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11 February 2014
Each franchisor has an interest in protecting its franchise system from imitation by third parties or former franchisees after a franchise agreement has ended. In relation to franchisees, a franchisor can usually protect itself by including post-contractual non-compete provisions and corresponding compensation provisions in the franchise agreement. However, post-contractual non-compete provisions can be agreed for a limited period only, and protect the franchisor only against direct competition by the franchisee. Once this period has expired, apart from the possibility of IP rights protection, the franchisor is entitled to protection against unfair imitation of its franchise system under the Act against Unfair Competition.
On September 26 2013 the Schleswig Higher Regional Court (16 U (Kart) 49/13) considered, among other things, the question of the extent to which unfair imitation arises if a franchisee continues to operate a franchise restaurant with an identical range of products, but under another name and colour concept.
The parties concluded a franchise agreement in 2004 for the operation of a Subway restaurant. The franchise agreement provided that after it had ended (by termination, among other things), the 'Subway' name could no longer be used. There was also a non-compete provision which stated that for one year following termination of the agreement, no other sandwich restaurant could be operated from the franchise premises. A fixed sum in compensation was set in the event of breach.
In 2010 the franchisee (defendant) discontinued payments. After unsuccessful reminders, the franchisor (plaintiff) terminated without notice. The defendant initially continued to operate the restaurant unchanged, with an identical range of products and under the name 'Subway'. It later changed the name to 'fresh!', with an almost identical design (eg, furniture, wall and counter design), which was subsequently changed through a repaint of furniture, floor tiles, walls and counter coverings.
Under the name 'fresh!', a group of the plaintiff's former franchisees together with the defendant discontinued their payments at the same time and received terminations. They each operated sandwich restaurants in their existing premises as a new chain, while keeping the acquired furniture.
The court affirmed, among other things, payment of the fixed compensation for the period of continued use of the 'Subway' name and the almost unchanged assumption of the external design concept, respectively, as well as the period of the post-contractual non-compete provisions.
However, the court refused to award further damages or injunctions in relation to the operation of the restaurant under the new name 'fresh!' and with the new colour design – including in association with the other franchisees – since according to the act this did not constitute imitation of the external design of the plaintiff's restaurants with unfair breach of competition.
No misleading as to origin
The court found that the public was not misled as to origin pursuant to Section 4(9a), since for such a finding the public must be given the impression that the imitation originated from the manufacturer of the original or its affiliate.
In this case, while the origin of the restaurant as a Subway restaurant was still clearly evident – even under the new name and colours – the name change and different colour scheme seemed to preclude customers from developing the impression that they were entering a Subway or affiliated restaurant. The new features gave the impression of a different restaurant chain from Subway, even to an undemanding customer with knowledge of Subway who sought out the restaurant of another chain, but with a range of comparable products.
No exploitation of reputation or infringement of reputation
The court further found that there was no exploitation of reputation according to Section 4(9b) of the act. This is the case only if the public addressed transfers their regard for the original to the imitation. Therefore, it is insufficient if a mere association with a different product is created and therefore attention is aroused; a transfer of the original product's reputation to the imitator's product is also necessary, requiring a noticeable reference to the manufacturer of the original. This did not arise here.
The clearly recognisable new name and the corporate design of fresh! left no doubt among consumers that they were entering a different business from Subway. Even regarding the products offered, customers were aware that although the goods were conceptually and practically identical, they could differ from Subway's in terms of taste and quality. The products' similarity alone and the competitive situation established between Subway and fresh! did not justify the assumption of infringement or exploutation of reputation
No improper acquisition of knowledge necessary for imitation
Likewise, there was no unfairness by improper acquisition of the knowledge necessary for imitation, according to Section 4(9c).
The defendant did not imitate Subway's design and management. Rather, he designed his restaurant as a Subway franchisee, with the consent and on the orders of the plaintiff, as Subway-like, and managed it accordingly. As this was all contractually compliant, it was therefore proper. The current incarnation of the restaurant was not even a conceptual imitation in breach of contract, but was rather a continuation of the existing restaurant under a new name.
It was not the case that, in the context of a contractual relationship, means which had been properly acquired were later exploited in breach of trust and used abusively for the purpose of imitation. After the franchise agreement had ended, the defendant continued to use only the furniture that he had acquired. The fact that, after more than six years as a franchisee, he provoked termination by non-payment of the franchise fees could not mean that the design of his restaurant in terms of its actual appearance could be regarded as having been improperly acquired.
Continuation of sandwich restaurant as new chain
The court also decided that the continuation of the defendant's sandwich restaurant at the same location and in association with other former franchisees under the common name 'fresh!' was not, for example, prohibited as a hindrance to fairness.
However, since prevention in relation to the restriction of the freedom to imitate does not in itself rise explicitly to unfairness (cf Section 4(9)), additional circumstances must arise in order to establish the specific unfairness as an exception. An unfair prevention may in particular arise in relation to the systematic imitation of a number of products of a competitor being taken into consideration in the overall assessment:
Overall, fresh! did not constitute a mere gross imitation, but rather constituted organised competition from the former system's participants, who were now using their properly acquired knowledge and abilities in the same market, in premises they had leased themselves and using means of operation they had acquired themselves. Essentially, this was a form of competition against which the plaintiff could not protect itself on the basis of the means available in the law on fairness. The plaintiff could seek to contest it – including with regard to the questionable disassociation practices of the former franchisees – only on the basis of the contract and the damages and competition clauses contained therein.
The decision shows that a franchisee can ultimately use the know-how of a franchisor after a franchise agreement has ended and the non-compete provision has legally expired for its purposes without breaching statutory restrictions.
It is therefore all the more important in practice that, apart from a non-compete provision, a franchise agreement also contains provisions protecting the franchisor over and above the provisions of the act against unwelcome imitation by franchisees leaving the franchise system. This is of particular of significance in relation to the exploitation of business and operational secrets.
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). The Noerr LLP website can be accessed at www.noerr.com.
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