Newfoundland and Labrador – Objections to litigation to be raised early (even if tentative) – #655

In 55668 Newfoundland and Labrador Limited v. Sullivan, 2022, NLSC 127, a franchisor-franchisee dispute arose between the parties. The Franchise Agreement contained an arbitration clause, however, the Plaintiffs proceeded by way of Statement of Claim. The Defendants did not take the position that the dispute was to be referred to arbitration in their original pleading, relying upon the Statement of Claim, which referred to conduct that occurred after the Franchise Agreement had been terminated. Later, the Plaintiffs corrected their pleading to provide that the impugned conduct occurred pre-termination. The parties disputed whether the arbitration clause terminated with the termination of the Franchise Agreement, and also whether the dispute fell within the scope of the arbitration clause. At trial, the Defendants argued that they had been prejudiced by the pleading amendment, which they asserted clearly gave them the right to arbitration. Justice Knickle held that, assuming the dispute fell within the terms of the arbitration clause, arbitration may have been the available option. However, the Defendants knew from the beginning of the litigation that the facts that were relevant to the dispute covered the period both before and after the termination; their failure to plead their right to arbitration in their Statement of Defence meant that they were out of time to object.

This case involved a franchisor-franchisee business relationship dispute. The Plaintiffs were the franchisee of the franchise known as Paul Davis Systems of St. John’s and related parties. The Defendants were the franchisor, Paul David Systems of Canada, and related parties. All the parties were in the business of offering restoration services.

The Franchise Agreement governed the business relationship between the parties. It permitted one of the Plaintiffs to operate under the trade name of “Paul Davis Systems of St. John’s” and to use the exclusive trademarks and trade secrets of Paul Davis Systems. It also established the requirements for royalty payments, which were due monthly. There were several other fees that were required either on a monthly or annual basis.

The Franchise Agreement gave the franchisor Paul Davis Systems of Canada the authority to terminate the franchise agreement, with or without an “option to cure” failures in adhering to the terms of the Agreement (clauses 17.1 and 17.2).

The Franchise Agreement also contained an arbitration clause that required disputes “relating to this Agreement or the … operation of the franchise” to be resolved by arbitration (clause 24.1):

“Any controversy or claim arising out of or relating to this Agreement or the acquisition or operation of the franchise, shall be settled by binding arbitration in accordance with arbitration procedures set forth in the Operations Manual. Any pending arbitration proceedings involving the Franchisee shall have no effect on [Paul Davis Systems of Canada’s] right to terminate this Agreement and such [sic] to terminate shall not be abrogated by the commencement of arbitration proceedings after termination has begun or has been concluded.”

The relationship between the parties deteriorated over time when one Defendant’s financial difficulties prevented the franchisee from making timely payments required under the Franchise Agreement and, on January 22, 2010, the franchisor changed the locks at the franchisee’s  premises. On January 26, 2010, the franchisor sent a letter to representatives of the franchisee advising that the Franchise Agreement was being terminated for breach under article 17.

The Plaintiffs brought two separate actions, which were tried together by Justice Knickle. They alleged that the Defendants had engaged in several torts: conspiracy, conversion of goods, and the tort of economic loss by unlawful means. They also claimed unjust enrichment and a breach of the duty of good faith against the franchisor Paul Davis Systems of Canada in one of the actions. Some of the Defendants counterclaimed for recovery of certain costs, and payment of fees.

At trial, the Defendant franchisor alleged the Defendants were prejudiced in their defence by a change of facts pleaded in an Amended Statement of Claim. The amendment, years after the original pleading, corrected the date that the locks were changed from February 5 (after the Franchise Agreement was terminated) to January 22 (before the Franchise Agreement was terminated. The franchisor argued that had they known that January 22 was the date the Plaintiffs  alleged that the locks were changed, and not February, they would have pleaded in their original Statement of Defence that any complaint about the franchisor’s conduct prior to January 26 (termination date) ought to have been addressed by way of arbitration under the Franchise Agreement. In other words, its position was that any claims arising out conduct that occurred during the term of the Agreement were to be resolved by way of arbitration; claims arising out of post-termination conduct were to be dealt with in the courts.

Justice Knickle rejected this argument and held that it was always known that the conduct relevant to the proceedings covered a time period that both pre-dated and post-dated the January 26, 2010, termination. Accordingly, the franchisor could always have asserted that any dispute between the parties arising from facts occurring pre-termination ought to have been arbitrated. Further, the Plaintiffs had always asserted that the entire dispute fell outside the scope of the arbitration clause. Justice Knickle found that nothing prevented the Defendants from asserting in their original Statement of Defence that the Plaintiffs’ complaints fell within it and should have been dealt with by arbitration.

Justice Knickle also noted that it was not clear whether it mattered when the conduct occurred that was the subject of the action. For example, in MDG Kingston Inc. v. MDG Computers Canada Inc. (“MDG”), 2008 ONCA 656, the arbitration clause of the franchise agreement explicitly referenced the continuing obligation of the parties to seek arbitration, even after the termination or rescission of the agreement.

While the arbitration clause in the Franchise Agreement was silent as to whether the requirement to arbitrate disputes survived the termination of the agreement, in MDG the court held that it was for the arbitrator to decide the issue as to whether or not an arbitrator retains jurisdiction over a dispute after the termination of an agreement. Therefore, regardless of when the locks were changed and assuming that the conduct gave rise to a dispute in the context of the Franchise Agreement, arbitration may have been an available option. Justice Knickel found, however, that since the Defendants chose not to plead that any complaint of the Plaintiffs ought to have been resolved by way of arbitration in their original Statement of Defence, even though it was open for them to do so, it was disingenuous of them to assert now that they were prejudiced by the Plaintiffs’ new assertion as to when the locks were changed.

In the result, Justice Knickle rendered a trial judgment on the merits, in which she allowed some of the claims advanced by the Plaintiffs and some of the Defendants’ claims advanced in the counterclaim.

Contributor’s Note:

This case highlights the importance that parties raise objections to proceeding to court instead of to arbitration early on in a proceeding – even if they are not certain of their right to arbitrate. Canadian courts have demonstrated they are willing to enforce valid arbitration clauses and hold parties to their bargain, but their unwillingness to entertain such arguments presented at the final hour without the objecting party having laid a proper foundation. Such objections should be made at the outside of the litigation and not at trial. Further, the court affirmed that arbitration applies in franchise disputes when the conduct that gave rise to the dispute was in the context of the franchise agreement.