The case below is from the Canadian Legal Information Institute (CanLII)

Ontario Supreme Court

Katotikidis v. Mr. Submarine Ltd.,

Date: 2002-05-09

Valerie Katotikidis and Anestas Katotikidis, Plaintiffs

and

Mr. Submarine Limited, Defendant

Ontario Superior Court of Justice Taliano J.

Heard: January 22-25, 2002

Judgment: May 9, 2002

Docket: 00/807

Mark Veneziano, for Plaintiffs

Jeffrey C. Goldberg, for Defendant

Taliano J.:

[1] The franchise industry is robust in Ontario. A visit to any mall bombards the consumer with familiar brand names, products and trademarks. Many aspiring entrepreneurs probably assume that ownership of a franchise selling a nationally recognized product is a passport to success and prosperity. As the story of this litigation unfolds, it will soon become apparent that such is not always the case particularly when principles of good faith go missing in the relationship between franchisor and franchisee. More will be said about good faith in due course but the immediate issue and the one that gives rise to this proceeding, is the defendant’s admission that it breached an agreement with the plaintiffs to award them a “Mr. Sub” franchise at Lloyd Jackson Square (“LJS”) in Hamilton. These reasons assess the extent of the plaintiff’s losses and determine whether punitive damages should be awarded.

The Facts

[2] The plaintiff, Valerie Katotikidis, came to Canada as a teenager and took a position as an employee for Mr. Sub in the early 1980’s. In 1983, she married her husband, her co-plaintiff, Anestas Katotikidis, who was already involved in the sub restaurant business, and they became Mr. Sub franchisees in 1986. They operated at different locations in the City of Hamilton until the events giving rise to this litigation. In 1990, they were awarded the Mr. Sub restaurant at the Eaton Centre, where they and the older of their children worked as a team until it closed, not with a bang, but with a whimper less than ten years later. Valerie Katotikidis was the main operator of the business in question and was the only plaintiff to testify. When I refer to the plaintiff in the singular in these reasons, I refer to Valerie Katotikidis.

[3] The closing of the Eaton Centre store was traumatic. At a point in time when the plaintiffs still had two years remaining on both their lease and franchise agreement, Eatons announced it was closing its department store in the mall. The closing had a serious impact on the plaintiffs’ business which was worsened when other businesses also left the mall. The plaintiffs tried to cope with these events by seeking concessions from their landlord as well as from the defendant. At the same time, they realized that the adjacent, but separately owned LJS, did not have a submarine sandwich operation. They thought that it could be a good location for a Mr. Sub. Armed with the realization that they would have to close at the Eaton Centre and the hope that they might be able to move their business to the near-by adjoining mall, they were cautiously optimistic about their future, provided they could hold out for the balance of their lease term and secure the new location. The plaintiffs therefore brought their idea to the defendant. The defendant responded that they were interested and would explore the possibilities with the landlord of LJS.

[4] In the meantime however, the plaintiffs were not surprised to be informed by letter dated October 26, 1999 (found at Tab 9, Ex. 1) that the defendant no longer considered their store in the Eaton Centre to be a viable location. The defendant indicated that it would not renew the lease or franchise agreement at that location when both agreements expired on November 30, 2000. The letter reminded the plaintiffs that they were not permitted for two years after closing, to engage in the submarine sandwich business within two miles of their existing location and within two miles of an existing Mr. Sub restaurant, in accordance with the terms of their franchise agreement. At this point, the plaintiffs were not concerned because they had been assured that their idea of moving to LJS was being seriously investigated and they were hopeful of being awarded the new franchise which would be located only 1380 feet from their current location.

[5] They had two good reasons to be hopeful. It had been understood that if an existing franchisee who was in good standing introduced a suitable new location to head office, all things being equal, that franchisee would be given the first opportunity to operate at that location. Since it was the plaintiffs who brought LJS to the defendant’s attention, they had every right to think they would be awarded the franchise if a store was opened there. There was yet another practice: if a new franchise was to be opened, it would be awarded to the next closest existing franchise operator provided he/she was in good standing. The plaintiffs knew that they were the next closest franchisees and that they were in good standing.

[6] Evidence by the plaintiffs as to the existence of these two practices was not contradicted by the defendant.

[7] When negotiations between Mr. Sub and LJS were successfully concluded on November 8, 1999, the defendant did offer the new site to the plaintiffs subject only to proof of bank approval, which had to be furnished within 48 hours. (see Tab 10, Ex. 1) It is not disputed that the plaintiffs accepted the offer of the franchise and forwarded the necessary bank approval within the time stipulated. That should have been the beginning of a return to prosperity for the plaintiffs. Instead it turned out to be the beginning of their worst nightmare.

[8] Without explanation and without warning or notice, the new franchise was offered to someone else. That was bad enough, but it was to get worse. Construction of the new store was completed and the new franchisee opened in direct competition with the plaintiffs in December 1999, causing the plaintiffs to lose even more of what was left of their business. They could only wonder what had gone wrong because no explanation was ever offered to the plaintiffs for this corporate behaviour, nor was one offered during the trial.

[9] The plaintiffs have honoured the terms of their franchise agreement that prohibits them from carrying on the business of a submarine sandwich operation in competition with the defendants, although the sandwich business is the only work that the plaintiff, Valerie Katotikidis has done in Canada.

