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Tim Hortons franchisee files suit against parent company over use of funds

Exteriors of theTim Hortons coffee shop at the corner of Scott St. and Wellington St East, is photographed on Mar 3 2017.

Fred Lum/The Globe and Mail

A Tim Hortons franchisee has filed a $500-million suit seeking class-action status on behalf of all the chain's Canadian restaurant owners against the parent company and its top executives, claiming they misused money from the franchisees' ad fund.

The legal claim says parent Restaurant Brands International Inc., which acquired Tim Hortons in late 2014 for $12.5-billion, has used "various strategies to extract more money out of the Tim Hortons franchise system at the expense of franchisees."

One such strategy has been improperly using money from the fund that the franchisees must contribute to – representing 3.5 per cent of their sales – and is aimed at marketing the Tim Hortons brand and the franchisees' offerings, according to documents filed in Ontario Superior Court on Monday.

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Read more: Inside the brutal transformation of Tim Hortons

Instead, the Oakville, Ont.-based company is using the money for other operational and administrative purposes and failed to provide statements about the uses, as required by the franchisee agreements, the claim says.

In another development on Monday, Elias Diaz Sese stepped down as president of Tim Hortons and his responsibilities are being taken over by Daniel Schwartz, chief executive officer of RBI, the company confirmed.

Mr. Diaz Sese will work with the chain's international teams to accelerate its global growth, it said. Franchisee sources said they were told about the leadership change on a morning conference call.

The legal claim, launched by Toronto franchisee Mark Kuziora, names Mr. Schwartz and Mr. Diaz Sese among the defendants as well as TDL Group Corp., a division of the company that oversees the franchisees.

"RBI has [funnelled] this money to itself, TDL and the individual defendants [executives] at the wrongful expense of the franchisees," the claim states. The court still has to give the green light for the class action to proceed.

Criticism of RBI's aggressive cost-cutting efforts has been mounting since a group of franchisees formed the Great White North Franchisee Association in March to represent them in talks with the parent company, which also owns U.S. fast-food chains Burger King and Popeyes Louisiana Kitchen. Franchisees have honed in on RBI's moves to push some expenses on to store owners and, in some cases, modify products and operations to save money or boost profit margins.

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Sami Siddiqui, president of Tim Hortons's Canadian division, said in a letter to franchisees on Monday: "We vehemently disagree with and deny all the allegations that have been made about our business and the brand.

"It is very unfortunate that certain owners have chosen to make these public accusations given that we have offered to let any owner come in and review the numbers with us, line by line, as we have done in the past. As we have discussed many times before, these types of public accusations will only hurt the brand that all of you have worked so hard to build."

The association, which is behind the lawsuit, said in an e-mailed statement that litigation was not its preferred option.

"It became the default option due to RBI's lack of transparency and unwillingness to answer important questions put to it in writing," the association said. "Our concerns are detailed in the claim."

"The franchise agreements stipulate that the contributions to the ad fund are for the specific purpose of advertising, marketing and sales promotion," the documents say. "There is therefore an express or implied obligation under the franchise agreements that TDL would direct the use of the ad fund solely for the purpose of advertising and marketing and not for any other purpose.

"This means that TDL is not permitted under the franchise agreements to use the ad fund to pay for its general operating/administrative expenses or the promotion of the sale of private-label products at non-franchised locations."

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If the franchisees' annual contributions of almost $300-million to the ad fund were used to cover corporate expenses, it "would enhance TDL's financial performance, RBI's stock price and the executive compensation received by the TDL/RBI executive group to the detriment of" the franchisees, the claim says.

RBI's shares have jumped almost 28 per cent since the beginning of 2017. On Monday, they rose 1.6 per cent to close at $81.78 on the Toronto Stock Exchange.

Still, RBI has faced criticism from an influential U.S. investment newsletter, Grant's Interest Rate Observer, which published a recent article called "Rumblings from the great white north" that raised questions about RBI's strategy.

In the legal claim, franchisee Mr. Kuziora says Tim Hortons has downloaded many of its corporate operating and administrative costs to the ad fund while the franchisees failed to fully benefit from their fund contributions. The company "has deliberately used ad fund contributions to pay for expenses that it was aware were not historically nor properly chargeable to the ad fund," the claim says.

The court document says the ad fund unofficially aimed to spend about 7 per cent of franchisee contributions on administrative expenses, mostly staffing of the fund.

But it says the company significantly increased administrative expenses, even though it dismissed almost half of the employees responsible for advertising and whose compensation had been previously charged to the fund.

The claim details other new costs charged to the fund, including those for franchisee training, research and development for product testing and menu development, a new "operations excellence" customer-service program and evaluating franchisees.

Tim Hortons also started to charge the fund for expenses incurred by its children's foundation and those tied to customers' preloaded debit cards, known as TimCards. The cards' unused balance, referred to as "breakage," has been going to the company rather than to the ad fund as had historically been the case, the documents say.

As well, Tim Hortons started to charge the fund "a disproportionate amount of operational expenses" in relation to U.S franchisees, says the claim, which is on behalf of the approximately 3,500 franchisees in Canada.

The claim says the company failed to provide the franchisees with an adequate audit of the fund, in breach of its duties of good faith and fair dealing. The association has said the fund's administrative expenses have more than doubled to $31-million in 2015 from $14.6-million in 2013.

The association executives have also said they want more clarity about higher costs franchisees are being charged by the company for their supplies such as coffee, sugar and bacon.

They have complained about Tim Hortons's profit centre "reengineering" to the company's favour, which they have said materially diminished franchisees' profit. (The company has countered that franchisees' profits have increased overall.)

And the shift to single-source suppliers has "led to product shortages adversely impacting sales, customer retention and the ability to meet system standards. Cost-cutting measures are also evident in the compromised quality of newly introduced products and equipment, while the cost of goods has been ballooning," the association said in a letter to RBI in March.

Five years ago, a proposed $2-billion class-action lawsuit against Tim Hortons was tossed out of court. That suit was over the chain's decision in in the early 2000s to introduce its "Always Fresh" flash-freezing baking, rather than baking from scratch, with franchisees arguing the company was unfairly ringing up profits at their expense.

The iconic Tim Hortons chain of coffee stores has a long history in Canada, growing from a single store in Hamilton. But now thought its growth and a series of mergers, its one pillar of a huge empire of brands that will now include Popeyes.
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