With a 12.5% market share and 210 stores in Quebec in the late 1990’s, Dunkin’ Donuts was an industry leader. By 2012, Dunkin Donuts’ Quebec presence had fallen precipitously to 13 stores.
At the same time, Tim Hortons increased its presence from 60 stores in 1995 to more than 300 stores by 2005. A Quebec court would later call it the “Tim Hortons phenomenon”. Dunkin Donuts’ franchisees were expressing their concern to the franchisor as early as 1996. The franchisees complained to the franchisor that it was not providing the support needed to combat Tim Hortons and the newly competitive marketplace. By 2000, the franchisees were demanding a plan from the franchisor, a plan which ultimately consisted of the franchisor contributing to store renovations and the recruiting of a new master franchisee. The plan failed and the situation continued to worsen. A group of franchisees collectively operating 32 Dunkin’ Donuts franchises then sued the Dunkin Donuts franchisor in Quebec. In the case of Bertico Inc. et al v. Dunkin’ Brands Canada Ltd., the franchisees claimed for the formal termination of their franchise agreements and leases, as well as for damages of $16.4 million stemming from the alleged repeated and continuous failure by Dunkin’ Donuts to fulfil its contractual obligations to protect and enhance the Dunkin’ Donuts brand in Quebec between 1995 and 2005.
The franchisees were entirely successful and were awarded $16.4 million in damages. The Quebec Court of Appeal reduced the quantum of damages to approximately $11 million but otherwise largely upheld the lower court’s decision. In doing so, the Court of Appeal confirmed the trial judge’s decision that the franchisor owed an implicit obligation of good faith to protect and enhance the brand. The franchisees, according to the court, were entitled to rely on the franchisor to take reasonable measures to protect them from changing market conditions.
The concern for franchisors across Canada is what effect this decision, together with a similar 1997 Quebec decision of Provigo Distribution Inc. v. Supermarche A.R.G. Inc., will have on the industry. Will franchisors be liable to their franchisees where the franchisor is deemed, in hindsight, to have failed to exercise prudent business judgment?
Will franchisors owe a duty to their franchisees to guarantee profitability and success?
While the Dunkin’ Donuts decision is disconcerting for franchisors, there were two factors which would limit the precedential nature of the decision. Firstly, the decision turned on facts that were specific to that case. Specifically, the franchise agreements contained express terms which placed an obligation on the franchisor to protect and enhance the value of the brand. Such terms are relatively rare and are generally not found in franchise agreements in Canada.
Secondly, the court relied on Article 1434 of the Civil Code of Quebec (CCQ) in finding the implied duty to protect the strength of the brand. In applying Article 1434 of the CCQ, the court found that the obligations owed by the franchisor to its franchisees are not only those explicitly stated in the agreements, but also implicit obligations that flow from the nature of the franchise agreements. The CCQ is unique to Quebec and decisions under it are not binding on courts outside of Quebec.
The Court of Appeal rejected the franchisor’s argument that the decision effectively imposed on it an obligation to guarantee its franchisees’ success. The court found that the franchisor was under an obligation of means, not an obligation of results. The franchisor was found liable as a result of a decade of failings. The franchisor was not found liable for the resulting decline of the value of the brand. If the franchisor had used reasonable efforts to maintain and enhance the brand, it would likely not have been found liable even if the value of the brand did, nonetheless, decline.
The concern is that the Dunkin’ Donuts decision may represent a slippery slope where other judicial bodies may rely on it when placing an implied duty on franchisors and ruling in favour of unhappy franchisees.
Given the unique fact-set underlying the Dunkin’ Donuts decision, and given that the decision is based on the Civil Code of Quebec, the decision is unlikely to affect future decisions, especially outside of Quebec. If nothing else, however, the decision should reinforce that franchisors must be attentive to ensuring that their franchisees comply with the standards of their franchise systems.
Franchisors may be liable, similar to as in the situation in Dunkin’ Donuts decision, for the harm to their brands caused by under-performing or non-compliant franchisees.
If, however, franchisors are saddled with an implied duty to maintain the integrity of their brands, it gives the franchisors additional grounds to address franchisees whose operations are below the standards of their brands. This may be a welcome result of the Dunkin’ Donuts decision as, in the present legal climate in Canada, it is extremely difficult to address franchisees who are not in full compliance with the franchisor’s system.
Jordan Druxerman is a franchising and licensing lawyer at Garfinkle Biderman LLP in Toronto. Jordan can be reached at 416 869 7628 or firstname.lastname@example.org