As those involved in the franchise community are well aware, the duty of good faith is a fundamental aspect of the franchisor-franchisee relationship. It presents significant compliance challenges for franchised businesses and their legal advisors. While no party enters an agreement with the expectation of failure or conflict, unforeseen circumstances often arise, necessitating resolution and mitigation. Therefore, it is crucial to engage legal counsel from the outset to ensure your interests are fully protected.
Procido's lawyers possess extensive experience in franchise law and are equipped to provide the necessary guidance.
Understanding the Duty of Good Faith
What exactly is the duty of good faith? When should it be applied, and what are its implications for your business?
The duty of good faith in Canada is enshrined in both common law and statutory law. The Supreme Court of Canada's landmark decision in Bhasin v. Hrynew (2014) established the duty of good faith as an organizing principle in Canadian contract law.
In franchising, the duty of good faith is intended to ensure that the parties to a contract fulfill and enforce the terms in an honest manner that aligns with the agreement's objectives. It does not exist as an independent obligation but is instead evaluated by considering the mutual goals of the parties as outlined in the contract.
Key Obligations
The duty of good faith and fair dealing encompasses the following key obligations:
- The franchisor must adhere to standards of honesty, fairness, and reasonableness, while also considering the interests of the franchisees, without malice or ulterior purpose.
- Parties must cooperate with each other to achieve the goals of the franchise relationship. This means working together to promote the success of the franchise system and avoiding actions that could harm the other party's business interests.
- Parties must act in a manner consistent with the reasonable expectations of the other party. This means considering the legitimate interests of the other party and avoiding actions that could unfairly disadvantage them.
- When the franchisor is granted discretion under the franchise agreement, such discretion must be exercised reasonably and with proper intent, avoiding arbitrary, capricious actions, or any conduct inconsistent with the reasonable expectations of the parties.1
- Parties must avoid bad faith conduct, such as:
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- Unfair or arbitrary exercise of discretion: Franchisors must exercise their discretion under the franchise agreement reasonably and fairly, without acting arbitrarily or capriciously.
- Unreasonable withholding of information: Franchisors must provide franchisees with the information they need to make informed decisions about their business.
- Unfair termination or modification of the franchise agreement: Franchisors must not terminate or modify the franchise agreement without a legitimate reason and in accordance with the terms of the agreement.
Determining Compliance with the Duty of Good Faith
The primary factor in determining whether the duty of good faith has been upheld is the content of the franchise agreement. In cases where parties seek to terminate a franchise agreement, courts typically analyze whether the termination process adhered to the terms of the agreement. Similarly, in situations involving non-renewal, courts have found that a franchisor's failure to communicate effectively with a franchisee—such as deliberately withholding critical information or failing to respond promptly to inquiries—constitutes a breach of the duty of good faith.
Case Study: Fairview Donut Inc. v. The TDL Group Corp.
In the leading franchise case of Fairview Donut Inc. v. The TDL Group Corp., Tim Hortons franchisees brought a challenge against their franchisor, Tim Hortons, over a new requirement mandating the purchase of par-baked donuts and lunch menu items directly from the franchisor, rather than preparing these items in-store as they had previously done. The franchisees contended that this new requirement negatively impacted their profitability, as the par-baked items were more expensive than the scratch-baked goods previously made in-store. However, the plaintiffs' claims were entirely dismissed. The court ultimately determined that the action could not succeed, as the franchisees were effectively asking the court to rewrite their franchise agreement in their favor—something the court was neither willing nor able to do.
Compliance with the Duty of Good Faith in System Changes
When it comes to system changes, courts evaluate system-wide decisions by franchisors differently than bilateral disputes between an individual franchisee and the franchisor. As suggested in the Fairview Donut case, compliance with the duty of good faith in the context of system changes requires the franchisor to demonstrate both a rational business purpose and meaningful consideration of the interests of the entire franchise system. Furthermore, any system-wide changes must be firmly grounded in the franchise agreement to comply with the principle of good faith.
Conclusion
The duty of good faith is a critical element in the franchisor-franchisee relationship, ensuring that both parties fulfill their contractual obligations in a manner that aligns with the agreed-upon objectives. It requires parties to act honestly, fairly, and cooperatively with each other. By understanding and applying the principles of good faith, franchisors and franchisees can build strong, mutually beneficial relationships and contribute to the success of the franchise industry in Canada.
As demonstrated in the Fairview Donut Inc. v. The TDL Group Corp. case, courts are reluctant to intervene in ways that would alter the fundamental terms of a franchise agreement. Instead, they focus on whether the parties have adhered to the principles of honesty, fairness, and reasonableness as outlined in the agreement. For franchisors, this means that any significant decisions—especially those affecting the entire franchise system—must be made with careful consideration of the agreement's terms and the broader impact on franchisees. Engaging knowledgeable legal counsel is essential for both franchisors and franchisees to navigate these complexities and ensure compliance with the duty of good faith, thereby safeguarding their business interests.
Footnote
1. Fairview Donut Inc. v. The TDL Group Corp., 2012 ONSC 1252 at paras. 502-503
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.