The Quebec Court of Appeal has recently upheld the 2012 decision of the Superior Court awarding substantial damages – CA$10.9 million – to former franchisees of Dunkin’ Donuts.1  Application for leave to appeal was filed with the Supreme Court of Canada on June 15, 2015; a decision is expected in August.

There are varying views as to whether this decision is a landmark decision that will influence future litigation in respect of franchise agreements or whether it is relevant only to franchisees in Quebec.

In any event, this case has garnered a lot of attention - and can be a lesson for both franchisors and franchisees. Our May 14, 2015 publication provides a summary of the Quebec Court of Appeal ruling. This bulletin will consider aspects of the decision in more detail, with particular attention to the nature of the franchise relationship and the concept of good faith. The decision contains several points that could be applied across Canada.

The Case: A Brief Review

Twenty-one Quebec Dunkin’ Donut franchisees (the “Franchisees”) brought an action against Dunkin’ Brands Canada Ltd. (the “Franchisor”), asking the Superior Court to terminate their existing leases and franchise agreements and to award them damages for breach of contract.2 The Franchisees alleged that the damages arose from the failure of the Franchisor, over a period of about ten years, to protect and enhance the Dunkin’ Donuts brand in Quebec in the wake of the Tim Horton’s onslaught.

The Franchisor denied that it had breached any of its obligations to the Franchisees.  In particular, the Franchisor asserted that it had complied with its obligations under its franchise agreements, while the Franchisees had not; that it was not the insurer of the Franchisees nor did it guarantee their success; and that since the Franchisees had signed releases, they were estopped from claiming damages.  The Franchisor cross-claimed for unpaid monies royalties and other monies.

Superior Court Decision – Failure to Protect the Brand

In the June 2012 Superior Court decision, Mr. Justice Tingley referred to two versions of English language franchise agreements entered into by the Franchisees.  The 1990’s version enumerated a number of obligations for performance by the Franchisor.  Although the judge, in particular, discussed obligations that he felt flowed implicitly from the general nature of the franchise relationship, he mentioned the assistance to be provided by the Franchisor.  In particular, he remarked on the explicit obligation in one agreement: “to continue its efforts to maintain high and uniform standards of quality, cleanliness, appearance and service at all DUNKIN’ DONUTS SHOPS, thus protecting and enhancing the reputation of DUNKIN’ DONUTS CANADA”. (emphasis in original)

The Superior Court determined that the Franchisor had breached its agreements with the Franchisees by failing “to protect and enhance both its reputation” and the “demand for the products of the Dunkin’ Donuts System”, in sum, the brand.”3 The trial judge asserted that the “Franchisor had assigned to itself the principal obligation of protecting and enhancing the brand and that it had failed to do so, thereby breaching the most important obligation it had assumed in its contracts.  It must accept the consequences of such failure…Franchisees cannot succeed where the System has failed.”4

The Superior Court stated that the failure:

  1. occurred over an extended period of time;
  2. was brought about by many acts and omissions during that time period; and
  3. that brand protection is an ongoing obligation of a franchisor.

Court of Appeal Decision

In undertaking the appeal, the Franchisor argued that the court mistakenly imposed on it a “new unintended obligation to protect and enhance the brand, outperform the competition and maintain indefinitely market share.”5 The Franchisor further alleged that the judge “characterized its obligations as having an intensity of result” that “effectively guarantees the financial success of all Dunkin’ Donut franchisees”. 6 In addition, the Franchisor argued that the judge’s decision to supplement the clear terms of the agreements with the use of implied obligations and the obligation of good faith was “unwarranted and unjustified in the circumstances”.7

Mr. Justice Kasirer, writing for the court, maintained that the Franchisor had wrongly characterized aspects of the franchise relationship that have been widely understood by the courts, including the duties imposed on franchisors by the nature of their agreements. He set out, in an extensive, well-reasoned decision, why the judge did not err in reaching his conclusions that there was a correlation between the Franchisor’s breaches of contract and the losses suffered by the Franchisees. The Court of Appeal only reduced the amount of damages and allowed the Franchisor a small set-off for lost royalty payments.

