Canada: Québec Court Of Appeal’s Dunkin' Case Judgment: Franchisor’s Liability Confirmed, But Awarded Damages Reduced

When it comes to franchise law, Québec is in a class of its own. Unlike other Canadian provinces, the franchise agreement in Québec is an innominate, onerous, synallagmatic contract of successive performance governed by the rules of common law under the Civil Code of Québec, as well as by certain statutes of general application.

Thus, franchise agreements in Québec are not defined or governed by any particular statute, as they are in Ontario with the Arthur Wishart Act (Franchise Disclosure), 2000, S.O. 2000, c. 3, or in Alberta with the Franchises Act, RSA 2000, c-F23.

The Québec franchise agreement is a contract concluded between two independent parties – the franchisor and the franchisee. They are bound by a contractual relationship, which is defined and determined by the parties in the agreement. As is the case with all contracts governed by Québec law, the franchise agreement contains explicit obligations, i.e., those set out by the parties to the agreement, and implicit obligations, i.e., those stemming from the nature of the agreement as well as from usage, equity and the law.

Given this context, franchise law in Québec is shaped by case law. Thus, it is through the various franchising judgments issued by the courts that the obligations respectively incumbent upon the franchisor and the franchisee are analyzed, defined and specified.

The Dunkin' case is clearly the biggest franchising court case in Québec's history since the Provigo1judgment in 1997. On April 15, 2015, the Québec Court of Appeal released a much-awaited decision with regards to this legal battle, which has been ongoing since 2003, between 21 franchisees collectively operating 32 Dunkin' Donuts establishments in Québec and the Canadian franchisor Dunkin' Brands Canada.

The 2012 Québec Superior Court judgment

First, a brief summary of the proceedings instituted by the franchisees against the Canadian franchisor Dunkin' Brands Canada:

In 2003, the franchisees filed a motion with the Québec Superior Court to terminate their franchise agreements and leases, and to seek damages from the franchisor. 

In their main complaint against the opposing party, the franchisees claimed that the franchisor had breached its contractual obligations by failing to protect and enhance the "Dunkin Donuts" brand in Québec from 1995 to 2005, when franchisees faced fierce competition from Tim Hortons.

The franchisees also criticized the franchisor's failure to execute its own action plan. In fact, towards the end of the 2000s, Dunkin' Brands Canada had established a voluntary program for its franchisees to deal with and respond to the intense competition offered by Tim Hortons. This voluntary program involved the franchisees making a sizeable investment to renovate their respective establishments as well as entering into a broad release for the benefit of the franchisor, in exchange for incentive payments from the franchisor. The action plan also provided that the franchisor would make an investment of nearly $20M to enhance the "Dunkin' Donuts" brand in Québec.

Nevertheless, for various reasons, including a lack of participation by the franchisees, the franchisor's program was never applied. The franchisor then transferred and assigned all of its franchise agreement rights to Couche-Tard. Couche-Tard later terminated these agreements, stating that the franchises were not profitable.

After a 71-day hearing, the Honourable Daniel H. Tingley, writing for the Québec Superior Court, released a lengthy decision totalling over 40 pages. The Superior Court found that the franchisor had breached its contractual obligations by failing to adequately support its franchisees, and failing to protect and enhance its trademark network in Québec. Consequently, the Superior Court cancelled the releases entered into by the franchisees, finding these to be abusive and to have been obtained through false representations, and the Court terminated the commercial leases and franchise agreements. The Court also awarded the franchisees almost $16.5M for loss of profits, loss of investment and various damages.

Among other things, what emerges from the judgment rendered by the Superior Court is that with regards to franchising in Québec, brand protection is an ongoing and successive obligation incumbent upon the franchisor.

An inscription in appeal was filed on July 24, 2012. This case is greatly significant for the Québec franchising industry —  not only because of its magnitude, but also due to the fact that the Canadian Franchise Association had filed a motion for intervention. This motion was denied.2 

The 2015 Québec Court of Appeal judgment

On April 15, 2015, the Honourable Nicholas Kasirer, writing for the Québec Court of Appeal, effectively upheld the Superior Court's decision, but reduced the quantum of damages awarded to the franchisees from $16.4M to $11M.

