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14 February 2017
Franchise agreements often contain pre-emption rights allowing franchisors to take over the shares or assets of their franchisees with priority over third parties. The rationale behind these rights is to guarantee the continuity and consistency of the network that the franchisor has gradually built and avoid the leakage of know-how to competitors.
Two recent court cases have shed some light on the validity of pre-emption rights and their enforcement with regard to franchisees and their shareholders.
The purpose of a pre-emption (or preferential) right is to grant to a given person a special right to buy shares or assets belonging to another person with priority over any interested third party.
In order to be enforceable, the scope of the pre-emption must be defined – in other words:
Second, the interest of the beneficiary must be legitimate. In a recent case concerning the food retail sector,(1) the Paris Court of Appeal held that the franchisor's interest in the pre-emption right was to secure its investments made over several years by preventing the appropriation of its commercial benefits by a competitor.
Further, the exercise of the pre-emption right must not have an anti-competitive effect. In highly concentrated industries, where the exercise of pre-emption rights (among others) may significantly increase barriers to entry on the market, pre-emption rights are likely to be problematic. For instance, the Competition Authority considers that the application of such clauses leads to a freeze in the geographic coverage of French large distribution groups in the food retail sector.(2)
Finally, the beneficiary must offer the same terms and conditions as those granted by the third-party acquirer.
Under French law, the principle is that the beneficiary of a pre-emption right which has been violated by the promisor may have the sale to a third party held null and void or substitute the third-party buyer in all its rights and obligations, provided that the third party knew of both:
Such principles have been recently enshrined in the Civil Code (further to the reform of French contract law).
However, there may be circumstances where it is no longer possible to cancel the contravening transaction or substitute the rights and obligations of the third party. In a case opposing two reputable DIY brands in France (Mr Bricolage and Bricorama), the Paris Court of Appeal noted that the franchisor Mr Bricolage had validly exercised its pre-emption right over the shares of three companies operating large DIY shops; however, before the judgment was issued, the shares of those companies were sold to a third party and the buyer was subsequently merged into a competing company as part of the Bricorama group. Hence, the franchisor could no longer own the companies, as they no longer existed as a result of their merger. In such circumstances, the court held that the franchisor's only available remedy was damages. It ruled that it was to be jointly and severally compensated by the sellers of those companies and Bricorama – not only for the loss of opportunity of becoming the owner of such businesses (which had significant economic, financial, property and competitive advantages), but also a loss arising from the unfair competition by Bricorama, which had a strategic interest in taking over such stores located close to hypermarkets. The court of appeal awarded Mr Bricolage damages amounting to €5.1 million, and the decision was upheld by the Supreme Court on September 20 2016.(3)
In addition to the effectiveness of pre-emption rights, the revised Civil Code provides for a mechanism aimed at strengthening legal security. From now on, if a third party knows or suspects that the shares it intends to buy may be subject to a pre-emption right in favour of a seller's partner (eg, a co-shareholder or franchisor), it has the right formally to ask the known or suspected beneficiary whether it intends to exercise its preferential right to buy. If the beneficiary does not indicate its position within a reasonable period, it is deemed to have waived its pre-emption right and the transaction between the seller and the third-party buyer may go through. It will be interesting to see whether this kind of mechanism is used in practice in future.
For further information on this topic please contact Raphael Mellerio at Aramis Law Firm by telephone (+33 1 53 30 7700) or email (firstname.lastname@example.org). The Aramis Law Firm website can be accessed at www.aramis-law.com.
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