Mr. Submarine Ltd. v. Sowdaey

Between
Mr. Submarine Limited, plaintiff, and
Behzad (Ben) Sowdaey, Molouk Karimzad and 1297300 Ontario
Inc., defendants

2002] O.J. No. 4401
Court File No. 00-CV-200769

Ontario Superior Court of Justice
Hoy J.

Heard: October 29-31 and November 1, 2002.
Judgment: November 18, 2002.
(69 paras.)

   Statutes, Regulations and Rules Cited:

Counsel:

1      HOY J.:— Mr. Submarine Limited, a franchisor, ("Mr. Sub") sues its franchisee, 1297300 Ontario Inc. ("129"), and its guarantor, Mr. Sowdaey, for damages for breach of the franchise agreement.  129 has ceased to operate the store in question and Mr. Sub no longer seeks the injunctive relief requested in its statement of claim.  Mr. Sub discontinued this action against Ms. Karimzad.  129 and Mr. Sowdaey claim damages against Mr. Sub on the grounds that Mr. Sub improperly terminated the franchise agreement and breached its duty to deal fairly with 129.

2      The issues are before me are the following:

THE FACTS

3      Mr. Sub is a national franchisor of fast food submarine sandwich shops with approximately 600 locations throughout Canada, about 450 of which are located in the greater Toronto area.  Mr. Sowdaey was trained as an engineer in his native Iran.  After 14 years of working in various jobs in Canada, he investigated acquiring a Mr. Sub franchise.  He had no experience in the food business.

4      Mr. Sowdaey determined that he wanted to buy an existing franchise on a resale basis, rather than acquire a new franchise from Mr. Sub.  By agreement dated March 12, 1998, Mr. Sowdaey, in trust for 129, agreed to purchase the assets of the existing Mr. Sub franchisee in Scarborough known as Store 258, which had been in operation for 16 years, for the price of $115,000.  Mr. Sowdaey negotiated directly with the existing franchisee, whom I refer to as the "vendor".  The purchased assets consisted of chattels, fixtures, machinery, equipment, the lease and tenant improvements, goodwill and the trade name, "as per Franchise agreement."  The purchase price was not allocated among the various assets.  The purchase and sale agreement was conditional upon Mr. Sowdaey being approved by Mr. Sub as a franchisee.

5      On July 20, 1998, Mr. Stephen Levinson, Mr. Sub's lawyer, sent letters to the lawyers for the vendor and Mr. Sowdaey, setting out the requirements of Mr. Sub in connection with the proposed transaction.  Mr. Levinson was an in-house lawyer with Mr. Sub for the first eight years of his career. He went into private practice in 1993 and since that time Mr. Sub has been his main client.

6      The franchise agreement required that a transfer fee be paid to Mr. Sub in an amount equal to 50% of the then current franchise fee to defray Mr. Sub's costs in connection with the transfer, including additional supervision and training, before consent to assignment would be granted.  Mr. Levinson's letters advised that unless the vendor and Mr. Sowdaey had contracted otherwise in their offer, it was the vendor's responsibility to pay a $5,350 transfer fee to Mr. Sub on closing.  In fact, Mr. Sowdaey and the vendor signed an amendment to the purchase and sale agreement pursuant to which Mr. Sowdaey agreed to pay the first $5000 of this transfer fee.  Mr. Levinson was aware of this arrangement, but Mr. Sowdaey failed to pass a copy of this amendment on to his own lawyer.

7      Another condition precedent to Mr. Sub's approval was that Mr. Sowdaey complete Mr. Sub's training program.  Mr. Levinson's letter was clear that Mr. Sub would determine whether Mr. Sowdaey was an approved purchaser only after he completed his training.  Mr. Sowdaey underwent three weeks training:  two weeks in a downtown training school and one week in a corporate owned store.  The vendor also provided an additional week of training following closing pursuant to the agreement of purchase and sale.

8      Mr. Sub also considered whether Mr. Sowdaey had adequate financing.  Based on whatever information was provided, it concluded he did.  Unfortunately, he did not. His total acquisition costs, including the purchase price payable to the vendor, legal fees, first and last months rent and utility deposits, but excluding the transfer fee, were approximately $140,000.  He used his total life savings of about $33,000; he borrowed $100,000 from his bankers:  and he borrowed the balance from his family.  The overdraft protection on his chequing account was his only working capital.  He admitted that he was told that he should expect losses in the first couple of years.

9      Mr. Sowdaey and his aunt, Ms. Karimzad, signed a franchise agreement with Mr. Sub (the "Franchise Agreement") and an assignment and guarantee agreement pursuant to which they assigned their interest in the Franchise Agreement to 129 and agreed to guarantee the performance by 129 of its obligations under the Franchise Agreement.  Key provisions of the Franchise Agreement are excerpted in Appendix "A" to these reasons. [Quicklaw note:  Appendix A was not attached to the copy received by Quicklaw and therefore is not included in the judgment.]  Both documents were executed "as of" July 20, 1998.  There was no evidence as to their actual date of execution.  129 also signed a ten-year lease with the landlord of the shopping plaza in which Store 258 was located.