At the outset, the Court of Appeal judgment brings interesting clarifications. It notes that the fact that the breakup of the Dunkin' Donuts franchise network in Québec is unprecedented in the province's annals of franchising has no bearing on the dispute between the parties before the courts. The Court further states that in fact, the dispute between Dunkin' Brand Canada and its Québec franchisees involves the application of widely accepted legal principles in Québec law, including the doctrine of implied obligations provided in section 1434 of the Civil Code of Québec and the duty of good faith set out in the Provigo judgment, which was rendered by the Court of Appeal nearly 18 years ago and holds undeniable precedential value.

A. The franchisor's grounds for appeal with regards to fault

The Court of Appeal rejected the seven main grounds of appeal raised by the franchisor with regards to fault.

Obligational content of the franchise agreement

The franchisor alleged that its obligation to protect and support the Dunkin' Donuts brand in Québec did not include the obligation to thwart all competition the franchisees might face, and the obligation to guarantee their profitability.

The Court of Appeal dismissed this first ground and affirmed that franchise agreements clearly state that the obligation of the franchisor is to make ongoing efforts to enforce high and uniform quality standards to protect and enhance the Dunkin' Donuts brand and reputation in Québec. This obligation is the very essence of the franchise agreement. Indeed, the franchise agreement establishes a long-term relationship of co-operation and collaboration between the franchisor and its franchisees — a relationship reflecting both common and diverging interests. To this end, the brand's protection is a crucial element and the franchisor must enforce it in a significant manner during the contractual relationship.

Thus, the Court of Appeal maintained the Superior Court's decision: the franchisor's obligation to protect and enhance the brand is ongoing and successive. The Court of Appeal noted that this is especially relevant considering the role and the powers given to the franchisor in the franchise agreement — that of constantly monitoring the network's operations and enforcing uniform standards. In this context, the franchisor's obligation to protect and enhance the brand was qualified by the Court of Appeal as a necessary complement to the franchise agreement by its very nature.

With regards to the implied duty of good faith as found in the Provigo judgment and which the Superior Court referred to extensively, the Court of Appeal wrote that the pursuit of diverging interests on the part of the franchisors and the franchisees does not constitute an obstacle to the duty of mutual good faith. On the contrary, the pursuit of diverging interests must be exercised within the parameters of the contract and of the inherent duty of good faith, a responsibility shared by the parties. The duty of good faith implies an obligation of co-operation which is the inherent feature of any relational contract such as the franchise agreement.

Thus, the Court of Appeal upheld the Superior Court's decision, stating that the franchisor has breached his duty to protect and enhance the brand.

Intensity of the franchisor's obligation to protect and enhance the brand

The franchisor argued that his obligation to protect and enhance the brand is an obligation of means and not an obligation of results.

The Court of Appeal rejected this argument on the grounds that the franchisor does not differentiate between intensity of obligation and quantum of damages.

Application of the "business judgment rule"

The franchisor argued that the "business judgment rule" must be applied.

The Court of Appeal rejected the proposed application of the "business judgment rule." Any business has discretion in conducting its business activities, but courts have the power to intervene when there are allegations of breach of contractual obligations from a party.

Assessment of the evidence with regards to measures undertaken by the franchisor

Measures undertaken by the franchisor to assist the franchisees in staving off the strong competition presented by Tim Hortons were not sufficiently taken into consideration, according to Dunkin' Brands Canada.

The Court of Appeal dismissed this argument, reiterating that the franchisor had tolerated bad performance on part of some franchisees that the Court of Appeal qualified as "bad apples" in its judgment, which disadvantaged the network of franchisees. Moreover, the measures taken by the franchisor were insufficient under the circumstances.

Lack of causal connection

The franchisor affirmed that there was no causal connection between the conduct of the franchisor and the damages suffered by the franchisees. This ground of appeal was also dismissed.

Validity of the releases

The franchisor asserted that the releases signed by the franchisees were valid and should not have been annulled by the Superior Court. This ground of appeal was rejected.

