Pizza Franchisee Unable to Slice Up Its Franchise Agreement!

Introduction

Most franchise agreements specifically: (i) grant the franchisee the right to operate a business from a single location; and (ii) state that the franchise agreement’s term expires either at a specified date or when the franchisee ceases to have the right to operate the franchised business from the premises, using wording along the following lines: 

“Subject to the provisions of this Agreement, the Franchisor hereby grants to the Franchisee the right and license to operate the Franchised Business at the location specified in Schedule “A” … for a term (the “Term”) equal to the lesser of: 

1. ten (10) years; and
2. the term of the Lease as may be the case, and any renewals thereunder;” 

The decision of the Saskatchewan King’s Bench in Vern’s Pizza Company Limited v 101011333 Saskatchewan Ltd,[1] involved the court determining when a franchise agreement which granted the franchisee a right to operate two franchised businesses from two separate leased locations, comes to an end. 

Background Facts

Vern’s Pizza Company Limited (the “Franchisor”) executed a single franchise agreement dated October 31, 2000, (the “Franchise Agreement”) with 101011333 Saskatchewan Ltd. (the “Franchisee”) for the operation of two Vern’s Pizza locations (the “8^th St. Location” and the “Central Location”) in Saskatoon, Saskatchewan.  The leases were entered directly between the Franchisee and the landlord of each location. The Franchise Agreement stated that the term (the “Term”) continued: 

“…for so long as the Franchisee shall have a good and valid Lease of the premises civically designated as [address of the premises to be used as the restaurant], or in the event that the Franchisee shall purchase the subject premises, for so long as the Franchisee shall carry on the business of a licensed restaurant on the premises, and for so long as the Franchisee shall fully and faithfully perform all of the covenants, terms and conditions herein contained.” 

Theoretically, the Franchise Agreement could have continued indefinitely.  However, on August 31, 2016, the lease for the 8^th St. Location ended.  Regrettably no reference to either the 8^th St. Location or the Central Location was included in the section of the Franchise Agreement dealing with the Term. The question was whether the Franchise Agreement continued even if one of the leases had ended.  

On October 19, 2016, the Franchisor gave written notice that the Franchise Agreement had ended due to the termination of the lease at the 8^th St. Location and, on December 27, 2016, requested the Franchisee stop operating the Central Location. The Franchisee, however, continued: (a) operating the Central Ave Location; and (b) remitting to the Franchisor the royalties required by the Franchise Agreement which the Franchisor accepted.  The Franchisor did not notify the Franchisee prior to end of the lease for the 8^th St. Location that the termination of the lease would also result in the termination of the Franchise Agreement.

The Franchisor commenced a summary judgment motion seeking the following remedies: 

1. An order confirming that the Franchise Agreement ended on August 31, 2016. 

2. A declaration that the Franchisee is wrongfully carrying on business, passing itself off as, and using the Franchisor’s franchise system and trademarks without the lawful right to do so. 

3. A permanent injunction requiring the Franchisee to cease and permanently refrain from carrying on business as a Vern’s Pizza’s franchisee. 

4. Judgment against the Franchisee for all net income earned by it after August 31, 2016.

The Franchisor’s Position 

The Franchisor’s position was that: 

1. The Term ended when the leases for one or both locations ended because the parties intended for a single franchise agreement that contemplated both locations. 
2. The term ‘restaurant’, though undefined in the clause describing the Term, was defined in other sections as inclusive of both locations. Therefore, any alternative would be illogical. 
3. By continuing to operate beyond the Term the Franchisee passed itself off as a Vern’s Pizza restaurant and violated the Franchisor’s trademarks with respect to the Trademarks Act and the Franchise Agreement. 
4. As a result of such passing off, the Franchisor ought to receive an accounting of profits or further damages because it lost the opportunity to replace the franchisee. 

The Franchisee’s Position 

The Franchisee asserted that: 

1. the parties intended that the 8^th Location and the Central Location operate as separate businesses even though the grant was contained in a single franchise agreement. This would allow one location to continue despite the fact that the second location had ceased operating.  
2. The parties’ intended separate franchise agreements, despite the fact only one agreement was executed, because the text in the Franchise Agreement was singular, i.e. referencing ‘restaurant’ instead of ‘restaurants.’ 
3. The ambiguity in the Term gave rise to a duty of honest performance that required the Franchisor to give notice that the Franchise Agreement would end if a lease ended; no notice was given. 
4. The Franchisor suffered no actual damages because royalties continued to be paid.

The Decision: 

The Court decided in favor of the Franchisor stating that the Franchise Agreement came to an end on October 31, 2016, and granting the Franchisor a permanent injunction refraining the Franchisee from carrying on a Vern’s Pizza franchise at the Central Location.  The court, by reading the Franchise Agreement as a whole, in its ordinary and grammatical sense, consistent with the surrounding circumstances, concluded that the parties had contemplated both locations stating that: 

1. The ordinary meaning of the ambiguous phrase “[address of the premises to be used as the restaurant]” i.e. not properly completed, within the Term included both locations because the term “restaurant” was defined elsewhere in the contract to include both locations. 

2. Other provisions of the Franchise Agreement referred to both 

3. The surrounding circumstances supported that the parties’ intention was for the Franchisee to operate both locations since the parties would otherwise have added specific wording or executed separate contracts if the intent was for the Franchisee to operate the two locations as separate franchises. 

The Court rejected the Franchisee’s assertions about the duty of honest performance, deciding instead that the Franchisor did not owe a duty to warn the Franchisee, stating that: 

1. The duty of honest performance requires that the Franchisor not actively mislead; intentional silence can be considered misleading but there was insufficient evidence to infer intentional silence by the Franchisor or that the Franchisor actively misled the Franchisee. 

2. The duty of honest performance does not impose a fiduciary duty or a duty of loyalty; mere silence by the Franchisor will not breach the duty of honest performance. 

Though the Franchisee’s continued franchise operation at the Central Ave Location breached both the Franchise Agreement and the Trademarks Act., the court concluded that such conduct did not constitute passing off.  The court held that the Franchisor did not suffer actual damages since the Franchisee continued to pay the royalties contemplated by the Franchise Agreement. No damages were awarded for the same reason.[2] 

Conclusion and Key Practice Tips 

Though this decision is largely unique to its own circumstances, it still contains several takeaways.  Firstly, as is always the case, careful drafting could have avoided any ambiguity.  Secondly, the duty of honest performance does not require one party to a contract to warn the other of its expiry, but this is not true of all situations. The duty may, for example, require parties to correct any misconceptions that the party is aware of. The court did, after all, note that if the Franchisor had known of the Franchisee’s mistaken understanding of the Term, remaining silent would have breached the duty of honest performance.

[1] Vern’s Pizza Company Limited v 101011333 Saskatchewan Ltd, 2024 SKKB 147.

[2] The Court also refused to award an accounting of profits or further damages because there were none. The evidence showed that the Franchisor had no intention of opening a replacement corporate store and there was no evidence on the cost to finding a new franchisee.