Franchise Class Actions: What to Expect in Canada

Although the geographic landscape in southern Ontario is similar to much of the northeastern United States, there are subtle traps for the franchisor who ventures northward expecting the franchise laws to be substantially the same. Southern Ontario contains the bulk of economic activity in Canada, and it has a franchise disclosure law based upon the U.S. Federal Trade Commission Franchise Rule. However, there are significant differences in how Canadian law in general will affect franchisors.

One of the differences that franchisors will encounter comes in the area of pure economic loss in the context of a franchise class action, and it is an area in which careful planning may mitigate the problem. While there are more legal differences than economic loss, including a statutory duty of good faith, material disclosure of all information, a statutory right to supply, arbitration, lower thresholds for class actions, and “loser pay” cost consequences, the most dramatic differences are with respect to the treatment of a pure economic loss in the context of the negligent performance of a contract.

Pure Economic Loss

Generally in the United States, there is no separate tort for a pure economic loss unless there is damage to some underlying property. This does not rule out fraudulent inducement to enter into a franchise agreement. But it effectively rules out any tort based on negligent performance of the franchise contract. (An excellent overview of the law of pure economic loss can be found in Franchise Law Journal, Volume 27, Number 3, 2008.)

The most famous (or infamous, depending on your point of view) use of the economic loss doctrine was Broussard v. Meineke Discount Muffler Shops, Inc., 155 F. 3d 331 (4th Cir. 1998) in which the franchisees sued Meineke. The franchisees charged that Meineke not spending the advertising contributions on advertising, as required by the terms of the franchise agreement, was not merely a breach of contract, but in fact was a tort, giving rise to punitive damages and treble damages under the relevant state law. (Punitive damages and treble damages are not available for a breach of contract.)

At the trial, the franchisees' legal theory prevailed, but the decision was reversed on appeal by the Fourth Circuit, which stated that the contractual issues had improperly morphed into a massive tort suit. The Fourth Circuit sent the matter back to the court for damages to be decided on purely contractual terms.

Broussard was arguably the most important class-action case in U.S. franchising history. But the appellate result, denying tort liability, might not have been reached by a Canadian court.

Concurrent Liability Under Contract and Tort in Canada

The general rule in Canada regarding economic loss is: If the contracting parties did not explicitly rule out the ability to sue tort, then the negligent performance of a contract further could result in liability and damages for a tort.

This was decided by the Supreme Court of Canada in BG Checo International Ltd. v. British Columbia Hydro and Power Authority [1993]1 S.C.R. 12:

“In [the] case, Hydro called for tenders to erect transmission towers and to string transmission lines. Checo had a representative inspect the area by helicopter before its tender was submitted. The representative noted that the right-of-way had been partially cleared, and also noted evidence of ongoing clearing activity. He assumed that there would be further clearing prior to the commencement of Checo's work.”

Hydro contracted out the clearing, which was not done properly; the failure to clear the right-of-way caused Checo extensive losses. Checo had to complete the clearing prior to fulfilling its contractual obligations, thus incurring a delay in its project.

The Supreme Court of Canada decided that Checo could sue Hydro on the tort of pure economic loss and recover not merely on a contractual basis, but on a tort basis. Checo recovered damages that were caused by the delay, losses that would not have been covered by contract. As the opinion stated:

“[If] a given wrong prima facie supports an action in contract and in tort, the party may sue in either or both, subject to any limit the parties themselves have placed on that right by their contract.

“This limitation on the general rule of concurrency arises because it is always open to parties to limit or waive the duties which the common law would impose on them for negligence. The mere fact that the parties have dealt with a matter expressly in their contract does not mean that they intended to exclude the right to sue in tort. It all depends on how they have dealt with it. In so far [sic] as the tort duty is not contradicted by the contract, it remains intact and may be sued upon.” (Emphasis added)

In summary, the doctrine of pure economic loss as distinct tort is a viable cause of action in Canada. As such, the U.S. Fourth Circuit's decision in Broussard (and many other U.S. decisions on similar fact patterns) is likely not good law in Canada.

Does It Matter to Franchisors?

Should the possibility of a Broussard-like liability worry franchisors expanding into Canada? Clearly, yes.

However, there are two differences that would lower the overall damage award. First, punitive awards in Canada are rare. As per the leading case on punitive damages, Whiten v. Pilot Insurance Co., 2002 SCC 18 (CanLII), the Supreme Court of Canada stated:

“An award of punitive damages in a contract case, though rare, is obtainable. It requires an 'actionable wrong' in addition to the breach sued upon.

