On February 24, 2012, the Ontario Superior Court dismissed an action by Tim Hortons franchisees alleging breach of contract, breach of duty of good faith, and unjust enrichment, among other things.
The court found that to grant the relief sought would “rewrite [the franchisees’] franchise agreements to give them a greater share of the profits they derive from the franchisor’s business system, products, trademarks and know-how,” which was something the court cannot do.1 The court also gave helpful guidance in respect to a franchisor’s obligations under the Ontario franchise legislation.
The one-minute version
The decision affirms the ability of franchisors to make system-wide changes and require franchisees to purchase supplies from designated suppliers, even if such purchases benefit the franchisor, but not the franchisees. The court’s findings as detailed in the lengthy decision can be summarized by the following excerpts:
- “Tim Hortons, as franchisor, is entitled to tell the franchisees what to buy and where to buy it, and what to sell and how to sell it. It is entitled to make a profit on what the franchisees are required to buy and it is entitled to determine the amount of its profit.”2
- “There are contractual and statutory limits to what Tim Hortons can do. It must abide by the terms of its contracts. It must deal fairly with its franchisees and act in good faith and in accordance with reasonable commercial standards in the performance and enforcement of its contract. It cannot deprive the franchisees of the benefits of the contract or undermine the very foundation of the contract. There is no evidence, considering the contract as a whole, that Tim Hortons has failed to discharge these obligations.”3
For franchisors making decisions that affect their business systems, franchisees, and chain-wide profits, there is considerable comfort in the Fairview Donut decision. Importantly, this decision clarifies the duty of good faith and fair dealing under the Wishart Act and affirms that a franchisor is not obliged to prefer the interests of its franchisees over its own interests, so long as the franchise agreement is performed and enforced in good faith.
The full decision is available here.
The chief complaint raised in the franchisees’ action was that they were forced to buy supplies and ingredients at unreasonably high costs that cut into their profits. Part of the increased costs were alleged to arise from various chain-wide changes adopted by the franchisor. As well, it was alleged that the franchisor required the franchisees to sell items at either break-even prices or at a loss.
This update focuses primarily on the court’s findings in respect of the franchisees’ allegations of breach of contract and breach of the franchisor’s common law and statutory duties of good faith and fair dealing under the Arthur Wishart Act (Franchise Disclosure), 2000 and similar legislation in other provinces.
The court examined the franchise agreements, which included rather standard provisions about the importance of maintaining uniformity across the franchise system, protecting the franchisor’s ability to make changes to the confidential system operating manual, requiring franchisees to purchase supplies from designated suppliers, and confirming the franchisor’s ability to recover rebates from such supply arrangements. The court’s decision is based on these particular agreements. Any similar complaint in a franchise context must be considered with reference to the applicable contractual provisions.
Changes to the franchise system
The court found that the changes at issue were reasonable commercial decisions that the franchisor was entitled to make and that were made with due regard for the impact of the changes on franchisees. The franchisor did not have a duty to agree with its franchisees, but simply to advise and consult with them, which the court found it had done.
The franchisees argued that any changes in method made by the franchisor had to provide franchisees with a financial benefit. The court rejected this as an unreasonable interpretation of the franchise agreement, finding instead that:
- there is nothing in the franchise agreements that entitles the franchisees to make a profit in general or on any particular product or product line. Rather, the franchise agreements permit the franchisor to convert systems and to set prices for ingredients and supplies that franchisees are required to purchase;
- there was no evidence that the changes prevented the franchisees from making a reasonable overall profit or rate of return; and
- perhaps most importantly, the franchisor is entitled to consider the profitability and prosperity of the system as a whole rather than focusing on particular franchisees’ profitability.
Control over the supply chain and pricing
Regarding supply chain and pricing issues, the court found there was no express or implied term in the franchise agreements, and no basis in the evidence, to support the franchisees’ claim that there was a custom of franchisors supplying ingredients to franchisees at “commercially reasonable” prices or prices lower than market prices.
On the contrary, the court pointed out that the Wishart Act itself recognizes that franchisors often do not sell products to their franchisees at the lowest price available in the market, citing the regulations under the Wishart Act requiring disclosure of such practices to prospective franchisees. The court found that the pricing of these ingredients is within the franchisor’s reasonable discretion, and there was no evidence that this discretion was exercised arbitrarily or capriciously or for an improper motive. The court noted that “…the decision of the franchisor to price the product at a level that generates a profitable return on its investment is not, on its own, an improper motive.”
Breach of duty of good faith and fair dealing
In determining whether the franchisor had demonstrated good faith and fair dealing in the performance and enforcement of the franchise agreements, the court noted that the duty of fair dealing as codified in section 3(1) of the Wishart Act was not a stand-alone obligation to be applied to every interaction between the franchisor and franchisee, but rather, that it required franchisors to act in good faith and in accordance with reasonable commercial standards in the performance and enforcement of a contract.
The court also outlined the following helpful principles in relation to the often-pleaded and little-understood statutory duty of good faith and fair dealing:
- the good faith provision of the Wishart Act (s.3(1)) is a codification of common law;
- the Wishart Act is entitled to generous interpretation to give effect to its remedial purpose;
- whether a party has breached the duty of fair dealing requires an examination of all the circumstances;
- the duty to act in good faith is only breached when a party acts in bad faith;
- good faith is a two-way street;
- a party may act in its self-interest; however, in doing so that party must also have regard to the legitimate interests of the other party;
- if A owes a duty of good faith to B, so long as A deals honestly and reasonably with B, B’s interests are not necessarily paramount;
- the duty of fair dealing is not a stand-alone duty that trumps all other contractual rights and obligations;
- the duty of fair dealing does not require a franchisor to prefer the franchisee’s interests to its own, and the franchisor is not a fiduciary in that sense; and
- the duty of good faith is not intended to replace the contract the parties have made with another contract or to amend the contract by altering its express terms.
The court rejected the franchisees’ claim that the franchisor had breached its duties of good faith at common law and under the Wishart Act. When considered in the context of the franchise agreements as a whole, and with regard to the benefits the franchisees were receiving as a result of their agreements, the changes complained of were not a breach of the franchisor’s duty of good faith and fair dealing, even if the immediate financial benefit to the franchisor was greater than the financial benefit to the franchisees.
The authors wish to thank Ms. Sasha Segal, articling student, for her help in preparing this legal update.
1 Fairview Donut Inc. v The TDL Group Corp. 2012 ONSC 1252 (CanLII), para. 667 [“Fairview Donut”].
2 Ibid., para. 672.
3 Ibid., para. 673.
Download Ontario court provides guidance to franchisors on obligations under the Arthur Wishart Act (pdf 101kb)