COURT FILE NO.: CV-20-00643317-00CL
DATE: 20200911
ONTARIO
SUPERIOR COURT OF JUSTICE
BETWEEN:
2161907 Alberta Ltd.
Applicant
– and –
11180673 Canada Inc.
Respondent
J. Thomas Curry, Brian Kolenda and Aoife Quinn, for the Applicant
Jeffrey Hoffman, for the Respondent
HEARD: August 31, 2020
judgment on application
C. Gilmore, J.
oVERVIEW
[1] This Application and Counter-Application concerns the conduct of both the licensee, 11180673 Canada Inc. (“111”) and the licensor, 2161907 Alberta Ltd. (“216”) with respect to a series of agreements including a License Agreement, Loan Agreement and Sublease all related to the opening of a “Tokyo Smoke”- branded store in Toronto. Tokyo Smoke is a leading cannabis brand.
[2] 216 seeks declarations that 111 breached the parties’ License Agreement, Sublease and Loan Agreement and that 111 must therefore vacate the premises at Unit A01131A, 21 Bloor Street East, Toronto (“the premises”). 216 also seeks a declaration that the Branding Fee is no longer owed to 111, and that 111 must pay all amounts owing under the License Agreement, the Consulting Agreement, the Loan Agreement and the Sublease.
[3] In its Counter-Application, 111 seeks declarations that the License Agreement is a Franchise Agreement, that 216 breached its implied contractual duty of good faith in the performance of the License Agreement, that 111 is owed the agreed upon Branding Fee of $2,000,000 plus HST and that 216 breached the Loan Agreement and Consulting Agreement, and wrongfully terminated the License Agreement and Sublease.
[4] 111 also sought relief from forfeiture of the License Agreement and Sublease, an injunction to prevent 216 from taking possession of the premises, and damages. However, it was agreed that 111 would not seek that relief at the August 31, 2020 hearing. 111 reserves the right to seek damages at a later date. Following this hearing, the parties agreed by way of Consent Order that 111 would vacate the Premises by September 8, 2020.
BACKGROUND FACTS
[5] 216 is the Ontario Licensee for Tokyo Smoke. It holds the exclusive license to use “Tokyo Smoke” intellectual property and operate retail cannabis operations in Ontario. In November 2019, 216 entered into a License Agreement, a Loan Agreement and a Sublease with 111 to enable the opening of a Tokyo Smoke-branded store in the Yorkville area of Toronto. 216 secured real estate which it sub-leased to 111, provided consulting services and a significant line of credit in order for 111 to buy inventory, train staff and build out the store.
[6] Mr. Justin Farbstein is the sole officer and director of 216, its President and the deponent in this Application.
[7] 111 is a licensee of 216. Mr. Robert Heydon (“Mr. Heydon”) is the sole officer, director and shareholder of 111 and the deponent in the Counter-Application. In August 2019 Mr. Heydon won a cannabis retail license in the lottery run by the Alcohol and Gaming Commission of Ontario (“AGCO”). This permitted him to submit an application for a retail operator license (“ROL”) and a retail store authorization (“RSA”) to the AGCO.
[8] 216 sought out lottery winners such as 111 in order to license their Tokyo Smoke brand at new retail locations. Mr. Heydon conceded he had no expertise in owning or operating a cannabis retail operation. He felt he would benefit from 216’s industry expertise and financial support including the agreement to pay 111 a Branding Fee of $2M for his store to use the “Tokyo Smoke” name, and the funding of start-up costs.
[9] By June 1, 2020, 216 had advanced over $1.5M in loans to 111 for inventory and store construction and was at the point of paying the $2M Branding Fee to 111 when an issue occurred on June 2, 2020 which 216 considered an Event of Default under the License Agreement. That event and the subsequent actions of the parties has led to these Applications.
The License Agreement
[10] On November 7, 2019 the parties entered into a Licensing Agreement with 216 as the Licensor and 111 as the Licensee. Under the Licensing Agreement, 216 sublicensed its intellectual property rights (the “Licensed Marks” or the “Marks”) to 111 to operate the premises.
[11] The License Agreement stipulated that 216 had the right to supervise the use of the Licensed Marks by 111 meaning that 216 controlled how the Tokyo Smoke brand was used for advertising and promotion of the store. 216 had an obligation to its head licensor, Canopy Growth Corporation (“Canopy”) to ensure that the store buildout reflected well on the Tokyo Smoke brand.
