1193430 Ontario Inc. v. Boa-Franc Inc.
[Indexed as: 1193430 Ontario Inc. v. Boa-Franc Inc.]
78 O.R. (3d) 81
[2005] O.J. No. 4671
Court of Appeal for Ontario,
Goudge, Feldman and Blair JJ.A.
November 1, 2005
*Application for leave to the Supreme Court of Canada was dismissed with costs April 13, 2006 (McLachlin C.J.C., Binnie and Charon).
Contracts -- Breach of contract -- Fundamental breach -- Trial judge finding that distributor breached implied good faith and communication term of distributorship agreement with manufacturer and that breach gave manufacturer just cause to terminate agreement without notice -- Distributor's appeal allowed -- Employment law concepts such as just cause should not be imported into commercial law context to govern distributorship agreements -- Commercial distributorship agreement may not be terminated for cause without notice unless cause constitutes fundamental breach -- Breach by distributor not amounting to fundamental breach.
A manufacturer of hardwood flooring terminated a distributorship agreement with the distributor after learning that the distributor, a prosperous private corporation, had sold shares to a retailer, a large public company with substantial debt and overhead, and had tried to conceal this fact from the manufacturer. The distributor sued the manufacturer for wrongful termination of its distributorship. The action was dismissed. The trial judge found that there was an implied term of the contract requiring good faith dealings and open communication. She found that the manufacturer had a legitimate interest in the transaction between the distributor and the retailer, that the distributor knew that the manufacturer had this interest and did not act honestly and reasonably and that the distributor breached the duty of good faith that it owed to the manufacturer when it entered into the transaction with the retailer without telling the manufacturer. She held that the breach gave the manufacturer just cause to terminate the relationship without notice. The distributor appealed.
Held, the appeal should be allowed.
There is no need, nor is it appropriate in a commercial law context, to import employment law concepts such as just cause to govern distributorship agreements. Applying ordinary contract principles to the right to terminate a distribution agreement for breach, the innocent party can only terminate without reasonable notice and be relieved of any further obligation if the breach of contract meets the test for fundamental breach. Here, even if there were a breach of an implied good faith and communication term of the agreement, it was not a fundamental breach. It did not substantially deprive the manufacturer of the whole benefit of the distributorship agreement. There was ongoing substantial performance of the contract by the distributor, and although both sides believed that good faith and communication were important aspects of their relationship, both sides acted in their own self-interest when it came to the disclosure of information regarding their business intentions. The manufacturer was not entitled to terminate the contract without giving reasonable notice.
APPEAL from the judgment of Sachs J. (2003), 2003 47647 (ON SC), 68 O.R. (3d) 382, [2003] O.J. No. 5138 (S.C.J.) dismissing an action for damages for breach of a distributorship agreement.
Marbry v. Avrecan International Inc., 1999 BCCA 172, [1999] B.C.J. No. 635, 67 B.C.L.R. (3d) 102, 171 D.L.R. (4th) 436, [1999] 10 W.W.R. 429, 44 C.C.E.L. (2d) 76 (C.A.), not folld Shelanu Inc. v. Print Three Franchising Corp. (2003), 2003 52151 (ON CA), 64 O.R. (3d) 533, [2003] O.J. No. 1919, 226 D.L.R. (4th) 577, 38 B.L.R. (3d) 42 (C.A.), apld Matchless Group Inc. v. Steelcase Canada Ltd., [2003] N.J. No. 160, 2003 NLSCTD 98, 229 Nfld. & P.E.I.R. 148, 124 A.C.W.S. (3d) 282 (S.C.T.D.), distd [page82] Martin-Baker Aircraft Co., Ltd. v. Canadian Flight Equipment, Ltd., [1955] 2 All E.R. 722, [1955] Q.B. 556, [1955] 3 W.L.R. 212, 99 Sol. Jo. 472, 72 R.P.C. 236 (Q.B.); Hillis Oil & Sales Ltd. v. Wynn's Canada Ltd., 1986 44 (SCC), [1986] 1 S.C.R. 57, [1986] S.C.J. No. 9, 71 N.S.R. (2d) 353, 25 D.L.R. (4th) 649, 65 N.R. 23, 171 A.P.R. 353, consd Other cases referred to Decro-Wall International SA v. Practitioners in Marketing Ltd., [1971] 2 All E.R. 216, [1971] 1 W.L.R. 361, 115 Sol. Jo. 171 (C.A.); Gutka v. Cargill Ltd., 1994 4879 (SK QB), [1994] S.J. No. 624, 127 Sask. R. 126, 52 A.C.W.S. (3d) 1149 (Q.B.); Hunter Engineering Co. v. Syncrude Canada Ltd., 1989 129 (SCC), [1989] 1 S.C.R. 426, [1989] S.C.J. No. 23, 35 B.C.L.R. (2d) 145, 57 D.L.R. (4th) 321, 92 N.R. 1, [1989] 3 W.W.R. 385 (sub nom. Syncrude Canada Ltd. v. Hunter Engineering Co.); Inno-Vite Inc. v. Rowland, 2005 7882 (ON CA), [2005] O.J. No. 1077, 3 B.L.R. (4th) 320, 138 A.C.W.S. (3d) 70 (C.A.), varg 2003 32162 (ON SC), [2003] O.J. No. 3171, 38 B.L.R. (3d) 181, 124 A.C.W.S. (3d) 1080 (S.C.J.); Llanelly Ry. & Dock Co. v. London & North Western Ry. Co. (1895), L.R. 7 H.L. 550, 45 L.J. Ch. 539, 32 L.T. 575, 23 W.R. 927, on appeal (1873), 8 Ch. App. 942, 42 L.J. Ch. 884, 29 L.T. 357, 21 W.R. 889 (C.A.); McKinley v. BC Tel, 2001 SCC 38, [2001] 2 S.C.R. 161, [2001] S.C.J. No. 40, 91 B.C.L.R. (3d) 1, 200 D.L.R. (4th) 385, 271 N.R. 16, [2001] 8 W.W.R. 199, 2001 C.L.L.C. 210-027, 2001 SCC 38, 9 C.C.E.L. (3d) 167; Paper Sales Corp. Ltd. v. Miller Bros. Co. (1962) Ltd. (1975), 1975 555 (ON CA), 7 O.R. (2d) 460, 55 D.L.R. (3d) 492 (C.A.); Saskatoon Sand & Gravel Ltd. v. Steve (1979), 1979 2402 (SK CA), 97 D.L.R. (3d) 685 (Sask. C.A.), affg 1973 940 (SK QB), [1973] S.J. No. 158, 40 D.L.R. (3d) 248 (Q.B.); Transamerica Life Canada Inc. v. ING Canada Inc. (2003), 2003 9923 (ON CA), 68 O.R. (3d) 457, [2003] O.J. No. 4656, 234 D.L.R. (4th) 367, 41 B.L.R. (3d) 1 (C.A.); WERAM (1975) Inc v. EMCO Ltd., 1999 14940 (ON SC), [1999] O.J. No. 3218, 2 B.L.R. (3d) 183, 90 A.C.W.S. (3d) 705 (S.C.J.)
Peter H. Griffin and Rebecca Jones, for appellant. Richard B. Swan and Melisse L. Willems, for respondent.
The judgment of the court was delivered by
1FELDMAN J.A.:-- The issue at trial was whether a manufacturer was entitled to terminate an exclusive distributorship contract without notice on the basis of "just cause".
2The trial judge held that the contract contained an implied obligation of good faith and good communication, that the distributor breached that obligation by selling his company without telling the manufacturer, and that that breach amounted to "just cause" to terminate the contract without notice. The issue on appeal is whether the trial judge erred in implying this term, or whether she erred in finding that breach of the term amounted to just cause for termination of the contract, without analyzing whether the breach amounted to a fundamental breach entitling the manufacturer to terminate the contract without notice. [page83]
Facts
3The parties to the distributorship agreement were the distributor, Salem Hardwood Flooring, a private corporation wholly owned by Mr. Vincent Fazzari, and the manufacturer, Boa- Franc Inc., another private corporation controlled by M. Pierre Thabet. The current appellant, 1193430 Ontario Ltd., is the assignee of Salem's claim against Boa-Franc, Salem's successor having gone bankrupt following Boa-Franc's termination of the distributorship agreement.
4Salem was a distributor of hardwood flooring including unfinished and pre-finished products. Boa-Franc was a manufacturer of hardwood flooring, at first only unfinished flooring, but by the end of 1989, partly with the support or encouragement of Mr. Fazzari, Boa-Franc began manufacturing a line of prefinished hardwood flooring called "Mirage". At that time, the men met to explore the possibility of Salem becoming the exclusive distributor of Mirage in Ontario. But because Salem was not willing or possibly unable to commit to certain volume sales levels, the exclusive distributorship arrangement was rejected in favour of a relationship where Salem was one of three companies distributing the Mirage product in Ontario. In 1992, one of the other distributors discontinued serving as a distributor of Mirage in Ontario and Salem became the exclusive distributor of Mirage for Metropolitan Toronto and the non- exclusive distributor with one other company for the rest of Ontario, excluding the area east of Kingston. Then on September 1, 1993, Salem became the exclusive distributor for Mirage in all of Ontario other than the area east of Kingston.
5The trial judge found that the terms of the agreement between the parties were partly written and partly admittedly implied. The written terms were contained in some letters exchanged between the parties. The trial judge concluded that the most important implied terms were: (1) the obligation to act towards each other in good faith; and (2) as admitted at trial, the obligation to give reasonable notice in the event of termination without just cause.
6Both parties agreed in evidence that there were no discussions between them regarding: (1) who would own the shares of Salem or who could be directors or officers; (2) with whom Salem could deal; (3) how Mr. Fazzari could apply his time outside of the business of Mirage; (4) of what businesses Mr. Fazzari could be a director or officer; and (5) what the financial situation of Salem had to be in order to retain the distributorship of Mirage. [page84 ]
7In June 1992, when Salem was to become more involved as exclusive distributor in part of Ontario, the parties agreed on some further terms of their relationship, some of which were recorded in a letter while others were only oral. One of the new terms of the relationship was that Salem was to make a "full commitment" to the Mirage product. This did not mean that Salem dealt only in Mirage; instead, it meant that Salem would hire a full-time sales representative for that product, obtain volume discounts, achieve a minimum sales volume, and expend $25,000 on Mirage advertising. Another new term was that Salem was not permitted to sell Mirage directly to the public, to contractors, in the Ottawa region or outside Ontario.
