The scope of the franchisor's pre-contractual duty to inform potential franchisees is a long-running issue in German franchise law and case law (for further details, please see "Franchisor's pre-contractual duty to inform"). The reason why this issue is so critical is that a breach by the franchisor of its pre-contractual duty to inform entitles the franchisee to cancel the franchise agreement and to claim damages from the franchisor. It is therefore in the interest of every franchisor to avoid any breach of its pre-contractual duty to inform.
A recent ruling handed down by the Frankfurt Higher Regional Court(1) provides further clarification on the scope of the franchisor's pre-contractual duty to inform its franchisees. The Court commented in particular on whether a franchisor is liable for representations made by a consultancy firm recommended by it or for a business plan prepared by that consultancy firm.
The defendant (the franchisor) runs a franchise system, the object of which is to operate cosmetic studios for permanent hair removal.
The plaintiff approached the defendant in May 2015, expressing interest in the franchise system. As part of the initial provision of information, the defendant gave the plaintiff a company brochure on its franchise system. After a reservation agreement had been signed, the defendant sent the plaintiff an information brochure for prospective franchisees and a location check. Upon the defendant's recommendation, the plaintiff then engaged a consultancy firm to draw up a business plan, which also included information from the defendant's area of business. The plaintiff presented this plan to its bank in order to obtain financing for the franchise business. The wife of the consultancy firm's chief executive officer (CEO) was also a franchisee of the defendant. In February 2016, the defendant and the plaintiff entered into the franchise agreement.
The business plan included the recommendation for the franchisee to conduct cold calling – for example, by approaching potential customers in shopping malls. After the plaintiff was unsuccessful in her cold-calling campaign to win customers, she closed her business. She challenged the franchise agreement on the grounds of fraudulent misrepresentation due to faulty pre-contractual information given by the defendant and demanded the cancellation of the franchise agreement. The defendant refused to cancel the agreement, demanded further payment of the franchise fees and imposed various contractual penalties, after issuing a warning.
In essence, the parties were in dispute over the question of whether the business plan provided by the consultancy firm had given the plaintiff false expectations due to misleading information and whether this could be attributed to the defendant.(2) The trial court ruled that the defendant had not breached its pre-contractual duty to inform the franchisee.(3) The information package provided had contained all essential information and the business plan prepared by the consultancy firm could not be attributed to the defendant. It had only been prepared at the plaintiff's instigation and had not been produced for clarification purposes, but to be presented to the bank for obtaining financing.
The appeal court, the Frankfurt Higher Regional Court, upheld that ruling, stating that any misrepresentations in a business plan prepared by a consultancy firm recommended by the franchisor but instructed by the franchisee cannot be attributed to the franchisor and therefore cannot be the basis of a pre-contractual breach of the duty to provide information.
First, the Court reiterated the requirements that are generally placed on the franchisor's pre-contractual duty to inform (within the meaning of section 311(2) of the German Civil Code). In principle, each party bears its own contractual risk. They must inform themselves about the risks and opportunities of the envisaged business relationship and form their own opinion of the market opportunities. It is not up to the franchisor to provide start-up advice to a potential franchisee. In particular, the franchisor does not have to inform the franchisee about the general risks of self-employment or draw up calculations for a franchisee that it is able to prepare itself with basic business knowledge.
However, the franchisor must not deceive or mislead the franchisee about circumstances essential to the contract. Also, the franchisor must inform the franchisee about circumstances that are known only to the franchisor and that the franchisor knows, or ought to know, would influence the franchisee's decision. This applies, in particular, to circumstances that are key to the franchisee's business success and that the franchisor is more familiar with due to its knowledge of the system and its position in the market. The scope of this duty to provide information cannot be defined in general terms, but depends on the circumstances of the individual case, taking into account the principle of good faith.(4)
Based on these principles, the Court held that the defendant had not breached any duty to inform. The Court did not have to comment on whether parts of the business plan prepared by the consultancy firm had been misleading or insufficient, since the actions of the consultancy firm could not be attributed to the defendant in the first place (under section 278 of the German Civil Code). According to German law, any fault on the part of the consultancy firm could be attributed to the defendant if the consultancy firm had acted as a vicarious agent of the defendant. A "vicarious agent" under German law is a person who, with the will of the obligor (in this case, the defendant), acts as the obligor's auxiliary in performing an obligation incumbent upon the latter. The Court found that these conditions had not been met.
