Tokyo Smoke Franchisor Did Not Act in Bad Faith but Wrongfully Terminated Franchise

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By: Anthony Pugh
Editor: Ben Hanuka

In 2161907 Alberta Ltd. v. 11180673 Canada Inc., an August 30, 2021, decision of the Court of Appeal for Ontario in a franchise dispute involving a Tokyo Smoke cannabis store, the court upheld a lower court’s finding that the franchisor wrongly terminated the franchise agreement and sublease, but overturned the lower court’s finding that the franchisor acted in bad faith. 

 Key Facts 

 As part of the franchise deal, the parties had entered into three agreements.   

• Under the licence agreement, the franchisor, 216, agreed to pay to the franchisee, 111, a $2 million branding fee.   
• Under the loan agreement, the franchisor agreed to loan about $1.5 million in start-up costs to the franchisee. 
• Under the sublease, the franchisor and sublandlord, leased the premises to the franchisee and subtenant, for a monthly rent amount of $105,409.   

Before opening the store, the parties had a dispute about whether their loan agreement would cover rent for the first month, June 2020, which was a significant amount.  216’s principal later admitted that he was mistaken about the loan agreement not covering the June rent.   

The store was scheduled to open in June 2020.  The franchisee, 111, advised that it would not open the store if it did not receive the loan to cover June rent.  The franchisor, 216, told 111 that it would arrange to have the rent deferred and that it would pay the branding fee soon. 

216 later reversed its position and terminated the licence agreement with 111, alleging that 111 had threatened to cease carrying on business.  111 nevertheless continued on with the store opening.   

216 did not pay the branding fee and instead started an application seeking a declaration that it had validly terminated the licence agreement. 

111 did not pay June and July rent, and 216 later terminated the sublease. 

At first instance, the application judge ruled that 111 had not defaulted under the licence agreement and that 216 had breached the licence agreement by terminating it.  She held that 111’s statements about not opening the store were an “emotional response to being given incorrect information at a critical time”.   

The judge also found that 216 acted in bad faith by “pouncing” on 111’s statement as an excuse to terminate and avoid paying the branding fee.  She held that the branding fee was owing, subject to certain deductions for unpaid rent. 

The Court of Appeal held that 216’s notice of termination was invalid 

216 appealed to the Court of Appeal, arguing that the application judge erred in law by relying on 111’s subjective intent, and that, objectively, 111’s statements constituted a threat to cease carrying on business. 

The Court of Appeal disagreed and held that 216’s termination of the licence agreement was invalid.  It applied the decision in the Supreme Court case of Sattva, which held that the interpretation of commercial agreements was a question of mixed fact and law.  The Application Judge’s decision was therefore owed deference. 

The Court of Appeal held that the application judge implicitly adopted an interpretation of the contract under which the threat to cease carry on business had to be objectively credible.  It held that this interpretation was reasonable.  It also held that the application judge was not simply relying on subjective intent – in the context of the communications, her assessment was also an objective one.  

The Court of Appeal set aside the finding of bad faith 

The Court of Appeal overturned the Application judge’s finding that 216, the franchisor, acted in bad faith. 

111, the franchisee, alleged that 216 knowingly mislead it.  But the evidence was that 216 was mistaken about the various issues, such as whether the loan agreement covered the June rent.  It was not trying to intentionally mislead 111 and, therefore, did not act in bad faith. 

About the allegation that 216 pounced on a statement by 111, the Court of Appeal held that this did not constitute bad faith conduct.  The fact that the basis for termination was invalid did not necessarily mean that the termination was so unreasonable, malicious or inconsiderate as to constitute bad faith.  There was also no indication that 216 intentionally engineered the circumstances giving rise to a potential right of termination.   

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