“Here, in addition to the contractual obligation to pay the claim, the respondent was under a distinct and separate obligation to deal with its policyholders in good faith. A breach of the contractual duty of good faith was thus independent of and in addition to the breach of contractual duty to pay the loss.

“The plaintiff specifically asked for punitive damages in her statement of claim and if the respondent was in any doubt about the facts giving rise to the claim, it ought to have applied for particular.”

Second, in Canada and all the provinces, there is no statutory basis or common law basis for trebling damages. But for most franchise systems, the prospect of even a $200 million award for negligent breach of contract would be enough to deter from expanding into Canada.

How Can the Franchisor Reduce Its Liability?

The most common solution, well-favored by franchisor attorneys, would be to treat the problem as a drafting problem: Simply follow the Supreme Court of Canada's
advice and draft out any tort liability. A number of franchise agreements already have this provision in their agreements.

Unfortunately, for those franchisors that wish to expand in Ontario, Manitoba, or arguably Alberta, the typical drafting solution will not to work. This is because of another major difference in franchising law between the countries, arising in those Canadian provinces that have adopted the U.S. style of disclosure laws. Briefly, the common law doctrine of good faith in the context of franchise agreements in the United States does not give rise to a separate head of obligations.

Yet, this is not true in Ontario, where the Arthur Wishart Act (Franchise Disclosure), 2000, S.O. 2000, c. 3, contains a statutory duty of good faith. Like many U.S. franchise laws, parties cannot contract out of their obligations under the Arthur Wishart Act. (Other provinces with franchise disclosure laws have similar provisions.):

Fair dealing

3.(1) Every franchise agreement imposes on each party a duty of fair dealing in its performance and enforcement. 2000, c. 3, s. 3 (1).

Right of action

(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. 2000, c. 3, s. 3 (2).

Interpretation

(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. 2000, c. 3, s. 3 (3).

The combination ' a statutory duty of good faith performance of a franchise contract that cannot be contracted out of and the possibility of concurrent liability under contract and tort ' gives rise to the possibility of liability and damages along the lines of Broussard. The overall solution cannot be found in better draftsmanship, and franchisors would be advised to adopt the solution that arose from the dust in the Broussard: create a viable, independent franchisee association that works collaboratively with the franchisor, with each party effectively maintaining a running watch on each other performance under the contract.

Michael Webster is a franchise attorney in Toronto, Canada. He can be contacted at 416-342-6144 or at [email protected].

Although the geographic landscape in southern Ontario is similar to much of the northeastern United States, there are subtle traps for the franchisor who ventures northward expecting the franchise laws to be substantially the same. Southern Ontario contains the bulk of economic activity in Canada, and it has a franchise disclosure law based upon the U.S. Federal Trade Commission Franchise Rule. However, there are significant differences in how Canadian law in general will affect franchisors.

One of the differences that franchisors will encounter comes in the area of pure economic loss in the context of a franchise class action, and it is an area in which careful planning may mitigate the problem. While there are more legal differences than economic loss, including a statutory duty of good faith, material disclosure of all information, a statutory right to supply, arbitration, lower thresholds for class actions, and “loser pay” cost consequences, the most dramatic differences are with respect to the treatment of a pure economic loss in the context of the negligent performance of a contract.

Pure Economic Loss

Generally in the United States, there is no separate tort for a pure economic loss unless there is damage to some underlying property. This does not rule out fraudulent inducement to enter into a franchise agreement. But it effectively rules out any tort based on negligent performance of the franchise contract. (An excellent overview of the law of pure economic loss can be found in Franchise Law Journal, Volume 27, Number 3, 2008.)

The most famous (or infamous, depending on your point of view) use of the economic loss doctrine was Broussard v. Meineke Discount Muffler Shops, Inc. , 155 F. 3d 331 (4th Cir. 1998) in which the franchisees sued Meineke. The franchisees charged that Meineke not spending the advertising contributions on advertising, as required by the terms of the franchise agreement, was not merely a breach of contract, but in fact was a tort, giving rise to punitive damages and treble damages under the relevant state law. (Punitive damages and treble damages are not available for a breach of contract.)

At the trial, the franchisees' legal theory prevailed, but the decision was reversed on appeal by the Fourth Circuit, which stated that the contractual issues had improperly morphed into a massive tort suit. The Fourth Circuit sent the matter back to the court for damages to be decided on purely contractual terms.

Broussard was arguably the most important class-action case in U.S. franchising history. But the appellate result, denying tort liability, might not have been reached by a Canadian court.

Concurrent Liability Under Contract and Tort in Canada

The general rule in Canada regarding economic loss is: If the contracting parties did not explicitly rule out the ability to sue tort, then the negligent performance of a contract further could result in liability and damages for a tort.

