Court File and Parties

COURT FILE NO.: CV-21-00658971-0000

DATE: 20210712

SUPERIOR COURT OF JUSTICE - ONTARIO

RE: 9925350 Canada Inc. and Hong Thuy Thi Nguyen, Plaintiffs

– AND –

Kevito Ltd., Defendant

BEFORE: E.M. Morgan J.

COUNSEL: Lloyd Hoffer and Lauren Parker, for the Plaintiffs

Allan Dick and Daniel Hamson, for the Defendant

HEARD: July 2, 2021

INTERLOCUTORY INJUNCTION

[1] Plaintiffs, 9925350 Canada Inc. (“992”), the owner of a Chatime bubble tea franchise, and its principal, Hong Thuy Thi “Teresa” Nguyen, move for an interlocutory injunction preventing the Defendant, the franchisor, from terminating and further interfering with 992’s franchise business pending a judgment on the merits.

[2] The Defendant alleges numerous breaches of the franchise agreement dated November 10, 2016 between itself and Teresa, and subsequently guaranteed and assigned by Teresa to 992 (the “Franchise Agreement”). It has placed inspectors in 992’s business premises and has issued a Notice of Termination of the Franchise Agreement. The Defendant submits that 992’s breaches of health and safety standards, in particular, give rise to its right under the Agreement to terminate the franchise.

[3] The Plaintiffs claim that the Franchise Agreement has not been interpreted by the Defendant in pursuit of reasonable commercial standards as required by the Arthur Wishart (Franchise Disclosure) Act, 2000, SO 2000, c.3 (the “Wishart Act”). They also allege that the Defendant has managed its relationship with 992 in a way that lacks good faith as required by both the Wishart Act and the common law. It is Teresa’s view that the Defendant has enforced the supposed health and safety standards with unreasonable severity making it impossible to comply in order to appropriate 992’s franchise for itself.

I. The franchise agreement

[4] The Franchise Agreement was for a 5-year term and granted 992 three options to renew, each for a further 5 years provided the lease of the business premises remained unexpired or could be renewed. Teresa invested $500,000 to acquire the franchise business. The Franchise Agreement sets out the operational obligations of the franchisee, including reference to requirements that are not in the body of the Franchise Agreement but that are contained in Operating Manuals. Those documents can be changed from time to time, apparently at the Defendant’s discretion as set out in article 9.01 of the Franchise Agreement:

The Franchisor shall loan to the Franchisee during the Term of this Agreement one (1) copy of the various applicable Operating Manuals created by the Franchisor, if applicable (hereinafter referred to, collectively, as the “Operating Manuals") containing mandatory and suggested specifications, System Standards, prescribed from time to time by the Franchisor and information relative to other obligations of the Franchisee hereunder and to the operation of the Restaurant. …. The Franchisor shall have the right, in the Franchisor's sole opinion, without prior notice to or approval of the Franchisee, to add, change, modify, withdraw, or otherwise revise the provisions of any one or more of the Operating Manuals from time to time to maintain the goodwill associated with the System and the Proprietary Marks, provided that no such revision shall alter unreasonably the Franchisee's rights under this Agreement. The provisions of the Operating Manuals (as revised from time to time) and the mandatory specifications, System Standards, procedures and rules app1icable to the System and such revisions made thereto from time to time by the Franchisor, shall constitute provisions of this Agreement as if fully set forth herein and the Franchisee agrees to be bound by the provisions of the Operating Manuals and all such revisions as though they were expressly set forth herein. All references to this Agreement shall include the provisions of the Operating Manuals and all such mandatory specifications, System Standards, operating procedures and rules, and all such revisions thereto.

