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Q&A with Frank Zaid: Rights and obligations

Photos © www.bigstockphoto.com
Photos © www.bigstockphoto.com

Q: What should franchisees know about recent class action court decisions affecting their rights and obligations?

A: There have been two unusual recent class action court decisions that have significant implications for franchisees. In the first case, the Ontario Court of Appeal allowed an appeal by an exclusive supplier of meat products to a franchise system that its supply of contaminated meat caused franchisees economic losses. In the second case, the individual principal of the representative franchisee plaintiff in an unsuccessful class action brought against a franchisor was held by the Ontario Superior Court of Justice to be personally liable for $1.7 million in costs awarded in favour of the franchisor.

The first case: A listeria outbreak
A sandwich shop franchisor had an exclusive supply agreement with a processed meat manufacturer for 14 core menu items to be supplied only by the manufacturer. Franchisees purchased the meat products from distributors who purchased the products from the manufacturer. The manufacturer recalled the products and temporarily closed its production plant after a listeria outbreak. The recall and closure affected the supply of two of the meat products used by the franchisees.

The franchisor brought a class action suit on behalf of its franchisees claiming damages on the basis the defendant negligently manufactured and supplied potentially contaminated meat, and negligently represented the meats were fit for human consumption. There was no evidence any customer of the franchisees was harmed by the contaminated products.

However, the franchisor also claimed franchisees suffered economic losses arising largely from the reputational harm they experienced from negative publicity associated with the food manufacturer following the listeria outbreak. The franchisor claimed damages for loss of past and future sales, and loss of capital and goodwill.

The lower court certified the class action. Both parties then brought applications for summary judgment without a trial. The court found the manufacturer owed a duty of care to the franchisees in relation to the production, processing, sale, and distribution of the meats and a duty of care with respect to any representations made that the meats were fit for human consumption and posed no risk of harm. The manufacturer appealed.

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The Ontario Court of Appeal allowed the appeal. The court found the lower court judge erred in finding the manufacturer’s relationship with the franchisees fell within a recognized duty of care to supply meat products fit for human consumption. The court held the defendant’s duty was owed to the franchisees’ customers, not the franchisees. The type of injury claimed—economic losses arising from reputational harm—did not fall within any scope of duty owed to the franchisees.

Franchisors and franchisee associations should examine supply contracts to ensure there are adequate indemnities and insurance coverage from suppliers.
Franchisors and franchisee associations should examine supply contracts to ensure there are adequate indemnities and insurance coverage from suppliers.

The Court of Appeal also found the lower court erred in finding the food manufacturer owed the franchisees a duty of care with respect to any representations made that the meats were fit for human consumption and posed no risk of harm. The manufacturer undertook in its contractual relationship with the franchisor to supply meat safe for human consumption by customers of the franchisees. The nature of that obligation was to ensure customers of the franchisees who ate the meats would not become ill or die as a result. The purpose of the obligation was not to protect the reputational interests of the franchisees. The duty of care with respect to any representations made that the meats were fit for human consumption and posed no risk of harm did not extend to the damages claimed for pure economic loss.

It was noted by the Court of Appeal that no one was harmed by eating the manufacturer’s meats at a franchisee location. The manufacturer recalled all of its meat products when it learned of the possible contamination. The Court of Appeal agreed with the lower court’s finding that there was a relationship between the manufacturer and the franchisees, but stated the lower court erred in failing to consider the scope of the relationship and the rights and duties that flow from the relationship.

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To enlarge the duty to safeguard the health and safety of customers to include a duty to protect the franchisees against reputational harm would constitute an expansion of any duty owed to the franchisees and extend it to a fundamentally different duty claimed by the franchisees.

Similarly, the Court of Appeal stated the manufacturer’s obligation to supply meat safe for human consumption by franchisees’ customers was to ensure they would not become ill or die as a result of eating the products, but not to protect the reputational interests of the franchisees, and that it was not reasonably foreseeable the franchisees’ reputational interests would be harmed.

The case has very important implications for franchisees and franchisors. In many franchise systems, the franchisor arranges for and controls the supply relationship, and franchisees have little or no ability to source their supplies. When there may be damage resulting to franchisees as a result of negligence on the part of the supplier, even though there is no direct contractual relationship between the supplier and the franchisees, why should the franchisees not be protected against both direct damages suffered by their customers and damage to goodwill and reputation caused as a result of that negligence? Franchisors and franchisee associations should examine supply contracts, particularly exclusive supply contracts, to ensure there are adequate indemnities and insurance coverage from suppliers to cover the franchisor and its franchisees for customer claims and loss of goodwill and reputation resulting from the negligence of the supplier regardless of the fact the supplier may not have a direct supply contract with the franchisees.

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