A chill wind blows in from the North
Fifteen years ago this column called the reader’s attention to the myth that the world beyond the United States “is an oasis free of lawyers and litigation.” Focusing on Canada, the column summarized a “raft of franchise legal disputes in recent days,” sounding an alarm for franchisors. Only a year later, in August 2003, the column found ample validation for that prediction.
Now, more than a decade later, we believe the trend is lamentably clear. Let’s look at three recent decisions, which we view as continued evidence that Canadian judges are increasingly viewing disputes through a lens that is slanted toward franchisees.
In Addison Chevrolet Buick GMC v General Motors of Canada, General Motors dealers located in the Toronto area, who maintained they were franchisees, had dealer agreements with General Motors Canada Limited (GMCL), a subsidiary of the U.S. General Motors Corp. GM declared bankruptcy and had its assets transferred to two new companies, General Motors Co. and General Motors LLC (collectively, GM US).
GMCL restructured its own dealer network and in that context GM US stipulated, through GMCL, that some Canadian dealerships would close, while other dealerships were to be retained in the network only if certain conditions were met, including the signing of new participation agreements with GMCL.
The franchisees claimed that, pursuant to the relevant franchise legislation, they were owed a duty of good faith and fair dealing by the parent company of their franchisor and that the duty had been breached by GM US’ conduct. They claimed that they were unable to offer incentives to increase their market share in the Toronto area due to the terms of the new participation agreements, and that the government bail-out money given to the parent companies was never shared with dealers in need of financial assistance. The franchisees alleged that GMCL and GM US were favoring their own profits over those of the dealers.
The motions court judge disagreed with the franchisees that they had a viable claim against GM US and, at a preliminary stage of the action, struck out the statement of claim to that extent. The appeal was allowed, however, and the Court of Appeal found it was not plain and obvious that the franchisees’ action had no reasonable prospect of success against GM US, (the test on such a motion brought at an early stage of the action). The fact that the claim might be a weak one was not relevant at that point. As a result, the franchisees’ action was allowed to proceed.
The takeaway: Even weak claims by franchisees may be permitted to continue through the litigation process if properly pleaded. A claim will have to be very tenuous indeed to be thrown out at an early stage.
In MEDIchair LP v DME Medequip Inc., a franchisee in the MEDIchair franchise system decided not to renew the franchise agreement at the end of the first renewal term. The franchise agreement contained a restrictive covenant that would prevent the franchisee from operating a similar store for 18 months after termination, within a 30-mile radius of a store of the franchisee or another franchisee. After termination the former franchisee’s principals immediately continued operating the same type of business, in the same place, under a different name.
The franchisor successfully applied to the court to enforce the restrictive covenant. On appeal, however, the court granted the appeal and allowed the former franchisee to continue operating under the new name. The issue for the court was whether the restrictive covenant was reasonable in scope, having regard to the legitimate, proprietary interests that MEDIchair was entitled to protect.
The Court of Appeal relied on the evidence that MEDIchair had decided not to grant a new franchise in the same territory as the former franchisee, or operate there itself. If that was MEDIchair’s decision, the court reasoned, it had no proprietary interest which warranted protection.
The takeaway: Franchisors should draft their restrictive covenants so as to protect only those interests which they truly intend to and need to protect. Overreaching may be fatal.
In Raibex Canada Ltd. v ASWR Franchising Corp., a franchisee sought rescission of its franchise agreement, alleging the franchisor had not made proper disclosure prior to the execution of the franchise agreement, in large part because the franchise disclosure document had not included a copy of the lease or the disclosure of its terms.
When the FDD was provided to the prospective franchisee, the location of the proposed franchise had not yet been identified and so the terms of the lease were unknown. The franchisor argued that the practice of making disclosure before a location is known is not unusual in the franchise industry.
The court was unmoved, stating: “If it is impossible to make proper disclosure because material facts are not yet known, then the franchisor is not yet ready to deliver the statutorily required disclosure document.” The court observed that financial disclosure is of the utmost importance to a prospective franchisee, including any substantial additional deposit under the head lease.
This decision is being appealed. In the meantime, the takeaway: If the finding respecting “premature disclosure” is upheld, franchisors in Canada who sublease physical locations to franchisees will have to change the common practice of granting franchises before a location for the franchise unit has been secured, or find a creative solution to this problem.
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A year ago, surveying the Canadian regulatory environment compared to that of the Unites States, we pronounced Canada “manageable.” That’s still true, but that chill wind has certainly made us less sanguine than we were.
Philip Zeidman is a partner in DLA Piper’s Washington, D.C., office and can be reached at email@example.com or 202-799-4272. Susan Friedman is
a partner in DLA’s Toronto office. Reach her at firstname.lastname@example.org or 416-365-3503.