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23 November 2010
In its judgment of September 7 2009 the Higher Regional Court of Dusseldorf clarified in unexpectedly clear form that even a strict integration of a franchisee by contractual provisions which leave him or her only limited commercial discretion is not subject to any legal objection if these provisions are necessary, for example, for the maintenance of quality standards, typical of the system.
This judgment is interesting not only because of the clarity of the wording, but also because of the legal spectrum covered. After finding that a purchase obligation was admissible under cartel law, the court undertook a comprehensive review of immorality (Section 138 of the Civil Code) and of the law on general terms and conditions (Section 307 of the Civil Code). In this way the court not only corrected the unfortunate effects of the lower court's comments, but also ensured greater legal certainty with regard to typical provisions in franchise agreements. Such provisions are neither immoral nor unreasonable within the meaning of the law on general terms and conditions.
The plaintiff (franchisee) and the defendant (franchisor) concluded a franchise agreement for the operation of a bakery in premises leased from the defendant. The agreement was for an indefinite period.
Apart from the obligation to pay rent and other charges, the plaintiff was bound by many other obligations, including an exclusive purchase obligation to buy all bakery products from the defendant. While the plaintiff was entitled to process the products (eg, by filling bread rolls) and to sell non-alcoholic drinks, it was obliged to purchase the ingredients necessary for making or processing the products from the defendant. The agreement also contained provisions on an obligatory and discretionary range of simple and processed bread products. The defendant also reserved the right to change the prices by written notification at the latest two weeks before their coming into force.
The plaintiff argued that the agreement was immoral under Section 138 of the Civil Code, since there was a noticeable lack of proportion between performance and consideration. The defendant imposed the entire commercial risk on the plaintiff by participating to a great extent in profit, but not in losses.
Likewise, the plaintiff argued that many provisions of the agreement should be found to be in breach of the law on general terms and conditions due to unreasonableness. The entire agreement should therefore be found to be invalid.
The plaintiff was also of the opinion that the agreement breached cartel law due to the indefinite duration in combination with the exclusive purchase clause.
The court dismissed the plaintiff's application for legal aid for its appeal against the first instance judgment because of lack of prospects of success.
No breach of cartel law
Firstly, the court found that no invalidity under Section 134 of the Civil Code in connection with cartel law provisions followed from the contractual exclusive purchase obligation. An obligation to take supplies exclusively is neither a breach of Article 101 of the European Treaty nor an inequitable hindrance within the meaning of Section 20 of the Competition Act, even if the agreement is for an indefinite period. Such exclusive purchase of the entire range of products is characteristic of a franchise.
In this aspect of the judgment, the court followed the judgment of the Federal Court of Justice.(1)
No immoral oppression
Neither could the court find immoral oppression. This would arise if the franchisee were almost completely subject to the will of the franchisor or if a number of one-sided, oppressive clauses appeared to render the franchise agreement immoral in the overall picture.
The agreement contained many provisions binding the plaintiff which, in fact, gave the appearance of a very narrow commercial degree of discretion. In particular, the core element of operating a bakery, namely independent selling, could be determined by the plaintiff itself only to a limited degree. In the actual core business, the only freedom remaining to the franchisee was the decision on the amount to be ordered and the choice of personnel.
This strict integration of the plaintiff, which in practice is usually a feature of franchising, was, however, balanced against obligations of the defendant of considerable weight which were to the advantage of the plaintiff. In particular, they constituted compensation for the restrictions on commercial freedom of activity to be accepted to the extent that they relieved the franchisee of not inconsiderable organisational challenges, as well as financial burdens.
While the commercial self-determination right was curtailed to a great extent, the franchisee accepted this in order to keep its commercial risk within limits.
In addition, a close integration of the franchisee is necessary for the idea of a franchise itself - namely, the far-reaching recognisability of the brand, as well as the idea of a certain standard of quality and a similar atmosphere in the shops. Likewise, the contractual provisions were not of such a nature, at least in significant points, that they did not stand up to the requirements of the review under Section 307 of the Civil Code. In particular, the clauses on exclusive purchase and reservation of price changes did not constitute an unreasonable disadvantage to the franchisee.
Other clauses typical in franchising were also deemed to be reconcilable with the law on general terms and conditions - namely, a termination clause (with notice periods of two weeks, three months or six months, depending on the length of the agreement), a right of extraordinary termination for good cause, a liability limitation clause, a contractual penalty clause, a confidentiality clause and a non-compete clause for the duration of the agreement.
The court expressed reservations only with regard to a provision on payments on account by direct debit, which in fact could have compelled the plaintiff to credit revenue which was not actually received. Since, however, this clause would ultimately have no significant adverse effects on the plaintiff, it was deemed in the end to be valid.
No usurious transaction
Finally, the conditions for a usurious transaction were not satisfied in the view of the court, because no noticeable disproportion between payment and consideration was evident.
Although the charges at a total of 22.49% of the system turnover were relatively high, the franchisee nevertheless retained adequate scope to realise a profit because, with the charges, the rent, equipment, insurance and electricity costs were already discharged. From the difference between the purchase and sale prices of the bakery products, the franchisee had an average margin of about 50%. In this situation, no noticeable disproportion could be established.
Franchisees often plead the invalidity of a number of provisions which are typical in franchise agreements as grounds for the immorality of the franchise agreement. However, this succeeds only in the rarest cases. This latest judgment is a good example.
The provisions in dispute are all necessary for the maintenance of typical quality standards in this system and the uniform presentation of the franchise system in the market, and for the protection of the franchisor's know-how. These are typical provisions arising from the concept of franchising itself and thus necessary. Certain restrictions of the franchisee's entrepreneurial freedom are inherent in the franchising concept and do not render these clauses, and therefore the franchise agreement, invalid.
The judgment of the court clarifies this in a very welcome manner, but also makes it clear that an overall balanced design of the franchise agreement is crucial.
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 (email@example.com or firstname.lastname@example.org).
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