;[8] and
• In a related context, it could be illegitimate for a landlord, whose non-compliance with the building code caused a flood, to refuse to provide a rent reduction unless the franchisee releases it from claims related to the flood.[9]

The key principle from all of these cases is that using an imbalance in bargaining power is entirely legitimate, but creating an imbalance in bargaining power by one’s own breach is not. As phrased in PIAC, a recent case by the United Kingdom Supreme Court, it is not acceptable to “directly maneuver the claimant into a position of vulnerability”.[10]

(2) Coercion of the Will

In assessing the impact on the party complaining about the duress, the court considers four factors:

• Whether that party protested at the time;
• Whether that party had an alternative available;
• Whether that party received independent legal advice; and
• Whether that party took steps to avoid the obligations after signing.[11]

Not all of these factors are equal. For instance, failure to protest and having alternatives appear to be fatal.[12] On the other hand, if there are no alternatives, the fact that the one party told the other to get legal advice is not necessarily fatal.[13] That being said, pressuring one party to sign immediately, before consulting counsel, has been found to be a coercion of the will.[14]

Unsettled Questions

There are two major unsettled questions in the law of economic duress. The first unsettled question is what practical value the doctrine has given the overriding duty of good faith and the statutory duty of fair dealing which regulates the parties to a franchise agreement. It is important to note that conduct amounting to economic duress can relieve the franchisee from performance and potentially give rise to a damage claim. A breach of the fair dealing / good faith obligation may only give rise to a damage claim or potentially be a basis for seeking equitable relief in the form of an injunction. It is unclear whether breaching the duty of good faith qualifies as illegitimate pressure. This question is of renewed interest because the court in PIAC suggested that the doctrine in the UK was limited because UK law does not recognize a duty of good faith like the one in Canada.[15] Almost all of the cases cited above were decided before Bhasin[16], where the Supreme Court of Canada recognized that there is a common law duty of good faith. Some were decided before adoption by legislation in various of the Canadian provinces including Ontario of a fair dealing obligation which parties to a franchise agreement owe to one another as an organizing principle applicable to all contractual relationships in Canada.

It is suggested here that the existence of the duty of good faith in contractual performance may further limit the scope of legitimate pressure, and correspondingly broaden the scope of illegitimate pressure that might give rise to economic duress. There might be some circumstances where exercising rights under a franchise agreement in a particular manner could be illegitimate:

• Even if a franchise agreement allows the franchisor to require the franchisee to purchase a minimum quantity of inventory from it, it might be illegitimate to increase that minimum inventory level to well above what the franchisee could possibly sell.[17]
• Even if a franchise agreement allows the franchisor to require the franchisee to make renovations, it might be illegitimate to require the franchisee to make expensive changes shortly before the end of the term.
• Even if a franchise agreement requires the franchisor to consent to any assignment of the franchise, it might be illegitimate to unreasonably refuse to consent to an assignment to a competent assignee,[18] in the hopes that the franchisee will sell to it at a lower price.
• Even if a franchise agreement requires the franchisor to consent to an extension of the franchise agreement, it might be illegitimate to mislead the franchisee into believing that it will consent to an extension, and then refuse to consent,[19] in the hopes that the franchisee will agree to modify terms in the renewed agreement.

In these cases, the franchisor imposes an unexpected cost or limitation on the franchisee, and that investment or burden does not benefit the franchisee. Substantially all of the benefits flow to the franchisor. In other words, the franchisor only considered its own interests, which would constitute a breach of the duty of good faith in franchise law.[20] As the franchisor could be found to have breached its fair dealing / good faith obligations in each of these examples depending on context, the fact that such conduct may also amount to economic duress may be of practical value when it comes to remedy.

The second but related unsettled question is whether economic duress can be used as a sword, as well as a shield. In NAV Canada, the New Brunswick Court of Appeal suggested in obiter that economic duress has been recognized as an independent tort in the UK, which applies the same test but perhaps a higher standard for finding illegitimate pressure.[21] The court did not express any opinion on whether that tort exists in Canadian law. If the tort does exist, then in addition to arguing the existence of economic duress to avoid an obligation, the franchises can make a claim for the duress including seeking damages.

Takeaways

Franchisors should be aware that, even if a franchisee agrees to do something over and above what is required by the franchise agreement, it may not be possible to enforce that new obligation. To limit this risk, franchisors should give franchisees ample time to consult counsel before they have to agree to the new obligation. This will not guarantee that the new obligation is enforceable, but it should make it more likely.