This was decided by the Supreme Court of Canada in BG Checo International Ltd. v. British Columbia Hydro and Power Authority [1993]1 S.C.R. 12:

“In [the] case, Hydro called for tenders to erect transmission towers and to string transmission lines. Checo had a representative inspect the area by helicopter before its tender was submitted. The representative noted that the right-of-way had been partially cleared, and also noted evidence of ongoing clearing activity. He assumed that there would be further clearing prior to the commencement of Checo's work.”

Hydro contracted out the clearing, which was not done properly; the failure to clear the right-of-way caused Checo extensive losses. Checo had to complete the clearing prior to fulfilling its contractual obligations, thus incurring a delay in its project.

The Supreme Court of Canada decided that Checo could sue Hydro on the tort of pure economic loss and recover not merely on a contractual basis, but on a tort basis. Checo recovered damages that were caused by the delay, losses that would not have been covered by contract. As the opinion stated:

“[If] a given wrong prima facie supports an action in contract and in tort, the party may sue in either or both, subject to any limit the parties themselves have placed on that right by their contract.

“This limitation on the general rule of concurrency arises because it is always open to parties to limit or waive the duties which the common law would impose on them for negligence. The mere fact that the parties have dealt with a matter expressly in their contract does not mean that they intended to exclude the right to sue in tort. It all depends on how they have dealt with it. In so far [sic] as the tort duty is not contradicted by the contract, it remains intact and may be sued upon.” (Emphasis added)

In summary, the doctrine of pure economic loss as distinct tort is a viable cause of action in Canada. As such, the U.S. Fourth Circuit's decision in Broussard (and many other U.S. decisions on similar fact patterns) is likely not good law in Canada.

Does It Matter to Franchisors?

Should the possibility of a Broussard-like liability worry franchisors expanding into Canada? Clearly, yes.

However, there are two differences that would lower the overall damage award. First, punitive awards in Canada are rare. As per the leading case on punitive damages, Whiten v. Pilot Insurance Co. , 2002 SCC 18 (CanLII), the Supreme Court of Canada stated:

“An award of punitive damages in a contract case, though rare, is obtainable. It requires an 'actionable wrong' in addition to the breach sued upon.

“Here, in addition to the contractual obligation to pay the claim, the respondent was under a distinct and separate obligation to deal with its policyholders in good faith. A breach of the contractual duty of good faith was thus independent of and in addition to the breach of contractual duty to pay the loss.

“The plaintiff specifically asked for punitive damages in her statement of claim and if the respondent was in any doubt about the facts giving rise to the claim, it ought to have applied for particular.”

Second, in Canada and all the provinces, there is no statutory basis or common law basis for trebling damages. But for most franchise systems, the prospect of even a $200 million award for negligent breach of contract would be enough to deter from expanding into Canada.

How Can the Franchisor Reduce Its Liability?

The most common solution, well-favored by franchisor attorneys, would be to treat the problem as a drafting problem: Simply follow the Supreme Court of Canada's
advice and draft out any tort liability. A number of franchise agreements already have this provision in their agreements.

Unfortunately, for those franchisors that wish to expand in Ontario, Manitoba, or arguably Alberta, the typical drafting solution will not to work. This is because of another major difference in franchising law between the countries, arising in those Canadian provinces that have adopted the U.S. style of disclosure laws. Briefly, the common law doctrine of good faith in the context of franchise agreements in the United States does not give rise to a separate head of obligations.

Yet, this is not true in Ontario, where the Arthur Wishart Act (Franchise Disclosure), 2000, S.O. 2000, c. 3, contains a statutory duty of good faith. Like many U.S. franchise laws, parties cannot contract out of their obligations under the Arthur Wishart Act. (Other provinces with franchise disclosure laws have similar provisions.):

Fair dealing

3.(1) Every franchise agreement imposes on each party a duty of fair dealing in its performance and enforcement. 2000, c. 3, s. 3 (1).

Right of action

(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. 2000, c. 3, s. 3 (2).

Interpretation

(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. 2000, c. 3, s. 3 (3).

The combination ' a statutory duty of good faith performance of a franchise contract that cannot be contracted out of and the possibility of concurrent liability under contract and tort ' gives rise to the possibility of liability and damages along the lines of Broussard. The overall solution cannot be found in better draftsmanship, and franchisors would be advised to adopt the solution that arose from the dust in the Broussard: create a viable, independent franchisee association that works collaboratively with the franchisor, with each party effectively maintaining a running watch on each other performance under the contract.

Michael Webster is a franchise attorney in Toronto, Canada. He can be contacted at 416-342-6144 or at [email protected].