[10] The plaintiff, who is now 37 years of age, is the mother of three children, aged 17, 16 and 17. All of them attend school and the two oldest helped out in the restaurant from time to time. She testified that the Eaton Centre location was particularly suitable for raising a young family because the hours of operation were to 5.30 p.m. on most days and only to 9:00 p.m. on other days. On the other hand, a freestanding location has much longer hours which are not conducive to family life. For that reason, after losing LJS, the plaintiffs rejected offers from the defendant to award then a freestanding location and no mall locations have been offered to them. Although the plaintiffs were prepared to buy the store at the LJS store, the current operator was and remains unwilling to sell. The plaintiffs’ restrictive covenant prohibits them from taking a job in the industry within a defined area until November 2002.

[11] Both the plaintiffs and the defendant retained restaurant consultants to calculate the plaintiffs’ losses and they agree in large measure on how those losses should be calculated. The plaintiffs’ expert is Mr. Douglas P. Fisher and his reports were filed as exhibits three and four. The expert retained by the defendant is Mr. Geoff Wilson and his reports were marked Exhibits seven and eight. I found both experts to be knowledgeable and articulate, both exemplifying an in-depth understanding of the restaurant industry. I accept their evidence where they agree and I only propose to discuss their differences. As agreed between counsel the findings that I make will be incorporated into new calculations for subsequent approval of the court.

The Issues

Lease Term:

[12] The defendant negotiated a lease on behalf of its new franchisee with LJS of seven years with a right of renewal for an additional five years. The issue is whether the plaintiffs should be awarded damages over seven or twelve years.

[13] Mr. Fisher testified that Hamilton is considered a very stable community within Southwestern Ontario. Accordingly, he did not feel that market demographics would change so substantially as to prompt Mr. Sub to leave LJS after only seven years of operation. In addition, the Mr. Sub operation suits the socio-demographic level of the community. Although he conceded that unforeseen changes similar to the closing of Eatons might alter the demographics, he pointed out that LJS did not have a major or anchor tenant, but rather a number of small tenants, so that the likelihood of a demise of LJS similar to what occurred at the Eaton Centre Mall is remote. He also pointed out that the plaintiffs had been in the submarine sandwich business for 16 years and were obviously good operators or they would not have been offered two prior Mr. Sub franchises in addition to the LJS franchise. Accordingly since they were experienced and successful operators, the likelihood of them being successful in the new location was high, in which case, the lease would almost inevitably be renewed. Finally, Mr. Fisher testified that the economy is now coming out of re-cession and growth is expected and predicted by economists. When asked about the announced layoffs at Ford in Oakville, he testified that they would have little or no bearing on mall operations in downtown Hamilton.

[14] Although Mr. Fisher did not say so, one might add that it makes good business sense to stay with a successful operation not only for the royalties it generates, but because longevity enhances the stability and reputation of the franchise. Indeed the defendant promotes long‑term relationships with its franchisees.

[15] The defence introduced evidence through Mr. Flynn, who is the defendant’s Vice-President of Franchise Development, that the decision to renew a lease at an existing location is made by evaluating several key factors such as the success of the existing operation, the financial viability of future operations at that site, and changes in demographics that have occurred or might occur. He stressed that the renewal of a lease is not a given, and that an in-depth assessment is done before a decision to renew is made.

[16] However, in cross-examination it became clear that all of the factors that are considered when deciding to renew an existing lease, favour the plaintiffs’ position on this issue. There is a strong probability that the lease of Mr. Sub at LJS will be renewed when it expires. The existing operation, even though it is in its early stages, is already exceeding the average sales reported by other franchises in the area. The lease renewal clause requires the landlord to renew at then prevailing rates and this protection will ensure that future rents will be competitive with other food court operators. In addition, the profit reported by the existing operator is already in excess of the profits projected by the defendant’s own cash flow (see Tab 5, Joint Book of Documents) proforma, and the profit projections by both experts for this operation were described by Mr. Flynn himself as being excellent. Given that the defendant’s own materials speak of having a long-term relationship with its franchisees, it is improbable that the defendant will fail to renew the existing lease. Accordingly, I have concluded that the tenia for calculating the plaintiffs’ damages is twelve years.

First Year Operations:

[17] Mr. Fisher’s calculations of the plaintiffs’ losses have as their starting point, the gross sales that the plaintiffs would have achieved in the first year of operation at LJS. By letter dated May 14, 2001, counsel for the defendant reported that the gross sales were $303,836. In spite of this admission, the defendant supplied its own expert with a different figure, that being $298,228. However, in cross-examination, it was demonstrated that this latter figure did not take a full 365 days into account and the actual figure would be in the vicinity of $302,000. In my opinion, once the admission is made, it can only be retracted under special circumstances which do not exist here. Accordingly, the starting point adopted by Mr. Fisher of $303,836 is the correct one.

Year 2 Sales:

[18] It was maintained by Mr. Fisher, that the plaintiffs would have been able to retain 50 percent of its customers from the Eaton Centre and bring them to the new location in LJS. Accordingly, Mr. Fisher carried forward 50 percent of the total sales from the last year of operation at the Eaton Centre and pegged 2nd year sales at $370,598. He justified this on the following grounds:

(i) the plaintiffs were local operators and would have built up a loyal customer base over the 10 years of their lease, many of whom would have followed them to LJS.

(ii) McDonald’s seem to be able to carry their clientele with them when they change locations.

(iii) customers have preferences, even in submarine sandwiches, and will seek out a Mr. Sub, particularly if the store is only a few minutes away.

(iv) Franchisors like McDonald’s often open units directly across the street from one another when market research indicates that the market can absorb more stores without negatively impacting other operations. This is called a market building approach rather than a market sharing approach.

(v) Edo Japan at LJS had experienced a growth in sales equivalent to 7 times the sales it previously had at the Eaton Centre. Sales of the new Mr. Sub operator in LJS are only 2.3 times that of the Eaton Centre. If the plaintiffs were operating the new Mr. Sub at LJS, Mr. Fischer opines that sales would be 5.5 times that of the Eaton Centre location.