8In May 1993, the parties decided to implement the "Master Dealer" Program, whereby a number of retailers would be selected to sell the Mirage product. Those retailers would be trained in the product and would become committed to the selling of the product. The program involved a co-ordinated approach to display, pricing and marketing. One of the chosen retailers was Floorco, a company that manufactured unfinished hardwood flooring and operated a number of retail flooring shops.
9The trial judge also found that although this was never discussed, there was an implied agreement that neither party would disclose to others, particularly the retailers, the price that Salem paid Boa-Franc for the Mirage product.
10In October 1993, about one month after Salem became Boa- Franc's exclusive distributor in most of Ontario, Mr. Fazzari began discussions with Floorco about a share purchase of Salem by Floorco. They reached an agreement in January 1994, and the sale closed in March. Mr. Fazzari took on a large role in Floorco's operations, while Mr. Rebick of Floorco became a director of Salem. The sale was not disclosed to Boa-Franc. The trial judge noted that Salem was a small, very profitable company, while Floorco was a large, public company with substantial overhead and debt.
11In a meeting in May 1994, M. Thabet told Mr. Fazzari that he had heard rumours about Salem and Floorco and asked what was going on. Mr. Fazzari gave a vague response that left M. Thabet under the impression that Mr. Fazzari had a supply contract with Floorco for unfinished flooring. Mr. Fazzari also said he would give M. Thabet a marketing plan in July.
12Following that meeting, M. Thabet was contacted by Mr. Steve Sharko, the salesman Salem had hired to sell Mirage in Ontario. They met in June, when Mr. Sharko reported that something had happened between Salem and Floorco, that Mr. Fazzari [page85 ]was now in charge of the Floorco manufacturing plant and that another employee was in charge of the Floorco shops. In December 1993, Mr. Sharko had made a secret written proposal to M. Thabet regarding the direct distribution of Mirage in Ontario, cutting out Salem as middleman. Mr. Sharko raised this proposal again in the June meeting.
13As a result of this information, M. Thabet did some further investigation and concluded that Mr. Fazzari had misled him and that he would terminate the agreement with Salem, but would not announce the termination until after he had collected the accounts receivable from Salem. He also reduced the amount of Mirage product he was shipping to Salem. In order to explain the reduction, M. Thabet lied to Mr. Fazzari, telling him that there had been a fire at the Boa-Franc plant.
14On July 15, 1994, M. Thabet delivered a termination letter to Salem citing several factors including Floorco's acquisition of the shares of Salem, which, the letter said, put Salem "in an impossible conflict of interest with respect to the distribution of Boa-Franc's products". Another factor cited was Salem's performance as a distributor. The letter stated that in a "recent performance survey" conducted by Boa- Franc, retail dealers had expressed a consistent level of dissatisfaction with Salem's performance. The letter also alleged that Salem had sold Mirage products directly to purchasers, thereby bypassing retailers. The letter claimed the right to terminate the distributorship agreement on the basis of fundamental breach of contract.
15Following the termination, Boa-Franc shipped only sufficient product to fill Salem's existing orders. The product was shipped C.O.D. Thereafter, Boa-Franc refused to sell Mirage to Salem or to Floorco. Boa-Franc became its own distributor in Ontario, hiring among others, Mr. Sharko, and within a few weeks its direct sales were at the same level as when Salem was their distributor.
16Salem and Floorco were unable to replace the Mirage business although they tried, for example, by purchasing equipment to produce their own prefinished product. However, before that plan could be implemented, Floorco filed a Notice of Intention to file for bankruptcy in May 1995. In March 1996, Gerald Hebert bought most of Floorco's manufacturing assets along with further equipment in February 1997, and by September 1997, production of prefinished hardwood flooring had reached an acceptable standard.
17Salem sued Boa-Franc for wrongful termination of its distributorship and for expropriating its Mirage distribution business. Salem claimed that it was entitled to damages equivalent [page86 ]to two years' notice. Salem acknowledged that good faith and good communication were terms of the contract, but said that those terms had to relate to other terms of the contract. As there was no term restricting Salem's ability to sell its shares, the duty of good faith and communication did not extend to discussing such a sale with Boa-Franc.
18Boa-Franc argued that fundamental to its choice of Salem as distributor was Salem's independence from the retailers and other manufacturers, and that this was implicitly understood by Salem. Salem's breach, which justified termination, was in agreeing to sell its shares to Floorco without first advising Boa-Franc. Boa-Franc also argued that the sale of Salem's shares to Floorco fundamentally changed the nature of the entity with which Boa-Franc had made its distributorship arrangement, and this change was in itself just cause for terminating the relationship.
The Trial Judge's Findings
19The trial judge viewed the central issue in the case as whether Boa-Franc had just cause to terminate its distributorship agreement with Salem. Otherwise, it was required to give reasonable notice.