[12] The current dispute turns in part on Section 26(c) of the License Agreement:
The Licensor has the right, without liability, cost or penalty, to terminate this agreement with immediate effect on written notice to the Licensee if one or more of the following occurs. …
(c) the Licensee ceases or threatens to cease to carry on business, or takes or threatens to take any action to liquidate its assets, or stops making payments in the usual course of business.
[13] In response to a refusal by 216 to advance 111 the June rent, Mr. Heydon advised representatives of 216 by email as follows, “Please inform Canopy we will NOT be opening. I will lay off staff tomorrow.” 216 was concerned about 111’s threat not to open and saw it as a “shakedown” for additional funds. Further, 216 was concerned that Mr. Heydon’s behaviour reflected negatively on his capacity to act honestly and had serious reservations about being in business with him for the 10-year initial term of the License Agreement. 216 was troubled that Canopy would lose confidence in it as Mr. Heydon’s threat was also sent to Canopy.
[14] Mr. Heydon’s position is that this was not a threat, he was simply dejected that 216 had not lived up to its commitment to pay June’s rent through the Loan A facility. Further, this was not a threat to cease operations as operations had not yet commenced. Mr. Heydon simply wanted the rent issue resolved.
[15] On June 2, 2020 the AGCO advised that the last condition had been removed from its RSA and the premises could open for business. However, 216 determined that Mr. Heydon’s threat to cease business operations was an Event of Default under the License Agreement and terminated the License Agreement on June 2, 2020. 216 pulled its staff from the premises and delivered Notices to 111 that it was in default of the License and Loan Agreements. This caused an acceleration of amounts owed under the Loan Agreement. Further, the termination of the License Agreement meant that 111 was obliged to discontinue use of the Tokyo Smoke brand.
[16] On June 3, 2020 111 opened the Store despite delivery of the Notices of Default. A Cease and Desist notice was delivered to Mr. Heydon on June 3, 2020 but he continued to operate the Store. Mr. Heydon took the position that 111 was not in default.
[17] 216 was also concerned when it learned that 111 had initiated a media campaign and issued Press Releases on June 15th and June 24th, 2020 regarding the opening of the Store, its Banksy art collection and reduced pricing of all inventory. The Press Releases were not approved by 216 who viewed them as an unauthorized use of the Marks. Cease and Desist Notices were delivered to 111 on June 16 and again on June 25, 2020 regarding the unauthorized use of the Marks and breaches of the License Agreement.
The Branding Fee
[18] The License Agreement stipulated that a Branding Fee was payable to 111 upon certain conditions including the issuance of the RSA. Under Article 14 of the License Agreement, Tokyo Smoke agreed to pay the Licensee an up-front Branding Fee of $2,260,000, inclusive of H.S.T:
In consideration for entering into this Agreement and the license to the Licensed Marks granted herein, and to support the rapid market penetration of the Licensed Marks in connection with the Store, the Licensor shall, upon the later of: (a) the date that the AGCO issues approval of the relocation of the premises in which the store will be located; (b) the date that the AGCO issues an ROL to the Licensee (the "ROL Issuance Date"); and (c) the date that the AGCO issues an RSA to the Licensee, pay the Licensee an upfront, one time, branding fee equal to two million dollars ($2,000,000) plus applicable HST (the"Branding Fee"). The Licensor shall pay the Branding Fee upon issuance of an RSA for the Store bearing the name Tokyo Smoke or "Tokyo Smoke 21 Bloor",
[19] The RSA was issued on April 7, 2020 but suspended until April 23, 2020 because of the pandemic. 111 sent an invoice for the Branding Fee to 216 on April 7, 2020. 216 took the position that the Branding Fee was not payable until the RSA was issued unconditionally, that is, upon inspection and the issuance of an approval notice. 111’s position is that the Branding Fee was due on April 23, 2020 but in any event was due on June 2, 2020 when the approval notice was delivered by the AGCO. Immediately upon receipt of the approval notice, Mr. Heydon forwarded it to Mr. Farbstein along with another copy of the invoice for the Branding Fee.
