Friday, July 27, 2012

Franchisor Breached Franchise Agreements By Failing to Protect, Enhance Brand in Quebec

A Massachusetts-based donut shop franchisor breached its agreements with 21 franchisees of 32 Quebec donut shops by failing to fulfill its contractual obligation to protect and enhance its brand in Quebec, a Quebec Superior Court has decided.

Thus, the franchisees were entitled to damages of (Can.) $16.4 million, representing the loss of the franchisees’ individual investments plus the sales that the franchisees would have realized during the period of 2000-2005 if the franchisor had met its obligations, minus the actual sales that the franchisees experienced during that period. The total amount would be apportioned among the franchisees as directed.

Closing of Franchises

The franchisor attributed the rapid closings of more than 200 of its shops in Quebec in less than a decade to underperforming franchisees and the "Tim Hortons’ phenomenon," the rapid rise to industry dominance of a competing franchise system. However, the cause was the franchisor’s failure to protect and enhance its brand, the most important obligation that the franchisor had assumed in its contracts, according to the court. The franchisor’s defense, an attempt to paint the franchisees as poor operators, was utterly devoid of substance.

All of the plaintiff franchisees had either closed or been sold for a fraction of their traditional value. Until the turn of the century, any of the franchises could have been sold for roughly 50% of annual sales, the court noted. No such value could be attributed to one of the franchises now, the court found. Thus, the franchisees lost their investments in the franchise system as well as profits.

The losses by the franchisees "followed hard upon the heels of the franchisor’s failures as night followed day," the court found. Lost profits flowing from lost sales in a growing market—caused by a franchisor that failed to protect its brand—and the loss of investments made to participate in such market fell readily into the category of damages that was an "immediate and direct consequence of the debtor’s default," the court quoted. Moreover, the losses were foreseeable at the time the agreements were signed by the parties. An underlying assumption of all franchise agreements was that the brand will support a viable commerce, the court reasoned.

The approach taken by the franchisee’s expert quantified the lost profits that the franchisees sustained at the expense of Tim Hortons, the principal beneficiary of the decline of the franchisor’s system in Quebec. Further, the franchisor should compensate the franchisees at least to the extent of the loss of any opportunity to sell their stores at traditional values due to the collapse of the franchisor’s system in Quebec. This was not a case where the court had to estimate future damages, the court explained.

Franchisor’s Counterclaims

The franchisor’s counterclaims against the franchisees for failing to pay royalties, advertising fund contributions, interest and other sums owing pursuant to the parties’ agreements; for damages for defamatory and prejudicial remarks; and for abuse of proceedings were without merit, the court decided. When contracts are fundamentally breached by one party, the other party cannot be held accountable for a subsequent breach by the prejudiced party.

Moreover, no demand letters for any of these counterclaims were ever sent to the franchisees. They arose, as an afterthought, along with the franchisor’s defense to its own breach of the parties’ agreements, the court commented.

The counterclaims grounded in defamation, abuse of proceedings, or for legal fees were not substantiated at trial. Whatever abuse there may have been in the proceedings arose from the reckless and unproven allegations in the franchisor’s defense, the court determined. The counterclaims could not "survive the damage caused to small business operators whose only breach came while trying desperately to survive in a market their franchisor abandoned."

The decision is Bertico, Inc. v. Dunkin’ Brands Canada, Ltd., CCH Business Franchise Guide ¶7412.

Further information regarding CCH Business Franchise Guide appears here.

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