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15 July 2003
A franchisee pays fees to the franchisor on a regular basis, as compensation for the services provided by the franchisor. This ongoing franchise fee may be distinguished from the one-off fee which is charged for entry into the franchise. In a judgment of December 2002 the Higher Regional Court of Hamburg considered whether the entry fee must be repaid proportionately in case of early termination of the franchise agreement.
The company concerned acted as distributor of the ISAR 2000 system, a computer-based booking and accounting system for business travel. The franchisor marketed ISAR 2000 in Germany through franchises. The franchisees installed the system at the premises of corporate customers and provided support to them. As consideration, the franchisees received a proportionate share of the proceeds from the trips sold. In the case at issue, the franchisee notified the franchisor that it did not wish to continue its cooperation with the franchisor. The franchisee took the view that the franchise agreement was invalid. It filed a claim demanding repayment of the entry fee. The Hamburg Regional Court held that the entry fee had to be repaid. This decision was confirmed on appeal.
The Higher Regional Court of Hamburg first confirmed the principle, established in previous case law, that the question of whether the entry fee must be repaid upon termination of the contract depends on what exactly the entry fee is consideration for in a given case.
Remuneration for services already provided
If the entry fee is paid in consideration of advance services provided by the franchisor, it need not be repaid. In such cases the entry fee is received not in return for the provision of know-how and its further development, but rather as compensation for the preliminary costs incurred by the franchisor in connection with setting up the franchise system. This could include:
In such cases the entry fee is a means of recovering the costs incurred by the franchisor in developing and building up its franchise system. To the extent that the entry fee is in consideration of development services which have already performed, a pro rata reimbursement in case of early termination of the franchise agreement is excluded.
Remuneration for ongoing services
The situation is different, however, where the entry fee is paid for services to be provided during the term of the franchise only. If the entry fee is not just a contribution towards the franchisor's costs in incorporating the franchisee into the system, but also a fee for the know-how and goodwill of the franchise and for other ongoing costs incurred by the franchisor, it must be considered as remuneration for ongoing services provided by the franchisor during the term of the contract. In case of early termination, the entry fee is then repayable pro rata as from the date on which the franchisor ceases to provide its services. Since the contract term has not yet unexpired, the entry fee has not been fully 'used up'.
In the case at hand the franchise agreement did not specify whether the entry fee was consideration for advance services provided by the franchisor before the contract was signed or for services provided during the term of the contract. The franchise merely stated that the entry fee must be paid for the "grant of the licence", whereas the ongoing fee had to be paid for software updates, use of a franchise hotline and further development of the system. From this, the Higher Regional Court of Hamburg concluded that the entry fee was to be paid for the licence granted during the franchise term, and hence for services yet to be provided. Therefore, the court decided that in case of early termination of the franchise agreement, the entry fee must be repaid pro rata.
Many franchises do not specify what the entry fee covers. In such cases the franchisor risks having to repay the entry fee pro rata if the franchise is terminated prematurely, whether by notice of either party or by termination agreement. If the franchisor wishes to avoid such repayment, the entry fee must be designed so that it is consideration only for the system development costs advanced by the franchisor.
For further information on this topic please contact Karsten Metzlaff or Karl Rauser at Nörr Stiefenhofer Lutz by telephone (+49 30 20 94 20 00) or by fax (+49 30 20 94 20 94) or by email (firstname.lastname@example.org or email@example.com).
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