[19] However Mr. Wilson disagreed. He testified that the plaintiffs would not have carried much, if any, of its last year sales to the new location because a new submarine shop had opened in the Eaton Centre after the plaintiffs closed and demand for submarine sandwiches in the Eaton Centre would have been met by this new operator. For those customers to have followed the plaintiffs to LJS, they would have had to walk a distance of approximately 1,380 feet and would have had to take either an elevator or escalator to a different level. He testified that consumers in the limited service restaurant business, shop on the basis of convenience. In other words, if a closer acceptable alternative is available to them in the food category, they will purchase at the closer location. Finally, Mr. Wilson explained that the difference in Edo Japan’s sales was attributable to the fact that the Eaton Centre location was run by a poor operator and that the new LJS operation was a superior location.

[20] In my view, it has not been established on a balance of probabilities how many customers if any, the plaintiffs would have been able to bring to LJS. No evidence was tendered to describe the plaintiff’s customer base or their degree of loyalty and I regard the opinion that 50 percent of those customers could have been maintained as little more than speculation. The fact that another submarine sandwich operation opened in the Eaton Centre following the closing of the plaintiff’s operation suggests that the demand in the Eaton Centre very well might have been satisfied by the new operator given the fact that customer convenience in this industry usually governs the consumer’s choice. I accept the evidence of Mr. Wilson on this subject. He stated that the demand for food products in a mall is generated by people who are already in the mall. For the most part, they are shoppers and employees who base their food choices on convenience and time. They have limited time to eat and they usually chose from products that are close at hand.

[21] This view is supported by the fact that once the new Mr. Sub opened at LJS, the plaintiffs lost gross sales of almost $90,000 in one year. Counsel have agreed that 50 percent of those lost sales were attributable to the new Mr. Sub and 50 percent to other factors. That is a huge drop in sales in one year and it suggests that customer loyalty is not nearly as strong as Mr. Fisher suggests.

[22] Although Mr. Wilson was prepared to acknowledge that the plaintiffs would have carried some of their business to the new location, he noted that the actual increase in sales at LJS was five percent over year one, approximately two percent of which would have been attributable to real and inflationary growth. The balance of three percent he attributed to business carry over from the Eaton Centre. I have no reason to disbelieve that figure and no reason to substitute a different one. Of the two choices between three percent and 50 percent, I prefer and accept the former.

Year 3 and Thereafter:

[23] In subsequent years, Mr. Fisher has allowed for a five percent increase in sales in order to reflect average increases in real growth which he estimates at two percent, and inflation, which he estimates at three percent. The combination of real growth and inflationary growth is called “nominal” growth.

[24] Mr. Wilson on the other hand has used a figure of 2.1 percent to reflect long-run average growth, 1.7 percent of which represents real growth, and .4 percent of which represents inflationary growth.

[25] Much of the trial time was devoted to this issue because it makes a major difference in the calculation of the plaintiffs’ losses. Mr. Fisher calculates those losses at $855,000 in his first report (Exhibit Three) and at $795,860 in his Response Report (Exhibit Four). Mr. Wilson’s calculation is approximately half of those amounts.

[26] Mr. Fisher conferred with Christopher Elliott, Economist for the Canadian Restaurant and Foodservices Association who indicated in a fax dated January 3, 2002 (Ex. C, Ex. 4) that projections for the years 2001 - 2005 suggested average annual real growth of 2.6 percent and average annual menu inflation of 2.2 percent. Nominal growth, which is the combination of the two, would therefore average 4.8 percent. By excluding the expected slowdown in sales in 2002, Mr. Elliott suggested that annual real growth is 3.2 percent, menu inflation would be 2.2 percent for a nominal growth of 5.4 percent.

[27] In an attempt “to be conservative”, Mr. Fisher used a five percent figure to represent increased sales over the loss period. To further support this figure, he relied on Ex. 12 which indicates that between 2000 and 2001 the increase in sales in the limited service restaurant category was 5.3 percent, higher than most other segments of the industry. He also asserts that the Canadian economy is now emerging from a recession which has suppressed inflation up until recently. He opined that more vigorous growth can be reasonably anticipated in the future.

[28] Mr. Wilson also contacted Mr. Elliott to discuss inflation rates and was told that between 1992 and 2000 the annual sales growth for limited service restaurants (into which category Mr. Sub restaurants fall) was 4.9 percent of which 2.8 percent represented unit growth, that is, growth due to increases in the number of restaurants. The remaining 2.1 percent represented same store sales growth, which includes menu inflation. Accordingly, Mr. Elliott considered the 2.1 percent figure to be nominal growth for the period in question.

[29] Armed with that information, Mr. Wilson looked to Statistics Canada for verification of these figures. In doing so, he examined historical inflation rates over an extended period in order to project rates of growth over a future span of seven to 12 years. He examined rates of inflation as reported by Statistics Canada from 1992 to 2000 and averaged the annual rates he so found. The average was 1.7 percent. Extrapolitating from those figures, he concluded that real growth over a similar period in the future would be the difference between 2.1 percent representing nominal growth and 1.7 percent representing inflationary growth, or .4 percent, which represents real growth. Accordingly, Mr. Wilson urged adoption of a growth factor of 2.1 percent as opposed to the five percent urged by Mr. Fisher.

