Canada: A Message To Franchisors: "Mind Your Brand"

Last Updated: January 10 2013
Article by Herbert Pinchuk and Daniel Khazzam

An expensive lesson for a large franchisor operating in Quebec was learned earlier this year. In the decision Bertico Inc. et al v. Dunkin' Brands Canada Ltd. (2012 QCCS 2809), the Superior Court of Quebec emphasized some of the consequences that might be faced by a franchisor which let its brand "slide" or failed to protect and enhance it.

Twenty-one Quebec Dunkin Donuts franchisees (the "Franchisees") sued Dunkin' Brands Canada Ltd., formerly Allied Domecq Retailing International (Canada) Ltd. ("ADRIC"), alleging the latter's breach of its principal obligation to protect and enhance the Dunkin Donuts brand in Quebec – an obligation which the Court found not only to be grounded in the franchise agreements between the parties but which, the Court also held, implicitly results from the nature of such agreements.

Until the mid-90s, the Dunkin Donuts brand enjoyed a significant presence and success in the Quebec market for coffee and donuts, experiencing very little competition. Around 1995, Tim Hortons began to aggressively increase its share of the market in a structured and well-executed manner, which concerned the Franchisees. The Franchisees also argued that during the following years, they struggled with ADRIC's high level of management turnover, a reduction of services offered, the franchisor's failure to remove underperforming franchisees from the Dunkin' Donuts network, the deterioration of the brand's image and a general lack of technical and management support from the franchisor.

After listening to the Franchisees' concerns in 2000, ADRIC proposed a voluntary remodel incentive program to the Franchisees which met certain prior conditions and were otherwise in compliance. Under this program, ADRIC agreed to contribute financially to the facilities of the Franchisees who participated and to invest $40 million in the "brand" in Quebec – $20 million of which would be the responsibility of the participating Franchisees. While ADRIC said that it would implement the program only if at least 75 stores in good standing participated, many Franchisees rejected the program, acting on the advice of their experts regarding its feasibility. Moreover, the general release in ADRIC's favour for any "faults" committed by it in the past, a pre-condition to the Franchisees receiving ADRIC's contributions, was a tough pill for them to swallow.

The Court, siding with the evidence submitted by the Franchisees' experts, criticized the program as economically unfeasible, and to the extent that ADRIC imposed the general release, it was illadvised and abusive towards the drowning Franchisees. Those Franchisees that participated in the program never saw the 15% increase in gross sales in the first year that ADRIC suggested they would enjoy and the latter did not inject anything close to $20 million of its funds to protect and enhance the brand. This misguided and poorly executed strategy to slow down store closures and improve the profits of existing stores was a failure.

The fallout from ADRIC's failure to protect and enhance its brand? Aside from terminating the leases and franchise agreements to which the Franchisees were subject, the Court awarded damages of $16.4 million to the Franchisees consisting of the profits lost by the Franchisees due to ADRIC's neglect, as well as their lost investments representing the difference in value had the Franchisees been able to sell their facilities at their traditional value.

This case serves as a cautionary note to franchisors operating in Quebec (and elsewhere). Franchise agreements are generally considered to be "contracts of adhesion" under the Civil Code of Quebec, that is, a contract whose essential stipulations are imposed by one party (in this case the franchisor) and are generally nonnegotiable. Clauses in such a contract that are deemed to be "abusive", as the Franchisees successfully argued was the case with ADRIC's general release, may be annulled or the obligations reduced by the courts.

This case also demonstrates that while franchisors are neither the "insurers" nor the "guarantors" of the success of their franchisees, they do have an ongoing, continuing and successive obligation to protect, support and enhance their brand, and they may be held accountable for their failure to do so, notwithstanding the very protective language generally inserted in franchise agreements for the benefit of and to protect the franchisor's interest.

It is to be noted that an appeal of the decision has been filed by ADRIC. This appeal is not likely to be heard for approximately two years. Until then, the franchise community awaits with interest further direction from the Quebec Court of Appeal.

With the assistance of Jordi Montblanch.

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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