British Columbia, Alberta, Manitoba, Ontario, New Brunswick, Prince Edward Island as well as Saskatchewan’s proposed franchise disclosure legislation (discussed in our recent blog) impose the statutory duty of fair dealing in the performance and enforcement of the franchise agreement on the parties to an agreement.
Consequently, franchisors and franchisees alike must be aware of the duty of fair dealing and how it applies to their franchise operations – including what is the duty of fair dealing and when will the duty of fair dealing be breached.
What is the duty of fair dealing?
The duty of fair dealing imposes an obligation to act in good faith and in accordance with reasonable commercial standards. This duty applies to franchisors and franchisees alike. Although, based on the nature of the franchisor-franchisee relationship, it is generally more onerous on franchisors as the duty applies in respect of the exercise of all rights and performance of all obligations imposed by franchise legislation.
On this note, the duty of fair dealing encompasses, yet expands, the contractual common law duty to act in good faith. To meet this obligation, franchisors and franchisees must act with honesty, fairness and in good faith when performing their obligations under the franchise agreement. At a minimum, parties are required to not tell lies or knowingly mislead one another throughout the franchise process.
The duty of fair dealing does not create a fiduciary obligation. Franchisors and franchisees can still act in their own best interests, but, when doing so they must have due regard of the interests of the other party.
A breach of the duty of fair dealing gives rise to a right of action for damages against the party in breach of this duty. As well, if two or more parties to a franchise agreement are found to be liable or accept liability, they are jointly and severally liable.
Among other things, in exercising their duty of good faith, franchisors and franchisees are generally expected to:
- respond promptly to reasonable requests from one another in relation to the franchise arrangement
- make payments clearly owed to one another in a timely manner
- exercise any discretion they may have in a reasonable manner – for example, a franchisor cannot exercise their discretion without any regard to the franchisee’s interests
On this note, franchisors have been found to be required to provide commercially reasonable support and guidance to franchisees during the course of the relationship, including minimizing the potential impact of its discount strategies on franchisees, providing franchisees with tools to counteract negative impacts, and generally cooperate and provide certain marketing and technical assistance.
The duty of fair dealing applies regardless of whether there is any express reference to it within the franchise agreement or associated documents. Similarly, the duty of fair dealing cannot be waived or contracted out of.
When is the duty of fair dealing be breached?
A claim for the breach of the duty of fair dealing is a distinct, separate legal claim. Not every breach of a contract will be a breach of the duty of fair dealing. It is possible for a breach of contract to occur between a franchisor and franchisee where there has not been a breach of the duty of good faith, or vice versa.
Although not an exhaustive list, some examples of where the duty of fair dealing has been found to be breached by a franchisor include circumstances where the franchisor:
- refused to recognize an oral agreement, unilaterally changed the terms and conditions for an agreed upon program, and withheld royalty rebates from a franchisee to gain leverage on the basis that, among other things, the franchisee used air miles for its own use and refused to allow inspections
- supplied a competitor with product inside the franchisee’s territory which eventually put the franchisee out of business
- knowingly misrepresented the terms of the franchise agreement, including the cost of opening, the size of the restaurant, the ability to resell and expand to the franchisee
- provided a competitor with discount codes to its products while keeping prices for franchisees who were required to purchase 90% of their products from the franchisor high and not offering any support or assistance
- did not provide a right of first refusal to a nearby area to a franchisee who wished to relocate and instead was awarded to a new franchisee
Examples of circumstances of where a franchisee(s) was found to be in breach the duty of fair dealing include circumstances where the franchisee(s):
- intentionally frustrated the franchise agreement by refusing to appoint a manager contrary to its legal obligations given the nature of the franchised business
- transferred assets of the franchise to a third party without the franchisor’s approval
- carried out a royalty strike by withholding royalty fees owing under the franchise agreement
- transferred the franchised business without franchisor approval as required by the franchise agreement
In contrast, examples in which the duty of good faith was not considered breached have included circumstances where:
- a franchisor refused to waive royalty payments to which it was entitled under the franchise agreement
- a franchisor did not investigate a site before approving it as a location for the franchisee where the circumstances, the franchisor had expressed concerns, brought these concerns to the franchisee’s attention, but the franchisee elected to proceed with the location
- a franchisor chose not to renew a franchise agreement
- a franchisor refused to make payment of a single royalty rebate
- a franchisee claimed the franchisor was obligated to ensure its landlord provided sufficient space
- numerous franchisees were terminated and provided with winding down agreements as a result of dire financial circumstances and an accompanying financial restructuring of the franchisor given this decision was made for valid economic and strategic reasons, with consideration of the interests of the franchisor and its continuing franchisees
The above lists are not exhaustive and the question of whether a franchisor or franchisee’s actions constitute a breach of the duty of fair dealing are highly fact specific. A reviewing Court will consider whether the party conducted itself fairly through the process with consideration to items such as the parties involved, the nature of the franchised business and the actions or inaction taken. How the duty of fair dealing will apply may vary considerably in the circumstances.
Key takeaways
The duty of fair dealing provides a standard by which franchisors and franchisees are expected to govern themselves and promotes greater equity and fair mindedness between franchise parties. As the duty of fair dealing is broad and applies across all actions taken throughout the franchisor-franchisee relationship, it is critical that franchisors and franchisees alike are confident that they understand what this duty encompasses, how it applies to them and take steps to ensure that this obligation is being met on an ongoing basis.
To this end, it is recommended that both franchisors and franchisees consult with experienced legal counsel when contemplating any major actions or decisions in connection with their franchise to ensure that they are aware of the specific risks that action may bring and identify appropriate steps to mitigate such risk.
MLT Aikins has extensive experience advising franchisors and franchisees on franchise structures, agreements, disclosure documents, enforcement and dispute resolution processes in Western Canada. Contact one of our franchise lawyers to learn more.
Note: This article is of a general nature only and is not exhaustive of all possible legal rights or remedies. In addition, laws may change over time and should be interpreted only in the context of particular circumstances such that these materials are not intended to be relied upon or taken as legal advice or opinion. Readers should consult a legal professional for specific advice in any particular situation.