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15 January 2013
The expansion of franchise systems may include the use of master franchisees. The franchisor concludes a master franchise agreement with a master franchisee, which is given the right to grant sub-franchises within a certain territory and thereby licenses the transferred know-how and trademark to sub-franchisees. The master franchisee thereby becomes the sub-franchisor, building up a network of franchisees. The franchisees are the contractual partners of the master franchisee.
In two judgments of July 19 2012 on copyright licence agreements, the Federal Court of Justice held that the expiry of a main licence does not, in the vast majority of cases, lead to the expiry of the related sub-licences (File I ZR 24/11 – Take Five; see also File I ZR 70/10 – M2Trade). The question is whether and to what extent this also applies to master franchising.
The licensor was a music publisher based in the United States and held the exclusive music publishing rights and the associated worldwide rights of use to the Paul Desmond composition "Take Five". The licensor granted the main licensee the exclusive publishing rights to the work for Europe, and the main licensee granted a sub-licence for the exclusive sub-publishing rights for Germany and Austria to the legal predecessor of the sub-licensee. In the course of litigation in the United States, in March 1986 the licensor and the main licensee concluded a termination agreement in which they agreed that all mutual obligations under the agreement were ended.
In the proceedings before the German courts the licensor sought a declaration that the sub-licensee was no longer the holder of the music publishing rights for Germany and Austria. It argued that due to the agreed termination of the licence agreement, the sub-licence of the sub-licensee was also terminated.
The District Court of Munich I initially granted the claim. However, the Higher Regional Court of Munich reversed that judgment on appeal. The licensor's appeal on a point of law was dismissed.
The Federal Court of Justice relied first on succession protection, as applicable in copyright law (Section 33 of the Copyright Act) and industrial property rights (Section 30(5) of the Trademark Act, Section 31(5) of the Design Act, Section 15(3) of the Patent Act and Section 22(3) of the Utility Models Act). Succession protection ensures that exclusive and simple rights of use remain valid if the holder of the right, which granted the right of use, changes. In copyright law, the same applies even if the licensor waives its rights. The purpose of succession protection is to protect the trust of the holder in the continuation of its right to enable it to recover its investment. Accordingly, the legislature assumes that the loss of the main licence does not necessarily lead to the loss of the sub-licence.
Weighing-up of interests
A weighing-up of the relevant interests shows that the interest of the sub-licensee in the continuation of the sub-licence outweighs the interest of the main licensor in revoking the sub-licence following expiry of the main licence.
Exclusive licence exists
It was irrelevant that the case involved an exclusive sub-licence for Germany and Austria. While this naturally restricts the right of the main licensee considerably because it cannot grant any other licence for that territory, the main licensor must accept this restriction because it consented to the main licensee granting exclusive sub-licences. Therefore, the main licensor must accept that its exclusive right of use is restricted by the exclusive rights of use granted to the sub-licensee.
The defence that the continuation of the sub-licence allows the main licensee to continue to profit from the ongoing licence payment of the sub-licensee while the main licensor gets nothing does not refute the above conclusions. The interest of the main licensor continues to prevail because it can claim against the main licensee after the termination of the main licence for assignment of its rights against the sub-licensee to payment of the licence fees. Therefore, the main licensor suffers no financial loss. The sub-licensee, on the other hand, can neither influence nor foresee the cause for termination of the main agreement. Therefore, due to the premature and unexpected loss of its right, the sub-licensee would frequently suffer considerable financial loss.
Reason for loss of main licence
The Federal Court of Justice held that the reason for the loss of the main licence was also irrelevant. In the course of the weighing-up of interests, it was not crucial whether the main licence was extinguished because of revocation for non-use or for another reasons outside the sub-licensee's sphere of responsibility.
It is doubtful whether the principles on which the Federal Court of Justice's judgments are based are transferable to master franchising agreements. The legal nature of a master franchise agreement is not necessarily comparable to that of a licence agreement. In fact, a master franchise agreement is a mixed agreement of various types of contract. Master franchise agreements contain more than a simple right to use a trademark, idea or concept. Apart from the obligation of the master franchisee to present a uniform image by using the corporate design and to maintain the prescribed quality level, the licensor also has a duty to develop the system further to adjust it to the market circumstances, and thereby maintain its competitiveness. Therefore, the franchisor has a considerably wider interest than a purely financial one in the cancellation of franchises (or sub-franchises). However, in order to ensure the best possible legal certainty, both the master franchise agreement and the sub-franchise agreement should contain provisions on the procedure to be followed if the master franchise agreement ends, irrespective of the reasons.
For further information on this topic please contact Karl Rauser or Karsten Metzlaff at Noerr LLP by telephone (+49 30 20 94 20 00), fax (+49 30 20 94 20 94) or email (email@example.com or firstname.lastname@example.org).
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