In our last issue, David Sterns wrote an article on the issues involved in the implementation of franchise system changes. Within weeks of the mailing of our newsletter, an important case from Ontario was released amplifying the issues.

On March 26, 2009, the Ontario Superior Court of Justice released its decision certifying an action brought on behalf of all Canada Midas franchisees against Midas Canada Inc. as a class action.

The action resulted from Midas’ decision in 2003 to cease the manufacturing and distribution of automotive parts to its franchisees and to require its franchisees to purchase their products from third-party suppliers. The franchisees asserted that this change, which was made without a formal amendment to the franchise agreement, breached Midas’ obligations to the franchisees. After the change, Midas’ financial performance improved greatly while the fortunes of the Midas franchisees suffered.

The court found that the franchise agreement in place at the time of the change permitted Midas to get out of manufacturing and distribution and that Midas did not breach any specific provision of the franchise agreement in doing so. However, the court found that this was not the end of the matter because Midas owed duties of good faith and fair dealing to franchisees in how it implemented the change.

Important to the decision was that the Midas franchise agreement stated that Midas had developed a system for the “successful” (i.e. profitable) operation of automotive repairs shops and had granted the right to the franchisees to use this system. The system had evolved to include the entitlement of Midas’ franchisees to receive a 14.5% discount off Midas’ best prices in exchange for which the franchisees had agreed to increase their royalties from 5% to 10% when the current form of franchise agreement was negotiated in 1980 between Midas and the franchisee association. The question of whether Midas breached its duties to the franchisees as a matter of law will require the court to determine if Midas improperly defeated the franchisees’ legitimate expectations when it changed the system in 2003.

Although the court found that Midas franchisees which joined the system after Midas exited manufacturing could not be part of the class, it nevertheless held that since there was a provision in the franchise agreement which required each franchisee to receive the benefits of any changes to the Midas system, those franchisees also have the potential to benefit from any changes which the litigation may bring including any changes in Midas’ royalty structure which may result.

Sotos LLP was counsel to the franchisees in this case. Our firm is proud of its tradition of promoting good franchising both in our representation of franchisors and large franchise groups against franchisors whose practices do not reflect these standards. The success of franchising depends on franchisors and franchisees conducting themselves in a manner which maximizes the growth and success of the brands they represent.