Introduction
Uniform presentation and product service and quality are crucial for the success of a franchise system. Not only do these enable customers to recognise and develop loyalty to each franchise in the system, but any breaches by individual franchisees against franchise agreement regulations can have adverse and damaging effects on the image or reputation of the entire franchise system. From the customer's viewpoint, the products or services of a franchise come from the same source. If the franchisee breaches regulations, the franchisor's only recourse is to terminate the franchise agreement without notice in order to prevent further damage to the franchise system, restore uniformity and recover customer trust.
On October 14 2014 the Munich Higher Regional Court (7 U 2604/13) dealt with a case of termination without notice due to breaches of the franchise agreement by a franchisee.
The franchisee of a fast-food restaurant sued for damages for unjustified termination without notice issued by the franchisor due to multiple breaches by the franchisee. The breaches were ascertained mainly in three audits by the franchisor and involved breaches of the franchisor's clothing, food, hygiene and cooking regulations.
The court dismissed the franchisee's claim since the termination without notice was ultimately valid. There was no causal breach by the franchisor within the meaning of Section 280(1) of the Civil Code – in the present case, an invalid termination – which was a requirement for the franchisee's damages claim.
The court first stated that the provision on termination without notice was not conclusive due to the franchise agreement's use of the phrase 'in particular'. This meant that apart from the contractual provisions, the statutory provisions on termination without notice also applied according to Section 314 of the Civil Code or Section 89a of the Commercial Code in commercial agency law (whether this provision for commercial agents could have been applied to the present franchise agreement was left open by the senate). It followed that a number of individual breaches by the franchisee – even though each individual breach did not satisfy the contractual requirements or reach the threshold of significance – could have justified the franchisor terminating the agreement according to Section 314(1) of the Civil Code if, in taking all circumstances into account and weighing the interest of both sides, the continuation of the contract was unreasonable for the franchisor.
The individual breaches were not 'mere trifles' because they exposed the franchisor to the risk of damage to reputation or brand image. Had individual breaches become known, the foreseeable reaction of the public would have affected not only the franchisee but above all the franchisor and other franchisees. It is inherent in a franchise system that the customer expects a uniform standard in each participating restaurant and negative deviations from this standard in any one restaurant will be attributed to the entire franchise.
The court took into account the interests of both parties and concluded that each breach would not justify termination without notice, even though the individual breaches were not mere trifles. In fact, only on considering all breaches together over a longer period did termination without notice appear defensible. The interest of the franchisee in the continuation of the agreement was secondary. The warning requirement was also satisfied because in earlier letters relating to events of a similar nature – although not listed in detail – the franchisor had adequately expressed that the agreement may be ended.
The delegation of operative businesses to individual franchisees is both a blessing and a curse for a franchise system. By granting franchises, system headquarters can concentrate on further developing know-how, products and services, while the operative business is usually delegated to franchisees which successfully operate a franchise as independent businesses at their own responsibility. However, in case of a breach of the franchise agreement, this is associated with the risk that it may not be possible to influence the franchisee to remedy irregularities quickly (eg, if the business was operated by the franchisor itself).
The decision shows that breaches, although individually not mere trifles, may be seen by the court as justifying termination without notice only when considered together. This is unfortunate if individual breaches are so serious that they risk the franchise system's reputation and image. In such cases, the franchisor must be able to react rapidly and effectively in order to avert damage to the system and other franchisees.
For further information on this topic please contact Karsten Metzlaff at Noerr LLP's Berlin office by telephone (+49 30 20 94 20 00) or email ([email protected]). Alternatively, contact Karl Rauser at Noerr's Munich office by telephone (+49 89 28 62 80) or email ([email protected]).The Noerr LLP website can be accessed at www.noerr.com.
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