[5] The same broad and unilateral discretion is built into the Franchise Agreement’s definition of System Standards in article 1.01(k), to which 992 as franchisee is also obliged to adhere:

‘System Standards’ means such standards with respect to the System as are prescribed from time to time in the Franchisor’s Operating Manuals, or otherwise communicated to the Franchisee in writing or other tangible form pertaining to the regulation of any one or more of the following with respect to the Restaurant:

(i) design, layout, décor, appearance and lighting: periodic maintenance, cleaning and sanitation; periodic remodeling; replacement of obsolete or worn-out leasehold improvements; equipment, fixtures, furnishings, signs, and delivery vehicles; periodic painting; and use of interior and exterior signs, emblems. lettering and logos and the illumination thereof;

(ii) types, models and brands of required fixtures, furnishings, equipment, signs,

delivery vehicles, materials and supplies;

(iii) required or authorized Products and Product categories; …

(iv) production, presentation, packaging and delivery of the Products and Product

retention and disposal; …

For greater certainty, all references to this Agreement include all System Standards as periodically modified.

[6] The range of the franchisor’s discretion to control everything done by the franchisee is extraordinary. It can, and does, seek to control not just whether a drink is to be shaken or stirred, but whether is to be stirred in a circular or figure eight motion, or how many times it is to be shaken in its preparation. And all such details can be changed at the Defendant’s whim.

[7] In addition, article 8.03(a) permits Kevito to terminate for any default, including violation of any Operating Manual or System Standard, upon notice and failure to cure within 15 days:

The Franchisee shall be deemed to be in default under this Agreement, and the Franchisor may, at its option, terminate this Agreement immediately if the Franchisee has not remedied such default within fifteen (15) days after notice of such default has been given by the Franchisor to the Franchisee:

(a) if the Franchisee fails to observe or perform any other term, covenant or obligation contained in this Agreement (other than as specified in Section 8.02) or in any other agreement between the Franchisor and Franchisee or contained in any Operating Manuals of the Franchisor, including without limitation the Franchisee's obligation to strictly adhere to the System Standards in effect from time to time.

[8] On top of all of this, article 8.06 of the Franchise Agreement allows the franchisor to exercise self-help upon termination, including seizing the franchisee’s entire business. The Defendant is given the…

immediate right to: ….

(a) enter upon and take possession of the Location to the absolute exclusion of the Franchisee;

(b) operate the Restaurant for its own account; and

all without resort to legal process, without being guilty of trespass, and without being liable for any loss or damage which may be occasioned thereby. The Franchisor shall have the right to take all such actions as it, in its sole and absolute discretion, deems necessary or desirable to carry out the foregoing.

[9] In terms of compensating the franchisee, article 8.08 of the Franchise Agreement gives the Defendant an option, but not an obligation, to buy the terminated franchisee’s inventory at cost. In addition, it may purchase the franchisee’s furniture, fixtures, equipment, and small wares at fair market value, and may take an assignment of 992’s interest in any leases of furniture, fixtures, equipment, and wares. The bottom line is that the Defendant is, at least on the face of the Franchise Agreement, empowered to take control of and to appropriate for itself the business on termination.

II. The inspections and the dispute

[10] 992 is one of the Defendant’s most profitable franchises. Twice in 2020 it received notice that it was the most profitable business in the entire chain. It is the Plaintiff’s speculation that the Defendant wishes to take over this profitable business and has engaged in a campaign of ultra-rigorous inspections in order to engineer that takeover.

[11] The Defendant denies that it has any designs on the Plaintiff’s business. Rather, it is the Defendant’s position that the Franchise Agreement gives it the right to conduct inspections and to expect that all franchisees, including 992, comply with company-wide, standard requirements with respect to cleanliness and drink preparation. It points out that the inspections did not just begin this past year, and were themselves part of the periodic follow-up on a “Warning Notice” that 992 received following poor inspection results in December 2019. Defendant’s counsel makes the point that in particular during the COVID pandemic, health and safety requirements have been very important for this business.