[30] When challenged in cross examination about the figures set out in Ex 12 indicating a 5.3 percent increase in sales for the limited services restaurants over a one year period between 2000 and 2001, Mr. Wilson stated that the figure represented only a snap shot and not a long term trend. He further stated that in his opinion, in order to accurately predict sales over a number of years into the future, the most reliable method is to look at a comparable period in the past. Wilson’s approach was therefore to look at long-term history of the specific category to produce a long-term projection of sales in that same specific category.

[31] For the most part I agree with and accept Mr. Wilson’s approach to this issue, with this qualification. I agree with Mr. Fisher that this figure is conservative if one considers that the economy is now emerging from what Mr. Fisher described as a recession and is expected to undergo fairly robust growth in the future, which it has not enjoyed in the recent past. Accepting Mr. Wilson’s approach and Mr. Fisher’s expectation of better future performance I have concluded that the appropriate growth factor for sales and expense calculations should be three percent. The two experts were able to agree on the vast majority of operating expenses. I will deal only with their differences.

Owners/Manager’s Salary:

[32] Both experts agree that the annual salary for a franchisee owner/manager would be in the $30,000 to $35,000 range. Mr. Fisher testified that since the plaintiffs were experienced operators with 16 years of experience, they would be in the high end of the range and he therefore allowed for a salary of $35,000.

[33] Mr. Wilson prepared a damage calculation containing both options, although he agreed that the business at LJS would support a manager’s salary of $35,000. Nonetheless he pointed out that in the first year of operation of LJS, the plaintiffs would have been operating two franchises, not one, meaning that they would have been compelled to hire a person with managerial skills to assist. I do not agree. The two locations were within a short distance of one another and given the nature of the business, I am satisfied that both operations could have been operated by one manager. Additionally, he argued that each franchise should be required to support a managerial salary, and he therefore opted for the lower of the two figures.

[34] My view is that the overlapping operation of the Eaton Centre store would have been brief and therefore Mr. Wilson’s argument for the $30,000 figure loses its force after November 30, 2000. In addition, the sales at LJS from its first year of operation is above the average of other Mr. Sub operations. It appears therefore that this will be a successful operation and the higher salary is justified from that point of view. I therefore agree with Mr. Fisher that the $35,000 manager’s salary he used is the correct figure.

Local Restaurant Marketing:

[35] In the plaintiff’s prior franchise agreement with Mr. Sub, there was no provision for local restaurant marketing and nothing was spent by the plaintiff’s under this category. It was generally the view of Mr. Calley, who was the business development consultant assigned by the defendants to assist the plaintiffs, that it was unnecessary for mall operators to advertise locally to stimulate business. He had always claimed that the franchisee in a food court operation does not create traffic in the mall, he simply takes advantage of the traffic that is already there. The plaintiff testified that the mall was its own attraction and that local advertising was unnecessary and had never been pursued. Mr. Fisher agreed. He states in his report that “there is very little one can do to generate specific food court sales. Once you market a customer to come to a food court you have no control over what they buy.”

[36] Be that as it may, the evidence is that the owner of the LJS franchise signed an agreement that contains a provision requiring him to spend two percent of sales on local advertising or face the possibility of termination of the agreement (see Ex. #9, page 15). In addition, this provision is part of the promotional materials used by the defendant to sell franchises. In other words prospective franchisees are encouraged to accept the necessity of this expenditure and it is included as an expense in the pro forma financial statement prepared by the defendant and distributed to potential new franchisees. Mr. Wilson testified that such clauses are common in franchise industry. In addition, he opined that each operator benefits by distinguishing himself locally from other operators in the food court, and that a good operator would promote catering packages through brochures and other media sources to sustain and develop the operation’s business potential.

[37] Apart from the foregoing, there is a paucity of evidence on this subject. For instance, it is not known whether this provision has become a mandatory provision in all of the defendant’s franchise agreements and that its inclusion would have been insisted upon by the defendant had the plaintiff been accepted as the operator at LJS. In such circumstances, making allowance for local advertising would be entirely justified. Should the absence of such evidence exclude the item from the calculations? My conclusion is that the plaintiffs losses are being calculated and presented by reference to the sales figures achieved at the new location and if that site is to be the comparator, then its operating expenses must also be accepted. One of those expenses is the provision for local advertising. That being the case, I am persuaded that Mr. Wilson is correct in taking that expense into account in calculating the plaintiffs’ losses.

Repairs and Maintenance:

[38] Mr. Fisher did not allow any expense for repairs and maintenance in the first year of operation of the LJS store, reasoning that in the first year of operation, everything is new and under warranty and repairs and maintenance are unnecessary expenses. Accordingly he only commences an allocation for this type of expense in year two and beyond.

[39] Mr. Wilson agreed that although expense for repairs and maintenance would not be anticipated in the first year of operation, the total for this category is something that should be averaged over the life of the business. He accordingly allocated $3,000 per year in accordance with Mr. Sub’s proforma commencing the first year, on the theory that towards the middle and end of the term, these expenses would be greater than the yearly average, just as the early years will be less than the yearly average. For that reason, the expense he felt should be allocated over each year of the lease.

[40] I agree with Mr. Wilson, particularly since I have found that the appropriate term for calculating damages is 12 years. Accordingly, I allow the repairs and maintenance provision of $3,000 for the first and subsequent years.

Equity Payback:

[41] Both experts agreed that if the plaintiff’s had been awarded the LJS franchise, they would have been required to invest $50,000 into the operation.

[42] By not being awarded the franchise, the equity down payment remained in the plaintiffs hands and interest on that sum would reduce their loss according to Mr. Wilson. The interest rate he attached to these funds was eight per cent.

