Éric Préfontaine, Jennifer Dolman, Gillian S.G. Scott
June 28, 2012
In an unprecedented decision released on June 21, 2012, the Quebec Superior Court held that the Dunkin’ Donuts franchisor in Quebec fundamentally breached its franchise agreements with its Quebec franchisees by failing to adequately support its brand and stem the tide of the “Tim Hortons phenomenon” in that province. In the decision, Justice Tingley held that the franchisor’s failure to protect the brand was enough to support the franchisees’ claim of fundamental breach of their franchise agreements, and that brand protection is “an ongoing, continuing and successive obligation” of the franchisor.
This case was a group action brought against Allied Domecq Retailing International (Canada) Ltd. (Dunkin’ Donuts) by twenty-one plaintiff Dunkin’ Donuts franchisees that collectively operated thirty-two Dunkin’ Donuts franchises in Quebec. Dunkin’ Donuts was historically a strong brand with 210 stores in its Quebec heyday in 1998. However, its market share had been slipping in Quebec with a wave of Tim Hortons franchises flooding the province through the late 1990s and early 2000s. Under what Justice Tingley named the “Tim Hortons phenomenon,” Tim Hortons’ stores had multiplied five times from sixty stores in 1995 to 308 by 2005, and in turn Dunkin’ Donuts market share plummeted from 12.5% in 1995 to 4.6% in 2003. The plaintiffs claimed that while they had voiced concerns to Dunkin’ Donuts about rejuvenating the Dunkin’ Donuts brand and business strategy in Quebec as early as 1996, they found Dunkin’ Donuts to be unsupportive and unresponsive to their concerns.
Claim and Decision
The plaintiffs brought an action against Dunkin’ Donuts for the formal termination of their leases and franchise agreements together with damages totalling $16.4 million. The claim alleged a repeated and continuous failure by Dunkin’ Donuts between 1995 and 2005 to fulfill its explicit contractual obligations to “protect and enhance” the Dunkin’ Donuts brand in Quebec. The plaintiffs’ action was based on breach of contract, namely the franchise agreements between each plaintiff and Dunkin’ Donuts. The plaintiffs’ claim succeeded in full.
In his decision, Justice Tingley held that under its franchise agreement, Dunkin’ Donuts had promised its franchisees to protect and enhance both Dunkin’ Donuts’ reputation and “the demand for the products of the Dunkin’ Donuts system,” which Justice Tingley equated with the Dunkin’ Donuts brand itself. It was Justice Tingley’s finding that Dunkin’ Donuts failed to honour this promise in the Quebec market during the period from 1995 to 2005. The Court held that Tim Hortons therefore gained significant market share in Quebec to the detriment of Dunkin’ Donuts and its franchisees.
Justice Tingley accepted in its entirety the evidence of Navigant, the plaintiffs’ damages expert. He therefore awarded, to the dollar, the plaintiffs’ claimed damages of $16.4 million. The damages assessment was intended to put the plaintiffs in the financial position they would have achieved had Dunkin’ Donuts retained its leadership role in the Quebec fast food market. The Court essentially accepted the plaintiffs’ expert’s calculation of the sales that the plaintiff franchisees would have realized for the period 2000-2005 if Dunkin’ Donuts had been able to contain the Tim Hortons’ phenomenon, and then subtracted the actual sales experienced by the plaintiff franchisees, in order to arrive at the final damages amount. They were also compensated for the loss of their investment, which was calculated to be 50% of their annual sales.
Justice Tingley treated the matter at issue in this case as one of fundamental breach of the franchise agreement by the franchisor.1 While franchisees often take the position in litigation that the franchisor has fundamentally breached the franchise agreement, thereby entitling the franchisee to treat the agreement as ending, courts have been reluctant to find that is the case where the franchisee has the ongoing right and ability to continue to operate its business within an existing and established system. In holding that Dunkin’ Donuts had fundamentally breached its franchise agreements with the plaintiffs despite the fact that the plaintiff franchisees had been able to carry on the business and use the Dunkin’ Donuts brand and system, Justice Tingley went farther than the Ontario Court of Appeal was prepared to go in the leading “fundamental breach” case of Shelanu Inc. v. Print Three Franchising Corp. On the facts of the Dunkin’ Donuts case, Justice Tingley effectively found that the plaintiff franchisees were substantially deprived of the benefit of the franchise agreement. Dunkin’ Donuts’ lack of action in the competitive Quebec market substantially deprived the franchisees of the opportunity to operate their businesses and capitalize on their investments in Dunkin’ Donuts.
Although Quebec does not have specific franchise legislation, franchisors are required to perform their contractual arrangements in good faith and are bound by a duty of loyalty towards their franchisees. These obligations are specifically referred to by Justice Tingley in the decision and stated to be implicit to the franchise agreement. The breach of such obligations, as in the breach of an explicit obligation under the franchise agreement, constitutes a civil fault and gives rise to the remedies available in the Québec Civil Code, including termination of the agreement and/or damages.
Specific Term of Agreement
This decision does not impose a new obligation on franchisors; in finding that Dunkin’ Donuts fundamentally breached the franchise agreement, the Court relied on a very specific and very unusual, term in the Dunkin’ Donuts franchise agreement regarding Dunkin’ Donuts’ obligation to protect the “demand for its products” in the relevant market.2 Accordingly, it is reasonable to presume that the outcome would have been quite different absent such specific language.