20The first issue addressed by the trial judge was whether Boa-Franc's allegation of poor performance constituted just cause to terminate. The trial judge noted that although Boa- Franc maintained its claim of poor performance by Salem over the ten years that the action was litigated leading up to the trial, at the trial Boa-Franc led minimal evidence to support the allegation and there was significant evidence to the contrary. Accordingly, the trial judge found that Boa-Franc did not have cause to terminate on the basis of poor performance.
21The trial judge also disposed of the cross-allegations of the parties that each had an agenda in their actions that sought to effectively cut out the other from the business. The trial judge concluded that neither of these alleged wrongful agendas had been proved to the requisite standard.
22The major issue considered by the trial judge was whether there was an implied term of the contract requiring good faith dealings and open communication, and if so, whether Salem had breached that duty by selling its shares to Floorco without first notifying Boa-Franc.
23The trial judge concluded that there was a duty of good faith in this case, based on the acknowledgment of the duty in the evidence, although in his evidence Mr. Fazzari sought to limit its [page87] application to dealings regarding the product. The trial judge then formulated three questions: (1) did Boa-Franc have a legitimate interest in the transaction between Salem and Floorco; (2) if so, was that interest considered by Salem; and (3) did Salem deal honestly and reasonably with Boa-Franc.
24The trial judge concluded that Boa-Franc had a legitimate interest in the Salem/Floorco transaction for several reasons: (a) it could not be assured that Salem would market Mirage prefinished flooring fairly with its own unfinished product; (b) the other Master Dealers would be concerned by the fact that the distributor was owned by one of the Master Dealers; (c) Floorco now had access to confidential information that Salem was not to disclose to retailers; (d) Mr. Fazzari had new responsibilities with Floorco that would be time-consuming and could interfere with Salem's long-term "full commitment" to the Mirage line; (e) Boa-Franc had a legitimate interest in Salem's financial stability, which had gone from a debt-free, profit-making company on its own, to a debt-laden company with recent losses with Floorco. The fact that M. Thabet could not say how many shares of Salem had to be sold before Boa-Franc's interest would be affected or how much time Boa-Franc expected Mr. Fazzari to devote to Mirage did not affect the trial judge's conclusion that Boa-Franc had an interest in the Salem/Floorco transaction.
25The trial judge further found that Salem knew that Boa- Franc had this interest and did not act honestly and reasonably, but instead took steps to conceal the transaction from Boa-Franc, including not telling Boa-Franc about it and misleading Boa-Franc when asked directly.
26The trial judge then concluded [at pp. 408-09 O.R.]:
Thus, I find that Salem breached the duty of good faith that they admitted they owed to Boa-Franc. The breach occurred when Salem entered into the Floorco transaction without telling Boa-Franc and further when Salem misled Boa-Franc about the nature of the transaction when Boa-Franc asked them about it. The breach gave Boa-Franc just cause to terminate the relationship without notice. Both parties admitted that good faith, trust and good communication were essential elements of their relationship. Without them, the relationship could not continue.
(Emphasis added)
27The trial judge had to deal with the troubling aspects of M. Thabet's conduct in concealing information from Salem, which spoke to a lack of good faith dealing on his part. The first instance of this conduct was his contact with Mr. Sharko in December 1993. In his proposal letter to M. Thabet regarding eliminating Salem as a distributor, Mr. Sharko said the letter [page88] was sent at M. Thabet's request. The trial judge concluded, however, that M. Thabet did not act on the letter before Mr. Fazzari misled him about the Salem/Floorco transaction and therefore his conduct did not disqualify Boa- Franc from the right to terminate the contract for just cause. The trial judge came to the same conclusion about M. [Thabet]'s lie about the plant fire, which was also excused by the trial judge on the basis that his trust had already been betrayed and he had to protect Boa-Franc's interests.
Issues
(1) Did the trial judge err by deciding the case based on an unpleaded defence, i.e., that Salem breached the implied term of good faith?
(2) Did the trial judge err in her interpretation of the scope of the duty of good faith within the contract?
(3) Did the trial judge err in law by finding just cause to terminate without notice without determining whether there was a fundamental breach of contract entitling Boa-Franc to terminate the agreement?
(4) Did the trial judge err in the measure of damages?
Analysis
(1) The pleadings issue
28The pleadings in this case were amended at trial. The appellant states that the respondent's Amended Statement of Defence does not plead that the agreement between the parties contained an implied term of good faith, that Salem breached that implied term, or that the breach provided Boa-Franc with just cause to terminate the distributorship agreement.
29However, the respondent did plead that under the distributorship agreement Salem was obliged to disclose to Boa- Franc on a fair and timely basis any material information known to Salem or its principals relevant to a material change in ownership, control or direction of Salem or any material conflicts of interest that might arise. The respondent also effectively pleaded that Salem breached this obligation. The trial judge found that this breach, which she associated with the more general duty of good faith, gave Boa-Franc just cause to terminate the relationship without notice. Furthermore, the appellant itself pleaded an obligation of good faith in the Statement of Claim. [page89]
30I agree with the appellant that the legal basis for the findings in this case went beyond the specifics of the Amended Statement of Defence. However, they arose out of both pleadings and out of the trial judge's perception of the evidence. In my view, this is not a case where the trial judge has found liability on a basis not contained in the pleadings of the parties.
