Volume Rebates Franchisee Class Action

In a judgment dated October 31, 2014 the Ontario Superior Court dealt with the duty of a franchisor to share volume rebates with its franchisees. Of real interest is how the judge applied statements contained in the recitals or preambles in the franchise agreement and its operations manual to interpret the franchisor’s duty to share rebates.

The case was a class action brought by on behalf of franchisees alleging that their franchisor failed to share volume rebates based on the franchisor’s statements that it had substantial purchasing power and was contractually obliged through its franchise agreement to share volume-related benefits with its franchisees and had failed to do so.

In the case the franchisor sells products and related services, both as a wholesaler and retailer. There were almost an an equal number of a total of approximately 580 franchised and corporate stores throughout Canada.

The franchise agreement required the franchisor to pass along volume rebates with its franchisees minus a reasonable mark-up. Following a detailed analysis of the franchise agreement and, in particular, recitals or preambles to the agreement, the trial judge interpreted the franchisor’s duty to share volume rebates as meaning that it would share the rebates “reasonably”. The agreement explicitly acknowledged that the recitals formed part of the agreement and were true in fact and substance. Thus, statements contained in the recitals became critical in interpreting the franchisor’s obligations.

The agreement stated that volume allowances would be allocated as particularly set forth in the franchisor’s operations manual. The manual stated that rebates may be included in the landed cost of specific products pursuant to the discretion of the franchisor. In a critical statement the judge confirmed that the duty of good faith and fair dealing under common law and in provincial franchise legislation obligated the franchisor to share rebates reasonably.

After analyzing the actual amount and nature of rebates, the judge concluded that the franchisor had passed on all rebates to its franchisees and the mark-ups were not unreasonable. However, in a supplementary affidavit filed by the franchisor, the franchisor stated that it in fact had little to no purchasing power with its major suppliers. The franchisees were so surprised by this statement that they moved to amend their pleadings to shift the major focus of the case to a new claim that the franchisor had falsely represented the nature and extent of its purchasing power and that these misrepresentations caused enormous damage to the franchisees who relied on the representations when becoming franchisees. This new issue remains to be decided in a subsequent hearing. However, until then, another key claim in the case is deferred.

The deferred claim is a novel allegation that the franchisor had an ongoing obligation under the good faith and fair dealing section of franchise legislation to provide franchisees with information about the volume rebates in addition to the obligation to disclosure certain specific information about volume rebates in a pre-sale disclosure document. The judge stated that the good faith and fair dealing principle cannot be used to compel ongoing disclosure. The legislation does not impose a continuous post-sale disclosure regime and there is no obligation on the part of a franchisor to provide ongoing disclosure, at least not for routine and non-material information.

But the franchisees’ argument that the franchisor failed to disclose material financial information that went to the very root of the agreement (i.e., more than routine and non-material information), and the franchisees’ motion to add a new claim regarding purchasing power, could create an obligation on the franchisor to provide ongoing post-sale disclosure of rebates.

Sounds complicated? You bet it is. But what is most important for both franchisors and franchisees is how the overall subject of the duty of a franchisor to share rebates and to provide ongoing disclosure of rebates will be determined by the courts. Yes, much depends in this case on specific statements made in the franchisor's franchise agreement and operations manual about sharing of rebates and the franchisor’s purchasing power. But many franchise agreements contain similar statements and many franchisors forget that what their operations manuals state will likely have the same force as obligations or representations contained in their franchise agreements.

Stay tuned for the next episode of this case when the court deals with the purchasing power issue.