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Diverging franchise rulings raise eyebrows

|Written By Julius Melnitzer

Two landmark franchise class action judgments have left both franchisors and franchisees with something to cheer about.

‘If you look at the jurisprudence as a pendulum, Tim Hortons represents a swing back to the middle of the spectrum,’ says Jennifer Dolman.

Early this year, franchisors across Canada hailed the Ontario Superior Court ruling involving Tim Hortons, Fairview Donut Inc. v. The TDL Group Corp., as a sign that judges will be taking a more balanced approach to franchise litigation going forward.

“Because the purpose of Canadian franchise legislation is to redress potential power imbalances between franchisors and franchisees, Canadian courts have tended to interpret this legislation broadly in favour of franchisees,” says Jennifer Dolman of Osler Hoskin & Harcourt LLP.

“If you look at the jurisprudence as a pendulum, Tim Hortons represents a swing back to the middle of the spectrum.”

Just a few months later, however, Quebec Superior Court Justice Daniel Tingley found that Dunkin’ Donuts had fundamentally breached its agreements with its Quebec franchisees by failing to adequately support the brand and stem the rapid rise of arch competitor Tim Hortons in Quebec.

He awarded $16.4 million in damages to the franchisees.

“Generally speaking, franchisees assume the competitive and other business risks,” says Jeffrey Hoffman of Gowling Lafleur Henderson LLP.

“But this case elevates the franchisor’s obligation to maintain standards of service to a responsibility to enhance the reputation of the brand and the demand for product.”

But reaction to the impact of both cases has been mixed.

Allan Dick of Toronto’s Sotos LLP, a franchise boutique, says there is nothing novel about the Tim Hortons case.

“The ruling is fairly consistent with accepted principles and as such is not a shift in the pendulum,” he says. “It is a win for franchisors on facts that are clearly within the accepted law.”

Dolman, however, says the 166-page judgment, in which Justice George Strathy dismissed the action, is a highly persuasive one that will be influential.

“I agree that Strathy does not make any novel points, but the manner in which he states the law and the length he goes to make his points make the decision a powerful precedent that will affect future cases.”

The Tim Hortons case was a proposed class action brought under Ontario’s franchise law, the Arthur Wishart Act, that imposes a duty of dealing fairly and in good faith on both franchisors and franchisees.

In it, the franchisee plaintiffs and proposed class representatives asked Strathy to consider whether Tim Hortons had an unlimited power to impose system changes on them and to charge them any prices it saw fit.

At the core of the case were the “Always Fresh” and “Lunch Menu” programs.

The Always Fresh program involved a change in the way the company produced baked goods.

After extensive communications with franchisees, Tim Hortons decided to switch the system from having them bake their own doughnuts to delivering frozen ones that they readied for sale.

The price increase in the cost of the frozen doughnuts significantly affected the profitability of the goods affected by the conversion.

With regard to the Lunch Menu, the plaintiffs complained that Tim Hortons had breached both its contractual duties and the duty to deal fairly by requiring franchisees to buy Lunch Menu item ingredients from the franchisor at prices that were higher than the market price.

Strathy, however, refused to look at these matters in isolation.

“The court made it clear that franchisees can’t use the duty of fair dealing to attack each and every aspect of the franchising relationship,” says Dolman.

“Rather, the court would look at the overall relationship and the overall benefits to the parties.”

In this case, it was clear that being a Tim Hortons franchisee was a profitable endeavour. Coffee, for example, was a lucrative and profitable item.

“And no one was complaining about the cost of coffee,”

Dolman notes.

From this perspective, it wasn’t reasonable to ask the court to take the profitability of the Always Fresh and Lunch Menu items in isolation and to assess the fairness and perhaps to rewrite the contract on that basis.

“The court made it clear that the franchisees had no right to make a profit on anything in particular,” says Dolman.

“The court recognized that the heart of franchising was uniformity and that individual franchisors could not just pick and choose what they wanted to comply with.”

The result might have been different, Dolman observes, if the franchisees were unprofitable.

“This was not the right system to attack on the basis of particular items’ profitability,” she says.

In contrast to their reaction to the Tim Hortons case, however, franchisors initially reacted with shock to Bertico Inc. v. Dunkin’ Brands Canada Ltd., which some have interpreted as meaning that franchisors have a fundamental, ongoing, continuing, and successive obligation to support their brands.

But many franchise lawyers say the industry has for the most part overreacted to the decision.

“The panic arises from the perception that franchisors must now ensure the success of their franchisees,” says Dolman. “My opinion is that amounts to an exaggeration of what the case says.”

Dolman points out that the decision turned on a unique contractual provision requiring Dunkin’ Donuts to protect the demand for its products in the relevant market.

“It is extremely rare to find in a franchise agreement an explicit obligation of this kind that effectively requires the franchisor to protect its brand from competition,” says Dolman.

“And it’s reasonable to presume that the outcome would have been quite different absent such specific language.”

But Dolman agrees that the decision is without precedent.

“This is the first franchise case in which a court has found that fundamental breach has occurred,” she says. “Historically, courts have been reluctant to make this finding even in fairly egregious cases where the franchisor has engaged in a whole litany of defaults.”

Dolman has little doubt that franchisee lawyers will be trying to make the most of the decision.

“Even though Justice Tingley acknowledged that franchisors are not the guarantors of franchisees’ success, we will be seeing franchisees’ lawyers trying to hold franchisors responsible for closures and for the impact of competitive tides,” Dolman says.

For his part, Hoffman agrees that Bertico is an unusual case whose application and precedential value should be confined to its unique facts. But that’s not to say that franchisors shouldn’t take heed of the decision.

“The message to the franchise community is that franchisors should create a meaningful, well-thought-out response in the face of increased competition or other forces that may be eroding their products’ market position, goodwill, trademark or brand,” he says.

According to Hoffman, Dunkin’ Donuts’ problem was it didn’t pass the “smell test” in this respect.

“Dunkin’ Donuts’ solution was to suggest that franchisees invest $200,000 in a remodelling program that never got off the ground,” he notes.

“Dunkin’ Donuts also failed to deliver on its promise to inject $20 million to revive the brand.”

The key difference between the results in Tim Hortons and Bertico might well be in the differing attitudes the franchisors took to their franchisees.

“Tim Hortons demonstrated that it had taken years to develop the program, done a number of studies, got feedback from the franchisees, and took account of their interests,” says Hoffman. “This was not the case in Bertico.”

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