In a unanimous decision, the Québec Court of Appeal has upheld the decision of the Superior Court which found that a franchisor must take reasonable measures to protect and enhance the value and reputation of its brand. Thus, the Court of Appeal generally upheld the judgment against Dunkin’ Donuts Brands Canada Ltd. requiring it to pay an amount of CA$10.9 million (reduced from a higher amount) to its franchisees for loss of profits and the failure to adequately protect and enhance the brand, individually as well as for the entire network.

Summary of the facts

For almost a decade, Dunkin’ Donuts was the leader of coffee and doughnuts quick-service restaurant businesses in Québec. Tim Hortons entered the Québec market, taking away a significant market share. Facing such severe competition, Dunkin’ Donuts’ franchisees asked their franchisor for help to prevent a considerable amount of them from going into bankruptcy. According to Dunkin’ Donuts’ franchisees, although a plan was developed, the measures taken by Dunkin’ Donuts pursuant to the plan were not enough. Consequently, they sued their franchisor for negligence and breach of contract, as it had allegedly failed to address the increasing competition and mismanaged its network.  (The operative facts occurred during the 1995-2003 time period.)

Dunkin’ Donuts alleged in the Superior Court that it was not responsible for its franchisees’ losses, but rather that the franchisees themselves caused them because of their poor management in running their businesses. The Court did not agree and this unsuccessful line of defense was abandoned on appeal. Instead, the franchisor changed its strategy and based its appeal arguments on the alleged first instance judge’s misinterpretation of both the explicit and implicit terms of the franchise agreement.

In its decision, the Québec Court of Appeal rejected Dunkin’ Donuts’ arguments, qualifying it as “harsh in its characterization of the [trial] judge’s work,” but partly disagreed with the Superior Court judge with respect to the assessment of damages.

Key points

(i) The implied obligations of the franchise agreement

The franchisor argued that the judge misinterpreted the franchise agreement, in particular by wrongly holding the franchisor to an obligation of “guaranteeing the profitability of the brand.”

The Court of Appeal disagreed with the argument and held that the franchisor does not have an obligation to cause a result but, rather, an obligation with respect to taking “reasonable measures to protect and enhance the brand.” The reasoning of the Court was based both on the interpretation of the express language of the franchise agreement and the intent of the parties, as well as the implied obligation of good faith in contract law pursuant to the application of article 1434 of the Civil Code of Québec.

The Court of Appeal instructed that clauses in a contract do not necessarily contain all the obligations the parties must respect during its execution. The Court held that a contract may be subject to implied obligations which flow from the nature of the franchise agreement, which governs a long-term cooperative and collaborative relationship between the franchisor and each individual franchisee, and are “continuing” and “successive,” meaning that they exist for as long as the contract is in effect.

Moreover, contrary to Dunkin’ Donuts’ view that the obligation of good faith simply precludes a franchisor from competing with its own franchisees, the inherent contractual duty to act in good faith was interpreted by the Court as a necessary complement to the franchise agreement, i.e, the obligation for a franchisor to support and assist its individual franchisees and the whole of the network in adjusting to new market conditions.

(ii) Damages

Regarding the assessment of damages, Dunkin’ Donuts argued that the Superior Court judge’s evaluation of damages was wrong, including not having taking into account unpaid royalties by the franchisees. The Court of Appeal partly upheld the reasoning of the franchisor, and reduced the amount awarded from CA$16.4 million to CA$10.9 million.

The Court said that, since there was an ongoing contractual relationship, the requirement that the franchisor pay damages does not excuse the franchisees from performing their own obligations under the franchise agreement, such as paying royalties, until the termination of the contract. Therefore, the amount of damages to be paid by the franchisor must be reduced by the amount of royalties payable by the franchisees.

Conclusion

It must be noted that this case is a Québec civil law decision based on the Civil Code of Québec – not the common law.  Dunkin’ Donuts has until mid-June to appeal the decision.  Even if the decision were affirmed on appeal, it is unclear whether the Dunkin’ Donuts decision will have any impact whatsoever extraterritorially. The Court of Appeals appears to have recognized a duty of franchisors to franchisees with respect to branding, marketing and competition assistance.

This decision – whether or not correctly decided – may provide franchisees a theory to seek to pursue obligations against franchisors not articulated in the franchise agreement.   As noted, however, whether that theory will ultimately survive remains to be seen, but franchisors need to be aware of this potential threat.

*Thomas Etienne is a summer student in the firm’s Montréal office.