MONTREAL – In a harshly-worded ruling in favor of franchisees, a judge chided Dunkin’ Brands Canada Ltd for its incompetence, negligence, and lack of support to store owners. He then ordered the international sub-franchisor to pay the 21 former franchise owners, operating 32 Dunkin’ stores, C$16.4 million (US$16M) plus legal fees.

Boston attorney Kevin R. McCarthy exclaimed, “This is a major decision.” Even though it is a Canadian lawsuit, he believes it has the potential of becoming a landmark case. He thinks the reasoning in this case is going to seep across the border. “The court found franchisor Dunkin' Brands to be responsible for not supporting the growth of the brand in Quebec. I believe we are going to be hearing more arguments made now by franchisees that the burden of developing the success of the system is not to be put directly and exclusively on franchisees’ shoulders. At least, at a minimum, it must be shared by the franchisor,” he said.

The lawsuit, filed in 2003 by franchisees under Bertico Inc. v Dunkin’ Brands Canada Ltd., claimed lost profits in the years of 2000 to 2005, causing all their stores to close. Following the 71-day trial, the judge surmised that Dunkin’ Donuts should compensate the owners for the loss of any opportunity to sell their stores at traditional values due to the collapse of the Dunkin’ system in Quebec. That calculation resulted in the judge’s C$16.4 million award to franchise owners.

Judge chastises Dunkin’ for failing to protect brand

In his June 22, 2012 order, Superior Court Justice Daniel H. Tingley did not mince words. “It is a sad saga as well of how a once successful franchise operation, a leader in its field — the donut/coffee fast food market in Quebec — fell precipitously from grace in less than a decade; literally, a case study of how industry leaders can become followers in free market economies."

The judge did not stop there. He said the greatest failing of all was how Dunkin’ Donuts’, then under Allied Domecq Retailing International Ltd, ADRIC, failed to protect its brand in the Quebec market. “No doubt the host of [sub-franchisor] failings chronicled by the franchisees contributed to the collapse of the Dunkin' Donuts' brand in Quebec. A successful brand is crucial to the maintenance of healthy franchises. However, when the brand falls out of bed, collapses, so too do those who rely upon it. And this is precisely what has happened in this case," he scolded.

Judge Tingley said Dunkin’ must accept the consequences of such a failure. “Franchisees cannot succeed where the system has failed. After sustaining several years of stagnant sales, narrowing profit margins and then losses, the franchisees have all had to close their stores. Their losses follow hard upon the heels of ADRIC's failures as night follows day."

The ruling also goes against Dunkin’s argument that the franchisees were poor operators, that they did not run clean, renovated stores in accordance to standards. He stated, “Their owners were amongst the most active committee members. Several of them chaired these committees at one time or another. Many of the owners operated several stores. They were for the most part the leaders amongst the Quebec franchisees. ADRIC failed miserably during the first sixty-six days of trial to paint the Franchisees as poor operators. This was a defense utterly devoid of substance."

Dunkin’s failure to keep competitor at bay

In his ruling, Judge Tingley reviews Dunkin’s history and franchise agreement, stating the donut chain has been operating in Quebec since 1961. In offering the use of its trademarks, trade names and proprietary programs, Dunkin’ allows franchisees to operate their business under its “Dunkin’ Donuts System” for up to 20 years. In return, franchisees pay franchise fees, advertising costs, insurance premiums, and agree to many restrictions and mandates in purchasing supplies and equipment for their stores, and  comply with renovation requirements.

Dunkin’ also set up a remodel incentive program to combat an aggressive competitor, Tim Horton, who had in the five preceding years captured a significant proportion of the fast food market in Quebec. Franchisees who agreed to renovate their stores early for incentive compensation payments from Dunkin’ were required to sign an agreement barring them from bringing any lawsuit against Dunkin’ ‘for whatever reason from the dawn of creation to the day the agreement was signed.”

Three years later when Tim Horton donuts supplanted Dunkin’ as the industry leader in the fast food market, Dunkin’ transferred and assigned its rights in its franchise contract with franchisees to a master franchisee, Couche-Tard.  The strict terms of this new 10-year agreement were laid out in detail.

