Quiznos Corp. franchise owners in Canada claim they’re not worried that the sandwich chain’s parent company has filed for bankruptcy protection in the United States. But experts say it’s too early to tell just what the filing will mean for franchise owners and for the class action lawsuit a group of current and former franchisees are bringing against the company in an Ontario court.
Peter Gidda, who owns one of the franchises in Lethbridge, Alta., says he’s not concerned. “We are totally different,” he says. “There’s nothing wrong in Canada.”
“No, we are not worried,” say the woman who answered the phone at a Quiznos in Abbotsford B.C. and identified herself as the owner, but who did not provide her name.
It might be more complicated though, given the ongoing litigation, it may be that franchises don’t want to talk – or have been told not to.
“We’re not supposed to talk about that,” says one Quiznos owner reached at his store in Sherwood Park, Alta. When asked about the bankruptcy protection filing, he directed calls to the company’s head office.
While Quiznos’ Canadian franchisor, the Quizno’s Canada Restaurant Corp., isn’t named as a debtor in the filing made with a Delaware bankruptcy court, Quizno’s Canada Holdings – the franchisor's direct parent, which oversees all the company’s operations in Canada – does hold some of the company’s over $500-million in debt and is named as a debtor. It is a wholly owned subsidiary of the Quiznos company.
Quiznos has been relatively more successful in Canada than the U.S. The chain, which had almost 5,000 locations worldwide in 2007, has been reduced to around 2,000 – with approximately 1,500 of those in the U.S. Quiznos currently has 371 locations in Canada, down from 450 stores in 2009. Only three of the Canadian locations are owned by the company, the rest are franchised.
Even if the situation at Quiznos continues to deteriorate, there’s not much those franchise owners can do, says Peter Snell, a partner at the Vancouver office of Gowlings Lafleur Henderson LLP who specializes in franchising.
“As a franchisee you don’t have a lot of options,” he says. While franchise agreements, the contract a franchisee signs when they buy the business, often include protections for the franchisor if the franchisee goes bankrupt. “The flip side doesn’t exist,” he says.
The only way out of most franchise agreements is to sell the franchise to some else. “Generally the franchisee doesn’t have any right to terminate the franchise agreement unilaterally,” Mr. Snell says.
Instead, franchisees have to hope the company can successfully turn things around, which does happen, Mr. Snell says. Or, if business continues to suffer, they have to “hope that whoever picks up the assets can do better.”
Only five provinces – Alberta, Ontario, New Brunswick, Prince Edward Island and Manitoba – have laws that are specifically intended to protect franchisees. According to Mr. Snell, those laws are mostly focused on pre-sale disclosure, requiring the franchisor to provide potential franchisees with a prospectus-like document detailing the company’s finances. In those provinces, even privately-held franchisors like Quiznos are required to provide the information.
Franchisees may also have other legal remedies outside of the franchise agreement and franchise-specific laws.
Allan Dick will be watching the Quiznos bankruptcy proceedings closely. He’s a litigator at Toronto’s Sotos LLP, a firm that specializes in franchise law. He’s one of the lawyers representing a group of current and former Quiznos franchisees who are suing the company.
The class-action lawsuit, which includes over 600 members (many former franchise owners), alleges that Quiznos forced its franchisees to pay too much for food and other supplies, Mr. Dick says. It also alleges that Quiznos required franchisees to buy all of their supplies from Michigan-based GFS Canada, and that Quiznos “illegally conspired with GFS to charge higher prices.”
A hearing is scheduled for early July, when an Ontario judge will hear motions by Quiznos and GFS to dismiss the case.
The suit was first filed in 2008, but was caught up in procedural wrangling as Quiznos and GFS challenged, and then appealed, the certification of the suit as a class action.
Mr. Dick says the bankruptcy proceeding in the U.S. could have an impact on the case, if the company’s reorganization plan goes through it could make it impossible to pursue action against some – though not all – of the Quiznos business units named in the suit.
“What it all means for the litigation isn’t known at this point,” says Mr. Dick.
Quiznos has a particularly complicated corporate structure. The filing in Delaware specifically names 15 subsidiaries, called “associated entities,” of Quiznos parent company, QCE Finance, that share in its debt. And there are several more “associated entities” that do not have the same liabilities.
All told, Quiznos owes more than $500-million to at least 10,000 creditors – from television broadcasters to food suppliers, according to the filing.
Contributing to the company’s inability to pay down this debt is the fact that the fees, or royalties, franchisees pay the company have already been used to secure previous loans. According to Mr. Dick, that’s what led to allegations of a price-fixing scheme.
“Most franchise companies make money from royalties,” he says, but in 2005, Quiznos used future royalties to securitize loans. That forced the company to find other revenue streams, including “the sale of franchises or the sale of food,” Mr. Dick says.
The company pursued a similar strategy in the U.S., requiring franchisees to buy supplies from American Food Distributors, one of its operating entities.
“Quiznos wanted to make more profit from franchisees,” says Janet Sparks, a Denver-based reporter who has written about the franchise business for 25 years for several franchise newsletters and websites. “That’s when the litigation started.”
She says franchisees were forced to pay “markups of up to 50 per cent,” which meant “it was very hard to a make a profit.” If a franchise went under, Quiznos would then re-sell it to a new owner, Ms. Sparks says.
In 2010, Quiznos settled a class-action lawsuit with 10,000 former and active franchisees, the settlement was worth approximately $206-million. Of that $206-million, $6-million was paid out in cash and another $10-million went to lawyers’ fees and expert witnesses. The remainder was distributed to franchisees in the form of discounts and debt forgiveness.
Despite the suit, little has changed for Quiznos franchisees. Many continue to lose thousands of dollars each year, she says. She adds she also believes these business practices are the reason for the company’s decline, dismissing suggestion the company failed to adapt in the consumer marketplace.
“This has got to do with a broken business model,” she says. “Until they get that fixed, franchisees will not be profitable.”
Quiznos is tight-lipped about both the lawsuit and the request for bankruptcy protection. Calls to the head office in Denver, the number listed on a recent press release from Quiznos Canada, were returned by Joele Frank, Wilkinson Brimmer Katcher, a New York-based PR firm who, among other things, specializes in “crisis communications.” The company refused to speak on the record.