(2) The scope of good faith as an implied term of the contract
31The appellant argues that the trial judge erred by relying upon an implied obligation of good faith to create a new, unbargained-for obligation under the contract -- i.e., the requirement that Salem disclose to Boa-Franc any change in ownership. In Transamerica Life Canada Inc. v. ING Canada Inc. (2003), 2003 9923 (ON CA), 68 O.R. (3d) 457, [2003] O.J. No. 4656 (C.A.), this court stated [at para. 53] that:
Canadian courts have not recognized a stand-alone duty of good faith that is independent from the terms expressed in a contract or from the objectives that emerge from those provisions. The implication of a duty of good faith has not gone so far as to create new, unbargained-for, rights and obligations. Nor has it been used to alter the express terms of the contract reached by the parties. Rather, courts have implied a duty of good faith with a view to securing the performance and enforcement of the contract made by the parties, or as it is sometimes put, to ensure that parties do not act in a way that eviscerates or defeats the objectives of the agreement that they have entered into.
(Citations omitted)
32It is important when considering this issue to be clear about what terms the trial judge did not find were implied in the contract, as well the scope of the implied duty of good faith and good communication. The trial judge made no finding that there was any implied term in the distributorship agreement limiting Salem's ability to deal in its shares, to choose its directors and officers or to choose with whom it would deal. Nor did she find that the agreement placed financial parameters on Salem or limited Mr. Fazzari's freedom to be a director or officer of other companies. The trial judge noted that the parties agreed that there was never any specific discussion of any of these matters between the parties.
33What the trial judge found, based on the evidence of the parties, was that they agreed that they needed to trust each other and that in that context they owed an obligation of good faith and good communication. In his response to questions on this issue, Mr. Fazzari limited his understanding of his obligation of good faith to an obligation to communicate about the products because it was a "buy-sell arrangement". The trial [page90] judge, however, interpreted the evidence as acknowledgement of the obligations as she found them. As it is the trial judge's role to assess the evidence and make findings of fact based on that evidence, a considerable degree of deference is accorded to her perception and assessment of that evidence.
34The breach of contract that the trial judge identified was not Salem's sale of its shares per se, but that Salem sold the shares without telling Boa-Franc, and then misled Boa-Franc about the nature of the transaction when asked about it. Although Boa-Franc had not bargained for any restrictions on Salem's ability to deal in its shares as a term of the distributorship agreement, because the particular sale to Floorco could affect Boa-Franc's legitimate business interests, there was a duty on Salem "to be honest and reasonable about the transaction".
35I see no error by the trial judge in finding that the parties both believed that their contract obliged them to act in good faith toward each other, particularly because the nature of the contract in this case is an ongoing relationship rather than a one-time performance obligation. Having said that, I question whether the general duty of good faith could require Salem as a term of its contract to disclose its change in ownership to Boa-Franc. No doubt Boa-Franc may have been interested in that information. However, such a requirement would appear to create a new, unbargained for right and obligation independent from the terms of the agreement between these two parties and from their contractual objectives, and therefore contrary to the principles set out in Transamerica. The critical question for me, however, is whether the breach of this obligation even if it could be said to exist, gave Boa- Franc the right in law to terminate the agreement without notice. In my view, it did not, because in law a commercial distributorship agreement may not be terminated for cause, without notice, unless the cause relied upon constitutes a fundamental breach of the agreement. Here, even if there were a breach of an implied good faith and communication term of the agreement, it was not a fundamental breach.
(3) The relationship between just cause to terminate and fundamental breach
36Having found the implied duty of good faith and good communication and breach of that obligation by Salem in failing to disclose its sale to Floorco and later not being forthcoming about it when asked, the trial judge concluded that the breach gave Boa-Franc just cause to terminate the agreement without notice, [page91] stating that because good faith, trust and good communication were essential elements of the arrangement, it could not continue without them.
37The concept of just cause for termination is borrowed from employment law. It has been incorporated by some courts into commercial distributorship contracts, together with the implied term or construction of the contract (discussed below) that an open-ended distributorship contract can be terminated on reasonable notice. The case law suggests more than one analytical origin for the incorporation of these concepts into distributorship agreements.
38Some case law suggests that the origin of implying a reasonable notice termination clause into a distributorship contract or incorporating it by interpretation is found in that branch of the law that seeks to characterize such a relationship as either one of employment or of independent contractor. This exercise of characterization is for the express purpose of determining whether terminating the specific relationship requires reasonable notice. Only the employment relationship requires reasonable notice for termination; an independent contractor can be terminated without notice.