[43] Mr. Fisher took the position that an equity investment is usually returned to a business owner at some point in time, usually in a three to four year time frame in the restaurant business. Additionally, Mr. Fisher took issue with the interest rate ascribed to these funds. He suggested a figure of between two and 2.5 per cent, which would be further reduced by taxes and bank charges to a negligible factor.

[44] I agree with Mr. Fisher on this point and would not make any allowance for this factor.

Encroachment:

[45] Both experts agree that when the LJS franchise opened, the plaintiffs suffered a loss of sales attributable to the new franchise in the sum of $44,750. That decline in sales occurred between December 17, 1999 and November 20, 2000. However, the experts disagree on the net loss to the plaintiffs assuming that there is any liability for this business encroachment. Mr. Fisher estimates the plaintiffs’ losses under this heading at $27,556 as set out at page 19 of Ex. 4. Assuming that there is liability, Mr. Wilson’s figure is $18,000 as set out at page 10 of Ex. 7.

[46] The difference between the two figures is attributable to the treatment of two categories of expense. Mr. Wilson included as an expense, the two per cent cost for local marketing whereas Mr. Fisher made no such allowance since it was not a requirement of the franchise agreement governing the Eaton Centre. As indicated earlier, this item should not be charged as an expense in calculating the encroachment losses since the plaintiffs were never required to incur this expense at the Eaton’s Centre.

[47] The second area of dispute is that of wages and benefits. Mr. Wilson attributed a figure of 17 per cent for this category. Mr. Fisher made no allowance for it.

[48] In Mr. Wilson’s calculations found in Ex. 17 (Appendix 4B) he demonstrates that the combination of the managers salary with employees’ wages and benefits total 27 percent of gross sales. The question is whether it is reasonable to expect that those percentages would reduce with a reduction of $44,750 in sales.

[49] Over a period of 365 days, the loss of $44,750 in sales would mean a loss of $122 per day. If Mr. Fisher’s suggestion is correct that the average sale is six dollars, that translates into approximately 20 lost customers per day. The question is whether that loss would lead to a reduction in payroll. In my view, for a small business to suffer a 15 percent reduction in sales would require an adjustment to salaries.

[50] Accordingly, I prefer the treatment of this issue set out in Mr. Wilson’s report, with two exceptions. He has included a provision for local restaurant marketing of two percent, which I have already disallowed as not being required by the terms of the plaintiffs’ franchise agreement. In addition, Mr. Wilson has allowed wages and benefits of 17 percent, which as I have previously observed, would have been reduced to reflect declining sales. A reduction in wages by five percent would lead to 57 percent in expenses or $25,498, producing a gross loss of $19,237. The future value of that sum at 12 percent is $21,545. I therefore fix the encroachment losses at $21,545.

[51] The next question that arises is whether or not there is any liability for encroachment. Mr. Sub breached its contract with the plaintiff by giving the LJS franchise to a third party. The encroachment losses suffered by the plaintiffs arise as a direct result of that breach of contract. If the defendants had given the contract to the plaintiffs, the plaintiffs would have opened the franchise either before or after the Eaton Centre franchise expired. If the LJS franchise had been opened before the Eaton Centre franchise expired, the plaintiff’s encroachment losses would have been offset by gains at LJS. If the LJS franchise had been opened after the Eaton Centre franchise expired, the plaintiff would have suffered no encroachment losses. As such, the plaintiff’s encroachment losses are the direct result of the defendant’s breach of contract, and the plaintiff should be compensated for those losses which I fix in the sum of $21,545.

Mitigation & Contingencies:

[52] Counsel agree that in assessing damages, the court is required to quantify the plaintiffs’ losses in accordance with well-known principles of contract law. The measure of damages for breach of contract is the amount sufficient to place the plaintiff in the same position in which he or she would have been in had the contract been performed. They also agree that generally, a plaintiff has an obligation to take all reasonable measures to reduce his or her damages. However, counsel disagree as to how these principles should be applied to this case.

[53] Counsel for the plaintiff quite properly points out that mitigation was not pleaded by the defendant and that no evidence was tendered on this subject. To therefore make any allowances for mitigation would be unfair to the plaintiff. Mr. Goldberg did not seriously contest this point and I have concluded that it would in the circumstances be unfair to reduce the plaintiff’s award on the ground of mitigation.

[54] With respect to contingencies, the plaintiffs take the position that the defendant has failed to adduce any evidence which would support a reduction in the damages by reason of specific or general contingencies and therefore suggests that the amount if any should be modest and certainly not greater than ten percent.

[55] The defence position is that contingencies should reduce the award significantly. For instance it was submitted by counsel for the defendant that the award should by reduced by the value of Mrs. Katotikidis’ unperformed work over the term of 12 years. This was a question that I raised during chamber discussions and during the course of argument.

[56] The argument goes as follows. Had the contract been performed, the plaintiff would have had to work at the business, as she had before, for as much as 64 hours per week in order to have earned the lost wages and profits that have been projected by both experts. Now that the contract has been breached, although it is true that she has been denied the opportunity to earn these monies, she is also relieved of the burden of working substantial hours each week over a 12-year period. It seems reasonable to suggest that her damages, as a reflection of the monies she has lost, should be discounted to reflect the value of the effort she would have had to expend to earn those monies. That would place the plaintiff in the same position she would have been had the contract not been breached. To award her all of the wages and profits, without deduction, puts her in a position which is superior to what she would have been in had the contract not been breached. This is suggested to be a double recovery.

