Injunctions in Franchise Disputes - Part 4: Injunctions and the Duty of Good Faith in Franchising
This is the fourth installment in Hoffer Adler LLP’s continuing Legal Insight Series focusing on injunctions in franchise disputes. For Parts 1, 2 and 3, of this Series, click here, here and here, respectively.
In this article, we discuss the Superior Court of Justice’s recent decision in 9925350 Canada Inc. v. Kevito Ltd. (“Kevito”). In the Kevito decision, the Court granted a franchisee a temporary injunction (pending trial or further order of the court) preventing the franchisor from terminating the franchisee’s franchise agreement, and preventing the franchisor from interfering with the conduct of the franchisee’s franchise business.
The decision is particularly interesting to franchisors and franchisees for two reasons. Firstly, it reflects what the current attitude of our courts is to the duty of good faith; the duty of good faith is both a general duty that contracting parties owe one another and also a specific duty that is imposed by the Arthur Wishart Act on parties to a franchise agreement. Second, it underscores the perils a franchisor confronts when attempting to terminate a franchise agreement based on the franchisee’s alleged failure to comply with the system’s standards, particularly when those standards are broadly defined and subject to unilateral change, and when strict and complete compliance may be unrealistic.
I. The Facts Behind the Kevito Decision
The Kevito decision involves a system of bubble tea franchises and corporate stores operating under the “Chatime” brand.
The plaintiff franchisee had twice in 2020 been recognized as being the most profitable business in the entire chain. This fact notwithstanding, the franchisor conducted a series of onerous inspections of the franchisee’s Chatime store between the end of 2020 and the beginning of 2021. The 2021 inspection was particularly exhaustive, taking place over 6.5 hours.
The inspections identified a long list of alleged infractions, many of which were highly specific (such as a shortage of ingredients that lasted for a matter of minutes). These inspections culminated in the franchisor asserting a right to terminate immediately, along with an offer that the termination be made effective after 90 days during which the franchisee would have an opportunity to sell, but the franchisor would operate the franchise for its own account. The franchisee was given 2 days in which to accept the offer. In addition, the franchisor began stationing an inspector full time in the plaintiff’s shop so that the franchisor could note, and correct, errors in real time as they occurred.
A Notice of Termination was eventually delivered.
II. The Court’s Decision
The Court in Kevito granted a temporary injunction, restraining the Chatime franchisor from terminating the franchisee’s franchise agreement, and preventing the franchisor from interfering with the franchisee’s franchise business, until such time as a full trial can take place or further order of the court.
As we discussed in one of our earlier posts concerning injunctions in franchising, a party seeking an injunction must meet a three-part test before the Court will grant the injunctive relief: the plaintiff must show that, even at this early stage of the litigation, there is already a “serious issue to be tried”, that the plaintiff will suffer “irreparable harm” (generally meaning a loss that cannot be compensated for by an award of damages), and that the “balance of convenience” weighs in favour of granting the injunction rather than denying it.
The Court found that the franchisee stood to suffer irreparable harm if the franchisor were not restrained from terminating, because the franchisee’s business would be destroyed; the Court was concerned with preserving the status quo until trial. On the balance of convenience, the Court again sided with the franchisee, preferring the franchisee’s evidence that its alleged infractions of the system standards were minimal and un-impactful to the system, over the franchisor’s evidence of any realistic concerns about health and safety.
The question of whether the franchisee had raised a serious issues to be tried turned on the duty of good faith and how that duty impacts on a franchisor’s enforcement of its system standards.
- Good Faith and Fair Dealing in the Franchise Relationship
Following earlier court decisions, the Court emphasized that a franchisor owes a duty to the franchisee to act in a way that can be characterized not only as honest, but as commercially reasonable, reflecting the unique relationship between a franchisee and a franchisor.
In granting the injunction, the Court accepted that the franchisee had raised a “serious issue to be tried” by its evidence that the franchisor’s conduct leading up to, and including termination, was a breach of the franchisor’s duty of good faith and fair dealing owed under the Arthur Wishart Act and at common law.
Amongst other things, the Court noted evidence that the plaintiff was singled out for system-wide deficiencies including with respect to standards not adhered to in the franchisor’s own corporate-run stores.
- The Perils of Terminating Based on an Alleged Failure to Comply with System Standards
A common feature of franchise agreements is the franchisor’s requirement that the franchisee strictly comply with the system’s standards and specifications. The franchisee’s failure to comply with those standards is usually grounds for terminating the franchise agreement.
The Chatime franchise agreement imposed standards that the Court found to be “severe”. The Court was sympathetic to the franchisee’s complaint that those standards were all but impossible fully to adhere to, and to the franchisee’s argument that the requirement of good faith, under both the Arthur Wishart Act and at common law, must “temper these extremes”, particularly when the Chatime franchisor (as is typically the case) retained the right to modify those standards unilaterally.
III. Key Takeaways
The Kevito decision should serve as a reminder to franchisors that, even if they enjoy unbridled contractual discretion to impose system standards on their franchisees, the exercise of that discretion will be subject to the duty of good faith. As a practical matter, that means that franchisors should take care not to engage in unreasonably onerous enforcement mechanisms and should be cautious about unjustifiably singling out any particular franchisee for non-compliance. The franchisor should place itself on a footing from which it can justify the manner of its enforcement of its standards. Regard to the legitimate interests of the franchisee is required. The Court in Kevito has signalled that courts will closely scrutinize allegations of a franchisee’s non-compliance with system standards; that scrutiny will be particularly close when the standards are broadly defined, subject to change, and capable of unduly onerous enforcement standards and mechanisms.
Hoffer Adler LLP represented the franchisee in the Kevito decision.