39An example of where this approach was taken, is in the British Columbia Court of Appeal decision in Marbry v. Avrecan International Inc., 1999 BCCA 172, [1999] B.C.J. No. 635, 171 D.L.R. (4th) 436 (C.A.). The issue was whether Marbry Ltd., the exclusive distributor for Reebok products in most of British Columbia, was more like an employee than an independent contractor. Avrecan had terminated the distributorship giving only one month's notice. The majority considered three factors: (1) the duration or permanency of the relationship, including the purchase of inventory; (2) the degree of reliance, including the significance of the percentage of Marbry's revenue that came from Reebok product sales; and (3) the degree of exclusivity. They concluded that because the relationship had the hallmarks of permanency, Marbry relied on Reebok for sales and Marbry dealt almost exclusively in the Reebok product, Marbry was more like an employee of Avrecan than an independent contractor. Therefore Avrecan was required to give Marbry reasonable notice (in that case, nine months) in order to terminate the distributorship.
40McEachern C.J.B.C., in dissent, questioned the propriety of implying a term that created or deemed an employment relationship between commercial parties when the parties themselves had not chosen that relationship. He suggested that one aspect of the employment relationship was being imported in [page92 ]order to alleviate perceived unfairness, while other aspects, such as tax obligations, were ignored.
41Other cases have applied an agency analysis to exclusive distributorship arrangements, concluding that if the distributor is an exclusive agent then that relationship requires reasonable notice to terminate: see e.g., Paper Sales Corp. Ltd. v. Miller Bros. Co. (1962) Ltd. (1975), 1975 555 (ON CA), 7 O.R. (2d) 460, 55 D.L.R. (3d) 492 (C.A.).
42However, a third line of cases approaches the issue from the perspective of contract interpretation rather than that of implied terms: was the contract intended to create a permanent relationship that was therefore only terminable by mutual consent of the parties and not unilaterally by either party? In Martin-Baker Aircraft Co., Ltd. v. Canadian Flight Equipment, Ltd., [1955] 2 All E.R. 722, [1955] Q.B. 556, the court considered the scope and effect of the Court of Appeal and House of Lords decisions in Llanelly Ry. & Dock Co. v. London & North Western Ry. Co. (1873), 8 Ch. App. 942, 42 L.J. Ch. 884 and (1895), L.R. 7 H.L. 550, 45 L.J. Ch. 539. In James L.J.'s judgment in the Court of Appeal, he had stated that subject to certain exceptions, all contracts with an unlimited term are intended to be permanent unless provided otherwise in the contract itself. One of the exceptions James L.J. identified encompassed contracts that involve trust and confidence, delegation of authority, the necessity of mutual satisfaction with the other's conduct and personal relations between the parties. Examples of such contracts were partnership, master and servant, principal and agent and employer and employee. Lord Selborne expressed the same idea in his speech in the House of Lords, stating that "an agreement de futuro, extending over a tract of time which, on the face of the instrument, is indefinite and unlimited, must (in general) throw upon any one alleging that it is not perpetual, the burden of proving that allegation, either from the nature of the subject, or from some rule of law applicable thereto" (p. 567 L.R.).
43In Martin-Baker, McNair J. noted that in the Llanelly case, notwithstanding the views expressed by James L.J. and Lord Selborne, "the majority of their Lordships ... decided in favour of permanency, ... but solely on the basis of the terms of that particular agreement" (pp. 730-31 All E.R.). McNair J. concluded that the doctrine of permanence discussed by James L.J. and Lord Selborne had no application to a commercial contract. However, even if it might apply to some commercial contracts, a licence or manufacturing agreement was an example of a relationship of mutual trust and confidence that came within one of the exceptions to the presumption of permanence, [page93 ]and therefore was a contract that was unilaterally terminable on notice.
44In 1986, the Supreme Court of Canada stated in Hillis Oil & Sales Ltd. v. Wynn's Canada Ltd., 1986 44 (SCC), [1986] 1 S.C.R. 57, [1986] S.C.J. No. 9, as a proposition of law, following Martin-Baker and other cases that:
If a distributorship agreement does not contain a provision for termination without cause it is so terminable only upon giving reasonable notice of termination.
45This is consistent with the approach of courts in other business contracts where the duration is not fixed and the courts have implied a term that the agreement could be terminated by either side on reasonable notice: see e.g., Weram (1975) Inc. v. EMCO Ltd., 1999 14940 (ON SC), [1999] O.J. No. 3218, 2 B.L.R. (3d) 183 (S.C.J.); Saskatoon Sand & Gravel Ltd. v. Steve, 1973 940 (SK QB), [1973] S.J. No. 158, 40 D.L.R. (3d) 248 (Q.B.), affd (1979) 1979 2402 (SK CA), 97 D.L.R. (3d) 685 (C.A.); Gutka v. Cargill Ltd., 1994 4879 (SK QB), [1994] S.J. No. 624, 127 Sask. R. 126 (Q.B.); Decro-Wall International SA v. Practitioners in Marketing Ltd., [1971] 2 All E.R. 216, [1971] 1 W.L.R. 361 (C.A.) (trial judge found that agreement was terminable on reasonable notice on either side and parties did not dispute this finding before Court of Appeal). What is reasonable will depend on the circumstances of each case including such factors as the expectations of the parties, the duration or intended duration of the relationship, the dependency of the business of the terminated party on the arrangement and the commercial climate for the product.