[20] The night before the approval notice was received by 111 (and subsequent to Mr. Heydon’s “threat” to cease operations), Mr. Farbstein on behalf of 216 advised Mr. Heydon that the Branding Fee would be sent later that week. On June 2, 2020, less than an hour after receipt of the approval notice, Mr. Farbstein advised Mr. Heydon that the Branding Fee would be paid “this week” and that he would speak to the landlord about deferral of the June rent.
[21] Mr. Heydon’s position is that at no point on June 2, 2020, prior to receiving the Notices of Default at 4:26 p.m., was he informed that the agreements were in default or at risk of being terminated. In fact, only hours before the Notices of Default were received, Mr. Farbstein advised that the Branding Fee would be paid and that he would speak to the landlord about deferral of the June rent.
[22] Mr. Heydon’s position is that the Branding Fee is due and payable. His counsel sent a default notice to 216 in respect of the non-payment of the Branding Fee. 216 takes the position that the $2M Branding Fee is no longer owed due to default under the various agreements.
The Loan Agreement
[23] Under Article 3 of the Loan Agreement, Tokyo Smoke agreed to provide the Licensee with a loan facility, in two parts:
Loan A: The maximum principal amount of Loan A will be $750,000.00 plus the aggregate amount of rent ("Additional Rent") due under a sublease of premises between the Lender as sublandlord and the Borrower as subtenant, in respect of the Premises (the "Sublease") for the period commencing on the conclusion of the Fixturing Period (as that term is defined in the Sublease) and ending on the date the Premises opens to the public (the "Opening Date"). Loan A will be available to the Borrower on the date the AGCO issues a retail operator licence to the Borrower;
and
Loan B: The maximum principal amount of Loan B will be $750,000.00.
According to Article 6 of the Loan Agreement, the purpose of the facility was:
(i) for Loan A: to finance construction of leasehold improvements to the Premises, decor, decorations, security system, POS system or other equipment to operate the Licensed Business or pay Additional Rent; and
(ii) for Loan B: to finance the purchase of inventory of cannabis and cannabis accessories, insurance premiums and human resources expenses (including costs relating to staff training and background checks).
[24] Mr. Heydon’s understanding was that June’s rent was to be paid under Loan A as the store was not projected to open on June 1st, the date the June rent was due. On June 1, 2020 Mr. Heydon was advised by a representative of 216 that his loans were fully drawn down and that 216 would not advance more than the stub period between June 1st and June 3rd. This was incorrect. In fact, Loan A was for $750,000 plus all rent.
The Sublease
[25] 216 was 111’s landlord pursuant to a Sublease between the parties dated November 1, 2019. Rent was due under the Sublease in the amount of $105,409.03 monthly. Any default under the Sublease, the License Agreement or the Loan Agreement gives 216 the right to terminate the Sublease unless the default is cured within seven days. The Sublease does not permit the setting off of rent against any amounts owed to 111 by 216.
[26] On May 25, 2020 Mr. Heydon sent a request for a draw for cannabis inventory of $333,000 and June rent. Mr. Heydon was informed by email that “Loan A” would cover rent for the prorated period in June before the store opened, a total of $10,540.90. On June 1st, Mr. Heydon requested a further advance of $95,000 for June rent. Mr. Farbstein advised Mr. Heydon that Loan A had been fully drawn down and that 216 had already lent 111 the maximum principal amount under the Loan Agreement. As later determined, this information relayed to Mr. Heydon was incorrect. In fact, the Loan A facility had no limit with respect to rent but the Loan B facility had been fully drawn down.
[27] On June 2, 2020, 216 was advised that Mr. Heydon had delivered a cheque for June’s rent directly to 216’s landlord. The landlord did not accept Mr. Heydon’s rent cheque as it was drawn on an account owned by Mr. Heydon and not on the loan account. Mr. Heydon was aware of this and did not advise 216 who was left with the impression that June’s rent had been paid. Mr. Heydon did not replace the rent cheque and concedes he should have advised 216 about this.
[28] Mr. Heydon’s counsel advised that 111 would not be paying the July 2020 rent due to 216’s wrongful termination of the agreements. 216 paid the July and August rent totalling $316,227.69 directly to the Landlord. As a result of 111’s failure to pay rent the Sublease was terminated on August 5, 2020.
[29] 216 maintains that it acted in good faith and despite termination of the Sublease and Licensing Agreements, it did not prevent 111 from operating the Store. For example, 216 allowed 111 to use its Point of Sale system.
