Québec Court of Appeal Recognizes Implied Obligations in Franchise Agreement: What Does This Really Mean?

On April 15, 2015, the Québec Court of Appeal released its long-awaited decision in Dunkin' Brands Canada Ltd. c. Bertico inc., 2015 QCCA 624. The Court applied its earlier decision in Provigo[1] in conjunction with the “theory of implied obligations” and the “duty of good faith” prescribed by the Québec Civil Code (“C.C.Q.”) to read into the franchise agreement, an implied contractual obligation on the part of the franchisor to protect and enhance its brand and found that it had manifestly failed to do so. The Court affirmed the lower-court’s decision on liability, but reduced the damages award.

Relying heavily on the unique facts of this case and the long-term, “relational nature” of franchise agreements, the Dunkin case confirms the implied obligations of franchisors under the C.C.Q. to enforce the terms and spirit of their franchise agreements and further reaffirms the obligation of good faith incumbent on both parties to support their “collaborative arrangement” in a manner that reflects the intention of the parties. After summarizing the background to the case and the Court of Appeal’s decision, we provide some practical take-away points.

Background

The story of this case began in the mid-1990s when Tim Hortons became a fierce competitor in the Québec fast-food and coffee industry. In 1996, the franchisees alerted the franchisor that the brand was collapsing and required the franchisor to establish a strategy to reclaim lost ground. The franchisor introduced a rejuvenation plan of sorts, that included, among other initiatives, a new corporate image program which offered franchisees a financial incentive if they committed to renovate their stores. However, in order to receive the financial incentive, franchisees were required to sign a release barring them from bringing a lawsuit of any kind against the franchisor.

The measures proposed by the franchisor’s plan did not produce the expected results and many franchisees closed their stores. In 2006, a group of twenty-one (21) franchisees brought an action against the franchisor seeking the termination of their lease and franchise agreements and damages for loss of investment and loss of profit.

As we discussed in a previous post,[2] in June 2012, after a 71 day hearing and additional evidence on damages, the trial judge awarded $16,4 million to the franchisees for the damages caused by the franchisor for its failure to fulfill its obligations over a ten-year period.[3] The trial judge ruled that imposing such releases in these circumstances was abusive and should be annulled given the circumstances in which the franchisees gave their consent.

The Court of Appeal Decision

The key issues before the Court of Appeal were:

• Whether the trial judge erred in finding that the franchisor was bound by an implicit obligation to protect and enhance the brand;
• Whether the trial judge erred by imposing an obligation on the franchisor to guarantee the success of its franchisees in the Québec market; and
• Whether the trial judge erred in annulling the releases.

An implicit obligation of means to protect and enhance the brand

The Court of Appeal agreed with the trial judge on the obligational content of the franchise agreements. Indeed, it considered that the franchisor was not only bound by the express terms of the agreements, which were found to “support the judge’s view that the franchisor would protect and enhance the value of the brand”, but also bound by obligations that could be implied into the agreement under the C.C.Q. as being incidental to the “nature of the franchise agreement” and implied obligations of good faith.

The Court of Appeal ruled that given the nature of a franchise agreement, the obligations to enhance and protect the brand are implicit to franchise agreements such as Dunkin’s franchise agreement, which are based on long term relationship and trust, pursuant to article 1434 C.C.Q. According to the Court, “the obligations owed by the franchisor were not only those explicitly stated in the agreements but also implicit obligations that flowed from the nature of the franchise agreement”. In the case at hand, these obligations arose from the role of the franchisor in overseeing the on-going operation of the network and the uniform system standards found in the franchise agreements.

According to the Court, the franchisor was empowered by the terms of the franchise agreement to play a very active role in, among others areas, “choosing appropriate franchisees and approving new acquirers of existing franchises, of advising franchisees at the start of the venture, of offering assistance to them along the way to be sure that each franchisee respected the system upon which the reputation on the brand rested”. The Court, explaining the reason why such an implicit obligation arose from the agreement, stated: “in this sense, the agreement was a “relational” one which, as is often the case in such long-term arrangements, “did not spell out all of its terms”.