10      Mr. Levinson wrote to the lawyers for the vendor and Mr. Sowdaey, asking for 48 hours' notice of the closing so that his client could attend.  The transaction closed on September 15, 1998, without notice to Mr. Levinson, without Mr. Sub's written consent and without payment of the transfer fee to Mr. Sub.  Mr. Sowdaey began operating Store 258 on September 15, 1998.  Mr. Sub demanded that Mr. Sowdaey and or 129 pay the transfer fee, and advised that if not paid by certified cheque within 7 days, consent to the purported re-sale would not be granted and the store would have to be de-identified as a Mr. Sub facility.  Mr. Sowdaey had different explanations as to why the fee had not been paid. First, he said that his deal with the vendor had changed and that it was the vendor's responsibility, not his.  Then he admitted that he had agreed with the vendor to pay the fee and said that his lawyer had paid the fee to Mr. Sub out of the closing proceeds.  He said that Mr. Sub would not have let him go to training if the fee had not been paid, yet training occurred before closing, when he says the fee was paid.  There is no evidence of payment.  I concluded that Mr. Sowdaey knew that it was his responsibility and hoped to avoid or delay payment because he did not have the money to pay.  This was the first of many problems that arose because Mr. Sowdaey was under-capitalized.  His changing testimony with respect to the transfer fee adversely affected his credibility and was only one of several instances of inconsistent testimony.  Mr. Sub ultimately allowed Mr. Sowdaey to pay the fee in instalments, over five weeks.

11      Mr. Sub employs what it refers to as "BDCs" or Business Development Consultants.  Responsibilities of a BDC include supervising the operation of stores within the BDC's assigned territory, renegotiating new franchise contracts and renewals, selecting sites, local store marketing and generally overseeing the franchisee's business and helping the franchisee grow its business.

12      Mr. Brian Breslin joined Mr. Sub as a BDC in April of 1998.  Between approximately November 1998 and September of 1999, he was responsible for Store 258.  Mr. Breslin had some 24 years experience in the food business with a number of companies and experience as an owner and operator of his own deli cafes.  By the time of this proceeding, he was no longer an employee of Mr. Sub.  He was a disinterested witness, his testimony was consistent and I found him to be credible.  I have accepted his testimony over that of Mr. Sowdaey's.

13      As a BDC, Mr. Breslin attempted to visit each of the some 60 locations within his territory at least once every four to six weeks.  He focused his attention on the poorer operations, visiting them more frequently.  He quickly identified Store 258 as one of the poorer operations.  None of the other franchisees had the number of problems that Store 258 did.

14      His first visit to Store 258 was on November 16, 1998.  He reviewed the standard list of questions that he customarily reviewed with new franchisees.  He subsequently made further visits on November 16, November 23 and November 25, 1998.  He telephoned Mr. Sowdaey on November 28 to provide advice on an operational matter.  He made subsequent visits on December 15 and December 29, for a total of six, rather than the customary one, visits in a roughly six-week period.  Due to a change in Mr. Sub's information technology systems made at the end of December 1998, precise dates of Mr. Breslin's visits after December 29, 1998 are not available.  Mr. Breslin testified that he continued to make more frequent visits to Store 258 than was customary after December 29, 1998.

15      On February 11, 1999, after conducting a site visit, Mr. Breslin delivered a letter to Mr. Sowdaey.  The letter stressed the importance of complying with the mandatory requirements for every Mr. Sub store and asked him to comply in full with these requirements.  Some of the deficiencies listed included the following:

16      The memo required Mr. Sowdaey to purchase a number of items to be in compliance, including a second soup unit, amber pans and lids, a new toilet seat, the clock, uniforms, a Wet Floor sign, brochures promoting Mr. Sub franchises and three framed food posters.  All of these items, with the exception of the toilet seat, were to be purchased from Mr. Subs' authorized supplier, Neate Roller.  Mr. Sowdaey knew that Articles 7.03, 7.04 and 7.06 of the Franchise Agreement, excerpted in Appendix "A" to these reasons, required that he only sell products approved by Mr. Sub and that all such products were to be purchased from Mr. Sub's approved supplier.  Mr. Sub had also provided Mr. Sowdaey with a detailed operational manual and provided him with modifications and updates on a regular basis throughout the term of the relationship.

17      With respect to the staff not wearing uniforms, Mr. Breslin testified that on each of his visits to Store 258 staff were either not fully in uniform or were not wearing the uniform at all, instead wearing jeans and tee-shirts with unauthorized logos.  Mr. Sowdaey knew that the Franchise Agreement required 129 to comply with Mr. Sub's specifications and standards with respect to uniforms.

18      By April 20, 1999, none of the key deficiencies outlined in the February 11, 1999 letter had been addressed. Mr. Breslin delivered a further letter to Mr. Sowdaey, dated April 20, 1999, stressing his need to comply with Mr. Sub's operational requirements and pointing out that he was in arrears of his financial obligations under the Franchise Agreement and had failed to properly complete the required weekly sales reports.  He also noted that Mr. Sowdaey attempted to stop him from carrying out an evaluation of the restaurant on April 15, 1999.  Mr. Sowdaey was requested to be in full compliance by May 20, 1999.