Franchisees should be aware that franchisors must follow the franchise agreement. If a franchisor threatens to breach the franchise agreement by adding a new obligation for no genuine consideration, the franchisee should protest before signing anything. Additionally, if the franchisor imposes a requirement that undermines the economic viability of the franchise, such as manipulating pricing or other levers to benefit itself at the franchisee’s expense, the franchisee should consult a lawyer before performing the new obligation. In rare cases, the franchisee might be able to avoid the new obligation.

Sotos LLP advises franchisors and franchisees on these and other issues arising from the ever-evolving legal landscape. If you would like to discuss how our firm can help your business, please contact us.

About Sotos LLP

As Canada’s leading franchising, licensing and distribution law firm, with over 20 legal professionals dedicated to the industry, we provide a comprehensive range of franchise law, corporate, private equity financing, commercial, litigation, intellectual property, employment and real estate services to franchisors. For over 40 years, we have been working with regional, national and international franchisors in every sector of the franchise industry from launch to exit including with their international expansion.

[1] Pao On v Lau Yui, [1979] 3 All ER 65 (PC).

[2] Stott v Merit Investment Corp (1988), 63 OR (2d) 545 (CA).

[3] Ellis v Subway Franchise Systems of Canada Ltd, 2000 CanLII 22770 (Ont Sup Ct) at para 39. See also 12399745 Ontario Ltd v Bank of America Canada, 2003 CanLII 26791 (Ont Sup Ct) at para 12.

[4] Dairy Queen Canada, Inc v MY Sundae Inc, 2017 BCCA 442 at para 61.

[5] Techform Products Ltd v Wolda (2001), 56 OR (3d) 1 (CA) at para 35.

[6] Knutson v The Bourkes Syndicate, [1941] SCR 419 at pp 422-423; NAV Canada v Greater Fredericton Airport Authority Inc, 2008 NBCA 28 at para 46; Burin Peninsula Community Business Development Corporation v Grandy, 2010 NLCA 69 at paras 4, 35.

[7] WH Violette Ltd v Ford Motor Co of Canada Ltd, 1980 CanLII 3250 (NB QB) at paras 5, 44, 48.

[8] Valley Equipment Ltd v John Deere Ltd, 2000 CanLII 17208 (NB QB) at paras 1, 248-249.

[9] DLG & Associates Ltd v Minto Properties Inc, 2014 ONSC 7287 at paras 21, 37-38, 101.

[10] Pakistan International Airline Corporation v Times Travel (UK) Ltd, [2021] UKSC 40 at para 4.

[11] Process Automation Inc v Norstream Intertec Inc, 2010 ONSC 3987 at para 71; DLG & Associates Ltd v Minto Properties Inc, 2014 ONSC 7287 at para 99.

[12] Luxor Food & Beverage Inc v Country Style Food Service Inc, 2008 BCSC 1433 at para 62.

[13] Burin Peninsula Community Business Development Corporation v Grandy, 2010 NLCA 69 at para 28.

[14] Stott v Merit Investment Corp (1988), 63 OR (2d) 545 (CA).

[15] Pakistan International Airline Corporation v Times Travel (UK) Ltd, [2021] UKSC 40 at paras 27-28.

[16] Bhasin v Hrynew, 2014 SCC 71.

[17] See generally Bark & Fitz Inc v 2139138 Ontario Inc, 2010 ONSC 1793 at paras 16-17, 21; Spina v Shoppers Drug Mart Inc, 2012 ONSC 5563 at paras 92, 170-171.

[18] See generally Quickie Convenience Stores Corp v Parkland Fuel Corporation, 2020 ONCA 453 at para 40; Cellular Baby Cell Phones Accessories Specialist Ltd v Fido Solutions Inc, 2014 BCSC 1959 at para 197.

[19] See generally Bhasin v Hrynew, 2014 SCC 71 at paras 72-73, 94, 103; CM Callow Inc v Zollinger, 2020 SCC 45 at paras 37-38, 89-92.

[20] See generally Shelanu Inc v Print Three Franchising Corp (2003), 64 OR (3d) 533 (CA) at para 69.

[21] NAV Canada v Greater Fredericton Airport Authority Inc, 2008 NBCA 28 at para 49.