46In employment law, an employer may terminate the employment of an employee without notice, where the employer has just cause for the dismissal of the employee. However, the circumstances where an employee can be terminated for cause are limited. The meaning of just cause in that context can be seen in the cases involving dishonesty. Not every act of dishonesty amounts to just cause for dismissal; the degree and type of dishonesty will determine whether what the employee did was serious enough to amount to just cause for dismissal. The test is whether the dishonesty causes a breakdown in the employment relationship: see McKinley v. BC Tel, 2001 SCC 38, [2001] 2 S.C.R. 161, [2001] S.C.J. No. 40, at para. 48. If the dishonesty does not cause such a breakdown, the employer may of course still terminate the employee, but only on reasonable notice.
47The issue that arises from this background is, to what extent is it appropriate or necessary to apply employment law concepts to a commercial distributorship agreement. I share the [page94 ]concern of McEachern C.J.B.C. in Marbry that even if it may in some ways resemble an employment relationship, a distributorship agreement is a commercial contract negotiated by business entities, each with its own interests to protect. Because it is a business relationship governed by contract, there is no reason why the ordinary rules of contract, including the rules for implying a term and for determining the consequences of a breach of contract ought not to apply. The incorporation of the concepts of termination on reasonable notice or for cause appear to have arisen in one line of cases from an analogy to employment law. However, in the other line, adopted in the Hillis Oil case, the concept of termination on notice comes from the interpretation of the contract itself and not from an analytical comparison of the particular contractual relationship with that of employee or independent contractor. I conclude that at this stage in the development and application of the law, there is no need, nor is it appropriate in a commercial law context, to import employment law concepts to govern distributorship agreements.
48Outside employment law, the concept of "just cause" is not used as a basis for terminating contracts. In fact, a breach of contract by one party does not relieve the innocent party of its duty to perform the contract unless the breach is fundamental or goes to the root of the contract: see generally Hunter Engineering Co. v. Syncrude Canada Ltd., 1989 129 (SCC), [1989] 1 S.C.R. 426, [1989] S.C.J. No. 23, at 499. Applying ordinary contract principles to the right to terminate a distribution agreement for breach, the innocent party can only terminate and be relieved of any further obligation if the breach of contract meets the test for fundamental breach. Therefore, if one wished to maintain the use of the nomenclature of termination for cause, the cause must amount to a fundamental breach of the contract before the innocent party can terminate and be relieved of its obligation to continue to perform.
49I note that this approach is consistent with the courts' definition of just cause for termination in the employment context. Only the most serious breakdown in the employment relationship will amount to just cause for dismissal. Most breaches by employees, including egregious ones, still leave the employer unable to terminate the employment except on reasonable notice.
50The test for determining whether a breach amounts to a fundamental breach that deprives the innocent party of "substantially the whole benefit of the contract" was recently restated by this court in Shelanu Inc. v. Print Three Franchising Corp. (2003), 2003 52151 (ON CA), 64 O.R. (3d) 533, [2003] O.J. No. 1919 (C.A.). In that case, [page95 ]the court adopted the application of five factors extrapolated by Professor Waddams from the case law, to analyze whether there has been a substantial failure of performance amounting to fundamental breach. They are: (1) the ratio of the party's obligation not performed to the obligation as a whole; (2) the seriousness of the breach to the innocent party; (3) the likelihood of repetition of such breach; (4) the seriousness of the consequences of the breach; and (5) the relationship of the part of the obligation performed to the whole obligation. Writing for the court, Weiler J.A. observed that the first and fifth factors appear to be aimed at ascertaining whether the contract was substantially performed; the second and fourth factors are aimed at measuring the effect of the breach on the innocent party; and the third factor assesses whether the aggrieved party should be released because repetition of the breach would make continued performance intolerable: see Shelanu, supra, at paras. 119-20.
51In this case, after concluding that Salem breached its duty of good faith by not disclosing the sale of its shares to Boa-Franc either before the transaction or after, with respect, the trial judge erred in law by going on to conclude that Boa- Franc had just cause to terminate the distributorship agreement without notice, because she failed to conduct an analysis of whether the identified breach amounted to a fundamental breach of the distributorship contract.
52I agree with the appellant that when an analysis is done applying the five factors enumerated by Professor Waddams, it cannot be said that the breach by Salem of the implied obligation of good faith and communication amounted to a fundamental breach of the distributorship agreement.
53On the issue of whether Salem substantially performed the contract (factors (1) and (5)), the trial judge found that there was no merit to Boa-Franc's complaints about Salem's performance as exclusive distributor.
54The real crux of the question of the seriousness of the breach was its effect on Boa-Franc. This factor is the basis for the very important distinction between an ordinary breach, on which an innocent party can always sue for damages, and a fundamental breach, which has to have a serious effect on the other party and therefore justifies termination of the agreement.
55In this case, Boa-Franc purported to stress the importance of good faith and good communication as essential elements of its relationship with Salem. However, as the trial judge noted, Boa-Franc concealed certain matters from Salem too, the most troubling of which the trial judge found was M. Thabet's contact with Mr. Sharko where he sought a proposal for Boa-Franc to do its [page96] own distribution and cut Salem out. The trial judge doubted M. Thabet's denial that he did not invite the proposal from Mr. Sharko. Furthermore, M. Thabet lied about a plant fire in order to protect his own commercial interest, once he had decided that he was going to end his arrangement with Salem.
