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18 September 2012
Non-compete clauses in franchise agreements frequently prohibit the franchisee from offering competing products in its franchise store or from acting for competitors outside of its franchise store. This is because the franchisor wishes to protect its system against competitors. However, the franchisee also has a financial interest in the franchisor not opening or operating a franchise store within the franchisee's territory (or permitting a third-party to do so).
A contractual non-compete clause was at the centre of a case before the Dusseldorf Higher Regional Court. Its decision(1) concerns the issue of the prerequisites for a franchisee's claim to information where it has reasonable suspicion of its franchisor having breached a contractually agreed non-compete obligation, and the right to claim damages from the franchisor.
The franchisor runs a chain of optician stores, some of which are operated as the franchisor's own stores and some as franchise stores by franchisees. The basis of the collaboration between the parties in dispute was a standard form franchise agreement. Clause 1.5 stated: "During the term of this agreement, [X, the franchisor] will neither open its own X specialist optician store nor permit a third party to do so in B."
Since 1999 the parties had been involved in numerous disputes which concerned the validity of contract terminations declared by the franchisor and in which the franchisee sought to prohibit the franchisor from operating a specialist optician store in B. Between March 2000 and August 2000 the franchisee no longer appeared on the market as a member of the franchisor's system. From August 2000 to November 2001 the franchisee again acted as system member before finally withdrawing from the market (although in a purely factual sense and without formally ending its franchise agreement at that time). In May 2000 the franchisor opened its own store in a shopping mall in B. It was finally decided, as res judicata in one of the disputes, that the franchise agreement had not legally ended until on November 7 2004.
The court found in favour of the franchisee insofar as it accorded to the franchisee a claim to information regarding the revenue from the sale of goods in the franchisor's store in B between May 2000 and November 2001, based on a breach of Clause 1.5 of the franchise agreement.
Claim to information to enforce a damages claim
The court first stated that a claim for contractual damages – which is to be proved based on, and with the help of, information obtained from the contracting partner – need not necessarily be established on the merits. Rather, mere reasonable suspicion of a breach of a contractual obligation, together with the finding that there was a predominant likelihood for such a damage claim, would be considered sufficient.
Factual withdrawal from franchise system is no hindrance
The court stated that the franchisor could not validly challenge the franchisee's contention of a breach of contract by arguing that the franchisee had factually left the franchise system temporarily and could not rely on the protection against competitors under Clause 1.5 during this period. This was because the franchisee's withdrawal was not based on an independent decision taken by the franchisee, but was exclusively the result of the franchisor having wrongfully terminated the contract between the parties and having enforced the judgment issued in its favour before it had become final. Meanwhile, the fact that the franchise agreement between the parties had legally remained in effect until November 7 2004 had been established on the basis of the non-appealable court decisions, in which the franchisor's notices of termination had been declared invalid.
Reasonable suspicion of breach of contract
The court found that there was a reasonable suspicion of a breach of contract by the franchisor in respect of the non-compete obligation, as the franchisor, in opening its branch store in B in May 2000, had itself created an uncertain situation.
By its purpose and meaning, the prohibition against competition in Clause 1.5 was meant to grant the franchisee a unique position in operating its franchise store, since no other franchisee was permitted to operate in the protected territory and the franchisor itself did not operate a franchise store there. The position that the franchisee should have enjoyed was violated not only in that the franchisor operated a store under the logo of the franchise brand in the protected territory, but also by the fact that circumstances had been created in which the relevant consumers might have concluded that the store was part of the franchise brand. While the franchisor, for most of the period at issue, had not used the franchise brand or advertised in a style that was typical of the brand, it had left unchanged both the store's exterior and the entire business organisation as a specialist store of the franchise brand. This led to the obvious risk of the relevant consumers associating the store with the franchisor.
Predominant likelihood of a damages claim
The court further stated that there was also a predominant likelihood that the franchisor was liable for damages to the franchisee based on suspicion of a breach of the contractual non-compete obligation.
Based on a realistic evaluation, it was sufficiently likely that the franchisee, as a result of the franchisor's breach of contract, had suffered financial damage "to some extent". The agreement on the prohibition of competition in Clause 1.5 alone proved that according to the parties' concurrent judgment, a competing business would, in the normal course of events, significantly impair the existing franchisee's turnover and earning prospects. In any event, due to the non-compliance with this contractual prohibition, the franchisee had suffered damage on the grounds that customers of the franchise system – who, but for the franchisor's breach of contract, would have been potential customers of the franchisee – now visited the franchisor's store in B. Given how well known the franchise system was, it was obvious that such customers existed.
The court went on to find that the franchisor was not discharged from its responsibility by the fact that it had initially been permitted, in the injunction proceedings, to offer and distribute in its store products with clearly affixed franchise product designations without advertising these products within or outside the store. This was because the injunction was merely a preliminary decision. Therefore, employing the care required in normal business practice, the franchisor could not legitimately have relied on the fact that such injunction would finally and correctly establish the content and scope of the clause on the contractual prohibition of competition. Indeed, the franchisor was faced with a different decision in the main proceedings.
The court's decision shows that an express agreement on prohibition of competition carries a potential risk for the franchisor: it must be prepared to be judged by such a prohibition, even if the agreement has been terminated (for further details please see "Court assesses contractual obligation to protect franchisee against competition").
This case also shows how important it is that following the issue of a notice of termination, no fait accompli be created too early - that is, not before the validity of the termination has been confirmed and the period for appeal is over.
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 (firstname.lastname@example.org or email@example.com).
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