For one thing, the defendant was not liable for preparing the business plan for the plaintiff. The purpose of the business plan was to obtain financing from a bank. It did not serve the purpose of providing information to the plaintiff. Besides, the consultancy firm was not engaged by the defendant, but by the plaintiff. The actions of the consultancy firm could not be attributed to the defendant simply because the defendant recommended that firm to the plaintiff or because of the existing personal connections (via the wife of the firm's CEO).
The Court also found that even an overall consideration of the circumstances did not justify a different result: irrespective of whether the defendant had provided the consultancy firm with incorrect or insufficient (ie, outdated) information regarding the business plan, it was up to the consultancy firm to verify and update information on the defendant and its franchise system.
The ruling of the Frankfurt Higher Regional Court offers welcome clarification on the question of the scope of the franchisor's pre-contractual duty to provide information to potential franchisees. If (as is usually the case) the franchisor has no contractual obligation to provide a business plan to the franchisee, the franchisor is also not liable for a business plan that an external consultancy firm prepares on behalf of the franchisee. This also applies if the franchisor has recommended a certain consultancy firm, which then prepares the business plan.
Nevertheless, the ruling shows that the outcome always depends on the circumstances of the particular case. In fact, the franchisor may become liable if it promises support in preparing a business plan or instructs an external consultant to prepare the plan. In these cases, or where the franchisor deliberately collaborates with the consultant to the detriment of the franchisee, other bases for liability are conceivable as well. Before instructing an external consultant, both the franchisor and the franchisee should therefore clearly define who is responsible for the instruction and its precise purpose.
For further information on this topic please contact Karsten Metzlaff or Jasmin Schulzweida at Noerr LLP's Hamburg office by telephone (+49 40 300 3970) or email ([email protected] or [email protected]). Alternatively, contact Tom Billing at Noerr LLP's Berlin office by telephone (+49 30 20 94 20 00) or email ([email protected]). The Noerr LLP website can be accessed at www.noerr.com.
(1) Ruling of 1 December 2021 – 12 U 7/21.
(2) The parties were also in dispute over whether and to what extent information should have been provided about any legal and factual difficulties in acquiring customers through direct acquisition measures. The Frankfurt Higher Regional Court did not establish any breach of duty, since:
- the plan as such had been explained;
- the plaintiff had not demonstrated that the defendant had been aware of such difficulties; and
- according to the case law of Germany's Federal Court of Justice, direct acquisition measures are not generally unlawful.
This aspect of the dispute is not considered in any more detail in this article, as the necessity of direct acquisition is a special feature of the franchise plan at issue.
(3) Darmstadt Regional Court, judgment of 25 November 2020 – 9 O 198/18.
(4) These principles have also been reiterated by the Hamburg Higher Regional Court in another recent decision (ruling of 25 February 2022 – 1 U 104/19). The duty to inform is also based on the future franchisee's specific, recognisable pre-contractual need for information. In addition, as regards the profitability of the franchise system, information on the achievable turnover must be provided. If the data material used is an estimate, the future franchisee must be clearly informed of this. On the basis of the material, the franchisee must be enabled to carry out a sufficiently well-founded and reliable economic profitability check or to have such check carried out by third parties. Any figures given must be based on a real reference system that allows a comparison with the planned business location concerned in the specific case. A breach of duty exists if the data is incorrect, outdated or misleading based on an overall consideration.