56Although the trial judge was clearly very concerned about this behaviour on the part of M. Thabet, she concluded that it did not change the fact that Boa-Franc was entitled to terminate the contract because of Salem's breach of its obligation of good faith. It may be true that the innocent party's conduct will not change the effect of an ordinary breach on which one could sue for damages. But where the innocent party seeks to terminate its obligations under the contract for fundamental breach, relying in part on the effect of the breach, the innocent party's own conduct under the agreement becomes an important barometer of the true significance of the same breach by the offending party. Where M. Thabet was prepared to conceal critical information from Salem that he was considering taking over the distribution of the product himself, and where he was prepared to lie to Salem in order to collect his accounts receivable during the currency of their arrangement, it can hardly be said that he valued good faith and good communications as critical features of their business arrangement.
57That observation also affects the third factor. The trial judge found that based on both parties' admissions that good faith and good communication were essential elements of their relationship, the relationship could not continue without those elements. However, despite their evidence, neither party lived up to their stated levels of integrity in their dealings with each other. In terms of the actual effect of the sale or of the breach on Boa-Franc, M. Thabet testified that there was no difference in his dealings with Salem from the time of the Salem sale to Floorco in March of 1994 until Boa-Franc terminated the agreement that same year in July.
58It is important that the breach here was not the actual sale of Salem. Unlike in the case of Matchless Group Inc. v. Steelcase Canada Ltd., 2003 NLSCTD 98, [2003] N.J. No. 160, 229 Nfld. & P.E.I.R. 148 (S.C.T.D.), where all Steelcase distributors were governed by provisions in a "Blue Book" that included a prohibition on the sale of the distributorship, in this case there was no express or implied term that Salem could not sell its shares. Mr. Fazzari testified that he would not have agreed to such a condition, had it been raised during their negotiations.
59Rather, the breach was Salem's failure to disclose the sale. One must therefore ask, had Mr. Fazzari discussed his plans [page97 ]with M. Thabet in advance, what could M. Thabet have done? Had he said that he objected to the sale and that he was not prepared to continue the distributorship if Salem proceeded with it, his only recourse would have been to give Salem reasonable notice of termination and, of course, to advise Mr. Fazzari that he would lose the distributorship if he proceeded with the sale: see also Inno-Vite Inc. v. Rowland, 2003 32162 (ON SC), [2003] O.J. No. 3171, 38 B.L.R. (3d) 181 (S.C.J.), at para. 11, vard (but not on this point) 2005 7882 (ON CA), [2005] O.J. No. 1077, 3 B.L.R. (4th) 320 (C.A.).
60Furthermore, the law has already acknowledged that distributorship agreements are the type of contract that involve mutual trust, and for that reason the parties each have a right to terminate the contract unilaterally on notice, in the event there is a breakdown of that trust: see Martin-Baker, supra, at p. 734 All E.R. In other words, situations like the one that occurred in this case are accommodated within the law of termination on notice. Termination for "cause" without notice is reserved for fundamental breaches of a separate contractual obligation or a fundamental breach of good faith in conjunction with a contractual obligation.
61I conclude that, applying the five factors approved of in Shelanu, Salem's breach of the implied term of good faith and communication in its contract with Boa-Franc -- assuming there was such a breach -- did not substantially deprive Boa- Franc of the whole benefit of the distributorship agreement to give Boa-Franc the right to terminate the contract without notice. There was ongoing substantial performance of the contract by Salem, and although both sides believed that good faith and communication were important aspects of their relationship, both sides acted in their own self-interest when it came to the disclosure of information regarding their business intentions. In those circumstances, weighing all the factors, it cannot be said that Salem's failure to disclose its relationship with Floorco amounted to a fundamental breach that allowed Boa-Franc to terminate the contract without giving reasonable notice.
(4) Did the trial judge err in the measure of damages?
62In the event that she erred in holding that Boa-Franc had just cause to terminate its agreement with Salem without notice, the trial judge considered what would have been a reasonable notice period in this case. She concluded that six months would have been appropriate. The appellant submits that the trial judge made a palpable and overriding error by failing to give due weight to certain factors. In my view, however, the trial judge considered all of the relevant factors and [page98] the expert evidence in arriving at her conclusion. I see no basis to interfere with her assessment.
63The trial judge also fixed 16.3 per cent as the gross margin figure to apply to the notice period. The appellant submits that the percentage should have been 19 per cent, and that the trial judge erred by employing a weighted average of the profits earned over the term of the contract rather than emphasizing recent experience. Again, the trial judge fully considered the expert and other evidence on this point. I can see no error in her approach or conclusion.
Conclusion
64I would allow the appeal, set aside the judgment, and grant judgment to the appellant for the amount of damages fixed by the trial judge. Costs of the appeal to the appellant fixed at $20,000. Costs of the trial to the appellant in the amount to be fixed by the trial judge.
Appeal allowed.