The Court of Appeal also relied on the implied obligation of good faith and the duties to assist and cooperate in concluding that the franchisor had a contractual obligation to its franchisees to “combat a competitor who, in the longer term, threatens the value of the brand ”.

Content of the implicit obligation to protect and enhance the brand

In terms of the content of the franchisor’s contractual obligation, the Court of Appeal stated that the obligation of the franchisor to enhance and protect its brand is not an obligation “to guarantee the franchisee’s success or insulate them from competition” but to take “reasonable measures to protect and enhance the brand”. In that regard, the Court reviewed the lower Court’s consideration of the franchisor’s efforts, and supported the lower Court’s findings that they were insufficient in the circumstances and were ultimately nullified by its years of alleged neglect and defaults.

The Court of Appeal nevertheless recognized that franchisor and franchisees may have divergent interests and in such context it is important “not to exaggerate the content of the implied obligation of good faith and its attendant “duty to collaborate””. In order words, “the pursuit of these divergent interests is possible, but only within the parameters of the terms of the contract and the implied obligation of good faith”.

A valid cancellation of the releases

The Court confirmed the validity of the cancellation by the trial judge of the releases signed by the franchisees after 2000 to obtain the contributions for the stores renovations.

At trial, the franchisor contended that the releases were freely agreed to by the franchisees and alleged that signing the releases was an ordinary commercial decision. The trial judge disagreed, finding that the releases were abusive and considered that “the necessary consent was missing or vitiated”.

On appeal, the Court of Appeal focused on the standard of review, noting that the question of whether consent had properly been given was a question of fact subject to review on a standard of overriding and palpable error. The Court of Appeal held that no overriding and palpable error of fact had been made and noted that “in these circumstances, misrepresentations can be grounds of nullity of contract pursuant to article 1401 C.C.Q.”.

The Takeaways

Although the findings in this case are potentially significant for franchisors operating in Québec, it is important to emphasize that this case presented unique facts and the reasonableness of the franchisor’s behaviour will always be assessed in accordance with the individual circumstances of the case. In Dunkin, there were clear findings of fact to the effect that the franchisor effectively failed to take any meaningful steps to respond to the collapse of its brand in the regional market despite numerous pleas for assistance from its franchisees.

Under the analysis in Dunkin, it appears that the obligations to enhance and protect the brand will be implied in many franchise agreements. However, on this point, the full scope of Dunkin remains unclear. At paragraph 65 of the decision, for example, the Court noted that there was “no express term [in the agreement] that would have ousted the implied obligations”, which suggests that drafting clarity on this issue may be sufficient to provide certainty going forward. Franchisors should review their franchise agreements in Québec with their legal counsel to reduce their potential liabilities under the implied obligations and to provide commercial certainty.

Since the Court of Appeal decided that the obligations to enhance and protect the brand was focused on whether the franchisor took reasonable steps in the circumstances, franchisors operating in Québec might consider developing legal compliance programs with their internal and external counsel to clarify the role of the franchisor. Such programs might contain a monitoring component for franchisee feedback on market conditions, a consultation component for ongoing dialogue with franchisees on market solutions, and a documentation component to ensure that all efforts, including enforcement measures taken against underperforming or delinquent franchisees, a noted criticism of the franchisor in the Dunkin case, are properly documented in a way that could be used effectively in litigation.

In closing while the Dunkin case will undoubtably be received with mixed reviews for its affirmation of implied duties on franchisors, it may, perhaps unintentionally, also serve as an added tool for franchisors to, now defensibly, take decisive enforcement action against non-compliant franchisees. Who wins, and who loses from this decision will ultimately remain to be seen!

[1] Provigo Distribution inc. c. Supermarché A.R.G. inc., [1998] R.J.Q. 47.

[2] https://www.mccarthy.ca/article_detail.aspx?id=5968

[3] Bertico inc. c. Dunkin’ Brands Canada Ltd., 2012 QCCS 2809.