Over the past decade, the province of Ontario has become a battleground with respect to class proceedings involving franchisors and franchisees. A new decision from Ontario’s courts has upheld a franchisor’s right to make changes to its franchise system and profit from product distribution within the system, and will hopefully serve as a reaffirmation of contract law and interpretation over amorphous and overbroad claims involving the duty of good faith. In this decision, Fairview Donut Inc. v. The TDL Group Corp.1, the Honourable Mr. Justice Strathy of the Ontario Superior Court of Justice granted summary judgment to Tim Hortons, a national Quick Service Restaurant (QSR) franchisor, with respect to a class proceeding brought on behalf of its franchisees in regards to changes to the Tim Hortons franchise system and allegations that Tim Hortons wrongly profited from these changes.
The case involved a claim by proposed representative plaintiff franchisees (the “plaintiffs”) concerning two changes to the Tim Hortons system. The first change was the introduction of a program called the “Always Fresh Conversion”, where Tim Hortons replaced in-store scratch baking of various baked goods with a system in which the dough for these products was partially baked and flash frozen at a centralized facility and completed in special ovens in the individual franchise stores. The plaintiffs alleged that the Always Fresh Conversion had resulted in increased costs to franchisees and that Tim Hortons was wrongly profiting from this change to the system. The second change involved an existing program, namely the Lunch Menu offered at Tim Hortons franchised restaurants. The plaintiffs alleged that Tim Hortons was requiring franchisees to sell Lunch Menu items at break-even prices or at a loss.
The plaintiffs alleged that Tim Hortons’ conduct regarding the Always Fresh Conversion and the Lunch Menu constituted (i) a breach of the parties’ franchise agreement, (ii) a breach of an implied term in the franchise agreement that ingredients would be sold to franchisees at commercially reasonable prices, (iii) a breach of the statutory and common law duty of good faith and fair dealing, and (iv) in respect of the Always Fresh Conversion, a breach of the Competition Act.
Justice Strathy found that the case was appropriate for summary judgment in that many of the causes of action alleged involved issues of contract and statutory interpretation and that it was not necessary to engage in extensive fact-finding to reach a decision on these issues.
- Breach of Contract
The court held that the franchise agreement explicitly gave Tim Hortons the right to introduce the Always Fresh Conversion and the Lunch Menu. Justice Strathy held that the specific language of the franchise agreement did not oblige Tim Hortons to only introduce changes to the System that were profitable to franchisees, and that Tim Hortons was entitled to consider the profitability and prosperity of the franchise system as a whole. The court stated:
In order to keep the system healthy and competitive, the franchisor must be permitted to introduce new products, new methods of production or sale, and new techniques during the life of a franchise agreement....It would not be commercially reasonable to require that the franchisor can only implement system-wide changes over the life of a particular franchise agreement if the proposed change is demonstration to be an improvement that benefits that particular franchisee. Nor would it be commercially reasonable to require the franchisor to demonstrate that every such change will be a financial benefit to every franchisee.
The court noted that the evidence on the motion demonstrated that both the Always Fresh Conversion and the Lunch Menu provided benefits to the franchisees, regardless of whether such a benefit was required.
- Breach of The Implied Term Regarding Pricing
Justice Strathy held that there was no implied term in the franchise agreement that the products the franchisees were required to purchase from Tim Hortons’ distribution system would be sold to franchisees at lower prices than they could obtain in the marketplace. The court noted that:
The plaintiffs were unable to point to any evidence that it is customary in the franchise business in general, or in the QSR business in particular, that the franchisor supplies all ingredients or other inputs to franchisees at prices that are lower than can be generally obtained in the marketplace....The evidence does not establish that it is the practice of franchisors generally, or of franchisors in the QSR business in particular, or of Tim Hortons, to pass on to their franchisees the benefit of their purchasing power in the case of every input they supply to franchisees.
The court helpfully noted that the regulations to the Ontario franchise disclosure legislation (the Arthur Wishart Act (Franchise Disclosure), 2000) requires franchisors to stipulate on their disclosure document that “the cost of goods and services acquired under the franchise agreement may not correspond to the lowest cost of goods and services available in the marketplace.” Moreover, the franchise agreement expressly allowed for Tim Hortons to make a profit on the price of goods sold to franchisees.
- The Duty of Good Faith and Fair Dealing
Justice Strathy found that Tim Hortons did not breach its duty of good faith and fair dealing in statute or common law by requiring the franchisees to participate in the Always Fresh Conversion or participate in the Lunch Menu.
The court noted that the duty of good faith and fair dealing relates to the performance and enforcement of the franchise agreement, and that the duty is not intended to replace the contract or amend the contract by altering its express terms.
The court found that there was nothing in the plaintiffs’ franchise agreements that entitles them to make a profit on their franchises generally or on any particular product or product line. Moreover, the franchisees were generally profitable and made reasonable returns on their investments. The Always Fresh Conversion and the Lunch Menu, and their associated pricing, did not deprive the franchisees of the benefits of their agreement nor did they defeat the purpose of the franchise agreement or make the operation of the franchises unprofitable.
Justice Strathy held that even if he had found that the immediate financial benefit to Tim Hortons from the system changes was greater than the financial benefit to the plaintiffs, this would not constitute a breach of the duty of good faith and fair dealing in all the circumstances.
- The Competition Act
In order to implement the Always Fresh Conversion, Tim Hortons entered into a joint venture with an unrelated manufacturer to supply the par baked goods for the franchised restaurants. Justice Strathy held that this distribution and supply arrangement was not in contravention of the Competition Act provisions (past and current) regarding price maintenance and conspiracy.
Justice Strathy held that the action could not succeed because “the plaintiffs are asking the Court to do something it cannot do – rewrite their franchise agreements to give them a greater share of the profits they derive from the franchisor’s business system, products, trademarks and know-how.” The court concluded by stating that “[i]t is simply not the responsibility of the court to step in to recalibrate the financial terms of the agreement made by the parties.” Summary judgment was granted and the plaintiffs’ claims were dismissed.
- The Class Proceeding
Justice Strathy did find that if the action had not been dismissed, he would have certified the action as a class proceeding, although the common issues certified were noticeably reduced as compared to those sought by the plaintiffs.
The success of the franchisor in this case is heartening to other franchisors in Canada, particularly those looking to update and modernize their franchise systems. This decision recognizes that so long as franchisors have the express contractual right to make changes and do so without defeating the purpose of their franchise agreements, system changes are a reasonable and supportable action by franchisors.
This case is also helpful in acknowledging that franchisors can profit from the distribution of products within their franchise systems (in accordance with their obligations under the franchise agreement) and that courts will not interfere with the bargains struck by franchise parties, even if these bargains are profitable to franchisors.