[30] 216 continued to provide Human Resources, Finance and Operations services to 111 through the Consulting Agreement which 111 could have terminated at any time on 60 days notice. 216 complained that Mr. Heydon did not take advice on human resource issues and hired personal acquaintances without retail experience whom he paid at higher than recommended wages. Further, he waived the recommendation for background checks on the store management, charged below margin prices, would not take advice on store fixturing or layout, and ordered more than double the recommended inventory.
THE ISSUES
Did 216 Validly Terminate the License Agreement?
[31] 216 takes the position that any dispute about June 2020 rent did not justify Mr. Heydon’s actions or threats which are clearly grounds for termination under the License Agreement. 111 submits that there were no grounds for termination because Mr. Heydon’s communication was not a threat but a mere expression of frustration. Further, the only reason for his frustration was as a result of misinformation.
[32] I do not accept 216’s explanation for the sequence of events on June 2, 2020. The factual matrix is interconnected. Mr. Heydon was upset and frustrated because he was given incorrect information about the payment of June rent. Mr. Heydon correctly assumed that he would be given rent money for June under Loan A. The information given to him by Mr. Farbstein that he had maxed out his loan facility was simply wrong. 216 submits that Mr. Farbstein had not read the License Agreement on the morning of June 2, 2020 and therefore was not aware of a remedy for Mr. Heydon’s erratic behaviour. However, Mr. Farbstein admitted on cross-examination that “on the morning of June 2, 2020, 216 was looking for a way to end the relationship with 111.”
[33] Mr. Heydon’s behaviour was not “erratic”. It was an emotional response to being given incorrect information at a critical time. One can understand his shock at being sent the Notices of Default only hours after being assured by Mr. Farbstein that the Branding Fee would be sent and an arrangement made in relation to the June rent. I accept the position of 111 that had Mr. Heydon been given the June rent under the Loan A agreement, the Store would have opened and this litigation would likely not have commenced. I find that the termination of the agreements by 216 was disingenuous as it was withholding payments from 111 that would have been used to fulfil the requirements under the agreements. I find that the statement made by Mr. Heydon that he intended to cease operations was in response to being told that the June rent would not be advanced and was not a repudiation of the Licensing Agreement.
[34] As for any breach of the Licensing Agreement by way of improper use of the Marks, I have no evidence of any prejudice suffered by 216 as a result. I accept that Mr. Heydon was trying his best to operate the Store without assistance from 216 and in the middle of a pandemic. The sites over which 111 had control were taken down.
[35] I therefore find that 216’s termination of the Licensing Agreement was not valid.
The Branding Fee
[36] 216 takes the position that after delivery of the Notice of Default on 4:26 p.m. on June 2, 2020, it was relieved from all unperformed future obligations under the License Agreement. Given that the purpose of the Branding Fee was to “support the rapid market penetration of the Licensed Marks in connection with the Store”, if the Store could not operate, the Branding Fee was not payable.
[37] The Branding Fee was an inducement to have Mr. Heydon enter into the contractual relationship and join the Tokyo Smoke brand. The payment was intended to be “up front” and payable immediately upon issuance of the RSA on April 23, 2020. While the parties’ conduct resulted in an agreed upon delay while conditions were met, 111 submits that if not due on April 23, 2020 the Branding Fee was certainly due on June 2, 2020. Mr. Farbstein confirmed this in his cross-examination.
Q. All right. The moment the RSA is in your hands at 8:41 a.m. on June 2, 2020, there's no doubt the Branding Fee was due and payable, correct?
A. At that time, I believe it was due and payable when he sent it to me. So I had not paged anyone when I received the e-mail. At that point, I believe it was due and payable. Correct. I agree with you.[^1]
[38] There is no doubt in terms of the timing of events that even after Mr. Heydon’s statement of frustration that he intended to cease operations, Mr. Farbstein confirmed that the Branding Fee would be sent.
[39] I agree with 111 that the language in the Licensing Agreement is mandatory. While the purpose of the Branding Fee was to support market penetration of the Marks, this was not a condition of payment. The only condition of payment was the issuance of the RSA. 216 continues to operate the premises under the Tokyo Smoke brand. It has received the benefit of associating their Mark with the retail operation but has not paid a Branding Fee.
