On February 24, 2012, Justice Strathy of the Ontario Superior Court of Justice issued his judgment on motions for certification of a class proceeding and summary judgement in Fairview Donut Inc. v. The TDL Group Corp.1
The case involved a claim for $2 billion in damages by a group of Tim Hortons franchisees (the “Plaintiffs”). The Plaintiffs complained about the following:
1. Tim Hortons conversion from a scratch-baking system to a par-baking system for donuts (the “Always Fresh Conversion”).
Until 2002, most baked goods sold in Tim Hortons store were baked on premises from scratch. Between 2002 and 2004, however, Tim Hortons replaced scratch baking with the ‘Always Fresh’ system where dough was partially baked and flash frozen at a centralized facility and then delivered to the franchisees who would complete the baking in specially designed ovens. The par-baked donuts were supplied by a joint venture in which Tim Hortons had an interest. The Plaintiffs argued that the Always Fresh Conversion breached express terms of their franchise agreements and that it breached an implied term of their franchise agreements to supply ingredients to franchisees at lower prices than they could obtain in the open marketplace.
2. The cost of ingredients and reduced profit margins associated with the addition of new items to Tim Hortons Luncheon Menu (the “Lunch Menu”).
The Plaintiffs argued that Tim Hortons' conduct in implementing the Always Fresh Conversion and the lunch menu breached their franchise agreements, as well as the franchisor’s common law duty of faith and its statutory duty of good faith and fair dealing under the Arthur Wishart (Franchise Disclosure) Act 2 of Ontario (“Wishart”). In addition, the Plaintiffs alleged that Tim Hortons violated the price maintenance and conspiracy provisions of the Federal Competition Act3 and that the conduct of Tim Hortons resulted in unjust enrichment. Originally, the Plaintiff also included a claim of negligent misrepresentation but this claim was abandoned before the decision was rendered.
In a decision that is over 150 pages in length, Justice Strathy granted summary judgment to the Defendants (the TDL Group Corporation and Tim Hortons) and refused to certify the class proceeding. Justice Strathy did note, however, that if he had not concluded that the claims of individual franchisees should be dismissed, he would have certified the class action.4
After discussing Tim Hortons’ corporate history, the identity of the representative Plaintiffs and details of the Always Fresh Conversion, including introduction of new lunch menu items, Justice Strathy took issue with the neutrality of Plaintiffs’ expert witnesses. In the end, he gave the Plaintiffs’ expert witnesses’ testimony little weight. Justice Strathy also noted that the Plaintiffs’ characterization of the common issues contained several unnecessary issues and assumptions. Notwithstanding those deficiencies, had he not dismissed the plaintiffs’ claim in summary judgment, Justice Strathy would have asked the parties to attempt a draft a set of agreed common issues.
Breach of Franchise Agreement
The Plaintiffs claimed that Tim Hortons breached the express or implied terms of the franchise agreement by requiring franchisees to purchase the par-baked donuts and the Lunch Menu ingredients at prices that were greater than ones charged in the open market or at a commercially unreasonable price.
A central part of the Plaintiffs’ argument was that the term “benefit”, as used in section 7.03(a) of Tim Hortons’ franchise agreement, meant a financial benefit to the franchisee.5
Justice Strathy, in response to this argument held that (emphasis added):
"In my view, it would be unreasonable to interpret section 7.03 as meaning that every new method or new product introduced into the Tim Hortons System and Confidential Operating Manual must be profitable in its own right. The franchisor is entitled to consider the profitability and prosperity of the system as a whole…"
Justice Strathy also noted that the conversion to the Always Fresh System was beneficial to the franchisees in a general sense because it outsourced a process that was “time-consuming, aggravating and wasteful”. The change to ‘Always Fresh’, stated Justice Strathy:
"was a rational business decision on the part of the franchisor that addressed legitimate problems experienced by franchisees… and legitimate concerns by Tim Hortons concerning the long-term viability of the scratch making method… (it was a) commercially reasonable decision to make."
In addition, it was decided that the Lunch Menu was not a substantial change to the franchise system, as Tim Hortons had been offering sandwiches, chili and soup since the early 1980s.
The decision also noted that Tim Hortons fulfilled its obligations to use reasonable efforts to develop new products compatible with the Tim Hortons system through consultations with the Franchisee Advisory Board and at annual meetings and conventions.
