Are Franchisees Under A Duty To Mitigate Their Rescission Losses?

Legal practitioners are well-acquainted with the common law doctrine of mitigation in contract law: when confronted with the breach of a contract, the non-breaching party is typically required to take reasonable steps to minimize its losses arising from the breach; the court will usually reduce the amount of damages awarded to the non-breaching party by the amount of loss that should have been avoided if the plaintiff had taken reasonable steps to mitigate.

Courts and scholars have identified various rationales underlying the duty to mitigate. A common explanation is that mitigation produces a “fair” outcome because it would be immoral or unfair to award the non-breaching party compensation for damages that it could have avoided by acting reasonably. Another explanation is that mitigation promotes the efficient use of market resources by directing the non-breaching party back to the marketplace; a related idea is that mitigation promotes efficiency by reducing the overall cost to both parties resulting from the breach.

Ultimately, both of those rationales are perhaps best understood as serving the fundamental objective of contract law damages, which is to place the non-breaching party in the position it would have been in had the contract been performed.


Mitigation of Losses Flowing from Breach of Contract

Since franchise agreements are contracts, it would seem to follow that franchisors and franchisees alike should be compelled to mitigate their losses resulting by a breach of the franchise agreement. Indeed, a number of Canadian courts have imposed a duty to mitigate on franchisors and franchisees in relation to ordinary breaches of a franchise agreement, such as the breach of a franchisee of a non-competition provision.

Mitigation of Losses Flowing from Rescission of Contract

The more challenging question is whether the duty to mitigate arises following the delivery by a franchisee of notice that it is rescinding the franchise agreement. Of course, any such duty would ordinarily only be imposed on franchisees, since it is franchisees who would be the ones rescinding the franchise agreement in almost all circumstances.

In considering whether franchisees are subject to a duty to mitigate their rescission losses, it is important to note at the outset that franchisees, at least in Canada, seeking rescission typically do so by recourse to the statutory rescission remedy made available under the various provincial franchise statutes; while an entitlement to rescission based on common law or equitable principles is routinely pleaded, it is seldom pursued in light of the more powerful statutory remedy.

The significance of pursuing statutory rescission as opposed to common law or equitable rescission arises from the fact that most of the Canadian franchise statutes expressly entitle franchisees to rescind “without penalty or obligation”. Mitigation can fairly be characterized as an obligation, in the sense that failure reasonably to mitigate stand to reduce the franchisee’s entitlement to damages. The argument can forcefully be made, then, that franchisees need not mitigate their rescission losses, at least to the extent such losses are being claimed pursuant to statute.

There is some appellate authority in support of that proposition. In the 2005 Dig This Garden decision, the Ontario Court of Appeal held that the phrase, ‘no penalty or obligation’, “may mean there is no obligation on the franchisee to mitigate vis-à-vis the franchisor” (emphasis added).

More recently, a lower Ontario court held in the brief Springdale Pizza Depot decision that “[Ontario’s franchising statute] is remedial legislation. There is no duty on a franchisee to mitigate. The franchisee is entitled to be made whole.”

The court’s observation that a franchisee is “entitled to be made whole” engages a subtler argument supporting the proposition that franchisees are not required to mitigate their rescission losses: the rationales for mitigation, which are focused on providing the non-breaching party with the financial benefits of the breached contract, do not neatly align with the objective of rescission, which is to relieve the parties of their obligations under the contract altogether.

The short answer, then, appears to be that franchisees are likely not under a duty to mitigate their rescission losses. Franchisors, of course, who might respond to a franchisee’s rescission by alleging that the franchisee is in breach of the franchise agreement, would be under a duty to mitigate the franchisor’s losses resulting from such breach.

Hoffer Adler LLP provides practical and cost-effective legal assistance to both franchisors and franchisees about all aspects of the franchising relationship. If you have any questions about a franchising matter, we would like to hear from you.