19      Mr. Breslin received customer complaints in respect of Store 258 at a rate of about three a month, which was significantly more than the five complaints per year that most stores averaged.  At least five of the complaints merited written responses.

20      On September 2, 1999, Mr. Breslin issued a further letter to Mr. Sowdaey.  He reiterated many of the same operational deficiencies first identified in the February 11, 1999 letter, including the absence of uniforms and the failure to comply with food safety procedures.  In the case of the uniforms, he noted that, "hats are not being worn, old aprons are still being worn, staff wear blue jeans, toeless sandals with bare feet and unauthorized tee-shirts."  He noted that wine and empty beer bottles were seen at the premises and that 129 did not have a liquor licence.  He required that the salad dressings that were more than one year beyond their expiry date and therefore posed a health risk to customers be removed from the premises.

21      In this memo, Mr. Breslin notified Mr. Sowdaey that he was in default under Article 7.03 of the Franchise Agreement and that the memo should be taken as an official notice under Article 20.01 of the Franchise Agreement.  The relevant portions of Articles 7.03 and 20.01 are set out in Appendix "A" to these reasons.  He advised Mr. Sowdaey that he was to be in full compliance by September 9, 1999.

22      As is the case with most franchisors, Mr. Sub employed what are called "mystery shoppers".  An individual, posing as a customer, attends on a site, customarily checks the washroom, buys and consumes the product, makes a visual assessment of the customer area of the premises, completes an assessment form and remits it to the franchisor.  Mystery shoppers are typically part-time employees with little or no experience in the food business.  In this proceeding, four reports of mystery shoppers form part of the evidence:  a first report dated June 19, 1999 which awards a score of 73%; a second report dated August 12, 1999 which awards a score of 88%; a third report dated August 25, 1999, which awards a score of 87%; and a final report dated October 27, 1999, which awards a score of 95% and is discussed further below.  Mr. Breslin testified that typically a score over 85% is acceptable to a franchisor.  Accordingly, the June 19, 1999 report would not have been acceptable to Mr. Sub.  The first three reports indicated that not all sales were being recorded by the person operating the cash desk.  In two instances, the sales person in question was indicated as being a female, and therefore was clearly not Mr. Sowdaey.  While the third instance involved a male and occurred over the lunch period when Mr. Sowdaey was typically in the store, Mr. Sowdaey says it was not him.  There is no evidence to contradict Mr. Sowdaey, and I have assumed all three instances were instances of employee theft.  Mr. Sowdaey testified that he terminated the responsible employees upon becoming aware of the theft.

23      By letter dated September 1, 1999, Mr. Levinson requested Mr. Sowdaey to attend at Mr. Sub's office on September 9, 1999 to discuss the results of the mystery shopper program.  Mr. Sowdaey and several other franchisees attended the September 9 meeting.  Mr. Levinson was present as a "notetaker".  This was the first time that Mr. Sowdaey was presented with the results of the mystery shopper program.  On September 14, 1999, Mr. Levinson wrote Mr. Sowdaey to confirm what transpired at the meeting.  Mr. Levinson wrote, "You may recall that during that meeting, many topics were discussed including operational deficiencies such as hand washing, customer complaints, customer service, and system compliance issues, and most importantly cash infractions, particularly the apparent failure to ring into the cash register certain sales as disclosed by the mystery shopper program."  Mr. Levinson warned that Mr. Sowdaey's continued and admitted use of unauthorized brands of products must cease immediately. Mr. Sowdaey was required to send in cash register tapes for the last three months.  Mr. Sowdaey was warned in the letter that the operational and cash infractions gave Mr. Sub the right to immediately terminate the Franchise Agreement, but that Mr. Sub would give him one last chance to rectify the problems.  The letter concluded, "Please be advised that should you not comply with the requirements as set out in this letter, or if you fail to adhere to the operations standards of Mr. Submarine Limited, or if the mystery shopper program uncovers further evidence of operational deficiencies and/or misrepresentation of sales, Mr. Submarine Limited shall not hesitate to terminate your Franchise Agreement without affording you any opportunity to cure the defaults."

24      By September of 1999, Mr. Sowdaey was still having difficulty covering his operating expenses.  Mr. Sub's authorized supplier, Neate Roller, would only deal with him on a COD basis.  Mr. Sowdaey admits he was undercapitalized. Neate Roller only delivered weekly.  Because he was on a COD basis, he could not order enough products to last an entire week.  He survived by buying product from Costco and Bridlewood Price Chopper, unauthorized suppliers.  Moreover, his view was that he should be able to buy from whomever he wanted, as long as it was the same product; it did not make sense that he should have to buy product from Neate Roller if he could buy it more cheaply somewhere else.  On cross-examination, Mr. Sowdaey admitted that he knew before completing the transaction that he was required to buy all products from the authorized supplier.

