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Contracts - Illegality - Severance

2176693 Ontario Ltd. v. Cora Franchise Group Inc. (Ont CA, 2015)

In this case the Court of Appeal engages in an extended consideration of the issue of severing portions of a contract for illegality, here in the context of the franchise-governing Arthur Wishart Act ("AWA"):
(a) General Principles of Severance

[35] Where part of a contract is unenforceable because enforcement would be contrary to statute or the common law, rather than setting aside the entire contract, courts may sever the offending provisions while leaving the remainder of the contract intact. Severance lies along a spectrum of remedies available when a provision of a contract is illegal, including voiding the contract in whole or in part. The appropriate remedy will depend on the particular context: Transport North American Express Inc. v. New Solutions Financial Corp., 2004 SCC 7 (CanLII), [2004] 1 S.C.R. 249, at para. 6. Courts are generally reluctant to sever contractual provisions because severance alters the terms of the original agreement between the parties: Shafron, at para. 32.

[36] Severance takes two forms: “blue-pencil” and “notional”. Blue-pencil severance involves removing part of a contract, as if by drawing a line through it. Notional severance “involves reading down a contractual provision so as to make it legal and enforceable”: Shafron, at para. 2. Where severance is appropriate, courts choose the technique that “in light of the particular contractual context involved, would most appropriately cure the illegality while remaining otherwise as close as possible to the intentions of the parties expressed in the agreement”: Transport North American Express Inc., at para. 32.

[37] Courts will consider the context of the contract at issue and any relevant policy considerations when assessing whether and how to sever provisions: see, for example, Shafron. Severance engages policy concerns to a certain degree beyond protecting the parties’ intentions, because the court is being asked to assist one party to enforce an otherwise unenforceable provision.

[38] The context here is a business relationship carried out through the vehicle of a franchise. Franchise agreements are contracts of adhesion, frequently in standard form with the “main provisions … presented on a ‘take it or leave it basis’”: Shelanu Inc. v. Print Three Franchising Corp. (2003), 2003 CanLII 52151 (ON CA), 64 O.R. (3d) 533 (C.A.), at para. 58. These contracts often give the franchisor a significant degree of control over the franchisee’s business. In interpreting franchise agreements, courts have applied “policy goals in addition to accuracy in giving effect to the parties’ intentions” and have expressed “concern about inequality of power within the contractual relationship, and the resultant need to protect the more vulnerable contracting party from abuse at the hands of the more powerful party”: Geoff R. Hall, Canadian Contractual Interpretation Law, 2nd ed. (Markham: LexisNexis Canada, 2012), at p. 194.

[39] For the reasons outlined below, in my view, s. 22.6.4 should not be read down to permit the appellant to require a release of only non-AWA claims. The blue pencil approach does not apply in the circumstances, because there is no phrase in s. 22.6.4 that could be struck to enable the clause to require a release of only non-AWA claims. The clause should not be notionally severed given that severance would undermine the purposes of the AWA.

(b) The Clauses Should Not Be Notionally Severed

[40] In my view, notional severance is not an appropriate remedy in the circumstances, as it could undermine the purpose of s. 11 of the AWA. This court’s decision in Midas Canada Inc. is not determinative of whether clauses in a franchise agreement purporting to require a release can be severed. However, the reasoning in that decision informs the analysis and supports the view that notionally severing or reading down clauses calling for a broad release would not be in line with the purposes of the AWA. Before continuing with the severance analysis, I pause to consider the Midas decision.


(ii) Relevant Factors for Notional Severance

[48] In Transport North American Express Inc., at para. 42, a case dealing with a contract providing for an illegal rate of interest, the Supreme Court adopted several factors to assess the appropriateness of notional severance or partial enforcement as a remedy in the face of an illegal provision in a contract. When re-worded to apply to the franchise context, the factors would read as follows: (1) whether the purpose or the policy of s. 11 of the AWA would be subverted by severance, (2) whether the parties entered into the agreement for an illegal purpose, (3) the relative bargaining positions of the parties and their conduct in reaching the agreement, and (4) the potential for the franchisee to enjoy an unjustified windfall. Although not in a statutory context, the Supreme Court relied on similar considerations in Shafron to conclude that, as a general rule, notional severance should not be available in the case of restrictive covenants in employment contracts (at paras. 37-41).

[49] While the context is different, some of the factors identified are useful in this case. Indeed, in Midas, MacFarland J.A. considered the first factor – the policies of the AWA – in concluding that the clauses at issue there were unenforceable. Here, the application judge considered similar factors as well. Considering these factors is also consistent with the court’s general approach to the interpretation of franchise agreements as discussed above, which takes into account policy goals and is concerned with the inequality of bargaining power between franchisors and franchisees.

[50] In my view, the illegal purpose factor, while appropriate in the illegal interest rate context, is not helpful when considering the terms of a franchise agreement. Franchise agreements are entered into for legal and legitimate business purposes, as was the case here. Even when considering a particular problematic clause, it will be rare that parties have an illegal purpose.