[12] The Defendant conducted intense inspections of 992 this year around the holiday season. On each of December 8 and 17, 2020 and January 4, 2021, inspectors showed up and, according to all descriptions, put 992 and its staff under a microscope. On January 4^th, in particular, the Defendant’s representatives spent 6 ½ hours in 992’s shop, scrutinizing everything from the faucets on the sink to the tea stored in the cupboards. They found, perhaps not surprisingly given the detailed nature of the franchisor’s mandatory standards, a series of problems and produced a list of infractions. Viewed in one way, the list of infractions is lengthy and therefore concerning to the franchisor who demands strict adherence to its health and safety measures. Viewed another way, the lengthy list of infractions is replete with non-problematic, de minimis matters that do not amount to real health and safety concerns but that do interfere with the franchisee’s ability to carry on normal business.

[13] By way of illustration, the Defendant reported that it had discovered that one water filter in the shop had not been properly cleaned, although that particular filter was hidden behind a sink and difficult to access. The Defendant’s inspectors also found one or two packets of tea not being served but sitting in storage were past the printed expiry date. They further reported that the thermometer on the refrigerator display case was calibrated to be off by a number of degrees, and there were shortages of ingredients for 14 minutes on one occasion and from 10:25 p.m. to closing time shortly thereafter on another occasion. There was also occasional improper or insufficient staff handwashing and cleanliness errors. Interestingly, employee mask wearing, which the Defendant portrays as an important point of contention with 992 during 2020-21, is not mentioned in the list of infractions produced after this lengthy and intensive inspection period.

[14] These inspections resulted in an inspector being stationed full time in 992’s shop so that the Defendant could note, and correct, errors in real time as they occurred. Counsel for the Plaintiff points out that the cleanliness “errors” often amount to the inspectors noting that the floor of the shop was wet right after a customer had walked in and out on a rainy or snowy day.

[15] Indeed, email correspondence from Teresa, the principal of 992, indicates that she was exasperated and her staff was exhausted by the level of demands that the non-stop inspection imposed. In at least one piece of correspondence in the record she complained that the cleaning demands were so non-stop that her staff could not properly attend to customers.

[16] By follow-up email to a meeting on January 6, 2021, the Defendant asserted the franchisor’s right to terminate immediately. Teresa was given an offer in which she was invited to sign the Defendant’s form of Surrender and Release Agreement. The email also states that 992 was required to deliver all keys and security passwords so that the Defendant could begin operating the location “for our own account”.

[17] The termination email also specified that the formal termination would take effect 90 days thereafter, during which time Teresa could attempt to sell the franchise to a new franchisee, subject to the Defendant’s approval under the Franchise Agreement. The Defendant’s representative said that Teresa could obtain legal advice with respect to the termination, but was given only two days – until 5:00 p.m. on January 8, 2021 – to accept the offer. The alternative to acceptance would have been the Defendant exercising the clauses of the Franchise Agreement giving it the right to terminate the franchisee without a further opportunity to sell.

[18] With the intervention of counsel for 992, the Defendant did not terminate the franchise on January 8, 2021. However, it delivered a Notice of Termination by letter dated February 11, 2021, which was to take effect on February 17, 2021.

[19] It is the Defendant’s position that the Franchise Agreement allowed it to terminate 992’s franchise given the list of infractions it had found in several inspections. Although the Defendant acknowledges that 992 was a profitable franchise, it considered Teresa to be a business person who thought the franchisor’s health and safety standards were nothing more than a “nuisance and impediment” to her business, and that she was thereby “ungovernable”. They treated her, in effect, as a rogue franchisee that threatened to run down the goodwill and reputation of the entire Chatime chain.

[20] The termination dispute also spawned a financial dispute between the parties, as the Defendant began to charge 992 for the inspection personnel and legal fees it incurred in pursuing its measures. 992 disputes that these amounts are properly owing to the Defendant, and so has not paid them. In response, the Defendant has begun withholding funds owed to 992 relating to online sales and gift cards administered by the franchisor on behalf of franchisees. This dispute is ongoing.