25      Mr. Sowdaey advised that Aberfoyle mineral water could be purchased at Costco at one-third the price that Mr. Sub branded Aberfoyle water could be purchased from Neate Roller.  Mr. Tilley explained this price discrepancy by saying that mineral water is a loss leader item for Costco.  Mr. Breslin conceded that for this reason a number of franchisees purchased their mineral water from sources other than Neate Roller.  Mr. Sowdaey says that the soup unit that he needed to be able to sell a second kind of soup cost $2000 from Neate Roller and was available from the manufacturer for $800.  He says he sold products such as small fruit juices and Lipton Brisk tea, that were not authorized products, because they sold well.  He explained the alcohol bottles on the premises as empties following a social gathering held in the store after hours.  Mr. Sowdaey had an excuse or an explanation for virtually every instance of the repeat non-compliance detailed.  He described Mr. Breslin as a "nit picker" who was just trying to push him to buy equipment.

26      The final mystery shopper report dated October 27, 1999 awarded a score of 95%.  It was delivered under cover of a letter from the Vice-President Operations and Procurement of Mr. Sub indicating that, "... the overall score of this visit is 95%.  This is considered to be an excellent result." When questioned with respect to the degree of improvement suggested by this report, Mr. Breslin noted that the report indicates that the shopper spent a total of four minutes on the premises and that the washroom was not visited.  He indicates that a four-minute visit is not adequate time to assess an operation.

27      On January 17, 2000, Mr. Levinson was instructed to send a regrettable letter to Mr. Sowdaey.  It advised that based on Mr. Sub's investigations, and extrapolating from the items not keyed into the cash register as noted on the mystery shopper visits, Mr. Sub had determined that 129 owed it $15,000 in royalty and advertising arrears on unreported sales.  Mr. Sub demanded payment within 14 days, failing which it would consider exercising its rights and remedies under the Franchise Agreement.  The value of the unreported sales on the three mystery shopper reports was about $10; there would have had to have been about $180,000 in unreported sales for royalty and advertising payments totalling $15,000 to have been due.  The level of reported sales appeared to have declined once 129 began operating Store 258; however, Mr. Sub did not lead any evidence as to the nature of the investigations that led it to demand a $15,000 payment from 129.

28      Mr. Sowdaey says that after receiving this letter, he spoke to Mr. Harding of Mr. Sub, who told him not to worry about it, that Mr. Harding was "working on it".

29      By letter dated March 3, 2000, Mr. Levinson advised that if a formal response to his January 17, 2000 letter was not received by March 10, 2000, Mr. Sub would have no alternative but to order the cessation of delivery of products to Store 258 and/or terminate the franchise.  Mr. Sowdaey was urged to engage the services of a lawyer.

30      In response, Mr. Sowdaey faxed back a copy of the letter to Mr. Levinson on which he had written, "We are waiting for response from Mr. Wayne Harding of Mr. Sub.  It is clear you have no idea what is going on.  So please don't waste our time."  Mr. Levinson sent a copy of Mr. Sowdaey's response to Mr. Harding, asking for comments.

31      In March of 2000, Tracey Crumb, who had replaced Mr. Breslin as the BDC responsible for Store 258, called in the Field Training Manager for the area, Mr. Herbert Dekerf. Mr. Dekerf had about 20 years' experience in the hospitality and food businesses, including as a franchisee.  As a Field Training Manager, his job was to attend at a franchisee's operation and provide additional training, or coaching, when requested to so by a BDC.  On March 30, 2000 he spent about 5 hours at Store 258.  On April 10, he issued a memo to Mr. Sowdaey and Mr. Crumb with respect to his March 30 visit.  It outlined the points talked about during the meeting.  These included that food items were put directly into steamwells from the coolers without preheating.  Mr. Dekerf highlighted that this was a food safety issue and that all food items needed to be preheated to 160% Fahrenheit before being put into the steamwells.  He noted that the standard Mr. Sub uniform was not being worn.  In his testimony, he clarified that staff were wearing jeans.  Cookies were baked the previous day and were not fresh.  Particularly important was that food safety was not being properly practised. Thermometers, temperature logs and hand washing procedures were not being properly utilized.  This was Mr. Dekerf's only visit to the store.  He indicated that it was not unusual to make only one visit to a store:  a BDC might elect to deal with problems himself rather than asking the Field Training Manager to re-attend.

32      In August of 2000, Mark Tilley became the Regional Director of Operations for Mr. Sub for a broad geographical region which included Store 258.  He had about 10 years experience in the food business, including as a franchisee with a competitor, Mr. Subway.  As a Regional Director, he oversaw BDCs in his region.  On becoming Regional Director, he reviewed the files relating to Store 258.

33      On August 16, 2000, Mr. Levinson sent another formal demand for payment to Store 258.  This time, Mr. Sub demanded that a total of $1,984.46 be paid by certified cheque by August 23, 2000, failing which Mr. Sub would be in a position to exercise its rights and remedies under the Franchise Agreement.  This amount represented arrears of royalty payments on reported sales and Mr. Sowdaey does not dispute that these amounts were owed.  Mr. Levinson sent many of these demand letters for Mr. Sub.  It is not uncommon for franchisees to be a week or two behind in royalty payments.

