Canada: Dramatic Expansion Of Liability For Franchisors In Canada – The Duty To Promote And Enhance Your Brand

Last Updated: July 3 2012
Article by W. Brad Hanna, FCIArb. and Laura Stefan

The Quebec Superior Court has just dramatically expanded the scope of liability for franchisors in Canada.  In Bertico Inc. et al. v. Dunkin' Brands Canada Ltd. ("Dunkin'")1 the Court held that a franchisor is required to promote its brand, fight off competitors and protect its market share for the benefit of the franchisees.

The Dunkin' decision has the potential to become a landmark decision that imposes additional obligations on franchisors and that develops new law in the area of franchisor-franchisee relations. 

We explain the Dunkin' case, and the significance of the ruling, below. 

The Facts

The plaintiffs, 21 former Dunkin' Donuts franchisees, sued the franchisor for its failure to protect and enhance the Dunkin' Donuts brand in Quebec. 

In the early nineties, Dunkin' Donuts was the market leader in Quebec, both by total sales and number of stores (over 250).  It had dominated the Quebec fast-food donut and coffee market for over 50 years.  By the mid-nineties, however, Tim Hortons was making an aggressive push into Quebec.  In 1996, the franchisees alerted the franchisor about their concerns that Tim Hortons was essentially eating their lunch in Quebec, and asked for a recovery plan to address the problem.  The franchisor implemented a remodelling program in response, but the economics of the program were not favourable to franchisees and only a handful invested in the facility improvements. 

By 2003, Tim Hortons had completely supplanted Dunkin' Donuts as the industry leader in Quebec.  Only 41 Dunkin' Donuts stores operated in Quebec by 2008, and approximately 11 stores remained at the time of the decision.  By contrast,  Tim Hortons increased from 60 locations in 1995 to 308 by 2005.  During that same period, virtually all Dunkin' Donuts franchisees in Quebec suffered stagnant sales (and most closed their doors) in spite of a growing fast food market. 

The plaintiffs sued the franchisor for negligence and breach of contract, claiming that the franchisor had made marketing, advertising and management errors that damaged the brand and that the product offerings were unsuitable for the Quebec market.  In essence, the plaintiffs alleged that the franchisor failed to address the competition presented by Tim Hortons, and that it allowed Tim Hortons to capture the market and render their franchises worthless.  The plaintiffs sought damages of $16.4 million as a result. 

The franchisor denied any breach of its obligations and alleged that the franchisees themselves were responsible for the decline of Dunkin' Donuts, claiming, among other things, that the franchisees failed to operate clean and renovated establishments.  The franchisor also defended on the basis that it is neither an insurer of the franchisees' businesses nor a guarantor of their success.  The franchisor also claimed that releases signed by some franchisees who participated in the remodeling program barred their claims.

The Decision

In a rather terse 43-page decision, the Court found in favour of the plaintiffs and awarded the full amount of their $16.4 million claim.  The Court observed that "Allowing Tim Hortons to capture the lion's share of the Quebec Fast Food donuts and coffee market between 1995 and 2003 was a huge and costly mistake", and concluded that the franchisor had breached both its express contractual obligations as well as those that are implicit in franchise agreements by their very nature. 

The Court relied upon provisions in the franchise agreement2 and the preamble of a subsequent amendment to conclude that the franchisor "had assigned to itself the principal obligation of protecting and enhancing its brand.  It failed to do so, thereby breaching the most important obligation it had assumed in its contracts.  It must accept the consequences of such a failure".   

Beyond finding that the franchisor was expressly required to protect and enhance its brand, the Court relied on a Quebec Court of Appeal decision3 for the proposition that franchisors are also bound by implied obligations which are "incident to" franchise agreements by their nature. Quoting the Quebec Court of Appeal's decision, the Court confirmed that:

The franchisor is bound to furnish to its franchisees any tools necessary to, if not prevent economic losses, at least minimize their impact on the franchisees.  [...] the franchisor must act in concert with the franchisees to develop an adequate commercial response allowing the franchisees to minimize their losses and to reposition their business in an evolving market.


The Court further observed that franchisors are bound by the duty of good faith and loyalty to work in concert with their franchisees. 

