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03 July 2007
Many franchise systems place an obligation on the franchisee to obtain its products from the franchisor or from suppliers designated by the franchisor. Such exclusive purchase obligations often cover up to 100% of the range of goods and can be problematic in franchise agreements from a legal perspective because they limit the choice of suppliers and hence can restrict competition. For this reason, antitrust law and the block exemption regulations for vertical agreements place general time limitations on such exclusive purchase obligations and permit them in principle for up to five years. If a purchase obligation exceeds this period, the franchisee must be allowed to obtain 20% of its goods from outside suppliers; up to 80% of the franchise partner's purchase volume may be affected.
However, the question arises whether an (exclusive) purchase obligation in a franchise agreement for 100% of the products which exceeds the term of five years is permissible in view of the particularities of franchising. In its 1986 decision on the bridal fashions franchise system Pronuptia de Paris, the European Court of Justice (ECJ) held that an exclusive purchase obligation in a franchise agreement does not constitute a restriction of competition if it is essential to the functioning of the franchise system. Such a circumstance would occur if the obligation is necessary to prevent the know-how provided from becoming available to competitors, or to protect the identity and reputation of the franchise system.
This ruling applies to cases, such as those regarding fashion articles, where uniform quality requirements cannot be imposed or where it is impossible to monitor quality standards economically. In numerous systems the objective quality requirements for contractual products have been assumed to be inadequate, despite their certain scope for interpretation, such that the Pronuptia decision has subsequently been applied to mean that exclusive purchase obligations can be justified for longer than the five-year term.
Following a decision of the Higher Regional Court of Düsseldorf(1) on April 11 2007, this justification no longer appears possible in the absence of further grounds; the court has tightened the requirements governing the admissibility under antitrust law of a 100% purchase obligation lasting for more than five years.
The plaintiff had been a franchisee of the German subsidiary of The Body Shop International plc since 1992. This British franchise system sold cosmetics, personal hygiene items and relevant ancillary products. Until the termination of the original franchise agreement in 2003, the franchisor had permitted all of its franchisees (in some cases for 20 years) to obtain up to 35% of their goods from outside suppliers. According to the new franchise agreement, for a term of seven years the franchisee had to obtain 100% of contractual products from the franchisor or from authorized suppliers. Only goods obtained through these channels could be offered and sold.
This exclusive purchase obligation was considered by the franchisee to be invalid under antitrust law. The franchisee therefore sought a declaration of invalidity from the courts, as well as a judgment ordering the franchisor to consent to an amendment of the franchise agreement such that the franchisee would be entitled to obtain 20% of its total annual purchase value - that is, the value of all purchases of contractual products according to the balance sheet for the previous year - for ancillary products from outside suppliers and sell them.
The franchisee was unsuccessful at first instance. In contrast, the appeal before the higher regional court was decided in favour of the franchisee and it was held that the exclusive purchase obligation was invalid and that the franchisor had to accept that ancillary products would be obtained from (unlisted) outside suppliers, totalling approximately 20% of all goods supplied.
The court found that exclusive purchase obligations violate the ban on cartels in Article 81(1) of the EC Treaty, which prohibits agreements that restrict competition. The point of departure in this finding is the assumption that, as a matter of principle, an exclusive purchase obligation constitutes a restriction of competition because the franchisee is restricted in the free choice of its suppliers for its entire range of goods. Contrary to the Pronuptia decision of the ECJ, the Higher Regional Court of Düsseldorf held that an agreement on an exclusive purchase obligation is not so essential to the survival and functioning of the franchise system as to override a finding of a restriction on competition.
The court first established that the exclusive purchase obligation was unnecessary to protect know-how or the identity or reputation of the franchise system. The court found this to be proven by the fact that, until the establishment of the new franchise agreements, the franchisor had accepted the purchase of up to 35% of products from outside suppliers. It was unclear to the court why a 100% purchase obligation was essential to protect the identity and reputation of The Body Shop franchise organization as of 2003. The court also pointed out that the correct composition and adequate quality of a range of goods could be ensured through corresponding objective requirements, as cosmetics and personal hygiene product lines are generally not subject to the same changing conditions as fashion items. Should this not apply to certain individual items, a contractual agreement prohibiting procurement of such items from outside suppliers could be made. According to the court, objective requirements could be verified without excessive expense during the contractually agreed control visits to the existing 20 to 25 franchisees. The court did not consider whether there was sufficient justification for an exclusive purchase obligation based on the argument that The Body Shop brand might be diluted by products obtained from outside suppliers, as the franchisor is in a position to limit the supplies of goods obtained from outside suppliers to ancillary products, and to impose quality and product range requirements.
Therefore, the court concluded that there was a perceptible restriction of competition. It did not consider an exemption of the exclusive purchase obligation from the ban on cartels under the block exemption regulation applicable to franchise agreements because this possibility exists only for exclusive purchase obligations with a maximum term of five years and not, as in the present case, seven years.
The court therefore held that the exclusive purchase obligation imposed on the franchisee was invalid. The court subsequently placed an obligation on the franchisor to allow the franchisee to obtain ancillary products amounting to 20% of the purchase value from outside suppliers, as provided for under the block exemption regulation.
Despite its careful reasoning, the decision is not absolutely convincing. In deeming it acceptable for the franchisor to verify compliance with its quality requirements within the context of control visits to the shops, the court contradicts the findings of the Pronuptia decision of the ECJ. In the ECJ decision the court precisely intended to take into account the fact that effective controls of quality standards cannot be demanded of the franchisee from an economic perspective. The higher regional court has ultimately disregarded this finding. In principle, the requirements circumscribing exclusive purchase obligations used in longer franchise agreements in a manner permissible under antitrust law have become stricter.
For further information on this topic please contact Karsten Metzlaff at Nörr Stiefenhofer Lutz's Berlin office by telephone (+49 30 20 94 2000) or by fax (+49 30 20 94 2094) or by email (email@example.com). Alternatively, contact Karl Rauser at Nörr Stiefenhofer Lutz's Munich office by telephone (+49 89 28 6280) or by fax (+49 89 28 0110) or by email (firstname.lastname@example.org).
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