But as early as August 2004, Couche-Tard defaulted under the Master Franchise Agreement. Four years later the master franchisee “surrendered and terminated all its rights.” The judge said the master franchise agreement and termination agreement “speak eloquently to the demise of the Dunkin’ Brand in Quebec, despite the efforts of the master franchisee. He expressed that allowing Tim Horton to capture the lions’ share of that market was a huge and costly mistake.  He said Dunkin’ breached its contract in failing to keep its competitor out of the hen-house, and that there is a direct correlation between Tim Horton’s successes in the Quebec fast food market and Dunkin’ Donuts’ losses.

Attorneys respond to ruling

David Sterns of Sotos LLP law firm in Toronto, Ontario affirms that Tim Horton’s is a powerful brand in Canada. “It has huge customer loyalty in brand recognition.” He said at one time Dunkin’ was very successful in Quebec, but you can see this dominance turning into this abject failure of the brand. “Canada Dunkin’ has become just a shell of its former self,” he stated.

Sterns thinks this decision confronts the whole question of where to lay the blame when a franchise system fails. “The issue the courts are grappling with is a fundamental one: What are the duties of the franchisor? You don’t often find the answer in the franchise agreement. While the details of the franchisee’s duties are spelled out, those of the franchisor are limited.” The Toronto attorney said franchisors have to do more than give buyers a name and a logo and cash their checks.

Frédéric Gilbert of Fasken Martineau, who represented the franchisees, said the Tingley decision will have major repercussions on how franchisees are protected and how franchisors' responsibilities are defined. "Justice Tingley has issued a rigorous judgment that has all the makings of a landmark franchising case in Canada. This decision will become a reference tool for setting the basic guidelines governing contractual relations between parties," stated Gilbert.

Gilbert believes that the determination and solidarity of the group of franchisees suing Dunkin’ played a key role in this legal action. "These people courageously overcame the many negative repercussions of what has been a very long saga. They valiantly confronted the countless financial and human pressures that are often seen in battles pitting David against Goliath. Even at their weakest moment they never gave up the fight, which is all to their credit."

Sterns agrees. “After nine years of litigation and a 71 day-trial, I give a lot of credit to the franchisees and their counsel for sticking with the case. “That’s what it takes. We are now seeing some law developing in this area.”   

Attorney McCarthy also believes the ruling has the potential to change the landscaping in the franchising world. “Traditionally, the franchisors shift the entire responsibility of the success of the franchise to the franchisees. The franchise industry is known to have one-sided franchise agreements. But this court has found the franchisor has a significant responsibility to make sure the system is successful. They can no longer abandon franchisees just because their franchise agreements may alleviate their duty,” McCarthy said. 

Dunkin’ declares damages awarded unwarranted

Dunkin’ Brands stated that it will appeal the Superior Court judgment. Karen Raskopf, senior vice president of corporate communications, gave this statement: “This lawsuit has been about issues that for the most part, occurred 10 - 15 years ago.  We strongly disagree with the decision reached by the Court and believe the damages awarded were unwarranted. We intend to vigorously appeal the decision."  

Dunkin’ Brands (Nasdaq: DNKN) issued a press release yesterday stating that it expects to increase its legal reserve in its current quarter in relation to the Quebec Superior Court’s ruling in the Bertico litigation. That announcement is referenced in the company’s 8-K filing.

In closing, attorney McCarthy, who some years ago was a vice president of Dunkin’ Donuts, said he clearly remembers the Canadian market, particularly Montreal, being considered one of the finest in the Dunkin’ system. Franchisees were even complimented by the national advisory board for their diligence and high standards. 

In reviewing the decision he adds, “Beyond the legal and moral ramifications of this case, the court's decision cuts to the heart of Dunkin' Brands vital strategic growth strategy. In fact, much of the value imputed to Dunkin's recent stock offering and rising stock price is predicted on new market and international growth. This value proposition is much more difficult to justify in light of a well litigated and thoughtful adjudication finding that Dunkin' failed to support and fight for its own brand even in a market like Quebec in which it once dominated.”

He adds, “This will make it harder to persuade major investors to develop new and more risky international and/or domestic markets, which has always been the unfulfilled dream of whoever owns Dunkin' Brands."

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