Arguments and Lessons: The Franchisor/Franchisee Relationship

The province of Quebec does not have franchise legislation. Many of the bases for the decision come from provisions of its Civil Code. Currently five provinces in Canada have franchise legislation: Alberta, Manitoba, Ontario, Prince Edward Island and New Brunswick. (British Columbia has draft legislation.) Many of the provisions in these statutes are similar to one other. Most franchises in Canada operate in at least one of these jurisdictions. As noted below, based upon the comments made by this court, some of the determinations could have ramifications across Canada.

(a) Franchise Agreements: Length and Nature of Relationship Matters

Mr. Justice Kasirer upheld the trial judge’s finding that the Franchisor had an obligation ‘to protect and enhance the brand’ based upon the whole of the agreements, as opposed to specific language in the agreements, and upon the length of the relationship. Although there is mention of implied obligations under the Civil Code, there is also reference to the agreements establishing a relationship of cooperation and collaboration between Franchisor and Franchisees, to obligations of protecting the brand and sustaining the system, of choosing new franchisees and approving assignments and of offering assistance and over-seeing the operation of the network and the uniform system of standards. Based upon the foregoing, the court determined it appropriate that the trial judge found that the Franchisor had a duty to assist its Franchisees “in staving off competition in order to promote the on-going prosperity of the network as an inherent feature of the relational franchise contract.”8

It is more common now for franchise agreements to be for a shorter period than the Dunkin’ Donut Agreements, such as five years.  Many franchise agreements do contain renewal provisions (most with requirements to sign the current form of agreement), and accordingly, there is still a possibility that a court would consider the term indicative of a long-term relationship and of an investment made by the franchisee.  Although franchise agreements currently have fewer or no explicit franchisor obligations, as set out in the Dunkin’ Donut agreements, most still contain terms acknowledging the system and the value of the brand, and, whether specified or not, the understanding that the franchisor has the system for the purpose of maintaining uniformity, quality control and the franchisee deriving some benefit therefrom.  It is therefore to be expected that going forward, franchisees will try to rely upon the relationship between the franchisor and its franchisees and the obligations of protecting the brand and the system, to be carried over into other provinces.

(b) Good Faith

The Court of Appeal made reference to a provision in the Civil Code9 to support the principle that the Franchisor had to act in good faith.  The section of the Civil Code relied upon is perhaps broader than just this duty to act in good faith. This concept first arose in an earlier Quebec decision.10

However, in provinces with franchise legislation, there is a provision which is similar: “Each franchise agreement imposes on each party a duty of fair dealing in its performance and enforcement.”11 The question is whether a court, depending on the situation, will look at the behaviour of a franchisor in the context of the legislation and consider that a franchisor has not met its duty of fair dealing in the performance and enforcement of its responsibilities under the franchise agreement.  This court decided that the duty of good faith “is not confined to the circumstances of franchisors who compete unfairly with their franchisees”.12 This argument of a franchisor needing to act in good faith may filter into other provinces where a court is willing to consider the nature of the relationship and impose an obligation to assist and cooperate with its franchisees.

(c) The Faults of the Franchisor

Although the manner in which a franchisor behaves is fact specific, in the Dunkin’ Donuts situation, the Franchisor was advised by the Franchisees on several occasions of issues with the franchise system in Quebec. The Franchisor did not respond.  It is possible that this Court of Appeal decision may set a new standard for how franchisors need to respond when approached by franchisees and advised of their concerns.  It mentioned monitoring and weeding out underperforming franchisees.  Mr. Justice Kasirer also mentioned that the behaviour of the Franchisor was indicative of “a failure to take reasonable measures to uphold the value and on-going prosperity of the brand.”   Although what reasonable steps may be fact specific, again, this decision may certainly raise the bar as to what a franchisor may be required to do to protect the value of its brand.

Will This Set a New Standard?

This decision of the Quebec Court of Appeal, while based to some extent on the provisions in the Civil Code and the agreements, sets out in concise terms why the Franchisor was liable in damages to its Franchisees.  Whether it sets the standard for common law provinces is not yet known.  But the reasons clearly state that franchisors owe a certain standard of behaviour to those parties with whom they contract; to act fairly, to enforce the implied obligations in their agreements and to act to support and enhance their brand.13 In this way, it would seem to be a lesson for all franchisors and will most certainly lead to a higher level of scrutiny of both new and existing contracts. It will be interesting to see if the Supreme Court decides to review these determinations and if so, what it finds in respect of the obligations of a franchisor.