[57] This position was neither pleaded nor was it dealt with by either expert in their respective presentations. The question is, would it therefore be appropriate for me to consider such a discount. Counsel for the defendant submitted that I was justified in taking this factor into account when considering a reduction of the plaintiffs’ award for contingencies. I am not persuaded however that a reduction to reflect the value of the plaintiff’s unperformed work can be justified as a contingency or otherwise. Certainly, the traditional treatment of a lost wage claim is not to make any deduction for the fact that the claimant is relieved of the burden of working. That may be because for some lost-pay claimants, working is not a burden. In any event, I am not persuaded that such a deduction is supportable on this ground.

[58] With respect to contingencies, the court will make an allowance for a contingency if the evidence is capable of supporting the conclusion that the occurrence of the contingency is a realistic as opposed to a speculative possibility. (see Graham v. Rourke, [1990] O.J. No. 2314 (Ont. C.A.) at 11-12, per Doherty, J.A.). In Rourke Mr. Justice Doherty explained contingencies in the following terms. General contingencies, which occur in life including such things as promotions, sickness, and accidents, are not readily susceptible to evidentiary proof and may be considered in the absence of such evidence. General contingencies will therefore support only a modest adjustment in the award. Specific contingencies, on the other hand, are those which are peculiar to the particular plaintiff, such as a particularly marketable skill or a poor work record. If a plaintiff or defendant relies on a specific contingency, positive or negative, that party must be able to point to evidence which supports an allowance for that contingency.

[59] There is no question that a modest allowance or deduction would be justified as a general contingency in this case. Such a deduction would reflect the normal ups and downs prompted by sickness, accidents and the vagaries of personal and family life that would be expected in a small business over the course of 12 years. However, in addition, given that the plaintiff is only in her late 30’s and has worked hard in the restaurant business ever since arriving in Canada while discharging family obligations at the same time, it is quite probable that she will return to work in the restaurant industry and that she will replace some of the lost income that has been projected over the next 12 years. The plaintiff is obviously a woman with significant working skills. She testified that it only took her 17 seconds to take an order for a submarine sandwich, make the sandwich and ring it out. It is there therefore doubtful that someone with such skill is likely to remain idle over the next 12 years. Nonetheless, the cases indicate that in determining the amount that should be attached to both adverse and favourable contingencies, the court should have regard to the over-all fitness of the award. As Dickson J. (as he then was) stated in Keizer v. Hanna, 1978 CanLII 28 (S.C.C.), [1978] 2 S.C.R. 342 (S.C.C.) at 351:

At the end of the day the only question of importance is whether, in all the circumstances, the final award is fair and adequate.

[60] In Lewis v. Todd reflex, (1980), 115 D.L.R. (3d) 257 (S.C.C.) at 267, Dickson J. stated:

If the figures lead to an award which in all the circumstances seems to the judge to be inordinately high it is his duty, as 1 conceive it, to adjust those figures downward, and in like manner to adjust them upward if they lead to what seems to be an unusually low award.

[61] Mindful of these directives, I will fix the allowance for contingencies after the revised damage calculations have been submitted to me.

Punitive Damages:

[62] Counsel for the plaintiff readily admits that to justify an award of punitive damages, the plaintiff must demonstrate that the defendant has committed an independent or separate action or wrong causing damage to the plaintiffs. In addition, the defendant’s conduct must be sufficiently harsh, vindictive, reprehensible, oppressive, high-handed, that it offends the court’s sense of decency. (see Whiten v. Pilot Insurance Co. [2002] S.C.J. No. 19 (S.C.C).

[63] It is important to set out a number of other principles that emerge from Whiten. They are:

• the general objectives of punitive damages are punishment (in the sense of retribution), deterrence of the wrongdoers and others, and denunciation.

• punitive damages are generally only given where the misconduct would otherwise go unpunished or other penalties are likely inadequate to achieve the objectives or retribution, deterrence and denunciation.

• the primary vehicle of punishment is the criminal law…and…punitive damages should be resorted to only in exceptional cases and with restraint.

• punitive damages should be rational. The court should relate the facts of the particular case to the underlying purpose of punitive damages and ask itself how, in particular, an award would further one or other of the objectives of the law, and determine the lowest award that would serve the purpose.

• the governing rule for quantum is proportionality. The overall award, that is to say compensatory damages plus punitive damages plus any other punishment related to the same misconduct should be rationally related to the objectives for which punitive damages are awarded. When awarded, they should be proportional to such factors as the harm caused, the degree of misconduct, the relative vulnerability of the plaintiff and any advantage or profit gained by the defendant.

[64] I note that in upholding the award of punitive damages in Whiten, the court observed that a contract between an insurer and its insured was one of utmost good faith because, although the insurer is not a fiduciary, it holds a position of power over an insured since the insured is in a vulnerable position and is entirely dependent on the insurer when a loss occurs. For that reason, in every contract of insurance, an insurer has an implied obligation to deal with the claims of its insured’s in good faith. It was held that a breach of the implied duty of good faith meets the requirement of an independent actionable wrong.

[65] In Vorvis v. Insurance Corp. of British Columbia, 1989 CanLII 93 (S.C.C.), [1989] 1 S.C.R. 1085 (S.C.C.), the Supreme Court of Canada acknowledged that punitive damages may be awarded in breach of contract cases although the court cautioned that such awards would be rare.

[66] The plaintiffs argue that the breach of the agreement to award the LJS franchise to the plaintiff was an actionable wrong from which damages flowed. In addition, it is argued that the opening of a competing franchise within close proximity to the plaintiffs’ existing store during the currency of the plaintiffs franchise agreement was a breach of the implied term of good faith and fair dealings implied in the franchise agreement or alternatively was a breach of a duty of good faith imposed by the Arthur Wishart Act and the common law. I will deal with the latter argument first.

