October 18, 2012

Some guidance from the courts on system change – the importance of consultation

Earlier this year, an important case was decided by the Ontario Superior Court of Justice about rights under the Arthur Wishart Act when system-wide changes are made to an entire franchise system. Although the decision has been appealed, it provides a number of helpful principles for franchisors considering important system changes.

In Fairview Donut Inc. v. The TDL Group, a number of Tim Hortons franchisees brought a claim which they were seeking to have certified as a class proceeding against Tim Hortons relating to two important system-wide changes. The first of these was the decision to eliminate scratch baking of donuts and other goods in-store. Scratch baking was replaced with “par baking,” in which baked goods were prepared at a centralized facility and frozen for delivery to stores. A number of franchisees complained the change to “par baking” was detrimental because their costs increased with few to no corresponding benefits. The second change involved Tim Hortons’ roll-out of lunch menu items like soups and sandwiches. Again, a number of franchisees complained that Tim Hortons required them to sell these items at break-even prices or at a loss, all while Tim Hortons continued to be paid rent, royalties, and advertising fees on the franchisee’s total sales.

The decision rejecting the franchisees’ claims on their merits is very lengthy, exceeding 150 pages. Given its sheer length, it is difficult to capture the diverse issues in a short update. The case considers issues including a franchisor’s obligation to act in good faith and its duty of fair dealing under the Arthur Wishart Act, principles of contractual interpretation, Competition Act issues in supply agreements, and more.

The court analyzed the contract and found that the franchisor had the right to make system changes of the nature complained of. However, the court carefully considered how the franchisor implemented its decisions.

One critical point of analysis repeatedly emerges in the decision as helpful guidance for other franchise systems: the importance of communication between a franchisor and its franchisees. When Tim Hortons was considering important changes to its system, it consulted with its franchisees before the changes were made, while the changes were being made, and afterwards. The judge described the discussions that occurred as “detailed” and “granular.” Ultimately, these extensive consultations helped to defeat the claim in part because (i) through these consultations and dialogue, many franchisees truly believed the changes were beneficial, not harmful, leading them to disagree with the franchisees who thought the changes were harmful, and (ii) the franchisor was able to demonstrate it discharged its obligations of fair dealing under the Arthur Wishart Act in part by listening and taking into account franchisee concerns.

Everyone knows about the importance of communication with others to resolve problems, understand concerns and to make better decisions. No one likes being forced to do things if they perceive no one is listening to their legitimate issues. The court’s decision in Tim Hortons is another reminder of this simple fact. Communication will not only help to make better business decisions, but may also help strengthen a franchisor’s legal case in support of making important changes to a franchise system. If you are contemplating system-wide changes to your system, it makes sense to speak with your professional advisors to put yourself in the best position.