III. Commercial reasonableness and good faith

[21] Plaintiffs’ counsel submits that while the Defendant relies on the letter of the very onerous Franchise Agreement, it is legally obliged to interpret and implement the contractual terms in a way which reflects good faith and fair dealing with its franchisee. Specifically, the Plaintiffs plead section 3 of the Wishart Act, which states:

(1) Every franchise agreement imposes on each party a duty of fair dealing in its performance and enforcement.

(2) A party to a franchise agreement has a right of action for damages against another party to the franchise agreement who breaches the duty of fair dealing in the performance or enforcement of the franchise agreement.

(3) For the purpose of this section, the duty of fair dealing includes the duty to act in good faith and in accordance with reasonable commercial standards.

[22] In Shelanu Inc. v. Print Three Franchising Corp., 2003 CanLII 52151 (ON CA), 2003 CarswellOnt 2038, at para 5, the Court of Appeal indicated that a franchisor must “have regard to [the franchisee’s] legitimate interests and to deal promptly, honestly, fairly and reasonably with [the franchisee].” In the franchise context, there is a limit to the extent to which a franchisor can impose its own interests to the detriment of the franchisee, even if the agreement on its fact gives it a right to do so. As the Court put it in Shelanu, at paras 68, “Good faith, ‘while permitting a party to act self-interestedly, nonetheless qualifies this by positively requiring that party, in his decision and action, to have regard to the legitimate interests therein of the other’”.

[23] The Court in Shelanu did not contend that the franchisee’s interests are superior to those of the franchisor, but it explained that the franchisor owes a duty to the franchisee to act in a way which can be characterized not only as honest, but as commercially reasonable: Ibid., at para 69. This approach, according to the Court of Appeal in subsequent cases, “reflect[s] the circumstances of that [franchise business] context, including the power dynamics of the unique relationship between franchisor and franchisee”: Trillium Motor World Ltd. v. General Motors of Canada Ltd., 2015 ONSC 3824, at paras 152, rev’d on other grounds, Trillium Motor World Ltd. v. General Motors of Canada Ltd., 2017 ONCA 545.

[24] Even apart from the Wishart Act, the Supreme Court of Canada has in recent years clarified that, as a matter of common law, ongoing, relational contracts such as franchise agreements must be reasonable in content and carried out in good faith: Bhasin v Hyrnew, 2014 SCC 71, at para 66. Plaintiffs’ counsel points out that, in fact, the Bhasin case is on point both in principle and factually. In Bhasin, the Court found a lack of good faith in a notice of non-renewal that the claimant there argued had been exercised for an improper purpose – to force the claimant to ultimately give up its business: Ibid., at para 97.

[25] At the heart of the Plaintiffs’ claim is that 992’s situation must be analyzed in the context of what the Court of Appeal called the “power dynamic” between franchisor and franchisee. Here, Plaintiffs’ counsel submits, the Defendant is purportedly authorized to impose procedures, techniques, and System Standards which are not defined or spelled out in the Franchise Agreement and which can be all but impossible to adhere to in the strictest sense. It is the Plaintiffs’ position that the requirement of good faith, under both the Wishart Act and at common law, must temper these extremes.

[26] Specifically, Plaintiffs’ counsel submits that the business context in interpreting the commercial reasonableness/good faith requirement is all important. This context includes, in the Plaintiff’s view, that the ability of the Defendant franchisor to have its representatives spend more than 6 hours scouring for infractions and deficiencies in the System Standards in order to arm itself for 992’s termination. The Plaintiff contends that although the Defendant poses its inspection and reporting regime as providing franchisees with an opportunity to cure any deficiencies in the system, there is in reality no opportunity to do so since complete adherence to those standards is a practical impossibility.