However, given the Court’s focus on a specific term in the franchise agreement, it is worth noting that Justice Tingley also comments that it is “an underlying assumption of all franchise agreements” that the “brand will support a viable commerce.” It can be anticipated that franchisees may rely on this language to argue a positive obligation on the part of franchisors to compete aggressively and support their brands even in the face of market-changing tides.
Franchisor Initiatives to Revive the Brand Found Lacking
In 2000, Dunkin’ Donuts attempted to implement a remodelling and updating program for its franchisees (the Remodelling Initiative). Under the Remodelling Initiative, franchisees were offered certain incentives to remodel their franchise locations on a more accelerated timeline than that required by their franchise agreements. However, franchisees were ultimately discouraged from participating in the Remodelling Initiative by: 1) Dunkin’ Donuts’ requirement that they enter into a broad release in order to participate; and 2) the franchisees’ independent experts’ opinions that they would experience an insufficient return on investment from the Remodelling Initiative given the situation in the Quebec donut and coffee market. The Remodelling Initiative was therefore an abject failure, and did not meet the level of franchisee participation required to move forward.
In 2003, in another move to revive the Dunkin’ Donuts brand in Quebec, Dunkin’ Donuts transferred and assigned its rights under its franchise agreements in Quebec to Couche-Tard, Quebec’s convenience store giant, with Couche-Tard as Master Franchisee (the Couche-Tard Initiative). Despite its history and practice of brand strength, retail success and strong reach within the Quebec local market, Couche-Tard could not revive the Dunkin’ Donuts brand and move its franchisees towards profitability. Couche-Tard defaulted under the Master Franchisee Agreement within approximately a year. Both the Remodelling Initiative and the Couche-Tard Initiative were examples of too little too late, and the Court found that they fell short of Dunkin’ Donuts’ obligations to support the brand and system in Quebec.
No Fault Attributed to Franchisees
Justice Tingley wholly rejected Dunkin’ Donuts’ position that the plaintiffs were poor operators and ought to share some of the blame for the failure of the Dunkin’ Donuts system in Quebec. The Court in this case was obviously impressed with the calibre of the franchisees in the plaintiff group, finding that they were model, exemplary franchisees and leaders in the Dunkin’ Donuts franchise network. The plaintiffs were characterized by Justice Tingley as “twenty-one of the best Dunkin’ Donuts Franchisees in Quebec” who should be “applauded, not pilloried” while the “réseau [franchise network] collapses around them due to the contractual faults of their franchisor”.
In that vein, all of the defendant’s cross-claims against the franchisees who had failed to pay arrears of royalties, ad-fund contributions and the like were dismissed in their entirety. Justice Tingley found that these cross-claims had “not been substantiated during 67 days of hearings.” He further held that “franchisees cannot succeed where the franchise has failed.”
Putting the Decision into Context
When considering the decision, franchisors should keep in mind that it is a Quebec decision, applying civil law, and is not binding on any court outside of Quebec. Dunkin’ Donuts has also announced its intention to appeal.
Furthermore, the case is very fact specific. There was a very lengthy trial heard over sixty-seven days with evidence of a “host of failings” of Dunkin’ Donuts on various fronts for over a decade (1995 to 2005). These failings were established both by the plaintiffs and by acknowledgments and admissions from several of Dunkin’ Donuts’ witnesses and exhibits.
As Justice Tingley emphasized in his reasons, Dunkin’ Donuts’ failure to protect its brand in Quebec was not the result of a single result or omission. The decision, although very critical of Dunkin’ Donuts, does not mean that franchisors are always responsible for their franchisees having to close their doors. Justice Tingley explicitly recognized that a franchisor is not a guarantor of success and appeared to accept the proposition put forward by Dunkin’ Donuts that a franchise should not be seen as an insurance policy. In some cases franchises may fail because the franchisees are poor operators and do not follow the system; in other instances, franchises may fail because of a change in market conditions that are beyond the franchisor’s control. Liability must apply, at least in part, on a franchisor’s good faith treatment of its franchisees in the face of market change.
Franchisors should be very cautious about inserting performance covenants of the type witnessed in this case in their franchise agreements to the effect that the franchisor will protect and enhance both its reputation and the demand for the products of the system. Including such clauses will necessarily leave the franchisor’s obligations open to a wide scope of interpretation by a court.
Jennifer Dolman is a partner, and Gillian Scott an associate specializing in franchise litigation in Osler’s Toronto office. Éric Préfontaine is a litigation partner practicing in Osler’s Montréal office.
1 While there has been some question regarding the exact status of the doctrine of fundamental breach at common law following the decision of the Supreme Court of Canada in Tercon Contracters Ltd. v. British Columbia  1 S.C.R. 69, the doctrine likely continues to apply outside of the context of exclusion clauses and certainly in the Province of Québec.
2 It is extremely rare to find an explicit obligation in a franchise agreement that the franchisor protect its brand from competition. However, explicit obligations that the franchisor protect the brand from infringement are commonplace.