34      On August 29, 2000, Mr. Tilley made a one-half hour visit to Store 258 with a colleague, Ross Gardner.  Mr. Sowdaey was busy serving a customer and unpacking an order from Neate Roller; there was virtually no discussion between Mr. Tilley and Mr. Sowdaey.  On August 31, 2000, he sent an email to Mr. Levinson.  Non-compliance by Store 258 detailed in that email included the following:

35      Mr. Tilley testified that having reviewed the file and seen repeat instances of non-compliance on his August 29, 2000 visit, he felt it was time to involve legal counsel. Mr. Tilley described closing a location as a, "lose/lose situation".  While closing a location is obviously a "lose" situation for a franchisee, it would also result in a loss of revenue to Mr. Sub and a resultant decrease in his own revenue-based bonus.  Mr. Sub makes money from the royalty stream generated by operating franchisees, not from franchise fees paid on the grant of new franchises or transfer fees paid on the transfer of existing franchises.  Mr. Sowdaey admitted that the better he did the better Mr. Sub did and that it was illogical to assert that Mr. Sub was setting him up to fail.

36      In explaining his August 31, 2000 email, Mr. Tilley noted that at one time before 129 became a franchise the secret sauce had been made by the franchisees, but that Mr. Sub had changed this procedure and arranged for its production by an outside supplier for food safety reasons. Mr. Tilley explained that Mr. Sub requires franchisees to buy products from authorized dealers for several reasons.  First, Mr. Sub can obtain the benefit of volume purchasing.  By requiring products to be purchased from approved suppliers, Mr. Sub ensures adherence to food safety standards and the ability to effect recalls.  Product standardization and standardized recipes throughout its national franchise are critical to its brand integrity.  The authorized supplier Neate Roller was not affiliated with Mr. Sub and Mr. Sub did not receive a commission on any sales made by Neate Roller to franchisees.

37      On September 7, 2000, on Mr. Tilley's instructions, Mr. Levinson again wrote Mr. Sowdaey.  He addressed three topics.  First, it was again asserted that Store 258 owed $15,000 in royalties on unreported sale. Secondly, payment of royalty arrears on reported sales in the amount of $2,531.80 was demanded.  In both cases, payment was to be made by September 14, 2000.  The operational deficiencies reported by Mr. Tilley were set out, and Mr. Sowdaey was required to contact Mr. Levinson upon receipt of the letter to arrange to attend a re-training program at his expense.  Mr. Levinson yet again advised that if the required payments and arrangements for re-training were not made Mr. Sub would not hesitate to terminate the Franchise Agreement.

38      Mr. Levinson received no response to this letter. Mr. Tilley instructed him to give Mr. Sowdaey a final chance. On September 19, 2000, Mr. Levinson wrote Mr. Sowdaey giving him an extension until noon September 22, 2000 to reply to him or Mr. Tilley, at which time Mr. Sub would instruct suppliers to cease deliveries to the store effective September 25, 2000. Mr. Sub reserved the right to exercise all of its remedies under the Franchise Agreement.

39      In response, Mr. Sowdaey faxed to Mr. Tilley the carbon copy of a two-page Ontario Ministry of Health, Public Health Branch document entitled "Food Premises Inspection Report-Items Critical to Food Safety".  It purports to be a report with respect to Store 258 and shows Store 258 to be in compliance with all food safety indicators observed by the inspector.  The date September 19 was written in ink on the first page.  The report does not include any handwritten comments and the boxes on page two are completed by one vertical line having been run through all of them.  Mr. Dekerf testified that he is familiar with these forms, that there is usually more information on the forms and that he has never seen page two completed in the manner that this form was completed.  Mr. Sowdaey admits that the inspector was a regular customer, but denies that the report was in any way "doctored".

40      On September 23, 24 and 25, Mr. Sowdaey bought five money orders, totalling $2500, all payable to Mr. Sub. As September 23 and 24 were on a weekend, I have assumed that they were all delivered to Mr. Tilley on Monday, September 25.

41      Mr. Sowdaey did not respond to Mr. Levinson and on September 25, 2000, on Mr. Tilley's instructions, Mr. Levinson sent a letter to Mr. Sowdaey terminating the Franchise Agreement and requiring him to de-identify the store as a Mr. Sub outlet by, among other things, removing the sign. It was not clear to me whether the money orders were delivered before or after Mr. Sowdaey received this letter.  In any event, Mr. Sub returned the money orders.  Mr. Tilley told Mr. Sowdaey that the money was not the issue, and that Mr. Sub's standards were higher than those of the Health Department.