The Plaintiffs argued that since section 15 of their License Agreement provided that the franchisee is an ‘independent contractor’, they are entitled to conduct their operations in a manner they felt was efficient and would maximize their returns. In Justice Strathy’s view, this phrase was a “standard piece of contractual boilerplate, inserted for the purpose of negating any suggestion that one party is the partner, agent or employee of the other.” The Plaintiffs’ interpretation of section 15 ignored the other benefits flowing to the franchisee as a result of the agreement.
The Plaintiffs claimed that it was an implied term of their franchise agreements that ingredients would be sold to them at commercially reasonable prices.
Justice Strathy held there was no evidence that it is the practice of franchisors generally or Tim Hortons in particular to pass on to their franchisees the benefit of their purchasing power in the case of every input they supply to their franchisees.
Justice Strathy also considered the mandatory disclosure statement in section 4(4) of Ontario Regulation 581/006 enacted under Wishart. The Regulation requires that every disclosure document include the following statement:
"The cost of goods and services acquired under the franchise agreement may not correspond to the lowest cost of the goods and services available in the marketplace."
Strathy concluded that “the statutory regime intended for the protection of franchisees (Wishart and its regulations) implicitly recognizes that the cost of goods supplied under a franchise agreement is frequently not the lowest cost available in the marketplace.”
As a result of this analysis, Justice Strathy concluded that the plaintiffs’ breach of contract claim had no possibility of success and dismissed it.
Good Faith and Fair Dealing Under Wishart
The Plaintiffs pled that conversion to the ‘Always Fresh’ system as well as addition of the new Lunch Menu was done in breach of its duty of good faith and fair dealing under Wishart, because it led to commercially unreasonable price margins and reduced profits for the franchisees.7
Justice Strathy took time to clarify the duty of good faith and fair dealing owed by a franchisor to a franchisee under Wishart. He noted (emphasis added)8:
"The duty imposed under section 3(1) is one of “fair dealing” in the “performance and enforcement of the franchise agreement and includes “the duty to act in good faith and in accordance with reasonable commercial standards” in that regard. The statute does not require that every interaction between the franchisor and the franchisee be subjected, in isolation, to a standard of “commercial reasonableness”. Still less does it require that the price of every commodity sold by a franchisor to the franchisees be commercially reasonable. What the statute requires is that the franchisor must act in good faith and in accordance with reasonable commercial standards in the performance of the contract."
This quote makes it clear that the duty of good faith and fair dealing will be applied contextually to the performance of the franchise agreement in its totality and not to isolated incidents.
Strathy characterized the Plaintiffs’ duty of good faith and fair dealing claims as follows:9
"Under the guise of Wishart, the Plaintiffs are really asking the court to re-write their contracts and to require Tim Hortons to perform these re-written contracts in a manner that the plaintiffs or their expert would find commercially reasonable."
Strathy found there was no evidence that the prices for the always fresh donut were set at levels that deprived the Tim Horton’s franchisee of the benefits of their agreement, defeated the purpose of the agreement or made the operation of a franchise unprofitable. He also found that the evidence reflected that most franchisees, including the Plaintiffs, made a reasonable level of profit and return on their investment. As such, the Plaintiffs’ claim for violation of the duty of good faith and fair dealing was also dismissed.
Strathy dismissed a claim of unjust enrichment by referring to his earlier statement that the franchise agreement permits Tim Hortons to make a profit and therefore their ‘enrichment’ could not be unjust.
Justice Strathy found the plaintiffs’ claims did not meet the requirements of price maintenance or conspiracy under the present or former Federal Competition Act.
In conclusion, Strathy held that the Plaintiffs’ action could not possibly succeed because its primary goal was to get the court to rewrite their franchise agreements to give them a greater share of profits and that their primary complaint was that they didn’t get a larger share of donut profits. What mattered primarily in terms of the claims for breach of contract and the duties of good faith and fair dealing, was whether the franchisees could make sufficient profit overall to justify their investments.
This is an extremely important decision in terms of Canadian franchise law. Its most important impacts are:
- Sending a clear signal that franchise class actions will not be ‘automatically’ certified by the Court;
- Making it clear that the duties of good-faith and fair dealing under Wishart will not be evaluated in isolation, but will be evaluated with respect to the performance of the franchise agreement in its totality;
- Making an unequivocal statement on product pricing and, in particular, that ‘better than market pricing’ is not required and may be rare in practice;
- Emphasizing the need for impartial expert witnesses and testimony; and
- Clarifying that language in franchise agreements that uses the term ‘independent contractor’ does not give franchisees increased autonomy but is rather a standard piece of contractual boilerplate.