Tim Hortons
Franchisees of the Tim Hortons chain in Canada are seeking class-action status for a lawsuit against the restaurant chain’s owner.

TORONTO — Franchisees of the Tim Hortons chain in Canada are seeking class-action status for a lawsuit against the restaurant chain’s owner in an escalating dispute over the parent company’s management of an advertising and marketing fund collected from franchisees.

Plaintiffs in the case accuse Oakville, Ont.-based The TDL Group Corp. (the operator of Tim Hortons) of “oppressive conduct” and seek the return of funds they allege were inappropriately spent, a full accounting of Tim Hortons Ad Fund and the payment of damages.

The lawsuit was filed June 19 in Ontario Superior Court.

Defendants in the case include TDL, the franchisor of the Tim Hortons franchise system; Restaurant Brands International (R.B.I.), the parent company of TDL; and numerous individuals, including Daniel Schwartz, chief executive officer of R.B.I., and Elias Diaz Sese, president of Tim Hortons.

R.B.I. declined to respond directly to the allegations in the lawsuit or by a representative of the franchisees, but offered a formal statement:

“Our strategy remains focused on delivering great guest satisfaction every day while continuing to find ways to evolve and grow the brand in a rapidly changing market. It is very disappointing that a few restaurant owners have opted to take actions against us when our focus remains on protecting and enhancing the brand. We vehemently disagree with and deny all the allegations that have been made about our business and the brand. We remain committed to working together with our restaurant owners to ensure the incredible Tim Hortons brand continues to be strong for many years to come.”

Discontent with the parent company is not limited to a “few” franchisees, said David G. Hughes, president of the Great White North Franchisee Association (G.W.N.F.A.). The group was established in January 2017 in response to concerns including the use of the Ad Fund. Mr. Hughes said “almost half” of franchisees in Canada have joined the new association.

“What we need is to turn the clock back to where we had a relationship (with the franchisor),” Mr. Hughes said. “Right now we don’t have a relationship.”

Tim Hortons has about 3,500 franchised locations in Canada. The shops sell coffee, baked foods and other products, including soups and sandwiches. All told, the company had 4,644 locations in Canada and the United States as of March 31.

Following the 2014 acquisition of Tim Hortons by Brazil-based 3G Capital in a $12.5 billion transaction, Tim Hortons was merged with Burger King Worldwide, Inc. (also acquired by 3G) to create Restaurant Brands International, Inc., a publicly traded company. Since the 2014 acquisition, TDL has used “various strategies to extract more money out of the Tim Hortons franchise system at the expense of franchisees,” the plaintiffs allege.

Specifically, the franchisees contend R.B.I. has used the Ad Fund in ways that are not permitted, “funneling money to itself, TDL” and to individual defendants whose incomes are dependent on R.B.I. financial results.

The Ad Fund is funded through mandated franchisee payments of 3.5% of gross sales. It collected C$700 million from franchisees during the period covered by the lawsuit.

The lawsuit enumerates intensive cost cutting conducted by TDL following the 3G Capital acquisition.

“This included a massive restructuring of TDL’s employee pool, directing the dismissal of a significant percentage of TDL’s employees, including those responsible for marketing activities, and increasing prices charged to franchisees for such staple and fundamental products as coffee.”

Instead of using the Ad Fund for its historic purposes, the plaintiffs suggest R.B.I. eyed the C$300 million in annual advertising/marketing funds as a source to “enhance (R.B.I.’s) financial performance, its stock price and the executive compensation received by the TDL/R.B.I. executive group to the detriment of the plaintiff and the proposed class members.”

TDL is accused of inappropriately charging operational/administrative expenses to the Ad Fund and failing to provide franchisees required statements of the Ad Fund operations, required by franchise agreements.

Historically, the plaintiffs allege, 7% of the Ad Fund was used to cover administrative expenses, mostly staffing. After the 2014 acquisition, though, administrative charges jumped 27%, even as staffing was reduced.

“The administrative expenses of TDL charged to the Ad Fund significantly increased from approximately $16,466,000 in 2014 to $21,102,000 in 2015,” the lawsuit alleges. “This increase in administrative expenses was despite TDL dismissing a large number of marketing personnel employed at TDL and despite the fact that the salaries of marketing personnel constituted 85% to 95% of total administrative expenses following the 3G takeover.”

The increase allegedly was used to cover expenses with scant if any connection to the Ad Fund, including customer service representatives, operations support personnel and staff in regional offices who support individuals running the Ad Fund. The lawsuit says none of these costs were “properly chargeable” to the Ad Fund.

Among other new uses of the fund, the lawsuit says TDL was using the Ad Fund for franchisee training, research and development and a new program aimed at evaluating franchisee customer service.

“TDL charged the Ad Fund for the promotion of TDL’s private label products that are sold through non-franchised channels, such as grocery stores, that competed with franchisees for sales of Tim Hortons branded coffee,” the lawsuit alleges. “Further, TDL started using Ad Fund contributions to pay grocery stores listing fees for products going into those stores.”

While TDL has discretion over how the Ad Fund is used, the plaintiffs say their complaint is bolstered by direct language in the franchise agreement. The agreement says the Ad Fund “shall not be used to defray any of (TDL’s) general operating expenses, except for such reasonable administrative personnel and overhead costs on a fully allocated basis as (TDL) may incur for activities related to the administration or direction of the Advertising Fund, which (TDL) shall be entitled to recover from the Advertising Fund.”

Plaintiffs are seeking C$500 million for breach of contract and another C$300 million in damages as well as C$300 million from other defendants.

On June 26, the G.W.N.F.A. said in a statement that a U.S. chapter has been created, and about half of U.S. franchisees have joined.

The dispute comes at a time in which Tim Hortons business has been flagging. In the first quarter ended March 31, R.B.I. said Tim Hortons comparable stores sales were flat (off 0.1%) versus the first quarter of 2016. By contrast, sales jumped 5.6% In the first quarter of 2016, versus 2015. System-wide sales growth was 3.3%, versus 7.9% in the year before quarter.

Tim Hortons adjusted EBITDA in the quarter was C$256.2 million, up 12% from C$227.8 million.