42      Mr. Sub arranged for a contractor to remove the vinyl lettering "Mr. Sub" from the storefront and pylon signs for Store 258 on September 27, 1998.  Mr. Sowdaey alleges that in doing this, the contractor caused damage to the wiring, which cost $4066 to repair.  He says that his landlord paid these amounts and deducted them from his deposit.  As evidence, he tendered a handwritten invoice from Keya Sign. No one from Keya Sign testified.  In response, Mr. Sub tendered a letter from its contractor confirming how the work was done and that no damage was caused.  Similarly, no one from the contractor testified.  Mr. Sub also tendered "before and after" photographs of the pylon sign for the Finch Avenue entrance and an "after" photo for the Bridletown exit, without particulars as to when the "after" photos were taken.  In cross-examination, following this exchange of equally unreliable evidence, Mr. Sowdaey admitted that it was possible that the contractors just scraped the name off and did not go near the wiring.  This exchange adversely affected Mr. Sowdaey's credibility.

43      Mr. Sowdaey continued to carry on business at the same location under the name "Subs & Subs" between September 25, 2000 and May 2001.  His gross revenues diminished significantly once he ceased operating as a Mr. Sub franchisee.  He admitted that it "could be" that prospective customers worried that the level of food quality and service associated with a Mr. Sub franchise were no longer there.  In May 2001, he gave back the premises to the landlord.  It was clarified in closing submissions that the equipment and other chattels at the location were taken by the landlord and that the landlord immediately rented the space.

(1)  DID MR. SUB PROPERLY TERMINATE THE FRANCHISE AGREEMENT IN ACCORDANCE WITH ITS TERMS?

44      It is clear to me that 129 repeatedly breached the Franchise Agreement.  The issue is whether Mr. Sub gave the required notice of termination.  Article 20.01 of the Franchise Agreement sets out when Mr. Sub may terminate the Franchise Agreement.  The relevant portions of that Article are set out in Appendix "A" to these reasons.

45      I have not accepted Mr. Breslin's letter of February 11, 1999 as a notice of default under subsection 20.01(a).  Having regard to the potentially serious consequences of such a letter, I believe that to constitute a notice of default for the purpose of that subsection, the letter must indicate the possibility that the franchisee's rights under the agreement may be affected as a result of non-compliance with the requirements of the letter.

46      Similarly, Mr. Breslin's letter of April 20, 1999 did not indicate what the consequence of non-compliance with his requests would, or could, be.  He indicated that, "It would be appreciated if you be in full compliance with all of the above issues by 20th May, 1999."  Interestingly, however, he gave Mr. Sowdaey 30 days, the maximum cure period provided for non-monetary defaults under subsection 20.01(a).

47      Mr. Breslin's letter of September 2, 1999 indicated that it should be taken as an official notice under Article 20.01 of the Franchise Agreement.  It was clearly intended to constitute a written notice of default under section 20.01(a).  Mr. Sowdaey pointed to the fact that Mr. Breslin demanded that all defaults be remedied within a period of seven days.  Mr. Sowdaey seemed to suggest that because section 20.01(a) provides that if a non-monetary default cannot be cured within a period of five days, the franchisee, "shall have such additional time as may be necessary, not to exceed in any event thirty (30) days, as long as the curing of such default is begun promptly and is prosecuted with due diligence", the September 2, 1999 letter did not constitute a notice of default.  I note that Mr. Sub did not terminate the Franchise Agreement upon the expiry of the seven-day period. In my view, the September 2, 1999 letter was a valid notice to remedy a default under section 20.01.

48      The next written notice of default was Mr. Levinson's letter of September 14, 1999.  He took the view that Mr. Sub was in a position to terminate the Franchise Agreement without further notice, presumably based on non-compliance with the demands in Mr. Breslin's letter of September 2, 1999, although this was not expressed, and possibly based on the misrepresentation of sales, which under subparagraph 20.01(c) entitled Mr. Sub to terminate without giving 129 an opportunity to cure.  Mr. Levinson indicated that Mr. Sub would give him one more chance to rectify the problems.  I am of the view that this letter also constituted a notice to remedy a default under section 20.01.

49      Mr. Levinson's letters of January 7, 2000 and March 3, 2000 demanding payment of royalties on an unsubstantiated level of unreported sales do not in my view constitute notices to remedy a default under section 20.01 of the Franchise Agreement.  In order for a document to constitute a notice of default there must in fact be a default.

50      Mr. Levinson's August 16, 2000 demand for payment of unpaid royalties on reported revenues also constituted a notice to remedy a default under section 20.01.

51      Between September 2, 1999 and August 16, 2000, 129 received three notices to remedy a default pursuant to Article 20.01.  Clause 20.01(c)(iii) of the Franchise Agreement permits Mr. Sub to terminate the Franchise Agreement without affording the franchisee any opportunity to cure the default effective immediately upon the franchisee's receipt of a notice of termination if the franchisee receives three or more notices to remedy a default pursuant to section 20.01 within any twelve month consecutive period, whether or not such defaults are corrected after notice thereof is given by Mr. Sub.