Prescription evidentiary objections

The franchisor affirmed that the arguments raised at trial court regarding the prescription were not considered and that some evidentiary objections asserted should have been granted. This ground of appeal was rejected.

B. The franchisor's grounds for appeal with regards to damages

With regards to damages, the franchisor affirmed that the Superior Court had erred in its assessment of damages awarded for loss of profit and loss of investment.

Loss of profit

Contradictory methods for calculating loss of profit were presented by the parties' respective experts at trial court. The preferred method of calculating losses was that of the franchisees, which is based on a comparison with Tim Hortons' growth during the relevant period.

Thus, the Superior Court awarded profit losses to the franchisees based on 100% of Tim Hortons' growth in Canada, totalling almost $7.4M between 2000 and 2005. In appeal, the franchisor asserted that it was unreasonable to adopt such a calculation method considering the major differences between Tim Hortons' and Dunkin' Donuts' business models. More specifically, the franchisor drew attention to the fact that Tim Hortons had a drive-through service, while Dunkin' Donuts did not.

The Court of Appeal intervened to review the amount awarded as loss of profits for the franchisees with regards to two aspects. The first pertained to the relevant period on which the loss of profit calculations were based. The Court of Appeal applied the three-year legal prescription period and subtracted an amount of $248,000 from the damages awarded by the Superior Court to the franchisees as loss of profit.

The second aspect pertained to royalties and other payments that franchisees owed under their franchise agreements. Taking into account the franchisor's condemnation to pay the franchisees' loss of profit, the latter are still obliged to pay any contribution owed as if the contract had been properly executed under the principle of performance by equivalence. Thus, an amount of $890,528 was subtracted from the amount awarded by the Superior Court as loss of profit.

Moreover, the Court of Appeal reviewed the trial court's decision and retained, as a basis for comparison, 75% of Tim Hortons' growth and not 100% as the Superior Court had calculated. The Court of Appeal deemed it necessary to take into account the competitive advantage held by Tim Hortons with its drive-through service, as well as the advantage Tim Hortons obtained from the weakening of Dunkin' Donuts' competition. It was also necessary to take imponderables into account, as had been done in the Provigo judgment.

The damages awarded to the franchisees as loss of profit were thus reduced from almost $7.4M to $4.4M.

Loss of investment

The Court of Appeal believed that the calculation of the damages awarded as loss of investment should have also been calculated through a comparison with Tim Hortons based on 75% of its growth rather than 100%. Moreover, the franchisees who received money from the franchisor to renovate their establishment will have to reimburse it.

The damages awarded as loss of investment were reduced from almost $9.1M to $6.5M.

Conclusion

In short, the judgment rendered by the Superior Court of Québec in 2012 has been completely maintained with regards to the liability of the franchisor, Dunkin' Brands Canada. As for the damages, the quantum has been revised by the Court of Appeal: the damages awarded by the franchisees have been reduced from $16.4M to $11M, plus interests and disbursements — an amount to be divided among the franchisees.

The parties have been given 60 days to request leave to appeal before the Supreme Court of Canada.

In another judgment rendered on April 15, 2015, the Court of Appeal also rejected the franchisor's appeal pertaining to special fees of $240,000 that were awarded to the franchisees by the Superior Court of Québec.3

What emerges from this Court of Appeal judgment is that the franchisor's obligations to protect and enhance the brand in its network of franchisees is far-reaching. It will be interesting to note the judgment's impact on the Québec franchise industry over the coming years.

Considering the increasingly fierce competition in many markets — due to a new entrant or the rise or regrouping of existing players — franchisors will need to be more proactive in protecting and enhancing their network's brand, as their actions are likely to be closely scrutinized by both franchisees and other industry players.

The Québec Court of Appeal decision is available here.

Footnotes

1 Provigo Distribution inc. v. Supermarché A.R.G. inc., 1997 CanLII 10209 (QC CA)

2 Bertico inc. c. Dunkin' Brands Canada Ltd., 2012 QCCS 2809

3 Dunkin' Brands Canada Ltd c. Bertigo inc. et al., Québec Court of Appeal, 500-09-023156-128 (April 15, 2015)

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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