"Time" to Pay Your Debts: Ontario Courts Weigh In on the Obligation to Pay Royalties in a Post-Expiry Overholding Period

In Coffee Time Donuts v. 2197938 Ontario Inc. (“Coffee Time”)[1],  the franchisor, Coffee Time, sought summary judgment for a claim for unpaid royalties and advertising fees from its franchisee in respect of a period from February 2016 to January 25, 2021. The franchisee resisted the claim by arguing that it was statute-barred under the Ontario Limitations Act, 2002, and insisting that the claim was unsuitable for summary judgment.

The history of the parties’ franchise relationship detailed a transition from a standard contractual relationship to an overholding scenario. Initially, the parties entered into a franchise agreement in 2009. The agreement expired on July 31, 2014 without a renewal provision. However, the franchisee continued operating and paying royalties as if the agreement was still in force. The franchisee stopped making payments on February 16, 2016 but continued to use the “Coffee Time” name and to secure goods from the system’s suppliers. The business relationship between the parties finally ended by consent several years later, on January 25, 2021. The plaintiff franchisor brought its claim on August 9, 2019, seeking unpaid royalties and advertising fees until the date of trial.

Justice Dow of the Ontario Superior Court of Justice had little regard for the franchisee’s argument that this action was not suitable for summary judgment. The Court was willing to determine whether the terms of the franchise agreement superseded its expiry in July 2014, and relied on the principles set out by the Ontario Court of Appeal in Ventas Inc. v. Sunrise Senior Living Real Estate Investment Trust, whereby commercial contracts are to be:

a)   given meaning in a manner that considers the agreement as a whole and avoids rendering one or more terms ineffective;

b)  determined in accordance with the intention of the parties and the language used;

c)  determined in a manner giving preference to the objective evidence over any subjective intentions, particularly where there is an ambiguity; and

d)  enforced in accord with good business sense to avoid a commercial absurdity.[2]

The Court noted that the franchisee had not cross-examined the franchisor’s representative on its affidavit evidence and had only tendered its own evidence that the franchisee had made its payments until February 2016 “out of courtesy.” The court flatly noted that this assertion “flies in the face of commercial realities” and proceeded to determine whether there was a genuine issue for trial in accordance with the summary judgment test set out by the Supreme Court of Canada in Hryniak v. Mauldin.[3] 

The Court found the terms of the expired franchise agreement remained operable until January 25, 2021 “on the basis the entirety of the agreement was being followed by the parties for almost 19 months following its expiry.” As alluded to above, the Court rejected the argument that the franchisee’s payment of royalties from the termination of the agreement (July 2014) until it stopped paying (February 2016) was a courtesy payment and not the fulfilment of a contractual obligation.

With that finding made, the Court then turned its attention to determining whether some of the franchisor’s claims were statute-barred. The Court interpreted the expired (but applicable) franchise agreement as giving rise to a cause of action when the franchisee failed to pay when due any monies required to be paid. The Court held that the franchisor’s claims for unpaid royalties for any period prior to two years before the Statement of Claim was issued were discoverable and therefore statute-barred under the Limitations Act, 2002.

Justice Dow ultimately held that the franchisor was entitled to summary judgment of the amounts billed from August 9, 2017 (two years before the claim was brought) to January 25, 2021. The Court also awarded interest on this amount at the steep rate of 24% per year (or 2% per month), as required under the expired franchise agreement.

The franchisee appealed this decision to Ontario Court of Appeal but the appeal was wholly unsuccessful.[4] The Court of Appeal upheld Justice Dow’s finding that the franchise agreement was continued by the conduct of both parties after the term of the written agreement expired, and highlighted that the conduct included continued purchases from exclusive suppliers, continued use of the system’s “Coffee Time” branding, and some limited royalty payments. The Court further upheld the calculation of damages based on the evidence submitted by the parties.

The takeaway from the decisions in Coffee Time is two-fold:

• The Court helpfully acknowledged that the terms of an expired franchise agreement may continue to govern if the parties continue to operate under the terms of that agreement in an “overholding” scenario, particularly where those terms involve the payment of funds owed;
• However, if the franchisor is seeking to act in respect of royalties that have accrued during the de facto overholding period, the franchisor must do so promptly in accordance with applicable limitation periods.

Overholding scenarios unfortunately arise in franchising as there are times where the parties continue to operate in the “no man’s land” of contract expiry or termination. The decisions in Coffee Time provides appellate-level assurance that if the parties continue to operate in a fashion whereby they continue to follow the substantive terms of the agreement, the concomitant obligation to pay royalties should continue.

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