We would like to ensure that you are still receiving content that you find useful – please confirm that you would like to continue to receive ILO newsletters.
22 December 2020
The Jena Higher Regional Court recently held that a clause which allows a franchisor to adjust the franchise fee at the beginning of each quarter and does not clearly disclose to the franchisee the scope of the fee increase mechanism is in breach of the law regarding general terms and conditions (Section 307 of the Civil Code), which applies to standard-form contracts and thus standardised franchise agreements.
In its ruling of 20 April 2018, the Erfurt Regional Court considered the franchisor's fee adjustment clause to be valid (Case 1 HK O 84/17). However, in its judgment of 22 April 2020, the Jena Higher Regional Court overturned the decision under appeal by declaring the fee adjustment clause to be invalid (Case 2 U 287/18). In contrast to the trial court, the appeals court held that the price adjustment clause did not stand up to a judicial review and thus unreasonably discriminated against the franchisee, since the reason for and the extent of possible fee increases were not sufficiently specified.
A franchisee who was active in the house building industry brought an action against its franchisor, asking the court to declare that the fee adjustment clause stipulated in the franchise agreement was invalid. The clause read as follows:
The currently applicable licence fees are stated in Annex 14 of this Agreement. The Annexes, as amended from time to time, are an integral part of this Agreement and will be updated by the Licensor at the beginning of each quarter.
The franchisee also claimed repayment of the increased franchise fees that it had paid based on this clause.
The franchise agreement, which was concluded in 2011, provided for a franchise fee for each house sold. With respect to the amount of the franchise fee, the fee adjustment clause referred to Annex 14, "as amended from time to time". Annex 14 provided for a different franchise fee depending on the type of house sold. When the agreement was concluded, the applicable version of Annex 14 was that of 1 July 2011, valid until 30 September 2011. The franchisor introduced a new version of Annex 14 as from 1 October 2012 and thus new (increased) franchise fee rates. Between July 2012 and July 2015, the franchisee paid a total of 34 invoices, all of which were based on the version of Annex 14 in force since 1 October 2012. In September 2015 the franchisee objected to the unilateral fee increase for the first time. With the action filed in 2017, the franchisee sought a court judgment declaring the fee adjustment clause to be invalid and ordering repayment of the increased (ie, overpaid) franchise fees.
The trial court ruled in the franchisor's favour and dismissed the franchisee's action. It considered the fee adjustment clause to be valid, stating that the clause did not unduly discriminate against the franchisee because the franchisor had not been in a position to specify the fee adjustment mechanism by means of more precise criteria. The court also held that the special right of termination granted to the franchisee argued against the existence of undue discrimination. The appeals court dissented with this line of reasoning.
Breach of transparency requirement
The appeals court considered the franchise agreement to be a standard-form contract. Clauses in standard-form contracts must comply with the transparency requirement of Section 307(1), Sentence 2 of the Civil Code. The appeals court held that the fee adjustment clause conflicted with the transparency requirement because it was not worded in sufficiently clear and understandable terms.
As a benchmark for assessing the price adjustment clause, the court referred to a 13 February 1997 decision of the Dusseldorf Higher Regional Court concerning a price adjustment clause used by a gas supply company (Case 6 U 49/96). The appeals court held that for a price adjustment clause to be clear and understandable, it must indicate the reason and extent of any subsequent price change. Further, it must be worded in such a way that the franchisee:
Any arbitrary or at-will fee increases must be excluded.
Accordingly, the appeals court found that the franchisor's fee adjustment clause did not meet these criteria. The fee adjustment clause itself did not specify any criteria relevant for changing the licence fees. Further, the list of house types set out in Annex 14 did not provide any such criteria, and the other terms of the franchise agreement did not contain any circumstances that could be used as a criterion for updating Annex 14. The franchise agreement provided only for a quarterly update of Annex 14, without any specification or limitation.
In contrast to the trial court's ruling, the balancing of interests conducted by the appeals court also operated in favour of the franchisee. The appeals court argued that due to the breach of the transparency requirement, the franchisee was unreasonably disadvantaged, which led to the invalidity of the fee adjustment clause.
According to the appeals court, the argument in favour of the clause's reasonableness was the fact that the franchisee had obviously not initially expected the franchise fees to remain unchanged over the term of the agreement. After all, the possibility that the franchise fees might be adjusted resulted from the fee adjustment clause in conjunction with Annex 14. The period of validity of the franchise fees indicated in Annex 14 was obviously limited in time. Moreover, in a franchise system based on a long-term contractual relationship, any arbitrary increase in franchise fees is not normally expected. The appeals court held that, in principle, it could be assumed that the franchisee's interests were synchronous to those of the franchisor. Finally, the franchisee could, to a certain extent, pass on the increase in franchise fees to its customers.
However, all of these considerations were insufficient for the appeals court to uphold the trial court's judgment. In contrast to the initial judgment, the appeals court held that it was indeed possible and reasonable for the franchisor to determine possible fee increase factors. The court cited several possibilities of how fee increase factors could have been defined. For example, the increase could have been linked to the expected rate of inflation for the provision of services. In any case, the appeals court held that upper limits for the fee increase should have been specified and, at the very least, a certain level of transparency with respect to the fee adjustment had to be ensured for the franchisee. However, the court noted that in the case at issue, transparency was missing entirely. The franchisee was not in a position to estimate the extent of a possible fee increase or verify the justification for the increase.
Further, there was no way for the franchisee to challenge any fee increase. Under the franchise agreement, the franchisee had only a right of objection if the franchisor made unilateral changes to the system manuals.
Thus, the appeals court limited the franchisor's claim to the franchise fee that had applied when the agreement was concluded. As such, the franchisor had to repay the franchise fees paid by the franchisee in excess of this original fee.
The Jena Higher Regional Court's decision shows that caution is needed when drafting fee adjustment clauses. When such fee adjustment clauses are used, there is a risk that the courts may find them to be unreasonably discriminatory and therefore invalid according to Section 307 of the Civil Code. Parties which do not wish to do without a fee adjustment clause entirely should formulate the fee increase mechanism as clearly and transparently as possible. The franchisee must be in a position to adequately estimate the extent of any possible fee increase and verify the justification for the increase. It is also advisable to set an upper limit on the fee increase. In addition, the franchise agreement should provide the franchisee with a special right of termination in the event of a fee increase.
For further information on this topic please contact Karsten Metzlaff or Jasmin Schulzweida at Noerr LLP's Hamburg office by telephone (+49 40 300 3970) or email (firstname.lastname@example.org or email@example.com). Alternatively, contact Tom Billing at Noerr LLP's Berlin office by telephone (+49 30 20 94 20 00) or email (firstname.lastname@example.org). The Noerr LLP website can be accessed at www.noerr.com.
The materials contained on this website are for general information purposes only and are subject to the disclaimer.
ILO is a premium online legal update service for major companies and law firms worldwide. In-house corporate counsel and other users of legal services, as well as law firm partners, qualify for a free subscription.