[67] The Arthur Wishart Act imposes a duty of fair dealing and the duty to act in good faith and in accordance with reasonable commercial standards on all franchise agreements before or after the coming into force of the Act, if the business is operated in whole or in part in Ontario. (see s. 2(2) of the Act)

[68] Notwithstanding, there is a presumption against the retroactive application of legislation. (see MacKenzie v. British Columbia (Commissioner of Teachers’ Pensions) 1992 CanLII 229 (BC C.A.), (1992), 94 D.L.R. (4th) 532 (B.C. C.A.)). That being the case, although the duties of good faith set out in the Act apply to all franchise agreements in Ontario, the duties do not apply to events which occurred prior to June 8, 2000, which is when the Act came into force. For this reason, I have concluded that the Act does not assist the plaintiffs to redress events which occurred prior to June 8, 2000.

[69] However, Ontario courts have held that franchisors owe a duty of good faith to their franchisees even absent the Arthur Wishart Act (see Shelanu Inc. v. Print Three Franchising Corp., [2000] O.J. No. 4129 (Ont. S.C.J.); Perfect Portions Holding Co. v. New Futures Ltd., [1995] O.J. No. 2113 (Ont. Gen. Div.); Country Style Food Services Inc. v. Hotoyan [2001] O.J. No. 2889 (Ont. S.C.J.)). As Nordheimer J stated in Shelanu Inc.:

…conduct by a franchisor or by a franchisee which demonstrates bad faith, or manifests an intention not to conduct itself fairly in its dealings with the other, would give rise to a claim for damages by the other party or would, in cases of more serious conduct, give rise to a right in the other party to terminate the franchise agreement.

[70] To appreciate the wisdom of these words, one need look no further than the terms of the franchise agreement between the plaintiffs and the defendant, found at Tab 8 of the Joint Document Brief. The recitals to the agreement attest to the franchisor’s “high reputation” with the public and the value of the franchisor’s “know-how” in the sale of submarine sandwiches. The third recital refers to the benefits of being identified with and licensed by the franchisor to sell its products. The terms of the agreement overwhelmingly favour the franchisor. The franchisee is bound to follow the requirements of the franchisor in virtually every aspect of his business. The location of the business and the lease must be approved by the franchisor; all leasehold improvements must be approved by the franchisor, performed by its agents and paid for by the franchisee; all equipment is to be supplied by the franchisor and paid for by franchisee; the franchisee may only sell menu items supplied by the franchisor and at prices controlled by the franchisor; methods of operation are controlled by the franchisor; books of account are to be kept on the premises and are liable for inspection by the franchisor at all times; the franchisor has the right to audit and monitor the business and royalties are to be remitted weekly along with supporting documentation; even on the death of a franchisee, the franchisor, has the right to acquire the business on terms stipulated in the agreement; the franchisee’s bank statements and records are subject to the franchisor’s examination; if the franchisor seeks security for payment of monies due to it under the agreement, the franchisee must provide it or be considered in breach of the franchise agreement; the franchise agreement is only assignable under conditions that protect the franchisor’s interest first and above all else. The agreement is terminable by the franchisor on the happening of a host of events and there is a right of re-entry by the franchisor that is all encompassing.

[71] To think that the franchisee is an independent operator, completely at arms length from the franchisor is to ignore the extent of the control that the franchisor exerts over every facet of the franchisee’s business. Given the terms of their working relationship, it is clear that the business affairs of both franchisor and franchisee are tightly intertwined and are interdependent. The fortunes of the franchisor will rise directly with those of the franchisee and vice versa, except in circumstances where one of the parties to the agreement distances itself from the operations of the franchise and chooses to act in its own self-interests, which is what occurred here.

[72] It is clear that unless powers of the magnitude demonstrated by the franchise agreement are harnessed or at the very least, tempered by implied obligations of fair dealing and good faith originating either as a rule of law or by necessary implication from the contract, their unrestrained exercise will inevitably lead to oppressive consequences. It was the abuse of the power imbalance between the contracting parties in Whiten that prompted the Supreme Court of Canada to uphold a significant punitive damage award based on the breach of an implied term of good faith.

[73] Notwithstanding, the disposition of this issue is more appropriately based on another aspect of this case which clearly supports the plaintiffs’ invocation of an implied term of good faith and fair dealing in the contract. It is this. The existence of the practice of giving to the next closest franchisee the first right of refusal to operate a new franchise supports the conclusion that the parties to this agreement had a reasonable expectation that their relationship would be governed by principles of good faith and fair dealing. The practice amounts to a recognition that an existing franchisee might be adversely affected by the establishment of a new franchise and should therefore be given the opportunity and the right to offset any such adverse impact. Yet nowhere in the franchise agreement is such an obligation expressed. Nevertheless, the mutual business interests of both franchisor and franchisee justify such a practice and good faith requirements demand it. The common law has historically recognized a general rule applicable to every contract that each party agrees, by implication, to do all things as are necessary to enable the other party to have the benefit of the contract. (see Butt v. McDonald (1896), 7 Q.L.J. 68 at 70-71)

[74] That principle would seem to be just another expression of the good faith argument being proposed by counsel for the plaintiffs, a concept that legal writers say does not readily lend itself to precise definition. (see Shannon Kathleen O’Byrne, “Good faith in Contractual Performance: Recent Developments” (1995), 74 Can. Bar Rev. 70). What is more readily identifiable is bad faith which is said to occur when one party, without reasonable justification, acts in a manner which substantially nullifies the bargained objective or benefit contracted for by the other, or to cause significant harm to the other, contrary to the original purpose and expectation of the parties. (see Gateway Realty Ltd. v. Arton Holdings Ltd. (No. 3), [1991] N.S.J. No. 362 (N.S. T.D.) at 14). That is what occurred here. By that I mean, the establishment of the competing restaurant so close to the plaintiff’s restaurant seriously undermined the rights and benefits that the plaintiffs were entitled to receive pursuant to their franchise agreement with the defendant.