[51] Similarly, the factor looking at the positions of the parties and their conduct in reaching the agreement may be of limited assistance in the franchise context. Unlike a loan on which an illegal rate of interest is charged, a franchise agreement covers a wide range of subjects and is often in standard form. As such, the parties’ conduct in reaching the agreement may not provide much insight into whether severance of a particular clause would be appropriate. However, I note that the relative bargaining positions of the parties may be relevant, especially given the concern about inequality of bargaining power in the franchise context.

[52] In the circumstances of this case, there are limited factual findings on which to assess the parties’ positions and conduct in forming the agreement, so this factor is of little assistance.

[53] Accordingly, I consider only the first and fourth factors: whether the purpose or policy of s. 11 of the AWA would be subverted by the mode of severance suggested by the appellant, and whether the franchisee would receive an unjustified windfall if the clause is held to be unenforceable in its entirety.

(iii) The Purpose and Policy of Section 11 of the AWA Would Be Subverted by Severance

[54] As MacFarland J.A. held in Midas, the purpose of the AWA is to protect franchisees (at para. 30). Section 11, in particular, aims to protect franchisees against more sophisticated franchisors who might seek to have franchisees contract out of their AWA rights. As the application judge noted, enforcing in part a clause calling for a general release raises the potential for abuse by franchisors.

[55] In the context of restrictive covenants in employment contracts, the Supreme Court cited similar concerns about abuse in holding that notional severance was not available as a remedy. The Court in Shafron concluded that, permitting notional severance would “[invite] employers to draft overly broad restrictive covenants with the prospect that the courts will only sever the unreasonable parts or read down the covenant to what the courts consider reasonable” (at para. 33). Applying the doctrine of notional severance would also “[provide] no inducement to an employer to ensure the reasonableness of the covenant and inappropriately [increase] the risk that the employee will be forced to abide by an unreasonable covenant” (at para. 41).

[56] As this court said in Shelanu Inc. v. Print Three Franchising Corp., at para. 66, the franchise context is similar to the employment context. Like employees, franchisees generally do not have equal bargaining power to the franchisor and are unable to negotiate more favourable terms (because franchise agreements are contracts of adhesion). Their relationship with the franchisor continues to be affected by a power imbalance because the franchisee must submit to inspections and audits and is often required to purchase items from the franchisor (Shelanu, at para. 66).

[57] Applying notional severance to clauses otherwise unenforceable under the AWA would similarly invite franchisors “to draft overly broad [provisions] with the prospect that the courts will only sever … or read [those provisions] down”. It would provide no incentive to franchisors to ensure their franchise agreements are in compliance with the AWA. It would also increase the risk that a franchisee – having signed a waiver or release of all claims – would erroneously believe it is not entitled to pursue any claims against the franchisor, including its AWA claims. “Reading down” contractual requirements that overreach would have a chilling effect on the exercise of franchisees’ rights. Each of these possibilities suggests that notional severance would diminish the protection offered by s. 11 of the AWA against franchisors who might seek to have franchisees contract out of their AWA rights.

[58] In my view, therefore, permitting notional severance of the overbroad clause in this case could subvert the policy and purpose of s. 11 of the AWA.

(iv) The Franchisees Would Receive a Windfall to Some Degree

[59] The issue here is whether there is a potential for the respondents to receive an unjustified windfall if the clause is struck in its entirety rather than read down to require a release of non-AWA claims alone. The appellant argues in effect that the respondents would receive a windfall: they bargained to provide a release of all claims in exchange for the appellant’s consent to a transfer of their rights under the franchise agreement, and if the clauses are severed in their entirety, they will not have to provide any release at all. The appellant contends that the application judge’s decision has the effect of giving franchisees more than they are entitled to and eroding the franchisor’s contractual rights beyond what is required to give effect to the protections under the AWA.

[60] To the extent that the respondents would no longer be required to release their common law claims, the appellant is correct that the respondents receive a greater protection than what they would have been entitled to. However, the extent of the windfall is difficult to assess, since there is significant overlap between the common law and AWA claims of a franchisee alleging misrepresentation. Of course, there is no “windfall” to the respondents by not requiring them to release their AWA claims as such a release would not be enforceable.

[61] In any event, the legitimate interests of the franchisor, in the context of an assignment, are protected even without the requirement of providing a release. As the appellant notes in its factum, “the purpose of Cora’s assignment provision is to ensure that the franchise agreement is assigned to a party that will be a competent franchisee able to operate the franchise in accordance with Cora’s standards.” All of the other conditions precedent to the franchisor’s approval of an assignment remain in place. In particular, the appellant does not lose its ability to approve the assignee as a franchisee.

(v) Conclusion on Notional Severance

[62] The potential for some windfall to the respondents in this particular case does not outweigh the potential for abuse and subversion of the purposes of s. 11 of the AWA if severance were permitted. Having regard to the relevant considerations, I conclude that the clause should not be notionally severed or read down to require only a release of non-AWA claims. Allowing franchisors to include such clauses in franchise agreements, knowing courts would only find them unenforceable in part, could serve to undermine the purposes of the AWA.

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