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In the absence of some other relevant fact, it is not a breach of the duty of good faith in contractual relationships to take advantage of a reason of a termination provision in a contract, even where that reason ultimately proven invalid

Ontario

,

Canada

In 2161907 Alberta Ltd. v. 11180673 Canada Inc., 2021 ONCA 590,  2161907 Alberta Ltd. (“216”) held the Ontario rights to the “Tokyo Smoke” cannabis brand, which it licensed to various retail operators. 11180673 Canada Inc. (“111”) and its principal, Mr. Robert Heydon, won a cannabis retail operator license in the allocation lottery held by the Alcohol and Gaming Commission of Ontario (“AGCO”) in August 2019.  In November 2019, the parties entered into a series of agreements for the operation of a Tokyo Smoke-branded cannabis store in Toronto. These agreements included a License Agreement for the use of the Tokyo Smoke brand and a Sublease whereby 111 rented the retail premises from 216. 216 offered 111 funding for start-up costs, including rent, and an inducement of approximately $2 million to open under the Tokyo Smoke banner (the “Branding Fee”). The Branding Fee would come due once 111 obtained its Retail Store Authorization from the AGCO.

Two days before the store was supposed to open, a dispute arose as to 216’s obligation to fund the payment of 111’s rent for the month of opening. Faced with 216’s refusal to pay, 111 advised 216 that it would not be opening the store as planned. 216 took the position that this was a threat to cease carrying on business and accordingly constituted a breach of their agreement. 216 terminated its relationship with 111, refusing to pay the Branding Fee.

216 brought an application seeking a declaration that 111 had breached their various agreements, that the Branding Fee was not payable, and that 11 must vacate the retail premises. 111 brought a counter-application seeking payment of the Branding Fee, and a declaration that 216 had wrongfully terminated the License Agreement and had breached its duty of good faith in the performance and enforcement of contractual relations.

216’s Termination of the License Agreement was Invalid

216 submitted that it validly terminated the License Agreement in response to Mr. Heydon’s genuine threat to cease carrying on business, pursuant to paragraph 26(c) of the License Agreement. The ONCA found that the application judge implicitly adopted one of two possible interpretations of paragraph 26(c). The judge did not err in finding that the threat had to be objectively credible in order to trigger default under the agreement.

The application judge’s finding that Mr. Heydon’s emotional frustration after 216 wrongly withheld the June rent did not meet the requirements of the parties’ termination clause was clearly reasonable. For the threats to be treated as an event of default under the License Agreement, a degree of objective credibility – or objective intent – or a real risk that Mr. Heydon’s threats would be carried out was required.

216 Did Not Breach its Duty of Good Faith to 111

The License Agreement contained an express contractual duty of good faith. The applications judge found that 216 “pounced” on Mr. Heydon’s threat, which was in breach of their duty of good faith. However, implicit from her reasons, other sources of bad faith informed the application judge’s analysis. The ONCA considered 4 sources of bad faith, detailed below.

The ONCA concluded that it would be inappropriate to characterize 216’s error as bad faith simply because that error set in motion the events that would culminate with 216’s invalid termination of the License Agreement. Instead, it was simply a case of breach of contract.

(a) 216 did not actively mislead 111

The ONCA found that 216 did not actively mislead 111 with its intention with respect to the Branding Fee or the deferral of rent. 216 simply changed positions in light of new information. The applications judge made no finding that the change in position was taken dishonestly or unreasonable nor was there any suggestion that it was taken capriciously or arbitrarily (paras 54-55).

(b) “Pouncing” by 216 did not constitute bad faith

The ONCA found that a party is not prevented from exercising a right of termination simply because it wishes to bring its relationship with the other party to an end. Nor should a party be prevented from ending a relationship because it will deprive the defaulting party of a payment that it would have received had the relationship continued. Where a party is anxious to end a relationship, and a valid reason to do so presents itself, that party is not, in the absence of some other relevant fact, prevented from “pouncing” on it (para 57).

While 216’s basis for terminating the Licence Agreement was ultimately proved invalid, its position on termination was not unreasonable, malicious, or so inconsiderate of 111’s legitimate contractual interests as to constitute bad faith. It was neither manufactured nor concocted. Mr. Farbstein believed Mr. Heydon’s threat constituted a breach (para 58).

(c) The Branding Fee

The ONCA acknowledged that, in Bhasin, the Supreme Court explained that a party has a duty not to evade its contractual obligations in bad faith. As a result, a party that manufactures an artificial reason to terminate a contract in order to avoid future payment obligations would likely be found to have acted in bad faith. However, as explained above, 216 believed the termination was justified. The fact that termination releases a party from making a significant payment does not amount to bad faith, even where a court later finds that the termination was invalid (para 66). Without an adverse credibility finding against Mr. Farbstein or some other reason to reject his testimony, there is no basis for 111’s suggestion that the termination of the License Agreement was an excuse manufactured by 216 to avoid payment of the Branding Fee (para 68).

(d) The doctrine from Mason v. Freedman did not apply

The ONCA distinguished Mason, where the vendor attempted to repudiate an agreement of sale on the basis that he was “unable or unwilling” to remove a defect on title. The evidence revealed that the vendor was engaging in a deliberate attempt to sabotage his sale and escape his bargain (paras 69-71).

On the facts in this case, Mr. Farbstein simply misinterpreted the Loan Agreement when he made the statements that triggered Mr. Heydon’s emotional response, which Mr. Farbstein in turn perceived as an event of default. His actions were not a deliberate attempt to create the conditions giving rise to 216’s right of termination (para 71).

April 14, 2022
– 2161907 Alberta Ltd. v. 11180673 Canada Inc., 2021 ONCA 590