[75] There is yet another justification for punitive damages. Counsel for the plaintiff argued that between December 1999 (when the franchise opened at LJS) and November 2000 (when the plaintiffs closed their Eaton Centre operation) the defendants never assisted the plaintiffs either in the form of reduced royalties or advice as to how to deal with their predicament. Although Mr. Colley had been in the habit of visiting their franchise at least once monthly when times were good, after sales fell, and with the opening of LJS, Mr. Colley never visited the plaintiffs again. Nor did the defendant offer any support of any kind to the plaintiffs. This was in breach of representations contained in the defendant’s own promotional material, found at Tab 5 of the Joint Book of Documents, which is distributed to potential franchisees. It includes the following representations: (the underlined portions constitute my own emphasis)

• As a franchise owner, you have the security of a strong, solid corporate support team.

• Mr. Sub’s Business Development Consultants are in the field every day to help you run your business, maximize sales, profits and operating standards.

• The Mr. Sub management team is a devoted group of professionals dedicated to helping your business grow.

• Why Mr. Sub? WE’RE THERE FOR YOU ALL THE WAY.

• Each franchisee is partnered with a Business development Consultant (BCD) to make the process of operating and managing your restaurant as successful as possible.

• A franchise-based business is a partnership and long-term relationship.

[76] These statements help to define the relationship between the plaintiffs and defendant. It is similar to that of a partnership, as I previously said and it is well accepted that duties of good faith and fair dealing are vital characteristics of partnership-type relationships. Partners are expected to act with utmost fairness and good faith towards one another. As Dubin C.J. stated in PWA Corp. v. Gemini Group Automated Distribution Systems Inc. reflex, (1993), 64 O.A.C. 274 (Ont. C.A.) at 284:

The essence of a partnership is that of mutual confidence and trust in one another, and it is of the essence of that relationship that mutual confidence be maintained.

[77] I am therefore driven to this conclusion. Given the nature of their relationship, the complete abandonment of the plaintiffs by the defendant when they were experiencing such serious difficulties in the operation of their Eaton Centre franchise was a serious breach of the defendant’s obligation to assist the plaintiffs when storm clouds gathered. When the plaintiffs themselves found a potential solution and presented it the defendant, it was incumbent on the defendant to do what it could to assist the plaintiffs to salvage what was left of their business. Based on the practices which had been followed up to that time, and based on the promises contained in the promotional material, the defendant had a legal obligation to assist the plaintiffs and offer LJS to them. The breach of that obligation constituted an actionable wrong. The defendant went two steps further. By actually opening a new restaurant in unreasonably close competitive proximity to the plaintiffs and then awarding the restaurant to someone else, the defendant violated the implied duties of good faith and fair dealing contained in their franchise agreement and promotional materials and thereby betrayed the trust that epitomizes the relationship between a franchisor and franchisee. The defendant’s behaviour constitutes an additional, independent, actionable wrong which satisfies the test in Whiten.

[78] With respect to the defendant’s submission that the award of punitive damages will provide the plaintiffs with an unnecessary double recovery, that is not warranted by the circumstances, I am not persuaded that the seriousness of the defendant’s behaviour can be so summarily excused. It is unfair and inequitable that a franchisee, who has worked with a franchisor over a period of ten years to develop a presence in a given location, should be ignored in the decision to open a competing business in such close proximity to them. The custom of giving the next closest franchisee the first right of refusal to operate a new franchise demonstrates that the franchiser’s rights were not absolute. Particularly is this true when the defendant did not trouble themselves to do market studies to determine whether the opening of a new franchise would impact on the plaintiff’s business. In the absence of such a study, it can only be presumed that the defendant was indifferent, callously and recklessly so in the circumstances of this case, to the impact that another restaurant opening less that 1500 feet away would have. One certainly could have assumed that the impact would have been negative and it was. The opening of a competing restaurant so close to the plaintiffs’ operation and awarding it to someone else when the plaintiffs’ were already heavily impacted by declining revenues was quite simply, an act of corporate callousness, in the circumstances of this case, and constituted such a serious breach of the good faith and the fair dealing requirements of the franchise agreement that the defendant’s behaviour should be condemned by the court.

[79] This is all the more true when the plaintiffs’ injury was exacerbated by the defendant insisting that the plaintiffs honour their restrictive covenant not to compete for two years within two miles of an existing Mr. Sub. The defendants had unfairly created a competing restaurant within 1500 feet of the plaintiff’s restaurant yet was now insisting that the plaintiffs not complete within two miles of any existing Mr. Sub. This was highly offensive corporate behaviour and its impact on the plaintiffs was overwhelming.

[80] The plaintiffs had been effectively put out of business and because of the restrictive covenant, she was prevented from earning a living in the only way she was trained to do, except in compliance with the terms of the franchise agreement, which the defendant itself had so flagrantly violated. That behaviour should and will attract punitive damages to deter other franchisors from similar forms of insensitive, high-handed behaviour.

[81] Since an award of punitive damages must be proportionate to an award of compensatory or non-pecuniary damages, I will fix those damages only after I have received further submissions on the revision of the calculations that this judgment dictates.

[82] Counsel should arrange a mutually convenient return date for further submissions to be heard in Hamilton through the trial coordinator’s office in St. Catharines at 905-988-6200, ext. 446.

Order accordingly.