Recent developments in franchise law are highlighted in two recent and notable cases.
Memphis Blues BBQ International Ltd. v. P.K. Johnson Inc., 2024 BCSC 497 (“Memphis Blues”) is a case from British Columbia.
1010805 Alberta Ltd. v. Sundial Growers Inc., 2024 ABKB 173 (“Sundial Growers”) is a case from Alberta.
The cases provide insights into the complexities of franchise agreements and the legal principles governing them. Together the cases address significant issues such as breach of contract, the application of constructive trusts, the duty of good faith, and the interpretation of franchise agreements, reflecting the evolving nature of franchise law in Canada.
The Memphis Blues Case
Facts
Memphis Blues BBQ International Ltd. (the Franchisor and Plaintiff) entered into two franchise agreements with the Defendants for restaurants in Surrey and in Abbotsford, British Columbia.
Memphis Blues alleged that the Defendants breached various terms of the franchise agreements, including by non-payment of royalties and disregarding prohibitions relating to the operation of competitive businesses.
The Defendants did not formally renew the franchise agreements but continued to operate Memphis Blues restaurants beyond the initial term. During this time, they incorporated "Trucking BBQ," violating the non-compete covenant, and defaulted on royalty payments. Memphis Blues filed a notice of civil claim for breach of contract, fiduciary duty, and unjust enrichment, alleging that the unpaid royalties were used to enhance real property owned by one of the co-defendants, Paul Daniel Johnson. Johnson applied to cancel the certificate of pending litigation (CPL) in February 2024.
Legal Issues and the Court’s Analysis
The court's focus was on whether the notice of civil claim disclosed a claim to an interest in land, as required by s. 215 of the Land Title Act. The court emphasized that for a CPL to be valid, the pleadings must assert an interest in the land subject to the certificate. The court examined whether the plaintiff's allegations of unjust enrichment met the criteria for establishing a remedial constructive trust. The court found that the notice of civil claim did not sufficiently plead a claim for a remedial constructive trust based on unjust enrichment. Specifically, it failed to plead the absence of a juristic reason for the alleged enrichment and deprivation and did not argue that monetary damages were inadequate. Consequently, the CPL was deemed invalid and ordered to be cancelled.
Comparisons with Ontario Jurisprudence
A similar outcome would likely occur in Ontario, where making out an interest in land is also required to support a CPL. In Mr. Greek Meats Inc. v. Mr. Zagros Management Inc., 2023 ONSC 791, the court declined to grant a CPL, finding that the transfer of funds did not transform an unsecured interest into an interest in land. This suggests a consistent principle across jurisdictions that debts under franchise agreements generally do not convert to interests in land.
The Sundial Growers Case
Facts
In 2017, Spirit Leaf Inc. began soliciting applications from potential franchisees. The Applicants signed Franchise Agreements with Spirit Leaf in 2019. In 2021, Sundial Growers Inc. acquired Spirit Leaf. Subsequently, in 2022, Sundial also acquired all shares of Alcanna Inc., which holds a 63% equity interest in Nova Cannabis. Nova Cannabis operates discount retail cannabis stores under the "Value Buds" banner, directly competing with Spirit Leaf.
Following the acquisition of Alcanna, Sundial became the indirect owner of the Spirit Leaf franchise system and the indirect majority owner of Nova Cannabis and its chain of Value Buds stores. In 2022, the Applicants brought arbitration proceedings against Spirit Leaf and Sundial to determine whether Sundial breached or induced the breach of the Franchise Agreement by acquiring Alcanna, thus becoming a majority owner of a competitor.
The parties entered into arbitration. The Arbitrator found that Spirit Leaf Inc. breached the duty of good faith under the Franchise Agreement by appointing individuals from Nova Cannabis in positions related to the performance of the Franchise Agreement. However, the Arbitrator awarded nominal damages of $1,000 to the Claimant and dismissed all other claims against Spirit Leaf Inc. and Sundial Growers Inc.
The Applicants appealed the Arbitrator’s decision.
Legal Issues and the Court’s Analysis
1. The Court’s jurisdiction to determine whether the Arbitrator properly interpreted the contra proferentem test: The court examined whether it had jurisdiction to determine if the Arbitrator properly interpreted the test of contra proferentem. Section 44(3) of the Arbitration Act restricts appeals on questions of law explicitly referred to the arbitral tribunal. The court found that there had been no explicit reference of this question, and therefore the Court had jurisdiction to decide this question.
2. Standard of Review: Following Sattva Capital Corp v Creston Moly Corp, 2014 SCC 53, the court determined that the appropriate standard of review for questions of contractual interpretation was reasonableness.
3. Interpretation of Contracts: The Applicants argue that the Arbitrator erred in her finding that in contracts of adhesion, such as the present one, contra proferentem only applies if the contract is ambiguous and even then, only if the general rules of contractual construction cannot resolve the ambiguity. The court found that the Arbitrator was correct in finding that contra proferentem only applies in cases of ambiguity, even in the franchise context, confirming that the Arbitrator did not err in her interpretation of the related contracts and her contractual interpretation of contra proferentem.
