Canada: Two Recent Court Decisions Have Caused A Stir In The Franchise Community

Tim Horton's Defeats Class Action on Motion for Summary Judgment

In February, 2012, a class action against Tim Horton's was dismissed on a motion for summary judgment.  Franchisees had complained that Tim Horton's conversion from in-store baking to a central baking/distribution system called "Always Fresh" increased costs to franchisees.  They also complained that the cost of goods used to prepare the Lunch Menu were too high with the result that they only broke even or lost money on the Lunch Menu.  They sought damages of $1B.

 Tim Horton's defended the claim arguing that the Always Fresh Conversion and Lunch Menu were permitted by the franchise agreement and that the franchisees had no right to obtain products at a particular price. It argued that it acted in good faith throughout the relationship.

Some franchisees did not support the class action.  They gave evidence that the conversion to the Always Fresh system improved their quality of life, allowed them to control inventory better, made them less reliant on bakers, allowed them to train staff quickly to bake donuts and reduced waste.  While there was an upfront cost to converting to the Always Fresh system, there were labour cost savings.  Tim Horton's communicated the changes to be made to its franchisees over a three-year period ending in 2004.  The Court found that, while the cost of donuts increased under the Always Fresh system (from 7 cents to 18-20 cents), there was evidence that had the change not been made, costs of in-store baking would have risen resulting in a cost of 30 cents per donut, due to increased labour and ingredient costs.  Retail prices for donuts also increased over time off-setting some of the cost increase of the Always Fresh system.

 With respect to the Lunch Menu, Tim Horton's and its Advisory Board of franchisees spent considerable time considering the Lunch Menu in general and menu items in particular.  They were alive to competitive threats in the market and the need to introduce new menu items only after careful consideration of the justification for a particular item, the cost of ingredients and the price at which it was to be sold. Considerable research was conducted with respect to demands for a particular product before decisions were made to introduce it or to replace some items with others.  Lunch Menu items were also used to cross-sell other items, such as coffee, and were important to maintaining customer flow.

Mr. Justice Strathy held that every product offering did not have to be profitable so long as Tim Horton's considered the "profitability and prosperity of the system as a whole" in making decisions about its menu offerings.

Justice Strathy dismissed the action after explaining that Tim Horton's did what its contract permitted it to do.  He found that the plaintiffs were trying to impose duties on Tim Horton's that did not exist:

The court's responsibility is to give effect to that contract and to require the parties to discharge their contractual obligations fairly, in good faith and in a commercially reasonable manner.  Under the guise of [bad faith] claims, the plaintiffs are really asking the court to re-write their contracts and to require Tim Horton's to perform those re-written contracts in a manner that the plaintiffs or their expert would find commercially reasonable. This is not the court's function.

This decision is under appeal. 

Quebec Superior Court Imposes a Duty on Dunkin' Donuts to Maintain and Enhance its Brand

In June, 2012, Mr. Justice Tingley of the Quebec Superior Court found Dunkin' Donuts liable for $16.4MM in damages to 21 of Dunkin's former franchisees.  The Judge ruled that Dunkin had a contractual obligation to take steps to protect its brand in the face of increased competition from Tim Horton's and that it failed to meet this obligation.  The Dunkin brand went from 212 stores in Quebec to only 115 stores over a ten year period (there are now only 13 stores in Quebec) while Tim Horton's increased the number of stores in Quebec from 60 to 308 over the same period of time.

Justice Tingely described this case as a "sad saga as well of how a once successful franchise operation, a leader in its field – the donut/coffee fast food market in Quebec – fell precipitously from grace in less than a decade; literally, a case study of how industry leaders can become followers in free market economies".

Justice Tingley ruled that Dunkin's franchise agreement "promise[d] to protect and enhance both its reputation and the "demand for the products of the Dunkin Donuts System"; in sum, the brand and that it did neither between 1995 and 2005.

The Judge based his decision on select provisions of the franchise agreement but the sections of the agreement referred to in the decision do not, on their face, impose the obligations on Dunkin' that the court concluded it had. For example, the trial judge took a clause that said that Dunkin' would develop marketing programs with a view to enhancing the brand and elevated them to an obligation to enhance the brand.

Nonetheless, Dunkin' made a number of promises to franchisees that, according to the trial judge, it did not keep. Dunkin' promised to inject $40MM to support the brand (half from franchisees and half from Dunkin').  This investment was never made.  Dunkin' encouraged franchisees to renovate their stores, on a voluntary basis, but sales did not increase for those that renovated.  This decision is under appeal. 

Conclusion

Tim Horton's carefully considered changes to its system to meet (and overtake) its competition.  It also solicited feedback from its franchisees before making those changes.  The case against it was dismissed. Contrast this result with the result in the Dunkin' case.  The court in Quebec concluded that Dunkin' failed its franchisees.  Whether it breached its agreements with its franchisees will now be considered by the Quebec Court of Appeal, but however the case turns out, the optics of the case were bad:  The Dunkin' system in Quebec sustained several years of stagnant sales, narrowing profit margins and then losses.  It was weak and vulnerable to competitive forces. It is unfortunate that Dunkin' did not recognize or respond to these forces,  both for its own sake and for the sake of its franchisees. 

The lessons from these cases for franchisors and brand holders:  Don't make promises that you don't intend to keep, dedicate resources to maintain and enhance your brand, and before implementing system-wide changes consider the impact of those changes on your franchisees.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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