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06 September 2011
In a recent case the defendant opened two shops in quick succession immediately adjacent to an existing shop in competition with its dealer. The plaintiff considered this action to be a serious breach of good faith and cited a Federal Court of Justice judgment in which direct sales by a company in parallel to an authorised dealer were considered to be in breach of good faith, even without the agreement of a clause protecting the authorised distributor's territory.(1)
The Dusseldorf District Court dismissed the claim - not on the grounds that the principal's action did not breach unwritten contractual good faith, but rather on the grounds that it was based on a sales policy decision that was free of arbitrariness and was not intended to cause damage.(2)
While the judgment did not involve a franchise system, its reasoning may be extended to similar situations within franchise systems. The judgment is therefore significant for franchise systems, especially since there are few rulings on the subject of imminent competition protection.
Some opinions have been expressed in legal commentary to the effect that a franchisor is subject to an obligation to protect against imminent competition even if this is not expressly included in the franchise agreement. This follows directly from the franchisor's main obligation to create for the franchisee a viable financial basis for the franchise. Otherwise, the franchisor would deprive the franchisee of promised market opportunities and would therefore render performance of its main obligations impossible.(3)
The correct opinion is that any such obligation must be restricted so as to provide the franchisee with a right of defence under Section 242 of the Civil Code if its financial existence is endangered in a sustained manner by the issue of further franchises within its catchment area.(4) It seems that previous judgments also rejected a general contractual obligation to protect against imminent competition.(5)
The plaintiff operated two shops - which were situated close to each other and were owned by the defendant, but managed by the plaintiff - on the basis of identical agreements concluded in 2006 and 2008. The nature of the business required the plaintiff to procure exclusive contracts for the principal. The plaintiff was not granted territorial protection or an exclusive customer base in the agreements.
In 2009 the plaintiff suffered substantial falls in turnover and profit, which it brought to the principal's attention on a number of occasions. The plaintiff attributed this to the fact that the principal had appointed four additional dealers in the immediate vicinity of the plaintiff's two shops. The plaintiff argued that this constituted a breach of contractual good faith, especially since the defendant had imposed especially extensive conditions on it. The plaintiff therefore demanded compensation from the defendant.
The defendant, on the other hand, argued that it had committed no breach of good faith. By approving additional dealers in the immediate neighbourhood, it had acted on the basis of a justified sales policy.
The court found that the claim had no basis and the plaintiff thus had no right to damages in accordance with Sections 280(1), 241(2) and 242 of the Civil Code. Upon interpreting the contracts between the parties, the court concluded that the defendant, in approving four additional shops, did not breach its contractual duty of good faith, since it acted neither arbitrarily nor with the intention to cause damage. Whether the plaintiff should have been classified as an authorised distributor or commercial agent was not discussed; the conditions for a breach of good faith are the same in both cases, according to Federal Court of Justice judgments.(6)
Contract terms are decisive
According to the Federal Court of Justice,(7) a contract between a manufacturer and an authorised distributor is based on close financial cooperation and is therefore subject to a higher degree of mutual good faith than other contracts.
If a distributor is granted an exclusive sales right, intervention in the protected sales territory is permitted on serious grounds only and with reasonable account being taken of any prejudicial consequences.(8)
However, a distributor enjoys less protection if no exclusive area of business is granted to it in the agreement.(9) In such cases the manufacturer may, in principle, appoint additional persons to transact in that area, even if the territory of the commercial agent is thereby reduced.(10)
However, the manufacturer is also subject to a duty of good faith in relation to an authorised distributor that does not enjoy exclusive sales rights.(11) While the manufacturer is free to organise the sale of its products as it deems fit, the dealer's interests should not be unjustifiably infringed. The point at which these interests collide must be determined on a case-by-case basis by interpreting the relevant contract.
The greater the extent to which dealers are integrated into the manufacturer's sales organisation and support it by committing capital and personnel, the more their legitimate market interests should be respected.(12) In the present case, the plaintiff was not deeply integrated into the defendant's business; in particular, as the defendant remained the owner of the stock, the plaintiff was subject to no minimum purchase or stock maintenance obligations, which would have imposed considerable financial burdens. In addition, the plaintiff had no exclusive sales right in a certain territory and thus enjoyed only reduced protection.
Reasonable grounds for sales decision
The court further held that even if the defendant's actions were considered to be a breach of good faith, this would not have constituted a serious intervention which would have been justified on reasonable grounds.
A manufacturer's decision to engage additional authorised distributors within a certain territory may depend on various factors, which must be left to its own entrepreneurial discretion to assess. In the case at hand, the court ruled that the defendant should not be prevented from pursuing an expansive competitive strategy. In particular, given the heightened competition in the area in question, it was understandable that the defendant wished to maintain a strong presence by appointing as many dealers as possible in this area. Under these circumstances, the plaintiff's interests should be subordinated.
The judgment has been appealed.
When the plaintiff took over the first shop in 2006, it was aware that the defendant planned to open another branch in the vicinity in 2008. Therefore, from the outset it could take the resulting opportunities into account in its planning and investment decisions. Furthermore, there were no indications in the agreement stating that the defendant would open no additional shops under its brand near the plaintiff's two shops.
Apart from these additional features in the present case, the Dusseldorf District Court's judgment shows that even without the agreement of a territorial protection clause, on transferring the findings to a franchise system, a franchisor can be subject to a duty of good faith to a franchisee.
The decision is to be welcomed because it confirms the principle of entrepreneurial discretion, according to which a principal – and therefore also a franchisor – is free to organise the sale of its products as it deems appropriate. A franchisor may not unjustifiably adversely affect a franchisee by acting arbitrarily, acting with the intention to cause damage or failing to take account of the franchisee's interests that are worthy of protection. Such disputes can largely be avoided by careful contractual drafting.
For further information on this topic please contact Karsten Metzlaff or Karl Rauser 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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