EU Competition Rules for Distribution Agreements #8: Franchise

Distribution Law Centre Competition & Regulation Martijn Jongmans Iris Graumans Minos van Joolingen Sophia Wittkämper

Why is competition law important in the distribution context?

Article 101(1) of the Treaty on the Functioning of the European Union prohibits anticompetitive agreements or concerted practices. Agreements infringing Article 101(1) are void and may expose your company to fines and/or damages before national courts and/or competition authorities. This is particularly important in the context of distribution agreements where private parties (i.e. your companies’ customers and competitors) are often the most likely to go to court or file complaints with competition authorities.

This note is part of a blog series in which we seek to provide guidance on the most relevant topics of EU competition law for distribution agreements. In this eighth blog we discuss the distribution method of Franchising.

What is it?

Franchising is a distribution method involving a franchisor, who establishes the brand’s trademark or trade name and a business concept or method, and a franchisee, who pays a royalty and often an initial fee for the right to do business under the franchisor's name and system. As such, franchising may enable the franchisor to establish, with limited investments, a uniform network for the distribution of its products or services. Franchising can therefore be an interesting option for a company with (international) expansion plans that cannot or does not want to (entirely) bear the required investments itself.

Franchise agreements typically contain licences of intellectual property rights (IPRs) for the use and distribution of goods or services and clauses relating to the provision of commercial or technical assistance by the franchisor to the franchisee. In addition, franchise agreements usually contain a combination of various vertical restraints concerning the products being distributed, for instance selective distribution and/or non-compete obligations.

Restriction of competition?

Because of the specific characteristics of franchising, obligations in franchise agreements that can be deemed necessary to protect IPRs or to maintain the common identity and reputation of the franchise network fall outside the scope of Article 101(1) TFEU.

In the Vertical Guidelines (par. 87) the Commission provides a list of IPR-related obligations that are generally considered necessary to protect the franchisor’s IPRs. The Commission clarifies that where such obligations fall within the scope of Article 101(1) TFEU, they are covered by the Vertical Block Exemption Regulation (‘VBER’).

For instance, restrictions that prevent the franchisee from using the know-how and assistance provided by the franchisor for the benefit of the franchisor’s competitors and non-compete obligations relating to the goods or services purchased by the franchisee that are necessary to maintain the common identity and reputation of the franchise network.

Notwithstanding the usual maximum term of five years that applies to other types of distribution agreements, it is acceptable for non-compete obligations relating to the goods or services purchased by a franchisee to apply for the entire duration of the franchise agreement, even if this is longer than five years. For post-term non-compete restrictions to be permitted in a franchise agreement, the following conditions apply:

  • they must be limited to the premises from which the franchisee operated;
  • they must be indispensable to protect the know-how; and
  • the duration must be limited to one year after the term.
 

Assessment under the VBER

Just like other vertical agreements, franchise agreements can benefit from the exemption under the VBER where neither the supplier’s nor the buyer’s market shares exceed 30% and the agreement does not include any hardcore restrictions. Imposing a fixed or minimum resale price on franchisees (i.e. Resale Price Maintenance) is therefore generally not allowed. However, there is one noteworthy exception when it comes to to franchising. In the context of a coordinated, short term (two to six weeks) low price campaigns, fixed resale prices may be considered on balance pro-competitive (c.f. Vertical Guidelines, par. 197(b)). For franchisors with dual distribution scenarios within their network the rules on information exchange as discussed in our blog on Dual distribution should be taken into account. The Vertical Guidelines confirm that under a franchise agreement it may be necessary for the franchisor and franchisee to exchange information relating to the application of a uniform business model across the franchise network. Franchise agreements that are not covered by the VBER require an individual assessment under Article 101 TFEU. Under that assessment it should be taken into account that the more important the transfer of know-how, the more likely it is that the vertical restraints create efficiencies and/or are indispensable to protect the know-how and thus fulfil the conditions of Article 101(3) of the Treaty.

The Dutch Franchise Act

In the Netherlands, franchise agreements are (also) governed by the Dutch Franchise Act which is incorporated in the Dutch Civil Code. A key incentive for the introduction of this Dutch Franchise Act in 2021 is the imbalance of power that generally exists between a franchisor and a franchisee. The act provides for a regulatory framework with requirements prior to entering into the agreement and for during and after its term, all intended to strengthen the position of a franchisee vis-à-vis the franchisor and establish a more balanced legal relationship. Before concluding a new franchise agreement, franchisors are obliged to provide new franchisees with a comprehensive set of information in a timely manner, subject to a stand-still period of four weeks. This includes a draft version of the franchise agreement and accompanying attachments, information regarding prior investments and (ongoing) payment obligations and, if available, financial data relating to the franchisor’s financial position, the intended location of the franchise and/or any comparable company. The Franchise Act also prescribes various mandatory rules related to the contents of the franchise agreement and the relationship between the franchisor and franchisee in general.
  • During the term of the agreement, the franchisee is entitled to various information that could be of interest for its franchise business, e.g. on planned changes to the agreement and required investments.
  • Franchisors are limited in their use of contractual clauses that allow them to unilaterally amend the franchise agreement or formula, considering the franchisees’ right to consent when predefined thresholds are met.
  • Any non-compete clause in the agreement should be limited in geographic scope, indispensable to protect transferred knowhow, must be in writing and may not exceed a period of one year after termination of the agreement.
  • The agreement must include provisions relating to the goodwill compensation for franchisees after termination of the agreement.
The Dutch Franchise Act is unique in the EU and provides franchisees based in the Netherlands a stronger position compared to regular distributors.

Key rules franchising

  • Article 101 TFEU does not apply to clauses in franchise agreements that are necessary to protect the know-how and goodwill of the franchisor that is licensed to the franchisee, and to maintain the common identity and reputation of the franchised network.
  • Franchise agreements can benefit from the exemption under the VBER where neither the supplier’s nor the buyer’s market shares exceed 30% and the agreement does not include any hardcore restrictions.
  • In the Netherlands, franchise agreements are (also) governed by the Dutch Franchise Act, which aims to establish a more well-balanced legal relationship between franchisors and franchisees.
 

FAQ's

As a franchisor can I impose an IPR related obligation on the franchisee not to engage, directly or indirectly, in any similar business? Yes, such an obligation is generally considered necessary to protect the franchisor’s IPRs. How are vertical restraints in franchise agreements assessed that fall within the scope of Article 101(1) TFEU? As a rule, vertical restraints in franchise agreements must be assessed using the principles applicable to the distribution system that most closely corresponds to the particular franchise agreement. For example, a franchise agreement that results in a closed network, where the franchisees are prohibited from selling to non-franchisees, must be assessed under the principles applicable to selective distribution. In contrast, a franchise agreement that does not create a closed network but provides territorial exclusivity and protection against active sales by other franchisees must be assessed under the principles applicable to exclusive distribution. A franchisor based in Germany and a franchisee based in the Netherlands have agreed that German law applies to their franchise agreement. Does this mean that the Dutch Franchise Act is not applicable? No this is not the case. With respect to franchisees based in the Netherlands, any clause in violation of the legal obligations regarding goodwill and the non-compete clause are void, regardless of the law governing the franchise agreement (see Article 7:922 of the Dutch Civil Code).   If you have any questions about the contents of this note, please contact Minos van Joolingen, Martijn Jongmans, Sophia Wittkämper or Iris Graumans of Banning’s Competition & Regulatory Team, telephone number +31 73 692 77 52.