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How franchisor system changes led to dismissal of injunction application, part two

Friday, June 11, 2021 @ 8:51 AM | By Ben Hanuka


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Ben Hanuka
This is the second article that analyzes the recent franchise decision in Greco Franchising Inc. v. Milito 2021 ONSC 3950, involving an interlocutory injunction application by a fitness studio franchisor, Greco Franchising (Greco), against an Ottawa-based franchisee, 2483425 Ontario Inc. (248), which the court ultimately dismissed in the franchisee’s favour.

As we discussed in the first article, the court found that Greco did not meet the strong prima facie case test. The court found that, on the one hand, it was clear that 248 was, strictly speaking, in violation of the non-compete covenant in the franchise agreement. On the other hand, the court also found that 248 had demonstrated a serious issue about whether Greco fundamentally breached the franchise agreement. The franchisee argued that Greco had fundamentally undermined the franchise agreement by directly marketing to 248’s members, financially restructuring the system and making major changes to 248’s role and restricting its opportunity to earn revenue through in-studio activities.

It is also noteworthy that, throughout this ordeal, 248 had ongoing and apparently intense communications with Greco and did not take steps without informing the franchise; in fact 248 had prolonged communications about its objections to the changes in the system.

Since 248 was able to show a serious issue about whether Greco had fundamentally breached the franchise agreement, it necessarily meant that Greco did not show a strong prima facie case in support of its position. In other words, the two are mutually exclusive — if a respondent demonstrates a serious issue in support of its case, an applicant cannot at the same time meet the strong prima facie case threshold.

Balance of convenience did not favour granting injunction 

On the irreparable harm and balance of convenience legs of the test, the court found that any damage to Greco’s goodwill, reputation and membership allegiance as a result of 248’s independent operation may be compensated in damages. Competition had already started, and based on the evidence from the parties’ negotiations, Greco was prepared to accept appropriate financial and de-branding arrangements to allow 248 to operate an independent fitness studio. For the court, these factors were not consistent with alleged irreparable harm to Greco.

In addition, granting an injunction would put 248 out of business, since there was little chance that it would rejoin the franchise system. Incidentally, this would have also reduced the ability of Greco to collect any damages from 248. The court also considered the interests of the 21 employees of 248 and the 190 members who joined the new fitness studio, who would suffer harm if the gym were to close.

There was also a side issue about 248’s new name, “TG Athletics.” “TG” stood for Tony Greco, who was a founder of the Greco fitness system. Greco Franchising alleged that the name was confusing with its franchise system for this reason. The court tended to agree with this, however it noted that Greco had contractual permission from the franchise to grant rights to the TG name and that it was possible that 248 was using the name legitimately. The franchise did not provide details of its contractual arrangements with Greco, and the court appeared to make a negative inference against Greco on this issue.

Changes to business model, impact on franchisee

In essence, the franchisor overhauled the business model and financial structure of the franchise by taking over the fitness classes, marketing, member payments and financial compensation. These changes were contrary to the franchise agreement and were significantly different from the original franchise model. Essentially, 248’s remaining role appeared to merely allow members to sign up for programs. It was thus effectively precluded from competing with the franchisor.

It was an important finding for the court that this may have very well amounted to fundamental changes to the franchise system (the ultimate finding on this issue is of course for the trial judge down the road, if it comes to that).

Further, Greco conceived of its new online program before the start of the pandemic. It therefore cannot be characterized as purely a response to the pandemic. If the system changes were necessary because of the pandemic, the evidence in the decision does not show why Greco wanted to make them permanent.

The decision does not indicate that there was any evidence that Greco consulted with or involved any other franchisees in this process, or if it did, to what extent it may have done so (unlike other cases about system changes, such as Fairview Donut Inc. v. The TDL Group 2012 ONSC 1252). Certainly, this particular franchisee was strongly opposed to it from the outset.

There is a mutual duty of good faith and fair dealing on parties to a franchise agreement both at common law and under the provincial franchise legislation in Canadian provinces. Given the far-reaching implications of the fundamental changes and their permanent nature, the good faith and fair dealings duty likely imposed on Greco an obligation to show that it had consulted with 248 and other franchisees in a meaningful and genuine way.

This duty probably also requires a franchisor in these circumstances to show some commercially reasonable grounds for imposing these fundamental changes as a result of the pandemic, including all the restrictions and exclusions that the franchisor sought to impose on the franchisees.

In the overall analysis, this decision appears to correctly imply that serious, fundamental and permanent changes to a franchise system can be meaningfully challenged by an affected franchisee if the impact on him or her is not fair, contravenes the contractual terms and does not meet the good faith and fair dealing standards of commercial reasonableness.

This is the second of a two-part series. Read the first article: How franchisor system changes led to dismissal of injunction application, part one.

Ben Hanuka is a member of the Ontario and British Columbia bars and practises in the areas of commercial and franchise litigation and arbitration. He is principal of Law Works®P.C. (in Ontario) and Law Works®L.C. (in British Columbia). He is a fellow of the Chartered Institute of Arbitrators.

Photo credit / KCHANDE ISTOCKPHOTO.COM

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