'Change Before You Have To': Franchise Lessons From Canada’s 'Donut Wars'*

Canada's two most significant franchise law decisions of 2012 demonstrate the fierce competitiveness of the quick-service restaurant (QSR) industry in Canada and the need for franchisors to adapt to changing market conditions by enacting well-thought-out system-wide changes or potentially face the economic and legal repercussions of failing to keep up.

The Ontario Superior Court of Justice decision in Fairview Donut Inc. v. TDL Group Corp. ("Tim Hortons"), which was recently upheld by the Ontario Court of Appeal, tells the story of a successful franchisor whose system-wide changes were upheld by the court over the objections of some disgruntled franchisees.1 In contrast, the Quebec Superior Court's decision in Bertico c. Dunkin' Brands Canada Ltd. ("Dunkin' Donuts") concerns a once-dominant franchise system that was, despite its best efforts, unable to keep up with a competitor - which, somewhat ironically, happened to be Tim Hortons - that was making inroads into its established territory in the province of Quebec.2 While Tim Hortons' sweeping changes were found to be a valid action within the bounds of its franchise agreements, Dunkin Donuts' alleged failure to stave off competition and prevent the franchise system's decline was found to be a breach of the franchisor's obligation to its franchisees to protect and develop the brand.

While these two cases may, at first blush, seem at odds, they share the common thread that franchisors are not only within their rights in enacting broad changes to stay relevant in the market, but (and to the dismay of franchisors) the court may ultimately focus on the result of those changes.

Tim Hortons

The Tim Hortons case was a proposed class action under Ontario's Class Proceedings Act, launched by a number of franchisees of the iconic Canadian coffee and donut franchisor Tim Hortons. The franchisees' claim arose from the franchisor's introduction of a new lunch menu and the switch from baking donuts and pastries from scratch on-site to a "par-baking" system known as the "Always Fresh conversion". Where franchisees were formerly required to hire bakers to make baked goods from scratch at each individual store, the new par-baking system involved partially baking donuts and pastries at a central facility, then flash-freezing and shipping them to stores where they were finished in specialized ovens. This eliminated the need to employ professional bakers at all franchise locations and ensured consistency across the franchise system. The franchisees alleged the new lunch menu and "Always Fresh" conversion required them to buy ingredients and supplies at above-market prices and sell certain menu items at break-even or a loss, which they alleged was a breach of their franchise agreements with Tim Hortons.

The plaintiff franchisees, proposing to represent a class spanning 500-800 franchisees operating approximately 2400 stores across Canada, claimed that the prices of certain ingredients they were required to buy from Tim Hortons became commercially unreasonable, eroding their ability to make a profit. They alleged several causes of action including breach of contract, misrepresentation, unjust enrichment, price maintenance and breach of the statutory duty of good faith under Ontario's Arthur Wishart Act (Franchise Disclosure)and similar franchise legislation in other provinces.

In the Ontario Superior Court of Justice decision, the court gave extensive reasons granting summary judgment to Tim Hortons and dismissing the franchisees' action. In granting summary judgment, the court acknowledged that, despite the voluminous record before the court, the case was not complex and essentially boiled down to the interpretation of the applicable legislation and franchise agreements.3

The court found no basis for the plaintiffs' claim that Tim Hortons was obligated to offer franchisees the lowest available prices in the marketplace for products and supplies, writing:

What matters, at the end of the day, is whether the franchisee makes sufficient profit overall to justify his or her investment and to remain in the business. The suggestion by the plaintiffs that the franchisor has an obligation to price every menu item so that they can make a profit on that particular item is not supported by the contract, by the law or by common sense. It is simply not the responsibility of the court to step in to recalibrate the financial terms of the agreement made by the parties.4 The court found that the franchise agreements did not confer a right for the franchisees to sell every menu item at a profit. If franchisees were losing money on lunch menu...