52      Subsequently, 129 received two more notices, Mr. Levinson's letters of September 7 and 19, 2000.  While these letters assert default based on non-payment of royalties on unsubstantiated unreported sales, they also assert default because of non-payment of royalties on reported sales and material operational problems.  Accordingly, in my view they are effective notices to remedy a default under section 20.01. If I am wrong in this, the result is the same.  Without these notices, 129 still received three notices to remedy a default in a twelve-month consecutive period and was entitled to terminate the Franchise Agreement pursuant to clause 20.01(c)(iii).

53      Subparagraph 20.01(a) provides a strict five day cure period , without provision for extension, in the case of non-monetary defaults.  Mr. Levinson's letter of September 7th gave 129 seven days and then a further extension for a total of fourteen days.  Payment of overdue royalties on reported income was not received within that time period.  On that basis, Mr. Sub was accordingly also entitled to terminate the Franchise Agreement pursuant to subparagraph 20.01(a). Moreover, with respect to the operational defaults, Mr. Sowdaey did not contact Mr. Tilley or Mr. Levinson for retraining, as required.  There is no evidence that Mr. Sowdaey promptly began curing all of the operational deficiencies after receipt of the September 7th notice and thereafter prosecuted such cure with due diligence, as required to extend the cure period for non-monetary defaults beyond the five-day period.

54      I am satisfied that Mr. Sub terminated the Franchise Agreement in accordance with its terms.

(2)  DID MR. SUB BREACH ITS DUTY TO DEAL FAIRLY?

55      The next issue before me is whether, while in acting in accordance with the terms of the Franchise Agreement, Mr. Sub breached its duty to 129 to act fairly by terminating the Franchise Agreement.

56      The provisions of the Arthur Wishart Act (Franchise Disclosure), 2000, S.O. 2000 c. 3 (the "Act") providing that every franchise agreement imposes on each party a duty of fair dealing in its performance and enforcement came into effect on July 1, 2000.  The Act provides that the duty of fair dealing includes the duty to act in good faith and in accordance with reasonable commercial standards.  The Act applies prospectively to agreements entered into before the coming into force of the Act.  The Act is accepted by the parties as codifying the common law in existence before its enactment.  Hence, the same good faith requirement applies to dealings between Mr. Sub and 129 throughout the course of their relationship.

57      In Machias v. Mr. Submarine Limited, [2002] O.J. No. 1261 Wilson J. provides an overview of the case law with respect to the development of the requirement that a franchisor and franchisee deal fairly with each other and I will not repeat it here.  The relationship between the parties to a franchise agreement is not a fiduciary relationship.  A franchisor is not required to put the interests of the franchisee ahead of its own interests.  Kelly J. provided a helpful definition of "good faith" in Gateway Realty Ltd. v. Arton Holdings Ltd. (1991), 106 N.S.R. (2d) 180 (S.C.), aff'd (1992), 112 N.S.R. (2d) 180 (C.A.), which was referred to by Wilson J. in Machias.  Conduct is not in good faith when it is in bad faith:  contrary to community standards of honesty, reasonableness or fairness.

58      In my view, Mr. Sub did not act in bad faith in terminating the Franchise Agreement.  While I was troubled by the letters, which were unreasonable and unfair, demanding payment of royalties based on unsubstantiated levels of unreported sales, the course of continued operational non-performance, particularly in the critical areas of food safety, over nearly two years justified termination. Notwithstanding the positive mystery shopper report of October 27, 1999 and the positive Health Department report of September 2000, I am satisfied that there was a continued pattern of material operational non-compliance.  As franchisor, Mr. Sub dedicated a greater than customary level of effort to helping 129 to improve its operational standards. 129 received numerous warnings.  To hold that Mr. Sub was not entitled to terminate the Franchise Agreement would in my view require that a franchisor be required to put the interests of its franchisee ahead of its own.

59      129 argues that, in the circumstances, if Mr. Sub had determined that it did not want 129 operating Store 258 any more, the fair thing to have done would have been to give 129 a reasonable period of time in which to endeavour to sell its operation to a purchaser acceptable to Mr. Sub.  Mr. Sowdaey had invested his life's savings into the business.  He was indebted to the bank.  He had also invested two years of his life in trying to make a go of it, working the brutally long hours required of franchisees, seven days a week.  There was no evidence before me that 129 had in fact proposed this to Mr. Sub.  Mr. Breslin's April 20, 1999 memo to Mr. Sowdaey points out his rental costs represented an unhealthy 29% of sales.  129 had committed to a ten year lease.  129's financial statements for the year ended November 30, 1999 show a deficit of $14,495.  Mr. Sowdaey's income tax return for the year ended 1999 shows that he was only able to take a salary of $10,500 from the business in 1999.  In 2000, 129 was still continually in arrears.  129 paid $115,000 for the assets of a healthy business with a 16-year track record and sales in excess of those which Store 258 was able to achieve under Mr. Sowdaey's management.  Given this dismal financial picture, it would not have been easy, or even perhaps possible, to have found a prospective franchisee to purchase 129's assets within a reasonable period of time.  The reasonable period of time would have to be established by reference to 129's level of non-compliance, and would accordingly would have been brief. Mr. Sowdaey perhaps recognized this:  he elected to continue to try and operate the store as Subs & Subs rather than attempting to sell the business.  Ultimately, 129's assets were transferred to or seized by its landlord on account of unpaid rent.

