May 12, 2015

The Dunkin’ Donuts Decision: Franchisors’ Liability for Letting Bad Apples Spoil the Bunch

Given the prevalence of wrongful termination cases in the franchise context, it may seem strange for a court to find that a franchisor would not only be justified in terminating certain franchisees but in some cases obligated to terminate those franchisees.  However, in the recent case of Dunkin’ Brands Canada Ltd. v. Bertico Inc.1 , the Quebec Court of Appeal found that Dunkin’ failed to take reasonable steps to protect and enhance the brand which failure was illustrated, in part, by its tolerance of underperforming franchisees in the system.

On appeal, Dunkin’ argued that the trial judge had misread the franchise agreement and imposed obligations on the franchisor that were not expressly assumed by it.  Rejecting this argument, the Court explained how the implied obligation to terminate the “bad apples” was supported by its express promise to promote the brand and was also a necessary extension of its express right to enforce brand standards:

The explicit contractual “right” it has to insist that the franchisee respect the uniform standards of the system brings with it a correlative obligation of means, owed collectively and individually to the complying franchisees, to see that the franchisees adhere to those standards 2 .

The concept of implied obligations described in this case might be disconcerting to franchisors at first blush.  Although, the implied obligation to ensure brand standards are followed across the system is not surprising and in any event, benefits both franchisees and franchisors.  From a fairness standpoint, underperforming franchisees should not be allowed to “free-ride” on the goodwill produced by those franchisees diligently complying with the system’s standards.  As identified in this case, the more egregious problem for both Dunkin’ and its franchisees was the impact of free-riders spoiling the Dunkin’ Donuts experience for customers and thereby deterring patronage of all other Dunkin’ Donut stores.

An important take-away for franchisors in this case is the need to be alert to obligations that are owed to the network of franchisees.  For example, when dealing with non-compliant franchisees and deciding whether to terminate them, franchisors should consider their obligations owed collectively to the network of franchisees (i.e., considering the impact of underperforming franchisees being and remaining in the system) in addition to their obligations to individual franchisees (e.g., ensuring there are proper grounds for termination).  This type of consideration of the “collective” is also seen in other aspects of franchise relationships, such as a franchisor’s right to allocate advertising fund monies in a way that benefits the whole system as opposed to pro rata each franchisee’s contributions. Franchisors have also been able to enforce obligations upon franchisees in past court decisions in part because of the impact that a non-performing franchisee can have on its fellow franchisees. This decision is consistent with that sentiment.

Ultimately, franchisors of successful systems already fulfill their implied obligation to promote the health of their brands and consider the interests of their franchisees as a whole; in which case, this decision merely reinforces those best practices.

1 Dunkin’ Brands Canada Ltd. v. Bertico Inc.

2 Ibid para 85