[40] The non-payment of the Branding Fee and the termination of all agreements by 216 meant that 111 was not in a position to pay rent or interest on its loans.
The Duty of Good Faith
[41] Much time was spent at the hearing of this matter dealing with whether or not the relationship between 111 and 216 was that of franchisor/franchisee. I agree with 216 that the Court does not need to decide that issue. The parties owed one another a contractual duty of good faith as per paragraph 51 of the Licensing Agreement which stipulated that “each party shall at all times act in good faith towards the other and shall use all commercially reasonable endeavors to ensure that this Agreement is complied with.”
[42] The Supreme Court of Canada in Bhasin v. Hrynew, 2014 SCC 71, [2014] 3 SCR, 494 established that the common law with respect to good faith means that the parties must not lie or otherwise mislead one another about matters related to the performance of a contract. 111 submits that 216 breached its duty of honesty, good faith and fair dealing when it i) advised that June’s rent was part of Loan B which was drawn down completely, ii) delayed payment of the Branding Fee suggesting that further conditions were required to be met, iii) advised 111 that the Branding Fee would be sent and arrangement made for the deferral of June rent only hours before serving 111 with the Notices of Default.
[43] I find that 216 carried out its true intention which was to find a way to end its relationship with 111. It did so by terminating the License and the Sublease Agreements within one day of the planned Store opening and based on a mere expression of frustration on the part of Mr. Heydon who rightfully expected to receive funds to pay his June rent in accordance with the Loan Agreement. Therefore, I find that 216 did not terminate the Licensing Agreement and the Sublease in accordance with its terms as no Event of Default occurred.
[44] Further, if 216 had paid the Branding Fee to Mr. Heydon, as he was led to believe it would, he would have been in a position to pay the June rent, loan interest and other amounts owing such as consulting fees.
[45] I further find that 216’s termination of the agreements was not done in good faith. While I do not find that 216 lied to 111, it pounced on a single statement made by Mr. Heydon as a basis to trigger default, thereby achieving its goal of ending the relationship with Mr. Heydon and attempting to discharge its obligation to pay the Branding Fee.
ORDERS
[46] Given all of the above, I make the following Orders;
[47] The Application is dismissed save as follows:
a. The Branding Fee shall be paid to 111 within 90 days net of the following amounts:
i. Any rent due and payable to September 8, 2020;
ii. Any accrued consulting fee plus interest owing to 216 (set out as $135,600 in 216’s factum);
iii. Any interest owing on Loan A and $25,000 towards Loan B;
iv. The Licensing fee for June, July and August 2020 being 6% of Gross Revenues.
b. As 216 retains the premises and all fixturing and stock, I do not Order that 111 repay the loans (other than interest and any amounts set out above). If 111 has removed fixtures, stock or other items purchased with the loan amounts those are to be returned to the Premises or the value of those items deducted from the Branding Fee. A complete accounting and inventory is to be completed forthwith to ensure that the proper amounts are deducted from the Branding Fee.
c. Any damages owed to 111 as a result of the finding of bad faith to be assessed at trial or as the parties agree.
COSTS
[48] 111 seeks $62,000 in partial indemnity costs inclusive of HST and disbursements. 216, if successful, would have sought $118,000 in all inclusive partial indemnity costs.
[49] 216 argues that if they are liable for costs, the amount should be reduced based on 111’s late breaking position that they were no longer seeking relief from forfeiture or an injunction. I agree that some portion of the material was devoted to those issues which were not argued.
[50] The costs sought by 111 are reasonable and certainly within the range of expectations of 216. I agree there should be some reduction based on a narrowing of the arguments. I note, however, that even without those arguments the matter took an entire day to argue.
[51] 216 shall therefore pay costs to 111 in the amount of $50,000. Costs are due and payable at the time the net Branding Fee is paid.
C. Gilmore, J.
Released: September 11, 2020
COURT FILE NO.: CV-20-00643317-00CL
DATE: 20200911
ONTARIO
SUPERIOR COURT OF JUSTICE
BETWEEN:
2161907 Alberta Ltd.
Applicant
– and –
11180673 Canada Inc.
Respondent
JUDGMENT ON APPLICAITON
C. Gilmore, J.
Released: September 11, 2020
[^1]: Cross-examination of Justin Farbstein, August 20, 2020 at Q 308.