[27] The Plaintiff also claims, and presents some evidence to support, that the Defendant has singled out 992 for system-wide “deficiencies”. These include strict cleanliness standards that cannot be adhered to even by the Defendant itself in corporate-run stores. Photographs taken by Teresa demonstrate that corporate stores have wet floors from customers tracking in rain and snow just as much as 992’s premises does. It is self-evident that this cannot be avoided, and that with frequent and lengthy enough inspections, this type of infraction of supposed health and safety standards will virtually always show up.

IV. Interlocutory injunction

[28] Under RJR-MacDonald Inc. v. Canada, 1994 CanLII 117 (SCC), [1994] 1 SCR 311, 333-34, in order to obtain an interlocutory injunction, the Plaintiffs must show:

a) that there is a serious question to be tried;

b) that they will suffer irreparable harm if the application were refused; and

c) that the balance of convenience in terms of relative harm to the parties favours them over the Defendant.

[29] In a case like this, where an injunction is not being sought to enforce a specific restrictive covenant but rather the good faith and reasonable terms of a relational contract are in dispute, the “serious question” analysis is at the low end of the approaches to the threshold issue: 1318214 Ontario Limited v Sobeys 2010 ONSC 4141, at paras 2, 19-26. This is all the more evident where, as here, a franchisee disputes the outright termination by the franchisor of the franchise business. In my view, this threshold is easily crossed under these circumstances. Given the requirements of the Wishart Act and the overall sense of commercial reasonableness and good faith imposed by the Supreme Court in Bhasin, the issues raised here are serious and highly contentious.

[30] The severity of the terms of the Franchise Agreement, combined with the ability of the Defendant to unilaterally change and impose new terms by enacting new System Standards, engages the very issues that the Wishart Act and the good faith requirement at common law address. I do not say, of course, that at this stage the Plaintiffs’ allegations in this respect are proven, as the evidence is not complete. This is an interlocutory motion and the Court cannot expect the parties to have all of their evidence in hand or to “lead trump” as they must in a summary judgment proceeding: Beckford v. Bathia, 2016 ONSC 5115, at para 11. The evidence will develop with discoveries and may turn out to be substantially different at trial than it appears today.

[31] The point of an interlocutory injunction in circumstances where there are, as here, serious issues to be tried, is to preserve the status quo so that there will be something left for both sides to fight about at trial. Given the strength of the evidence that the Plaintiffs have adduced to date, I have seen all of the merits that I need to see to conclude that the “serious question” hurdle has been crossed: Quizno’s Canada Restaurant Corp. v. 1450987 Ontario Corp., 2009 CanLII 20708 (ON SC), [2009] OJ No 1743 (SCJ), para 11.

[32] As for irreparable harm, Defendants’ counsel submits that this is a case about money and nothing else. The Supreme Court said expressly in RJR-MacDonald that “‘[i]rreparable’ harm refers to…harm which either cannot be quantified in monetary terms”. From the Defendant’s point of view, the name, trademarks, and market for the product belongs to the franchisor, not the franchisee, and while the franchisee has a right to claim financial compensation in accordance with the Franchise Agreement there is no reason to preserve the status quo in order to pursue that claim. The Plaintiffs can, if successful, be made whole by damages regardless of whether they are still in the franchise business.

[33] That said, the courts have recognized that where a failure to grant an injunction will result in the destruction of a business, irreparable harm will ensue regardless of whether a claim in damages is part of the plaintiff’s case: Bark & Fitz Inc. v 2139138 Ontario Inc., 2010 ONSC 1793, at paras 30-33. Courts in Ontario have for some time acknowledged that termination of a franchise, with its attendant loss of profits and business reputation for the owner, constitutes irreparable harm: TDL Group Ltd. v. 1060284 Ontario Ltd. (2001), 1986 CanLII 2631 (ON SC), 15 OAC 354, at paras 12-13 (Div Ct). Moreover, the fact that the Defendant says that upon its takeover it will continue to operate the franchise out of its present location is no answer to the fact that the Plaintiffs will have had their own business undermined: Golden Globe Pizza Inc. v. Domino’s Pizza of Canada Ltd., 2010 BCSC 356, at para 19.

