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Earlier this year, we reviewed two recent Supreme Court of Canada decisions, the first of which clarified the scope of the duty of honesty in contractual performance, and the second which clarified the nature and scope of the duty to exercise contractual discretion in good faith.

 In a recent decision, the Ontario Court of Appeal considered both Supreme Court of Canada decisions in its ruling on a cannabis licensing and rental deal gone wrong. 

Companies Enter Into Cannabis Licensing and Rental Deal

The appellant corporation holds the Ontario rights to the “Tokyo Smoke” cannabis brand, which it licenses to various retail operators. 

The respondent company 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 the respondent rented the retail premises from the appellant. 

Additionally, the appellant offered the respondent 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 the respondent had obtained its retail store authorization from the AGCO. 

The parties anticipated that the store would open in early June 2020.

Parties’ Deal Falls Through

However, two days before the store was supposed to open, a dispute arose as to the appellant’s obligation to fund the payment of the respondent’s rent for the month of opening. 

Faced with the appellant’s refusal to pay, the respondent advised the appellant that it would not be opening the store as planned. 

In the appellant’s view, this was a threat to cease carrying on business and accordingly constituted a breach of their agreement. Thus, the appellant terminated its relationship with the respondent and refused to pay the branding fee.

Parties Go to Court Over Failed Deal

Subsequently, the appellant brought an application seeking a declaration that the respondent had breached its various agreements, that the branding fee was not payable, and the respondent must therefore vacate the retail premises. 

In response, the respondent brought a counter-application seeking, among other things, payment of the branding fee and a declaration that the appellant had wrongfully terminated the license agreement and breached its duty of good faith in the performance and enforcement of contractual relations. 

Lower Court Finds Bad Faith Breach of Agreement 

The application judge dismissed the appellant’s application and granted the respondent’s application. She declared that the appellant had no valid reason to terminate the agreements, that it had acted in bad faith, and ordered it to pay the branding fee.

In part, the application judge found that the respondent’s communication to the effect that it would not be opening the store was not an event of default under the license agreement, describing it instead as “an emotional response to being given incorrect information at a critical time”. As a result, she concluded that the appellant’s termination of the license agreement was invalid. 

Additionally, she held that the appellant’s termination of the agreements was not done in good faith following testimony that the appellant had been looking for a way to end the relationship and had “pounced” on the respondent’s statement as a way to terminate the relationship and avoid paying the branding fee.

The appellant appealed the decision to the Ontario Court of Appeal.

Court of Appeal Overturns Finding of Bad Faith

On appeal, the appellant argued that, based on the following provision of the licensing agreement, it was entitled to end the agreement when the respondent threatened to cease carrying on business:

“26. The Licensor has the right, without liability, cost or penalty, to terminate this agreement with immediate effect on written notice to the Licensee if one or more of the following occurs.

(c) the Licensee ceases or threatens to cease to carry on business, or takes or threatens to take any action to liquidate its assets, or stops making payments in the usual course of business;”

However, the court found that the application judge had correctly decided that the respondent’s emotional frustration, viewed in context, did not meet the requirements of the parties’ termination clause. 

The court then turned the question of whether the appellant had breached its duty of good faith in contractual performance. The court began by noting that the application judge had not had the benefit of the above-mentioned Supreme Court of Canada decisions, as they had not yet been released.

The court therefore reviewed the application judge’s ruling with the benefit of the guidance provided by the two Supreme Court of Canada decisions. In the result, it found that that the application judge had erred in her conclusion of bad faith, stating:

“Put simply, in terminating the License Agreement, [the appellant] did not seek to undermine [the respondent]’s interests in bad faith. While [the appellant]’s notice of termination was, by definition, an attempt to put an end to the agreement, the termination right in question formed part of the parties’ bargain and reflected, among other things, the licensor’s legitimate interest in protecting its brand in circumstances that the parties expressly stipulated would give rise to a right of termination.”

As such, the court ruled that the application judge’s finding of bad faith had to be set aside.

Finally, the court dismissed the appellant’s ground of appeal relating to sublease.

In the result, the court therefore set aside the application judge’s finding of bad faith, but otherwise dismissed the appeal.

Contact Bader Law For Experienced Advice on Cannabis Business and Licensing Matters

Running a business involves an infinite number of both daily and long-term decisions, all of which will impact your venture. Choosing the appropriate legal structure will influence your success as it will affect your business from start-up options and share capital, to providing for future investment and profit-sharing. The way in which a business is structured will also have a significant effect on risk and liability.

Deciding how to structure your business is a task best undertaken with the guidance of an experienced corporate lawyer with noteworthy experience advising business owners on risk and liability.  At Bader Law, our business services lawyers have been advising clients who are looking to make the best choices about how to organize their business venture for several years.  We work hard to protect your financial and legal interests while ensuring your company operates successfully.

The business services our team offers include experience advising and assisting cannabis start-ups with business structure and licensing matters.

The business law team at Bader Law has decades of experience in establishing new legal identities for businesses throughout Mississauga and the Greater Toronto Area, be it as a private corporation, a limited liability partnership, a sole proprietorship, or a corporation needing to make a private placement of securities. Contact us online or at (289) 652-9092.