Mr. Justice Tingley of the Quebec Superior Court recently found Dunkin' Donuts liable for C$16.4MM in damages to 21 of Dunkin's former franchisees. The media has been abuzz with reports on the decision because the Judge ruled that Dunkin' had a contractual obligation to take steps to protect its brand in the face of increased competition from the Tim Hortons chain and that it failed to meet this obligation. The Dunkin' brand went from 212 stores in the Province of Quebec to only 115 stores over a ten year period (there are now only 13 stores in Quebec) while Tim Hortons increased the number of stores in Quebec from 60 to 308 over the same period of time. Dunkin' has announced that it will appeal this ruling.

Justice Tingley described this case as a "sad saga as well of how a once successful franchise operation, a leader in its field – the donut/coffee fast food market in Quebec – fell precipitously from grace in less than a decade; literally, a case study of how industry leaders can become followers in free market economies".

The case was based in breach of contract. The learned trial judge ruled that Dunkin's franchise agreement "promises to protect and enhance both its reputation and the “demand for the products of the Dunkin' Donuts System”; in sum, the brand. It did neither between 1995 and 2005. The brand has withered in Quebec by all relevant measures, however successful it may continue to be in the United States or elsewhere in the world... ."

“But the greatest failing of all was [Dunkin]’s failure to protect its brand in the Quebec market. No doubt the host of failings chronicled by the Franchisees contributed to the collapse of the Dunkin' Donuts’ brand in Quebec. A successful brand is crucial to the maintenance of healthy franchises. However, when the brand falls out of bed, collapses, so too do those who rely upon it. And this is precisely what has happened in this case.  Opinion at ¶57.

“[Dunkin] had assigned to itself the principal obligation of protecting and enhancing its brand. It failed to do so, thereby breaching the most important obligation it had assumed in its contracts. It must accept the consequences of such a failure. As noted above, Franchisees cannot succeed where the System has failed. After sustaining several years of stagnant sales, narrowing profit margins and then losses, the Franchisees have all had to close their stores.” Opinion at ¶58.

I believe the trial judge misinterpreted provisions of the franchise agreement. Dunkin did not (at least not expressly) "assign to itself" as the trial judge put it, the principal obligation of protecting and enhancing the brand. For example, the trial judge took a clause that said that Dunkin' would develop marketing programs with a view to enhancing the brand and elevated it into an obligation to enhance the brand, i.e. to guarantee success in the face of increased competition from Tim Horton's.

The footnotes to the decision, moreover, reveal that the learned judge based his decision on "Obligations that flow implicitly from the general nature of franchise arrangements and explicitly from the Franchise Agreements; for example paragraphs 3C and 3E of the pre-2002 Agreements". But, paragraphs 3C and 3E did not require Dunkin' to do the things that the court held it was obligated to do.

The appeal of this matter will hopefully provide further guidance regarding the specific obligation of a franchisor to protect the brand in Quebec. In the meantime, it remains difficult to see how the learned trial judge reached his conclusions on the basis of the agreement alone.

Quebec, of course, is not a common law jurisdiction. Its law is codified in the Civil Code of Quebec ("C.C.Q.") and other statutes. Perhaps Article 1437 of the C.C.Q. permitted the trial judge to make the finding that he made, notwithstanding the express language of the franchise agreement. The decision does not refer to Article 1437, but it reads: "A contract validly formed binds the parties who have entered into it not only as to what they have expressed in it but also as to what is incident to it according to its nature and in conformity with usage, equity or law".

In response to this increased competition, Dunkin' promised to inject C$40MM to support the brand (half from franchisees and have from Dunkin'). This investment was never made. Dunkin' encouraged franchisees to renovate their stores, on a voluntary basis, suggesting that a renovation would increase sales by 15%. Renovations cost approximately C$200,000. For those that renovated, sales did not increase. According to the decision, the program never got off the ground. Dunkin' required franchisees to sign general releases in favour of Dunkin' as part of the renovation program in order to receive incentive payments. These releases were set aside by the Court as being abusive under Articles 1398 to 1407 of the C.C.Q.

The trial judge described the request for releases as follows: [69] " It was overkill, ill advised and, in the context of a time when the Franchisees were struggling just to survive, it was abusive to impose it upon those who chose to adopt the Franchisor’s recommendations, albeit under false pretences and on the faith of representations that turned out to be equally false".