[34] Defendants’ counsel argues that there is no reputational or livelihood loss at stake here for Teresa as owner of 992, as she is a nurse by profession and can always fall back on that vocation in order to make a living. In my view, that argument misses the mark by a wide margin. The point is not whether the person who owns a business whose imminent destruction is at stake has something else to do to earn a living; every industrious person can likely think of something else to do if she puts her mind and effort to it. The point is whether, if no interlocutory injunction is granted, the business owner will have this business to come back to if her position is vindicated at trial.

[35] As has been said in other franchise or dealership cases, given the nature of the business relationship “I accept that this principal of what will constitute irreparable harm applies to the case at bar”: Erinwood Ford Sales Ltd. v. Ford Motor Co. of Canada Ltd., 2005 CanLII 16616, at para 78. The nature of the relationship between the parties is such that the franchisor holds the cards. It is necessary for the franchise to be preserved in the franchisee’s hands pending trial if the trial itself is not to be rendered in some respect moot by the franchisee’s irretrievable loss of the business.

[36] Turning to the balance of convenience, this stage of the test involves evaluating the relative impact on the parties of granting or withholding the injunction. It will necessarily vary from case to case. The Defendant submits that it highly values its System Standards, and that its own business reputation, trademarks and goodwill may be run down if 992 is permitted to stay in operation much longer.

[37] The evidence before me does not support the Defendant’s contention that having 992 continue in business pending trial will derogate from the franchise system as a whole. The Plaintiffs have so far done a better job in demonstrating that the infractions of the System Standards are minimal and unimpactful than the Defendant has in demonstrating that the health and safety concerns that it expresses are realistic. In fact, what the evidence shows so far is that a successful and highly profitable franchise business is at risk of being lost if it is not permitted to stay in operation pending trial.

[38] I do not know why the Defendant has sought to enforce the franchise-wide standards more strictly against 992 than anyone else, including itself as manager of company-run stores. As indicated earlier in these reasons, Teresa is of the view that the Defendant simply wants to appropriate the value of her business to itself. Her counsel points out that there are potentially several 5-year renewals still available to 992, and that the business still has a relatively long way to go.

[39] There is no direct evidence of the Defendants having these kind of designs on 992’s business. I would say, however, that the circumstantial evidence of a franchisor seeming to come down excessively hard on a highly profitable franchisee suggests that Teresa’s theory might not be too imaginative to take seriously. But all of that remains to be adjudicated at trial. Whatever the case turns out to be, it is clear that if there is no interlocutory injunction preserving the status quo the Plaintiffs will never have an opportunity to have their theory and their rights determined on the merits.

[40] The balance of convenience is therefore in the Plaintiffs’ favour.

V. Disposition

[41] Pending trial or until further order of the court, the Defendant is restrained from terminating or acting upon its purported termination of 992’s franchise. The Defendant is further restrained from interfering with the continued conduct of 992’s business, in particular by the repeated attendance of its personnel at 992’s premises. The Defendants’ inspections of 992’s premises are, absent specific leave of the court to the contrary, to be carried out at pre-determined and pre-announced intervals that are reasonably timed in the sense that they do not exceed the frequency and duration of inspections carried out by the Defendant for the majority of its other franchisees.

[42] I make no order with respect to the financial dispute between the parties or the withholding of funds from one another. Those matters will be resolved at trial.

[43] The parties may make written submissions on costs. I would ask Plaintiffs’ counsel to send to my assistant by email short submissions (2 pages maximum) within two weeks of today, and for Defendants’ counsel to send to my assistant equally short submissions within two weeks thereafter. There is no need to deliver copies of authorities cited in these submissions, provided that any cases are cited with full citations so that they can be found online.

Date: July 12, 2021

Morgan J.