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15 January 2019
In a partial judgment delivered on 26 October 2018 (37 O 10335/15), the Munich Regional Court I established a new precedent for competition restriction, which is prohibited in franchising systems under Section 1 of the Act against Restraints on Competition. The court found that a reference to "participating restaurants" in a franchisor's TV advertising was insufficient and violated the price maintenance prohibition. The ruling also included jarring declaratory decisions for all franchising systems based on franchising contracts that provide for centralised, bundled advertising by the franchisor for the benefit of the entire system. It remains to be seen whether an appeal of the decision might improve this situation.
The two plaintiffs operated fast food restaurants as franchisees. The defendant was a franchisor. The franchise agreements into which each of the plaintiffs had entered with the defendant required the franchisee to pay an advertising royalty calculated as a sales percentage.
Advertising royalties must be used for advertising, sales promotions and public relations for the general benefit of all franchise restaurants. Further, the franchisor may bundle advertising royalties into an advertising fund.
The franchisor used the advertising royalties to advertise products which were served in the plaintiffs' restaurants at low prices. For example, at regular intervals during a period of several years, it initiated the advertising campaigns 'King of the Month' and 'Try-it Weeks', during which various products (eg, hamburgers and other sandwiches) sold by the plaintiffs were advertised at a lower-than-normal price.
The dispute centred on TV ads that were broadcast by German TV channels ProSieben, Sat1 and RTL in the context of the 'King of the Month' and 'Try-it Weeks' advertising campaigns. At the end of each ad, the following disclaimer appeared for a few seconds in small print across the bottom edge of the screen or along the side: "In all participating restaurants. As long as supplies last. Non-binding price recommendation." The price, presented in large print in the ad, was not followed by an asterisk.
The plaintiffs contested the franchisor's advertising campaigns. In 2012 the plaintiffs:
By charging lower prices during the advertising campaigns, the franchisees had increased their sales and thus their sales-based advertising royalties. However, the plaintiffs argued that instead of profiting from the campaign, they had incurred financial losses. Therefore, only the franchisor had profited because the increased sales had also increased the amount of advertising royalties that it had received.
The plaintiffs also argued that, despite the words "non-binding price recommendation", the advertising had in reality had a binding effect. The plaintiffs stated that in their daily business operations, they had been forced to deal with customers who did not understand why they had not received the 'King of the Month' deal (a special offer for a hamburger) at the advertised lower price and had subsequently visited other franchise restaurants in the same system out of protest.
The plaintiffs petitioned the court to order the defendant to stop using their advertising royalties for the 'King of the Month' and 'Try-it Weeks' advertising campaigns.
The Munich Regional Court I found in favour of the plaintiffs and ordered the franchisor to discontinue using the plaintiffs' advertising royalties for the disputed advertising campaigns. In particular, the franchisor could no longer advertise via the disputed TV ads with respect to any of the plaintiffs' products.
The court upheld the following grounds for the plaintiffs' cease and desist claim.
First, the franchisor had not used the advertising royalties for the benefit of all franchise restaurants (a duty under Section 9(2) of the franchise agreement) because the TV ads for 'King of the Month' and 'Try-It Weeks' ad campaigns had violated statutory cartel and price maintenance prohibitions. Further, its advertising had not adequately clarified that not all franchise restaurants were participating in the advertised low-price campaigns.
The advertising constituted a concerted practice by the franchisor and its franchisees. Each franchisee's contractual consent to centralising the advertising and their subsequent uncontradicted participation in the franchisor's advertising campaigns constituted a 'concerted practice' within the meaning of the law on the prohibition of cartels (Section 1 of the Act Against Restraints of Competition).
The court further stated that the advertising had violated the price maintenance prohibition. As the price recommendations had led to binding fixed prices and the TV ads' reference to "participating restaurants" was insufficient, the plaintiffs had been forced to sell their products at the recommended prices.
The TV ads' disclaimer "In all participating restaurants. As long as supplies last. Non-binding price recommendation" was deemed insufficient because it was difficult to read: the words appeared on screen in barely legible small lettering, often vertically, for only a few seconds at the end of the ads. When the disclaimer ran horizontally, it appeared briefly (ie, for two to three seconds). Further, the court held that viewers would not have had any reason to read the disclaimer because it was not linked to the price using an asterisk. Therefore, the consumers targeted by the advertising connected the ads prices to every franchisee in the system without exception.
Further, the 'King of the Month' and 'Try-it Weeks' advertising campaigns were not short four-to-six-week campaigns with an option not to participate, which the European Commission deems permissible as an exception. On the contrary, the uniform advertising campaigns were carried out over several years, which undermined the fact that they applied to various products at various times.
The Munich Regional Court I's decision deserves special attention as it relates to advertising with non-binding price recommendations, which is common among franchisors.
All things considered, it may be agreed that advertising as described (ie, small lettering, short on-screen periods and no reference by asterisk) constitutes a violation of the price maintenance prohibition. However, contrary to the court's opinion, a reference to a non-binding price recommendation which appears on screen for two to three seconds should be deemed adequate. It is definitely possible to read a reference to the fact that a price is non-binding in two to three seconds, and such references are common in advertising; the size of the lettering is also a matter of opinion. However, the court is arguably correct in deeming it essential that the price be connected to the disclaimer of its non-binding nature using asterisks.
However, it is debatable whether the advertising campaigns in question were special sales campaigns of four to six weeks, which are permitted as an exception. If such campaigns applying to all products at the same time are permitted, a special sales campaign for one product could be run after such a campaign for another product. Nevertheless, the Munich Regional Court I rejected this 'escape route' from classifying the situation as price maintenance.
Further, the court incorrectly assumed that advertising by a franchisor constitutes a 'concerted practice' within the meaning of the law on the prohibition of cartels (Section 1 of the Act Against Restraints of Competition) where:
Franchisees' general consent to a franchisor's centralised advertising does not sufficiently constitute a concerted practice that restricts competition. By their very nature, franchising systems include general advertising, which is essential for establishing market presence. If only for this reason, no restriction of competition occurred here. Likewise, franchisees' uncontradicted participation in advertising campaigns does not constitute a concerted practice. On the contrary, franchisees are usually free to decide whether to participate in advertising campaigns.
The court's decision is not yet final. The franchisor has appealed against the judgment.
For further information on this topic please contact Karsten Metzlaff or Tom Billing at Noerr LLP by telephone (+49 30 20 94 20 00) 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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