4. Sundial’s Status under the Franchise Agreements: The Applicants contested the Arbitrator's finding that Sundial was not bound by the Franchise Agreements or a franchisor under Alberta’s Franchises Act. The court upheld the Arbitrator’s interpretation, noting that Sundial was not directly involved in granting the franchise and did not meet the criteria of an "associate" under the Act. There are two branches to the definition of “associate” under section 1(2) of the Alberta’s Franchises Act: (i) whether the person was “directly involved in the granting of the franchise”; or (ii) “if there are continuing financial obligations by the franchisee to that person and significant operational controls by that person on the franchisee”. The Arbitrator had found that Sundial was not an associate under the first branch for the same reason that she found that Sundial was not a franchisor. As for the second branch, the Arbitrator found that the financial obligations under the agreement are owed to Spirit Leaf and not Sundial. The Arbitrator had noted that, although monies paid by the franchisee to Spirit Leaf may ultimately end up with Sundial, or that stocking Sundial products had been made a condition for the financial support offered by Spirit Leaf to franchisees using money from Sundial, it did not demonstrate a financial obligation owed by the franchisee to Sundial. Finally, the Arbitrator had dismissed the notion that there was a separate implied or verbal “franchise agreement” between Sundial and the franchisees because Sundial provides strategic and business advice, shared corporate services and other functions to Spirit Leaf and its franchisees.
5. Piercing the Corporate Veil: The Applicants argued for piercing the corporate veil between Spirit Leaf and Sundial. The court upheld the Arbitrator’s finding that corporate separateness is the rule, and to disregard this rule would require significant misconduct, such as fraud. The allegations did not meet this threshold as a breach of contract or breach of good faith would not be enough to justify such a remedy. Recognizing the specific context of a franchise relationship, the Arbitrator found that the allegations and evidence did not justify piercing the corporate veil, and there was no evidence presented to support the allegations that Sundial was “using Spirit Leaf’s franchise relationship with the Claimants to impose significant losses and monetary damages on the Claimant”, as alleged by the Claimants.
6. Acquisition and Competing Businesses: The Arbitrator found that Spirit Leaf did not own, control, or operate the Value Buds stores. She concluded that Sundial was not a party to the Franchise Agreements and thus could not have breached them. The Franchise Agreements permitted the franchisor to own and operate competing businesses outside the franchisee's territory and did not prohibit competing stores within the territory if they were not part of the franchise system. The court found no errors in the Arbitrator's conclusions, affirming that Sundial's acquisition of a company with an ownership interest in a competing retailer did not breach the Franchise Agreements.
7. Breach of Franchise Agreements by Acquisition: The court upheld the Arbitrator's conclusion that Spirit Leaf was the contracting party and did not commit the alleged breaches because it did not own, operate, or control the competing Value Buds stores. Even if a breach of contract by Spirit Leaf were proven, the Arbitrator would not conclude that Sundial had committed the tort because this would require factors over and above actual inducement. As such, Sundial’s acquisition of Value Buds did not cause Spirit Leaf to be in breach of the Franchise Agreements.
8. Fundamental Breach: The Arbitrator found a breach of the duty of good faith because Spirit Leaf had employed the CEO of Nova Cannabis concurrently as a director. However, the Arbitrator found that this was not a fundamental breach entitling the Applicants to treat the contract as at an end, noting the breach as it did not deprive the Applicants of the entire benefit of the contract. The court agreed, noting that the breach of good faith, while serious, did not justify termination of the agreements.
9. Nominal Damages for Breach of Good Faith: The Applicants argued that the damages, being $1,000 per franchisee, were inadequate, citing cases with more severe franchisor misconduct. In the present case, the sole breach found by the Arbitrator was in relation to the appointment of the CEO of Nova Cannabis concurrently as a director. The court upheld the Arbitrator’s award of $1,000 per franchisee for the breach of good faith, as the Applicants had not demonstrated actual damages flowing from the breach, and the nominal amount was deemed appropriate to affirm the breach of duty.
10. Costs Award: The Arbitrator’s award of costs is discretionary and should only be disturbed if it was based on an error of principle, or if it was wholly unreasonable. In the circumstances of this case, the Applicants did not demonstrate that the costs were unreasonable or based on an error. As such, the court did not find any error justifying varying the Arbitrator’s findings concerning costs.
In sum, the Applicants did not demonstrate any reviewable error in the Arbitrator’s decision. Accordingly, the appeal was dismissed.
Takeaways
The Sundial Growers case underscores the importance of precise allegations in franchise disputes, particularly regarding claims of breach of duty of good faith. Litigants must carefully identify which parties are responsible for specific breaches. The franchisee's attempt to broadly accuse both Sundial and Spirit Leaf of the same violations was not accepted by the court, highlighting the need for discipline and specificity in legal claims.
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