The Court accepted the plaintiffs' evidence that the franchisor had failed to adequately consult with, support and assist franchisees, lacked corporate stores to test products and train staff, had a high turnover of executives and not enough business and operations representatives to adequately service the franchises, and had failed to remove underperforming franchisees from the system.

The Court expressed its ultimate conclusion in strong language:

But the greatest failing of all was [franchisor's] failure to protect its brand in the Quebec market.  No doubt the host of failings chronicled by the Franchisees contributed to the collapse of the Dunkin Donuts' brand in Quebec.  A successful brand is crucial to the maintenance of healthy franchises.  However, when the brand falls out of bed, collapses, so too do those who rely upon it.  And this is precisely what has happened in this case.
...

This particular breach was not the result of a single act or omission... It was a failure over a period of a decade... to protect the brand brought about by a multiplicity of acts and omissions occurring during the period.  Brand protection is an ongoing, continuing and successive obligation (emphasis added). 

While the Court confirmed that a franchisor is not an insurer or guarantor of the success of its franchisees, it nonetheless held that "[the franchisor] is responsible to them for the harm caused by its failure" to enhance and protect the brand. 

Implications of the Decision

The decision in Dunkin' expands the scope of liability for franchisors dramatically.  Although never mentioned expressly anywhere in the liability portion of the decision, the Court appears to have employed a fundamental breach approach4.  In essence, the Court found that the franchisor, by not addressing the in-roads being made by Tim Hortons and allowing the Dunkin' Donuts brand to collapse in Quebec, substantially deprived the plaintiffs of the benefits (having a saleable brand) they expected from being franchisees. 

Regrettably, particularly given the potential ramifications of the decision, the Court's reasoning is much abbreviated.5  Consequently, it is difficult to draw a bright line around the type of franchisor conduct or inaction that will result in liability, and that which will not.  Among other things, the Dunkin' case offers no demarcation about:

  • When the principle that franchisors are not the insurers or guarantors of the success of their franchisees (as the Court at least recognized) gives way to franchisors being held liable for their failure to adequately promote the franchise system; 
  • How much market share must be lost for a court to conclude that the franchisor failed to address the problem or failed to adequately promote its brand for the benefit of franchisees; and
  • What specifically must a franchisor do to demonstrate that it has complied with its obligations to promote the brand, particularly when the franchisor suffers a loss of market share to a competitor despite its efforts to address same.

Obviously, the dramatic demise of the Dunkin' Donuts brand in Quebec, coupled with the complete failure of over 200 franchisees in the province, drove the result in the decision.  The decision should arguably be restricted in its application to only those franchise systems that suffer a similarly disastrous fall from grace. 

The franchisor will be appealing the decision.

Footnotes

1 The decision was rendered on June 21, 2012 and was made public on June 25, 2012.

2 The most significant of these provisions is s. 3.C. of the franchise agreement, which provided: "[The franchisor agrees] to continue its efforts to maintain high and uniform standards of quality, cleanliness, appearance and service at all DUNKIN DONUTS SHOPS, thus protecting and enhancing the reputation of DUNKIN DONUTS CANADA, DUNKIN DONUTS OF AMERICA INC. and the demand for the products of the DUNKIN DONUTS SYSTEM and, to that end, to make reasonable efforts to disseminate its standards and specifications to potential suppliers of the FRANCHISEE upon the written request of the FRANCHISEE" (emphasis added).

3 Provigo Distribution Inc. c. Supermaché A.R.G. Inc., [1998] R.J.Q. 47 (C.A.), p. 61.

4 The Court referred once to the concept of fundamental breach in its analysis of the franchisor's cross-claims for arrears of royalties and other amounts, stating that "[...] when contracts are fundamentally breached by one party, the other party cannot be held accountable for a subsequent breach by the prejudiced party."

5 The Court's actual analysis of the franchisor's liability is exceptionally brief (about 5 pages), particularly given that the trial lasted over 70 days.

The foregoing provides only an overview. Readers are cautioned against making any decisions based on this material alone. Rather, a qualified lawyer should be consulted.

© Copyright 2012 McMillan LLP

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Authors
W. Brad Hanna, FCIArb.
Laura Stefan
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