Appeal rulings clear the path for franchise class actions

“The purpose of the Act is to protect franchisees. The provisions of the Act are to be interpreted in that light. Requiring franchisees to give up any claims they might have against a franchisor for purported breaches of the Act in order to renew their franchise agreement, unequivocally runs afoul of the Act.” The court also agreed, with Justice Cullity that the right of association given to franchisees under s. 4 of the Act includes the right to bring a class action and therefore cannot be contracted away.

The Lawyer Weekly
September 3, 2010

Appeal rulings clear the path for franchise class actions
David Sterns

Two recent decisions of the Ontario Court of Appeal helped level the playing field in franchise disputes. Both cases involved class actions by franchisees against their franchisor over the supply of products necessary for the franchisees’ business. In both cases, the court strongly endorsed class actions as a means of redressing the traditional imbalance in the franchise relationship.

Power imbalance is the silent presence in most disputes between franchisee and their franchisor. This is because franchisors typically enjoy the upper hand over franchisees, from the drafting of the governing agreements, to the franchisor’s broad discretionary powers during the relationship over such things as the price and supply of raw materials, and rights of termination and repossession of the franchisee’s business.

This imbalance does not go away when the franchisees sue the franchisor. In fact, it usually escalates, making such disputes a perilous adventure for franchisees.

In 2038724 Ontario Ltd. V. Quizno’s Restaurant Corp., [2010] O.J. Bi. 2683 (C.A.), the franchisees brought a national class action against Quiznos and its designated supplier, Gordon Food Services (GFS), over alleged overcharging on supplies. The defendants opposed certification primarily on the grounds that damages were not common among the franchisees and would have to be established individually.

Quiznos was successful in these arguments at first instance, but the decision was overturned by the Divisional Court in a two-to-one decision released in 2009. After granting leave to appeal to the defendants, the Court of Appeal released a unanimous decision in June affirming the Divisional Court majority and endorsing class actions as a means of resolving system-wide franchise disputes. Such disputes, wrote Justice Robert Armstrong for the court, are “exactly the kind of case for a class proceeding.”

The court dismissed arguments that the claim would be unmanageable due to the different levels of profitability and differing buying patterns of the franchisees. Such facts, even if relevant, paled in comparison to the commonality of the franchisees’ claims rooted in a single distribution system and a single distribution agreement between the defendants.

The Quiznos franchise agreements presented an additional obstacle to certification in the form of a “class-action waiver” in every franchise agreement. The waiver purported to prevent the franchisees from initiating or being part of any class action. Justice Paul Perell, who heard Quiznos’ motion to stay the class action ([2008] O.J. No. 833) together with the certification motion, declined to enforce the waiver, finding that it interfered with the proper administration of justice.

Provisions such as class action waivers reflect a growing tendency by franchisors to prevent collective action through contract drafting.

The Ontario Court of Appeal’s decision in 45341 Ontario Ltd. V. Midas Canada Inc., [2010] O.J. N. 2845 involved a provision commonly found in franchise agreements requiring franchisees to execute a general release in favour of the franchisor as a condition of renewing their franchise agreement upon expiry. At issue in Midas was whether the franchisor could rely on such a provision to force the representative plaintiff in a certified class action to choose between renewing its expired franchise agreement or releasing its claim in the class action. Justice Maurice Cullity held at first instance that such a requirement violated protections given to franchisees under the Arthur Wishart Act (Franchise Disclosure), 2000 and was therefore unenforceable. The Court of Appeal agreed. Writing for the court, Justice Jean MacFarland held:

“The purpose of the Act is to protect franchisees. The provisions of the Act are to be interpreted in that light. Requiring franchisees to give up any claims they might have against a franchisor for purported breaches of the Act in order to renew their franchise agreement, unequivocally runs afoul of the Act.”

The court also agreed, with Justice Cullity that the right of association given to franchisees under s. 4 of the Act includes the right to bring a class action and therefore cannot be contracted away. How this important finding will affect other common contractual provisions, including mandatory arbitration clauses, will undoubtedly be litigated before long.

Franchising is still viewed by some as a zero-sum game in which the franchsor’s profit comes only at the expense of its franchisees, and vice versa. This status quo remained unchallenged for many years because of the overriding imbalance and economic dependency inherent in the relationship. Class actions are a game changer as they offer a real chance of compensation for system-wide breaches.

Quiznos and Midas recognize the practical challenges faced by franchisees in suing their franchisor, and will go a long way in allowing franchisees the chance for a fair fight.

David Sterns is a litigation partner in Sotos LLP in Toronto, and was counsel for the plaintiffs in Quiznos and Midas.

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