Under French civil law, a party to a contract has a duty of loyalty to its contracting party in the performance of the contract. In a recent decision dated March 15 2017, the Supreme Court applied this duty of loyalty to a franchisor which had concluded a framework contract for the opening of 18 outlets over a five-year period with a master franchisee which ultimately faced financial issues. The court held that the franchisor did not cooperate with, assist or advise the master franchisee loyally because it provided overly optimistic and insufficient financial data. The court also held that it had terminated the framework contract in an unfair manner because it did not propose acceptable terms and conditions considering the master franchisee's financial issues.
The case related to the French bakery brand Paul and one of its master franchisees. The two parties concluded a framework contract for the opening of 18 outlets in the south of France over a five-year period. The master franchisee eventually managed to open only five outlets, all of which ended up facing financial difficulties.
The franchisor and master franchisee tried to negotiate a settlement agreement, whereby the franchisor agreed to waive part of the franchise fees, subject to getting one share in the share capital of the master franchisee in addition to various information, veto and call option rights. As the master franchisee considered such requirements to be too onerous, the settlement agreement was never signed.
The franchisor thereafter sent the master franchisee a formal notice to perform the framework contract – namely, to open all of the outlets as provided for by the framework contract. Since the formal notice was unsuccessful, the franchisor terminated the framework contract and did not renew the franchise agreements.
The master franchisee, which ultimately became bankrupt, considered that the plan to open 18 outlets in five years was based on overly optimistic financial data provided by the franchisor and was therefore unrealistic. The master franchisee filed a claim against the franchisor for unfair termination of the framework contract and breach of its pre-contractual disclosure duty.
In relation to the claim for unfair termination of the framework contract, the Supreme Court upheld the Paris Court of Appeal's decision on January 7 2015:
"After having noted that the framework contract could not be performed without the close and loyal collaboration of the parties and that the opening of new outlets remained associated with the success of the other outlets, the franchisor having the power to check the setting up conditions and to refuse any project if it did not meet this objective, the court of appeal, without obliging the franchisor to renegotiate the framework contract, could hold that loyalty required to negotiate, if the framework contract turned out to be hardly achievable, and to propose acceptable conditions."
As noted by the Paris Court of Appeal, the purpose of the franchise contract was to reiterate the franchisor's commercial success through the franchisee and, to this end, the framework contract gave the franchisor the power to approve or refuse the opening of any new outlet. Accordingly, the franchisor should have assisted the master franchisee in order to enable the latter to overcome the financial issues that were caused by the franchisor by, for example:
- reducing the rent paid by the master franchisee pursuant to a commercial lease concluded with an affiliate of the franchisor; and/or
- amending the agreement concluded with another affiliate for the supply of specific products which, in fact, had no specific features.
Instead, the franchisor:
- considered that the master franchisee was in breach of the framework contract;
- proposed a settlement agreement the purpose of which was not to offer acceptable commercial conditions; and
- ultimately terminated the latter.
The framework contract expressly allowed the franchisor to terminate the contract in the event that the master franchisee failed to open the 18 outlets. However, in considering the relevant circumstances, the court held that this termination was unfair.
The master franchisee was awarded €150,000 in damages for loss of the opportunity to earn future profits as a result of the franchisor's unfair termination of the framework contract. In assessing the damages, the Paris Court of Appeal held that the probability of earning future profits was low since the opening of further outlets was almost impossible.
With respect to the claim that the franchisor breached its pre-contractual duty, the Paris Court of Appeal considered that the franchisor had provided inappropriate financial data to the master franchisee for the purpose of elaborating its financial forecasts.
First, "the franchisor did not sufficiently take into account the local market issues and the competition resulting from the outlets that it directly operated and obviously overestimated the strength of its concept and its brand". The financial forecasts differed from the actual financial statements by 30% to 50%. Since the franchisor provided financial data to the master franchisee which used this information to elaborate on and send its own financial forecasts to the franchisor, the court considered that "the elaboration of the financial forecasts under these circumstances of collaboration implied that in receiving them without expressing any comment, the franchisor necessarily validated them".
Second, the franchisor detailed various expenses necessary to open the outlets but remained silent with respect to many others. The court therefore held that the franchisor "did not collaborate in a loyal manner, did not inform and advise its co-contracting party, did not assist it in a loyal manner".
Interestingly, the court considered that the franchisor could not escape its liability by invoking a clause in the franchise agreement which stated that the franchisor assisted the master franchisee with the elaboration of its financial forecasts and provided financial data to it, but, in any event, the master franchisee formulated them under its own responsibility so that the franchisor could not be held liable in this regard.
The court even held that the master franchisee's background as a former executive of McDonald's and Pizza Del Arte could not relieve the franchisor from its liability. The master franchisee had no reason to doubt the franchisor since the latter was a confirmed franchisor which provided the master franchisee with elements established thanks to its proven technical and commercial know-how.
However, the Paris Court of Appeal was mistaken in awarding damages amounting to almost €2 million for all the losses incurred by the master franchisee as a result of the provision of the wrong and insufficient financial data, such as the franchisees' bankruptcy proceedings costs and the bank debts incurred by the bankrupt master franchisee. The Supreme Court held that "the damage resulting from the breach of any pre-contractual disclosure duty consists in the loss of the opportunity not to enter into the contract or to enter into the contract on more favourable terms, but not all the loses incurred". The Supreme Court therefore reversed the Paris Court of Appeal's decision in this respect.
The above decision highlights three key elements for players in the franchise sector:
- Franchisors are not legally required to perform a local market study, nor are they required to provide any financial forecast to franchisees. However, when a franchisor decides to do so, it may be held liable to the franchisee if such information turns out to be wrong, even more so if it actively participates in the elaboration of the franchisee's financial forecasts.
- Franchisors have a duty of loyalty and must help their franchisees to overcome any issues – in particular, where such difficulties are caused by the franchisor.
- Franchisors cannot hide behind disclaimers to escape from liability or a termination clause to escape from the duty to negotiate during financial hardship. These provisions can be set aside by the courts having regard to the duty of loyalty which governs any contractual relationship.
For further information on this topic please contact Raphael Mellerio or Bertrand Baheu-Derras at Aramis Law Firm by telephone (+33 1 53 30 7700) or email ([email protected] or [email protected]). The Aramis Law Firm website can be accessed at www.aramis-law.com.