60      If I am wrong in concluding that in the circumstances Mr. Sub did not have a duty to help 129 sell its business to a prospective franchisee, then I think that the measure of damages would be the difference between what a prospective franchisee and a purchaser who was not a prospective franchisee would have paid for the assets.  The damages would not be the money that 129 and Mr. Sowdaey lost on this business venture and that they claim.  Mr. Sub made no guarantee that the business would succeed.  129 and Mr. Sowdaey do not claim that Mr. Sub made any misrepresentation with respect to the profitability of Store 258 that induced them to enter into the purchase transaction with the vendor.

(3)  MR. SUB'S ENTITLEMENT TO DAMAGES

61      Mr. Sub claims damages equal to the present value of royalty and advertising contributions it would have received if Mr. Sub had not terminated the Franchise Agreement as a consequence of 129's breach and 129 had continued to operate Store 258 for the eight years remaining in the term of the Franchise Agreement.  It calculates this amount as $111,939.  Its calculations were based on the average level of royalties generated by 129 in the two years it operated Store 258 and assumed 2% sales growth and a prevailing interest rate of 5%.  The calculations were prepared by Mr. Sub's controller, a recently qualified Certified Management Accountant who has a vested interest in the results. Surprisingly, Mr. Sowdaey did not challenge these calculations.  I cannot, however, accept them.  Mr. Sub painted 129 as a failing business, and I accepted that characterization.  Such a characterization is inconsistent with an assumption or expectation that the same level of royalties would continue to be generated over the balance of the term, or even that Store 258 would continue in operation. 129 did not promise to be successful and remain in operation for the term of the Franchise Agreement or to generate a fixed level of royalty revenue.  Mr. Sub knew at the commencement of the relationship that there was a risk that 129's business would fail.  In fact, Mr. Sub required 129 to acknowledge this business risk when it signed the Franchise Agreement.  Based on Mr. Sub's depiction of 129's under capitalization, if 129 had performed its operational obligations under the Franchise Agreement, its business was still destined to fail.

62      I suspect that Mr. Sub does not make this claim for damages seriously.  Mr. Sowdaey's banker has obtained judgment against him in respect of the money borrowed to buy Store 258.  After a period of unemployment, Mr. Sowdaey has obtained employment at $50,000 per annum and his wages are garnisheed by his banker.  He is divorced and has two children to support.  Likely, a judgment in favour of Mr. Sub in the amount claimed would precipitate an assignment in bankruptcy by Mr. Sowdaey.

63      I also note that there is no competing sandwich shop in the area.  Mr. Sub has not granted a franchise or set up a corporate owned store in the area.  Mr. Sub made no efforts to mitigate the damages it claims for lost future royalties.

64      129 did promise to comply with Mr. Sub's mandatory specifications, standards and operating procedures relating to the franchised business and I concluded that it failed to do so.  The kind of damages sought by Mr. Sub do not, however, arise from those breaches.  There was no evidence, for example, of diminished royalty revenue during the term of the relationship or impairment of the value of Mr. Sub's trademark as a result of non-compliance with these operational standards.

65      The evidence before me was that 129 owed royalty arrears on reported sales in the amount of $2,531.80 at the time of termination.  Mr. Sub is entitled to that amount, possibly with pre-judgment interest thereon in accordance with the Courts of Justice Act, and no more.

66      In the circumstances, I also believe it is unfair and unreasonable for Mr. Sub to claim damages in the amount of $111,939 and if necessary would be prepared to hold that to do so in the circumstances is a breach of its duty of fair dealing in its enforcement of the Franchise Agreement.  This is by no means to suggest that a franchisor cannot usually recover damages from a franchisee for a breach of a franchise agreement.  The special factor here is that the franchisor is in essence claiming damages because the franchisee's business failed.

67      Mr. Sowdaey counterclaimed for the alleged costs of repairing the pylon signs described at paragraph 43 of these reasons.  As set out in paragraph 43, I have not accepted that Mr. Sub caused this damage.  Accordingly, the damages awarded are not reduced by the amount of the Keya invoice.

(4)  CONCLUSION

68      Mr. Sub is entitled to damages in the amount of $2,531.80.  129 and Mr. Sowdaey's counterclaim is dismissed. In the circumstances, my view is that there should be no costs in this matter.  I will however entertain brief written submissions received within 21 days of the release of these reasons with respect to pre-judgment interest and costs.  Any such submissions with respect to costs should include a draft bill of costs, together with supporting dockets, a summary of the total number of hours spent by each lawyer on the file (exclusive of time spent at the trial), and details of counsel's year of call, actual hourly rate and the actual amount Mr. Sub or Mr. Sowdaey, as the case may be, has paid and will be required to pay its or his counsel in this matter.

69      I appreciated counsels' joint and organized presentation of the documents in this matter.

HOY J.